Commonly Asked Questions Regarding Bankruptcy

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Melvyn Lloyd
6 years ago
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1 Commonly Asked Questions Regarding Bankruptcy What is the purpose of the automatic stay? To give the debtor (or trustee) time to catch its breath and to prevent dissipation of the debtor's assets before an orderly distribution to creditors. In re Siciliano, 13 F.3d 748 (3rd Cir. 1994); SEC v. Brennan, 230 F.3d 65 (2nd Cir. 2000). What is stayed? What can a creditor not do? As a general rule of thumb, all efforts to collect a debt from the debtor are stayed. More specifically, the Bankruptcy Code stays "commencement or continuation... of a judicial, administrative, or other proceedings against the debtor... to recover on a prepetition claim against a debtor." 11 U.S.C. 362(a)(1). The automatic stay does more than just prevent a creditor from filing a lawsuit against the debtor. The debtor is also forbidden to take any action against the debtor in existing lawsuits, and to attempt to collect an existing judgment. With some exceptions, it also forbids attempts to obtain possession of debtor's property, and the creation, perfection or enforcement of any lien against debtor's property. If you are unsure, consult a bankruptcy attorney and file a motion in the bankruptcy court seeking clarification. When it comes to an automatic stay, it is better to ask for permission that forgiveness. 1

2 What is not stayed? What can a creditor do? Claims arising from the debtor's post-petition activities are generally not subject to the automatic stay. Bellini Imports, Ltd. v. Mason & Dixon Lines, Inc., 944 F.2d 199 (4th Cir. 1991). If you assert a claim based on post-petition activities and obtain a judgment, however, you will not be able to enforce your judgment against the debtor while the automatic stay remains in effect. Claims brought by the debtor to collect a debt it is owed are not stayed. If you are defending a suit brought by the debtor, the debtor can continue its suit against you. If you have a defense of setoff, your defense will be subject to the automatic stay. Newbery Corp. v. Fireman's Fund Ins. Co., 95 F.3d 1392 (9th Cir. 1996). Your counterclaim will also be subject to the automatic stay. You may be able to ask the presiding judge for relief and for an imposition of an equitable stay of claims against you until the automatic stay has terminated. Certain conduct detrimental to the debtor is not barred, including: criminal proceedings; the collection of alimony, maintenance or support; governmental proceedings involving enforcement of police or regulatory powers; and presentment of negotiable instruments (so if the debtor gave you a check, you can deposit it but remember the payment may be an avoidable preference). Does the stay apply only to the debtor? Yes, unless the bankruptcy court expressly extends the stay to non-debtors because of unusual circumstances. Actions against a debtor's co-debtors and codefendants are not stayed, nor are claims against guarantors and sureties of debtor. Queenie, Ltd. v. Nygard Int'l, 321 F.3d 282 (2nd Cir. 2003); Reliant Energy Servs., Inc. v. 2

3 Enron Canada Corp., 349 F.3d 816 (5th Cir. 2003); In re Third Eighty-Ninth Assocs., 138 B.R. 144 (S.D.N.Y. 1992). What do you mean by unusual circumstances? A bankruptcy court can expand the stay to non-debtors in rare occasions. Generally, if the debtor has a sufficient "identity of interests" with a non-debtor, a court may expand the stay to a non-debtor. This really means that the non-debtor must be the real party in interest. A.H. Robins Co. v. Piccinin, 788 F.2d 994 (4th Cir. 1986). A bankruptcy court can also extend the automatic stay to claims asserted against directors and officers of the debtor if their cooperation is essential to the bankruptcy efforst. Lomas Fin. Corp. v. Northern Trust (In re Lomas Fin. Corp.), 117 B.R. 64 (S.D.N.Y. 1990). When does the automatic stay begin? Immediately upon debtor's filing of its petition for bankruptcy. 11 U.S.C. 362(a) ("a petition [commencing a bankruptcy case] operates as a stay, applicable to all entities....") When does the automatic stay terminate? The stay is effective for the duration of the bankruptcy case. Maritime Elec. Co. v. United Jersey Bank, 959 F.2d 1194 (3rd Cir. 1991). Because the stay operates to protect both the debtor and its creditors, the debtor alone cannot waive the automatic stay. Id. With respect to in rem proceedings, the stay will terminate automatically if the debtor abandons the property. 11 U.S.C. 362(c)(1). What happens if a creditor violate the automatic stay? 3

4 If the creditor did not have notice of the debtor s filing for bankruptcy (or independent notice of the automatic stay), the creditor will not be held in contempt. Any action the creditor took, however, take will either be void, or voidable at the debtor's option (depending on your jurisdiction). If a creditor s violation was knowing, the creditor will be held in contempt, along with any persons who aided the creditor in violating the automatic stay (including officers and attorneys). Sanctions can include compensating the debtor for actual damages (including debtor s attorneys fees) and punitive fines. Eskanos & Adler, P.C. v. Leetien, 309 F.3d 1210 (9th Cir. 2002). Some authority exits that corporate debtors are not entitled to recover damages, but don't risk it. A bankruptcy judge will find you in contempt if you violate the automatic stay. But what if a creditor believes it must proceed to protect itself? The bankruptcy court has discretion to lift the automatic stay, or to modify it. In re C&S Grain Co., 47 F.3d 233 (7th Cir. 1995). A debtor by itself cannot stipulate to the relief from the automatic stay. Section 362(d) of the Bankruptcy Code expressly permits relief from the automatic stay upon a showing of cause. Cause includes a lack of adequate protection for creditors, discussed below. Secured creditors seeking to proceed solely against estate property are entitled to a hearing on their request for relief from the automatic stay within 30 days. The hearing is limited, however, to the issues of whether they are entitled to relief. Section 362. When can a creditor seek adequate protection? A creditor can seek adequate protection (above and beyond the protection its collateral affords) if the automatic stay does not adequately protects its interests (Section 362), a debtor seeks to use, sell or lease property in which a creditor has a security 4

