The Breathing Spell

For the beleaguered company struggling for a profit and fighting valiantly through costs, claims, and creditors to keep the ship afloat, a “breathing spell” can be very attractive. The United States Bankruptcy Code provides a breathing spell. The technical name is the “automatic stay” (a freeze or stop sign against creditor action). The automatic stay operates as a temporary injunction or prohibition against creditor collection or enforcement action. No creditor may commence a new lawsuit, or continue an existing lawsuit, or take any foreclosure steps, or send a threatening letter, or make a collection phone call. Upon the debtor’s filing of the bankruptcy petition, creditor action must stop, as a matter of federal law. The debtor company has shelter under the wing of the Bankruptcy Court, and an opportunity in a calm atmosphere to re-assess operations and make a “fresh start” toward profitability.

The creditor may seek “relief from the automatic stay”, or a passport through the injunction or prohibition, in order to pursue collection activity against the debtor company. It frequently happens that a creditor insists on going forward against the debtor. The creditor must ask court permission to do so. The court holds a hearing on whether to grant “relief from the automatic stay”. One ground for such “relief” is “cause”, a broad term not defined under the Bankruptcy Code. So the court’s determination must be very fact specific. The court balances the interests of debtor and creditor.

One kind of “cause” for relief from the automatic stay is lack of “adequate protection” of a secured creditor’s “interest” in property of the debtor. If debtor owns Blackacre, debtor has an ownership interest in Blackacre and lender has a security interest in Blackacre. Say that the value of Blackacre declines, after the date debtor files its Chapter 11 petition, January 1, for example. On February 1, for example, secured creditor may file its motion (request) for “relief from the automatic stay”. Secured creditor says to debtor, in effect, “my collateral is declining in value, and I cannot foreclose and try to save its value, because your bankruptcy ‘automatic stay’ stops me. So I ask the court to lift the automatic stay with respect to my claim against Blackacre.” Frequently, debtor and secured creditor make a negotiated agreement for periodic payments that compensate creditor for decline in value or give secured creditor “adequate protection” against such loss. Meanwhile, debtor remains in possession of Blackacre and continues to own and operate Blackacre, without foreclosure.

In this way, debtor gets a “breathing spell” while the Bankruptcy Court prescribes protection for the interest of creditor appropriate to the particular facts and circumstances.