Immediately upon filing a bankruptcy petition under any chapter of the U.S. Bankruptcy Code, there arises by operation of law an "automatic stay" that operates as a prohibition, applicable to all entities, of most collection and enforcement actions against the debtor. The debtor is not required to serve notice of the bankruptcy in order to obtain the stay. The automatic stay maintains the status quo and protects the debtor's property from being inequitably divided among the debtor's creditors1. The stay remains in effect until (1) the case is closed, (2) the case is dismissed, (3) the discharge is granted or denied, (4) the property is no longer property of the estate, or (5) the stay is lifted by order of the bankruptcy court.
The automatic stay protects only the "debtor" in Chapter 7 and 11 cases. The "debtor," which is defined in section 101(13) of the Bankruptcy Code, does not extend to related but legally separate entities such as corporate affiliates or partners in debtor partnerships, nor does it apply to codebtors or codefendants. The stay is, however, extended to codebtors in connection with certain claims in cases under Chapters 12 and 13. The scope of the automatic stay is described in section 362(a) of the Bankruptcy Code.
The Scope of the Automatic Stay
Litigation Proceedings: The automatic stay prohibits commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have commenced before the initiation of the bankruptcy case, or to recover a claim against the debtor that arose before the initiation of the bankruptcy case.
Pre-Petition Judgments: The automatic stay prohibits the enforcement-against the debtor or against property of the estate-of a judgment obtained before the commencement of a bankruptcy case. Therefore, all collection activity, including levies, garnishments, restraining notices, and all post-judgment collection remedies, are stayed.
Property of the Estate: The filing of a bankruptcy case creates an estate composed of all legal or equitable interests of the debtor in property wherever located and by whomever held as of the commencement of the case. The estate created is broad and includes both tangible and intangible property of the debtor as of the commencement of the case as well as any interests acquired by the estate after commencement. Once a bankruptcy petition has been filed, the automatic stay prohibits a creditor from taking "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."
Creation, Perfection, and Enforcement of Liens: The automatic stay prohibits any act to create, perfect, or enforce any lien against "property of the estate." The stay also prohibits any act to create, perfect, or enforce against "property of the debtor" any lien to the extent that such lien secures a claim that arose before the
commencement of the bankruptcy case.
"Lien" is defined in the Bankruptcy Code and includes judicial liens, statutory liens (e.g., federal tax liens), and security interests created by agreement (e.g., real property mortgages). By its terms, the stay prohibits the creation of new liens, the perfection of prior liens, or the enforcement of previously perfected liens against "property of the estate" or against "property of the debtor" when such liens secure claims that arose prior to the bankruptcy filing. Therefore, actions to foreclose mortgages, seizure of collateral subject to a lien, and the sale of collateral repossessed prior to the bankruptcy filing are all prohibited by the automatic stay. The automatic stay, however, does not prohibit the perfection of security interests during certain allowed grace periods, even if there is an intervening bankruptcy, as described below.
Acts to Collect Pre-Petition Claims: The automatic stay prohibits any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title. This covers "acts" that may not rise to the level of litigation described above, such as telephone calls by bill collectors. A creditor violates the automatic stay under this section simply by accepting voluntary payments from the debtor on account of a prepetition debt, even where the debtor has taken no steps to coerce or pressure the debtor into making such payments2.
Setoffs of Mutual Debts: The automatic stay prohibits (in effect defers) the setoff of any debt owing to the debtor that arose before the commencement of the bankruptcy case against any claim against the debtor. Non-bankruptcy law generally recognizes the common law right of parties to offset mutual debts and credits. By imposing the automatic stay upon setoff rights, the Bankruptcy Code establishes a procedure for notice and a hearing to permit prior court review and approval of all proposed setoff actions.
Exceptions to the Automatic Stay
The automatic stay is expressly limited by the exceptions listed in section 362(b) of the Bankruptcy Code, which include the following:
Criminal Prosecutions: The automatic stay does not apply to the commencement or continuation of any criminal action or proceeding (whether in State or Federal Court) against the debtor.
Alimony, Maintenance, or Support: The automatic stay does not prohibit the commencement or continuation of an action for the establishment of paternity, or the establishment or modification of an order for alimony, maintenance, or support.
Perfection of Certain Interests in Property: The automatic stay does not apply to certain acts to perfect, or to maintain or continue the perfection of, certain interests in property or to the extent that such act is accomplished within certain grace periods (e.g., perfection of mechanics' liens, filing of UCC financing continuation statements). If a creditor has a grace period for perfecting its interest under nonbankruptcy law that is effective against an intervening lien creditor, then it will also be effective after an intervening bankruptcy filing.
Actions Under Governmental Unit's Police or Regulatory Power: The automatic stay does not apply to the commencement or continuation of actions or proceedings to enforce police or regulatory powers of a governmental unit (or an organization exercising authority under the Chemical Weapons Convention), including the enforcement of non-money judgments obtained in such proceedings.
Setoffs in Certain Securities Related Transactions: The automatic stay is not applicable to certain commodities and securities setoffs, setoffs by repo-participants and setoffs by swap participants.
HUD Foreclosures: The automatic stay does not prohibit the commencement of foreclosure actions by the U.S. Secretary of Housing and Urban Development of certain mortgages insured under the National Housing Act.
Tax Audits, Notices of Tax Deficiency, Demand for Returns and Assessments: The automatic stay does cover any act to collect any tax, or to create, or perfect, or enforce any tax lien. It does not cover the continuation of an audit by a governmental unit to determine tax liability, the issuance to the debtor by a governmental unit of a notice of tax deficiency, the demand for tax returns, or the making of an assessment for any tax and issuance of a notice and demand for payment of such an assessment. (Any tax lien that would otherwise attach to property of the estate by reason of such an assessment does not take effect unless the tax is a debt of the debtor that will not be discharged in the case and such property or its proceeds are transferred out of the estate to, or otherwise revested in, the debtor.)
