Does a creditor’s good-faith belief that an attempt to collect non-dischargeable debt does not violate a bankruptcy court’s discharge order protect the creditor from contempt?
This case asks the Supreme Court to determine what role, if any, good-faith belief plays in relation to contempt and bankruptcy discharge orders. Petitioner Bradley Weston Taggart contends that the bankruptcy code does not afford protection for creditors who violate a discharge order, even when a creditor holds a good-faith belief that his or her attempt at collection is permissible under the law. Respondents Shelley A. Lorenzen and others counter that the bankruptcy code must consider a creditor’s good-faith belief, because otherwise creditors would be held in contempt for minor violations that make it harder for them to seek collection of non-dischargeable debt. The outcome of this case will have significant implications on the limits of creditor liability and debtor protection in the discharge context as well as implications for legal advocacy, state taxation, and the economy.
Questions as Framed for the Court by the Parties
Whether, under the Bankruptcy Code, a creditor’s good-faith belief that the discharge injunction does not apply precludes a finding of civil contempt.
Petitioner Bradley Weston Taggart, a real estate developer, owned a twenty-five percent interest in Sherwood Park Business Center (“SPBC”). In 2007, Taggart transferred his interest in SPBC to his lawyer, John Berman. When Terry Emmert and Keither Jehnke, co-owners of SPBC, learned that Taggart transferred his interest in SPBC to Berman, they filed suit in Oregon state court against Taggart and Berman. Emmert and Jehnke alleged that Taggart breached SPBC’s operating agreement when he failed to notify them of the transfer to Berman, which deprived them of the opportunity to buy Taggart’s interest. Each side sought attorneys’ fees pursuant to the operating agreement.
Just before the trial commenced in 2009, Taggart filed a voluntary Chapter 7 Bankruptcy petition in a federal bankruptcy court. The state court stayed the proceedings pending the resolution of Taggart’s bankruptcy petition.
After Taggart received his bankruptcy discharge in 2010, Emmert and Jehnke, represented by their attorney Stuart Brown, resumed the proceedings in state court against Taggart and Berman. After Emmert and Jehnke served Taggart with a deposition subpoena, Taggart moved to dismiss the claims against him because he had received his discharge. Notwithstanding the bankruptcy discharge, the state court denied Taggart’s motion and concluded that he was a necessary party in the suit. The state court also decided, however, that it would not award any monetary judgment against Taggart. Taggart did not appear or participate in the trial. After the trial, the state court nullified the transfer of Taggart’s interest in SPBC to Berman and expelled Taggart from SPBC. The state court also entered a judgment that allowed the parties to petition for attorneys’ fees.
Brown subsequently filed a petition for attorneys’ fees on behalf of Emmert, Jehnke, and SPBC, seeking to recover from both Taggart and Berman. But Brown limited the attorneys’ fees sought from Taggart to only those accrued after the bankruptcy discharge. Brown alleged that this was proper because Taggart had actively opposed the state court action after the bankruptcy discharge and thus properly “returned to the fray.” Taggart objected, arguing that the bankruptcy discharge precluded any claim for attorneys’ fees. The state court ruled against Taggart, issuing an award of attorneys’ fees to SPBC and finding that Taggart was liable for attorneys’ fees accrued the bankruptcy discharge because he had “returned to the fray.” The state court, however, did not award attorneys’ fees to Jehnke and Emmert in their individual capacities.
While the state court attorneys’ fees proceedings unfolded, Taggart asked the federal bankruptcy court to reopen his bankruptcy proceeding. The federal bankruptcy court obliged. Taggart quickly moved to hold Jehnke, Emmert, SPBC, and Brown in civil contempt for violating the bankruptcy discharge by seeking to recover attorneys’ fees from him. The federal bankruptcy court denied Taggart’s motion and endorsed the state court’s decision. Taggart appealed to the federal district court, which reversed and remanded the case. The federal district court concluded that Taggart had not properly “returned to the fray,” thus barring any recovery of attorneys’ fees from Taggart.
