Form 13.6
Motion for Relief Stay - Bonded Contract Proceeds
Surety Counsel
Name and Address
Attorneys for Surety
UNITED STATES BANKRUPTCY COURT
DISTRICT OF ___________
In re:
Case No.
Chapter Number: 7
Principal
Debtor.
SURETY’S MOTION TO
COMPEL ABANDONMENT BY
THE CHAPTER 7 TRUSTEE OF
DEBTOR’S CLAIMS AGAINST
BANK, MEMORANDUM OF
POINTS AND AUTHORITIES IN
SUPPORT OF MOTION TO
COMPEL ABANDONMENT
AND FOR STAY RELIEF
(PERSONAL PROPERTY AND
NON-BANKRUPTCY FORUM)
Date:
I.
INTRODUCTION
Surety (“Surety”) was, and is, pre-petition surety for the Debtor. As set forth in the accompanying
Declaration of [Claims Handler] of Surety, Surety has paid over $2,240,342.82 in losses on a single bond
issued for the Debtor on a public works project. This project is, in part, the subject of pre-petition State
Court litigation brought by the Debtor and Surety against Bank, entitled Principal & Surety v. Bank, (the
“State Court Action”).
Specifically, the State Court Action involves a construction project of the Debtor bonded by Surety,
on which the amount of approximately $___________ in contract funds were placed by Obligee in a
retention escrow account (“Retention Account”). Bank was escrow agent. Surety has paid claims on its
bonds and is subrogated to all contract funds, including the proceeds of the Retention Account. Prepetition, Bank, in violation of its duties as escrow agent, and in violation of its duties with respect to
funds held in trust on construction projects, and further in violation of its express agreement with the
Debtor and Surety, transferred the funds in the Retention Account to a deposit account and then proceed
to sweep those funds as a purported setoff on account of indebtedness apparently owing by the Debtor on
a commercial loan. At the time of Bank’s unauthorized removal of the Retention Account funds, the
remaining amount of the Retention Account was $__________________. Surety is subrogated to the
Retention Account and all claims of the Debtor’s estate for recovery against Bank. All of the Debtor’s
claims against Bank were also fully assigned to Surety pre-petition. In the State Court Action, Surety
seeks the principal balance of $__________________, plus interest, punitive and consequential damages,
attorneys’ fees and costs, and expenses. The Debtor has been a co-plaintiff with Surety in the State Court
Action in name only but retains no pecuniary or material interest in the claims against Bank. The Debtor
is and has been at all times a mere stakeholder for Surety with respect to the claims against Bank.
The Chapter 7 Trustee has filed a motion with respect to the State Court Action to purportedly sell the
claims of the Debtor, which is also scheduled for hearing on _________________, ___, and to which
Surety will separately object.
Surety hereby moves the Bankruptcy Court for an order compelling the estate’s abandonment of the
Debtor’s claims in the State Court Action as unduly burdensome to the estate. 11 U.S.C. § 554. As set
forth herein, title to the claims passed to Surety pre-petition. For the Chapter 7 trustee to prosecuted, sell
or assign the claims, the Chapter 7 trustee would first have to cure all defaults to restore title to the
Debtor’s estate, which would require payment to Surety of over $2.2 million, which is neither feasible nor
realistic in this Chapter 7 case.
In addition thereto, or in the alternative, Surety further moves the Bankruptcy Court for an order of
the Bankruptcy Court granting relief to Surety from the automatic stay on two grounds relating to the
State Court Action as follows:
(1) Personal Property: Surety moves the Bankruptcy Court for stay relief for Surety to assert, as
subrogee and assignee, all of the Debtor’s claims against Bank in the State Court Action. Surety, as
subrogee and assignee, is subrogated in equity for the Debtor and entitled to assert, prosecute, and collect
upon all of the Debtor’s claims against Bank. Because Surety’s losses are in excess of $_____________
and the principal damages sought in the State Court Action are a mere fraction of that at
$________________, even with punitive and other damages, and interest, Surety believes that there is no
equity for the Debtor’s estate; and
(2) Non-Bankruptcy Forum: Surety moves the Bankruptcy Court for a comfort order for stay relief
for all parties to liquidate their claims by, through, and against the Debtor in the State Court Action. The
State Court Action involves the Debtor as a co-plaintiff with Surety; the Debtor was made a co-plaintiff in
name only. Surety as subrogee and assignee is substituted in interest for the Debtor and will prosecute the
Debtor’s claims against Bank. Bank has a counter-claim against the Debtor and claims offsets against
which the Surety will defend. Therefore, ultimately, the liquidation of all claims from the State Court
Action will determine whether Bank or the Surety is prevailing party. To the extent that any judgment
were to issue from the State Court Action against the Debtor specifically, those claims would be subject
to the jurisdiction of the Bankruptcy Court and the normal claims procedures.
