It’s Tuesday morning and you’re at your desk finishing your first cup of coffee. You scan your Google Calendar and mentally work through your day ahead. Suddenly, the familiar voice of your secretary crackles through the speaker on your desk phone. She coolly relates that your client Mrs. Jones is on the phone and she’s frantic. Something about the trial tomorrow and how it is has to be postponed.
Your mind quickly snaps into action. The Jones file; a hotly contested divorce case with child custody issues. The Wednesday hearing is to decide who will get custody. You’ve been planning this for weeks…months even.
You connect to Mrs. Jones. She relates that her husband has just filed bankruptcy and he’s smugly claiming that the trial date now must be postponed. The words Automatic Stay echo in the phone as she repeats them over and again. She certainly is frantic, but you calm her down. You tell her that her husband may be mistaken - after all he isn’t a lawyer and he filed his bankruptcy case pro se. You promise to get back to her in an hour.
A hazy memory of a lunch seminar discussing changes to the Bankruptcy Code pertaining to Family Law comes to mind. Your recall isn’t what it used to be so you reach for the Rolodex and find the number of your trusted local bankruptcy attorney and make the call.
II. What is the Automatic Stay of Bankruptcy?
Title 11 of the United States Code is often referred to as the Bankruptcy Code or simply the Code. The Code is often technical and complex which leads many non-bankruptcy attorneys to avoid it completely. One area of the Code that all practitioners should have a working understanding of is the Automatic Stay.
Embodied in the Code at 11 U.S.C. Section 362, the Automatic Stay is essentially an injunction against claimants and creditors of a bankrupt debtor which prohibits most actions against the debtor or property of the estate of the debtor. As the name implies it is "automatic". No motion or other action is required. Upon the filing of a bankruptcy petition with the clerk of the bankruptcy court, the Automatic Stay goes into effect.
The rationale behind the Automatic Stay is twofold. It protects the debtor from creditor actions, giving the debtor breathing room. It also benefits creditors by preventing one creditor from having an advantage over other creditors. Bankruptcy is supposed to be an orderly process of liquidating a debtor’s assets and determining the validity of creditor claims. The Automatic Stay levels the playing field and eliminates the typical race to the courthouse whereby creditors would eviscerate the debtor asset by asset. 1
The Automatic Stay applies to a very wide variety of actions against the debtor and its property. However, there are important exceptions. This article explains the basic functions of the Automatic Stay as well as some of the exceptions that are typically encountered by general practitioners and non-bankruptcy attorneys. For any attorney, having a working understanding of the Automatic Stay and its exceptions is imperative to the diligent representation of your clients.
III. What Actions are Stayed?
The Automatic Stay applies to a broad classification of actions against a debtor. Section 362(a) enumerates eight categories; each of which defines certain actions which must be stayed:
"(1) the 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 been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title;
(2) the enforcement, against the debtor or against property of the estate, of a judgment obtained before the commencement of the case under this title;
(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;
(4) any act to create, perfect, or enforce any lien against property of the estate;
(5) 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 case under this title;
(6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title;
(7) the setoff of any debt owing to the debtor that arose before the commencement of the case under this title against any claim against the debtor; and
(8) the commencement or continuation of a proceeding before the United States Tax Court concerning a corporate debtor’s tax liability for a taxable period the bankruptcy court may determine or concerning the tax liability of a debtor who is an individual for a taxable period ending before the date of the order for relief under this title."2
As demonstrated, the Automatic Stay applies to most litigation proceedings (with some exceptions to be explained below), including the issuance of process for claims that were either commenced or could have been commenced before the filing of the bankruptcy case. Further, the stay prohibits enforcement of judgments obtained before the filing of the bankruptcy case as against the debtor or its property. This would encompass all garnishments, levies, citation proceedings or other forms of execution of the judgment. Upon the filing of the bankruptcy case, all of these actions must cease.
