Lifting the Automatic Stay in Bankruptcy — When Litigation Can Proceed Despite a Bankruptcy Filing
Published .
A defendant's bankruptcy filing can bring pending litigation to an abrupt stop.
Under 11 U.S.C. § 362, the filing of a bankruptcy petition ordinarily creates an automatic stay prohibiting a broad range of actions against the debtor and property of the bankruptcy estate. No separate court order is required. The stay arises by operation of law.
For a personal-injury lawyer, however, a defendant's bankruptcy does not necessarily mean the tort case is over.
When liability insurance is available, it may be possible to obtain relief from the automatic stay for the limited purpose of establishing the debtor's liability and recovering from applicable insurance without pursuing the debtor's personal assets.
That distinction can preserve an otherwise valuable personal-injury claim.
What Is the Automatic Stay?
The automatic stay is one of the fundamental protections provided by bankruptcy law.
Under 11 U.S.C. § 362(a), the filing of a bankruptcy petition generally stays numerous actions, including:
• commencement or continuation of judicial proceedings against the debtor that were or could have been commenced before bankruptcy;
• enforcement of prepetition judgments against the debtor or estate property;
• acts to obtain possession or control of property of the bankruptcy estate;
• acts to create, perfect, or enforce certain liens;
• collection activity concerning prepetition claims; and
• other conduct specified by the statute.
The purpose is broader than simply giving the debtor temporary relief from creditors.
The stay also protects the bankruptcy estate from a chaotic race in which individual creditors seize assets while the bankruptcy court is attempting to administer them collectively.
The Stay Is Automatic
A common mistake is to think the stay begins only after the debtor's lawyer sends notice or after the bankruptcy court enters an order.
It does not.
Subject to statutory exceptions and special rules, the stay generally arises when the bankruptcy petition is filed.
A lawyer who learns that an opposing party has filed bankruptcy should therefore stop and determine immediately whether the contemplated litigation activity is stayed.
Do not wait for a formal notice from the bankruptcy court.
A Bankruptcy Filing Does Not Automatically Stay Every Proceeding Involving the Debtor
Section 362 is broad, but it is not limitless.
The statute contains express exceptions. Some proceedings are outside the stay altogether. Others may involve non-debtor parties who are not automatically protected merely because a co-defendant filed bankruptcy.
The first question therefore should not be:
"Someone filed bankruptcy, so is the whole case stayed?"
It should be:
"Exactly what proceeding or act is proposed, against whom, and does § 362 actually stay it?"
The Stay Usually Protects the Debtor, Not Every Co-Defendant
Suppose a negligence action names three defendants and one files Chapter 7.
The bankruptcy ordinarily stays continuation of the action against the debtor.
It does not automatically provide bankruptcy protection to the other two defendants merely because they were sued in the same complaint.
There can be exceptional circumstances in which proceedings against non-debtors are stayed or enjoined, but those circumstances should not be presumed.
Counsel should determine precisely which parties are protected before allowing an entire multi-defendant case to stop unnecessarily.
The Personal-Injury Defendant Who Files Bankruptcy
Consider a familiar problem.
A negligent driver causes a serious automobile collision. The injured plaintiff files suit. The defendant has automobile liability insurance.
Six months later, the defendant files Chapter 7 bankruptcy.
The plaintiff receives a bankruptcy notice.
At first glance, the case appears to have disappeared into bankruptcy.
But the real economic target of the tort action may never have been the defendant's checking account, house, or wages.
It may have been the defendant's liability insurance.
That changes the practical analysis considerably.
Insurance Changes the Equation
Liability insurance exists to protect the insured against covered claims and to provide a source of compensation for injured claimants.
The bankruptcy discharge generally protects the debtor from personal liability for dischargeable debts. It does not necessarily eliminate the liability of another entity, such as an insurer, for the same debt.
Section 524(e) of the Bankruptcy Code provides that, except as otherwise provided, discharge of a debtor's debt does not affect the liability of another entity for that debt.
That provision becomes extremely important in insured tort litigation.
