Bankruptcy Court Rules "Make-Whole" Provision Creates Enforceable Liquidated Damages

From the Top in Brief

On June 3, 2019, the U.S. Supreme Court ruled in Taggart v. Lorenzen, 139 S. Ct. 1795 (2019), that a bankruptcy court may hold a creditor in civil contempt for attempting to collect on a debt that has been discharged in bankruptcy "if there is no fair ground of doubt as to whether the [discharge] order barred the creditor’s conduct." In so ruling, the Court vacated and remanded a ruling by the U.S. Court of Appeals for the Ninth Circuit rejecting a "strict liability" standard and applying a subjective standard under which a creditor may not be held in civil contempt if it has a "good faith belief" that the discharge order does not bar collection, even if that belief is unreasonable.

Bradley Taggart ("Taggart") formerly owned an interest in Sherwood Park Business Center, an Oregon company. In 2008, the company and its two other owners (collectively, "Sherwood") sued Taggart and certain other defendants in Oregon state court, alleging breach of fiduciary duty, expulsion, and breach of contract. In 2009, before trial, Taggart filed a no-asset chapter 7 case in the District of Oregon. The bankruptcy court entered an order in 2010 discharging Taggart’s debts.

Section 727(b) of the Bankruptcy Code states that "[e]xcept as provided in section 523 [excepting certain debts from discharge] … , a discharge under … this section discharges the debtor from all debts that arose before the date of the order for relief under this chapter." Section 524(a)(2) of the Bankruptcy Code provides that a discharge order "operates as an injunction" barring creditors from collecting any debt that has been discharged.

After Taggart received his discharge, Sherwood continued with the state court litigation. Although Sherwood did not seek monetary damages from Taggart, it did seek an award of the attorney’s fees Sherwood incurred after Taggart filed for bankruptcy. Citing the Ninth Circuit’s ruling in In re Ybarra, 424 F.3d 1018 (9th Cir. 2005), the state court ruled that Taggart’s discharge in bankruptcy did not discharge Sherwood’s claim for postpetition attorney’s fees because Taggart "returned to the fray" by participating in the state court litigation after entry of the discharge order.

Taggart asked the bankruptcy court to hold Sherwood in civil contempt for violating the discharge order. The court refused, holding that no contempt citation was warranted because Taggart had "returned to the fray." A district court reversed that ruling on appeal, and on remand, the bankruptcy court held Sherwood in civil contempt. In so ruling, the bankruptcy court applied a "strict liability" standard. It reasoned that a contempt finding and sanctions were warranted because Sherwood had been "aware of the discharge" order and "intended the actions which violate[d]" the order.

A bankruptcy appellate panel vacated the sanctions order, and the Ninth Circuit affirmed on appeal. According to the Ninth Circuit, 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."

In January 2019, the Supreme Court granted certiorari to consider whether "a creditor’s good-faith belief that the discharge injunction does not apply precludes a finding of civil contempt."

Writing for the unanimous Court, Justice Breyer explained that the Court’s determination was informed by sections 524(a)(2) and 105(a), the latter of which authorizes a court to "issue any order, process, or judgment that is necessary or appropriate to carry out the provisions" of the Bankruptcy Code. According to Justice Breyer, "[T]hese provisions authorize a court to impose civil contempt sanctions when there is no objectively reasonable basis for concluding that the creditor’s conduct might be lawful under the discharge order."

Sections 524(a)(2) and 105(a), Justice Breyer noted, bring with them "the old soil" of historical equity jurisprudence, which traditionally empowered courts to impose civil contempt sanctions to coerce compliance with an injunction or to compensate a complainant for noncompliance. Because an objective standard has generally been applied to this issue in non-bankruptcy cases, Justice Breyer reasoned that the same "fair ground of doubt standard" should apply in the bankruptcy context. "[C]ivil contempt therefore may be appropriate," he wrote, "when the creditor violates a discharge order based on an objectively unreasonable understanding of the discharge order or the statutes that govern its scope."

Justice Breyer faulted the Ninth Circuit’s standard as being inconsistent with traditional civil contempt principles and unfair to "debtors [forced] back into litigation (with its accompanying costs) to protect the discharge that it was the very purpose of the bankruptcy proceeding to provide." He was equally critical of the strict liability standard imposed by the bankruptcy court, noting that such a standard might provoke a flood of costly litigation by risk-averse creditors seeking an advance determination as to the scope of a discharge order.

Finally, Justice Breyer rejected Taggart’s argument that a strict liability standard is appropriate because many courts have applied such a standard in remedying violations of the automatic stay imposed by section 362 of the Bankruptcy Code. According to Justice Breyer, the specific language regarding sanctions for a stay violation in section 362(k)(1) differs from the more general language of section 105(a). Moreover, he wrote that "[t]he purposes of automatic stays and discharge orders also differ: A stay aims to prevent damaging disruptions to the administration of a bankruptcy case in the short run, whereas a discharge is entered at the end of the case and seeks to bind creditors over a much longer period."

On June 28, 2019, the Court granted certiorari in Rodriguez v. Fed. Deposit Insurance Corp., No. 18-1269 (U.S. June 28, 2019), in which it can resolve a split in the circuits over whether state or federal law governs the ownership of tax refunds when a subsidiary generated the losses but the government pays the refund to the bankrupt corporate parent.

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