 of Federal Judicial Center Orientation Series for United States Bankruptcy Judges. Discharge and Dischargeability with the Honorable A. Thomas Small Chief Bankruptcy Judge for the Eastern District of North Carolina. Judge Small was appointed to the bankruptcy court in 1982. He received his BA degree from Duke University in 1965 and his JD from Wake Forest University School of Law in 1969. The Eastern District of North Carolina has two authorized bankruptcy judgeships and two primary places of holding court, including Raleigh where Judge Small sits. Welcome to our session on Discharge and Dischargeability. Discharge is the heart of a debtor's fresh start. It's the primary reason that debtors file for bankruptcy relief. It's important and it should come as no surprise that over one-third of all adversary proceedings involve either an objection to discharge under section 727 or complaints to determine dischargeability of debts under section 523 of the bankruptcy code. Today we'll be talking about the bankruptcy basics. We'll talk about the effect of discharge, discharge procedures, practical aspects of bankruptcy, and the substantive aspects of section 727 and section 523. Now the effect of discharge varies of course depending upon the chapter that the debtor is in. A chapter 7 discharge eliminates the debtor's liability for most pre-bankruptcy debts. That discharge however is subject to the exceptions set out in 523 of the bankruptcy code. The chapter 13 discharge is broader and it's more generous to the debtor. Not all of the 523 exceptions are applicable to the chapter 13 discharge. Dets that are not discharged in chapter 13 include alimony and child support. Long-term debts that mature after the completion of the plan where the debtor is curing defaults that occurred prior to bankruptcy. Fines and penalties and judgments arising from drunk driving are also not discharged in a chapter 13 case. In chapter 13 the discharge comes at the end of the case after the debtor has completed all of the plan payments. And what are discharged are those debts that are dealt within the plan. If the debtor proposes to pay 60 cents on the dollar to unsecured creditors the remaining 40 percent is forgiven. In a chapter 11 case the discharge comes upon confirmation before all the plan payments are made. All debts that arise before confirmation are discharged. The 523 exceptions apply to the chapter 11 discharge if the debtor is an individual. If the debtor is a corporation the 523 exceptions do not apply. As a general rule the discharge will not affect the obligations of third-party non-debtors, guarantors, co-makers. Their obligations are not affected by the debtor's discharge. Also the discharge does not affect otherwise valid liens. Of course a trustee can avoid liens under the trustee's avoiding powers, a debtor can avoid liens under section 522f, but that takes an affirmative act. The discharge by itself does not affect otherwise valid liens. Let's talk about discharge procedure. Discharge and dischargeability actions are adversary proceedings and all the formal requirements of adversary proceedings apply. There's got to be a filing fee, a complaint has to be filed. These are core proceedings which the bankruptcy judge may hear and determine. The bankruptcy court has exclusive jurisdiction over complaints filed under section 727 objections to the debtor's discharge. Also the bankruptcy court has exclusive jurisdiction under 523a2, a4, and a6 where complaints objecting to the dischargeability of specific debts. The bankruptcy court however has concurrent jurisdiction with state courts with respect to complaints filed under other sections of 523. That means if you've got an obligation and the issue is whether or not it is an obligation that is alimony or child support, either the bankruptcy court or the state court can make that determination. Well what if you have a dischargeability issue under a2, 4, or 6 where the bankruptcy court has exclusive jurisdiction and a state court has already decided that issue prior to bankruptcy. For example if you have a judgment in a state court action that says that an obligation was incurred as a result of a willful and malicious injury inflicted by the debtor. Well that determination would be binding on the bankruptcy court in an action under 523a6 because it's already been decided by the state court and the bankruptcy court can no longer decide that under the doctrine of collateral estoppel. Most chapter 7 debtors get their discharge, but discharges like stretched ski pants are not for everyone and creditors have an opportunity to file objections to the discharge. In complaints filed under section 727, 523a2, 4, and 6 creditors have 60 days from the first date set for the meeting of creditors to file that objection and that's so because of bankruptcy rule 4004a and bankruptcy rule 4007c. Courts strictly construe these filing bar dates. If the creditor is too late that's just too bad. Even if the creditor has a pretty good excuse and if the creditor has a pretty strong case to have the debtor's discharge denied, if the complaint is filed too late the debtor's discharge will be granted. Bankruptcy rule 4005 provides that the burden of proof where you have a complaint objecting to the debtor's entire discharge under section 727 is on the trustee or creditor that's trying to deny the debtor the discharge. In actions under section 523, the burden is