Prosecuting Defendants in Bankruptcy

This post summarizes an unusual point of law that recently caught me by surprise, and it’s one which I don’t believe we’ve ever directly covered on the criminal law blog before: the impact of bankruptcy on criminal charges.

After reading that introduction, I know some of you may be tempted to skip this one, but bear with me — whether you’re prosecuting or defending, and whether it’s a complex felony embezzlement case or a simple misdemeanor failure to return rental property, this could potentially be a pretty big deal. (Alternatively, if that’s not enough to hook you, please click through anyway to see a personal announcement at the end of this post.)

Need to Know Basis:

At some point, surely, I was taught the basics of bankruptcy law. A bar exam prep session, at least…? I can’t be certain of that, but I am certain that if I ever did learn about it, that information promptly fled to the back of my mind as soon as I began practicing criminal law in state court. And why wouldn’t it? Bankruptcy is a separate civil proceeding involving federal law, and it takes place in a different set of courts. Any potential impact that process might have on a misdemeanor larceny charge working its way through criminal district court seemed pretty minimal.

Most of the time that will be true, but not always.

The Rule and the Exception:

Criminal practitioners who occasionally work in civil practice (or who were better students in law school) may already be thinking “I’m pretty sure there’s a statute that covers this.” Indeed there is — it’s found in 11 U.S.C. § 362(a), which says that filing a petition under the applicable bankruptcy provisions creates an automatic stay on the commencement, continuation, or enforcement of a wide variety of proceedings against the debtor to recover debts, enforce liens, or obtain property. The broad language of Section 362(a)(1), in particular, would apparently even bar criminal prosecutions against the debtor, since it applies to the commencement or continuation of any “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.”

That tension is resolved by an exception found in the next section, 11 U.S.C. § 362(b)(1), which clarifies that the filing of a bankruptcy petition does not operate as a stay “under subsection (a) of this section, of the commencement or continuation of a criminal action or proceeding against the debtor.” Other exceptions under this subsection likewise allow for the commencement or continuation of other proceedings regarding domestic violence, child custody, license suspensions, the exercise of certain police and regulatory powers, and others. So in a typical criminal case example, the mere fact that the defendant has filed a bankruptcy petition would not bar the state from simultaneously prosecuting him for larceny, fraud, false pretenses, or any other applicable offense, even if the victim would be barred from filing his or her own civil action for damages:

…the automatic stay of Bankruptcy Code § 362(a) does not apply to criminal prosecutions. Section 362(b) provides that “[t]he filing of a [bankruptcy] petition … does not operate as a stay … of the commencement or continuation of a criminal action or proceeding against the debtor.” 11 U.S.C.A. § 362(b)(1). Giving the words of the statute their plain meaning, § 362(b) applies to all criminal actions, regardless of the underlying aim of the prosecution. See In re Gruntz, 202 F.3d 1074, 1085 (9th Cir.2000) (en banc) (“Quite simply, the Bankruptcy Code declares that § 362 does not stay ‘the commencement or continuation of a criminal action or proceeding against the debtor.’ On its face, it does not provide any exception for prosecutorial purpose or bad faith. If the statutory command of the Bankruptcy Code is clear, we need look no further: it must be enforced according to its terms.”).

In re Simonini, 69 Fed. Appx. 169 (4th Cir. 2003). Based on feedback from a few prosecutors who frequently handle financial crimes, my sense is that most of them were generally aware of the law up to this point, but (like me) they were surprised to discover that this exception comes with an important limitation.

The Exception to the Exception (to the Exception):

Notwithstanding the clear language and precedent above, the cases have applied what amounts to a judicially created exception to the statutory exception. The state’s prosecution might not be stayed by the bankruptcy petition, but how did that case first come to light? In the real world, most fraud and financial crimes only come to the attention of law enforcement or prosecutors when they are reported by the victim. But when that victim is the creditor in the bankruptcy case, he or she is actually barred from seeking out criminal charges as an alternative means to try to collect the debt after a bankruptcy petition has been filed. See, e.g., In re Heeley, Case No. 14–03291–5–DMW (Bankr. E.D.N.C. Dec. 11, 2014) (creditor violated the stay by referring matter to worthless check program for prosecution); In re Negrete, Case No. 07–00540–9–JRL (Bankr. E.D.N.C. Aug. 10, 2009) (once a debtor files a bankruptcy petition, a creditor may not subsequently approach a prosecutorial entity to prompt a criminal action to recover debt without violating the automatic stay).

