Cecily Zamora
The ability to discharge debts incurred by fraud is a highly contested issue in bankruptcy law. In the US, the Bankruptcy Code's §523(a)(2)(A) section specifically exempts debts obtained by false pretenses, a false representation, or actual fraud from being discharged. This means that if a debt is proven to have resulted from fraud, it cannot be eliminated through bankruptcy, even if the debtor was not the perpetrator of the fraud. The Supreme Court has upheld this interpretation, emphasising that the law focuses on the occurrence of fraud rather than the identity of the fraudulent actor. However, the law also protects honest debtors, allowing them a fresh start through bankruptcy proceedings.
| Characteristics | Values |
|---|---|
| Can a debtor discharge a debt obtained by fraud? | No, the Supreme Court has ruled that § 523(a)(2)(A) of the Bankruptcy Code precludes a debtor from discharging a debt obtained by fraud, regardless of the debtor’s own culpability. |
| What is fraud? | Fraud involves misrepresentations or omissions that cause a loss to a victim. |
| What is the deadline for a creditor to bring an adversary proceeding? | A creditor has about 90 days to bring an adversary proceeding. |
| What is the deadline for a creditor to object to the debtor's discharge? | A creditor must file a complaint in the bankruptcy court before the deadline set out in the notice. |
| Can a debtor repay a discharged debt? | Yes, a debtor may voluntarily repay a discharged debt even though it can no longer be legally enforced. |
| Can the court revoke a discharge? | Yes, the court may revoke a discharge under certain circumstances, such as if the debtor obtained the discharge fraudulently. |
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What You'll Learn
Debts obtained by fraud
Common law fraud is a tort, a civil wrong, that generally involves the intentional misrepresentation of facts for personal gain or to cause harm to another party. It is important to distinguish between common law fraud and statutory fraud. The latter refers to fraud defined by specific federal or state statutes, such as fraud in the context of bankruptcy or securities fraud. While common law fraud may be dischargeable in bankruptcy, statutory fraud is often specifically excluded from discharge.
In the United States, bankruptcy law provides a pathway for individuals and businesses to resolve their debts and get a fresh start. However, not all debts are treated equally, and certain types of debts obtained by fraudulent means may be exempt from discharge. The Bankruptcy Code contains specific provisions to address debts incurred through fraud and to protect the rights of both debtors and creditors.
Section 523(a)(2)(A) of the Bankruptcy Code outlines that a discharge under Chapter 7 or 11 does not apply to any debt "for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor's or an insider's financial condition." This means that if a debt was incurred as a result of the debtor's fraudulent actions or misrepresentations, it may be deemed non-dischargeable.
To prove that a debt is non-dischargeable due to fraud, a creditor must demonstrate that the debtor made a false representation or omission, did so knowingly and intentionally, and with the intention of deceiving the creditor. Additionally, the creditor must show that they justifiably relied on the debtor's misrepresentation and that this reliance resulted in a loss or damage. This standard of proof is higher than simply showing that a false statement was made; it requires evidence of a deliberate intent to defraud.
Courts have generally interpreted "false pretenses, a false representation, or actual fraud" broadly to encompass a wide range of deceptive conduct. This can include not only explicit misstatements but also intentional omissions or failures to disclose material information. For example, if a debtor applies for a loan and intentionally fails to disclose significant existing debts or liabilities, this could be considered a form of fraud that makes the loan non-dischargeable.
It is worth noting that the specific provisions and case law interpretations may vary depending on the jurisdiction and the specific bankruptcy court handling the case. As such, it is always advisable to seek the guidance of an experienced bankruptcy attorney when dealing with issues related to debts obtained by fraud and their dischargeability in bankruptcy proceedings.
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Creditor's rights
In the United States, bankruptcy law does not focus solely on the debtor's interests; it seeks to balance multiple, often competing interests, including those of creditors.
Creditors' rights in bankruptcy proceedings include the right to be heard with regard to the liquidation of the debtor's nonexempt assets in Chapter 7 and the debtor's repayment plan under Chapter 13. All creditors are also entitled to challenge the debtor's right to a discharge. In addition, all creditors are entitled to share in payments from the bankruptcy estate, but only according to the priority of their claims. Bankruptcy law favors priority claims like child support, as well as secured claims. Secured claims are those in which collateral secures the debt, and the creditor can repossess and sell the property if the debtor defaults on payments.
Creditors with unsecured debts, such as medical or credit card debt, can file a proof of claim, attend the first meeting of creditors, and file objections to the discharge. They can also review the bankruptcy papers for inaccuracies and, in some cases, request the court's approval to take the debtor's deposition to ensure they receive the full amount owed, given the debtor's assets and other debts. However, unsecured creditors may not be paid in Chapter 7 and may not be entitled to payment in Chapter 13, depending on the priority and number of secured debts.
If a debtor files for Chapter 13 bankruptcy, a creditor with a lien is entitled to the value of the debt or collateral, whichever is less. In the case of redemption, the debtor can buy back the property by paying a lump sum equal to the replacement value of the collateral, which is often less than the debt owed. If the debtor and creditor cannot agree on the replacement value, the court can determine it through a valuation hearing.
In some cases, the bankruptcy trustee may ask a creditor to return money the debtor paid before filing for bankruptcy. The bankruptcy code prohibits debtors from preferring one creditor over another. The trustee may recover payments made on previous debts within 90 days of a bankruptcy filing unless specific requirements are met.