on the creditor who's trying to determine that a specific debt is non-dischargeable. The exception to that rule low is under section 523a8 where the debtor is trying to discharge a student loan on the grounds that repayment would constitute an undue hardship on the debtor or the debtor's family. In that case the burden of proof is on the debtor. The standard of proof in actions under 523 according to a Supreme Court decision in Grogan versus Gardner is preponderance of the evidence and courts have extended that standard and applied that standard in actions under 727 and that is true even though the issue is the debtor's fraudulent intent. Usually under state law fraud has a standard of clear strong and convincing. That is a more stringent standard than the preponderance of evidence that applies in 727 and 523. Now it's not uncommon to find statements in various opinions that say that if the issue is discharge all doubts should be resolved against the creditor and in favor of the debtor. That's because of the fresh start policy. Well don't be misled by those statements because the clear trend at least at the circuit level is that debtors are having a more difficult time getting their discharges granted. You'll find cases that say that these issues should be construed against the creditor but in the same case the debtor's discharge will be denied. Now I'd like to turn to two practical problems you may face when you try discharge and discharge ability proceedings. It's not uncommon in a chapter 7 case for that chapter 7 attorney to try to withdraw from the case when the discharge complaint is filed. Typically the attorney has gotten the fee before the case is filed and that fee does not include adversary proceedings. So when the adversary proceeding is filed the attorney wants out of the case when the debtor can't pay for that representation. Important thing to keep in mind is that the attorney can't just walk away from the case. It's up to the bankruptcy judge to decide whether or not to let the attorney out. Judge Wopner may like trying prose cases but I can assure you that most bankruptcy judges don't so keep in mind that whether or not the attorney leaves the case is within your discretion. Another problem relates to the settlement of these types of proceedings. Typically you'll have a multiple count complaint. You'll have the counts relating to the 727 issues whether or not the whole discharge should be denied and you'll have the counts that relate to the discharge ability of specific debts under 523. Not surprisingly most of these adversary proceedings like all adversary proceedings are settled and the way they're usually settled is with the creditor withdrawing the complaint and the debtor reaffirming all or part of that creditor's debt. Well that's the best of both worlds for that creditor. No other creditor can go against the debtor because of the discharge and only that creditor can pursue the remaining obligation. That may be unfair to the other creditors especially if there are strong grounds for denying the debtor's entire discharge. At a minimum the court has to notify the trustee that the case has been settled along those lines. That's required by bankruptcy rule 7041 and the bankruptcy judge may want to go beyond that and notify all creditors that the settlement has been entered and that the debtor's discharge will be granted. The bankruptcy code used to require debtors to attend discharge hearings before they could receive the discharge and this caused all sorts of problems. It was time-consuming. It created a burden on an overburden clerk's office and it created a burden for the debtors. It made them miss a day to work of work to come to these discharge hearings. Now discharge hearings are optional. It's up to the court and most courts have decided not to hold discharge hearings but I would suggest that there is a valid reason for holding discharge hearings. If you think about it most debtors could go through a bankruptcy proceeding and never come before a bankruptcy judge. I think it's important for debtors to see somebody in a black robe. It indicates to them that they've done something serious and they have the protection of the federal system behind them. In our district our 341 meetings are held in our courthouse so what I do is I assemble all the debtors immediately prior to their 341 meeting and conduct the discharge hearing. I realize that's not practical in many districts but it seems to work for us. Some debtors may want to reaffirm debts that have been discharged. To be enforceable reaffirmation agreements must meet the requirements of section 524c3. The agreements must be signed before the discharge is entered. They must be filed with the court and the debtor has the option of rescinding the reaffirmation agreement 60 days after it's filed with the court. If the debtor is represented by an attorney the attorney has to file an affidavit certifying that the reaffirmation agreement does not result in an undue hardship to the debtor or the debtor's dependence. If the debtor is not represented by an attorney then the bankruptcy court gets into the act. A hearing has to be held. Frequently I'll do it by telephone conference call and at that hearing the bankruptcy judge has to determine not only that it's not an undue burden on the debtor but also that it's in the debtor's best interest to reaffirm that debt. Frequently the reaffirmation agreements involve debts that are secured by the debtor's home, mobile home or automobile and there are some circuits that hold that a chapter 7 debtor must reaffirm the debt before they can keep the car or the mobile home or their home. There are other circuits however like the 4th circuit where I said where the debtor does not have to reaffirm the debt to keep the automobile. As long as the payments are current the creditor is not able to repossess that collateral and if you're in that a district like that or a circuit like that it really doesn't make sense and it's not in the debtor's best interest to reaffirm those obligations. Let's turn now to the substantive aspects of section 727. 