Mcle Article: Test Your Knowledge: Recent Developments in Insolvency Law
| Jurisdiction | California,United States |
| Author | Thomas R. Phinney and Paul Pascuzzi |
| Citation | Vol. 2019 No. 3 |
| Publication year | 2019 |
Thomas R. Phinney and Paul Pascuzzi
Tom Phinney is a partner at Parkinson Phinney in Sacramento California, founded in 2005, specializing in creditor representation and bankruptcy litigation. He is certified as a Business Bankruptcy Specialist by the American Board of Certification, and as a Bankruptcy Specialist by the California State Bar.
Paul J. Pascuzzi is a partner at Felderstein Fitzgerald Willoughby Pascuzzi & Rios LLP in Sacramento. Mr. Pascuzzi is a former Chair of the Executive Committee and the Insolvency Law Committee of the Business Law Section. Mr. Pascuzzi's practice focuses on all aspects of business bankruptcy and insolvency law.
Welcome to the sixth annual edition of our article covering recent developments in bankruptcy law. This article comes from a program we present for the Bankruptcy and Commercial Law Section of the Sacramento County Bar Association. Once again, we invite you to test your knowledge of recent developments in the area of insolvency law. Unless otherwise noted, all references are to the Bankruptcy Code. We provide a summary of the facts, issues, and holdings from a mix of ten recent important and interesting bankruptcy decisions. For MCLE credit, please answer the twenty true/false questions at the link provided at the end of the article. Good luck!
This case clarifies and details the standard for a finding of contempt for violation of the discharge injunction in § 524(a). Prior to filing his bankruptcy case, Taggart purported to transfer his 25% interest in a limited liability company to his attorney, Berman. Two of the other LLC members sued Taggart and Berman in Oregon state court for breach of the LLC's operating agreement based on a right of first refusal provision and also sought attorneys' fees.
Shortly before the state court trial, Taggart filed a chapter 7 bankruptcy case, staying the state court action, and Taggart received a discharge.
After the discharge, the suing LLC members continued prosecuting the state court action to void the transfer of Taggart's LLC interest to his attorney. Taggart moved to dismiss the claims against Taggart in light of his bankruptcy discharge. The state court denied the motion, finding that Taggart was a necessary party. The parties agreed, however, that no monetary judgment would be entered against Taggart. After the trial, the state court unwound the transfer of Taggart's interest in the LLC and expelled Taggart from the LLC.
Taggart did not appear at or participate in the trial. He did appear at his deposition prior to trial and at a hearing for entry of judgment at which Taggart provided testimony and argument. Following the hearing, the state court entered a judgment that allowed any party to petition for attorneys' fees.
The winning LLC members moved for attorneys' fees in state court against Taggart and the transferee. The request for attorneys' fees against Taggart was limited to fees incurred after the date of his discharge. The winning LLC members argued that, notwithstanding Taggart's discharge, he could still be held liable for attorneys' fees because Taggart had "returned to the fray" (i.e., Taggart had "willingly engaged in opposing them in the state court action after obtaining his discharge"). Under In re Castellino Villas, A.K.F. LLC, 836 F.3d 1028, 1034-37 (9th Cir. 2016), if a debtor "returns to the fray" by engaging in post-petition litigation on a pre-petition claim, a creditor may seek attorneys' fees if the new litigation was not within the "fair contemplation of the parties" prior to the bankruptcy petition.
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The state court found that Taggart had "returned to the fray," and it awarded post-discharge attorneys' fees. Taggart then moved the bankruptcy court to reopen his bankruptcy case and filed a contempt motion against the LLC members for "knowingly" violating the discharge injunction by seeking fees against him. The bankruptcy court denied Taggart's motion for contempt, finding that the state court correctly decided the issue that Taggart had "returned to the fray."
Taggart appealed the rulings by the state court and the bankruptcy court, both of which were reversed on appeal. The federal district court and Oregon Court of Appeals found that Taggart's actions were insufficient to constitute a "return to the fray" and barred recovery of attorneys' fees against Taggart. The district court remanded the case to the bankruptcy court to determine whether the LLC members "knowingly violated the discharge injunction." On remand, the bankruptcy court answered this question in the affirmative and held the LLC members in contempt for a knowing stay violation.
