Ninth Circuit Applies Scotus Standard in Discharge Injunction Case

Posted by NCBRC - December 2, 2020

On remand from the Supreme Court, the Ninth Circuit found that, under the Supreme Court’s objective standard, the debtor’s active post-bankruptcy litigation in state court of the terms of his separation from his business partnership established sufficient cause for his business partner creditors to have a reasonable belief that he had “returned to the fray” and that their motion for attorney’s fees would not violate the discharge injunction. Lorenzen v. Taggart, No. 16-35402 (9th Cir. Nov. 24, 2020).

Prior to filing for bankruptcy, the debtor was involved in state court litigation with two business partners (the “creditors”) concerning the debtor’s misuse of company funds. The creditors sought to void the debtor’s transfer of his business interest to his lawyer, expel the debtor from the company, and force the debtor to allow the creditor to buy out his interest. The debtor counterclaimed for attorney’s fees as authorized by the business agreement permitting fee shifting to the prevailing party. After the debtor obtained his bankruptcy discharge, the state court dismissed the creditors’ monetary claims, but the action continued with respect to non-monetary claims. The debtor actively participated in the litigation over the terms of his separation from the company and the proper valuation of his interest. He did not dismiss his counterclaim for attorney’s fees. Ultimately, the debtor lost in state court and was expelled from the firm. The creditors then filed a motion for attorney’s fees incurred in the post-bankruptcy litigation arguing that, under In re Ybarra, 424 F.3d 1018 (9th Cir. 2005), the debtor “returned to the fray.” In response, the debtor reopened his bankruptcy case to bring an action for violation of the discharge injunction.

Finding the creditors liable for civil contempt, the bankruptcy court applied a “strict liability” standard under which a violation of the discharge injunction may be found when the creditor knew of the bankruptcy discharge and intended the action that violated it. In re Taggart, 522 B.R. 627 (Bankr. D. Or. 2014). The BAP reversed, finding that the creditors could be held in contempt only if they were aware that the discharge injunction applied to their conduct. In re Taggart, 548 B.R. 275 (B.A.P. 9th Cir. 2016). The Ninth Circuit affirmed, finding that so long as the creditors had a genuine belief that their conduct did not violate the discharge injunction, even if that belief was unreasonable, they could not be held in contempt. In re Taggart, 888 F.3d 438, 444–45 (9th Cir. 2018). The Supreme Court vacated and remanded, finding that an objective test applied under which “a court may hold a creditor 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.” Taggart v. Lorenzen, 139 S. Ct. 1795 (2019).

On remand, the Ninth Circuit framed the question under the Supreme Court’s articulated standard as “whether the Creditors had some—indeed, any—objectively reasonable basis for concluding that Taggart might have ‘returned to the fray’ and that their motion for post-petition attorney’s fees might have been lawful.” The court found that the debtor failed to dismiss his counterclaim and actively litigated the terms of his separation from the company, including challenging the proper valuation date for buy-out purposes. The debtor was the only party who stood to gain by a higher valuation as the bankruptcy trustee had abandoned the claim, and the debtor’s lawyer would not receive any of the proceeds from the buy-out. Based on this conduct, the court concluded that “the Creditors had an objectively reasonable basis to conclude that Taggart might have ‘returned to the fray’ in the Oregon state court to obtain some economic benefit from a higher evaluation of the sale of his ownership stake in SPBC and in the amount of interest that had accrued after the date payment was due for the forced sale.”

The court affirmed the BAP’s reversal of the bankruptcy court’s finding of civil contempt.

Taggart 9th Cir Nov 2020


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