727a1 provides that only an individual in chapter 7 can receive a discharge. That's true also in chapter 13 cases but for a different reason of course only individuals can be debtors in chapter 13. In chapter 11 both individuals and corporations get a discharge. Probably the most important subsection of 727 is 727a2. If within one year of bankruptcy the debtor with the intent to hinder, delay and defraud creditors transfers, destroys, mutilates or conceals property the debtor's discharge should be denied. Well what if the debtor transfers all of the debtor's non-exempt assets to exempt assets on the eve of bankruptcy. The courts are divided on this issue. Some courts take the position that the sky's the limit anything goes. Pre-bankruptcy planning is perfectly legitimate. Other courts take the position that if you're too aggressive in your pre-bankruptcy planning then your discharge can be denied and I think bankruptcy judges are pretty much evenly split on that issue. The legislative history to section 522 says that it is not fraudulent per se to transfer non-exempt assets to exempt assets on the eve of bankruptcy but you'll find many cases while citing that legislative history will deny the discharge to the overly aggressive pre-bankruptcy planner under section 727a2. The one-year time limit is important in 727a2. If a transfer is made outside that one-year period the debtor gets the discharge so if a debtor transfers his residence to his mother-in-law waits a year and a day to file the bankruptcy petition is he home free? Maybe not. There's a doctrine called continuing concealment that several circuits have applied and that doctrine provides that it makes no difference when the transfer was made. If there is a continuing concealment then that debtor will lose the discharge under 727a2. Now 727a3 and a5 pretty much go hand in hand. a3 provides that if the debtor conceals destroys or fails to keep records the discharge is denied. a5 provides if the debtor does not satisfactorily explain the loss of assets the debtor's discharge and denied. A good case that discusses a3 and a5 is the in-ray Dolan case. In that case the debtor used what I refer to as the high man defense. Mr. Dolan was a cocaine addict and his defense was your honor. I couldn't keep records because I was too high man. The sick circuit however didn't buy that and Mr. Dolan's discharge was denied. What kind of records does a debtor have to keep? Well of course it depends upon the specific circumstances of the case. If it's a complicated case the debtor's records will have to be more detailed and more complete. Under section 727a4 a debtor's discharge is denied if the debtor gives a false oath, makes a bribe or withholds information. What constitutes a false oath? Well it's got to be materially false given with intent to deceive and it must relate to the debtor's assets. A reckless indifference to the truth has been held to be tantamount to fraudulent intent for purposes of 727a4. The provisions of 727a6 and a10 are pretty self-explanatory so in the interest of time I won't go over those but before we leave 727 I did want to mention the bankruptcy judge's obligation to report crimes under 18 USC 3057a. If a bankruptcy judge has reasonable grounds to believe that a crime has been committed the bankruptcy judge has an obligation to make a report to the U.S. Attorney. The report can be in writing it can be an it can be an oral report. Of course if you've got an obligation to make a report you want to be sure that you document the fact that you've made that report. You've got no obligation to tell the party that you're complaining about that you've made the report and you've got no obligation to give advance notice that you're going to make the report. Trustees have the same obligation that the bankruptcy judge has to report crimes to the U.S. Attorney and there may be situations where it is better for the trustee to make the report than for the bankruptcy judge to make the report. For example if the litigation is still going on if the dischargeability litigation is still going on the judge could be criticized for not being impartial if the judge made a report prior to hearing the case that a criminal act had been committed. Let's turn now to the exceptions to discharge under section 523. 523a1 provides that certain taxes are not discharged current taxes taxes where there's been no return filed or a fraudulent return file. Section 523a2 is probably the most used section of 523. 