This month I want to talk a bit about the discharge of debts. After all, the fresh start that is one of the key attributes of bankruptcy is dependent upon the discharge provided by Section 727, 944, 1228, or 1328 of the Bankruptcy Code. 111 U.S.C. §§ 101 et seq. (2006) (the “Code”).
Discharge of corporations and other non-individual debtors does not occur in Chapter 7. 2Id. § 727(a)(1). This is a change from prior law in which such entities were discharged following liquidation. 3For cases filed after October 1, 1973, the former Federal Rule of Bankruptcy Procedure 405 removed a requirement for corporate debtors to apply for discharge. Fed. R. Bankr. P. 405 (repealed 1978). Before Rule 405, the Bankruptcy Act differentiated between individual and corporate debtors as to the timing and process for discharge, but both types of debtor were nonetheless eligible for the relief. Chandler Act of 1938, Pub. L. No. 75-696, § 14a, 52 Stat. 840, 850 (repealed 1978). The change was intended to end trafficking in corporate shells for tax or securities purposes. 4S. Rep. No. 95-989, at 7 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5793 (“A change from current law will prevent corporations from being discharged in liquidation cases. Corporations are not in the same situation as individual debtors, and the discharge of a corporation promotes trafficking in corporate shells, a form of bankruptcy fraud.”); H.R. Rep. No. 95-595, at 384 (1978), reprinted in 1978 U.S.C.C.A.N. 5963, 6340 (“This is a change from present law, under which corporations and partnerships may be discharged in liquidation cases, though they rarely are. The change in policy will avoid trafficking in corporate shells and in bankrupt partnerships.”).
Today, on the other hand, a corporation (or other non-individual) receives a blanket discharge under Section 1141(d), or, if it is liquidating and ceasing business, it receives no discharge at all. 5Section 1141(d)(3) reads: (3) The confirmation of a plan does not discharge a debtor if—(A) the plan provides for the liquidation of all or substantially all of the property of the estate;(B) the debtor does not engage in business after consummation of the plan; and(C) the debtor would be denied a discharge under section 727 (a) of this title if the case were a case under chapter 7 of this title.Code § 1141(d)(3). The only exceptions to this broad discharge are certain government related debts incurred through fraud 6See Id. § 1141(d)(6). and debts held by creditors who lacked notice and so were denied due process of law. 7Mullane v. Cent. Hanover Bank & Trust, 339 U.S. 306, 314 (1950) (“An elementary and fundamental requirement of due process in any proceeding which is to be accorded finality is notice reasonably calculated, under all the circumstances, to apprise interested parties of the pendency of the action and afford them an opportunity to present their objections.”); Piedmont Trust Bank v. Linkous (In re Linkous), 990 F.2d 160, 162 (4th Cir. 1993) (“[A] bankruptcy court confirmation order generally is treated as res judicata. However, we cannot defer to such an order on res judicata grounds if it would result in a denial of due process in violation of the Fifth Amendment of the United States Constitution.”).
