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 Noon petition 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) Exceptions  § 362(b) 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 : recall section 105 “necessary and proper clause-type” provsion.

Scope of stay General principles under § 362(a) 1. Timing – prepetition claims only Claim Claim Stayed Not Stayed

Who protect? 2. Only protect Debtor Not 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). Any way for CR to proceed? 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”.) What if CR cashes check? 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) [preserves the right of setoff] and 542(b)[entity that owes a debt to estate must pay it (turnover) except to the extent of right of setoff]

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) OR ? Other acts to collect? 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?

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). What is the policy? 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 stay. What might the INS Co. argue to be cause? Show “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. That’s all D had.

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. Would the result be different if D were in Ch.13? See 1301. In chapter 13 do have a special “co-debtor” stay, § 1301

The Repo/turnover puzzle Facts – in chronological order: 1. Dr defaults 2. SP rightfully repos collateral 3. 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: turnover provision, 542.

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). [Plus some post-petition stuff, e.g., 546(a)(6)]

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?

Statute, finale 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)

Practical Effect? What is the practical effect of the reading the Court gives section 542? See first full paragraph, p.196.

Effect Read § 542(a) as effectively 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.

Effect If the secured party can’t get or retain possession, what protection is afforded that creditor regarding its property interest in the collateral? See top p.196 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 to insure protection of its substantive property rights. What if C’s substantive rights aren’t given adequate protection? See 362(d)(1). If C does 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 (liquidation value) 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

Outcome Justified, but any legislative or judicial authority? 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