United States: Violations Of The Bankruptcy Discharge Injunction

The recent case of In re Micah Cade McKinney, Case No. 21-50046-rlj-11 (Bankr. N.D. Tex., April 28, 2022) provides insight as to violations of the bankruptcy discharge injunction.

Contempt litigation in bankruptcy court is occasionally driven by intentional, willful conduct on the part of a creditor - perhaps out of spite that the debtor who owed them money had filed for bankruptcy in the first place. But more often than not, violations of the automatic stay or the discharge injunction occur out of a misunderstanding of the applicable law. This case represents an example of the latter.

Since December, 2018, the Debtor, Micah McKinney, and his wife Leslie McKinney, were parties to a divorce case in State Court. On March 31, 2021, the State Court held a hearing on two motions filed by Leslie McKinney in the divorce case: a motion for enforcement of temporary orders and a motion to allocate a tax refund. The State Court orally granted Leslie McKinney's requested relief on the record, holding Micah McKinney in contempt and ordering that he transfer approximately half of a $3 million tax refund to Leslie McKinney.

On April 5, 2021, before any written order was issued by the State Court, Micah McKinney filed this chapter 11 bankruptcy case. The case was primarily filed because Micah McKinney did not have the funds to comply with the State Court's March 31 ruling.

On August 22, 2021, after a lengthy mediation, Micah McKinney and Leslie McKinney entered into a settlement agreement that resolved all their divorce disputes save for certain SAPCR ("suits affecting the parent-child relationship") issues. The terms of the settlement agreement were incorporated into Micah McKinney's bankruptcy plan ("Plan"). On November 4, 2021, the Plan was confirmed. Under the Plan, and the settlement agreement incorporated therein, Leslie McKinney released all claims against Micah McKinney, including claims in the divorce case, except for certain post-petition SAPCR issues. The Plan also states that all claims of the Lanfear Firm, which represented Leslie McKinney in the divorce case, were released. The order confirming the Plan includes a broad injunction ("Discharge Injunction") barring all actions to enforce any pre-confirmation claims against Micah McKinney in a manner inconsistent with the terms of the Plan. At the time of the hearing the subject of this case, Micah McKinney had satisfied all his obligations to Leslie McKinney under the Plan.

On February 17, 2022, Leslie McKinney, through the Lanfear Firm, filed a motion in the divorce case requesting entry of two orders related to the State Court hearing held on March 31, 2021 ("Motion to Enter"). The orders, as proposed, provide that Micah McKinney be incarcerated if he fails to pay several pre-bankruptcy claims to Leslie McKinney, the Lanfear Firm, and others; they also required that Micah McKinney place the $3 million tax refund in escrow for payment of a claim to the Lanfear Firm. Each of the claims addressed by the proposed orders were discharged through the order confirming Micah McKinney's Plan. After counsel for Micah McKinney emailed Leslie McKinney's counsel on February 17, 2022, voicing Micah McKinney's objection to the Motion to Enter as a violation of the Discharge Injunction, counsel for Leslie McKinney said she did not intend to seek the relief in the Motion to Enter but simply wanted a clear record to ease the adjudication of the remaining

SAPCR issues in State Court. Subsequently, Leslie McKinney filed an amended motion on February 28, 2022 ("Amended Motion to Enter") that added language to the orders stating that their entry was not an attempt to enforce relief but, rather, to accurately reflect the record. A hearing on the Amended Motion to Enter was set in State Court for March 22, 2022.

On February 25, 2022, Micah McKinney filed a motion seeking to hold Leslie McKinney and the Lanfear Firm in contempt for violating the Discharge Injunction by filing the Motions to Enter. On March 1, 2022, he filed a motion for a preliminary injunction, which was granted on March 8, 2022, enjoining Leslie McKinney and the Lanfear Firm from pursuing their Motion to Enter and Amended Motion to Enter (collectively "Motions to Enter") and enjoining the State Court from entertaining the Motions to Enter at the March 22 hearing. The Court took the motion for contempt under advisement.

When a creditor violates the discharge injunction in a bankruptcy case, a bankruptcy court may hold the creditor in contempt to compensate the debtor for the violation and to coerce the creditor into compliance with the injunction. Placid Refining Co. v. Terrebonne Fuel & Lube, Inc. (In re Terrebonne Fuel & Lube, Inc.), 108 F.3d 609, 612-13 (5th Cir. 1997). This authority derives from 11 U.S.C. § 105, which allows a bankruptcy court to enter any order necessary to carry out the provisions of the Bankruptcy Code. Cirillo v. Valley Baptist Health Sys. (In re Cirillo), No. 09-10324, 2014 WL 1347362, at *4 (Bankr. S.D. Tex. Apr. 3, 2014). To determine whether a party should be held in contempt for violating a discharge injunction, courts employ an

objective standard, and contempt is appropriate when "there is not a 'fair ground of doubt' as to whether the creditor's conduct might be lawful under the discharge order." Taggart v. Lorenzen, 139 S. Ct. 1795, 1804 (2019).

