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Supreme Court Decides Civil Contempt Standard for Violations of Discharge Orders

Successful bankruptcy cases typically end with a court order releasing a debtor from liability for most pre-bankruptcy debts.  This order, generally known as a “discharge order,” prohibits the debtor’s creditors from trying to collect on those now-discharged debts.  See 11 U.S.C. § 524(a)(2).  But it is not always clear which debts are covered by a discharge order.  Some pre-bankruptcy debts are exempted from discharge by the Bankruptcy Code.  For example, section 523 of the Bankruptcy Code exempts certain debts of individual debtors from discharge, and section 1141 exempts certain debts of corporate debtors from discharge under chapter 11.  See 11 U.S.C. §§ 523(a), 1141(d)(6).  For other debts, it may be unclear whether they arose before or after the bankruptcy.  See In re Ybarra, 424 F.3d  1018 (9th Cir. 2005) (considering under what circumstances a discharge order covers an attorney’s fee award for fees incurred post-petition in an action brought before the bankruptcy petition).  Courts enforcing a discharge order’s prohibition on debt collection have thus struggled with the appropriate standard for holding a person in contempt for attempting to collect on a discharged debt.  Does it require that the person knew that the discharge applied to the debt, or is it sufficient that the discharge did in fact apply to the debt?

On June 3, the Supreme Court unanimously ruled on the appropriate standard to apply to this question.  Charting a course in between the approaches of the lower courts whose decisions it was reviewing, the Court held that a party can be held in civil contempt for violating a discharge order is appropriate only  where “there is no objectively reasonable basis for concluding that the creditor’s conduct might be lawful.”  Taggart v. Lorenzen, 587 U.S. ___, slip op. at 2 (2019).

Bradley Taggart, the petitioner, was sued in Oregon state court by Sherwood Park Business Center and two of its owners (collectively, “Sherwood”) on a claim that Taggart had breached the Business Center’s operating agreement.  While the litigation was ongoing, Taggart filed for bankruptcy under chapter 7 and ultimately obtained a discharge order.  After the case was resolved, the Oregon state court entered judgment against Taggart, and Sherwood sought an award of the attorneys’ fees it had incurred after the filing of Taggart’s bankruptcy petition.  Sherwood argued that because Taggart had continued to affirmatively pursue the litigation after filing the bankruptcy petition, he was liable for the post-petition fees under the Ninth Circuit’s decision in In re Ybarra.  That court agreed and awarded Sherwood $45,000 in attorneys’ fees.  Taggart then returned to the bankruptcy court and sought to hold Sherwood in civil contempt for violating the discharge order.  The bankruptcy court initially agreed with the state court’s ruling that Taggart had affirmatively continued to pursue in the litigation, but upon reversal by the district court on that question, held Sherwood in civil contempt.  The bankruptcy court applied what it deemed a “strict liability” standard, holding that to find a creditor in civil contempt for attempting to collect on a debt subject to a discharge order, it is only necessary that the creditor know of the discharge order and intend to collect on a covered debt.  The Ninth Circuit reversed on appeal, holding that if a creditor has a good faith belief that the discharge order does not apply to the debt, that good-faith belief precludes civil contempt.

In an opinion by Justice Breyer, the Supreme Court rejected the approach of both the bankruptcy court and the Ninth Circuit.  The Court pointed to the general language of section 105 of the Bankruptcy Code, authorizing a court to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.”  11 U.S.C. § 105(a).  The Supreme Court held that this general language, the source of the authority of bankruptcy courts to hold creditors in contempt for violating discharge orders, implicitly incorporated the general equitable principles governing when civil contempt is appropriate.  Noting, on the one hand, the importance of fair notice before imposing penalties for violating an injunction, and, on the other hand, case law holding that subjective belief was insufficient to block civil contempt, the Court ruled that the appropriate standard was whether there was “fair ground for doubt” that the discharge order applied to the debt at issue, or, in other words, whether “the creditor violate[d] a discharge order based on an objectively unreasonable understanding of the discharge order’s scope.”  Slip op. at 7.

Justice Breyer explained why the Court rejected the contrary standards used by the lower courts.  As for the Ninth Circuit’s good-faith belief standard, he reiterated the point that the standard was inconsistent with traditional civil contempt principles, and noted also that its application would require determinations about difficult-to-disprove states of mind and could encourage creditors to try to collect discharged debts on shaky legal grounds.  As for the bankruptcy court’s strict liability standard, defended by Taggart at the Supreme Court, the Court considered and rejected several arguments made by Taggart in defense of this approach.  Taggart argued that the standard would not be unfair to creditors because they could seek an advance determination from the bankruptcy court of whether the debt was in fact covered by the discharge order.  See Fed. R. Bankr. Proc. 4007(a).  The Court rejected this argument, however, reasoning that such a standard would lead to widespread use of the advance determination procedure, contrary to Congress’s expectations and leading to additional costs and delays.  Taggart also argued by analogy to the approach taken by many lower courts to violations of the automatic stay, which applies a standard akin to strict liability.  The Court rejected this argument as well, noting that the language authorizing remedies for violations of the automatic stay is much more specific than the language in section 105, and also noting that the purposes of the automatic stay and the discharge order differ.  The Court thus concluded that the Ninth Circuit erred, vacated its judgment, and remanded for application of the correct standard.

Parenthetically, the Court noted that section 362, which authorizes remedies for violations of the automatic stay, requires a “willful violation” of the stay.  11 U.S.C. § 362(k)(1).  The Court stated that the word “willful” is not typically associated with strict liability, but that its meaning was often dependent on its context.  Whether the Court has doubts about the application of a strict liability standard in the automatic stay context, a question not directly at issue in this case, remains to be seen.