Automatic Stay Litigation

By Dennis J. Wickham

The mere filing of a bankruptcy petition creates an injunction preventing acts against the Debtor or its assets. The injunction applies to all creditors whether or not they have notice of the bankruptcy, and without any action by the Bankruptcy Court. The automatic stay, found in section 362 of the Bankruptcy Code, is extremely broad, and creditors generally must obtain prior relief from the Bankruptcy Court before taking any prescribed actions. The automatic stay serves several purposes: first, it gives the Debtor an opportunity to reorganize, free of adverse creditor action; second, it prevents creditors from racing to the court house to grab assets or to obtain unfair advantages over other creditors; and third, to permit an orderly liquidation of the case. See House Report No. 595, 9th Congress, 1st Session, at page 340 (1977).

What Is Stayed by the Filing of a Bankruptcy Petition?

Section 362 is so broad as to deny entities1 the ability to take almost any action outside the Bankruptcy Court that would give them any rights or advantages. Generally, three kinds of things are stayed:

  • filing or continuing lawsuits against the Debtor;
  • affecting any rights against property of the Estate;
  • exercising set-off rights.
  1. Lawsuits Against the Debtor.The automatic stay prevents the commencement or continuation of any judicial, administrative, or other action or proceedings against the Debtor. 11 U.S.C. section 362(a)(1). The stay extends to appeals by the Debtor where the Debtor was a defendant in the underlying case. Sheldon v. Munford, Inc., 902 F.2d 7 (7th Cir. 1990) (Appeal by debtor-defendant is stayed); Borman v. Raymark Industries, Inc., 946 F.2d 1031 (3d Cir. 1991) (Appeal by debtor-defendant is stayed). The stay applies even though the ruling for the Debtor is favorable. Ellis v. Consolidated Diesel Electric Corp., 894 F.2d 371 (10th Cir. 1990) (Stay precludes entry of summary judgment in favor of debtor-defendant.)
  2. Not Lawsuits by the Debtor.The stay does not extend to actions by the Debtor. Carley Capital Group v. Fireman’s Fund Ins. Co., 889 F.2d 1126 (D.C. Cir. 1989); Boone v. Beacon Bldg. Corp., 613 F.Supp. 1151, 1155 (D.N.J. 1985); Trans-Caribbean Lines v. Tracor Marine, 49 B.R. 360 (Bankr. S.D. Fla. 1985).
  3. Not Lawsuits Based on Post-Bankruptcy Conduct.The stay generally does not extend to claims arising after the filing of the bankruptcy case. Holland Am. Ins. Co. v. Succession of Roy, 777 F.2d 992 (5th Cir. 1985). Section 362(a)(1) applies to actions which were or could have been filed against the Debtor before the case was filed, or actions to recover “claims” against the Debtor. The term “claims,” however, is defined broadly in Bankruptcy Code section 101(5) to mean both (a) right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured; and (b) right to an equitable remedy for breach of performance if any breach could give rise to a right to payment. Ohio v. Kovacs, 469 U.S. 274 (1985) (state court mandatory injunction subject to stay because only remedy was to pay money.) This notion of a contingent or unmatured claim can differ from when a claim arises under state law. Compare, for example, In re Frenville Co., 744 F.2d 332 (3rd Cir. 1984) (indemnity claim against the Debtor does not arise under state law until after claimants were sued post-petition—not subject to stay) with In re A.H. Robins, 839 F.2d 198 (4th Cir. 1988) (indemnity claim within definition of a “claim”).
  4. Discovery Against Debtor.If the Debtor is not a defendant, the automatic stay would not appear to prevent any discovery against the Debtor, its officers or employees.2 The Court, however, may enjoin such discovery pursuant to 11 U.S.C. section 105. In re Johns-Manville Corp., 41 B.R. 926 (Bankr. S.D.N.Y. 1984) (discovery would adversely impact reorganization efforts); In re Penn-Dixie Indus., Inc., 6 Bankr. 832 (B.R. S.D.N.Y. 1980) (discovery would divert Debtor’s energy and money from reorganization efforts.)
  5. Demand Letters.Section 362 proscribes actions to collect a pre-petition claim. Thus, sending a default or demand letter may violate the stay. In re Perry, 729 F.2d 982 (4th Cir. 1984).
  6. The stay prevents the enforcement against the Debtor or against the property of the estate (even if title is in the name of another party) of a judgment obtained before the case was commenced. 11 U.S.C. section 362(a)(2). This prohibition includes efforts to renew a judgment so that the judgment lien does not expire post-petition. In re Ward, 52 Bankr. 13 (Bankr. W.D. Pa. 1985). Nevertheless, the Debtor must have some interest in the Property. If a lender completes a foreclosure sale (including recording a trustee’s deed) before the bankruptcy, the automatic stay does not affect the lender’s ownership of the property. If the Debtor remains in possession, however, the mere possessory interest is protected by the stay (although the Court is likely to grant stay relief where only a possessory interest is claimed by the Debtor.)
  7. Acts Over Property.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 is stayed. 11 U.S.C. section 362(a)(3).
  8. Liens On Property.The stay prevents any act to create, perfect, or enforce any lien against property of the estate arising from pre-bankruptcy claims. Section 363(a)(4)-(5).
  9. Collect Claims.Any act to collect, assess, or recover a claim against the Debtor that arose before the commencement of the case is stayed. Section 362(a)(6).
  10. Set-Off of Pre-Petition Debts.While the Bankruptcy Code recognizes and generally preserves set-off rights, creditors may not exercise any debt owing to the Debtor that arose before the case was filed against any claim against the Debtor without prior Bankruptcy Court approval. Section 362(a)(7). Other sections of the Bankruptcy Code affect the exercise of set-off rights. See 11 U.S.C. section 553.
  11. Tax Court Litigation.The automatic stay also enjoins the commencement or continuation of a proceeding before the United States Tax Court concerning the Debtor. Section 362(a)(8).

