Circuit Split: Should Subjective Intent Preclude a Finding of Civil Contempt in a Discharge Injunction Violation Case?

December 5, 2018

Does a creditor’s good-faith belief that a discharge injunction does not apply to its debt preclude a finding of civil contempt? Due to a circuit split, the U.S. Supreme Court was asked to decide this issue. 

Once a debtor receives a bankruptcy discharge, it “operates as an injunction against the commencement or continuation of an action … to collect, recover or offset any such debt as a personal liability of the debtor.”  11 U.S.C. § 524(a)(2).  The purpose of the discharge injunction is to ensure the debtor receives a “fresh start” and is not coerced into repaying a discharged debt. If a creditor’s contempt is established, the debtor may be able to recover damages as a sanction against the creditor. 

Generally, courts hold a creditor in contempt for violation of the discharge injunction if (i) the creditor knew the discharge injunction was applicable, (ii) the creditor intended to take the action, and (iii) the action was an attempt to collect a discharged debt. A majority of courts allow punitive damages for a violation of the discharge injunction. In considering whether punitive damages are appropriate, courts generally consider whether the creditor specifically intended to violate the discharge injunction. In the First, Fourth, and Eleventh U.S. Circuit Courts of Appeals, however, the creditor’s intent is not a defense to a finding of contempt, but rather only a factor in determining whether punitive damages are appropriate. On the other hand, the Ninth Circuit recently held that the creditor’s subjective, good-faith belief that the discharge injunction did not apply to its debt precluded a finding of civil contempt.

In Lorenzen v. Taggart (In re Taggart), the creditors were involved in state court litigation with the debtor. 888 F.3d 438 (9th Cir. 2018).  The creditors admitted that the debtor had been in bankruptcy, but argued that the debt (award of attorneys’ fees) arose post-discharge, and thus, the discharge injunction did not apply. The state court agreed. The debtor then reopened his bankruptcy case and the bankruptcy court denied the debtor’s motion for contempt. After a series of appeals in both state and federal courts, the creditors were barred from recovering attorneys’ fees against the debtor; however, the creditors were not held in contempt.

The Ninth Circuit found that knowledge of a bankruptcy case was insufficient to impute knowledge of the applicability of the discharge injunction. Instead, the creditor must have knowledge of the applicability of the injunction to the particular debt. Further, the Ninth Circuit ruled that a creditor’s good-faith belief that an action does not violate the discharge injunction precludes a finding of civil contempt, even if the discharge injunction applied and creditor’s belief was “unreasonable.”  Because the creditors in Taggart believed the discharge injunction did not apply, even though they ultimately were overruled, the Ninth Circuit agreed that the creditors could not be held in contempt.

The debtor appealed to the U.S. Supreme Court. In his petition for writ of certiorari, the debtor points to a circuit split on the issue of whether a creditor’s good-faith, subjective knowledge of the applicability of the discharge injunction precludes a finding of civil contempt. The debtor cited cases from the First, Fourth, and Eleventh Circuits in support of his position that a creditor’s good-faith mistake is not a valid defense and contrary to the Ninth Circuit’s ruling.  See IRS v. Murphy, 892 F.3d 29 (1st Cir. 2018); Bradley v. Fina (In re Fina), 550 Fed. App’x. 150, 154 (4th Cir. 2014); In re Hardy, 97 F.3d 1384 (11th Cir. 1996).

The debtor asserts that the Ninth Circuit’s holding “asks innocent debtors to absorb the costs of creditor mistakes, and it deprives debtors of the essential tool for ending discharge violations and recovering their losses.” Two amicus briefs were filed in support of the debtor’s position. The creditor’s response to the petition for writ of certiorari is due mid-December. 

Early next year, the Supreme Court will decide whether to hear the case.