In one of his last decisions before retirement this week, Bankruptcy Judge Robert D. Drain of New York declined to follow dicta from recent court of appeals decisions in his circuit and ruled that the bankruptcy court can entertain a nationwide class action for violations of the discharge injunction.
In his 82-page opinion on June 3, Judge Drain also imposed terminating sanctions on a lender for what he called “repeated, lengthy, and willful discovery failures, including its submission of false affidavits and repeated misrepresentations to the Court . . . before it conceded the falsity of such affidavits and representations.”
The Class Action
An individual named Anderson received a chapter 7 discharge covering credit card debt. Despite the discharge, the credit card lender continued reporting the debt as charged off rather than discharged in bankruptcy. After discharge, the debtor reopened the chapter 7 case and filed a class action in Judge Drain’s bankruptcy court alleging that the failure to report the debt as discharged was an attempt at bringing pressure to repay the debt and thus violated the discharge injunction under Section 524 of the Bankruptcy Code.
The lender filed a motion to compel arbitration, relying on a provision in the credit card agreement. Judge Drain denied the motion to compel arbitration in May 2015, and the lender took an immediate appeal, permitted by the Federal Arbitration Act. The district court upheld denial of the motion to compel arbitration.
On the lender’s subsequent appeal to the Court of Appeals, the Second Circuit held that discharge is the “foundation” and the “central purpose” of bankruptcy. Therefore, the appeals court said that arbitrating a claimed violation of the discharge injunction would “seriously jeopardize” the proceeding because (1) the discharge injunction is integral to providing a fresh start, (2) the claim was made in “an ongoing bankruptcy matter,” and (3) the bankruptcy court’s equitable power to enforce its own injunctions is “central to the structure of the Code.”
Arbitration, the appeals court said, therefore presented “an inherent conflict with the Bankruptcy Code,” because “the bankruptcy court alone has the power to enforce the discharge injunction.” Without citation of authority, the circuit court said that the discharge injunction is “enforceable only by the bankruptcy court and only by a contempt citation.”
Having found an “inherent conflict,” the Second Circuit held that the bankruptcy judge did not abuse his discretion in ruling out arbitration. Anderson v. Credit One Bank, N.A. (In re Anderson), 884 F.3d 382 (2d Cir. March 7, 2018), cert. denied, 139 S. Ct. 144 (2018). To read ABI’s report, click here.
Technically speaking, the Second Circuit only upheld denial of arbitration. The appeals court did not decide whether Judge Drain was entitled to entertain a nationwide class action seeking damages for violation of the discharge injunction.
Second Circuit Rules Again on Arbitration and Discharge
Arbitration with regard to discharge came to the Second Circuit again in 2020 in Belton v. GE Capital Retail Bank (In re Belton), 961 F.3d 612, 615-17 (2d Cir. 2020), cert. denied, 141 S. Ct. 1513 (2021). In Belton, the Second Circuit rejected an appeal by lenders contending that Anderson was no longer good law after Epic Sys. Corp. v. Lewis, 138 S. Ct. 1612 (2018).
Like Anderson, Belton involved two lenders who had charged off the debtors’ credit card debt before bankruptcy. After discharges in chapter 7, the lenders continued to report the debts as charged off rather than discharged. Contending that failing to report the debts as discharged was an effort to coerce repayment, the debtors reopened their bankruptcy cases and mounted a purported nationwide class action seeking a contempt citation and damages for violating the discharge injunction.
The bankruptcy court denied the lenders’ motion to enforce an arbitration clause in the credit card agreements, and the district court affirmed. The Second Circuit in Belton upheld denial of the motion to compel arbitration. But there was more.
In deciding that the debtor was not compelled to arbitrate a discharge violation, the Second Circuit said, “we have not endeavored to address whether a nationwide class action is a permissible vehicle for adjudicating thousands of contempt proceedings, and neither our decision today nor Anderson should be read as a tacit endorsement of such.”
In a nationwide class action, the Second Circuit said that the bankruptcy court would be interpreting other judges’ discharge injunctions. The appeals court found “severe tension” with the idea in Anderson that the bankruptcy court would be denying arbitration to interpret its own order. The Second Circuit therefore said, “It seems to us that this rationale is anathema to a nationwide class action.”
The Second Circuit affirmed the district court but remanded for further proceedings consistent with the opinion, presumably meaning that the lower courts should nix the nationwide class action. To read ABI’s report on Belton, click here.
After Belton, we are left with Second Circuit dicta proscribing nationwide class actions in bankruptcy court.
Back to Anderson in Bankruptcy Court
While Anderson was winding its way through the Second Circuit, discovery before Judge Drain was not proceeding smoothly. The occasion for his June 3 opinion was a motion for sanctions brought by the class plaintiff against the lender.
Three questions remained for determination by Judge Drain: (1) Could the bankruptcy court entertain a nationwide class action; (2) did the lender violate the debtors’ discharges by reporting that the debts were “charged off,” not “discharged; and (3) if the lender was liable, what were the damages?
Judge Drain addressed all three in his June 3 opinion, beginning with the ability to conduct a nationwide class action. He recognized that the imposition of sanctions for violating an injunction are “generally” imposed by the court that entered the injunction.
Judge Drain observed that a discharge “in individual, consumer bankruptcy cases is a national form from which the bankruptcy courts may not deviate.” Moreover, he said, discharge is “supported by a statutory injunction under section 524(a)(2) of the Bankruptcy Code and the power conferred on the Court by section 105(a).” He differentiated the more expansive Section 105(a) from the All Writs Act applicable in district courts. The All Writs Act only grants power in aid of the courts’ “respective jurisdictions.”
