United States: U.S. Supreme Court Rejects "Unreasonable But Good Faith Belief" Defense For Creditors In Violation Of Discharge Injunction

At the conclusion of a bankruptcy, the court typically enters an order discharging the debtor from personal liability for most pre-bankruptcy debts. This "discharge order" bars creditors from attempting to collect any debt covered by the order from the debtor personally. 11 USC § 524(a)(2). But after the discharge, creditors may be confused about the permissible post-discharge interactions with the debtor. So how does a court decide whether to sanction a creditor for collection activities that violated the discharge injunction, if the creditor genuinely believed they were allowed?

In a unanimous opinion delivered by Justice Breyer, the U.S. Supreme Court held in Taggart v. Lorenzen¹ that a creditor can be held in civil contempt for violating a bankruptcy court's discharge order, if there is "no fair ground of doubt" as to whether the order barred the creditor's conduct. The Court vacated and remanded the Ninth Circuit's holding in 888 F.3d 438, 445 (9th Cir. 2018), which allowed creditors an "unreasonable belief" defense to alleged discharge violations. Under that standard, even a creditor that subjectively but unreasonably believed their actions were permissible despite the discharge injunction could not be sanctioned.

Bradley Taggart formerly owned an interest in Sherwood Park Business Center, LLC. When the LLC members learned that he transferred his interest, they sued Taggart for violating the operating agreement. To stop the state court trial, Taggart filed Chapter 7 bankruptcy. After receiving a discharge, the Oregon court denied Taggart's dismissal from the suit, and the LLC members sued him for attorneys' fees. Taggart then reopened his bankruptcy case to hold his creditors in contempt for violating the discharge injunction. While the state court ordered Taggart to pay the attorneys' fees, the bankruptcy court held his creditors in contempt for pursuing fees in violation of the discharge. The Bankruptcy Appellate Panel reversed, disagreeing that the creditors' subjective, good-faith beliefs were irrelevant. By the time the state litigation concluded, it was settled that the judgment against Taggart did violate the discharge, and that he could not be forced to pay attorneys' fees. As to whether the violation was sanctionable, the Ninth Circuit Court of Appeals affirmed the BAP's reversal of contempt sanctions, holding that the LLC could not be held in contempt so long as it had a subjective belief—however unreasonable—that it was entitled to fees from Taggart.

Rejecting the Ninth Circuit's standard, the Supreme Court established a more moderate standard: civil contempt sanctions may be appropriate "when the creditor violates a discharge order based on an objectively unreasonable understanding of the discharge order or the statutes that govern its scope." In doing so, the Court found the middle ground between the "strict liability" standard Taggart proposed, requiring preapproval from the bankruptcy court to act, and the "even if unreasonable" defense to discharge violations advocated for by Taggart's creditors.

The Court's opinion allows a "good faith belief" defense so creditors do not risk contempt for any discharge violations, so long as they had a reasonable (albeit mistaken) belief that their conduct was permissible. The Court, however, did decide that an unreasonable mistake should not shield creditors from liability. It remains to be seen if the "no fair ground of doubt" standard for assessing discharge injunction violations can be extended to automatic stay violations.

Moving forward, Taggart establishes the applicable standard for whether a court should impose sanctions against a creditor for violation of the discharge injunction. If you are owed a debt that may have been discharged, please make sure you consult an attorney to ensure that your intended collection actions do not fall under Taggart's "no fair ground of doubt" category of sanctionable conduct.

Co-Author, Ameena R. Khan, Summer Associate

Footnote

1 Taggart v. Lorenzen, No. 18-489, 2019 U.S. LEXIS 3890 (June 3, 2019).

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