Will the Ninth Circuit Remand Prevent the decision in Taggart from Giving Creditors “Immunity” for violations of the Discharge Injunction.
On June 16, 2020 the Ninth Circuit Court of Appeals will hear oral argument on a critically important case that governs the application of the legal standard for a knowing violation of a discharge order. Lorenzen v. Taggart,(In re Taggart), Case No. 16-35402 et al. This case, on remand from the Supreme Court, is one of the first circuit court cases to address the application of the Supreme Court’s ruling that permits a banrkuptcy court to hold a creditor in civil contempt for violating a discharge order where there is not a “fair ground of doubt” as to whether the creditor’s conduct might be lawful under the discharge order. Taggart v. Lorenzen, 139 S.Ct. 1795, 1804 (2019).
What is at stake on remand is how strictly the circuit courts will apply this newly announced standard of “fair ground of doubt.” We argued in our amicus brief on behalf of a group of bankruptcy judges (retired) and bankruptcy law professors that there was no basis for any doubt. It is well established that when a pre-bankruptcy contract calls for payment of attorneys’ fees to prevailing parties, the legal fees that arise from litigation under such contract are squarely within the parties’ fair contemplation, even if such fees are earned post-discharge. See In re SNTL Corp., 571 F.3d 826, 843 (9th Cir. 2009). This principle pertained to the facts in this case.
A ruling in favor of Taggart is important to assure that the standard of “fair doubt” does not give rise to a host of make-weight arguments that permit creditors to ignore the discharge and to avoid sanctions.
The facts: Bradley Taggart entered into a business arrangement with two others—Messrs. Emmert and Jehnke; all were co-owners of a limited liability company for the development of a shopping center. The governing agreement provided for attorney’s fees if there was a dispute among the parties. A dispute arose when Taggart was claimed to have improperly transferred his 25% interest. He was sued in state court for both damages and to unwind the transfer. The co-owners also sought attorney’s fees for the cost of the litigation based on the parties’ written agreement.
On November 4, 2009, and on the eve of the state court trial, Taggart filed for relief under Chapter 7. The state court action was stayed. On February 23, 2010, Taggart received his discharge.
Post-discharge lawsuit based on pre-bankruptcy contract. After Taggart was granted a discharge, Taggart’s creditors sought to revive the state court suit; they claimed Taggart was a necessary party because he was still the holder of a 25% interest. Taggart’s co-members had actual knowledge of the discharge order. Taggart’s former co-members sought attorney fees in state court for the cost of the trial, invoking the pre-bankruptcy contract provision.
Taggart asked the bankruptcy court to find the creditors in contempt and to award monetary sanctions for violating the discharge injunction. His argument was correct. As a matter of law, the discharge embraces all “debts” that arose before the date of the filing. 11 U.S.C. § 727(b). A debt is a liability on a claim, 11 U.S.C. § 101(12). and a claim includes any right to payment, even if contingent and unmatured. § 101(5). A contingent claim which is discharged is one within the parties “fair contemplation” at the time of the bankruptcy filing. California Dept. of Health Services v. Jensen, 995 F.2d 925 (9th Cir. 1993). The Ninth Circuit has held that where the parties execute a prepetition agreement providing for attorneys’ fees, then even fees earned post-bankruptcy are within the parties’ contemplation, and hence subject to the discharge order. In re STNL Corp.. v. Ctr. Ins. Co., 571 F.3d 826 (9th Cir. 2009).
The creditors’ principal argument was that they were entitled to disregard the discharge order because Taggart had supposedly “returned to the fray,” relying on Boeing North American, Inc. v. Ybarra (In re Ybarra), 424 F.3d 1018(9th Cir. 2005). Ybarra held that when a discharged debtor actively and voluntarily seeks to prosecute a pre-bankruptcy claim in order to obtain relief, and there is a right to attorney fees in the underlying case, if the discharged debtor loses, then he is liable for the post-bankruptcy attorney fees. But, Ybarra is of limited viability at best, and conflicts with the overarching notion of what is within the scope of the discharge and the meaning of what is a contingent claim. The so-called Ybarra “return to the fray” notion should not be used to redefine the federal standard for what is a contingent claim.
After various rounds of litigation and appeals, on December 16, 2014 the U.S. Bankruptcy Court for the District of Oregon found that creditors had violated the discharge order by continuing to sue him in state court on claims that had been discharged.
Ninth Circuit holds subjective belief in non-application of discharge avoids contempt sanctions. The Ninth Circuit reversed, holding that a creditor’s knowing violation of the discharge injunction could not be remedied by a contempt sanction if the creditor had a good faith, subjective belief that the discharge did not apply to its claim. Lorenzen v. Taggart,(In re Taggart), 888 F.3d 438 (9th Cir. 2018). The Ninth Circuit held that even an “unreasonable belief” can satisfy this good faith standard. Id. at 444.
Supreme Court. Taggart sought review by the U.S. Supreme Court. Our group filed an amicus brief in support of Taggart. We argued that the ruling by the Ninth Circuit was incorrect, and that in effect, it made ignorance of the law a complete defense to a knowing violation of the discharge injunction, even if the creditor’s ignorance of the law was based on an unreasonable assumption. We argued that the statutory injunction of § 524(a)(2) was designed to prevent creditors from ignoring the discharge of debtors, and then later avoiding sanctions based on an assertion of a subjective belief that the discharge did not apply to them. We argued that the Ninth Circuit’s decision would likely permit abusive creditor conduct.
The Supreme Court issued its decision on June 3, 2019. The Court did not accept the highly subjective standard endorsed by the Ninth Circuit. Instead, it held that “a court may hold a creditor in civil contempt for violating a discharge order where there is not a ‘fair ground of doubt’ as to whether the creditor’s conduct might be lawful under the discharge order.” 139 S.Ct. 1795, 1804 (2019). It held that the standard was generally “objective.” Id. at 1802. It remanded the case for further proceedings in accordance with this standard.
The remand risk. The standard announced by the Supreme Court is still too lax and could lead to creditor abuse. The Ninth Circuit can help underscore Taggart insistence on an objective standard by holding that the Ybarra defense does not weaken the standard for what is a dischargeable, contingent claim. Were it to do so, then the combined ruling that “doubt” is enough and a circuit court ruling that one can have doubt that a classically contingent claim is not discharged, could create an unfortunate opportunity for creditors to be more aggressive in risking post-bankruptcy litigation.
The full implications of the Supreme Court’s decision will just now begin to emerge; it is hoped that the lower courts do not create a permissive environment where creditors know they can bring law suits on discharged claims, and then use their greater economic resources to outlast any chapter 7 debtor who defends, and thus become increasingly immune to the discharge order.
Congressional fix. The Code currently contains no express standard for violation of the discharge injunction. This in turn led the bankruptcy court to rely on the powers under 11 U.S.C. § 101 and a civil contempt sanction. Thus the legal standard that emerged was not a “strict liability” standard. The appellees made much of the notion that contempt is a serious remedy and hence the standard for violation of the discharge injunction must be forgiving. We argued in turn that the standard should be a near strict liability standard, and that where, as here, the creditors knew of the discharge injunction and intended to take the action they took, a resulting violation gives rise to a sanction. It may be that the discharge injunction needs the statutory remedy similar to that for stay violations—which provides for attorney’s fees, actual damages, and where appropriate, punitive damages.