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When a debtor files for bankruptcy, section 362(a) of the bankruptcy code prohibits almost all creditors from trying to collect from that debtor. This is called the automatic stay, as it goes into effect automatically upon the initiation of a bankruptcy proceeding. 

Bankruptcy courts harshly punish creditors who violate the automatic stay, so any creditor whose debtor has filed for bankruptcy needs to be familiar with what can and can’t be done once the stay is in place, as well as the best available options to collect as much of what is owed to them as possible.

What Is the Automatic Stay?

The automatic stay is a prohibition on most collection attempts against a debtor once the debtor has filed for bankruptcy. Although the stay is partly intended to protect the debtor against harassment by creditors during the proceedings, it also helps maintain order in the bankruptcy case and makes sure that creditors are treated equally. 

A bankruptcy effectively consolidates all of a person’s debts into a single proceeding and determines which creditors are paid from a limited pool of assets. The stay ensures that no creditor can receive payment directly from the debtor to the disadvantage of other creditors.

The prohibitions of the stay are very broad. The following types of activity are all prohibited once the automatic stay is in place and throughout the remainder of the bankruptcy proceeding:

• Contacting a debtor to demand payment
• Suing a debtor to collect on a debt
• Attempting to collect on a judgment already issued against the debtor
• Repossessing a debtor’s assets or keeping possession of already repossessed assets
• Any attempt to create or enforce a lien against the debtor’s assets

Punishment for violating the stay can be harsh. Section 362(k)(1) of the bankruptcy code allows the judge overseeing a bankruptcy to award actual damages, attorneys’ fees, and punitive damages against creditors who willfully violate the stay. 

In one case, a bank that foreclosed on a bankrupt couple’s house after the automatic stay was in place was required to pay $45 million in damages, far more than the value of the house. Courts define a willful violation of the stay as a purposeful attempt to collect debt after the stay has been imposed, meaning the creditor does not need to know he or she is violating the stay to be found liable. Instead they merely need to have made an actual attempt to collect the debt during the time the stay was in effect.

In short, once a debtor files for bankruptcy, a creditor should contact a lawyer before attempting to collect anything from the debtor. A bankruptcy lawyer can determine whether any of the stay’s exceptions apply to the creditor or whether the only recourse is to try to receive payment through the bankruptcy process.

Who Is Bound by the Automatic Stay?

Almost all creditors are included in the automatic stay. However, section 362(b) of the code carves out a few exceptions. In addition to exceptions for state governments to continue criminal and certain civil cases against a person, certain private creditors have exemptions from the stay, such as:

• Spouses seeking domestic support orders like alimony or child support
• Lessors of nonresidential real property after the lease has expired
• A creditor with a lien on real property if the debtor filed bankruptcy for improper purposes
• Lessors of residential real property (like apartments) evicting a debtor for endangering the property or using illegal drugs

Any creditor with questions about whether they are exempt from the automatic stay should contact a bankruptcy lawyer immediately to discuss their options.

Secured Creditors and the Automatic Stay

With a few exceptions, secured creditors are bound by the automatic stay. This means that attempting to repossess the collateral or keeping the collateral after it has already been repossessed can lead to serious consequences. However, there are certain protections for secured creditors.

While the stay is in effect, a debtor is generally allowed to continue using the property that a secured creditor has a lien on, such as a car or house. To ensure the secured creditor is able to recover the value of their lien, the secured creditor is entitled to adequate protection under section 361(d). Adequate protection means a guarantee that the value of the collateral won’t be diminished. Adequate protection issues often arise around car loans, especially if the debtor intends to drive long distances in the car and therefore bring down its value.

If there is no adequate protection or the debtor does not have an equity interest in the collateral, the creditor may request the court lift the stay and allow repossession of the property. Bankruptcy courts generally lift the stay if it’s likely that the secured creditor’s interest won’t be protected while the property is in the hands of the debtor. 

In some cases, usually involving a business as the debtor, a court may require the debtor to make monthly payments to keep possession of the collateral. Courts will also lift the stay if the debtor does not have equity in the collateral and the collateral is not necessary for a reorganization of the debtor’s affairs.

Foreclosures and the Automatic Stay

The automatic stay also prohibits foreclosures. If a foreclosure is in progress when the debtor files for bankruptcy, the creditor must halt the foreclosure, no matter how far along in the process. Once this happens, the creditor must request the stay be lifted or make a deal with the debtor for the foreclosure to proceed while the bankruptcy and the stay are in effect.

If the property to be foreclosed on is the debtor’s home, bankruptcy courts will usually not lift the stay, especially if the debtor has nowhere else to live. Lifting the stay for a foreclosure involves the same legal test as with other secured property. However, if the property is where the debtor lives, the court usually finds that it is necessary for reorganization and declines to lift the stay. In a commercial bankruptcy or foreclosure of real property that isn’t the debtor’s home (such as a vacation house), courts are more willing to lift the stay, especially if the debtor does not have equity in the property. 

The automatic stay is lifted at the end of any bankruptcy proceeding. What this means for a mortgagee depends on the chapter of bankruptcy the debtor filed. Secured creditors are entitled to be repaid the amount of their lien. 

In a chapter 7 liquidation, this usually means the mortgagee can proceed with the foreclosure unless they have agreed to a payment plan with the debtor. As in any bankruptcy, the creditor and debtor are free to negotiate a reaffirmation agreement, in which the debtor keeps possession but continues to pay the debt after bankruptcy.

In a chapter 11 or chapter 13 payment plan, the debtor will be required to continue paying the mortgage after the bankruptcy case. In chapter 11 or 13, the mortgagee cannot foreclose based on failures to pay before the bankruptcy, but can foreclose if the debtor fails to pay under the plan. 

Foreclosing under these circumstances requires petitioning the court to dismiss the debtor’s bankruptcy proceeding. The court will consider a number of factors in deciding whether to dismiss, such as the debtor’s good faith and the number of missed payments. Whether the court dismisses the bankruptcy proceeding and allows the foreclosure to move forward often comes down to arguments made in court. An experienced bankruptcy attorney can evaluate the specifics of your situation and determine whether it’s possible to seek dismissal.

What Should I Do if One of My Debtors Files for Bankruptcy?

If someone who owes you money files for bankruptcy, contact a bankruptcy lawyer as soon as possible. Bankruptcy proceedings are highly technical and it’s easy to unintentionally violate a rule and face fines, or lose your claim. At Rosenblum Law, we have experience with bankruptcy cases on both the debtor and creditor sides, so we know how to make sure you get as much of what you are owed as possible. Call 866-815-3649 for a free consultation today.