Dan Prieto and Mark Douglas
In a decision that could have significant ramifications in bankruptcy cases, a divided panel of the U.S. Court of Appeals for the Second Circuit ruled in 2021 that the standard articulated by the U.S. Supreme Court in Taggart v. Lorenzen, 139 S. Ct. 1795 (2019), for the imposition of contempt sanctions due to a violation of the bankruptcy discharge injunction in a chapter 7 case, also applied to contempt sanctions imposed for repeated violations of bankruptcy court orders declaring a home mortgage current. SeePHH Mortgage Corp. v. Sensenich (In re Gravel), 6 F.4th 503 (2d Cir. 2021), reh’g en banc denied, No. 20-1 (2d Cir. Nov. 1, 2021), petition for cert. denied, No. 21-1322 (U.S. June 13, 2022).
In 2022, the Fourth Circuit expanded the reach of Taggart even further. In Beckhart v. Newrez LLC, 31 F.4th 274 (4th Cir. 2022), a three-judge panel of the Fourth Circuit ruled that “Taggart also applies when a court is considering whether to hold a creditor in civil contempt for violating a plan of reorganization of debts entered under Chapter 11.” More broadly, the court wrote, “Nothing about the Supreme Court’s analysis in Taggart suggests it is limited to violations of Chapter 7 discharge orders … or that the Court’s decision turned on considerations unique to the Chapter 7 context.”
Given these holdings, two circuit courts of appeals have now concluded that Taggart casts a wider net in bankruptcy than the language of that opinion might have suggested.
In Taggart, the Supreme Court ruled that a bankruptcy court may hold a creditor in civil contempt for attempting to collect on a debt that has been discharged in bankruptcy “if there is no fair ground of doubt as to whether the [discharge] order barred the creditor’s conduct.” Taggart, 139 S. Ct. at 1801.
Taggart left open the question of whether the “fair ground of doubt” standard should apply to violations of other bankruptcy court orders or provisions of the Bankruptcy Code, such as a chapter 11 plan confirmation order, a discovery order, or the automatic stay. Many courts have weighed in on the issue, with mixed outcomes. See, e.g., Deutsche Bank Trust Co. Americas v. Gymboree Group, Inc., 2021 WL 3618229, *11 (E.D. Va. Aug. 16, 2021) (“Because there is fair ground for doubt concerning the requirements of the 2017 Plan and related disbursements, the record does not warrant a finding of contempt”); In re Jeong, 2020 WL 1277575 (B.A.P. 9th Cir. Mar. 16, 2020) (applying the Taggart standard in upholding a bankruptcy court order granting a chapter 7 trustee’s request for contempt sanctions for a willful violation of the stay); In re GL Master Inc., 2022 WL 34686, *2 (Bankr. C.D. Cal. Jan. 3, 2022) (applying the Taggart standard in ordering contempt sanction for willful and repeated violations of discovery orders); In re GYPC, INC., 634 B.R. 983, 991 (Bankr. S.D. Ohio 2021) (“The court will apply the Taggart standard in determining whether any stay violations committed by Eastport entitle GYPC to damages under a civil contempt theory”); Tate v. Fairfax Village I Condominium, 2020 WL 634293 (Bankr. D.D.C. Feb. 10, 2020) (citing Taggart in finding a willful violation of the stay in a chapter 13 case and imposing sanctions under section 362(k)(1) of the Bankruptcy Code). But seeIn re Franklin, 614 B.R. 534, 546 n.19 (Bankr. M.D.N.C. 2020) (in a chapter 13 case involving a request for automatic stay violation sanctions under section 362(k), noting the distinction between a discharge injunction and the automatic stay and stating that “[e]ven if the standard in Taggart applied to § 362(k), no reasonable creditor objectively could have believed [the creditor’s] actions in this case did not violate the automatic stay”); In re Spiech Farms, LLC, 603 B.R. 395, 408 n.22 (Bankr. W.D. Mich. 2019) (in a chapter 7 case, stating that “[t]his court does not read Taggart to change the Sixth Circuit’s standard for determining whether a creditor can be held in contempt for violating the automatic stay”); see also Fid. & Deposit Co. of Maryland v. TRG Venture II, LLC, 2022 WL 952737, *2 n.1 (N.D. Ill. Mar. 30, 2022) (declining to address whether the Taggart standard should apply to contempt for violation of an injunction in a chapter 11 plan and a confirmation order where the issue was not raised on appeal).
Gravel involved debtors in three separate chapter 13 cases filed in the U.S. Bankruptcy Court for the District of Vermont and the company originating and servicing the home mortgages (the “originator”) for all of those debtors. The originator repeatedly violated Rule 3002.1 of the Federal Rules of Bankruptcy Procedure (the “Bankruptcy Rules”), which requires a mortgage lender to file a notice itemizing all fees, expenses, or charges incurred in connection with a mortgage during a bankruptcy case.
