Peter Bronson: What is an ‘automatic stay’? |

Peter Bronson: What is an ‘automatic stay’?

If you have been a creditor of a bankrupt individual or company, you probably have encountered the “automatic stay” that applies in every bankruptcy case.

What is the “automatic stay” and how does it operate? Here are the answers to some common questions about the stay.

Under the U.S. Bankruptcy Code, the filing of a bankruptcy petition by any person or business entity immediately creates an “automatic stay” ” a legal halt to almost all actions against the debtor, including:

– The filing or continued prosecution of any lawsuit or other legal proceeding;

– Enforcement of any judgment;

– Any demands for payment or other collection activities;

– Transactions with the debtor that are outside the ordinary course of business;

– Setoffs without court approval;

– Creation or enforcement of any lien; or

– Any act to exercise control over any property of the debtor.

While most normal communications with the debtor are unaffected by a bankruptcy, any communications which constitute a demand or threat of some kind are

prohibited. This means that not only collection activities, but also threats to initiate collection activities are equally impermissible.

Are there exceptions to the stay?

Yes. The acts and proceedings which are not prohibited by the automatic stay include: Criminal proceedings; a governmental entity’s exercise of its police power; marriage dissolution (except division of property); family support obligations; paternity suits; child visitation rights; and tax audits. Also, the stay may be limited to 30 days if a prior bankruptcy by the debtor has been dismissed, and there may not be any stay at all if two recent bankruptcies have been dismissed. The stay is also

inapplicable where the debtor has been involved in a small business case in the past two years.

But where it applies, it truly is automatic. Actions taken in violation of the stay are void, even if the person taking the action had no knowledge of the bankruptcy.

The stay operates only in favor of the debtor. So all collection activities are barred; and even the act of receiving money from the debtor, in payment of a pre-bankruptcy debt, may violate the automatic stay. But the automatic stay does not excuse a person who owes money to the debtor from meeting his obligations.

Can the stay be overturned?

Prior court approval is required, after a written motion and a hearing, before any action may be taken that would violate the automatic stay. A creditor making such a motion must show good cause, according to standards set forth in the Bankruptcy Code. (Space does not permit us to discuss those standards here; we’ll have to leave

that for a future column.)

Can you do business with a bankrupt debtor?

The automatic stay raises many interesting issues for people and companies that had been doing business with the debtor before the bankruptcy filing.

For example: Assume you have been doing business with a company that has filed for reorganization under Chapter 11, and the debtor company wants to continue “business as usual.” This is generally permitted. The automatic stay does not prevent new post-petition business dealings with the debtor. While there are certain circumstances where the debtor is required to obtain court permission to engage in such new business dealings, it is generally not an automatic stay violation for an outside party to agree to enter into such business dealings with the debtor.

But there are limitations. For example, if a debtor, after filing for Chapter 11 protection, wants to exchange a piece of equipment owned pre-bankruptcy (i.e., property of the bankruptcy estate) for a new piece of equipment, Bankruptcy Court approval would be required. Similarly, with some narrow exceptions, return of property or collateral by a debtor to the seller may also require Court approval.

Now, let’s assume that your debtor has filed for bankruptcy not under Chapter 11 (reorganization)but under Chapter 7 (liquidation), and wants to continue to do business with you. Your legal rights and obligations are entirely different under Chapter 7.

In a Chapter 11 case, the debtor retains control of his business and can operate it normally (unless there is a showing of good cause ” such as fraud or embezzlement ” for asking the court to take control away from the debtor and appoint a bankruptcy trustee to run the business).

However, in a Chapter 7 case, a trustee is always appointed to take charge of the debtor’s assets. In rare circumstances, the trustee might get bankruptcy court permission to operate the business for a short period of time, but Chapter 7 always results in liquidation of the assets of the business (unless the case is converted to Chapter 11 or 13, or is dismissed). Further, a Chapter 7 debtor has no control over the business operations in bankruptcy; only the trustee can exercise control over the assets.

How does the stay affect unlawful detainer proceedings?

The automatic stay applies to eviction proceedings. If a landlord has commenced an unlawful detainer action against a tenant, the case is halted by the tenant’s bankruptcy filing ” although the landlord still may be able to obtain quick possession of the property in the bankruptcy court if he obtained a judgment prior to the filing of the bankruptcy case.

When a corporation goes bankrupt, exactly who is protected by the stay?

The automatic stay normally does not stop any proceedings against parents, subsidiaries, affiliates, officers, directors, employees or guarantors of a bankrupt corporation.

What happens if someone violates the automatic stay?

What are the consequences if a creditor violates the automatic stay? If the bankruptcy debtor is an individual, someone who willfully violates the stay can be held liable for the actual damages caused by the violation, including punitive damages. Where the debtor is a business entity, the bankruptcy court can issue a contempt citation or impose monetary sanctions for intentional violation of the stay.

Does the automatic stay apply in “involuntary” bankruptcies?

The automatic stay applies in all bankruptcy cases, including an ” involuntary case”, i.e., a situation where creditors (usually three or more) have joined together to file a petition that forces a debtor into bankruptcy against its will. In an involuntary case, the stay usually will protect the debtor for at least 30 days. So when an involuntary petition is filed, the debtor can generally do business as usual for at least 30 days, while the automatic stay prevents all creditors from trying to collect from the debtor.

This is one of many reasons why creditors should think carefully before filing an involuntary case against a debtor.


Peter C. Bronson, of Nevada County, is a partner in the Sacramento offices of Kelly Lytton & Vann LLP. His law practice emphasizes creditors’ rights, insolvency, commercial litigation and mediation. Write him at This column is not intended as legal advice in any specific business situation or dispute; specific strategic decisions always depend upon the specific facts.

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