First Circuit Liberally Interprets the Police and Regulatory Stay Exception

So long as the government does not attempt to collect, the First Circuit held that contempt proceedings in state court fall under the police and regulatory exception to the automatic stay when the government is pursuing “an order commanding disgorgement of ill-gotten gains accumulated in direct violation of a court order.”

Even if contempt proceedings in state court were aimed at both effectuating public policy and furthering the state’s pecuniary interest, the First Circuit went on to hold in its April 22 decision that the applicability of the police power exception depends on the “totality of the circumstances.”

The Debtor’s Repeated Contempt

Before he filed bankruptcy, the debtor was in hot water in state court for failing to turn over rents he collected from property he did not own. The property was owned by a decedent’s estate that owed about $200,000 to the state health department. In other words, the debtor had collected and kept rents that should have gone to the state.

Before bankruptcy, the debtor had been held in contempt twice in the state court for failure to turn over rents and keys to the property. Since he had not paid all of some $5,000 that he had already been directed to give the health department, the state court scheduled another contempt hearing and threatened 30 days in jail. The day before the contempt hearing, the debtor filed a chapter 7 petition.

The debtor did not appear at the contempt hearing, contending he was protected by the automatic stay. The state court evidently found him and put him in jail for a day for violating court orders four times. He then “vanished,” Circuit Judge O. Rogeriee Thompson said in her opinion for the appeals court.

After bankruptcy, the state court held the debtor in contempt twice more for missing three hearings and continuing to violate court orders. The state court ordered the debtor to turn over more than $50,000 in rents plus $10,000 in attorneys’ fees as a sanction for violating court orders. The court again threatened 30 days in jail if the debtor were not to comply.

The state health department then moved in bankruptcy court for an order modifying the automatic stay. The debtor cross-moved to hold the state in contempt for violating the stay.

The bankruptcy court found cause for modifying the automatic say and allowed the state to pursue a judgment for the $200,000 that the state was claiming. The stay modification did not allow the state to collect a judgment.

The bankruptcy court also denied the debtor’s motion for violating the automatic stay, finding that the contempt proceedings in state court fell under the police and regulatory exception to the automatic stay.

The district court affirmed, prompting the debtor’s appeal to the circuit.

The Generous Reading of the Exception

Section 362(b)(4) provides that bankruptcy does not stay a proceeding by “a governmental unit . . . to enforce [its] police and regulatory power, including the enforcement of a judgment other than a money judgment . . . .”

To decide if the exception applied, Judge Thompson evaluated whether the contempt proceedings were designed to effectuate public policy or to further the government’s pecuniary interest. She cited the Seventh and Ninth Circuits for holding that civil contempt proceedings fall under the exception because they deter litigation misconduct.

Judge Thompson said that some features of the contempt order were “plainly not” aimed at collecting a judgment. She mentioned the orders requiring the debtor to hand over the keys “to a house that he does not own.”

As to the monetary aspects of the contempt proceedings, Judge Thompson said that “no court ordered [the debtor] to satisfy the judgment against him.”

Judge Thompson then turned to the features of the contempt orders directing the debtor to pay sanctions and turn over rents he had collected in violation of court orders. She made a distinction “between a judgment prematurely awarding assets to creditors ahead of the process permitted by the bankruptcy court (exactly the sort of thing the automatic stay is intended to prevent [citation omitted]) and an order commanding disgorgement of ill-gotten gains accumulated in direct violation of a court order.”

“Federal courts regularly approve the application of the police power exception to the latter,” Judge Thompson said. Two decisions recently reported in Rochelle’s Daily Wire were among the authorities she cited. See In re RGV Smiles by Rocky L. Salinas D.D.S. P.A., 20-70209, 2021 WL 112182, at *6 (Bankr. S.D. Tex. Jan. 6, 2021), and Stewart v. Holland Acquisitions Inc., 15-01094, 2021 WL 1037617, at *1 (W.D. Pa. Mar. 18, 2021). To read ABI’s reports, click here and here.

Judge Thompson explained that the contempt orders would not give any priority to the state because the bankruptcy court had not permitted enforcement of money judgments.

Judge Thompson held that the contempt proceedings did not further the state’s pecuniary interest. Even if some elements of the proceedings did assist the state economically, the result would be the same, she said.

“Where the application of the police power exception contains various elements, some of which effectuate a public policy and others of which could involve pecuniary interests,” Judge Thompson said that “we examine the totality of the circumstances” and what the action is primarily designed to do.

“Any way we slice it,” Judge Thompson said, the state court’s “contempt orders pass the public policy test and are not to serve a pecuniary purpose.” She therefore affirmed the lower courts and held that the state court’s “contempt orders are excepted from the automatic stay under the police power exception.”