The LLC members appealed to the Bankruptcy Appellate Panel ("BAP"), which reversed the contempt ruling. The BAP held that the LLC members could only be held in contempt if they "knowingly" violated the discharge injunction. Because the LLC members had a subjective good faith belief that the discharge injunction did not apply to their attorneys' fee claim against Taggart, the BAP concluded that they did not "knowingly" violate the discharge injunction and, thus, could not be held in contempt.
Taggart appealed the BAP's ruling to the Ninth Circuit Court of Appeals, which affirmed the BAP ruling. The court held that knowledge of the applicability of the discharge injunction must be proven as a matter of fact and may not be inferred simply because the creditor knew of the bankruptcy proceeding. In reaching its ruling, the Ninth Circuit predominantly relied on what it viewed as a "clear" statement of law in In re Zilog, Inc., 450 F.3d 996, 1007 (9th Cir. 2006). Zilog held that a subjective good faith belief that the discharge injunction does not apply precludes a contempt finding. The creditor's good faith belief that the discharge injunction does not apply to the creditor's claim precludes a finding of contempt, even if the creditor's belief is unreasonable.
The United States Supreme Court granted certiorari in this case in early January. Courts in other circuits have used a standard for finding contempt more akin to strict liability, holding that good faith is essentially irrelevant. Another point that may have caught the Supreme Court's attention is the Ninth Circuit reliance on Zilog and holding that an erroneous belief could qualify, even if "unreasonable," as long as it was held in good faith. That reference was probably unnecessary, and overlooked the fact that Zilog was a special case where the unreasonable belief was excusable because the creditors were led astray by the debtor's misstatements.
UPDATE: The United States Supreme Court issued its decision in this matter on June 3, 2019. The Court held that neither standard developed by the lower courts was appropriate. Instead, the Court ruled that a creditor may be held in civil contempt for violating a discharge order if there is "no fair ground of doubt" as to whether the order barred the creditor's conduct. In other words, civil contempt may be appropriate if there is no objectively reasonable basis for concluding that the creditor's conduct might be lawful.1
In this case, the Ninth Circuit applied § 108(c) to validate a judgment debtor examination lien that otherwise would have expired a couple of years earlier.
In June 2010, a judgment creditor ("Good") obtained an Order to Appear for Examination ("ORAP") against a judgment debtor ("Debtor"). The ORAP was personally served on the Debtor. Pursuant to California Code of Civil Procedure section 708.110(d), "[s]ervice of the order creates a lien on the personal property of the judgment debtor for a period of one year from the date of the order unless extended or sooner terminated by the court." The ORAP lien is a so-called "secret" lien because there is no public filing required for its creation.
In August 2010, the Debtor filed a Chapter 7 case. Good never sought an extension of the ORAP lien. In 2013, a dispute arose between Good and the Debtor's Chapter 7 trustee ("Trustee") over whether the ORAP lien was still effective. Good relied on § 108(c), which provides:
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If applicable nonbankruptcy law . . . fixes a period for commencing or continuing a civil action . . . [that] has not expired before the date of the filing of the petition, then such period does not expire . . . until 30 days after notice of the termination or expiration of the stay under section 362 . . . ." (emphasis added).
Good argued that § 108(c) tolled the one-year period of California Code of Civil Procedure section 708.110(d) until thirty days after notice that the stay had terminated, which had not yet happened. The bankruptcy court ruled in favor of the Trustee, holding that the ORAP lien had expired. Good appealed, and the Bankruptcy Appellate Panel reversed, ruling that the ORAP lien had not expired.
On further appeal by the Trustee, the Ninth Circuit agreed with the BAP that the ORAP remained in effect during the bankruptcy case and did not expire. The court held that extending the ORAP lien as provided under Code of Civil Procedure section 708.110(d) constituted the "commencing or continuing [of] a civil action" within the meaning of § 108(c). Therefore, the ORAP lien remained in effect under § 108(c).
The Ninth Circuit relied on its own precedent: Spirtos v. Moreno (In re Spirtos), 221 F.3d 1079 (9th Cir. 2000), holding § 108(c) tolled the period to renew a judgment that would otherwise have expired during the bankruptcy, and Miner Corp. v. Hunters Run Ltd. Partnership (In re Hunters Run Ltd. P'ship), 875 F.2d 1425 (9th Cir. 1989), holding that § 108(c) applies if the automatic stay...
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