A Primer on the Automatic Stay For Nonbankruptcy Lawyers

The Bencher—September/October

By Shayna M. Steinfeld, Esquire, and Kristin H. Jain, Esquire

The filing of a petition under Title 11 of the United States Code commences a bankruptcy case. The Bankruptcy Code is broken into Chapters. Chapters 1, 2, 3, and 5 apply to all cases; chapters 7, 9, 11, 12, 13, and 15 are “types” of cases governed under their chapters. “…[O]ne of the most fundamental debtor protections provided by the bankruptcy laws” is the automatic stay of section 362. Midlantic Nat’l Bank v. New Jersey Dep’t of Envtl. Protection, 474 U.S. 494, 503, 106 S.Ct. 755, 760, 88 L.Ed.2d 859 (1986). The automatic stay applies immediately and automatically to all cases (with certain exceptions for debtors who file multiple cases or subchapter V small business cases) and prohibits certain actions that pose a threat of harm to the debtor or the debtor’s estate.

Upon filing, the entity or individual filing the case is the “debtor.” On the petition date, section 541 creates an “estate.” The debtor’s estate is, in simplified terms, all debtor’s property and interests in property (real or personal, tangible or intangible) that existed on the date of filing with the continuing addition of certain post-petition assets. The debtor is allowed certain exemptions, which must be declared and are generally determined by state law, although some states allow use of federal exemptions.

The automatic stay applies to all persons or entities and broadly targets acts, including:

• The commencement or continuation of any proceeding against the debtor that was or could have been commenced prior to the bankruptcy filing. §362(a)(1).
  
• Any act to obtain possession of property of the estate or from the estate or to exercise control over property of the estate. §362 (a)(3).
  
• Any act to collect, assess, or recover a pre-petition claim against the debtor. §362 (a)(6).
  
• Enforcement of a pre-petition judgment against the debtor or debtor’s estate. §362(a)(2)
  Section 362 is long and contains self-executing exceptions that attorneys rely upon at their own risk. The exceptions are varied and difficult to apply. For example, the exceptions include:
  
• The commencement or continuation of a criminal proceeding. §362(b)(1).
  
• Certain family law proceedings such as paternity, divorce, child custody, visitation, establishment of domestic support obligations, and pursuit of domestic violence but not for distribution or collection of estate property. §362(b)(2)(A).
  
• Certain proceedings regarding the suspension, withholding, or restriction of driver’s, professional, or occupational licenses. §362(b)(2)(B)-(G)
  
• Acts to perfect or maintain perfection of a security interest. §362(b)(3)
  
• Acts by the government to commence or continue police and regulatory power. §362(b)(4)
  

The interplay of relying upon exceptions to the automatic stay versus respecting the breadth of the stay and its protection of the debtor and debtor’s estate is complex, as demonstrated by the recent U.S. Supreme Court decision in City of Chicago v. Fulton No. 19-357, 2021 WL 125106 (U.S. Jan. 14, 2021). The court held that the mere act of holding collateral (cars repossessed pre-petition for failure to pay parking tickets) did not violate the automatic stay. The city retained the repossessed cars rather than surrendering them. The debtor claimed that such retention violated the automatic stay. The city argued that the 362(b)(3) exception applied and, alternatively, debtor’s interpretation of section 362 mooted section 542, which provides for turnover of estate property. Prior to the decision, circuit court authority was split.

The Rollins case exposed other intricacies inherent in exceptions to the stay. Rollins v. Campbell (In re Rollins), 243 B.R. 540 (N.D.Ga. 1997), aff’d, 140 F.3d 1043 (1998). The Rollins debtor filed his petition while Cobb County pursued him for criminal abandonment of his child. After an exhaustive analysis, the bankruptcy court determined the character of the county’s conduct (enforcement of debtor’s suspended sentence to compel support payments) was analogous to a civil contempt proceeding. Therefore, the revocation proceedings were not criminal in character and violated the automatic stay. The court awarded the debtor actual damages, including attorneys' fees. The Eleventh Circuit reversed, finding the county’s enforcement excepted under section 362(b)(1). Rollins v. Campbell (In re Rollins), 243 B.R. 540, 545-546 (11th Cir. 1997).

