Automatic Stay Violations: Void or Voidable?

When a debtor files bankruptcy an automatic statutory injunction takes immediate effect which prohibits the commencement or continuation of collection actions against the debtor or property of the debtor’s bankruptcy estate. The automatic stay is very broad in scope and offers the debtor a “breathing spell” to develop a repayment or reorganization plan, or time for the bankruptcy trustee to effect an orderly liquidation of the debtor’s assets. The automatic stay also prevents creditors from a chaotic scramble to obtain the debtor’s assets.

Occasionally, a creditor will collect in violation of the automatic stay. Usually this is done from ignorance. For instance, suppose the debtor filed a bankruptcy petition at 11:59 and the debtor’s home was sold at a non-judicial foreclosure at 12:00. While the creditor did not intentionally violate the automatic stay, the act itself is a violation because it was legally prohibited. The question then arises, is the act void or merely voidable. In other words, did the foreclosure sale have any legal effect, and must it be voided by the court?

Bankruptcy courts around the county disagree whether a collection action in violation of the automatic stay is void (has no legal effect), or is merely voidable (the bankruptcy court must declare the act violated the stay). In our example if the foreclosure sale is void ab initio (void from the beginning), the debtor need only notify the creditor of the bankruptcy filing. If the creditor wants to foreclose on the home, it must first petition the bankruptcy court for relief from the automatic stay in order to proceed.

On the other hand, if the foreclosure sale is merely voidable, the debtor must seek an order from the bankruptcy court voiding the foreclosure sale. The court will consider the circumstances and decide whether to grant the creditor relief from the automatic stay retroactively, which validates the foreclosure sale in our example. A majority of the federal circuits hold that an action in violation of the automatic stay is void ab initio, but a few courts still consider these actions voidable.

Professor Mason Coolet once said, “Procrastination makes easy things hard, hard things harder.” Delay in filing bankruptcy often proves Cooley’s point. Filing early can avoid many problems in your bankruptcy case, including actions by creditors.