II. STATEMENT OF FACTS
[Recitation of facts including debtor’s petition filing, history, bonded projects, losses, claims, etc.]
III NATURE OF SURETYSHIP
As noted, Surety is surety for the Debtor on the Bonded Contracts. Suretyship is an ancient
undertaking long recognized and long favored by the law. Pearlman v. Reliance Inc. Co., 371 U.S. 132,
136 et seq. (1962) At its most basic level, a surety is defined as one who contracts to answer for the debt
or default of another. The “principal” under the bond (here, the Debtor) is the party that is primarily
obligated on the undertaking—the performance of work and payment of subcontractors, suppliers and
laborers--and the surety (here, Surety) is the party that is secondarily obligated in the event that the Bond
principal fails to perform or pay. The “obligee” on a construction contract performance bond is the project
owner (here, Obligee). The beneficiaries of a payment bond are the subcontractors, suppliers, and
laborers. The obligees and beneficiaries are the parties with the right to make a call on the bond.
Suretyship is a form of performance guaranty under which the surety suffers a loss by its performance
or payment of the principal’s obligations only if the principal fails to perform its obligations. The surety’s
bonds are tripartite contracts, creating obligations among the principal (the Debtor), the obligee (owners),
and the surety (Surety). Cates Construction, Inc. v. Talbot Partners, 21 Cal. 4th 28, 58 (1999). The
surety, in effect, provides its financial strength and credit on behalf of the principal and in favor of the
obligee and beneficiaries to secure the principal’s contract performance and payment obligations. More
specifically, a contract performance bond generally guarantees the performance by the principal of the
work in accordance with, and as limited by, the performance bond and the relevant contract. A payment
bond generally guarantees the payment of valid subcontractors, suppliers, and laborers, in accordance
with, and as limited by, the payment bond and the relevant contracts.
In sum, the basic elements of subrogation are: (1) the existence of an obligation of the principal to the
obligee; (2) the failure of the principal to perform that obligation; (3) rights in the obligee arising from the
principal’s failure to perform; and (4) the performance by the surety, pursuant to the suretyship, of the
obligation that the principal failed to perform. Prairie State Nat’l Bank v. United States, 164 U.S. 227
(1896)
Numerous statutes require that surety bonds be issued in a variety of circumstances. All public works
construction projects—which includes all of the Bonded Projects here--require that the contractor obtain
payment and performance bonds. Thus, by providing the required bonds, sureties facilitate and stabilize
the operation of various industries, including commercial and retail, and effectuate public policy by
providing performance protection for the numerous “obligees” and performance protection in the form of
payment for the potential “claimants,” in accordance with the bonds.
However, suretyship is not insurance. Pearlman, 371 U.S. at 140, fn 19 (“[S]uretyship is not
insurance.”). Rather, the [obligee] required bonds to be posted for its own security.”); Lumbermens
Mutual Casualty Co. v. Agency Rent-A-Car, Inc., 128 Cal. App. 3d 764, 769 (Cal. Ct. App. 1982),
superseded on other grounds (“A surety bond is not an insurance policy”); Cates Construction, Inc., 21
Cal. 4th at 44 (noting that suretyship is not insurance; surety bonds, unlike typical insurance policies, are
not characterized by “elements of adhesion, public interest, or fiduciary responsibility”).
Moreover, unlike insurance, a surety is not expected to bear the ultimate risk of loss. Pearlman, 371
U.S. 132; Safeco Ins. Co. of America v. Schwab, 739 F.2d 431, 433 (9th Cir. 1984); Milwaukee
Construction Co. v. Glens Falls Insurance Co., 367 F.2d 964 (9th Cir. 1966).
Indeed, surety bonds are issued based upon the underwriting assumption that the surety will be made
whole and not incur any losses:
We have recognized that “[s]ureties, unlike insurers, profit solely from the premiums they
collect. Indemnification rights guard against potential losses, help reduce the surety’s
risk, and keep premiums relatively low.” [footnote omitted]. Further, we have noted that
“the right to subrogation distinguishes suretyship from insurance, and such right is
considered by the surety in arriving at the amount of bond premium.
Insurance Company of the West, 122 Nev. at 460, 134 P.3d at 701 (emphasis added).
