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Automatic Stay of Proceedings in Bankruptcy

Cite this article as: Jason Mance Gordon, "Automatic Stay of Proceedings in Bankruptcy," in The Business Professor, updated January 21, 2015, last accessed April 8, 2020, https://thebusinessprofessor.com/knowledge-base/automatic-stay-of-proceedings-in-bankruptcy/.
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Automatic Stay of Proceedings in Bankruptcy
This video explains what is an Automatic Stay of Proceedings in Bankruptcy.

Next Article: Authority of Debtor in Possession to Use Business Assets


What is the authority of the debtor in possession?

Stay of Proceedings – The DIP may enforce or employ the Section 362 stay of proceeding provisions against existing debtors. This broad authority gives the DIP power to continue operations with existing creditors without being subjected to debt-collection practices that may thwart the reorganization of the estate. The DIP’s authority trumps any rights to collection or agreement not to contest a debt that is present in the debt agreement. Upon request of a party in interest and after notice and a hearing, the court may grant relief from the stay. The justifications for relieving the stay are as follows:

⁃    No Equity in Property – The debtor does not have any equity in the property and it is not necessary for an effective reorganization; or

⁃    Example: The debtor purchases equipment that is financed by the seller. At the time of filing bankruptcy, the debtor owes more on the loan than the equipment is worth. The equipment is not necessary for the continued operations of business, so the creditor may seek relief from the stay to repossess the equipment and sell it.

⁃    For Cause – The court may relieve the stay of proceeding for cause, including the lack of adequate protection of an interest in property.

The primary limitations of the automatic stay are that it does not stop certain criminal actions, paternity suits, collection of domestic support obligations, or actions by a governmental unit exercising its police and regulatory power. The police or regulatory power exception should be narrowly construed when the actions result in financial penalty or forfeiture. Courts generally employ two tests to determine whether the stay should apply in these situations:

⁃    Pecuniary Purpose Test – If the primary purpose of the government unit’s action looks back and punishes for past conduct, it should not be excepted from the stay as an exercise of police or regulatory power.

⁃    Public Policy Test – If the primary purpose of government action relates to stopping a continued threat to public safety or health, it should be excepted from stay as police or regulatory power.

One factor that the court will consider is whether relieving the stay would cause irreparable harm to the bankruptcy rehabilitative process.

⁃    Discussion: Why do you think the bankruptcy law allows a DIP to selectively enforce the Section 362 stay of proceedings? Do you think a creditor should be able to petition for the removal of the stay under the above-referenced situations? How do you feel about the application of the stay to certain police or regulatory powers of government agencies? Do the above-referenced tests for making this determination affect your opinion?

⁃    Practice Question: ABC Corp files for Chapter 11 Bankruptcy. The DIP issues notice to all debtors of the corporation to halt any collection efforts. Several secured creditors are concerned about their interest. Under what grounds can these creditors seek a lift for stay from the bankruptcy court?

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