The Effect of the Bankruptcy Automatic Stay on State Court Litigation
| Jurisdiction | United States,Federal |
| Citation | Vol. 02 No. 1990 Pg. 243 |
| Pages | 243 |
| Publication year | 1990 |
1990, February, Pg. 243. The Effect of the Bankruptcy Automatic Stay on State Court Litigation
As bankruptcy filings increase, so does the impact of the bankruptcy automatic stay on various stages of state court litigation. This interplay between federal and state power has produced complex constitutional issues affecting the judicial function in of the federal system. Further, it has generated a set of basic rules and opportunities of which non-bankruptcy trial lawyers should be aware when parties to lawsuits seek bankruptcy protection.
This article defines the somewhat changeable boundaries of the bankruptcy stay, as well as clarifying when the stay is applied and how it is affected by appeals. The effects of federal abstention on avoiding or expanding the stay also are discussed.
With certain enumerated exceptions, Bankruptcy Code ("Code") § 362(a) provides that the bankruptcy petition operates as an automatic stay of all actions against the debtor or the debtor's property to recover pre-petition claims.(fn1) In particular, under Code § 362(a)(1), a petition operates as an automatic stay of "the commencement or continuation . . . of a judicial, administrative or other action or proceeding against the debtor." The petition also automatically stays actions "to recover a claim against the debtor. . . ."
The automatic stay is central to federal bankruptcy protection because it provides the debtor with the breathing room necessary for a fresh start. It is also an unusual, far-reaching federal interference with the independent powers of state courts. However, the federal courts recognized early on that without such all-encompassing powers to freeze state court actions against bankrupt debtors, such debtors could not effectively marshall their assets for the ultimate benefit of their creditors. Indeed, the power to stay state court actions against a bankrupt was first recognized by the U.S. Supreme Court in 1845 as an implicit equitable power of the federal bankruptcy courts.(fn2) This was long before Congress granted that power explicitly.
Constitutional attacks on the stay power, based on the due process and impairment of contracts clauses, were rejected long ago.(fn3) More recent attacks have been attempted under the Tenth Amendment, which gives the states all powers not expressly reserved to the federal government. These attacks also have been rejected.(fn4)
The precise contours of the automatic stay frequently are the subject of litigation. Although these remain in flux to a great extent, the following are some fairly well-settled rules.
1. The stay is automatic in that to invoke its protection, the debtor need not take any affirmative action other than to file a petition.(fn5)
2. Creditors seeking relief from the stay must do so by motion in the bankruptcy court. Relief will be granted for "just cause" or, in the case of a stay against the debtor's property, by showing that the debtor has no equity in the property and that the property is not necessary to an effective reorganization.(fn6)
3. The debtor has the burden of proof on all issues except the issue of lack of equity.(fn7)
4. Once a creditor requests relief from the stay, it automatically expires within thirty days unless continued after notice and a hearing.(fn8)
In addition to these rules, there are other attributes of the automatic stay that are well-settled. For example, the stay applies to creditors whether or not they have actual knowledge of the filing.(fn9) Actions taken in violation of the stay are void.(fn10) Creditors and their attorneys who knowingly violate the stay may be held in civil contempt(fn11) and also, by the express terms of Code § 362(h), may be liable for actual and punitive damages.(fn12)
The stay also may restrain the state courts themselves---not just actions taken
by creditors in those courts. For example, if a defendant in a state court action petitions for bankruptcy after the case has been tried but while it is under advisement in the state court, at least one bankruptcy court has suggested the state court is stayed from issuing a judgment.(fn13) Similarly, if the matter is not final because of a pending appeal, the petition may prevent the appellate court from proceeding with the appeal.(fn14) A provision in the 1978 Bankruptcy Reform Act expressly stated that the bankruptcy courts may not directly enjoin state courts. However, that provision was deleted in 1984.(fn15)
Finally, if a state court enters judgment against a debtor and that judgment becomes final as a matter of state law before the debtor files for bankruptcy, the judgment is binding on the bankruptcy...
To continue reading
Request your trial