This month I want to write about Section 362(a) and (b) of the Bankruptcy Code (the “Code”). 111 U.S.C. §§ 101 et seq. (2006). These tell the coverage and extent of the automatic stay. The stay is perhaps the most significant tool available in bankruptcy.
Section 362 is the direct descendant of rule-based automatic stays that were first promulgated in 1973. 2See, e.g., Fed. R. Bankr. P. 11–44 (repealed 1978) (automatically staying actions against the debtor and lien enforcement for cases filed under Chapter XI); id. advisory committee’s note (“This rule reflects a broad and automatic stay policy to permit the Chapter XI process to unfold and the debtor to confirm a plan free of proceedings elsewhere.”); Fed. R. Bankr. P. 12–43 (repealed 1978) (comparable provision for cases in Chapter XII); Fed. R. Bankr. P. 10–601 (repealed 1978) (comparable provision for cases in Chapter X). Before then a stay had to be obtained in each case by application or by filing the equivalent of an adversary proceeding.
The stay of Section 362(a) has been described as a shield not a sword. 3Oberg v. Aetna Cas. & Surety Co. (In re A.H. Robins Co.), 828 F.2d 1023, 1026 (4th Cir. 1987) (“Our system of law universally frowns on a party who would use the stay as both a sword and a shield.”); Winters ex rel. McMahon v. George Mason Bank, 94 F.3d 130, 136 (4th Cir. 1996) (“Section 362 is a shield, not a sword.”); In re Mirant Corp., 314 B.R. 347, 353 & n.14 (Bankr. N.D. Tex. 2004) (same). But like any injunction it inhibits the activities of third parties and so has offensive as well as defensive uses. The sanctions for violation of the stay are powerful persuaders for persons that might act against the debtor or the estate.
Section 362(a) of the Code provides the stay itself, stating:
- (a) Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303 of this title, or an application filed under section 5(a)(3) of the Securities Investor Protection Act of 1970, operates as a stay, applicable to all entities, of—
- (1) the commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title;
- (2) the enforcement, against the debtor or against property of the estate, of a judgment obtained before the commencement of the case under this title;
- (3) any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate;
- (4) any act to create, perfect, or enforce any lien against property of the estate;
- (5) any act to create, perfect, or enforce against property of the debtor any lien to the extent that such lien secures a claim that arose before the commencement of the case under this title;
- (6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title;
- (7) the setoff of any debt owing to the debtor that arose before the commencement of the case under this title against any claim against the debtor; and
- (8) the commencement or continuation of a proceeding before the United States Tax Court concerning a tax liability of a debtor that is a corporation for a taxable period the bankruptcy court may determine or concerning the tax liability of a debtor who is an individual for a taxable period ending before the date of the order for relief under this title.
11 U.S.C. § 362(a)(1)–(8).
Subsection (1) of Section 362(a) protects both the debtor and, by extension, the estate from suits that were brought or could have been brought against the debtor prepetition. Though the subsection only stays suits brought against the debtor, 4See
E3 Biofuels—Mead, LLC v. QA3 Fin. Corp., 384 B.R. 580, 582 (D. Kan. 2008) (“The rationale behind Section 362(a)(1), however, is to distinguish actions against a debtor from actions by the debtor because actions by the debtor usually produce recovery for the bankruptcy estate or at worst leave its value unaffected.”) (emphasis added). state courts often want the assurances of a bankruptcy court order before proceeding with suits brought by the debtor. Moreover, the stay extends to counterclaims asserted against the debtor in such an action. 5Id. (“In multiple claim and multiple party litigation, the Court must analyze claims, counterclaims, crossclaims and third-party claims to determine which are subject to the bankruptcy stay. Here, the automatic stay clearly bars the counterclaims and third party claims for damages against [the debtor].”) (citations omitted).Interestingly, the court in E3 Biofuels considered both situations—that is, allowing a debtor to proceed with its declaratory judgment and staying a defendant’s counterclaim against the estate. Id. The court concluded that the debtor’s declaratory action claim had to be stayed because, despite the literal application of Section 362(a), the suit “expose[d] the bankruptcy estate to the same risks as the counterclaims and third-party claims.” Id. The subsection also does not bar suit against the debtor in the bankruptcy court where the debtor’s case is pending. 6Prewitt v. N. Coast Vill., Ltd. (In re N. Coast Vill., Ltd.), 135 B.R. 641, 643 (B.A.P. 9th Cir. 1992) (“Although the statutory language does not differentiate between proceedings in bankruptcy courts and proceedings in other courts, the application of the stay to proceedings against the debtor in the home bankruptcy court would be illogical and would not serve the purposes underlying the automatic stay.”).