The Automatic Stay is important because it creates a prohibition against any attempt by a creditor or third party to exercise control over "property of the estate". The filing of the bankruptcy case creates an estate to be administered by a trustee (or in Chapter 11 cases a debtor in possession) for the benefit of creditors. All non-exempt property or rights to property of the debtor become property of the bankruptcy estate. Property of the estate is a broad concept and encompasses all legal and equitable interests of the debtor in property located anywhere and in any other person’s possession.
This prohibition prevents any attempt to collect on claims against the debtor. Claims against the debtor can take infinite forms but examples include debts to a credit card lender or medical provider. The prohibition goes so far as to include even phone calls and other acts which are intended to get the debtor to pay the debt.
Section 362(a) also applies to certain acts to create, perfect, or enforce a lien against property of the debtor to the extent that the lien secures a claim that arose before the filing of the bankruptcy case. One example would be a bank or creditor conducting a sale of the debtor’s property secured by a security agreement and perfected by a UCC-1 filing. Such a sale would be in violation of the Automatic Stay and must therefore be delayed until court authority is granted or perhaps indefinitely. Certain exceptions to the Automatic Stay do allow perfection of certain liens (see discussion below).
The last major category of prohibited actions typically encountered by most general practitioners concerns setoffs of mutual debts. Setoff generally means that each party owes the other party a debt from their mutual business activities and that rather than each party paying the full amount, a setoff is taken by one party against the other. The Automatic Stay does not allow this, but a creditor can file a motion with the court to seek approval for the setoff after proper notice to the interested parties.
IV. Sanctions for Violating the Automatic Stay
Generally, acts taken in violation of the Automatic Stay are void.3 Beyond that, the Bankruptcy Code provides for penalties that can be imposed for violation of the Automatic Stay. 11 U.S.C. Section 362(h) provides:
"An individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages."
One important aspect of Subsection 362(h) is that it only applies to individuals. Thus, a corporation cannot recover damages for violation of the Automatic Stay. 4 Also, the penalty provisions only apply to willful violations of the stay. Willful for this section does not mean that a creditor had specific intent to violate the stay, but means that the creditor acted with knowledge that the bankruptcy case had been filed.5 Furthermore, acts which may seem rather insignificant can be a violation of stay subjecting the creditor to sanctions. In the Seventh Circuit, a mere technical violation of the stay, such as a computer generated collection letter sent to the debtor, has been found to be willful.6
V. Exceptions to the Automatic Stay
The Automatic Stay has limitations. Section 362(b) contains no less than 28 specific exceptions to the Automatic Stay. Some of these sections are extremely technical and apply to very limited circumstances that the general practitioner is not likely to encounter. However, there are important exceptions that every lawyer should know. Some of the major exceptions deal with Family Law. So harkening back to Mrs. Jones in our prior example - perhaps there is hope!
Criminal Law Exceptions: Subsection 362(b)(1) excepts the application of the Automatic Stay to the commencement or continuation of any criminal action or proceeding (whether in State or Federal Court) against the debtor.
Family Law Exceptions: Subsection 362(b)(2)(A) contains exceptions to the Automatic Stay for various domestic relations matters. Specifically, the stay does not prohibit commencement or continuation of a civil action or proceeding:
(i) for the establishment of paternity;
(ii) for the establishment or modification of an order for domestic support obligations;
(iii) concerning child custody or visitation;
(iv) for the dissolution of a marriage, except to the extent that such proceeding seeks to determine the division of property that is property of the estate; or
(v) regarding domestic violence;
So it would appear the Mr. Jones was not correct. The child custody hearing would not be stayed by his pro se bankruptcy filing, nor would most actions in domestic relations that do not involve the division of property.
Perfection of Certain Liens Exceptions: Pursuant to Subsection 362(b)(3), the Automatic Stay is inapplicable to certain acts to perfect, or to maintain or continue the perfection of, certain interests in property to the extent that a bankruptcy trustee would be subject to such perfection. Therefore, if applicable nonbankruptcy law provides for a grace period to perfect a lien that arose prior to the filing of the bankruptcy case, then the Automatic Stay would not apply to subsequent perfection after the bankruptcy case is filed.
