A Hypothetical:
You’ve sued an individual in state court for injunctive and other relief. Your defendant then files bankruptcy and receives a Chapter 7 discharge. Then, you ask the state court to determine that you can proceed with the lawsuit, despite the bankruptcy discharge. The state court says you can, and so you do.
Debtor reopens the bankruptcy and seeks a contempt citation against you for violating the discharge injunction.
The Question:
Can you be sanctioned for violating the discharge injunction, under the foregoing facts, if the state court’s authorization to proceed was wrong?
That is the essence of of the facts and question now before the U.S. Supreme Court in the case of Taggart v. Lorenzen, Supreme Court Case No. 18-489 (certiorari granted on January 4, 2019).
Litigation Facts
Sherwood Park Business Center, LLC, and its members sued Bradley Taggart in state court because Taggart transferred his membership interest in Sherwood to another person. The plaintiffs sought to unwind that transfer and to expel Taggart from the company. Taggart counterclaimed for attorneys fees.
On the day before trial, Taggart filed Chapter 7 bankruptcy, in which he later received a discharge.
After Taggart’s discharge, Sherwood resumed the state court lawsuit, which went to trial without Taggart’s participation—but with his attorney present. The state court ruled in Sherwood’s favor by unwinding Taggart’s transfer and enforcing the right of first refusal held by other Sherwood members.
Then, the same plaintiffs sued Taggart in state court to recover attorney fees they incurred after Taggart received his discharge. Simultaneously, they asked the state court to determine whether the discharge injunction prevented their fee request, citing this proposition from In re Ybarra, 424 F.3d 1018 (9th Cir. 2005):
a debtor cannot, after being “freed from the untoward effects of the contracts” through a discharge, voluntarily “return to the fray and to use the contract as a weapon” without allowing “the same weapon to be used against him.”
Taggart argued that he did not voluntarily return to any fray.
State and Federal Court Rulings, Appeals & Reversals
The state court ruled that Taggart had returned to the fray, so the discharge injunction did not apply. So the case progressed. Ultimately, the state court awarded plaintiffs a judgment against Taggart for their attorney fees incurred after entry of his discharge. Taggart appealed to the state appellate court.
Meanwhile, Taggart reopened his bankruptcy and moved to hold his state court opponents in contempt for violating the discharge injunction.
Here is a chronology of state and federal court-proceedings that ensued:
December 9, 2011—Bankruptcy Court denies Taggart’s contempt motion, finding no error in the state court’s actions; Taggart appeals to the U.S. District Court.
August 6, 2012—U.S. District Court reverses and remands to the Bankruptcy Court—declaring that Taggart had not returned to the fray.
November 26, 2014—State appellate court declares that Taggart had not returned to the fray and reverses the state court’s attorney fee award against Taggart.
March 17, 2015—Bankruptcy Court, on remand from the U.S. District Court, finds that Taggart’s opponents willfully violated the discharge injunction and enters orders of contempt and sanctions against them; Taggart’s opponents appeal to the Ninth Circuit BAP (instead of the U.S. District Court, which had already ruled against them).
April 12, 2016—Ninth Circuit BAP rewards appellants’ forum selection decision by reversing the Bankruptcy Court’s contempt and sanctions orders; Taggart appeals to the Ninth Circuit Court of Appeals.
April 23, 2018—Ninth Circuit affirms the BAP reversal; Taggart appeals to the U.S. Supreme Court.
January 4, 2019—U.S. Supreme Court grants certiorari.
