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U.S. Supreme Court Sets Legal Standard for Violations of Bankruptcy Discharge Order

Posted By USFN, Monday, July 8, 2019

by Kinnera Bhoopal, Esq.

McCalla Raymer Leibert Pierce, LLC

USFN Member (AL, CA, CT, FL, GA, IL, MS, NV, NJ, NY)

 

  

On June 3, 2019, the U.S. Supreme Court issued an opinion in Taggart v. Lorenzen, 2019 U.S. LEXIS 3890 after a series of appeals in the lower courts. The Ninth Circuit courts vacillated on the type of legal standard to apply in a bankruptcy related civil contempt case ranging from strict liability to a subjective standard. However, the U.S. Supreme Court unanimously decided that the legal standard to apply when determining whether to impose civil contempt sanctions for violating a discharge order is an objective standard termed “the fair ground of doubt.” Id. at 133.

The Petitioner, Bradley Taggart, was sued by the Sherwood Company in State Court. Before the trial started, Taggart filed a Chapter 7 bankruptcy case and received a discharge. After the discharge order was entered, Sherwood moved to recover attorney fees that were incurred post-petition from Taggart. Both the State Court and the Bankruptcy Court agreed that Taggart was liable for the attorney fees. These courts followed the guidance of a Ninth Circuit case,
Boeing North American, Inc. v. Ybarra (In re Ybarra), 424 F.3d 1018 (9th Cir. 2005). The Ybarra Court held that post-petition attorney fees stemming from pre-petition litigation were usually discharged unless the debtor “returned to the fray” post-petition. Id. at 1024. The State Court and Bankruptcy Court determined that because Taggart undertook actions with respect to the litigation with Sherwood Company following the discharge, and thus returned to the fray, Sherwood’s petition to recover attorney fees did not constitute a violation of the discharge order.  Taggart v. Lorenzen, 2019 U.S. LEXIS at 133-134. 

 

Taggart appealed to the Federal District Court, which concluded that Taggart did not “return to the fray” and thus remanded the case to the Bankruptcy Court. Based on the District Court’s ruling, the Bankruptcy Court held Sherwood in civil contempt for violating the discharge order employing a strict liability standard. Under this standard, any violation of the discharge order whether malicious or innocuous, reasonable or not, would be subject to sanctions. Since Sherwood was aware that a discharge order was entered and intentionally sought to collect a debt, it was held in civil contempt. In re Taggart, 522 B.R. 627 (Bankr. D. Or. 2014).

 

Sherwood appealed, and the Bankruptcy Appellate Panel vacated the sanctions, which the Ninth Circuit affirmed by employing a more liberal legal standard referred to as the subjective standard. Lorenzen v. Taggart (In re Taggart), 888 F.3d 438 (9th Cir. 2018). The Ninth Circuit found that Sherwood had a subjective, good faith belief that the post-petition attorney fees were not discharged thus it held that Sherwood was not in civil contempt. See id. at 444. The Ninth Circuit went further to state that a good faith belief precludes a finding of civil contempt even if the creditor’s beliefs are unreasonable. Therefore, a creditor’s subjective belief of righteousness is sufficient to evade sanctions under this legal standard. See id. at 444.

 

Given the divergent legal standards employed by the lower courts, the U.S. Supreme Court granted certiorari to answer the narrow question of what the applicable legal standard is when a bankruptcy discharge order is violated. The Supreme Court’s analysis began with the statutory provisions of 11 U.S.C. §524 and §105, which authorize bankruptcy courts to impose civil contempt sanctions.  Section 524 of the United States Bankruptcy Code (“Bankruptcy Code”) states “a discharge order operates as an injunction against the commencement or continuation of an action, the employment of process, or an act to collect, recover or offset” a discharged debt. Given that Section 524 of the Bankruptcy Code evokes injunctions, the U.S. Supreme Court reasoned that parallels may be drawn from the long-standing history governing injunction violations, which it then applied to the bankruptcy paradigm.

 

The U.S. Supreme Court explained that civil contempt also exists outside of bankruptcy and in those contexts the U.S. Supreme Court has held that there should not be a finding of civil contempt when there is “a fair ground of doubt” about whether a party acted unlawfully. This is an objective standard because a party’s subjective belief that he was complying with an order will not insulate him from civil contempt if the party’s belief was objectively unreasonable. This standard also acknowledges that civil contempt is a severe remedy such that explicit notice of what constitutes unlawful conduct is necessary before holding a party in civil contempt.

 

Moreover, the U.S. Supreme Court noted that a problem with the strict liability standard is that it is all encompassing and would promote excessive use of an extraordinary remedy for any perceptible breach regardless of the reasonableness of a creditor’s conduct. Conversely, the subjective standard relies too heavily on a creditor’s state of mind, which is difficult to prove. Additionally, the subjective standard deviates from principles of equity because a party’s subjective belief does not have to be reasonable or prudent to evade liability.

 

Based upon the findings detailed above, the U.S. Supreme Court ruled that an objective standard is the prevailing legal standard to apply in bankruptcy related civil contempt cases. It further held that a creditor may be held in civil contempt for violating a bankruptcy discharge order when there is not a “fair ground of doubt” as to whether the creditor’s conduct was unlawful under the discharge order. Consequently, the Supreme Court vacated and remanded the case to the Ninth Circuit Court of Appeals to review the matter using the objective standard.

 

In issuing this ruling, the U.S. Supreme Court struck a balance between protecting the integrity of a bankruptcy discharge order while not exposing creditors to an excessive risk of liability. Therefore, Bankruptcy Courts in every jurisdiction are now required to use the more moderate, “fair ground of doubt,” standard when determining whether to hold a party in civil contempt for violating a bankruptcy discharge order. While the U.S. Supreme Court’s ruling is of national importance it is particularly notable for the Ninth Circuit where creditors previously enjoyed a more favorable, deferential, standard of review. However, the U.S. Supreme Court’s standard will help foster equity between the competing interests of debtors and creditors in a more clear and objective manner.

 

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