FILED APR 12 2016 1 SUSAN M. SPRAUL, CLERK 2 ORDERED PUBLISHED U.S. BKCY. APP. PANEL OF THE NINTH CIRCUIT
3 UNITED STATES BANKRUPTCY APPELLATE PANEL 4 OF THE NINTH CIRCUIT 5 In re: ) BAP No. OR-15-1119-JuKiF ) BAP No. OR-15-1158-JuKiF 6 BRADLEY WESTON TAGGART, ) (related appeals) ) 7 Debtor. ) Bk. No. 09-39216-RLD7 ______________________________) 8 ) TERRY W. EMMERT; KEITH JEHNKE;) 9 SHERWOOD PARK BUSINESS CENTER,) LLC; SHELLEY A. LORENZEN, ) 10 Executor of the Estate of ) Stuart Brown, ) 11 ) Appellants, ) 12 ) v. ) O P I N I O N 13 ) BRADLEY WESTON TAGGART, ) 14 ) Appellee. ) 15 ______________________________) 16 Argued and Submitted on March 17, 2016 at Pasadena, California 17 Filed - April 12, 2016 18 Appeal from the United States Bankruptcy Court 19 for the District of Oregon 20 Honorable Randall L. Dunn, Bankruptcy Judge, Presiding _________________________ 21 Appearances: Hollis K. McMilan argued for appellants 22 Terry W. Emmert, Keith Jehnke, and Sherwood Park Business Center, LLC; James Ray Streinz, McEwen 23 Gisvold LLP, argued for appellant Shelley A. Lorenzen; John M. Berman argued for appellee Bradley Weston 24 Taggart. _________________________ 25 26 27 Before: JURY, KIRSCHER, and FARIS, Bankruptcy Judges. 28 1 JURY, Bankruptcy Judge: 2 3 Sherwood Park Business Center, LLC (SPBC) commenced a state 4 court lawsuit against chapter 71 debtor, Bradley Weston Taggart 5 (Debtor), BT of Sherwood, LLC (BT), and Debtor’s attorney John 6 M. Berman (Mr. Berman), prior to Debtor’s bankruptcy filing. 7 Terry W. Emmert (Mr. Emmert), Keith Jehnke (Mr. Jehnke), and 8 Debtor were members of SPBC. The litigation arose due to 9 Debtor’s transfer of his membership interest in SPBC to another 10 LLC entity. The membership was ultimately purchased by Mr. 11 Berman, in violation of SPBC’s operating agreement. Among other 12 things, SPBC sought to unwind Debtor’s transfer of his 13 membership interest and expel him from the company. Debtor and 14 BT answered the complaint and asserted a counterclaim against 15 Mr. Emmert, Mr. Jehnke, and SPBC for attorneys’ fees. 16 Debtor filed his bankruptcy petition on the eve of the 17 state court trial and subsequently received his discharge. Mr. 18 Emmert and Mr. Jehnke, represented by Stuart M. Brown (Mr. 19 Brown),2 resumed the state court litigation postpetition. They 20 sought no money judgment against Debtor due to his discharge. 21 The action ultimately went to trial. Debtor did not appear, 22 although Mr. Berman did. After trial, the state court ruled in 23 favor of SPBC by unwinding Debtor’s transfer of his membership 24 1 25 Unless otherwise indicated, all chapter and section references are to the Bankruptcy Code, 11 U.S.C. §§ 101-1532, and 26 “Rule” references are to the Federal Rules of Bankruptcy Procedure. 27 2 Shelley A. Lorenzen (Ms. Lorenzen) is the executor of Mr. 28 Brown’s estate.
-2- 1 interest and reinstating Mr. Emmert’s and Mr. Jehnke’s right of 2 first refusal to purchase the interest under the SPBC operating 3 agreement. 4 Mr. Brown later filed a petition (Petition) in the state 5 court on behalf of Mr. Emmert, Mr. Jehnke, and SPBC, seeking 6 attorneys’ fees and costs for the period after Debtor’s 7 discharge. At the same time, he sought a ruling from the state 8 court on the issue whether the discharge injunction applied to 9 the post-discharge fee request, asserting that Debtor had 10 “returned to the fray” under the holding in Boeing North 11 American, Inc. v. Ybarra (In re Ybarra), 424 F.3d 1018 (9th Cir. 12 2005). Debtor opposed, arguing that he had not voluntarily 13 returned to the fray under the Ybarra rule. After a hearing, at 14 which Debtor testified, the state court issued a written ruling, 15 finding that Debtor had returned to the fray and thus the 16 discharge injunction did not apply to the post-discharge request 17 for attorneys’ fees and costs under the Ybarra rule. The state 18 court awarded SBPC its attorneys’ fees and costs, but denied 19 fees and costs as to Mr. Emmert and Mr. Jehnke. 20 Prior to the state court’s ruling, Debtor reopened his 21 bankruptcy case and filed a motion seeking to hold Mr. Emmert, 22 Mr. Jehnke, and Mr. Brown (collectively, Appellants) in contempt 23 for violating the discharge injunction under § 524(a)(2). The 24 bankruptcy court ruled on the matter after the state court had 25 ruled. The bankruptcy court denied Debtor’s motion, finding no 26 error with the state court’s ruling on the applicability of the 27 discharge injunction under Ybarra. Upon its own de novo review, 28 the bankruptcy court also found that the record supported the
-3- 1 finding that Debtor had voluntarily returned to the fray in the 2 state court litigation and thus the discharge injunction did not 3 apply to Appellants’ request for post-discharge attorneys’ fees. 4 At Mr. Brown’s request, the state court entered judgment in 5 favor of SPBC pursuant to its previous award. 6 Debtor appealed the bankruptcy court’s decision to the 7 district court. The district court reversed, finding that 8 Debtor’s actions in the state court litigation were not 9 sufficiently affirmative and voluntary to be considered 10 returning to the fray under the Ybarra rule. The district 11 court remanded the matter to the bankruptcy court to determine 12 whether Appellants knowingly violated the discharge injunction 13 by seeking attorneys’ fees in the state court. 14 On remand, the bankruptcy court found that Debtor had 15 proved by clear and convincing evidence that Appellants 16 willfully violated the discharge injunction since they were 17 aware of the discharge injunction and intended the actions which 18 violated it. The court entered an order for contempt. After a 19 subsequent hearing, the bankruptcy court entered a judgment 20 awarding sanctions in favor of Debtor against Mr. Emmert, Mr. 21 Jehnke, SPBC, and Mr. Brown. 22 Mr. Emmert, Mr. Jehnke, and SPBC filed a timely appeal from 23 the judgment (BAP No. OR-15-1119). Ms. Lorenzen, as executor 24 for Mr. Brown’s estate, filed a separate notice of appeal from 25 the same judgment (BAP No. OR-15-1158). As further discussed 26 below, we conclude that the bankruptcy court erred by applying 27 an incorrect legal standard to determine whether Appellants had 28 actual knowledge that the discharge injunction applied to their
