Post-Taggart, Ninth Circuit BAP Holds That "No Fair Ground of Doubt" Standard Applies to Automatic Stay Violations

In Taggart v. Lorenzen, 139 S. Ct. 1795 (June 3, 2019), the U.S. Supreme Court ruled that a bankruptcy court may hold a creditor in civil contempt for attempting to collect on a debt that has been discharged in bankruptcy "if there is no fair ground of doubt as to whether the [discharge] order barred the creditor's conduct." However, the ruling did not address whether the same standard should apply to violations of the automatic stay. A Ninth Circuit Bankruptcy Appellate Panel crossed that bridge in Suh v. Anderson (In re Jeong), 2020 WL 1277575 (B.A.P. 9th Cir. Mar. 16, 2020). In a nonprecedential opinion, the three-judge panel applied the Taggart standard in upholding a bankruptcy court order granting a chapter 7 trustee's request for contempt sanctions for a willful violation of the stay.

Scope of the Automatic Stay With Respect to Lien Perfection

Section 362(a) of the Bankruptcy Code provides that, with certain exceptions, the filing of a bankruptcy petition operates as a stay of most creditor collection activities with respect to the debtor or its property, including (as set forth in subsection (a)(4)) "any act to create, perfect, or enforce any lien against property of the estate." One of the exceptions is set forth in section 362(b)(3), which provides that the automatic stay does not apply to:

any act to perfect, or to maintain or continue the perfection of, an interest in property to the extent that the trustee's rights and powers are subject to such perfection under section 546(b) of this title or to the extent that such act is accomplished within the period provided under section 547(e)(2)(A) of this title.

Sections 546(b) and 547(e)(2)(B) of the Bankruptcy Code address the grace periods granted to creditors under applicable nonbankruptcy law to perfect liens or security interests. See, e.g., U.C.C. § 9-317 (providing that a creditor that files a financing statement with respect to a purchase-money security interest within 20 days after the debtor receives delivery of the collateral has priority over the rights of any intervening lien creditor).

Under section 546(b)(1), a bankruptcy trustee's "strong-arm" powers as a lien creditor or hypothetical bona fide purchaser as of the petition date are subject to:

any generally applicable law that—

(A) permits perfection of an interest in property to be effective against an entity that acquires rights in such property before the date of perfection; or

(B) provides for the maintenance or continuation of perfection of an interest in property to be effective against an entity that acquires rights in such property before the date on which action is taken to effect such maintenance or continuation.

Section 547(e)(2)(A) provides that, for the purposes of avoiding a preferential transfer, with certain exceptions, a transfer is made "at the time such transfer takes effect between the transferor and the transferee, if such transfer is perfected at, or within 30 days after, such time."

Taken together, sections 362(b)(3), 546(b)(1), and 547(e)(2)(A) permit a creditor to perfect, or maintain or continue perfection of, its lien or security interest after a bankruptcy filing without violating the automatic stay or risking preference liability, provided the creditor takes these actions within any time period prescribed by applicable nonbankruptcy law. See Collier on Bankruptcy ("Collier") ¶ 362.05[4] (16th ed. 2020).

Remedies for Violation of the Automatic Stay

Actions taken in violation of the stay are generally void. See Collier at ¶ 362.12[1] (noting that although a minority of courts find that actions violating the stay are merely voidable, the majority rule is that such actions are void ab initio). Section 362(k)(1) of the Bankruptcy Code grants a cause of action for willful stay violations, providing that "an individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys' fees, and, in appropriate circumstances, may recover punitive damages."

However, section 342(g)(2) of the Bankruptcy Code provides that a "monetary penalty" may not be imposed on a creditor under section 362(k) for violation of the stay unless the conduct that is the basis for the violation occurs after the creditor has received notice of the filing of the bankruptcy case.

Because section 362(k)(1) refers to an "individual," rather than the "trustee" or the "debtor," the provision has generated a fair amount of controversy concerning whether it can be invoked only by a "natural person," as distinguished from a business debtor, a trustee, a creditor, or another stakeholder. See Collier at ¶ 362.12[3] (citing and discussing cases and noting that "[t]here is little reason to adopt a tortured reading of the statute in order to provide corporate or partnership debtors or trustees with a remedy for stay violations"). For example, some courts have ruled that a bankruptcy trustee is not "an individual" under section 362(k). See, e.g., Havelock v. Taxel (In re Pace), 67 F.3d 187, 193 (9th Cir. 1995); In re Fiddler Gonzalez & Rodriguez, P.S.C., 415 F. Supp. 3d 297, 301–02 (D.P.R. 2019); In re Morgenstern, 542 B.R. 650, 658–59 (Bankr. D.N.H. 2015). However, the unavailability of relief under section 362(k) does not preclude a trustee from seeking the imposition of sanctions as an exercise of the bankruptcy court's civil contempt powers under section 105(a), which provides that the court may "issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title." Spookyworld, Inc. v. Town of Berlin (In re Spookyworld), 346 F.3d 1, 8 (1st Cir. 2003); Pace, 67 F.3d at 193; Fiddler Gonzalez, 415 F. Supp. 3d at 302; In re O'Malley, 601 B.R. 629, 660 (Bankr. N.D. Ill. 2019).

