Government Working Group A

Working Group Proposal #7: Section 362(b)(4)

The filing of a bankruptcy petition creates an automatic stay under section 362(a) that enjoins the initiation or continuation of civil actions that affect the debtor or property of the estate. The Bankruptcy Code makes special exceptions in sections 362(b)(4) and (5) that permit the government to initiate actions that affect the debtor and property of the estate in connection with the government’s essential police and regulatory functions. However, the Code does not make a specific exception that would permit governmental agencies, acting in their police or regulatory capacities, to exercise control over property of the estate. The absence of a specific exception hinders the ability of government agencies to carry out their important licensing and regulating functions that protect the safety and welfare of others.

The Recommendation

The Commissioners in Government Working Group A agreed that the Commission should recommend the following statutory amendment to 11 U.S.C. § 362(b)(4):

11 U.S.C. § 362(b)(4) should be amended to read as follows:

(b) the filing of a petition under section 301, 302, or 303 of this title, or of an application under section 5(a)(3) of the Securities Investor Protection Act of 1970, does not operate as a stay -

. . .

(4) under subsection (a)(1) of this section, of the commencement or continuation of an action or proceeding by a governmental unit to enforce such governmental unit’s police and regulatory power, including an act to exercise control over property of the estate.

Background

The filing of a bankruptcy petition stays the commencement or continuation of most proceedings against the debtor and property of the debtor’s bankruptcy estate. [ FN: See 11 U.S.C. §362(a)(1).] For the most part, parties wishing to pursue actions against the debtor or against property of the estate must obtain permission from the bankruptcy court. This automatic stay generally applies to allcreditors, including government entities that are acting as creditors. [ FN: See Hillis Motors Inc. v. Hawaii Automotive Dealers ’ Ass ’n , 997 F.2d 581, 586 (9th Cir. 1993); In re University Medical Center , 973 F.2d 1065, 1073 (3d Cir. 1992); In re Pearson , 917 F.2d 1215 (9th Cir. 1990), cert. denied , 112 S. Ct. 514 (1992).]

The Bankruptcy Code provides several governmental exceptions to the automatic stay that allow police and regulatory actions to go forward. Under section 362(b)(4), the filing of a petition does not stay a proceeding by a government unit to enforce its police or regulatory power. [ FN: "The filing of a petition . . . does not operate as a stay under subsection (a)(1) of this section, of the commencement or continuation of an action or proceeding by a governmental unit to enforce such governmental unit ’s police or regulatory power. " 11 U.S.C. §362(b)(4). See also Board of Governors of the Federal Reserve System v. MCorp Financial Inc. , 112 S. Ct. 459 (1991) (section 362(b)(4) excepted from stay Federal Reserve Board ’s administrative proceedings against debtor). See also 11 U.S.C. §362(b)(5) (excepting from the stay actions under section (a)(2) of the enforcement of judgment, other than money judgment, obtained in action or proceeding by governmental unit to enforce such governmental unit ’s police or regulatory power). .] In this regard, the Supreme Court stated in 1990 that it was "not persuaded . . . that the automatic stay provisions have any application to ongoing, nonfinal administrative proceedings." [ FN: MCorp , 112 S. Ct. at 464.] The legislative history indicates that Congress created this carve-out to permit the continuation of proceedings by governmental units to "stop violation of fraud, environmental protection, consumer protection, safety, or similar police or regulatory laws." [ FN: H.R. Rep. 595, 95th Cong., 1st Sess. 342-43 (1977); S. Rep. No. 989, 95th Cong., 2d Sess. 51-52 (1978).]

Yet, the exception’s language stops short of giving government entities carte blanche in fulfilling their police and regulatory functions. The exercise of control over property of the estate pursuant to police and regulatory power is not exempted specifically from the automatic stay. [ FN: 11 U.S.C. §362(a)(3) stays "any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate. " Congress added the "exercise control over " language in the Bankruptcy Amendments and Federal Judgeship Act of 1984. See 2 Collier on Bankruptcy ¶ 362.04[3] (15th ed. 1996).] This becomes relevant when a government agency (e.g., Federal Aviation Administration, local zoning authorities, mining regulators), wants to revoke or suspend a license in which the bankruptcy estate has an interest. [ FN: Most agree that a licensee holds at least some proprietary interest in a license, an interest that becomes property of the estate upon the filing of a bankruptcy petition. See , e.g. , In re Gull Air , 890 F.2d 1255 (1st Cir. 1989); In re Draughon Training Inst. Inc. , 119 B.R. 921 (Bankr. W.D. La. 1990).]