On remand, the federal bankruptcy court found that Jehnke, Emmert, SPBC, and Brown knowingly violated the bankruptcy discharge and its corresponding injunction by seeking to recover attorneys’ fees from Taggart. The federal bankruptcy court accordingly held Jehnke, Emmert, SPBC, and Brown’s estate in civil contempt and imposed sanctions on them. By this time, Brown had passed away; Shelley A. Lorenzen, the executor of Brown’s estate, took his place in the litigation.
Jehnke, Emmert, SPBC, and Lorenzen appealed the federal bankruptcy court’s decision to the Bankruptcy Appellate Panel for the Ninth Circuit (“BAP”), which reversed the civil contempt holding. The BAP found that Jehnke, Emmert, SPBC, and Brown had not knowingly violated the bankruptcy discharge and its corresponding injunction because they had a good-faith belief that the injunction did not apply to the attorneys’ fees claim.
While the federal courts adjudicated the civil contempt issue, the Oregon Court of Appeals reversed the Oregon state court’s decision awarding attorneys’ fees to SPBC. Similar to the federal district court, the Oregon Court of Appeals determined that Taggart had not “returned to the fray.” Thus, the bankruptcy discharge barred any recovery of attorneys’ fees from Taggart. In sum, the rulings by the Oregon Court of Appeals and the federal district court barred Jehnke, Emmert, SPBC, and Brown’s estate from recovering any attorneys’ fees from Taggart. Additionally, the BAP’s ruling absolved Jehnke, Emmert, SPBC, and Brown’s estate of civil contempt liability and sanctions.
Taggart appealed the BAP’s ruling to the United States Court of Appeals for the Ninth Circuit. Jehnke, Emmert, SPBC, and Lorenzen cross-appealed the federal district court’s ruling that Taggart had not “returned to the fray.” The Ninth Circuit affirmed the BAP’s holding that the federal bankruptcy court erred when it held Jehnke, Emmert, SPBC, and Brown’s estate in civil contempt. The Ninth Circuit concluded that a good-faith but erroneous or unreasonable belief of entitlement to attorneys’ fees cannot confer civil contempt liability or sanctions. The Ninth Circuit did not reach the issue raised by the cross-appeal.
CAN GOOD FAITH SHIELD CREDITORS FROM CIVIL CONTEMPT PROCEEDINGS?
Petitioner Bradley Weston Taggart argues that the Supreme Court has maintained the longstanding position that a good-faith belief is irrelevant and does not provide relief for civil contempt liability, including in bankruptcy cases. The Ninth Circuit, Taggart contends, went against Court precedents and erred when it considered a creditor’s subjective belief. Thus, Taggart argues that a discharge injunction is effective regardless of a creditor’s subjective belief, since Congress has not provided that a discharge order’s effectiveness is dependent on a creditor’s mindset. The overarching goal of bankruptcy, Taggart notes, is for the debtor to receive a “fresh start,” which cannot be accomplished if subjective belief is taken into account. As a result, Taggart contends, the Ninth Circuit’s holding—that good-faith or subjective belief shields a creditor from civil contempt proceedings—undermines the purpose of bankruptcy proceedings and places a burden of non-compliance on the debtor as opposed to the creditor.
Respondent Shelley A. Lorenzen and others (“Lorenzen”) argue that a person should not be held in contempt when that person had a good-faith belief and that bankruptcy courts may exercise contempt power only when “necessary or appropriate,” which is not the case here. Lorenzen explains that Taggart’s position would amount to strict liability, automatically holding creditors in contempt regardless of their good-faith belief of doing nothing wrong, which does not comport with the discretion given to bankruptcy courts under 11 U.S.C. § 105 to exercise their contempt power. In this regard, Lorenzen contends that the Court should uphold the Ninth Circuit’s holding providing that good-faith belief protects a creditor from civil contempt liability because otherwise debtors would prevent creditors from collecting non-dischargeable debts, frustrating the purpose of bankruptcy proceedings.
