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No Notice: How Unnotified Creditors Can Violate a Discharge Injunction

Here is the scenario: You are a creditor.  You hold clear evidence of a debt that is not disputed by the borrower, an individual.  That evidence of debt could be in the form of a note, credit agreement or simply an invoice.  You originated the debt, or perhaps instead it was transferred to you — it does not matter for this scenario.  At some point the borrower fails to pay on the debt when due.  For whatever reason, months or even years pass before you initiate collection efforts.

Finally, you seek to collect on the unpaid debt. Those collection efforts include letters and phone calls, and maybe even personal contact, all of which are ignored.  Then you employ an investigator and an attorney.  You eventually obtain a default judgment from a state court, which the borrower (unsurprisingly) refuses to pay.  You then garnish the borrower’s wages to pay the debt.  You collect a few payments before the borrower informs you that the debt was discharged in bankruptcy.  Wait . . . how could that be?  You never received notice of the bankruptcy, you didn’t have an opportunity to file a proof of claim, until now you never saw the discharge order.  Indeed, you come to find out that the borrower never listed you on his bankruptcy schedules and you never received notice that there was a bankruptcy.

The way the borrower informs you of the bankruptcy is even more disturbing. The borrower serves a Motion for Sanctions that he filed in the bankruptcy court.  He is asking the bankruptcy court to set aside your state court judgment, for the return of his garnished wages, for emotional distress damages, and for a whole bunch of attorney’s fees that he incurred to reopen the case and file the Motion for Sanctions.[i]

You say to yourself, “No way!” Surely, the bankruptcy court cannot punish you for a case you knew nothing about.  After all, isn’t it the Debtor’s burden to list all of his creditors.  There was no way that your debt was discharged.  Think again, you could be in trouble!

Here’s why. Due to the complicated interaction of multiple sections of the bankruptcy code and the way in which courts have interpreted that interaction in no-asset Chapter 7 Bankruptcy cases, your debt was discharged and your collection efforts were in violation of the discharge injunction despite the fact that you lacked knowledge of the bankruptcy.  In a Chapter 7 case, § 727(b) discharges a debtor “from all debts that arose before the date of the order for relief” except as provided in § 523.  Section 524, also known as the discharge injunction, applies to any “debt discharged under section 727” and operates as an injunction against the commencement or continuation of an action, or an act, to collect, recover or offset any personal liability of a debtor.  Generally speaking, Debtors receive a discharge under § 727(a), and the scope of that discharge is set forth by § 727(b).  Pursuant to § 727(b), a prepetition debt is discharged as a matter of law, unless it is nondischargeable under § 523.

Ahah-your debt must fall under § 523, or so you think. After all, § 523(a)(3)(A) states “A discharge under section 727 . . . does not discharge an individual debtor from any debt neither listed nor scheduled under section 521(a)(1) of this title, with the name, if known to the debtor, of the creditor to whom such debt is owed, in time to permit . . . timely filing of a proof of claim, unless such creditor had notice or actual knowledge of the case in time for such timely filing.”  You never had notice, did not to get to file that proof of claim, and you knew nothing about the case until that sanctions motion arrived on your doorstep.  Sure you are protected by § 523, right?

Not so fast. Section 523 does not apply to all Chapter 7 cases.  It is “well accepted that the failure to give notice to a creditor will be disregarded in a Chapter 7 no asset case and that in such cases failure to schedule a prepetition debt will not preclude the discharge of that debt.”[ii] When a debtor’s case is administered as a no-asset case with no set claims bar date and, therefore, has no cut off for the “timely filing of a proof of claim,” an unlisted creditor is not deprived the opportunity to file a timely proof of claim.[iii]  Because the time to file a proof of claim never passes, it matters not that the debtor failed to list a creditor in the first place.  Nor does it matter why the debt was not listed.  The 10th Circuit, for example, says that “equitable considerations,” such as the Debtors’ reasons for failing to schedule the debt or the creditor, “do not impact the dischargeability” of the prepetition debt under § 523(a)(3)(A).[iv]

All this bouncing around the Bankruptcy Code takes us back to § 524 for an explanation of why no notice is actually required. Section 524(a)(2) of the Bankruptcy Code, which creates the discharge injunction, is unambiguous and makes no distinction between debts which are discharged following notice to a creditor and those that are discharged despite a lack of notice. Section 524 provides:

(1)        discharge in a case under this title–

(2)        operates as an injunction against the commencement or continuation of an action, the employment of process, or an act, to collect, recover or offset any such debt as a personal liability of the debtor, whether or not discharge of such debt is waived[v]

Thus, a lack of knowledge of the discharge does not provide a defense for a creditor who attempts to collect in violation of the discharge injunction.

