The Bottom Line

The reach of regulatory oversight over bankrupt entities has become blurred in recent years, especially following some of the decisions in Chrysler and General Motors cases that limited the states’ police powers when actions were brought that could benefit private parties.  In a recent decision, however, the Fifth Circuit in In re Halo Wireless, Inc., Case No. 12-40122, 2012 WL 2212429 (5th Cir. June 18, 2012), upheld the continuation of privately initiated proceeding brought before public utility commissions (“PUC”) against Halo Wireless (“Halo”) alleging improper use of their networks and nonpayment of fees to customers, holding that such proceedings fell within the exception under to the automatic stay under section 362(b)(4) of the Bankruptcy Code.  This decision strengthens the arguments of regulators when assessing whether their administrative proceedings – especially over claims brought by private parties under the applicable state regulations – can proceeding post-bankruptcy.

What Happened

Texas and Missouri Telephone Companies, TDS Communications Corp., and the AT&T Companies (the “Telephone Companies”) initiated twenty regulatory proceedings in state PUCs against Halo. The Telephone Companies alleged that Halo was improperly using their telecommunications networks without an interconnection agreement and was not paying them required access fees. As a result of the various PUC proceedings, Halo commenced chapter 11 cases in August 2011 to stay these matters.

The Telephone Companies moved for a ruling that the PUC proceedings are exempt from the automatic stay under 362(b)(4) of the Bankruptcy Code as regulatory proceedings brought by governmental units.  The bankruptcy court granted the request, holding that the PUC proceedings fell outside of the automatic stay, but cautioning that the PUCs could not liquidate the claims against Halo, nor could they take any action affecting the debtor-creditor relationship between Halo and any creditor or potential creditor.  Halo appealed the bankruptcy court’s ruling directly to the Fifth Circuit.

On appeal, the Fifth Circuit upheld the decision that the exemption applied.  Two issues were addressed.  First, are the proceedings commenced by private parties being “continued by” a governmental unit?  This question arose because, even though the actions against Halo were being prosecuted by the PUCs, which are governmental units, they were initiated by the Telephone Companies.  Second, if proper governmental proceedings, are the proceedings in furtherance of the states’ police and regulatory powers.  On this second issue, the Fifth Circuit explained that courts use two related tests to determine whether a proceeding falls under the governmental unit exception to the automatic stay – the  “pecuniary purpose test” and the “public policy test.” The pecuniary purpose test examines whether the government action seeks to protect a pecuniary interest in a debtor’s property (which type of action is stayed) or to protect the public safety and health (which type of action is exempt from the stay). The public policy test asks whether the government action seeks to effectuate public policy (i.e., exempt from stay) or adjudicate private rights (i.e., stayed). 

On the issue of who needs to initiate the action to fall within 362(b)(4), Halo argued that the PUC proceedings do not fall within the governmental unit exception to the automatic stay because the Telephone Companies initiated the proceedings against it, so the PUC proceedings primarily sought a “pecuniary interest” in Halo’s property and, thus, the proceedings adjudicated the Telephone Companies’ private rights, rather than a public policy.

The Fifth Circuit, however, rejected the debtor’s argument, holding that the PUC proceedings fell within the governmental unit exception because the proceedings were similar to actions the state regulatory commissions may, themselves, take to protect their public policy interests. In addition, even where a private party initiates a proceeding, the governmental unit exception can still apply because section 362(b)(4) of the Bankruptcy Code applies to “the commencement or continuation of an action or proceeding by a governmental unit. . . .” (emphasis added).  Thus, a matter may be continued by the state regulatory commission, even though it was initially commenced by a private party under the applicable regulations. 

On the second point, the Fifth Circuit found that enforcement of the states’ telecommunications laws and policies were a valid exercise of police powers, even though the Telephone Companies were seeking monetary relief.  The Court also disagreed with Halo’s characterization of the PUC proceedings as essentially mere private contract actions brought by the Telephone Companies. It reasoned that the PUCs enforced the government’s interest in regulating telecommunications by ensuring that telecommunications providers interact appropriately with local telephone companies and follow applicable rules and regulations.  As such, the PUC proceedings meet both the pecuniary interest test and the public policy test by protecting public health and safety and effectuating public policy.  The suits “will aid in determining what kind of telecommunications provider Halo is, how it should interact with the local telephone companies with which it deals, and whether its interactions with them thus far have followed the applicable rules and regulations.” 

In its decision, the Fifth Circuit emphasized that the purpose of the governmental unit exception to the automatic stay is to prevent wrongdoers from using the Bankruptcy Court as a haven to escape the consequences of their misdeeds.

Why the Case is Interesting:

The Fifth Circuit declined to follow certain lower court opinions, like the decision in In re Reyes, Case No. 10-52366-C, 2011 WL 1522337, at *6 (Bankr. W.D. Tex. Apr. 20, 2011), which held that the governmental unit exception to the automatic stay only applies where the governmental unit itself initiated the proceeding in question. According to Reyes, if a private party initiates a regulatory action, even if the action is prosecuted on an ongoing basis by the governmental unit, the action does not fall within the exception and is subject to the automatic stay. The Fifth Circuit’s decision provides a broader interpretation of the oversight of regulated debtors and, importantly, expands the scope of who may have the right to adjudicate issues – the bankruptcy court or the regulatory unit.  However, even this decision requires a finding that the regulator is continuing the action, even though it was commenced by a private party.