Brace for Impact: Cal Supreme Court holds that the “Community Property Presumption” trumps the “Form of Title Presumption”

In November 2018 we wrote about In re Brace, in which the Ninth Circuit Court of Appeals asked the California Supreme Court to decide whether the “form of title presumption” trumps the “community property presumption” when spouses take title to real property as joint tenants.  To read our prior post, please click HERE.

On July 23, 2020, in a very thorough decision that will have a big impact on family, bankruptcy, and debtor-creditor law, the California Supreme Court answered the Ninth Circuit’s questions.  The decision can be read HERE.

In sum:  Property acquired by spouses with community funds on or after January 1, 1975, is presumed to be community property even if title to the property is taken in joint tenancy.  The grant deed, in itself, is not sufficient to overcome the community property presumption.  What is required to overcome the community presumption depends on whether the property was acquired before or after January 1, 1985.

Why does it matter when the property was acquired?  In the 1970s, the California legislature enacted landmark reforms to the community property system.  Those reforms, which went into effect on January 1, 1975, eroded prior rules that emphasized the manner in which title was held.  Still, spouses could “transmute” property from community property to separate property (and vice versa) by an oral or written agreement or a common understanding between the spouses.  However, effective January 1, 1985, new legislation provided that a transmutation is not valid unless it is made in writing and satisfies certain requirements.

This decision will have a huge impact in bankruptcy cases, especially chapter 7 cases, in which only one spouse files for bankruptcy.

Consider the following example:  John and Jane own a house that they bought after they were married.  The grant deed says that they took title as “John and Jane, husband and wife, as joint tenants.”  The house is worth $500,000.  Their mortgage is $300,000.  John files a chapter 7 petition, but Jane does not join in.  As is his right, John claims a $75,000 homestead exemption in the property.

Under a 2003 Ninth Circuit case called Summers, the chapter 7 trustee would not sell the house because it would not generate any funds for unsecured creditors.  If she were to sell the house, about $35,000 would go to pay brokerage fees and closing costs, and $300,000 would go to the mortgage company.  That leaves $165,000.  Half of that would be paid to Jane for her one-half joint tenancy interest.  That leaves $82,500.  From that the trustee would pay John his $75,000 homestead exemption.  That leaves $7,500.  The trustee’s statutory fee for selling the property would exceed $7,500.  Since a sale would generate nothing for unsecured creditors, the trustee would “abandon” it back to the debtor.  John and Jane would keep the house, and creditors would receive nothing.

Now, under Brace, the trustee will sell the house because John’s bankruptcy estate includes all community property in which John had an interest when he filed for bankruptcy.  See 11 U.S.C. § 541(a)(2).  After paying costs of sale and the mortgage, the trustee will pay John his homestead exemption and the remaining $90,000 will be used to pay costs of administration (such as the trustee’s fee) and unsecured creditors.  John and Jane will lose the house, and creditors will receive something on account of their claims.

As we predicted in our prior post, the California Supreme Court’s answer will have a significant impact on cases in which only one spouse files for bankruptcy.  In many such cases, the answer makes it more likely that debtors’ houses will be sold and creditors will be paid.

 

Telephonic 341(a) Hearings—A Brief Primer

By Brad D. Krasnoff, Esq.
Chapter 7 Panel Trustee, Central District of California


As you may know, due to the COVID-19 pandemic, all section 341(a) hearings conducted by panel chapter 7 trustees are being done telephonically. At this writing, these telephonic hearings will be conducted (at least locally, and likely nationwide) through early September 2020.

This protocol, which was initiated in late March 2020, has impacted significantly the manner in which these hearings are conducted. Through the efforts of the Office of the United States Trustee and the panel trustees, the hearings process, while challenging, has proceeded fairly efficiently. To further aid the conduct of these hearings, a few suggestions (to counsel and to parties without counsel) follow.