All is not lost. Despite the mandate of § 524, not all bankruptcy courts (which are still courts of equity) have divorced themselves from equitable principals. The court in In re Wilcox refused to sanction an unlisted creditor for violation of the discharge injunction despite the creditor’s prosecution of a state-court collections case. The Wilcox Court stated that it:

cannot blame the Creditors for their confusion which, after all, proceeds in large measure from the Debtor’s incomplete disclosure in Schedule F and the mailing matrix. Under the circumstances, and up to this point in time, their filing and prosecution of the [state court] lawsuit is not contemptuous. If, however, they continue to pursue their claims against the Debtor without also seeking a declaration . . . that their claims are excepted from discharge under § 523(a)(3), they run the risk of violating the Discharge, especially now that they have a better understanding of their rights.[vi]

The ultimate lesson to be learned is that creditors need to exercise the utmost caution in their pursuit of borrowers, especially if there is reason to believe that borrower filed bankruptcy. A search of public bankruptcy filings before collection efforts are begun, may be the ounce of prevention that is worth a pound of cure.  If the borrower produces a bankruptcy discharge, a creditor should retain counsel to review the case and determine whether § 523 applies to the case.  Lack of notice is not enough to prevent liability.

[i]  The scenario is based on the recent case out of the District of Utah, In re Slater, No. 09-21947, 2017 WL 2656119, at *1 (Bankr. D. Utah June 20, 2017), where the Court concluded that creditor “should be placed in civil contempt for violation of the discharge injunction of 11 U.S.C. § 524. The Default Judgment in the State Action is void pursuant to § 524(a).”  The court also found the creditor liable to Debtors for actual damages for all wages garnished, as well as costs and reasonable attorney fees incurred by the Debtors in bringing the motion to enforce the discharge order. Other cases in other jurisdictions have come to similar conclusion based on similar rational, although facts and the creditors level of knowledge of the bankruptcy tend to vary slightly. Cf. In re Greenberg, 526 B.R. 101 (Bankr. E.D.N.Y. 2015) and In re Haemmerle, 529 B.R. 17, 20 (Bankr. E.D.N.Y. 2015).

[ii]   In re Delafied 246 Corp., No. 05-13634ALG, 2007 WL 2332527, at *2 (Bankr. S.D.N.Y. Aug. 14, 2007)); In re Herzig, 238 B.R. 5 (E.D.N.Y.1998).

[iii] It should be noted that there is currently a Circuit split on the issue of whether an unlisted debt in a no-asset bankruptcy is automatically discharged by operation of law. The Third, Sixth, Ninth, and Tenth Circuits follow the “mechanical approach” and hold that any such debt is discharged by operation of law; therefore, there is no need to reopen the case and determine dischargeability regardless of the debtor’s reason for failing to list the debt. See In re Parker, 264 B.R. 685, 694 (10th Cir. 2001); In re Madaj, 149 F.3d 467, 471 (6th Cir. 1998); In re Judd, 78 F.3d 110, 115 (3d Cir. 1996); In re Beezley, 994 F.2d 1433 (9th Cir. 1993); see also In re Cruz, 254 B.R. 801, 807 (Bankr. S.D.N.Y. 2000) (summarizing cases).  In contrast, the First, Fifth, Seventh, and Eleventh Circuits have held that motions to reopen a no-asset Chapter 7 case should be granted to amend the list of creditors—thus subjecting the unlisted creditor to the bankruptcy discharge—unless the omission was the result of fraud or intention. See Colonial Surety Co. v. Weizman, 564 F.3d 526 (1st Cir. 2009); In re Faden, 96 F.3d 792, 797 (5th Cir. 1996); In re Baitcher, 781 F.2d 1529, 1534 (11th Cir. 1986); In re Stark, 717 F.2d 322 (7th Cir. 1983).  In these jurisdictions, the Debtor’s basis for failing to list the Debt could be scrutinized as part of the process to reopen the case.  While this doesn’t mean that the debt will not be discharged, it adds a level of scrutiny to the debtor’s failure to list the debt in the first place and provides a creditor additional notice of the bankruptcy.

