Known frauds, swindlers, and thieves do not generally fare well in bankruptcy court no matter how dire their debts. Not, at least, if their creditors are fighting the good fight. While the law of land is on the whole forgiving toward those overwhelmed with debt, the U.S. Bankruptcy Code is not particularly merciful toward petitioners whose misdeeds have been exposed in bankruptcy proceedings.
Yet with companies accused of massive fraud emerging from the ashes of Chapter 11, many in the public have the mistaken impression that bankruptcy court is a place debtors go to absolve even the most egregious of sins. Not true. Creditors can file suits objecting to the discharge of debts, and often those suits hinge on allegations of questionable conduct.
For this aspect of the system to work, creditors must tenaciously challenge debtor conduct when questions of fraud, criminal activity, the hiding of assets, or false representation emerge. Any lawyer representing civil or criminal defendants who are also debtors should be well aware of the challenges their clients may face in seeking discharges.
According to the U.S. Bankruptcy Code, if a creditors' objection to a discharge is successful, the debtor is forever precluded from discharging the debt at issue. Grounds warranting the denial of a discharge include, among others:
That short and not exhaustive list of grounds raises a host of concerns for lawyers, even those not engaged in bankruptcy practice. Corporate or individual clients who may one day face a bankruptcy filing, or those on the verge of filing, deserve sound counsel that will help them avoid being challenged by creditors for their actions.
For example, if the debtor knowingly and fraudulently omits a valuable asset from his bankruptcy schedules, or transfers that asset to a third party to preclude the asset from being sold to pay creditors, the court will likely sustain a creditor's objection to a discharge.
Moreover, such actions as listed above not only warrant the denial of a discharge, but also constitute a criminal offense punishable by a fine and/or imprisonment for no more than five years. Debtors and their attorneys should appreciate the willingness of the United States Attorney's office to prosecute bankruptcy fraud. Care should be taken when completing and signing all schedules.
Creditors may also target a debtor's conduct in incurring the debt, especially if some form of fraud was involved. A creditor, for example, can allege in a suit that a debtor filed a materially false financial statement to secure a loan. If successful, the suit will result in the court's deeming the debt non-dischargeable, and the debtor will be incapable of escaping liability for the loan.
Other sustainable creditor objections concern debt incurred through fraud while the debtor was acting in a fiduciary capacity, or if it was incurred through embezzlement or larceny. If a debtor steals money from his employer, for example, his personal liability on the subsequent judgment may be deemed non-dischargeable.
Similarly, the court may withhold relief for debt incurred as a result of willful and malicious injury by the debtor to another person. A judgment of compensatory and punitive damages for intentional infliction of emotional distress will not be discharged if the debtor's actions were willful and malicious.
Just as it frowns on fraudulent behavior and the hiding of assets, the U.S. Bankruptcy Code disapproves of spending sprees by people on the verge of filing for bankruptcy protection. There are two instances in which a debt will be presumed to be non-dischargeable, requiring the debtor to provide evidence to rebut that presumption. First, consumer debts exceeding $1150 owed to a single creditor for "luxury goods or services," and incurred 60 or fewer days before a bankruptcy filing, are presumed to be non-dischargeable. The same goes for cash advances aggregating over $1150 and withdrawn 60 or fewer days before a filing.
The term "luxury goods or services" is not defined by the Code. The Code does, however, exclude from this category goods or services reasonably acquired for the support or maintenance of the debtor or a dependent. Courts look to the circumstances surrounding the purchase to determine whether the good or service should be deemed a luxury. For example, a $17,000 debt to purchase a new motor vehicle may be found non-dischargeable where (1) the debt was incurred two weeks before the bankruptcy filing and (2) the debtor already owns four vehicles.
Because an aggressive creditor will fight the discharge of questionable debts, bankruptcy proceedings often spawn prolonged litigation. Attorneys representing debtors and creditors can do much prior to and during the proceedings to position clients to their best advantage. Next week, we'll take a look the exemptions debtors can claim to keep certain assets from being sold to pay creditors.