Chapter 18-3 Automatic Stay

18-3 Automatic Stay

18-3:1 Effect of the Automatic Stay

When a bankruptcy petition is filed, the Bankruptcy Code acts to enjoin all legal action against the bankruptcy mortgagor—called "the debtor" in bankruptcy proceedings. The automatic stay prohibits the commencement or continuation of any "judicial, administrative, or other action or proceeding against the debtor" that arose before the petition was filed.⁷ Penalties for violating the automatic stay include contempt, punitive damages and attorney's fees.⁸

The filing of a bankruptcy petition creates a "bankruptcy estate," consisting of all of the mortgagor's assets, including causes of action possessed by the mortgagor. The automatic stay prohibits taking action to recover property of the bankruptcy estate or debtor.⁹ Consequently, a pending foreclosure action is immediately stayed by the initiation of a bankruptcy proceeding if the mortgagor or title owner is the bankruptcy debtor or codebtor, or if the property which is the subject of the foreclosure is property of the estate or debtor.¹⁰ Upon the filing of bankruptcy, foreclosure practitioners should cancel any scheduled hearings, suspend discovery efforts, and advise the court to the extent necessary to cancel trials or pending foreclosure sales. Actions taken in violation of the stay are void as a matter of law.¹¹ Further, developing case law suggests that failing to undo actions which were inadvertently taken in violation of the stay could also give rise to sanctions for violation of the automatic stay.¹²

Notably, however, in most instances the automatic stay does not preclude continuation of an action on a promissory note or guaranty against a non-debtor co-obligor or guarantor, unless the mortgagor files under Chapter 13 and the debt at issue is a consumer debt.¹³ This is because the automatic stay under Section 362 of the Bankruptcy Code only extends to the debtor and property of the debtor.¹⁴

18-3:2 Termination of the Automatic Stay

The automatic bankruptcy stay can terminate automatically when the bankruptcy case is closed or dismissed.¹⁵ However, a mortgagee who does not want to wait for the bankruptcy stay to expire as a matter of law can move the bankruptcy court for relief from the automatic stay by filing a motion for relief from stay.¹⁶ If no request for relief from the automatic stay is filed, the foreclosure action remains stayed until the bankruptcy concludes or the automatic stay terminates by operation of law.¹⁷ Once the automatic stay is lifted, the foreclosure trial court must be notified by one of the parties through filing a copy of the bankruptcy court order that authorized the termination of the stay, or similar documents which terminated the stay. In some jurisdictions, the local Chapter 13 model plan provides that the stay is automatically lifted if the plan provides for surrender of the property, direct payment to the lender, or where the plan does not provide for any payment/treatment to the mortgagee.¹⁸ However, given the severe penalties for violating the automatic stay, the safer course of action is to obtain an order granting stay relief or comfort order.¹⁹ An order granting stay relief allows the mortgagee to proceed against the property in rem but not against the mortgagor personally.²⁰ The bankruptcy court will usually enter an order terminating the automatic stay if there is insufficient equity in the property, there has been a default in taxes or insurance, the mortgagor does not provide the creditor with payments or a replacement lien on other property sufficient to protect the mortgagee during the pendency of the bankruptcy case and if the property is not necessary to an effective reorganization or repayment plan in a Chapter 11 or 13 case.²¹ Bankruptcy courts will also grant stay relief if the Bankruptcy Petition was filed in bad faith.²² At least one bankruptcy court has allowed stay relief where the prepetition agreement between the mortgagor and mortgagee provided for stay relief in the event of a bankruptcy and there was evidence that the bankruptcy was filed solely to delay or frustrate the...