1.  Please cooperate with the trustees. Many of them are actively reaching out to the debtors and/or their counsel on their upcoming calendars to both provide instruction (an example: please do not put us on hold—the music is very distracting) and to request things (such as copies of valid IDs and SSI verifications). Please promptly and completely engage with the trustees regarding these requests and follow their instructions carefully and accurately. Send the trustees the requested ID and SSI copies. Send the trustees completed domestic support obligation (DSO) forms if the debtor has such court-ordered obligations. Send the trustees the completed declaration regarding pro se document preparation if the debtor did not have counsel assist in the case. If there are questions, reach out to the trustee—sooner rather than later. All of these things can and will greatly facilitate the process.

2.  Please be prepared for the hearings. Especially for parties with counsel, your counsel is typically knowledgeable regarding the standard questions posed by trustees in each case. Take the time to prepare the debtors regarding these questions, as well as potential questions which may arise in a given case depending on the contents of the papers. As the saying goes, a little preparation can go a long way.

3.  Please be proactive. Reach out to the trustee if there are questions. As alluded above, if there are issues that clearly exist based on what the papers contain, touch base with the trustee and provide information necessary to address the issues and be prepared to address those issues at the hearing. Doing this will greatly enhance the efficiency of the course of the hearings.

My present sense of things is: “so far so good.” The stakeholders in this process have largely tried to make this all work, and have largely succeeded. Of course, we can all do better sometimes, and hopefully the above suggestions, along with continued good faith and cooperation, will make things work even better as we wind our way through the COVID-19 crisis.

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Case Analysis: Pier 1 Imports Pandemic Rent Deferral; Equity; “Forum Shopping”; and the Dissolution of a Mega Retailer

In re Pier 1 Imports, Inc., No. 20-30805-KRH, 2020 WL 2374539 (Bankr. E.D. Va. May 10, 2020)

The bankruptcy court in the chapter 11 cases of furniture retailer Pier 1 Imports and affiliates granted the debtors’ motion to defer paying some of their rent payments.  On first blush, this ruling may seem inconsistent with the requirement that debtors stay current on their post-bankruptcy filing rent obligations.

In reaching its decision, the court took stock of the extreme circumstances confronting the debtors, the country and the world in the time of the COVID-19 (Coronavirus) pandemic.  The debtors filed for chapter 11 relief on February 17, 2020, aiming to confirm a plan within 60 days.  However, that timeframe became impossible.  The Court explained:

As the Debtors aptly stated in their Motion, “[t]he world has changed since the filing of these chapter 11 cases.”[]  On the Petition Date, the Debtors foresaw “potential disruptions from the COVID-19 virus [] currently facing China and other parts of the world,” but those disruptions were seen as temporary impacts on inventory shipped from China…. These forecasted limited supply disruptions were nothing compared to what the next few months would bring. No constituency in these cases predicted that the world would effectively grind to a halt.

In the coming weeks, numerous cities, counties, and most states issued versions of “stay at home” or “safer at home” orders, effectively closing the debtors’ stores overnight.

In considering the debtors’ request, the court stated that it was not “abolishing” the rent payments.  In fact, the court stated that rent payments are required under 11 U.S.C. § 365(d)(3).  The issue is timing. The court decided to allow the debtor to defer portions of rent payments temporarily during the COVID-19 shutdown. The court found that it had discretion to enter such an order pursuant to the broad equitable authority codified in 11 U.S.C. § 105(a) (“the court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title”).

The court reasoned that a debtor is obligated to timely perform under its leases.  However, the failure to perform does not result in a separate remedy.  Rather, it gives the landlord an administrative claim that must be paid on the effective date of a confirmed plan, no sooner (not superpriority).  The landlord may, nevertheless, be entitled to adequate protection under 11 U.S.C. § 361.  The court ruled that the landlords were adequately protected because the debtors continued to make all ordinary insurance, security, utility and other similar payments to maintain the premises, as well as promised to make cure payments by July 2020.

The court concluded that the relief “serves to pause the case in order to allow the Debtors an opportunity to make these Bankruptcy Cases succeed for the benefit of all creditors, including the Lessors.”  Moreover, the court saw “no feasible alternative to the relief” requested by the debtors.  The debtors cannot conduct sales of their in-store inventory until the COVID-19 emergency orders are relaxed.  The court concluded that the temporary delay of rent payments was necessary for the benefit of all constituents and creditors–employees, vendors, suppliers, secured creditors, as well as the landlords.