The plaintiff may not be permitted to collect a judgment from the debtor personally, but that does not necessarily mean the plaintiff cannot establish liability in order to recover from available liability insurance.
Seeking Relief From the Stay
Section 362(d) authorizes the bankruptcy court to grant relief from the automatic stay under specified circumstances, including "for cause."
A tort claimant may file a motion asking the bankruptcy court to modify the stay so that litigation can proceed in another court.
The requested relief can be narrowly tailored.
For example, the claimant may ask for permission to:
• continue the pending tort action;
• establish the debtor's liability;
• determine damages;
• obtain a judgment if necessary; and
• pursue recovery only from available liability insurance.
The claimant may expressly agree not to execute upon the debtor's personal assets or property of the bankruptcy estate.
That limitation can substantially alter the practical balance considered by the bankruptcy court.
Ask for What You Actually Need
A motion for relief from stay should not necessarily ask for unrestricted permission to pursue the debtor.
If the objective is insurance recovery, say so.
A proposed order might permit the claimant to prosecute the tort action to judgment or settlement but prohibit collection against:
• the debtor personally;
• property of the debtor;
• property of the bankruptcy estate; or
• assets other than applicable insurance proceeds.
The exact language should fit the particular case and bankruptcy chapter.
Narrow relief can make clear that the plaintiff is not attempting to circumvent bankruptcy.
Why Would a Bankruptcy Court Permit the Case to Continue Elsewhere?
A bankruptcy judge may have little reason to transform the bankruptcy court into a personal-injury trial court when:
• the tort case was already pending elsewhere;
• state law governs liability;
• liability insurance exists;
• the insurer is providing a defense;
• the claimant agrees to limit collection appropriately;
• continuation will not materially interfere with administration of the bankruptcy estate; and
• another court is already positioned to determine liability and damages.
The question is whether sufficient cause exists for relief from the stay.
The availability of insurance can be an important consideration in that analysis.
The Insurer May Already Be Paying for the Defense
This is an important practical fact.
If a liability insurer is obligated to defend the debtor, continuing the tort litigation may impose little or no direct defense expense upon the bankruptcy estate.
The insurer may select counsel, pay defense costs, conduct discovery, retain experts, negotiate settlement, and satisfy a covered judgment up to applicable limits.
That is materially different from litigation in which the debtor or estate must finance the defense.
The motion for stay relief should therefore identify the existence and nature of insurance when that fact supports the requested relief.
Obtain the Policy Information
Do not simply assume insurance exists because an adjuster was involved before bankruptcy.
Determine:
• the insurer;
• policy number if available;
• policy period;
• liability limits;
• whether coverage has been accepted;
• whether the insurer is defending under a reservation of rights;
• whether coverage litigation exists;
• whether defense costs erode the limits;
• whether umbrella or excess coverage exists; and
• whether other insureds are involved.
The bankruptcy filing is not a reason to stop investigating insurance.
It may make that investigation more important.
Insurance Proceeds and Property of the Estate
The relationship between liability insurance and property of the bankruptcy estate can be legally complex.
The debtor's contractual rights under an insurance policy may constitute estate property under 11 U.S.C. § 541. Whether particular insurance proceeds are estate property can depend upon the policy, the type of coverage, who is insured, who is entitled to payment, and the circumstances of the bankruptcy.
Counsel should therefore avoid the overly broad statement that "insurance is never property of the estate."
Sometimes the correct argument is narrower:
Even if the policy or some interest associated with it constitutes estate property, cause exists to modify the stay so that the claimant may proceed against the available coverage subject to the limitations imposed by the bankruptcy court.
Precision is safer than slogans.
The Discharge Injunction Is a Separate Issue
The automatic stay and bankruptcy discharge are related but different.
The automatic stay generally operates during the bankruptcy case.
A discharge creates a separate injunction under 11 U.S.C. § 524 prohibiting efforts to collect discharged debts as personal liabilities of the debtor.
Thus, even after the automatic stay terminates, counsel must consider whether the discharge injunction affects continued litigation.
Again, § 524(e) becomes important when the purpose of continuing the action is to establish liability as a prerequisite to recovery from another entity such as an insurer.