Ninth Circuit Ruling
The Ninth Circuit held that Taggart’s opponents “could not be held in contempt because they did not knowingly violate the discharge injunction.” Here’s the Ninth Circuit Rationale:
A contempt sanction in the context of a discharge injunction is subject to a two-part test: “the movant must prove that the creditor (1) knew the discharge injunction was applicable and (2) intended the actions which violated the injunction”;
“To satisfy the first prong, knowledge of the applicability of the injunction must be proved as a matter of fact and may not be inferred simply because the creditor knew of the bankruptcy proceeding”;
“Additionally, the creditor’s good faith belief that the discharge injunction does not apply to the creditor’s claim precludes a finding of contempt, even if the creditor’s belief is unreasonable”; and
“In this case, the bankruptcy court abused its discretion by . . . applying an incorrect rule of law”—it incorrectly held that “a good faith belief that the discharge injunction was inapplicable to the Creditors’ claims was irrelevant for purposes of determining whether there was a ‘knowing’ violation of the discharge injunction.”
At the U.S. Supreme Court
The question before the U.S. Supreme Court, on which it granted certiorari, is this:
“Whether, under the Bankruptcy Code, a creditor’s good-faith belief that the discharge injunction does not apply precludes a finding of civil contempt.”
According to the Petition for a Writ of Certiorari, the Ninth Circuit’s ruling is in conflict with all other circuit courts, bankruptcy appellate panels, and bankruptcy courts that have addressed the matter. Consider the following information from the Petition.
–First Circuit
The First Circuit, in In re Pratt, 462 F.3d 14 (1st Cir. 2006), held that a creditor’s violation of the discharge injunction was actionable despite the lack of “bad faith” and that “the standard for a willful violation” is met “if there is knowledge of the stay and the defendant intended the actions which constituted the violation.” Additionally, when a willful violation occurs, the bankruptcy debtor is entitled to recover “compensatory damages, together with other appropriate relief under Bankruptcy Code § 105(a).”
–Fourth Circuit
The Fourth Circuit, in In re Fina, 550 F. App’x 150 (4th Cir. 2014), held that “contempt sanctions” in the discharge context are controlled by a “two-part test”: “(1) whether the creditor violated the injunction, and (2) whether he or she did so willfully.” The Fourth Circuit added that the “willfulness prong requires only that the acts taken in violation of the injunction be intentional” so that “a good faith mistake is generally not a valid defense.”
–Eleventh Circuit
The Eleventh Circuit, in In re Hardy, 97 F.3d 1384 (11th Cir. 1996), held that Section 105 authorizes relief for discharge violations, irrespective of a creditor’s good faith: “the focus of the court’s inquiry in civil contempt proceedings is not on the subjective beliefs or intent of the alleged contemnors in complying with the order, but whether in fact their conduct complied with the order at issue.”
–Bankruptcy Appellate Panels
Two bankruptcy appellate panels are in accord with the Eleventh, First and Fourth Circuits: see In re Martin, 474 B.R. 789 (B.A.P. 6th Cir. 2012), and In re Culley, 347 B.R. 115 (B.A.P. 10th Cir. 2006).
–Bankruptcy Courts
Dozens of bankruptcy court opinions, nationwide, are contrary to the Ninth Circuit’s position. See pages 19-21 of the Petition for a Writ of Certiorari for a listing of such cases.
–A Third Circuit Issue
The Petition adds the following information (at 21-22):
At the rehearing stage below, one of the respondents argued that the Ninth Circuit does not “stand alone” in its position, suggesting that the Third Circuit holds a similar position, citing In re Ben Franklin Hotel Assocs., 186 F.3d 301, 309 (3d Cir. 1999); and
“This assertion is twice curious,” the Petition says, because (i) it “supports, not diminishes, the need for this Court’s immediate review,” and (ii) the Third Circuit actually held that the bankruptcy court did not “abuse [its] discretion” in declining contempt in light of the “unusual facts” before it.
Conclusion
The Taggart facts and question before the Supreme Court are fascinating. And, apparently, the Ninth Circuit is alone in holding that a court order can shield a person from sanctions for violating the discharge injunction.
It’s obvious that the issue is a contentious one, given the numerous reversals on appeal in both state and federal courts that have already occurred in the Taggart case.
Can’t wait to see how the briefing, oral arguments and ultimate ruling shape up in this case!
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