Lawson Burich Associates, Inc. v. Axelrod (In Re Lawson Burich Associates, Inc.)
Docket: 82 Civ. 5383 (RWS)
Court: District Court, S.D. New York; June 29, 1983; Federal District Court
An appeal was made by Lawson Burich Associates, Inc. (the Debtor) from a June 2, 1982 order by Bankruptcy Judge Roy Babitt, which denied the Debtor's requests for injunctive relief and contempt against state respondents, including David Axelrod, the New York State Commissioner of Health, and Robert Abrams, the New York Attorney General. The U.S. District Court for the Southern District of New York affirmed the order.
The case originated from issues surrounding the Haym Salomon Home for the Aged, a residential health care facility in Brooklyn, New York. In 1980, both federal and state authorities aimed to revoke the Home's Medicaid and Medicare provider agreements, prompting the Home to seek legal action to prevent termination. A class action was also initiated, leading to a settlement that appointed the Debtor as a voluntary receiver under New York Public Health Law. The Debtor was to manage the Home until receiving its own operating certificate, at which point the Home's assets would be transferred to it.
A receivership agreement established on March 21, 1980, allowed the Debtor to operate the facility and was extended multiple times, with the last extension ending June 1, 1982. Under the agreement, the Debtor was to be reimbursed for reasonable expenses incurred during operation, contingent upon Medicaid and Medicare reimbursements. However, the Department of Health contended that some payments made to Debtor officers were improperly classified as receivership fees, leading to a discovery of over $150,000 taken in excess. Consequently, the Department imposed new conditions on the receivership, including prohibiting fee collections, requiring an accounting, mandating the return of certain funds, and necessitating the resignation of Bartholomew J. Lawson from his roles within the Debtor.
The Department determined that the Receiver did not comply with the Agreement and the February 8 extension agreement. On May 26, 1982, Raymond D. Sweeney notified the Debtor of its failure to meet contractual obligations, a negative finding from the Public Health Council regarding the Debtor's character, and the Department's decision to terminate the temporary receivership effective June 1, 1982, based on paragraph 1.03 of the March 21, 1980 Agreement. The termination revoked the operating certificate and prohibited the Debtor from incurring new financial obligations or entering new contracts. The Debtor was instructed to prepare for an orderly transfer of operations and retain all records at the facility. Following this, on May 27, the Department sought a court order to appoint the Commissioner of Health as interim receiver and to retrieve funds due to the Home, with the order served on May 28, scheduled for a hearing on June 1. On that date, before the hearing, the Debtor filed for reorganization under Chapter 11 of the Bankruptcy Code, claiming the Agreement, operating certificates, and assets were its property, invoking a stay against state actions to divest it of these rights under section 362(a).
A hearing took place before Justice Joseph J. Dowd after the filing of a reorganization petition by the Debtor. Debtor's counsel informed the court that the Commissioner was prohibited from terminating the operating certificate as of midnight June 1, and that the proceeding initiated by the Commissioner was stayed under section 362(a) of the Bankruptcy Code. Following arguments regarding the Commissioner’s request for a temporary and permanent receiver, the hearing was adjourned for lunch.
During the recess, the Debtor's attorney initiated an adversary proceeding against the Commissioner of Health, the Attorney General, and Justice Dowd, seeking to hold them in contempt for violating section 362 and to prevent any further actions against the Debtor. Judge Babitt subsequently signed an order to show cause for a hearing on June 2, 1982, but did not issue a temporary restraining order.
Upon learning there was no temporary stay from the Bankruptcy Court, Justice Dowd approved the Department’s application for a temporary receiver while awaiting the Bankruptcy Court’s determination. At the June 2 hearing, Judge Babitt ruled that the Debtor's petition filed early on June 1 prevented the State from terminating the contract. He noted a lack of evidence suggesting that patient health and safety were at risk, stating that without such evidence, he could not justify changing receivers mid-process. He emphasized the importance of maintaining stability for the residents and indicated that the current administration was adequately managing the home. Furthermore, he disputed the Department's assertion that they were not stayed, arguing that the action taken by Justice Dowd to appoint a temporary receiver was unauthorized. The Department's counsel claimed the stay did not apply due to the nature of their actions, but the court disagreed, stating that this was not a valid exercise of police powers.
Judge Babitt ruled to restore the Debtor's operations, allowing a due process hearing to determine the issuance of a permanent operating certificate. The Attorney General sought a stay pending appeal, which was denied, prompting a request for a memorandum order for immediate review. Judge Babitt subsequently stayed his order until 3:00 p.m., stating that the automatic stay does not impede state law procedures regarding the Debtor's nursing home operations and restoring the Debtor's status prior to June 1, 1982. Shortly thereafter, he vacated this order and issued a new memorandum, concluding there was no basis for contempt against respondents and no automatic stay under section 362(a) regarding the operation of nursing homes, emphasizing state regulation and resident needs. The Debtor appealed this second order. Following this, the parties appeared before Justice Dowd, who appointed David Axelrod, M.D. as the permanent receiver of the nursing home and mandated the transfer of all records to him. The Debtor's argument relies on section 362(a)(1) of the Bankruptcy Code, asserting it applies to their situation and challenging the applicability of the exception under section 362(b)(4), while also claiming relevance under section 362(a)(3) without providing supporting authority for its position on receiver-held property.
