Private Party Access to the Governmental Exception to the Automatic Stay

Private Party Access to the Governmental Exception to the Automatic Stay

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The automatic stay is one of the most fundamental protections offered to debtors. It is often described as stopping the creditor's race to the courthouse while affording the debtor an opportunity at a fresh start. In re McMullen, 386 F.3d 320, 324 (1st Cir. 2004) (quoting In re Jamo, 283 F.3d 392 (1st Cir. 2002)). The breadth of the automatic stay is not unlimited; specific exceptions exist, including an exception for the commencement or continuation of a proceeding by a governmental unit to allow enforcement of its police or regulatory power. 11 U.S.C. §362(b)(4) (2004). However, the governmental unit may not rely on this exception to collect a money judgment against the debtor or the estate.

The First Circuit Court of Appeals recently held that creditors did not violate the automatic stay when they submitted a complaint against a chapter 13 debtor with the Massachusetts Division of Registration for Real Estate Agents. In re McMullen, 386 F.3d 320, 322 (1st Cir. 2004). Significantly, the First Circuit held that a private party could file a complaint with a regulatory agency notwithstanding the debtor's pending bankruptcy case. This decision signals a broadening of the §362(b)(4) exception to the automatic stay.

The §362(b)(4) Exception to the Automatic Stay

The purpose of the §362(b)(4) exception to the automatic stay is to prevent the creation of a safe haven for wrongdoers through the use of the bankruptcy courts. In re Berg, 230 F.3d 1165, 1167 (9th Cir. 2000). Two tests have developed to determine whether a particular proceeding qualifies for the exception: the "public policy" test and the "pecuniary purpose" test. Relevant to this article is the public policy test, which provides that a court must determine whether the government action will effectuate a public policy, or will only adjudicate private rights. If the government seeks to effectuate a public policy, the automatic stay will not be imposed. However, if the government's action is to adjudicate the rights of private citizens, the automatic stay should be imposed. Id. at 1165 (quoting In re Universal Life Church, 128 F.3d 1294 (9th Cir. 1997)). It has also been recognized that merely because a private party benefits financially from the outcome of the governmental unit's regulatory actions, that fact alone will not result in the imposition of the automatic stay. Id. at 1168 (noting "although private parties may benefit financially...the deterrent effect of monetary penalties can be essential for the government to protect its regulatory interests").1

Early Case Law Required a Governmental Unit to Initiate the Proceeding with the Purpose of Enforcing Its Police or Regulatory Power

Early opinions held that to be entitled to the exception, a proceeding for the enforcement of police or regulatory power must have been initiated by a governmental unit. The language of §362(b)(4) supports this conclusion, as it provides that the automatic stay will not apply to "the commencement or continuation of an action or proceeding by a governmental enforce such governmental unit's...police and regulatory power...." 11 U.S.C. §362(b)(4) (emphasis added).2

The governmental unit must seek enforcement of its police or regulatory power for the exception to apply. In In re Massenzio, 121 B.R. 688 (Bankr. N.D.N.Y. 1990), the court found that the New York State Department of Insurance violated the automatic stay because actions it took post-petition were not for the enforcement of police or regulatory power. An insurance company filed a complaint with the department alleging that an insurance agent collected premiums but failed to remit them to the insurance company in violation of insurance regulations. One year later, the insurance agent filed his bankruptcy case. After the bankruptcy case was filed, the department conducted hearings and revoked the agent's license. The bankruptcy court found that the department's actions violated the automatic stay.

The Massenzio court reasoned that when a governmental unit goes beyond the "abatement" of prohibited or regulated activity and seeks to impose monetary sanctions, or if the enforcement of the police or regulatory power seeks to enforce a pre-petition obligation of the debtor, the actions of the governmental unit are not excepted from the stay. Id. at 691. The court found that the department was not seeking to protect the health, safety and welfare of the public, but was instead seeking to protect the pecuniary interest of the insurance company when it revoked the debtor's license. The court also expressed its belief that if the debtor had voluntarily paid the amounts owing to the insurance company, his license would not have been revoked.

