In Kelo vs City of New London,[1] the Supreme Court, by the barest of majorities, upheld the constitutionality of a condemnation of private property for the purpose of conveying it to another private party, as part of a development plan that would create jobs, increase the tax base and revitalize an economically distressed city.[2] The decision has provoked profound controversy.[3] The question addressed here is whether a Kelo-type condemnation would be stopped by a bankruptcy case.
A governmental condemnation of bankruptcy estate property, under the eminent domain power,[4] is obviously an “exercise of control over property of the estate” and thus prohibited by the automatic stay,[5] unless some exception applies. Although under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA)[6] there are now 26 exceptions to the automatic stay, the only applicable one remains the governmental police or regulatory power exception.[7] That exception applies to:
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.[8]
Unless this exception is applicable, the government is stayed from condemning estate property.[9] In a typical condemnation, where the property is either a threat to public health, safety or morals or needed by the government itself, this exception is easily seen to be applicable.
A Kelo-type condemnation, by contrast, does not concern any threat emanating from the property or any need by the government itself for the property. Rather, the government takes the property from one private person and conveys it to another for the sole purpose of economic development. Presumably, this type of condemnation does not involve the enforcement of any generally applicable, preexisting regulation. Therefore, the government’s regulatory power is not implicated. What about the police power?
The Police or Regulatory Power Exception to the Automatic Stay
The police power is generally viewed as encompassing the health, safety or morals of the public.[10] The purpose of the police or regulatory power exception to the automatic stay has been described as preventing debtors from “frustrating necessary governmental functions by seeking refuge in bankruptcy court”[11] and preventing “the bankruptcy court from becoming a haven for wrongdoers.”[12] Many courts construing this exception have applied two interrelated tests: a “pecuniary purpose” test and a “public interest” test.[13] The formulation used by the Sixth Circuit for these tests is as follows:
Under the pecuniary purpose test, reviewing courts focus on whether the governmental proceeding relates primarily to the protection of the government’s pecuniary interest in the debtor’s property, and not to matters of public safety. Those proceedings which relate to matters of public safety are excepted from the stay. Under the public policy test, reviewing courts must distinguish between proceedings that adjudicate private rights and those that effectuate public policy. Those proceedings that effectuate public policy are excepted from the stay.[14]
In addition, the Supreme Court has expressly rejected the notion that, in applying the police or regulatory power exception to the automatic stay, the bankruptcy court has a role in scrutinizing the government’s action against the debtor to determine the action’s validity or legitimacy.[15]
Application to Kelo-Type Condemnations
Applying these principles to a Kelo-type condemnation is not necessarily easy. Courts do not agree on whether the police or regulatory exception should be broadly or narrowly construed,[16] or whether the exception applies to the enforcement of the same law.[17] Nevertheless, two significant factors militate against finding the police or regulatory power exception applicable. First, in a strictly Kelo-type condemnation, the debtor has not violated any law. Thus, the debtor is not a wrongdoer, nor is it attempting to use the bankruptcy court to frustrate the enforcement of any generally applicable law. In particular, the public health, safety and morals are not at risk from the debtor’s property. Second, the government is not taking the property for itself, but taking it to convey it to a different private party. This is intended to increase the tax base—a putatively pecuniary purpose—as well as to revitalize an economically depressed area and create jobs—two matters arguably involving the promotion of public policy. The balance between the pecuniary interest and public purpose, however, seems to militate against the public purpose, because the government’s use of its eminent domain power in these circumstances is implicated only after the last, best offer to purchase the property is declined by the owner. Therefore, the government’s role becomes essentially the compeller of the sale and the arbiter of the acquisition price (in the guise of just compensation) between two private parties. Therefore, a Kelo-type condemnation ought to be considered outside the scope of the police or regulatory power exception to the automatic stay.
Relief from the Stay?
