When a debtor files a petition to commence a case under the Bankruptcy Code, an automatic stay goes into effect that generally prohibits creditors from taking any further actions to enforce their rights against the debtor or its property. Section 362(a)(3) of the Bankruptcy Code provides that "a petition . . . operates as a stay, applicable to all entities of - (3) any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate."
In Larami Limited v. Yes! Entertainment Corporation, plaintiff Larami Limited was a manufacturer and seller of toy products, including high-powered water guns known as "Super Soakers." On May 25, 1999, Larami was issued a patent for the "expandable bladder technology" that it developed for use in its Super Soakers water guns. Less than one month later, on June 17, 1999, Larami filed a patent infringement action, claiming that defendant Yes! Entertainment Corp. was selling water guns that utilized the expandable bladder technology.
Yes! had previously commenced a case under chapter 11 of the Bankruptcy Code. Infinity Investors Limited, Yes!'s postpetition lender and the co-defendant in Larami's patent infringement suit, had taken possession of Yes!'s assets, including the allegedly infringing water guns, after Yes! defaulted under the debtor-in-possession financing agreement in July 1999.
Infinity filed a motion seeking to enforce the automatic stay or, alternatively, to transfer venue to the bankruptcy court. According to Infinity, Larami's lawsuit was automatically stayed by operation of Bankruptcy Code section 362(a)(3).
The court observed that because Larami's patent was issued nearly three months after Yes! filed its bankruptcy petition, the patent infringement cause of action arose postpetition. Moreover, Larami's $100,000 damages claim was limited to damages arising from infringing activity that occurred postpetition. The court explained that section 362(a)(3) is generally inapplicable to postpetition causes of action and would not prohibit the commencement of litigation based on postpetition claims for damages. However, the court acknowledged that section 362 would not permit efforts to collect on a judgment obtained from a postpetition claim. In the event a judgment is obtained on a postpetition cause of action, a plaintiff must obtain relief from the automatic stay before attempting to satisfy a judgment from property of the bankruptcy estate.
Having concluded that the automatic stay did not prohibit Larami from seeking money damages based on a cause of action that arose postpetition, the court turned its attention to Larami's request for the court to enjoin the production or sale of the allegedly infringing water guns. Infinity asserted that Larami's request for an injunction was an attempt to "exercise control over" property of the estate, in contravention of Bankruptcy Code section 362(a)(3). The court focused on whether the lawsuit could be characterized as an attempt to directly exercise control over estate property. The court rejected Infinity's argument and concluded that Larami did not seek to seize control of any inventory or equipment. In fact, the court noted that Larami had agreed that Yes! would remain in possession of the inventory and would be free to modify the water guns in order to avoid future infringement. Instead of an attempt to exercise direct control over property of the bankruptcy estate, the court characterized Larami's suit as an attempt to prevent allegedly unlawful conduct.
The court explained that the purpose of section 362(a)(3) is to prevent interference with a bankruptcy court's orderly disposition of estate property. The court opined that every party who opposes the debtor's view of its rights does not necessarily violate section 362. Moreover, it emphasized that section 362 was not meant to preclude postpetition suits to enjoin unlawful conduct. In fact, the court stated that if section 362(a)(3) were interpreted to prevent the type of relief sought by Larami's suit, businesses that operated postpetition could violate patent rights with impunity.
The decision is a reminder to debtors that the automatic stay is intended for the limited purpose of providing a breathing spell from the collection actions of creditors. It serves as a warning that courts will not allow the automatic stay to be employed as a shield for the protection of a debtor's unlawful postpetition conduct.
Larami Limited v. Yes! Entertainment Corp., 244 B.R. 56 (D.N.J. 2000).