Attempts by Private Parties to Invoke the Exception

Prior to McMullen, private parties attempted to invoke the exception by asserting they were acting as governmental units when they initiated an action. For example, in In re Revere Copper & Brass Inc., 32 B.R. 725 (S.D.N.Y. 1983), two corporations brought an action, post-petition, against the debtor in the U.S. District Court alleging that the debtor violated the Clean Water Act. The corporations argued that they sought to enforce the terms and conditions of the debtor's waste water discharge permit and therefore were entitled to be given the status of a governmental unit. The corporations contended that they were acting as private attorneys general attempting to enforce environmental laws. This argument failed. Relying on the statutory definition of governmental units and the legislative history of the Code, the court held: "[c]learly...the term 'governmental unit' in the Bankruptcy Code refers exclusively to actual governmental groups and not to organizations acting in a governmental capacity. The exception to the automatic stay for governmental units was intended to allow state, federal or foreign entities to continue to proceed or to commence actions against debtors." Id. at 727.

Case Law Expands the Exception

Recent cases reflect that the courts are reconsidering the requirement that to be entitled to the exception, proceedings must be initiated by a governmental unit. In Alpern v. Lieb, 11 F.3d 689 (7th Cir. 1993), the defendants moved for sanctions against an attorney pursuant to Rule 11 of the Federal Rules of Civil Procedure. The motion for sanctions was granted, and the attorney appealed. While the appeal was pending, the attorney filed a bankruptcy case and argued that the appeal was stayed. The court held that although the motion for sanctions was filed by a private person, the exception applied and the appeal was not stayed. Directly contrary to Revere Copper & Brass Inc., the court found that, based on the long history of allowing the private enforcement of penal and regulatory laws, the stay did not apply. The court reasoned that this private enforcer, or private attorney general, acted as an agent for the Federal Judiciary, the "governmental unit" that enacted Rule 11 to punish unprofessional behavior. The court also noted that although the sanctions were entirely pecuniary, that fact alone did not take the action outside of the exception. Id. at 690.

Likewise, in U.S. ex rel. Jane Doe v. X Inc., 246 B.R. 817 (E.D. Va. 2000), the court held that the exception applied to a qui tam suit under the False Claims Act, notwithstanding the fact that the United States had not yet intervened.3 More than one year after the plaintiffs initiated their suit, the defendants filed bankruptcy cases. Although the court first explained that the exception "applies only to police or regulatory actions brought by a 'governmental unit,'" the court nevertheless concluded that the exception applied. Id. at 819.

Relying on cases that analyzed 11th Amendment immunity issues, the court held that the United States is the real party in interest in a qui tam suit because the government receives a substantial share of any damages recovered and because the government retains significant control over the litigation, even if it does not participate in the proceeding. Id. at 819-20. Therefore, the court held that the exception applied even though the government did not participate in the proceeding. The private party qualified as a governmental unit.

Courts have also found that when a private party initiates an action prior to the commencement of a bankruptcy case, refusal to dismiss the action post-petition is not a violation of the automatic stay. An Illinois bankruptcy court held that a private party did not violate the automatic stay when she refused to dismiss her complaints of sexual harassment, sex discrimination and retaliatory discharge after her employer filed a bankruptcy case. In re Pincombe, 256 B.R. 774 (Bankr. N.D. Ill. 2000). The employee filed her complaint and attended a fact-finding conference with the Illinois Department of Human Rights, both of which occurred before the bankruptcy case was filed. The debtor argued that the employee's refusal to dismiss the complaint was a violation of the automatic stay, but the court disagreed.

The court relied on the fact that all of the employee's actions occurred pre-petition. The debtor's arguments failed because it could not cite any supportive authority and because the Equal Employment Opportunity Commission could act on its own without the employee's participation. Because the employee took no actions outside of the administrative proceedings, she did not violate the automatic stay. Id. at 781-82.

McMullen Further Expands the Exception

Cases leading up to McMullen found that private parties did not violate the automatic stay because they acted as governmental units when initiating actions, or they initiated actions prior to the filing of a bankruptcy case. McMullen further expands the exception and allows private parties to submit complaints to governmental agencies post-petition, and without asserting that they are acting as agents of governmental units.

