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4th Cir. Cancels Bankruptcy Order for Civil Contempt of Creditor and Declares Taggart Standard to Apply

The United States Court of Appeals for the Fourth Circuit recently ruled that the “without reasonable doubt” standard established by the United States Supreme Court in Taggart vs. Lorenzena case involving an alleged breach of a Chapter 7 release order, governed civil contempt proceedings for breach of a confirmed Chapter 11 reorganization plan.

Below Taggart, 139 S.Ct. 1795 (2019), “civil contempt should not be raised where there is a valid reason to doubt the wrongfulness of the defendant’s conduct”. the Taggart standard is objective, and “a party’s subjective belief that it was complying with an order will usually not protect it from civil contempt if that belief was objectively unreasonable”.

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Two borrowers (“debtors”) filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code. The bankruptcy court upheld a plan to reorganize debtors’ debts that included several properties that had large mortgage balances.

Under the confirmation order, the debtors were able to retain possession of one of the mortgaged properties, a North Carolina beach house (“Property”), while the creditor (“Creditor”) retained a security claim for the total outstanding mortgage balance. The confirmation order indicated the date when the first payment was due, but did not specify the payment amount or how the payment would be calculated. The order further provided that debtors were entitled to “ten days’ written notice” before the creditor could “enforce its remedies in the state courts with respect to the security” in the event of debtors’ default.

Several years later, the defendant (“Servicer”) took over the service of the accounts receivable. Servicer believed the account was delinquent due to missed payments prior to bankruptcy proceedings and therefore sent letters and notices of default to debtors that showed increasing amounts due and overdue. The debtors attempted to correct the account without success.

Five years later, Servicer acknowledged that the former 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.

After learning of the foreclosure proceedings, the debtors filed an emergency motion for contempt of bankruptcy court, alleging that Servicer breached the confirmation order by placing the account in default and seeking to seize the property despite the fact that debtors have 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 confused and ambiguous such that it could not be held in contempt.

The bankruptcy court found Servicer in contempt and imposed penalties, finding that “[a] the finding of civil contempt is justified where there is demonstration, by clear and convincing evidence, of “four factors set out in the pre-Taggart decision Ashcraft v Conoco, Inc.218 F.3d 288, 301 (4th Cir. 2000).

Servicer appealed and the trial court overturned. The trial court concluded that the Taggart standard applied, and “the contempt order of the bankruptcy court f[ell] away from meeting him “like Servicer” ha[d] established just cause for doubt with respect to the unclear terms of the Confirmation Order.

The debtors appealed to the Fourth Circuit, arguing that Taggart did not apply to breaches of Chapter 11 confirmation orders, and yet the bankruptcy court correctly applied the Taggart Standard.

The Fourth Circuit disagreed, believing there was nothing in the Taggart analysis to suggest that it was limited to violation of the Chapter 7 discharge orders nor to show that the decision was based on considerations unique to the Chapter 7 context.

As you may recall, in Taggartthe U.S. Supreme Court has addressed the standard to “hold[ing] a creditor in civil contempt for attempting to collect a debt which a discharge order “entered under Chapter 7 of the Bankruptcy Code ‘immunized from collection’.” 139 S.Ct. 1795, 1799 (2019 ).

By deciding Taggartthe United States Supreme Court first considered the general provisions of the Bankruptcy Code which provide that a discharge order “operates as an injunction”, 11 USC § 524(a)(2), and that a court may “make any order, proceeding, or judgment necessary or proper to enforce the provisions of this title.” § 105(a). See Taggart, 139 S.Ct. to 1801. The Supreme Court found that these general statutory provisions incorporate the “traditional principles of the practice of equity” that have long governed the manner in which courts enforce injunctions”, including “the potent weapon of civil contempt”. Identifier. (quotation marks omitted). Thus, the Supreme Court pointed out that “[t]Bankruptcy laws… do not grant courts unlimited power to hold a creditor in civil contempt. Identifier.

the Taggart The court ruled that the civil contempt standard “is generally objective” and that such orders are inappropriate “where there is a reasonable ground for doubt as to the wrongfulness of the defendant’s conduct”. Identifier. to 1801-02. The Supreme Court concluded that “[t]These traditional principles of civil contempt apply directly to the context of discharge from bankruptcy. Identifier. to 1802, 1804.

The Fourth Circuit held that the standard set forth in Taggarta case involving an alleged violation of a Chapter 7 discharge order, governed civil contempt proceedings under Chapter 11. The Court noted that the power of a bankruptcy court to enforce its own orders flowed from the same statutes and general principles invoked by the Supreme Court in Taggart.

In that decision, the Fourth Circuit disagreed with the debtors’ argument that the bankruptcy court had applied the Taggart standard to find Servicer in contempt. The written order of the bankruptcy court did not mention Taggart nor its standard of non-just cause for doubt. Instead, the bankruptcy court order stated “[a] the finding of civil contempt is warranted where there is a demonstration…of “the four factors discussed in a case prior to Taggart and had nothing to do with bankruptcy. Thus, the Fourth Circuit could not conclude that the bankruptcy court had applied the correct legal standard.

The Court of Appeals also disagreed with Servicer’s assertion that the trial court did not err in reversing the bankruptcy court’s order. First, the Fourth Circuit found that the trial court erred in appearing to give determinative weight to Servicer’s claim and relying on legal advice from outside counsel, as the Fourth Circuit has long argued that an attorney’s opinion “is no defence” for “civil contempt”. In re Walters868 F.2d 665, 668 (4th Cir. 1989).

The Court of Appeal noted that this had been confirmed in Taggart where the Supreme Court explained that “[t]The absence of will does not dispense with civil contempt. 139 S.Ct. to 1802. Under Taggart“a party’s subjective belief that it was complying with an order does not usually protect it from civil contempt if that belief was objectively unreasonable”, but evidence of recourse to the opinion of a counsel may be taken into account in determining 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 petition on the correct legal standard, including any necessary additional investigation. The Court of Appeal emphasized that any sanction imposed by the lower court must be supported, in kind and amount, by a sufficient evidentiary record.

In summary, 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 debt reorganization, Taggart also applies.

Thus, the Fourth Circuit reversed the trial court’s order and remanded the case with instructions to reverse the bankruptcy court’s order and proceed with the proceeding on the advice of the appeals court.