Introduction:
Most creditors understand that when the debtor fails to pay for a significant period that time is of the essence. Most debtors are in debt to numerous creditors and have finite assets. Usually, the creditor that moves fastest, obtaining judgment and/or attachment of assets can prevail over other creditors seeking the same assets that have delayed in seeking legal redress. That is true whether the assets are inventory or real property, the creditor moving fastest is usually better protected.
But there is an important exception to this rule. If the debtor has commenced bankruptcy proceedings, then the creditor who continues collection efforts is facing significant sanctions from the Federal Bankruptcy Court. This article shall discuss the process that then ensues and the effect of the automatic stay in bankruptcy.
Basic Law:
The right to file bankruptcy proceedings is a Constitutional right of every debtor. One goal of the founders of the United States was to avoid the threat of debtor prisons that existed in England and much of Europe at that time. In those jurisdictions, if one was in debt, one could be arrested and held in prison until the debt was paid. If the debt remained unpaid, the debtor remained in prison indefinitely. The concept was that it gave incentive to the debtor and his or her family and friends to pay off the debt and get the debtor free.
In reality, being in prison eliminated the ability of most debtors to earn any money and pay off the debt and the debtors without help from more monied family members or friends languished for years, often dying of the diseases that infested such prisons.
The men who wrote the Constitution wanted such methods banned and enshrined in the Constitution the right of every person to erase all debts once every seven years, excepting only those debts founded on intentional wrongdoing such as criminal actions and fraud. This was Federal law, thus exists in every state, and the Federal Bankruptcy Courts are the forum for filing bankruptcy and for enforcing the rights of both debtors and creditors.
Bankruptcy procedure normally has the debtor list all of his or her assets above a certain amount and the court then distributes them pro rata among the creditors, with secured creditors getting access to the secured assets first.
Bankruptcy courts have wide discretion and creditors can appear and form committees to protect their interests, but at the end of the day, almost all bankruptcies end with the bankrupt keeping a few exempt assets, surrendering the rest of his or her assets, and creditors receiving pennies on the dollars owed, or nothing. The bankrupt is then discharged from the proceedings and starts with a clean slate, though the credit is ruined for some years.
All creditors are required to bring their claims before the bankruptcy courts only. All state actions are stopped (“stayed”) by the Federal Court automatically since the Federal Court is the only forum for determining who is paid and how much. And the stay is automatic.
When a debtor initiates bankruptcy proceedings, an automatic stay immediately goes into effect preventing any actions against the debtor and the debtor’s property. 11 USC §§ 103(a), 362(a). The automatic stay applies in all types of bankruptcy. Further, even if the bankruptcy filing is a sham, and later dismissed by the Court, the automatic stay still goes into effect until the dismissal. Wekell v. United States (9th Cir. 1994) 14 F3d 32, 33.
1. Application of the automatic stay
Pursuant to 11 U.S.C. § 362(a)(1), the automatic stay prohibits creditors and other parties from commencing or continuing an action against the debtor that was or could have been commenced prepetition. Additionally, the automatic stay prevents creditors from enforcing a pre-bankruptcy judgment against the debtor or its property, i.e., “any act to obtain possession of property of the estate.” 11 U.S.C. § 362(a)(3).
Although the automatic stay does not prevent the debtor from appealing claims made by the debtor, the debtor may not appeal claims against him or her while the automatic stay is in place. Parker v. Bain, 68 F.3d 1131, 1137–1138.
2. Application to third parties
However, the automatic stay does not protect nonbankrupt third parties even when the codefendants are closely related to the debtor. U.S. v. Dos Cabezas Corp. (9th Cir. 1993) 995 F.2d 1486, 1491 (“the automatic stay does not extend to actions against parties other than the debtor, such as codebtors and sureties.”)
California courts have held that bankruptcy of one defendant in a multidefendant case does not stay the proceeding as to the other defendants. Queenie, Ltd. v. Nygard Int'l (2nd Cir. 2003) 321 F3d 282, 287; In re Miller (9th Cir. BAP 2001) 262 BR 499, 503-504 & fn. 6; Fortier v. Dona Anna Plaza Partners (10th Cir. 1984) 747 F2d 1324, 1329-1330.
However, courts have made exceptions where the debtor is an indispensable party to the pending action. In these instances, the court may issue an injunction to stay the entire action. United States v. Dos Cabezas Corp. (9th Cir. 1993) 995 F2d 1486, 1491, fn. 3.
The Risks to Creditors:
Should an individual willfully violate the stay, the debtor, if injured, shall recover actual damages and possibly punitive damages. 11 U.S.C. § 362(k)(1). Further, the Court has the power to impose various sanctions, including contempt of court.
And whether intentional or not, any assets or funds obtained by a creditor ignoring the stay will be reclaimed by the Court thus the creditor seeking to evade the stay will achieve no profit and will have incurred the costs of collection without profit.
Additionally, all the other creditors have an interest in protecting the finite assets of the debtor left and most will actively seek to inform the court of such violation of the stay and even file petitions to hold the creditor ignoring the stay in contempt.
In short, the odds of successful collection are nil, and if somehow one succeeds, one faces action by the Court, perhaps spurred on by other creditors, which will risk losing whatever was attached and affirmative sanctions from the Court.
Keep in mind that even if one is unsuccessful in pursuing collection, the same sanctions could be and often are imposed by the Court.
Notice to all creditors is required to be sent out by the bankrupt but even if such notice is somehow not received, and while the court will take into account the fact that the creditor acted without intention to violate the stay in determining sanctions, such sanctions are still possible and the assets seized, if any, will be required to be delivered to the Court.
There is also bankruptcy law that sums paid within a certain period before bankruptcy must be returned to the court in fairness to the other creditors. Often a creditor who succeeded in collecting monies months before the actual filing receives a letter from the Trustee in Bankruptcy requiring repayment of all sums received, and if the creditor refuses, the Trustee can bring action before the Court.
Conclusion:
Too many creditors assume that once bankruptcy is filed there is no chance to collect any further monies. That is often true, but the wise creditor will stay actively involved in the bankruptcy proceeding since assets are often located which will result in a partial paydown.
One of the ways those assets are found is to determine what sums, if any, were voluntarily paid out to other creditors and reporting it to the Court. Those assets will be returned to the Court to be divided among all the creditors.
One aspect that is always true is that ignoring the stay is never wise. Bankruptcy courts are proud of their powers and the Trustee in Bankruptcy is paid based on the amount in the bankrupt’s estate.
A common effort of debtors is to favor one or another creditor, hoping for a future business relationship or to favor a friend or family member. During the first bankruptcy hearing, creditors and the Trustee can ask the debtor, under oath, what transfers were made and when, including payments to other creditors. The creditor who takes a chance by ignoring the stay is likely to pay a heavy price.