Starting now, all creditors must exercise more caution when trying to collect against discharged bankruptcy debtors, because a creditor’s good faith belief that the discharge injunction did not apply is no longer a viable defense. On Monday, June 3, 2019, the U.S. Supreme Court clarified the standard for awarding sanctions against a creditor for violation of the discharge injunction, unanimously holding that a court may hold a creditor in civil contempt for violating a discharge order if there is “no fair ground of doubt” that the discharge order barred the creditor’s conduct.  Taggart v. Lorenzen, 587 U.S. __ (2019).

Bradley Taggart (“Taggart”) owned an interest in an Oregon company called Sherwood Park Business Center (“Sherwood”). In 2007, Sherwood and some of the other owners filed a lawsuit against Taggart in state court, claiming that Taggart had breached Sherwood’s operating agreement. On the eve of the state court trial, Taggart filed a voluntary petition for relief under Chapter 7 of the Bankruptcy Code. At the conclusion of his bankruptcy case, Taggart received an order granting him a discharge under Section 727 of the Bankruptcy Code “from all debts that arose before the date of the order for relief” (subject to certain exceptions that are not relevant here). Section 524 of the Bankruptcy Code explains that a discharge order “operates as an injunction” that bars creditors from collecting any debt that has been discharged. In Taggart’s case, any damages that would have resulted from the state court litigation were subject to the discharge. 

After entry of the discharge order, Sherwood obtained a judgment in its favor against Taggart in the state court lawsuit. Sherwood then tried to recover attorneys’ fees that were incurred after Taggart filed for bankruptcy. Under Ninth Circuit precedent, a discharge order in bankruptcy normally covers post-petition attorneys’ fees stemming from pre-petition litigation, unless the discharged debtor “returned to the fray” after filing for bankruptcy. Sherwood argued that Taggart “returned to the fray” post-petition and so was liable for attorneys’ fees. The state court agreed and held Taggart liable for $45,000 in post-petition attorneys’ fees.

Believing that the state court’s award of attorneys’ fees was a violation of the discharge order, Taggart brought the issue before the bankruptcy court. The bankruptcy court ultimately issued civil contempt sanctions because Sherwood had been “aware of the discharge” order and “intended the actions which violate[d] it,” and awarded Taggart over $110,000 in attorneys’ fees and damages.

Sherwood appealed and the US Court of Appeals for the Ninth Circuit agreed with its position, stating that a “creditor’s good faith belief” that the discharge order “does not apply to the creditor’s claim precludes a finding of contempt, even if the creditor’s belief is unreasonable.” Taggart appealed, asking the U.S. Supreme Court to decide whether a creditor must show a good faith belief that the discharge injunction does not apply to it in order to avoid a finding of civil contempt.

With this case, the U.S. Supreme Court establishes a new legal standard for holding a creditor in civil contempt when a creditor attempts to collect a debt in violation of a bankruptcy discharge order. The Court looked to non-bankruptcy cases to determine how and when to find a party in civil contempt and subject to sanctions, stating that civil contempt “should not be resorted to where there is a fair ground of doubt as to the wrongfulness of the defendants conduct.” Reminding us that civil contempt is a severe remedy, the Court reiterated that principles of “basic fairness requir[e] that those enjoined receive explicit notice of what conduct is outlawed” before being held in civil contempt.

The Court concluded that a court may hold a creditor in civil contempt for violating a discharge order if there is “not a fair ground of doubt as to whether the creditor’s conduct might be lawful under the discharge order.” The Court acknowledged that a creditor’s subjective, good faith belief that the discharge did not bar collection may still be relevant to the analysis, but only to determine the extent of the sanctions.

Notably, the Court also rejected Taggart’s request that the standard to find civil contempt be simply that the creditor (i) was aware of the discharge and (ii) intended the actions that violated the order. Because most creditors are aware of discharge orders and intend to collect the debt, the Court found that this standard would be too similar to strict liability and disregard whether there was a reasonable basis for the creditor to conclude that its conduct did not violate the discharge order. This could also cause risk-averse creditors to seek advance determinations from bankruptcy courts that their collection would not violate the discharge order, which would only result in more federal litigation, higher judicial costs, and additional delays.

The standard set forth by the Court this week resembles the criminal law objective standard, or the “reasonable person,” where the court is required to view the circumstances of the case from the standpoint of a hypothetical reasonable person, ignoring the unique and particular characteristics of the defendant (which would be the subjective standard).

Before sending out that collection notice, creditors should now ask, “would the reasonable creditor have fair ground to doubt that the discharge order applies here?” If the answer is no–i.e., there is no reasonable doubt that the discharge applies to this particular collection effort–then the creditor should put a hold on that notice, as a court will likely find that the creditor violated the discharge and punish the creditor with civil contempt.

In reality, not much is expected to change in discharge violation practice, as most courts and practitioners were using this standard anyway, if only unofficially (and as evidenced by the Court’s unanimous decision). That said, creditors are wise to consult with experienced bankruptcy counsel if a discharge order might stand between collection and the debtor.

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Photo of Maria A. Diakoumakis Maria A. Diakoumakis

Maria A. Diakoumakis is a Member in the Bankruptcy, Insolvency & Creditors’ Rights Practice Group, and is a member of the Business Services, Commercial Lending, Consumer Financial Services, and Financial Industry Group in the Chicago office of Dykema. Ms. Diakoumakis has represented secured creditors, landlords, equipment lessors, indenture trustees, Chapter 11 trustees, unsecured creditors, liquidating trustees, and special servicers in all aspects of corporate restructuring matters, including chapter 7, 11 and 13 proceedings, out-of-court workouts, and assignments for the benefit of creditors. She regularly represents secured lenders and mortgage servicers in a wide range of bankruptcy litigation matters, and in cash-collateral, relief from stay, plan confirmation, and section 363 sale proceedings. Ms. Diakoumakis has successfully defended multimillion dollar preference and fraudulent transfer lawsuits on behalf of creditors in various industries in multiple jurisdictions throughout the nation. She also routinely represents the nation’s largest financial institutions and mortgage servicers in connection with United States Trustee’s and Chapter 13 Trustees’ investigation of Chapter 7 and Chapter 13 bankruptcy filings and practices.