Bankruptcy is a process that permits people to discharge debts, but not all debts are dischargeable. In a recent opinion, the U.S. District Court for the Eastern District of Michigan (the “District Court”) reversed a U.S. Bankruptcy Court for the Eastern District of Michigan (the “Bankruptcy Court”) ruling that a state court criminal restitution claim is dischargeable.

THE BACKGROUND FACTS

The case involves Dean J. Smith (“Smith”), who was involved in a road rage incident with Angela Seidel (“Seidel”). According to the District Court, Smith injured Seidel during the incident and was criminally charged and pled no contest. As part of his sentencing, Smith was ordered to pay restitution, as required by the Michigan constitution, in the amount of $76,427.20.

The restitution was to be paid to the Midland (Michigan) County Clerk, who would distribute it to Seidel or her insurer, Auto Owners Insurance Company (“Auto Owners”), to the extent that Auto Owners paid for Seidel’s bills for medical treatment.

Shortly thereafter Smith filed for Chapter 7 bankruptcy. He listed Seidel, Auto Owners and the 42nd Circuit Court for Midland County as creditors, but they did not appear or object. Smith received a discharge.

Auto Owners paid Seidel’s medical expenses in full and an order was entered amending the previous restitution order, ordering Smith to pay the outstanding restitution amount directly to Auto Owners. Smith then moved to re-open his bankruptcy case and filed a motion alleging that Auto Owners had violated the automatic stay by taking actions to collect the restitution debt.

The Bankruptcy Court directed that an adversary proceeding be filed. Auto Owners moved for summary judgment on the basis that state court criminal restitution orders are non-dischargeable debts pursuant to 11 U.S.C. section 523(a)(7), which provides that a debtor is not discharged from a debt “to the extent such debt is for a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit, and is not compensation for actual or pecuniary loss….” The Bankruptcy Court denied the motion, reasoning that the restitution was not for the benefit of a governmental unit and was compensation for an actual pecuniary loss. Auto Owners appealed.

THE APPEAL

On appeal the District Court reviewed the Bankruptcy Court’s decision to deny summary judgment. It began by noting that, despite the narrow language of Bankruptcy Code Section 523(a)(7), in the case of Kelly v. Robinson, 479 U.S. 36 (1986) “the United States Supreme Court has held that restitution arising from state criminal conviction falls within this exception to dischargeability.”

Two factors influenced the Supreme Court’s decision in Kelly. First, the Supreme Court noted that, under the Bankruptcy Act of 1898, courts had refused to discharge restitution arising from criminal sentences, and Congress had not expressed any intention to change the interpretation of this judicially created concept. Second, the Supreme Court recognized that the right to create and enforce penal sanctions is part of the sovereignty retained by the states. Therefore, the Supreme Court expressed its “deep conviction that federal bankruptcy courts should not invalidate the results of state criminal proceedings.”

Based on Kelly, the District Court reversed the Bankruptcy Court and ordered that Smith’s restitution is nondischargeable. In so doing, the District Court distinguished cases involving civil restitution awards given that “civil restitution is intended only to resolve disputes between two or more parties.” Criminal restitution, on the other hand, “is for the benefit of society as a whole.” Cases that involve criminal restitution, therefore, implicate “the strong interests that sovereign states have in formulating and enforcing their own criminal justice systems that drove the Supreme Court’s decision in Kelly.”