Bankruptcy Court Clarifies Automatic Stay in Chapter 11 Case

The US Bankruptcy Court for the Central District of California recently addressed the scope of the automatic stay in In re Klein, 669 B.R. 877.

According to a Duane Morris alert, the court held that parties who filed state court actions to assert competing interests in an estate’s assets violated 11 U.S.C. § 362(a)(3), which bars acts to obtain possession of or exercise control over property of the estate.

The decision demonstrates the risks creditors face when attempting to litigate claims outside of bankruptcy while estate interests are pending before the court.

The dispute arose after debtor Leslie Klein filed for Chapter 11. His estate included a 50 percent interest in Life Capital Group LLC and claims tied to rights in insurance policy proceeds worth over $30 million.

The Chapter 11 trustee commenced an adversary proceeding to avoid Klein’s pre-petition release of these rights as a preferential or fraudulent transfer.

Shortly thereafter, Leslie Klein & Associates Inc. and EKLK Foundation filed state court lawsuits asserting interests in the same proceeds, prompting the trustee to seek enforcement of the stay and sanctions.

The bankruptcy court found that both the debtor’s membership interest and the trustee’s avoidance claims constituted estate property. By asserting competing rights in state court, respondents attempted to exercise control over this “bundle of rights,” satisfying all three elements of the Ninth Circuit’s Bialac test for a stay violation.

The court held the respondents in contempt, finding no reasonable basis for their actions, and reserved the right to impose monetary sanctions for later proceedings.

The case demonstrates the breadth of Section 362(a)(3). Parties risk sanctions when bypassing the bankruptcy court to pursue overlapping claims. The safer course is to seek stay relief before proceeding in another forum.