The biggest bankruptcy-related case of the US Supreme Court’s just-completed term presents creditors with clearer guidance in pushing the protective boundaries of a bankruptcy discharge. Contempt sanctions, with all their frightening unpredictability, menace creditors who violate these boundaries, but this latest case guides creditors to safe passage in the numerous instances where the law leaves a reasonably debatable gap.
On 3 June 2019, the Court announced its decision – uncharacteristically unanimous – in Taggart v. Lorenzen, holding that creditors neither face strict liability nor enjoy unreasonable subjective prerogative when collecting debts that might have been previously discharged in bankruptcy. Instead, the traditional rules of equity practice apply here to exempt creditor action from contempt sanction in cases where an objective, fair ground of doubt existed as to whether the particular debt was subject to discharge and therefore to the injunction against collection. Contempt is an appropriate remedy, the Court held, when there is no objectively reasonable basis for concluding that the debt fits within an exception to discharge and its collection is thus lawful.
The result might be viewed as a defeat for the creditor in the case, who argued that it was insulated from contempt by virtue of its subjective belief that its conduct was lawful and thus not violative of the debtor’s discharge. But the case can and should be regarded as a win for creditors in general, and likely even for the creditor involved here.
The preferred position in the lower courts, as applied in this case, had been to hold creditors in contempt so long as they were aware of the discharge and had acted intentionally to collect a debt that was eventually held subject to discharge, despite the creditor’s reasonable belief to the contrary. The US Bankruptcy Courts are generally quite enthusiastic about protecting debtors and the results of their rehabilitation in bankruptcy, so creditors faced serious liability for good faith violations of sometimes ambiguous discharge limits.
No more. While objectively unreasonable interpretation of the extent of the discharge will not protect reckless creditors (and why should it?), objectively reasonable doubt as to whether a particular debt is encompassed by the discharge injunction has now been confirmed as a viable shield against contempt. The simple facts of the Taggart case nicely illustrate this.
Taggart and his business associates had been embroiled in litigation over his alleged violation of an agreement concerning their venture. While Taggart sought shelter in bankruptcy, the litigation resumed after his discharge was entered, most likely because the case concerned non-monetary obligations whose resolution was unaffected by his discharge. When that case concluded in Taggart’s associates’ favour, however, they sought monetary relief, demanding Taggart pay $45,000 in litigation fees they had incurred after his bankruptcy filing.
While US bankruptcy law famously provides debtors a ‘fresh start’, it also offers a fresh start to creditors, who are free to collect debts that arise after the bankruptcy filing. But as they often do, the courts have created exceptions to this neat situation, and the exceptions are not as neat as might be desirable. Taggart’s business associates acknowledged on the one hand that debt for fees related to litigation initiated pre-bankruptcy would normally be discharged, but on the other hand, they pointed to an exception for cases where the debtor had “returned to the fray” in resuming the litigation post-bankruptcy. The associates asserted that Taggart had “returned to the fray” and his debt for fees related to this litigation was therefore not subject to the discharge injunction.
The subsequent trajectory of the dispute exemplifies the notion of ‘objectively reasonable doubt’. The state trial court and then the federal Bankruptcy Court both held that Taggart had returned to the fray, so the discharge did not prevent his associates from collecting these prepetition fees. The District Court on appeal disagreed. It held that Taggard had not returned to the fray, and it remanded for appropriate modification of the Bankruptcy Court’s ruling.
Because the debt was shielded by the discharge injunction in light of the District Court’s ruling, the Bankruptcy Court held that Taggart’s associates were strictly liable for their violation of that injunction, held them in contempt, and sanctioned them $112,000. An appellate panel and the Court of Appeals again disagreed, holding that Taggart’s associates’ good faith belief (even if unreasonable) that the discharge injunction did not apply insulated them from contempt liability.
While the Supreme Court – to no one’s surprise – reversed the unmoored ‘subjective good faith’ approach of the Court of Appeals, it preserved the objective defense of reasonable confusion. As illustrated by the ‘return to the fray’ rule, it is not at all uncommon for exceptions to the discharge injunction to be ambiguous and amenable to serious doubt. The state trial court and the federal Bankruptcy Court agreed that the exception applied, while the District Court disagreed, revealing a fairly obvious “fair ground of doubt” as to the lawfulness of the creditors’ conduct. Time will tell how the Court of Appeals evaluates the situation, but chances are Taggart’s associates will again escape contempt liability.
In the complex world of international investment and business re-organisation, there will often be complex rules as to the boundaries of the bankruptcy discharge and its exceptions.
Creditors wisely invest in the services of clever lawyers to find points of leverage in pre- and post-bankruptcy negotiation. The US Supreme Court has just usefully clarified how creditors and their counsel might turn the vagueness of discharge jurisprudence to their advantage.