Filing bankruptcy triggers an automatic stay, a procedural device that plays an important role in the bankruptcy process. The automatic stay is triggered immediately upon the filing of a bankruptcy petition and substantially stops all acts and proceedings against the debtor and its property—this includes the exercise of remedies, litigation, collection efforts, and acts to create, perfect, and enforce liens. The automatic stay, however, only applies to prepetition events. In other words, the automatic stay only bars suits against the debtor with respect to claims made prior to the filing of the bankruptcy petition (or based upon prepetition conduct or events). Thus, it may not protect a debtor against a suit on a cause of action that arises based wholly on post-petition conduct.
The automatic stay is intended to protect both debtors and creditors; however, the primary purpose is to help the debtor. The stay provides the debtor both time and space free from the pressure and interference of creditors as they determine how to move forward. Secondarily, the stay generally benefits creditors by protecting the value of the bankruptcy estate as other creditors seek to get their share first. This allows the estate to be distributed in a manner that is both orderly and as fair as possible to all creditors.
The scope of the automatic stay is broad. It applies to all creditors, whether secured or unsecured, and to all of the debtor’s property, wherever located. It forbids creditors from pursuing both formal and informal actions and remedies against the debtor and its property. It also covers remedies that could be exercised outside of the US. However, consensual negotiations with the debtor are permissible.
The automatic stay is triggered by the filing of the bankruptcy petition and becomes effective without a court order and without notice to creditors. Subsequently, the stay is terminated automatically in two situations:
- As to particular property, when the property ceases to be a part of the bankruptcy estate
- When the bankruptcy proceedings are closed/dismissed or when a discharge is granted/denied, whichever comes first
There are certain actions that violate the stay outlined in §362(a) of the Bankruptcy Code:
- Filing or continuing to litigate previously filed proceedings pursuant to a prepetition claim against the debtor
- Enforcing a prepetition judgment against the debtor
- Obtaining possession or control over estate property, regardless of timing
- Creating, perfecting, or enforcing a lien against estate property or debtor property (if related to a prepetition claim)
- Any act to collect, recover, or assess a prepetition claim against the debtor
- A setoff of prepetition debts arising from different transactions
- All U.S. Tax Court proceedings
Courts disagree about whether or not inaction can violate the stay. The majority view, held by the Second, Seventh, Eighth, Ninth, and Eleventh Circuits, holds that inaction does violate the automatic stay. The minority view, held by the Third, Tenth, and D.C. Circuits, holds that it does not.
Despite the power of the stay, it is temporary (it may be lifted by the court under certain circumstances) and it is subject to certain limitations and exceptions. Some notable judicial limitations include:
- The stay does not extend to third parties, such as a debtor’s guarantors, affiliates, co-debtors, officers, co-defendants, and partners.
- However, there are certain circumstances where a non-debtor may be protected
- Under the stay, a beneficiary may draw down on a letter of credit.
- A bank can temporarily freeze a debtor’s bank account.
- The stay only applies to actions brought against the debtor. The debtor can still bring a claim without violating the stay.
- The stay does apply to recoupment actions, which are actions to net mutual claims arising out of the same transaction.
- The statute of limitations is generally not tolled by the stay.
- The stay does not relieve the debtor of their corporate governance requirements.
There are 28 statutory exceptions outlined in Bankruptcy Code §362(b). Many of these exceptions only apply in very specific circumstances. Some notable exceptions include:
- Criminal actions against the debtor
- Certain civil actions including: paternity, domestic support, child custody, divorce, and domestic violence
- The perfection of security interest under relation-back statutes
- This is the most relevant exception for creditors
In order for a creditor to take any action listed under §362(a) and not listed in §362(b), a creditor must first obtain “relief from the stay.” Relief from the stay can be granted by request or on the court’s own accord. Relief from the stay is usually sought by secured creditors for various reasons. Relief can take many forms including: termination, annulment, modification, and conditioning. There are four grounds for obtaining relief from they stay:
- “For Cause” including lack of adequate protection.
- With respect to acts against property if the debtor has no equity interest in the property and the property is not necessary to an effective reorganization.
- With respect to single asset real estate, if within 90 days the debtor fails to file a plan of reorganization that has a reasonable possibility of being confirmed OR the debtor begins to pay monthly installments to the creditor.
- With respect to acts against real estate, if the case was filed as part of a scheme to delay, hinder, and defraud creditors.
If an individual is harmed by a willful violation of the automatic stay, the individual may recover actual damages and potentially punitive damages under Bankruptcy Code §362(k).
Creditors may occasionally attempt to have a debtor waive their right to an automatic stay prepetition. Courts balance several factors in determining the enforceability of such waivers.
For additional resources on bankruptcy topics, see:
Need assistance in managing the bankruptcy process? Freeman Law attorneys offer unique cross-disciplinary expertise in taxation, litigation, and forensic accounting and asset tracing, positioning the Firm to handle complex bankruptcy litigation on behalf of debtors, creditors, and trustees, as well as bankruptcy taxation matters. Our Firm offers value-driven services and provides practical solutions to navigate complex bankruptcy laws. Contact Freeman Law to schedule a consultation or call (214) 984-3000 to discuss your tax or bankruptcy concerns.