The Bankruptcy Appellate Panel for the Ninth Circuit held in substance that a bankruptcy court cannot decline to rule on a request for a comfort order and must tell a creditor whether its contemplated action will or will not violate the discharge injunction.
The facts and the procedural history were horribly complicated, with a chapter 7 discharge 10 years ago and convoluted post-discharge litigation between the debtor and a creditor. In state court, the creditor was alleging after discharge that the debtor was the alter ego for two of his companies that the chapter trustee had abandoned.
To make it simple, assume that the debtor believed that his discharge meant he could have no alter ego liability for debts owing by the two companies.
Threatened with contempt for a discharge violation, the creditor commenced an adversary proceeding in bankruptcy court seeking a declaration (i.e., comfort order) that the suit in state court did not violate the discharge injunction. After the debtor answered and failed to contest any of the factual allegations in the complaint, the creditor moved for judgment in its favor on the pleadings.
The bankruptcy court denied the motion for judgment on the pleadings and dismissed the creditor’s adversary proceeding without prejudice. The bankruptcy judge said he could not guess what relief the state court might ultimately grant. The bankruptcy judge believed he could not decide whether there had been a discharge violation until after the state court resolved the lawsuit.
The bankruptcy judge did not bar the creditor from proceeding in state court. However, the bankruptcy judge warned the creditor that it “would . . . be doing so at your own peril . . . if you don’t prevail across the board, you may be faced with a contempt proceeding.”
The creditor appealed, although dismissal of the adversary proceeding without prejudice would seem to suggest that the order was not final and therefore not appealable.
Finality
In his April 15 decision for the BAP, Bankruptcy Judge Robert J. Faris first dealt with appealability.
Judge Faris said that the order “was final inasmuch as it conclusively denied [the creditor’s] requested relief and ended the litigation.” The decision, he said, was “sufficiently final for the purpose of this appeal. Even if it were interlocutory, we would grant leave to appeal.”
The decision reads like precedent for situations where a bankruptcy court denies a lift-stay motion without prejudice, but the appellate court nonetheless decides that the order was final. Cf Ritzen Group Inc. v. Jackson Masonry LLC, 140 S. Ct. 582, 205 L. Ed. 2d 419 (Sup. Ct. Jan. 14, 2020). For ABI’s report on Ritzen, click here.
Creditors Are Entitled to Comfort Orders
On the merits, Judge Faris explained how the bankruptcy judge believed he could not decide whether there would be a discharge violation “without speculating about the outcome of the state court proceedings.” The bankruptcy judge, he said, “evidently thought that the state court’s decision might make it unnecessary to determine whether the discharge applied.”
Under the “return to the fray doctrine,” where a debtor waives discharge by taking part in litigation after bankruptcy, Judge Faris explained that a creditor’s suit might not violate the injunction. In such circumstances, he said, a “creditor who relies on it without obtaining a prior bankruptcy court order is taking a risk.”
When the scope of discharge is unclear, Judge Faris said that creditors “are often well advised to seek the bankruptcy court’s guidance in order to avoid an inadvertent violation of the discharge injunction.” Otherwise, the creditor will be “in an impossible position.”
Judge Faris therefore held “that declining to clarify the scope of the discharge . . . was an abuse of discretion.” He reversed and remanded to the bankruptcy court with directions to enter judgment for the creditor because the debtor had conceded that the suit would not violate the discharge injunction.
The ABI Consumer Commission Report
The ABI Commission Report on Consumer Bankruptcy agrees with Judge Faris. The report said that a “party should not have to guess whether its interpretation of the necessarily broad language of section 524 will comport with the views of a bankruptcy judge who later will interpret that language.”
In the Report, the Commission also recommended that a creditor or a debtor be allowed to obtain a so-called comfort order about the applicability of the discharge injunction on an expedited basis “through motion practice rather than through an adversary proceeding for a declaratory judgment.”
Prof. Robert M. Lawless, the reporter for the Commission, said that the BAP case was “a perfect example where a declaratory judgment action wastes the parties’ time and money. The uncertainty around the scope of the discharge should not be leverage for litigation tactics.”
Commission member Rudy J. Cerone agreed, saying that “the creditor should not have been forced to incur the declaratory judgment litigation expense because the former debtor conceded that the relief sought in the state court litigation did not violate his discharge order.”
Mr. Cerone added that Taggart v. Lorenzen, 139 S. Ct. 1795 (June 3, 2019), “would have prevented a finding of contempt even if the acts technically violated the discharge injunction.”
Prof. Lawless is the Max L. Rowe Professor of Law and co-director of the Program on Law, Behavior & Social Science at the University of Illinois College of Law. Mr. Cerone is a partner with McGlinchey Stafford PLLC in New Orleans.
To read the ABI Commission Report, click here. The discussion of discharge violations appears at pages 15-18.
The Bankruptcy Appellate Panel for the Ninth Circuit held in substance that a bankruptcy court cannot decline to rule on a request for a comfort order and must tell a creditor whether its contemplated action will or will not violate the discharge injunction.
The facts and the procedural history were horribly complicated, with a chapter 7 discharge 10 years ago and convoluted post-discharge litigation between the debtor and a creditor. In state court, the creditor was alleging after discharge that the debtor was the alter ego for two of his companies that the chapter trustee had abandoned.
To make it simple, assume that the debtor believed that his discharge meant he could have no alter ego liability for debts owing by the two companies.
Threatened with contempt for a discharge violation, the creditor commenced an adversary proceeding in bankruptcy court seeking a declaration (i.e., comfort order) that the suit in state court did not violate the discharge injunction. After the debtor answered and failed to contest any of the factual allegations in the complaint, the creditor moved for judgment in its favor on the pleadings.
The bankruptcy court denied the motion for judgment on the pleadings and dismissed the creditor’s adversary proceeding without prejudice. The bankruptcy judge said he could not guess what relief the state court might ultimately grant. The bankruptcy judge believed he could not decide whether there had been a discharge violation until after the state court resolved the lawsuit.
The bankruptcy judge did not bar the creditor from proceeding in state court. However, the bankruptcy judge warned the creditor that it “would . . . be doing so at your own peril . . . if you don’t prevail across the board, you may be faced with a contempt proceeding.”