It is widely known that one of the basic tenets of U.S. bankruptcy law is the imposition of the automatic stay under section 362(a) of the Bankruptcy Code to provide a debtor with the proverbial “breathing spell” from collection efforts and allow a debtor to discharge its prepetition debts. But what happens when creditors attempt to circumvent this prohibition to leverage payment on their existing prepetition debts? The Sixth Circuit Court of Appeals recently had the opportunity to rule on such an instance in Weary v. Poteat where a creditor attempted to invoke the criminal prosecution exception to the automatic stay in hopes of leveraging payment on his outstanding debt. As you will see, however, the Court of Appeals was having none of it.
Prior to the commencement date, the debtor rented property from a landlord in Hendersonville, Tennessee. Some time after the debtor defaulted on her rent and moved out of the rental property, the landlord filed a civil action in Tennessee state court seeking approximately $25,000 in past due rent. A month later, the debtor filed for chapter 7 bankruptcy protection in the United States Bankruptcy Court for the Eastern District of Tennessee. After receiving notice of the bankruptcy filing and the imposition of the automatic stay pursuant to section 362(a) of the Bankruptcy Code, the landlord sent letters to both the debtor’s attorney and her mother in which he acknowledged that he could no longer pursue remedies in the civil action but expressed his intention to pursue criminal charges against the debtor which, according to the letters, would ultimately be far more costly for the debtor. The letters further stated that the debtor would face substantial jail time and intimated that she might lose her position as a public school teacher.
In response, the debtor moved the bankruptcy court to hold the landlord in contempt for violating the automatic stay. In his defense, the landlord argued that his letters, which he asserted communicated his intent to pursue criminal prosecution, came within the criminal prosecution exception to the automatic stay under section 362(b)(1) of the Bankruptcy Code. Section 362(b)(1) exempts from the automatic stay the “commencement or continuation of a criminal action or proceeding against the debtor.” The bankruptcy court first noted that, although the automatic stay does not prohibit all communications from a creditor to a debtor, “a stay violation is made out by actions that are coercive or harassing in nature.” The court then observed that the landlord’s letters were not in the nature of a criminal prosecution but rather, they communicated a threat to pursue prosecution, and the “spirit and motivation” behind the letters demonstrated that they served no other purpose other than “to threaten, harass and intimidate the Debtor in an effort to coerce her into paying him.” After examining a number of factors, including the landlord’s sophistication, ability to pay, and demeanor (which the court characterized as “open defiance of the stay”), the bankruptcy court imposed punitive damages again the landlord in the amount of $7,500.
On appeal to the district court, the landlord asserted that the bankruptcy court erroneously applied an “expanded interpretation” of the section 362(b)(1) criminal prosecution exception by considering the purpose for which the landlord intended to pursue criminal charges against the debtor. The district court, however, displayed little sympathy for the landlord and affirmed the bankruptcy court’s decision. The district court explained that the bankruptcy court did not hold the landlord outside the protection of the exception because his intention to pursue criminal charges was motivated by his desire to collect on the debt owed to him, but rather the bankruptcy court found fault because the landlord’s letters, which were not in furtherance of any criminal prosecution, were “a thinly veiled attempt to coerce payment of the debt, violating [the debtor’s] ‘breathing spell’ from collection efforts.”
The district court also rejected the landlord’s argument that the bankruptcy court’s decision amounted to an infringement on his First Amendment right to petition for redress or grievances. The district court explained that “the automatic stay does not restrain [the landlord’s] freedom to pursue criminal charges with the local governmental authorities, but it does restrain his freedom, as a creditor, to communicate a threat to the debtor, based on the possibility of criminal prosecution, in order to induce payment.” Undeterred, the landlord appealed to the Sixth Circuit Court of Appeals.
As the landlord did not challenge the bankruptcy court’s findings that the purpose of his letters was to coerce payment from the debtor, that they had been sent with knowledge of the imposition of the automatic stay, and that the circumstances of the case (i.e., the willfulness of the landlord’s violation and his manifest defiance of the stay) justified an award of punitive damages, the Court of Appeals quickly found no error with the bankruptcy court’s ruling as affirmed by the district court.
With respect to the landlord’s contention that his letters were expressions of intent to exercise his right to pursue criminal charges, the Court of Appeals found that the communications “indisputably did not advance criminal prosecution and, therefore, do not come within the plain language of the exception.” The Court of Appeals further held that because the communications were found to be a threat with the purpose to induce payment, a finding the landlord had not challenged, they “clearly ran afoul of the plain language of the automatic stay, prohibiting ‘any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the bankruptcy cases.’” The Sixth Circuit similarly dismissed the landlord’s First Amendment argument in short order both for failing to cite to any authority in support of his position and also failing to explain how his right to legitimately pursue charges against the debtor with local authorities would be hindered by the bankruptcy court’s order.
Behind the automatic stay is a clear policy rationale to grant temporary relief to the debtor from creditors, and also to prevent dissipation of the debtor’s assets before an orderly distribution to creditors can be effected. Although the Bankruptcy Code provides certain exceptions to the automatic stay, those exceptions are limited and creditors should think twice about invoking those exceptions in an attempt to leverage or coerce payment on their prepetition debts.
Sec. 362. Automatic stay
(a) Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303 of this title, or an application filed under section 5(a)(3) of the Securities Investor Protection Act of 1970, operates as a stay, applicable to all entities, of -
(2) the enforcement, against the debtor or against property of the estate, of a judgment obtained before the commencement of the case under this title;
(3) any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate;
(4) any act to create, perfect, or enforce any lien against property of the estate;
(5) any act to create, perfect, or enforce against property of the debtor any lien to the extent that such lien secures a claim that arose before the commencement of the case under this title;
(6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title;
(7) the setoff of any debt owing to the debtor that arose before the commencement of the case under this title against any claim against the debtor; and
(8) the commencement or continuation of a proceeding before the United States Tax Court concerning a corporate debtor's tax liability for a taxable period the bankruptcy court may determine or concerning the tax liability of a debtor who is an individual for a taxable period ending before the date of the order for relief under this title.
Sec. 362. Automatic stay
. . . (b) The filing of a petition under section 301, 302, or 303 of this title, or of an application under section 5(a)(3) of the Securities Investor Protection Act of 1970, does not operate as a stay-
(1) under subsection (a) of this section, of the commencement or continuation of a criminal action or proceeding against the debtor[.]