Not all courts are troubled by the absence of specific language authorizing government entities to exercise control over this property; some have taken a flexible approach and concluded that section 362(b)(4) permits government agencies to exercise control over property of the estateto enforce police or regulatory powers without seeking bankruptcy court permission. [ FN: See , e.g. , Cournoyer v. Lincoln , 790 F.2d 971 (1st Cir. 1986) (section 362(b)(4) exempts town ’s removal of used truck parts from debtors ’ property, which had violated zoning ordinance); In re Yellow Cab Cooperative Ass ’n , 96 K 256, 1996 WL 520497 (D. Colo. Sept. 12, 1996) (reversing bankruptcy court ’s order enjoining public utilities commission from prohibiting debtor from transferring taxis to another company); In re Universal Life Church Inc. , 191 B.R. 433, 442 (E.D. Cal. 1995) (automatic stay does not bar revocation of tax-exempt status); Carr and Company Investments, Ltd. v. St. Tammany Parish Policy Jury , 88-0542, 1989 WL 65530 (E. D. La. June 13, 1989) (property rezoning exempted from stay under section 362(b)(4)); In re Heritage Village Church & Missionary Foundation Inc. , 87 B.R. 401, 404 (D.S.C. 1988) (section 362(b)(4) precludes bankruptcy court from enjoining revocation of debtor ’s tax- exempt status), aff ’d , 851 F.2d 104 (4th Cir. 1988); Vaspourakan, Ltd. v. Licensing Bd. for the City of Boston , 85 B.R. 189 (D. Mass. 1988) (board ’s refusal to transfer liquor license to debtor not stay violation); In re Synergy Development Corp. , 140 B.R. 958 (Bankr. S.D.N.Y. 1992) (not stay violation to withhold debtor ’s license to operate health club for failure to post bond); In re Edwards Motor Home Sales Inc. , 119 B.R. 857 (Bankr. M.D. Fla. 1990) (state permissibly revoked mobile home dealer license for failure to be bonded); In re Christmas , 102 B.R. 447, 460 (Bankr. D. Md. 1989) (revocation of debtor ’s horse trainer license excepted from stay under section 362(b)(4)). See also In re Gull Air Inc. , 890 F.2d 1255 (5th Cir. 1989) (non-discretionary automatic termination of right to use landing slots under "use or lose " provision due to post-petition non-use did not violate section 362(a)(3)); In re Grace Coal Co. , 155 B.R. 5 (Bankr. E.D. Ky. 1993) (debtor enjoined from mining without operating permit pursuant to 28 U.S.C. §959(b) ); Colonial Tavern Inc. v. Byrne , 420 F. Supp. 44 (D. Mass. 1976) (under Bankruptcy Act, bankruptcy court could not enjoin city licensing board from suspending debtors ’ liquor licenses).]

Traditionally, however, exceptions to the automatic stay have been construed rather narrowly. [ FN: See , e.g. , Hillis Motors Inc. v. Hawaii Automobile Dealers ’ Ass ’n , 997 F.2d 581, 590 (9th Cir. 1993).] This tendency had led other courts to read section 362(b)(4) literally and thus hold that section 362(a)(3) stays even legitimate police and regulatory attempts to exercise control over property of the estate, limiting the exception’s application to the proceedings that lead to the determination that exercising such control is necessary. [ FN: See , e.g. , In re Draughon Training Institute Inc. , 119 B.R. 921 (Bankr. W.D. La. 1990) (although school license revocation proceeding was within section 362(b)(4) exception, actual revocation of school license violated automatic stay); In re Cattle Congress Inc. , 179 B.R. 588 (Bankr. N.D. Iowa 1995) (revocation of gaming facility license violated automatic stay), remanded on other grounds , 91 F.3d 1113 (8th Cir. 1996). Accord In re Hillis Motors Inc. , 997 F.2d 581 (9th Cir. 1993) (holding that section 362(b)(4) does not except acts that are described by section 362(a)(3), although also holding that commerce department ’s action of dissolving corporation was not police or regulatory action). See also In re Horizon Air Inc. , 156 B.R. 369 (N.D.N.Y. 1993) (district court issuing temporary restraining order against F.A.A. revocation of flight operating license for alleged safety violations pending resolution of preliminary injunction hearing).]

