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How Reporting a Crime May Subject You to Sanctions

July 11, 2016

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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.

  1. 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.
  2. 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.

 

  1. Prosecuting Authority: 

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.

  1. Creditors:

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.

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Will your claim in bankruptcy withstand the test?

May 18, 2015

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Within the past year bankruptcy courts and federal courts adjudicating bankruptcy appeals have further developed the law governing claims in bankruptcy which are generally governed by Sections 501 and 502 of Title 11 of the United States Code (the “Bankruptcy Code”) and related Federal Rules of Bankruptcy Procedure. Below is a discussion regarding two distinct cases that discuss the validity and priority of claims in bankruptcy.

Consumer Debt Buyers Beware: Think Before Filing A Proof of Claim

The Eleventh Circuit Court of Appeals held that a Chapter 13 debtor could prosecute an adversary proceeding against a consumer debt buyer for violating the Fair Debt Collections Practices Act (“FDCPA”) based on the creditor filing a proof of claim on debt which was uncollectible under the Alabama statute of limitations. Crawford v. LVNV Funding, LLC, 758 F.3d 1254 (11th Cir. 2014).

It appears the Eleventh Circuit’s decision comes in response to a significant increase in the number of consumer debt buyers “armed with hundreds of delinquent accounts purchased from creditors” who are filing proofs of claims on debts which are unenforceable pursuant to state statutes of limitation.

Factual And Procedural Background

Stanley Crawford, the Chapter 13 debtor and plaintiff in the adversary proceeding (“Crawford”) owed a debt in excess of $2,000 to a furniture company (the “Debt”). In September 2001 the furniture company sold the Debt to an affiliate of LVNV Funding, LLC[1]. Crawford’s last transaction on the account related to the Debt occurred in October 2001. Pursuant to Alabama’s three-year statute of limitations the Debt became unenforceable in both state and federal court in October 2004. Ala. Code Section 6-2-37(1).

In 2008, Crawford sought Chapter 13 bankruptcy protection. LVNV filed a proof of claim in attempt to collect from Crawford’s bankruptcy estate even though the Debt had been unenforceable under the Alabama statute of limitations for over four years.

Neither Crawford nor the Chapter 13 bankruptcy trustee objected to LVNV’s proof of claim. The trustee paid LVNV on the Debt from Crawford’s bankruptcy estate. It was not until four years later, in May 2012, that Crawford objected to LVNV’s claim through an adversary proceeding pursuant to Federal Rule of Bankruptcy Procedure (“FRBP”) 3007(b). Crawford alleged that LVNV routinely filed stale claims and that LVNV violated the FDCPA by attempting to collect the time-barred Debt.

The bankruptcy court dismissed Crawford’s adversary proceeding in its entirety. This decision was affirmed by the district court on appeal and subsequently appealed to the Eleventh Circuit which reversed the lower court’s ruling.

 

Fair Debt Collections Practices Act And The Least Sophisticated Consumer Test

The FDCPA is a consumer protection statute which prohibits false, deceptive or unfair debt-collection practices. The FDCPA regulates debt-collectors’ conduct. Note that not all creditors are considered “debt-collectors”. The FDCPA defines a debt-collector as one who, “regularly collects . . . debts owed or due or asserted to be owed or due another.”

Congress provided consumer debtors with a private right of action to enforce the FDCPA’s prohibitions. Debt collectors who violate the FDCPA can be liable for actual damages, statutory damages up to $1,000 and reasonable attorney’s fees and costs.

Pursuant to Section 1692e of the FDCPA, “a debt collector may not use any false, deceptive, or misleading representation or means in connection with the collection of any debt.”

Under Section 1692f, “a debt collector may not use unfair or unconscionable means to collect or attempt to collect any debt.”

The FDCPA does not define “unfair” or “unconscionable”. The Eleventh Circuit has concluded that these terms are vague and ambiguous.  As a result of the ambiguity the Eleventh Circuit has adopted a “least-sophisticated consumer” standard to assess whether a debt collector’s conduct is deceptive, misleading, unconscionable or unfair. The test is not whether the particular consumer involved was deceived or mislead. Instead, the threshold is whether the “least sophisticated consumer” would have been.

Eleventh Circuit’s Analysis

The Eleventh Circuit readily concluded that LVNV maintained a practice of filing time-barred proofs of claims because, unless the debtor or trustee objects, the time-barred claim is automatically allowed under 11 U.S.C. Section 502(a)-(b) and FRBP 3001(f). This results in Chapter 13 debtors paying the debt from his or her future wages as part of the Chapter 13 repayment plan, even though the debt is time-barred and unenforceable.

The Eleventh Circuit opined that a debt-collector’s filing of a time-barred proof of claim creates a misleading impression to a bankrupt debtor that the debt collector can legally enforce the debt. On that basis, the “least sophisticated” debtor may fail to object to the claim. In considering the Bankruptcy Code’s automatic allowance provision, in a Chapter 13 case, an otherwise unenforceable and time-barred debt will be paid from the debtor’s future wages as part of the Chapter 13 repayment plan. This necessarily reduces the funds available for legitimate creditors to recover on enforceable claims. Moreover, requiring a debtor to object to time-barred claims consumes a debtor’s resources, similar to filing a limitations defense in state court.

