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Financial Services Law Insights and Observations

Supreme Court holds that creditor may be held in civil contempt for violation of bankruptcy discharge injunction

Courts U.S. Supreme Court Bankruptcy

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On June 3, the U.S. Supreme Court unanimously held that a creditor may be held in civil contempt for violating a bankruptcy court’s discharge order “if there is no fair ground of doubt as to whether the order barred the creditor’s conduct.” At issue was Section 524(a)(2) of the Bankruptcy Code, which specifies that a discharge order triggers an automatic injunction against any creditor that attempts to collect a pre-bankruptcy discharged debt.  In the case before the Court, a defendant to a lawsuit proceeding in state court filed for Chapter 7 bankruptcy during the course of that litigation.  After the bankruptcy court entered a discharge order, the state court ordered the debtor to pay the plaintiffs’ attorneys’ fees. While the monetary judgment would have ordinarily violated the discharge, the state court concluded that it was permissible under a lower-court doctrine holding that the discharge no longer applies when a debtor “return[s] to the fray” of litigation after filing for bankruptcy. The bankruptcy court appellate panel vacated the bankruptcy court’s decision and the  9th Circuit affirmed, concluding that a creditor may not be held in contempt for violating a discharge order if the creditor held a subjective good faith belief—even if “unreasonable”—that its actions did not violate the injunction.

Upon review, the Supreme Court reversed the 9th Circuit’s opinion, noting that the standard for civil contempt “is generally an objective one,” and nothing about a bankruptcy court discharge order should modify that principle.  The Supreme Court emphasized that “a party’s subjective belief that [the party] was complying with an order ordinarily will not insulate [the party] from civil contempt if that belief was objectively unreasonable,” and that civil contempt “may be appropriate when the creditor violates a discharge order based on an objectively unreasonable understanding of the discharge order or the statutes that govern its scope.” The -debtor’s argument for a standard that would operate like a “strict-liability” standard—where creditors who are unsure of whether a debt has been discharged can obtain an advance determination from the bankruptcy court prior to attempting to collect the debt—was also rejected. The Supreme Court stated that because “there will often be at least some doubt as to the scope of such orders,” a preclearance requirement may “lead to frequent use of the advance determination procedure,” as well as additional costs and delays.

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