In a unanimous, and perhaps unsurprising, decision, the Supreme Court determined that a creditor may be held in civil contempt for violating the discharge injunction if there is “no fair ground of doubt” as to whether the creditor’s conduct was barred by the order placing that injunction. The Supreme Court declined to adopt the standard of either of the courts below – the bankruptcy court’s strict liability standard or the Ninth Circuit’s good faith belief “even…if unreasonable” standard. Instead, the Supreme Court determined that “civil contempt may be appropriate if there is no objectively reasonable basis for concluding that the creditor’s conduct might be lawful.”
In the underlying case, a plaintiff in a prepetition state court suit sought post-petition attorneys’ fees from the defendant after the defendant received a discharge in his Chapter 7 bankruptcy case. The state court allowed the plaintiff to collect those fees, and the defendant filed a motion with the bankruptcy court to hold the plaintiff in civil contempt for violation of the discharge injunction. The bankruptcy court initially determined the fees were exempt from the discharge order because the defendant had “returned to the fray” in state court post-petition. The district court disagreed, and on remand, the bankruptcy court held that if the fees were subject to the discharge injunction, the plaintiff was in violation of that injunction because it was “aware of the discharge” and “intended the action.” The standard, the district court stated, was similar to the “strict liability” standard found in other areas of the law.
On further appeal, the Ninth Circuit applied a standard far from strict liability. It held that a creditor could not be held in contempt for violation of the discharge injunction if it had a “good faith belief” that the discharge injunction did not apply to its action, “even if the creditor’s belief is unreasonable.”
Both the district court’s and the Ninth Circuit’s standards would have proven problematic and expensive for all parties. The district court’s strict liability standard would have resulted in more cautious behavior by creditors, including more frequent requests for an advance determination of the applicability of the discharge to a specific course of conduct. Conversely, the Ninth Circuit’s subjective standard would have relied too heavily on “difficult-to-prove states of mind,” leading to more costly discharge violation litigation for both debtors and creditors.
The Supreme Court clarified the standard to be used in determining whether a creditor has violated the discharge injunction. The Supreme Court analyzed the historical use of an objective standard grounded in reasonableness and fairness, and adopted a standard found in an 1885 case – that “civil contempt ‘should not be resorted to where there is [a] fair ground of doubt as to the wrongfulness of the defendant’s conduct.’” The Supreme Court reasoned that under the “fair ground of doubt” standard, a creditor’s good faith can be analyzed, but only under that objective standard of reasonability.
The Supreme Court’s objective standard is good news for everyone. An objective standard grounded in reasonableness and good faith levels the playing field for the post-discharge relationship between creditors and debtors. Creditors may be less risk-averse in their engagement with debtors, particularly in those areas in which there is a “fair ground of doubt” as to the application of the discharge injunction. This environment will benefit debtors who seek information about their loans or loss mitigation after their discharge. As we recently discussed, servicing mortgage loans for borrowers who have received a discharge of the debt is fraught with issues. Further, in the financial services arena, there are non-bankruptcy laws and regulations, such as the FDCPA and the FCRA that seem to conflict with the Bankruptcy Code. These conflicts, which make the post-discharge relationship difficult to navigate, have created what is practically a universally recognized “fair ground of doubt.” A creditor acting reasonably and in good faith may therefore find a shield in the Supreme Court’s new standard.