-4- 1 fee request in the state court as required under the holding in 2 Zilog, Inc. v. Corning (In re Zilog, Inc.), 450 F.3d 996 (9th 3 Cir. 2006). Accordingly, we REVERSE the bankruptcy court’s 4 finding of contempt and VACATE the judgment awarding sanctions. 5 I. FACTS3 6 A. Prepetition Events And Debtor’s Bankruptcy Filing 7 Debtor was a general contractor who operated through a 8 corporation, Builders, Inc. (Builders). He developed several 9 business parks, anchored by tenants who also were owners. In 10 October 1999, SPBC was formed to build and operate a two- 11 building business park in Sherwood, Oregon. SPBC was initially 12 owned by four members, each with a 25% member interest: Debtor, 13 Mr. Jehnke, John Hoffard, and Anthony Benthin. Debtor was 14 designated as the manager. At some point, Mr. Emmert succeeded 15 to the member interest of Mr. Benthin in SPBC.4 The operating 16 agreement governed the operations of SPBC, including transfers 17 of ownership. Under the agreement, members had the right of 18 first refusal before any transfer was made and any transfer of a 19 membership interest had to be approved by a majority of the 20 other members. 21 In late 2004, Debtor began experiencing financial 22 difficulty. In connection with Builders, he stopped paying the 23 payroll withholding to the Oregon Department of Revenue (ODR) 24 and the Internal Revenue Service (IRS) and began diverting funds 25 3 Many of the background facts are set forth in the 26 bankruptcy court’s Memorandum Decisions dated December 9, 2011, 27 and December 16, 2014. 4 28 Mr. Hoffard apparently joined with Debtor in filing the counterclaim against Mr. Emmert, Mr. Jehnke, and SPBC.
-5- 1 intended for the business to his own use. Tax liens of about 2 $250,000 were placed against him as a result of unpaid 3 withholdings for Builders. 4 At some point in 2004, Mr. Emmert acquired a 50% ownership 5 interest in Builders. Thereafter, relations between Debtor and 6 Mr. Emmert became contentious. 7 In 2005, Debtor encouraged three creditors to file an 8 involuntary bankruptcy petition against Builders, which had 9 become insolvent while the SPBC buildings were being 10 constructed. The IRS claim in the Builders’ bankruptcy case for 11 unpaid withholding was (with interest) about $400,000, and the 12 ODR had filed liens for about $110,000. These liens were filed 13 in Washington and Deschutes Counties and attached to all real 14 and personal property that was either owned by Debtor in late 15 2005 or acquired after the date. 16 Mr. Jehnke replaced Debtor as the SPBC manager in 2005. 17 It was also discovered sometime in late 2004 or early 2005 18 that Debtor had diverted about $30,000 in cash from SPBC for his 19 own purposes. These funds were designated for a deposit for 20 steel building materials. Because Debtor refused to return the 21 money or otherwise apply it to the building materials, SPBC 22 initiated an arbitration. The arbitrator found that Debtor 23 converted the funds and breached his fiduciary duty to SPBC. In 24 2008, the award was confirmed in a judgment in favor of SPBC and 25 against Debtor. Mr. Berman represented Debtor in the 26 arbitration and paid the award on Debtor’s behalf. 27 Debtor’s financial condition subsequently deteriorated 28 further. In mid-2007, Debtor, with the assistance of Mr.
-6- 1 Berman, formed BT and transferred his 25% member interest in 2 SPBC to BT. Debtor pursued this so that he could sell his 3 interest in the new LLC without complying with the restrictions 4 imposed by SPBC’s operating agreement for the sale of his 5 membership interest. Unable to sell his interest in BT to a 6 third party, Debtor transferred his entire membership interest 7 in BT to Mr. Berman in exchange for payments totaling $200,000. 8 Mr. Berman became a member in SPBC. 9 In September 2008, SPBC filed a complaint against Debtor, 10 BT, and Mr. Berman in the state court, asserting claims for 11 breach of fiduciary duty, expulsion due to breach of contract, 12 attorneys’ fees, and declaratory relief (State Court Lawsuit). 13 An amended complaint asserted essentially the same claims with 14 elaborating allegations. SPBC sought to expel Debtor from the 15 company and to unwind the transfers between Debtor and BT so 16 that Mr. Emmert and/or Mr. Jehnke could purchase Debtor’s 17 membership interest. In October 2009, Debtor filed an answer to 18 the amended complaint, asserting affirmative defenses and 19 stating a counterclaim for attorneys’ fees against Mr. Emmert, 20 Mr. Jehnke, and SPBC. 21 On November 4, 2009, the day that the trial in the State 22 Court Lawsuit was to begin, Debtor filed a chapter 7 petition. 23 In Schedule B, Debtor did not mention any interest in either 24 SPBC or BT, but he did include a potential attorneys’ fee award 25 on his counterclaim in the State Court Lawsuit. Shortly after 26 the filing, the chapter 7 trustee in Debtor’s case filed a 27 report of no assets available for distribution, and Debtor 28 received his discharge by order entered on February 23, 2010.
