Fourth Circuit: “Fair Ground of Doubt” Standard Applies to Contempt Allegations in Chapter 11 Cases

May 13, 2022

In June 2019, the U.S. Supreme Court issued its unanimous decision in Taggart v. Lorenzen, through which it turned to general standards governing contempt outside of bankruptcy in holding a creditor may not be found in contempt for its failure to comply with a discharge injunction when a fair ground of doubt exists as to whether the creditor’s actions are wrongful. 139 S. Ct. 1795, 1799–1804 (2019).

Because the holding in Taggart related to a creditor’s purported violation of a chapter 7 discharge injunction, subsequent case law has questioned whether the standard set out for civil contempt in Taggart should also apply when a creditor is alleged to be in contempt of a confirmed plan of reorganization under chapter 11 of the Bankruptcy Code. See, e.g., In re Kimball Hill, Inc., 620 B.R. 894, 903 (Bankr. N.D. Ill. 2020), aff’d sub nom. Fid. & Deposit Co. of Maryland v. TRG Venture II, LLC, No. 20 C 6105, 2022 WL 952737 (N.D. Ill. Mar. 30, 2022)). See also a 2020 McGuireWoods legal alert, “New ‘Fair Ground of Doubt’ Standard for Alleged Discharge Violations: Tread Carefully.”

Through its recent decision in Beckhart v. NewRez LLC, the U.S. Court of Appeals for the Fourth Circuit effectively answered this question in the affirmative. 31 F.4th 274 (4th Cir. 2022). Specifically, the court held that “the standard adopted in Taggart also applies when a court is considering whether to hold a creditor in civil contempt for violating a plan of reorganization … under [c]hapter 11.” Id. at 275.

In Beckhart, the debtor (a married couple) filed a petition under chapter 11 of the Bankruptcy Code. Through the chapter 11 case, the bankruptcy court confirmed the debtor’s chapter 11 reorganization plan. Id. at 276. Pursuant to the order confirming the plan, the debtor was permitted to retain possession of certain real property; however, the plan neglected to specify the amount of each payment that would need to be made to the creditor secured by the property. While the order did set forth certain actions the secured creditor could take upon the occurrence of a default, it otherwise provided that, “[e]xcept as modified herein, the [d]ebtor shall continue to pay the creditor’s claim according to the original loan terms.” Id.

Years after the chapter 11 case, a new loan servicer took over the debtor’s account. Despite the debtor’s regular monthly payments, the servicer believed the account to be past due, and therefore, in default. Although the servicer eventually acknowledged that the prior servicer had not adjusted the loan following the debtor’s chapter 11 case, the servicer simultaneously initiated foreclosure proceedings. Id. The debtor argued the servicer had violated the order confirming its chapter 11 plan by placing the account in default and seeking to foreclose. The servicer, however, claimed its actions were justified under the confirmation order. In the alternative, the servicer argued the confirmation order was ambiguous, and as a result, confusing. Because of the confirmation order’s ambiguity and the ensuing confusion, the servicer asserted it could not be in civil contempt under the Taggart standard.

Without referencing Taggart and instead relying on a contempt standard set out in a case predating Taggart, the bankruptcy court found the servicer in contempt. (See Beckhart, 31 F.4th at 276-77.) On appeal, the district court—while conceding the Taggart standard applied — reversed the bankruptcy court’s decision. Id. at 277. The district court reasoned that the bankruptcy court’s contempt order did not meet the Taggart standard because the servicer had “established a fair ground of doubt with regard to the unclear terms of the confirmation order.” Id. In fact, the district court noted that evidence of the servicer’s reliance on the advice of outside counsel was “undisputed evidence” of acting in “good faith.” Id.; see also id. at 278 (rejecting this finding entirely in stating “this Court had squarely held—long before Taggart—that advice of counsel ‘is not a defense’ to ‘civil contempt.’” (citing In re Walters, 868 F.2d 665, 668 (4th Cir. 1989))).

When before the Fourth Circuit, the debtor argued that, inter alia, the Taggart standard did not apply. Id. at 277. The Fourth Circuit disagreed, and in doing so, explained that regardless of the chapter under which a bankruptcy petition is filed, the authority of a bankruptcy court to enforce its own orders “derives from the same statutes and the same general principles the Supreme Court relied on in Taggart. And those principles make clear that the logic of Taggart applies broadly.” Id. In other words, the Taggart standard was not meant to be confined solely to issues of contempt under chapter 7. Id. Accordingly, through its decision in Beckhart, the Fourth Circuit clarified the Taggart standard for civil contempt applies equally among each chapter of the Bankruptcy Code under which a debtor may file a petition.