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Bankruptcy Basics for San Diego Businesses: The Automatic Stay

As a San Diego or California business, occasionally you deal with customers or clients who have gotten so far underwater in terms of debt and financial obligations that they are forced to file bankruptcy. Bankruptcies are governed by federal law. See 11 U.S.C. §§ 101 et seq.

In this article, we discuss what is called the “automatic stay.” This is a part of the bankruptcy code that prohibits any efforts to collect monies due to your business after the bankruptcy has been filed (at least until you receive permission from the Bankruptcy Court to continue efforts to collect).

The Automatic Stay: Legal Principles

When an individual or business files for bankruptcy, the basic idea is that all of the assets of the individual or business are liquidated and then distributed to the creditors. Bankruptcy is intended to be “fair” in that all the creditors — in each class and category — are expected to receive similar payouts (if any). As an example, if there are three main creditors, most would consider it unfair if Creditor A received 50% “on the dollar” but the other two creditors received only 10% of what was owed to them. One of the purposes of the automatic stay is to prevent some creditors from seizing an unfairly large percentage of the debtor’s assets.

As the name would imply, the automatic stay is a legal principle that is triggered automatically when the debtor files for bankruptcy. The “stay” is directed at creditors and each and every creditor must immediately stop, cease, and stay any and all efforts to collect debts that are owed to it. This includes phone calls, letters, litigation, repossessions, and everything else.

A knowing violation by a creditor will result in financial penalties being imposed by the Bankruptcy Court.

Lifting The Stay: Legal Principles

As indicated above, under the Bankruptcy Code, creditors are put into various categories depending on the type of debt. For example, taxes and obligations owed to governmental entities are in one category, secured creditors — those who have collateral to secure payment — are in another category, and unsecured creditors are in yet another. If you are a secured creditor, you can ask the Bankruptcy Court for permission to resume efforts to foreclose on the collateral that is securing the debtor’s payment obligation. This is called a Motion to Lift The Automatic Stay. The most common example is with respect to mortgage foreclosures filed by lenders. Motions To Lift are routinely granted by the Bankruptcy Courts. Other examples include:

Car loans and repossessions
Department store lines of credit/credit cards granting a security interest in the items purchased
Landlord efforts to evict tenants/lessees
And more

San Diego Corporate Law: Protecting Your Business Via Contract

There are many ways that San Diego businesses can protect themselves from being harmed by debtors filing bankruptcies. First, be careful to whom you extend credit. Second, be careful how much credit is given. Third, contract clauses can be added to your vendor/customer agreements giving your business a security interest in the goods being sold. Fourth, use reasonable late fees, monthly interest, and attorney’s fees clauses to maximize the debt owned. A good corporate lawyer can help.

Contact San Diego Corporate Law Today

For more information, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard provides a complete array of legal services for businesses here in San Diego and surrounding communities, including reviewing and drafting business contracts, and all services related to business formation. Mr. Leonard can be reached at (858) 483-9200 or via email.