Of course, determining that a Kelo-type condemnation is subject to the automatic stay does not end the discussion, because relief from the stay may be granted “for cause.”[18] What constitutes “cause” is not in any way set forth in the statute. The case law makes “cause” dependent on the circumstances.[19] Obviously, a bankruptcy case filed in bad faith, apart from being subject to dismissal, provides grounds for relief from the automatic stay.[20] In a legitimately filed case, establishing cause may well be different if the case is a liquidation rather than the rehabilitation of a business.[21] Suppose that the property subject to a Kelo-type condemnation is the sole premises of a viable business, which plans to fund a substantial distribution to creditors while preserving equity for its owners and a significant number of jobs for its employees, all of which would be ruined by the confiscation of the premises. Suppose further that the value of the premises in a condemnation proceeding would result in an inferior distribution to creditors, no equity for the owners and no jobs for the employees. Such a case places the government’s desire to proceed with a Kelo-type condemnation on a collision course with the express purpose of Congress in enacting chapter 11, namely the preservation of going-concern values and jobs.[22] Relevant considerations such as the interference with rehabilitative efforts,[23] harm to the creditors[24] and even, where state and local governmental action is involved, the supremacy clause,[25] may well result in the bankruptcy court’s refusal to permit a Kelo-type condemnation to proceed.
Conclusion
Bankruptcy is not supposed to interfere with legitimate governmental action. The bankruptcy court is not supposed to inquire about the legitimacy of a governmental action in determining whether the police or regulatory power exception to the automatic stay is applicable. The U.S. Supreme Court has sustained the constitutionality of a Kelo-type condemnation. Nevertheless, the conclusion that such a condemnation is impervious to bankruptcy is wrong. The police or regulatory power exception does not cover all legitimate governmental activities; in particular, those involving the government’s pecuniary interest are not excepted from the automatic stay. A Kelo-type condemnation does not enforce any governmental regulation against a wrongdoing debtor, nor does it result in the government’s own acquisition of property. It involves the substitution of one private property owner for another, one whose business development plan is favored by the government. As a result, it should be held to be outside the police or regulatory power exception, and thus subject to the automatic stay. Moreover, in an appropriate case—one in which the subject premises houses a viable business being rehabilitated where the condemnation values will not equal the values proposed to be distributed to creditors and equityholders under a confirmable plan, and jobs will be lost—relief from the stay ought to be denied.
[1] 545 U.S. 469 (2005).
[2] Id. at 472.
[3] See, e.g., Maurer, William R., “Let There Be ‘Blight’: Welcome to the Post-Kelo World,” OpinionJournal, Jan. 11, 2007 (available at http://www.opinionjournal.com/cc/?id=110009506).
[4] U.S. Const. amend. V provides in relevant part: “nor shall private property be taken for public use, without just compensation.” This provision is made applicable to the states by the Fourteenth Amendment. Kelo, 545 U.S. at 472 n.1.
[5] 11 U.S.C. §362(a)(3).
[6] Pub. L. 109-9, 119 Stat. 23.
[7] 11 U.S.C. §362(b)(4).
[8] Id. The legislative history of this provision elaborates: “Thus, where a governmental unit is suing a debtor to prevent or stop violation of fraud, environmental protection, consumer protection, safety or similar police or regulatory laws or attempting to fix damages for violation of such law, the action or proceeding is not stayed under the automatic stay.” S. Rep. No. 989, 95th Cong., 2d Sess. 52 (1978); H.R. Rep. No. 595, 95th Cong. 1st Sess. 343 (1977).
[9] It is worth noting that in railroad reorganization proceedings under the Bankruptcy Act, the provisions for an automatic stay provided no such exception. Bankruptcy Act §§77(a), 77(j) (repealed 1978); former Bankruptcy Rule 8-501. As a result, the Seventh Circuit held that a condemnation proceeding was subject to the automatic stay, In re Chicago, Milwaukee, St. Paul & P. R. Co., 738 F.2d 209, 211-12 (7th Cir. 1984), but where the condemnation did not interfere with the rehabilitation of the railroad, relief from the stay should be granted. In re Chicago, Milwaukee, St. Paul & P. R. Co., 739 F.2d 1169, 1173 (7th Cir. 1984).
[10] Barnes v. Glen Theatre, Inc., 501 U.S. 560, 569 (1991) (plurality opinion); Anaya v. Crossroads Managed Care Sys., Inc., 195 F.3d 584, 591 (10th Cir. 1999); see Keystone Coal Ass’n v. DeBenedictis, 480 U.S. 470, 503 (1987).
