The Match Continues First Circuit Rules on Remedies for Discharge Violations

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Dec/Jan 2000

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Round three in the battle over enforcement of the discharge injunction is set to begin. The Court of Appeals
for the First Circuit recently sent the parties scrambling back into the ring by concluding that in cases of
collection of discharged debt, consumers have remedies under §105 of the Bankruptcy Code that go
beyond proceedings for contempt of the discharge order.<a href="#1" name="1a">1</a> In reaching this conclusion, the court breathed
content back into §105, a Code provision that had been swallowed by its limiting principles.

In round one, consumers and various retailers including Sears, May Co. Stores and Federated
Department Stores agreed to settle a series of highly publicized class-action cases brought by consumers
based on the companies' collection of discharged debt.<a href="#2" name="2a">2</a> The affected consumer debtors argued that the
retailers had illegally collected discharged debt based on various unfiled and therefore unenforceable
reaffirmation agreements. The retailers ultimately refunded tens of millions of dollars to consumers with
interest and paid other damages and attorneys fees.<a href="#3" name="3a">3</a>

In round two, the creditors fought back. In a series of cases, creditors successfully argued that consumers
have no private right of action for violations of the discharge injunction under §524, §105 or state law, and
that remedies are therefore limited to individual actions for contempt in the court that entered the
discharge.<a href="#4" name="4a">4</a> Under this defense, creditors do not necessarily assert that their collection of discharged debt
was legal, only that consumers have no potential claims that can be maintained jointly by a class.

The success of these arguments temporarily left most debtors without effective remedies for systemic
violations of the discharge, since contempt proceedings for individually affected consumers on a massive
scale are expensive and impractical. Not only would each affected debtor have to reconnect with a
(perhaps long-forgotten) bankruptcy lawyer, but records would have to be recovered, cases would have
to be reopened, and individual proceedings would have to be conducted over amounts that are often less
than $200 per debtor. Consumer lawyers began to believe that creditors who had pervasively ignored the
discharge would be permitted to retain substantial profits from their misconduct.

<h3>Consumers Not Down for the Count</h3>

The appeals court decision in Bessette<a href="#5" name="5a">5</a> now rings the bell for round three. The court found that
consumers do have cognizable remedies (other than contempt) under the Bankruptcy Code for violations
of the discharge injunction and that courts must examine whether class treatment for those claims is
available under Bankruptcy Rule 7023. In reaching these conclusions, the First Circuit rejected a series of
arguments that creditors had successfully made in the district court.

The district court in Bessette (like other courts that similarly dismissed discharge violation class actions)
had concluded that §524 provides no private right of action. It next concluded that §105 does not supply
the needed authority for courts to order remedies for violations. And finally, it concluded that even though
the Bankruptcy Code provides no remedy when the discharge injunction is violated, the Code nevertheless,
by occupying the field, pre-empts all state law that might supply the necessary remedy.<a href="#6" name="6a">6</a>

The district court concluded that a consumer's only remedy for a violation of the discharge injunction
is a claim for contempt. The court in Bessette and other courts have expressed a related concern that a
remedy for violating a court order can only be fashioned by the court that issued the discharge order that
was violated.<a href="#7" name="7a">7</a> This principle alone, in the view of those courts, precludes a national class action.

<h3>Discharge Injunction</h3>

The discharge injunction in §524(a) is a special creature of statute. It was enacted in 1970 to make the
bankruptcy discharge more easily enforceable.<a href="#8" name="8a">8</a> While many statutes give courts the power to craft
injunctive relief, there are relatively few other instances in which Congress itself has set out the terms of
an injunction.

The Supreme Court has repeatedly said that when a court has authority under a statute to issue an
injunction, that authority alone is sufficient to give the court power to order related equitable relief such as
restitution, disgorgement and divestiture of profits obtained in defiance of the injunction.<a href="#9" name="9a">9</a> The debtor's case
for the availability of broad equitable relief under the Bankruptcy Code seems even stronger. Congress in
§524 has done more than simply grant bankruptcy courts the permission to issue an injunction; it has
written the injunction itself and made it applicable to every case. And equally important, it has granted
power under §105 that appears explicitly designed to supply authority to do equity when a Code provision
is violated.

