To proceed or not to proceed? That is often the question that a creditor has in regard to taking further legal action against a debtor that has just filed a bankruptcy case.
Under section 362 of the Bankruptcy Code, a wide-ranging injunction — dubbed the “automatic stay” — arises immediately upon the filing of a bankruptcy case. That injunction enjoins — pending further Bankruptcy Court order — most legal actions by creditors against either the debtor or the debtor’s property, which is referred to in bankruptcy parlance as “property of the [debtor’s] estate.” Although the automatic stay is quite clear, it is often decidedly unclear whether a particular piece of property is “property of the estate” at the time of a debtor’s bankruptcy and, thus, subject to the automatic stay against creditor actions. Given that it is rarely a good idea to violate a court-imposed injunction, the breadth of the stay is an issue that tends to interest most business lawyers and businesspeople.

The Fifth Circuit recently addressed the issue in Brown v. Chesnut and held that the creditor should err on the side of presuming that the automatic stay applies or risk sanctions for violating the stay. Writing for the Court, Judge Clement concluded that the automatic stay is violated where a creditor forecloses on property that “arguably” belongs to the debtor, even though a state court subsequently determines that it is not “actually” the debtor’s property. The U.S. District Court had previously concluded that, because the debtor’s claim of ownership in the property was subsequently held to be without merit, the creditor’s foreclosure sale of the property without first obtaining a modification of the automatic stay did not violate the stay. However, Brown v. Chestnut stands for the proposition that, where the merits of the debtor’s ownership claim have not yet been resolved at the time of foreclosure, the risk of damage to the debtor’s estate was sufficient to require the creditor to seek a modification of the automatic stay before proceeding with foreclosure.
In short, tread carefully when confronted with an argument that the automatic stay enjoins an intended action. Getting the stay modified to allow an action against property is usually simpler and more efficient than defending the cloud on title to the property that results from an assertion that an action taken without Bankruptcy Court approval violated the automatic stay.