The automatic stay is a fundamental concept of the US Bankruptcy Code and a primary reason many debtors file for bankruptcy protection. It is a statutory injunction arising immediately upon the filing of a bankruptcy case without bankruptcy court intervention. The stay is found at Section 362 of the Bankruptcy Code and applies to acts against a debtor and its property. Creditors are prevented from enforcing their state law rights in furtherance of the goals of granting debtors a fresh start while equitably distributing their assets.
The scope of the stay is broad, and it is often difficult to determine whether particular actions are covered. Pending lawsuits and other judicial proceedings are stayed and cannot be continued nor commenced if based on pre-petition contracts, leases, or conduct. Judgments against a debtor or its property generally cannot be enforced. Judicial and self-help actions to obtain possession of, dispose of, or exercise control over property as well as creating, perfecting, or enforcing liens are stayed. Creditors also cannot collect or recover claims that arose pre-bankruptcy or set off debt they owe debtors against claims they hold against those debtors.
Certain actions are not subject to the automatic stay and can be commenced or continued after a bankruptcy case is filed. This includes acts by landlords to obtain possession of the leased property under commercial leases of real property that terminated because the term of the lease expired. Similarly, eviction and unlawful detainer actions by landlords of residential leases who have obtained a judgment of possession prior to the bankruptcy filing are not subject to the stay. There are other exceptions to the automatic stay beyond the scope of this alert, but experienced counsel should be consulted to assess whether the stay is applicable before taking action.
The consequences of violating the automatic stay can be severe and include being held in contempt and ordered to pay actual damages, attorneys’ fees, and possibly punitive damages. In fact, the Bankruptcy Code generally provides that an individual injured by any willful violation of the stay shall recover actual damages, including costs and attorneys’ fees, and in appropriate circumstances, may recover punitive damages. Especially given these risks of violating the automatic stay, if there is any doubt as to its applicability, it is best to file a motion with the bankruptcy court requesting a determination that the automatic stay does not apply or, alternatively, granting relief from the automatic stay.
A creditor can obtain relief from the automatic stay under Section 362(d) of the Bankruptcy Code by filing a motion with the bankruptcy court. There are various grounds for granting the motion, the first of which is “cause, including the lack of adequate protection of an interest in property of such party in interest.” Secured creditors and certain other parties are entitled to adequate protection with respect to property they have an interest in, which includes protection for any diminution in value of that property. Most often, adequate protection is provided by cash payments but can also be in the form of liens or an administrative priority claim against the debtor. If the debtor does not provide that adequate protection, relief from the automatic stay can be granted for cause. In addition to a lack of adequate protection, other factors can constitute cause for relief from the automatic stay, including the failure to make post-bankruptcy payments to landlords and personal property lessors.
Creditors can also be granted relief from the automatic stay with regard to property if the debtor does not have equity in the property and it is not necessary to an effective reorganization. In order to have equity in the property, the value of the property must exceed the debt secured by the property. In order for the property to be necessary to an effective reorganization, the property must be essential to a reorganization that is—or is soon to be—reasonably in progress.
Creditors have the burden of proof on a motion for relief from stay under Section 362(d) on the issue of the debtor’s equity in the property, and the debtor has the burden of proof on all other issues. In practice, creditors nonetheless often assert in their motions that all grounds for relief from the stay have been met.
In most reorganization cases, bankruptcy courts will be more reluctant early in the case to grant relief from the automatic stay with regard to property a debtor contends is needed for the reorganization. Of course, if there is an urgent need for relief, a motion for relief should be filed. Moreover, under Section 362(f) of the Bankruptcy Code, the bankruptcy court, with or without a hearing, shall grant relief from the stay as is necessary to prevent irreparable damage to the creditor’s interest in property if the interest will suffer such damage before notice and a hearing.
In conclusion, it is critical for creditors to consult with experienced counsel before taking any action that could violate the automatic stay and in assessing their options.
The Thought Leadership Committee of Barclay Damon’s Restructuring, Bankruptcy & Creditors’ Rights Practice Area issues alerts and blogs on an ongoing basis to keep clients, colleagues, and friends up to date on important developments in the insolvency space. If you have any questions regarding the content of this alert, please contact the author, Kevin Newman, partner, at knewman@barclaydamon.com; Janice Grubin or Jeff Dove, Restructuring, Bankruptcy & Creditors’ Rights Practice Area co-chairs, at jgrubin@barclaydamon.com and jdove@barclaydamon.com; or Robert Wonneberger, Thought Leadership Committee chair, at rwonneberger@barclaydamon.com.