In Bessette v. Avco Fin. Servs., 230 F.3d 439 (1st Cir. 2000), Judge Drain said that the First Circuit reversed an order barring a class action except in the court that issued the discharge. The Boston-based appeals court noted that discharge is a statutory injunction, not one crafted for an individual case.
Judge Drain declined to follow the dicta in Belton and concluded that the bankruptcy court could serve as the forum for a nationwide class suit.
Terminating Sanctions
Judge Drain turned to the question of sanctions under Bankruptcy Rule 7037 and Federal Rule 37(b), based on the lender’s alleged shortcomings in discovery. The plaintiff was seeking a default judgment sanction.
Judge Drain exhaustively surveyed the record and found that the lender had “consistently thwarted” discovery. At a discovery hearing, he said that one of the lender’s arguments was “just ridiculous.” On another occasion, he said it was “the stupidest argument I’ve heard in a long time.” If there were further violations of discovery obligation, he warned the lender several times that he would rule against them on the merits.
The hearing on the sanctions motion “was one of the most extraordinary that I have held during 20 years on the bench,” Judge Drain said. Among other things, he found that two affidavits claiming that the lender had produced all responsive documents were incorrect. On directing the filing of post-hearing briefs at the conclusion of the hearing, Judge Drain warned the lender that he was “now considering entering a default judgment on the Plaintiff’s Rule 37 motion.”
After considering the post-hearing briefs, Judge Drain found that the lender had violated three discovery orders despite “warnings of severe consequences to [the lender] if they were not complied with.” He held that a default judgment was “just” because:
[The lender] falsely stated to the Court nine different times . . . in counsel’s letters, counsel’s representations during hearings and
in pleadings, and twice in verifications under penalty of perjury by its Rule 30(b)(6) witness — that it had provided a complete
response to Plaintiff’s document requests. The falsity of these representations was neither minor nor a matter of excusable neglect;
indeed, [the lender] has not offered any excuse for its knowing failures.
Instead, counsel [for the lender] belatedly acknowledged that both he and [an officer of the lender] knew that [the officer’s] March 22, 2016 Amended Verification was false (meaning that her first, January 18, 2016 verification also was false), yet she signed and he filed it and kept its falsity from the Plaintiff and the Court for the next six months.
Judge Drain found that the lender was “equally in bad faith” by having an officer sign “two false verifications.” The officer, he said, “was unprepared and unresponsive” at her deposition probing the adequacy of the lender’s document production.
Judge Drain said he would “therefore apportion[] responsibility jointly and severally between client and counsel.” If the lender and counsel are unable to agree on apportionment, he cited a New York district judge for saying that “they may ask the Court to intercede.”
Turning to the question of what sanctions to impose, Judge Drain said that requiring the firm and the client only to pay the plaintiff’s attorneys’ fees in the discovery dispute “would insufficiently address [the lender’s] prolonged, willful, bad faith conduct and the prejudice . . . to the Plaintiff.” He said that the lender’s “systematic conduct was in bad faith and in full knowledge that it was violating [the plaintiff’s] discharge under the Bankruptcy Code.”
Judge Drain found that the lender had “engaged in prolonged, extraordinary, wrongful efforts to prevent the exploration of its defenses to the complaint’s allegations; it never articulated a valid basis for its continued refusal to correct its credit reports [and] lied not only about its discovery efforts but also misrepresented to the Court and obfuscated in discovery.”
Believing it “hard to see how [the lender] would ever defeat Plaintiff’s claim that its policy violated the discharge,” Judge Drain held that “a default judgment is warranted” in light of the lender’s “repeated, serial, systematic violation of discharges around the nation and the continuing violation of them, after notice, in [plaintiff’s] case and, if the class is certified, as to each other class member, as well, so as to discourage such violations in the future.”
In addition to judgment by default, Judge Drain awarded the plaintiff his costs and attorneys’ fees for enforcing his discharge. He directed the plaintiff’s counsel to file a fee application within 60 days.
The record was not sufficient for Judge Drain to fix the proper amount of per capita sanctions for each class member, except to say that it should be “mild.” He said that non-compensatory damages should range between $50 and $1,000 for each class member who does not opt out.
The Judgment and Class Certification
Judge Drain ended his opinion by listing the relief he was granting to the plaintiff in a judgment. Under Federal Rule 37(b), he held the lender in violation of the plaintiff’s discharge under Sections 524(a)(2) and 727(b). Under Section 105(a), he sanctioned the lender for the plaintiff’s reasonable legal fees and expenses, plus a “mild non-compensatory sum between $50 and $1,000,” to be determined after the court fixes the fees and expenses and determines the size of the class following the opportunity of class members to opt out.
Judge Drain certified and drew the contours of the class as being individuals whose credit reports after May 2007 showed debts as having been charged off rather than discharged, as long as the debts were unsecured and not reaffirmed. He created a subclass of those who repaid discharged debts. In addition to sanctions, the subclass members would be entitled to repayment if they could show that their payments were “proximately caused” by the erroneous credit reporting.
Members of the classes would be entitled to opt out, making the findings of liability and damages not binding on the lender.
In one of his last decisions before retirement this week, Bankruptcy Judge Robert D. Drain of New York declined to follow dicta from recent court of appeals decisions in his circuit and ruled that the bankruptcy court can entertain a nationwide class action for violations of the discharge injunction.
In his 82-page opinion on June 3, Judge Drain also imposed terminating sanctions on a lender for what he called “repeated, lengthy, and willful discovery failures, including its submission of false affidavits and repeated misrepresentations to the Court . . . before it conceded the falsity of such affidavits and representations.”