Creditors must act quickly after a debtor files for bankruptcy to prove that a civil debt falls within the definition of fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny. They must initiate an adversary proceeding within 60 days of the first day of the Section 341 meeting of creditors, which usually occurs about 30 days after the debtor files the bankruptcy petition. Creditors have the right to seek an extension, but only within the first 60 days.
If a debt is based on a civil judgment arising from the debtor's allegedly fraudulent actions, the creditor has the burden of proving that the debt should not be discharged. A judge will make the final decision, and if the ruling is that fraud occurred, the debt cannot be discharged in any future bankruptcy filings by the debtor.
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Bankruptcy court proceedings
There are 90 bankruptcy districts across the US, with a bankruptcy court for each judicial district. Bankruptcy judges are appointed by the United States Court of Appeals and serve 14-year terms.
The bankruptcy process begins when the debtor files a petition with the bankruptcy court. This can be done by an individual, spouses, or a corporation or other entity. The bankruptcy court will then evaluate the debtor's financial situation and decide how their assets may be used to repay their debts. The decision often leads to the discharge of certain debts, meaning the debtor is no longer responsible for them. However, some debts are ineligible for discharge, including tax claims, child support, alimony payments, and personal injury debts.
There are different types of bankruptcy cases, referred to by their chapter in the US Bankruptcy Code. Individuals may file for Chapter 7 or Chapter 13 bankruptcy, while businesses may file for Chapter 7 to liquidate or Chapter 11 to reorganise. Chapter 15 bankruptcy is used when the debtor has assets or debts in multiple countries.
During the bankruptcy process, the debtor's involvement with the bankruptcy judge is usually limited. In a typical Chapter 7 case, the debtor does not appear in court unless there is an objection. In a Chapter 13 case, the debtor may only appear before the judge at a plan confirmation hearing. The only formal proceeding the debtor must attend is the meeting of creditors, held at the offices of the US trustee. This is also known as a 341 meeting, as the debtor must attend so that creditors can question them about their debts and property.
In cases of fraud-related debts, a creditor has about 90 days to bring an adversary proceeding. This usually occurs after the meeting of creditors, which is scheduled around 30 days after the debtor files the bankruptcy petition. The court will consider whether the debtor held property in trust for someone else and used it for a purpose not permitted by the owner. It will also look for misrepresentations or omissions that caused a loss to the victim. If fraud is found, the debt cannot be discharged, and this ruling will apply to any future bankruptcy filings by the debtor.
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Revoking a discharge
A bankruptcy discharge releases the debtor from liability for certain types of debts. In other words, the debtor is no longer legally required to pay off discharged debts. The discharge prohibits the creditors from taking any collection action, including legal action and communications with the debtor.
However, a bankruptcy discharge can be revoked under certain circumstances. For instance, in a Chapter 7 case, a trustee, creditor, or the US trustee may request the court to revoke the debtor's discharge based on allegations of fraud, failure to disclose the acquisition of property that would constitute the bankruptcy estate, or any acts of impropriety. The request for revocation must be filed within one year of the discharge or before the case is closed. The court will then decide whether to revoke the discharge.
In Chapter 11, 12, and 13 cases, the court can revoke the discharge if it is obtained through fraud. The grounds for requesting revocation depend on whether Chapter 7 or Chapter 13 bankruptcy was filed. In Chapter 7, bankruptcy fraud, failure to disclose assets, or disobedience of court orders are grounds for revocation. In Chapter 13, the grounds are similar to Chapter 7, with the request for revocation needing to be made within one year of the discharge.
If a bankruptcy discharge is revoked, the debtor remains liable for previously discharged debts. Additionally, the debtor may face fines, asset forfeiture, or criminal prosecution. It is important to consult a bankruptcy attorney for specific advice on debt discharge and revocation.
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Fraudulent intent
In the United States, common law identifies nine elements needed to establish fraud, which include the "representer's state of mind or intent". The fourth element of common law fraud requires the representer to either have knowledge of the falsity of their statement or be reckless in their ignorance of its truth. This means that false representations made recklessly and without regard for their truth can be considered equivalent to intentional misrepresentations.
The fifth element of common law fraud is the representer's intent to induce the other party to act in accordance with the representation. This means that the fundamental character of fraud is the communication of a misimpression to induce another to rely on it.
In the case of Bartenwerfer v. Buckley, the Supreme Court held that § 523(a)(2)(A) of the Bankruptcy Code precludes a debtor from discharging a debt obtained by fraud, regardless of the debtor’s own culpability. The Court found that the section turns on how the money was obtained, not who committed fraud to obtain it. This decision was unanimous.
In another case, the Supreme Court held that a debtor who is liable for their partner's fraud cannot discharge that debt in bankruptcy, regardless of their own culpability. The Court analysed the statute at issue, which states:
> "A discharge under section 727...of this title does not discharge an individual debtor from any debt...(2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by (A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor's or an insider's financial condition."
Therefore, based on the legal precedent set by these cases, it can be concluded that common law fraud, including the element of fraudulent intent, is not dischargeable in bankruptcy.
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Frequently asked questions
Common law fraud involves misrepresentations or omissions that cause a loss to a victim.
No, the Supreme Court has ruled that § 523(a)(2)(A) of the Bankruptcy Code precludes a debtor from discharging a debt obtained by fraud, regardless of the debtor’s own culpability.
The Supreme Court has held that the debt must result from someone's fraud, but Congress was agnostic about who committed it. This means that even if the debtor was not the individual that defrauded creditors, the debt cannot be discharged.
The creditor has 90 days to bring an adversary proceeding. If the creditor does not act, the debt is discharged.
