For better or worse, lenders have become increasingly familiar with the strange dynamic that is the post-bankruptcy minefield created by their borrowers filing a bankruptcy petition. Immediately, lenders begin thinking about how they can minimize the write-off, how they can reduce exposure, how they can avoid violations of the automatic stay, whether they can convince a borrower to reaffirm debt, and many other questions that often must be analyzed situationally. There often is no single answer that can be given that applies to all bankruptcies alike.
While the search for efficient and simple one-size-fits-all answers is elusive, it is surprising then that two related sections of the Bankruptcy Code that apply to all bankruptcy cases in which an individual is the debtor is often overlooked. As most lenders know, the most powerful tools a borrower has at his disposal in a bankruptcy are the automatic stay and the discharge. But what many overlook, is that the discharge is subject to attack. 11 U.S.C. § 523(a)(2) allows a creditor to attack the dischargeability of any specific debt that was either obtained by fraud or was based on a written financial statement that was materially false (assuming the creditor relied on that statement).
Further, 11 U.S.C. § 727(a) provides that a debtor’s discharge generally can be denied if the debtor conceals property within one year or after the filing of the bankruptcy. This section also provides that a discharge can be denied if the debtor makes a false oath in a bankruptcy case or fails to explain the dissipation of assets.
As a result, the Bankruptcy Code should invite creditors to immediately review all pre-bankruptcy financial representations made by the now-bankrupt debtor. In various cases, such an analysis yields surprising results. Just over the past few years, major news media have reported on two such cases that most are generally aware of:
The owner of the dance studio in the popular show Dance Moms hid over $250,000 from her creditors and trustee; and
The couple from the show The Real Housewives of New Jersey hid millions from their creditors. But the same traps that these now-infamous reality-TV stars fall into can catch all debtors.
Spilman recently has represented a few lenders in successful objection to discharge cases. In this author’s personal experience, objection to discharge cases generally follow the same trend:
A borrower provides financial statements at the inception of the loan and at various renewal stages showing a strong asset base;
When the borrower suddenly finds himself under financial pressure, a fair amount of “pre-bankruptcy planning” takes place;
When the bankruptcy petition finally is filed, there are discrepancies between the most recent financial statements provided to the lenders and the detailed bankruptcy schedules filed in the case (each of which is made under oath); and,
When the debtor is subject to examination and scrutiny, various assets (including avoidable transfers) start coming to light.
In one recent case handled by Spilman attorneys, the string of discovery requests, third-party subpoenas, and depositions led to the discovery of nearly $300,000 in assets concealed from the creditors and the trustee. Thus, the process of objecting to discharge not only preserved all of the creditors’ post-bankruptcy rights, but it also revealed substantial assets that will be liquidated by the trustee in payment of unsecured claims.
While it is certainly true that denials of a discharge are an exception rather than the rule, these sections of the Code provide a useful tool for creditors that should become a standard element of a lender’s post-bankruptcy analysis. Just one omission has been held by courts to be sufficient to deny a debtor’s discharge. Additionally, the resulting examination by all parties in interest can reveal hidden assets that allow unexpected recovery by lenders.
In short, lenders should never forget to closely compare pre-bankruptcy financial statements and credit reports to the schedules and statements filed in a debtor’s bankruptcy case.