Encanto Restaurants American Bankruptcy Institute Brief

American Bankruptcy Institute

VOLO, 1st Circuit Court Opinion

Summarized & Released 3-30-17 by William J. Amann, Esq.

Craig, Deachman & Amann, PLLC

United States Bankruptcy Appellate Panel for the First Circuit

Bankruptcy Case Nos. 12-08567-MCF & 12-08570-MCF (Consolidated)

Adversary Proceeding No. 14-00030-MCF

BAP No. PR 16-034

Encanto Restaurants, Inc.

Plaintiff-Appellant

v.

Luis Aquino Vidal, et al

Defendants-Appellees

Encanto Restaurants, Inc. ("Encanto"), the purchaser of substantially all of the assets of the chapter 11 debtor, Cousins International Food, Corp., a/k/a IHOP Caguas (the "Debtor"), appeals. By its appeal, Encanto attempts to challenge two refusals by the bankruptcy court: one relating to Encanto's requests for relief under § 362, and a second relating to its requests for relief under a certain sale order (the "Sale Order").

Encanto lacks standing to pursue an appeal from the June 2016 Order and the Judgment to the extent that those rulings denied Encanto's requests for relief for alleged violations of § 362's automatic stay. Further, the bankruptcy court committed no error when it declined to grant Encanto relief for alleged violations of the Sale Order. Thus, we DISMISS a portion of this appeal for lack of standing and, as to the remainder of the appeal, we AFFIRM.

In October 2012, the Debtor filed a voluntary petition for chapter 11 relief in the United States Bankruptcy Court for the District of Puerto Rico. The Debtor did not disclose the pendency of the Local Court Action in its Statement of Financial Affairs or list the Aquinos as creditors in its Schedules. Therefore, the Aquinos did not receive notices regarding the proceedings and deadlines in the Debtor's bankruptcy case.

On December 28, 2012, the Debtor, CIF, and Encanto filed an "urgent joint motion" with the bankruptcy court seeking judicial approval of the sale to Encanto of substantially all of the Debtor's assets, including two IHOP restaurants (the "Restaurants"), free and clear of all liens, claims, interests, and encumbrances, pursuant to § 363 and § 365 (the "Sale Motion"). Additionally, they requested a determination that Encanto was a good faith purchaser. The Asset Purchase Agreement accompanying the Sale Motion provided that Encanto would not assume or be liable for any obligations of the Debtor, including any employee liabilities or causes of action or resulting from the Debtor's operation of the Restaurants. After a hearing, on February 26, 2013, the bankruptcy court entered an order approving the Asset Purchase Agreement (as amended) and the Sale Order, thereby approving the proposed sale. The Sale Order provided, inter alia, that Encanto would not be "liable, either directly or indirectly, as successor, transferee or otherwise, for any liabilities or interests of the Debtor[ ] . . . as a result of the sale or purchase of the Assets or employment of any former employee of the Debtor.

Again, Aquino was never given notice of the bankruptcy proceedings by the Debtor as ordered by the state court (state court was handling Aquino's wrongful termination action against the Debtor pre-petition).

The state court issued a judgment in favor of Aquino, against the Debtor for $60,000. Aquino filed motions in the bankruptcy court trying to assign liability for the judgment to Encanto under the theory of successor liability. In December 2013, Encanto filed a "notification" in the Local Court Action, in which it asked the Local Court to take notice of the Sale Order and of the "nullity" of any procedural events in the Local Court Action that post-dated the petition date, including, but not limited to, the Local Court Judgment. Additionally, Encanto requested the dismissal of the Local Court Action pursuant to § 362(a)(1). Together with the Debtor, Encanto also filed an Urgent Joint Motion for an Order to Show Cause in the bankruptcy court, asking that court to compel the Aquinos and Attorney Cortés Babilonia to demonstrate why they should not be found in contempt for violating the automatic stay and the Sale Order. The bankruptcy court denied the motion due to the movants' failure to commence an adversary proceeding against the Aquinos.

On appeal, Encanto's position is that it "has a pecuniary interest in the outcome of the appeal" as the purchaser of the Debtor's assets. Encanto maintains that the bankruptcy court erred in declining to rule that the Judgments were "void ab initio," regardless of notice, because they were entered in violation of the automatic stay, which took effect as soon as the bankruptcy petition was filed. Further, Encanto rejects the notion that the Aquinos lacked notice of the bankruptcy proceedings, contending that while "[e]ven a simple verbal notification" would have sufficed, the Defendants actually received formal written notification on November 15, 2012 via the Informative Motion.