-7- 1 The State Court Lawsuit was stayed while Debtor’s case was 2 pending. 3 B. Post-discharge Events 4 1. The State Court Proceedings 5 After Debtor received his discharge, Mr. Brown resumed the 6 State Court Lawsuit on behalf of Mr. Jehnke and Mr. Emmert. He 7 served Debtor with a subpoena for a deposition on April 9, 2010. 8 Mr. Berman filed a motion for a protective order on Debtor’s 9 behalf, requesting that the subpoena be quashed. Evidently the 10 state court denied the motion because Debtor appeared for his 11 deposition and was examined. 12 The state court scheduled the trial for May 18, 2010. The 13 day before, Mr. Berman filed a motion to dismiss the claims 14 against Debtor. Mr. Berman asserted that dismissal was proper 15 since the claims against Debtor related solely to his pre- 16 bankruptcy conduct and thus were subject to his discharge. 17 The motion did not mention Debtor’s counterclaim against Mr. 18 Emmert, Mr. Jehnke, and SPBC for attorneys’ fees. 19 The motion to dismiss was argued on the first day of the 20 trial. Mr. Brown agreed that his clients would not be seeking 21 monetary relief against Debtor, but argued that Debtor was a 22 necessary party with respect to the expulsion claim. The state 23 court ruled that no money judgment would be entered against 24 Debtor, but otherwise denied the motion to dismiss. Mr. Berman 25 renewed the motion to dismiss the claims against Debtor at the 26 end of trial. The state court denied the motion. Debtor did 27 not appear or testify at the trial. 28 Following the trial, the state court generally found in
-8- 1 favor of SPBC. Mr. Brown drafted the Findings of Fact and 2 Conclusions of Law (Findings and Conclusions) which the state 3 court later signed. All counterclaims of Debtor and BT were 4 dismissed with prejudice. Debtor’s transfer of his interest in 5 SPBC was unwound and the right of first refusal to purchase the 6 interest according to the provisions in the operating agreement 7 was triggered. The judgment provided that the purchase price 8 shall be the fair market value of SPBC as of the date of entry 9 of judgment, multiplied by Debtor’s 25% interest less any unpaid 10 post-bankruptcy petition attorneys’ fees and costs, and any 11 prevailing party fees which might be assessed against Debtor 12 under Oregon law. The Findings and Conclusions were entered on 13 July 29, 2010. 14 Although the issue of attorneys’ fees was discussed, that 15 issue was not decided at the judgment stage. The state court 16 entered a general judgment on May 26, 2011. Debtor and BT 17 appealed the judgment. 18 Subsequently, Mr. Brown filed the Petition seeking 19 attorneys’ fees and costs on behalf of Mr. Emmert, Mr. Jehnke, 20 and SPBC.5 The Petition acknowledged that Debtor’s liability 21 for fees, if any, “would be limited to fees incurred after he 22 filed for bankruptcy on November 4, 2009[,]” citing In re 23 Ybarra. 24 In opposition, Debtor argued: 25 Not only have I not sought to be involved with this litigation at any time, especially after my 26 bankruptcy, but I sought to be dismissed prior to the 27 5 28 The attorney who represented SPBC authorized Mr. Brown to file the Petition on behalf of SPBC.
-9- 1 recent trial. I note that Emmert and Jehnke contend that I ‘joined the fray’ by seeking a protective 2 order. . . . Any legal fees incurred by Emmert and Jehnke in this matter were mostly not in litigation 3 with me because I did not have much to do with this case. . . . It is submitted that when I received a 4 discharge in bankruptcy, that discharge protected me from any liability such as being sought in this 5 matter, both for attorney fees and for any costs. It is important to point out that I sought nothing in 6 this litigation. 7 Mr. Brown clarified at the August 1, 2011 hearing on the 8 Petition that only post-discharge attorneys’ fees and costs were 9 sought from Debtor. In arguing that Debtor returned to the fray 10 under the Ybarra rule, Mr. Brown noted that on the one hand, Mr. 11 Berman will say he does not represent Debtor and will not accept 12 service, but on the other hand, Mr. Berman will come into court 13 and file something on behalf of Debtor. Next, he pointed out 14 that Debtor had moved for a protective order post-discharge, 15 filed a motion to dismiss the claims against him, and never 16 dismissed his counterclaim for an award of attorneys’ fees and 17 costs. Mr. Brown further asserted that Debtor claimed the 18 attorneys’ fees that might be awarded to him in the litigation 19 as an asset in his bankruptcy case. This evidence, according to 20 Mr. Brown, showed that Debtor had not abandoned his counterclaim 21 for attorneys’ fees against Mr. Emmert, Mr. Jehnke, and SPBC. 22 Finally, Mr. Brown argued that although Debtor claimed to have 23 asked to be dismissed from the litigation, this was not true. 24 Rather, Debtor asked for dismissal of the claims against him on 25 the grounds that those monetary claims were discharged by his 26 bankruptcy. Mr. Brown maintained that all these facts showed 27 that Debtor was participating in the litigation going forward. 28 Mr. Berman called and examined Debtor as a witness at the
-10- 1 hearing on the Petition. Debtor testified that he was tired of 2 the litigation that had been going on for years and that he 3 never intended to participate in any manner in the lawsuit after 4 his bankruptcy discharge. He also testified that after he filed 5 his bankruptcy petition, he did nothing to attempt to assert his 6 right under the state court counterclaim for attorneys’ fees. 7 At another point, Mr. Berman stated on the record that he was 8 representing Debtor. Finally, in argument, Mr. Berman again 9 noted that Debtor had no involvement in the case. At that 10 point, Mr. Berman informed the state court that Debtor had filed 11 a motion for contempt in the bankruptcy court alleging that 12 Appellant had violated the discharge injunction. Mr. Berman 13 opined that the state court could decide the matter or wait and 14 hear what the bankruptcy court said. After the hearing 15 concluded, the state court took the matter under advisement. 16 On August 11, 2011, the state court issued a letter opinion 17 (Letter Opinion) addressing the Petition. The Letter Opinion 18 states in relevant part: 19 The court notes that In re Ybarra, 424 F[.]3d 1018 (9th Cir. 2005) holds that the trial court has power 20 to award post-petition attorney fees against a debtor who continues to pursue litigation post-petition that 21 had been begun pre-petition. This is consistent with the federal case law the court reviewed. 22 Taggart filed an answer that was file stamped October 23 28, 2009. The answer contained a counterclaim for attorney fees based on Section 13.6 of the Operating 24 Agreement. 