In Rem OrdersA Necessary Exception to the Stay

In Rem OrdersA Necessary Exception to the Stay

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Editor's Note: For more analysis of automatic stay abuses and in rem orders, see Chaves, "In Rem Bankruptcy Refiling Bars: Will They Stop Abuse of the Automatic Stay Against Mortgagees?," 24 Cal. Bankr. J. 1 (Winter 1997).

Among the many consumer bankruptcy proposals contained in the National Bankruptcy Review Commission's final report is a proposal to limit the applicability of the automatic stay with respect to specific estate property that may have been part of a scheme to use bankruptcy to thwart foreclosure sales. Consumer Bankruptcy Proposal 1.5.6. proposes two distinct remedies, each tailored to address automatic stay abuses where a property owner transfers, for little or no consideration, a fractional interest in certain property (usually real estate) to several individuals or entities who then file successive bankruptcies with the sole objective of invoking an automatic stay. These stay abusers succeed in delaying the foreclosure by carefully timing the new bankruptcies to coincide with the date when the secured lender obtains relief from the automatic stay in the prior bankruptcy. As the Commission's report observes, abusive transferees of fractional interests typically do not fulfill the duties imposed on them by the Bankruptcy Code, such as attending the first meeting of creditors. As a result, often before the secured creditor can obtain relief from the automatic stay, the court dismisses the transferee's bankruptcy case.

The NBRC's Remedy

The first of the two Commission proposals provides that:

Section 362 should be amended to provide that the filing of a petition by an individual does not operate as a stay with respect to property of the estate transferred to that individual by another individual who was a debtor under title 11 within 180 days of the filing of the instant petition, unless the court grants a stay with respect to such property after notice and a hearing on request of the debtor.

If Congress were to adopt this proposal, it would shift the burden on certain debtors who meet the criteria to prove their entitlement to a stay upon the filing of a new bankruptcy. A problem with this proposal is its apparent limitation to "individuals" and not "entities," leaving open the possibility of using "entities" as vehicles for the perpetration of these bankruptcy schemes that abuse the automatic stay, rather than "individuals." Another problem with this proposal is that it only applies to property that a debtor received from someone who was previously a debtor within 180 days of the new bankruptcy. This is easy to circumvent, however, because it would not apply to debtors that already owned their fractional interests long before even the first bankruptcy was filed. A benefit of the proposed change is that it carves out a clear exception to the automatic stay for cases that satisfy the statutory requirements.

The second of the two Commission proposals to control abuse of the automatic stay may prove more effective in the long run but requires the discretion of the court. It provides, in pertinent part, that:

After notice and a hearing, a bankruptcy court should be empowered to issue in rem orders barring the application of a future automatic stay to identified property of the estate for a period of up to six years when a party could show that the debtor had transferred such real property...or fractional shares of avoid creditor foreclosure...A subsequent owner of the property...who files for bankruptcy...should be permitted to petition the bankruptcy court for the imposition of a protect innocent parties who were not a part of a scheme to transfer the property to hinder foreclosure...

The Commission's in rem order proposal strikes at the heart of the abusive behavior by removing any incentive for debtors to file bankruptcy petitions solely to trigger the automatic stay since it would create an exception to the automatic stay for real property that is subject to an in rem order. The Commission's proposal is balanced in that it leaves open the possibility for innocent debtors to obtain a stay if they were not part of a scheme to transfer property to hinder foreclosure.

The in rem order proposal further provides bankruptcy judges with more effective tools to deal with abusive bankruptcy filings than the limited tools presently contained in the Bankruptcy Code. The present statutory remedies available to a bankruptcy judge include a dismissal of the debtor's case under §707(b) (dismissal of case where discharge of primarily consumer debts would be a substantial abuse), §1112(b), §1208(c) or §1307(c) (dismissal for cause where it is in the best interests of creditors), with or without prejudice under §105 (the "all writs " equity power of court) or §109(g) (cannot be a debtor for 180 days where prior case dismissed for willful failure to abide by bankruptcy court orders or case voluntarily dismissed following the filing of a motion for relief from the automatic stay) to the filing of a new case, or a lifting of the automatic stay under §362(d). It is because debtors may so easily circumvent these remedies by, in the case of a dismissal or stay relief, simply commencing a new case, or in the case of a dismissal with prejudice, transferring legal title to a different person who in turn files the new case, that the in rem order is so necessary.

The ease with which debtors may obtain the automatic stay may have invited abuses. Indeed, the automatic stay was a significant innovation of the Bankruptcy Code, since it provided virtually anyone capable of filing a bankruptcy petition with the power to invoke the broad injunctive power of the bankruptcy court without any of the showings normally required to obtain an injunction—such as likelihood of success, irreparable harm or the posting of a bond. However, this transfer of the discretionary injunctive power of the court led to the abusive filing of bankruptcy petitions ad seriatim solely to trigger the automatic stay with no intention of prosecuting any of the cases to seek discharge or to reorganize.

Judicial Approaches

If Congress adopts the Commission's proposal, it would validate a remedy that bankruptcy courts in California already have used for some time in the form of prospective stay relief. The earliest reported case under the Bankruptcy Code that applied a prospective stay relief remedy dates from 1984. In re Bradley (Cashman Investment Corp. v. Robinson), 38 B.R. 425 (Bankr. C.D. Cal. 1984). Over time, a number of bankruptcy decisions gave further definition to the scope of the remedy; e.g., In re Villareal, 46 B.R. 284 (Bankr. C.D. Cal. 1984); In re Kinney, 51 B.R. 840 (C.D. Cal. 1985); In re Abdul-Hasan, 104 B.R. 263, 264 (Bankr. C.D. Cal. 1989); In re Taylor, 116 B.R. 728, 730 (Bankr. E.D. Cal. 1990); In re Cherokee New York Investments, 1995 WL 548182 (1995) (unreported case); and In re Snow, 201 B.R. 968 (Bankr. C.D. Cal. 1996).

The most recent case that discusses an in rem stay relief order also provides the most comprehensive discussion of the problems surrounding use of in rem stay relief orders. In re Fernandez, 1997 Bankr. Lexis 1285 (Bankr. C.D. Cal. 1997). One problem is the dilemma that a secured lender faces after it receives an in rem stay relief order: Does it have the right to foreclose in reliance on the in rem order when the debtor files a new bankruptcy case, or, to avoid exposure to liability under §362(h), is it required first to seek and obtain an order for relief from stay in every later bankruptcy case, after notice to every later debtor, before foreclosing?

As the court in Fernandez acknowledged, nothing in the Bankruptcy Code solves the lender's dilemma, and that, to the contrary, §362(a) always puts the lender in jeopardy if it elects to foreclose before obtaining a new order for relief in every subsequent bankruptcy case. The court solved the lender's dilemma in Fernandez by holding that lenders would not be required to obtain yet another order for stay relief before completing their foreclosures, even though the new debtor may not have been afforded written notice of the motion for relief from stay in the prior case that another debtor had filed.

While the court in Fernandez concluded that §105(a) gave bankruptcy courts authority to take appropriate action to prevent abuse of the bankruptcy process and, further, that such authority included the issuance of in rem relief from stay orders that are enforceable in later bankruptcy cases, the Commission's proposal would make such authority express and would define a much needed, new, exception to the automatic stay.

Journal Date: 
Monday, December 1, 1997