As all lenders know, the filing of a bankruptcy petition operates as an automatic stay against further collection efforts. The scope of the automatic stay, as established by Section 362 of the Bankruptcy Code, is comprehensive. Not only is the creditor stayed from pursuing legal actions against the debtor, the creditor is also stayed from undertaking any act to obtain payment of the debt or to create or enforce a lien against the debtor's property. According to the congressional history, the purpose of the automatic stay is to "give the debtor a breathing spell from his creditors," to "stop all collection efforts, harassment and foreclosure actions" and to relieve the debtor of the "financial pressures that drove him into bankruptcy." H.R. Rep. No. 595, 95th Cong., 1st Sess. 340, reprinted in, 1978 U.S. Code Cong. & Admin. News 5963, 6296-97.
The automatic stay represents the most effective weapon available to a debtor in bankruptcy. For this reason, a secured lender will frequently attempt to obtain a waiver of the automatic stay as part of a negotiated workout agreement. The primary purpose of the waiver is to ensure that the lender will be able to realize on its collateral without further delay in the event the workout fails.
This article includes a sample waiver provision. The discussion below summarizes the current status of the debate on enforcement of pre-petition waivers of the automatic stay.
The good news for lenders is that waiver provisions have been enforced by a number of courts. However, the issue has not been addressed by a court sitting in Minnesota. The decision in In re Club Tower L.P., 138 B.R. 307 (Bankr. N.D. Ga. 1991), illustrates the sort of analysis used by courts to enforce waivers of the automatic stay.
The debtor in Club Tower financed the acquisition and construction of an apartment building with funds provided by a local mortgage lender. The debtor subsequently defaulted in payment of its indebtedness to the lender. After workout negotiations, the debtor and lender entered into a forbearance agreement under which the debtor agreed that lender would be entitled to immediate relief from the automatic stay in the event that the debtor filed a petition for relief under the Bankruptcy Code. In return, the lender agreed to forbear from exercising its remedies while the debtor attempted to generate additional equity for the project.
The workout failed and the debtor filed a petition under Chapter 11 of the Bankruptcy Code. Not surprisingly, the debtor developed second thoughts concerning the wisdom of its waiver of the automatic stay. The bankruptcy court, however, enforced the waiver, holding that "enforcing a pre-bankruptcy agreement by which a debtor agrees not to oppose the granting to a lender of relief from stay is significantly different from a provision which prohibits a debtor from filing a bankruptcy petition..."
According to the Club Tower court, "there is no violation of public policy" associated with a waiver of the automatic stay, since the "debtor still retains the benefits of the automatic stay as to other creditors, as well as all the other benefits and protections provided by the Bankruptcy Code, including, but not limited to, the right to conduct an orderly liquidation, discharge debt or pay it back on different terms, assume or reject executory contracts, sell property free and clear of liens, and pursue preferences and fraudulent conveyance claims." In other words, according to the decision in Club Tower, a debtor that has waived the automatic stay "still retains the core rights under the Bankruptcy Code and has the ability to make a "fresh start."
According to an opinion published in August 1994, "the courts which have directly considered the issue with regard to pre-petition waivers have uniformly assumed that the clause remains valid." In re Powers, 170 B.R. 480 (Bankr. D. Mass. 1994). The leading cases in this area include In re Cheeks, 167 B.R. 817 (Bankr. D.S.C. 1994); In re Hudson Manor Partners Ltd., 28 Collier Bankr. Cas. 2d 221 (Bankr. N.D. Ga. 1991); In re Weaton Oaks Office Partnership, 1992 U.S. Dist. LEXIS 18781 (D.Ill. Dec. 9, 1992); In re Gulf Beach Development Corp., 48 B.R. 40 (Bankr. M.D. Fla. 1985); In re Orange Park South Partnership, 79 B.R. 79 (Bankr. M.D. Fla. 1987); and In re Citadel Properties, Inc., 86 B.R. 275 (Bankr. M.D. Fla. 1988).
Although generally valid, pre-petition waivers of the automatic stay are not self-executing. As indicated in another recent decision:
Enforcement of a forbearance agreement does not in itself mean that in all bankruptcy cases where one exists, the automatic stay will be lifted. These agreements do not oust this Court's jurisdiction to hear objections to stay relief filed by other parties in interest. It simply means that this Court will give no weight to a Debtor's objection as this conflicts with and is in derogation of the previous agreement. In re Cheeks, 167 B.R. 817 (Bankr. D.S.C. 1994).
