A recent order from the United States Bankruptcy Court for the Southern District of New York puts to test the theory that “it is better to ask for forgiveness than permission.”  After a lengthy dispute in the bankruptcy cases of Arcapita Bank B.S.C.(c) and its affiliates (the “Debtors”), the court held Bahrain Islamic Bank (“BisB”) in civil contempt for willfully violating the automatic stay.  After it pays any fees and costs awarded to the Unsecured Creditors Committee (the “Committee”), BisB may realize the truth of another piece of common wisdom, “nothing in life is free” – not even forgiveness.

Background

The Debtors filed for bankruptcy on March 19, 2012, however, the relationship between the Debtors and BisB began long before.  The Debtors, as a licensed Islamic wholesale bank, and BisB, a Bahraini corporation that operates as an Islamic commercial bank, routinely entered into Shari’a-compliant short-term investments with one another.  As a result of these transactions, the Debtors owed $9.8 million to BisB that was set to mature less than a week before the petition date.

During the same week that the $9.8 million was set to mature, BisB sent the Debtors three “Investment Offers,” each one in the amount of $10 million, which the Debtors accepted.  These “Investment Offers” resulted in the Debtors transferring to BisB $30 million, and BisB agreeing to rollover the maturity of the $9.8 million by one week.

After the Debtors filed for bankruptcy, the Debtors and BisB entered into discussions that culminated in BisB returning to the Debtors $20 million of the $30 million investment.  BisB kept the remaining $10 million, asserting a right to setoff the transaction proceeds against the debts owed to it by the Debtors.  However, BisB never sought approval from the bankruptcy court before exercising the setoff, claiming that setoff was permitted under Bahraini law.  BisB continued to maintain this position even after the Central Bank of Bahrain issued a legally binding Formal Direction on July 4, 2012, directing BisB to either return the money or seek relief from the bankruptcy court.

In August 2013, the Committee initiated an adversary proceeding against BisB, alleging that BisB had violated the automatic stay by unilaterally exercising the setoff.  The adversary proceeding continued for nearly a decade, and the bankruptcy court did not issue a final order in the matter until April 23, 2021, when it granted the Committee’s motion for summary judgment, finding that BisB violated the automatic stay by the setoff.  However, despite finding that the violation was willful, the bankruptcy court noted that monetary relief under section 362(k) of the Bankruptcy Code for violations of the automatic stay did not apply to corporate debtors.  Accordingly, the Committee filed a motion seeking attorneys’ fees and costs from BisB pursuant to the legal theory of civil contempt, brought pursuant to section 105(a) of the Bankruptcy Code and the court’s inherent contempt powers.

The Court’s Holding

In Taggart v. Lorenzen, 139 S. Ct. 1795 (2019), the Supreme Court stated that civil contempt for violations of the bankruptcy discharge injunction is inappropriate if there is fair ground of doubt as to the wrongfulness of a defendant’s conduct.  Thus, if a party subjectively believes itself to be acting in the right, but that belief is objectively unreasonable, a court may still impose sanctions.  In analogizing this to the non-legal world, this is colloquially referred to as the “you should have known better” standard.

Although Taggart addressed violations of the bankruptcy discharge, the bankruptcy court applied the Court’s rationale in Taggart to BisB’s stay violation.  The bankruptcy court found that BisB should have known better than to hold on to the disputed $10 million setoff for over a decade.  In making its ruling, the bankruptcy court highlighted that in the Southern District of New York, as well as other districts, if there is any doubt as to whether an action is prohibited by the automatic stay, the correct approach is to seek stay relief from the court.  The court stated that since BisB knew of the automatic stay and knew that the Debtors believed the stay to apply to the setoff asserted by BisB, then BisB acted objectively unreasonable by not seeking relief from the automatic stay before exercising the setoff.

The bankruptcy court rejected BisB’s argument that it acted reasonably because (a) Bahraini law permitted the setoff, and (b) it was unclear at the time of setoff whether the bankruptcy court could exercise personal jurisdiction over BisB.  First, the bankruptcy court found that pursuant to Bahraini law, the Formal Direction issued by the Central Bank of Bahrain took precedence over the provision of the Bahraini Civil Code that BisB relied on, making BisB’s reliance on Bahraini law unreasonable.  Second, the bankruptcy court stated that whether or not BisB believed that the court had personal jurisdiction over it at the time of setoff was not relevant to the contempt order, reasoning that allowing such an argument would provide a blank check for any foreign creditor to ignore the automatic stay by claiming uncertainty whether the court has personal jurisdiction.

Conclusion

Some may believe that it is better to ask forgiveness than permission.  However, BisB’s actions in this case highlight the dangers of creditors relying too heavily on this approach.  By unilaterally asserting the right to setoff and litigating a nearly decade-long adversary proceeding based on that asserted right, BisB may ultimately be required to pay significant attorneys’ fees and costs.  The BisB case teaches us that if there is a question as to whether or not the automatic stay applies, it might be best to resolve the dispute up front and ask the court for relief from stay.  After all, as the old saying goes, it is better to be safe than sorry.