The protection of the surety from risk of loss comes in many forms, including the protection of
indemnity from its principal. It also comes by virtue of the surety’s equitable rights of subrogation by
which it can stand in the shoes of its paid claimants, the principal, or the obligee, to assert such parties’
rights to reach any and all funds by which it may reimburse itself for its outlay. Pearlman, 371 U.S. 13.
IV. ABANDONMENT BY THE CHAPTER 7 TRUSTEE OF THE DEBTOR’S CLAIMS IN THE
STATE COURT ACTION IS PROPER
11 U.S.C. § 554 (b) provides that “[o]n request of a party in interest and after notice and a hearing,
the court may order the trustee to abandon any property of the estate that is burdensome to the estate or
that is of inconsequential value and benefit to the estate.”
The Chapter 7 Trustee’s abandonment of all of the Debtor’s claims in the State Court Action is proper
in accordance with the provisions of 11 U.S.C. § 554 and Federal Rules of Bankruptcy Procedure 6007(b)
because they are unduly burdensome and of no value to the estate.
In order for the estate to collect under, sell or otherwise dispose of the Debtor’s claims in the State
Court Action, the Chapter 7 Trustee would be tasked with curing the substantial defaults of the Debtor,
including completing performance of the each of the Project and paying all unpaid subcontractors and
suppliers the amounts due to them. To date, Surety has paid over $_________________ on the subject
bonds. As a result, as set forth below, Surety is already subrogated to all of the claims, and all such claims
were assigned to Surety pre-petition under the applicable State law and agreements. Title has passed to
Surety. Therefore, for the Chapter 7 Trustee to restore the claims and be able to prosecute or assign the
Debtor’s claims in the State Court Action, the Chapter 7 Trustee would have to make a payment to Surety
of over $________________________ to cure the Debtor’s defaults and restore title to the estate. As
such, the Bonded Contracts present only burden and no value to the estate. Therefore, abandonment by
the Chapter 7 Trustee of the Bonded Contracts is appropriate here.
Moreover, as set forth in Perlman v. Catapult Entertainment, Inc. (In re Catapult Entertainment, Inc.),
165 F.3d 747 (9th Cir. 1999), the estate may not assume an executory contract over a non-debtor’s
objection if applicable State law would bar assignment to a third party. Here, the Chapter 7 trustee cannot
assume the Debtor’s claims in the State Court without curing the Debtor’s $2.2 million in defaults that
give rise to Surety’s subrogation rights. Because the claims cannot be assumed, they cannot be assigned
by the Chapter 7 trustee either. Moreover, the Chapter 7 trustee’s time to assume the underlying bonded
contract has long since passed in this Chapter 7 case.
V. SURETY IS ENTITLED TO STAY RELIEF TO ASSERT AND COLLECT UPON ALL OF
THE ESTATE’S RIGHTS AGAINST BANK
Pursuant to the provisions of 11 U.S.C. § 362(d)(1), Surety is entitled to adequate protection of its
interest in the claims in the State Court Action because there is no equity cushion to the estate. Lack of
adequate protection of an interest in property is recognized as grounds for relief from the automatic stay.
See, e.g., Scrima v. John Services Agency, Inc., 103 B.R. 128 (W.D.Mich. 1989); In re Kornhauser, 184
B.R.. 425 (Bankr.S.D.N.Y. 1995).
Surety is also entitled to relief from the automatic stay under 11 U.S.C. § 362(d)(2) which provides
that relief from the automatic stay shall be granted if the debtor does not have any equity in the property
and the property is not necessary to the debtor’s effective reorganization. See United Sav. Ass’n v.
Timbers of Inwood Forest Assoc.., Ltd., 484 U.S. 365, 375 (1988).
In In re San Clemente Estates, 5 B.R. 605 (Bankr.S.D.Cal. 1980), the court held as follows:
§ 362(d)(2) reflects congressional intent to allow creditors to immediately proceed against
the property where the debtor has no equity and it is unnecessary to the reorganization, even
where the debtor can provide adequate protection under § 362(d)(1).
Id. at 610.
In In re Mikole Developers, Inc., 14 B.R. 524, 525 (Bankr.E.D.Pa. 1981), the court stated that in
determining whether equity exists in the property for purposes of § 362(d)(2), all encumbrances are
totaled, whether or not all the lienholders have joined in the request for relief from stay. The Ninth Circuit
has concurred with this view in Stewart v. Gurley, 745 F.2d 1194 (9th Cir. 1984).
Here, the Debtor’s estate has no remaining interest in the State Court Action because Surety
subrogates to the Debtor’s claims and all claims were assigned to Surety pre-petition.
