A decision from the Ninth Circuit Bankruptcy Appellate Panel is emblematic of courts inveighing against Kelly v. Robinson, 479 U.S. 36 (1986), where the Supreme Court held that criminal restitution is nondischargeable under Section 523(a)(7), even though it is payable to the victim of the crime, because (1) the victim had no control over the decision to award restitution or the amount of the award, and (2) the decision to impose restitution turned on the penal goals of the state, not the victim’s injuries.

Some courts, like the Ninth Circuit and the BAP in this case, are advocating a narrow interpretation of Kelly, where the Supreme Court arguably departed from the language of the statute to achieve a socially desirable result.

The 45-page BAP opinion on July 3 by Bankruptcy Judge William J. Lafferty, III, is required reading with regard to the narrowing scope of the Rooker-Feldman doctrine and the state of play on dischargeability of costs imposed on lawyers in disciplinary proceedings.

The Disciplinary Suspension

For mishandling client funds, the Nevada Supreme Court suspended a lawyer twice. Both suspension orders assessed actual costs of the disciplinary proceeding against the lawyer, along with $2,500 mandated by the Nevada Supreme Court’s rule.

After the lawyer received a chapter 7 discharge, the Nevada Supreme Court, which we shall call the NSC, reinstated the lawyer on several conditions, one requiring payment of the costs and the $2,500 by the end of the lawyer’s two-year probation. The NSC did not decide whether the costs had been discharged. Rather, the NSC saw no discrimination under Section 525(a).

The subsection says, “a governmental unit may not deny, revoke, suspend, or refuse to renew a license . . . [with] respect to . . . a person that is or has been a debtor under this title . . . solely because such bankrupt or debtor is or has been a debtor under this title . . . .” [Emphasis added.]

The lawyer reopened his bankruptcy case and moved for sanctions, contending that the state bar violated Section 525(a) by conditioning reinstatement on payment of disciplinary costs.

The bankruptcy court ruled that the disciplinary costs were not discharged. Even if they were, the bankruptcy court reasoned that the bar’s actions were not “solely” on account of the lawyer’s bankruptcy. In addition, the bankruptcy court believed that the Rooker-Feldman doctrine was a preclusion to setting aside the NSC’s imposition of the costs. The lawyer appealed to the BAP.

Rooker-Feldman

Before reaching the merits, Judge Lafferty was called up to decide whether the Rooker-Feldman doctrine prevented the BAP from deciding whether the NSC improperly imposed costs. Named for two Supreme Court decisions, Rooker-Feldman bars lower federal courts for lack of subject matter jurisdiction from engaging in appellate review of state court judgments.

Judge Lafferty began by saying that Rooker-Feldman is not a constitutional doctrine. Rather, it is subservient to the plenary power of Congress over bankruptcy. He analyzed two Ninth Circuit decisions. One found Rooker-Feldman inapplicable to state court decisions about the automatic stay, and the second found the bankruptcy court not bound by a state court decision regarding the discharge injunction.

Judge Lafferty cited one of the circuit decisions for saying that the invocation of Rooker-Feldman would “undermine” the unified federal bankruptcy system. After lengthy analysis, he held that the two Ninth Circuit decisions “equally apply to state court orders that incorrectly interpret § 525(a) because such orders undermine the discharge injunction.”

A contrary rule, Judge Lafferty said, would give governmental entities “a back door to violating the discharge injunction.” Finding no Rooker-Feldman violation, he turned to the merits.

Were Disciplinary Costs Discharged?

To decide whether there was a discriminatory violation under Section 525(a), Judge Lafferty was first tasked with deciding whether the disciplinary costs were excepted from discharge by Section 523(a)(7). Under subsection (a)(7), a debt is not discharged if it is “a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit, and is not compensation for actual pecuniary loss . . . .”

The dischargeability analysis begins with Kelly, supra, a case involving criminal restitution. Judge Lafferty said that “Kelly essentially created an exception to the plain statutory construction of § 523(a)(7) for debts arising from state criminal statutes.” [Emphasis in original.]

After pages of analysis, Judge Lafferty said,

[W]hile the post-Kelly case law interpreting § 523(a)(7) continues to evolve, one point remains clear: the authorities do not provide a bright line rule regarding whether disciplinary costs, or any debts, are per se excepted from discharge simply because they arise in the context of an attorney disciplinary proceeding.

Judge Lafferty nonetheless distilled three “general guidelines” from Ninth Circuit precedent. First, disciplinary costs are nondischargeable if the state legislature has amended the statute by having the costs serve a penal purpose. Second, he saw the Ninth Circuit as having gradually cabined Kelly while telling courts to hue to the “plain statutory language of Section 523(a)(7).”

Third, the Ninth Circuit has said that costs are discharged if the costs were not a “fine, penalty or forfeiture” or were compensation for “actual pecuniary loss.”

Having identified the principles in Ninth Circuit precedent to be applied, Judge Lafferty examined the NSC rule to decide whether costs imposed on disciplined lawyers are dischargeable.

Judge Lafferty said there was no Nevada precedent interpreting the NSC rule imposing costs on disciplined lawyers. He observed that the NSC rule “does not contain any language indicating that costs imposed under the rule are meant to be penalties, or that the rule is meant to serve a penal purpose, such as rehabilitation or protection of the public.”

Therefore, Judge Lafferty held “that the disciplinary costs imposed on Debtor [under the NSC rule] were discharged.”

The State Bar Violated Section 525(a)

The bankruptcy court had decided that the state bar did not violate Section 525(a) because the refusal to reinstate the lawyer was not “solely” on account of the failure to pay disciplinary costs.

“To the extent the only barrier to Debtor’s reinstatement [was] payment of the disciplinary costs,” Judge Lafferty decided that “the State Bar has violated § 525(a).” However, the record was incomplete as to whether there were other grounds to prevent reinstatement.

Judge Lafferty reversed and remanded for the bankruptcy court to decide whether the failure to reinstate was based on grounds other than the failure to pay costs.