Under the Supreme Court precedents, it follows that equitable relief other than contempt remedies is
available. Nevertheless, until the Court of Appeals decision in Bessette, the trend of the case law was to
find that the statutory injunction blocked federal equitable relief. To do so, these cases not only minimized
the inherent equitable authority of the district courts, but also read content out of §105.

<h3>The Appeals Court Decision</h3>

The appeals court in Bessette reclaims the power of the district court (and by extension of the
bankruptcy court) to fashion equitable remedies to effectuate specific provisions of the Code. The court
properly found that it need not reach the question of whether there is a private right of action under §524,
since §105 grants authority to the district court to fashion equitable relief necessary to effectuate the
discharge injunction. It holds simply that "§524 is enforceable through §105."

Tellingly, the court found that, if appropriate, a district court can certify a class necessary to effectuate
relief under §105. The court thus rejects the argument that only the court that issued the discharge order can
grant relief for a discharge violation. It correctly notes that §524 is a statutory injunction that is uniform in
every case, and not an "individually crafted" order in which the insight of the judge that issued the order
is integral to the appropriate scope of relief.

The court thus remanded the case to the district court to revisit whether class certification is appropriate.
The appeals court left open the possibility that the district court could refer the case to the bankruptcy court
for resolution. It noted that the bankruptcy court also has power under §105 to enforce §524 together with
the authority under Rule 7023 to maintain class actions.

<h3>Court's Pre-emption Ruling Leaves Many Open Questions</h3>

Several courts also have found that debtors, due to pre-emption, may not fall back on state law
claims.<a href="#10" name="10a">10</a> Although (1) pre-emption of state law is generally disfavored, (2) the Bankruptcy Code draws
heavily on state law for many critical bankruptcy determinations<a href="#11" name="11a">11</a> and (3) these courts had just found no
federal remedy applicable to plaintiff's claims, they nevertheless concluded that Congress left no room in
the statutory scheme for state enforcement.<a href="#12" name="12a">12</a>

The First Circuit appeared to deliver a knockout punch to debtors on these issues by claiming that
field pre-emption applies in the bankruptcy context. A careful reading of the court's analysis, however,
suggests that it actually followed the more limited conflict approach. Under that approach, each provision
of state law must be analyzed separately to determine if it creates specific conflicts with the applicable
federal scheme.

Based on its earlier ruling, the Bessette court initially observed that a district or bankruptcy court, in
fashioning relief under §105, may order a defendant to disgorge unjust profits from its illegal conduct.
It logically follows that a state court claim for unjust enrichment is duplicative and would be in "conflict
with Congress's plan" for enforcement of §524 through §105. Since the plaintiffs in Bessette did not
assert any other state law claims, no further discussion was needed. Oddly, the court then summarized
the two pre-emption approaches and stated that it relied on field pre-emption in reaching its decision.

Raising more questions about its analysis, the First Circuit then cited with approval several decisions
where pre-emption was not found on the basis that the state law claims did not conflict with relevant
Code sections. For example, the Bessette court distinguished another First Circuit panel decision<a href="#13" name="13a">13</a> that
found a state law tort claim arising out of a violation of the automatic stay was not pre-empted because
there was no "comparable overlap" between the remedies available under §362 and state law remedies
for false imprisonment, negligence and abuse of process. Similarly, the court distinguished a recent
Eighth Circuit decision that found no "overlap" between the Code and a state consumer protection statute
prohibiting creditor contact with a debtor who is represented by counsel, where the creditor had sent a
copy of a letter soliciting a reaffirmation agreement directly to the debtor.<a href="#14" name="14a">14</a>

Ultimately, the First Circuit's limited holding as to the plaintiffs' unjust enrichment claim is correct, and
its favorable reference to decisions applying a conflict analysis suggests that debtors may assert certain state
law claims that are not simply "alternative mechanisms" for remedies available for violations of the
automatic stay and discharge injunction. Likewise, to the extent that a creditor's compliance with state law
does not impede its enjoyment of rights under the Bankruptcy Code, creditors should be held accountable
for violations of consumer protection statutes such as those regulating debt collection and unfair and
deceptive trade practices.

