By: Donald L Swanson
It’s helpful, every now and then, to receive a refresher on basic bankruptcy laws.
We have such a refresher—on relief from stay rules for pursuing a pre-petition lawsuit—in this opinion: In re Dandurand, Case No. 24-40401, South Dakota Bankruptcy Court (decided May 23, 2025; Doc. 192).
This article is the second in a two-part “refresher” series from the In re Dandurand opinion. The first-part article is linked here.
Facts
Debtor is the sole owner and operator of a Company that manufactures sunflower seeds, kettle potato chips, and pretzels.
Company has some tough luck, with a fire that burns down its facility, a national recall from its supplier, and cash flow problems.
A Private Equity firm offers to purchase Company. Negotiations result in a Stock Purchase Agreement, under which Private Equity is to acquire 90% of Debtor’s shares in Company for “$1.00 and other good and valuable consideration.”
The Stock Purchase Agreement does not close. So, Private Equity sues Debtor in state court for specific performance.
In response, Debtor files this Chapter 11 bankruptcy. In the bankruptcy:
- Debtor moves to reject the Stock Purchase Agreement as an executory contract; and
- Private Equity moves for relief from the automatic bankruptcy stay so the state court lawsuit can proceed—under both § 362(d)(1) (for “cause”) and § 362(d)(2) (for no equity and no necessity).
After an evidentiary hearing and written closing arguments, the Bankruptcy Court:
- grants Debtor’s motion to reject the Stock Purchase Agreement; and
- denies Private Equity’s motion for relief from automatic stay.
What follows is a summary of the Bankruptcy Court’s analysis of and ruling on Private Equity’s motion for relief from stay.
Burdens of Proof
Under its relief from stay motion, Private Equity has the burden of proof on whether there is is equity in Debtor’s property, and Debtor bears the burden on all other issues (§362(g)).
A creditor moving for relief from stay must make a prima facie case that cause exists, but Debtor has the ultimate burden of proof in opposing the motion, except where equity-in-property is at issue.
Whether the bankruptcy stay should be lifted lies in the bankruptcy court’s sound discretion.
Relief from Stay under § 362(d)(1)—for “cause”
Under §362(d)(1), Private Equity must make a prima facie case that cause exists.:
- “cause” is defined as “any reason whereby a creditor is receiving less than his bargain from a debtor and is without a remedy because of the bankruptcy proceeding.”
–“Without a Remedy” Standard
Under such definition, a party with a remedy in the bankruptcy cannot establish cause.
In this case, Private Equity has a bankruptcy remedy—namely, a claim for damages arising from Debtor’s rejection of the Stock Purchase Agreement:
- rejection of the Stock Purchase Agreement is an incredibly powerful tool for Debtor in this bankruptcy; but
- Private Equity still has a remedy—namely, a pre-petition claim against Debtor for rejection damages under § 365(g) and § 502(b)(6), the amount of which will be decided by the Bankruptcy Court through the bankruptcy process.
–Misconduct Standard
“Cause” can also be established by proving a debtor’s misconduct, which Private Equity alleges in this case to include:
- Debtor’s “settlement threats”; and
- Debtor’s pre-petition solvent status—i.e., Debtor’s personal debts and personal obligations arising from Company’s debts were not in default nor had any collection actions been initiated.
However, the Bankruptcy Court declares that Debtor did not need to be insolvent to file bankruptcy, and the evidence shows that Debtor at the Petition date:
- had an ever-increasing financial burden;
- had been borrowing money to pay debts; and
- had been considering a bankruptcy filing for some time.
Moreover, the Bankruptcy Court finds that, (i) Debtor’s testimony is credible, and (ii) Debtor did not engage in any misconduct.
–Prejudice v. Hardship Balancing Standard
In considering “cause” under § 362(d)(1), a bankruptcy court must balance:
- potential prejudice to debtor, the bankruptcy estate and other creditors; against
- hardship if the moving party is not allowed to proceed outside bankruptcy.
Five factors are used to balance the hardships. And here is how the Bankruptcy Court identifies and applies each of those five factors.
First Factor—Judicial Economy. In Dandurand, the Bankruptcy Court finds that it is in a better position than the state court to handle disputes between Debtor and Private Equity. That’s because:
- the disputes are over Debtor’s stockholder interests, which interests (i) are property of Debtor’s bankruptcy estate, and (ii) are being addressed in Debtor’s proposed plan of reorganization;
- the Bankruptcy Court has jurisdiction over both Debtor and Private Equity on the disputes between them;
- both Debtor and Private Equity consented to a final judgment by Bankruptcy Court on Private Equity’s relief from stay motion; and
- the only additional party (i.e., Company) in the state court proceeding is only a minor player—that’s because the requested relief in state court (i.e., transferring 90% of Debtor’s stockholder interests in Company to Private Equity) does not require any action by Company.
Second Factor—Trial Readiness. The trial readiness question is whether the investment of resources already made in the state court lawsuit would likely be wasted if trial is deferred.
Private Equity asserts that the state court lawsuit could have been ready for trial by the Petition date, but for Debtor’s delays. Debtor insists, by contrast, that delays were actually caused by Private Equity’s constant withholding of discovery and failure to cooperate.
The Bankruptcy Court finds from the evidence that:
- delays in the state court lawsuit were caused by both parties and were within the usual course of litigation; and
- the state court lawsuit would not be ready for trial for another year or more because:
- not a single deposition had been taken though ten were projected, document production disputes require discovery motions to resolve, experts need to be hired and disclosures made, valuations need to be performed, etc.
