The police power exception to the automatic stay in Section 362 should have allowed the milk regulatory authority in Puerto Rico to compel the sale of a chapter 12 debtor’s milk quota, according the First Circuit.

The November 21 opinion by Circuit Judge David F. Hamilton also tells us that the collateral order doctrine can allow an appeal if a governmental unit is enforcing the police power exception when a private party would be stuck with a nonappealable interlocutory order. A judge on the Seventh Circuit, Judge Hamilton was sitting in the First Circuit by designation.

The Stay Violation

The chapter 12 debtor was a dairy farmer in Puerto Rico, where a governmental agency tightly regulates milk producers. The agency licenses dairy farms and grants a quota defining how much milk the producer can sell. Only licensed dairies can produce milk for public consumption.

After the debtor began his chapter 12 case, the agency alleged that the farmer had been engaged in milk trafficking, or selling milk that the farm had not produced. The agency revoked the farm’s license and directed the debtor to sell the license. The highest commonwealth court in Puerto Rico upheld the license revocation, but the debtor still did not sell the license.

Then, the agency “began taking steps” to sell the license at public auction, Judge Hamilton said. Before the auction occurred, the debtor commenced an adversary proceeding in bankruptcy court seeking a declaration that the agency had violated the automatic stay in Section 326. The debtor sought actual and punitive damages plus an injunction barring the agency from selling the license.

Over the agency’s objection, the bankruptcy court enjoined the auction and granted the debtor’s summary judgment motion by finding that the agency had violated the automatic stay. The bankruptcy court called for another hearing on damages. Judge Hamilton said that the bankruptcy court never quantified damages while appeals were pending.

On appeal, the district court upheld the automatic stay violation and held that the police power exception did not apply. The agency appealed to the First Circuit.

Appellate Jurisdiction

Before reaching the merits, Judge Hamilton confronted the question of whether the circuit court had appellate jurisdiction.

Judge Hamilton decided that the district court in substance had permitted the agency to undertake an interlocutory appeal under 28 U.S.C. § 158(a)(3) and Bankruptcy Rule 8004.

On appeal to the circuit, the rules are different, however. Judge Hamilton said that the circuit court has appellate jurisdiction over final orders from the district court under 28 U.S.C. § 1291 and from a final order of a district court in a bankruptcy appeal under 28 U.S.C. § 158(d)(1). The debtor and the agency took the position in the Court of Appeals that the district court’s order was final and therefore appealable under 28 U.S.C. § 158(d)(1).

Finality was an issue for Judge Hamilton, because the district court had upheld the finding of a stay violation but had remanded the case for a decision on damages. Ordinarily in bankruptcy appeals, he cited the First Circuit for having said that a bankruptcy appeal is not appealable as of right under Section 158(d) unless it ends the adversary proceeding “entirely” on the merits and leaves nothing for the bankruptcy court to do aside from the entry of judgment. In re Financial Oversight & Management Bd. for Puerto Rico, 52 F.4th 465, 483 (1st Cir. 2022).

Judge Hamilton found salvation for the appeal by following Eddleman v. United States Dep’t of Labor, 923 F.2d 782 (10th Cir. 1991). There, the Tenth Circuit held that the federal Labor Department could mount an appeal from an otherwise interlocutory order where the district court had found that the government violated the automatic stay by continuing an agency enforcement action. The district court in Eddleman had remanded to the bankruptcy court for further proceedings on damages.

Judge Hamilton described the Tenth Circuit as having “held that the practical effect of the bankruptcy and district courts’ decisions was to deny the [Labor] Department relief from the stay, which in that circuit would ordinarily be appealable as a final decision.” He added,

[T]he Tenth Circuit then held that the open issue of damages did not defeat finality. The court compared the situation to a district court’s rejection of a defense of absolute or qualified immunity, which is appealable as a final decision to the extent that the decision turns on a question of law.

Judge Hamilton went on to say that the Tenth Circuit distinguished cases involving actions taken by private parties. The Denver-based appeals court, he said, “emphasized its reliance on the important governmental interests protected by the police power exception.”

Agreeing with the Tenth Circuit, Judge Hamilton found appellate jurisdiction, holding:

The bankruptcy and district courts’ denials of [the agency’s] motion for summary judgment based on the police power exception are final decisions appealable under the collateral order doctrine — at least to the extent the denials turned on issues of law, just as a similar denial of summary judgment based on absolute or qualified immunity is appealable in a case, for example, under 42 U.S.C. § 1983.

Estate Property or Not?

Turning to the merits, Judge Hamilton undertook de novo review of the bankruptcy court’s grant of summary judgment in finding an automatic stay violation. First, he confronted the question of whether the debtor’s milk quota was estate property that would be protected by the automatic stay.

The milk quota, Judge Hamilton said, could be sold, leased or pledged as collateral. Although milk quotas were “heavily regulated,” he held that they were estate property because “quotas limit, but do not eliminate, a licensee’s proprietary interest.”

The Police Power Exception

Having found estate property protected by the automatic stay, Judge Hamilton turned on the police power exception to the automatic stay in Section 326(b)(4). Subsection (b)(4) provides an exception to the automatic stay for

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.

On the applicability of the police power exception, Judge Hamilton first examined whether the agency’s action fell under the language of the statute.

Judge Hamilton saw the agency’s action as an exercise of regulatory power and noted that revocation of the license would not produce a money judgment in favor of the government. Although an auction of the license would generate cash, government regulations required the agency to pay any liens on the license and turn over excess proceeds to the debtor.

With little hesitation, Judge Hamilton held that compelling an auction was a regulatory activity of the agency under the police power exception to the automatic stay.

Two Extrastatutory Tests

To invoke the police power exception, the First Circuit previously had announced two additional tests. The first is the “public policy test.”

Judge Hamilton found that the revocation of the milk license promoted public policy rather than adjudicated private rights because regulation was designed to keep unsafe milk off the market.

Judge Hamilton said it was “clear” that the agency action passed the second test, known as the “pecuniary interest test.” Simply stated, he said that the agency “has no pecuniary interest in [the debtor’s] dairy license or milk quota. The agency will not receive any proceeds of the auction of [the debtor’s] milk quota.”

Taking a different approach, the two lower courts both found the police power exception inapplicable because they believed the agency was protecting the financial interests of the secured creditor by directing sale proceeds to the lender.

Judge Hamilton said that the agency was “required by law” to protect the interests of the secured creditor. “That does not mean,” he said, that the agency “was taking action against [the debtor] for the pecuniary benefit of the lienholder.” He said there is no “atextual rule to the effect that any time a government action serves any private pecuniary interest to any degree, the police power exception cannot apply.”

Judge Hamilton reversed, holding that the agency was entitled to summary judgment in the adversary proceeding declaring there was no violation of the automatic stay.