[iv] In re Parker, 313 F.3d 1267, 1268 (10th Cir. 2002).

[v] See 11 U.S.C. § 524(a)(2). See Green v. Welsh, 956 F.2d 30, 32 (2d Cir.1992).

[vi] In re Wilcox, 529 B.R. 231, 238 (Bankr. W.D. Mich. 2015); see also In re Johnson, 521 B.R. 912, 916 (Bankr. W.D. Ark. 2014)(finding that the debtor failed to notify the creditor. Therefore the creditor was under no obligation to return the money it had collected from the debtor’s state tax return and the debtor’s motion for contempt was denied.)

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It’s Not Final, and That’s Final: The Ninth Circuit’s Gugliuzza Decision

appellate court concept with gavel. 3D rendering

As we have noted in another post, Non-Final Finality: Does One Interlocutory Issue Resolved in a Bankruptcy Court Order Render All Issues Addressed in the Order Non-Appealable?, not all orders in bankruptcy cases are immediately appealable as a matter of right.  Only those orders deemed sufficiently “final” may be appealed without additional court authorization.  See 28 U.S.C. § 158(a)(3) (interlocutory order may be appealed only with leave of the court).  Appeals from “final” bankruptcy-court orders usually are first heard by a United States district court or a bankruptcy appellate panel (a “BAP”), which have jurisdiction “to hear appeals from final judgments, orders, and decrees” from bankruptcy courts.  Id. § 158(a)(1).

What happens when a district court or a BAP properly exercises appellate jurisdiction over a bankruptcy court’s order, and ultimately remands the matter back to the bankruptcy court for further fact finding?  Is the district court or BAP’s appellate mandate sufficiently final to appeal as a matter of right to the Circuit Court of Appeals?  The Ninth Circuit Court of Appeals recently wrestled with this question in In re Gugliuzza, Case No. 15-55510 (9th Cir. Mar. 24, 2017).

Bullard v. Blue Hills Bank

In Bullard v. Blue Hills Bank, the United States Supreme Court held that a bankruptcy court’s order is final only if it “alters the status quo and fixes the rights and obligations of the parties.”  Bullard v. Blue Hills Bank, 135 S. Ct. 1686, 1689 (2015).  An order denying plan confirmation generally does not satisfy this standard, as long as it leaves the debtor free to propose another plan, because “[t]he parties’ rights and obligations remain unsettled” and the “possibility of discharge lives on.”  Id. at 1693.  In the Supreme Court’s view, “final” simply “does not describe this state of affairs.”  Id.

The Court also observed that every “climb up the appellate ladder and slide down the chute can take more than a year.”  Id.  Given this reality, it would “not make much sense to define the pertinent proceeding so narrowly that the requirement of finality would do little work as a meaningful constraint on the availability of appellate review.”  Id.

Despite providing relative clarity on the non-finality of orders denying plan confirmation, Bullard did not create a new set of bright-line rules.  Rather, it attempted to provide relative guideposts for the rules of finality, which the Court acknowledged “are different in bankruptcy.”  Id. at 1692.  Whether Bullard actually provided meaningful overall clarity remains subject to debate.  Furthermore, Bullard did not directly address the finality of a district court or BAP’s intermediate appellate ruling when the mandate remands a matter back to bankruptcy court.

The Ninth Circuit’s Prior Decisions:  In Conflict with Bullard?

The Ninth Circuit Court of Appeals recently wrestled with the apparent tension between Bullard and the Ninth Circuit’s earlier decision of In re Bonner Mall Partnership, 2 F.3d 899 (9th Cir. 1993).  In Bonner Mall, the Ninth Circuit held that, under certain circumstances, it could exercise jurisdiction over an appeal of a decision by a district court sitting in an appellate capacity “even though a district court has remanded a matter [to the bankruptcy court] for factual findings on a central issue.”  Under Bonner Mall, a district court’s appellate ruling is sufficiently final, despite a remand, if the central issue “is legal in nature and its resolution either 1) could dispose of the case or proceeding and obviate the need for factfinding; or 2) would materially aid the bankruptcy court in reaching its disposition on remand.”  Bonner Mall, 2 F.3d at 904.