Actions to Obtain Possession of Terminated Nonresidential Real Property Leases: The automatic stay does not apply to any act by a lessor to the debtor under a lease of nonresidential real property that has terminated by the expiration of the stated term in the lease (either before or after the filing of the bankruptcy case) to obtain possession of such property.
Presentment of Negotiable Instruments: The automatic stay does not prevent the presentment of a negotiable instrument and the giving of notice of, and protesting dishonor of, such an instrument. These formal steps may be required under applicable law before remedies may be asserted against certain secondary obligors of such instruments.
Foreclosures Under Merchant Marine Act: The automatic stay does not prevent the commencement, continuation, and conclusion to judgment of certain actions brought against a Chapter 11 debtor by the U.S. Secretary of Transportation or Secretary of Commerce relating to the foreclosure of preferred ship or fleet mortgages and related actions.
Accreditation, Licensing, and Eligibility Under Higher Education Act When Debtor is an Educational Institution: The automatic stay does not prohibit any action by an accrediting agency regarding the accreditation status of the debtor as an educational institution. It also does not prohibit actions by a State licensing body regarding the licensure of the debtor as an educational institution. Finally, it does not prohibit actions by a guaranty agency or the U.S. Secretary of Education regarding the eligibility of the debtor to participate in
programs under the Higher Education Act of 1965.
Statutory Liens for Ad Valorem Property Taxes: The automatic stay does not prohibit the creation or perfection of a statutory lien for an ad valorem property tax that arises after the commencement of the bankruptcy case.
Labor Strikes Under Norris-LaGuardia Act: Labor strikes subject to the Norris-LaGuardia Act are not subject to the automatic stay. The Norris-LaGuardia Act explicitly withdraws jurisdiction from all courts of the United States, including bankruptcy courts, to issue injunctions against strikes "in any case involving or growing out of a labor dispute." The Act defines "labor dispute" as "[a]ny controversy concerning terms or conditions of employment, or concerning the association or representation of persons in negotiating, fixing, maintaining, changing, or seeking to arrange terms or conditions of employment, regardless of whether or not the disputants stand in the proximate relation of employer and employee."
Sanctions for Violations of the Automatic Stay
Contempt: The automatic stay of the Bankruptcy Code has the same effect as a court-ordered injunction. Therefore, once a party has actual notice of the stay, any violation is punishable as a contempt of court3. The sanctions typically imposed for violation of the stay include damages and attorneys' fees incurred by the debtor due to the violation, and such sanctions can be imposed regardless of whether the party willfully disregarded the stay4.
Relief from the Automatic Stay: On request of a party-in-interest and after notice and a hearing, the court is required to grant relief from the stay, such as by terminating, annulling, modifying, or conditioning such stay:
(1) for cause, including the lack of adequate protection of an interest in property of such party in interest;
(2) with respect to a stay of an act against property covered by the stay, if (A) the debtor does not have equity in such property and (B) such property is not necessary to an effective reorganization; or
(3) with respect to the stay of an act against single asset real estate (as defined under the Bankruptcy Code), by a creditor whose claim is secured by an interest in such real estate, unless, not later than the date that is 90 days after the entry of the order for relief (or such later date as the court may determine for cause by order entered within that 90-day period), (A) the debtor has filed a plan of reorganization that has a reasonable possibility of being confirmed within a reasonable time or (B) the debtor has commenced monthly payments to each creditor whose claim is secured by such real estate (other than a claim secured by a judgment lien or by an unmatured statutory lien) of which payments are in an amount equal to interest at a current fair market rate on the value of the creditor's interest in the real estate.
Factors bankruptcy courts may consider in deciding whether the stay should be lifted for cause include interference with the bankruptcy proceedings, the debtor's good or bad faith, injury to the debtor and other creditors if the stay is modified, injury to the moving party if the stay is not modified, and a proportionality and weighing of the harms from modifying or continuing the stay5. One of the most common bases for finding cause to grant relief from the stay is a lack of adequate protection6. Adequate protection is not defined in the Bankruptcy Code, but the Code gives examples of adequate protection that may be given. It includes periodic cash payments to compensate for any decrease in value of the interest of the party making the request, additional or replacement liens to compensate for any decrease in value of the interest of the party making the request, and, finally, the catchall that permits such relief "as will result in the realization by such entity of the indubitable equivalent of such entity's interest in such property"7.
1 See Matter of Rimsat, Ltd., 98 F.3d 956, rehearing denied (7th Cir. 1996); In Re Masterson, 189 B.R. 250 (Bankr. D.R.I. 1995); In Re Meis-Nachtrab, 190 B.R. 302 (Bankr. N.D. Ohio 1995).
2 See In Re Germansen Decorating, Inc., 149 B.R. 517 (Bankr. N.D. Ill. 1992).
3 See Fidelity Mortgage Inv. v. Camelia Bldrs., Inc., 550 F.2d 47 (2d Cir. 1976), cert. denied, 429 U.S. 976, (1977).
4 Vuitton et Fils, S.A. v. Carousel Handbags, 592 F.2d 126 (2d Cir. 1979). In addition to sanctions available for contempt, section 362(h) of the Bankruptcy Code expressly provides for the award of damages, including costs and attorneys' fees and, in appropriate circumstances, punitive damages, when a willful violation of the stay occurs that causes injury to an individual.
5 See In Re Milne, 185 B.R. 280 (Bankr. N.D. Ill. 1995).
6 See Collier on Bankruptcy, 15th Edition, 362.07[b], p. 82.
7 See Collier on Bankruptcy, 15th Edition, 362.07[b][c], pp.83-90.