The Discharge in Bankruptcy - Open Avenues for Consumer Creditors

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Spilman Thomas & Battle, PLLC

In a typical consumer bankruptcy, a debtor seeks the benefit of two concepts. First, the debtor seeks the breathing room afforded that debtor by the automatic stay. Second, the debtor seeks to discharge all debt obligations adjudicated in the bankruptcy case. Absent these protections, a bankruptcy filing serves little purpose. As a result, a creditor who can attack the debtor's entitlement to a discharge threatens the very heart of any filing.

Creditors have two options to attack the discharge in a consumer bankruptcy. First, a creditor can attack the discharge broadly and assert that a debtor cannot discharge any of his or her debts. Section 727 of the Bankruptcy Code (Title 11 of the United States Code) sets forth the grounds for attack here. Generally, the basis for such objection hinges on the debtor's conduct related to his or her debts. Case law is replete with references to the fact that bankruptcy affords protection to the "honest, but unfortunate" debtor but does not afford the same protection to debtors who are dishonest or outright fraudulent.

Second, a creditor can assert that the specific debt owing to that creditor is not dischargeable under Section 523 of the Bankruptcy Code. This relief is narrower than that permitted under Section 727, and, if a creditor can navigate through one of the specific enumerated exceptions set forth in Section 523, the creditor obtains narrower relief: only that creditor's debt is excepted from the discharge. Importantly, for public policy reasons, a creditor and debtor can mutually settle an action brought under Section 523, but they cannot settle an action brought under Section 727.

Between the two, Section 523 affords the better, more tailored relief most creditors seek. This section includes some very specific types of debt. For example, debt for taxes (which, by case law can include taxes paid by credit cards) and debts of more than $500 incurred within 90 days of a filing (say, large credit card purchases for non-necessities) are not dischargeable. Additionally, debts obtained through false pretenses (i.e., false representations in personal financial statements) are not dischargeable under Section 523. Under this prong of Section 523, a creditor must show that the creditor would not have loaned money, products, or services absent those misrepresentations. Thus, only financial information (provided in writing) at loan or credit origination is relevant.

That said, Section 727 allows a more generalized showing of dishonesty to trigger its relief. For example, if a creditor obtains personal financial statements annually from a debtor and learns that a debtor's net worth went up after the creditor already loaned money, the creditor can still use the information in that statement to compare against the debtor's bankruptcy schedules and list of disclosed assets. If the creditor finds serious discrepancies between the disclosures in recent financial statements (even if those financial statements were not used to advance debt) and the disclosures in bankruptcy, a creditor can use the discrepancy to mount an attack on the debtor's discharge.

As should be clear from the examples above, a creditor can do several things during the course of its relationship with a debtor to maximize the opportunity to apply pressure in a bankruptcy case. First, a creditor can require detailed financial statements at loan or credit origination. Second, a creditor can require annual financial documents after origination. Third, a creditor can monitor closely the larger transactions and flag for its own records those transactions that appear to be for domestic support obligations, taxes, fines, customs, duties, and the like, which would not be dischargeable in a bankruptcy. These debts are pretty summarily excluded from discharge, and a creditor can often win judgment on these points without developing an extensive factual record.

We  have recommended litigation aimed at preventing the discharge of debtors and their debts in several situations. While this litigation must be used wisely, and sparingly, it is an oft-overlooked tool in the bankruptcy litigator's toolkit. If one believes that a debtor may be concealing assets or if one believes a debtor may be collectible immediately after exiting bankruptcy or at any point thereafter, discharge litigation should be considered.

 In some cases, we even have been able to raise such persuasive issues that the United States Trustee's Office has joined in the litigation and helped offset costs of information gathering, depositions, and the like. In those cases, we often find that a debtor has been concealing far more assets than originally believed, thus improving the recovery for our clients significantly. We have pursued this litigation both more generally (under Section 727 or the generalized "fraud" portions of Section 523), and we have pursued it more specifically (to attack discharge of certain credit card debts, or portions thereof).

If you think you have a case where you can attack the discharge of your debts or the general discharge of your debtors, whether you are a creditor, appointed trustee, or other party in interest, chances are you should contact an attorney. But be careful. Time is not on your side. The deadline to object is 60 days after the first date set for the initial meeting of creditors, and, absent an order extending that deadline before the deadline passes, parties in interest can no longer attack the discharge in all but the rarest of circumstances.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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