One example of this process would be the post-petition perfection of a pre-petition mechanics lien. As long as the mechanics lien arose prior to the filing of the bankruptcy case, then the act of perfecting it after the filing of the bankruptcy case does not violate the Automatic Stay. Another example is the filing a continuation statement to maintain a lien created by a UCC filing and such action would not be prohibited by the Automatic Stay.
Also, the perfection of an interest in property may not be prohibited by the Automatic Stay if it can be accomplished within the statutory grace period provided by Section 547(e)(2)(A) of the Code. This section allows for the perfection to relate back to the date of transfer (a pre-petition date), so long as the perfection is completed within 30 days of the actual transfer of property between the parties.
Government Police Powers Exception: Pursuant to Subsection 362(b)(4), 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. This also includes the enforcement of non-money judgments obtained in such proceedings.
HUD Foreclosure Exception: Certain types of foreclosure actions are also not stayed. Subsection 362(b)(8) excepts foreclosure actions by the U.S. Secretary of Housing and Urban Development of certain mortgages insured under the National Housing Act.
Taxing Authority Exceptions: Subsection Section 362(b)(9) provides that the Automatic Stay does apply to an act to collect a tax, or to create, or perfect, or enforce a tax lien. It does not apply to 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.
Terminated Non-Residential Lease Exception: Under subsection 362(b)(10), the Automatic Stay will not apply to any act by a lessor against the debtor to obtain possession of real property under a lease of nonresidential real property that has terminated by the expiration of the stated term of the lease before the commencement of or during the bankruptcy.
Presentment of Negotiable Instruments Exception: 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 as provided in subsection 362(b)(11). This preserves the rights of the holder to take required actions under applicable law before remedies may be asserted against other potential obligors of the negotiable instrument.
Statutory Liens for Ad Valorem Property Taxes: Pursuant to subsection 362(b)(18), the Automatic Stay does not apply to the creation or perfection of a statutory lien for an ad valorem property tax that arises after the commencement of the bankruptcy case.
Residential Eviction Exception: This provision contained in subsection 362(b)(22) provides that the Automatic Stay does not stop an eviction proceeding if the landlord has already obtained a judgment of possession prior to the bankruptcy case being filed and such judgment is based on a lease or rental agreement. Also, subsection 362(b)(23) excepts the application of the Automatic Stay to an eviction based on endangerment of the rented property or the illegal use of controlled substances on the property.
VI. Relief from the Automatic Stay:
Section 362(c) provides that a party can obtain relief from the Automatic Stay after notice and a hearing. Typically, the creditor moving for relief from the stay is a secured creditor attempting to retrieve its collateral. If the conditions for relief are met, the court is required to grant relief from the stay, such as by terminating, annulling, modifying, or conditioning such stay.
There are specific standards for relief from the Automatic Stay. Motions for relief must state that they are "for cause." This can mean that property is depreciating in value, or the creditor’s interest in the property has not been adequately protected. Also, the court will consider whether the debtor has any equity in the subject property and whether such property is necessary for an effective reorganization.
Motions to Modify the Automatic Stay are treated in an expedited manner. The Code provides that the bankruptcy court must hold a preliminary hearing within 30 days after the motion is filed with a final hearing within another 30 days. These dates can be extended by agreement of the parties.
Motions to Modify the Automatic Stay can be contentious. This is especially true early in a bankruptcy case. The debtor is typically trying to retain a secured creditor’s collateral so that it can utilize the property in its reorganization (e.g. Chapter 11 and Chapter 13 cases). If the creditor succeeds in modifying the stay and exercising its rights to the collateral, the debtor’s attempts to reorganize may be severely diminished. Thus, a debtor is likely to fight in order to keep the property.
The court will attempt to balance the competing interests by considering such factors as harm to the debtor and other creditors if the stay is modified, damages to the moving party if the stay is not modified and whether the debtor has acted in good faith. A debtor can often satisfy a creditor – at least temporarily - by offering "adequate protection". Adequate protection can take the form of additional collateral or replacement liens or monthly cash payments to the creditor. This protects the creditor by providing a quid pro quo for the possible decrease in value of its collateral while it remains in the debtor’s possession.
