Clients can’t all be sweet little grandmas on Social Security. Sooner or later, every consumer lawyer will end up running into the occasional “bad actor”: someone hoping to dodge criminal fines, restitution or benefits overpayment. Someone who has done something a little sketchy.
That’s not a bad thing, per se. “The fresh start” is one of our axioms, and that fact (that it’s an axiom) implies certain things about human nature. We see (hopefully) in our clients that people are dynamic and learn from their mistakes, and that poor decisions often issue from places of terror or need. The credit counseling and financial management requirements would suggest a hypothesis that sometimes, people find their way into our offices because they didn’t know any better. They might have caused their own financial mayhem, but a lot of our clients will get it right the second time.
Two recent decisions, however, have made clear that the Bankruptcy Code may not, in some respects, give certain bad actors the opportunity to get it right, even the first time. Everyone may be the worse for it.
The Automatic Stay: How It Works, and Why
Section 541(a) provides that the commencement of a bankruptcy case creates an estate comprised of all property, or rights to property, that the debtor may have anywhere in the world. The estate’s bigger in chapter 13; most notably, § 1306(a)(2) expands the estate to include the debtor’s post-petition wages.
At the moment a case is filed, § 362(a) of the Code provides for a stay, applicable to all entities, of substantially all collection activity against the debtors and against the estate. Formally, it stays (among a few other things) the commencement or continuation of any action to collect debts and recover claims; it forbids the enforcement against the debtor or property of the estate of any judgment already obtained; it forbids any act to obtain possession of estate property; it forbids any act to create/perfect/enforce any lien against estate property; it forbids any act to enforce any lien against property of the debtor if that lien secures a claim that arose before the case was filed; and it forbids any act to recover a claim against the debtor.
Filing for bankruptcy is often life-changing for our clients. The calls stop, the letters stop, the garnishments stop, and a measure of order reappears in their lives.
It’s not just for them, though. The automatic stay is really for the benefit of the process itself. A chapter 7 trustee has to know that assets aren’t going through a “disorderly, piecemeal dismemberment” while she’s busy hiring an auctioneer (that turn of phrase being from Mann v. Chase Manhattan Mortgage Corp., 316 F.3d 1, 3 (1st Cir. 2003)). Orestes, being pursued by the Furies, would’ve had a hard time funding a chapter 13 plan. If everything didn’t stop, the system wouldn’t work.
But certain debtors are virtually unable to reorganize because the automatic stay doesn’t always stay everyone.
United States v. Robinson
After being intimately involved with a mail-and-wire fraud scheme and defrauding more than 1,000 victims, James Robinson was sentenced to just shy of eight years in prison and was ordered to pay criminal restitution in the amount of $386,875. He had filed for chapter 13, exempting, most saliently, an IRA worth about $45,000.
In United States of America v. Robinson,[1] the Sixth Circuit found that the automatic stay doesn’t prevent the federal government’s efforts to collect their restitution from the debtor, or from his estate property. The government had moved, with two arguments, for a declaratory judgment in the bankruptcy case, hoping to seize for itself as much as it could.
Its first argument was that the automatic stay doesn’t prevent, under § 362(b)(1), “the commencement or continuation of a criminal action or proceeding against the debtor.” Their collection efforts were a part of that, but that argument didn’t actually stick. The Sixth Circuit held that the filing of a petition allows the commencement of a criminal proceeding against the debtor, and so property of the bankruptcy estate remained off limits according to § 362(b)(1).