<h3>Section 105 Gets New Life</h3>

As a rash of decisions have struggled to find limiting principles for the broad language in §105, courts
have become cautious about applying the authority apparently available under that section. The often-cited
maxim that §105 is not "a roving commission to do equity"<a href="#15" name="15a">15</a> had become a reason for many courts to
approach §105 as if it has no content.

But the Supreme Court has said that under §105, "a court may exercise its equitable power...as a means
to fulfill some specific Code provision."<a href="#16" name="16a">16</a> Although it seems axiomatic that the discharge protection
constituting the goal of most consumer bankruptcy filings is a "specific Code provision" worthy of
vindication under the court's equitable powers, the several courts that have found otherwise read §105 as
if it is explicitly limited to permitting contempt remedies. But contempt is no more explicitly found in the
plain language of §105 than restitution, disgorgement or any other equitable remedy.

Ultimately, the reasoning behind decisions like Walls and Pertuso (and that of other courts that are not
in the First Circuit) as to the limited power available under §105 may be more troubling than these
non-bankruptcy courts understand. Rulings that the bankruptcy court lacks power to order disgorgement
under §105—even when disgorgement is necessary to effectuate other provisions of the Code—has
far-reaching implications for the administration of the bankruptcy system.

For example, such a holding, if affirmed by higher courts, would effectively overrule a line of cases
related to bankruptcy court oversight of professional fees. Those cases conclude that bankruptcy courts
may invoke §105(a) to order disgorgement of professional fees that are obtained in a manner that is
inconsistent with Code §328 governing compensation of professionals.<a href="#17" name="17a">17</a> Since there clearly is no
"private right of action" under §328, §105 is the necessary source of authority. Decisions giving content
to §105 like that of the appeals court in Bessette are thus of critical importance.

<h3>Decisions Awaited from Other Courts of Appeals</h3>

The Courts of Appeals for both the Sixth and the Seventh Circuit are expected to issue decisions on
similar issues in the coming months.<a href="#18" name="18a">18</a> Since plaintiffs typically have a choice of jurisdictions for
proceeding in national class actions on issues that affect consumers uniformly on a national basis, it is
likely that no matter how those courts rule, litigation over remedies for violations of the discharge will
continue. If the Sixth and Seventh Circuits issue rulings that limit consumer remedies, we look forward
to seeing you here in New England (or better yet perhaps in Puerto Rico).

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Bessette v. Avco Financial Services, No. 99-2291, 2000 U.S. App. Lexis 26919, — F.3d — (1st Cir. Oct.
27, 2000). <a href="#1a">Return to article</a>

<a name="2">2</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Sears Roebuck & Co., 222 B.R. 181 (D. Mass. 1998)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Lantanowich, 207 B.R. 326 (Bankr. D. Mass. 1997)</a>. <a href="#2a">Return to article</a>

<a name="3">3</a> Sears's legal problems related to its bankruptcy collection practices may not be over. A Texas court had certified a class action concerning
Sears's alleged practice of misleading consumers about the claimed value of its collateral. Although the Fifth Circuit Court of Appeals
recently vacated the district court's decision to certify under Rule 23(b)(2), the court of appeals remanded the case to the district
court with a strong hint that the case could properly be re-certified under Rule 23(b)(3). Bolin v. Sears Roebuck & Co., No.
99-20627, 2000 U.S. App. Lexis 27326, — F.3rd — (5th Cir. 2000). <a href="#3a">Return to article</a>

<a name="4">4</a> See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Wells Fargo Bank N.A., 253 B.R. 460 (E.D. Cal. 2000)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Norwest Fin. Inc.
(In re Holcomb), 234 B.R. 79, 83 (Bankr. N.D. Ill. 1999)</a>; Pertuso v. Ford Motor Credit Co., 1998 U.S.
Dist. Lexis 21191 (E.D. Mich. Dec. 30, 1998), appeal docketed, No. 99-1132 (6th Cir. 1999); <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v.
Zale Del. Inc., 242 B.R. 444 (N.D. Ill. 1998)</a>, appeal docketed, No. 99-4239 (7th Cir., 1999). Compare,
e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Norwest Fin. Cal., 245 B.R. 389 (E.D. Cal. 2000)</a> (finding a private right of action). <a href="#4a">Return to article</a>