Subsection (2) specifically protects both the estate and the debtor from judgment creditors who obtained judgments prepetition. The protection extends beyond monetary awards and prevents, for example, a judgment directing a debtor to take remedial actions, although an exception to the stay may apply. 7This situation and the exception often arise in environmental cases where the debtor has been ordered to take remedial actions for environmental liabilities and a government agency seeks to enforce those actions. See Commonwealth Oil Ref. Co. v. U.S. Envtl. Prot. Agency (In re Commonwealth Oil Ref. Co.), 805 F.2d 1175 (5th Cir. 1986) (holding that the automatic stay does not prevent the EPA from closing down a hazardous waste facility); Penn Terra, Ltd. v. Dept. of Envtl. Res., 733 F.2d 267, 271 (3d Cir. 1984) (holding that agency’s enforcement of ordered remedial actions was not an action clothed as money judgment, thus the automatic stay did not apply).
Since the addition to the prohibited acts of the “exercise of control over property of the estate” in 1984, 8As originally written, Section 362(a) only prevented any act to “obtain possession of the property of the estate,” prompting the addition of “exercise of control” in 1984. See Bankruptcy Amendments and Federal Judgeship Act of 1984, Pub. L. No. 98–353, § 441, 98 Stat. 333, 371. The change indicates that “Congress evidently believed that the purpose of staying acts for possession was defeated if plaintiffs were still free to try to control or otherwise direct how the debtor used his property.” Amplifier Research Corp. v. Hart, 144 B.R. 693, 694 (E.D. Pa. 1992). subsection (a)(3) has been among the most often cited parts of Section 362(a). Thus, filing a joint tax return, 9Official Comm. of Unsecured Creditors v. PSS Steamship Co. (In re Prudential Lines Inc.), 928 F.2d 565, 574 (2d Cir. 1991) (holding that a parent corporation would exercise control of property of the estate by claiming for the debtor on a joint tax return a worthless stock deduction that would have effectively destroyed the value of the debtor’s net operating loss carryforward). attacking a debtor’s lessor, 1048th Street Steakhouse, Inc. v. Rockefeller Grp., Inc. (In re 48th Street Steakhouse, Inc.), 835 F.2d 427, 430 (2d Cir. 1987). refusing to turnover a debtor’s car that was repossessed prepetition, 11Thompson v. General Motors Acceptance Corp., LLC, 566 F.3d 699, 701–02, 2009 BL 113525, at *2-3, (7th Cir. 2009). pursuing causes of action belonging to the trustee, 12Am. Nat’l Bank of Austin v. MortgageAmerica Corp. (In re MortgageAmerica Corp.), 714 F.2d 1266, 1277 (5th Cir. 1983) (holding that causes of actions under the Texas Fraudulent Transfer Act belong to the trustee as property of the estate, thus the stay barred creditors from pursuing such claims post-petition). and a state agency dissolving a debtor-corporation while the stay was in effect 13Hillis Motors, Inc. v. Haw. Auto. Dealers’ Ass’n, 997 F.2d 581, 590 (9th Cir. 1993). have all been held to violate the stay.
Subsections (4) and (5) prohibit the creation, perfection, or enforcement of a lien against property of, respectively, the estate or the debtor. Unlike subsection (4), subsection (5) does not prevent lien creation, perfection, or enforcement to secure or recover a post-petition claim against the debtor. Further, subject to narrow exceptions, an unperfected lien at case commencement will be voidable. 1411 U.S.C. § 544(a)(1) (allowing the trustee the status of a perfected judicial lien creditor for the purpose of avoiding unperfected liens).
Section (6) of Section 362(a) is the bane of bill collectors in that it prohibits acts to collect prepetition debts. A collection agency that nevertheless attempts to collect a prepetition debt will be in contempt of court. 15U.S. Lines, Inc. v. GAC Marine Fuels, Ltd. (In re McLean Indus., Inc.), 68 B.R. 690, 694–97 (Bankr. S.D.N.Y. 1986) (discussing a bankruptcy court’s authority to enforce orders with contempt; see also Fed. R. Bankr. P. 9020. Indeed even an effort to obtain so-called “critical vendor” status for dealing with a debtor post-petition may violate subsection (6). 16In re CoServ, L.L.C., 273 B.R. 487, 499 n.22 (Bankr. N.D. Tex. 2002). Notably even assessment of a prepetition claim is prohibited.
