Stephanie Slater writes:

The United States Supreme Court granted certiorari to determine the applicable legal standard for holding a creditor in civil contempt when a creditor attempts to collect a debt that falls within an issued bankruptcy discharge order.  In Taggart v. Lorenzen, 139 S.Ct. 1795 (2019), the Court unanimously decided to adopt an “objective standard,” holding that a court has permission to issue civil contempt sanctions against a creditor where there is “not a fair ground of doubt” in determining whether the creditor’s conduct is lawful under the discharge order.  While holding a creditor in civil contempt for violating a bankruptcy discharge order is not litigated as frequently as other bankruptcy matters, the Supreme Court’s decision could have an effect on how creditors act in bankruptcy and will impact how courts interpret these types of contested issues.

Petitioner Bradley Taggart was a part owner of Sherwood Park Business Center.  The company and two other owners filed a lawsuit against Taggart in Oregon state court.  The lawsuit claimed that Taggart breached the Business Center’s Operating agreement, but Taggart filed for Chapter 7 bankruptcy before the trial began.  As is typical in the conclusion of a bankruptcy proceeding, the Federal Bankruptcy Court granted a discharge order releasing Taggart from liability for his pre-bankruptcy debts.

Oregon state court eventually entered a judgment against Taggart, which prompted Sherwood to seek attorney’s fees incurred after the Chapter 7 bankruptcy petition date.  A point of contention between the parties was whether Taggart “returned to the fray.” If Taggart did return to the fray, a discharge order would not cover post-petition attorney’s fees from pre-petition litigation.  If Taggart did not “return to the fray,” the bankruptcy discharge order would immunize collection of post-petition attorney’s fees that are the result of pre-petition litigation.

This was the beginning of a back and forth battle between Taggart and Sherwood.  Taggart went back to Federal Bankruptcy Court to argue that (1) he did not “return to the fray” in state court based on the definition set in In re Ybarra[1] and (2) that the court should take action and hold Sherwood in civil contempt for violating Taggart’s discharge order.  Ultimately, the court did not agree with either of Taggart’s arguments.  Taggart then appealed to Federal District Court. The court agreed with Taggart’s arguments and remanded the case to the Bankruptcy Court.

The Bankruptcy Court used a standard similar to strict liability and determined that it was appropriate to hold Sherwood in civil contempt.  The Bankruptcy Court decided that Sherwood should be held in civil contempt because Sherwood was “aware of the discharge” order and “intended the actions.”

Sherwood appealed and the Bankruptcy Appellate Panel decided to do away with the sanctions.  The Ninth Circuit agreed with the decision and used a subjective standard that if a creditor has a “good faith belief” that a discharge order “does not apply to the creditor’s claim,” they are not subject to contempt even if the creditor’s belief is unreasonable.

Discharge orders are not detailed or lengthy in nature, but they do have an important effect on creditors and the individual debtor.  Pursuant to §524(a)(2) of the Bankruptcy Code, a discharge order  “operates as an injunction” barring creditors from collecting on any of the debt that has been discharged under the order and §105 allows a court to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.”

Justice Breyer delivered the opinion and found it helpful to look at how civil contempt sanctions are used outside of bankruptcy.  In the past, the Court recognized that civil contempt is a severe remedy and that based on principles of fairness, a party should have explicit notice of what they can and cannot do before being held to the extremes of civil contempt.  This standard is generally an objective standard, and when there is a “fair ground of doubt” regarding the wrongfulness of the conduct, civil contempt is not appropriate.  According to the Court, these traditional civil contempt principles are easily transferrable to analyze issues surrounding bankruptcy discharge orders.

The Court first addressed its apprehensions with the Ninth Circuit’s “subjective standard.”  The Court was concerned it placed too much of an emphasis on states of mind that are difficult to prove which would ultimately force parties back into litigation, defeating the purpose of the discharge order.  Next, the Court rejected Taggart’s strict liability “awareness” and “intention” standard and doubted Taggart’s proposed “solution” for creditors to obtain an advance determination from the federal bankruptcy court as to whether the creditor’s debt was discharged.  The Court feared this would create more litigation, additional costs, and delays disadvantaging not only debtors, but creditors as well.

In a desire to strike a “careful balance” between the interests of debtors and creditors, the Court believed that an objective standard was appropriate.  Rooted in traditional principles of civil contempt, a court can use civil contempt sanctions on a creditor for violating a discharge order where there is not a “fair ground of doubt” as to whether the creditor’s conduct is lawful under the discharge order.

[1] In re Ybarra, 424 F. 3d 1018, 1027 (9th Cir. 2005).

Stephanie Slater is a summer associate, resident in the firm’s Wilmington office.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in Delaware and regularly practices before the United States Bankruptcy Court for the District of Delaware. You can reach Carl at (302) 622-4272.