The US District Court for the Eastern District of North Carolina recently overturned a US bankruptcy ruling for the Eastern District of North Carolina. The bankruptcy order held the mortgage maintenance staff of Newrez, LLC (“Newrez”) and the holder of the mortgage note in civil contempt for failing to comply with the terms of the approved individual chapter 11 debtor plan (the “Plan”). LLC Newrez v. Beckhart, No. 7: 20-cv-00192-BO, 2021 US Dist. LEXIS 125293, at * 1 (EDNC July 6, 2021). The District Court concluded that the vague terms of the Plan, coupled with Nyurez’s good faith in attorney’s advice in the interpretation of these terms, were sufficient to establish that Nyurez had an objectively reasonable basis for his behavior, thus protecting him from civil penalties for contempt. according to the rule established in Taggart vs. Lorenzen, 139 C. Ct. 1795 (2019). The court’s appeal highlights the benefits for the creditor of seeking legal advice when the bankruptcy orders governing the creditor’s claim are unclear.
The controversy related to the Plan’s approach to Newrez’s secured claim. At the time the debtors voluntarily filed a Chapter 11 lawsuit in 2009, they owned a beach house with over $ 22,000 upfront mortgage, resulting from ten months of non-payment. The plan did not provide for pre-petition debt settlement or post-petition payments that should have been made prior to confirmation. This was confirmed against the objections of Narouz’s predecessor at the end of 2010, and around the same time debtors began making payments to the Plan. Newrez began servicing mortgages in 2014 and treated the loan as if it had been in default from then until 2019, based on significant unsecured debt. Debtors have repeatedly argued that the loan was in accordance with the terms of the Plan and challenged Newrez’s decision that it was overdue.
In January 2020, the debtors filed a petition with the bankruptcy court, seeking the recognition of Nevrez and the loan holder as civil contempt of court for not complying with the terms of the Plan, and demanded substantial sanctions. After hearing evidence, the bankruptcy court ruled that Nurez and the owner were contempt of court and estimated monetary sanctions of more than $ 110,000, consisting mainly of loss of wages, loss of a start-up opportunity and attorney fees. Newrez filed an appeal and the District Court overturned it.
In analyzing the bankruptcy order, the District Court referred to the standard of civil contempt clarified by the Supreme Court in Taggart: A creditor may be held liable for violating a bankruptcy order if there is no “fair reason to doubt whether the order prohibits the lender’s conduct.” Taggart, 139 C. Ct. at 1799. Thus, civil contempt is appropriate only when there is no “objectively reasonable basis for concluding that the creditor’s behavior may be lawful.” Identifier.
Having decided that there was good reason to doubt that the Plan required Nevrez to treat mortgages as current and not default, the Court focused on several issues that the Plan left unanswered in relation to mortgages:
The order confirmation does not say anything about how much [the debtors] will be outstanding on the loan as of November 25, 2010, or how the outstanding, if any, pending petition of $ 22,836.40 will be paid. Although the order set a deadline for the first payment, it did not offer any guidance as to how much that payment would be.
Beckhart, 2020 US Dist. LEXIS 125293, address * 7. In addition, the court noted that the terms of the Plan created additional confusion, as the Plan was intended to leave the rights of the holder of the mortgage unchanged, except as expressly provided in the Plan, but the Plan did not provide for any relationship to debt or payments after filing a petition. Identifier. Likewise, the court found that since Newrez had repeatedly sought and relied on outside counsel for advice to conduct himself in accordance with the Plan, he had objectively reasonable grounds to believe that his conduct was lawful. Identifier. at * 8-9 (with reference to Waller vs. Sprint Mid Atl. Tel., 77 F. Supp. 2d 716, 722 (EDNC 1999)). He also found that the same reliance on an outside lawyer clearly showed that Newrez had acted in good faith in adopting an interpretation of the Plan “which appeared to be consistent with the contractual terms of the loan.” Identifier. at 8. Since Neurez found there were just grounds for doubting whether the Plan prohibited his conduct, and because he had an objectively reasonable basis for doing so, the court concluded that the bankruptcy order that held him disrespectful “did not corresponds to reality “. below the standard required for a contempt of court ”, and set aside the order and returned the case to the bankruptcy court for further proceedings.
Beckhart Demonstrates a dual benefit to the lender in seeking competent legal advice if there are any questions about the interpretation or impact of bankruptcy orders on the lender’s claims. First, trusting legal advice can help establish that the creditor has acted in good faith, which is important because Taggart did not rule out the permissibility of disrespect for the creditor if he acts in bad faith. See Taggart, 139 C. Ct. at 1802 (“Our cases suggest, for example, that civil penalties for contempt of court can be justified when a party acts in bad faith”). Second, acting on the advice of a lawyer in good faith may provide the creditor with an objectively reasonable basis for concluding that his conduct is permitted under the order in question. This is especially useful where, as in Beckhart, the order is unclear and can be interpreted in different ways.