In two of the three Vermont cases, the bankruptcy court had entered an order (a “current order”) declaring that the debtors were current on all pre- and post-bankruptcy payments, fees, and charges. Less than a month after the court issued the current orders, however, the originator began listing in the debtors’ statements fees allegedly incurred during the periods encompassed by the orders, but did not include those fees in the amounts due. In those two cases, the originator had not filed the notices required by Bankruptcy Rule 3002.1. There was no current order in the third case, but the originator listed fees in that debtor’s statements (but did not include the fees in the amount due), without filing a Bankruptcy Rule 3002.1 notice.
For violating the rule, the bankruptcy court imposed $75,000 (i.e., $1,000 for each of the 25 violations in all three cases) in sanctions under Bankruptcy Rule 3002.1. In addition, invoking its “authority … to impose punitive sanctions on parties who violate court orders,” the court imposed a total of $300,000 in sanctions for violation of the two current orders. Reasoning that it “may hold a creditor in contempt for that party’s violation of an injunction order,” the court applied the Taggart contempt standard and “impos[ed] punitive sanctions” on the originator for its violation of the orders.
The district court reversed on appeal, ruling that the $375,000 in sanctions exceeded the bankruptcy court’s “statutory and inherent powers.” The district court remanded the case to the bankruptcy court, which later imposed the same $75,000 in sanctions for violating Bankruptcy Rule 3002.1, but reduced the punitive sanctions for violating the current orders to $225,000.
The Second Circuit granted the originator’s request for a direct appeal of the second sanctions order. A divided three-judge panel of the Second Circuit vacated and reversed the second sanctions order.
Initially, the majority explained that a bankruptcy court’s “narrowly circumscribed” contempt power derives from a court injunction—an equitable remedy—and section 105(a) of the Bankruptcy Code, which authorizes the court to issue “any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code].”
The majority concluded that the originator “did not, as a matter of law, violate” the current orders because those orders specifically prohibited the originator “from disputing that the debtors are current (as set forth herein) in any other proceeding” but “did not enjoin the recording of expired fees on the statements” sent to the debtors. Gravel, 6 F.4th at 511.
In so ruling, the majority applied the contempt standard established in Taggart. “Without an express injunction [barring the originator from sending out statements reflecting expired fees],” the majority wrote, there was a “fair ground of doubt as to whether the listed fees can form the basis for contempt.” Id. According to the majority, the bankruptcy court “could have crafted an order that would have forbidden the conduct” at issue. Id. at 513.
The majority also held that the $75,000 sanction for failure to file Bankruptcy Rule 3002.1 notices “went beyond the relief authorized by that rule,” and that, given the absence of any finding of bad faith below, it was “dubious” whether the bankruptcy court “could exercise its inherent power to do that which is unavailable under powers expressly defined” in Bankruptcy Rule 3002.1. Id. at 516.
The dissent agreed with the majority’s holding that the current orders “did not clearly and unambiguously prohibit” the originator’s conduct for which the bankruptcy court imposed $225,000 in sanctions, but disputed vacatur of the $75,000 sanction, reasoning that either Bankruptcy Rule 3002.1 or the bankruptcy court’s inherent powers authorized the sanction.
On April 4, 2022, the chapter 13 trustee filed a petition seeking U.S. Supreme Court review of the Second Circuit’s decision. The Supreme Court denied the petition on June 13, 2022. See Sensenich v. PHH Mortgage Corp., No. 21-1322 (U.S. June 13, 2022).
In August 2009, Gordon and Stella Beckhart (the “debtors”) filed for chapter 11 protection in the Eastern District of North Carolina. At the time of the bankruptcy filing, the debtors were in arrears to the tune of nearly $23,000 under a loan secured by real property owned by them in North Carolina.
The debtors proposed a chapter 11 plan under which the mortgage loan would be reinstated. The servicer of the loan (together with its successor, the “servicer”) objected to the plan, stating that it failed to make any provision for the payment of prepetition arrearages or the application of postpetition principal or interest payments. The servicer also voted to reject the plan, but the bankruptcy court confirmed the plan over its objection.
The confirmation order provided that, “[e]xcept as modified herein, the [debtors] shall continue to pay the creditor’s claim according to the original loan terms.” The order specified the date on which the first payment would be due after confirmation, but did not state the amount or how it would be calculated. The order also provided that, in the event of a default, the debtors would be entitled to 10 days’ written notice before the lender could exercise its state court remedies with respect to the property. The servicer did not appeal the confirmation order.