DOES GOOD FAITH MATTER IN BANKRUPTCY?
Taggart argues that the Ninth Circuit’s “good faith” requirement will harm debtors since creditors could claim a good-faith mistake to avoid compensating the debtor for any losses from that mistake. According to Taggart, Congress did not create a “good faith” exception because Congress recognized that allowing such an exception would cause debtors to challenge creditors who claim innocent mistakes—thereby increasing debtors’ litigation costs when debtors need to recover assets. It follows, Taggart explains, that creditors, who made good-faith mistakes, could simply ask a bankruptcy judge about their rights—such a mechanism avoids placing the burden on debtors to challenge a creditor’s good-faith belief. Hence, Taggart states, the Ninth Circuit’s holding will allow creditors to avoid responsibility for their actions, which will not only harm debtors but also drain court resources when judges have to distinguish genuine defenses from mere pretenses.
Likewise, Taggart explains that bankruptcy courts, under 11 U.S.C. § 105, have used their “statutory contempt power” to provide debtors monetary compensation when creditors have violated § 524 discharge injunctions. Specifically, Taggart adds that a creditor is found liable for “statutory contempt” when that creditor (1) is “aware of the discharge injunction” and (2) have “intended the actions” that violated the discharge injunction. The purpose of discharge injunctions, Taggart explains, is to halt all collection actions against a debtor—punishing noncomplying creditors with civil contempt is necessary because otherwise the discharge order becomes ineffective, and the debtor would be left worse off. Taggart emphasizes that the Ninth Circuit is wrong to have considered a creditor’s good faith because the imposition of civil contempt liability depends on whether the discharge injunction was violated or not—whether the creditor violated the discharge injunction in good faith or not does not matter. Taggart warns that considering creditors’ “good faith” will undermine the purpose of bankruptcy proceedings in providing debtors a “fresh start” and will pervert the textual language of the Bankruptcy Code. Taggart thus posits three rationales derived from the statutory language of § 105: (1) Congress did not explicitly authorize a “good faith” defense under § 524 regarding discharge orders, (2) the Ninth Circuit’s permission of a “good faith” defense will conflict with § 362(k) that governs violations of the automatic stay, and (3) Congress explicitly allowed a creditor to rely upon the bankruptcy court to determine whether a debt is dischargeable, instead of a good-faith assumption that a debt is not dischargeable.
Taggart contends that, without a discharge order, a debtor cannot seek relief through bankruptcy to improve their financial situation. Instead, the Ninth Circuit’s holding, Taggart argues, will cause a debtor to incur expenses due to a creditor’s good-faith mistake. According to Taggart, disproving a creditor’s good-faith belief entails hearings and evidence collection—both will be costly to the debtor and the court. As a result, Taggart argues, Congress did not provide for a “good faith” exception—instead, imposition of civil contempt liability does not depend on a creditor’s good-faith belief, and a creditor’s discharge injunction violation—whether due to good-faith mistakes or not—entitles a debtor to recover damages.
Lorenzen counters Taggart’s argument—that creditors should pay for damages when they violate the terms of a discharge order and any “good faith” exception harms the financial interests of debtors—in two ways. First, Lorenzen contends that civil contempt liability is not meant to make a debtor whole, but it instead acts as a sanction to punish attorneys, which carries dire consequences. Second, Lorenzen argues that a strict-liability standard would, in effect, force creditors to pay damages regardless of whether they attempt to comply with discharge orders. Taggart’s proposal that good-faith creditors can seek guidance from courts, Lorenzen maintains, is flawed because Congress has not specified that creditors can seek court guidance before collection. Lorenzen furthers that, under the Bankruptcy Code, debtors would still incur post-discharge litigation costs even if Taggart’s proposal were adopted. Moreover, Lorenzen continues, Taggart fails to consider the fact that federal courts share jurisdiction with state courts over which debts are dischargeable.
