The ongoing coronavirus pandemic has had a devastating financial impact on many individuals and businesses. Due to unforeseen job losses, medical bills, and the general downturn in the global economy, many individuals and businesses were forced to file for bankruptcy. As such, this article explores a key component of bankruptcy – the automatic stay and how it impacts debtors and creditors.
What is the automatic stay?
Bankruptcy is a process in which a debtor struggling massively to pay off delinquent accounts seeks protection through the formal legal process. In the typical bankruptcy case, the debts are compared with available assets, and the court approves a plan to repay a portion of the debts with the assets and discharges or forgives the remaining debts by “discharging” them.
The automatic stay is a court-ordered injunction or pause on collection actions, including litigation, against the debtor. It is automatic because it becomes effective immediately when the debtor files the bankruptcy petition. The automatic stay provides the debtor some breathing room to organize its financial affairs and prevents a race to the courthouse by the creditors to collect against the debtor while there are still available funds. By pausing enforcement actions against the debtor, the debtor, with the help of the trustee and approval of the court, has time to develop a plan for repayment of its debts, if possible.
How long does the automatic stay last?
The automatic stay lasts for the entirety of the case until the debts are discharged. Once the case is over and the debts are discharged, a creditor can resume collection actions on debts not discharged during the bankruptcy. However, a creditor is prohibited from ever attempting to collect discharged debts.
To prevent abuse of the bankruptcy process, the automatic stay does not last as long for repeat filers. If the debtor had a bankruptcy case pending in the previous year, the stay terminates after 30 days, unless the debtor or someone else involved in the case, like the trustee, asks the court to continue the stay by proving the debtor initiated the current case in good faith. If a debtor has filed three or more bankruptcies within a one-year period, the debtor is likely abusing the process, and the stay will not take effect.
Are there exceptions to the automatic stay?
Congress has decided some actions are so important that the automatic stay does not apply to them. The most common of these enforcement actions include the following:
● lawsuits to establish paternity or to collect child support or alimony;
● criminal proceedings;
● repayment of loans from certain pensions;
● evictions by a landlord when the lease has been terminated prior to the bankruptcy filing; and
● actions by taxing authorities to conduct tax audits, issue deficiency notices, demand tax returns, and make tax assessments. However, attempts to collect the deficient taxes like issuing a tax lien or seizing the property are stayed.
A creditor can also request relief from the automatic stay, even if the situation is different from the scenarios described above. A creditor does this by filing a motion for relief from the automatic stay, also called a motion to lift the stay. To do so, the creditor must convince the court that there is “cause, including the lack of adequate protection of an interest in property of such party in interest,” that would justify the court removing the protection of the automatic stay from the specific enforcement action involving the creditor. In other words, the court must determine if keeping the automatic stay in place will unfairly prejudice the creditor and provide no financial benefit or harm to the other creditors. Given the broad standard for relief from the automatic stay, a court has wide discretion in making this determination.
If a creditor files a motion for relief from the automatic stay, the debtor or other creditors may oppose the motion, arguing there is no good cause to remove the collection action from the protection of the automatic stay. The court will hold a hearing on the motion, and, if successful, the creditor can continue to pursue the collection action in a different forum like state court.
How does the automatic stay impact a civil litigation case?
The answer depends on who filed bankruptcy. If a defendant in the case filed bankruptcy, the civil litigation case is stayed, and the plaintiff must wait for resolution of the bankruptcy case before continuing the civil litigation case against the defendant. A defendant usually notifies the court and other parties by filing a notice of automatic stay or similar document. If the potential debt at issue in the civil litigation is discharged in the bankruptcy case, the case against the defendant would not continue even after the bankruptcy is over.
If there are multiple defendants, the automatic stay generally applies only to the debtor defendant, not the other defendants. However, the entire case could be stayed if the proceeding against the other defendants would impact the bankruptcy estate.
In certain situations, it may be possible for the bankruptcy court to lift the stay to allow the civil litigation case to continue. For example, in a case where the plaintiff’s claim is covered by insurance, the plaintiff may want to seek relief from the automatic stay if the defendant files bankruptcy. The insurance payment would not be considered part of the bankruptcy estate to be divided among potential creditors, and the plaintiff would be prejudiced by being prevented from seeking recovery of the insurance proceeds.
If the debtor is a plaintiff in a civil litigation case, the automatic stay would likely not impact the case. The automatic stay prevents collection actions directed against the debtor. The bankruptcy trustee would likely be motivated to continue the case to obtain more money for the bankruptcy estate to be split among the applicable creditors.
What happens if a creditor violates the automatic stay?
Given the policy reasons for the automatic stay, violations of the stay are not taken lightly by the bankruptcy court. Collection actions in violation of the automatic stay are unenforceable, and, depending on the case, a creditor could be required to pay the debtor punitive damages, compensatory damages, and attorney’s fees.
As seen above, the interplay between bankruptcy and civil litigation can be challenging to navigate. One of our experienced tax and business attorneys will be able to advise you on the impact of bankruptcy on your case and the next steps to avoid violating the automatic stay.