The following is a case update written by Monique D. Jewett-Brewster, a shareholder of Hopkins & Carley, ALC, analyzing a recent decision of interest:
A New York bankruptcy court recently held that a taxing agency (i) did not violate the discharge by attempting to collect a restitution debt, but (ii) did violate the discharge by trying to collect a penalty debt. However, the court further held that no liability arises from the violation because the creditor had an objectively reasonable basis for believing its actions were lawful. In re Jaynes, 2020 Bankr. LEXIS 3467 (Bankr. N.D.N.Y. Dec. 11, 2020).
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On October 2, 2015, Debtor Frederick E. Jaynes was arrested for possessing several hundred cartons of unstamped and untaxed cigarettes. In August 2016, he pled guilty to selling unstamped cigarettes, a Class D Felony under New York tax law. In October 2016, the Monroe County Supreme Court issued an order directing Jaynes to pay the New York State Department of Taxation and Finance (DTF) restitution in the amount of $39,395.40, the amount of the unpaid cigarette tax, in addition to five years of probation supervision. On November 10, 2016, DTF issued a Notice of Determination of total penalties against Jaynes of $454,200.00 (approximately $600.00 for each of the 762 cartons found in his possession) for the “tax period ended date” and “file due date” of October 2, 2015—the date Debtor was found in possession of the untaxed cigarettes.
On May 15, 2019, Jaynes (Debtor) filed a voluntary petition for relief under chapter 7. In his schedules, Debtor listed DTF as holding a single, priority unsecured debt described as “2015 cigarette taxes”. Debtor received his discharge in August 2019.
In January 2020, Debtor filed an ex parte motion to reopen his case. Thereafter, Debtor filed a motion requesting the court to award civil contempt sanctions against DTF pursuant to 11 U.S.C. § 105(a) for its alleged violation of the discharge injunction provided in section 524 of the Bankruptcy Code. Specifically, Debtor argued that the entirety of the $490,324.89 that DTF attempted to collect post-discharge constituted dischargeable excise taxes under the Code. In its opposition to the motion, DTF clarified that it had assessed Debtor’s total debt of $490,324.89 in two separate accounts: first, for “Restitution” in the net balance of $36,124.89; and second, for a civil “Penalty” of $454,200.00.
Almost one year later (due to delays attributable to the Covid-19 pandemic), the bankruptcy court ruled that DTF violated section 524’s discharge injunction for attempting to collect the Penalty post-discharge; however, the court denied Debtor’s motion for sanctions.
Analyzing the dischargeability of DTF’s restitution claim, and citing to the U.S. Supreme Court’s decision in Kelly v Robinson, 479 U.S. 36, 47, 107 S.Ct. 353, 93 L.Ed.2d 216 (1986), the bankruptcy court acknowledged that federal bankruptcy courts should enforce penal sanctions so as not to invalidate the results of state criminal proceedings. As such, the court concluded, DTF’s restitution claim survived entry of Debtor’s discharge order.
The court then examined 11 U.S.C. § 523(a)(7)(B), which expressly excepts from the discharge any debt that is “a fine, penalty or forfeiture payable to and for the benefit of a governmental unit, and is not compensation for actual pecuniary loss, other than a tax penalty … imposed with respect to a transaction or even that occurred before three years before the date of the filing of the petition.” The court also reviewed Bankruptcy Code section 507(a)(8)(E), which discusses priority of “excise” taxes, or taxes imposed on the manufacture, sale, or use of goods, such as a cigarette tax, or on an occupation or activity. Undertaking a complex analysis of New York state tax law, the court ultimately agreed with Debtor’s assertion that the Penalty was an excise tax penalty assessed due to Debtor’s failure to pay the cigarette tax and/or use tax for the cartons of unstamped cigarettes in his possession on or about October 2, 2015, the date of Debtor’s arrest. As Debtor filed his petition on May 15, 2019, more than three years thereafter, the bankruptcy court concluded that Debtor’s personal liability for the Penalty had been discharged.
Examining a second decision by the Supreme Court, Taggart v Lorenzen, 139 S.Ct. 1795, 1799, 204 L.Ed.2d 129 (2019), the court then acknowledged that civil contempt for violating a discharge order may be appropriate if there is no objectively reasonable basis, i.e., no “fair ground of doubt,” for concluding that the creditor’s conduct might be lawful. The court also observed that while the “fair ground of doubt” standard identified in Taggart is an objective one, a party’s subjective intent, or good faith behind its actions, is also relevant to the contempt analysis. Rejecting Debtor’s contention that DTF should have known its entire debt was discharged due to entry of Debtor’s discharge, the court pointed out that Debtor failed to seek a determination of the dischargeability of either the Restitution or Penalty components of DTF’s claim. The court also observed that had Debtor classified the DTF debt as nonpriority in his schedules, as he did in his sanctions motion, then it would have alerted DTF that dischargeability was at issue. Analyzing the record, the court found that DTF had a fair ground to doubt that the Penalty had been discharged. Consequently, the court concluded that a finding of contempt was not warranted under the facts and circumstances of the case before it.
Under the Ninth Circuit’s binding precedent prior to the Supreme Court’s ruling in Taggart, if a creditor had a “good faith belief” that the discharge injunction did not apply, then a contempt finding would be inappropriate. See Lorenzen v Taggart (In re Taggart), 888 F.3d 438, 444-45 (9th Cir. 2018). This was true even if the creditor’s belief was unreasonable. Id. at 444 (“Although the Creditors … were ultimately incorrect, their good faith belief, even if unreasonable, insulated them from a finding of contempt.”) Thus, as aptly recognized by the U.S. Bankruptcy Appellate Panel of the Ninth Circuit in In re Freeman, 608 B.R. 228, 234 (B.A.P. 9th Cir. 2019), the Ninth Circuit’s Taggart standard for the issuance of contempt sanctions for violation of the discharge injunction was more “forgiving to creditors”. Still, although the Supreme Court rejected the Ninth Circuit’s “good faith belief” standard, it also opined that subjective intent is not always irrelevant. Taggart v Lorenzen, 139 S.Ct. at 1801. Thus, like the court in Jaynes, bankruptcy courts should correctly consider a creditor’s subjective, good faith in determining the appropriate sanctions for any unintentional violation of the discharge injunction.
For discussion of similar issues, see:
- 2019-23 Comm. Fin. News NL 46, Creditor May Be Held in Civil Contempt for Violating Bankruptcy Discharge When There is No “Fair Ground of Doubt” As to Whether Creditor’s Conduct Might Be Lawful. [Taggart v. Lorenzen, 2019 WL 2331303 (U.S. 2019).]
- 2019-39 Comm. Fin. News NL 77, U.S. Bankruptcy Appellate Panel of the Ninth Circuit Vacated Order Denying Debtor’s Motion to Hold Secured Creditor in Civil Contempt for Violation of Discharge Injunction. [In re Freeman, 608 B.R. 288 (B.A.P. 9th Cir. 2019).]
These materials were authored by Monique D. Jewett-Brewster, a shareholder of Hopkins & Carley, ALC, a member of the ad hoc group and the 2018-19 Chair of the CLA Business Law Section, with editorial contributions by the Hon. Meredith A. Jury (United States Bankruptcy Judge, C.D. Cal., Ret.), also a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.