SCOTUS Adopts “No Fair Ground of Doubt” Standard for Violations of Bankruptcy Discharge Order

In a unanimous decision, the U.S. Supreme Court ruled recently in Taggart v. Lorenzen that a creditor in a bankruptcy case may be held in civil contempt, and subject to sanction, where there is “no fair ground of doubt” about whether the discharge order barred the creditor’s conduct.

Creditors engaging with consumers post-discharge often face litigation for alleged violations of the discharge order. The litigation risk is particularly acute for mortgage loan servicers engaging with consumers who continue to make mortgage payments post-bankruptcy but whose personal liability on the mortgage loan has been discharged. The Supreme Court’s decision is a welcome development because it establishes an objective standard a creditor can use to assess the risk of violating a bankruptcy discharge order when engaging with a consumer post-discharge.

Bradley Taggart, part-owner of an Oregon company, was sued in Oregon state court by the other owners for breach of the operating agreement. Before trial, Taggart filed for Chapter 7 bankruptcy and ultimately received a discharge. Post-discharge, the state court entered judgment in favor of the plaintiffs, who subsequently filed a petition in state court seeking attorney’s fees incurred after Taggart filed his bankruptcy petition.

All parties agreed that, under precedent from the U.S Court of Appeals for the Ninth Circuit, a discharge order would normally cover and discharge post-petition attorney’s fees stemming from prepetition litigation (as here) unless the discharged debtor “returned to the fray” of litigation after filing for bankruptcy. Agreeing with the plaintiffs that Taggart had “returned to the fray” post-petition, the state court found Taggart liable for the plaintiffs’ post-petition attorneys’ fees. Taggart went back to the bankruptcy court and argued that, because the discharge order barred the plaintiffs from pursuing post-petition attorneys’ fees, they should be held in civil contempt for violating the order. The bankruptcy court disagreed, finding that there was no violation of the discharge order because Taggart had “returned to the fray.”

On appeal, the district court determined that Taggart had not “returned to the fray” and the plaintiffs were therefore in violation of the discharge order. On remand from the district court, the bankruptcy court found the plaintiffs in civil contempt and applied a standard akin to strict liability. The bankruptcy court held that civil contempt sanctions were appropriate because the plaintiffs were “aware of the discharge” order and “intended the actions which violate[d]” it. The bankruptcy court awarded Taggart his attorneys’ fees and costs, damages for emotional distress, and punitive damages.

On appeal, the Bankruptcy Appellate Panel vacated these sanctions, and the Ninth Circuit affirmed the panel’s decision but did so by applying a much different standard than the bankruptcy court. The Ninth Circuit concluded 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.” Because the plaintiffs had a “good faith belief” that the discharge order “did not apply” to their claims, the Ninth Circuit held that civil contempt sanctions were improper.

The Supreme Court reversed the Ninth Circuit and ruled unanimously that a court may impose civil contempt sanctions for a discharge order violation where “there is no objectively reasonable basis for concluding that the creditor’s conduct might be lawful under the discharge order.” Calling this a “fair ground of doubt standard,” the Supreme Court also offered a differently worded formulation under which 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.”

In adopting this standard, the Supreme Court rejected the strict liability standard urged by Taggart and applied by the bankruptcy court, as well as the subjective “good faith belief” standard applied by the Ninth Circuit. In the Supreme Court’s view, its “fair ground of doubt” standard “strikes the ‘careful balance between the interests of creditors and debtors’ the Bankruptcy Code often seeks to achieve.”

While not as favorable to creditors as the Ninth Circuit’s subjective standard, the Supreme Court’s decision provides creditors with an objective standard based on reasonableness for assessing the risk that post-discharge activity will violate a bankruptcy discharge order. The Supreme Court remanded the case for further proceedings consistent with the opinion.

An earlier version of this article was originally published on Ballard Spahr’s Alerts & Publications.

Alan S. Kaplinsky is Co-Practice Leader of Ballard Spahr’s Consumer Financial Services Group. Alan developed pre-dispute arbitration provisions in consumer contracts, and has counseled financial services companies on the topic and defended companies enforcing arbitration agreements. Alan specializes in counseling financial institutions on bank regulatory and transactional matters and defending financial institutions that have been sued in individual and class action suits and by government enforcement agencies. Alan is also a past adjunct professor at Temple University James E. Beasley School of Law.

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