Section 362: The Automatic Stay in Bankruptcy

When an individual or business files for bankruptcy, a legal protection known as the automatic stay is immediately triggered. This injunction halts most collection activities, providing the filer, or debtor, with relief from financial pressures. The stay is a core part of the bankruptcy process, creating a controlled environment for financial affairs to be addressed under court supervision. It benefits both the debtor and the creditors by ensuring an orderly process.

The Automatic Stay

The automatic stay is established under Section 362 of the U.S. Bankruptcy Code. Its power is granted by federal law and applies nationwide the moment a bankruptcy petition is filed, regardless of the chapter. For the debtor, the stay provides a “breathing spell” from collection calls, lawsuits, and wage garnishments. This allows time to organize finances and develop a path forward.

For creditors, the stay ensures the orderly administration of the debtor’s assets. It prevents a chaotic “race to the courthouse” by preserving the estate for equitable distribution according to the Bankruptcy Code’s priority system. Any action taken by a creditor in violation of the stay is generally void and can lead to penalties, including liability for actual damages and, in some cases, punitive damages.

Scope of Prohibited Actions

The automatic stay prohibits a wide range of collection activities that were or could have been initiated before the bankruptcy filing. This includes the following actions:

• Starting or continuing judicial, administrative, or other proceedings against the debtor.
• Enforcing a pre-bankruptcy judgment, such as garnishing wages or levying bank accounts.
• Taking possession of or control over property of the bankruptcy estate, which includes repossessing vehicles or proceeding with most evictions without court permission.
• Creating, perfecting, or enforcing liens against the debtor’s property, such as initiating a foreclosure.
• Attempting to collect, assess, or recover a pre-bankruptcy claim through any means, including phone calls and collection letters.

Exceptions to the Automatic Stay

While the stay is extensive, it is not absolute. The Bankruptcy Code contains specific exceptions that allow certain legal actions to proceed, often for public policy reasons.

A primary exception is for criminal proceedings. The filing of bankruptcy does not stop the start or continuation of a criminal case against the debtor. Any resulting fines or restitution orders are not affected by the bankruptcy.

Actions related to domestic support obligations are also exempt. This allows for the establishment or modification of alimony or child support orders. The collection of these obligations from property that is not part of the bankruptcy estate, such as post-filing income, is also permitted to continue.

Certain actions by governmental units to enforce their police or regulatory powers are exempt from the stay. This allows agencies to continue actions that protect public health, safety, and welfare, such as compelling a debtor to clean up a hazardous waste site. This exception does not extend to government actions to collect a debt.

The tax system also has specific exceptions. The stay does not stop a tax authority from conducting an audit, issuing a notice of tax deficiency, demanding tax returns, or making a tax assessment. These actions are considered part of the administrative process of determining tax liability.

Duration and Termination of the Stay

The automatic stay is not indefinite and terminates automatically when certain events occur. For actions against the debtor, the stay continues until the case is closed, dismissed, or a discharge is granted or denied. After the stay lifts, creditors may resume collection on any debts not discharged in the bankruptcy.

The stay protecting an asset continues until that property is no longer part of the bankruptcy estate. This can happen if the trustee sells or formally abandons the property. Once property leaves the estate, creditors with liens against it may be able to enforce them.

For individuals who have previously filed for bankruptcy, the law limits the duration of the stay. If a debtor had a single prior bankruptcy case dismissed within one year of the current filing, the stay automatically terminates 30 days after the new case is filed. The debtor can file a motion to persuade the court to extend the stay by showing the new case was filed in good faith.

If a debtor had two or more prior bankruptcy cases dismissed within the preceding year, the automatic stay does not go into effect at all. In this situation, the debtor must proactively file a motion and convince the court that the filing is in good faith to have the stay imposed. These provisions are designed to prevent abuse of the bankruptcy system.

Obtaining Relief from the Stay

Creditors can ask the bankruptcy court to lift the stay by filing a “motion for relief from the stay.” This legal request requires the creditor to present a valid reason for the court to terminate, annul, modify, or condition the stay. The court then schedules a hearing to consider the motion.

The most common basis for relief is “for cause,” which can include a lack of adequate protection for the creditor’s interest in a piece of property. For example, a secured creditor might argue that the debtor is not making payments and has let insurance on a vehicle lapse, causing the collateral’s value to decline. This lack of protection can be cause to lift the stay to allow repossession.

Another ground for relief applies to acts against property. A creditor can obtain relief by proving two conditions: the debtor has no equity in the property, and the property is not necessary for an effective reorganization. To show a lack of equity, the creditor must demonstrate that the total amount of liens on the property exceeds its fair market value.

When a motion for relief is filed, the creditor has the burden of proof on the issue of the debtor’s equity in the property. The debtor has the burden of proof on all other issues, such as whether the property is needed for reorganization. If the court grants the motion, the creditor is free to proceed with the specific action they were previously prohibited from taking.