Reasons for the Proposed Change

As illustrated by the split in the case law, the current police and regulatory exceptions are not sufficiently inclusive to ensure that a government agency can take a necessary definitive act to exercise control over property of the estate in a valid police or regulatory capacity without being held to have violated the automatic stay. Congress enacted section 362(b)(4) to permit certain government actions to go forward when necessary to enforce laws that implicate public safety andwelfare; the proposed amendment would clarify that government entities can exercise control over property of the estate, when doing so is a valid exercise of their police and regulatory powers, without having to re-litigate the matter in the bankruptcy court.

After a lengthy discussion on this matter, which included specific mention of the limits on the scope of the amendment, the Commissioners and discussants reached consensus that there was no reason not to recommend this adjustment.

No Expansion of Exception’s Scope

This proposed change is not intended to alter the substantive scope of the section 362(b)(4) governmental exception to the automatic stay. [ FN: The proposed amendment would not change the outcome when courts hold that an act does not fall within an agency ’s police and regulatory powers. See , e.g. , In re University Medical Center ,, 973 F.2d 1065 (3d Cir. 1992) (withholding Medicare payments was enforcement of contractual rights, not police and regulatory action, and violated automatic stay); In re Farmer ’s Market Inc. , 792 F.2d 1400, 1043 (9th Cir. 1986) (refusal to transfer liquor license due to nonpayment of taxes violated automatic stay); In re Corporacion de Servicios Medicos Hospitalarios de Fajardo , 805 F.2d 440 (1st Cir. 1986) (department of health ’s revocation of debtor ’s operating license was not police and regulatory action, but was contractual action) ; In re North , 128 B.R. 592 (Bankr. D. Vt. 1991) (state suspension of chiropractor ’s license to compel debtor to pay taxes was not within police and regulatory powers); In re Massenzio , 121 B.R. 688 (Bankr. N.D.N.Y. 1990) (insurance department ’s revocation action against debtor was triggered by debtor ’s failure to pay debt and violated stay); In re St. Louis South Park II Inc. , 111 B.R. 260 (Bankr. W.D. Mo. 1990) (forfeiture of nursing home debtor ’s certificate of need not police and regulatory action, violated stay); Island Club Marina Ltd. v. Lee Co., Fla. , 32 B.R. 331, 336 (Bankr. N.D. Ill. 1983) (due to lack of evidence that agency ’s withdrawal of building permit was pursuant to police and regulatory power, violated stay) . See also In re Medicar Ambulance Co. Inc. , 166 B.R. 918 (Bankr. N.D. Cal. 1994) (suspension of Medicare payments not police and regulatory action, violated stay) . Cf. In re Orthotic Center Inc. , 193 B.R. 832 (N.D. Ohio 1996) (Medicare overpayments not property of estate, but if they were, suspension would not violate stay because it was within police and regulatory powers).] The distinctions between "purely pecuniary" and "police and regulatory" matters have been developed by the case law and would remain in full force and effect. [ FN: Courts generally use one of several similar tests to discern the nature of the government ’s action. Using the "pecuniary purpose test, " a court assesses whether the proceeding relates primarily to the protection of the government ’s pecuniary interest and not to public policy matters. In re Eddleman , 923 F.2d 782, 791 (10th Cir. 1991); United States v. Nicolet Inc. , 857 F.2d 202 (3d Cir. 1988). "The terms ‘police and regulatory power ’ as used in those exceptions refer to the enforcement of state laws affecting health, morals, and safety but not regulatory laws that directly conflict with the control of the res or property of the bankruptcy court. " Hillis Motors Inc. v. Hawaii Automobile Dealers ’ Ass ’n , 997 F.2d 581, 591 (9th Cir. 1993), citing In re Missouri v. United States Bankr. Ct. for the E.D. of Ark. , 647 F.2d 768, 776 (8th Cir. 1981), cert. denied , 102 S. Ct. 1035 (1982) (state liquidation of grain warehouse violated stay). One court has offered a slight variation on the pecuniary purpose test: "as a general matter, section 362(b)(4) does not include governmental actions that would result in a pecuniary advantage to the government vis- à-vis other creditors of the debtor ’s estate. " In re Commonwealth Companies Inc. , 913 F.2d 518, 523 (8th Cir. 1990) (emphasis added). The "public policy test " focuses on whether the proceedings are intended to effectuate public policy or whether they are adjudications of private rights. NLRB v. Edward Cooper Painting Inc. , 804 F.2d 934 (6th Cir. 1986).] The recommendation would not permit government agencies touse section 362(b)(4) to enforce contractual rights without seeking automatic stay relief, [ FN: In re University Medical Center , 973 F.2d 1065, 1074 (3d Cir. 1992) (withholding Medicare payments not police and regulatory), citing In re Corporacion de Servicios Medicos Hospitalarios , 805 F.2d 440, 445 (1st Cir. 1986).] nor would it allow a government entity to revoke a license as a means to collect a debt from the debtor or to advance the pecuniary interest of the government or a third party. [ FN: Ohio v. Kovacs , 105 S. Ct. 705 (1985).]

