Taggart Means No Strict Liability for Violating a Corporate Debtor’s Automatic Stay

In a case with highly complex facts, Bankruptcy Judge Guy R. Humphrey of Dayton, Ohio, dealt with a creditor who took an “ill-advised” action in violation of the automatic stay in a corporate debtor’s chapter 11 case.

Judge Humphrey decided in his November 22 opinion that he was obliged to apply Taggart in deciding whether the creditor could be held in contempt. In the absence of persuasive authority, the creditor was off the hook for contempt given the “fair ground of doubt” about the creditor’s stay violation. Judge Humphrey nonetheless found a remedy that was still available. Whether the remedy has any value is debatable.

So it is today in bankruptcy after Taggart. Creditors face no contempt sanctions if they can argue with a straight face that their actions didn’t violate the automatic stay. Whether they knew it or not, the justices of the Supreme Court have taken away some of the efficacy of the automatic stay under Section 362(a), now that lower courts are ruling that Taggart applies to all contempt sanctions in bankruptcy, not just violations of the discharge injunction.

Stay Violation Buried in Complex Facts

The facts were maddeningly complex but amounted to this: A company sold its assets to a buyer in return for cash and some preferred stock in the buyer. The purchase agreement called for adjustments of the purchase price after closing based on cash flow and the level of working capital.

If the working capital and cash flow proved too low, the seller would lose some or all of the preferred stock.

Four months after the seller’s chapter 11 filing, the buyer sent a notice to the seller claiming there was a working capital deficiency and demanding payment of the deficiency. Evidently, the preferred stock would be the largest asset in the seller’s bankruptcy. However, the letter was more than a year late under the asset purchase agreement.

According to Judge Humphrey, the buyer did not know that the seller was in bankruptcy when the first letter went out. In response to the letter, counsel for the debtor told the buyer about the bankruptcy and the automatic stay.

A few months later, the seller sent a second letter to the debtor, this time claiming a cash flow deficiency and declaring that the seller lost the preferred stock as a consequence. Now aware of the bankruptcy, the letter said that the buyer was not demanding payment.

Also after bankruptcy, the buyer sued the seller’s principals in state court. The debtor was not named as a defendant. If it went to judgment, Judge Humphrey said that the outcome as a practical matter would determine whether the debtor had indeed lost the preferred stock, even though the debtor was not a party in the suit.

By now, the case had converted to chapter 7. The trustee sued the buyer in bankruptcy court, claiming violations of the automatic stay and seeking contempt sanctions.

Assuming there were violations of the automatic stay, Judge Humphrey was first tasked with deciding whether Taggart limits the ability of corporate debtors to win sanctions for contempt.

Taggart Applies to Corporate Debtors

In Taggart v. Lorenzen, 139 S. Ct. 1795 (2019), the Supreme Court held 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.

Before Taggart, Judge Humphrey said that lower courts in the Sixth Circuit applied a standard akin to strict liability where a creditor could be held in contempt even if the creditor subjectively believed that the action was not a stay violation. He said that the Sixth Circuit itself had approved the strict liability standard “at least implicitly.”

Judge Humphrey acknowledged that Taggart did not address the contempt standard for corporate debtors and noted “that different policy imperatives exist in addressing a violation of the automatic stay rather than a discharge violation.”

Congress has not given corporate debtors a private right of action similar to the relief afforded to individual debtors in Section 362(k), Judge Humphrey said. In other words, corporate debtors cannot assert a strict liability standard “because it is inconsistent with the conclusion in Taggart that damages for contempt under § 105, and the private right of action supporting damages under § 362(k)[,] have different standards.”

Although he cited courts’ rulings to the contrary, Judge Humphrey applied “the Taggart standard in determining whether any stay violations committed by [the buyer] entitle [the debtor] to damages under a civil contempt theory.”

Clear Authority Required for Contempt after Taggart

Next, Judge Humphrey applied Taggart to the three asserted stay violations, beginning with the first letter demanding payment to cure the working capital deficiency.

The first letter violated the stay by demanding payment. Given the debtor’s ignorance of the bankruptcy, Judge Humphrey held that contempt was not available and no damages could be awarded.

The second letter was no stay violation, but for a different reason. The letter did not demand payment, but notified the debtor about the loss of preferred stock in view of the cash flow deficiency.

The second letter was no stay violation, Judge Humphrey said, because it was a “classic recoupment” to which the automatic stay does not apply. The buyer was offsetting mutual debts and credits arising from the same transaction.

The state court suit against the two principals did violate Section 362(a)(3), even though the debtor was not a defendant. Why? Because, as Judge Humphrey said, “the ultimate resolution of [the state court suit would decide] whether the potentially most significant estate asset, the [preferred stock], is of any value.”

Judge Humphrey explained that the suit in state court at least had the potential for interfering with the debtor’s contractual rights in the preferred stock. The buyer should have sought a modification of the automatic stay, he said.

Even so, Judge Humphrey held that the state court suit was not contemptuous under Taggart.

There was no “persuasive authority,” and the legal issues were “less clear.” Consequently, there was a “fair ground of doubt” and no basis for a contempt finding under Taggart. Although the buyer’s actions were “ill-advised,” the buyer had “an objectively reasonable basis” for believing the suit in state court was not a stay violation, Judge Humphrey said.

While contempt was off the table, Judge Humphrey cited the Sixth Circuit for the proposition that an action in violation of the stay is “invalid and voidable.” He therefore held that the buyer’s actions “in violation of the stay are invalid and void.”