The Automatic Stay

Posted by Zev Shechtman, Esq. on January 7, 2015

Guest Post By Zev Shechtman, Esq.
Danning, Gill, Diamond & Kollitz, LLP

The threat of bankruptcy is ever present in the world of distressed property investing.  The filing of a bankruptcy petition triggers an automatic stay that stops actions by other parties against the debtor and the debtor’s property.  While this can result in delays of asset acquisitions and dispositions, it is not necessarily an insurmountable obstacle. In some cases it may even create opportunities for deals.

Statutory Background
The automatic stay codified in section 362(a) of the Bankruptcy Code prevents, “automatically” upon the filing of a bankruptcy petition, among other things:

(1) the commencement or continuation… of a judicial, administrative, or other action or proceeding against the debtor…;

(2) the enforcement, against the debtor or against property of the estate, of a judgment obtained before the commencement of the [bankruptcy] case…;

(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; [and]

(6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title….

In other words, the automatic stay stops a wide range of actions against a debtor or the debtor’s property, including foreclosure, eviction and other collection and enforcement actions.

(1) What happens to a foreclosure if the property owner files for bankruptcy protection?

If a debtor files for bankruptcy before the debtor’s property is sold in foreclosure, the foreclosure sale is barred by the automatic stay.  If the sale goes through despite the bankruptcy filing, in the Ninth Circuit such sale is void.  However, if the debtor files for bankruptcy protection after the completion of the foreclosure, then the automatic stay generally does not affect the validity of the sale.

The automatic stay is not necessarily a permanent bar from proceeding with foreclosure.  A lien holder seeking to foreclose after the bankruptcy filing may file a motion seeking relief from the automatic stay under 11 U.S.C. § 362(d) seeking an order “terminating, annulling, modifying or conditioning” the stay.  To obtain such an order, the movant must generally show (1) “cause, including the lack of adequate protection”; or (2) that “the debtor does not have an equity in such property” and “such property is not necessary to an effective reorganization.”[1]  “Adequate protection” can be satisfied in various ways, including by an equity cushion in the collateral above the value of the lien.  

As an example, if a property is worth $500,000 and the lien against the property is for $700,000, the lien holder would likely argue under section 362(d)(2) that relief from the automatic stay should be granted because there is no equity in the property and that such an “underwater” property cannot be useful in any reorganization.  If the lien holder succeeds in obtaining an order granting relief from stay, then the lien holder can proceed with foreclosure under applicable nonbankruptcy law.

There is an exception to the automatic stay (among others) benefiting a lien holder who previously obtained an order for relief from stay on the basis that the bankruptcy filing was part of a scheme to hinder, delay or defraud creditors involving unauthorized transfers of the property or multiple bankruptcy filings.  If the lien holder previously obtained the order as to the same real property within two years before the new bankruptcy filing, such lien holder can proceed with foreclosure or other enforcement action without seeking relief from stay.  However, the debtor in the new bankruptcy case can ask for relief from the prior order based on changed circumstances or good cause shown.[2]  

(2) Can the automatic stay result in opportunities for asset purchasers?

It is important to remember that while the automatic stay stops a foreclosure of property, it does not prevent a chapter 7 trustee from selling the same property.  Indeed, if the chapter 7 trustee determines that a sale of property pursuant to 11 U.S.C. § 363 will benefit the estate, the bankruptcy filing allows for a sale by the trustee without resort to foreclosure.  A sale under section 363 can be advantageous to lien holders, who may prefer to avoid a lengthy foreclosure, and junior lien holders in particular who may receive full value from a bankruptcy sale.  A section 363 sale is also attractive to asset purchasers because it affords an opportunity to purchase property free and clear of liens and other interests.

Knowledgeable buyers of bankruptcy assets can create opportunities to realize value for lien holders and bankruptcy estates.  For example, a buyer scanning bankruptcy schedules for underwater properties may consider contacting a lien holder (typically a financial institution that is the beneficiary under a trust deed) with respect to an attractive property and inquiring whether such lien holder would consent to a short sale by the bankruptcy trustee.  Trustees typically do not sell assets that are over-encumbered, but if the lien holder is willing to allot a certain portion of the proceeds that are subject to its lien to the estate (or “carve out”) in an amount sufficient to benefit creditors, then a trustee may consider selling the property under section 363.  This could benefit the lien holder if it saves time and expense in the foreclosure process, and it could benefit the investor who may be able to acquire a valuable property.  

A relief from stay motion, which is intended to enable a lien holder to foreclose on a property, can also serve as an opportunity for potential purchasers.  The hopeful buyer can contact the lien holder, through the attorney who filed the motion, and inquire regarding the possibility of a short sale.  The lien holder may welcome the opportunity to shortcut the relief from stay and foreclosure processes and to see the property brought directly to a sale under section 363.  

(3) How does the automatic stay impact the efforts of an owner trying to obtain possession of property from a debtor who is a former owner or tenant?

If the debtor as lessee does not voluntarily vacate the leased property, the owner generally needs to obtain relief from the automatic stay before the owner can proceed with eviction proceedings.  As discussed above, relief from stay may be given for “cause”, which includes a debtor’s failure to pay rent.    

There are exceptions to the automatic stay, making it possible for the owner to proceed with efforts to obtain possession of the property pursuant to applicable nonbankruptcy law without first filing a motion for relief from stay.  These exceptions include:

  • Acts by a lessor to obtain possession of nonresidential real property where the lease has terminated by the expiration of the stated term of the lease before or after the filing of the bankruptcy petition;[3]

  • Eviction or unlawful detainer proceedings against a residential tenant under a lease or rental agreement where the lessor obtained a judgment for possession of the property against the debtor before the bankruptcy filing,[4]  but subject to specific provisions allowing for the cure of monetary defaults by the debtor;[5] and

  • Evictions seeking possession of residential real property based on “endangerment” of the property or use of illegal controlled substances on such property.[6]

The automatic stay is a broad protection for debtors affecting a wide range of assets in different ways under different scenarios.  It can be a formidable obstacle, but can sometimes create deal opportunities.  

A party subject to the automatic stay should evaluate whether the filing of a motion for relief from stay is appropriate or whether an exception to the automatic stay applies in any given circumstance.  Even where an exception to the automatic stay may apply, a party may choose in certain situations to file a motion for relief from stay to avoid a potential argument by the debtor or trustee that the party has knowingly violated the automatic stay.[7]


[1] Additional bases for relief from stay exist in “single asset real estate” cases, 11 U.S.C. § 362(d)(3), and cases filed as part of a scheme to hinder delay and defraud creditors involving unauthorized real property transfers or multiple bankruptcy filings.  11 U.S.C. § 362(d)(4).

[2] 11 U.S.C. § 362(b)(20).

[3] 11 U.S.C. § 362(b)(10).

[4]  11 U.S.C. § 362(b)(22).

[5] 11 U.S.C. § 362(l).

[6] 11 U.S.C. § 362(b)(23).

[7] 11 U.S.C. §§ 362(k), 105(a).


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You May Also Be Interested In:
The 363 Bankruptcy Sale Procedure – Broken Down and Simplified
Property of the Estate Under 11 U.S.C. § 541

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