In re DeFelice, Case No. 5-86-00648

• Decision Date: 08 September 1987
• Docket Number: Adv. No. 5-86-0197.,Case No. 5-86-00648
• Court: United States Bankruptcy Courts. Second Circuit. U.S. Bankruptcy Court — District of Connecticut
• Parties: In re John DeFELICE, Debtor. STATE OF NEW YORK by Robert ABRAMS, Attorney General of the State of New York, Plaintiff, v. John DeFELICE, Defendant.

77 B.R. 376 (1987)

In re John DeFELICE, Debtor.

STATE OF NEW YORK by Robert ABRAMS, Attorney General of the State of New York, Plaintiff, v. John DeFELICE, Defendant.

Case No. 5-86-00648, Adv. No. 5-86-0197.

United States Bankruptcy Court, D. Connecticut.

September 8, 1987.

Victor Olds and Barbara A. Flatts, Asst. Attys. Gen., New York City, for plaintiff.

James Berman, Zeisler & Zeisler, P.C., Bridgeport, Conn., for defendant.

MEMORANDUM OF DECISION ON MOTION TO STRIKE

ALAN H.W. SHIFF, Bankruptcy Judge.

I BACKGROUND

On November 9, 1984, the Attorney General of the State of New York ("Attorney General") commenced a complaint against John DeFelice in the Supreme Court of the State of New York, County of St. Lawrence, seeking injunctive relief, restitution, damages and costs under New York Executive Law § 63(12). In that action the Attorney General alleged that DeFelice made numerous misrepresentations regarding the sale and/or subdivision of certain New York real estate. A temporary restraining order was granted, followed by a preliminary injunction, enjoining DeFelice from carrying on or transacting business as a real estate subdivider, broker or salesman in New York and from making the false and fraudulent representations set forth in the complaint. On September 26, 1986, while a motion for contempt for violation of the preliminary injunction was pending, DeFelice filed a chapter 7 petition in this court. The Attorney General thereupon filed this adversary proceeding, alleging, in the third cause of action of his amended complaint, that certain claims of consumer creditors listed in DeFelice's Schedule A-3 are nondischargeable under Code section 523(a)(2)(A).¹ In response, DeFelice filed a motion to strike the third cause of action, asserting that the Attorney General lacks standing to challenge the dischargeability of debts on behalf of the listed creditors.

II DISCUSSION

Motion to Strike to be Treated as a Motion to Dismiss

A motion under Bankr.R. 7012(f), Rule 12(f) Fed.R.Civ.P. is not the proper procedure for seeking dismissal of a portion of a complaint. Salazar v. Furr's, Inc., 629 F.Supp. 1403, 1411 (D.N.M.1986); 5 Wright and Miller, Federal Practice and Procedure, § 1380 (1969). In view of the fact that the motion attacks the Attorney General's standing to maintain this suit, it will be treated by this court sua sponte as a motion to dismiss for failure to state a claim upon which relief may be granted under Bankr.R. 7012(b)(6), Rule 12(b)(6) Fed.R.Civ.P. See Spell v. McDaniel, 591 F.Supp. 1090, 1113 (E.D.N.C.1984); Continental Illinois Nat'l Bank & Trust Co. of Chicago v. Doppelt (In re Doppelt), 57 B.R. 124, 127 (Bankr.N.D.Ill.1986). The parties have agreed to this treatment.

A motion to dismiss under Rule 12(b)(6) F.R.Civ.P. will not be granted

"unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 102, 2 L.Ed.2d 80 (1957). Moreover, in passing on a motion to dismiss, the allegations of the complaint must be construed in favor of the plaintiff. Scheuer v. Rhodes, 416 U.S. 232, 236, 94 S.Ct. 1683, 1686, 40 L.Ed.2d 90 (1974); Fine v. City of New York, 529 F.2d 70, 75 (2d Cir.1975).

Dahlberg v. Becker, 748 F.2d 85, 88 (2d Cir.1984), cert. denied, 470 U.S. 1084, 105 S.Ct. 1845, 85 L.Ed.2d 144 (1985).

Standing

DeFelice claims that § 523(c)² limits standing to sue under § 523(a)(2)(A) to creditors to whom the allegedly nondischargeable debts are owed.³ Asserting that § 523(c) is clear and unambiguous, DeFelice argues that it should not be stretched beyond its statutory contours to embrace a state policy consideration not contemplated by Congress. DeFelice reminds the court that "it is the responsibility of courts to construe, not reconstruct, the law." In re Maiorino, 15 B.R. 254, 258 (Bankr.D.Conn.1981).

The Attorney General, on the other hand, submits that New York Executive Law § 63(12)⁴ empowers him to act on behalf of victims of fraud and that public policy favors granting the Attorney General standing in dischargeability litigation to implement the state's statutory scheme. Alternatively, the Attorney General claims that his standing to maintain this proceeding is based upon the doctrine of parens patriae. For the reasons that follow, DeFelice's motion to dismiss is denied.

a. Public Policy

While the principle of construction urged by DeFelice is sound, it is well settled that "Congress did not intend for bankruptcy laws to abrogate the States' police powers." In re Berry Estates, 812 F.2d 67, 71 (2d Cir.1987). Indeed, bankruptcy and state law are accommodated by a judicially created concept granting deference to state policies that do not conflict with federal law. See Kelly v. Robinson, ___ U.S. ___, 107 S.Ct. 353, 359, 93 L.Ed.2d 216 (1986); Midlantic Nat'l Bank v. New Jersey Dep't of Environmental Protection, 474 U.S. 494, 106 S.Ct. 755, 760, 88 L.Ed.2d 859 (1986). There is no such conflict here.

