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Bench & Bar
The newsletter of the ISBA’s Bench & Bar Section

January 2018, vol. 48, no. 7

Returning to the fray after discharge

“Once more unto the breach, dear friends, once more.”

- Henry V, Act III, Scene I

 

The “return to the fray” doctrine is a little-known theory that could result in harsh consequences for debtors that receive a discharge in bankruptcy, but choose to continue litigating post-discharge against creditors or other entities. It is important for attorneys to know about and understand this concept so that they can properly advise their clients, but judges also need to be cognizant of the doctrine to be sure that any such litigation is properly before them.

“Return to the fray” is a fairly simple concept, but is best explained using an example:

Debtor owns a home, but falls behind on mortgage payments and finds himself in foreclosure where Lender seeks the property, damages, and contractually-authorized attorneys’ fees. Debtor claims that Lender engaged in some sort of misdeed in dealings with Debtor, so Debtor counterclaims against Lender for breach of contract (the same contract that allows Lender to recover its attorneys’ fees). Before the foreclosure case is concluded, however, Debtor seeks bankruptcy relief under Chapter 7 of the United States Bankruptcy Code and eventually receives a discharge. After the discharge, Debtor continues to litigate his counterclaim against Lender. By continuing to litigate against Lender after receiving a discharge, Debtor has voluntarily returned to the fray of litigation.

The effect of a voluntary return to the fray is what must be understood. It is well-known that a discharge in bankruptcy discharges all claims and debts that arose before the date of the order for relief (i.e. the filing of the petition under Chapter 7 of the United States Bankruptcy Code). 11 U.S.C 727(b). A “claim” is a right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured. 11 U.S.C. 101(5)(A). For Lender’s post-petition attorneys’ fees in the example above to be discharged, a court would need to find that the claim for attorneys’ fees was a contingent claim under 11 U.S.C. 101(5)(A) and therefore discharged.

In the example, Debtor’s contract with Lender was entered into before the order for relief, but Debtor, instead of walking away from the liability, voluntarily continued the state court action against Lender for his counterclaim of breach of contract. To complete the story in the example, Lender defended against the counterclaim and eventually prevailed at trial. Lender then sought attorneys’ fees for fees incurred only after the order for relief was entered.

A similar scenario was seen in Siegel v. Federal Home Loan Mortgage Corporation, 143 F.3d 525 (9th Cir. 1998). Siegel attempted to claim that FHLMC’s (a/k/a “Freddie Mac”) claim for fees against him was discharged because the mortgage contract that contained the fee-shifting clause was entered into pre-petition, and therefore was a contingent claim that was discharged upon the successful completion of his petition in bankruptcy. While the court agreed with Siegel that any doubts regarding the dischargeability of a claim should be resolved in favor of finding that a contingent claim existed, it also found that even though the future is always contingent, that does not mean that a bankrupt is discharged regarding everything he might do in the future.

The Siegel court held that if actual liability was dependent on what others might do, then it would be a contingent liability that was discharged; however, because the liability was contingent on what Siegel decided to do, the contractual liability was not a “claim” that was discharged. The court noted that Siegel “had been freed from the untoward effects of contracts he had entered into. Freddie Mac could not pursue him further, nor could anyone else. He, however, chose to return to the fray and to use the contract as a weapon. It is perfectly just, and within the purposes of bankruptcy, to allow the same weapon to be used against him.” Siegel at 533.

The last line of the conclusion in Siegel succinctly sums-up the case when it states “… any right to avoid the attorney’s fees provision of his contract fell short of protecting him when he voluntarily undertook this post-bankruptcy action against Freddie Mac.” Siegel at 534.

Other holdings in other cases have been similar to Siegel. See, e.g., In re Ybarra, 424 F.3d 1018 (9th Cir. 2005)(“by voluntarily continuing to pursue litigation post-petition that had been initiated pre-petition, a debtor may be held personally liable for attorney fees and costs that result from that litigation”); In re Clarkson, 377 B.R. 283 (W.D. Washington – Tacoma 2007)(“the Debtor’s post-petition actions in pressing the State Court Lawsuit are sufficient to find that the post-petition fees and costs at issue were not discharged in their bankruptcy”); In re Hadden, 57 B.R. 187 (W.D. Wisconsin 1986)(“If the debtor chooses to enjoy his fresh start by pursuing pre-petition claims which have been exempted, he must do so at the risk of incurring post-petition costs involved in his acts”).

Despite not being widely known, attorneys and judges alike can benefit from understanding this doctrine. Attorneys can counsel their debtor clients about possible post-petition liability, and they can also advise their creditor clients about the potential of pursuing discharged debtors for post-petition matters. The judiciary can benefit by understanding the nuances associated with discharges in bankruptcy and how a discharge does not necessarily mean that debtors can never have liability on pre-petition contracts.

Regardless of authority to the contrary noted herein, no one should ever assume that post-petition actions by debtors are not subject to discharge. The point of Chapter 7 of the United States Bankruptcy Code is to provide debtors an opportunity for a fresh start, freed from the yoke of debt, and this opportunity is maintained in a stalwart fashion by bankruptcy courts. Violations of the discharge injunction are often met with swift and harsh penalties by bankruptcy courts, including actual damages, attorneys’ fees, and sometimes punitive damages. Pursuing a discharged debtor should never be taken lightly. Further, the “return to the fray” doctrine is not universally accepted, and while one court may view a debtor’s post-petition action to be outside of the protections of the discharge injunction, others may not. See, e.g., In re Residential Capital v. PHH Mortgage, 558 B.R. 77 (S.D.N.Y. 2016)(“There is no basis for reading an exception for “voluntarily ... returning to the fray” into the Bankruptcy Code”). Any possible claim against a discharged debtor that may have been involved in the debtor’s bankruptcy should be brought to the attention of the bankruptcy court so that a ruling can be made on whether the debtor is liable for returning to the fray, or not. A motion to modify the discharge injunction could be filed, and the bankruptcy court could grant it, deny it, or deny it as being moot. Failure to seek any guidance from the bankruptcy court before proceeding against a discharged debtor is simply ill-advised.

Pre-petition litigation involving debtors often continue once a bankruptcy discharge has been granted. Courts and counsel alike should know and understand that a debtor may have liability for returning to the fray, and debtors and creditors need to be advised so that they can make informed decisions on whether to go once more unto the breach.