Subsection (7) deals with offsets. It bars offset of any debt owed to the debtor prepetition. It does not bar the offset of a debt to the debtor arising post-petition provided that mutuality exists and that every other requirement for offset is met. 17In re Romano, 52 B.R. 586, 589 (Bankr. M.D. Fla. 1985) (“Debts must be mutual to [a]ffect a valid set-off, that is, each party must owe a debt each directly to the other. The debts must be in the same right and between the same parties standing in the same capacity.”) (citations omitted). See also
Palm Beach Cnty. Board of Pub. Instruction v. Alfar Dairy, Inc. (In re Alfar Dairy, Inc.), 458 F.2d 1258, 1262 (5th Cir. 1972) (reaching same result when construing Section 68 of the Bankruptcy Act), cert. denied, 409 U.S. 1048 (1972).
Subsection (8) addresses proceedings before the U.S. Tax Court. The rules are slightly different for corporate and individual debtors, and the provision will be of limited applicability. It is somewhat duplicative of Section 362(a)(1).
With regard to the twenty-eight exceptions to the automatic stay 18Some additional exceptions to the automatic stay are contained elsewhere in the Code. enumerated in Section 362(b); many are limited to special cases—for example, subsections (14) and (15) apply to educational institutions. Some, though limited in application, are reinforced by other sections of the Code. For example, subsections (6), (7), and (17) are reinforced by Sections 555, 556, and 559 that not only restate the exception from the stay but specify that settlement of certain commercial transactions may not be inhibited by a stay under, e.g., Section 105 of the Code.
Of the exceptions listed in Section 362(b), I only want to address a few of the most important ones. While the exceptions might be critical in terms of the effectiveness of bankruptcy relief, most may be obviated by stays obtained under Section 105. 19See, e.g., Mirant Corp. v. Potomac Elec. Power Co. (In re Mirant Corp.), 378 F.3d 511, 523–24 (5th Cir. 2004) (“While § 105(a) permits bankruptcy courts to enjoin actions that are excepted from the automatic stay by §362(b)(4), this authority is typically used to stop proceedings excepted under § 36[2(b)(4)] only ‘in exceptional circumstances.’”) (internal citations omitted) (quoting La. Pub. Serv. Comm’n v. Mabey (In re Cajun Elec. Power Coop.), 185 F.3d 446, 457–58 & n.18 (5th Cir. 1999)). Section 105(a) states:
(a) The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title. No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process.
11 U.S.C. § 105(a). A stay under Section 105, however, must meet the test for an injunction: likelihood of success on the merits, irreparable injury to the debtor or the estate, balancing of the equities, and public policy.
20E.g., Hull v. Quitman Cnty. Bd. of Educ., 1 F.3d 1450, 1453 (5th Cir. 1993); In re Phila. Newspapers, LLC, 407 B.R. 606, 616–17, 2009 BL 142461, at *6-7 (E.D. Pa. 2009) (discussing various approaches to whether an injunction should issue when Sections 362 and 105 overlap). Subsection (1) of Section 362(b) excepts: “(1) under subsection (a) of this section, … the commencement or continuation of a criminal action or proceeding against the debtor[.]” 11 U.S.C. §362(b)(1).
An effort to enjoin a governmental unit from exercising police powers, however, must account for Younger v. Harris, 401 U.S. 37 (1971). Thus, there is an added requirement for such an injunction that the beneficiary be faced with more than a single state court prosecution.
Subsection (3) excepts from the stay:
- (3) under subsection (a) of this section, … any act to perfect, or to maintain or continue the perfection of, an interest in property to the extent that the trustee’s rights and powers are subject to such perfection under section 546(b) of this title or to the extent that such act is accomplished within the period provided under section 547(e)(2)(A) of this title[.]
11 U.S.C. §362(b)(3). This provision allows perfection of certain liens post-petition. The reference to Section 546 applies to certain liens such as mechanics and materialsman liens. 21Yobe Elec., Inc. v. Graybar Elec. Co., Inc. (In re Yobe Elec., Inc.), 30 B.R. 114, 118 (Bankr. W.D. Pa. 1983) (considering the history of Section 546(b) and holding that the filing of mechanic’s lien was not stayed, within the exception of Section 362(b)(3), because state law related back the date of perfection to prefiling date), aff’d, 728 F.2d 207 (3d Cir. 1984) (adopting the bankruptcy court opinion); see also Marietta Baptist Tabernacle, Inc. v. Tomberlin Assocs., Architects, Inc., 576 F.2d 1237, 1239 (5th Cir. 1978) (holding that filing a notice to perfect an architect’s lien did not violate the stay under former Rule 11-44). The reference to Section 547 allows perfection of certain (e.g., UCC) liens through recording. 22H.R. Rep. No. 95-595, at 371 (1978), reprinted in 1978 U.S.C.C.A.N. 5963, 6327 (discussing the interaction of perfection under the UCC and Section 546; “The purpose of the subsection is to protect, in spite of the surprise intervention of bankruptcy petition, those whom State law protects by allowing them to perfect their liens or interests as of an effective date that is earlier than the date of perfection.”).