<a name="5">5</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Avco Fin. Servs. Inc., 240 B.R. 147 (D. R.I. 1999)</a>. <a href="#5a">Return to article</a>

<a name="6">6</a> The district court also addressed a technical question under RICO. That issue will not be addressed here. <a href="#6a">Return to article</a>

<a name="7">7</a> See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra.</a> <a href="#7a">Return to article</a>

<a name="8">8</a> H. Rep. No. 91-1502, 91st Cong. 2d Sess. 1-2 (1970). <a href="#7a">Return to article</a> <a href="#8a">Return to article</a>

<a name="9">9</a> See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. American Stores Co., 495 U.S. 271, 110 S.Ct. 1853, 109 L.Ed. 2d 240
(1990)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Warner Holding Co., 328 U.S. 395, 66 S.Ct. 1086</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… L.Ed. 1332 (1946)</a>. <a href="#9a">Return to article</a>

<a name="10">10</a> See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Zale, supra</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, supra</a> (district court opinion). <a href="#10a">Return to article</a>

<a name="11">11</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Monts, 906 F.2d 1468 (10th Cir. 1990)</a>. The interplay between state and federal law has been recognized
as a reflection of Congress's respect for important state interests in bankruptcy matters (<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Roach, 824 F.2d 1370, (3d.
Cir. 1987)</a>), particularly in the area of property interests. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. United States, 440 U.S. 48, 57, 99 S.Ct. 914, 919, 59 L.Ed 2d 136 (1979)</a>. <a href="#11a">Return to article</a>

<a name="12">12</a> Since there is no explicit statutory language pre-empting state law in §524, state law claims are valid except (1) where the federal
statutory scheme controlling a particular subject is so pervasive that Congress clearly intended to "occupy the field" to the complete exclusion
of state law, or (2) where a particular state law or action is in direct conflict with federal law such that enforcement of the state
law would "stand as an obstacle to the accomplishment and execution" of the purposes of the federal statute. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Cty. v. Automated Medical Labs Inc., 471 U.S. 707, 713, 85 L.Ed. 2d 714,105 S.Ct. 2371 (1985)</a>. <a href="#12a">Return to article</a>

<a name="13">13</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Commercial Union Insurance Co., 928 F.2d 486 (1st Cir. 1991)</a>. <a href="#13a">Return to article</a>

<a name="14">14</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Roebuck & Co. v. O'Brien, 178 F.3d 962 (8th Cir. 1999)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Trust Co. v. Smith, 212 B.R.
599 (B.A.P. 8th Cir. 1997)</a>. Interestingly, the Eighth Circuit in O'Brien held that since Congress did not intend to
exclusively regulate the bankruptcy area, there can be no field pre-emption. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 966-67</a>. <a href="#14a">Return to article</a>

<a name="15">15</a> See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Secretary of Health & Human Servs. (In re Ludlow Hosp. Soc'y Inc.), 124 F.3d 22, 27 (1st
Cir. 1997)</a> (quoting Chiasson v. J. Louis Matherne & Assocs. (In re Oxford Management Inc.), 4 F.3d 1329, 1334 (5th Cir. 1993)). <a href="#15a">Return to article</a>

<a name="16">16</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Bank Worthington v. Ahlers, 485 U.S. 197, 206, 108 S.Ct. 963, 99 L.Ed. 2d 169 (1988)</a>. <a href="#16a">Return to article</a>

<a name="17">17</a> See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Kids Creek Partners, 219 B.R. 1020, 1022 (Bankr. N.D. Ill. 1998)</a> aff'd. on other grounds,

2000 U.S. App. Lexis, 469 (7th Cir. 2000); <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Kearing, 170 B.R. 1, 7 (Bankr. D. D.C. 1994)</a>. <a href="#17a">Return to article</a>

<a name="18">18</a> See footnote 4, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; <a href="#18a">Return to article</a>

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