A. The Debtor Is A Mere Stakeholder For Surety
Due to Surety’s equitable right of subrogation to all of the Debtor’s claims and pre-petition
assignments, the Debtor is and has been at all times a mere stakeholder for Surety with respect to the
claims against Bank. As set forth in the General Indemnity Agreement attached to the Surety Declaration
as Exhibit B thereto, all contract funds such as the Retention Account and the proceeds thereof, are also
trust funds for the benefit of Surety. (Surety Decl., Exh. B, ¶ 11.)
Although a debtor’s bankruptcy estate includes all legal or equitable interests of the debtor in property
as of the commencement of the case, the Bankruptcy Code recognizes that the property of the bankruptcy
estate does not include any interest in which the debtor holds only bare legal title. 11 U.S.C. § 541(d).
B. Surety Subrogates To All of The Debtor’s Rights Against Bank
Subrogation is the act of the law of substituting one party for another and depends not on contract but
on principles of equity. Caito v. United Cal Bank, 20 Cal. 3d 694, 704 (1978); Fifield Manor v. Finston,
54 Cal. 2d 632, 638-640 (1960).
Pursuant to the doctrine of equitable subrogation, upon a bond principal’s (here, the Debtor’s) default
in completing the Project and making payments to its subcontractors and suppliers, and the surety’s
(Surety’s) payment thereof, the surety (Surety) acquires an equitable lien in all funds reachable through its
subrogation rights. Conversely, the defaulted bond principal (here, the Debtor) loses all legal and
equitable interest in those funds by virtue of the surety’s payment on its behalf. Pearlman v. Reliance Inc.
Co., 371 U.S. 132 (1962).
The basic elements of subrogation are: (1) the existence of an obligation of the principal to the
obligee; (2) the failure of the principal to perform that obligation; (3) rights in the obligee arising from the
principal’s failure to perform; and (4) the performance by the surety, pursuant to the suretyship, of the
obligation that the principal failed to perform. Prairie State Nat’l Bank v. United States, 164 U.S. 227
(1896); District of Columbia v. Aetna Ins. Co., 462 A.2d 428, 430 (D.C.App. 1983).
It has long been held that a surety’s subrogation rights ordinarily entitle it to stand in the shoes of, and
to assert the rights of, any one or a number of parties, including: (1) its payee—the party it has paid, such
as the Obligee, and subcontractors and suppliers; (2) any party for whose benefit the surety’s payment is
made to discharge the bond principal’s obligations, and (3) the party on whose behalf the surety’s
payment was made; i.e., the bond principal, here the Debtor. Pearlman, 371 U.S. at 138-139, 141; Balboa
Ins. Co. v. U.S., 775 F.2d 1158, 1161 (Fed. Cir. 1985); In re Colt Engineering, Inc., 288 B.R. 861 (Bankr.
C.D.Cal. 2003).
In Pearlman, the U.S. Supreme Court noted that “there are few doctrines better established than that a
surety who pays the debt of another is entitled to all the rights of the person he paid to enforce his right to
be reimbursed.” Pearlman, 371 U.S. at 136-137 (emphasis added); Prairie State, 164 U.S. at 231 (holding
that subrogation is the “right to resort to the securities and remedies which the creditor [the payee] was
capable of asserting against its debtor, [the bond principal]…”); American Surety Co. of New York v.
Bethlehem Nat’l Bank of Bethlehem, 314 U.S. 314, 317 (1941) (“Among the oldest of these doctrines is
the rule of subrogation whereby ‘one who has been compelled to pay a debt which ought to have been
paid by another is entitled to exercise all the remedies which the creditor possessed against that other.’”)
(emphasis added).
Where all of the elements of subrogation are met, as set forth above, the surety such as Surety is
entitled to an equitable lien in all funds and inventory reachable through its subrogation rights. Pearlman,
371 U.S. at 136-137. Moreover, the equitable lien relates back to the date of the bond. See American
Fidelity Company, 266 F.2d at 914 (“This subrogation, sometimes called an ‘equitable lien,’ relates back
to the date of the bond, and is therefore superior to any conflicting claim thereafter asserted by another.”).