Sections 944, 1228, and 1328 provide their own discharge mechanics and delineate exceptions to discharge. The discharge afforded by Section 1328(a) is somewhat broader than its Chapter 12 counterpart, but has been narrowed by amendments to the Code. 8Section 1328(a) states:(a) Subject to subsection (d), as soon as practicable after completion by the debtor of all payments under the plan, and in the case of a debtor who is required by a judicial or administrative order, or by statute, to pay a domestic support obligation, after such debtor certifies that all amounts payable under such order or such statute that are due on or before the date of the certification (including amounts due before the petition was filed, but only to the extent provided for by the plan) have been paid, unless the court approves a written waiver of discharge executed by the debtor after the order for relief under this chapter, the court shall grant the debtor a discharge of all debts provided for by the plan or disallowed under section 502 of this title, except any debt—(1) provided for under section 1322 (b)(5);(2) of the kind specified in section 507 (a)(8)(C) or in paragraph (1)(B), (1)(C), (2), (3), (4), (5), (8), or (9) of section 523 (a);(3) for restitution, or a criminal fine, included in a sentence on the debtor’s conviction of a crime; or(4) for restitution, or damages, awarded in a civil action against the debtor as a result of willful or malicious injury by the debtor that caused personal injury to an individual or the death of an individual. Sections 1228(b) and 1328(b) provide for a so-called hardship discharge when a plan cannot be completed. The discharge provision that gives rise to the most litigation, however, is Section 727 and its list of bases for denial of discharge. Section 727(a)–(c) states:
(a) The court shall grant the debtor a discharge, unless—
(1) the debtor is not an individual;
(2) the debtor, with intent to hinder, delay, or defraud a creditor or an officer of the estate charged with custody of property under this title, has transferred, removed, destroyed, mutilated, or concealed, or has permitted to be transferred, removed, destroyed, mutilated, or concealed—
(A) property of the debtor, within one year before the date of the filing of the petition; or
(B) property of the estate, after the date of the filing of the petition;
(3) the debtor has concealed, destroyed, mutilated, falsified, or failed to keep or preserve any recorded information, including books, documents, records, and papers, from which the debtor’s financial condition or business transactions might be ascertained, unless such act or failure to act was justified under all of the circumstances of the case;
(4) the debtor knowingly and fraudulently, in or in connection with the case—
(A) made a false oath or account;
(B) presented or used a false claim;
(C) gave, offered, received, or attempted to obtain money, property, or advantage, or a promise of money, property, or advantage, for acting or forbearing to act; or
(D) withheld from an officer of the estate entitled to possession under this title, any recorded information, including books, documents, records, and papers, relating to the debtor’s property or financial affairs;
(5) the debtor has failed to explain satisfactorily, before determination of denial of discharge under this paragraph, any loss of assets or deficiency of assets to meet the debtor’s liabilities;
(6) the debtor has refused, in the case—
(A) to obey any lawful order of the court, other than an order to respond to a material question or to testify;
(B) on the ground of privilege against self-incrimination, to respond to a material question approved by the court or to testify, after the debtor has been granted immunity with respect to the matter concerning which such privilege was invoked; or
(C) on a ground other than the properly invoked privilege against self-incrimination, to respond to a material question approved by the court or to testify;
(7) the debtor has committed any act specified in paragraph (2), (3), (4), (5), or (6) of this subsection, on or within one year before the date of the filing of the petition, or during the case, in connection with another case, under this title or under the Bankruptcy Act, concerning an insider;
(8) the debtor has been granted a discharge under this section, under section 1141 of this title, or under section 14, 371, or 476 of the Bankruptcy Act, in a case commenced within 8 years before the date of the filing of the petition;
(9) the debtor has been granted a discharge under section 1228 or 1328 of this title, or under section 660 or 661 of the Bankruptcy Act, in a case commenced within six years before the date of the filing of the petition, unless payments under the plan in such case totaled at least—
(A) 100 percent of the allowed unsecured claims in such case; or
(B)
(i) 70 percent of such claims; and
(ii) the plan was proposed by the debtor in good faith, and was the debtor’s best effort;
(10) the court approves a written waiver of discharge executed by the debtor after the order for relief under this chapter;
(11) after filing the petition, the debtor failed to complete an instructional course concerning personal financial management described in section 111, except that this paragraph shall not apply with respect to a debtor who is a person described in section 109 (h)(4) or who resides in a district for which the United States trustee (or the bankruptcy administrator, if any) determines that the approved instructional courses are not adequate to service the additional individuals who would otherwise be required to complete such instructional courses under this section (The United States trustee (or the bankruptcy administrator, if any) who makes a determination described in this paragraph shall review such determination not later than 1 year after the date of such determination, and not less frequently than annually thereafter.); or
(12) the court after notice and a hearing held not more than 10 days before the date of the entry of the order granting the discharge finds that there is reasonable cause to believe that—
(A) section 522 (q)(1) may be applicable to the debtor; and
(B) there is pending any proceeding in which the debtor may be found guilty of a felony of the kind described in section 522 (q)(1)(A) or liable for a debt of the kind described in section 522 (q)(1)(B).
(b) Except as provided in section 523 of this title, a discharge under subsection (a) of this section discharges the debtor from all debts that arose before the date of the order for relief under this chapter, and any liability on a claim that is determined under section 502 of this title as if such claim had arisen before the commencement of the case, whether or not a proof of claim based on any such debt or liability is filed under section 501 of this title, and whether or not a claim based on any such debt or liability is allowed under section 502 of this title.
