Collection agent must discontinue lawsuit in state court when it becomes aware debtor is filing for bankruptcy protection

Law Reporter, Apr 2003

Eskanos & Adler, P.C. v. Leetien, 309 F.3d 1210 (9th Cir. 2002).

The Ninth Circuit Court of Appeals held that a law firm acting as a collection agent was properly sanctioned for refusing to discontinue a collection action in state court after the debtor filed for bankruptcy protection.

Here, a debtor filed for Chapter 7 bankruptcy protection. The holder of an unsecured claim against the debtor was notified of this filing. A law firm filed a collection action in state court against the debtor on behalf of the creditor. The debtor received notice of this filing. The debtor's lawyer attempted to speak with one of the attorneys at the firm but was unable to find a lawyer willing to take his call. The debtor's lawyer left a message regarding the pending bankruptcy with a legal assistant at the firm. The law firm did not dismiss the state court action until several weeks after receiving the message, and gave no notice that it had discontinued its collection activity.

The debtor filed an automatic stay violation motion under 11 U.S.C. sec 362(h). Section 362(a) of the statute prohibits the continuation of post-petition collection actions in non-bankruptcy fora against a debtor. A federal bankruptcy court found that the law firm willfully violated the stay by its unjustified delay in having the case dismissed and imposed sanctions against it. A U.S. district court affirmed this decision and the sanctions imposed.

Affirming, the Ninth Circuit said that collection actions maintained in state court threaten the proper execution of bankruptcy proceedings by exposing debtors' estates to multiple collection actions, undermining debtors' ability to reorganize their financial affairs, and creating the possibility that one creditor will obtain payment to the detriment of all others.

The court rejected the law firm's argument that the prohibition against continuing a collection action should not include the mere act of maintaining an active claim. The court explained that the maintenance of an active case carries the action forward by not removing the threat it poses to the debtor. Active state lawsuits exist as more than placeholders, because the risk of a default judgment looms over the debtor throughout, and so attorneys must be engaged to defend against that possibility. Consequently, the court concluded that sec 362(a) imposes an affirmative duty on collection agents to discontinue collection actions once bankruptcy protection is sought.

Debtor's Counsel

*Michael G. Doan, Carlsbad, Cal.

Mark L. Miller, San Diego, Cal.