Author’s Commentary:

1).  Since the Supreme Court’s Law v. Siegel decision, bankruptcy courts have tended to refrain from exercising their equitable powers lest they be accused of seeking to “alter the balance struck by the statute.”  Law v. Siegel, 571 U.S. 415, 427, 134 S. Ct. 1188, 1198 (2014).  The Pier 1 court was indeed careful to emphasize that its ruling was not inconsistent with the Bankruptcy Code, and thus the court acted within the proscribed bounds of its equitable powers.  Moreover, at a time when governments are taking dramatic action for the benefit of the health and safety of society, it may seem consistent with these extraordinary times for a bankruptcy court to take a broader view in crafting its judicial decisions.  However, if they appeal, it will not be surprising if the landlords argue that the court exceeded its authority by favoring equity over the rights of the landlords. 

2).  One might reasonably wonder why Pier 1 filed its chapter 11 case in Richmond, Virginia. After all, it is a Texas-based retailer. One might wonder the same thing about another pandemic victim, retail giant J Crew, based in New York, which filed its chapter 11 case in Richmond in May 2020. The Eastern District of Virginia’s bankruptcy court was also home to the Toys R Us, Gymboree and Circuit City bankruptcy cases. Of all of these cases, only Circuit City, the first in this line of cases, was actually based out of Virginia.

The answer resides in the bankruptcy venue laws.  A corporation can file for bankruptcy anywhere it or an affiliated debtor is incorporated. Thus, even if a conglomerate has a single affiliate, with no active operations, in a given jurisdiction, it is eligible to file there. These venue provisions give rise to a phenomenon known as “forum shopping,” where debtors, their banks and professionals select a filing venue that they believe will be favorable to them for one reason or another. Oftentimes the jurisdiction is viewed as debtor or bank friendly. The Richmond court had a reputation for speedy proceedings, letting debtors out of union contracts, and tolerance for high professional fees. Added to this list surely must be willingness to curb landlord rights. Richmond is one of a few select runners up on the exclusive short list of bankruptcy courts, dominated by Delaware, with the Southern District of New York in second place, receiving the lion’s share of “mega” bankruptcy cases. Because forum shopping makes it harder for employees, small businesses, and local and state governments to fully participate in the process, and deprives most courts of the opportunity to participate in the development of the law, there is a growing movement to enact bankruptcy venue reform.  See, e.g., letter from bankruptcy judges and letter from attorneys general to members of Congress. H.R.4421 – Bankruptcy Venue Reform Act of 2019 seeks to enact such venue reform.

3).  Unfortunately, Pier 1’s efforts have not proved adequate to overcome the forces of the global pandemic. As of May 19, 2020, the company is preparing to wind down its business and close all of its stores.  Sadly, this is expected to be true for many brick and mortar retailers, which were already struggling as the result of web-based competition led by Amazon.com.  The pandemic is an historic and seemingly unstoppable push over the proverbial cliff for many companies in the retail sector.

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The Small Business Reorganization Act of 2019 (SBRA)

Effective February 22, 2020

In 2019, Congress amended the United States Bankruptcy Code by enacting the Small Business Reorganization Act (the SBRA). One of the most important features of the SBRA is the creation of a new bankruptcy option for small businesses, Subchapter V of chapter 11 of the Bankruptcy Code.  Subchapter V is designed to streamline the chapter 11 process and remove some of the challenges for small businesses seeking to reorganize through bankruptcy. See, e.g., Statement of Senate proponents of SBRA.

Initially, Subchapter V was available to debtors with aggregate secured and unsecured debt of no more than $2,725,625.  11 U.S.C. § 101(51D).  However, as part of the CARES Act, signed into law March 27, 2020 as an emergency response to the COVID-19 pandemic, for one year the debt limit has been increased to $7,500,000, opening these provisions to a broader segment of businesses.  See H.R. 748, section 1113.