Eleventh Circuit Holding

The Eleventh Circuit, therefore, held that under the “least sophisticated consumer standard”, LVNV’s filing of a proof of claim for a time-barred Debt was unfair, unconscionable, deceptive and misleading under Sections 1692e and 1692f of the FDCPA.

In reaching this conclusion, the Eleventh Circuit expressly avoided the pending circuit split as to whether the Bankruptcy Code preempts the FDCPA.[2] LVNV did not argue preemption. LVNV only argued that its conduct did not fall under the FDCPA, or, alternatively, did not offend the FDCPA’s prohibitions.

International Treaty Thwarts Administrative Claim

The Bankruptcy Court for the Eastern District of Pennsylvania ruled on an issue of first impression. The Bankruptcy Court held that trade creditors who supplied goods to a debtor prior to its bankruptcy filing were not entitled to administrative priority status of their claims under Bankruptcy Code Section 503(b)(9). The Court reasoned that the goods were “received by the debtor” at the time they were placed on the vessels at Chinese ports, which was more than 20 days before the debtor’s bankruptcy filing. As a result, the debts were general unsecured debts. In re World Imports, Ltd., 511 B.R. 738 (Bankr. E.D. Pa. 2014).

Under Bankruptcy Code Section 503(b)(9) trade creditors who supplied the debtor with goods during the 20-day period prior to the debtor’s bankruptcy filing have administrative priority claims. These creditors can assert an administrative claim for “the value of any goods received by the debtor within 20 days before the date of commencement of a case under this title in which the goods have been sold to the debtor in the ordinary course of such debtor’s business.”

Based on the language in Section 503(b)(9) the date in which the debtor “received” the trade creditor’s goods is imperative. If a debtor is found to have received the goods anytime outside of the 20-day prepetition period, the creditor is only entitled to collect pro rata with other general unsecured creditors.[3]

Factual And Procedural Background

In this case the goods were shipped FOB (Free On Board) to the debtor from Shanghai and Xiamen. The goods were loaded on the vessel at the port of shipment more than 20 days before the debtor’s bankruptcy filing, but the debtor took physical possession of the goods in the United States during this 20-day prepetition period.

The creditors argued before the Bankruptcy Court that, because the Bankruptcy Code does not define the word “receive,” the Court should apply the definition of the term “receipt” found in the Uniform Commercial Code (“UCC”) article regarding the sale of goods. Under the UCC, “receipt” is taking physical possession of the goods. Under this definition, the debtor would have “received” the goods within the 20-day pre-petition period and the trade creditors would have administrative priority claims for the outstanding amounts due and owing.

However, the debtor and the creditors’ committee argued that the UCC’s definition of “receipt” should not apply because the relevant law at issue was international commercial law. Under international law, in a FOB sale, the transfer of the property to the buyer occurred once the goods were put on the ship, not when the buyer subsequently took physical possession of the property. Accordingly, under this theory, the debtor would have “received” the goods when they were first put on the vessels at port in China, before the 20-day prepetition period.

Bankruptcy Court’s Holding and Analysis

The Bankruptcy Court agreed with the debtor and the creditors’ committee and concluded that the debtor “received” the goods when they were placed on the vessels in China. The Bankruptcy Court reasoned that the transactions were governed by the Convention on Contracts for the International Sale of Goods (CISG), not the UCC. Under the CISG the risk of loss or damage passes to the buyer at the time the goods are placed on the vessel at port.

Accordingly, in addressing this issue of first impression, the Bankruptcy Court held that with respect to goods shipped FOB from overseas, the date the debtor “received” the goods is the date when the goods are loaded onto the vessel at the port of shipment, not later when the debtor actually took possession of the goods.

 

[1] LVNV Funding, LLC is among a group of affiliates and defendants in the adversary proceeding referred to here as “LVNV”.

[2] See Simmons v. Roundup Funding, LLC, 622 F.3d 93, 96 (2d Cir. 2010) (bankruptcy Code preempts FDCPA); Walls v. Wells Fargo Bank, N.A. 276 F.3d 502, 510 (9th Cir. 2002) (same); Simon v. FIA Card Ser., N.A., 732 F.3d 259, 271-74 (3d Cir. 2013) (bankruptcy code does not preempt FDCPA); Randolph v. IMBS, Inc., 368 F.3d 726, 730-33 (7th Cir. 2004) (same).

[3] In re World Imports, Ltd. does not address the 45-day reclamation period under 11 U.S.C. § 546(c). However, this section is helpful for trade creditors to consider if their buyer files for bankruptcy protection. Under this section a seller may reclaim its goods from the bankruptcy debtor if: (1) the seller sold goods to the debtor in the ordinary course of the seller’s business; (2) the debtor received the goods while insolvent within 45 days before debtor’s bankruptcy case was commenced; and (3) the seller demands reclamation of the goods in writing (A) not later than 45 days after the date of the debtor received the goods or (B) not later than 20 days after the debtor’s bankruptcy was commenced, if the 45-day period expires after the debtor’s bankruptcy was commenced.

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