5 interest (Section 363), or a debtor obtains credit secured by a lien senior to a threatened creditor s lien (Section 364). The adequate protection is limited to the value of the secured creditor s interest in the secured property. What are some examples? If a secured creditor is owed $1 million, secured by $2 million in collateral, the creditor will not be entitled to adequate protection. The creditor s collateral itself provides adequate protection. Even if the value of collateral declines, the creditor will be protected. Conversely, if that same creditor were instead owed $2 million, secured by $1 million in collateral, the creditor can seek adequate protection, but only as to the first $1 million that is protected by the collateral. The remaining $1 million is simply unsecured debt. A more common example is a creditor who has $1 million in debt, protected by $1.1 million in collateral. A decline in the value of the collateral will likely threaten the security of the creditor. In this case, the creditor is likely entitled to adequate protection of the $1 million he is owed and that is secured. Okay, but what is adequate protection? Section 361 of the Bankruptcy Code provides some examples of what it means when it talks about adequate protection, but there is no set definition. A creditor might be entitled to a cash payment from the estate, or periodic payments from the estate. A creditor might be entitled to an additional lien. More commonly, a creditor will ask for adequate protection in the form of an order requiring the debtor to pay taxes due on the collateral, to maintain adequate insurance on the collateral, or to keep current on senior debt secured by the same collateral. A creditor should ask itself: what can I do to make 5

6 sure that the value of the debtor s property securing my collateral will not decrease below the amount I am owed? That is adequate protection. What if the debtor owes me money, but it is not secured by collateral? protections do unsecured creditors have? What As an unsecured creditor, you want to maximize the payment you are entitled to receive. Often, this means keeping a close eye on the debtor and its plans for reorganization. One helpful tool that benefits all unsecured creditors is the official Unsecured Creditors Committee. What is the official Unsecured Creditors Committee? It is a committee formed by the Bankruptcy Trustee under 11 U.S.C It is designed to represent the interests of all unsecured creditors and advise the bankruptcy court on how the unsecured creditors view the bankruptcy efforst. How is the Committee formed? The Trustee will review the bankruptcy petition and send questionnaires and solicitations to the largest creditors identified on the petition. This will usually also inform prospective members of the first meeting. If a creditor wants to participate, the creditor should return the materials and participate in the first meeting (which may be by telephone). The committee is usually comprised of between 5 to 7 members, but it can be larger or smaller depending on the case. If an unsecured creditor is not part of the Committee, how is its voice heard? Individual unsecured creditors still can represent themselves in the bankruptcy process. They are entitled to file any objections or requests for relief that they see fit. If a creditor was not invited to become a member of the Committee and the creditor nonetheless wishes to be on it, the creditor should contact the Trustee. Generally, the 6

7 creditor will want to explain that it has particular expertise that may be useful to the Committee, or that the Committee as it currently stands does not adequately represent that creditor s interests. What are the advantages of being on the Committee? Subject to bankruptcy court approval, the Committee may retain counsel and other professionals (often, financial advisors) to advise and represent the Committee as a whole. The bankruptcy estate picks up the bill. (Individual members may still need to hire their own counsel and professionals to the extent their needs diverge from the committee.) Because the interests of individual unsecured creditors and those of the Committee are often aligned, this enables an individual unsecured creditor to force the debtor to pay for a good amount of legal and financial work. Also, reasonable expenses of Committee members are paid for out of the bankruptcy estate. The biggest advantage, however, is that an unsecured creditor gets more input into the reorganization of the debtor. Individual unsecured creditors are often paid little attention in the bankruptcy process. What are the disadvantages of being on the Committee? The Committee may meet up to several times each month (usually be telephone), and an unsecured creditor will need to devote enough time to participate in these meetings and otherwise conduct Committee business. It will be, minimally, a few hours each month. Committee members are not compensated for their time (just for their actual expenses). Committee members also have a fiduciary interest to act in the best interests of the Committee as a whole, so they need to be sure they make informed decisions and do not manipulate events for their own gain at the expense of other unsecured creditors. 7

8 The author recommends that if you are invited to participate, you should do it at least once to see if you think it is useful. For more information, please contact: Barry P. Kaltenbach Shareholder Kubasiak, Fylstra, Thorpe & Rotunno, P.C. 20 S. Clark Street, 29 th Floor Chicago, IL (312)

Presentation will focus on three major topic areas:

Presentation will focus on three major topic areas: Secured Creditors and Vehicles What actions can a secured creditor take upon the debtor s stated intention to surrender the vehicle? For what actions