There are lots of discussions about non-dischargeability or pre-bankruptcy agreements not to discharge a debt, but every now and again it is good to take a look at debt collection at its most raw: Pay or go to jail. The Wall Street Journal speculates that Ken Lay will likely avoid jail, but it seems that a fair number of folks are facing the pokey when they do more outrageous things like write a check for groceries when they don't have enough money in the bank.

A recent decision out of the Fourth Circuit gives us an excuse to revisit the area of debt collection and police enforcement. In re Simonini, 69 Fed. Appx. 169 (unpublished 4th Cir. 2003). It seems that Mr. Simonini wrote a check to a Nevada casino. He returned home to North Carolina, where he later filed for chapter 13. The Nevada district attorney (DA) began a criminal prosecution of the debtor for a bad check, which the DA continued post-petition, obtaining a warrant from the state of North Carolina and an extradition order so Mr. Simonini could be returned to Nevada.

The district court¹ analyzed the facts with two irrefutable proposals, neatly juxtaposed: A true criminal prosecution is never stayed, and a true attempt to collect debts is always stayed. The court tries to find the line in between. In a lengthy and thoughtful discussion, the court resolves the pre-emption issue in favor of the bankruptcy powers.

The district court examines the two tests often used to determine whether the DA's actions violate the stay: the principal-purpose test (why did the attorney general (AG) do it—collection or criminal prosecution?) and the bad-faith test (did the AG do it to violate the injunction intentionally?). The court rejects both tests, finding them "vague" and unworkable. It proposes a new test instead, the "core impact" on the debtor. Do the DA's actions have the impact of debt collection or is this debtor being treated like a criminal defendant? The relevant question: does the prosecution turn on full restitution, or is restitution just part of a larger panoply of remedies? Another telling test is this: Does the money flow straight back to the complaining party, or does it go to the state?

This case is easy, says the court. The DA actually sent letters that said, in effect, pay or go to jail. The DA even offered a monthly payment plan. The court explains that the DA and sheriff's office often act as the "heavy" for the hotel.

The best part of this opinion comes at the end. The court explains that the idea of getting the sheriff to collect some debts raises an ancillary fairness question of "why some special-interest creditors should benefit from the weight of the state in attempting to collect a debt while the majority of ordinary creditors must comply with federal law by working with the automatic stay and discharge. When a state allows itself to serve as debt collector for private interests, it manipulates the federal deference accorded it by exploiting that deference for the commercial advantage of some lobbies." We're in favor of enforcing the laws, and it is possible that the debtor here was unsavory (a query that cannot be answered based on the published facts). Either way, however, this state action is about money—unsecured debt and civil actions, not about putting people in jail. The court concluded, "the central purpose of the Bankruptcy Code is to marshal creditors and organize distribution. When creditors circumvent that marshaling process, preventing the bankruptcy judge from organizing all the creditors, the interests of none are served." Amen.

But the Fourth Circuit reversed the district court. Citing the "plain meaning" of §362(b)—and thereby cutting off any need to make sense of what is happening in Nevada—the court ruled that all criminal prosecutions are exempt from the automatic stay. Period. Evidently that language is so clear to the court that the legislative history didn't even merit a mention:

The effect of an exception [under §362(b)] is not to make the action immune from injunction. The court has ample other powers to stay actions not covered by the automatic stay. Section 105, of proposed title 11, derived from Bankruptcy Act §2a(15), grants the power to issue orders necessary or appropriate to carry out the provisions of title 11... There are some actions, enumerated in the exceptions, that generally should not be stayed automatically upon the commencement of the case, for reasons of either policy or practicality. Thus, the court will have to determine on a case-by-case basis whether a particular action which may be harming the estate should be stayed."

S. Rep. No. 989, 95th Cong., 2d Sess. 51 (1978); H.R. Rep. No. 595, 95th Cong., 1st Sess. 342 (1977).

Even when the "plain meaning" folks beat us about the head and ears with §362(b)(4), we note that no words are self-executing. Someone still needs to figure out whether the act in question is debt collection or a true criminal prosecution. To say "pay up" or be prosecuted seems to us to be pure debt collection disguised as a criminal prosecution. The bankruptcy courts look through form to substance in many areas—leases as security interests, for example. Why not here?

The policy difficulty with the Fourth Circuit's position is the violence it does to equality of distribution in bankruptcy. The creditor who runs to the DA gets repayment in full from a debtor desperate to stay out of jail, while the creditor who imposes a $25 charge and runs the check through the bank again gets discharged. When practices vary from region to region, as they evidently did in Simonini, the distortions are more pronounced as a Nevada creditor with a friendly DA gets much more leverage than a North Carolina creditor and a more skeptical DA. The Fourth Circuit result seems to implicate the same policies that animate §545 of the Code, which is designed to prevent the states from manipulating lien laws to change Code priority rules.It is fortunate that the decision is not precedential.

The policy problem is illustrated by another debtor who faced jail recently: In re Gallipo, 282 B.R. 917 (Bankr. E.D. Wash. 2002). Ms. Gallipo was in a heap of trouble: four criminal fines for driving under the influence or without a license, four criminal fines for shoplifting and some general unsecured debt. She filed for chapter 13 to try to straighten things out. She didn't make much money, and she proposed to put a disproportionate share of her $50 disposable income for 60 months to paying the driving and shoplifting fines.

The court said discrimination in favor of paying her criminal traffic fines in full was all right, but she could not discriminate in favor of paying her shoplifting fines. Why not? The court said that unless she began paying her traffic fines she couldn't get her driver's license back. Without a driver's license, she can't do anything, and there was no hope for a repayment plan. As a result, the discrimination was essential to the plan. (Sort of like first-day orders that prefer the aggressive suppliers in a big chapter 11.) But the shoplifting fines wouldn't make a difference in her life. They would also be non-dischargeable, but she won't go to jail, said the court, if she doesn't pay. (We really hope her parole officer read this opinion.) Because she can still complete her plan without discriminating in favor of the shoplifting fine, she cannot give those creditors anything extra.

So the issue is squarely on the table: If there had been a Nevada DA hot on Ms. Gallipo's trail, threatening to put her in jail unless she paid, evidently the Washington bankruptcy court thinks that would be a good reason to discriminate in favor of that one creditor in chapter 13. In other words, all the other chapter 13 creditors can give up their percentage repayments so that the single creditor with a friendly DA can collect in full.

The case is a reminder of the enormous leverage of the threat to put someone in jail, and how bankruptcy tries to negotiate the shoals between giving the debtor a fresh start and letting the government enforce the non-bankruptcy laws. Sometimes the law seems to hit a few rocks.

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Footnotes

¹ 282 B.R. 604 (W.D.N.C. 2002). Return to article