A Creditor’s Good Faith Belief Precludes Sanctions for Civil Contempt for Mistaken Violations of a Debtor’s Discharge Injunction, Holds Recent Ninth Circuit Case

By: Elayna Z. Matthews, Creditors’ Rights & Bankruptcy Lawyer

The Ninth Circuit recently held that when a creditor attempts to collect from a debtor after the debtor has received a discharge from a U.S. Bankruptcy Court case, the creditor is not liable for civil contempt penalties or sanctions if the creditor held a subjective, good faith belief that its actions did not violate the debtor’s discharge injunction. See Lorenzen v. Taggert (In re Taggart), 16-35402 (9th Cir. April 23, 2018). As a general matter, after a debtor has filed bankruptcy, and particularly after a debtor has successfully earned a discharge in a bankruptcy case, creditors are prohibited from continuing to pursue that debtor in any collection matter relating to any debt incurred prior to the bankruptcy filing. There are various exceptions to this rule; one exception is when a debtor voluntarily “re-enters the fray” of an ongoing litigation that began before the debtor filed bankruptcy. However, the penalties for violating a debtor’s discharge injunction are very severe and include sanctions for civil contempt. Creditors are thus advised to be abundantly cautious and seek legal counsel before engaging in any post-bankruptcy collection efforts.

In the In re Taggert case, the debtor filed for bankruptcy under Chapter 7, and earned a standard discharge. Before the bankruptcy case was filed, the debtor was a defendant in a litigation case. After filing for bankruptcy, the debtor continued to participate in the litigation, though much less frequently than the other parties in the lawsuit. After the lawsuit had concluded, the court entered an award for attorney fees in favor of the plaintiffs and against the debtor-defendant. The debtor re-opened his Chapter 7 case to seek civil contempt penalties against the plaintiffs for seeking to recover attorney fees from the debtor after he had obtained a bankruptcy discharge, arguing that the plaintiffs violated the debtor’s discharge injunction. In response, the plaintiffs argued that they truly held a good faith belief that the discharge injunction did not apply to their award of attorney fees against the debtor because the debtor had participated in the litigation after the discharge was entered. Thus, the plaintiffs argued that their actions fell within an exception to the discharge injunction because the debtor’s participation in the litigation after filing for bankruptcy constituted “re-entering the fray” of litigation.

The Ninth Circuit in Taggert firmly held that a creditor’s subjective, good faith belief that its post-discharge collection efforts did not violate the discharge injunction precludes the court from finding the creditor in contempt or sanctioning the creditor with penalties, even if the creditor’s good faith belief was objectively unreasonable. The Court restated its rule that, for a court to sanction a creditor for violating the discharge injunction, the court must find both that (1) the creditor knew the discharge injunction applied to the debtor, and (2) the creditor intended the specific actions that allegedly violated the discharge injunction. As to the first element, the Court held that if a creditor can prove that it held a subjectively true and good faith belief that its actions did not violate the discharge injunction, then a court is prohibited from finding that the creditor knew the discharge injunction applied. As such, a creditor’s good faith belief that its actions do not violate the discharge injunction insulate the creditor from liability for sanctions for inadvertently violating the bankruptcy code.

While the Ninth Circuit’s opinion is a well-reasoned statement of the law that supports creditors’ good faith actions, all creditors should still exercise the utmost caution before trying to collect any debt from any debtor who has filed bankruptcy or who has earned a discharge in a bankruptcy case. The Taggert opinion only applies to actions taken by creditors after a debtor has earned a discharge; the Court did not hold whether the same rule applies to a creditor’s actions taken after a debtor files for bankruptcy. In addition, a creditor must be prepared to put forth evidence to prove that it had a good faith belief that it did not violate the discharge injunction, which depending on the specific facts of the case, could be quite difficult to do. If you have any questions about this post, please feel free to contact one of the attorneys in our Financial Services Practice Group.

To read the full opinion, click this link. (http://cdn.ca9.uscourts.gov/datastore/opinions/2018/04/23/16-35402.pdf).

Elayna Matthews is an associate in the Litigation and Creditors’ Rights & Bankruptcy practice groups. The information in this article is not intended to provide legal advice. For a professional consultation, please contact Erich Paetsch or Elayna Matthews at Saalfeld Griggs PC.  503.399.1070.  elayna@sglaw.com  © 2018 Saalfeld Griggs PC

Elayna Zammarelli

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