15: Automatic Stay © Charles Tabb 2010. What is the “automatic stay”? INJUNCTION – Stops...

15: Automatic Stay© Charles Tabb 2010

What is the “automatic stay”?

• INJUNCTION– Stops collection of pre-bk debts– Protects property of estate

• AUTOMATIC– Effective upon filing of petition– Without notice– Self-executing

enforcement

• Actions that violate the stay are ineffective• Whether or not actor had notice of stay• If actor knew of stay, can be sanctioned

11:59:59 am Noonpetition filed foreclosure sale

Role in bankruptcy system

1st – protect integrity of collective action for CRs Stops all collection efforts, protects estate

STAY

Estate assets

Need permission

• Cr must get permission from bankruptcy court to proceed– Ex. to foreclose lien

• Called “relief from stay” , § 362(d)

• Avoid chaos and scramble for assets; orderly, supervised process instead

Collective proceeding replaces race

• For most claims (especially unsecured claims), no race at all

• Orderly process: – all CRs file claims, Trustee sorts out, and makes

distribution on pro rata basis

role

• 2nd – facilitates “fresh start”Gives debtor a “breathing spell”

Can’t be harassed by CRs any more on pre-bk debts!• No more phone calls• No more dunning letters• No more repos• No more sheriff levies

Scope: how broad?

• Acts stayed § 362(a)– if not listed in (a), not stayed

• Exceptions § 362(b)• Injunction– If either not stayed under (a), or excepted under

(b), always possible to ask the bankruptcy court to issue an actual injunction

Scope of stay

• General principles under § 362(a)– 1. Timing – prepetition claims only

Claim Claim

Stayed Not Stayed

Who protect?

• 2. Only protect DebtorNot protect Co-debtors

What protect?

• 3. Protects – A. Property of estate from ALL interference

– B. Property of debtor from collection of prepetition debts

4.1(a)

• Creditor has a properly perfected security interest in Debtor’s Jeep to secure a debt of $15,000. Debtor defaults. One week later, Debtor files chapter 7. Creditor seizes the Jeep and sells it pursuant to Creditor’s state-law default remedies, without any knowledge of the bankruptcy filing.

Answer 4.1(a)

• Repo & sale of collateral?

• Violates § 362(a): (1), (3), (4), (6)• If CR wants to proceed against collateral, must

get relief from stay, § 362(d)

4.1(b)

• Same facts as in question a, except Creditor seized the Jeep before the Debtor filed bankruptcy and scheduled the sale for May 1 at 2:00 p.m. Debtor filed bankruptcy at 1:59 p.m. on May 1. Creditor then sold the Jeep at 2:00 p.m.

Answer 4.1(b)

• Repo before bankruptcy, foreclosure sale after

• Violates same sections as in problem 4.1(a). • Even if repo before, can’t continue with

foreclosure sale• Again, must ask Bk court for relief from stay

4.1(c)

• Creditor obtains a judgment against Debtor for $10,000 before Debtor files bankruptcy. Debtor files chapter 7 on May 1. On May 2 Creditor has a writ of execution issued and sends the sheriff to levy on Debtor’s nonexempt property.

Answer 4.1(c)

• Enforcement of prepetition judgment

• Violates same sections as in problem a, and also § 362(a)(2)

4.1(d)

• Creditor has a writ of garnishment issued and served on Debtor’s Employer on June 1. Under state law, Employer must send Creditor 25% of Debtor’s paycheck each month thereafter, without the Creditor having to take any further steps. Debtor files chapter 7 on June 2. One June 9, Employer sends Creditor a check pursuant to the garnishment order.

Answer 4.1(d)

• Ongoing garnishment?

• CR has obligation to stop ongoing garnishment, see § 362(a)(1) (“continuation”)

• If cashes check, violates (a)(2), (5), (6)

4.1(e)

• Debtor, Inc. has a checking account with a balance of $5,000 at Bank. Debtor also is in default on a loan debt of $8,000 owing to Bank. Debtor files chapter 11. Bank sets off the checking account against the loan debt, reducing the loan balance to $3,000 and reducing the checking account balance to zero.

Answer 4.1(e)

• Setoff

• Violates § 362(a)(7), also (a)(3) & (6)• Analogous to lien enforcement• Must ask for relief from stay before set off

4.1(f)

• Same facts as in question e, except Bank does not actually set off the checking account. Instead, Bank freezes the account, denying Debtor access to it.

Answer 4.1(f)

• Freeze?

• Supreme Court held ≠ violation under (a)(7) or (3) (Citizens’ Bank v. Strumpf)

• Preserve setoff right, not exercise it– Read in harmony with 553(a) and 542(b)

4.1(g)

• Debtor leases space from Lessor for use as a restaurant. Debtor defaults on its lease. Debtor files chapter 11. Lessor posts the following notice in the lobby outside the restaurant, on Lessor’s own property, in large block letters: DEBTOR IS A DEADBEAT!! DEBTOR DOES NOT PAY ITS DEBTS. SHAME!

