The Ninth Circuit Bankruptcy Appellate Panel wrote a decision teeing up a case where the Ninth Circuit can decide whether a claim for intentional infliction of emotional distress from a violation of the discharge injunction survived the Supreme Court’s Taggart decision.

The December 20 BAP opinion by Bankruptcy Judge Scott H. Gan also closed the door to loopholes that a secured creditor might use to avoid liability under Section 524(i) for failure to credit payments under a chapter 13 plan.

The Cure Required by the Plan

A couple confirmed a plan one month after filing a chapter 13 petition in 2014. When the secured creditor did not file a claim, the debtors filed a claim asserting that the arrears on their home mortgage were about $19,000. The lender never filed an amended claim.

The plan called for curing the $19,000 in arrears during the life of the chapter 11 plan and paying the mortgage currently.

At the end of the 60-month plan, the debtor had paid some $166,000, more than the $165,500 called for under the plan.

The chapter 13 trustee filed a notice of final cure payment. The lender responded with a statement saying that the debtors had paid the arrears in full and that the debtors were current on postpetition payments.

The trustee filed a final report, and the debtors received their discharges.

After discharge, the lender began rejecting the debtor’s monthly mortgage payments and claimed that the mortgage was delinquent by more than $10,000. The debtors filed an adversary proceeding in bankruptcy court. The procedural machinations were complex, but here’s essentially what happened.

The debtors’ complaint alleged that the lender had violated the discharge injunction under Section 524(a)(2) by failing to credit the mortgage payments they made after discharge. The complaint sought damages for intentional infliction of emotional distress.

The lender responded with a motion to dismiss, which the bankruptcy court granted. Valdellon v. Wells Fargo Bank N.A. (In re Valdellon), 659 B.R. 377 (Bankr. E.D. Cal. April 30, 2024). To read ABI’s report, click here.

The bankruptcy court reasoned that the failure to credit post-discharge payments could not be in violation of Section 524(i), which deals with payments under a plan. The bankruptcy court also believed that Taggart v. Lorenzen, 139 S. Ct. 1795 (2019), obviated the possibility of having emotional distress damages for a discharge violation. To read ABI’s report on Taggart, click here.

In discovery during the adversary proceeding, it came out that the lender was claiming the actual arrears were more than the $19,000 to be cured under the confirmed plan.

Section 524(i)

The debtors’ appeal required the BAP to interpret Section 524(i), which provides,

The willful failure of a creditor to credit payments received under a plan confirmed under this title . . . shall constitute a violation of an injunction under subsection (a)(2) if the act of the creditor to collect and failure to credit payments in the manner required by the plan caused material injury to the debtor.

Bankruptcy Rule 3002.1(f) and (g) were adopted to create a procedure where, as occurred in this case, the lender agreed with the trustee’s determination that defaults had been cured.

In his opinion for the BAP, Judge Gan said that “the court may grant relief through a civil contempt order” because “§ 524(i) makes a willful failure to credit payments under a plan a violation of the discharge injunction.” He analyzed the extent to which Taggart changed the rules for contempt of the discharge injunction.

Other than declaring there must be no fair ground of doubt about the wrongfulness of the creditor’s actions, Judge Gan quoted the Ninth Circuit for saying that Taggart “‘did not otherwise alter a movant’s threshold burden of going forward.’ Mellem v. Mellem (In re Mellem), 625 B.R. 172, 178 (9th Cir. 2021).”

To state a claim for contempt under Section 524(i), Judge Gan said that the debtor must alleged a willful failure to credit payments received under the plan and show material injury. To determine whether the debtor’s complaint alleged a plausible claim, he said, “it is not necessary for Debtors to specify exactly how [the lender] failed to credit the payments, when the allegations are that [the lender] failed to give the arrearage payments their curative effect.”

The lender, Judge Gan said, “must apply the payments to the debt in the manner directed by the plan.” Requiring the debtor to show how the lender misapplied payments “would obviate the statute’s purpose in cases where the creditor refuses reinstate a loan and effectuate a cure of prepetition arrears.”

In the complaint, the debtors had asserted that they made all payments required by the plan and had made post-discharge payments until the lender stopped accepting their payments. “These allegations,” Judge Gan said, “are plausibly suggestive of a violation of § 524(i),” because the lender “is bound by the terms of the confirmed plan” that fixed the cure at $19,000.

Furthermore, Judge Gan said, the entry of the discharge order “necessarily determined that Debtors made all payments under the plan.” He therefore held that the “Debtors are not precluded from seeking relief under § 524(i).”

Did Taggart End Emotional Distress Damages?

Having held that the debtors were entitled to assert a discharge violation arising from Section 524(i), Judge Gan turned to the question of whether the court could award damages for emotional distress.

Citing the BAP’s decision in Ocwen Loan Servicing, LLC v. Marino (In re Marino), 577 B.R. 772, 788-88 (B.A.P. 9th Cir. 2017), aff’d in part & appeal dismissed in part, 949 F.3d 483 (9th Cir. 2020), Judge Gan said, “We have previously held that bankruptcy courts can award compensatory damages for emotional distress caused by willful violations of the discharge injunction.”

Judge Gan said that the bankruptcy court had rejected the BAP’s analysis in Marino by relying on the “old soil” statement by the Supreme Court in Taggart. “We do not read Taggart so broadly,” Judge Gan said.

Taggart, Judge Gan said, “did not address the range of permissible compensatory damages available under civil contempt, nor did it hold that courts should not look to § 362(k) by analogy in deciding compensatory damages for civil contempt.” He was “not persuaded that Taggart compels us to depart from our precedent in Marino.”

Citing the Supreme Court precedent, Judge Gan said that the “measure of compensation for civil sanctions is not limited to pecuniary losses.” He went on to say, “We expect that violations of the discharge injunction often will involve nonpecuniary damages,” because one of the benefits of a discharge is “peace of mind.”

Judge Gan set aside dismissal of the adversary proceeding and remanded for further proceedings.