Accordingly, trial readiness weighs in favor of the Bankruptcy Court retaining the dispute.
Third Factor—Resolution of Preliminary Bankruptcy Issues. Private Equity argues, (i) the Stock Purchase Agreement is the sole reason for Debtor’s bankruptcy filing, and (ii) this is a two party dispute that can and should be resolved outside of bankruptcy.
Such arguments are unavailing because:
- Debtor’s motion to reject the Stock Purchase Agreement is granted;
- the Bankruptcy Court will need to decide the amount, if any, of Private Equity’s rejection damages, as part of its jurisdiction over core matters; and
- there is nothing left for the state court to decide.
Accordingly, resolution of preliminary bankruptcy issues weighs in favor of the Bankruptcy Court retaining the dispute.
Fourth Factor—Creditor’s Chance of Success on the Merits. The evidence is unclear on whether Private Equity would be successful on the merits in state court. So this fourth factor is neutral.
Fifth Factor—Cost of Defense, Other Burdens, and Impact on Other Creditors. The Bankruptcy Court finds that distractions and costs to Debtor in defending the state court lawsuit would adversely impact Debtor’s efforts to reorganize and the administration of the bankruptcy estate—
- especially since the Stock Purchase Agreement can be more efficiently addressed in the Bankruptcy Court than in state court.
Uncontradicted testimony before the Bankruptcy Court is that:
- Debtor’s bankruptcy attorney received $215,000 from Debtor for protecting Debtor’s interests; and
- the state court lawsuit would require an additional $400,000 to $500,000 in Debtor’s legal fees, with over a year of trial preparation remaining.
As another cost/burden, Debtor contends that, if Private Equity were to prevail in the state court lawsuit, Debtor would no longer be employed by Company—impairing Debtor’s ability to reorganize and pay creditors.
The Stock Purchase Agreement is unclear on Debtor’s employment status after closing. But the Bankruptcy Court finds it “reasonable to believe,” after this contentious fight, that:
- Private Equity “would terminate Debtor’s employment”; and
- Debtor’s noncompete clause in the Stock Purchase Agreement would severely restrict Debtor’s ability to obtain other employment.
Accordingly, costs, burdens and impacts weigh in favor of the Bankruptcy Court retaining the dispute.
Ruling on Motion for Relief from Stay
Here’s how the Bankruptcy Court rules, based on its analysis summarized above and below, on Private Equity’s Motion for relief from the automatic bankruptcy stay.
–Under § 362(d)(1)
Private Equity has failed to make a prima facie case that “cause” exists under § 362(d)(1), as explained above.
–Under § 362(d)(2)
Private Equity has also failed to establish lack of equity and necessity under § 362(d)(2). Here’s how.
Equity Standard. Private Equity’s entire argument, to establish a lack of equity, relies upon Debtor listing the value of the Company’s shares on bankruptcy schedules at $0.00. But Private Equity provided no evidence on:
- whether Company’s corporate shares are being maintained;
- whether the value of such shares is declining;
- whether adequate protection exists; or
- whether insurance coverage is sufficient.
Instead, Private Equity acknowledges that the Company’s corporate stock at issue:
- have an actual value greater than $1.00 based on, (i) the Company’s leasehold interests involved, and (ii) Company’s prior-year revenue; and
- are not subject to any lien of Private Equity.
Debtor by contrast, testifies that:
- the scheduled value of Company’s corporate shares is based on book value—not fair market value; and
- the actual value of the 90% of Company’s corporate shares is “more than $1.00.”
Further, the Bankruptcy Court finds:
- because of the rejection, Private Equity has no claim of any sort against Company’s shares of stock;
- the value of such shares has increased during the bankruptcy case; and
- such increased value improves both the bankruptcy estate’s interest and Debtor’s chances at successfully reorganizing.
Necessity Standard. Since Private Equity failed to prove a lack of equity, the burden of proof does not shift to Debtor on the second part of §362(d)(2) (necessity for an effective reorganization). Had the burden shifted, however, Debtor still wins.
As to legal standards for necessity here (under § 362(d)(2)):
- the Supreme Court requires a Debtor to show “a reasonable possibility of a successful reorganization within a reasonable time” to satisfy § 362(d)(2)’s necessity component;
- more specifically, a debtor must show that the proposed plan of reorganization is feasible and, therefore, likely confirmable; and
- that’s because feasibility contemplates “the probability of actual performance of provisions of the plan”—the test being whether things which are to be done after confirmation can actually be done.
The Bankruptcy Court finds as to necessity:
- Debtor has timely filed a plan of reorganization, which has been accepted by all voting creditors except Private Equity;
- Debtor’s post-petition monthly operating reports show that Debtor’s cash flow is positive and increasing and that Debtor’s bills, taxes and insurance are being timely paid;
- Debtor has not taken a salary since filing—but that should change soon, which improves plan feasibility; and
- Debtor exercised sound business judgment in rejecting the Stock Purchase Agreement, which also improves plan feasibility.
Therefore, a reasonable possibility exists that Debtor can successfully reorganize within a reasonable time by retaining Company’s stock—and that establishes necessity.
Appeal
The Court’s ruling is, of course, on appeal — to the Eighth Circuit Bankruptcy Appellate Panel.
Conclusion
Here’s a “Thank you” to the In re Dandurand Court for its refresher on the law of relief from stay to pursue a pre-petition lawsuit.
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