The debtors began making the monthly payments on the date specified in the confirmation order and continued to do so in accordance with the terms of the mortgage. Nearly four years after confirmation of the plan, the servicer informed the debtors that their account was past due in the amount of approximately $50,000. After several attempts to resolve the dispute over the course of the next five years failed, the servicer served the debtors with a notice of foreclosure in January 2020.
The debtors then filed a motion in the bankruptcy court for civil contempt and sanctions against the servicer and the lender (collectively, the “defendants”). After an evidentiary hearing, the bankruptcy court entered an order finding the defendants to be in civil contempt and directing them to pay monetary sanctions in the amount of approximately $115,000 to the debtors.
The defendants appealed the contempt order to the district court, which reversed. According to the district court, the defendants “established a fair ground of doubt with regard to the unclear terms of the confirmation order, and the bankruptcy court’s contempt order falls far short of meeting the Taggart standard for imposing the serious finding of civil contempt against appellants.” Newrez, LLC v. Beckhart, 2021 WL 3361707, *2 (E.D.N.C. July 6, 2021), vacated and remanded, 31 F.4th 274 (4th Cir. 2022). Notably, the district court stated:
The Court is not convinced by [the debtors’] argument that the discharge order referenced in Taggart is different from the confirmation order at issue here, thus making the case inapplicable here. Regardless of the name of the document, both orders concern payment or repayment with regards to the declaration of bankruptcy and an outstanding amount owed at the time of the filing, and the similarities between the documents far outweigh the differences.
Id. According to the district court, the confirmation order was confusing because it did not expressly address what amount the debtors would owe on the loan as of the confirmation date or how the pre- and postpetition arrearages would be repaid, if at all. In addition, the court noted, by adopting a reading that seemed consistent with the contractual terms of the loan and that was objectively reasonable, the defendants acted in good faith. Finally, the district court stated that the defendants “were repeatedly advised by counsel that they could collect the amounts due from appellees under the original mortgage contract.” Id. at *3.
The debtors appealed to the Fourth Circuit.
The Fourth Circuit’s Ruling
A three-judge panel of the Fourth Circuit held that the standard adopted in Taggart applies when a court is considering whether to hold a creditor in civil contempt for violating a chapter 11 plan of reorganization. Because it concluded that neither the bankruptcy court nor the district court properly applied the Taggart standard, the panel vacated the district court’s ruling and remanded the case below.
Writing for the panel, U.S. Circuit Court Judge Toby Heytens explained that, because the Supreme Court’s analysis was based on “traditional principles of equity practice” that have “long governed how courts enforce injunctions,” the scope of Taggart is clearly not limited to violations of chapter 7 discharge orders and “governs civil contempt under Chapter 11 of the Bankruptcy Code as well.” Beckhart, 31 F.4th at 277 (citations omitted). He acknowledged that chapter 11 reorganizations differ in many ways from chapter 7 liquidations but wrote that “a bankruptcy court’s authority to enforce its own orders—regardless of which chapter of the Bankruptcy Code those orders were issued under—derives from the same statutes and the same general principles the Supreme Court relied on in Taggart.” Id. at *3.
According to Judge Heytens, the bankruptcy court did not apply the Taggart standard at all but, rather, a four-factor test for civil contempt articulated in a Fourth Circuit nonbankruptcy decision that long predated Taggart. The Fourth Circuit panel went on to state that the district court misapplied the Taggart standard in overturning the bankruptcy court’s contempt order. In particular, the district court erroneously granted controlling weight to the defendants’ reliance on the advice of counsel as a sufficient defense to civil contempt. According to Judge Heytens, this is contrary to long-standing Fourth Circuit law as well as the Supreme Court’s statement in Taggart that “‘[t]he absence of willfulness does not relieve from civil contempt.'” Id. (quoting Taggart, 139 S. Ct. at 1802). Judge Heytens noted, however, that “while relying on the advice of outside counsel is not a complete defense in and of itself, it may still be considered in appropriate circumstances as a relevant factor under the Taggart standard.” Id. at *3 n.*.
Having concluded that both lower courts “erred in analyzing the threshold question of whether [the defendants] may be held in civil contempt at all,” the Fourth Circuit held that the district court’s ruling should be vacated and the case should be remanded to the bankruptcy court “to reconsider the contempt motion under the correct legal standard.” Id.
In Gravel and Beckhart, two circuit courts of appeals appear to have definitively answered a major question left unanswered by Taggart—namely, whether the “fair ground of doubt” standard applies to contempt for violation of bankruptcy court orders other than orders discharging chapter 7 debtors. Other lower courts have also adopted this expansive interpretation of Taggart. By declining to review the Second Circuit’s ruling in Gravel, the Supreme Court passed up the opportunity to weigh in on the issue.
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Originally Published At The Mondaq Platform