Can state regulatory agencies move ahead with lawsuits against businesses who file for bankruptcy in order to enforce consumer protection and business laws, or does the automatic stay's broad injunctive sweep capture those actions? The answer depends on whether the state is acting in its regulatory capacity or simply like another creditor - and the distinction is not always clear.
The intersection of the automatic stay and the "police power" exception to it surfaced recently when, on September 30, 2020, New York's Attorney General filed a lawsuit in the Supreme Court of the State of New York, County of New York against Town Sports International, LLC ("Town Sports"), a sports club and gym operator that recently sought chapter 11 bankruptcy protection in the United States Bankruptcy Court for the District of Delaware.1 The complaint alleges that Town Sports committed fraud and engaged in deceptive acts and practices in violation of various applicable state laws when, among other things, Town Sports failed to honor some members' cancellation requests and continued charging monthly fees despite Town Sports' gyms being closed due to the Covid-19 pandemic.2 In its request for relief, the New York Attorney General asked the court to order Town Sports to transfer a $250,000 bond to the New York Attorney General, grant restitution for affected customers in New York, disgorge all ill-gotten gains, and impose monetary penalties.3
Given Town Sports' pending bankruptcy case, a court will need to determine whether the attorney general's lawsuit runs afoul of the automatic stay, which bars the initiation or continuation of most litigation against the debtor, or whether it fits within the "police power" exception to the automatic stay. Under that exception, actions are not stayed to the extent they seek only "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."4 Indeed, the New York Attorney General expressly cited that exception in the complaint it filed against Town Sports in arguing the automatic stay did not apply to its lawsuit.5 Town Sports, on the other hand, disagreed and proceeded to submit a letter to the New York court arguing that the attorney general's suit was stayed by its bankruptcy filing.
In resolving this dispute, the first question will be which court is entitled to resolve automatic stay disputes like this one: the state court or the bankruptcy court? Courts are split on this question...
