The Debate Continues: Can Creditors Enforce the Automatic Stay?

Contributed by Victoria Vron
The automatic stay is one of the cannons of U.S. bankruptcy law.  A violator of the automatic stay can be held in contempt of court and ordered to pay damages, including, in certain circumstances, punitive damages.  While it is clear that a debtor in possession or a trustee has standing to assert a violation of the automatic stay, it is not as clear whether creditors have such standing.  Although many courts have grappled with this question (as evidenced by a quick case law search), there appear to be many views on this issue.  Two recent conflicting decisions by bankruptcy courts on opposite sides of the country exemplify the split.
The decisions in In re Killmer, No. 07-36011 (CGM) (Bankr. S.D.N.Y. Nov. 15, 2013), and In re Pax America Development, LLC, No. 10-62980 (PC) (Bankr. C.D. Cal. Nov. 15, 2013), involve many similar facts.  In both cases, the chapter 7 debtors owned real property as their main asset.  In both cases, the real property was sold postpetition through foreclosure without the foreclosing creditors seeking relief from the automatic stay.  In both cases, the chapter 7 trustees did not prosecute the violation of the automatic stay.  In Killmer, the chapter 7 trustee ultimately abandoned the property to the debtor, presumably because there was no equity value.  In Pax America, the chapter 7 trustee also appears to have abandoned the property.  After both cases were closed, non-foreclosing secured creditors sought to reopen the chapter 7 cases to seek to void the sales and/or seek damages for violation of the automatic stay.
Although both Killmer and Pax America have many similarities, the bankruptcy courts reached very different decisions on the question of whether a secured creditor had standing to challenge a violation of the automatic stay.  In Killmer, Judge Morris granted the secured creditor’s motion to reopen the chapter 7 case, finding that the creditor would have standing to bring a motion to enforce the automatic stay and void the sale.  In Pax America, Judge Carroll, while granting the secured creditor’s motion to reopen the chapter 7 case, denied the creditor’s motion for damages for an admitted violation of the automatic stay on the ground that creditors do not have standing to seek such damages.
The reasoning behind each court’s decision is summarized below.
Killmer Court’s Decision
Citing the Ninth Circuit’s 1993 decision in Hillis Motors, Judge Morris explained that “[w]hile the automatic stay is often viewed as a benefit to debtors because it provides a ‘breathing spell’ from collection efforts, the stay ‘also protects creditors as a class from the possibility that one creditor will obtain payment on its claim to the detriment of all others.’”  Judge Morris also cited the Second Circuit’s decision in Ostano Commerzanstalt, which states that “[s]ince the purpose of the stay is to protect creditors as well as the debtor, the debtor may not waive the automatic stay.”  Accordingly, Judge Morris found no reason why a creditor who is harmed by a stay violation should not be able to seek redress for its injury.
Pax America Court’s Decision
Citing two other Ninth Circuit decisions from the early 1990s (Pecan Groves and Franck), Judge Carroll found that, because the only legal beneficiaries of the automatic stay are the debtor and the trustee, a creditor does not have standing to seek damages for violation of the automatic stay.  That individual creditors might incidentally benefit from the automatic stay (e.g., because the automatic stay provides for the orderly distribution of property of the debtor’s estate) or be injured in some way by its violation does not give those creditors standing under the Bankruptcy Code to bring an action claiming that the stay was violated.  Creditors must speak to the bankruptcy court through the trustee with respect to stay violations.  The Ninth Circuit’s Franck decision, relied upon by the bankruptcy court in Pax America, is founded on a textual interpretation of section 362(a) of the Bankruptcy Code, which the Ninth Circuit read to protect only the “debtor” and “property of the estate” from enumerated threats.
The uncertainty as to whether creditors have standing to void a foreclosure sale conducted in violation of the automatic stay should be disconcerting, especially to secured creditors — and especially in chapter 7 cases.  If the trustee has no incentive to enforce a violation of the automatic stay (whether it’s because the property will ultimately be abandoned or otherwise), secured creditors, such as second-lien lenders, face the risk that their collateral may be sold outside of the bankruptcy process and they may be powerless to void such a sale (at least in certain jurisdictions).  In jurisdictions that would reach the same conclusion as the Pax America court, secured creditors need to be vigilant as to what’s happening with their collateral during the bankruptcy case and not rely solely on the bankruptcy process.  The situation in Killmer and Pax America is unlikely to occur in most chapter 11 cases where debtors in possession generally have an incentive to prevent violations of the automatic stay and the sale of property outside of the bankruptcy process.