25 The answer also sought to have plaintiff’s claim to be dismissed against him. This was consistent with the 26 oral Motion to Dismiss raised at the time of trial. Taggart never abandoned his counterclaim for attorney 27 fees. Rather he continued to pursue his position 28 -11- 1 postpetition that the plaintiff’s claim against him be dismissed which, if successful, would have led to 2 Taggart having a contractual right to obtain attorney fees. 3 The court awards attorney fees in favor of BT of 4 Sherwood [sic-actually, SPBC] in the amount sought at oral argument. My notes are difficult to decipher but 5 I believe that amount was $44,691.50. (It may be accurately $44,611.50 as the ten column is the one I 6 am having trouble reading.) Costs and disbursements sought as well as the standard prevailing party fee 7 are also appropriate. 8 [SPBC] is the prevailing party with respect to Brad Taggart (as noted above) . . . . 9 10 In the end, the state court granted SPBC its attorneys’ 11 fees and costs, but denied Mr. Emmert’s and Mr. Jehnke’s 12 requests. 13 2. The Bankruptcy Court Proceedings 14 Meanwhile, about one month earlier, on July 13, 2011, 15 Debtor had reopened his case and filed a motion in the 16 bankruptcy court seeking to hold Mr. Brown, Mr. Emmert, and Mr. 17 Jehnke in contempt for seeking attorneys’ fees and costs in the 18 state court in violation of the discharge injunction under 19 § 524. Debtor repeated his arguments that he made no claim to 20 any interest in SPBC and that he filed bankruptcy because he did 21 not want any further involvement with SPBC, Mr. Emmert, or Mr. 22 Jehnke. He further reiterated that he did not participate in 23 the state court trial and made no claims in the trial. Finally, 24 he contended that the request for attorneys’ fees in the state 25 court was causing him extreme emotional distress and that Mr. 26 Brown, Mr. Emmert, and Mr. Jehnke were denying him a fresh 27 start. Debtor sought sanctions consisting of his attorneys’ 28 fees and costs, $50,000 for emotional distress, and $100,000 in
-12- 1 punitive damages for Appellants’ intentional violation of the 2 discharge injunction. 3 The bankruptcy court held an evidentiary hearing on 4 November 14, 2011. The court acknowledged that the state court 5 had concurrent jurisdiction to decide whether the discharge 6 injunction was violated, but its decision had no effect if the 7 state court “got it wrong.” The bankruptcy court also observed 8 that it had to determine whether Debtor’s involvement in the 9 state court litigation, either directly or through Mr. Berman, 10 fit within the Ybarra rule. The bankruptcy court took the 11 matter under advisement. 12 On December 9, 2011, the court issued its decision. 13 Finding that the state court applied the correct legal standard 14 under Ybarra, the bankruptcy court concluded that the state 15 court’s factual findings regarding Debtor’s return to the fray 16 were not clearly erroneous. After conducting an independent 17 review of the state court proceedings, the bankruptcy court 18 observed that due to the “mixed record,” it was not sure whether 19 any of Debtor’s actions, on his own or through Mr. Berman, would 20 establish that Debtor renewed active participation in the State 21 Court Lawsuit post-discharge. Apparently, the pivotal fact for 22 the bankruptcy court’s analysis was the state court’s 23 determination that Debtor’s attempted transfer of his membership 24 interest in SPBC was ineffective and thus would be unwound, and 25 that Debtor would be paid for that interest.6 Accordingly, the 26 6 27 In other words, although Debtor claimed he asserted no interest in SPBC in the litigation, because the state court 28 (continued...)
-13- 1 bankruptcy court found that Debtor re-engaged in the State Court 2 Lawsuit, effectively returning to the fray for Ybarra purposes. 3 The court concluded that Debtor did not meet his burden of proof 4 by clear and convincing evidence showing that Appellants had 5 willfully violated the discharge injunction. 6 On January 18, 2012, Mr. Brown submitted a supplemental 7 judgment (Supplemental Judgment) to the state court in 8 connection with its previous award of attorneys’ fees and costs 9 to SPBC. 10 On January 23, 2012, the bankruptcy court entered the order 11 denying Debtor’s motion for contempt. Debtor moved for 12 reconsideration, which the bankruptcy court denied. 13 3. The District Court Proceedings 14 Debtor appealed the bankruptcy court’s order denying his 15 motion for contempt to the district court. The district court 16 reversed, based on its conclusion that Debtor’s actions in the 17 state court were not sufficiently affirmative and voluntary to 18 be considered returning to the fray under Ybarra. The district 19 court remanded the matter to the bankruptcy court to consider 20 whether Debtor had proven that Appellants “knowingly” violated 21 the discharge injunction in seeking the attorneys’ fees and 22 23 24 6 (...continued) 25 unwound the transfer of his membership interest, he was once 26 again a member of SPBC. The return to the status quo gave Mr. Emmert and/or Mr. Jehnke the right of first refusal to purchase 27 his interest as per the operating agreement. Therefore, Debtor would receive payment for his interest from one of them, separate 28 and apart from the monies paid to him by Mr. Berman.
-14- 1 costs in the state court.7 2 4. The Remand Proceedings 3 On November 7, 2014, the bankruptcy court heard further 4 oral argument on the issue whether Appellants “willfully” 5 violated the discharge injunction and took the matter under 6 advisement. 7 On December 16, 2014, the bankruptcy court issued its 8 decision. The court recited the two-part test in the Ninth 9 Circuit for determining whether there was a willful violation of 10 the discharge injunction set forth in Zilog. In Zilog, the 11 Ninth Circuit cited with approval the standard adopted by the 12 Eleventh Circuit for violation of the discharge injunction: 13 “[T]he movant must prove that the creditor (1) knew the 14 discharge injunction was applicable and (2) intended the actions 15 which violated the injunction.” 450 F.3d at 1007 (citing 16 Renwick v. Bennett (In re Bennett), 298 F.3d 1059, 1069 (9th 17 Cir. 2002) (citing Hardy v. United States (In re Hardy), 97 F.3d 18 1384, 1390 (11th Cir. 1996)). 19 Although the bankruptcy court cited the correct test for a 20 finding of willfulness from Zilog, it instead used the test from 21 Hardy in connection with the first prong of the test - the 22 actual knowledge requirement. There, the knowledge requirement 23 is phrased as whether the defendant in the contempt action “knew 24 25 7 Mr. Emmert, Mr. Jehnke, and SPBC recognized in their 26 reply brief that we have no jurisdiction to review the district court’s order. Ms. Lorenzen recognized this as well in her 27 opening brief. We express no opinion on the question whether Debtor “returned to the fray,” because that issue is before the 28 Ninth Circuit, not us.
