SCOTUS Clarifies When a Creditor Is in Contempt for Violating a Bankruptcy Discharge

Yesterday, the U.S. Supreme Court clarified when a creditor may be held in contempt for violating a bankruptcy court's discharge order. (Taggart v. Lorenzen, 587 U.S. -- (2019) No. 18-489.) The court held that neither strict liability nor the creditor's subjective belief governs. Instead, an objective standard applies:  the creditor may be held liable if there is "no fair ground of doubt" as to whether the discharge order barred the particular conduct of the creditor. (Id. at p. 2.)

A discharge order is one of the primary benefits--in some cases the only lasting benefit--of filing for bankruptcy. It is the main mechanism by which the bankruptcy laws provide debt relief. Once a discharge order is entered, creditors are enjoined from attempting to collect a debt that is covered by the order. (Note, between the time the bankruptcy petition is filed and the discharge order is entered, debt collection is enjoined by virtue of the automatic stay under 11 U.S.C. section 362.)

The debtor in Taggart had received a Chapter 7 discharge but then faced a $45,000 state court attorney's fees award from litigation of a discharged claim. The creditor believed that the debtor had "returned to the fray" of the litigation after the bankruptcy discharge and that, therefore, the attorney's fees liability was not covered by the discharge order. The lower courts ultimately disagreed and awarded $112,000 in sanctions to the debtor and against the creditor, applying a strict liability standard under which a creditor would be liable for violating a discharge order if (1) the actions of the creditor were ultimately found to violate the discharge and (2) the creditor intended the actions which violated the discharge, regardless of the creditor's knowledge or belief of the applicability of the discharge order. The U.S. Court of Appeal for the Ninth Circuit then reversed based on a subjective standard, which would have insulated the creditor if it had a good faith belief that its actions were consistent with the discharge order.

The Supreme Court rejected both the strict liability standard and the subjective test. Instead, the court held that the bankruptcy court may impose contempt sanctions when "there is no objectively reasonable basis for concluding that the creditor's conduct might be lawful under the discharge order." The court reasoned that the governing Bankruptcy Code sections should be interpreted to incorporate the civil contempt standard in the non-bankruptcy context, which provides there is no contempt when there is "a fair ground of doubt" as to the wrongfulness of the defendant's conduct.
--MTB