Under subchapter V, small business debtors are not automatically afforded the benefit of the automatic stay and must first demonstrate the case was necessitated by circumstances beyond the debtor’s control that were not foreseeable at the time the case was filed and that it is more likely than not that the court will confirm a feasible (non-liquidating) plan within a reasonable time. §362(n)(1) and (2)

The automatic stay may be enlarged by a bankruptcy court exercising its section 105 equitable powers to protect non-debtors, but it is not common. There must be a threat to the estate or the ability of the debtor to reorganize coupled with “unusual circumstances.” Unusual circumstances exist if the continuation of the non-bankruptcy proceeding will interfere with the Bankruptcy Case. See, Union Trust Philadelphia v. Singer Equip. Co, Inc. (In re Union Trust Philadelphia, LLC), 465 B.R. 765, 770 (Bankr. E.D. Pa. 2011).

Courts use a four-part test to determine whether “unusual circumstances exist” to enjoin actions against non-debtors: (1) is there a danger of imminent, irreparable harm to the estate or the debtor’s ability to reorganize; (2) is there a likelihood of a successful reorganization; (3) a balancing of the relative harm as between the two parties; and (4) a balancing of the public interest in successful reorganization against. competing societal interests. Union Trust, 465 B.R. at 771. In addition, there may be an automatic co-debtor stay under sections 1201 and 1301.

The court in A.H. Robins Co. v. Piccinin, 788 F.2d 994 (4th Cir. 1986) extended the stay to the debtor’s officers and directors who, along with the debtor, were defendants in thousands of lawsuits concerning a medical device. The officers and directors were entitled to indemnification. The court found unusual circumstances supported extension of the automatic stay because the litigation threatened property of the estate, burdened the debtor (i.e., requiring the time and attention of the debtor’s officers and directors), and impeded the debtor’s efforts to reorganize in contravention of public policy.

Violations of the automatic stay are treated with a heavy hand. First, any act taken in violation of the automatic stay is void or voidable. (The circuit courts are split on this.) Second, the attorney, the client, or both may be liable for the debtor’s actual damages, including attorneys’ fees, and, in cases of willful violations, punitive damages. §362(k). Lack of notice of the bankruptcy case is generally no excuse, although bankruptcy courts do weigh the circumstances when determining whether a stay violation should result in sanctions. If an attorney or his or her client has notice and proceeds with any one of myriad violative acts, the court will have no sympathy, and the attorney should expect an unequivocal response.

Likewise, a debtor may not entice a creditor to violate the stay. A debtor may not actively participate in state court proceedings while failing to notify the opponent of ongoing bankruptcy proceedings only to later assert the opponent violated the automatic stay. In re Calder, 907 F.2d at 956-57. A “stealthily silent” debtor may not weaponize the stay by sitting idly by while a creditor, lacking notice of the bankruptcy case, obtains a default judgment and enforces the judgment by the seizure of debtor’s property under the debtor’s watchful eye only to then be notified of the bankruptcy case and sued for conversion. In re Smith Corset Shops, 696 F.2d at 977. Such antics do not sit well with courts mired in automatic stay gamesmanship. Bankruptcy rewards the honest debtor seeking a fresh start, not tricksters.

Once a case is filed, attorneys and their clients must cease activity while determining next steps. Consider whether the delay occasioned by seeking a lift stay order threatens the case. Is the debtor the only defendant? Is the debtor a necessary party to the litigation? Are there insurance proceeds available to pay any judgment? Are those proceeds property of the debtor’s estate? (This is a complex analysis for which attorneys should seek counsel from a bankruptcy practitioner.) What is the court’s practice when a notice of bankruptcy is filed? Some state courts administratively close the entire case, or create barriers to proceeding against non-debtor defendants, or once the attorney obtains a lift stay—they do this often without notice.