Under Taggart, three elements must be proven for a court to hold a party in contempt: "(1) the party violated a definite and specific order of the court requiring him to . refrain from performing . particular . acts; (2) the party did so with knowledge of the court's order; and (3) there is no fair ground of doubt as to whether the order barred the party's conduct." In re City of Detroit, Mich., 614 B.R. 255, 265 (Bankr. E.D. Mich. 2020).

The Court had no trouble finding that Leslie McKinney and the Lanfear Firm violated the Discharge Injunction by filing the Motions to Enter. The Discharge Injunction states:

AS OF THE EFFECTIVE DATE ALL HOLDERS OF CLAIMS AGAINST THE DEBTOR . ARE HEREBY PERMANENTLY ENJOINED AND PROHIBITED FROM . THE COMMENCING OR CONTINUATION IN ANY MANNER, DIRECTLY OR INDIRECTLY, OF ANY ACTION, CASE, LAWSUIT OR OTHER PROCEEDING OF ANY TYPE OF NATURE AGAINST THE DEBTOR OR THE ESTATE, WITH RESPECT TO ANY SUCH CLAIM OR INTEREST ARISING OR ACCRUING BEFORE THE EFFECTIVE DATE, INCLUDING WITHOUT LIMITATION THE ENTRY OR ENFORCEMENT OF ANY JUDGMENT, OR ANY OTHER ACT FOR THE COLLECTION, EITHER DIRECTLY OR INDIRECTLY, OF ANY CLAIM OR INTEREST AGAINST THE ESTATE OR THE DEBTOR.

The proposed orders on the Motions to Enter directed that Micah McKinney was to make payments to Leslie McKinney for a portion of the $3 million tax refund and payments to the Lanfear Firm for attorney's fees-obligations that were expressly discharged by confirmation of the Plan. The Discharge Injunction enjoins the "continuation in any manner" of "the entry or enforcement of any judgment" on a prepetition claim. As an action that continues to seek entry in State Court of a prepetition claim, Leslie McKinney and the Lanfear Firm's filing of the Motions to Enter plainly violated the Discharge Injunction. So too would a hearing on the motions or the State Court's issuance of an order on the motions. The Court rejected the notion that the inclusion of a disclaimer in the motion saying that it was not an attempt to collect any of the monetary relief or awards therein saved the conduct from contempt. And the Court flatly rejected any thought that the requested State Court order was needed to accurately reflect the record. Any further proceedings in the State Court were stayed by Micah McKinney's bankruptcy filing. In addition, the savings language did nothing to solve the critical issue, which is that any continuation of a discharged claim violates the Discharge Injunction regardless of the purpose of the continuation. The Court made clear that Entry of an order against a debtor on a prepetition claim during the pendency of a bankruptcy case violates the automatic stay; and entry of an order against a debtor on a prepetition claim after the debtor receives a discharge violates the Discharge Injunction.

Turning to the second prong of the Taggart test, the Court easily found the existence of knowledge, as Leslie McKinney and the Lanfear Firm did not dispute that they were aware of the Discharge Injunction when they filed the Motions to Enter. Both were claimants under the plan, actively negotiating with Micah McKinney before its approval. They both received distributions under the plan post-confirmation. The Amended Motion to Enter expressly recognized that the Plan resolves the monetary relief sought through their motions.

Turning to the final prong under Taggart, the Court found that Leslie McKinney and the Lanfear Firm had "no objectively reasonable basis for concluding that [their] conduct might be lawful." Despite Leslie McKinney's belief that she was acting lawfully, the Court found no objective basis for concluding that her and the Lanfear Firm's continued prosecution of claims in State Court on a prepetition claim would not violate the Discharge Injunction-such conduct directly violates the injunction's clear and plain language.

Finding that all three elements of the Taggart test had been met, the Bankruptcy Court found Leslie McKinney and the Lanfear Firm in contempt. The Court therefore turned to fashioning an appropriate sanction. The Court found that evidence made clear that neither Leslie McKinney nor the Lanfear Firm intended to violate the Discharge Injunction. Therefore, the Court found that, while she never had an objectively reasonable basis for concluding she was not violating the Discharge Injunction, she had shown that she was "not proceeding in bad faith but, instead, under a misguided understanding of how she was restrained under the Discharge Injunction." Therefore, despite a request for attorneys' fees and punitive damages, the Court ultimately limited its damage assessment to a sanction of $250/day for every day after the date that this order became final that Leslie McKinney failed to file a notice in State Court withdrawing the Motions to Enter.

The refusal to grant attorneys' fees to Micah McKinney was somewhat surprising, but the Court determined that, in this case, further sanction was not necessary or appropriate under the circumstances.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.