Avoiding Stay Violations in a Bankruptcy Case

Focus Antitrust & Trade Regulation/Bankruptcy & Commercial Law

Avoiding Stay Violations in a Bankruptcy Case

BY JASON ENRIGHT

When the specter of bankruptcy arises, if there is one thing most nonbankruptcy practitioners know, it is that they do not want to violate the automatic stay. This fear is well founded. In addition to actual damages, violations of the stay can result in a finding of contempt by the bankruptcy court and an award of sanctions if the violator had actual notice of the bankruptcy case and the stay. Let’s examine the scope of the stay and how to avoid becoming ensnared in a troublesome stay violation.

Two very important things immediately happen when a bankruptcy case is filed. First, everything that the debtor owns, whether by legal or equitable title—including intangible property, such as causes of action—becomes property of the bankruptcy estate (subject to exemption from the estate by individual debtors under state or federal exemption laws). Second, the automatic stay arises under section 362 of the Bankruptcy Code.

The automatic stay is a statutory injunction, which effectively stays all actions against the debtor and property of the estate. The purpose of the stay is to preserve the status quo in order to protect the debtor’s assets, provide temporary relief from creditors, and help further an equitable distribution among creditors by preventing a race to the courthouse to collect on unpaid debts. With the status quo preserved, the bankruptcy court and creditors have an opportunity to evaluate the debtor’s financial condition, and the court can adjudicate creditors’ claims in the case.

The scope of the automatic stay is broad. Formal service of process is not required to effectuate the stay and no particular notice need be given to subject a party to the stay. Generally, the stay precludes any act to obtain possession of, or exercise control over, property of the estate, as well as any act to collect, assess, or recover any claim from the debtor that arose prior to the filing of the bankruptcy case. All proceedings that could have been commenced at the time of the filing are stayed, including arbitration, administrative, and judicial proceedings. The stay also prohibits the enforcement of pre-petition judgments and any act to create, perfect, or enforce a lien against property of the estate or property of the debtor. The stay is sufficiently broad to cover a wide variety of routine and informal collection activities, including telephone calls, demand letters, and other forms of “dunning” the debtor. It even goes so far as to preclude offset of debts owing to the debtor with claims against the debtor.

Section 362(b) contains 29 exceptions to the stay, which include the commencement of criminal actions, divorce actions, actions by a governmental unit to enforce police or regulatory powers, and actions involving setoff in connection with securities, commodities and forward contracts, among many other exceptions.

Does the automatic stay extend to non-debtor parties, such as principals or guarantors of the debtor? Generally, no. In the Fifth Circuit, the stay may extend to non-debtors only under unusual circumstances, such as when the debtor and non-debtor have interests so intertwined that an action against the non-debtor would essentially be an action against the debtor, or when an action against the nondebtor would detrimentally impact the debtor’s ability to reorganize. Ordinarily, a non-debtor must take affirmative steps to obtain stay protection, such as filing a motion to extend the stay, but such motions are not often granted.

Even though the stay does not usually cover actions against non-debtors, counsel should still exercise caution against non-debtors. The Fifth Circuit has held that even attempting to exercise control over “arguable” property of the estate violates the stay. Thus, while taking action against a non-debtor, you may unwittingly be attempting to exercise control over property of the estate. For example, if you are suing a nondebtor for property fraudulently transferred by the debtor, even though you are not suing the debtor, if the property is subject to clawback, it is property of the estate. Also, in the Fifth Circuit, alter ego claims are property of the estate—so an alter ego action against a non-debtor can violate the stay. And with insurance claims, suing a nondebtor when insurance proceeds are payable to the debtor (and are therefore property of the estate) can violate the stay. The key here is to make sure the property subject to the action is not property of the estate or even “arguable” property of the estate.

So, after carefully reading through section 362, what should you do if there is any doubt the stay applies? Out of an abundance of caution, file a motion with the bankruptcy court to lift or modify the stay to take the desired action. If there is one thing to remember with respect to the automatic stay—it is always best to ask the court for permission rather than forgiveness. HN

NEED TO REFER A CASE?

Jason Enright is an Associate at Winstead PC and can be reached at jenright@winstead.com.

AT THE HEART OF DALLAS THE RIGHT MOVE

Thomas Haskins

Litigation Partner

Tommy Haskins knows quality when he sees it. “I came from a very large firm and was immediately impressed with the people at Barnes & Thornburg,” he says. “We have former U.S. attorneys and in-house counsel, and other outstanding lawyers, plus a talented and supportive back-office team. “We also represent some of the most sophisticated companies and individuals in the world, handling their most critical legal needs. Yes, our rates are competitive, but that doesn’t come at the expense of quality.” As for his transition to the firm, Tommy says the emphasis on lateral integration “is like nothing I’ve ever seen. I was given the resources needed to make personal connections in our offices across the country. Within a few months, I had established relationships with someone in every office, and years later I work on matters with those same individuals. “Here we truly think and act as one firm, all dedicated to the same goal: delivering the highest quality service to our clients. And our deep bench across the country provides incredible opportunities for me and my clients. “That’s been a huge ignitor for my practice and book of business,” Tommy says. He’s also been impressed with Barnes & Thornburg’s deep commitment to diversity, equity and inclusion. “Early on, one of our highly successful partners converted fulltime to developing and implementing market-leading DEI policy and programming. I think that puts us ahead of the pack and demonstrates a commitment beyond lip service. “Importantly, it’s not simply because our clients and communities demand it, but because it’s the right thing to do, which is why we have been committed to these efforts for years. I am very proud of that, and it solidifies why Barnes & Thornburg is the right firm — for me and my clients.”

The DBA Lawyer Referral Service Can Help. Log on to www.dallasbar.org/ lawyerreferralservice or call (214) 220-7444.

Tommy Haskins is a proud partner in the Dallas office of Barnes & Thornburg, one of the largest law firms in the country, with more than 700 attorneys and other legal professionals serving clients worldwide.

29th Annual DBA Golf Tournament

Though it was a rainy day, spirits were bright at the 2021 socially distanced DBA Golf Tournament, benefiting Access to Justice. Held at the new Texas Rangers Golf Club, the tournament raised funds for the Entrepreneurs in Community Lawyering program, which provides resources and mentoring to new attorneys in the Dallas area who serve clients of modest means. Congratulations to the Winstead PC team—the 2021 Law Firm Challenge winner! Thank you to everyone who supported and sponsored the tournament, and a big thank you to our Golf Committee and Co-Chairs Steven Aldous and Brad Monk. We appreciate you!