The litigation should be structured so that it does not become an attempt to collect personally from a discharged debtor.
Do Not Sue First and Ask Permission Later
If the automatic stay applies, violating it can have serious consequences.
The safer practice is to obtain the required bankruptcy-court relief before continuing stayed litigation.
That includes more than simply enforcing a judgment.
Depending upon the circumstances, prohibited continuation may include:
• filing or prosecuting motions;
• taking discovery;
• conducting depositions;
• pursuing trial;
• obtaining judgment;
• collection activity; and
• other continuation of the stayed proceeding.
When in doubt, determine the stay's scope before acting.
Consequences of Violating the Stay
Section 362(k) provides a damages remedy for an individual injured by a willful violation of the automatic stay, including actual damages and, in appropriate circumstances, punitive damages.
A "willful" violation does not necessarily require malicious intent in the ordinary sense.
Continuing prohibited conduct with knowledge of the bankruptcy can create substantial problems.
Once counsel learns of the filing, ignoring it is not a sound strategy.
The Bankruptcy Court Controls the Stay
The court handling the underlying tort case does not ordinarily grant relief from the bankruptcy stay.
The motion is filed in the debtor's bankruptcy case.
That means personal-injury counsel may need to appear in bankruptcy court even though the underlying claim is being litigated in a Maryland circuit court or federal district court.
The lawyer should obtain the bankruptcy docket, determine the chapter, identify debtor's counsel and trustee, and review relevant deadlines before proceeding.
Chapter 7 Versus Chapter 13 Can Matter
The nature of the bankruptcy case matters.
A Chapter 7 liquidation differs from a Chapter 13 reorganization.
The status of estate property, the duration of the case, the debtor's ongoing obligations, plan issues, discharge timing, and practical effect of litigation can differ.
Do not use a motion prepared for one chapter mechanically in another without examining the case.
Proof of Claim Versus Stay Relief
A tort claimant may also need to consider filing a proof of claim.
That is a different question from obtaining relief from stay.
A proof of claim asserts the claimant's right to participate as a creditor in the bankruptcy case.
A motion for relief from stay seeks permission to proceed with activity otherwise prohibited by § 362.
Depending upon the circumstances, a claimant may need:
• neither;
• one;
• or both.
The existence of liability insurance, potential personal recovery, bankruptcy assets, dischargeability issues, and claims bar dates can affect the decision.
Do Not Miss the Claims Bar Date While Focusing on the Tort Case
Personal-injury counsel may understandably focus on obtaining stay relief and forget that the bankruptcy case has its own deadlines.
That can be a serious mistake.
Review the bankruptcy notice and docket immediately for:
• proof-of-claim deadlines;
• deadlines to challenge dischargeability where relevant;
• deadlines to object to discharge;
• trustee notices;
• plan deadlines in reorganization cases; and
• hearings concerning relevant insurance or settlement issues.
Bankruptcy runs on its own calendar.
The tort docket does not protect the claimant from missing bankruptcy deadlines.
What If the Defendant Filed Bankruptcy Before the Tort Suit?
The same issue can arise before litigation begins.
Suppose a claimant is injured, but before the complaint is filed the tortfeasor files bankruptcy.
Filing a new lawsuit against the debtor may violate the automatic stay.
The claimant may first need relief from the bankruptcy court permitting commencement of the action.
That can be particularly important when a lawsuit is required to establish the insured's legal liability before the claimant can recover under the liability policy.
Do not assume that an unfiled tort action can simply be commenced because the plaintiff intends to collect only insurance.
Obtain appropriate relief when the stay applies.
What Happens to Limitations?
A bankruptcy filing creates another timing issue.
Section 108(c) of the Bankruptcy Code addresses certain nonbankruptcy limitations periods when commencement or continuation of an action is stayed.
Its operation can be technical and should not be reduced to the statement that "bankruptcy automatically tolls limitations."
That can be dangerously imprecise.
Counsel should calculate the ordinary limitations deadline, analyze § 108(c), determine when the stay terminates or is modified, and obtain stay relief sufficiently early to avoid unnecessary limitations litigation.
