The Extent of the Protections of the Automatic Stay Under Bankruptcy Code Section 362(a)
The filing of a petition under the Bankruptcy Code acts as an automatic stay against almost anything a creditor can do against the Debtor or its property. Absent approval from the bankruptcy court, creditors cannot file lawsuits, repossess collateral, enforce judgments, perfect liens, or set off debts. This prohibition generally even includes such minutiae as sending a collection letter to the Debtor.
Violations of the automatic stay are considered contempt of court, and can be punished by severe civil penalties. Anyone connected to a violation of the stay is subject to these penalties, including attorneys and individual employees of creditors.
Exceptions to the Automatic Stay Provision Under Section 362(b)The automatic stay does not act as a stay against certain actions, such as tax audits, criminal proceedings, paternity or divorce proceedings, certain alimony or child support collection actions, governmental regulatory or other “police power” actions, actions to repossess leased nonresidential real estate where the lease has expired by its own terms, and the presentment and notice of dishonor of a negotiable instrument (such as a check).
Creditors with an interest in particular property of the Debtor’s estate are entitled to seek relief from the automatic stay from the bankruptcy court if they can make the proper showing. As described below, there are two available avenues for obtaining relief from the automatic stay.
First, the creditor can show “cause, including the lack of adequate protection” of that creditor’s interest in the property.
Generally, this means that the value of the creditor’s collateral will diminish during the bankruptcy case. Since security interests are property interests protected by the United States Constitution, the Bankruptcy Code cannot prohibit a secured creditor from realizing the value of its collateral. (2)
In order to avoid losing the protection of the automatic stay, therefore, the Debtor must show that the creditor’s interests are “adequately protected.” This means that the Debtor must show that the creditor will eventually end up with the same value as the property was worth on the date of the bankruptcy filing.
If the property will diminish in value during the bankruptcy case, the Debtor must show that it is making periodic payments equal to the diminution in value, or the Debtor may provide additional liens on unencumbered property to secure the debt.
If the property is not diminishing in value (i.e., real estate), the Debtor must only show that it is maintaining the property (i.e., insuring the property and paying property taxes).
Other than a lack of adequate protection, the creditor may show other “cause” for relief from the automatic stay. “Cause” is not defined in the Bankruptcy Code, but may include situations where the Debtor is not properly utilizing the property or is otherwise jeopardizing the creditor’s likelihood of receiving the value of the property.
Second, the creditor can show that the Debtor has no equity in the property, and that the property is not necessary for an effective reorganization.
The first half of this test simply means that the property is worth less than the secured debt.
The second half of the test means that the Debtor cannot demonstrate that a reasonably confirmable plan of reorganization, to which the property is essential, is likely to be filed in a reasonable period of time.
Secured creditors have sometimes won on this issue by showing that they do not intend to vote in favor of any plan of reorganization proposed by the Debtor, and the Debtor cannot therefore propose a confirmable plan.
Section 362 Motions in All Cases — the “Compelling Circumstances” Test
Creditors who wish to pursue non-bankruptcy litigation against a Debtor (i.e., tort creditors who are trying to reach insurance policy proceeds) cannot obtain relief from the automatic stay unless they can show “compelling circumstances.” Implementation of this test helps prevent the Debtor from being distracted by litigation occurring outside of the bankruptcy case.
In order to show “compelling circumstances,” a creditor must show that it is suffering irreparable injury by the delay resulting from the automatic stay, and that pursuit of the litigation will cause the Debtor no great inconvenience.