Some of the major features of Subchapter V include:

1.  Chapter 11 Plan Filed Within 90 Days After the Bankruptcy Filing, And Only Debtor May Propose A Plan. This is different from a typical chapter 11, where the debtor has the exclusive right to file a plan for the first 120 days, and that exclusive right may be extended for up to 18 months if the court finds “cause.”  Once exclusivity expires, other parties may submit a plan.  Eliminating the costs and risk associated with plans being proposed by competing parties, Subchapter V provides that only the debtor may submit a plan.  11 U.S.C. § 1189(a).  Further, Subchapter V requires that the plan be filed within 90 days after the filing of the petition, shortening the length of time in bankruptcy court.  11 U.S.C. § 1189(b).  And an extension is only allowed “if the need for the extension is attributable to circumstances for which the debtor should not justly be held accountable.”  11 U.S.C. § 1189(b). Among other key requirements, unless all classes of creditors vote in favor of the plan, the plan must pay creditors an amount equal to its projected disposable income over a three to five year period.  11 U.S.C. § 1191(c)(2)(A).

2.  Owners May Keep Equity in Company (No Absolute Priority Rule). The absolute priority rule in chapter 11 requires that owners contribute new value to keep their equity in the reorganized company.  That requirement is expressly eliminated from Subchapter V, removing a major financial cost and risk from the reorganization process.  11 U.S.C. § 1181(a).

3.  Discharge. If a plan is consensual (meaning, all classes of creditors vote in favor of it), the debtor will receive a discharge upon confirmation.  If the plan is not consensual, and if the debtor makes its required plan payments, its remaining debts are discharged.  11 U.S.C. § 1192.

4.  Trustees. All Subchapter V cases have a trustee, a professional fiduciary, who oversees the case.  11 U.S.C. § 1183.  The trustee’s role includes investigating the business and financial affairs of the debtor, and may include distributing plan payments.  This role is more limited than the role of a chapter 7 trustee or that of a trustee appointed in chapter 11 case for cause.  Unlike those situations, in Subchapter V the debtor stays in control of its business operations.  That is, the debtor remains a “debtor in possession” unless removed for “cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor.”  11 U.S.C. § 1185.

5.  No Disclosure Statement is Required Unless Ordered by the Court for Cause. In a typical chapter 11, the debtor is required to prepare a “disclosure statement” which the court reviews for adequacy of information as a preliminary step before the plan can be voted on by creditors and confirmed by the court.  This is one of the factors that contributes to the time and expense of a typical chapter 11 case.  Subchapter V eliminates that step from the process unless ordered by the court for cause.  11 U.S.C. § 1181(b).

6.  No Creditors’ Committee. Creditors’ Committees can play an important role in chapter 11 cases.  The committee allows creditors to advocate collectively for the best interests of all of the general unsecured creditors (or other classes of creditors or interest holders).  However, it is also sometimes cited as a major expense that prevents small businesses from utilizing and successfully emerging from chapter 11.  Subchapter V eliminates committees from the process, unless expressly ordered by the court in the case.  11 U.S.C. § 1181(a).

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Nationwide Bankruptcy Courts Allow Amendment of Petitions to Streamlined Reorganization under Subchapter V of Chapter 11

Courts throughout the country are broadly permitting amendment of bankruptcy petitions filed prior to the effective date of the Small Business Reorganization Act (“SBRA”) to Subchapter V of Chapter 11.

Here is a discussion of four cases reaching this conclusion.

In re Progressive Sols., Inc., No. 8:18-bk-14277-SC, 2020 WL 975464 (Bankr. C.D. Cal. Feb. 21, 2020).

Debtor may amend its petition in a case filed prior to enactment of SBRA.  The debtor sought authority to amend the case from a small business chapter 11 case to a subchapter V small business debtor case (lest there be confusion, a “small business case” is a small business chapter 11 case that is not a “subchapter V” case.  11 U.S.C. § 101(51C)).  The case was first filed on November 21, 2018 as a small business chapter 11 case.  At a hearing on February 20, 2020, the day after the SBRA became effective, the debtor asked that the petition be re-designated a subchapter V “small business debtor” petition.  The court ruled that the amendment can be made at any time without leave of court pursuant to FRBP 1009(a).