Subsection (4) of Section 362(b) excepts:
- (4) under paragraph (1), (2), (3), or (6) of subsection (a) of this section, … the commencement or continuation of an action or proceeding by a governmental unit or any organization exercising authority under the Convention on the Prohibition of the Development, Production, Stockpiling and Use of Chemical Weapons and on Their Destruction, opened for signature on January 13, 1993, to enforce such governmental unit’s or organization’s police and regulatory power, including the enforcement of a judgment other than a money judgment, obtained in an action or proceeding by the governmental unit to enforce such governmental unit’s or organization’s police or regulatory power[.]
11 U.S.C. § 362(b)(4) (emphasis added). Despite confusing references to the Chemical Weapons Convention, this provision’s importance is in excepting from most provision of the automatic stay regulatory actions by a governmental unit. The provision has been construed to exempt a broad range of governmental activities. 23E.g., Wade v. State Bar of Ariz. (In re Wade), 948 F.2d 1122, 1125 (9th Cir. 1991) (state bar disciplinary proceedings); Word v. Commerce Oil Co. (In re Commerce Oil Co.), 847 F.2d 291, 296–97 (6th Cir. 1988) (enforcement of water quality control standards); Brock v. Rusco Indus., 842 F.2d 270, 273 (11th Cir. 1988) (enforcement of minimum wage laws); Cournoyer v. Town of Lincoln, 790 F.2d 971, 974–77 (1st Cir. 1986) (enforcement of zoning ordinances); E.E.O.C. v. Hall’s Motor Transit Co., 789 F.2d 1011, 1013–14 (3d Cir. 1986) (employment discrimination actions). A person, as opposed to a governmental unit, may not take advantage of the exception when acting under a status as a private enforcer. 24U.S. ex rel. Fullington v. Parkway Hosp., Inc., 351 B.R. 280, 290 (E.D.N.Y. 2006) (holding that the police and regulatory power exception did not apply to claims brought by a qui tam plaintiff against the debtor under the False Claims Act, 31 U.S.C. §§ 3729–33 (2006)). See also 11 U.S.C. § 101(27) (defining “governmental unit” without reference to private actors or qui tam plaintiffs).
Note that Section 362(b)(4) does not generally except government action from the stay. A government unit enforcing its regulatory power may not create, perfect, or enforce a lien, conduct an offset, enforce a money judgment, or (inconsequentially) commence a tax court suit.
The last part of Section 362(b) I want to mention as being broadly applicable is subsection (10), which excepts from the stay:
- (10) under subsection (a) of this section, … any act by a lessor to the debtor under a lease of nonresidential real property that has terminated by the expiration of the stated term of the lease before the commencement of or during a case under this title to obtain possession of such property[.]
11 U.S.C. §362(b)(10). This only applies to nonresidential leases (though subsections (22) and (23) apply to residential leases). However, it can have a critical effect on a case involving leased property.
Together with Section 362(c), which provides for stay termination, Section 362(a) and (b) fix the scope of the automatic stay. The bankruptcy court is the proper court to determine whether property is subject to the stay, 25Bonneville Power Admin. v. Mirant Corp. (In re Mirant Corp.), 440 F.3d 238, 244 (5th Cir. 2006); Brown v. Chesnut (In re Chesnut), 422 F.3d 298, 303 (5th Cir. 2005) (“[B]y providing bankruptcy courts broad discretion to lift stays, Congress has evinced an intent to constitute the bankruptcy courts as the proper forum for the vindication of creditor rights.”) (internal citations omitted). However, district courts in other federal districts also have jurisdiction and authority to determine whether the stay applies. In re Mahurkar Double Lumen Hemodialysis Catheter Patent Litig., 140 B.R. 969, 973 (N.D. Ill. 1992) (Easterbrook, Circuit Judge, sitting by designation) (holding that a district court presiding over a multidistrict patent litigation possessed authority to determine proceedings in Illinois were stayed by the automatic stay in a Delaware bankruptcy). and the ultimate lesson is that when there is doubt about the stay’s applicability, the wise party—that is, not the debtor—assumes it does apply. The debtor, on the other hand, should assume in close cases it does not apply and use Section 105(a) accordingly.
The automatic stay is one of the most potent weapons in the bankruptcy arsenal. While its use, like a spider’s web, generally requires waiting for a party to fall afoul of it, its proper use is critical for the bankruptcy practitioner.
