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The district court reversed a bankruptcy court’s holding that a state’s lawsuit alleging Medicaid fraud should be stayed due to the defendant’s bankruptcy. The court held that the Medicaid Fraud Act, New Mexico’s Fraud Against Taxpayers Act, and the Unfair Practices Act were sufficiently analogous to the federal False Claims Act, which is exempt from the automatic stay, and that the state’s stated goal of preventing future fraud by the defendant met the public policy test for an exception to the stay.

The state of New Mexico appealed a lower court’s order denying its motion to override the automatic stay triggered by Bloomfield Nursing Operations LLC’s bankruptcy filing, arguing the stay is inapplicable to a Medicaid fraud enforcement action.

The state’s case alleged Bloomfield chronically understaffed their nursing facilities, thereby failing to deliver the basic care services they were paid to provide. The state used a simulation app to analyze the company’s staff and resident information, and found it would be physically and mathematically impossible for Bloomfield to have provided the required level of care to their residents, given the staffing levels.

As a result of this lawsuit and others, Bloomfield field for Chapter 11 bankruptcy and the New Mexico State Court entered an order staying the state’s Medicaid fraud case. The state filed a motion seeking an order that its case was exempt from the stay, which was denied. The court noted the stated was only seeking one form of non-monetary relief: injunctive relief as a remedy for alleged violations of the Unfair Practices Act. The court was also unconvinced by the state’s given public policy reasons for pursuing its lawsuit. The state appealed.

The district court noted that courts have applied two tests to determine whether proceedings fall within the exception to the automatic stay for bankruptcy: the pecuniary purpose test, which seeks to protect the government’s pecuniary interest in the debtor’s property, and the public policy test, which asks whether the government is effectuating public policy rather than adjudicating private rights.

In its appeal, the state argued the state court improperly applied a subjective test that analyzed the legitimacy of the state’s enforcement action, rather that an objective test considering the statute’s stated purpose. The state also argued the exception should apply because the suit was brought pursuant to the state’s police power. Bloomfield argued the exception should not apply because the state is bringing the action for solely financial purposes. Bloomfield also argued the state’s request for a preliminary injunction is inapplicable because there was a cessation of any activity to enjoin.

First, the court held the bankruptcy court did not exceed its authority when it applied the pecuniary purpose and public policy tests. While a bankruptcy court may not make a preliminary or independent determination of the legitimacy of an enforcement action, they are allowed to: 1) decide whether the primary purpose of an action is to protect pecuniary interests or to protect public safety and health; and 2) decide whether the purpose of the law is to promote public safety and welfare or protect pecuniary interests. While a bankruptcy court’s determination of the primary aim of an enforcement action may seem like it is attacking the legitimacy of the action, it should not be considered illegitimate if the bankruptcy court is staying within the bounds of the outcomes provided by the pecuniary purpose and public policy tests. The district court held the bankruptcy court stayed within those bounds.

However, the district court held the state’s suit fell within the exception to the automatic stay. The bankruptcy court was unconvinced by the state’s arguments because Bloomfield has not operated since 2012 and therefore there is no conduct to deter or regulate; because the state’s only non-monetary relief sought is a preliminary injunction; and because the statutes brought by the state are compensatory in nature and designed to remediate damages.

First, the district court held that the state’s requested relief was not barred by the fact that there is no ongoing illegal conduct. While the purpose of an injunction is to prevent future violations, a defendant must clear a high bar to show that there is no reasonable expectation that the wrong will be repeated. The district court found that Bloomfield failed to make this showing. The fact that they have not operated in seven years does not prevent them from beginning new operations in year eight. Further, while the lag of litigation presents the possibility of a wrongdoer ceasing their illegal conduct by the time the actual prosecution begins, this does not mean that those wrongful acts should go unpunished.

The court did not rule on the merits of the injunction, but only whether the exception to the automatic stay should apply. While the bankruptcy court held the injunction served no purpose, the district court held the merits should be litigated in New Mexico State Court.

Second, the fact that monetary relief is sought does not preclude an action from falling within the scope the exception. The plain language of the statute allows for actions of a money judgment, just not enforcement of a money judgment. Further, when the government seeks to impose a financial penalty, it is plainly acting in its police or regulatory capacity.

The court also found evidence that the Medicaid Fraud Act, New Mexico’s Fraud Against Taxpayers Act, and the Unfair Practices Act fall under the exception. In its report on the Bankruptcy Reform Act of 1978, the Senate Judiciary Committee stated that “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 of such a law, the action or proceeding is not stayed under the automatic stay.” Previous courts have found that pursuing fraud under the Medicaid Fraud Act is substantively similar to claims under the False Claims Act, and that FATA is analogous to the FCA. In sum, the court held that the statutes cited by New Mexico as governing its claims all fell within the type of laws contemplated by Congress and other courts as being exempt from the automatic stay for bankruptcy. Therefore, the bankruptcy court erred in determining that the state’s suit failed the public policy test because the underlying statutes have provisions to recover damages.