-15- 1 that the [discharge injunction] was invoked.” In re Hardy, 97 2 F.3d at 1390. Further relying on Hardy, the bankruptcy court 3 found that this test did not allow the court to consider 4 Appellants’ subjective beliefs, good faith or otherwise, 5 regarding whether, as a legal matter, the discharge applied to 6 the proceedings. As a result, the court concluded that the test 7 for actual knowledge was akin to a strict liability test. 8 The court further decided that neither the state court’s prior 9 decision or its decision on the applicability of Ybarra 10 insulated Appellants from a “willfulness” finding. Apparently, 11 the bankruptcy court reached that conclusion on the basis that 12 the state court’s decision was wrong and its decision was 13 reversed. 14 Based on this reasoning, the bankruptcy court decided that 15 Debtor had proved the actual knowledge requirement by clear and 16 convincing evidence. In other words, Appellants had actual 17 knowledge of the discharge injunction at the time they filed the 18 Petition in the state court requesting attorneys’ fees and 19 costs. The court concluded: “As such they are charged with 20 knowledge of the discharge injunction.”8 21 In considering whether Appellants intended the actions 22 which violated the discharge injunction, the bankruptcy court 23 found that there was no dispute. Mr. Brown testified he 24 prepared and submitted the Supplemental Judgment. Because Mr. 25 26 8 We assume the bankruptcy court made this finding because 27 Mr. Emmert and Mr. Jehnke had requested their attorneys’ fees and costs and not because they sought entry of the Supplemental 28 Judgment which only applied to SPBC.
-16- 1 Brown would not have proceeded without approval from his 2 clients, and because the record did not reflect that Mr. Emmert 3 and Mr. Jehnke had instructed Mr. Brown not to proceed with the 4 Petition, the court found that they also intended the actions 5 that led to the entry of the Supplemental Judgment. The court 6 thus found Debtor had proved the second element of the 7 willfulness test by clear and convincing evidence. The 8 bankruptcy court found the Supplemental Judgment void and 9 entered an order holding Appellants in contempt for violating 10 the discharge injunction. 11 Subsequently, the bankruptcy court held an evidentiary 12 hearing regarding Debtor’s damages and issued a written decision 13 on March 17, 2015. While Debtor requested emotional distress 14 damages of $50,000, the bankruptcy court ultimately found that 15 he was entitled to $5,000, awarded jointly and severally against 16 Appellants. With respect to the attorneys’ fees and costs, the 17 bankruptcy court awarded fees in the amount of $101,450 and 18 costs of $4,143.71 for a total of $105,593.71, jointly and 19 severally against Mr. Emmert, Mr. Jehnke, and SPBC, and 20 attorneys’ fees and costs totaling $92,118.71 against Mr. 21 Brown’s estate, payable jointly and severally as part of the 22 total attorneys’ fees and costs award against Appellants. 23 Finally, Debtor requested $100,000 in punitive damages, 24 which he later reduced to $20,000. As to Mr. Brown, the court 25 found punitive damages were not appropriate since they would 26 serve no deterrent purposes with respect to his estate. The 27 court awarded $2,000 in punitive damages jointly and severally 28 against Mr. Emmert, Mr. Jehnke, and SPBC.
-17- 1 The bankruptcy court entered the order on March 26, 2015. 2 Four days later, the court entered the judgment regarding the 3 sanctions. 4 On April 13, 2015, Mr. Emmert, Mr. Jehnke, and SPBC filed a 5 timely notice of appeal from the judgment. On the same day, Ms. 6 Lorenzen filed a motion to extend the time for appeal. After a 7 hearing, the bankruptcy court granted the motion on April 27, 8 2015, extending the time to file a notice of appeal for fourteen 9 days after the entry of the order. On May 11, 2015, Ms. 10 Lorenzen filed a timely notice of appeal from the judgment.9 11 II. JURISDICTION 12 The bankruptcy court had jurisdiction pursuant to 28 U.S.C. 13 §§ 1334 and 157(b)(2)(O). We have jurisdiction under 28 U.S.C. 14 § 158. 15 III. ISSUE 16 Did the bankruptcy court abuse its discretion by finding 17 that Appellants willfully violated the discharge injunction? 18 IV. STANDARDS OF REVIEW 19 Determining whether the bankruptcy court applied the 20 correct legal standard is a question of law that the panel 21 reviews de novo. See Bell Flavors & Fragrances, Inc. v. Andrew 22 (In re Loretto Winery, Ltd.), 107 B.R. 707, 709 (9th Cir. BAP 23 1989). 24 9 The Panel issued a one-judge order requiring Ms. Lorenzen 25 to file a response as to why BAP No. OR-15-1158 should not be 26 dismissed as untimely as it appeared the notice of appeal was filed one day late. The confusion arose due to the entry of a 27 wrong event code on May 11, 2015, which was later corrected on the following day. The Panel deemed her appeal timely and a 28 briefing schedule was set.
