EVENTS THAT ORIGINATED BEFORE A BANKRUPTCY IS FILED: WHAT POST-PETITION ACTION OR INACTION CONSTITUTES A STAY VIOLATION? WAGE GARNISHMENTS, SEIZURE.

August 6, 2020

Author: Andrew M. Thaler Esq.

The filing of bankruptcy operates as an automatic stay of the enforcement of a judgment against the debtor or property of the estate, the commencement or continuation of litigation against the debtor, the taking of possession or control of property of the estate, and more. Creditors are often placed in a position of not knowing what to do when they learn that a debtor has filed bankruptcy. Some common scenarios are where, prior to bankruptcy, (i) a creditor seized the debtor’s vehicle, (ii) the Sheriff garnished and is holding debtor’s wages, or (iii) creditor’s counsel engaged in litigation have pending outstanding interrogatories, subpoenas, motions or other court hearings. 

The stay is automatic and goes into effect the instant a debtor files bankruptcy regardless of whether the creditor has knowledge of the bankruptcy or not. What the creditor does or does not do (including what the creditor knows or does not know) will dictate whether a violation of the stay will result in actual damages, costs, attorneys’ fees, and in certain instances punitive damages.  

A “willful” violation of the automatic stay will result in damages, costs and attorneys’ fees. It is important to remember that the willfulness requirement does not require a specific intent by the creditor to violate the stay. Instead it is sufficient to show that the creditor knew that the automatic stay was in effect and then intentionally acted (or failed to act) in a manner that violated the stay. Good faith is insufficient to excuse a creditor from liability for debtor’s actual damages, but it may prevent imposition of punitive damages.  

The Bankruptcy Code requires that any entity in possession of property of the estate deliver it to the trustee/debtor without condition or any further action—the provision is self-executing. A majority of courts, including the Second Circuit, have held that a creditor must immediately turn over property in which the estate has an interest and that passive retention is an act to exercise control over property of the estate. A minority of courts hold that passive retention only maintains the status quo, is not an affirmative action, and therefore not a violation of the stay.  

For instance, the Second Circuit has specifically held that a seized vehicle must be immediately returned to the debtor. Further, if a creditor is garnishing wages, the Sheriff must be notified of the bankruptcy, the wage garnishment must cease and the previously garnished wages still held by the Sheriff turned over to the debtor. Counsel for the creditor must withdraw all discovery and a formal request must be made to the state court to cancel any scheduled hearings in the matter. These actions or inaction as described above constitute a continuation of actions against the debtor in violation of the stay.

 Taking the above into consideration, a creditor should not be lulled into a false sense of security that because a vehicle was lawfully seized or proper legal action to collect on a debt was taken that the creditor can sit by and do nothing once a bankruptcy is filed. It is dangerous to force the Debtor to make an application to the bankruptcy court to compel return of a vehicle, the withdrawal of wage garnishments etc. Creditors that violate the stay do so at their peril. If the debtor is forced to act, the creditor can anticipate being responsible for actual damages, attorneys’ fees, costs and punitive damages for its willful behavior.

 As one judge has put it, creditor or the creditor’s legal representative has an affirmative duty, post-petition, to discontinue any proceeding it has initiated or continued, or to take appropriate steps to halt that proceeding if the proceeding: (i) jeopardizes or threatens in any way the integrity of the bankruptcy estate, or (ii) exposes the debtor to harassment or coercion or otherwise inhibits the debtor’s breathing spell from her creditors. 

It is mandatory that creditors and their representative timely discontinue or take affirmative action, as appropriate, when confronted with a bankruptcy filing. Demands for payment, even if automatically generated by a computer will not be an excuse. Post-petition setoffs to satisfy pre-petitions debts are not permitted. Recoupment however, perhaps the topic of another article, is not subject to the automatic stay because it is a special mechanism for adjusting obligations arising from the same transaction.

There is an exception for ministerial acts, but the exception is a narrow one. For example, the Second Circuit has held that entry of judgment by the court clerk one day after the debtor filed a bankruptcy petition was a ministerial act that did not constitute a continuation of a judicial proceeding because the court was persuaded that the judge had endorsed the judgment the day before the bankruptcy, and at that point a hearing on the merits was concluded. Accordingly, the clerk’s post-petition entry of the judgment, after the stay became effective, did not violate the stay.

It should be noted that the United States Supreme Court recently granted certiorari to settle a conflict amongst circuit courts on whether an entity that is passively retaining possession of property in which a bankruptcy estate has an interest has an affirmative obligation under the Bankruptcy Code to return that property to the debtor or trustee immediately upon the filing of the bankruptcy petition. That case arose out of Chicago’s vast vehicle impoundment program, which is part of a national trend, where cities are seizing cars for unpaid tickets and refusing to return them to bankruptcy filers unless steep fees for towing, impounding and storing are paid.

Andrew M. Thaler is founding partner of Thaler Law Firm PLLC, a panel Chapter 7 Bankruptcy Trustee E.D.N.Y. He is rated “AV Preeminent” by Martindale-Hubbell, the highest professional excellence, and selected to the Super Lawyers list in the category bankruptcy & creditor/debtor rights in the NY Metro area.

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