In A Bankruptcy Case, When Might A Debtor File A Lawsuit Asking The Court To Decide Whether Or Not A Debt Will Be Discharged?
In order to answer this question, I will first explain what happens in the more common version of this scenario, in which a creditor challenges the discharge of a debt.
- A Creditor Files A Nondischargeability Action
If a creditor feels it can establish to the judge’s satisfaction that the debt was incurred through fraud, breach of fiduciary duty, or as a result of doing willful and malicious harm to a person or property, it can initiate an adversary proceeding. It will probably be heard before a bankruptcy judge, as it’s very rare to get a jury trial in bankruptcy court.
That sort of nondischargeability action is only initiated by a creditor.
Occasionally, we see a creditor initiate a more sweeping kind of nondischargeability lawsuit. Rather than challenging the discharge of a particular debt, the creditor challenges the entire discharge. There are several reasons a creditor might do this, but the most common is if it looks like the debtor has engaged in fraud on the court.
Challenging the entire discharge of debts in a bankruptcy case is often based on what the debtor did before filing the bankruptcy petition. That is, the creditor can accuse the debtor of defrauding people, lying, and inducing people to invest in scams such as Ponzi schemes. These are all events that happened prior to the debtor filing the bankruptcy papers.
Sometimes challenges to the entire discharge are based on bad behavior the debtor exhibited postpetition (that is, after filing the bankruptcy petition). For instance, the debtor may have destroyed records so that the trustee couldn’t investigate. Another common example is if the creditor suspects that the debtor lied in their bankruptcy papers and hid assets.
In any case, challenging the entire discharge of debt is done under a different portion of the Bankruptcy Code — section 727 — than a challenge to the discharge of a particular debt under section 523.
For example, if the debtor engaged in a fraudulent transfer during the year prior to filing a Chapter 7 petition, then the debtor is ineligible for a Chapter 7 discharge because of § 272(a)(2). Of course, the fraudulent transfer has to be proved.
- The Debtor Files A Dischargeability Action
There are a few scenarios in which a debtor might initiate an adversary proceeding asking the court to determine that a particular debt is dischargeable.
- Discharging Student Loans
The first is student loan debt. According to section 523(a)(8) of the Bankruptcy Code, you cannot discharge student loans in bankruptcy, unless repaying them would constitute an undue hardship.
The term “undue hardship” is somewhat vague. However, it is understood by courts to be more than simply say, “I’m having a little trouble and do not want to pay this student loan.” What is required to establish undue hardship?. The seminal case is the New York case In re Brunner, that put forward the commonly used standard — the so-called “Brunner Test.”
The Brunner Test has three prongs that court use to determine undue hardship:
- Based on your current circumstances, you cannot maintain a minimal standard of living for yourself and your dependents if you are forced to repay the student loans.
- Your current financial state is likely to continue for the entire repayment period.
- You have made a good faith effort to repay your student loans.
Satisfying these three prongs does not, per se, mean that the student loans will be discharged when the Court grants you a discharge. Due process for the lender requires that you initiate an adversary proceeding to determine the dischargeability of the debt. If the Court enters a judgment discharging the debt, then the debt will be discharged when you receive your discharge. This process is not necessarily all-or-nothing. There have been some cases where debtors have been able to get a partial discharge of a large student debt.
Unfortunately, the case law has, for the most part, not been favorable to debtors. Part of the reason is if you are a good candidate to challenge the discharge of a student loan, you probably don’t have the resources to hire a really good attorney. Therefore, most of the eligible candidates wind up representing themselves, or hiring a much more affordable attorney who is inexperienced or not particularly good. The attorneys representing lenders, on the other hand, tend to be extremely sophisticated, experienced, and expensive. This has led to a large body of case law in favor of lenders rather than debtors. However, there have been some favorable cases dotted around the country in which debtors have been able to discharge some or all of their student debt.
- Discharging Tax Debt
Another kind of debt a debtor might challenge the non-dischargeability of is tax debt. Tax debt (specifically, income tax debt) for a particular tax year is dischargeable if it satisfies all the following requirements:
- The tax return for the given tax year was due, with extensions if you got them, at least three years and one day before you file the bankruptcy petition,
- You filed a legitimate, nonfraudulent tax return at least 2 years and one day before you file the bankruptcy petition, and
- The tax you wish to discharge was assessed more than 241 days before you file the petition.
Even if you are convinced that your tax debt satisfies all of the above requirements, the taxing authority may disagree. If that happens, you must initiate an adversary proceeding to get a determination of dischargeability.
- Discharging A Nondomestic Support Obligation To An Ex-spouse
Yet another type of debt that a debtor may sue to discharge is debt owed to a spouse or former spouse that is not domestic support, and that was incurred during the process of a divorce decree or a separation agreement.
A personal bankruptcy filed under any chapter will never discharge a debt that is a domestic support obligation, i.e., child support or alimony.
What about a debt to an ex-spouse that isn’t domestic support, and that was incurred as part of a separation agreement or divorce? It depends.
A simple example illustrates what’s going on there. Suppose during the divorce proceeding, the divorce judge assigns you some of the credit card debt held jointly in your marriage. You later file a bankruptcy petition and get a discharge. What happens to the credit card debt that was assigned to you? As long as the credit card company didn’t successfully challenge its discharge, the debt was discharged, vis-á-vis the credit card company. If the credit card company seeks to collect the debt from your ex-spouse, and your ex-spouse refuses to pay and asserts that the obligation is yours.
The credit card company can still collect from the ex-spouse because the bankruptcy didn’t discharge the ex-spouse’s liability to the credit card company. At that point, your ex will ask the divorce judge to order you to pay the ex, so that the ex can pay the credit card company; and the divorce judge will grant the request. In that sense, you have a debt to the ex that is not domestic support. That debt is not dischargeable in bankruptcy, except in a Chapter 13. This means that you only have to pay the debt through the Chapter 13 plan at the same percentage as other general unsecured debt.
However, there have been some cases in which certain debts that were incurred as part of a separation agreement or divorce decree have been considered domestic support, even though they were not child support or alimony.
If you in a Chapter 13 bankruptcy, and your ex files a proof of claim asserting that entire debt is domestic support, you can object to the claim using a claim objection rather than an adversary proceeding. If you can convince the judge that the debt is not domestic support, then you will pay it at the same percentage as the general unsecured debt, and at plan completion the unpaid portion will be discharged.
In sum, there are situations in which a debtor might seek a dischargeability determination.
- Discharging Student Loans
For more information on Initiating An Adversary Proceeding To Determine The Dischargeability Of A Debt, an initial consultation is your best next step. Get the information and legal answers you are seeking by calling (562) 777-9159 today.
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