However, there is also an exception to the exception to that exception, in the sense that if the creditor had already approached a law enforcement agency or prosecutor’s office about criminal charges before the bankruptcy petition was filed, then the automatic stay would not apply, even if it were true that the creditor’s (or the prosecutor’s) primary motivation was only to collect the same debt at issue in the bankruptcy proceedings:

Practically speaking, the import of the court’s decision is that once a debtor files a petition for bankruptcy, a disgruntled creditor may not then approach a governmental prosecutorial entity in order to prompt a criminal action to recover the debt. If the creditor already has complained to authorities by the time a petition is filed, those authorities may commence or continue a criminal prosecution, even one intended to result in direct restitution to the victim/creditor, as they see fit. But if the debtor files for bankruptcy before a creditor complains to prosecuting authorities, that complaint—though it may still, in the discretion of prosecutors, result in a criminal prosecution—may constitute a violation of the automatic stay or discharge injunction.
The court concludes that governmental prosecutors may initiate and continue criminal prosecutions without violating the automatic stay even if, as in this case, the primary purpose of the prosecution is to collect a dischargeable debt.
The court finds further that a creditor or other entity (other than a governmental prosecutor) violates the stay if it initiates criminal proceedings after a bankruptcy petition is filed and if the primary purpose is to collect a dischargeable debt.

In re Byrd, 256 B.R. 246 (Bankr. E.D.N.C. Nov. 16, 2000).

All clear? Let’s look at a couple examples.

First, imagine a creditor who believes he is owed several hundred dollars in back rent from a debtor, and he has been unsuccessful in collecting that money after receiving a check that was rejected for insufficient funds. Despite having notice that the debtor has filed a bankruptcy petition, an agent of the creditor then seeks criminal charges related to the worthless check through the magistrate’s office instead of participating in the bankruptcy process. Another creditor with claims against the same debtor for a few thousand dollars (and knowledge of the pending bankruptcy case) also files a complaint with the police in an attempt to recover restitution, resulting in criminal charges of embezzlement against the debtor and leading to her arrest. Similar facts were at issue in the related cases of In re Kimbler, 618 B.R. 437 (Bankr. E.D.N.C. 2020) and In re Kimbler, 624 B.R. 774 (Bankr. E.D.N.C. 2020), and in both cases the court found that the creditors violated the automatic stay and acted with the primary motivation of circumventing that stay to recover the money owed. On their original claims of less than $5,000 in total, the creditors were hit with sanctions, attorneys’ fees, and punitive damages that added up to nearly $60,000.

While acknowledging that “the State Court was not stayed in prosecuting the Criminal Action against the Debtor,” the Kimbler courts concluded that sanctions against the first creditor were appropriate because “a creditor’s criminal referral of a worthless check debt, whether motivated in whole or in part by a hope of getting reimbursed, constitutes a violation of the automatic stay” and without the creditor’s “intent to collect the pre-petition debt, the Criminal Action would never exist.” Kimbler, 624 B.R. at 779, 780-81. As for the second creditor’s case, the court found a similar violation by the creditor and further opined in a footnote that “a more astute District Attorney’s office would more likely have inquired about the bankruptcy and mitigated some of the damages the Debtor incurred.” Kimbler, 618 B.R. at 442, fn. 10. For officers, magistrates, and prosecutors, the takeaway from those cases is that even if a criminal prosecution prompted by a creditor acting in violation of the stay is technically possible, as a practical matter it may end up putting the alleged victim in a far worse position than if the matter had been left to the bankruptcy court.

For a contrary example, imagine a creditor who has lent money to a debtor for a real estate development, but the repayment falls through. After doing some digging the creditor believes it to be part of a pattern of fraud, and “wishing to see that justice was done and that the Debtor was prevented from defrauding others” he presents the matter to the District Attorney, who files criminal charges. Subsequently, the debtor files for bankruptcy. On similar facts, the court in In re Gherini, Case No. 11–08087–8–RDD (Bankr. E.D.N.C. 2014) concluded that the creditor was obviously pursuing criminal charges based on a sense of “public duty to prevent further frauds being perpetrated on the public, and to see that justice was done, full well knowing that recovery of any amount from the Debtor was most likely impossible” and furthermore had “made contact with the District Attorney several months prior to the filing of the bankruptcy petition.” Gherini at 2-3.Therefore, the creditor was not barred from presenting the matter to the authorities for investigation and prosecution, nor was the state barred from commencing or continuing any criminal action resulting from it. Id.

In short, whether it’s a part of the initial complaint intake, charging decision evaluation, or early court proceedings, it may be beneficial to all parties involved if someone simply remembers to ask: “by the way, before we go any further, is there anything happening in bankruptcy court with this matter?”

One Final Announcement:

After making it through this topic, readers can decide for themselves whether this is good news or bad news, but I wanted to close by saying that this will likely be my last regular post on the blog.

Since coming to the School in 2017, I have had the privilege of being one of those rare people who could honestly say that he loved his job, and I am enormously grateful for the opportunities, support, and friendship I have experienced here. In a few weeks I will be stepping away from my current role as Prosecutor Educator, but I won’t be going too far. I am very honored to be joining the North Carolina Conference of District Attorneys as their new Director of Training, where I hope to continue serving and advising prosecutors for many years. To all of the staff, colleagues, and legal professionals who made my time here at the School so enjoyable, thank you, and I look forward to continuing to work with you in my new role.

Take care, and thanks so much for reading.