Here’s what you need to know about the automatic stay—and strategies for getting past it.

As part of a series of articles discussing strategies for private lenders to deal with bankrupt borrowers, this piece takes a deeper look into when the automatic stay applies and strategies for getting around it. We examine grounds for dismissing the bankruptcy or filing a motion for relief from the automatic stay.

What is an automatic stay?

The automatic stay is an injunction that comes into force immediately when a borrower files for bankruptcy. As a lender, you must halt all efforts to collect on your loan, to stop the foreclosure process, to record any liens or renew judgments, and to stay lawsuits.

Violations of the automatic stay could result in sanctions, and acts done in violation of the stay, even unknowingly, are void. For example, liens recorded or foreclosure sales after a bankruptcy has been filed could be voided, leading to costly consequences.

However, you can postpone the foreclosure sale date indefinitely in the hope you can find a way around the stay. Also, you must continue to send your regular monthly loan statements to the borrower. Beyond that, do not contact the borrower. Any contact must go through the borrower’s attorney or by making proper filings with the bankruptcy court.

When the Automatic Stay Does Not Apply

Before tackling the automatic stay, make sure it applies.

First, is the collateral part of the bankruptcy estate? As an example, consider a case recently where a private lender gave a loan on a property held by an LLC. The LLC’s parent company filed for bankruptcy, not the LLC. The automatic stay applied only to the parent company, and the lender was free to foreclose. However, in such situations, be aware that the parent company may ask the court to extend the stay to the LLC.

Another instance is when one person in a married couple files for bankruptcy. The property of the other, non-filing spouse is not part of the bankruptcy unless it’s a community property state.

If the borrower filed a bankruptcy that was dismissed within one year before the current bankruptcy, the automatic stay lasts just 30 days. If three or more bankruptcies were dismissed within a year, there is no automatic stay. However, the debtor may ask the court to reimpose the stay for cause.

The automatic stay may not apply if the debtor had a prior case dismissed for failure to comply with a court order, or if a motion for relief from stay was filed in a previous case and the debtor dismissed it before the motion could be heard by the court.

There is no automatic stay if relief from stay was granted in a prior case involving the same debtor and the same property in the last two years. Equally, if the court issued an order forbidding the debtor from filing for bankruptcy, there would be no automatic stay.

In all these cases, don’t assume that there is no stay and foreclose. Being wrong could be costly. It is recommended that before proceeding with foreclosure, you should file a motion for relief from stay to confirm there is no stay.

Grounds for a Motion to Dismiss

Once you’ve determined the automatic stay applies to the collateral real property securing your loan, the next step is to analyze whether there are valid grounds to ask the court to dismiss the bankruptcy. If the bankruptcy is dismissed, the automatic stay goes away, and you can foreclosure.

If the property is owned by a corporation or LLC, figure out if the bankruptcy was properly authorized under the governing document. This document dictates the requirements for a corporation to file for bankruptcy. For instance, if the governing document requires the unanimous vote of all shareholders to file for bankruptcy, make sure the authorization that accompanies the petition follows those rules.

The goal of a chapter 11 bankruptcy is to confirm a plan. If you can argue with evidence that the debtor has no realistic possibility of confirming a plan, that would be grounds for dismissal. Indications are a lack of income, the debtor is stalling, or the property is deep underwater.

Bad faith is another ground for dismissal. Indications are an incomplete petition, fraud, multiple bankruptcies, few employees, little or no cash flow, few unsecured creditors, or allegations of wrongdoing by the debtor’s principals.

Check to see if the debtor is over the chapter limits. To file a chapter 13, the debtor must have less than $419,275 in unsecured debt and $1,257,850 in secured debt. Under the new small business chapter 11 subchapter V, the limit is normally less than $2,725,625 in non-contingent debt. Due to the coronavirus, this was increased to $7,500,000 from March 2020 to March 2021, which, as of press time, Congress is likely to extend. In a chapter 7, the debtor must not have too high of an income, called a means test. Breaking these limits is grounds for dismissal.

Grounds for Relief from Stay

If you’ve determined the automatic stay applies to your collateral and you don’t have grounds for dismissal, the next step is to determine whether you can move for relief from stay; that is, asking the court for permission to lift the stay specifically for you to foreclosure.

The most common ground for private lenders is when the debtor has no equity in the property, and the property is not necessary for reorganization. The first prong is simply that the property is completely underwater.

The second only concerns chapters 11 and 13, in which the debtor is trying to confirm a plan. To satisfy this prong, provide evidence that an effective reorganization may occur without the collateral property at issue or that the debtor is unlikely to successfully reorganize. Courts usually rule in favor of the debtor on this prong to give the debtor a chance. If the bankruptcy drags on, you can move the court for relief from stay by saying the debtor is delaying because reorganization is not possible. In a chapter 7, the second prong is eliminated because it is a liquidation, and the debtor is not trying to confirm a plan.

Inadequate protection payments are grounds for relief from stay. These are monthly payments from the debtor to a secured creditor to protect their collateral from a diminution in value during the bankruptcy. If the court orders such payments and the debtor does not make them or they are inadequate, the court could grant relief from stay to foreclose. Adequate protection is a great tool for private lenders that will be discussed in a future article.

Relief from stay may be granted if you present evidence the bankruptcy was filed in bad faith or as part of a “scheme to hinder, delay, or defraud creditors.”

Indicators include:

• Having few creditors.
• Transferring the property just before bankruptcy.
• Newly created entities.
• An incomplete petition.
• Relief from stay granted to you in a previous case.
• The debtor being ordered not to file for bankruptcy.
• Any circumstantial evidence supporting a claim for abuse of the bankruptcy system.

 You’ll notice that there is a crossover of grounds for a motion to dismiss.

If your relief from stay is granted, foreclose as quickly as permissible to prevent the debtor from playing games. Jurisdictions treat what happens next in different ways. In California, you may foreclosure and get paid what you’re owed. If there’s a deficiency, then you have to file a claim with the bankruptcy court as an unsecured creditor. Other jurisdictions require different steps.

Finally, file relief from stay only if you have credible grounds. Don’t file one just to be “aggressive.” Otherwise, you could lose credibility and have trouble filing one later when better grounds exist, such as delay or the lack of a reasonable plan.

The next article will discuss how to deal with the bankruptcy if you cannot dismiss the case or get relief from stay.