Supreme Court Decides Case About Collection Attempts on Discharged Debt

The U.S. Supreme Court recently clarified the standard for holding a creditor in contempt after attempting to collect a debt from someone who's received a bankruptcy discharge.

If you’ve had debts discharged in bankruptcy, an injunction prevents creditors from trying to collect on those discharged debts. But what if a creditor attempts to collect anyway? Generally, the creditor will be in contempt of the discharge order. In Taggart v. Lorenzen, 2019 WL 2331303 (June 3, 2019), the U.S. Supreme Court considered the case of a creditor that unquestionably knew about a debtor's discharge order, but argued it had a subjective belief it was acting in compliance with that order while trying to collect from the debtor—and therefore wasn't in contempt.

In rendering its decision, the U.S. Supreme Court set a standard for determining when to punish creditors that violate the discharge injunction.

What’s a Bankruptcy Discharge?

In a bankruptcy, once you get a discharge, you’re no longer liable for paying the debt. When you get the discharge, the bankruptcy court imposes an injunction that prohibits the creditor from continuing to try to collect the debt from you. A bankruptcy court will hold a creditor in contempt if the creditor attempts to collect a discharged debt.

Sometimes, though, it might not be apparent to a creditor whether a particular debt has been discharged. Certain debts—like most student-loan debts, fraudulently incurred debts, and domestic-support obligations—survive a bankruptcy discharge. As a result, a creditor might not be sure about whether attempts to collect will violate the discharge. Also, debt collectors and debt buyers sometimes claim that the discharge order doesn’t apply to them or that they didn’t know about the order.

In Taggart, the Supreme Court determined how a court should decide whether to sanction a creditor for collection activities when the creditor knowingly violates the discharge, but claims it was legally allowed to do so.

Background of the Taggart Case

The court’s decision in Taggart applies to situations when a creditor knows about a bankruptcy discharge and takes intentional actions because it believes the discharge doesn’t apply to its actions. The facts surrounding this case were complicated: After the discharge, the creditor (Sherwood) sued the debtor (Taggart), who was the creditor’s former business partner, over ownership of the business. At the end of the litigation, the state court ordered Taggart to pay attorneys’ fees. Taggart returned to the Federal Bankruptcy Court, seeking civil contempt sanctions for Sherwood's attempted collection of those attorneys' fees in violation of the discharge order.

All parties agreed that, under the Ninth Circuit's decision in In re Ybarra, 424 F. 3d 1018 (2005), a discharge order would normally cover—and thereby discharge—postpetition attorneys' fees stemming from prepetition litigation unless the discharged debtor “returned to the fray” after filing for bankruptcy. Here, Sherwood argued that Taggart had “returned to the fray” postpetition and therefore was liable for the postpetition attorneys' fees that Sherwood sought to collect.

The U.S. Court of Appeals for the 9th Circuit concluded that Sherwood wasn't in violation of the discharge order because Sherwood had a subjective belief—even if unreasonable—that it was entitled to go after Taggart for those fees. (See In re Taggart, 888 F. 3d 438, 444 (9th Cir. 2018)). The U.S. Supreme Court rejected that holding.

The Supreme Court’s Holding

The Supreme Court reversed the Ninth Circuit’s decision, which favored creditors. Ultimately, the Court held that the proper standard to apply in this type of case was an objective standard, rather than a subjective one. Specifically, the Supreme Court stated a creditor may be held in civil contempt for violating the discharge injunction if there is “no fair ground of doubt” as to whether the injunction order barred the creditor’s conduct. The Court also said that “civil contempt may be appropriate if there is no objectively reasonable basis for concluding that the creditor’s conduct might be lawful.” Accordingly, the Supreme Court vacated the judgment and remanded the case for further proceedings consistent with its opinion.

How This Decision Might Affect Mortgage Servicing

Because the Supreme Court has determined that the proper standard is an objective one, loan servicers might now become more willing to discuss options with borrowers seeking information about their mortgage loans or about loss mitigation options after a discharge. Previously, borrowers who have received a discharge regarding a mortgage debt have often found it difficult to get information from their servicers because it was unclear what actions might constitute illegally trying to collect on the mortgage debt and thus violate the discharge order. So, servicers were nervous about dealing with borrowers who'd received discharges in bankruptcy.

The Taggart decision might make creditors less concerned about dealing with borrowers on loss mitigation and other issues after a bankruptcy discharge because they'll be held in contempt only if there is no objectively reasonable basis for concluding that the creditor's conduct might be lawful.

Talk to a Lawyer

If a creditor or debt collector is trying to collect a debt from you in violation of a discharge injunction, consider talking to a lawyer to learn about your rights and options. A consumer can generally seek damages under either civil contempt or, if a debt collector is involved, the Fair Debt Collection Practices Act (FDCPA). Depending on the jurisdiction and situation, you might be able to file a lawsuit under the FDCPA and get actual damages, as well as up to $1,000 in statutory damages, plus attorneys’ fees.

Effective date: June 3, 2019