After a chapter 7 discharge, suing on an unsecured loan agreement that had been dressed up to look like a sale of the debtor’s homestead didn’t let the lender off the hook under Taggart. In a nonprecedential opinion, the Fifth Circuit upheld the bankruptcy court’s decision holding the lender in willful contempt of the discharge injunction and granting the debtor an award of damages and attorneys’ fees.

The opinion is significant because the Fifth Circuit undertook a thorough legal analysis of a complex document to decide that the loan was unsecured, not secured. The opinion could be understood to mean that advancing a plausible (but incorrect) legal argument does not avoid contempt liability by giving rise to a “fair ground of doubt” under Taggart.

The Disguised Loans

Although the language in the documents was complex, a series of three loan agreements boiled down to this: In return for borrowing money, the debtor “sold” his homestead to the lender. At the end of the term of the loan, the debtor could repurchase the home by paying back the loan with interest. Meanwhile, the debtor could remain living in the home.

Only the first of three agreements was filed in the county land records. The three checks from the lender all had notations about a “loan.”

When the debtor did not repay the loan, the lender sued in state court, aiming to obtain title to the property. The debtor filed a chapter 7 petition, listing the home as his exempt homestead. The debtor listed the lender as an unsecured creditor.

Through the lender’s attorney, the lender received notice of the debtor’s discharge. Despite the notice of discharge, the lender returned to state court with a motion seeking a declaration that the lender owned the home. Although the debtor told the creditor that the suit was barred by the discharge order, the lender proceeded to obtain a default judgment stating that the lender owned the home. The lender changed the locks on the home.

The debtor then filed an adversary proceeding in bankruptcy court alleging that the lender committed a willful violation of the discharge injunction.

The bankruptcy judge found the three agreements to be loans, not sales of the home. The bankruptcy court also ruled that the lender had no perfected lien and that the loans were unsecured claims. Finding a willful violation of the discharge injunction, the bankruptcy court awarded the debtor title to the property along with actual damages and attorneys’ fees.

On appeal, the district court affirmed, prompting the lender’s appeal to the Fifth Circuit.

No ‘Fair Ground of Doubt’ that the Lender Was Unsecured

The lender was evidently aware of Taggart, because the Fifth Circuit’s per curiam opinion on January 28 characterized the lender as arguing that the “discharge order did not contain clear and specific language prohibiting the [lender] from seeking a declaratory judgment in [state court] that [the lender] had title to the property in question.” See Taggart v. Lorenzen, 139 S. Ct. 1795 (2019). To read ABI’s report, click here.

More particularly, the appeals court described the lender as claiming to have “an objectively reasonable basis for believing they owned the property, such that their conduct did not support a contempt holding.”

To hold someone in contempt for violating the bankruptcy discharge, the Fifth Circuit quoted Taggart for saying “there must be no objectively reasonable basis for concluding that the creditor’s conduct might be lawful under the discharge order” and that there may be no “‘fair ground of doubt’ as to whether the creditor’s conduct might be lawful under the discharge order.” Id. at 560, 565.

After quoting some of the language in the standard form discharge notice, the appeals court concluded that “the discharge order plainly” precluded the lender from trying to collect an unsecured loan. If it were a lien, the circuit said the lender might have had a right to foreclose.

The appeals court therefore described the question as being “whether the [lender] had an objectively reasonable basis to believe that the discharge order did not bar [the lender’s] conduct.”

Examining the record, the appeals court identified probative evidence to support the bankruptcy court’s finding that the lender was willfully pursuing collection of an unsecured, discharged debt. The circuit court then ruled as follows:

The [lender] thus had no objectively reasonable basis to believe [its] conduct was lawful under the discharge order, and the bankruptcy court was within its bounds to hold [the lender] in contempt and order the relief it did.

There was more. The Fifth Circuit held that the purchase and sale agreement was void under Texas law and the Texas Constitution. From the legal conclusion, the appeals court went on to say that the lender’s belief that it was buying the debtor’s property “was not objectively reasonable because the agreements manifestly did not comply with either the Texas Constitution or Texas property law.”

Finding that the bankruptcy court’s findings were “well supported by the record,” the Fifth Circuit affirmed, holding that the lender had made unsecured personal loans and “thereafter willfully violated the discharge order in attempting to collect that debt without a reasonable basis to believe they could properly do so.”