Taggart

In Taggart, the Supreme Court ruled that a bankruptcy court may hold a creditor in civil contempt for attempting to collect on a debt that has been discharged in bankruptcy "if there is no fair ground of doubt as to whether the [discharge] order barred the creditor's conduct." In so ruling, the Court vacated and remanded a ruling by the U.S. Court of Appeals for the Ninth Circuit rejecting a "strict liability" standard and applying a subjective standard under which a creditor may not be held in civil contempt if it has a "good faith belief" that the discharge order does not bar collection, even if that belief is unreasonable.

Section 727(b) of the Bankruptcy Code states that "[e]xcept as provided in section 523 [excepting certain debts from discharge] . . . , a discharge under . . . this section discharges the debtor from all debts that arose before the date of the order for relief under this chapter." Section 524(a)(2) of the Bankruptcy Code provides that a discharge order "operates as an injunction" barring creditors from collecting any debt that has been discharged.

Writing for a unanimous Court in Taggart, Justice Breyer explained that the Court's determination was informed by sections 524(a)(2) and 105(a). According to Justice Breyer, "[T]hese provisions authorize a court to impose civil contempt sanctions when there is no objectively reasonable basis for concluding that the creditor's conduct might be lawful under the discharge order."

Sections 524(a)(2) and 105(a), Justice Breyer noted, bring with them "the old soil" of historical equity jurisprudence, which traditionally empowered courts to impose civil contempt sanctions to coerce compliance with an injunction or to compensate a complainant for noncompliance. Because an objective standard has generally been applied to this issue in nonbankruptcy cases, Justice Breyer reasoned that the same "fair ground of doubt" standard should apply in the bankruptcy context. "[C]ivil contempt therefore may be appropriate," he wrote, "when the creditor violates a discharge order based on an objectively unreasonable understanding of the discharge order or the statutes that govern its scope."

Justice Breyer faulted the Ninth Circuit's standard as being inconsistent with traditional civil contempt principles and unfair to "debtors [forced] back into litigation (with its accompanying costs) to protect the discharge that it was the very purpose of the bankruptcy proceeding to provide." He was equally critical of the strict liability standard imposed by the bankruptcy court, noting that such a standard might provoke a flood of costly litigation by risk-averse creditors seeking an advance determination as to the scope of a discharge order.

Finally, Justice Breyer rejected the debtor's argument that a strict liability standard is appropriate because many courts have applied such a standard in remedying violations of the automatic stay. According to Justice Breyer, the specific language regarding sanctions for a stay violation in section 362(k)(1) differs from the more general language of section 105(a). Moreover, he wrote, "The purposes of automatic stays and discharge orders also differ: A stay aims to prevent damaging disruptions to the administration of a bankruptcy case in the short run, whereas a discharge is entered at the end of the case and seeks to bind creditors over a much longer period."

In Jeong, a Ninth Circuit Bankruptcy Appellate Panel considered whether the Taggart standard should apply to automatic stay violations.

Jeong

Moo and Myoungja Jeong (together, the "debtors") hired Min W. Suh ("Suh") as their attorney for the purpose of filing a joint chapter 7 case in the Central District of California in January 2019. At the time of the filing, the debtors owned a residence encumbered by three deeds of trust: a first-priority deed of trust in favor of an institutional lender; a second-priority deed of trust in favor of Young Soo Oh ("Oh"); and a third-priority deed of trust in favor of Christopher Kwon ("Kwon").

Because the legal descriptions appended to the deeds of trust in favor of Oh and Kwon did not accurately describe the property, the chapter 7 trustee demanded that Oh and Kwon consent to the avoidance and preservation of the liens for the benefit of the estate. However, claiming that he represented Oh and Kwon as well as the debtors, Suh prepared and recorded "corrective" deeds of trust on June 27, 2019, that remedied the defective property descriptions.

The trustee, claiming that postpetition recordation of the deeds violated the automatic stay, filed a motion to impose sanctions on the debtors, Suh, Oh, and Kwon. Suh argued that the actions were permitted under section 362(b)(3), which he claimed permits any and all steps necessary to perfect a security interest against property of the estate without limitation. According to Suh, recordation of the new deeds did not violate the stay because they merely corrected a minor mistake and related back to the pre-bankruptcy date of the original instruments. Finally, because the debtors hired new lawyers after he recorded the corrective instruments, Suh argued that he was not in contempt because he could not have remedied any alleged stay violation.

Before the bankruptcy court convened a final hearing on the contempt motion, the debtors, Oh, and Kwon settled with the trustee by paying $6,000 of the trustee's $10,000 in attorneys' fees and costs and by reconveying the deeds of trust.

