California Court Discusses Default Judgments in Bankruptcy Adversary Proceedings

Default judgments are disfavored in bankruptcy litigation, particularly when they prevent a party from presenting defenses to serious financial allegations. The strong policy preference for adjudicating cases on the merits rather than on procedural missteps was demonstrated in a recent California ruling in which a creditor successfully challenged a bankruptcy court’s refusal to set aside default in an adversary proceeding. If you are navigating a bankruptcy adversary proceeding, it is crucial to consult a knowledgeable California bankruptcy attorney to protect your rights.

Case Setting

It is reported that the debtor filed for Chapter 11 bankruptcy in August 2021. In 2022, a creditor affiliate asserted a claim against the debtor for unpaid contract obligations. The debtor then reportedly initiated adversary proceedings against that creditor and others, alleging claims such as unjust enrichment and preferential transfers. The creditor and its affiliates retained the same attorney, who allegedly failed to comply with discovery rules, missed filing deadlines, and failed to appear at hearings. Despite these issues, the same attorney was later retained to represent another related entity in a new complaint filed by the debtor in August 2023.

It is alleged that when the debtor initiated a second adversary proceeding against this related entity, the same attorney failed to file a timely answer, resulting in the entry of default in October 2023. Although the attorney filed a motion to set aside the default, it was rejected after the bankruptcy court found his conduct to be part of a broader pattern of gamesmanship. Allegedly, the attorney later filed additional motions, offering explanations including misfiling, travel-related delays, and clerical errors. Despite these submissions and the retention of new counsel, the bankruptcy court repeatedly denied all motions to set aside default.

It is reported that the creditor then sought a new trial in the district court, arguing that the bankruptcy court’s refusal to set aside default was improper, especially where the default was attributable to the counsel’s conduct and not the client’s own actions.

Grounds for Granting a Default in a Bankruptcy Adversary Case

The trial court reviewed the bankruptcy court’s decision under an abuse of discretion standard, focusing on the factors required to set aside default under the Federal Rule of Civil Procedure 55(c). These include whether the defaulting party engaged in culpable conduct, whether the party has a meritorious defense, and whether setting aside default would prejudice the opposing party.

The court emphasized that defaults are a “drastic step” and should be reserved for extreme circumstances. The trial court found that although the attorney’s conduct may have amounted to gross negligence or even bad faith, there was no evidence that the client was aware of or complicit in that misconduct. Under Ninth Circuit precedent, grossly negligent conduct by counsel cannot be imputed to the client absent a showing that the client knew of the misconduct.

The court further concluded that the bankruptcy court erred in finding that setting aside default would prejudice the debtor. According to established case law, prejudice requires more than delay; it must involve concrete harm such as loss of evidence or increased risk of fraud. The court determined that these factors were not present, especially given that the creditor had retained new counsel and was prepared to litigate the matter properly.

The trial court reversed the bankruptcy court’s orders and remanded the case for further proceedings. The decision reinforces the principle that parties should not be denied their day in court based on the failings of their legal representatives, particularly when there is no indication of bad faith on the part of the client.

Consult a Skilled California Bankruptcy Attorney

Bankruptcy litigation involves strict procedural rules, and errors by counsel can have serious consequences. The skilled California bankruptcy attorneys of the Law Office of Matthew Roy have extensive experience representing clients in bankruptcy disputes and adversary proceedings. If you are facing legal challenges in a bankruptcy case or seeking to set aside a default, contact us for a confidential consultation. Call (916) 361-6028 or reach out through our online form to schedule an appointment.