In re Moore Props. of Pers. Cty., LLC, No. 20-80081, 2020 WL 995544 (Bankr. M.D.N.C. Feb. 28, 2020).

On February 10, 2020, nine days before the effective date of SBRA, the debtor filed a small business chapter 11 case.  A creditor immediately objected because the debtor was the owner of three real properties, and its primary activity was the business of owning or operating real estate, making the debtor ineligible for designation as a “small business debtor” under then language of 11 U.S.C. § 101(51D).  Five days after the effective date of SBRA, the debtor filed an amended petition to one under subchapter V.  The court authorized the amendment in light of SBRA’s revision to section 101(51D).  That statute used to say that a debtor whose primary activity is the business of owning or operating real estate is not a “small business debtor,” but now the exception applies to a debtor who operates “single asset real estate.”  Here the debtor owned three separate properties, each leased for third party farming operations, so it was not a single asset real estate debtor.  At the time of the hearing the “small business debtor” designation was correct and the debtor was entitled to amend as of right under FRBP 1009.

In re Body Transit, Inc., No. BR 20-10014 ELF, 2020 WL 1486784 (Bankr. E.D. Pa. Mar. 24, 2020).

Citing the two cases discussed above, the court agreed that the debtor has the right to amend its petition.  Further, it determined that the standard applicable to a creditor’s objection is whether the creditor will be prejudiced by the amendment or whether the amendment is made in bad faith.  Because the objecting creditor did not satisfy its burden of proof, the court overruled the objection and approved the amendment.

In re Bello, No. 19-46824, 2020 WL 1503460 (Bankr. E.D. Mich. Mar. 27, 2020).

An individual case was originally filed under chapter 13, then converted to chapter 11 and, finally, after the effective date of SBRA, the debtor amended the petition to one under Subchapter V.  Applying Moore, the court approved the amendment.

Supreme Court Copyright Decision that is Important for Bankruptcy Practitioners

Allen v. Cooper, 589 U.S. ___, 2020 WL 1325815 (2020)

On March 23, 2020, the United States Supreme Court struck down the Copyright Remedy Clarification Act of 1990 (“CRCA”), holding that Congress had no authority under either Article I of the U.S. Constitution or Section 5 of the Fourteenth Amendment to abrogate sovereign immunity for States that infringe on protected copyrights.  Allen v. Cooper, 589 U.S. ___, 2020 WL 1325815 (2020).  To read the full decision, click here.

While the demise of the CRCA may not at first blush appear relevant to bankruptcy practitioners, the Court’s opinion includes a discussion with significant implications for the practice of Bankruptcy law.  Plaintiff in Allen v. Cooper asked the Court to adopt the ruling in Central Virginia Community College v. Katz, 546 U.S. 356 (2006), finding that Congress either had the authority to abrogate state sovereign immunity with regard to copyright claims or that the States waived their sovereign immunity rights as to intellectual property at the time of the plan of the Constitutional Convention.  Namely, Allen asked the Court to hold that the States understood in 1789 that Article I of the Constitution gave Congress the authority to codify uniform laws affecting copyrights and patents, including the authority to bind the States in federal courts as to these laws.

Despite expectations by some legal commentators that the Court in Allen v. Cooper would reject Allen’s argument and signal a future overturning of Katz, the Court affirmed that the Bankruptcy Clause is “unique” among Article I Clauses, suggesting that the Supreme Court would likely affirm Katz in future cases involving the Bankruptcy Clause.

Reversal of Katz would have a significant impact on bankruptcy proceedings in the United States, as it would deprive bankruptcy court jurisdiction over the States in many circumstances.  States are major creditors in bankruptcy cases, so their ability to assert sovereign immunity would likely change the bankruptcy landscape.

Bankruptcy Court Holds Unscheduled Claim Is Not Discharged

West Valley Medical Partners, LLC v. Menaker (In re Menaker), __B.R.__, No. 1:13-BK-13562-MB, 2019 WL 3064875 (Bankr. C.D. Cal. July 8, 2019).

