Supreme Court Adopts Objective Standard for Contempt for Discharge Violations, Overturning Ninth Circuit Precedent

On Behalf of | Jun 7, 2019 | Uncategorized |

In Taggart v. Lorenzen, 587 U.S. ___ (2019), the Supreme Court has clarified the standard under which a creditor may be held in civil contempt for violating a bankruptcy discharge order. Taggart was a former co-owner of a company with two other owners. The company and other owners sued Taggart for breach of their operating agreement. Before trial, Taggart filed for Chapter 7 bankruptcy and ultimately received a discharge of his pre-petition debts. Notwithstanding their knowledge of the discharge, the attorney for the company and other co-owners sought and obtained an award from the state court of post-petition attorney fees against Taggart. Pursuant to In re Ybarra, 424 F.3d 1018 (9th Cir. 2005), a creditor is not entitled to post-petition attorney fees stemming from prepetition litigation unless the bankruptcy debtor returns to the fray. In this case, it was ultimately decided that Taggart had not returned to the fray, leaving the remaining question of whether the company and co-owners should be held in civil contempt for violating the discharge order.

The Oregon Bankruptcy Court held, akin to strict liability and/or the standard for contempt for violations of the automatic stay, that since the company and co-owners knew about the discharge order and intended actions which violated it, they were in contempt. The Ninth Circuit Court of Appeals disagreed and held that a creditor’s good faith belief that its conduct does not violate a discharge order precludes a contempt finding, even if that belief was unreasonable.

Here, the Supreme Court disagreed with both rulings and articulated the standard as follows:

A court may hold a creditor in civil contempt for violating a discharge order where there is not a “fair ground of doubt” as to whether the creditor’s conduct might be lawful under the discharge order.

In adopting the “fair ground of doubt” standard, the Court held that the language of Sections 105 and 524 of the Bankruptcy Code were obvious transplants from other traditional legal sources governing injunctions and that, consequently, the “oil soil,” i.e., other notes of decisions regarding the imposition of an injunction follow from it. Among the traditional standards of equity practice governing when a party is in civil contempt for violating an injunction is that those enjoined have explicit notice of what conduct is outlawed and that those who must obey an order will know what the court intends to require and what it means to forbid.

While overturning the Ninth Circuit subjective standard for when civil contempt for violating a discharge order can be imposed, the Supreme Court also held that the subjective belief of a creditor may still be relevant in determining the appropriate sanction.

In disagreeing with the Oregon Bankruptcy Court’s strict liability interpretation, the Supreme Court not only distinguishes between standards governing the enforcement of the automatic stay vs. a discharge order, but it appears to hint at the possibility that other Ninth Circuit precedent governing the automatic stay may be invalid. Section 362(k) provides that an individual injured by a willful violation of the automatic stay shall recover actual damages and may in the appropriate circumstances recover punitive damages. The Ninth Circuit has previously held that a bankruptcy trustee is ineligible to receive damages under the “robust remedy” of Section 362(k) because he or she is not an “individual” for purposes of the statute. See Knupfer v. Lindblade (In re Dyer), 322 F.3d 1178, 1189 (9th Cir. 2003). Instead, the Ninth Circuit has held that a bankruptcy trustee can recover damages as a sanction for ordinary civil contempt under Section 105(a) of the Bankruptcy Code. Id. In Taggart, however, the Supreme Court cites Section 362(k) in contrast to Section 105(a) as a protection against “disruptions to the administration of a bankruptcy case . . . .” Accordingly, it appears that the Supreme Court disagrees with the Ninth Circuit’s precedent that bankruptcy trustees cannot seek relief under Section 362(k) because the intent of Section 362(k) is to protect the trustee’s administration of a bankruptcy case, e.g., property of the estate.

In sum, the Supreme Court has clarified that the standard governing when a creditor may be held in contempt for violating a discharge order is an objective one to be analyzed under traditional equitable standards governing the enforcement of an injunction. In so clarifying, it may have provided grounds to overturn other Ninth Circuit precedent governing whether a bankruptcy trustee can obtain “robust remedies” such as punitive damages for violations of the automatic stay.

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