The U.S. Court of Appeals for the Fourth Circuit recently held that the "no fair ground of doubt" standard established by the Supreme Court of the United States in Taggart v. Lorenzen, 139 S. Ct. 1795 (2019), a case involving alleged violation of a Chapter 7 discharge order, governed civil contempt proceedings for violation of a confirmed reorganization plan under Chapter 11.
Under Taggart, "civil contempt should not be resorted to where there is a fair ground of doubt as to the wrongfulness of the defendant's conduct." The Taggart standard is objective, and "a party's subjective belief that she was complying with an order ordinarily will not insulate her from civil contempt if that belief was objectively unreasonable."
A copy of the opinion is available at: Link to Opinion
Two borrowers ("Debtors") filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code. The Bankruptcy Court confirmed a reorganization plan for Debtors' debts which included several properties that had significant mortgage balances.
Under the confirmation order, Debtors were able to maintain possession of one of the mortgaged properties ("Property"), while the creditor ("Creditor") retained a securing claim for the total outstanding mortgage balance. The confirmation order provided a date that the first payment was due, but did not provide a payment amount or provide for how the payment would be calculated. The order further provided that Debtors were entitled to "ten days written notice" before the creditor could "exercise its state court remedies with respect to the collateral" should Debtors default.
Several years later, Defendant ("Servicer") took over servicing of Debtors' account. Servicer believed the account to be past due because of the payments missed prior to the bankruptcy proceedings, and as a result sent Debtors letters and notices of default which showed increasing amounts owed and past due. Debtors attempt to correct the account without success.
Five years later, Servicer acknowledged that the prior servicer "did not adjust the loan in accordance with the Confirmed Chapter 11 Plan." However, two weeks later, Servicer began foreclosure proceedings on the Property.
Upon learning of the foreclosure proceedings, Debtors filed an emergency motion for contempt in the bankruptcy court, alleging Servicer violated the confirmation order by placing the account in default and seeking to foreclose on the Property despite Debtors having paid on time under the confirmed plan. Servicer argued that (1) its actions were justified under the confirmation order; and alternatively (2) the terms of the order were confusing and ambiguous, so it could not be held in contempt.
The bankruptcy court found Servicer in contempt and awarded sanctions, holding that "[a] finding of civil contempt is warranted when there is demonstration, by clear and convincing evidence, of" four factors set out in the Court's pre-Taggart decision Ashcraft v. Conoco, Inc., 218 F.3d 288, 301 (4th Cir. 2000).
Servicer appealed and the trial court reversed. The trial court concluded that the Taggart standard applied, and "the bankruptcy court's contempt order f[ell] far short of meeting" it as Servicer "ha[d] established a fair ground of doubt with regard to the unclear terms of the confirmation order."
Debtors appealed to the Fourth Circuit, arguing that Taggart did not apply to violations of Chapter 11 confirmation orders, and that regardless, the bankruptcy court correctly applied the Taggart standard.
The Fourth Circuit disagreed, holding that there was nothing in the Taggart analysis to suggest it was limited to the violation of Chapter 7 discharge orders nor to demonstrate that the ruling turned on considerations unique to the Chapter 7 context.
As you may recall, in Taggart, the Supreme Court of the United States addressed the standard for "hold[ing] a creditor in civil contempt for attempting to collect a debt that a discharge order" entered under Chapter 7 of the Bankruptcy Code "has immunized from collection." 139 S. Ct. 1795, 1799 (2019).
In deciding Taggart, the Supreme Court of the United States first discussed general provisions of the Bankruptcy Code which provide that a discharge order "operates as an injunction," 11 U.S.C. § 524(a)(2), and that a court may "issue any order, process or judgment that is necessary or appropriate to carry out the provisions of this title." § 105(a). See Taggart, 139 S. Ct. at 1801. The SCOTUS concluded that these general statutory provisions incorporate "traditional principles of equity practice" that have "long governed how courts enforce injunctions" including "the potent weapon of civil contempt." Id. (quotation marks omitted). Thus, the SCOTUS emphasized that "[t]he bankruptcy statutes ... do not grant courts unlimited authority to hold creditor in civil contempt." Id.
The Taggart court ruled that the standard for civil contempt "is generally an objective one" and that such orders are inappropriate "where there is a fair ground of doubt as to the wrongfulness of the defendant's conduct." Id. at 1801-02. The SCOTUS concluded that "[t]hese traditional civil contempt principles apply straightforwardly to the bankruptcy discharge context." Id. at 1802, 1804.
The Fourth Circuit held that the standard set forth in Taggart, a case involving alleged violation of a Chapter 7 discharge order, governed civil contempt proceedings under Chapter 11. The Court noted that a bankruptcy court's authority to enforce its own orders derived from the same statues and general principles relied on by the SCOTUS in Taggart.
In so ruling, the Fourth Circuit disagreed with Debtors' argument that the bankruptcy court had applied the Taggart standard in finding Servicer in contempt. The bankruptcy court's written order did not mention Taggart nor its no-fair-ground-of-doubt standard. Instead, the bankruptcy court's order stated "[a] finding of civil contempt is warranted when there is a demonstration…of" the four factors discussed in a case that predated Taggart and had nothing to do with bankruptcy. Thus, the Fourth Circuit could not conclude the bankruptcy court applied the correct legal standard.
The Appellate Court also disagreed with Servicer's assertion that the trial court did not commit error in overturning the bankruptcy court's order. First, the Fourth Circuit found that the trial court erred in appearing to grant controlling weight to Servicer's request for and reliance on legal advice from outside counsel, as the Fourth Circuit has long held that the advice of counsel "is not a defense" to "civil contempt." In re Walters, 868 F.2d 665, 668 (4th Cir. 1989).
The Appellate Court noted this was further confirmed in Taggart where the Supreme Court explained that "[t]he absence of willfulness does not relieve from civil contempt." 139 S. Ct. at 1802. Under Taggart, "a party's subjective belief that she was complying with an order ordinarily will not insulate her from civil contempt if that belief was objectively unreasonable," but evidence of reliance upon advice of counsel can be considered in making the determination of whether the party's conduct was objectively unreasonable.
The Fourth Circuit ruled that the correct remedy was for the bankruptcy court to reconsider the contempt motion under the correct legal standard, inclusive of any additional factfinding necessary. The Appellate Court emphasized that any sanction imposed by the lower court must be supported, in type and amount, by a sufficient evidentiary record.
In sum, the Fourth Circuit held that when a court is considering whether or not to hold a creditor in civil contempt for violating a Chapter 11 plan for reorganization of debts, Taggart also applies.
Thus, the Fourth Circuit vacated the order of the trial court, and remanded the case with instructions to vacate the bankruptcy court's order and for further proceedings consistent with the Appellate Court's opinion.
Ralph T. Wutscher
Maurice Wutscher LLP
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