(c)(1) The trustee, a creditor, or the United States trustee may object to the granting of a discharge under subsection (a) of this section.
(2) On request of a party in interest, the court may order the trustee to examine the acts and conduct of the debtor to determine whether a ground exists for denial of discharge.
Code § 727(a)–(c). These bases for denial of discharge, incidentally, closely parallel certain bankruptcy crimes under 18 U.S.C. § 152. 918 U.S.C. § 152 states:A person who—(1) knowingly and fraudulently conceals from a custodian, trustee, marshal, or other officer of the court charged with the control or custody of property, or, in connection with a case under title 11, from creditors or the United States Trustee, any property belonging to the estate of a debtor;(2) knowingly and fraudulently makes a false oath or account in or in relation to any case under title 11;(3) knowingly and fraudulently makes a false declaration, certificate, verification, or statement under penalty of perjury as permitted under section 1746 of title 28, in or in relation to any case under title 11;(4) knowingly and fraudulently presents any false claim for proof against the estate of a debtor, or uses any such claim in any case under title 11, in a personal capacity or as or through an agent, proxy, or attorney;(5) knowingly and fraudulently receives any material amount of property from a debtor after the filing of a case under title 11, with intent to defeat the provisions of title 11;(6) knowingly and fraudulently gives, offers, receives, or attempts to obtain any money or property, remuneration, compensation, reward, advantage, or promise thereof for acting or forbearing to act in any case under title 11;(7) in a personal capacity or as an agent or officer of any person or corporation, in contemplation of a case under title 11 by or against the person or any other person or corporation, or with intent to defeat the provisions of title 11, knowingly and fraudulently transfers or conceals any of his property or the property of such other person or corporation;(8) after the filing of a case under title 11 or in contemplation thereof, knowingly and fraudulently conceals, destroys, mutilates, falsifies, or makes a false entry in any recorded information (including books, documents, records, and papers) relating to the property or financial affairs of a debtor; or(9) after the filing of a case under title 11, knowingly and fraudulently withholds from a custodian, trustee, marshal, or other officer of the court or a United States Trustee entitled to its possession, any recorded information (including books, documents, records, and papers) relating to the property or financial affairs of a debtor,shall be fined under this title, imprisoned not more than 5 years, or both. The general rule is that exceptions to discharge or the bases for denial of discharge are to be construed narrowly. 10E.g., Hudson v. Raggio & Raggio, Inc. (In re Hudson), 107 F.3d 355, 356 (5th Cir. 1997) (“Intertwined with this burden is the basic principle of bankruptcy that exceptions to discharge must be strictly construed against a creditor and liberally construed in favor of a debtor so that the debtor may be afforded a fresh start.”) (citing Murphy v. Robinson Inv. Co. v. Cross (In re Cross), 666 F.2d 873, 880 (5th Cir. 1982)); Loe, Warren, Rosenfield, Katcher, Hibbs & Windsor, P.C. v. Brooks (In re Brooks), 371 B.R. 761, 766 (Bankr. N.D. Tex. 2007) (“Narrowly reading exceptions to discharge ensures that the Bankruptcy Code will provide a deserving debtor with a discharge that indeed provides a fresh start.”). However, courts have often construed them in a less than debtor-friendly manner. 11See, e.g., Sholdra v. Chilmark Fin. LLP (In re Sholdra), 249 F.3d 380, 382–83 (5th Cir. 2001) (holding that a debtor amending statements in his schedules only after depositions revealed a falsity supported a finding of fraudulent intent and a denial of discharge); Beaubouef v. Beaubouef (In re Beaubouef), 966 F.2d 174, 177–78 (5th Cir. 1992) (affirming a denial of discharge where the debtor’s schedules included several false statements regarding his former ownership interest in a shell corporation and the debtor failed “to take advantage of the opportunity to clear up all inconsistencies and omissions … [, which] constituted reckless indifference to the truth and, therefore, the requisite intent to deceive”).