Answer 4.1(g)

• Other acts to collect?

OR ?

What about § 362(a)(6)? “any act to collect” what was Cr trying to accomplish?

* possible 1st Amendment free speech issue

4.1(h)

• Debtor graduated from University with honors. Debtor owes $2,000 in parking tickets to University. Debtor files chapter 7. University refuses to give Debtor his diploma or to release Debtor’s transcript.

Transcript?University of Illinois

College of Law

504 E. Pennsylvania Avenue Champaign, Illinois 61820

Student Name: Oliver Wendell Holmes College: Law – Urbana Champaign Day/Month of Birth: 02/02/1902 Fall 2007 NO. TITLE CR. Gr. PTS. LAW 602 Property 4 A+ 16 LAW 603 Torts 4 A+ 16 LAW 606 Constitutional Law I 4 A+ 16 LAW 609 Legal Writing & Analysis 2 S 0 LAW 627 Legal Research 1 S 0 Spring 2008 LAW 601 Contracts 4 A+ 16 LAW 604 Criminal Law 4 A+ 16 LAW 607 Civil Procedure 4 A+ 16 LAW 610 Introduction to Advocacy 3 S 0 Earned Hrs GPA Hrs Points GPA TOTAL: 30.00 24 96 4.0

Answer 4.1(h)

• Withholding transcript?

In re Kuehn, 563 F.3d 289 (7th Cir. 2009)• Act to collect, § 362(a)(6) “coercive effect“ test

4.1(i)

• Debtor has been seeing Creditor, a chiropractor, for years. Debtor falls behind $500 in payments owing to Creditor. Debtor files chapter 7. Creditor refuses to treat Debtor any longer, even on a current cash basis, unless Debtor pays his past due debt.

Answer 4.1(i)

• Refusal to deal?

OR ?

Refusal to deal?

• Argue

• It’s a free country! No obligation to treat a patient.

• Not acting to collect, just declining to treat indeed, no “ACT” at all

Refusal to deal?

• Argue

• “Coercive effect” test – an “act to collect”• Would treat patient IF paid debt

Remedy?

• If find that chiropractor DID violate the stay, what remedy?Just sanction CR for stay violation?

Or enter mandatory injunction ordering Cr to treat the patient?

4.1(j)

• Same facts as question i, except Creditor asks Debtor (nicely) if Debtor would be willing to reaffirm his prepetition debt.

Answer 4.1(j)

• Request to reaffirm?

• Argue “any act to collect”, (a)(6)-- pressure on DR

• Argue Code allows reaffirmations, § 524(c) – closely regulated

4.1(k)

• Insurance Co. insures Debtor’s business for fire and casualty risk. The insurance policy permits either party to cancel the policy on 30 days’ notice at any time and for any reason. Debtor files chapter 11. The next day Insurance Co. cancels the policy, giving Debtor the 30-day notice.

Answer 4.1(k)

• Cancellation of insurance?

• Violates stay, § 362(a)(3)– Insurance policy = property estate– Cancellation = “exercise control”

Keep insuring?

• Does that mean that Insurance Co. has to KEEP insuring DR?

What about CBOT?• The Dr’s (and thus the estate’s) property interest is

limited unqualified 30-day cancellation right* however, in a bankruptcy case, we’ll see that the non-dr party’s K right to cancel is trumped by Code (see § 365(e)) if termination is solely b/c of bk filing

So INS Co must ask Bk Court for relief from stayShow “cause” – increased risk

4.1(l)

• Same facts as question k, except that Insurance Co. gives Debtor the 30-day cancellation notice the day before Debtor files chapter 11.

Answer 4.1(l)

• Running of cancellation period?

• No violation• No “act” of any sort• Once cancellation notice given pre-bk, defined

Dr’s property right – only 30 more days

4.1(m)

• Creditor loans $5,000 to Debtor and, as a condition thereto, requires Debtor’s mother (“Mom”) to co-sign the note. Debtor defaults and files chapter 7. Creditor sues Mom

Answer 4.1(m)

• Sue co-DR?

• No violation• Stay only protects DR• In chapter 13 do have a special “co-debtor”

stay, § 1301

The Repo/turnover puzzle

• Facts – in chronological order:1. Dr defaults2. SP rightfully repos collateral3. Dr files bk (usually chapter 11 or 13)

Butner/CBOT

• At time of bankruptcy, what are the respective property interests of the SP and DR?

SP DR– Possession title– Right to sell

Estate

What does DR (as DIP) want?

• Wants the whole pie back!• i.e., wants SP to turn over the repo’d collateral

to the Dr (as DIP, representing estate)

SP’s piece of pie Dr (as DIP)

But it isn’t the Dr’s pie any more!

• Why should SP have to do that? Once SP has rightfully repo’d the collateral prior to bk, SP now has a big piece of the pie that is its “property” – NOT the DR’s

Whiting Pools

• Supreme Court case of United States v. Whiting Pools, Inc. raises issue whether the SP who has rightfully repo’d prior to bk has any obligation to turn over the repo’d collateral

Statutory scheme

The “turnover” statute: § 542(a): “an entity … in possession of property that the trustee may use … under § 363 … shall deliver” that property to the Tee

Statute, cont.