What is Not Stayed? 362(b) contains a number of exceptions to the automatic stay, including:

  1. Criminal proceedings and investigations against the Debtor. (Section 362(b)(1)).
  2. Collecting alimony, support and maintenance from property that is not property of the estate. [These claims are generally exempt from discharge.] (Section 362(b)(2)).
  3. Exercise of Police Power. The commencement or continuation of acts to enforce the police or regulatory powers of a governmental unit are not stayed. A dispute regularly arises when the government seeks both civil remedies (“claims for money”) and mandatory injunctions. See Ohio v. Kovacs, 469 U.S. 274 (1985); and Brock v. Rusco Indus. Inc., 842 F.2d 270 (11th Cir. 1988). (Sections 362(b)(4).
  4. Bankruptcy Actions. While a creditor may not employ state law methods such as filing an action or recording a lien to perfect a lien or security interest after the filing of a case, the Bankruptcy Code in many instances permits perfection by filing a pleading with the Bankruptcy Court. See 11 U.S.C. section 546(b). Most courts hold that filing an adversary proceeding in the Bankruptcy Court based on state law claims does not violate the automatic stay because there is an implied exception for actions filed in the Bankruptcy Court itself.
  5. Set off of certain mutual debts involving commodity claims and securities contracts. (Section 362(b)(6)).
  6. Set off of claims by a participant in certain repurchase agreements. (section 362(b)(7)).
  7. Commencement of foreclosure actions by HUD. (Section 362(b)(8)).
  8. Tax audits, issuance of a notice of tax deficiency, or seeking assessments of non-dischargeable tax debts. (Section 362(b)(9)).
  9. Lessor actions against expired leases. Section 362(b)(10) permits a commercial lessor to commence or continue unlawful detainer proceedings where the lease expired by its own terms before the bankruptcy case was filed. This does not permit such actions where the lease was terminated early because of a default.
  10. Presentment and notice of dishonor or negotiable instruments. (Section 362(b)(11)).
  11. Certain ship foreclosure actions are permitted after 90 days after the filing of the case. (Section 362(b)(12) and (13)).
  12. Actions regarding accreditation, licensing, or eligibility of certain schools as educational institutions. (Sections 362(b)(14) and (16)).
  13. The creation or perfection of a property tax lien for post-petition taxes.
  14. The exercise of set-off of mutual debts under certain “swap” agreements. (Section 362(b)(17)).

How Long Does the Stay Remain in Effect? The stay remains in effect until the earliest of:

  • the dismissal of the case;
  • the closing of the case;
  • the discharge of the debtor is entered;3or
  • the entry of an order terminating, vacating or modifying the automatic stay. 11 U.S.C. section 362(c).

A dispute often arises when property of the estate is abandoned. Trustees often abandon property when they determine that there is no equity in the property or that it is not worth the costs of maintaining it. While the stay as to “property of the estate” ends upon abandonment, section 362(a)(5) stays action against property of the Debtor. In re Motley, 10 B.R. 141 (Bankr. M.D. Ga. 1981). The creditor should seek stay relief (often granted on an ex parte basis) before taking action after abandonment. In practice, however, creditors often fail to obtain stay relief after abandonment and risk sanctions from the Debtor. How to Obtain Stay Relief.