523a2a says that there is no discharge when a when credit was extended based on false pretenses. Now this comes up frequently with respect to credit card debt. If a debtor knows that the debtor cannot make payments under the credit card yet continues to use the credit card those obligations are non-dischargeable. Also if a debtor purchases luxury goods aggregating more than $1,000 within 60 days of bankruptcy or gets cash advances aggregating more than $1,000 within 60 days of bankruptcy those obligations are not discharged. 523a2b provides that credit extended based on written false financial statements are not discharged. The creditor must prove that the financial statement was materially false that it was given with the intent to deceive and that the creditor reasonably relied on that false statement. Does reasonable reliance also apply to false pretenses under a2a? Well the Supreme Court in field versus man's addressed that issue and said that the creditor if the issue is false pretenses need not show reasonable reliance but must show justifiable reliance. Well what's the difference between reasonable reliance and justifiable reliance? Frankly I have no idea. Under section 523a3 there's no discharge of a debt when the creditor was not listed when the creditor had no knowledge of the case or if the creditor found out about the case too late to file a claim or to file a complaint under section 523a24 or 6. Of course most chapter 7 cases are no asset cases no claims are filed and there's no claim bar date. In that situation the debtor can just amend the schedules add the creditor and the debt is discharged. But what if the case has been closed? Does the debtor have to reopen the case? Does the clerk have to retrieve the file from archives? Well the trend of the cases does not require reopening of the case and the cases say that all the debtor has to do is to notify the creditor and that debt is discharged unless it's 1 under 523a24 or 6. Under section 523a4 debts are rising from larceny or embezzlement or from a breach of fiduciary obligation are not discharged. If the ground for denying discharge is breach of a fiduciary obligation it must be a true fiduciary obligation a true trust created either by contract statute or the conduct of the parties. A mere breach of a constructive trust is not enough to deny the discharge ability of that debt under section 523a4. 523a5 deals with debts in the nature of alimony and support and you'll have a lot of these cases and I think you'll find that they're probably the least pleasant to try. The crucial issue is what was the party's intent when they entered into that divorce settlement? Well the problem is whether or not it was alimony or support or something else a property settlement was probably the furthest thing from these parties minds they were interested in dissolving the marriage and they were interested in the bottom line how much do I get how much do I have to pay. So the court must look at all the circumstances to determine what the party's intent was when they entered into that arrangement. Non-alimony marital obligations are also non-dischargeable under 523a15. The exception though is where the debtor has no ability to make those payments and where the debtor's discharge is more beneficial than the detriment to the spouse or the debtor's dependence. 523a6 provides that debts incurred as a result of willful and malicious acts are not discharge. Most courts hold that specific malice is not required. All the creditor has to show is that there was an intentional act in disregard of the rights of the other party. There have been a number of cases where doctors have been denied or medical malpractice claims have come under 523a6 where the doctor did not have medical malpractice insurance. 523a7 provides that there is no discharge for fines and penalties. 523a8 provides that there's no discharge for student loans where the government has guaranteed the loan or a non-profit institution has guaranteed the loan. The exception is when the loan is more than seven years old or repayment would create an undue hardship for the debtor and the debtor's dependence and again it is the debtor that has the burden of proof if the issue is undue hardship. I've had a number of cases where doctors have tried to discharge their debts that they incurred while they were in medical school. I think almost uniformly the doctors have lost in that situation. It will probably be the same for lawyers unless the lawyer failed the bar exam five times which was the fact pattern in the case of In Ray Bryant. 523a9 provides that obligations arising from drunk driving judgments are not discharged. 523a10 provides that non-dischargeable obligation in prior cases are not subsequently discharged in a later Chapter 7 case. Section 523a11 and a12 say that obligations to federal agencies that regulate financial institutions are not discharged. 523a13 says that restitution awarded in connection with federal crimes is not discharged. 523a14 provides that obligations incurred to pay otherwise non-dischargeable taxes are not discharged and 523a16 provides that post petition condominium assessments are non-dischargeable even though the agreement was entered into prior to bankruptcy. Now once the discharge is entered the automatic state terminates and it's replaced by a permanent discharge injunction. That discharge injunction is the debtor's protection from creditor harassment. Now I know you're thinking right now that you've probably been harassed long enough on the issue of discharge and dischargeability and I agree. So that'll conclude our session. I hope it has been helpful to you and with that you all are discharged.