A Creditor Must Tell a Non-Bankruptcy Court to Stop Violating the Stay

On pain of contempt for violating the automatic stay, a creditor must attempt to stop a non-bankruptcy court from continuing civil contempt proceedings against a debtor for failure to pay a judgment representing a dischargeable debt, according to the Bankruptcy Appellate Panel for the Sixth Circuit.

The BAP’s holding seems to mean that a creditor cannot remain silent but must take action to stop a non-bankruptcy court from proceeding with any litigation that violates the automatic stay.

The case demonstrates the importance of the upcoming decision by the Supreme Court in Taggart v. Lorenzen, 18-489 (Sup. Ct.). If the high court upholds the Ninth Circuit, good faith will be a defense to violation of the automatic stay, and the BAP would have been forced to rule the opposite.

The Facts

The BAP was dealing with a case where neither side was sympathetic.

In divorce proceedings, a wife won a property settlement award in 2006. After appeals and rehearings, the state court entered an order in 2012 directing the husband to pay about $36,500 within 21 days. The couple continued litigating for another nine months until the state court directed the husband to pay the $36,500 by October 1. In the event the husband did not pay, the state court scheduled a sentencing hearing for October 8 on the wife’s motion for contempt.

The husband did not pay. Instead, he filed bankruptcy on October 4 and filed a “suggestion of bankruptcy” with the state court. At the sentencing hearing on October 8, the state judge said she had performed her own research and concluded that the automatic stay did not apply to the contempt proceeding. When asked by the judge, counsel for the husband-debtor said he did not have any authority contrary to the judge’s conclusion.

The state court judge proceeded to send the husband-debtor to jail for 30 days, saying he could spring himself earlier by paying $36,500. The debtor was in jail for 10 days when the parties submitted an agreed order in state court releasing the debtor from jail and holding his sentence in abeyance “pending resolution of the relevant issues in the [debtor’s] pending bankruptcy matter.”

After the debtor was released from jail, he dismissed his bankruptcy. Following dismissal, the wife filed a motion to reimpose the contempt sentence. The debtor-husband then filed a second bankruptcy.

Three years after he had been sent to jail for 10 days, the debtor-husband filed an adversary proceeding in his second bankruptcy to hold the wife and her counsel in contempt for violation of the automatic stay in the first bankruptcy. The divorce was stayed pending resolution of the second bankruptcy.

After presentation of the debtor-plaintiff’s case in the contempt proceeding, the bankruptcy judge dismissed the contempt action, finding insufficient evidence to show a stay violation by the wife and her counsel. The debtor appealed, winning a victory in a March 4 opinion for the BAP by Bankruptcy Judge Guy R. Humphrey.

The Finding of Contempt

Judge Humphrey stated the general principle that continuation of proceedings to collect a matrimonial property division are automatically stayed, absent an exception to the automatic stay. He found no exceptions.

First, Judge Humphrey said that the contempt proceedings did not fall under the “criminal action” exception to the stay in Section 362(b)(1), because the contempt proceedings in state court were civil in nature. The debtor could have purged his contempt by paying $36,500.

There was no criminal element, Judge Humphrey said, since the contempt order was “not calculated to punish” and “does not contemplate a monetary penalty beyond compliance with the property settlement.”

Likewise, there was no “court-made exception” to the stay, such as the ability of a judge to uphold the dignity of the court. Judge Humphrey said there was nothing in the record to indicate that the judge was upholding the dignity of the state court.

Significantly, Judge Humphrey went on to say that no court has made an exception that “would allow a state court to except itself from the stay to enforce a dischargeable money judgment.” Jailing the debtor, he said, was “nothing short of the use of debtor’s prison.”

Finding no exceptions to the stay, Judge Humphrey ruled that the sentencing hearing and confinement were stay violations. He then turned to the question of whether the wife or her counsel were liable for having themselves violated the automatic stay.

Judge Humphrey laid out reasons why there could be liability, such as the failure of the wife or her counsel to take “action to prevent the incarceration.” He said that recent cases “appear to be uniform in holding that creditors have a duty to stay the post-petition enforcement of pre-petition civil contempt orders issued by state courts.”

Judge Humphrey held that the wife and her counsel “had a duty to take affirmative action to prevent the use of the sentencing hearing . . . to coerce payment of the dischargeable property settlement.”

The BAP could not rule on liability because the bankruptcy court had dismissed the adversary proceeding at the conclusion of the debtor’s case, before the wife and her counsel had an opportunity to explain what actions they had taken, if any, to forestall incarceration.

Judge Humphrey went on to list actions they could have taken to avoid violation of the stay, such as (1) filing a motion for relief from the stay, (2) filing a motion to vacate the contempt order in view of the bankruptcy, or (3) submitting an agreed order to hold the state court contempt proceedings in abeyance pending resolution of automatic stay questions in bankruptcy court.

Judge Humphrey said there was “no evidence in the record” that counsel for the wife “took any of the available steps to prevent the sentencing hearing from proceeding . . . in violation of the automatic stay.” He nonetheless remanded the case, allowing counsel and the wife to “present evidence on whether they took affirmative action” to prevent a stay violation.

[N.B.: There is language in the opinion implying the BAP’s view that the wife’s lawyer alone should be held in contempt.]

The Significance of Taggart

The BAP decision underscores the significance of the Supreme Court’s upcoming decision in Taggart.

At oral argument on April 24, the Supreme Court will wrestle with the question of whether subjective good faith is a defense to a stay violation. The circuits are split. The First Circuit does not permit a good faith defense, while the Ninth Circuit has held that a good faith belief that the stay does not apply is a defense, even if the belief is “unreasonable.” See Lorenzen v. Taggart (In re Taggart), 888 F.3d 438 (9th Cir. April 23, 2018).

If the Supreme Court upholds Taggart, the wife and her counsel should be off the hook because the state court judge’s belief about the inapplicability of the stay surely gave them a good faith belief that the stay did not apply.