The Supreme Court Rejects a Strict Liability Standard for Considering Violations of the Discharge Injunction

Beau Hays

Hays, Potter & Martin, LLP

Peachtree Corners, GA

TAGGART v LORENZEN, __ U.S. __, (No. 18-489, June 3, 2019)

            A unanimous Supreme Court has announced a standard of review for contempt actions based upon the discharge injunction in §524(a)(2), which differs from that applied by any court previously considering the question:  A creditor may be in civil contempt for violating the discharge injunction if there is “no fair ground of doubt” as to whether the order barred the creditor’s conduct.  The Court specifically labeled the limits of this doubt as being “when there is no objectively reasonable basis for concluding that the creditor’s conduct might be lawful.”

            Previous to this pronouncement, courts had been applying what was generally called a “strict liability” standard – a simple two-prong test of (1) was the creditor aware of the discharge order and (2) did the creditor intend the action violated the Order.  “[T]his court adopted a two-pronged test to determine willfulness in violating the automatic stay provision of § 362. Under this test the court will find the defendant in contempt if it: ‘(1) knew that the automatic stay was invoked and (2) intended the actions which violated the stay.’  This test is likewise applicable to determining willfulness for violations of the discharge injunction of § 524.”  In re Hardy, 97 F.3d 1384, 1390 (11th Cir., 1996).  In the Taggart case, the Bankruptcy Court for District of Oregon followed the “strict liability” standard in sanctioning the creditor’s conduct; the good faith belief of the creditor that its actions were not a violation of the discharge injunction was irrelevant to the analysis. 

            The flaw in this mechanistic approach is evident from the facts in the Taggart case.  The decision by the Ninth Circuit BAP spends six pages reciting the facts which led to the Bankruptcy Court’s decision to sanction the creditor.  Included in that lengthy tale is the fact that both an Oregon state trial court and the Bankruptcy Court itself had previously determined that the creditor’s action was not a violation of the discharge injunction.  After the U.S. District Court over-ruled the Bankruptcy Court’s finding, the case went back to the Bankruptcy Court, which was placed in the odd position of determining the sanction for contempt resulting from action the Court had previously approved.  The creditor appealed the $100+k sanction award to the Ninth Circuit BAP.

            The BAP reversed the Bankruptcy Court.  After reviewing the usual strict liability standard, the BAP focused on the first prong of the test, whether the creditor had “actual knowledge” that the discharge order applied to its actions.  Since the facts of the case show that, in large part, the post-discharge litigation revolved primarily around whether the claims were discharged at all, the BAP found that until that issue had been decided adversely to the creditor, the creditor “could not possibly have been aware that the discharge injunction was applicable.”  Emmert v Taggert, 548 B.R. 275, 291 (9^th Cir BAP 2016).  As the BAP noted, the decision by the US District Court that the injunction did apply actually ended the creditor’s actions – and the BAP was unwilling to sanction a party for simply litigating a disputed issue.

            The Debtor then appealed to the Ninth Circuit, which affirmed the BAP while changing the analysis used to determine that the creditor had not been in contempt.  Where the BAP focused on the creditor’s knowledge of the applicability of the discharge injunction, the Ninth Circuit ruled that – as to this first prong – “the creditor’s good faith belief that the discharge injunction does not apply to the creditor’s claim precludes a finding of contempt, even if the creditor’s belief is unreasonable.”  Lorenzen v Taggert, 888 F.3d 438, 444 (9^th Cir. 2018).  As the creditor here clearly had a good faith belief, the contempt finding was held to be erroneous.

            The Debtor applied for certiorari to the Supreme Court, to challenge the Ninth Circuit’s “good faith belief” standard.  The Court agreed with the Debtor that the Ninth Circuit was wrong, but also rejected the “strict liability” approach applied in the Bankruptcy Court and urged by the Debtor. 

            Instead, the Court found that the test to be applied is whether there is “no objectively reasonable basis” for the creditor’s conduct.  (The Court did not directly declare that the two-prong analysis is overruled, but the discussion makes clear that the Court did not believe that the “strict liability analysis is appropriate at all.)  The Court looked at this issue from the traditional principles of civil contempt when applied to other injunction violations.  The Court emphasized that, outside the bankruptcy context, contempt is not appropriate “where there is a fair ground of doubt as to the wrongfulness of the Defendant’s conduct.”  [Page 6, cit. omitted]  The Court made plain that the creditor’s subjective belief is not decisive (as the Ninth Circuit had found) but might assist the court in deciding what sanction – if any – would be appropriate.

            Since the courts below had not applied this “objectively reasonable basis” standard, the case was remanded.  Given the Bankruptcy Court’s prior conclusion that the creditor was correct in claiming that the injunction did not apply, it seems likely that that Court will conclude the creditor had the requisite “fair ground of doubt” necessary to avoid sanction for contempt.

            While not as creditor-friendly as the Ninth Circuit’s “good faith basis” standard would have been, the Taggert opinion does give a glimmer of hope to creditors in discharge injunction litigation.  It may not be often that the “fair ground of doubt” can be established, but compared to the strict liability test utilized up to this point, a creditor with a credible argument may proceed with the thought that it may avoid a sanction simply for trying.

            An even more encouraging note for creditors comes in the final paragraph of the Taggert opinion.  The Debtor contended that a strict liability approach would be consistent with the standard used to remedy stay violations.  The Court distinguished the specific language in §362

(“willful violations”) with the general authority under §105, but then commented in a parenthetical that “willful” is also not typically associated with strict liability.  The Court noted that it was not deciding whether “willful” in §362 would support a strict liability standard, but the implication is that the Court would view sympathetically a creditor sanctioned for an objectively reasonable action but ultimately found to violate the automatic stay.