For creditors dealing with debtors in the shadow of bankruptcy, a common scenario repeats itself.
The creditor repossesses the collateral, forecloses an account or opens a bank account, and then the debtor files for bankruptcy. What should the bank or the garnishing creditor do? The filing of a bankruptcy petition automatically interrupts the efforts to collect the debts owed by the debtor outside of the bankruptcy. The “automatic stay” offers fundamental protection to debtors, by imposing a complete cessation of collection activity. Creditors violate the stay at their own risk. If you violate the stay, even without intention to do so, you can be held in contempt and forced to pay damages. But can the creditor take a bank account hostage without violating the stay?
Earlier this year, a United States Supreme Court unanimously ruled that simply withholding property after filing for bankruptcy does not violate automatic stay. (You can read our report here.) The automatic suspension only prohibits affirmative acts that would disrupt the status quo real estate from bankruptcy at the time of filing for bankruptcy.
The Supreme Court case concerned impounded vehicles. The city of Chicago impounded debtors’ vehicles for non-payment of fines and refused to return the vehicles after the debtors filed for bankruptcy. The debtors alleged that the City had violated the automatic stay and they sought and obtained rotation orders from the bankruptcy courts. The United States Supreme Court ruled that creditors cannot disrupt the status quo at the time of filing for bankruptcy, but neither can they 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 has not committed any violation of the automatic stay by refusing to return vehicles already in its possession when filing debtor bankruptcies.
Recently, a Pennsylvania bankruptcy court applied the same reasoning when judgment creditors served a writ of execution on the debtor’s credit union, which attached itself to the debtor’s deposit account. The debtor then filed for bankruptcy and repeatedly asked the creditors to release the seizure. The creditors refused. The debtor initiated adversarial proceedings against the creditors, alleging a willful violation of the automatic stay and seeking a rotation order and damages.
The bankruptcy court ruled in favor of the creditors. The bankruptcy court found that the creditors had taken no positive steps to enforce or otherwise continue to pursue the garnishment. Creditors had only pledged “inaction” – just like the city of Chicago. By doing nothing more than keeping a valid garnishment, the bankruptcy court ruled that the creditors had not violated the automatic stay. Additionally, the bankruptcy court noted that creditors were not required to withdraw the foreclosure as it would put them at a more disadvantage than they were on the date of the petition. They had the right to maintain the status quo.
This decision is not made by a North Carolina bankruptcy court, and creditors are urged to proceed with caution in these situations. The critical 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 sanctions.
Creditors should also be aware that a separate section of the Bankruptcy Code allows a debtor to initiate rotation proceedings to recover property. Creditors faced with this situation should consult with a lawyer to determine whether they are more likely to prevail in a rotation hearing or whether they should avoid the time and expense and voluntarily return the assets to the debtor.