Maryland Business Litigation Lawyer BlogYour Customer Filed for Bankruptcy: Now What?
Many business creditors know that their customers are in financial distress before a bankruptcy filing. In this post, we cover two major issues that creditors must be aware of when a business or individual, perhaps a customer, borrower, or supplier, files a petition for bankruptcy protection: (1) the automatic stay and (2) the proof of claim and its firm deadline.
In football, when the referee blows the whistle, all play must stop and there can be serious penalties for “late hits.” You can think of the automatic stay the same way. When a debtor files a voluntary petition to initiate a bankruptcy case in a U.S. Bankruptcy Court, an “automatic stay” goes into effect under 11 U.S.C. § 362(a). In the legal arena, a “stay” means a pause, stop, or freeze. The courts take the automatic stay very seriously.
For example, Judge Michelle Harner of the U.S. Bankruptcy Court for the District of Maryland explains that “[t]he automatic stay is a core and critical component of the bankruptcy system.” In re Siegal, 591 B.R. 609, 621 (Bankr. D. Md. 2018). The automatic stay protects both debtors and creditors. It “provides the debtor with a breathing spell from the harassing actions of creditors, and it protects the interest of all creditors by preventing dismemberment of the debtor’s assets before the debtor can formulate a repayment plan or, in liquidation cases, the court can oversee equitable distribution of the debtor’s assets.” In re Schwartz-Tallard, 803 F.3d 1095, 1100 (9th Cir. 2015)). Therefore, “courts scrutinize, and take seriously, alleged violations of the automatic stay.” In re Siegal, 591 B.R. at 621. Note that the automatic stay is just that; it is automatic, which means it “operates without the necessity for judicial intervention” and it “remains in force until a federal court either disposes of the case or lifts the stay.” See In re Soares, 107 F.3d 969, 975 (1st Cir. 1997) (internal citations to the Bankruptcy Code omitted). This means that the debtor does not need to ask a judge to order an automatic stay.
Once the automatic stay goes into effect, creditors must cease all efforts to collect a debt from the debtor in bankruptcy. This prohibition on debt collection does not just mean that a creditor may not take formal legal action such as filing a lawsuit against the debtor or serving the debtor with a lawsuit filed before bankruptcy or serving a bank or wage garnishment, even one that was issued by a court prior to the bankruptcy filing. Courts hold that informal conduct such as sending demand letters, making phone calls or texts to a debtor, or sending bills for pre-bankruptcy petition debts, even without threats to sue the debtor, may violate the automatic stay. In re Siegal, 591 B.R. at 624 (citing In re Robinson, No. 10-12932-SSM, 2011 WL 832857, at *2 (Bankr. E.D. Va. Mar. 3, 2011)).
The penalties for violating the automatic stay are severe. Under the U.S. Bankruptcy Code (11 U.S.C. § 362(k)), a “willful” violation of the automatic stay occurs when a party knows about a bankruptcy case and acts deliberately in violation of the automatic stay. Again, the results are harsh and can cause a creditor not only to lose their leverage but to end up paying the debtor. Specifically, a willful violation may expose a creditor to a claim for compensatory damages, payment of the debtor’s attorneys’ fees, and in some cases, punitive damages. Violating the automatic stay or even being accused of a violation is a quick way to go from offense to defense.
So, what should you do if you receive notice of a bankruptcy filing?
First, be sure not to miss the proof of claim deadline. The purpose of a proof of claim is to assert a right to receive payment in a bankruptcy case. See 11 U.S.C. 101(5) (defining proof of claim). In some Chapter 7 liquidation cases, where the debtor’s assets are liquidated to repay creditors and the debtor’s debts are discharged, there may not be a proof of claim deadline if the debtor has no assets to be sold. However, where there are assets, Rule 3003(c) of the Federal Rules of Bankruptcy Procedure requires the court to set a claims bar date, i.e., a deadline after which creditors may no longer file a proof of claim. Indeed, a case may change from a “no asset” case to one where creditors must file a proof of claim to assert their right to payment, so paying attention to bankruptcy notices is a must. One should note that Rule 9006(b)(1) gives the court discretion to enlarge the time to file claims but only “where the failure to act was the result of excusable neglect.”
At the very minimum, you should file a proof of claim before the deadline. If you fail to do so, you have likely forfeited your right to recovery in the bankruptcy case. Note, however, that there are some exceptions for a late-filed claim under the Supreme Court’s decision in Pioneer Inv. Servs., Co. v. Brunswick Assocs. Ltd. P’ship, 507 U.S 380 (1993). In that case, the Supreme Court adopted an “excusable neglect” standard for late-filed claims and guided lower courts to consider several factors in determining whether to allow a late-filed claim, including the relevant circumstances surrounding the late claim, the danger of prejudice to the opposing party, the length of the delay and its potential impact on judicial proceedings, the reason for the delay, including whether it was within reasonable control of the moving party, and whether the movant acted in good faith. See Pioneer, 507 U.S. at 388. This potential safety hatch is available only in rare circumstances, so it is far better to file a proof of claim to give yourself a fighting chance at a recovery in a bankruptcy case.
Silverman Thompson’s business litigation group has decades of experience handling bankruptcy cases, related litigation, and resolving disputes between debtors and creditors. Please contact the firm toll-free for additional information and a free consultation at 800.385.2243.
jbuchman@silvermanthompson.com
Disclaimer: This blog is informative in nature. The information contained herein is not to be considered legal advice and there is no attorney-client relationship formed between Silverman Thompson and the reader.