Automatic Stay for a Business: 7 Actions It Stops and 5 It Does Not

Many entrepreneurs and small business owners looking for debt relief realize that time is of the essence. One of the most powerful provisions in bankruptcy is the automatic stay that kicks in upon filing a bankruptcy petition. The automatic stay prevents creditors from most collection activities, including legal action, garnishment, repossessions, and other efforts. It is automatic - there is no need for a hearing or any other action.

The bankruptcy stay bars any step in a lawsuit, the enforcement of a judgment, repo or foreclosure, the placing of liens, harassing collection calls, setoffs by your bank, and Tax Court proceedings. But there are exceptions: criminal cases, regulatory cases, tax audits, and the termination of an expired lease. A non-bankruptcy co-debtor is also still vulnerable.

All of this trouble can pop up together. The landlord sends an eviction notice. The lender accelerates the loan. A vendor gets a judgment, and a bank levies the company’s account, all within a few weeks. The stay levels the playing field. Otherwise, the creditors who act the quickest would take your remaining assets. As a matter of public record, the bankruptcy stay begins upon the filing of the petition with the Clerk’s office. No notice is required, but it’s in the creditor’s best interest to avoid violating the stay. In some courts, the violation makes the creditor’s act void - not just voidable. A foreclosure sale or judgment entered during the stay generally has no effect.

A bankruptcy filing stops legal proceedings against you in the first place, such as creditors who sue you. That means that creditors cannot start proceedings against you or continue those already underway. Likewise, creditors cannot enforce judgments they’ve already won. That goes for bank levies and garnishments.

Since nobody may take or exercise control over any company property, a bankruptcy petition freezes repossession of equipment and vehicles and foreclosure. Nobody can create or enforce a lien on that property either.

Collection phone calls and demand letters for unpaid debt must stop, and your bank cannot take money you deposit to repay old debts it is owed, or “set off” the debt. That keeps whatever money is left available for business expenses. And although a bankruptcy doesn’t stop the IRS from auditing you, it does halt any pending proceedings in Tax Court.

The stay does not halt criminal prosecutions. And government agencies can continue to regulate and monitor you. What they can’t do is use the courts to collect a fine. The IRS (and similar state agencies) can still audit your tax returns, send a notice of deficiency, demand to see your tax returns, and make an assessment with a demand for payment. Utilities also get special treatment under Chapter 11. Federal law says that, if a utility doesn’t get adequate assurance of payment within 30 days after filing for bankruptcy, it may cut off service.

If the lease has run its course, the landlord can start eviction and retake the premises as if the tenant filed no bankruptcy petition. If, on the other hand, the lease has not run out at that point, filing generally brings an end to any eviction then in progress. You usually have 120 days from the date of filing to keep or reject the lease and only one 90-day extension to ask for. For now, pay the current rent. Now imagine that the lease ended earlier for another reason. Let’s say you defaulted months before bankruptcy. If the landlord had the right to end your lease before bankruptcy, the question turns on state law. These facts are very tricky to sort out, so you have to examine them right away if this issue comes up.

Shields the Company but Not You Personally

There is one serious limitation to bear in mind if you are the owner of the business. The automatic stay shields the company but not you personally. A creditor that holds a guarantee you made still has the legal right to pursue you and any property not owned by the business. To shield the owner of the business takes a separate court order. It can be done in exceptional cases, but only after the person who signed the guarantee makes a motion, testifies, and shows there’s a good reason to do it. Never assume. The Chapter 13 co-debtor stay is meant for consumer debts. But the co-debtor stay does not cover anybody who co-signed a business loan, even a personal guarantor.

Relief from the Stay

Generally, the stay continues until the bankruptcy case is closed or dismissed, or relief from the stay is granted. A creditor who stands to lose money because the bankruptcy is pending can ask the judge to modify or lift the automatic stay. If the creditor has collateral, and the collateral is not being protected, the creditor may be able to convince the court to lift the stay. Or the judge may lift the stay if the company has no equity in the property, and the property isn’t needed for a reorganization. The debtor has to prove that keeping the property is a must for the company’s reorganization. These motions move fast. After it asks for relief from the stay, the creditor will be free to move against its collateral 30 days later if the court doesn’t stop it. The best strategy against these motions is to be prepared and act quickly. The debtor may lose the asset if it is not.

A typical example of the automatic stay in action is a restaurant owner who had a dispute over the lease and a lender who threatened repossession of equipment. In bankruptcy, the eviction stopped and the repo men took a breather. The owner began to weigh the options of whether to keep the lease, restructure the equipment loan, and save the business. The pause lets you decide on a survival strategy and firm up your plan. How you go about it depends on what suits your business. If keeping it running while its plan is in place makes sense, a Chapter 11 filing is the answer. Other companies are better off with a court-supervised wind-down in which the court assigns a trustee. That is Chapter 7. You may qualify for special treatment if your debt is $3,424,000 or less. It is called Subchapter V. Also keep in mind that a corporation or an LLC gets no discharge under Chapter 7.

Whatever path you choose, the ban on creditor action after the petition is filed is strict, so a good rule is to keep copies of every letter and phone record you get from creditors, and every court paper served, and get legal advice on how to deal with anything aggressive. Even if a violation is minor, document it, at least in a call log. At times a company will need to get contempt sanctions against a creditor that violates the automatic stay. The judge decides what to do in these cases. And if you are renting, check today to see if your lease has already run out.