The United States Court of Appeals, Tenth Circuit opened the door to the Objective-Coercion Principle in discharge injunction violations. In doing so, however, it distinguished the facts of the case at hand and ruled against the debtors because neither the Bankruptcy Court findings, nor the Debtor's testimony met the guidelines set out by the 10th Circuit.
In the case In re Paul, Circuit Judge Stephen H. Anderson issued the opinion that states that the Objective-Coercion Principle "operates as an overarching exception" to the rule that actions that do not directly violate the 11 U.S.C. §524 discharge injunction may still be a violation of §524(a)(2) if it can be shown that a "creditor acted in such a way as to 'coerce' or "harass' the debtor improperly so as to theoretically force them to pay a discharged debt.
The 10th Circuit, therefore, adopts the theory first established by the 1st Circuit Court of Appeals in its decision In re Pratt in 2006, except that the 10th Circuit did not find that the facts before it in In re Paul met the standard set.
This is good news for discharged debtors everywhere, especially those that are also seeking claims that might have violated the Fair Credit Reporting Act or Fair Debt Collection Practices Act. This is so because if the debtors discharged from bankruptcy can reasonably show that notations on their credit report, that were wrongly stated, re-aged, and were left unchanged reasonably acted to collect the debt, even though the reporting of a debt, even improperly, might not otherwise violate the § 524 discharge injunction, such an act, would objectively violate the intent of § 524(a)(2) -- even if no "bad faith" existed on the part of the creditor reporting or the agency reporting the debt.
This represents my immediate interpretation of the law, but what I state above was not the facts that existed in In re Paul. In that case, the creditor in the Paul's Chapter 7 bankruptcy continued with a lawsuit filed pre-petition against both the Pauls and a corporation the Pauls operated or owned. Unclear in the Court's opinion was how the Pauls were removed from the lawsuit, but they apparently were removed in every way except as "nominal defendants".
According to Black's Law Dictionary, a "nominal defendant" is a person who is joined as a defendant in an action, not because he or she is immediately liable in damages, or because any specific relief is demanded as against him or her, but because his or her connection with the subject-matter is such that the Plaintiff's action would be defective under the technical rules of practice if he or she were not joined.
In the 5th Circuit this might involve some litigation against the debtors where it is made abundantly clear that the Plaintiff is only seeking whatever damages an insurance company insuring the debtor might have to pay. In this case the 10th Circuit did not elaborate as to what action had previously been undertaken in state court to now provide for the Pauls as only nominal defendants.
A good time after the discharge of the Pauls' Chapter 7 bankruptcy the creditor proceeded against the corporation that had not filed bankruptcy. In doing so, the creditor issued subpoenas requiring the Pauls to appear for depositions. It seemed important to the 10th Circuit that the creditor stated on the deposition notice that she would not be pursuing any facts or evidence related to the Pauls' personal or individual discharged claim. It seemed to matter to the Bankruptcy Court that the creditor sought contempt against the Pauls for not showing up in another state for a civil deposition, which was not the state's rule as to non-party defendants. However, the state court eventually remedied this problem itself by removing the sanctions when it learned that the Pauls were non-parties. The Bankruptcy Court was also moved by the fact that once the sanction proceeding was brought or threatened that the creditor brought a post-petition defamation claim against Rudy Paul, which the Bankruptcy Court found baseless.
The 10th Circuit found that the Bankruptcy Court had the equitable power under 11 U.S.C. § 105(a) to enforce and remedy violations of substantive provisions of the Bankruptcy Code, including in particular the discharge injunction of § 524(a)(2), and in applying the same standard for recovery as the Bankruptcy Court's powers allow in automatic stay violations. But, the 10th Circuit also found that these equitable powers cannot be exercised contrary to or in excess of the terms of the substantive Code provision being enforced, as they found existed in the Pauls' case, with the exception of the Objective-Coercion Principle.
In short, debtors have to show that a party took some action as specifically prohibited by § 524(a)(2), namely the party had to undertake an action to "to collect, recover or offset any [discharged] debt ... of the debtor". That was not shown in the Pauls' case because they were only nominal defendants in the state court lawsuit, and the defamation claim, whether questionable or not, was clearly a post-petition claim that only applied to actions claimed to have taken place post-petition.
The 10th Circuit stated that the concept of the "fresh start" could not be used as some sort of "general gloss" or "license for courts to go beyond the particular prohibitions specified in the statute to shield debtors from adverse contingencies".
Here the actions brought were against a third party corporation, which had not filed bankruptcy. The Debtors were only "nominal defendants" and the creditor in setting depositions had specifically stated in the papers served on the Pauls that they were not being pursued in their individual capacities on the debt, but only as witnesses related to the corporation. And, the defamation action, no matter how unsound, was clearly a post-petition action.
So, to summarize, the 10th Circuit stated clearly, in that § 524(a)(2) had not been directly violated, that the Pauls could have still recovered against the creditor if they could establish that the culmination of various actions taken by the creditor would have resulted in coercion that would have pressured the Pauls to pay the pre-petition debt. Notice, however, that I did not say that the actions were intended to coerce them into paying the pre-petition debt or claim. That does not have to be established because the Court said that "bad faith" is not an issue.
