The Ninth Circuit Bankruptcy Appellate Panel explored what it called “the fringes of the bankruptcy discharge injunction” and the meaning of “personal liability of the debtor” in Section 524(a).
The BAP decision by Bankruptcy Judge Christopher M. Klein employed the standard adopted by the Supreme Court in U.S. Bank NA v. The Village at Lakeridge LLC, 138 S. Ct. 960 (2018), to determine the scope of appellate review.
The February 22 decision also deals with the ability of bankruptcy courts to review decisions by state probate courts. Judge Klein, of Sacramento, Calif., was sitting on the BAP by designation. Beginning in 1998, Judge Klein served 10 years on the BAP.
The Trust
A mother created a revocable family trust in 1980 to distribute her estate on her death in equal shares to her three children. The trust permitted the mother to designate lifetime transfers for deduction from the beneficiary’s share of the final estate.
In 2004, the daughter borrowed $75,000 from her mother, evidenced by a note. The daughter received a discharge in 2009 in her no-asset chapter 7 case.
In writing in 2012, the mother designated the $75,000 as a lifetime transfer to be deducted from the daughter’s share of the estate. The mother died in 2017.
The daughter objected to the trust trustee’s final report to the state probate court. She contended that the $75,000 had been discharged in her bankruptcy and should not be deducted from her equal share of the trust. The probate court overruled the objection, ruling that the mother had intended for the $75,000 lifetime transfer to be treated as an advance on the daughter’s share of the trust.
Having lost in probate court, the daughter reopened her 2009 bankruptcy, claimed that the $75,000 had been discharged, and sought to hold the trust’s trustee in contempt. The bankruptcy judge said there was no “debt” to be discharged and denied the motion for contempt. The daughter appealed.
The Probate Exception
The proceedings in the probate court prompted Judge Klein “to revisit our jurisdiction regarding the Probate Court activity in light of the so-called ‘probate exception’ to federal jurisdiction.”
Judge Klein said it was “plausible” that the decision in probate court could be void under Section 524(a)(1) if a collection of debt was involved. Likewise, it was “plausible” that actions in the probate court could violate the discharge injunction in Section 524(a)(2).
“To be sure,” Judge Klein said, “the power to enforce the discharge injunction does entitle bankruptcy courts to determine whether judgments rendered by nonbankruptcy courts operate to determine the personal liability of a debtor with respect to a discharged debt or entail the collection, recovery, or offset of a discharged debt as a personal liability of the debtor.”
Ninth Circuit authority led Judge Klein to say that “if the state court construes the discharge incorrectly, then its judgment may be void to the extent it offends the discharge and is subject to collateral attack in federal court.”
“It follows that the probate exception does not necessarily constrain bankruptcy court jurisdiction to police subterfuges and enforce the bankruptcy discharge so long as there is no exercise of in rem jurisdiction over the res of the family trust or invasion of the legitimate province of state appellate courts,” Judge Klein held.
De Novo or Clear Error?
The bankruptcy court had found that no debt was being collected, thus giving rise to no violation of the discharge injunction.
On appeal, Judge Klein was required to identify the proper scope of review: Was it “clear error” or “de novo”?
When a case involves mixed questions of law and fact, the Supreme Court said in Lakeridge that it “all depends” on whether the work of the appellate court is “primarily legal or factual.” Id., 138 S. Ct. at 967. To read ABI’s report on Lakeridge, click here.
Because “questions of law predominate,” Judge Klein decided that “review is de novo.”
Was There a ‘Debt’ Being Collected?
Reviewing the decision by the bankruptcy court de novo as an issue of law, Judge Klein addressed “the scope of the protection afforded by the bankruptcy discharge.”
Under Sections 524(a)(1) and (a)(2), the discharge injunction prohibits an effort at collecting a “personal liability of the debtor.” Judge Klein went on to say that “[a]nything that does not qualify as a ‘claim’ for purposes of § 101(5) probably is not a ‘debt’ for purposes of the § 524(a)(2) injunction.”
Judge Klein therefore framed the question as whether the trustee of the trust “was collecting, recovering, or offsetting a discharged ‘debt.’”
To answer the question, Judge Klein referred to California probate law to conclude that the mother “was entitled as a matter of law to direct the disposition of her assets at death in any manner she chose.” Treating the $75,000 lifetime gift as an advance, he said, “does not amount to collecting a debt ‘as a personal liability’ of the debtor within the meaning of § 524(a)(2).”
Judge Klein described the implications were he to rule for the daughter. He said it “would amount to ruling that the discharge of a debt in bankruptcy forever bars a testator or settlor of a trust from adjusting a legacy or distribution.” It would also “stretch the concept of ‘personal liability of the debtor’ beyond reasonable bounds and stray into the realm of testamentary dispositions.”
Just as the mother could have disinherited the daughter entirely, Judge Klein said there was “nothing to prevent [the mother] from requiring that $75,000 in lifetime transfers be considered advances on an inheritance.”
Judge Klein therefore upheld the bankruptcy court’s decision that the trustee’s actions in the probate court did not amount to collecting a debt.
Was There Contempt?
Having decided there was no debt being collected, the bankruptcy court had denied the daughter’s motion for contempt.
The ruling on contempt of the discharge injunction implicated the standard enunciated by the Supreme Court in Taggart v. Lorenzen, 139 S. Ct. 1795 (2019). The Supreme Court held in Taggart that there can be no sanctions for civil contempt of the discharge injunction if there was an “objectively reasonable basis for concluding that the creditor’s conduct might be lawful under the discharge order.” Id. at 1801. To read ABI’s discussion of Taggart, click here.
As a matter of law, Judge Klein said, the discharge injunction was not violated. The trustee of the trust therefore had an “objectively reasonable basis” for believing that conduct in the probate court did not violate the discharge injunction.
Judge Klein therefore upheld denial of the contempt motion.
Observation
Appellate courts sometimes fail to apply the standard from Lakeridge when reviewing decisions by bankruptcy courts involving mixed questions of law and fact. Applying the proper standard could alter the outcome on appeal.
For example, imagine an appeal from a finding of “undue hardship” for the discharge of student loans under Section 523(a)(8). In this writer’s view, the facts would usually predominate on appeal amid mixed questions of law and fact. Applying “clear error” review would ordinarily preclude an appellate court from imposing its own judgment, regardless of whether the ruling in bankruptcy court went in favor of the debtor or the lender.
The Ninth Circuit Bankruptcy Appellate Panel explored what it called “the fringes of the bankruptcy discharge injunction” and the meaning of “personal liability of the debtor” in Section 524(a).
The BAP decision by Bankruptcy Judge Christopher M. Klein employed the standard adopted by the Supreme Court in U.S. Bank NA v. The Village at Lakeridge LLC, 138 S. Ct. 960 (2018), to determine the scope of appellate review.
The February 22 decision also deals with the ability of bankruptcy courts to review decisions by state probate courts. Judge Klein, of Sacramento, Calif., was sitting on the BAP by designation. Beginning in 1998, Judge Klein served 10 years on the BAP.