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Automatic Stay Violations Void Rather than Voidable

August 2002


Courts disagree whether creditor actions undertaken in violation of bankruptcy's automatic stay are void, such that they are deemed to be of no effect as a matter of law, or are merely voidable, such that they will be recognized unless and until the bankruptcy trustee or the debtor obtains a court order declaring that the act violated the stay and (perhaps) sanctioning the perpetrator. In In re Mitchell and In re Best Payphones, the 9th Circuit bankruptcy appellate panel and a New York bankruptcy court adopted the majority position in holding that actions violating the automatic stay are void ab initio. In re Mitchell also addresses whether the safe harbor afforded to an unknowing recipient of an unauthorized post-petition transfer constitutes an exception to the automatic stay.

The Automatic Stay

Upon the filing of a voluntary or involuntary bankruptcy petition, an automatic statutory injunction is activated to prevent any entity from commencing or continuing actions against the debtor or property of the debtor's bankruptcy estate for the purpose of collecting on a debt that arose prior to the bankruptcy petition date. Thus, Bankruptcy Code section 362(a) stays, among other things, "the commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case . . . or to recover a claim against the debtor that arose before the commencement of the case." The "automatic stay" also precludes the enforcement of a pre-bankruptcy judgment against the debtor or its property, "any act to obtain possession" of estate property, to exercise control over estate property and a wide variety of creditor enforcement actions, including perfecting a lien on the debtor's property and "any act to collect, assess or recover a claim against the debtor that arose before the commencement of the case."

The automatic stay is broad in scope and applies to almost every formal and informal action against the debtor or its property. Its purpose is to give the debtor a breathing spell from creditors during which either the debtor can devise a repayment or reorganization plan or a bankruptcy trustee can effect an orderly liquidation of the debtor's assets. The automatic stay also protects creditors by averting a scramble for the debtor's assets and facilitating an orderly liquidation procedure under which all similarly situated creditors are treated equally.

Automatic Stay Exceptions and Relief from Stay

Certain actions are excepted from the automatic stay. Most of these exceptions are based upon important policy considerations developed over many years predicated upon the perception that certain actions should not interrupted or foreclosed by a bankruptcy filing because the prejudice suffered by non-debtors outweighs the "breathing spell" policy underlying the automatic stay. Thus, Bankruptcy Code section 362(b) provides that the stay does not preclude, among other things, the commencement or continuation of criminal, paternity, child support, alimony or maintenance actions, certain setoffs by stock and commodities brokers, forward contract merchants and securities clearing agencies, tax audits or the issuance of a notice of tax liability and actions by a commercial lessor to obtain possession of leased property if the lease expired prior to the bankruptcy filing.

While the stay in Bankruptcy Code section 362(a) is automatic, it is not permanent. As a general rule, the stay of actions against a debtor's property continues until the asset is no longer part of the bankruptcy estate (i.e., when the property has been sold or abandoned or when the estate no longer exists because the case is dismissed). The stay of any other act specified in the statute continues until the earliest of closure or dismissal of the bankruptcy case or the denial or grant of a discharge to the debtor. However, the automatic stay may be lifted earlier. Any entity seeking relief from or modification or termination of the stay may petition the bankruptcy court for this purpose. The court will grant the request if it finds "cause" to do so. "Cause" is typically found where the debtor cannot adequately protect a creditor's interest in property, or where the debtor lacks "equity" in the asset (e.g., because it is encumbered by mortgages in excess of the value of the property) and the property is not necessary for the debtor, in a chapter 11, 12 or 13 case, to reorganize effectively.

It is generally recognized that the debtor may not waive the automatic stay. Still, the stay is a shield, not a sword. If the debtor affirmatively acts, such as by commencing litigation post-bankruptcy, the defendant is permitted to defend itself without running afoul of the automatic stay (although, in defining the parameters of a defense, many courts distinguish between mandatory counterclaims, which are allowed, and permissible counterclaims, which are not). In addition, some courts have construed certain provisions of the Bankruptcy Code other than section 362(b) to create implicit exceptions to the automatic stay. Once such provision is section 549(c), which provides an exception to the bankruptcy trustee's power to avoid unauthorized post-petition transfers of real property "to a good faith purchaser without knowledge of the commencement of the case and for fair equivalent value." According to some courts, because transfers of estate property without court authority are precluded by the automatic stay and would therefore be void, the exception set forth in section 549(c) to the trustee's ability to avoid post-petition transfers also acts as an exception to the automatic stay.

