Ordinarily, the exercise of a municipality’s police and regulatory powers is immune from the automatic stay under Section 362(b)(4). Typically also, federal district courts — not bankruptcy courts — adjudicate lawsuits under 42 U.S.C. § 1983 for a governmental unit’s deprivation of someone’s constitutional rights. Likewise, bankruptcy courts sometimes don’t rule on disputes between nondebtor third parties.
In an extraordinary case from Long Island, N.Y., a bankruptcy judge didn’t just hold a municipality in violation of the automatic stay. Rather, Bankruptcy Judge Robert E. Grossman held an 18-day bench trial, culminating in a 71-page opinion where he found that a municipality “intentionally trampled on the constitutionally protected rights of the [purchaser of a debtor’s assets] . . . which the Court finds outrageous and conscious-shocking.”
Because the municipality gave “absolutely no regard . . . to the proper procedure to follow,” Judge Grossman found a violation of the buyer’s constitutional right to due process under the Fourteenth Amendment. The August 11 opinion ends by scheduling a trial on damages, which could run into the millions of dollars.
The opinion teaches a lesson: When removing a lawsuit from state court to bankruptcy court, don’t presume to know how a bankruptcy judge will rule.
The Chapter 11 Case
The corporate debtor owned a waterfront restaurant on Long Island that had been severely damaged in two unprecedented storms. The corporate debtor filed a chapter 11 petition, but the debtor in possession was supplanted by a chapter 11 trustee.
The trustee quickly moved to sell the property. Judge Grossman approved the sale to a third party, who had bid $4.65 million in cash. The backup bidder was the secured lender with a $4.6 million credit bid.
After the sale, the restaurant ceased operations. Before the sale closed, the municipality placed a placard on the property saying it was dangerous and unfit for human occupation. The placard prohibited anyone from entering the property without permission from the municipality. The municipality may have been hoping that the placard would impel the buyer to remedy structural deficiencies caused by the storms.
Instead, the placard caused the winning bidder to walk away from the sale. Judge Grossman later ruled that the winning bidder was not entitled to recover its deposit of $651,000. The decision against the winning bidder was upheld on appeal in district court.
After the winning bidder’s default, the lender was obliged to (and did) close the deal as the backup bidder. Eventually, the municipality removed the placard, but the lender was only able to sell the property for $2.8 million — that is, almost $2 million less than its bid.
No Withdrawal of the Reference
Believing that the municipality improperly placed the placard on the property, the lender sued the municipality in state court, raising claims under the U.S. Constitution and state law. The municipality removed the suit to federal court, where it ended up before Bankruptcy Judge Grossman as an adversary proceeding.
One month after Judge Grossman denied the municipality’s motion to dismiss, the municipality evidently had a change of heart and filed a motion to withdraw the reference. District Judge Joanna Seybert denied the withdrawal motion. Bethpage Federal Credit Union v. Town of Huntington (In re Joe’s Friendly Service & Son Inc.), 17-0190, 2019 BL 454549, 2019 US Dist. Lexis 204355, 2019 WL 6307468 (E.D.N.Y. 2019).
Judge Seybert found “mandatory withdrawal inappropriate because resolution of [lender’s] claims requires the simple ‘application of a federal statute to a particular set of facts.’” She also said that the “the circumstances here indicate forum shopping” because the municipality removed the suit to bankruptcy court but moved to withdraw the reference one month after the bankruptcy judge denied the motion to dismiss.
After the substitution of new counsel, Judge Seybert noted that the municipality for the first time argued that the bankruptcy court had no subject matter jurisdiction and that the municipality did not consent to the bankruptcy court’s entry of final orders. The new contentions, she said, provided further support for forum-shopping.
In denying the motion to withdraw the reference, Judge Seybert found no reason to rule on the municipality’s contention that the bankruptcy court lacked jurisdiction. She left the question of subject matter jurisdiction for Bankruptcy Judge Grossman to decide in the first instance.
The Constitutional Claims
While withdrawal of the reference was in district court, the lawsuit was plodding along in bankruptcy court. On the first day of trial, Bankruptcy Judge Grossman denied the municipality’s motion to dismiss for lack of jurisdiction. He went on to dismiss some of the individual defendants and some of the claims against the municipality.
Unless there is a settlement, the next appeal will be a humdinger, but that likely can’t happen until Judge Grossman rules on damages.
On the merits of the due process claim, Judge Grossman found that placarding the property “severely diminished the Property’s value.” He said that placarding the property in violation of local regulations “erroneously deprived” the lender “of protected property rights without due process.”
Finding that the placarding was “tainted with procedural irregularities, taken with a culpable state of mind and for an improper purpose,” Judge Grossman held that the municipality “intentionally trampled on the constitutionally protected rights of the [lender].” He found the conduct “outrageous and conscious-shocking.”
Judge Grossman found a violation of the lender’s substantive due process rights because the municipality gave “absolutely no regard . . . to the proper procedure.” As we said, the next step is a trial to determine damages.
Observations
An appeal will be interesting, to say the least.
Was there subject matter jurisdiction? Did the bankruptcy court have constitutional power to enter a final order? Did the municipality consent to final adjudication in bankruptcy court? Should the reference have been withdrawn for trial?
If the bankruptcy court was not entitled to enter a final order, will Judge Grossman’s decision be taken as a report and recommendation? Were any of his findings clearly erroneous? Would the district make its own findings from a de novo review of the record? Would the district court afford the municipality a new trial?
Stay tuned!
Ordinarily, the exercise of a municipality’s police and regulatory powers is immune from the automatic stay under Section 362(b)(4). Typically also, federal district courts — not bankruptcy courts — adjudicate lawsuits under 42 U.S.C. § 1983 for a governmental unit’s deprivation of someone’s constitutional rights. Likewise, bankruptcy courts sometimes don’t rule on disputes between nondebtor third parties.
In an extraordinary case from Long Island, N.Y., a bankruptcy judge didn’t just hold a municipality in violation of the automatic stay. Rather, Bankruptcy Judge Robert E. Grossman held an 18-day bench trial, culminating in a 71-page opinion where he found that a municipality “intentionally trampled on the constitutionally protected rights of the [purchaser of a debtor’s assets] . . . which the Court finds outrageous and conscious-shocking.”
Because the municipality gave “absolutely no regard . . . to the proper procedure to follow,” Judge Grossman found a violation of the buyer’s constitutional right to due process under the Fourteenth Amendment. The August 11 opinion ends by scheduling a trial on damages, which could run into the millions of dollars.
The opinion teaches a lesson: When removing a lawsuit from state court to bankruptcy court, don’t presume to know how a bankruptcy judge will rule.