Supreme Court Establishes Standard for Contempt of the Discharge Injunction

When a successful consumer bankruptcy case has run its course, the Bankruptcy Court issues an Order of Discharge. The discharge does a couple of very important things. It voids the future effect of judgments taken against the debtor prior to bankruptcy (except to the extent that the lien of a judgment has validly attached to the debtor’s property before the case was filed). And it “operates as an injunction against the commencement or continuation of an action . . or an act, to collect, recover or offset any debt as a personal liability of the debtor . . ..” Bankruptcy Code section 524(a)(1) and (a)(2). That is, the discharge is accompanied by a permanent federal court injunction prohibiting debt collection. Period.

What happens when a creditor violates the discharge injunction, say by suing you on a discharged debt? Under the standard just set by the Supreme Court, the question is essentially whether a reasonable creditor in a similar position to the violator would or should have known that the action in question was prohibited by the discharge. In the ordinary case, this will be fairly easy to establish. The more complex the facts, the greater the uncertainty.

The case is Taggart v. Lorenzen. In the court of appeals from which the appeal to the Supreme Court was taken, the Ninth Circuit decision had allowed creditors in a fairly complex fact pattern to escape contempt sanctions for violations of the bankruptcy discharge based on their subjective belief that their actions were not in violation of the discharge. The Supreme Court reversed, saying that the bankruptcy court may hold a creditor in contempt for violating the discharge if “there is no fair ground of doubt” that the action violated the discharge order, i.e., if a reasonable creditor would have known . . .”

In establishing this objective standard for contempt, the Court rejected a strict liability standard. Its not enough just that there was a violation for the creditor to be in contempt. The test is essentially: ‘you should have known better.’ It remains to be seen what implications this decision may have for violations of the automatic stay. More later.

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