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Note: Fitness Management Group (Debtor), which operated numerous health club facilities in North Carolina selling prepaid memberships had been in and continued in violation of provisions of North Carolina consumer laws requiring it to post bonds or letters of credit to assure delivery of the promised future services. After Debtor filed for bankruptcy reorganization, the Attorney General of North Carolina moved for a declaration that its actions against Debtor were exempt from the automatic stay that applies to all actions against the debtor. The U.S. Bankruptcy Court for the Western District of North Carolina, Charlotte Division, Whitley, J., granted the motion as modified.

The Judge concluded that North Carolina's actions fell within the statutory exemption for a governmental unit exercising its police and regulatory power, including those intended, as here, to protect consumers. The Judge noted that North Carolina could seek injunctive relief prohibiting violations of state law but that any award of damages would constitute a debt of the Debtor. The Judge also indicated that expenditures in compliance with the state law could be compelled and Debtor required to obtain a legally mandated standby LC or bond and indicated that it would retain jurisdiction for any claim for permission to expend funds in excess of US$10,000 as required by the bankruptcy statute.

The relevant text of the North Carolina Statute Section 66-118 requires that:

a. Health clubs must file sworn statements with the [Attorney General's Office] AGO twice a year attesting the amount of outstanding liabilities covered by a bond or letter of credit "in favor of the State of North Carolina and in a form approved by the [AGO]";

b. The [AGO] maintains the bonds or letters of credit required by N.C.G.S. § 66-124;

c. Health clubs must obtain the [AGO's] permission to release a bond or letter of credit outside of its normal expiration or cancellation, such as when a health club changes ownership;

d. The [AGO] is permitted to file claims on the bond or letter of credit on behalf of consumers, and if the claims exceed the amount of the bond, the surety must pay the bond to the [AGO] for distribution among claimants....

[JEB/naa]

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