To preserve the status quo, someone, debtor or creditor, must file a suggestion of bankruptcy. If filing a notice of bankruptcy, delineate who the debtor-defendant is and whether other defendants either are debtors or benefit from the automatic stay. Attorneys should carefully determine whether the automatic stay applies to the case or jump to the next step if they simply want the bankruptcy court to rule. (This is commonly referred to as a “comfort order.” Let the court give you authority even if you believe it isn’t needed.)

Consider obtaining an order “lifting” the automatic stay so that litigation may proceed. To obtain an order, attorneys must demonstrate, among other things, that either (i) the automatic stay may not apply (i.e., the case falls within one of the enumerated exceptions) and that the creditor is seeking confirmation of the same from the court or (ii) the harm to the debtor or the debtor’s estate is outweighed by the harm to the creditor, and (iii) that the lift stay may be crafted so as to limit harm to the debtor or the debtor’s estate.

A movant must establish either proof of “cause” to lift the stay or, if the stay applies to property, proof that the debtor lacks equity in the property and that the property is not necessary to the reorganization. §362(d). The analysis is fact intensive, but it generally revolves around whether the lift of the stay will resolve the issue, whether lifting the stay will result in further interaction with the bankruptcy process, whether the movant is trying to litigate a claim in a specialized forum (i.e., tax court), whether an insurance carrier will have financial responsibility for any judgment, whether the lift stay promotes judicial economy, and, in some courts, whether the movant has any likelihood of success.

Are the damages a client seeks payable applicable insurance policy? If they are, attorneys might convince the bankruptcy court that the policy proceeds are not property of the debtor’s estate and that the attorney should be allowed to proceed for the purpose of recovering against the policy. See, e.g. Owaski v. Jet Florida (In re Jet Florida Systems, Inc.), 883 F.2d 970 (11th Cir. 1989); Matter of Fernstrom Storage and Van Co., 938 F.2d 731, 735-36 (7th Cir. 1991); but see Tringali v. Hathaway Machinery Co., Inc., 796 F.2d 553, 561 (1st Cir. 1986) (discussing whether policy proceeds are property of the estate for lift stay purposes).

Is there a jurisdictional issue? Bankruptcy courts lack jurisdiction to liquidate, try or determine a personal injury/tort claim. 28 U.S.C. §157(b)(2)(B) and (O); 28 U.S.C. §157 (b)(5). See, e.g., Myles v. Xinergy Corp. (In re Xinergy, Ltd.), 2015 WL 3643418 at *4 (Bankr. W.D.Va. 2015) (lifting stay to allow sexual harassment claims, as personal injury torts, to proceed in state court in absence of bankruptcy court jurisdiction). Courts have consistently held that the automatic stay was never intended to preclude a determination of tort liability and attendant damages. In re Thomas, 211 B.R. 838, 840, 842 (Bankr. D.S.C. 1997); Pieklik v. Hudgins (In re Hudgins), 102 B.R. 495, 497 (Bankr. E.D.Va. 1989); In re Todd Shipyards Corp., 92 B.R. 600, 603 (Bankr. D.N.J. 1988) and In re Bock Laundry Machine Co., 37 B.R. 564, 567 (Bankr. N.D.Ohio. 1984).

Furthermore, attorneys may have other tools with which to protect a creditor-client in a bankruptcy case, such as contesting discharge/dischargeability, objections to plan confirmation, filing proofs of claim, moving for the appointment of a trustee, or to dismiss. Bankruptcy is a very complex practice area, and it is wise to seek experienced counsel to navigate its waters.

Shayna M. Steinfeld, Esquire, board-certified by the American Board of Certification in both consumer and business bankruptcy law, is a shareholder of Steinfeld & Steinfeld PC in Atlanta, Georgia. She is a member of the W. Homer Drake Jr. Georgia Bankruptcy American Inn of Court. Kristin H. Jain, Esquire, is the managing member of Skierski Jain PLLC in Dallas, Texas where her practice centers upon the representation of clients in commercial bankruptcy and restructuring matters. She is a past member of the Hon. John C. Ford American Inn of Court.