  1. By Stipulation.The Debtor cannot merely agree to waive the stay; the Bankruptcy Court must issue an order modifying the stay on notice to creditors. In re Randall Enterprises, Inc., 115 B.R. 292 (Bankr. D. Colo. 1990). Moreover, in a case where a Trustee has been appointed, the Trustee must also consent. Stipulations granting or modifying the automatic stay require prior notice to certain creditors before they can be approved by the Court. Bankruptcy Rule 3001 requires service of a motion for approval of such a stipulation upon any Creditors’ Committee (or if none is appointed in a Chapter 11 case, upon the 20 largest unsecured creditors). If no objection is filed within 15 days of notice, the Court may approve the stipulation without holding a hearing.4
  2. By Noticed Motion.A party-in-interest may obtain stay relief by filing a motion for relief from automatic stay in the Bankruptcy Court where the case is pending. The motion must state the grounds for relief, and should be accompanied by declarations or affidavits showing cause exists for the modification or waiver or the automatic stay. The motion and accompanying papers must be served on the Debtor’s counsel and the Debtor.5 Movants should also check local rules regarding other required filings. For example, the Southern District of California requires obtaining a Relief From Stay Number from the court clerk, and servicing a form Notice of Relief From Stay indicating such number. Service of the motion is not complete until the form has been served on the Debtor.

Section 362(e) contains a trap for unwary debtors. Thirty days after the filing and service of a motion for stay relief, the automatic stay is terminated unless the Court orders that the stay remain in force. Although local practice varies, in most courts, the Debtor has the burden of ensuring that a preliminary hearing be held within the 30-day period.6 The court cannot reimpose the automatic stay, but can issue an injunction under 28 U.S.C. section 105. Spagnol Enters., Inc. v. Atlantic Fin. Fed. Sav. Ass’n., 33 B.R. 129 (W.D. Pa. 1983); In re Codescso, Inc., 24 B.R. 746 (Bankr. S.D.N.Y. 1982). Injunctive relief under section 105, however, is left to the discretion of the Bankruptcy Court.In re Wood, 33 B.R. 320 (Bankr. D. Id. 1983). In most cases, the Court holds a preliminary hearing within 30 days of filing. If the Court finds a “reasonable likelihood that the party opposing relief from such stay will prevail at the conclusions of a final hearing,” the Court will order the stay to remain in effect pending the final hearing. 11 U.S.C. section 362(e). In practice, however, the Court will often set the matter for a final hearing if there is a disputed issue of fact as to equity or other cause (without ruling that the Debtor is likely to win on the merits of the dispute.) The final hearing must be commenced within 30 days of the preliminary hearing. 11 U.S.C. section 362(e). Nevertheless, in many jurisdictions movants are pressured to waive the 30-day requirement (the Court suggests that the final hearing will commence for 2 minutes within the 30-day period, but then be continued.) Grounds for Stay Relief. Section 362(d) provides for stay relief “for cause.” The statute defines cause as including: (1) lack of adequate protection; and (2) as to property of the estate, that the Debtor does not have equity in the property and it is not necessary to an effective reorganization. The moving party has the burden of proof on the issue of equity; the Debtor has the burden of proof on all other issues. (Section 362(g)).

  1. Lack of Adequate Protection.11 U.S.C. section 361 provides a list of some of the ways adequate protection may be provided to protect the holder against any decrease in the value of its interest in the Debtor’s property resulting from the automatic stay. The movant seeking adequate protection or relief from stay for lack of adequate protection, nevertheless, should provide evidence that the value of the property is declining. United Savings Association v. Timbers of Inwood Forest Associated, Ltd., 484 U.S. 365, 98 L.Ed. 2d 740 (1988) (secured creditor is not entitled to compensation for loss of the time value of money).
  2. Bad Faith Filings.“Cause” exists for modifying the automatic stay where the bankruptcy case is found to have been filed in bad faith. See In re Arnold, 806 F.2d 937 (9th Cir. 1986) (citing with approval Matter of Little Creek Development Co., 779 F.2d 1068 (5th Cir. 1986)). Virtually all of the bad faith cases involve single asset real estate cases, which are the current lepers in the bankruptcy world. While the cases note a number of factors, as discussed below, the most significant factor in practice appears to be the “new debtor syndrome.” In such cases, a new corporation or partnership is created shortly before the bankruptcy for the purpose of filing a bankruptcy case. These new debtor cases are almost uniformly found to be bad faith filings. The other factors listed by the Court as indicative of a bad faith filing, however, are:
  • the bankruptcy involves a single-asset partnership with no employees, virtually no unsecured debt and no true purpose of reorganization (and the Debtor will not be able to confirm a plan because there will be no consenting impaired class);
  • the Debtor’s primary asset does not produce an income stream sufficient to service the outstanding debt on the Property;
  • the Debtor filed this case on the eve of foreclosures;
  • the Debtor continued to incur post-petition obligations for which it has no prospects of repayment through a plan of reorganization; and
  • the case involves a two-party dispute more properly resolved outside the Bankruptcy Court’s jurisdiction.
  1. Insured Claims.While there is little case law on point, a common motion for stay relief seeks to pursue individual tort claims where the Debtor is fully insured. Except in mass tort cases, Courts commonly grant stay relief to pursue the action to judgment so long as all collection efforts are limited to the insurance carrier. The “good cause” is elimination of a claim otherwise entitled to be paid from the bankruptcy estate.
  2. Lack of Equity and No Prospects for Reorganization.The most common asserted ground for stay relief by secured lenders is that the Debtor has no equity and the property is necessary for an effective reorganization. Note that both elements must be proven, lack of equity is not enough. Although in a single asset case, Debtors often argue that the property is critical to reorganization, the phrase “necessary to an effective reorganization” means that a reasonable possibility of a successful reorganization within a reasonable time. United Savings Association v. Timbers of Inwood Forest Associated Ltd., 484 U.S. 365, 98 L.Ed. 2d 740 (1988). While courts will not hold a confirmation hearing in the context of a stay relief motion, stay relief will be granted where there is no equity and the Debtor proposes a plan which is not confirmable on its face. In re Richardson Group, Inc., 107 B.R. 353 (Bankr. M.D. Fla 1989) (income insufficient to service debt).