Later, in the post-Bullard decision of Landmark Fence, the Ninth Circuit questioned whether the “flexible approach” to finality remained valid after BullardIn re Landmark Fence, 801 F.3d 1099, 1103 n.1 (9th Cir. 2015).  The court went so far as to observe that the “flexible test is arguably in conflict with the Supreme Court’s decision in Connecticut National Bank v. Germain, 503 U.S. 249, 253 (1992),” as well as BullardId.  The Ninth Circuit declined to reconcile the apparent doctrinal conflict, however, because even the flexible approach was “stretched beyond its breaking point” by the appeal in that case, which involved “a district court order that includ[ed] a remand to the bankruptcy court with explicit instructions to engage in ‘further fact-finding.’”  Id. at 1101.

In evaluating appellate jurisdiction over district court order in that case, the court analyzed four factors:  “(1) the need to avoid piecemeal litigation; (2) judicial efficiency; (3) the systemic interest in preserving the bankruptcy court’s role as the finder of fact; and (4) whether delaying review would cause either party irreparable harm.”  Id. at 1102.  The Ninth Circuit ultimately dismissed the appeal, observing that when “an intermediate appellate court remands a case to the bankruptcy court, the appellate process likely will be much shorter if we decline jurisdiction and await ultimate review of all the combined issues.”  Id. at 1103.

In re Gugliuzza:  A New Per Se Rule?

Against this backdrop, in Gugliuzza, the Ninth Circuit considered whether a district court’s order was sufficiently final to confer appellate jurisdiction under 28 U.S.C. § 158(d)(1), when the order affirmed in part and reversed in part a bankruptcy court’s grant of summary judgment, and remanded a discrete issue to the bankruptcy court for further fact finding.  The appeal arose from an adversary proceeding, in which the Federal Trade Commission (“FTC”) obtained a judgment of non-dischargeability against the debtor under 11 U.S.C. § 523(a)(2)(A), on a motion for summary judgment.  The debtor appealed the judgment to the district court, which affirmed in part, reversed in part, and remanded for factual findings on one of the counts asserted by the FTC.

The debtor appealed the district court order to the Ninth Circuit, arguing that despite the remand, the district court’s ruling was immediately appealable under Bonner Mall and its progeny.  The debtor argued that under Bonner Mall, the Ninth Circuit could exercise appellate jurisdiction because the appeal raised “purely legal issues” and a decision could materially aid the bankruptcy court in its decision-making process on a central issue in the case.

The FTC, by contrast, argued that Bullard and Landmark Fence required dismissal of the appeal, so that the bankruptcy court could promptly consider the issue on remand.  The Ninth Circuit agreed, holding that the Bullard and Landmark Fence decisions “clearly limit the applicability of the Bonner Mall line of cases.”  Bullard established that orders may be considered “final” for purposes of Section 158(d) “only when they ‘finally dispose of [a] discrete dispute[] within the larger case.’”  A decision that “remands a case for further fact-finding will rarely have this degree of finality, unless the remand order is limited to ministerial tasks.”

Thus, to the extent Bullard did not already do so, the Gugliuzza decision effectively overrules Bonner Mall and its progeny.  In addition, although the Ninth Circuit professed consistency between its remaining “longstanding precedent” and Bullard, the Gugliuzza decision arguably creates a new bright-line rule that alters, or at least simplifies, the four-factor test for finality previously employed in Landmark Fence and other decisions.  That rule may be summarized as follows:  A decision that remands a case for further fact-finding is not final under 28 U.S.C. § 158(d) unless the remand order is limited to purely ministerial tasks.

Gugliuzza appears to bring additional clarity to a narrow set of cases involving remand orders at the intermediate appellate level.  It remains to be seen whether the Ninth Circuit and other courts will ultimately revise or replace their “flexible standard” tests in other contexts.  Bankruptcy and appellate practitioners should carefully consider finality issues with every bankruptcy court order and at every stage of a bankruptcy appeal, and would be wise to keep an eye on this evolving doctrine.

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