-18- 1 The bankruptcy court’s finding of a willful violation of 2 § 524 is reviewed for clear error. Sciarrino v. Mendoza, 201 3 B.R. 541, 543 (E.D. Cal. 1996) (citing McHenry v. Key Bank (In 4 re McHenry), 179 B.R. 165, 167 (9th Cir. BAP 1995)) (reviewing a 5 willful violation of the automatic stay). A finding is clearly 6 erroneous when it is illogical, implausible, or without support 7 in the record. United States v. Hinkson, 585 F.3d 1247, 1262 8 (9th Cir. 2009) (en banc). 9 We review the decision to impose sanctions for contempt for 10 an abuse of discretion. Knupfer v. Lindblade (In re Dyer), 322 11 F.3d 1178, 1191 (9th Cir. 2003); Nash v. Clark Cty. Dist. Atty’s 12 Office (In re Nash), 464 B.R. 874, 878 (9th Cir. BAP 2012). We 13 review for clear error the trial court’s factual findings in 14 support of a punitive damages award. Bergen v. F/V St. Patrick, 15 816 F.2d 1345, 1347 (9th Cir. 1987). 16 A bankruptcy court abuses its discretion if its decision is 17 based on an incorrect legal rule, or if its findings of fact 18 were illogical, implausible, or without support in the record. 19 Hinkson, 585 F.3d at 1262. 20 V. DISCUSSION 21 In a chapter 7 case, with exceptions not relevant here, 22 “[t]he [bankruptcy] court shall grant the debtor a discharge.” 23 § 727(a). When entered, that order “discharges the debtor from 24 all debts that arose before the date of the [bankruptcy 25 filing].” § 727(b). Section 524(a) prescribes the legal effect 26 of a discharge: 27 (a) A discharge in a case under this title—. . . (2) operates as an injunction against the commencement or 28 continuation of an action, the employment of process,
-19- 1 or an act, to collect, recover or offset any such debt as a personal liability of the debtor, whether or not 2 discharge of such debt is waived[.] 3 “The purpose of the discharge injunction is to protect the 4 debtor from having to put on a defense in an improvident state 5 court action or otherwise suffer the costs, expense and burden 6 of collection activity on discharged debts.” In re Eastlick, 7 349 B.R. 216, 229 (Bankr. D. Idaho 2004) (citing Levy v. Bank of 8 the Orient (In re Levy), 87 B.R. 107, 108 (Bankr. N.D. Cal. 9 1988). 10 A. Contempt Standards: Willful Violation of Discharge Injunction 11 12 A party who knowingly violates the discharge injunction 13 under § 524(a)(2) can be held in contempt under § 105(a). “The 14 standard for finding a party in civil contempt is well settled: 15 The moving party has the burden of showing by clear and 16 convincing evidence that the contemnors violated a specific and 17 definite order of the court. The burden then shifts to the 18 contemnors to demonstrate why they were unable to comply.” In 19 re Bennett, 298 F.3d at 1069. In Bennett, the Ninth Circuit 20 went on to say that “[a]s discussed by the Eleventh Circuit in 21 Hardy, to justify sanctions, the movant must prove that the 22 creditor (1) knew the discharge injunction was applicable and 23 (2) intended the actions which violated the injunction.” Id. 24 (citing In re Hardy, 97 F.3d at 1390 (citing Jove Eng’g, Inc. v. 25 Internal Revenue Serv., 92 F.3d 1539, 1555 (11th Cir. 1996))). 26 Later, in Dyer the Ninth Circuit again cited Hardy in 27 connection with its analysis regarding the distinction between 28 sanctions authorized for a “willful” violation of the automatic
-20- 1 stay under § 362(k) and those imposed under the bankruptcy 2 court’s contempt power contained in § 105(a). The Ninth Circuit 3 explained that “[i]n determining whether the contemnor violated 4 the stay, the focus ‘is not on the subjective beliefs or intent 5 of the contemnors in complying with the order, but whether in 6 fact their conduct complied with the order at issue.’” 322 F.3d 7 at 1190 (citing In re Hardy, 97 F.3d at 1390; McComb v. 8 Jacksonville Paper Co., 336 U.S. 187, 191 (1949) (Because civil 9 contempt serves a remedial purpose, “it matters not with what 10 intent the defendant did the prohibited act.”)). The Ninth 11 Circuit subsequently noted: 12 Under both [§ 362(k) and § 105(a)], the threshold question regarding the propriety of an award turns not 13 on a finding of ‘bad faith’ or subjective intent, but rather on a finding of ‘willfulness,’ where 14 willfulness has a particularized meaning in this context: 15 ‘[W]illful violation’ does not require a specific 16 intent to violate the automatic stay. Rather, the statute provides for damages upon a finding that the 17 defendant knew of the automatic stay and that the defendant’s actions which violated the stay were 18 intentional.’ 19 322 F.3d at 1191 (quoting Havelock v. Taxel (In re Pace), 67 20 F.3d 187, 191 (9th Cir. 1195)) (citing In re Hardy, 97 F.3d at 21 1390). 22 The Dyer court further expounded on the actual knowledge 23 aspect of “willful” for contempt by noting that unlike § 362(k), 24 where a party with knowledge of bankruptcy proceedings is 25 charged with knowledge of the automatic stay, in the context of 26 contempt, actual knowledge of the automatic stay is required. 27 Id. at 1191-92 (“Generally, a party cannot be held in contempt 28 for violating an injunction absent knowledge of that
-21- 1 injunction.”). Applying these principles, the Ninth Circuit 2 declined to affirm the bankruptcy court’s decision finding Mr. 3 Lindblade and his attorney in contempt because it was not clear 4 that they were aware of the automatic stay injunction at the 5 time they recorded a deed of trust. The court opined: “They 6 may not have been familiar with that particular Code provision.” 7 Id. at 1191;10 see also In re Zilog, 450 F.3d at 1008 (noting 8 that Dyer “simply reiterates the well-established proposition 9 that only actual knowledge of the discharge injunction suffices 10 for a finding of contempt”). 11 Three years later in Zilog, the Ninth Circuit again 12 reiterated its approval of Hardy’s two-part test for finding a 13 willful violation of the discharge injunction as stated in 14 Bennett and Dyer. In re Zilog, 450 F.3d at 1007, 1008 n.12 15 (noting that a contempt order entered for violation of the 16 automatic stay or discharge injunction is governed by the same 17 standards, namely those applicable to all civil contempt 18 proceedings). In Zilog, the Ninth Circuit provided further 19 guidance on the “actual knowledge” requirement under the first 20 prong of the test. First, the court made clear that whether a 21 party has actual knowledge of the injunction is a fact-based 22 inquiry and must be found; it can neither be presumed nor 23 imputed. In re Zilog, 450 F.3d at 1007-08. Second, the Ninth 24 Circuit further explained there must be evidence showing that 25 the alleged contemnor was aware of the discharge injunction and 26 that it was applicable to his or her claim. Id. at 1009. 27 28 10 Ultimately the Ninth Circuit affirmed on a different ground which is not relevant here.
