CHAPTER 3, C. Examining Subjective, Unreasonable Good Faith and the Discharge Injunction

• Jurisdiction: United States

C. Examining Subjective, Unreasonable Good Faith and the Discharge Injunction

ABI Journal

May 2019

Stephanie C. Lieb

Trenam Law

Tampa, Fla.

Dana L Robbins

Burr & Forman, LLP

Tampa, Fla.

The U.S. Supreme Court has long recognized that one of the fundamental purposes of bankruptcy is to release honest debtors from oppressive debts.¹ Section 524 of the Bankruptcy Code provides for a discharge, designed to "ensure that debtors receive a 'fresh start' and are not unfairly coerced into repaying discharged prepetition debts,"² and to "eliminate any doubt concerning the effect of the discharge as a total prohibition on debt-collection efforts."³

Bankruptcy courts are empowered to safeguard this fresh start and deter creditor misconduct by invoking their civil contempt powers under § 105. Under § 105, bankruptcy courts may "issue any order, process, or judgment that is necessary or appropriate to carry out"⁴ Code provisions. However, contempt may often be the only remedy for a discharge injunction.

In In re Taggart, the Ninth Circuit Court of Appeals held that a creditor's knowing violation of the discharge injunction does not warrant civil contempt when the creditor had a subjective, good-faith belief that the discharge did not pertain to its claim, even if that belief is "unreasonable."⁵ However, this ruling conflicts with the First,⁶ Fourth⁷ and Eleventh Circuits,⁸ as well as two bankruptcy appellate decisions,⁹ not to mention dozens of lower court decisions. The Supreme Court granted certiorari to resolve the circuit split relating to this bedrock principle of bankruptcy law: the discharge injunction. It will decide whether, under the Bankruptcy Code, a creditor's good-faith belief that the discharge injunction does not apply precludes a finding of civil contempt.

In determining whether a violation of the discharge injunction occurred, Taggart considered a two-part test: whether the violating creditor (1) knew the discharge injunction was applicable, and (2) intended the actions that violated the injunction.¹⁰ An interpretation of the first prong of this test was at the heart of the issue in Taggart.

The Majority View and the Discharge Landscape

Before Taggart, the majority of courts considering whether a creditor violated the discharge injunction held that the creditor's subjective good-faith intent was irrelevant. For example, more than two decades ago, the Eleventh Circuit in In re Hardy held that § 105 grants courts independent statutory contempt powers to award monetary and other sanctions regardless of the creditor's subjective good faith.¹¹ The Hardy court reasoned that "the focus of the court's inquiry in civil contempt proceedings is not on the subjective beliefs or intent of the alleged contemnors in complying with the order, but whether in fact their conduct complied with the order at issue."¹² Under § 105, a showing of "bad faith" is not required.¹³ Likewise, the First Circuit in In re Pratt acknowledged that the "federal bankruptcy law interest in according debtors a fresh start, free from objectively coercive reaffirmation demands, must be accorded supremacy."¹⁴ In Pratt, the debtors moved to reopen their bankruptcy case to seek sanctions against a creditor whose claim was secured by an interest in the debtors' motor vehicle. The debtors alleged that the creditor violated the discharge injunction by refusing to either release its secured lien or repossess the vehicle.¹⁵

On appeal, the First Circuit relied on its earlier decision in Fleet Mortgage Group Inc. v. Kaneb.¹⁶ In Kaneb, the court rejected the argument that a violation of the automatic stay was not willful if the creditor had made a good-faith mistake. Instead, the court held that the standard for a willful violation is met "if there is knowledge" of the automatic stay and "the defendant intended the actions which constituted the violation."¹⁷ Applying Kaneb's reasoning to violations of the discharge injunction, the First Circuit in Pratt held that although the creditor's actions were not in "bad faith," they were objectively coercive in their effect and thus willfully violated the discharge injunction.¹⁸

After Taggart was decided, the First Circuit in Internal Revenue Serv. v. Murphy reaffirmed Pratt and held that the term "willful" has an established meaning, under which a creditor's "good-faith belief in a right to the property is not relevant to a determination of whether the violation was willful."¹⁹ The First Circuit reasoned that under the creditor's interpretation, "it is hard to imagine a case where a [debtor] could ever collect against [a creditor] for a violation of the automatic stay or discharge order," which would render a debtor's legal protections a "near nullity" because a creditor "encounters no risk" for pursuing discharged debts "as long as it has a 'good faith' or 'reasonable belief' for its conclusions."²⁰

Similarly, the Fourth Circuit in In re Fina held that the creditors' intentions were "irrelevant" in determining whether it had violated the discharge injunction because "a good-faith mistake is generally not a valid defense."²¹ Since there was no dispute that the creditors were aware of the discharge injunction when they filed an action against the debtor, the creditors' violation was deemed willful.²² In reaching that conclusion, the Fina court noted that the creditors had bypassed the bankruptcy court's discharge injunction and that "[t]he proper course for the appellants was to first seek leave of the bankruptcy court before pursuing a judgment against the debtor."²³

Each of these courts rejected the application of a subjective approach in determining whether a violation of the discharge injunction was willful. Then the Ninth Circuit decided In re Taggart, thus creating a circuit split on the issue.

In re Taggart: Facts and Analysis

Before filing for bankruptcy, the chapter 7 debtor in Taggart allegedly transferred his interest in a limited liability company (LLC) without providing notice and an opportunity for the other members to exercise their right of first refusal. The other members sued the debtor for breach of the LLC's operating agreement.²⁴ On the eve of trial, the debtor filed a chapter 7 case.²⁵

After the debtor...