A complaint to deny discharge may be brought by a creditor, the trustee, or the U.S. Trustee. Federal Rule of Bankruptcy Procedure 4004 governs such complaints. A creditor who brings a Section 727 complaint, however, should be cognizant of Rule 7041. This rule requires notice before such a complaint can be dismissed voluntarily by the plaintiff. I often see complaints by creditors under both Section 727 and Section 523. The two sections are related conceptually. But Section 523 claims exempt from discharge only certain debts owed to specific creditors, while a successful Section 727 claim benefits all creditors of the bankruptcy estate.
Creditors may have the idea that the club of Section 727 will scare a debtor into settling the Section 523 claim. This strategy can be dangerous. By undertaking a Section 727 action a creditor adopts a sort of fiduciary position vis-à-vis other creditors. 12See Young v. Higbee Co., 324 U.S. 204, 211–14 (1945) (holding that preferred shareholders appealing a confirmation order owed a duty of good faith to all preferred equity class members and that the appeal, although brought by individuals, sought relief for the benefit of all class members); Bankr. Receivables Mgmt. v. de Armond (In re de Armond), 240 B.R. 51, 53 (Bankr. C.D. Cal. 1999) (“In filing a [section] 727 claim a plaintiff takes on a fiduciary duty to the creditor body. A plaintiff violates this fiduciary duty when it appropriates for itself the settlement of such litigation.”). Thus, if the debtor pays to settle a discharge action, the creditor who brokered the settlement may be required to share the settlement proceeds with other creditors. 13In re de Armond, 240 B.R. at 58–59. The decision in In re de Armond provides a thorough explanation for the problems caused by using a Section 727 claim offensively with a section 523 claim. “The tension between these two kinds of claims, and the duties of the plaintiff arising from the filing of a [section] 727 claim are particularly important when the plaintiff attempts to settle the [section] 523 claim and dismiss the [section] 727 claim.” Id. at 55. A creditor pocketing the proceeds of such a settlement may abuse his duty to the creditor body by using other creditors’ leverage to increase his own return. See Young, 324 U.S. at 212 n.12; In re de Armond, 240 B.R. at 58. Moreover, the trustee or another creditor may take over the Section 727 part of the action and so upset the settlement.
Besides objecting to discharge, a creditor, the trustee, or the U.S. Trustee may seek revocation of a discharge for a period of time. Section 727(d) and (e) states:
(d) On request of the trustee, a creditor, or the United States trustee, and after notice and a hearing, the court shall revoke a discharge granted under subsection (a) of this section if—
(1) such discharge was obtained through the fraud of the debtor, and the requesting party did not know of such fraud until after the granting of such discharge;
(2) the debtor acquired property that is property of the estate, or became entitled to acquire property that would be property of the estate, and knowingly and fraudulently failed to report the acquisition of or entitlement to such property, or to deliver or surrender such property to the trustee;
(3) the debtor committed an act specified in subsection (a)(6) of this section; or
(4) the debtor has failed to explain satisfactorily—
(A) a material misstatement in an audit referred to in section 586 (f) of title 28; or
(B) a failure to make available for inspection all necessary accounts, papers, documents, financial records, files, and all other papers, things, or property belonging to the debtor that are requested for an audit referred to in section 586 (f) of title 28.
(e) The trustee, a creditor, or the United States trustee may request a revocation of a discharge—
(1) under subsection (d)(1) of this section within one year after such discharge is granted; or
(2) under subsection (d)(2) or (d)(3) of this section before the later of—
(A) one year after the granting of such discharge; and
(B) the date the case is closed.
Code § 727(d)–(e). The time limits in Section 727(e) are echoed by Federal Rule of Bankruptcy Procedure 9024, which limits time-wise the applicability of Federal Rule of Civil Procedure 60(b) to discharge and confirmation orders. These time limits illustrate the importance accorded to finality in the discharge context by Congress.
Section 727 and its companion rules give a creditor a powerful tool for thwarting a debtor’s efforts to obtain a fresh start. But it is a tool to be used infrequently and with care. Besides the pitfalls discussed above, the creditor objecting to discharge can expect its objection to be hotly contested given that it negates the advantage of a debtor’s bankruptcy.