-22- 1 To be held in contempt, the [alleged contemnors] must not only have been aware of the discharge injunction, 2 but must also have been aware that the injunction applied to their claims. To the extent that the 3 deficient notices led the [alleged contemnors] to believe, even unreasonably, that the discharge 4 injunction did not apply to their claims because they were not affected by the bankruptcy, this would 5 preclude a finding of willfulness. Id. at n.14. 6 Taken together, Bennett, Dyer, and Zilog, demonstrate that 7 the Ninth Circuit has crafted a strict standard for the actual 8 knowledge requirement in the context of contempt before a 9 finding of willfulness can be made. This standard requires 10 evidence showing the alleged contemnor was aware of the 11 discharge injunction and aware that it applied to his or her 12 claim. Whether a party is aware that the discharge injunction 13 is applicable to his or her claim is a fact-based inquiry which 14 implicates a party’s subjective belief, even an unreasonable 15 one. Of course, subjective self-serving testimony may not be 16 enough to rebut actual knowledge when the undisputed facts show 17 otherwise. See Chionis v. Starkus (In re Chionis), BAP No. 18 CC-12-1501-KuBaPa, 2013 WL 6840485, at *6 (9th Cir. BAP Dec. 27, 19 2013) (reversing the bankruptcy court’s finding that actual 20 knowledge of the discharge injunction was not shown based on 21 alleged contemnor’s self-serving testimony when the undisputed 22 facts showed otherwise). 23 With respect to the second prong - the intent requirement 24 for a finding of willfulness - the analysis concerning a 25 “willful” violation of the discharge injunction is the same as a 26 finding of willfulness in connection with violation of the 27 automatic stay under § 365(k). In connection with the second 28 prong’s intent requirement, we have previously observed that
-23- 1 “the bankruptcy court’s focus is not on the offending party’s 2 subjective beliefs or intent, but on whether the party’s conduct 3 in fact complied with the order at issue.” Rosales v. Wallace 4 (In re Wallace), BAP No. NV-11-1681-KiPaD, 2012 WL 2401871, at 5 *5 (9th Cir. BAP June 26, 2012) (citing Bassett v. Am. Gen. Fin. 6 (In re Bassett), 255 B.R. 747, 758 (9th Cir. BAP 2000), rev’d on 7 other grounds, 285 F.3d 882 (9th Cir. 2002) (stating that courts 8 have applied an objective test in determining whether an 9 injunction should be enforced via the contempt power) (citing In 10 re Hardy, 97 F.3d at 1390); see also In re Dyer, 322 F.3d at 11 1191 (noting that a “willful violation” does not require a 12 specific intent to violate the automatic stay). 13 Accordingly, each prong of the Ninth Circuit’s two-part 14 test for a finding of contempt in the context of a discharge 15 violation requires a different analysis, and distinct, clear, 16 and convincing evidence11 supporting that analysis, before a 17 finding of willfulness can be made. This is consistent with the 18 Ninth Circuit’s reluctance “to hold an unwitting creditor in 19 contempt.” In re 1601 W. Sunnyside Dr. #106, LLC, 2010 WL 20 5481080, at *4 (Bankr. D. Idaho Dec. 30, 2010). 21 B. The Ybarra Rule 22 While a discharge in bankruptcy generally relieves a debtor 23 from all prepetition debts, the Ninth Circuit has adopted a 24 11 The clear and convincing evidence standard requires the 25 moving party to “place in the ultimate factfinder an abiding 26 conviction that the truth of its factual contentions are ‘highly probable.’” Colorado v. New Mexico, 467 U.S. 310, 316 (1984). 27 Factual contentions are highly probable if the evidence offered in support of them “instantly tilt[s] the evidentiary scales in 28 the affirmative when weighed against the evidence [the non-moving party] offered in opposition.” Id.
-24- 1 different standard for determining for discharge purposes when 2 an attorney’s fee claim arises. “Under that standard, even if 3 the underlying claim arose prepetition, the claim for fees 4 incurred postpetition on account of that underlying claim is 5 deemed to have arisen postpetition if the debtor ‘returned to 6 the fray’ postpetition by voluntarily and affirmatively acting 7 to commence or resume the litigation with the creditor.” 8 Bechtold v. Gillespie (In re Gillespie), 516 B.R. 586, 591 (9th 9 Cir. BAP 2014) (citing In re Ybarra, 424 F.3d at 1026–27). The 10 rule is invoked to prevent a debtor from using the discharge 11 injunction as a sword that enables him or her to undertake 12 risk-free postpetition litigation at others’ expense. Id. 13 (citing In re Ybarra, 424 F.3d at 1026). “The Ybarra rule 14 applies regardless of whether the litigation begins prepetition 15 or postpetition, regardless of the nature of the underlying 16 claim, and regardless of the forum in which the postpetition 17 litigation takes place.” Id. at 591-92(citing In re Ybarra, 424 18 F.3d at 1023-24). 19 C. Analysis 20 Due to the Ybarra rule, the scope of the discharge order 21 here was ambiguous with respect to the post-discharge attorneys’ 22 fees and costs. Whether a debtor voluntarily returns to the 23 fray under the Ybarra rule is a factual question subject to 24 dispute as demonstrated by the state and bankruptcy courts’ 25 ruling on the one hand, and the district court’s ruling the 26 other hand. A creditor seeking to invoke the Ybarra rule would 27 necessarily need to seek such a determination from a court. 28 Section 524(a)(2) clearly was not designed to prohibit
-25- 1 actions that seek an Ybarra determination. We have previously 2 said that a party seeking a bankruptcy court determination 3 regarding the scope of the discharge should file an adversary 4 complaint seeking declaratory relief. See Ruvacalba v. Munoz 5 (In re Munoz), 287 B.R. 546, 556 (9th Cir. BAP 2002). 6 Appellants’ request for a Ybarra ruling in the state court was 7 essentially the same as a request for declaratory relief 8 regarding the scope of the discharge. We fail to see how 9 following this procedure equates to a violation of § 524(a)(2). 10 On Debtor’s novel theory of the discharge, any person, creditor 11 or non-creditor, who sought declaratory relief regarding the 12 scope of the discharge injunction would forever be barred, under 13 pain of contempt sanctions, from filing an adversary proceeding 14 to seek a court’s ruling on the issue.12 Appellants should be 15 praised, not sanctioned, for having followed a correct procedure 16 to resolve the Ybarra issue. 17 Further, once the state court decided that the discharge 18 19 12 At oral argument, Debtor’s attorney took the position 20 that Appellants proceeded in the state court at their own risk since only the bankruptcy court had authority to decide the scope 21 of the injunction. This proposition is not correct. In Pavelich v. McCormick, Barstow, Sheppard, Wayte & Carruth LLC (In re 22 Pavelich), 229 B.R. 777 (9th Cir. BAP 2000), we noted: “With 23 respect to the discharge itself, state courts have the power to construe the discharge and determine whether a particular debt is 24 or is not within the discharge.” Id. at 783. The Panel further stated that if the state court construes the discharge correctly, 25 its judgment will be enforced. However, if the state court 26 construed the discharge incorrectly, then its judgment may be void and subject to collateral attack in federal court. To the 27 extent Debtor collaterally attacked the state court’s ruling in the bankruptcy court, the bankruptcy court not only upheld the 28 state court’s ruling, but independently found that he had entered the fray under Ybarra.
