For creditors dealing with debtors in the shadow of bankruptcy, a common scenario repeats itself.
The creditor repossesses the security, attaches an account or triggers a bank account, then the debtor files for bankruptcy. What should the bank or seizing creditor do? Filing a bankruptcy petition automatically halts efforts to collect pre-petition debts from the debtor outside of bankruptcy. The “automatic stay” provides fundamental protection to debtors, imposing a complete halt to collection activity. Creditors breach the stay at their own risk. If you violate the stay, even without intending to do so, you can be held in contempt and ordered to pay damages. But can the creditor take a bank account hostage without violating the stay?
Earlier this year, a unanimous U.S. Supreme Court ruled that simply withholding property after a bankruptcy filing does not violate the automatic stay. (You can read our report here.) Automatic suspension only prohibits affirmative acts that would disturb the status quo property from bankruptcy at the time of filing for bankruptcy.
The Supreme Court case involved impounded vehicles. The City of Chicago had seized the debtors’ vehicles for non-payment of fines and refused to release the vehicles after the debtors filed for bankruptcy. The debtors alleged that the City breached the automatic stay, and they sought and obtained rotation orders from the bankruptcy courts. The US Supreme Court has ruled that creditors cannot interfere status quo when filing for bankruptcy, but they also cannot be punished for not taking positive steps to change the status quo at the request of the debtor. In other words, the City of Chicago committed no automatic stay violation by refusing to return vehicles already in its possession when the debtors filed for bankruptcy.
Recently, a Pennsylvania bankruptcy court applied the same reasoning when judgment creditors served a writ of execution on the debtor’s credit union, which was attached to the debtor’s deposit account. The debtor then files for bankruptcy and repeatedly asks the creditors to lift the seizure. The creditors refused. The debtor initiated adversarial proceedings against the creditors, alleging willful breach of the automatic stay and seeking a reversal order and damages.
The bankruptcy court agreed with the creditors. The bankruptcy court found that the creditors had taken no affirmative action to enforce or otherwise continue to pursue the pre-petition foreclosure. The creditors had only engaged in “inaction” – as had the city of Chicago. By doing nothing more than maintaining a valid pre-petition garnishment, the bankruptcy court found that the creditors had not violated the automatic stay. Further, the bankruptcy court noted that the creditors were not required to withdraw the garnishment as it would place them at a greater disadvantage than they were on the date of the petition. They had the right to maintain status quo.
This decision was not made by a North Carolina bankruptcy court, and creditors are urged to exercise caution in these situations. The essential requirement is to maintain the status quo. A creditor with collateral in hand cannot rush to liquidate it after filing for bankruptcy. This would violate the automatic suspension and would likely warrant penalties.
Creditors should also be aware that a separate section of the Bankruptcy Code allows a debtor to initiate transfer proceedings to recover assets. Creditors facing this situation should speak with an attorney to determine whether they are more likely to prevail in a turnover hearing or whether they should avoid the time and expense and voluntarily render the property to the debtor.