A Sacramento bankruptcy judge issued a hard hitting judgment against Bank of America for the way it handled a single residential foreclosure in Lincoln, California.  Referring to the famous novelist whose works evoke oppressive and nightmarish characteristics, Judge Klein wrote: “Franz Kafka lives… [and] he works at Bank of America.”  This ruling has been widely discussed for the hefty award recovered by the plaintiff.  In addition to the harsh ruling, Judge Klein memorialized a rule that was not previously addressed in case law – the affirmative duty of an attorney to search bankruptcy filings to confirm whether a violation of a stay order was likely.  While this rule could arguably be characterized as dicta, because there were no claims against the attorneys in the suit, all attorneys should take note of this rule or risk serious consequences.  The relevant facts are summarized below.

In 2008, the plaintiffs entered into a loan with the expectation that they could refinance or modify the loan immediately after closing. However, after closing, Bank of America said that it would not consider a loan modification request unless and until the homeowners ceased making payment.  Accordingly, in 2009, the homeowners defaulted on their loan payments, which triggered a series of troublesome events.  During the course of the ensuing years, Bank of America strung along the homeowners with multiple “lost” loan modification requests, while at the same time pursuing foreclosure.

The homeowners eventually filed for chapter 13 bankruptcy, which triggered an automatic stay of the impending foreclosure. Despite receiving notice of the bankruptcy, Bank of America proceeded with a trustee’s sale in June 2010 and ordered that eviction proceedings be commenced.  The homeowners testified that they were constantly harassed by the bank and were eventually served with a Three-Day Notice to Quit, which created an impression that the homeowners must move within three days or face eviction by the sheriff.  Eventually and without notifying the homeowners, Bank of America began to take steps to rescind the foreclosure and did not pursue an eviction action pursuant to the bankruptcy automatic stay.  However, it was too late, the homeowners moved out and began renting another residence.  Assuming that the bank had now taken their home, the homeowners directed that their chapter 13 case be voluntarily dismissed.

In December 2010 and without notifying the homeowners, Bank of America recorded a Notice of Rescission of Trustee’s Deed Upon Sale. In April 2011, the bank returned the house keys to the homeowners.  The homeowners filed a lawsuit against the bank for violating the bankruptcy automatic stay.  The court found that throughout this ordeal Bank of America consistently, willfully, and intentionally engaged in actions that violated the automatic stay.  The case made its way to federal court after a state appellate court ruled that the federal damages remedy for a stay violation preempts a state wrongful foreclosure action that is based solely on a stay violation.

The court addressed various aspects of damages and explained that liability for a stay violation continues “at least until full restitution is actually made, or if after the expiration of the stay, the court orders full restitution.” In a series of damages calculations, the court determined that the homeowners suffered $1,074,581.50 in actual damages, which includes $70,000 in attorney fees.  The court also awarded punitive damages equal to $45 million, of which $40 million must be given to public service entities.  Finally, the court reinstated the mortgage with the debt fixed as of February 1, 2009.

In arriving at this substantial damages figure, the court noted that a willful violator of a stay order runs the risk that the victim will be “abnormally vulnerable to emotional distress and to abnormal consequences.” Indeed, under 11 U.S.C. 362(k)(1) “an individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages.”  The court stated that this section includes “tort-like” damages, meaning that “the so-called ‘thin-skull’ or ‘eggshell plaintiff’ rule applies.”

Rather than draw out the litigation in appeals, Bank of America and the plaintiffs, as part of recent settlement discussions, have agreed to settle the litigation for an undisclosed amount less than $46 million but more than $6 million.

Much has been written about this decision, but there was also an important message to attorneys that was not highlighted in prior articles. As part of its damages analysis, the court, relying on California Code of Civil Procedure section 128.7, suggested that the law firm that represented Bank of America should have been pursued for damages.  California Code of Civil Procedure section 128.7 requires that an attorney undertake reasonable inquiry under the circumstances to confirm that the claims being made are warranted in law and in fact.

The court explained that attorneys have an affirmative duty to search bankruptcy filings prior to undertaking an unlawful detainer action to determine whether the action would violate an automatic stay under the bankruptcy code, stating “A reasonable inquiry under the circumstances required checking public, free computer databases that show the pendency of bankruptcy cases.” To the authors’ knowledge, this is the first time a court has explicitly declared an affirmative duty on attorneys to search bankruptcy filings prior to undertaking an action in pursuit of remedies which may result in the violation of a stay order, which include, as an example, an unlawful detainer action or a foreclosure.

This case should serve as a striking example of the risks associated with violating a stay order. Damages for such a violation can be far-reaching and the liability can extend not only to the lender, but also to the lender’s attorney.

Photo of Sylvia Arostegui Sylvia Arostegui

Sylvia Arostegui is a partner in the Real Estate group and brings deep real estate, business, finance and project development experience in a wide variety of industries, including real estate, traditional and renewable energy, mixed-use development, hospitality, and healthcare.

In her real estate…

Sylvia Arostegui is a partner in the Real Estate group and brings deep real estate, business, finance and project development experience in a wide variety of industries, including real estate, traditional and renewable energy, mixed-use development, hospitality, and healthcare.

In her real estate and project development practice, Sylvia assists developers, borrowers and lenders, landlords and tenants, and investors and land owners in the full spectrum of business, financial and commercial real estate transactions, including acquisition; disposition; project development and construction; ground, office and retail leases; easement and access agreements; title; site control; and construction contracts.