Encanto asks the Panel to: (1) reverse the June 2016 Order and the Judgment; (2) declare the Judgments void ab initio; (3) remand for a hearing on damages resulting from the Defendants' willful violation of the automatic stay; (4) rule that it was entitled to acquire the Restaurants free and clear of the Defendants' claims; and (5) declare the Sale Order enforceable against the Defendants.

The Defendants argue that Encanto was not diligent in notifying creditors of the Sale Motion and Sale Order and that they (Aquino et al) were entitled to notice and since they didn't get actual notice, could not have violated the automatic stay.

As an initial matter, we reject Encanto's argument that its "party in interest" standing as an asset purchaser in the bankruptcy case is sufficient to confer unequivocal and unfettered appellate standing here. This argument is unpersuasive, as "[w]e apply a 'person[ ] aggrieved standard,' not a 'party in interest' standard, to determine bankruptcy appellate standing." Hlatky v. Murphy (In re Genesys Research Inst., Inc.), BAP No. MB 16-027, slip op. at 13-14 (B.A.P. 1st Cir. Sept. 12, 2016) (citing In re Combustion Eng'g, Inc., 391 F.3d 190, 217 (3d Cir. 2004)). Secondly, and perhaps more importantly, Encanto, as a non-debtor, cannot be aggrieved by the bankruptcy court's refusal to grant it relief under § 362. See Austin v. Unarco Indus., Inc., 705 F.2d 1, 4 (1st Cir. 1983) (stating that "the automatic stay provisions of . . . § 362(a) apply only to the bankrupt debtor"); Codfish Corp. v. F.D.I.C. (In re Codfish Corp.), 97 B.R. 132, 135 (Bankr. D.P.R. 1988) ("As a general rule the automatic stay . . . is limited to debtors and does not protect codebtors.") (footnote omitted) (citations omitted). The automatic stay is one of the most "fundamental [ ] protections" of a debtor in a bankruptcy case. Lynch v. Johns-Manville Sales Corp., 710 F.2d 1194, 1197 (6th Cir. 1983) (quoting S. Rep. No. 95-989, at 54-55 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5840-5841). Indeed, the principal function of the stay is to protect the debtor and property of the estate. See id. As the Sixth Circuit stated, "[n]othing in the legislative history counsels that the automatic stay should be invoked in a manner which would advance the interests of some third party . . . ." Id.

Encanto lacks standing to appeal the bankruptcy court's order to the extent that the bankruptcy court declined to find a stay violation, declined to enjoin the state court litigation and declined to award damages based on § 362. Once the Debtor sold substantially all of its assets to Encanto, the Debtor was divested of all right, title, and interest in those assets and they ceased to be a part of the estate. They were no longer protected by the automatic stay. Encanto is not the debtor for purposes of § 362 and therefore, it is not the beneficiary of the automatic stay's protections. Encanto points to no controlling authority extending the automatic stay to protect a purchaser in a transaction authorized under § 363.

We reach a different conclusion, however, as to Encanto's standing to appeal from the bankruptcy court's refusal to grant relief under the Sale Order. As noted above, the Sale Order authorized the sale of property of the estate to Encanto free and clear of liens, claims, and encumbrances under § 363(f), and that authorization is broad enough to extend to the Defendants' claims against the Debtor. When the Defendants sought to enforce their claims against the Debtor. Encanto looked to the "free and clear" provisions of the Sale Order. This, we believe, is sufficient to confer appellate standing on Encanto, but only with respect to the bankruptcy court's refusal to grant relief under the Sale Order. Encanto's efforts in this respect do not suffer from the same defects that defeated its efforts to appeal the bankruptcy court's refusal to grant relief under the automatic stay.

However, failure to provide proper notice of the bankruptcy proceedings to the Aquinos, who were known creditors, as required by the law of this circuit, proves fatal to Encanto's claims against the Defendants. Indeed, the First Circuit makes it plain that a "creditor has a right to assume that proper and adequate notice will be provided before his claims are forever barred." Arch Wireless, Inc. v. Nationwide Paging, Inc. (In re Arch Wireless, Inc.), 534 F.3d 76, 83 (1st Cir. 2008).