 

Violations of the Automatic Stay

Although the Bankruptcy Code contains a fairly detailed list of actions which are and which are not precluded by the automatic stay, it does not address the ramifications of failing to abide by its dictates, except in one respect. Under Bankruptcy Code section 362(h), any "individual" injured by a willful violation of the stay is entitled to recover actual damages, including attorneys' fees, and in appropriate circumstances, may recover punitive damages. However, other than providing for a remedy, the Bankruptcy Code does not explain whether actions taken in violation of the stay are void from their inception, and should be deemed never to have occurred, or whether such actions are merely voidable, such that they will be permitted to stand unless and until the debtor, the bankruptcy trustee or some other party-in-interest in the bankruptcy case complains to the court. The distinction is an important one, given the potentially significant legal and property rights and remedies connected with a wide variety of actions that arguably run afoul of the automatic stay, whether they be voluntary, involuntary, knowing or unknowing.

In Kalb v. Feuerstein, the United States Supreme Court examined the issue under the former Bankruptcy Act and held that actions in violation of the automatic stay are void. The circuit courts that have addressed this issue in the context of the present day Bankruptcy Code are split. The minority view is that an act taken in violation of the automatic stay is not void, but merely voidable. The Fifth and District of Columbia Circuits subscribe to this position. A majority of the circuits hold that an action in violation of the automatic stay is void ab initio, although some courts, like the Third Circuit, have recognized that the bankruptcy court's power to grant relief from the stay retroactively may make a stay violation merely voidable under appropriate circumstances. The law is not quite so clear in the Sixth Circuit. While two panels of that court have held that actions in violation of the automatic stay are void, one panel has held that acts violating the automatic stay are invalid and "voidable." The Eighth Circuit has yet to address this issue, and expressly declined to do so in a recent opinion.

The Ninth Circuit bankruptcy appellate panel and a New York bankruptcy court addressed the legal implications of violating the automatic stay and certain other related issues in In re Mitchell and In re Best Payphones, Inc.

In re Mitchell

Tyrone and Eva Mitchell (collectively, the "debtor") filed a bankruptcy petition the day before Value T Sales, Inc. ("Value T") had scheduled a foreclosure sale on their residence. Value T went ahead with the sale anyway (although it is unclear whether it had knowledge of the bankruptcy filing), and acquired the property at foreclosure for approximately $300,000. Upon learning of the debtor's bankruptcy filing shortly thereafter, Value T sought an order from the bankruptcy court modifying the automatic stay and validating the foreclosure sale on the basis that the debtor filed its bankruptcy case in bad faith (having filed five petitions in the past four years). Alternatively, Value T sought a determination that the foreclosure sale could not be avoided because it was excepted from the automatic stay by reason of Bankruptcy Code section 549(c). Value T recorded its deed on the transferred property before the bankruptcy court acted on its requests. The bankruptcy court ultimately denied Value T's motions.

On appeal, the bankruptcy appellate panel for the Ninth Circuit addressed whether section 549(c) is an exception to the automatic stay, such that Value T validly acquired the debtor's property at the foreclosure sale as a bona fide purchaser without notice of the debtor's bankruptcy filing. Noting that the law in the Ninth Circuit is that actions taken in violation of the stay are void, the court rejected Value T's assertion that section 549(c) "validates the sale and creates a unique exception to the automatic stay."

Section 549(c), the court emphasized, is not intended to cover the same actions prohibited by the automatic stay, nor is it rendered moot by the stay's "voiding" of all prescribed violations. Rather, it noted, section 549(c) is an exception only to actions brought by a bankruptcy trustee or chapter 11 debtor-in-possession under section 549(a) to avoid unauthorized post-petition asset transfers initiated by the debtor. According to the court, unlike in the context of asset transfers violating the automatic stay that involve parties other than the debtor, "Congress saw fit to protect BFP's in [section] 549 but not in [section] 362, presumably expressing its intent to afford greater protection to BFP's who purchase from debtors than to those purchasing at sales violating the automatic stay." Turning to the facts before it, the appellate panel affirmed the bankruptcy court's denial of Value T's motion for a determination that the foreclosure sale was valid by reason of Bankruptcy Code section 549(c) because the bankruptcy trustee was not attempting to avoid the sale under section 549(a), but sought to set aside the foreclosure sale because it violated the automatic stay.

In re Best Payphones, Inc.