The Debtor failed to demonstrate that the temporary receiver had any rights or ownership interest in the Home’s property, as defined by the New York Public Health Law or the March 21, 1980 contract. Article IV of the Agreement outlines the powers and duties of the Receiver, which align with those of a receiver in mortgage foreclosure actions. The judicial appointment of a temporary receiver following a Chapter XI bankruptcy petition does not breach the automatic stay under section 362(a)(3). Article 3.02 clarifies that the property and equipment at the Facility are owned by the Facility free of liens and are designated for the Receiver’s use. However, the contemplated transfer of property to the Debtor did not occur, and the receivership was ultimately terminated. The State's notice of termination and appointment of a receiver occurred before the Debtor's bankruptcy filing, thereby implying that the Debtor held only a "naked legal right to possession" until the midnight of June 1, 1982. The Debtor has not established itself as the permanent operator of the Home under Article 28 of the New York Public Health Law, rendering section 362(a)(3) inapplicable. The ongoing issue relates to the section 362(b)(4) exemption for governmental actions exercising police or regulatory power. The Debtor references In the Matter of National Hospital and Institutional Builders Co. v. Goldstein, where the City of New York attempted to revoke a nursing home's Certificate of Occupancy (C.O.) despite an injunction from a Bankruptcy Judge. The Bankruptcy Court ruled that the City lacked sufficient cause to vacate the stay and that the revocation was not a legitimate exercise of police power, citing the City’s discriminatory motives against the nursing home operators.
The district court reversed the Bankruptcy Court's decision, determining that zoning falls outside the Bankruptcy Court's exclusive jurisdiction. The Second Circuit, however, reversed this finding, ruling that the City must petition the Bankruptcy Court to revoke the automatic stay and demonstrate good cause, which includes proving that the revocation is not pursued in bad faith. The case was remanded for the district court to review the bankruptcy court's findings regarding the City's good faith. The Second Circuit clarified that bad faith entails more than just legal or factual errors. It affirmed that the Bankruptcy Court had the authority to evaluate whether a valid exercise of police power justified lifting the stay, focusing on the City’s good faith actions.
The comparison to Goldstein highlighted differences: in Goldstein, a continuing property right was involved, while the Agreement in the current case was set to expire. The State had initiated proceedings before the Bankruptcy petition was filed, and Judge Babitt did not apply the stay, citing section 362(b)(4) as applicable. Unlike Goldstein, there were no allegations of bad faith here.
The Debtor referenced relevant case law to argue that state powers exercised concerning financial obligations rather than public health and safety concerns render the section 362(b)(4) exemption inapplicable. It is acknowledged that this exemption is to be narrowly construed to allow governmental units to act in the public interest. Past cases indicated that state actions primarily for financial reasons do not qualify under this exemption. The statutes in question seem aimed at protecting the financial interests of creditors rather than public health and safety, suggesting that the regulatory nature of the N.L.R.B. proceedings relates more to financial concerns than to public welfare.
Petitioners' objectives focus solely on safeguarding the financial interests of certain depositors rather than addressing violations of consumer or environmental protection laws. The Fifth Circuit's decision in *National Labor Relations Bd. v. Evans Plumbing Co.* is contrasted with the current situation, where the State's actions aim to sustain the operation of a health facility amid financial difficulties, thereby promoting public health and welfare. The New York Public Health Law mandates the protection and promotion of public health, placing the Department of Health in charge of overseeing hospital and related services. The Debtor claims the State is misusing the law to enforce financial interests rather than its intended health protections, arguing that discussions surrounding financial matters disqualify the State from invoking its police power. However, if the Debtor is misappropriating funds meant for patient care, patient health and safety could be at risk. The State's intervention is justified to maintain the facility's operations and ensure resident welfare. Evidence presented indicates that the Debtor has taken unauthorized payments exceeding $150,000 and obstructed access to financial records, prompting the Department to seek court intervention to prevent further fund diversion and to ensure adequate patient care, highlighted by substantial weekly Medicaid revenues of approximately $85,000 needed for operations.
Removal of State funds by the respondents before the return date of the Order to Show Cause jeopardizes the facility's viability. The State alleges that the debtor/appellant misappropriated essential funds, risking the operation of the Home and the personal accounts of its residents. The Department contends that the Receiver's financial management practices threaten the Home's operations, which are regulated for the residents' health and safety. The court affirms Judge Babitt's decision not to abuse his discretion in applying the section 362(b)(4) exemption, leading to the dismissal of the appeal.
Section 2810(1) allows owners of residential health care facilities to request a receiver's appointment by the department to manage the facility. The receivership can be terminated by mutual agreement or written notification from either party. Section 2810(2) mandates the commissioner to apply to the supreme court for a receiver's appointment if a facility's operating certificate is revoked, requiring proof of such revocation. The order to show cause must allow for personal service on the property owners and, if they cannot be personally served, alternative service methods are permitted. Completion of service is confirmed by filing proof with the county clerk or the clerk of New York City.
The order to show cause takes precedence over all other court business unless a competing proceeding with similar statutory precedence is identified. A hearing may be held for interested parties to present evidence. If warranted, the commissioner or a designated individual will be appointed as receiver to manage the facility, and the court will set a reasonable monthly rental based on various factors, including the facility's condition. This rental, which cannot exceed the reimbursable amount under the medical assistance program (unless an existing bona fide lease is in place), will be paid to the facility's owners for the duration of the receivership.
Injunctions may be issued by the supreme court to prevent violations of this article or related regulations. The public health council or commissioner can request the attorney general to initiate such actions. A temporary injunction may be granted without requiring security if there is proof of potential injury from the violation. Findings from the public health council or the commissioner will serve as prima facie evidence in injunction actions.
Additionally, under Bankruptcy Rule 12-43, a petition stays all court proceedings against the debtor and enforcement of liens on their property. The Second Circuit ruled that the previous Bankruptcy Act applies since the petition was filed under it, but noted that while local regulations are exempt from the automatic stay, the bankruptcy court retains the authority to enjoin local regulations if deemed to be enforced in bad faith.
