Bankruptcy may not shield remediation of deteriorated properties

The treatment of Health and Safe Code Receiverships under the Bankruptcy Code There are numerous exceptions and exemptions to the automatic stay under 11 U.S.C. §362. In the case of health and safety receiverships, bankruptcy courts have determined that receiverships may continue, despite the automatic stay provisions, on the grounds that 11 U.S.C. §362 should not apply to a receivership, or in the alternative, that relief from stay is warranted for cause. A Health and Safety Receiver A receiver can be appointed in substandard housing cases in order to address unsafe conditions that pose a danger to the health and safety of residents or the public. California Health & Safety Code §17980.7 permits the appointment of a receiver where the substandard conditions at a property are determined to "substantially endanger the health and safety of the public, and the property owner has been unable or unwilling to remediate those conditions." (County of Sonoma v. Quail (2020) 56 Cal.App.5th 657, 672.) Once appointed, the health and safety receiver takes control of the property, and with the appointing court's authorization, attempts to abate the nuisance conditions. (Id.; Cal. H & S Code §§17980.6, 17980.7.) The receiver will follow the court's orders to bring the property up to code. Specifically, the receiver will hold assets for the court, while the owner of the substandard property and their agents are enjoined from collecting rents from tenants, interfering with the receiver, and encumbering or transferring the substandard property. (Cal. H & S Code §17980.7(c)(3).) The Bankruptcy Petition and the Automatic Stay After a health and safety receiver is appointed, the property owner may file a petition for bankruptcy relief. Upon the filing, the automatic stay provisions of 11 U.S.C. §362 come into effect, and actions involving property of the estate are generally stayed. However, bankruptcy courts have held that a health and safety receiver may continue to address the property violations on the grounds that 11 U.S.C. §362 should not apply to the receivership, or in the alternative, that relief from stay is warranted for cause. First, a receivership can be exempt from the automatic stay because it is an enforcement of a governmental unit's police and regulatory powers, which is specifically exempted under 11 U.S.C. §362(b)(4). Bankruptcy Code §362(b) provides that the filing of a petition does not operate as a stay as follows: [U]nder paragraph (1), (2), (3), or (6) of subsection (a) of this section, of the commencement or continuation of an action or proceeding by a governmental unit... to enforce such governmental unit's or organization's police and regulatory power, including the enforcement of a judgment other than a money judgment, obtained in an action or proceeding by the governmental unit to enforce such governmental unit's or organization's police or regulatory power[.] In Lockyer v. Mirant Corp. (9th Cir. 2005) 398 F.3d 1098, the Ninth Circuit determined that a suit comes within the exception of §362(b)(4) if it satisfies either the "pecuniary purpose" or "public purpose" test. (Id. 1108-1109.) Under the "pecuniary purpose" test, "the court determines whether the [government] action relates primarily to the protection of the government's pecuniary interest in the debtors' property or to matters of public safety and health." (Id. at 1108, citing NLRB v. Continental Hagen Corp. (9th Cir. 1991) 932 F.2d 828.) "If the suit seeks to protect the government's pecuniary interest, the §362(b)(4) exception does not apply. However, if the suit seeks to protect public safety and welfare, the exception does apply." (Id. at 1109.) Moreover, under the "public purpose" test, the court analyzes if the government seeks to "effectuate public policy" or to adjudicate "private rights." (Id., citing NLRB, 932 F.2d at 833.) "If the government seeks the former, the exception applies; if the government seeks the latter, it does not." (Id.) In a health and safety receivership, the receiver is appointed because the property is in a condition which substantially endangers the health and safety of the public pursuant to Health & Safety Code §17980.6. Accordingly, a health and safety receiver's appointment could meet the "pecuniary purpose" and "public purpose" tests employed in the Lockyer case. The ability of state and local governments to regulate the safety of its properties is an important exercise of their police or regulatory powers, and therefore, an action in which a health and safety receiver is appointed could be considered exempt from the automatic stay pursuant to §362(b)(4). Alternatively, a bankruptcy court can also determine that a health and safety receivership should be granted relief from the automatic stay for "cause" under 11 U.S.C. §362(d)(1). Specifically, even if a bankruptcy court determined that a health and safety receivership is automatically stayed by §362(a), since a health and safety receiver is appointed to abate public nuisance conditions at a property to protect public safety and welfare, this could provide sufficient grounds for a bankruptcy court to grant relief from stay under §362(d)(1). This basis is particularly appropriate when a receiver's intended work in the receivership is not to enforce a money judgment, but to protect the health and safety of citizens. Recently, bankruptcy courts in the Central and Eastern Districts of California have issued orders confirming these findings. The courts' rulings have acknowledged that the automatic stay did not appear to apply to the health and safety receivership actions under the "police powers" exception in §362(b)(4), and alternatively, if the automatic stay did apply, there appeared to be "cause" for relief from the stay as the health and safety receiver needed to proceed with the remediation of conditions at the property that were dangerous to its occupants and the surrounding community. These rulings highlight that if a property owner files for bankruptcy relief after a health and safety receiver is appointed to remediate conditions at a property, there is a valid basis for the health and safety receivership to continue to complete the remediation work as directed by the appointing court. Byron Z. Moldo is a partner and Sonia Singh is an associate in the Bankruptcy, Receivership and Creditors' Rights Department at Ervin Cohen & Jessup LLP.