The 10th Circuit relying on the language in In re Schlichtmann, 375 B.R. 41, 95-97 (Bankr. D. Mass. 2007), stated:
"[T]he discharge prohibits prepetition creditors only from collecting their prepetition debts. It is not [a] lifelong shield against other acts–including . . . assertions of claims, and litigation–by those same creditors, even where these other acts are undertaken wrongfully and in bad faith. If an act is not in fact one to collect or enforce a prepetition debt, then whatever its faults, it is not a violation of the discharge, even though undertaken by the holder of a discharged debt".
The 10th Circuit nonetheless ruled that a: "debtor may establish that a creditor who has taken an action not overtly prohibited by § 524(a)(2) nevertheless violated the discharge injunction, but to do so the debtor must 'prove not merely that [the creditor's] act is not what it appears to be, but that the act in question is one to collect a discharged debt in personam".
This is the so-called Objective-Coercion Principle.
It is an objective standard, because the court does not look for bad faith (or I guess lack of good faith) on the part of the creditor, but conducts its own objective inquiry to determined if the actions of the creditor lacked "any reason other than coercion".
The 10th Circuit said that although the creditor's actions in In re Paul did not violate § 524(a)(2), that the creditor could still be held in contempt if it could be determined, on a factually sufficient record, that the effect of the state litigation was nevertheless to harass or coerce the Pauls into paying discharged debts. The Court just noted that in this case such a thing was not proved and that the Bankruptcy Court did not make such a determination. So much for having a factually sufficient record.
The 10th Circuit specifically stated that the Bankruptcy Court's criticism of the creditor in In re Paul was not unjustified. In fact, it probably was justified. The issue was whether the creditor's "conduct had a coercive effect on the Pauls, pressuring them to pay off any discharged pre-petition claims". (Emphasis added). And, for future reference that is the standard that has to be proved or established. Not what the creditor necessarily intended (although that might be relevant) to collect a pre-petition claim personally, but what was the effect the actions of the creditor had on the debtors.
In short, the objective standard is from the perspective of the debtors, in this case the Pauls, and what they actually believe, and whether there were any objective facts to argue against coercion. In other words, the debtors had better say the effect of the action was that they believed their only possible recourse was to pay the debt to stop the actions and get the creditor out of their hair, and from an objective factual and legal basis, the creditor better have not just a legitimate legal right to do what it is doing, but it had better make economic sense that they are undertaking such an set of actions. The testimony of the debtors that they felt pressured to pay a pre-petition claim (regardless of the intent of good faith of the creditor), and the creditor pursuing either a right not allowed, or for no other good economically relevant reason, is likely to cause the creditor a substantial amount of trouble.
Think of it like a restraining order in which the creditor is ordered not to be found within 100 feet of the debtor. If the creditor is found there, it had better have a legitimate reason to be there. Otherwise, the harassment to the debtor for the creditor being there is going to overcome some argument the creditor was just hanging out. The argument that the creditor was at the mall doing some necessary shopping, rounded the corner and ran into the debtor that the creditor did not know would be at the mall, is going to be a better position that the creditor was just hanging out in the debtors front yard staring at their overgrown grass.
From the Pauls' own testimony this was not established or even stated.
As for whether a post-petition lawsuit, based upon post-petition actions of the debtor Ruby Paul is baseless, the 10th Circuit specifically stated that the state court in which the suit was brought would have to make this determination. But, if the state court so found this to be true, then the Bankruptcy Court could then conduct a Objective-Coercion hearing to determine if this baseless suit had such an effect as required on the debtors.
To me, this point is terribly important as to all of the collection lawsuits now being filed out of venue, out of jurisdiction, after the statute of limitations, etc. If the court hearing these lawsuits finds the lawsuit is baseless as such, the bankruptcy court can then be asked to review whether the lawsuit was brought simply to coerce or harass the debtor.
Further the 10th Circuit seems to adopt the 1st Circuits "raison d' etre gap" standard, wherein the court can determine if there is no other reasonable reasons for the creditor to be taking the actions it is taking. If not, the court can infer a covert agenda implicating § 524(a)(2) prohibitions. What seemed to save the creditor in In re Paul from this determination was that she specifically disclaimed any such action while setting the depositions, no matter how inappropriately the demand for the debtors to travel to another state for the depositions. Also, the pursuit of the corporation in question had a legitimate purpose apart from the Pauls' discharge. The 10th Circuit stated that "[o]f course, conduct that facially appears permissible may still violated § 524(a)(2) if its objective effect is prohibited, i.e., if it really serves to pressure the debtor to pay a discharged debt."
Unfortunately, neither the Pauls nor the Bankruptcy Court in In re Paul ever stated that the acts outside of § 524(a)(2) pressured or coerced them in any way to pay their pre-petition claim. If they had, the outcome might well have been different.
(Pictured is the 10th Circuit Court of Appeals courtroom)