The defendant-debtors leased commercial property form the plaintiff creditor prior to their bankruptcy filing.  They vacated the premises more than three years before the end of the lease term and then filed a voluntary chapter 13 petition.  They did not schedule the plaintiff’s claim or give it notice of the bankruptcy filing or the deadline to file a claim.  Their plan was confirmed and did not include any payments to plaintiff.  Plaintiff filed a complaint for breach of the lease in state court.  The defendants thereafter amended their schedules to add plaintiff as an unsecured creditor.  The defendant-debtors obtained their discharge and the case was closed.  The plaintiff moved to reopen the case to obtain a determination that its claim was not dischargeable under section 523(a)(3)(A) of the Bankruptcy Code.

Section 523(a)(3)(A) provides that a claim is not dischargeable if it is “neither listed nor scheduled … in time to permit . . . timely filing of a proof of claim, unless such creditor had notice or actual knowledge of the case in time for such timely filing.”

The court overruled the debtors’ equitable arguments, allegations of actual knowledge, and their laches defense.  Based on a plain reading and application of the statute, the court ruled in favor of the plaintiffs, holding the claim nondischargeable under section 523(a)(3)(A).

Bankruptcy Court Rules that Federal Energy Regulatory Commission Does Not Have Concurrent Jurisdiction Over Rejection of Power Purchase Agreements

PG&E Corp. v. Fed. Energy Reg. Comm’n (In re PG&E Corp.), No. AP 19-03003, 2019 WL 2491247 (Bankr. N.D. Cal. June 7, 2019).

The debtors filed an adversary proceeding seeking a judgment enjoining the Federal Energy Regulatory Commission from impacting the debtors’ ability to reject power purchase agreements and related relief.

Shortly after the debtors announced their intent to file for bankruptcy protection, power purchase agreement counterparties filed administrative proceedings with the Federal Energy Regulatory Commission seeking a ruling that FERC must approve rejection of a PPA.  On Janaury 25 and 28, 2019, FERC ruled that it has concurrent jurisdiction with the bankruptcy court to consider rejection of PPAs.  On January 29, 2019, the debtors filed their voluntary bankruptcy petitions.  On the petition date, the debtor aslo filed an adversray proceeding for decalaratory and injunctive relief barring FERC from impacting the debtors’ ability to reject PPAs.  In its detailed analysis, the bankruptcy court stated unequivocally that there is no concurrent jurisdiction between FERC and the bankruptcy court with respect to rejection of executory contracts.  Pursuant to 28 U.S.C. §§ 157(b)(2) and 1334(a), the bankruptcy court has the exclusive authority and jurisdiction over the rejection of executory contracts under section 365 of the Bankruptcy Code, including PPAs.

Criminal Conviction Evidenced a Lack of Good Faith in Student Loan Dischargeability Action

In re Hurley, 601 B.R. 529 (B.A.P. 9th Cir. 2019).

The debtor incurred student loan debt while studying for his law degree and L.L.M. in taxation.  In 2009 he was hired as a revenue agent for the IRS.  In 2016, he was criminally convicted for receiving a bribe in his role as an IRS agent.  He was sentenced to 30 months in prison followed by three years of supervised release.  He was disbarred.  Upon his release from prison, the debtor lived in a halfway house in Seattle.

After his conviction, the debtor filed a chapter 7 petition.  The debtor had approximately $256,000 in student loan debt.  He filed a complaint, from prison, seeking to discharge his student loan debt.  He argued that, under section 523(a)(8) of the Bankruptcy Code, the debt should be discharged because it imposed an undue hardship.  The debtor claimed that because of his conviction, incarceration, and disbarment, he would be unable to regain employment at his previous level, and would therefore be unable to pay his debt.  He was 45 years old with a three-year-old child, but did not claim to have medical or other conditions preventing him from working.  The defendants (the government and lender) filed a motion for summary judgment. The defendants’ motion for summary judgment was granted based on a finding that the debtor did not establish that he made a good faith effort to repay the loans.