The bankruptcy court concluded that Suh's actions amounted to a "clear-cut violation" of the automatic stay. The court accordingly entered an order holding Suh in contempt and imposing compensatory contempt sanctions against him in the amount of $4,000, representing the unpaid amount of the trustee's attorneys' fees and costs. In so ruling, the court found that when Suh recorded the new deeds of trust, he was aware of the automatic stay, he willfully violated the stay, and he "raised no fair ground of doubt that he should not be held in civil contempt." Suh appealed to a Ninth Circuit Bankruptcy Appellate Panel.

The Bankruptcy Appellate Panel's Ruling

A three-judge bankruptcy appellate panel affirmed the award of sanctions.

Citing Taggart, the court concluded that the bankruptcy court did not violate its discretion by finding Suh in contempt and relied on the appropriate standard in doing so. Addressing the standard for contempt in connection with an automatic stay violation, the panel noted that:

We assume that the contempt standard applied to the discharge violation in Taggart also applies to a violation of the automatic stay. Neither the parties, nor the bankruptcy court, has suggested that any other standard should apply. Furthermore, application of the same contempt standard for stay violations and bankruptcy discharge violations is consistent with the Ninth Circuit's prior precedent holding that the same contempt standards apply to both violations of the automatic stay and violations of the discharge injunction. See Zilog, Inc. v. Corning (In re Zilog, Inc.), 450 F.3d 996, 1008 n.12 (9th Cir. 2006), partially overruled on other grounds by Taggart, 139 S. Ct. at 1802.

The appellate panel rejected Suh's argument that recording the corrective deeds did not violate the automatic stay because, pursuant to sections 362(b)(3) and 546(b), recordation of the deeds related back to the time the original deeds were recorded prepetition. "[N]othing under California law," the court wrote, "gives holders of trust deeds any grace period or right to record corrective trust deeds for the purpose of obtaining priority over an intervening lien creditor or bona fide purchaser." Citing Taggart, the appellate panel agreed with the bankruptcy court's determination that "Suh's stay exception theory did not constitute a reasonable ground for Suh to doubt the applicability of the automatic stay to his actions."

The appellate panel also ruled that the bankruptcy court did not abuse its discretion by directing Suh to pay the outstanding balance of the trustee's attorneys' fees and costs as a compensatory civil contempt sanction. Finally, although the appellate panel concluded that the trustee could not recover attorneys' fees and costs incurred in defending Suh's appeal under section 362(k) (citing Pace, 67 F.3d at 193), it held that he could recover such fees and double costs under Rule 8020(a) of the Federal Rules of Bankruptcy Procedure, which authorizes a district court or a bankruptcy appellate panel to "award just damages and single or double costs to the appellee" if the court determines that an appeal is frivolous.

Outlook

Jeong is not the only case finding that the Taggart standard applies to willful violations of the automatic stay. For example, in Tate v. Fairfax Village I Condominium, 2020 WL 634293, at *3 n.2 (Bankr. D.D.C. Feb. 10, 2020), the court cited Taggart in finding a willful violation of the stay in a chapter 13 case and imposing sanctions under section 362(k)(1).

Other courts have been more equivocal on the issue. See, e.g., In re Franklin, 2020 WL 570092, at *8 (Bankr. M.D.N.C. Jan. 24, 2020) (in a chapter 13 case involving a request for automatic stay violation sanctions under section 362(k), noting the distinction between a discharge injunction and the automatic stay and stating that "[e]ven if the standard in Taggart applied to § 362(k), no reasonable creditor objectively could have believed [the creditor's] actions in this case did not violate the automatic stay"); In re Spiech Farms, LLC, 603 B.R. 395, 408 n.22 (Bankr. W.D. Mich. 2019) (in a chapter 7 case, stating that "[t]his court does not read Taggart to change the Sixth Circuit's standard for determining whether a creditor can be held in contempt for violating the automatic stay") (citation omitted).

In In re Bello, 612 B.R. 389 (Bankr. E.D. Mich. 2020), the court, without mentioning Taggart, found that creditors in a chapter 11 case willfully violated the automatic stay and were subject to sanctions under section 362(k) by filing a motion seeking the appointment of a receiver of a nondebtor corporation wholly owned by the chapter 11 debtor because the creditors knew about the bankruptcy case and deliberately filed the receivership motion). Similarly, in Chavez-Villasenor v. U.S. Dep't of Educ. (In re Chavez-Villasenor), 2020 WL 2062274 (Bankr. D. Or. Apr. 9, 2020), the court, without mentioning Taggart, found that the defendant willfully violated the automatic stay under section 363(k) when the government's computer system erroneously set off a postpetition tax refund against a prepetition debt.

These courts' differing approaches are unsurprising, in light of Justice Breyer's statements in Taggart concerning the differences in language between sections 362(k)(1) and 105(a) and the differences in purpose between the discharge injunction in section 524, which binds creditors over an extended period of time, and the automatic stay in section 362(a), which is of limited duration. Courts and commentators will surely continue to debate whether there should be a different standard applied to violations of the automatic stay, either willful (and therefore subject to section 362(k)(1)) or otherwise.

A version of this article was published in Lexis Practice Advisor. It appears here by permission.