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On January 21, 1999, the Bankruptcy Appellate Panel for the Tenth Circuit ("BAP") reversed the court below, and held that creditors who fail to pursue a nondischargeability action under Section 523(a)(2) of the Bankruptcy Code may be subject to sanctions in the form of attorneys' fees. See Household Bank, N.A. (Nevada) v. Sales (January 21, 1999). The BAP found that merely granting a default judgment in favor of the debtor defendant was an insufficient sanction against the creditor plaintiffs.

In Sales, the plaintiffs were two credit card issuers. The debtor sought to dismiss the plaintiffs' non-dischargeability complaint based on: (i) plaintiffs' failures to investigate alleged fraud prior to commencing action under Section 523(a)(2) of the Bankruptcy Code; and (ii) plaintiffs' failures to allege or produce any facts or evidence to establish debtor's fraud relative to debtor's high credit card balances.

The bankruptcy court granted debtor a default judgment, but awarded no sanctions for fees against the plaintiffs. The debtor then sought relief under Bankruptcy Rule 9011 and Section 523(d) of the Bankruptcy Code. Section 523(d) mandates attorneys' fees if a plaintiff's position is not "substantially justified." (Bankruptcy Rule 9011 also requires plaintiff's counsel to proceed in good faith.) The bankruptcy court denied sanctions because it made no finding regarding bad faith or lack of substantial justification.

On appeal, the BAP held that, if a debtor succeeds in discharging a debt that was the subject of a nondischargeability lawsuit, the burden is on the creditor to prove that its lawsuit was substantially justified (or that special circumstances render an award of fees unjust). If the creditor cannot meet its burden, the court must award sanctions as a matter of law under Section 523(d) in the form of fees and costs.

The Sales case is the most recent in a line of cases designed to curtail abusive nondischargeability litigation by creditors. Litigation aimed at forcing consumer debtors into onerous settlement agreements to avoid additional legal costs will not be tolerated. Section 523(d) is designed to limit these "unfair collection tactics", and Sales sends a clear message to the bankruptcy courts to employ Section 523(d) as mandated.