Sanctions Standard Clarified for Bankruptcy Creditors
A creditor who attempts to collect a debt in violation of a bankruptcy discharge order is subject to civil contempt sanctions. Resolving disagreements between the lower courts over when such sanctions are appropriate, the U.S. Supreme Court recently clarified the standard to unanimously hold a creditor may be sanctioned for violation of the post-discharge injunction where there is not a “fair ground of doubt” as to whether the debt was discharged in bankruptcy.
In Taggart v. Lorenzen, Bradley Taggart filed for bankruptcy under Chapter 7 of the Bankruptcy Code in the midst of defending a lawsuit brought against him in an Oregon state court by his former company and business partners. The bankruptcy court discharged all of Taggart’s pre-bankruptcy debts and enjoined his creditors from collecting any debt that had been discharged.
Following the issuance of the discharge order, Taggart’s former company sought to recover the attorney fees it incurred after Taggart filed for bankruptcy in the state court litigation, in which he actively participated. The Oregon state court eventually held Taggart liable for approximately $45,000 of the company’s attorney fees.
Taggart argued the fee award violated the discharge order and the bankruptcy court agreed, imposing civil contempt sanctions on the company. The Bankruptcy Appellate Panel and the Ninth Circuit Court of Appeals disagreed, however, vacating the sanctions. Specifically, the Ninth Circuit held that civil contempt sanctions were unwarranted because the company had a “good faith belief” the discharge order did not apply to its claims because Taggart had “returned to the fray” in the state court litigation.
In vacating the Ninth Circuit’s judgment, the Supreme Court concluded the Bankruptcy Code “authorize[s] a court to impose civil contempt sanctions when there is no objectively reasonable basis for concluding that the creditor’s conduct might be lawful under the discharge order.” (Emphasis added.) The Court reasoned this standard strikes the careful balance between the interests of creditors and debtors that the Bankruptcy Code often seeks to achieve. It further stated the “good faith” standard applied by the Ninth Circuit is inconsistent with traditional civil contempt principles, under which parties cannot be insulated from a finding of civil contempt based on their subjective good faith, that it relies too heavily on difficult-to-prove states of mind and that it may too often lead creditors who stand on shaky legal ground to collect discharged debts.
In sum, creditors must be careful not to rely solely on their subjective belief that their actions to collect a debt are not in violation of a discharge order. Instead, to avoid the possible imposition of civil contempt sanctions, creditors need to proceed cautiously, consult with counsel about potentially applicable exceptions from discharge and ensure that there is an objectively reasonable basis to conclude their conduct is lawful under the discharge order.
Disclaimer: The article in this publication has been prepared by Eastman & Smith Ltd. for informational purposes only and should not be considered legal advice. This information is not intended to create, and receipt of it does not constitute, an attorney/client relationship.