Argument preview: Justices to consider sanctions for violating bankruptcy discharge

Taggart v. Lorenzen, which will be argued on April 24, the last day of oral arguments for October Term 2018, presents a straightforward legal question for the justices. Specifically, when a debtor has received a discharge in bankruptcy, does a creditor’s good-faith belief that a particular collection activity does not violate the bankruptcy discharge protect the creditor from sanctions for contempt?

The overwhelming majority of discharge disputes arise in consumer bankruptcies when common creditors like credit-card issuers or taxing authorities argue that the bankruptcy proceeding did not discharge some particular debt. In the simplest case, a credit-card issuer that sued a cardholder on a credit-card debt that the bankruptcy court had discharged often would be held in contempt. Conversely, if the government sued to collect a tax debt that was nondischargeable (such as a debt for which the debtor never filed a return), that suit would not violate the discharge.

This case is nothing like that, but rather arises from a web of internecine bickering among the owners of a small business. The bankrupt in this case (petitioner Bradley Taggart) formerly held an interest in an Oregon business, but attempted to sell it. The other members of the business and the business itself sued Taggart in state court, arguing that Taggart’s attempt to sell the business was wrongful. Taggart filed for bankruptcy, which stayed the litigation for a time.

After the bankruptcy case concluded, though, the litigation resumed. Taggart sought dismissal from the litigation (because the bankruptcy had discharged his obligations to the creditors), but the state court refused to dismiss him, reasoning that it could enter an order clarifying title to the business without violating Taggart’s discharge. Eventually, the state court entered a judgment expelling Taggart from the business and ordering Taggart to pay the creditors’ attorney’s fees.

At that point, Taggart returned to the bankruptcy court, asking it to hold the creditors in contempt for violating the bankruptcy discharge. Taggart did not challenge the order expelling him from the business, but he did challenge the award of attorney’s fees as monetary relief inconsistent with the discharge of Taggart’s obligations to the business by the bankruptcy court. The bankruptcy court denied Taggart’s request under a line of cases holding that the discharge does not protect a debtor who “returns to the fray” of litigation after receiving the discharge. Taggart appealed the bankruptcy court ruling to the district court, which disagreed, reasoning that Taggart’s litigation in the state court was not really voluntary – he had, after all, sought to be dismissed from the case. When the case eventually reached the court of appeals, that court held that the bankruptcy court could not hold Shelley Lorenzen and the other respondents in contempt so long as they had a “good faith belief” that the discharge did not bar the litigation against Taggart, even if that belief in fact was unreasonable.

That complex morasse of litigation produces an atypical scenario, in which it is reasonable to think that well-meaning lawyers might not have understood the implications of the bankruptcy discharge for the litigation against Taggart. But, faced with a square circuit conflict, the justices nevertheless agreed to review the case. On the merits, the case is a bit unusual for the bankruptcy docket, because it does not involve any particular provision of the bankruptcy code or federal law more broadly: The Bankruptcy Code defines the discharge, but does not define what should happen to those that violate it. On that question, courts rely on a general federal common law of contempt, under which federal courts over the years have developed rules and standards for defining when particular conduct so violates a judicial order that the court should hold the actor in contempt. In this particular area, it appears that the Supreme Court has never examined the state of mind necessary for a creditor to be held in contempt of the bankruptcy discharge.

Turning to the arguments, Taggart can win only if he can identify a standard under which Lorenzen would be held in contempt despite the state trial court’s contemporaneous view that everything Lorenzen did was proper. What Taggart suggests (following one line of lower-court authority) is that the defendant’s state of mind is irrelevant, and that a party aware of a discharge acts at its own peril if it pursues the debtor without first seeking guidance from the bankruptcy court on the scope of the discharge. A strong amicus brief filed by a group of law professors and retired bankruptcy judges emphasizes the importance of a robust contempt sanction to ensuring that the consumer discharge is effective on the ground; a weak sanction would make it too easy for creditors to routinize efforts to collect discharged debts. On the point in question, the brief criticizes a “mistake of law” defense like the one accepted here – the creditors admittedly violated the discharge, but they acted in good faith because they made a “mistake of law.” For the amici, complicating discharge litigation with subjective questions about the creditor’s state of mind that justified their “mistake of law” would make it too hard for courts to rein in abusive post-discharge collection activity.

On the other side, Lorenzen does not defend the holding of the court of appeals that even an unreasonable understanding of the discharge would be adequate to protect the creditor from contempt sanctions, so long as the belief is held in good faith. Rather, Lorenzen argues that a creditor’s reasonable good-faith belief that its activities did not violate the discharge should be enough to protect it. In Lorenzen’s view, the creditors’ activities plainly were reasonable because the state court approved them. The problem with that argument, of course, is that Lorenzen can prevail only if the justices determine that this view of the discharge was reasonable.

The U.S. solicitor general filed an amicus brief in support of neither party, offering a view much like Lorenzen’s. On the one hand, the solicitor general emphatically rejects the lower court’s view that any good-faith belief, however unreasonable, is enough to preclude a finding of contempt. Nor does the government agree with Taggart that a creditor should be held in contempt if it acts in the face of reasonable doubt without first seeking approval from the bankruptcy court. The solicitor general is particularly concerned that such an interpretation would hamper tax authorities, which frequently sue to collect non-dischargeable tax debts. For the government, the natural approach is to vacate the decision of the court of appeals and remand for the lower courts to evaluate the reasonableness of Lorenzen’s conduct.

It seems unlikely that the court will affirm the judgment of the court of appeals, when even the respondent is unwilling to defend that court’s reasoning. What we’ll be looking for in the argument is a sense of how much leeway the court thinks creditors need in pursuing collection efforts after a bankruptcy discharge. The court often is sympathetic to the government’s needs for effective collection of tax revenues, but some of the justices have evinced considerable concern in recent years about abusive debt collection. I’ll be watching to see how Justice Sonia Sotomayor reacts, because she has the most on-the-ground experience wrestling with these questions in a trial court and at the same time has been at the forefront of the group concerned about overreaching debt collectors.