Rochelle's Daily Wire

Holding that a bankruptcy court may not enforce a discharge order entered in another district, the Second Circuit nixed the idea of a nationwide class action alleging contempt of the discharge injunction.

The Second Circuit found support for its holding by extrapolation from Taggart v. Lorenzen, 139 S. Ct. 1795,1799 (2019), where the Supreme Court held that a bankruptcy court may hold a creditor in civil contempt when there is objectively “no fair ground of doubt” that the creditor violated the discharge injunction. To read ABI’s report on Taggart, click here.

In the August 2 opinion, the Second Circuit said that “expanding a bankruptcy court’s civil contempt powers with respect to discharge orders [] may likely be good policy. But courts must take statutes as they find them, and, as written, the [Bankruptcy] Code leaves intact the longstanding equitable principles regarding the enforcement of injunctions.”

The Purported Nationwide Class Action

Having scheduled a bank as having a claim for about $1,100, the debtor filed a chapter 7 petition. The bank received notice of the filing and the debtor’s discharge.

A few months after discharge, the debtor pulled her credit report to find that the $1,100 debt was still listed as “written off” rather than “discharged.” The debtor demanded that the bank notify the credit reporting agency that the debt had been discharged. According to the debtor, the bank refused.

After the debtor reopened her chapter 7 case, the bank removed the “charged off” notation.

The debtor filed a purported nationwide class action in the New York bankruptcy court where she had received her discharge. The complaint alleged that the bank had continued reporting discharged debts as “charged off” to harm the debtors’ credit ratings and coerce the debtors to repay discharged debts.

The bank filed a motion to compel arbitration under an arbitration clause in the credit card agreement. The bankruptcy court denied the arbitration motion, and the district court affirmed.

On the first appeal to the Second Circuit, the appeals court held that contempt proceedings for violation of the discharge injunction are not arbitrable and are in the exclusive jurisdiction of the bankruptcy court. GE Capital Retail Bank v. Belton (In re Belton), 691 F.3d 612 (2d Cir. June 16, 2020). To read ABI’s report, click here.

[Note: ABI’s report on Belton said that the opinion contained “strongly worded dicta that the bankruptcy court may not maintain a nationwide class action to rectify violations of the discharge injunction.”]

On remand to the bankruptcy court, the bank filed a motion to dismiss for failure to state a claim and to strike the class action allegations. The bankruptcy court denied the motion to dismiss and rejected the bank’s plea to strike the class allegations. The district court certified a direct appeal, which the circuit accepted.

Class Action ‘No’; Plausible Claim ‘Yes’

In his opinion for the appeals court, Circuit Judge Richard C. Wesley framed the question as whether one bankruptcy court has authority to enforce discharge orders entered by “other bankruptcy courts across the country.” He said that Taggart was “instructive,” referring to the Supreme Court’s holding that contempt powers of the bankruptcy court incorporate “traditional standards in equity practice.” Taggart, supra, 139 S. Ct. at 1801.

In other words, Judge Wesley said that the contempt powers of bankruptcy courts are no greater than the powers “wielded by courts outside of bankruptcy.” Next, he cited the “longstanding equitable principle” that the issuing court is the only court responsible for sanctioning contumacious conduct. Indeed, he said, “Plaintiff fails to offer a single example of one court exercising its civil contempt authority on behalf of another court’s injunction.”

The notion of nationwide class actions on discharge violations, Judge Wesley said, is “in tension with our repeated observation that ‘a bankruptcy court has “unique expertise in interpreting its own injunctions and determining when they have been violated.”’ In re Gravel, 6 F.4th 503, 513 (2d Cir. 2021).”

Judge Wesley admitted that discharge orders “might often be issued on standard forms,” but he said that “the appropriateness of civil contempt sanctions, and in what form, are considerations that can still benefit from the unique insight a bankruptcy court can gain in presiding over a proceeding.”

“In any event,” Judge Wesley said, “Taggart does not suggest that the statutory basis of the discharge injunction is of any significance in determining its manner of operation or how it might be enforced.”

Judge Wesley said that the debtor “seeks a bankruptcy-specific expansion of the civil contempt power beyond its longstanding limits at equity.” Although Congress could intervene, he said that departing from “long tradition” is not “lightly implied,” citing the Supreme Court.

Following the “cautionary approach” in Taggart, Judge Wesley held, “A bankruptcy court’s civil contempt authority does not extend to other bankruptcy courts’ discharge orders in a nationwide class action.”

Having stricken the class action allegations, Judge Wesley turned to the question of whether the debtor had alleged a plausible claim of discharge violation.

Among other arguments, the bank contended that the complaint failed to state a claim because the bank had sold the debt. Judge Wesley rejected the argument, declining “to impose a rule whereby creditors can avoid their obligations under a discharge order by covertly passing their debt off to third parties.”

Judge Wesley found that the debtor had satisfied the Taggart standard because the complaint “plausibly alleges that [the bank’s] refusal to correct her tradeline was objectively, and purposively, coercive.”

Circuit Split

Although the Second Circuit did not cite Bessette v. Avco Fin. Servs., 230 F.3d 439 (1st Cir. 2000), the decision from the First Circuit arguably gives rise to a split of circuits. Bessette reversed an order barring a class action except in the court that issued the discharge and could be read to hold that discharge is a statutory injunction, not one crafted for an individual case.

Note also that the case before the Second Circuit opened “Pandora’s Box” in the manner that worried the dissenters in Coinbase Inc. v. Bielski, 143 S. Ct. 1915, 216 L. Ed. 2d 671 (Sup. Ct. June 23, 2023). To read ABI’s report, click here.

In Coinbase, the Supreme Court held that denial of a motion to compel arbitration automatically imposes a stay on the entire action in the trial court, pending appeal from the order denying arbitration.

Credit card agreements and consumer loan documents often contain arbitration clauses. If a debtor claims injury by a lender’s attempt to collect a discharged debt, the bankruptcy court likely will deny an arbitration motion under Second Circuit authority like Belton.

In future cases of alleged discharge violations, will bankruptcy courts be obliged to halt proceedings for contempt until there is a final order on appeal from denial of the arbitration motion? In a case like the one before the Second Circuit, will a debtor be unable to enforce the discharge injunction (or perhaps the automatic stay) until two layers of appellate courts have ruled on the arbitration motion?

Just imagine how arbitration motions could muck up bankruptcies, consumer and chapter 11!