-26- 1 did not bar Appellants’ claim for attorneys’ fees, Appellants 2 were entitled to rely on that decision. A party who acts in 3 reliance on a facially valid determination that the discharge 4 does not apply cannot be guilty of “willfully” violating the 5 discharge injunction.13 6 Even if Appellants had not raised the Ybarra question to 7 the state court, we would overturn the bankruptcy court’s 8 decision on other grounds. Although the bankruptcy court 9 recited the Zilog test, it applied the wrong legal standard for 10 determining whether Appellants had the sort of actual knowledge 11 necessary for a finding of willfulness. As a result, its 12 factual findings were clearly erroneous. 13 Despite citing the two-part test in Hardy with approval in 14 Bennett, Dyer, and Zilog, the Ninth Circuit has never adopted 15 the test word for word. Under the first prong, the Hardy test 16 states that a defendant will be held in contempt if it “knew 17 that the [discharge injunction] was invoked.” Since adopting 18 the Hardy test, the Ninth Circuit has always replaced the word 19 “invoked” with the word “applicable.” Therefore, the bankruptcy 20 court erred when it relied on the Hardy test rather than using 21 the Ninth Circuit’s test as restated. 22 By adopting the Hardy test, the bankruptcy court improperly 23 13 24 One might argue that, because a state court decision incorrectly construing the scope of the discharge is not only 25 erroneous, but also void, In re Pavelich, 229 B.R. at 782, 26 reliance on such a determination is no defense. But, as we explain below, in order to recover for a violation of the 27 discharge injunction, the debtor must establish the actor’s subjective state of mind. In this case, there is no reason to 28 think that Appellants subjectively knew or believed that the state court’s decision was wrong.
-27- 1 “charged” Appellants with actual knowledge of the discharge 2 injunction simply because it had been entered at the time they 3 sought their attorneys’ fees in the state court. Rather than 4 conducting any inquiry into whether Appellants were aware that 5 the discharge injunction applied to their fee request as 6 instructed in Zilog, the court imputed such awareness by strict 7 liability. It is certainly possible that Appellants held an 8 objectively reasonable belief that, for reasons specific to 9 Debtor’s conduct in the state court, the discharge injunction 10 did not apply to their post-discharge attorneys’ fee request 11 under the Ybarra rule. In any event, as stated above, they 12 followed the proper procedure by seeking the court’s decision on 13 the scope of the discharge. 14 The bankruptcy court also improperly found that Appellants 15 were not “insulated” from a willfulness finding after the state 16 court and bankruptcy court found in their favor - apparently on 17 the basis that the state court got it wrong and the bankruptcy 18 court was reversed by the district court. This reasoning is 19 more in line with the standard for finding a willful violation 20 of the automatic stay under § 362(k), where a legitimate dispute 21 as to a creditor’s right to take the action that violates the 22 automatic stay may not relieve a willful violator of the 23 consequences of his or her act. 24 Finally, the court concluded that Appellants’ subjective or 25 good faith beliefs were irrelevant. Although this strict 26 liability analysis may be either consistent with the standards 27 for a willful violation of the automatic stay because there is 28 no specific intent requirement embedded in § 362(k) or with an
-28- 1 analysis under the second prong of the test for deciding 2 willfulness, it cannot apply to the first prong of the discharge 3 violation test which requires actual knowledge of applicability. 4 Taken together, the bankruptcy court’s “strict liability” 5 analysis is closer to the standards for finding a willful 6 violation of the automatic stay under § 362(k), which is the 7 derivation of the Hardy test. Alternatively, at best, the 8 court’s analysis conflated the objective inquiry under the 9 second prong of the willfulness test regarding intent with the 10 fact intensive inquiry under the actual knowledge requirement in 11 the first prong. 12 Due to the application of an improper legal standard, the 13 bankruptcy court’s factual findings regarding Appellants’ actual 14 knowledge are clearly erroneous and not supported by the record. 15 It is undisputed that Appellants had actual knowledge that 16 Debtor’s discharge had been entered at the time they sought the 17 post-discharge attorneys’ fees under the Ybarra rule in the 18 state court. However, they could not possibly have been aware 19 that the discharge injunction was applicable to their fee 20 request until the Ybarra question was adjudicated. Once the 21 bankruptcy court confirmed the state court’s ruling and made its 22 own independent decision on the matter, ruling in Appellants 23 favor, all doubts regarding whether the discharge injunction 24 applied were resolved; i.e., under Ybarra, the post-discharge 25 fee request fell outside the scope of the discharge injunction. 26 The bankruptcy court’s ruling was binding on Debtor and SPBC 27 28
-29- 1 until it was overruled.14 2 This is not a case where Appellants knew of the discharge 3 injunction and continued to press their attorneys’ fee claim in 4 the state court under the assumption that the discharge 5 injunction did not apply to them. Rather, all along the way, 6 they sought a judicial determination that the discharge 7 injunction did not apply. We fail to see how the Zilog standard 8 for actual knowledge is met under these facts. 9 In the end, there is no clear and convincing evidence in 10 the record that shows Appellants had actual knowledge that the 11 discharge injunction applied to their post-discharge fee request 12 in the state court. The facts actually suggest the opposite. 13 Although the discharge order was in place at the time Appellants 14 made their fee request in the state court, the order itself did 15 not advise Appellants of the scope of the injunction under the 16 Ybarra rule. Nor could it, since that was up to a court of 17 competent jurisdiction to decide the question as to whether 18 Debtor voluntarily returned to the fray. 19 VI. CONCLUSION 20 For the reasons stated, we REVERSE the bankruptcy court’s 21 finding of contempt and VACATE its judgment awarding sanctions. 22 23 24 25 26 27 14 While Debtor suggests that Appellants were dilatory in 28 vacating the Supplemental Judgment, this was not a basis for the bankruptcy court’s ruling.
-30-