1. Surety, As Performing Surety, Is The “Best Of Secured Creditors”
To the extent of its subrogation rights, Surety, as performing surety, is accorded priority in the
accounts receivable and proceeds of the Bonded Contracts over all of the estate’s other creditors,
including its other allegedly secured creditors. A surety’s right of subrogation places a lien on all property
reachable by the surety to reimburse it. Thus, Surety, as a performing surety, is not a general or
“unsecured creditor” of its bond principal, but is the “best of secured creditors.” U.S. v. Munsey Trust Co.
of Washington, D.C., 332 U.S. 234, 240 (1947) (“…one whose own appropriation and payment of money
is necessary to create a fund for general creditors is not a general creditor… In fact, he [the payor] is the
best secured of creditors; his security is his own justified refusal to pay what he owes until he is paid what
is due him.”) (emphasis added); see also Bethlehem, 314 U.S. at 317 (“The surety is a special kind of
secured creditor. For its claim against the principal is secured by its right of subrogation to the remedies
of the creditor which it has been compelled to pay.”); First Nat’l Bank of Seattle v. City Trust, Safe
Deposit & Surety Co. of Philadelphia, 114 F. 529, 533 (9th Cir. 1902) (holding that the paying surety as
entitled to an “equitable lien” on all funds reachable by its subrogation rights) (emphasis added); In re
E.R. Fegert, Inc. v. Coral Construction, Inc. 88 B.R. 258, 260 (“Fegert”) (9th Cir. B.A.P) (“Thus the
equitable lien granted the surety entitles it to precedence over the Trustee in bankruptcy of the debtorcontractor.”) (emphasis added).
In Pearlman, 371 U.S. at 136-137, the U.S. Supreme Court noted that the surety’s subrogation right
gives it a “security interest” or “equitable lien or prior right,” such that the surety becomes the “outright
legal or equitable owner” of subrogated funds. Similarly in Bethlehem, the Supreme Court further noted
that the surety, like Surety, is not only substituted for its payee, but the surety also succeeds to the payee’s
means for enforcing its rights, becoming a secured creditor in the enforcement of those rights:
Succeeding to the creditor’s right, the surety also succeeds to the creditor’s means for
enforcing it. The surety is a special kind of secured creditor. For its claim against the
principal is secured by its right of subrogation to the remedies of the creditor which it has
been compelled to pay.
Bethlehem, 314 U.S. at 317 (emphasis added).
As applied here, this means that Surety is subrogated to the interests of the obligees on the bonds,
including the Obligee, the Debtor (pre-petition), as well as the subcontractors and suppliers it has paid.
The subrogation right acquired by a surety, such as Surety, occurs automatically, and the surety is not
required to take any further step to perfect its right: “when one is entitled to substitution in place of one
entitled to institute and to maintain an action, neither a written, nor an oral contract, is necessary to effect
a transfer of such right . . .” In re Alliance Properties, Inc., 104 B.R. 306, 311 (Bankr.S.D.Cal. 1989)
(“[The surety] is not required to file a financing statement to perfect this inchoate lien since it exists as a
matter of equity rather than by contract.”).
2. To The Extent Of Surety’ Subrogation Rights, The Debtor’s Estate Loses All Right To
The Claims In The State Court Action
To the extent of Surety’ subrogation rights, the estate has no interest in the funds or claim. When a
bond principal such as the Debtor here has failed to pay its obligations to its subcontractors and suppliers,
and the surety has made payment on its behalf, the bond principal loses all legal and equitable rights to
any and all funds reachable by the surety’s subrogation rights. See, e.g., Pearlman, 371 U.S. 132.
For instance, in Pearlman, the U.S. Supreme Court held that where the surety pays the principal’s
obligations, the surety through subrogation becomes the owner of all funds reachable through its
subrogation rights, such that “this property interest of the surety never became a part of the bankruptcy
estate to be administered, liquidated, and distributed to general creditors of the bankrupt.” Id. at 136
(emphasis added). Further, because the property never became part of the bankruptcy estate, the Court
held that the property could “not vest in the trustee” and could not be distributed to other creditors besides
the surety: “[t]he Bankruptcy Act simply does not authorize a trustee to distribute other people’s property
among a bankrupt’s creditors.” Id. at 135-136; see also Prairie State, 164 U.S. at 232.
The Pearlman and Prairie State decisions have also been followed by the Ninth Circuit courts, as
well as several District and Bankruptcy Courts of California. See, e.g., First Nat’l Bank, 114 F. at 532
(“By abandoning the contract the contractors lost the right to compel the city to pay them any sum
whatever on account of the work which they had done.”); Fegert, supra, 88 B.R. at 260 (observing that
the surety’s subrogation right is “superior to the interest of the bankruptcy estate” and holding that “the
equitable lien granted the surety entitles it to precedence over the Trustee in bankruptcy of the debtorcontractor.”); Butler v. Pacific Nat’l Ins. Co. (9th Cir. 1967) 375 F.2d 518, 520 (holding that the surety
“standing in the shoes of a materialman had a priority” to the subject funds “over the contractor’s trustee
in bankruptcy”); Covenant Mutual Ins. Co. v. Able Concrete Pump (N.D.Cal. 1984) 609 F.Supp. 27;
Alliance Properties, supra, 104 B.R. at 311; In re Massart Co. (W.D. Wash. 1989) 105 B.R. 610, 613
(“[The defaulted contractor] did not have a legal or equitable interest in the progress payment . . . [T]he
progress payment was not the property of the bankruptcy estate.”).
