The Bankruptcy Process: The Automatic Stay Part 2

The Automatic Stay: Part 2

The automatic stay is a “timeout” for debtors and enjoins all creditor collection activities as soon as a debtor files for bankruptcy.[1] It serves three purposes. First, by stopping collection efforts against the debtor, the stay gives the debtor relief from the financial pressures that drove him into bankruptcy. Second, it assures creditors that the debtor’s other creditors are not racing to the courthouse to pursue independent remedies that may drain the debtor's assets. Finally, it gives the bankruptcy court an opportunity to secure the interests of both the debtor and creditors while preserving the debtor's assets for repayment of his obligations.

Unless the bankruptcy court grants a creditor’s motion for relief from the automatic stay, it remains in effect until a court grants, denies, or discharges the bankruptcy petition. While broad in scope, there are several actions to which the automatic stay does not apply. Section 362(b) of the Bankruptcy Code lists exceptions to the automatic stay, which reflect Congress’ policy decisions that the rights of certain parties should take precedence over the debtor’s need for breathing room.[2]

First, there’s the “criminal proceeding” exception. U.S.C. §362(b)(1) of the bankruptcy code provides that the automatic stay will not apply to “the commencement or continuation of a criminal action or proceeding against the debtor.”[3] This exception applies to all criminal matters, including misdemeanors and even traffic infractions.[4] For example, if the debtor is convicted of writing a bad check and ordered to pay a fine and complete community service, the automatic stay will not halt his obligation to pay the fine and perform community service.

Still, this doesn’t allow a creditor to threaten to bring criminal charges to get around the automatic stay. In a recent case that went before the Sixth Circuit Court of Appeals, Weary v. Poteat, a tenant who had fallen behind in her rent payments declared bankruptcy. The landlord sent letters to the debtor, saying that he would pursue criminal charges against her for not paying rent on time.[5] The debtor argued that the landlord violated the automatic stay while the landlord argued that his letters fell within the criminal prosecution exception.

The bankruptcy court agreed with the debtor and found that the landlord’s letters violated the automatic stay. They weren’t part of an active criminal prosecution. Instead, the letters communicated a threat to pursue prosecution if the tenant didn’t pay back the rent owed. The landlord made “a thinly veiled attempt to coerce payment of the debt,” which is prohibited by the automatic stay.

The second exception is for “domestic support obligations.” Domestic support obligation is a new term introduced by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, and it encompasses the following family law issues:

·         proceedings to establish paternity;

·         proceedings to establish or modify an order for domestic support obligations

·         proceedings to establish child custody or visitation, and

·         proceedings to determine if there has been any domestic violence.[6]

The most common way this exception is litigated is with monthly child and spousal support payment determinations.[7] An individual that is obligated to pay spousal or child support or alimony will not be relieved of this duty after a filing for bankruptcy and the automatic stay does not prevent the enforcement of these obligations.[8]

Thus, a state can withhold the debtor’s income for payment of a child or spousal support order, revoke a debtor’s driver’s license or professional license, report and provide information about the debtor’s overdue support obligations to a consumer reporting agency and use any other legal method to enforce domestic relations obligations even while the automatic stay is in effect.[9]

The third exception permits an employer or retirement plan administrator to withhold sums from a debtor's income payments to recoup any funds that a debtor borrowed from her qualified pension, IRA, or 401K account.[10] Therefore, payroll deduction repayments may continue during a pending bankruptcy proceeding.[11] This exception is in the debtor’s interest because it allows debtors to avoid the penalties and tax consequences for defaulting on loans and failing to comply with qualified account requirements.[12]

Fourth is the “IRS exception.” While the automatic stay prevents the Internal Revenue Service from collecting on back taxes and sending a debtor a notice of levy on wages, salary, or other income,[13] there are several actions that it can take with regards to a debtor, even with an automatic stay in place. The IRS is permitted to:[14]

·         assess taxes;

·         audit a debtor to determine tax liability; or

·         demand to see the debtor’s tax returns.

Actions taken in violation of the automatic stay are void and without effect.[15] Section 362(h) provides the following:

“Except as provided in paragraph (2), an individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys' fees, and, in appropriate circumstances, may recover punitive damages.”[16]

Punitive damages can be awarded if the creditor’s conduct is particularly egregious. Determining egregious conduct depends on the facts. In one case, a court awarded a debtor punitive damages totaling $65,700 after the creditor contacted the debtor over 90 times after he filed for bankruptcy, seeking to get paid on a $6,500 debt.[17]

On top of these punitive damages, a court may award damages for emotional distress if the debtor can clearly establish he suffered significant harm and can demonstrate a causal connection between the violation and the harm.[18] In one case, the Bankruptcy Court for the District of Oregon awarded a married couple damages for emotional distress and attorneys’ fees due to the IRS' violation of an automatic stay of collection activities after the couple filed for bankruptcy. There, the debtors filed for Chapter 13 bankruptcy and were paying creditors according to the terms of their repayment plan, but the IRS sent four notices demanding payment and sent two notices to levy on the husband’s social security benefits.[19] The court sided with the debtors, finding a violation of the automatic stay and awarded damages for emotional distress. The court determined that any reasonable person would suffer emotional harm from the IRS’s haranguing and notices.[20]  

The automatic stay is a valuable tool for debtors. But, bankruptcy laws have developed with the needs of creditors also taken into consideration. The automatic stay isn’t a permanent method of keeping creditors at bay during a bankruptcy proceeding and though it may appear to be broad, it is nuanced in scope.