The debtor appealed to the Bankruptcy Appellate Panel.  The BAP affirmed.  Under section 523(a)(8) of the Bankruptcy Code, a student loan is not dischargeable unless the debtor establishes that repaying the debt would “impose an undue hardship on the debtor and the debtor’s dependents.”  The Ninth Circuit has adopted the three-pronged Brunner test to determine whether a debtor has established undue hardship: (1) that the debtor cannot maintain, based on current income and expenses, a minimal standard of living for herself and dependents if forced to repay the loans; (2) additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period; and (3) the debtor has made good faith efforts to repay the loans. Brunner v. N.Y. State Higher Educ. Servs. Corp. (In re Brunner), 46 B.R. 752, 756 (S.D.N.Y. 1985), aff’d, 831 F.2d 395, 396 (2d Cir. 1987) (adopted by United Student Aid Funds, Inc. v. Pena (In re Pena), 155 F.3d 1108, 1111-12 (9th Cir. 1998)).

The BAP agreed with the bankruptcy court’s finding that the debtor’s criminal conduct was not a factor beyond his reasonable control, and the bankruptcy court did not err by taking it into consideration.  However, the BAP was careful to avoid setting a “bright-line rule that a debtor with a criminal conviction can never establish good faith.”  The BAP and the trial court noted that the debtor did make reasonable efforts to repay the debts, but that the balance of factors still weighed against the requisite finding of good faith.

Supreme Court Sets Standard for Civil Contempt for Violation of Discharge Order

Taggart v. Lorenzen, 139 S. Ct. 175 (2019).

The Supreme Court held that a court may hold a creditor in civil contempt for violating a discharge order if there is “no fair ground of doubt” as to whether the order barred the creditor’s conduct.  That is, there is no objectively reasonable basis for concluding that the creditor’s conduct might be lawful.

The debtor was a defendant in state court litigation prior to his chapter 7 bankruptcy filing.  The debtor obtained a discharge in his bankruptcy case.  Thereafter, the state court entered judgment against the debtor and the creditor-plaintiff applied to the state court for attorneys’ fees incurred after the debtor-defendant filed his bankruptcy petition.  The state court found that the debtor had “returned to the fray” after the bankruptcy filing, justifying an award of postpetition attorneys’ fees under the Ninth Circuit precedent of In re Ybarra, 424 F.3d 1018 (9th Cir. 2005).

The debtor sought a bankruptcy court order barring the creditor from collecting postpetition attorneys’ fees and holding the creditor in civil contempt.  The bankruptcy court denied the debtor’s request, finding, like the state court, that the debtor returned to the state court “fray.”  The district court reversed and remanded.  On remand, the bankruptcy court applied a standard likened to “strict liability.”  It found that civil contempt sanctions were appropriate because the creditor was “aware of the discharge” order and “intended its actions which violated” it.  The creditor appealed.  The BAP vacated the sanctions and the Ninth Circuit affirmed the BAP.  The Ninth Circuit held that “a ‘creditor’s good faith belief’ that the discharge order ‘does not apply to the creditor’s claim precludes a finding of contempt, even if the creditor’s belief is unreasonable.’”

The Court began its analysis with two applicable Bankruptcy Code provisions.  Section 524(a)(2) states that a discharge order serves as an “injunction against the commencement or continuation of an action” among other things.  Section 105(a) authorizes the court to “issue and order…necessary or appropriate to carry out the provisions” of the Bankruptcy Code.  The Court explained that its “conclusion rests on a longstanding interpretive principle: When a statutory term is ‘obviously transplanted from another legal source’ it ‘brings the old soil with it.’”  Here, the “‘old soil’ includes the ‘potent weapon’ of civil contempt.”  Such power is limited by the “traditional standards in equity practice.”  In nonbankruptcy cases, civil contempt is not employed when there is a “fair ground of doubt as to the wrongfulness” of conduct.  This requires application of an objective reasonableness standard.  The Ninth Circuit erred when it applied a subjective standard for civil contempt.  The judgment was thus reversed and the case remanded.