Eighth Circuit Affirms Sanctions for Violation of Discharge Injunction and Affirms Decision that Prior Bankruptcy Court Order and Related State Court Judgments had no Preclusive Effect

By Karl Johnson posted 23 days ago

Karl Johnson, Hellmuth & Johnson, PLLC
Jeffrey Klobucar, Bassford Remele, P.A.

 Contributing Editor: Karl Johnson, Hellmuth & Johnson, PLLC

            In First State Bank of Roscoe and John Beyers v. Stabler (In re Stabler), 914 F.3d 1129 (8th Cir. 2019), The Eighth Circuit affirmed sanctions for violating a final bankruptcy discharge injunction and affirmed findings that neither a prior bankruptcy court order nor a related state court judgment had preclusive effect.

            When the debtors’ agricultural services business failed, a principal at their bank counseled them to seek bankruptcy protection and introduced them to a bankruptcy attorney who had previously represented the bank on various matters. After the debtors received their bankruptcy discharge, the bank still held security interests in land and farm equipment owned by the debtors and a lien against a parcel of land owned by the debtors’ parents. Instead of foreclosing on this collateral and booking a large loss, the bank persuaded the debtors and their parents to execute new notes and grant new security interests in an aggregate amount that far exceeded the value of the original collateral through complex transactions involving straw persons. The bank also arranged for the debtors to take out a new loan from a third-party bank to pay down the balance that was owed prepetition to the bank.  

            After the debtors defaulted and the bank began collection efforts on the new notes, the debtors and their parents initiated a state court proceeding against the bank and its principal, alleging, among other things, that the post-discharge notes were unenforceable and improper reaffirmations of discharged debt, that the bank committed fraud by misrepresenting whether debts were still owed, and that the bank and the bankruptcy attorney conspired and breached their fiduciary responsibilities because the bankruptcy attorney was representing the bank’s interests rather than those of the debtors. The bank asserted counterclaims and argued that forbearance from foreclosing served as permissible consideration for new security interests and new repayment commitments.

            After the bank moved for summary judgment on some of its counterclaims, the debtors filed an adversary complaint seeking sanctions for violation of the discharge injunction. After the state court granted summary judgment in the bank’s favor on two out of four counterclaims, the bank moved to dismiss the adversary complaint. While the bankruptcy court made fact findings that suggested it would grant the motion to dismiss, it expressly abstained from ruling on the motion and suggested that the debtors could return to bankruptcy court if the state court ruled in the debtors’ favor.

            Subsequently, the state court reversed its own earlier grant of summary judgment in favor of the bank and held that the bank’s principal “devised a scheme through which he would convince [the debtors] to continue paying on their discharged debt.” When the debtors recommenced the adversary proceeding, the bankruptcy court rejected the bank’s arguments that the bankruptcy court’s earlier order was res judicata or that the debtors’ failure to obtain sanctions from the state court precluded such relief. The bankruptcy court found the bank in contempt and awarded sanctions attorney fees in favor of the debtors. After the bank appealed, the district court affirmed.

            The Eighth Circuit found that neither the bankruptcy court’s prior order nor the failure to obtain sanctions from the state court precluded the bankruptcy court from awarding sanctions and attorney fees. First, the Eighth Circuit noted that bankruptcy court’s decision to abstain included an invitation for the debtors to return to bankruptcy court if the state court ruled in their favor. In other words, the bankruptcy court believed further action would not be precluded. Second, the Eighth Circuit noted that neither the concurrent jurisdiction of the state court nor the debtors’ failure to seek sanctions deprived the bankruptcy court of its authority to enforce its own orders. Third, the Eighth Circuit held that abstaining from hearing an issue is inherently not a ruling on the merits and therefore cannot have preclusive effect. Finally, the Eighth Circuit held that the bank never had a good faith basis for believing forbearance could be valid consideration for new notes exceeding the value of the collateral. In a footnote, the Eighth Circuit noted that the bank’s actions predate Venture Bank v. Lapides, 800 F.3d 442 (8th Cir. 2015), which has since clarified that “a secured creditor’s post-discharge forbearance is not sufficient to take a reaffirmation agreement outside the purview of § 524(c)” regardless of whether the new notes are limited to the value of the collateral.