Lorenzen thus argues that a court’s contempt power is not “necessary or appropriate” when a person has a good-faith belief about the inapplicability of a court order. Specifically, the plain language of § 105, Lorenzen explains, gives bankruptcy courts discretion when to impose civil contempt liability as opposed to a mandatory sanction. In this regard, Lorenzen articulates three principles which protect a creditor from civil contempt liability when that creditor has a good-faith belief regarding the meaning of an unclear discharge order. First, Lorenzen maintains that a court exercises its discretion to impose civil contempt liability, instead of a mandatory sanction, when a person purposefully disobeys the court. Second, civil contempt liability is justified, Lorenzen posits, when a person clearly knows that his or her conduct would violate a court order that carries civil contempt liability. Third, Lorenzen asserts that the Court has accepted good faith as a factor when contemplating civil contempt liability, providing that a “reasonable, good-faith belief” may prevent civil contempt liability, and blatant bad faith warrants it. With this in mind, Lorenzen believes that, for the bankruptcy system to be fair and to promote efficiency, bankruptcy courts must consider creditors’ good-faith beliefs because otherwise creditors would face civil contempt liability no matter how small the violation is, and this would prevent creditors from rightly collecting non-dischargeable debts.
Finally, Lorenzen believes that Taggart’s position is contrary to the Bankruptcy Code because it makes creditors to be held in contempt even when they believed in good faith that their actions would not violate the discharge order. Hence, Lorenzen adds that it is necessary for bankruptcy courts to consider good faith, since other provisions of the Bankruptcy Code already account for good faith, where courts examine the subjective belief, objective factors, and circumstances to prevent a party from acting in bad faith to avoid liability. Accordingly, Lorenzen argues that the absence of explicit languages proves that Congress did not provide for mandatory civil contempt liability for discharge injunction violations. Lorenzen therefore concludes that the harshness of civil contempt liability should only be employed when a creditor violates the automatic stay, not a discharge order, and that creditors should not bear additional costs.
LIMITS OF CREDITOR LIABILITY
The National Consumer Bankruptcy Rights Center and the National Association of Consumer Bankruptcy Attorneys (collectively “NCBR”), in support of Taggart, assert that the Supreme Court should reject the Ninth Circuit’s good-faith-belief-even-if-unreasonable framework because the standard will give creditors “a free pass” to disregard the bankruptcy discharge injunction, seek to collect on debts, and require debtors to demonstrate that the creditor did not act in good faith. The Ninth Circuit’s framework, according to the NCBR, has already and will continue to insulate creditors who cite ignorance or good-faith efforts from liability for bankruptcy discharge injunction violations, thus giving creditors license to predatorily seek to collect on debts.
The Honorable Eugene Wedoff, the Honorable Leif Clark, and bankruptcy law professors (collectively “Bankruptcy Scholars”), in support of Taggart, contend that the Ninth Circuit’s framework is “highly problematic” as applied to institutional and corporate creditors, as courts will be unable to discern the subjective beliefs of institutions and corporations. The United States, in support of neither party, also rejects the Ninth Circuit’s framework, but unlike the NCBR, advocates for a no-fair-ground-of-doubt standard—a standard that strikes an “appropriate balance between debtor and creditor interests.”
The National Creditors Bar Association (“NCBA”), in support of Lorenzen, counters that limiting civil contempt liability and sanctions to only the instances in which creditors or their attorneys act with subjective bad faith creates a system where only “truly wrongful” conduct is penalized. The State of California and twenty-six other states (collectively “States”), in support of Lorenzen, maintain that the process undertaken by creditors of determining if debts have been discharged involves significant complexity and uncertainty. State law, according to the States, often imposes an added layer of complexity and uncertainty to the process. As a result, a strict liability standard for civil contempt liability and sanctions in this context would unduly burden States and state agencies—which already face difficulties in determining whether debts have been discharged—in their attempts to collect on debts.
