“My Lawyer Made Me Do It” Isn’t an Absolute Defense Against Bankruptcy Court Penalties | Ward and Smith, Pennsylvania
The lesson learned from the case was that the bankruptcy court cannot sanction a creditor if there is an objectively reasonable basis to conclude that the creditor’s conduct is legal.
The moral was that a creditor can avoid the time, expense, and risk associated with contempt and sanctions litigation by taking basic steps to ensure confirmed Chapter 11 plans are clear and specific. The moral is even more glaring now as a recent decision by the Fourth Circuit Court of Appeals reveals that the parties continue to fight in court over the easily avoidable penalty order. The ruling also clarifies when and why a bankruptcy court can sanction a creditor.
In 2009, the Beckharts filed for Chapter 11. At the time, they were nearly a year behind on a loan secured by the Kure Beach property. The loan officer objected to the planning confirmation because it did not specify how post-application mortgage payments would be applied to principal and interest. The bankruptcy court upheld the plan without clarifying the issue, but the administrator did not ask the court to reconsider its order, nor appeal.
The Beckharts paid for five years. Shellpoint acquired the loan from the original managing agent and treated it as default on the basis of accrued outstanding arrears. Periodically, Shellpoint would send default letters to the Beckharts, challenging the default. Shellpoint’s attorney said the confirmation order did not change the terms of the loan agreement and the loan remains in default. The case escalated when the Beckharts filed complaints with the Consumer Financial Protection Bureau. Shellpoint started foreclosure, then told the Beckharts it was stopping foreclosure, but then posted a Notice of Foreclosure Hearing on the Beckharts’ door (allegedly due to an error).
In January 2020, the Beckharts asked the bankruptcy court to find Shellpoint in contempt and impose monetary penalties on them. The court held a hearing in June and in September 2020 found Shellpoint in contempt. The court charged Shellpoint with $115,000 in penalties for lost wages, “loss of a fresh start”, attorney’s fees and travel expenses.
Bankruptcy courts have the power to hold a party in civil contempt and impose penalties for breach of a confirmed plan. The liability test is based on a recent U.S. Supreme Court decision — Taggart vs. Lorenzen. The Taggart the test prohibits sanctions whether there was an “objectively reasonable basis for concluding that the creditor’s conduct might be lawful”. There can only be contempt for breach of the release injunction “if there is no good reason to doubt that the order prohibited the conduct of the creditor”.
In reversing the bankruptcy court’s decision, the district court noted that the plan and confirmation order did not state how much the debtors owed on confirmation, did not specify how the $23,000 arrears would be paid. and did not fix the amount of the first payment. . Confusingly, the confirmation order also stated that the original terms of the loan would remain in effect unless modified. Finally, the district court noted that Shellpoint was repeatedly advised by an attorney that its behavior was permitted and that seeking the advice of outside counsel is a sufficient defense against civil penalties. Based on all of these facts, the District Court found that Shellpoint acted in good faith and interpreted the Confirmation Order in a manner consistent with the contractual terms of the loan, which was objectively reasonable.
Taggart was a Chapter 7 case involving a violation of the discharge, but the Fourth Circuit held that the “no good cause for doubt” test applied broadly in bankruptcy – including in Chapter cases. 11.
But the Fourth Circuit disagreed with the district court’s decision to overturn the bankruptcy court’s decision because the creditor had sought and received legal advice from outside counsel. The Fourth Circuit has ruled that an attorney’s opinion is not an absolute defense to civil contempt. The Court suggested that, according to the Taggart test, counsel’s advice “may always be considered in appropriate circumstances to be a relevant factor” and “a party’s reliance on the advice of outside counsel may be instructive, at least in part, as to whether that party’s belief that it was complying with the order was objectively unreasonable.”
The Fourth Circuit found that both lower courts erred and sent the case back to the bankruptcy court to “reconsider the contempt motion on the correct legal standard, including any further investigation that may be necessary.”
Creditors can be reassured by the “no reasonable cause for doubt” test, which is more lenient than a strict liability standard. But creditors cannot blame their lawyer for perilous conduct and expect the court to exonerate them.
But the most important conclusion has not changed: creditors must insist on clear and precise regime conditions. After more than two years of litigation, Shellpoint remains under sanctions. All of this could have been avoided if the loan officer had insisted that the plan spell out how the Beckharts’ payments would be applied to settle the arrears.