The U.S. Supreme Court and the federal courts similarly uphold the surety’s subrogation rights over
the rights of the trustee and defaulted contractor’s creditors, holding that such creditors are no more than
assignees of the Debtor’s interest and thus limited by the Surety’s subrogation rights. See Prairie State,
164 U.S. at 240 (holding that the defaulted contractor and bond principal “could not transfer to the bank
any greater rights in the fund than they themselves possessed. Their rights were subordinate to those of
the United States and the sureties.”); Henningsen v. U.S. Fidelity & Guaranty, 208 U.S. 404, 409-411
(1908) (noting that where the surety’s subrogation rights have been shown, “the bank can make no claim
by reason of the assignment” since, through assignment, the assignee takes no greater rights than its
assignee, and the surety’s rights are superior to that of the assignor); U.S. Fidelity & Guaranty v. Housing
Authority of the Town of Berwick (“Berwick”) (5th Cir. 1977) 557 F.2d 482, 485 (holding that “(an)
assignor can assign no better rights than he has, and the assignee, of course, acquires no better rights than
the assignor has.”).
In summary, because the Surety paid on the bonds, it was subrogated to all sums in the Retention
Account pre-petition, both subrogating to the Debtor’s and the Obligee’s positions with respect to the
Retention Account, among other things. Further, on account of Surety’s payment on the Debtor’s behalf,
Surety subrogates in equity to all claims for reimbursement, ahead of all right of the Debtor’s estate or its
other creditors. Because Surety subrogates to all of the Debtor’s rights against Bank for reimbursement,
including with respect to the Retention Account, such that there are no claims in the State Court Action
inuring to the benefit of this bankruptcy estate.
C. The Debtor Assigned All Rights To Surety Pre-Petition
In addition to Surety’s rights of subrogation, all of the Debtor’s claims in the State Court Action were
fully assigned to Surety pre-petition through that certain General Indemnity Agreement executed by the
Debtor in favor of Surety, which provides in pertinent part as follows:
D. Assignment
(See Rawlins Decl., Ex. B, General Indemnity Agreement, p. 3.)
The Debtor defaulted with respect to the Project pre-petition. Therefore, cumulative with Surety’s
subrogation rights, all of the Debtor’s claims were assigned pre-petition and there are no claims of the
Debtor’s estate at this time.
VI. STAY RELIEF SHOULD BE GRANTED TO ALL PARTIES TO LIQUIDATE THEIR
CLAIMS IN THE STATE COURT ACTION
In addition to, or in the alternative, Surety further seeks a comfort order allowing all claims, crossclaims, and defenses to be liquidated in the State Court Action. This includes that Surety seeks to assert
all claims of its own and as assignee and subrogee of the Debtor. Further, whatever claims of offset or
setoff Bank may have against Surety based upon claims it has against the Debtor, if any, should be
litigated in the existing State Court Action forum. This will not in any affect the Debtor nor will it put the
estate to a hardship because Surety is prosecuting and defending the claims. To the extent that any
judgment were to issue against the Debtor (which Surety believes is highly unlikely), no collections could
occur outside of the confines of the Bankruptcy Court.
A. The Movants Request Stay Relief To Liquidate Claims Against The Debtor
The automatic stay may be terminated “for cause,” including for lack of adequate protection pursuant
to 11 U.S.C. section 362(d)(1). The ultimate burden is on the Debtor opposing the relief to establish
absence of “cause.” See Code § 362(g); In re Gauvin, 24 B.R. 578, 580 (Bankr. 9th Cir. 1982). If Debtor
is unable to establish absence of cause, the Court “shall” lift the automatic stay. See In re Tucson Estates,
Inc., 912 F. 2d 1162, 1166 (9th Cir. 1990). “Cause” is not defined in the Bankruptcy Code and is
determined on a “case-by-case basis.” Universal Life Church, Inc. v. United States I.R.S. (In re Universal
Life Church), 127 B.R. 453, 455 (E.D. Cal. 1991).
