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Objective Test for a Creditor's Compliance with the Bankruptcy Discharge Injunction

In Taggart v. Lorenzen, 139 S. Ct. 1795, 1802 (2019), the Supreme Court overruled the Ninth Circuit by requiring an objective test for a creditor's compliance with the bankruptcy discharge injunction. The nation's highest court explained that "a party's subjective belief that she was complying with an order ordinarily will not insulate her from civil contempt if that belief was objectively unreasonable." Id. This ruling went against more recent Ninth Circuit case law that a "'good faith belief' that the discharge order 'did not apply'" to a creditor's claims would prevent a court from ordering civil contempt sanctions against such a creditor. Id. at 1801.

Following Taggart, the Ninth Circuit Bankruptcy Appellate Panel has now vacated and remanded a bankruptcy court's decision that a national mortgage lender was not subject to sanctions for commencing foreclosure after its lien was paid off. In In re Freeman v. Nationstar Mortg. LLC (In re Freeman), No. CC-18-1261-TaFS, 2019 Bankr. LEXIS 3465, at *1 (B.A.P. 9th Cir. Oct. 29, 2019), the lender "commenced post-discharge proceedings to foreclose its lien," then eventually "reconveyed its trust deed" once the debtor had commenced contempt proceedings. Based on the reconveyance, the Bankruptcy Appellate Panel vacated the trial court's ruling that the lender did not willfully violate the discharge injunction. Id. at *2. The record of the Chapter 13 case below indicated that the lender's previous counsel had negotiated a consensual payoff with the debtor at a reduced valuation. Id. at **4-5. The debtor had even filed an unopposed modified plan that resulted in an early payoff, which the debtor consummated. Id. at **6-7.

The Panel's review of the record below led to its conclusion that the lender committed a discharge violation. Id. at **15-16. Citing state law that payment of a lien extinguishes the lien automatically, the Panel also determined that the lower court was incorrect to rule that the lender's lien had remained in existence until the point of the lender's reconveyance. Id. at *17. The Panel thus reversed, vacated, and remanded so that the lower court could apply the Supreme Court's objective Taggart standard instead of the Ninth Circuit's subjective test.

The Freeman case underscores the need for lenders and their counsel to review a case carefully following a loan transfer or change in representation. The lender in Freeman had commenced foreclosure proceedings after counsel for the lender's predecessor-in-interest had agreed to a consensual payoff of the loan through the debtor's plan. Despite the loan changing hands, the Bankruptcy Appellate Panel did not excuse the lender's discharge violation. Servicers and lenders should therefore pay special attention to servicing notes following a loan transfer.

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