Best Payphones, Inc. ("Best") was engaged in the business of operating public payphones in New York City. Prior to filing for chapter 11 protection in October of 2001, Best was sued in administrative proceedings before the New York City Environmental Control Board (the "ECB Proceeding") by the New York City Department of Information Technology and Telecommunications (the "City") for allegedly operating payphones without a proper permit. Two months later, an administrative law judge dismissed the violations (the "ECB Order"), ruling that the City had failed to establish that Best's right to operate the payphones had been terminated validly. The City sought to modify the automatic stay for the purpose of appealing the ECB Order. It argued that the ECB Proceeding was excepted from the automatic stay as an action by a "governmental unit" to enforce its "police or regulatory powers." The City also contended that the EDB Order was void as a violation of the automatic stay.

The bankruptcy court addressed only the latter. It found that the ECB Order was void because its issuance "violated the automatic stay, even though it was based entirely on the pre-petition record." According to the court, "once triggered by a debtor's bankruptcy petition, the automatic stay suspends any non-bankruptcy court's authority to continue judicial proceedings then pending against the debtor." While ministerial court actions are excepted, the court emphasized, the issuance of a decision by a judge or similar officer "is clearly prohibited, and therefore, void." Still, the court recognized, although an action taken in violation of the stay is void, a bankruptcy court nevertheless has the power to validate it retroactively because Bankruptcy Code section 362(d) expressly authorizes the court to "terminate" or "annul" the stay. An order terminating the automatic stay, the court observed, acts only prospectively, "but an order annulling the stay nunc pro tunc acts retroactively to validate otherwise void actions taken post-petition." Based upon its conclusion that the ECB Order was void, and the fact that the City sought only to terminate the stay rather than annulling it with retroactive effect, the court ruled that the City's motion for relief from the automatic stay was moot since there was no valid order upon which it could base its appeal.

Analysis

In re Mitchell and In re Best Payphones, Inc. are consistent with the majority view concerning the legal consequences of actions taken in violation of the automatic stay. Such actions are deemed to be void, rather than merely voidable. This means that they will be given no legal effect, unless the bankruptcy court exercises its discretion to annul the automatic stay, and thereby retroactively legitimizes the conduct in question. Annulment is most frequently granted in cases where actions in violation of the stay were taken without knowledge of the debtor's bankruptcy filing and the court determines that the party seeking annulment would have been entitled to relief from the stay had it been aware of the bankruptcy filing and sought that relief from the bankruptcy court . However, unknowing conduct alone is no excuse, given the important policy considerations underlying the automatic stay and its purpose in protecting both the debtor and its creditors.

The decisions also illustrate that the scope of the automatic stay is broad, and exceptions to its reach are narrowly construed in keeping with the important protections it affords. As noted by the bankruptcy appellate panel in In re Mitchell, Congress knew how to create an exception to the automatic stay "as it has provided eighteen of them" in Bankruptcy Code section 362(b). Additional exceptions should not be presumed.

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Value T Sales, Inc. v. Mitchell (In re Mitchell), 278 B.R. 839 (B.A.P. 9th Cir. 2002).

In re Best Payphones, Inc., 279 B.R. 92 (Bankr. S.D.N.Y. 2002).

Kalb v. Feuerstein, 308 U.S. 433 (1940).

Picco v. Global Marine Drilling Co., 900 F.2d 846 (5th Cir. 1990).

Bronson v. United States, 46 F.3d 1573 (D.C. 1995).

In re Soares, 107 F.3d 969 (1st Cir. 1997).

Constitution Bank v. Tubbs, 68 F.3d 685 (3d Cir.1995).

Parker v. Bain, 68 F.3d 1131 (9th Cir. 1995).

Franklin Sav. Ass'n v. Office of Thrift Supervision, 31 F.3d 1020 (10th Cir. 1994).

Rexnord Holdings, Inc. v. Bidermann, 21 F.3d 522 (2d Cir. 1994).

In re Albany Partners, Ltd., 749 F.2d 670 (11th Cir. 1984).

Matthews v. Rosene, 739 F.2d 249 (7th Cir. 1984).

In re Smith, 876 F.2d 524 (6th Cir. 1989).

National Labor Relations Bd. v. Edward Cooper Painting, Inc., 804 F.2d 934 (6th Cir. 1986).

Easley v. Pettibone Michigan Corp., 990 F.2d 905 (6th Cir.1993).

Riley v. United States, 118 F.3d 1220, 1222 n. 1 (8th Cir.1997).

Text Box Excerpt:

The void/voidable distinction is an important one, given the potentially significant legal and property rights and remedies connected with a wide variety of actions that arguably run afoul of the automatic stay, whether they be voluntary, involuntary, knowing or unknowing.