Creditor Had Affirmative Duty to Stop State Contempt Action

Posted by NCBRC - May 29, 2020

“A creditor, who has put a collection effort into motion must affirmatively act to stop, stay, or hold the collection effort in abeyance or risk incurring liability once a bankruptcy commences.” Valentine v. Valentine, No. 19-40593, Adv. Proc. No. 19-4022 (E.D. Mo. Jan. 27, 2020).

Before he filed for chapter 7 relief, the debtor and the creditor were divorced. The divorce agreement obligated the debtor pay his ex-spouse domestic support. At some point after their divorce the debtor fell behind on his payments and sought to modify the support agreement. His efforts were unsuccessful and, in a state court contempt action, he was ordered to sell his residence to pay the domestic support debt. He failed to do so and continued to reside in the property. He filed for bankruptcy on February 1, 2019. Within days of filing his petition, on February 4, 2019, the state court held a second hearing for contempt due to his failure to sell his residence. Though his ex-spouse’s divorce counsel knew of the bankruptcy filing, he did not attempt to stop the contempt hearing. At the conclusion of the hearing, the state court found the debtor had filed for bankruptcy in order to remove the residence from the grasp of the creditor. The court issued an Order & Confinement holding in part: “[Debtor] to remain confined until he pays the sums due and owing in principal sum of $64,003.73 as of 1-22-18 or otherwise purges himself of contempt.” Pursuant to this order, the debtor was jailed for four days. On appeal, the state appellate court vacated the Order & Confinement finding that the debtor had no avenue for purging the contempt.

The debtor filed an adversary proceeding in his bankruptcy case seeking sanctions against his ex-spouse and her divorce attorney (the defendants), alleging that they violated the automatic stay by allowing the state contempt hearing to go forward.

As an initial matter, the court found that even though formal notice of the bankruptcy filing did not issue until February 6, the automatic stay was in place as soon as the debtor filed his petition on February 1. The divorce attorney actually knew of the bankruptcy filing at the time of the February 4th hearing.

In a lengthy opinion following a hearing, the bankruptcy court found that the state court contempt hearing was part of the defendants’ efforts to collect on the debt by forcing the debtor to sell his residence. Because the residence became part of the bankruptcy estate when the debtor filed his petition on February 1st, it was shielded from creditors by operation of the automatic stay. The court found that the creditor and her attorney had an affirmative obligation to inform the state court of the bankruptcy and make an effort to stop the hearing unless continuation of the February 4th hearing was subject to an exception to the automatic stay.

To determine whether an exception to the stay applied, the court turned to section 362(b). Section 362(b)(1) provides that a state court criminal action may be continued without violating the stay. Here, however, the parties agreed that the state contempt action was civil rather than criminal. Therefore, this provision did not apply.

Section 362(b)(2) lists exceptions for continuing civil actions geared toward the collection of domestic support obligations.

Section 362(b)(2)(A) excepts from the automatic stay state court actions for the establishment or modification of domestic support. In this case, the domestic support order was already established and the debtor’s attempt to modify it had been denied. Therefore, this exception did not apply.

Section 362(b)(2)(B) permits collection of domestic support obligations from property that is not property of the bankruptcy estate. In this case, the state court order required the debtor to repay his debt by sale of his residence, or through other, unspecified, means. The residence became property of the bankruptcy estate as soon as the petition was filed on February 1. There was no transcript of the state contempt hearing, and neither the state court nor the defendants in the adversary proceeding identified any non-estate property the debtor could have used to satisfy the domestic support debt. In fact, part of the reason the Order & Confinement was reversed on appeal was because the court had not identified any funds from which the debtor could have purged his contempt. Because the state court did not specifically identify non-estate property that could be used to pay the debt, the court found that this exception was inapplicable.

Section 362(b)(2)(C) permits a domestic support creditor to withhold income that is estate property for the payment of a judicially ordered domestic support obligation. Because the state court order did not involve withholding or garnishment of income this exception did not apply.

The automatic stay will also not interfere with a civil contempt hearing that is intended to uphold the dignity of the court. This exception does not apply, however, when the contempt action is motivated by an intention to collect a debt or embarrass or harass the debtor.

Here, the court found that the purpose of the February 4th hearing was solely for the purpose of coercing the debtor to pay his domestic support debt using estate property. In fact, the state court stated in its Order & Confinement: “On February 1, 2019 subsequent to demands to follow through with his offer to purge the Debtor voluntarily withdrew his offer to purge by preventing the sale of the Real Estate and transferring control of the Real Estate to the Federal Bankruptcy Court to stop the sale of the Real Estate which was Debtor’s offer to purge.” Based on this language, the bankruptcy court found the purpose of the February 4th hearing was to punish the debtor for filing for bankruptcy and to force him to use estate property to pay his debt.

Having found that no exception existed to prevent application of the automatic stay, the bankruptcy court turned to the defendants’ conduct. It found that a creditor has an affirmative duty to cease any ongoing collection efforts even if those efforts were commenced prior to the filing of the bankruptcy petition. The creditor must take action to stop a collection effort already underway. “For decades, bankruptcy courts have rejected the idea that creditors may shirk their responsibilities to stop judicial proceedings that serve the primary purpose of a collection effort that the creditor set into motion.”

Having found that the defendants’ actions violated the automatic stay, the court went on to address whether that violation was “willful.” At the adversary hearing, the creditor’s attorney maintained that it was not until the day of the February 4th hearing that he first learned of the bankruptcy case from the debtor’s bankruptcy counsel. He further stated that, as an attorney specializing in domestic relations, he was not familiar with the obligations imposed by the bankruptcy. Furthermore, he argued that he had no control over the actions of the state court.

The bankruptcy court was unmoved by the creditor’s counsel’s plea of ignorance as to the requirements and obligations of bankruptcy. It found that the creditor’s counsel should have, at the very least, sought a continuance of the February 4th hearing to give himself time to acquaint himself with the law.

The court was also unpersuaded by the debtors’ attempt to transfer responsibility for the February 4th hearing and the Order & Confinement to the state court. Calling this shift of responsibility a “red herring,” the court stated, “[t]he adjudications of the state court judge are not the issue before the Court. The issue is the Defendants’ failure to behave in a way befitting a creditor and its agent bound by federal law to comply with the automatic stay.” The defendants had an affirmative duty to inform the state court of the pending bankruptcy and the application of the automatic stay, and to at least attempt to halt the state contempt proceedings.

The bankruptcy court found that the defendant attorney’s failure to take affirmative action to stop the “collection train,” was a willful violation of the automatic stay. Furthermore, the court found debtor’s ex-spouse likewise liable for willful violation of the stay where the collection efforts were undertaken on her behalf. The court concluded that by allowing the contempt hearing to go forward and by failing to take any action to prevent or vitiate the consequences of the hearing, the defendants’ actions from the date of the February 4th hearing and the February 8th release of the debtor from jail, constituted willful violations of the automatic stay.

The court awarded damages in the amount of $520.00 for lost wages, $400.00 for emotional distress ($100.00/incarceration day), $5,974.00 in expenses associated with the debtor’s efforts to get out of jail and appeal the Order & Confinement, and reasonable attorney’s fees related to the costs of the adversary proceeding.

As to punitive damages, the court found that the defendant attorney’s conduct in failing to make any effort to acquaint himself with the law of bankruptcy or to stop the collection efforts of the state court, was subject to punitive damages in the amount of $1,000.00.

The creditor, ex-spouse, was not likewise subject to punitive damages as she was not present at the February 4th hearing and acted in reliance on her attorney’s advice.

Valentine Decision

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