Bankruptcy and Customs Penalties

Lawyers often have a tendency to wrongly believe that some question of particular interest to them is wholly unique and has never been addressed. The resolution of the matter, therefore, will “make new law” and put the lawyer into the legal history books. The opposite also happens. We often believe we know something to be true and assume that there must be precedent supporting whatever proposition we hope is the law.

Such was the case with the impact of a bankruptcy filing in the course of a civil penalty case at the Court of International Trade. There had been an understanding among some importers and certainly among some members of the bankruptcy bar that filing for bankruptcy protection would automatically stay the penalty case pending the outcome of the bankruptcy process.

The stay derives from 11 U.S.C. §362(a), which states the following:

Except as provided in subsection (b) of this section, a petition filed under section 301, 302, or 303 of this title, or an application filed under section 5(a)(3) of the Securities Investor Protection Act of 1970, operates as a stay, applicable to all entities, of—

(1)  the commencement or continuation, including the issuance or employment of process, of a 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, or to recover a claim against the debtor that arose before the commencement of the case under this title.

On its face, this law would appear to prevent the continuation of the § 1592 penalty case. 

Purely anecdotal evidence supported that proposition. Lore in some corners of the customs bar includes stories of Customs and Border Protection dropping penalty cases after a bankruptcy filing. This makes sense on several fronts. First, the bankruptcy surely indicates that he importer is in financial extremis. As a practical matter, it might be impossible or close to impossible to collect anything approaching what the government is seeking. Second, the penalty will be set by the CIT judge, who is required to take into consideration the defendant’s ability to pay. The bankruptcy filing indicates that the ability to pay is, at best, minimal. So, even if the case were not stayed, the thought was that Justice would decide that continuing to pursue the case was not a good use of limited resources.

But, if you asked a customs lawyer to prove anything I just wrote in the previous paragraph, you were likely to get some non-specific answer about how the issue was settled a long time ago or how it’s in the bankruptcy law. One time, a few years back, I asked a couple bankruptcy lawyers about this, and got the answer that “as a practical matter, the case will go away.” That is was not a concrete statement of law.

Recently, this largely theoretical question became exceedingly practical in two cases before the U.S. Court of International Trade. The first involved a meat packer called Rupari Food Services. The second involved an importer of athletic apparel called Greenlight Organic Inc. Both involved ongoing penalty cases in which the defendant filed for bankruptcy protection. In both cases, the defendant asserted that the automatic stay prevented any further proceedings in the CIT penalty case. For disclosure purposes, I was co-counsel to Rupari through the penalty litigation up to the bankruptcy.

In both cases, the Department of Justice pointed out that the automatic stay has several exceptions specifically stated in the statute. The relevant one here is § 362(b)(4), which permits the continuation of actions by a governmental unit seeking “to enforce such governmental unit’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[.]”

Customs and Border Protection is clearly a governmental unit. That means the question is whether a customs penalty is Customs seeking to enforce its police and regulatory power. While the answer to that question may seem obvious, it is not. A common perception has been that the exercise of police and regulatory power is limited to the prevention of a present threat to public health and safety or to stop an ongoing fraud. If there is o present threat or ongoing fraud, then the exception does not apply and the penalty case at the Court of International Trade should be stayed.

There is law on this question and it involves a two-part test. The first is whether the government action is primarily directed at protecting its pecuniary interest in the debtor’s property, as opposed to protecting the public health and safety. The second test is whether the government action is directed at effectuating public policy rather than adjudicating private rights. If the purpose of the action is to protect the government’s pecuniary interest or to adjudicate private rights, then the exception is inapplicable, and the stay will apply.

In these cases, the United States is seeking to secure payment of a debt, specifically the administratively assessed customs penalty. That means there is a pecuniary interest at stake. But, that interest is not sufficient to overcome the exercise of police powers. According to both decisions, the collection of a customs penalty is an effort to effectuate public policy rather than adjudicate private rights. According to the legislative history to the bankruptcy stay, the stay does not apply where the government is suing a debtor to prevent or stop a fraud or similar police or regulatory laws, or is attempting to fix damages for a violation of such law.

Consequently, in both these cases, the Court of International Trade held that the bankruptcy stay does not apply. Moreover, the case may proceed to the entry of judgment. That judgment will serve to fix the amount of the liability, which remains unsecured. The judgment does not convert the government into a secured creditor, nor does it force the payment of the debt. But, it does give the United States a perfected claim to be pursued in the bankruptcy proceeding.

In the end, the United States is going to have to be satisfied with whatever the creditors are able to work out. It may not be very much, which may be why these claims have apparently been dropped in the past. But, the current policy appears to be to pursue the matter in the CIT despite the bankruptcy. This is an important development for anyone facing a significant penalty and thinking that bankruptcy may be a strategy to avoid the claim.