Automatic Stay

The automatic stay is a powerful federal injunction under Section 362 of the U.S. Bankruptcy Code that goes into effect the instant a borrower files a bankruptcy petition. It immediately prohibits all creditors — including mortgage note holders and their servicers — from taking any collection action, continuing foreclosure proceedings, or even contacting the borrower about the debt.

What the Automatic Stay Prohibits

For note investors, the automatic stay freezes your ability to pursue resolution on a defaulted loan. The following actions are prohibited once the stay is in effect:

Violations of the automatic stay can result in sanctions, attorney's fees, and damages awarded to the borrower. Even inadvertent violations — such as an automated collection letter sent after filing — can expose the note holder to liability.

How Note Investors Encounter the Automatic Stay

You will encounter the automatic stay in two common scenarios:

During due diligence: When evaluating a note for purchase, check PACER for active or recent bankruptcy filings. A note with an active stay requires a different resolution timeline and strategy. It is not necessarily a deal-killer, but it affects your pricing and projected hold time.

After acquisition: If your borrower files bankruptcy while you hold the note, all workout and foreclosure activity must stop immediately. Your servicer should have protocols to flag bankruptcy filings and pause all activity. If you are self-servicing or working directly with counsel, you must monitor for filings proactively.

Lifting the Automatic Stay

The stay is not permanent. Secured creditors — including note holders — can petition the bankruptcy court for relief from the stay by filing a motion for relief (MFR). The court will typically grant relief if:

• Cause exists — the borrower is not making post-petition payments, or the property is declining in value without adequate protection for the creditor.
• No equity and not necessary for reorganization — in a Chapter 7 case, if the borrower has no equity in the property and it is not needed for the bankruptcy estate, the court will often lift the stay to allow foreclosure.
• Bad faith filing — serial filers who use bankruptcy solely to delay foreclosure may face shortened or eliminated stays under Sections 362(c)(3) and 362(c)(4).

Impact on Note Investment Strategy

The automatic stay adds time and legal cost to your resolution timeline. A Chapter 13 plan can last three to five years, during which the borrower may cure arrears through the plan while you receive reduced or restructured payments. Factor this into your pricing: notes with active bankruptcy filings trade at deeper discounts precisely because the stay limits your options and extends your hold period.

That said, the automatic stay also protects your collateral. While the stay is in effect, junior lien holders and other creditors cannot foreclose either, preserving your position. And in Chapter 13 cases, the court-supervised repayment plan can ultimately bring the borrower current — converting your non-performing asset into a re-performing loan.