Title 18 of the U.S. Code, “Crimes and Criminal Procedure,” figures into the analysis, however. It provides that, “[n]otwithstanding any other Federal law […] a judgment imposing a fine may be enforced against all property or rights to property of the person fined […].”[2]
The government’s second argument was that this overrides the automatic stay, and the Sixth Circuit agreed. The word “notwithstanding” “simply excludes application of the referenced [law].”[3] “The Bankruptcy Code, like any other federal statute, must yield if it conflicts with § 3613(a).” [4]
The Sixth Circuit additionally looked to the legislative history of the Criminal Code. Section 3613 was part of the Mandatory Victims Restitution Act, which incorporated the “notwithstanding” language in 1996. Sections 362 and 541 were enacted in 1978; therefore, the MVRA could’ve specifically excluded them if Congress intended to do so.[5] Furthermore, § 3613(e) provided that criminal debts and liens survive bankruptcy discharge – and so Congress would’ve surely thought to carve out an exception for bankruptcy law when it drafted § 3613(a), if it had intended to do so.[6]
The government may seize Robinson’s assets and estate assets, even though he is in bankruptcy, the debt is nondischargable, and there’s never been a finding of bad faith in the filing of his petition or plan. However, the implications should arch some eyebrows. If a debtor is liable for federal criminal restitution, it would be very difficult to keep his chapter 13 plan on its axis: The government may, if it so chooses, levy his assets and garnish his wages during the entire pendency of the case.
In re Dawn Marie Sori
Dawn Marie Sori received unemployment compensation to which she was not entitled. At the time she filed her chapter 13 bankruptcy, she owed the Illinois Department of Employment Security (IDES) $7,058 for unemployment benefits received between April 3 and Sept. 25, 2010. She filed for chapter 13 on Jan. 13, 2012, and the IDES promptly filed a proof of claim.
A post-petition audit at the IDES found her liable for additional money (the overpayment, it appears, actually lasted until April 2011). On Jan. 30, 2014, the Illinois Attorney General filed a criminal complaint against Sori, obtained a warrant for her arrest, required her to surrender and post $1,000 bail, and contacted her repeatedly on the telephone thereafter. A few months later, they sent Sori a receipt for a $116.91 payment, stating that, “[a]s of 04/18/2014, your outstanding Unemployment Insurance overpayment balance is $0.00,” but the criminal complaint continued to pend. Various agents of the State of Illinois told Sori’s counsel that “there was no record of any ongoing collection efforts by IDES,” and, on the same day, that “collection efforts had been ongoing for over eight months after the Debtor filed the bankruptcy petition.”[7]
Sori’s attorneys filed a motion for sanctions against the Illinois Department of Employment Security and an Assistant Illinois Attorney General, perhaps just out of frustration.
Sanctions are the traditional means to enforce the stay. Section 362(k)(1) of the Bankruptcy Code provides that if the automatic stay is violated, “an individual injured by any willful violation of a stay […] shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages.”
The state argued that its violations of the stay were not, in fact, willful because they were exempt from the stay under §§ 362(b)(1) and (b)(4). Yet, the filing of a petition does not stay “the commencement or continuation of a criminal action or proceeding against the debtor[.]” (The Sori court, unlike the Sixth Circuit, did not discuss the ontological difference between the debtor and property of the debtor’s bankruptcy estate.)
Courts disagree, the Sori court writes, about whether § 362(b)(1) in fact permits even bad-faith criminal prosecutions or attempts to collect a pre-petition debt.[8] The majority of courts have held that the exception in § 362(b)(1) is absolute regardless of prosecutorial purpose or alleged bad faith.[9] According to this view, § 362(b)(1) is a “clear and straightforward declaration” that the filing of a bankruptcy petition does not operate as an automatic stay of criminal prosecutions of the debtor.
The minority of cases suggest looking to the motive behind the criminal prosecution and then refusing to apply the exception when the primary motivation is collection of a debt being treated by the bankruptcy. But if the primary motive of the creditor is to punish the debtor for violating a criminal law, then it’s okay.[10]
Section 362(b)(4), meanwhile, is a messy little jangle of Code that exempts from the stay “the commencement or continuation of an action or proceeding by a governmental unit [...] to enforce such governmental unit’s [...] police and regulatory power, including the enforcement of a judgment other than a money judgment, obtained in an action or proceeding by the governmental unit to enforce such governmental unit’s ... police or regulatory power[.]”[11]
According to the court, the state’s actions in its efforts to collect Sori’s unemployment overpayment were except from the stay in light of both § 362(b)(1) and (b)(4).[12]
As to § 362(b)(1), the court found that all criminal proceedings are exempt from the automatic stay, regardless of the purpose for which the proceeding was brought. The plain language of the section admits no exception for prosecutorial purpose or bad faith, it found.