In McMullen, the creditors, Richard and Lori Sevigny, entered into a contract to purchase real estate, and Judith McMullen, a licensed real estate agent, acted as the broker. McMullen accepted a deposit in the amount of $10,200 from the Sevignys. The sale fell through, and McMullen did not return the deposit, asserting that she never had possession of it. McMullen later filed for relief under chapter 7 of the Code, and the case was subsequently converted to a chapter 13 proceeding. According to the court, the Sevignys misunderstood the effect of conversion to chapter 13 and therefore believed the bankruptcy case had been dismissed.

Nevertheless, after the bankruptcy petition was filed, the Sevignys submitted a complaint against McMullen with the Massachusetts Division of Registration for Real Estate Agents, claiming that the deposit was fraudulently retained. The Sevignys did not assert they were acting in a governmental capacity. The division dismissed the complaint because it concluded there was not sufficient evidence that McMullen had the deposit, but McMullen filed an adversary proceeding in her bankruptcy case arguing that the Sevignys violated the automatic stay. The bankruptcy court ruled in favor of the Sevignys, and the district court affirmed.

The First Circuit agreed with the lower court that the regulatory proceeding fell within the division's police or regulatory powers. The court also distinguished Massenzio because the division only had power to revoke or suspend McMullen's license. It could not order McMullen to return the funds to the Sevignys, and it could not order any other restitutionary remedy. Id. at 327. According to the court, this case was unlike Massenzio because, in that case, the department had the specific goal of awarding money to the complaining insurance company, and its actions were focused on the pecuniary rights of private citizens, not public policy or regulatory measures. Id. at 327, n.2.

The McMullen court further reasoned that a private party's reporting of wrongful conduct to a governmental regulatory unit is not the "commencement of a proceeding" and is not an "act to collect." The court acknowledged that the automatic stay is typically broadly construed; however, "the same public policy reasons which undergird the §362(b)(4) exception counsel against any rule which might dissuade private parties from providing governmental regulators with information which might require enforcement measures to protect the public from imminent harm." Id. at 328. Although McMullen argued that the Sevignys were motivated by their desire to obtain repayment of the deposit, the court disagreed, reasoning that the Sevignys did not make a post-petition threat before filing the complaint, which could be interpreted as an act to collect under §362(a)(6), nor did they make the continuation of the proceeding contingent upon repayment. The court also rejected an argument that a bad-faith exception should be applied to the exception based on an emerging "rule that 'bankruptcy courts should not inquire into the "legitimacy" of ongoing administrative enforcement proceedings in determining whether the police power exception applies to them.'" Id. at 328 (quoting In re Spookyworld, 346 F.3d 1 (1st Cir. 2003)).


While §362(b)(4)'s exception to the automatic stay was narrowly construed in the past, there has been a trend to broaden the scope of the exception. Courts now allow private parties to initiate certain regulatory or administrative proceedings as agents for the government, and also recognize a private party's right to continue certain proceedings that were initiated pre-petition. The McMullen court has expanded the exception even further by recognizing a private party's right to lodge a complaint against a debtor, post-petition, and without obtaining relief from the automatic stay, as long as the regulatory agency deciding the matter cannot order a restitutionary award and the private party has not threatened action in an attempt to gain repayment of a pre-petition obligation. Although private parties might now be able to enjoy the benefits of §362(b)(4), the most prudent course of action for any nongovernmental unit is to obtain relief from the automatic stay before commencing or continuing actions that appear to invoke the police or regulatory power.


1 In Berg, a creditor was attempting to have an attorney sanctioned for unprofessional conduct. The creditor initiated the proceedings prior to the debtor filing his bankruptcy case. The creditor sought relief from the stay to continue the sanctions proceedings. Therefore, Berg is distinguishable from McMullen. Return to article

2 The Code defines a governmental unit as the "United States; state; commonwealth; district; territory; municipality; foreign state; department, agency or instrumentality of the United States (but not a U.S. Trustee while serving as a trustee in a case under this title), a state, a commonwealth, a district, a territory, a municipality or a foreign state; or other foreign or domestic government." 11 U.S.C. §101(27) (2004). Return to article

3 A qui tam suit is an "[a]ction brought under statute that allows a private person to sue for a penalty, part of which the government or some specified public institution will receive." Black's Law Dictionary 1282 (8th ed. 2004). Return to article

Journal Date: 
Friday, April 1, 2005