Court Rules That Regulatory Actions Can Violate the Stay, Especially When You Say You Are Trying to Collect a Debt

An opinion from San Antonio Bankruptcy Judge Leif Clark examines when a claim against a non-debtor can violate the automatic stay. The short answer is: when the creditor says he is doing it to collect from the debtor. The long answer requires an examination of the interplay between 11 U.S.C. Sec. 362(a)(1) and 362(b)(4). In re Reyes, No. 10-52366-C (Bankr. W.D. Tex. 4/20/11). You can read the opinion here.

What Happened

The Reyes case arises from a real estate transaction gone bad. Josie Jones sued real estate broker Liza Reyes in state court and recovered a judgment. The Court succinctly described what happened next:

After the verdict was rendered, Jones and her lawyer, Robert Wilson, met with the debtor in a conference room at the courthouse. There, the debtor informed Wilson that they intended to file for bankruptcy. In response, Wilson, in the hearing of not only the debtor but also members of the debtorʼs family, told the debtor that he would “run them out of business by filing a complaint with the TREC (Texas Real Estate Commission) and close them down to get the money.” After the debtor filed for bankruptcy, Wilson, true to his word, filed a complaint in September 2010, on behalf of his client, with the TREC. The complaint took a number of months to prepare, and Wilson billed his client for the service. The TRECʼs procedures do not require a pre-investigation as a prerequisite to instituting such a complaint. Instead, the filing of the complaint itself necessitates an investigation by the Commission. If such an investigation results in a determination of wrongdoing on the part of the agent, and if a finding of damages is made, then the the TREC may make a monetary award to the complaining witness, and may subsequently seek reimbursement from the agent in the amount of the award. Wilson is well aware of these rules and procedures, this being one of his areas of practice.

Opinion, pp. 1-2.

The Debtors filed a Motion for Contempt against Jones and her attorney for violating the automatic stay by filing the Complaint with TREC. The Bankruptcy Court agreed with the Debtors and ruled that the stay had been violated.

The Automatic Stay By the Numbers

Among other things, the automatic stay prohibits:

(1) the commencement or continuation . . . of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case;

* * *

(6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title.

It is clear that the respondents commenced an administrative proceeding that could have been commenced before the commencement of the case and that the claim against the Debtor arose before the commencement of the case. More difficult is the question of whether it was a proceeding to recover a claim against the debtor.

The Court answered this question in the affirmative, but only after an extensive discussion of whey the exception to the automatic stay of Sec. 362(b)(4) did not apply. Sec. 362(b)(4) allows

the commencement or continuation of an action or proceeding by a governmental unit . . . to enforce such governmental unit's police and regulatory power . . .

Notably, Sec. 362(b)(4) does not allow a private party to commence an action to enforce a governmental unit's police and regulatory power. Additionally, the Court found it significant that the TREC was required to act on the complaint.

Here, by contrast, the filing of a complaint that stated the requisite grounds for an investigation commences such an investigation, without any independent discretion on the part of the Commission. The TREC had no independent choice in the matter once that complaint was filed. The institution of an action that necessarily required further prosecution was not the mere discharge of a public duty, . . . .

Opinion, p. 8.

Further, the Court found that Ms. Jones, who lives in California, was unlikely to be motivated by a desire to protect Texas residents from unethical real estate brokers, and was more likely to be motivated by collection of money.

The Court ultimately found that the respondents were using the TREC as a vehicle to recover a claim against the debtor. Judge Clark stated:

The filing of this complaint is more correctly viewed as Wilsonʼs following up on his threats -- and his hope to recover his judgment from the debtor indirectly, by way of the TREC. Viewed that way, Jonesʼ initiation of this complaint, carefully crafted by Wilson, is better understood as the commencement or continuation of a proceeding against the debtor to collect on a prepetition debt, in violation of section 362(a)(1).

Opinion, p. 9.

What Does It All Mean?

Does collection of a judgment "from the debtor indirectly" violate the automatic stay? It is black letter law that the automatic stay does not protect non-debtors. Thus, absent the Sec. 1301 co-debtor stay, a creditor is free to proceed against a guarantor or other co-obligor after the debtor has filed bankruptcy. This raises the question of how the TREC is different from any other party who might be jointly or contingently liable on a debt of the debtor.

The Court stated that "(t)he TREC . . . does have the authority to compel payment from the debtors" but did not fully explain that statement. Under Texas law, a person who recovers a judgment against a license or certificate holder for a prohibited practice, may apply for payment from the Texas Real Estate Recovery Trust Account. Tex. Occ. Code Sec. 1101.612. The TREC may revoke a license "if the commission makes a payment from the real estate recovery trust account to satisfy all or part of a judgment against the license or registration holder " and that "a person is not eligible for a license or certificate until the person has repaid in full the amount paid from the account for the person, plus interest at the legal rate." Tex. Occ. Code Sec. 1101.655(a) and (c).

Thus, the Court is correct that the TREC could coerce repayment of amounts paid from the real estate recovery trust account by revoking the debtor's license until the amount was repaid. However, it is unclear that they could do so while the Debtor was in bankruptcy. Sec. 362(b)(4) allows a governmental unit to enforce a judgment "other than a money judgment." Thus, it seems likely that the TREC could not revoke the debtor's license for failure to repay the real estate recovery trust account. Further, Sec. 525(a) states that a governmental unit may not revoke a license based on failure to pay "a debt that is dischargeable in the case under this title."

Sec. 525(a) may provide the glue that holds the court's opinion together. The TREC may revoke a license for failure to pay a nondischargeable debt. The Texas Occupations Code provides that in order to recover from the real estate recovery fund "the person shall verify to the commission that the person has made a good faith effort to protect the judgment from being discharged in bankruptcy."

In this case, the respondents had filed a complaint to determine dischargeability but had not yet proceeded to trial. Had the respondents first obtained a nondischargeable judgment and then filed a complaint with TREC, there would have been no violation. The automatic stay terminates upon entry of the discharge and the discharge does not apply to nondischargeable debts. Here, the respondents jumped the gun. Rather than waiting until they had a nondischargeable judgment, they acted immediately to take actions which would have threatened the debtor's livelihood by threatening her license.

It was a matter of timing rather than a matter of absolute prohibition. It was also really foolish for the lawyer to tell the debtor in the hearing of multiple witnesses that he would "run them out of business by filing a complaint with the TREC and close them down to get the money."

Implications for Hot Check Cases

It is an open secret in Texas that County Attorneys' offices act as a collection agency for merchants who received dishonored checks. It is also quite clear that the automatic stay does not apply to "the commencement or continuation of a criminal action or proceeding against the debtor." 11 U.S.C. Sec. 362(b)(1). Therefore, it is clear that the County Attorney does not violate the automatic stay by filing hot check charges.

However, under the logic of Reyes, it is intriguing to ask whether the merchant who initiates hot check charges as a debt collection device could be held liable for violating the stay. The difference between subsections (b)(1) and (b)(4) may provide the answer. Sec. 362(b)(4) is limited to actions by governmental actions, while 362(b)(1) is not. Thus, if hot check charges are criminal actions, a private party may initiate hot check charges without violating the stay. They only way around that would be to say that hot check charges are not legitimate criminal actions at all, but are really debt collection actions in substance. Unfortunately, telling a state what it can and cannot criminalize probably runs afoul of the Constitution.