The courts repeatedly have held that stay relief to allow parties to complete liquidation of claims in
another forum. In doing so, they have considered a variety of factors in determining whether to lift an
automatic stay to allow pending litigation to proceed. These factors include: (1) whether another forum is
more appropriate to resolve the claims at issue; (2) whether judicial economy and public policy support
lifting the stay; and (3) whether lifting the stay would cause the bankruptcy estate “great prejudice.” See
In re Aquarius Disk Serv., Inc., 254 B.R. 253, 260 (Bankr. N.D. Cal. 2000) (considering issues of judicial
economy and public policy in evaluating motion for relief from automatic stay); Edmondson v. American
W. Airlines, 148 B.R. 920 (Bankr. D. Ariz. 1993) cited with approval in Santa Clara Co. Fair Ass’n v.
Sanders (In re Santa Clara Co. Fair Ass’n), 180 B.R. 564, 566-67 (B.A.P. 9th Cir. 1995) (listing factors
relevant to determining whether there is “cause” for granting relief from automatic stay, including
whether another forum is more appropriate to resolve claims, judicial economy, public policy, and any
prejudice to bankruptcy estate). A review of these factors clearly establishes that ample “cause” exists
here for relief from the automatic stay.
B. The Forum
The State Court is the appropriate forum for resolving the parties’ respective claims here. The
litigation essentially involves only state law with a cast of at least 36 parties. No bankruptcy law is
implicated. See O’Rourke v. Cairns, 129 B.R. 87, 91 (Bankr. E.D. La. 1991) (noting that when only state
law is involved, that court is “the more appropriate forum for resolving the case” and “the result reached
will more likely be consistent with other state law decisions”). This reason alone provides sufficient
“cause” for lifting the stay. See In re Marvin Johnson’s Auto Serv., 192 B.R. 1008, 1013 (Bankr. N.D.
Ala. 1996) (“‘Cause’ for granting relief from the stay may exist if the equities in a particular case dictate
that a lawsuit, or some other similar pending action, should proceed in a forum other than the bankruptcy
court for the purpose of liquidating the claim on which the lawsuit is premised.”); see also In re Murray
Indus., Inc., 121 B.R. 635, 636 (Bankr. M.D. Fla. 1990) (noting that allowing a matter to proceed in a
more appropriate forum constitutes “cause” to lift an automatic stay pursuant to section 362(d)(1)).
Moreover, “[t]he legislative history of section 362(d)(1) emphasizes the section’s applicability to
proceedings in another tribunal.” In re Rexene Prods. Co., 141 B.R. 574, 576 (Bankr. D. Del. 1992). “The
legislative history of § 362(d)(1) states that ‘a desire to permit an action to proceed to completion in
another tribunal may provide cause’ for relief from a stay.” In re Universal Life Church, Inc., 127 B.R. at
455 (quoting H.R. No. 95-595, 95th Cong., 1st sess. (1977), p. 343, 1978 U.S. Code Cong. & Admin.
News 5787, 6300)
Specifically, the legislative history provides: “It will often be more appropriate to permit proceedings
to continue in their place of origin, when no great prejudice to the bankruptcy estate would result, in order
to leave the parties to their chosen forum and to relieve the bankruptcy court from any duties that may be
handled elsewhere.” In re Marvin Johnson’s Auto Serv., Inc., 192 B.R. at 1013 n.4 (quoting legislative
history).
Indeed, the wisdom of granting stay relief for the liquidation of claims in other fora in appropriate
circumstances is so compelling that it has been done even in regard to issues that are particularly within
the bankruptcy court’s purview, where it otherwise might seem most likely that a bankruptcy court would
not grant such stay relief. See In re Saunders, 103 B.R. 298, 299 (Bankr. M.D. Fla. 1989) (court grants
stay relief to state court case nearing trial that shares issues with dischargeability action, with instructions
to return with results). Thus, the granting of stay relief so a creditor’s claims could be liquidated in
another forum is common,1 and in this case involving strictly non-bankruptcy issues, it is entirely
appropriate.
C. Judicial Economy
Moreover, in this instance allowing the State Court to preside over the balance of the State Court
Action manifestly serves the interests of judicial economy for all concerned. See Santa Clara Co. Fair
Ass’n, Inc., 180 B.R. at 566-67; In re Westwood Broad. Inc., 35 B.R. 47 (Bankr. D. Haw. 1983).
