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July 28 — Trying to collect on a debt that was discharged in a prior bankruptcy does in fact violate the prior bankruptcy's discharge injunction, the Eleventh Circuit held in a case of first impression.
While some bankruptcy courts have disagreed with the approach used in this case, Judge Ed Carnes found that the discharge injunction “prohibits filing a proof of claim for a discharged debt where the objective effect of the claim is to pressure the debtor to repay the debt.” But the court disagreed with the lower courts' approach to sanctions and ordered the bankruptcy court to reevaluate whether sanctions were appropriate.
A new bill was recently proposed in the Senate that would require banks and debt buyers to notify credit reporting agencies, like Equifax, Experian, Trans Union, when a consumer's debt has been discharged in bankruptcy. Debts that have been wiped out in bankruptcy can sometimes continue to plague a debtor and are often referred to as “phantom” or “zombie” debts.
The discharge injunction bars creditors from trying to collect on discharged debts “as a personal liability of the debtor,” under Section 524(a)(2) of the Bankruptcy Code. The creditors in this case, who filed a proof of claim in the debtors' second bankruptcy for a debt that had been discharged in the first bankruptcy, argued that filing a proof of claim doesn't have any effect on a debtor's personal liability. The creditors claimed there was no violation of the discharge injunction because the claim was filed against the bankruptcy estate and not the debtors personally.
The circuit court said that the phrase “as a personal liability of the debtor” was “too ambiguous to dictate a clear result in any case where a creditor makes a claim against an estate or a party other than a debtor in a way that ultimately forces the debtor to pay.” Turning to the legislative history of the discharge injunction, the court said that Congress intended it to ensure that debtors wouldn't be “pressured” in any way to repay a debt that had been discharged.
Both the Second and Tenth Circuits have “identified ‘pressure' to repay a debt as the litmus test for whether the action affected the debtor's personal liability within the meaning of § 524(a)(2),” the court said.
“Adopting the reasoning of our sister circuits, we hold that the test for whether a creditor violates the discharge injunction under 11 U.S.C. § 524(a)(2) is whether the objective effect of the creditor's action is to pressure a debtor to repay a discharged debt, regardless of the legal entity against which the creditor files its claim,” the court said.
A recent Tennessee case, Moore v. Comenity Capital Bank (In re Moore), 2014 BL 270090, 521 B.R. 280 (Bankr. E.D. Tenn. 2014), also held that “the act of filing a proof of claim for a discharged debt can violate the discharge injunction of 11 U.S.C. § 524(a),” according to research conducted by Bloomberg BNA. That case relied in part of the Eleventh Circuit's decision in Crawford v. LVNV Funding, LLC, 2014 BL 191857, 758 F.3d 1254 (11th Cir. 2014), which held that filing a proof of claim to collect a stale debt in a Chapter 13 case was a violation of the Fair Debt Collection Practices Act.
The court concluded that filing the proof of claim was an act to collect a debt as a personal liability of the debtors in violation of the discharge injunction. The court said that because filing the proof of claim “triggered an increase in the [debtors'] projected bankruptcy plan payments,” it “created the kind of pressure to which the statute is sensitive.”
In this case, both the bankruptcy court and the district court found that sanctions were appropriate. The lower courts characterized certain non-compensatory sanctions as “coercive,” which usually means sanctions intended to bring an end to an ongoing contempt. But the circuit court found these sanctions were in fact punitive, meaning intended to punish the creditors, and therefore the bankruptcy court “erred by failing to afford [the creditors] the due process that imposing such sanctions requires.” The court noted that the creditors withdrew the proof of claim promptly and admitted their mistake in filing it in this case.
The court also remanded on the issue of compensatory sanctions for emotional distress, and directed the bankruptcy court to reconsider that issue under the proper standard.
Nicholas Heath Wooten of Nick Wooten, LLC, Auburn, Ala., represented the debtors.
John Evans Bailey and Robert Austin Huffaker, Jr. of Rushton Stakely Johnston & Garrett, PA, Montgomery, Ala., and Paul Joseph Spina, III of Yearout Spina & Lavelle, PC, Birmingham, Ala., represented the creditors.
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