Bankruptcy should not become an excuse to stop calendaring the underlying claim.
Multiple Claimants and Limited Insurance
Bankruptcy can become even more complicated when numerous tort claimants compete for limited insurance proceeds.
That situation may implicate:
• interpleader;
• bankruptcy stay issues;
• property-of-estate questions;
• insurer obligations;
• allocation among claimants;
• proof-of-claim issues;
• coverage disputes; and
• settlement approval.
A lawyer should not view the motion for stay relief in isolation when the debtor faces mass tort or multiple-claimant exposure.
The insurance structure and bankruptcy structure must be considered together.
Co-Defendants and Contribution Claims
Suppose the debtor is one of several tortfeasors.
The plaintiff's claim against non-debtor defendants may continue, while claims for contribution or indemnification involving the debtor may be stayed.
This can complicate discovery, verdict forms, settlement, and allocation of fault.
Counsel should identify separately:
• plaintiff's direct claims;
• claims against the debtor;
• claims against non-debtors;
• crossclaims;
• contribution claims; and
• indemnification claims.
The bankruptcy filing may affect each differently.
Domestic Relations, Evictions, Foreclosures, and Other Exceptions
The Bankruptcy Code contains numerous exceptions and specialized provisions concerning the automatic stay.
Certain domestic-relations matters are excepted from the stay. Special provisions govern residential leases, repeat bankruptcy filings, secured creditors, foreclosure activity, criminal proceedings, governmental regulatory actions, and other matters.
A lawyer should therefore consult the specific provisions of § 362 rather than relying upon the generalized proposition that bankruptcy "stops everything."
It does not.
Secured Creditors and Lack of Adequate Protection
Personal-injury lawyers most often encounter stay relief in insured tort litigation, but § 362(d) is used extensively by secured creditors.
A secured creditor may seek relief based upon lack of adequate protection of its interest in collateral.
Relief may also be available under § 362(d)(2) when the debtor lacks equity in property and the property is not necessary to an effective reorganization, subject to the statutory requirements.
These motions frequently involve:
• mortgages;
• automobiles;
• equipment;
• commercial property;
• depreciating collateral; and
• unpaid postpetition obligations.
Thus, "lifting the stay" covers a much broader range of bankruptcy practice than tort litigation.
What the Motion Should Establish in an Insured Tort Case
A well-supported motion seeking limited relief to continue tort litigation should ordinarily explain:
• the nature of the underlying claim;
• where and when the accident occurred;
• the status of the pending litigation, if any;
• the existence of applicable liability insurance;
• the insurer's role in defending the action;
• why another court is the appropriate forum to determine liability and damages;
• the extent to which continued litigation will burden the bankruptcy estate;
• precisely what relief is requested; and
• whether the claimant agrees to limit collection to insurance proceeds or otherwise refrain from pursuing estate assets.
The motion should tell the bankruptcy judge why granting relief will not defeat the purpose of the bankruptcy stay.
The Proposed Order Matters
Do not treat the proposed order as an afterthought.
If the agreement is that the plaintiff may continue litigation solely to establish liability and recover insurance, the order should say so clearly.
Ambiguous language can create later disputes about whether the plaintiff may:
• conduct discovery;
• proceed to trial;
• obtain judgment;
• negotiate with the insurer;
• settle;
• pursue excess coverage;
• execute against the debtor;
• pursue estate property; or
• take other action.
The order should match the relief actually needed.
A Practical Example
A client is seriously injured when another driver runs a red light.
The tortfeasor has a $250,000 automobile liability policy.
Suit is filed in the Circuit Court for Howard County. The insurer retains defense counsel and answers the complaint.
The defendant then files Chapter 7.
The state-court action stops as to the debtor.
Plaintiff's counsel reviews the bankruptcy docket and confirms the insurance coverage. Rather than abandon the tort case, counsel files a motion in bankruptcy court seeking relief from the automatic stay for the limited purpose of continuing the Maryland tort action and recovering from applicable insurance.
