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Supreme Court applies objective test in bankruptcy case

The Supreme Court ruled on June 3 that creditors in Virginia and around the country may be held in civil contempt if they pursue payment of a debt that has been discharged in a bankruptcy. The nation's highest court applied an objective reasonableness standard to decide a case involving an Oregon business center's efforts to collect a debt from a real estate developer who had filed for bankruptcy. This standard means that creditors can be held in contempt when they seek payment of a debt that they have no reasonable basis to believe is not included in a discharge order.

The real estate developer based his lawsuit on the principle of strict liability. He argued that the business park should be held in contempt because it took action knowing that a bankruptcy had been filed and a discharge order issued. The bankruptcy court agreed and ruled in the man's favor. However, a bankruptcy appellate court reversed the ruling and the U.S. Court of Appeals for the 9th Circuit affirmed. Those courts based their decisions on the business park's good faith belief that the discharge order did not include the debt in question.

The Supreme Court took a different approach than the lower courts. Its objective reasonableness standard is not as severe as the man's strict liability argument but does not allow creditors to avoid contempt by merely by claiming that they acted in good faith. In a unanimous decision, the justices ruled that the good faith argument does not apply when creditors have no fair grounds to doubt the debt they are pursuing is included in a discharge order.

Attorneys may take legal action against creditors that seek payment of debts included in a Chapter 7 bankruptcy petition even before a discharge order has been issued. This is because an automatic stay is issued when a bankruptcy is filed that orders creditors to cease their collection efforts.

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