Post-Discharge Litigation Violates Discharge Injunction

Posted by NCBRC - November 3, 2021

The appellants were liable for willful violation of the discharge injunction when they pursued post-discharge state litigation and garnishment based on pre-petition conduct even though the debtor could have but did not raise the discharge as a defense in the state litigation. Morgan v. Morgan, No. 20-291 (D. Utah Oct. 25, 2021).

The debtor and his brother-in-law ran separate lending operations giving rise to decades of conflict between them. When the debtor filed for chapter 7 bankruptcy in 2010, he did not list his brother-in law or his brother-in-law’s company, Summit Development and Lending Group, Inc. (appellants), as creditors. The trustee determined his was a no-asset case and the court granted the debtor a discharge. Four years later, the Utah Department of Commerce, Securities Division, found appellants liable for fraud and fined them $140,000. In 2018, the appellants filed a state civil action seeking indemnification against the debtor based on the securities case. The debtor failed to appear in that case and the state court entered a default order against him for the entire fine. The debtor notified both the state court and the appellants that because the conduct upon which the fine was based occurred before he filed his chapter 7 petition, the cause of action was covered by his discharge and the litigation violated the discharge injunction. The appellants then obtained a writ of garnishment from the state court based on the default judgment.

The debtor reopened his bankruptcy case seeking an order of contempt. After a hearing, the bankruptcy court found the appellants had violated the discharge injunction and awarded the debtor $68,180.27 in damages.

On appeal, the district court began with appellants’ argument that the bankruptcy judgment was barred by the doctrine of claim preclusion. Under Utah law, claim preclusion bars relitigation of causes of action when the “(1) two actions involve the same parties; (2) a claim raised in the second action was raised, or could and should have been raised, in the first; and (3) the first action concluded with a final judgment on the merits.”

The appellants argued that the debtor should have raised the issue of his discharge as an affirmative defense in the state liability case. The appellants further argued that when the debtor did raise the issue in the garnishment proceedings, the state court found against him. The district court disagreed. It found that while the issue of whether the claim was discharged was a common issue in both the state court action and the discharge injunction claim, the two causes of action were not the same “claim” as required under Utah claim preclusion. The court noted that the question actually implicated Utah’s “issue preclusion,” which bars relitigation of “facts and issues underlying causes of action,” but the appellants did not raise issue preclusion as a basis for reversal, and the court found that it had been waived.

To the extent the court’s ruling provided the debtor with a “second bite at the apple,” the court noted that Congress recognized this possibility and determined that bankruptcy creates an exception to the prohibition against collateral attack on a state court’s judgment.

The court found the bankruptcy court did not err in rejecting the appellants’ argument based on res judicata.

The appellants next argued that the court erred in finding that the violation was willful. A creditor willfully violates the discharge injunction when there “is no fair ground of doubt” as to whether its conduct violated the discharge order. The bankruptcy court based its finding on the fact that the appellants knew of the bankruptcy and the debtor’s discharge at least by the time of the garnishment action if not before. Relying on Watson v. Parker (In re Parker), 264 B.R. 685, 695–98 (B.A.P. 10th Cir. 2001), aff’d, 313 F.3d 1267 (10th Cir. 2002), the court found that because the state lawsuit originated pre-petition and the debtor’s bankruptcy was a “no asset” case, the fact that the cause of action was not listed in the bankruptcy petition did not except it from discharge. In re Parker thus eliminated any “fair ground of doubt” the appellants might have claimed as a defense to the charge of willfulness.

For the same reason, the court rejected the appellants’ argument that, because the state court permitted them to garnish the debtor’s wages, they had a reasonable basis for believing that their conduct was permissible. The state court did not address the issue of discharge, and the law established in Parker dictated that the claim was discharged.

Finally, the appellants challenged the amount of the bankruptcy court’s award as unreasonable and excessive. Specifically, the appellants challenged the $61,643.00 fee awarded to the debtor’s bankruptcy counsel. The appellants argued that the fee application, which included “block billing,” was insufficiently specific and showed duplicative and wasteful expenditures. They further argued that the attorneys failed to show that their pay rate was reasonable.

The court found no error in the bankruptcy court’s award finding that “the issue on appeal is not whether A&K’s fees were reasonable, but whether the bankruptcy court committed clear error or abused its discretion in finding that the fees the A&K attorneys requested were reasonable.” The district court found the fee records met the requirement of being “meticulous, contemporaneous time records . . . . [that] reveal, for each lawyer for whom fees are sought, all hours for which compensation is requested and how those hours were allotted to specific tasks.” It further found that the bankruptcy court properly addressed whether the time spent on the bankruptcy litigation was appropriate and whether the fees were commensurate with similarly situated lawyers. To the extent the attorneys’ fees were based on the work of two partners, rather than a partner and a less costly attorney, the court found the attorneys conceded that point when they voluntarily reduced their fee demand from over $80,000 to the $61,643 the court awarded. The court also found that the wide disparity between the debtor’s attorney fees and the appellants’ attorney fees was not relevant to the reasonableness of the debtor’s attorney fees.

Thus, the court found no clear error or abuse of discretion in the attorney fee award.

The court affirmed.

Morgan D Utah Oct 2021

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