The Governmental Unit Exemption to the Automatic Bankruptcy Stay Extends to a Final Judgment for Attorneys’ Fees as a Sanction

By Kelly A. Karstaedt, Esq.

In every bankruptcy action that is filed, a stay of any collection-type activities automatically comes into place for the duration of the pending action.  However, there are certain proceedings that are exempted from this automatic stay and allowed to proceed against the debtor during a pending bankruptcy action.  One such exemption is a proceeding by a governmental entity to enforce its regulatory or police power.  It is widely accepted that such proceedings to benefit the governmental entity may continue, but what if the final benefit rests with a private citizen?

 

The filing of a petition for bankruptcy operates as a stay of most types of collection and legal proceedings.  See 11 USC § 362(a).  There are multiple exemptions to this automatic stay requirement, especially when it comes to the activities of the government.  One such exemption is as follows:

 

The filing of a petition…does not operate as a stay…of the commencement or continuation of an action or proceeding by a governmental unit or any organization exercising authority under the Convention on the Prohibition of the Development, Production, Stockpiling and Use of Chemical Weapons and on Their Destruction, opened for signature on January 13, 1993, to enforce such governmental unit’s or organization’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 or organization’s police or regulatory power…  11 USC § 362(b)(4).

 

In order to understand this exemption, it is important to define the key phrases contained therein.  So what is a governmental unit?  This term is defined in the bankruptcy code as “United States; State; Commonwealth; District; Territory; municipality; foreign state; department, agency, or instrumentality of the United States, a State, a Commonwealth, a District, a Territory, a municipality, or a foreign state; or other foreign or domestic government.”  See 11 USC § 101(27).

 

Defining “police and regulatory power” is more difficult and has been left to the interpretation of the judiciary throughout the years.  The question for this article is whether a court can hear a Motion for Attorneys’ Fees as a Sanction while a bankruptcy action is pending as an exercise of its police and regulatory power.  The majority answer would be yes.  While only a minority of courts has tackled this particular issue and ruled upon it so far, the case law weighs in favor of granting the exemption.

 

It is the general consensus among courts that court-ordered sanctions imposed against a debtor for abuses to the judicial system fall under its ‘governmental unit’ regulatory and police power exemption.  See Alpern v. Lieb, 11 F.3d 689, 690 (7th Cir. 1993) (Rule 11 sanctions ordered by the court against debtor are exempt under § 362(b)(4)); In re Berg, 230 F.3d 1165, 1168 (9th Cir. 2000) (Section 362(b)(4)’s “government regulatory exemption exempts from the automatic stay an award of attorneys’ fees imposed under Rule 38 as a sanction . . .”); O’Brien v. Fischel, 74 B.R. 546, 551 (D. Haw 1987) (A monetary penalty imposed by the court as a sanction was exempt under § 362(b)(4)); Keitel v. Heubel, 126 Cal. Rptr. 2d 763, 769 (Cal.Ct.App. 2002) (A private-party, non-attorney, cannot insulate themselves “from the sanctioning power of [the] court by filing [a] bankruptcy case” because of the governmental unit exemption under § 362(b)(4)).

 

In order for a governmental entity to continue with a proceeding during bankruptcy, the purpose of the proceeding must pass the pecuniary purpose test and the public policy test.  Maritan v. Todd, 203 B.R. 740, 744 (N.D.Okla. 1996).  “Under the ‘pecuniary purpose’ test, the court asks whether the government’s proceeding relates primarily to the protection of the government’s pecuniary interest in the debtor’s property and not to matters of public policy.”  Maritan, 203 B.R. at 743 (quoting Eddleman v. U.S. Dep’t of Labor, 923 F.2d 782, 790 (10th Cir. 1991)).  Actions by a governmental unit that represent a direct application of that unit’s police or regulatory powers for the protection of public health and safety are exempt from the automatic stay.  O’Brien, 74 B.R. at 549.  The imposition of sanctions is a direct application of the judiciary’s regulatory powers, which “serve to protect the general public from needless, harassing, and abusive litigation.”  O’Brien, 74 B.R. at 550.  Entering a judgment for sanctions against a debtor who previously engaged in inappropriate, abusive or fraudulent behavior in another court is not engaging any pecuniary interest of the court.  It is merely an exercise in keeping the stream of federal litigation free from unnecessary and abusive legal obstructions.  O’Brien, 74 B.R. at 549.  A Motion for Attorneys’ Fees as a Sanction would also pass the public policy test because the measure is being taken to effectuate the public policy of discouraging bad behavior in court, not adjudicating a private right to recovery.  Maritan, 203 B.R. at 744.

 

The fact that a private party will be benefitting from the continuation of the matter is irrelevant to the cause.  The exemption clearly applies to any proceeding where a governmental entity, a court, is enforcing its regulatory power by applying sanctions.  An exemption for sanctions under § 362(b)(4) extends to “situations where the monetary penalty accrues to the benefit of individuals, rather than to the governmental unit.”  O’Brien, 74 B.R. at 551 (citing E.E.O.C. v. The Rath Packing Co., et al., 37 B.R. 614, 617 (S.D.Iowa 1984)).  In Alpern, a Motion for Rule 11 Sanctions against the debtor was filed by a private person and the fees were to be paid to that private party.  11 F.3d at 690.  The Seventh Circuit held that this was irrelevant because “while the form of sanction is often and was here an order to pay attorney’s fees to the opponent in the litigation, it is still a sanction, just as an order of restitution in a criminal case is a sanction even when it directs that payment be made to a private person rather than to the government.”  Id.  The Seventh Circuit explained that such sanctions “are meted out by a governmental unit, the court,” and therefore exempt under § 362(b)(4).  Id.  In fact, the Seventh Circuit stated that, in this context, the private party filing for sanctions and receiving the monetary award can be seen as a “private attorney general” and “viewed as an agent of the ‘governmental unit’” for the purposes of enforcing the court’s rules.  Id.

 

The overwhelming reason for allowing a Motion for Attorneys’ Fees as a Sanction to proceed during a bankruptcy action is public policy.  “It is the purpose of Section 362(b)(4) to prevent endangerment of the public that would result from permitting a bankrupt to avoid statutes and regulations enacted in furtherance of governmental police powers.”  United States v. Standard Metals Corp., 49 B.R. 623, 625 (D.Colo. 1985).  The public policy advanced by having court-ordered sanctions fall under the § 362(b)(4) exemption is in “preventing the bankruptcy court from becoming a haven for wrongdoers.”  O’Brien, 74 B.R. at 550.  The government’s ability to enforce its laws, rules, and regulations would be “obstructed by the escape mechanism that § 362(a) would provide if . . . enforcement actions would be stayed on the filing of a bankruptcy petition.”  The Rath Packing Co., 37 B.R. at 616-17.  It is in the best interest of the public to disallow a debtor from utilizing the bankruptcy system to avoid punishment for wrongdoings in another action simply by filing a petition.  Allowing an escape by way of bankruptcy would fly in the face of creating the system of sanctioning such inappropriate behavior in the first place.

 

It is clear from not only the plain language of the Bankruptcy Code, but federal case law rulings from around the country, that an individual cannot avoid entry of a judgment for sanctions by filing for bankruptcy.  The governmental entity exemption for enforcement of its police and regulatory power does extend to application of sanctions against a debtor, whether those sanctions be attorneys’ fees or not and whether the benefit is to a private entity or not.

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