2nd step: what is “property that the trustee may use … under § 363”?

“trustee may use … property of the estate”§ 363(b),(c)

Statute, cont.

• 3rd step: what is “property of the estate”?

“all legal or equitable interests of the debtor in property as of the commencement of the case”§ 541(a)(1)

summary

542(a) (“property tee may use under 363”)

363(b) & (c) (“property of estate”)

541(a)(1)(“legal or equitable interests of

DR as of commencement”)

Statute, finale

• As of “the commencement of the case,” did the debtor have a “legal or equitable interest … in property” that included possession?

NO (“possession”)

SP DR

Holding in Whiting Pools?

• In Whiting Pools, what did Supreme Court hold about SP’s obligation to turn over the collateral it had rightfully repo’d?

Turn it all over! Estate (DR as DIP)

Justification?

• Read § 542(a) as giving estate a possessory right in the collateral itself“… In effect, § 542(a) grants to the estate a possessory interest in certain property of the debtor that was not held by the debtor at the commencement of reorganization proceedings. The Bankruptcy Code provides secured creditors various rights, including the right to adequate protection, and these rights replace the protection afforded by possession.”

The deal

Turnover 542(a) SP Estate

“Adequate Protection” 361

Role of “adequate protection”

• For the SP, “adequate protection” under § 361 replaces its non-bk procedural rights

• If not get adequate protection, could get relief from stay under § 362(d)(1)– Then could foreclose lien and sell collateral– But need permission from bk court

Pareto efficient

• Theory of Bankruptcy Code in dealing with secured crs Pareto efficiency

• Make one group better off (residual claimants, such as unsecured Crs and equity) without making any other group (SP) worse off

Applied in Whiting pools

• See Pareto efficiency on facts of Whiting Pools:– Collateral in the hands of the Dr is worth ~ $162K,

can be used to run business, unsecured Crs paid much more

– Only worth $35K in hands of IRS– Adequate protection: give IRS the “value” of their

collateral right• i.e., IRS cannot be worse off

Adequate Protection and Pareto

• Necessary condition of Pareto efficiency is that no group be worse off

• In bankruptcy, when make SP turn over collateral, have to be sure that the “adequate protection” it is given is fully compensatory for the rights it gives up, namely, possession and the right to foreclose

history

• Supreme Court also relied on history– Legislative history – testimony that a DR to

reorganize needs to be able to get back repo’d collateral

– Precedent under prior law (RFC v Kaplan) – allowed similar relief

When does turnover right end?

• How long does the estate’s turnover power under § 542(a) persist to give the estate the power to pull back into the estate property that a SP has repo’d?

End of turnover power

• Turnover power ends when Dr has NO property interest left at time files bankruptcy

• When the “pie” is all gone,can’t get it back

So, if SP has already sold collateral at foreclosure, no turnover power left

Turnover without Adequate Protection?

• Thompson case raises the issue of whether a SP who has rightfully repo’d prior to Bk has an obligation not only to turn over the collateral to the estate under § 542(a), but indeed to do so before it is given adequate protection

scenario

• Dr default• SP repos (often DR’s car)• DR files bk (often chapter 13)• Dr says “give me back my car”• SP says, “sure, as soon you give us adequate

protection”

• DR says – that is a stay violation!

Violate what?

• SP says, “violate what?” • We are rightfully in possession of the

• Answer: § 362(a)(3) – “exercise control” over property of the estate

What property of estate?

• Since SP is rightful possessor of car, what exactly IS the “property of the estate” over which it is “exercising control”?

(mis)-reading Whiting Pools

• Courts hold: the turnover power (542(a)) gives the estate a possessory right in the collateral

• Automatic and self-executing!• Thus SP is NOT lawfully in possession, estate

has the possessory interest, and SP is thus exercising control over estate property

Is that right?

What happened to role of adequate protection? What about the deal?

Turnover 542(a) SP Estate

“Adequate Protection” 361

Review statutes

• 542(a) refer to property can use under 363• 363 condition use of property on providing

adequate protection, see 363(e)

What about Whiting Pools, though?

• Courts always cite Whiting Pools as support for automatic turnover power

• But in Whiting Pools the IRS WAS given adequate protection before it had to turn over the collateral

Coordinating with stay relief?

• SP can get relief from stay if not given adequate protection, 362(d)(1)

• DR can get turnover, via 542(a)/363(e), if gives “adequate protection”

Makes sense to have the Dr and SP file dueling motions with the court – Dr for turnover, SP for stay relief – with the single and identical issue being: adequate protection

Freezing and status quo?

• Recall that Supreme Court held in Strumpf case that a bank did NOT violate the stay when it simply FROZE the DR’s bank account

• How is SP’s retention of repo’d car, pending Ct determination of adequate protection, any different?