District Court Reverses Discharge Violation; Finds Some Violations Too Technical to Punish

Are some violations of the discharge injunction too technical or trivial to justify enforcement? According to a U.S. District Court Judge in Texas, the answer is yes, and the holding, if correct, may highlight an important distinction between the penalties for violation of the stay and the discharge. No. SA-06-CV-0439-RF, Cadles of Grassy Meadows II, LLC v. Joyce Gervin (W.D. Tex. 11/21/06)(Royal Ferguson, D.J.).

20+ Years of Background (That’s Over a Fifth of a Century!)

The facts in the Gervin case are pretty complex and span over 20 years of time. However, a thumbnail sketch should be able to capture the essentials. Back in 1983, George Gervin was granted a 50% interest in a partnership called the 401 Group. In both 1984 and 1992, George assigned half of his interest in the 401 Group to his wife Joyce Gervin. While the 401 Group was informed of this transfer, Joyce was never formally admitted as a partner.

In 1986, he was sued by TCAP on a $2 million debt, which resulted in an agreed judgment in 1989. For nine years, TCAP and various assignees tried to chase George and succeeded in obtaining a charging order against George’s interest in the 401 Group.

George and Joyce filed for chapter 7 bankruptcy in San Antonio in 1998. The Gervins did not disclose their separate interests in the 401 Group, referring to it as community property. While the Gervins received a discharge, the Bankruptcy Court also determined that TCAP and its successor held a valid lien against George’s interest in the 401 Group.

Cadles of Grassy Meadows acquired the debt in 2000. Some four years later, on September 15, 2004, Cadles asked the Washington state court to compel the sale of the 401 Group, so that it could attach and sell George’s 50% partnership interest. On September 21, 2004, Joyce’s counsel informed Cadles that she owned a 25% interest in the 401 Group. Then on September 24, 2004, Joyce filed an action in Bankruptcy Court seeking to prevent the sale of her interest as being in violation of the discharge. She succeeded in obtaining a preliminary injunction. Notwithstanding the bankruptcy court injunction, the Washington state court entered an order compelling the sale of George’s interest in the 401 Group; however, the state court did not determine the extent of George’s interest.

Meanwhile, back in Texas, the Bankruptcy Court entered summary judgment finding that Joyce did in fact own a 25% interest in the 401 Group and that Cadles had violated Joyce’s discharge by trying to collect from her property. After a trial on damages, the Bankruptcy Court awarded Joyce $25,000 for emotional distress and $18,190 in attorney’s fees.

The District Court Ruling

Cadles was not very happy with this result and appealed. On appeal, the U.S. District Court sustained the Bankruptcy Court’s ruling that Joyce had a valid 25% interest in the 401 Group. However, it reversed the contempt judgment, finding that either there was not a violation of the discharge at all, or that the violation was so insignificant as to be unworthy of recompense.

While the Bankruptcy Court granted summary judgment that the discharge injunction had been violated, the District Court could not discern any detailed findings as to how the discharge had been violated. Indeed, Cadles contended that the Bankruptcy Court had initially intended to hold a separate hearing on the discharge violation, but instead signed an order finding the violation had occurred. This left the District Court to make its own examination.

Initially, the District Court noted that Bankruptcy Courts have the power to enforce their orders through contempt and that damages may be awarded. However, in order to find contempt, there must be an unambiguous order and an obvious violation of the order. Here, there was a prior order allowing pursuit of George’s interest in the 401 Group, but no determination of the extent of that interest. The District Court found that this made “it difficult for Cadles to assess if its actions were violating the order.” Order Granting in Part and Denying in Part, p. 17.

The Court found that this alone was sufficient to negate the finding of contempt. However, the Court went on to find that there was not an obvious violation of a court order either. In this case, Cadles sought the charging order on September 15, 2004, but did not learn about Joyce’s claimed interest in the 401 Group until September 21, 2004. Three days later, Joyce filed the adversary proceeding. Thus, when Cadles began pursuing the charging order on the 15th, it had no basis for knowing that this action would violate the discharge at the time.