[11] SEC v. Brennan, 230 F.3d 65, 71 (2d Cir. 2000) (quoting City of New York v. Exxon Corp., 932 F.2d 1020, 1024 (2d Cir. 1991)).
[12] Berg v. Good Samaritan Hosp. (In re Berg), 230 F.3d 1165, 1167 (9th Cir. 2000) (quoting O’Brien v. Fischel, 74 B.R. 546, 550 (Bankr. D. Haw. 1987)).
[13] McMullen v. Sevigny (In re McMullen), 386 F.3d 320, 325 (1st Cir. 2004); Chao v. Hospital Staffing Servs. Inc., 270 F.3d 374, 385-86 (6th Cir. 2001); Universal Life Church, Inc. v. United States (In re Universal Life Church, Inc.), 128 F.3d 1294, 1297 (9th Cir. 1997), cert. denied, 524 U.S. 952 (1998); see United States v. Commonwealth Cos. (In re Commonwealth Cos.), 913 F.2d 518, 523-24 and n.6 (8th Cir. 1990)
[14] Chao v. Hospital Staffing Servs., 270 F.3d at 385-86 (quoting Word v. Commerce Oil Co. (In re Commerce Oil Co.), 847 F.2d 291, 295 (6th Cir. 1988)). The Sixth Circuit has adopted the Eighth Circuit’s refinement of the pecuniary purpose test to focus on whether the government’s action would “result in a pecuniary advantage to the government vis-à-vis other creditors of the debtor’s estate.” Id. at 388 and n.9 (quoting Commonwealth Cos., 913 F.2d at 523-24).
[15] Federal Reserve Board v. MCorp., 502 U.S. 32 (1991). The court construed a prior version of §362(b)(4), which, among other things, did not provide an exception to §362(a)(3), the exercise of control over property of the estate.
[17] Compare Chao v. Hospital Staffing Servs., 270 F.3d at 394 (holding, after extensive analysis, that a lawsuit by the Secretary of Labor to prevent the trustee from selling “hot goods”—goods produced in violation of the Fair Labor Standards Act, 29 U.S.C. §§205-206, 215(a) and 216(c), which the payment of certain minimum and overtime wages to employees—does not come within the police or regulatory power exception to the automatic stay) with Brock v. Rusco Indus. Inc, 842 F.2d 270, 273 (11th Cir. 1988) (holding summarily that such a lawsuit does come within the police or regulatory power exception to the automatic stay).
[18] 11 U.S.C. §362(d)(1)
[19] See, e.g., Sonnax Indus., Inc. v. Tri Component Prods. Corp. (In re Sonnax Indus., Inc.), 907 F.2d 1280, 1286 (2d Cir. 1990).
[20] See id. at 1287
[21] See In re F.A. Potts & Co., 49 B.R. 517, 58-19 (Bankr. E.D. Pa. 1985) (granting relief from the stay to permit a state court condemnation proceeding in a confirmed, liquidating chapter 11 case). In this case, the Delaware Solid Waste Authority sought relief from the stay, rather than rely on the police or regulatory power exception, which was unmentioned in the opinion. The court noted that the debtor and the creditors’ committee did not contest the Authority’s right to acquire the property, but rather which forum, the Delaware state court or the bankruptcy court, would decide the value of the property for condemnation purposes.
[22] See H.R. Rep. No. 595, 95th Cong., 1st Sess. 220 (1977).
[23] See Chicago, Milwaukee, St. Paul & P. R. Co., 739 F.2d at 1173.
[24] See Berry Estates Inc. v. State of New York (In re Berry Estates Inc.), 812 F.2d 67, 71 (2d Cir. 1987).
[25] U.S. Const. art. VI, cl. 2; see Perez v. Campbell, 402 U.S. 637, 650-52 (1971) (state statute denying a driver’s license to a bankrupt who discharged without fully satisfying a debt arising from an automobile accident held unconstitutional under the supremacy clause as violating the Bankruptcy Act’s fresh start policy).