The Cheeks court enforced the debtor's pre-petition waiver of the automatic stay. Other courts have refused to enforce a waiver of the automatic stay over the objection of the unsecured creditors in the case. The decision in In re Sky Group International, Inc., 108 B.R. 86 (Bankr. W.D. Pa. 1989), for example, held that the "orderly liquidation procedures" contemplated by the Bankruptcy Code cannot be placed in jeopardy by a debtor's pre-petition waiver of the automatic stay. According to the Sky Group opinion, "to grant a creditor relief from stay simply because the debtor elected to waive the protection afforded the debtor by the automatic stay ignores the fact that it also is designed to protect all creditors and to treat them equally." A similar result was reached in Farm Credit of Central Florida v. Polk, 160 B.R. 870 (M.D. Fla. 1993).
It may not be possible to reconcile all of the decisions in this area. The Powers opinion suggests that cases involving a pre-petition waiver of the automatic stay should be resolved on a case by case basis, and that the factors that should be considered include "the extent to which the creditor waived rights or would be otherwise prejudiced if the waiver is not enforced; the effect of enforcement on other creditors; and, of course, whether there appears to be a likelihood of a successful reorganization." According to the Powers court, "once the pre-petition waiver has been established, the burden is upon the opposing parties to demonstrate that it should not be enforced."
As noted above, the bankruptcy courts in Minnesota have not been asked to enforce a pre-petition waiver of the automatic stay. Recent bankruptcy decisions, however, have tended to favor out of court settlements. There appears to be a trend in favor of upholding commercial contracts entered into by sophisticated parties. As indicated in Club Tower, "enforcing pre-petition settlement agreements furthers the legitimate public policy of encouraging out of court restructurings and settlements... The Bankruptcy Code recognizes that the filing of a bankruptcy petition might not always be the most efficient means of restructuring the relations of a debtor and its creditors."
Most of the commentators in this area also suggest, however, that lenders take the following steps to enhance the possibility that a waiver of the automatic stay will be enforced in a later bankruptcy case:
Generally speaking, waivers should be used only in the commercial context.
Waivers should be included only in a written workout agreement executed following a default. The workout agreement should contain the debtor's acknowledgement that the loan is in default, that the lender has the present legal right to exercise its remedies, that the indebtedness is due and payable in accordance with its terms, in full, and without offset, deduction, or counterclaim.
The lender should be prepared to make a meaningful concession in return for the waiver. This concession will typically take the form of an agreement to forbear from the exercise of its available rights and remedies for some significant period of time; subject, of course, to the debtor's compliance with the terms of the agreement.
The debtor should be represented by counsel, and the workout agreement should contain the debtor's acknowledgement that he or she has consulted with counsel with regard to the waiver's consequences.
Obviously, every lender should anticipate a bankruptcy filing when negotiating a workout agreement. When appropriate, the lender should be prepared to negotiate for a waiver of the automatic stay in bankruptcy. Although there are no guarantees, a properly drafted waiver may assist a lender in obtaining relief from the automatic stay with minimal delay in the bankruptcy proceeding.
Sample Waiver Provision
In recognition of the risks associated with the Lender's execution and performance of this Agreement, and in consideration of the recitals and mutual covenants contained herein, and for other good and valuable consideration, including the agreement of the Lender to forbear from the exercise of its rights and remedies, the receipt and sufficiency which are hereby acknowledged, Borrower and Guarantor hereby agree that in the event that Borrower or any Guarantor (by their own action or by the action of its, his or her shareholders or creditors, if applicable), shall on or before _____________, file with any bankruptcy court of competent jurisdiction or be the subject of any petition for relief under the Bankruptcy Code of 1978 (as amended, the "Bankruptcy Code"), (b) be the subject of any order for relief issued under the Bankruptcy Code, (c) file or be the subject of a petition seeking a reorganization, arrangement, composition, readjustment, liquidation, dissolution, or similar relief under any present or future federal or state act of law relating to bankruptcy, insolvency, or other relief for debtors, (d) have sought or consented to or acquiesced in the appointment of any trustee, receiver, conservator, or liquidator, (e) be the subject of any order, judgment or decree entered by any court of competent jurisdiction approving a petition filed against such party for the reorganization, arrangement, composition, readjustment, liquidation, dissolution, or similar relief under any present or future federal or state act or law relating to bankruptcy, insolvency, or relief for debtors, then, in any such event, the Lender shall thereupon be entitled to relief from any automatic stay imposed by Section 362 of the Bankruptcy Code, or otherwise, on or against the exercise of the rights and remedies otherwise available to the Lender as provided in the Loan Documents, and as otherwise provided by law, and Borrower and each Guarantor hereby waive the benefit of such automatic stay and consent and agree to raise no objection to such relief.