The Court went on to state that even if there had been a violation, it was too minor to warrant damages. Judge Ferguson stated:

“While the Bankruptcy Code provides bankruptcy courts with the power to find a party in contempt, the code does not require such a finding. As the Supreme Court notes, ‘[the Bankruptcy Code] does not provide bankruptcy courts with a roving writ, much less a free hand. The authority bestowed thereunder may be invoked only if, and to the extent that, the equitable remedy dispensed by the court is necessary to preserve an identifiable right conferred elsewhere in the Bankruptcy Code.’ Cadle’s violation of the discharge injunction, if one existed at all, was technical, trivial, and most certainly not the kind of action contempt findings were meant to prevent.”

Order Granting in Party and Denying in Part, pp. 18-19.

Both parties were dissatisfied with the District Court’s split decision and an appeal to the Fifth Circuit is currently pending.

What is the Relevant Time Period?

There is a serious disconnect between the way in which the Bankruptcy Court and the District Court viewed the undisputed facts. The District Court essentially looked at three different time periods. First, there was the period from September 15, 2004, the date on which Cadles requested the sale order, until September 21, 2004, the date on which Joyce gave notice of her interest in the 401 Group. Because Cadles had no notice prior to this date, it could not be held charged with violation of the discharge. There was a second period from September 21, 2004 until September 24, 2004 in which Cadles knew of Joyce’s interest but did not withdraw its request. The District Court found that this inaction was either a non-violation or a technical violation. Finally, there was the period after September 24, 2004 in which the parties were litigating the issue of Joyce’s interest in Bankruptcy Court. The District Court did not consider this to be a violation.

The Bankruptcy Court did not divide its analysis into periods. However, in its Memorandum Decision on damages, No. 04-5138, (Bankr. W.D. Tex. 11/12/05), the Court was clearly considering a much lengthier period of violation. In assessing damages, the Court recounted that Joyce made 20 panicked calls to her accountant over the period of a year and that she did not sleep well for a period of two years. Memorandum Decision, p. 13. However, it is difficult to discern either a one year period or a two year period from any of the documents in the record. The earliest date on which Cadles took action was September 15, 2004. The Bankruptcy Court entered summary judgment finding that Cadles was in contempt on May 17, 2005. The Bankruptcy Court entered its Memorandum Decision on damages on November 12, 2005. Thus, the only way a period of a year or more could apply is if the Bankruptcy Court found that Cadles was in contempt for violating the discharge during the entire period from its first filing to the Bankruptcy Court’s ruling on damages. However, during all but nine days of this period the parties were litigating the extent of Joyce’s interest in the 401 Group in Bankruptcy Court. It seems likely that the Bankruptcy Court assessed damages for the period in which the parties were litigating the extent of Joyce's property interest and therefore the extent of her protection under the discharge.

What Standard Did the Courts Apply?

Although both the Bankruptcy Court and the District Court ruled on the discharge issue, neither court explicitly set out the legal standard it was applying. The Bankruptcy Court appeared to apply a strict liability standard. The unstated premise of the Bankruptcy Court ruling seems to be that because Cadles tried to levy on Joyce’s property, Cadles violated Joyce’s discharge regardless of whether Cadles had actual knowledge of Joyce’s interest and that this violation continued during the entire period in which Cadles disputed Joyce’s ownership interest in the 401 Group. The District Court, on the other hand, applied a knowing violation standard. The District Court did not charge Cadles with a duty to act until it had knowledge of Joyce’s claimed interest and therefore, knowledge that collection efforts would violate her discharge. From that point, there was a delay of a mere three days before Joyce initiated proceedings to declare her interest in the Bankruptcy Court. While Cadles proceeded subsequent to the Bankruptcy Court filing, it was careful to limit its action to proceeding against George’s interest, whatever that might be.