Prosecution of claims at issue in the State Court is convenient for the parties since they are already
immersed in that proceeding and the State Court has overseen many matters between the parties. See
Edmondson, 148 B.R. at 923 (noting that judicial economy favored permitting the action to proceed in
state court given the location of the witnesses and parties). In addition, allowing the State Court Action to
1
See, e.g., Beguelin v. Volcano Vision (In re Beguelin), 220 B.R. 94, 98 (B.A.P. 9th Cir. 1998) (affirming
bankruptcy’s court’s decision to grant relief from automatic stay to allow full liquidation of plaintiff’s claim
against the debtor in state court); Santa Clara Co. Fair Ass’n, Inc., 180 B.R. at 565-67 (affirming order of
Bankruptcy Court modifying automatic stay to allow the claimant to pursue an employment discrimination
action against the debtor in State Court); In re Aquarius Disk Serv., Inc., 254 B.R. at 261 (granting relief from
automatic stay to allow plaintiffs to liquidate their claim in the pending state court action); Edmondson, 148
B.R. at 923-24 (modifying automatic stay to allow claimant to establish liability and liquidate damages in State
Court); In re Parkinson, 102 B.R. 141, 143 (Bankr. C.D. Il. 1988) (lifting automatic stay to permit the plaintiff
to proceed with a single state court action against the debtor and his co-defendants); In re Rabin, 53 B.R. 529,
531-32 (Bankr. D. N.J. 1985) (lifting automatic stay to permit movants to proceed in pending state court action
to liquidate claims against debtor); In re Westwood Broad., Inc., 35 B.R. 47, 49 (Bankr. D. Haw. 1983) (lifting
automatic stay “for the sake of judicial economy” to permit plaintiffs to proceed with the state court trial to
adjudicate all issues among plaintiffs, debtors, and nondebtor defendants in one action); In re Phila. Athletic
Club, Inc., 9 B.R. 280, 283 (Bankr. E.D. Pa. 1981) (modifying stay to permit “plaintiff to continue state court
action against debtor and other defendants to its conclusion for the purpose of liquidating her claim against the
debtor”).
proceed would relieve this Court of the responsibility to oversee potentially burdensome litigation with
which it is entirely unfamiliar in deference to a court that knows it well already. There is no reason for
this Court to have to retrace litigation that the State Court already understands in minute detail.
Additionally, the retracing of steps by the many other parties to the State Court Action, which are not
debtors in bankruptcy, militate in favor of allowing the litigation to continue in the State Court Action.
D. Burden
There is absolutely no reason to presume that litigation of the substantive issues in the State Court
would subject the Debtor’s estate to a greater expense than disposing of them in this Court. See In re
Rabin, 53 B.R. at 531. Indeed, quite the contrary is true. To date, Surety is prosecuting and defending the
claims. Further, to litigate in this Court, the Debtor (and, not so incidentally, the Movants), as well as the
numerous other Parties to this litigation, would have repeat too many of the steps that they undertook
already in the State Court. The State Court, which has governed the dispute between the parties since the
beginning, and has issued rulings that have shaped the outcome of that dispute, is the logical court to
issue final rulings. In any event, “[t]he cost of defense alone is ordinarily not considered a sufficient basis
for denying relief from the stay.” In re Marvin Johnson’s Auto Serv., Inc., 192 B.R. at 1016; see also In re
Santa Clara Co. Fair Ass’n, Inc., 180 B.R. at 566 (“litigation costs to a bankruptcy estate do not compel a
court to deny stay relief”); In re Rabin, 53 B.R. at 532 (“The cost of defending the state court action in the
state court has not been considered so prejudicial as to require continuance of the stay.”). Additionally,
“[w]here neither prejudice to the bankruptcy estate nor interference with the bankruptcy proceeding is
demonstrated, the desire of a stayed party to proceed in another forum is [itself] sufficient cause to
warrant lifting the automatic stay.” In re Larkham, 31 B.R. at 276 (emphasis added). Finally, as noted
above, these claims will have to be liquidated somewhere. The choice is not between the cost of
liquidation and the avoidance of the cost of liquidation; rather it is between liquidation that is likely to
less expensive for the parties (in the State Court) and liquidation that is likely to be more expense for
them (and to delay this case needlessly).
VII CONCLUSION
For all of the foregoing reasons, Surety respectfully requests that the Court compel the Debtor’s
estate’s abandonment of all of the Debtor’s rights, claims, causes of action, cross-actions and defenses in
the State Court Action, and permit Surety stay relief to pursue all such claims. Further, Surety requests a
comfort order of stay relief for all parties to assert and liquidate all of their claims in the State Court
Action.
It is so respectfully submitted,
Dated:
By:
Attorneys for Creditor