Thus, this proposal does not resolve the disputes underlying the frequent litigation over whether an action is purely pecuniary or police and regulatory, [ FN: See , e.g. , cases cited in notes 11 & 12. Nor does the proposed amendment affect what would constitute property of the estate in the first instance. See , e.g. , Pension Benefit Guaranty Corp. v. Braniff Airways Inc. , 700 F.2d 935, 942 (5th Cir. 1983) (court prohibited from using section 105 to protect landing slots since slots are not property of estate). Cf. In re Gull Air Inc. , 890 F.2d 1255 (5th Cir. 1989) (debtor had limited proprietary interest in landing slots).] nor does it alter the potential consequences for acting in violation of the automatic stay (e.g., sanctions, contempt) if the government’s exercise of control over property of the estate is challenged and ultimately found not to be police or regulatory. The proposal only would ensure that government agencies have the proper tools to carry out their police and regulatory responsibilities.

Competing Considerations

Representatives of various government entities have proposed that section 362(b)(4) also should exempt legitimate government actions to obtain possession of property of the estate. The discussants generally recognized that an exception for the seizure of estate property would be much broader than necessary to address the identified problems (i.e. licensing, consumer safety regulations) and might open the door to additional complications. The Commissioners and discussion participants agreed that a government agency should be able to fulfill its regulatory and licensing responsibilities if it were authorized to exercise control over property of the estate without seeking stay relief. This issue has been re-raised in the context of a discussion of civil forfeiture actions, where it may be considered further.

At least one government official also has endorsed an even larger carve-out that would allow government agencies to pursue actions "to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title" without seeking stay relief from the bankruptcy court. [ FN: Such actions currently are stayed by 11 U.S.C. §362(a)(6).] Most discussants agreed that this would go well beyond what is necessary to preserve the essential governmental tools to defend the public welfare and would upset the balance established by the Bankruptcy Code.

On the other end of the spectrum, some might conclude that this proposed change supplies additional leverage to government entities, enabling them to pursue mere pecuniary actionswithout court authority or supervision. Those who take this position might argue that bankruptcy courts can resolve lift stay actions expeditiously and therefore it is not an undue burden on government entities to require them to have the stay lifted before they take final acts to control property of the estate. However, the Commissioners who deliberated on the issue determined that the proposed statutory change does not broaden the range of actions that can be pursued without bankruptcy court authority. Thus, there would be no change in the treatment of government actions that constitute mere debt collection, and debtors and trustees would retain their tools for challenging the propriety of such actions.