As to § 362(b)(4), the court found that the state was acting within the scope of its police or regulatory power, quoting a press release issued by the Illinois Attorney General’s office, averring that “[p]rosectuing these cases deters fraud and maintains the resources of the unemployment insurance program to help those people it is intended to assist – the unemployed.”[13]
The opinion doesn’t mention this, but the state never filed a nondischargability adversary proceeding against Sori. This is a surprising omission. Section 523(a)(2) of the Code provides that a debt isn’t discharged if that debt relates to money owed because of false pretenses, or use of a materially false writing. Section 523(a)(6) provides that a debt is not dischargeable if it was caused by a willful, malicious injury by the debtor to another entity, or to that entity’s property. It would seem that if a state is bringing a criminal prosecution against Sori for the conduct at issue, they would’ve felt confident with the lower, preponderance-of-the-evidence burden of proof needed for dischargeability actions.[14]
The state, however, can continue doing whatever it wants: “Because IDES did not violate the automatic stay, the Court will not order IDES to cease all collection efforts against the Debtor, nor will it order the Illinois Attorney General to dismiss the criminal proceeding.”[15] Of course, incarceration would likely occasion a sharp reduction in payments to Sori’s creditors.
Incentives
Robinson’s restitution and Sori’s overpayment appear to be nondischargeable. Nevertheless, the federal government in Robinson, and the State of Illinois in Sori, are making it really quite difficult for these folks to succeed in their chapter 13 bankruptcies. Both have other debts. The government actors can, and endeavor to, plunder their estates without reference for what would be best for their unsecured creditors.
James Robinson’s Schedule F, amended a week after the petition date, disclosed $15,592 in other debts, aside from his restitution. Dawn Sori’s Schedule F disclosed $5,640 in general unsecured debts, not including the IDES. While Robinson had filed for chapter 13 bankruptcy once before in the past eight years, his trustee then paid 100% of his allowed unsecured claims, so he would’ve been entitled to a chapter 7 discharge, at least not under § 727(a)(9).
Why should someone like Robinson endeavor to pay a fraction of his claims if the U.S. won’t take time off from levying and liening while he does so? And if someone like Sori is going to get thrown in jail based on an (election-year) crackdown on unemployment overpayments, why shouldn’t she just knock out a chapter 7 and discharge as much as she can?
We can hypothesize good answers to these questions, but nothing’s clear-cut from just the opinions and what we can find on PACER. But whatever we don’t know, a government’s single-minded focus on collection, notwithstanding a good-faith effort at a chapter 13 repayment, seems weird in light of the traditional incentives.
Don’t we want them to pay their creditors? Wouldn’t the government have a better shot at collecting from a debtor who had managed to discharge everyone else? And isn’t it possible that the bankruptcy court’s oversight, when partnered with the government’s own, might reduce a criminal’s chances of being able to hide or dispose of assets? Finally, as the interest on nondischargeable debt is itself nondischargeable,[16] wouldn’t it be nice to allow up to 60 months of interest to compound?
When bad actors seek bankruptcy protection, their governmental creditors might have the authority to cheerfully ignore the automatic stay. But that doesn’t mean that they should.
[1] 2014 WL 4116476 (6th Cir. Aug. 22, 2014).
[2] 18 U.S.C. § 3613(a).
[3] Robinson at *4, citing Deutsche Bank Nat’l. Trust Co. v. Tucker, 621 F.3d 460, 464 (6th Cir. 2010).
[4] Robinson at *4.
[5] Id. at *5.
[6] Id. at *6.
[7] In re Sori, 513 B.R. 728, 730-31 (Bankr. N.D. Ill. 2014).
[8] Id., at 733.
[9] Id., collecting cases.
[10] Id., again collecting cases.
[11] Id. at 734.
[12] Id. at 736.
[13] Id. at 737, citing a press release.
[14] See, generally, Grogan v. Garner, 498 U.S. 287-88 (1991).
[15] Id. at 736.
[16] See, generally, In re Davenport, 353 B.R. 150 (Bankr. S.D. Tex. 2006).