In determining the extent of any equity, questions often arise as to the amount of the secured lender’s claim because of affirmative defenses and offsets. The Bankruptcy Court is permitted to consider the existence of such claims and defenses. Nevertheless, stay relief proceedings are summary in nature, and not the appropriate forum to resolve such disputes. See H.R. Rep. No. 595, 95th Cong. 1st Session 344 (1977). Vale Mills Corp. v. Gellert, 55 B.R. 970 (Bankr. N.H. 1985);Bialac v. Harsh Inv. Corp., 694 F.2d 625 (9th Cir. 1982).

  1. Effect of Pre-Bankruptcy Workout Provisions.A number of courts have upheld stipulations made in the context of pre-petition workouts in which the Debtor received forbearances and other consideration, and agreed that if a bankruptcy was later filed, the lender would be entitled to stay relief. These cases generally involve single asset cases. In re Colonial Ford, Inc., 24 B.R. 1014 (Bankr. Utah 1982); Matter of Gulf Beach Development Corp., 48 B.R. 40 (Bankr. N.D.V.Fla. 1985);In re International Supply Corp. of Tampa, Inc., 72 B.R. 510 (Bankr. N.D.V.Fla. 1987); In re Citadel Properties, Inc., 86 Bankr. 275 (B.R. N.D.V.Fla. 1988); In re Orange Park South Partnership, 79 Bankr. (B.R. N.D.V.Fla. 1987); In re Club Tower L.P., 138 B.R. 307 (Bankr. N.D.V.Ga. 1991); In re Aurura Investments, Inc., 134 BR. 982 (Bankr. V.M.D.Fla. 1991). But see In re Sky Group International, Inc., 108 B.R. 86 (Bankr. W.D. Pa. 1989); In re MacFarlane Webster Associates, 121 B.R. 694 (Bankr. S.D.N.Y. 1990).

1 “Entities” is defined in section 101(15) and includes government units such as the United States Internal Revenue Service. Unless otherwise stated, all citations are to the United States Bankruptcy Code (Title 11 of the United States Code).

2 An action seeking sanctions against the Debtor for failure to comply with a discovery request may be stayed under sections 362(a)(1) and (a)(3).

3 In a typical Chapter 7 case involving an individual, the discharge can be entered 6 to 8 weeks after the case was filed. Nevertheless, the grant of a discharge operates as its own stay of certain action by holders of dischargeable debts. See 11 U.S.C. section 524.

4 Where the stipulation is reached in settlement of a stay relief motion (discussed below), the Court may waive notice if the Creditors’ Committee or 20 largest unsecured creditors received notice of the motion. For that reason, movants should always serve a copy of any motion for stay relief on the Creditors’ Committee or 20 largest unsecured creditors.

5 By local rule, the United States Bankruptcy Court for the Southern District of California requires naming as respondents any other party holding an interest in any property which is the subject of an automatic stay. See Local Rule 4001.

6 Parties often stipulate to hold the hearing more than 30 days after filing. The stipulation should contain a recital that the stay remain in effect notwithstanding section 362(e).

For more information, contact:

Dennis Wickham

October 7, 2013  |  Categories: Business Insolvency & Creditors’ Rights
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