Additionally, the United States, rejecting Taggart’s proposed rule, notes that his proposal will almost always result in cases where courts can impose civil contempt liability on the bankruptcy discharge order violator. The United States further claims that Taggart’s proposal—creditors seek advanced determinations of debt dischargeability to insulate themselves from liability—is “impractical” for creditors such as the government, and would inhibit creditors from rightly collecting non-discharged debts. The United States argues that the advanced-determination method would impose significant costs on creditors in their efforts to collect debts.
PROTECTIONS FOR BANKRUPTCY DEBTORS
The NCBR argues that the Ninth Circuit’s framework effectively shifts to debtors the cost of maintaining a post-discharge “fresh start.” The NCBR posits that the Ninth Circuit’s framework has already and will continue to result in cases in which creditors’ ignorance of bankruptcy law imposed significant costs on debtors rather than creditors. This is particularly appalling, according to the NCBR, because debtors generally do not have the resources to defend against creditors who disregard bankruptcy discharge injunctions and seek to collect on debts. The Ninth Circuit’s framework, the Bankruptcy Scholars claim, will allow creditors to “intimidate” underrepresented and pro se debtors into relinquishing their post-discharge “fresh start.”
The States counter, noting that a standard protecting creditors who acted with objective reasonableness in collecting a debt neither offends the debtors’ “fresh start” nor degrades protections for debtors. The States argue that a debtor still has several avenues for recourse against creditors who engage in conduct or threaten to engage in conduct that violates a bankruptcy discharge injunction—including invoking the bankruptcy court’s authority or seeking Bankruptcy Rule 9011 sanctions for bad faith conduct. The objective reasonableness standard, the States conclude, both protects debtors from predatory conduct by creditors and allows creditors to collect on non-discharged debts.
EFFECTS ON LEGAL ADVOCACY, STATE TAXATION, AND THE ECONOMY
The Bankruptcy Scholars argue that in addition to the burden imposed by the cost and time related to litigating disputes arising from a bankruptcy discharge order, the Ninth Circuit’s framework will impose hardship on debtors related to finding a new legal counsel. The Bankruptcy Scholars explain that the legal counsel that represented the debtors in their Chapter 7 Bankruptcy proceedings have no duty or obligation to represent them during post-discharge proceedings. And, the Bankruptcy Scholars further, while creditors will generally be “well-funded” and “well-represented” by legal counsels, debtors’ legal counsels will be more likely to “unbundle” their legal services and decline to represent the debtors in post-discharge proceedings if the Supreme Court affirms the Ninth Circuit’s framework. Additionally, the Bankruptcy Scholars stress that an effective bankruptcy discharge system—in addition to benefiting debtors—also benefits the economy as a whole because debtors can resume being productive members of a society once they are “freed from the oppressive weight” of debt.
The NCBA argues that Taggart’s proposed rule would effectively ask courts to impose civil contempt liability on a strict liability basis and would thus chill legal advocacy by obligating attorneys to choose between, on the one hand, their duty of loyalty and zealous advocacy to their clients and, on the other hand, their fear of personal harm stemming from the possibility of civil contempt liability, discipline, and revocation of licensure. The NCBA notes that courts have consistently recognized that the risk of civil contempt liability alone may have a chilling effect on the legal advice that attorneys provide to their clients in good faith. This undesirable chilling effect, the NCBA maintains, would only be exacerbated if the Supreme Court adopted Taggart’s proposed rule. The States add that a strict liability standard would improperly chill taxation and regulation by the States, and States may even write off a significant amount of obligations. If the Supreme Court adopted Taggart’s proposed rule, according to the States, the States may determine that the economic costs and risks of seeking to collect taxes and other debts in good faith outweigh the potential benefits.
- Daniel Gill, SCOTUS to Consider Creditors’ Collection Acts Post-Bankruptcy, Bloomberg Law (Jan. 4, 2019).
- Amy Howe, More on Today’s Orders, SCOTUSblog (Jan. 4, 2019).
- Sarah B. Boehm and Patrick L. Hayden, Circuit Split: Should Subjective Intent Preclude a Finding of Civil Contempt in a Discharge Injunction Violation Case, Lexology (Dec. 5, 2018).