Supreme Court Clarifies When Creditors Can Collect in Bankruptcy (1)

The U.S. Supreme Court clarified when a creditor can be held liable for violating a bankruptcy discharge order, rejecting a federal appeals court’s subjective standard that left few satisfied.

Justice Stephen G. Breyer, writing for a unanimous court, said June 3 that neither a creditor’s strict liability from violating the order nor a purely subjective standard—in which creditors may have a reasonable belief that they can collect on debt—is appropriate in holding creditors liable.

An “objective reasonableness” standard must be used to find a creditor liable for civil contempt sanctions for violating a bankruptcy discharge order when there is no “fair ground of doubt” that the action was barred, the court said. That means that the U.S. Court of Appeals for the Ninth Circuit’s decision that applied a subjective good-faith standard was wrong, and that court will now have to apply the Supreme Court’s objective standard that has been used outside of bankruptcy since 1885.

“This ruling ought to encourage both debtors and creditors,” Craig Goldblatt, a partner with Washington’s Wilmer Cutler Pickering Hale and Dorr, told Bloomberg Law. “In cases in which there is real ambiguity about whether a particular action violates the discharge injunction, go to the bankruptcy court to seek clarification.”

Remaining Uncertainty

Both creditors and debtors praised the ruling for overturning the Ninth Circuit’s standard, which all of the parties at oral argument argued was wrong, although some uncertainty remains regarding how the new standard will be applied.

“It should be hard for a creditor to allege it didn’t know the discharge barred the collection actions, but now there is wiggle room that could be harmful to the honest but unfortunate debtors who were granted a discharge of their debts,” said Jenny Doling, a partner with Doling Shaw & Hanover in California.

Nicole M. Strickler, an attorney with Messer Strickler Ltd., Chicago, who filed a friend of the court brief in the case on behalf of the National Creditors Bar Association, said the Supreme Court’s new standard is good news for creditors because “it recognizes that reasonable minds may differ, and in such cases, creditors shouldn’t be punished.”

Contract Dispute

The case arose from a contract dispute between Bradley Taggart and his business partners. Taggart filed for Chapter 7 protection on the eve of an Oregon state trial, allowing him to wipe out his financial obligations and escape the case.

Taggart’s former business partners tried to collect attorneys’ fees from him that were incurred after he filed bankruptcy because he voluntarily “returned to the fray” by rejoining the state court case after his bankruptcy case ended.

The bankruptcy court imposed sanctions against Shelley A. Lorenzen of $105,000 for attorney’s fees, $5,000 for emotional distress, and $2,000 for punitive damages. The Bankruptcy Appellate Panel, however, reversed.

The Ninth Circuit affirmed, concluding that Lorenzen acted under a good faith belief that the discharge injunction didn’t apply to his claims. Under the Ninth Circuit’s test, creditors had a defense even if their belief was unreasonable.

Taggart appealed to the Supreme Court, which heard oral argument April 24.

In its June 3 decision, the Supreme Court said a creditor may be held in civil contempt for violating a bankruptcy discharge order where there isn’t a “fair ground of doubt as to whether the creditor’s conduct might be lawful under the discharge order.”

Parties’ Reaction

Attorneys representing both parties in the case told Bloomberg Law they expect their client’s position to ultimately prevail on remand.

Lorenzen “acted reasonably every step of the way, and doesn’t deserve to be held in contempt of court,” said Nicole A. Saharsky, Mayer Brown LLP, Washington, who represented Lorenzen.

“We are confident that the Ninth Circuit will recognize that on remand,” she said.

“We took this case up to the Supreme Court to eliminate the Ninth Circuit’s subjective good-faith standard, and we accomplished that goal,” Taggart’s attorney, Daniel L. Geyser, Geyser PC, Dallas, told Bloomberg Law after the ruling.

The Supreme Court’s new standard—objective reasonableness—will protect debtors in the vast majority of cases, including this one,” Geyser said.

The Supreme Court agreed with U.S. Solicitor General Noel J. Francisco’s position in the case that the fair ground of doubt standard was the appropriate one to apply in this context.

The case is Taggart v. Lorenzen, U.S., No. 18-489, 6/3/19.