It is fundamental that bankruptcy court is not to be used as "a haven for wrongdoers". In re Berry Estates, supra, 812 F.2d at 71 (citing In re Flight Transp. Corp. Securities Litigation, 730 F.2d 1128, 1136-37 (8th Cir.1984), cert. denied, 469 U.S. 1207, 105 S.Ct. 1169, 84 L.Ed.2d 320 (1985); In re Teltronics, Ltd., 649 F.2d 1236, 1239-42 (7th Cir.1981); 2 Collier on Bankruptcy ¶ 362.05, at 362-42). Section 63(12), which authorizes the Attorney General to institute civil actions and seek restitution, among other sanctions, is a codification of that state's public policy of prohibiting deceptive business practices and protecting vulnerable consumers. See Giummo v. Citibank, N.A., 107 Misc.2d 895, 436 N.Y.S.2d 172, 174 (N.Y.Civ.Ct. 1981).

I disagree with DeFelice's argument that § 523(c) must be applied literally. The district court in People of the State of New York v. Hemingway (In re Hemingway), 39 B.R. 619 (N.D.N.Y.1983) reached a similar conclusion and permitted the Attorney General to challenge the dischargeability of a restitution debt ordered by the state court under § 63(12) for the benefit of consumers. I therefore decline to follow Minnesota v. Pierson (In re Pierson), 17 B.R. 822 (Bankr.D.Minn.1982) as DeFelice urges. The Pierson court held that although the state had filed three criminal complaints against the debtor, and apparently intended to seek restitution for injured creditors, it did not have standing to challenge dischargeability under § 523(a)(2)(A) since it was not a creditor to whom a debt was owed. DeFelice's reliance on Missouri ex rel. Ashcroft v. Cannon (In re Cannon), 31 B.R. 823 (Bankr.E. D.Mo.), aff'd, 36 B.R. 450 (E.D.Mo.1983), aff'd, 741 F.2d 1139 (8th Cir.1984), is also misplaced. Unlike § 63(12), the Missouri consumer protection statute at issue in that proceeding did not authorize the Attorney General to recover restitution on behalf of individual consumers. Rather, the Attorney General was limited by law solely to seeking injunctive relief. Indeed, the Cannon court, citing Kansas ex rel. Miller v. Bradbury, 4 B.C.D. 263 (Bankr.D.Kan. 1978), distinguished the Missouri Merchandising Practices Act from the Kansas Consumer Protection Act under which that state's Attorney General had been granted creditor status on the ground that the Kansas statute specifically authorized the Attorney General to recover damages on behalf of consumers. Cannon, supra, 31 B.R. at 826.⁵

DeFelice also argues that Congress has restricted governmental challenges to dischargeability of debts arising out of the violation of a state's regulatory powers to actions brought under § 523(a)(7).⁶ I disagree. It does not follow that § 523(a)(7) is an exclusive remedy, and DeFelice has cited no court decision or commentary to support his contention.

Code subsections 362(b)(4) and (5)⁷ permit a state to commence or continue an action to enforce its police or regulatory powers without the restraint of the automatic stay. The legislative history of these subsections reveals a congressional intent to protect the economic welfare of consumers as well as public health and safety interests:

"Thus, where a governmental unit is suing a debtor to prevent or stop violation of fraud, environmental protection, consumer protection, safety, or similar police or regulatory laws, or attempting to fix damages for violation of such a law, the action or proceeding is not stayed under the automatic stay. . . . The exception extends to permit an injunction and enforcement of an injunction, and to permit the entry of a money judgment, but does not extend to permit enforcement of a money judgment." (emphasis added)

H.R.Rep. No. 595, 95th Cong., 1st Sess. 343, reprinted in 1978 U.S.Code Cong. & Admin.News 5963, 6299; S.Rep. No. 989, 95th Cong.2d Sess. 52, reprinted in 1978 U.S.Code Cong. & Admin.News 5787, 5838. It would be anomalous for a state to be permitted to institute or continue such an action but lack standing to challenge the dischargeability of the underlying debt necessary to make that action meaningful. Accordingly, I find that public policy considerations favor the conclusion that the Attorney General has standing to maintain this proceeding on behalf of DeFelice's consumer creditors.

b. Parens Patriae

Apart from the public policy considerations recounted above, I also conclude that the Attorney General has standing to maintain this action against DeFelice under the doctrine of parens patriae.

The Supreme Court in Alfred L. Snapp & Son, Inc. v. Puerto Rico ex rel. Barez, 458 U.S. 592, 102 S.Ct. 3260, 73 L.Ed.2d 995 (1982) held that in order to have standing under the doctrine of parens patriae, a state must "articulate an interest apart from the interests of particular private parties, i.e., the State must be more than a nominal party." Id. at 607, 102 S.Ct. at 3268. That element was recently emphasized by the Court of Appeals for this circuit in Peop...