If your company is behind on loans and leases and you are weighing a bankruptcy filing, you will hear a lot about the automatic stay. In short, the automatic stay is an injunction that is put in place the moment a business files a bankruptcy petition. It is broadly protective as to the scope of things it stops from happening, and we’ll get to a bit of that in a minute. Unlike a court order, you don’t have to apply for the stay and convince a judge to grant you one. Although bankruptcy may put a stop to most collection actions, there are many exceptions. Here are six things the stay stops, and three it doesn’t.
The Stay Stops
The first is litigation. Once you file, any court action currently underway must be stayed. That means it must be stopped. It is also true that once a bankruptcy is filed, a creditor is essentially prohibited from filing a new lawsuit. As a practical matter, when a company is in trouble, there are going to be a lot of creditors clamoring for their share of whatever is left. The point of the automatic stay is to put everyone on ice so that there is an orderly and equitable distribution of the limited assets. Without the stay, whoever got to the courthouse first would be paid at everyone else’s expense.
The second thing the stay stops is foreclosure on secured property. This could be real estate, or anything else the creditor has security for. Let’s say that a creditor is holding a security interest in the company’s automobile fleet, equipment, and inventory. Once you file for bankruptcy, the creditor cannot repossess the company’s vehicles, use of which are a critical part of your daily operations. No chance to repossess your inventory, either. That protection is not unconditional, though: the lender who has a security interest in that property can ask to “break the stay” and foreclose (or seize the collateral). The court can lift the stay for cause, a term the Bankruptcy Code never defines. To repossess or foreclose, the lender must show you don’t have any equity and that the asset is not necessary to reorganize your business. Also, if you don’t have insurance on the collateral, that can be cause too.
Third, the stay stops the collection calls and the demand letters. Every effort to collect a debt that was owed before the case was filed has to stop, and that includes the creditor who is scaring you with calls and demand letters. If the creditor continues after that, then it is violating the stay.
Fourth, it stops public shaming. A guy who was owed less than $1,000 stuck a sign out in front of his store that harangued the debtor (in a very small town) and was ordered to pay compensatory damages for emotional distress, $16,000 in attorneys’ fees, and $3,000 in punitive damages.
Fifth, it stops a collector from reaching into your bank account. You know what they say about buckets of water? It’s a lot easier to keep than to scoop. The same goes for protecting your cash. One court awarded $50,000 in punitive damages against a debt collector for taking money out of a customer’s bank account and calling her repeatedly, despite knowing the customer was in bankruptcy. It is true that a creditor’s debt collection activity doesn’t have to be one active effort. There could be a series of smaller acts.
Sixth, the stay stops the creditor who says nobody told it about the bankruptcy. If a creditor calls and hears that you have filed, any further collection activity is a violation. Notice from the bankruptcy court is not needed. The stay arises automatically the moment a bankruptcy case is filed, and even without the notice, in the Eleventh Circuit, anything done in violation of the stay is void and has no legal effect. Courts elsewhere are split on whether such acts are void or merely voidable.
Creditors who ignore the stay pay for it. A violation of the stay is willful if the creditor knew the stay was invoked and intended to do whatever the creditor did, but need not intend to violate the stay. For an individual hurt by a willful violation, the rule is blunt: If somebody breaks a bankruptcy stay on purpose, they’ve got to pay for your damages, including your lawyer, and if it’s particularly bad, they might have to pay punitive damages as well.
What the Stay Doesn’t Stop
Let’s switch gears and talk about what the stay doesn’t stop. First, the stay does not stop a criminal proceeding. Criminal contempt is outside the stay, but watch the word “contempt.” A civil contempt is something that is subject to the automatic stay. An ex-spouse who wanted to keep the debtor in prison until he paid child support was violating the bankruptcy stay. The Eleventh Circuit upheld that finding, because the contempt order was civil, not criminal.
Second, the stay does not stop government enforcement. This is anything the federal or state government does to protect public safety and welfare. Generally, the action has to serve some underlying public policy.
Third, the stay does not stop a creditor from presenting a check. If you present a check for payment or protest a negotiable instrument, those actions are not stayed. Courts have said a payday lender can cash a check after a debtor files without violating the stay. In other words, even though the stay comes down at the moment you file, it doesn’t necessarily put a stop to all activity. Nor does it necessarily act as a total bar to the lender’s action against you.
The Stay Does Not Last Forever
Even in a first case the stay does not last forever. Unless the court changes it, the automatic stay continues to exist until either the case closes, the case is dismissed, or the court gives or denies a discharge. There is one more limit if this is not your first bankruptcy. If you had one case pending within the past year, the automatic stay ends 30 days after you file your new case unless you can convince the judge that you are filing in good faith. That hearing has to be finished within those 30 days. Typically, if you haven’t had a significant change in circumstances since the last case, your second case is presumed to be filed in bad faith. If the debtor’s second case was not in good faith, the stay is not extended. Third time is not the charm, either. If a debtor has had two cases pending in the prior year, the stay does not come into effect at all. On the other hand, you can move the court within 30 days of your filing to get the stay and overcome the presumption that you’re filing the case in bad faith.
The stay is your friend in a time of trouble. It can provide you with the breathing room you need to work out your financial issues. But don’t count on it to be unlimited or unconditional. Some creditors will try to circumvent it, and it only stops so much. Remember, filing for bankruptcy puts many things on hold but there are exceptions.