VII. Automatic Stays under Bankruptcy Chapter 13:
A special exception to Chapter 13 cases is the extension of the Automatic Stay to co-debtors of the debtor. The co-debtor need not be in bankruptcy for the stay to apply. Thus, if there is a co-debtor or guarantor on the debt with the Chapter 13 debtor, the creditor cannot proceed against that party without first securing relief from the Automatic Stay.
VIII. Stay Termination by Operation Law:
Since the amendments to the Bankruptcy Code in 2005 (sometimes referred to as BAPCPA for the Bankruptcy Abuse Prevention and Consumer Protection Act) a debtor can be subject to automatic termination of the stay for failure to file a Statement of Intentions as to secured property. Code section 521(a)(2) provides that the debtor must file the statement of intention no later than 30 days after the filing of the bankruptcy petition. If the debtor fails to file the Statement of Intentions or fails to perform the stated intentions within the time specified in section 521(a)(2), the stay is terminated as to the collateral and it is no longer property of the estate.
IX. Special Provisions for Repeat Filers:
BAPCPA drastically changed the way the Automatic Stay applies to repeat filers. In the pre-BAPCPA days it was not uncommon for a Chapter 13 debtor to file two or three cases before either succeeding at reorganization or succumbing to the loss of their property (usually a house or car) to the secured creditor. The amendment installed strict limits on the duration of the Automatic Stay for repeat filers.
Debtors who had a prior case pending in the last year which was dismissed get a stay of 30 days; debtors with two or more cases pending in the past year which were dismissed get no stay at all. The debtor in those situations must seek a stay from the court in order to have the protection of the automatic (or not so automatic) stay.
X. When does the Automatic Stay End?
The Automatic Stay remains in effect until a judge lifts the stay at the request of a creditor; the debtor gets a discharge; the bankruptcy case is closed; or the item of property is no longer property of the estate. In the typical Chapter 7 case, the Automatic Stay will terminate approximately 90 to 100 days after the filing of the bankruptcy case. This is the date whereby most "no asset" cases are closed and the debtor receives a discharge. In a Chapter 13 case the stay remains effective for the life of the Chapter 13 Plan. However, prudent creditors will be aware that the Automatic Stay is replaced by a permanent injunction prohibiting creditors from taking any actions with respect to discharged pre-petition debts that were prohibited during the bankruptcy case by the Automatic Stay.
The Automatic Stay is a fundamental element of bankruptcy law. Every creditor or claimant of a debtor needs to be aware of how the stay functions and when it applies. While certain exceptions to exist to the implementation of the Automatic Stay, they are limited and can be very technical. Providing good counsel to your clients requires a working knowledge of if, when, and how the Automatic Stay applies.
1 See Matter of Rimsat, Ltd., 98 F.3d 956, rehearing denied (7th Cir. 1996);
2 11 U.S.C. 362(a)
3 In re Enyedi, 371 B.R. 327, 334 (N.D. Ill.2007)
4 In re Prairie Trunk Railroad, 125 B.R. 217, 220-222 (N.D. Ill. 1991)
5 In re Roete, 936 F.2d. 963, 965 (7th Cir. 1991)
6 In re Price, 42 F.3d 1068 (7th Cir. 1994)
Arthur Rummler is a sole practitioner with an office in Glen Ellyn, Illinois. He concentrates his practice in all phases of bankruptcy, including consumer, business and trustee cases. Mr. Rummler is a 1987 graduate of the University of Michigan Ross School of Business Administration and a 1991 graduate of the Chicago-Kent College of Law. Actively participating in the DuPage County Bar Association, he is currently serving as a member of the DCBA Brief Board, Chairman of the Entertainment Committee and has appeared in Judge’s Night for the past two years. He makes his home in Downers Grove with his wife Claire and children Jackson and Christian.