The proposed order expressly prohibits execution against the debtor personally or property of the bankruptcy estate.
If relief is granted, the personal-injury action can proceed within the boundaries established by the bankruptcy court.
The bankruptcy protects the debtor.
The liability policy can still perform the function for which it was purchased.
And the injured plaintiff does not lose a legitimate source of compensation merely because the insured filed bankruptcy.
The Practical Lesson
When a defendant files bankruptcy, do not automatically close the personal-injury file.
Ask instead:
Is there insurance?
Then determine:
What exactly does the automatic stay prohibit, and what limited relief do I need from the bankruptcy court to reach that insurance lawfully?
In many insured tort cases, the correct response to a bankruptcy filing is not abandonment of the claim.
It is a carefully drafted motion for relief from stay.
Related Maryland Cases and Authorities
• 11 U.S.C. § 362(a) — establishes the automatic stay and identifies the principal categories of prohibited conduct.
• 11 U.S.C. § 362(b) — identifies numerous statutory exceptions to the automatic stay.
• 11 U.S.C. § 362(d) — authorizes relief from the automatic stay, including relief for cause and specified relief involving property.
• 11 U.S.C. § 362(k) — provides a damages remedy for an individual injured by a willful violation of the automatic stay.
• 11 U.S.C. § 524(a) — establishes the discharge injunction.
• 11 U.S.C. § 524(e) — provides generally that discharge of the debtor does not affect the liability of another entity for the discharged debt.
• 11 U.S.C. § 541 — defines property of the bankruptcy estate and is relevant to determining the estate's interest in insurance policies and, depending upon the circumstances, insurance proceeds.
• 11 U.S.C. § 108(c) — addresses certain nonbankruptcy filing periods when commencement or continuation of an action is stayed.
• A.H. Robins Co. v. Piccinin, 788 F.2d 994 (4th Cir. 1986) — leading Fourth Circuit authority addressing the automatic stay, proceedings involving non-debtors, and the unusual circumstances in which protection may extend beyond the debtor.
• In re Edgeworth, 993 F.2d 51 (5th Cir. 1993) — influential authority explaining the distinction between the debtor's interest in an insurance policy and entitlement to particular liability-policy proceeds and addressing pursuit of insurance following bankruptcy.
Official District of Maryland Bankruptcy Court Resources
The following court resources accompany the pro forma motion and order below. Tailor the papers to the chapter, insurance arrangements, assigned judge, and current procedural requirements. The samples are not official court forms.
Court guidance on filing a motion for relief from the automatic stay: https://www.mdb.uscourts.gov/pro-se/filing-motion-for-relief-automatic-stay
Current local bankruptcy rules and appended local forms, including Local Bankruptcy Rule 4001-1: https://www.mdb.uscourts.gov/files/localrules.pdf
Court homepage for current notices, judges, calendars, and filing resources: https://www.mdb.uscourts.gov/
Before filing, review Federal Bankruptcy Rules 4001, 7004, and 9014 and Local Bankruptcy Rule 4001-1 for notice, hearing, service, and proposed-order requirements. Serve the required parties, including the debtor and trustee as applicable, and file proof of service. A stay-relief order ordinarily is itself stayed for 14 days under Rule 4001(a)(3), unless the court orders otherwise. Do not proceed before the relief is effective. Relief does not adjudicate coverage or confer rights greater than the policy provides.
Pro Forma Insurance Proceeds Only Motion and Proposed Order
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF MARYLAND
In re:
[DEBTOR NAME],
Debtor.
Case No. [__________]
Chapter [7/13]
[PLAINTIFF/CLAIMANT NAME],
Movant,
v.
[DEBTOR NAME],
Respondent.
MOTION FOR RELIEF FROM AUTOMATIC STAY FOR THE LIMITED PURPOSE OF PROCEEDING AGAINST AVAILABLE LIABILITY INSURANCE
Movant, [Claimant], by counsel, pursuant to 11 U.S.C. § 362(d)(1), Federal Rule of Bankruptcy Procedure 4001, and Local Bankruptcy Rule 4001-1, moves for limited relief from the automatic stay and states:
1. Respondent/Debtor filed a petition for relief under Chapter [7/13] of the Bankruptcy Code on [date].
2. Before the bankruptcy filing, Movant asserted a claim against the Debtor arising from [briefly describe automobile collision, premises occurrence, professional negligence, or other event] occurring on [date].