The difference between the courts’ rulings may well reflect their differing perspectives. The Bankruptcy Court, which deals with the automatic stay on a day in, day out basis, appeared to apply the same standard which would apply to a stay violation. By contrast, the District Court, which issues and enforces injunctions on a regular basis, applied a more conventional contempt standard. The distinction between the two is critical because the stay and the discharge, while both expressed as injunctions, have different scopes and remedies attached to them.

The automatic stay of section 362 includes a private right of action contained in §362(h). Section 362(h) allows any individual harmed by a willful violation of the stay to recover damages and allows additional relief if appropriate. A violation can be “willful” without a specific intent to violate the stay. A willful violation occurs where there is knowledge of the stay and intent to commit the act which violated the stay. Brown v. Chesnut, 422 F.3d 298 (5th Cir. 2005); Fleet Mortgage Group, Inc. v. Kaneb, 196 F.3d 265 (1st Cir. 1999).

On the other hand, there is no private right of action contained in the discharge injunction. Walls v. Wells Fargo Bank, 276 F.3d 502 (9th Cir. 2002). Instead, the discharge may be enforced under the Bankruptcy Court’s inherent contempt powers under §105. As suggested by the District Court, the civil contempt powers should not be applied where the application of the order (in this case the discharge injunction) is not clear. On the other hand, the automatic stay, which operates like a sheriff trying to maintain order in a midst of a saloon brawl, has a stricter application.

The distinction between the statutes rests on more than a simple happenstance of drafting. The automatic stay serves a broader purpose than the discharge injunction. As noted by the Fifth Circuit in Chesnut, the automatic stay is designed to protect creditors as well as debtors. The stay exists to preserve the estate, as well as to protect the debtor from collection efforts. The discharge injunction, on the other hand, exists solely to protect the debtor.

The Chesnut case provides a good counterpoint to the present one. In Chesnut, a creditor was informed that the debtor had an interest in real property titled in the name of his non-filing spouse. The creditor made a determination that this claim was erroneous and proceeded to foreclose. The U.S. District Court subsequently concluded that the creditor was correct in its assessment that the debtor lacked an interest in the property. However, the Fifth Circuit reversed, finding that the stay extended to an arguable interest in property, even if that interest was subsequently found to be lacking. The Court found that it was important to allow the Bankruptcy Court to examine the merits of the claim prior to allowing the creditor to proceed and noted the broad latitude given to the court to modify the stay upon request.

In the Gervin case, however, the creditor began by proceeding against property which appeared to be property which the Bankruptcy Court had expressly ruled was subject to the creditor’s non-dischargeable lien. Upon being informed that another party claimed an unrecorded interest in this property, the creditor paused and then amended its request to seek only the husband’s interest. This decision proved to be wise, since the interest of the other party was later validated. The important distinction here is that the creditor, faced with a possibly spurious claim, did not blindly proceed in the face of a dispute. While the creditor could be faulted for failing to immediately disclaim an interest in Joyce’s property, this delay was more technical or trivial and did not impugn the integrity of the court.

Gervin may prove to be an unusual case dependent upon unusual facts. In the typical discharge violation case, the application of the discharge is clear and the violation is obvious. However, Gervin certainly raises the possibility that some incidental violations of the discharge may not justify the invocation of the contempt power. An isolated collection letter may not be enough to suggest that the creditor is contemptuous of the authority of the Bankruptcy Court and its orders. If a violation could have been remedied by something less drastic, such as a phone call or a cease and desist letter, then perhaps resort to a full-blow adversary proceeding is premature. However, if a creditor is given fair warning that its actions violate the discharge and chooses to continue its efforts, then it would be contemptuous in both the popular and the legal sense of the word.

Disclaimer: One part of my practice involves representing creditors accused of violating the discharge. As a result, I have an interest in the arguments being advanced here. However, I do not represent the Cadle Company or its affiliates.