You are a creditor and your loan is secured by personal property, let’s say equipment. The borrower recently filed for bankruptcy protection. You receive a phone call from a friend advising you that someone has a moving truck outside the borrower’s business location and it looks like they are stealing equipment. You don’t know who is moving the equipment — but you do know it’s without your permission and in violation of the security agreement. You are furious. You think a crime is being committed and you want tell the appropriate authorities. You call the police, file a police report and hope the police will recover the equipment so your collateral remains intact. A few weeks later, the chapter 11 debtor files an action against you for willful violation of the automatic stay and requests sanctions again you under 11 U.S.C. 362(k)(1)! Will you have to pay sanctions?
Believe it or not, the answer may be yes.
Most business professionals know about the automatic stay under 11 U.S.C. 362. When a debtor files for bankruptcy protection, a creditor may not take any action to collect on its debt without a court order granting it relief from stay. One exception to the automatic stay is the “commencement or continuation of a criminal action or proceeding against the debtor” but that exception is not absolute. 11 U.S.C. 362(b)(1). Litigation over this exception generally arises over whether a particular proceeding is in fact a “criminal action or proceeding,” or is it really just a disguised attempt to collect a debt.
Courts have taken two positions on this issue.
Prosecuting Authority Pursuing Criminal Charges: The first is that a criminal proceeding initiated by a prosecuting authority is excepted from the stay, regardless of whether the proceeding results from the debtor’s failure to pay a debt.
Creditor Pursuing Criminal Charges: The courts are split on whether a creditor may pursue criminal charges after a bankruptcy has been filed. Some courts consider the creditor’s motivation for initiating the criminal prosecution: if the creditor did so to collect a debt rather than to benefit the public good, the action violates the stay. Courts that consider the creditor’s motives generally apply a “stringent” test that finds a stay violation only when the creditor’s primary motive was to collect its debt.
The 9th Circuit provides the leading authority on Section 362(b)(1), in County of Los Angeles v. Gruntz (In re Gruntz), 202 F.3d 1074 (9th Cir. 2000) (en banc). Before Gruntz, a criminal proceeding did not fall under the 362(b)(1) exception if the purpose of a criminal proceeding was to collect upon a financial obligation. Hucke v. State of Oregon, 992 F.2d 950, 953 (9th Cir. 1993). The Ninth Circuit in Gruntz overruled Hucke and held that Section 362(b)(1) applies to all criminal proceedings regardless of whether there is a financial element. 992 F.2d at 1085-86. Several other courts around the country follow this ruling. See, e.g., Weary v. Potent (In re Poteat), 2015 WL 4747883, *4 (E.D. Tenn. 2015); In re Dunn, 2013 WL 1091737, *7 (Bankr. E.D. Tenn. 2013); Simonini v. Bell (In re Simonini), 69 F. App’x 169, 170-71 (4th Cir. 2003); In re Bartel, 404 B.R. 584, 590-91 (BAP 1st Cir. 2009).
While that long standing principle is clear enough, Gruntz did not address the issue of criminal proceedings vis-à-vis non-governmental actors. Rather, Section 362(b)(1) is limited to only governmental entities. Weary v. Poteat (In re Poteat), 2015 WL 4747883, *4 (E.D. Tenn. 2015); Bender Industrial Group, Inc. V. Herbert (In re Herbert), 2015 WL 1579575, *3 (Bankr. D. Or. 2015) see also Heath v. Alabama, 474 U.S. 82, 88 (1985) (“The dual sovereignty doctrine is founded on the common-law conception of crime as an offense against the sovereignty of the government”). The Herbert bankruptcy court reviewed the Ninth Circuit’s opinion in Gruntz and several other authorities, observing that Gruntz refers to state sovereignty several times, and most importantly specifically states that the parties to a criminal proceeding are between the state and the accused. Herbert, at *3.
In In re Byrd, 256 B.R. 246 (Bankr. E.D.N.C. 2000), the court addressed Section 362(b)(1) as it pertains to a creditor. Byrd involved a violation of the discharge injunction (which is not materially different than a violation of the automatic stay). In that case, the debtor negotiated two checks pre-petition. While the debtor’s civil liability was discharged, the debtor was subsequently arrested and required to repay the creditor in full to be released from custody. The bankruptcy court ruled that Section 362(b)(1) did not protect the creditor, but nonetheless concluded that the creditor did not violate the discharge injunction because the creditor did not take any affirmative action to collect on his debt.
Conversely, the bankruptcy court in Pearce v. E.L.W. Corp. (In re Pearce), 400 B.R. 126 (Bankr. N.D. Iowa 2009), sanctioned a creditor who filed a post-petition criminal complaint for non-payment of a pre-petition debt. The court ruled that every creditor has a right under Section 523 to seek to except a debt from a debtor’s discharge or object to discharge under Section 727, but a creditor cannot utilize the criminal process to improve its position at the expense of other creditors. Pearce, 400 B.R. at 132.
The Nevada bankruptcy court reached a similar conclusion as the courts in Byrd and Pearce. See Fidler v. Donahue (In re Fidler), 442 B.R. 763 (Bankr. D. Nev. 2010). While the Court did not enjoin the criminal prosecution, it left the bankruptcy court open to determine whether the creditor violated the bankruptcy discharge.
There are courts that hold that a creditor does not violate the automatic stay when it reports a crime to the police or applies for a criminal warrant that would initiate a criminal complaint pursuant to state law. In re Dunn, 2013 WL 1091737 at *2 (Bankr. E.D. Tenn. 2013). In Dunn, the bankruptcy court recognized the split of authority among the courts. While the Court believed the facts created a close question, it was ultimately persuaded that it should apply the unambiguous language of § 362(b) to except all criminal proceedings from the automatic stay regardless of who initiated the criminal proceeding or the purpose for which the proceeding was brought. It noted that “Congress was capable of being very specific when it intended to be.” Id. at *7. Interestingly, the District Court in Tennessee in Poteat (2015 WL 474883 *5) recognized the bankruptcy court’s reasoning in Dunn. It accepted the Dunn holding but distinguished it by stating “to the extent that the criminal prosecution exception of subsection (b)(1) covers the actions of private parties, the scope of the exception is limited to conduct that fundamentally advances the important state interest at stake – the commencement or continuation of a criminal action or proceeding.” Poteat, *5. However, the § 362(b) exception does not apply to an action beyond that purpose to include collecting a debt.
It appears that if a creditor is accused of violating the automatic stay (or discharge injunction) by initiating a criminal complaint or proceeding, then at least some bankruptcy courts will require the creditor to prove that it did not intend to collect on its debt when it initiated the criminal prosecution. Whether the creditor’s intent is ultimately exonerated, it will require the creditor to defend itself before a bankruptcy court, which will likely include an expenditure of attorney’s fees, cost, and attendant risk.
Word to the wise: if a creditor is truly concerned about its collateral, the safest avenue is to bring the issue to the attention of the bankruptcy court or bankruptcy trustee as soon as possible.