3. [An action concerning that claim is presently pending in the Circuit Court for ______ County, Maryland, Case No. ______.] OR [Movant has not yet commenced the underlying civil action because the automatic stay prevents commencement of an action against the Debtor.]
4. Upon information and belief, the Debtor was insured against the liability asserted by Movant under a policy issued by [Insurance Company], Policy No. [if known], providing liability limits of approximately $[amount] [and applicable excess/umbrella coverage, if any].
5. Movant seeks relief from the automatic stay solely to the extent necessary to establish the Debtor's liability and damages and to recover from available liability insurance.
6. Movant does not seek authority through this Motion to execute upon or otherwise collect any resulting judgment from the Debtor personally or from property of the bankruptcy estate.
7. The requested relief therefore will permit the underlying liability claim to be adjudicated while preserving the protections afforded to the Debtor and the bankruptcy estate.
8. To the extent the liability insurer is obligated to defend the Debtor, the defense of the underlying action will be provided by the insurer rather than funded from assets of the bankruptcy estate.
9. Section 362(d)(1) authorizes the Court to grant relief from the automatic stay "for cause."
10. Section 524(e) further provides, except as otherwise provided by the Bankruptcy Code, that discharge of a debt of the debtor does not affect the liability of another entity for that debt.
11. Cause exists to modify the stay for the limited purpose requested because Movant seeks to establish liability and damages principally or exclusively as a prerequisite to recovering against available liability insurance and does not seek recovery from the Debtor personally or from property otherwise protected by the bankruptcy estate.
12. Permitting the underlying action to proceed in the court in which it is pending [or would otherwise properly be filed] will allow the liability and damages issues to be determined in the forum ordinarily responsible for adjudicating those issues without unnecessarily converting this bankruptcy proceeding into a tort action.
WHEREFORE, Movant respectfully requests that this Court:
A. Modify the automatic stay imposed by 11 U.S.C. § 362 to permit Movant to commence and/or continue the underlying civil action against the Debtor for the purpose of establishing liability and damages;
B. Permit Movant to conduct discovery, participate in mediation or settlement proceedings, prosecute the action through trial and judgment, and take such other steps as are reasonably necessary to establish and resolve the insured claim;
C. Permit Movant to recover any settlement or judgment from applicable liability insurance proceeds, including any applicable primary, excess, or umbrella insurance coverage;
D. Provide that Movant shall not execute upon or otherwise seek collection of any judgment against the Debtor personally or against property of the bankruptcy estate except upon further order of this Court; and
E. Grant such other and further relief as the Court deems appropriate.
Respectfully submitted,
THE BELSKY LAW FIRM
By: ______________________________
Alan J. Belsky
Counsel for Movant
[Address]
[Telephone]
[Email]
PROPOSED ORDER
Upon consideration of Movant's Motion for Relief from Automatic Stay, and any response thereto, it is this ___ day of ________, 20, by the United States Bankruptcy Court for the District of Maryland,
ORDERED, that the automatic stay imposed by 11 U.S.C. § 362 is modified to permit [Movant] to commence and/or continue the civil action arising from [occurrence] against Debtor [name] for the limited purpose of establishing liability and damages and recovering from applicable liability insurance; and it is further
ORDERED, that Movant may conduct discovery, participate in mediation or settlement proceedings, proceed to trial and judgment, and undertake other actions reasonably necessary to prosecute or resolve the insured claim; and it is further
ORDERED, that Movant may recover any settlement or judgment from available primary, excess, umbrella, or other applicable liability insurance proceeds; and it is further
ORDERED, that Movant shall not execute upon or otherwise seek collection of any resulting judgment against the Debtor personally or against property of the bankruptcy estate except upon further order of this Court.
UNITED STATES BANKRUPTCY JUDGE