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Archive for the ‘Discharge Of Debts’ Category

The Surprising Benefits: Fraud Debt Collections in Bankruptcy

July 16th, 2018 at 7:00 am

Being accused of defrauding a creditor is unusual in consumer bankruptcy cases. A creditor would have to jump through significant hoops. 

 

Most Debts are Discharged (Permanently Written Off) in Bankruptcy

The federal Bankruptcy Code has a list of the kinds of debts that are not discharged. This list details the conditions under which these kinds of debts don’t get discharged. (See Section 523 on “Exceptions to discharge.”)

Essentially, all your debts get discharged unless any of them fit one of the listed exceptions.

The Fraud Exception

One of the most important exceptions to discharge is the one stating that debts, “to the extent obtained, by… false pretenses, false representation, or actual fraud,” might not be discharged. (Section 523(a)(2)(A) of the Bankruptcy Code.)

This is an important exception to discharge because it could apply to many different kinds of debts. The other exceptions to discharge apply to very specific categories of debts. For example, these other exceptions include child and spousal support, various taxes, and student loans. But the fraud exception could apply to just about any debt if it was incurred in a fraudulent way.

What Makes for a Fraudulent Debt?

Your creditor would have to demonstrate that its debt should not be discharged because you incurred that debt fraudulently. If the creditor fails to do so the debt WILL get discharged and you’ll no longer legally owe it.  

To avoid discharge of the debt, the creditor would have to present evidence and prove EACH of the following:

  1. you made a representation
  2. which you knew at THAT time was false
  3. you made that representation for the purpose of deceiving the creditor
  4. the creditor relied on this representation
  5. the creditor was damage by your representation.

For example:

  1. a person gets a loan by representing that he or she has a certain amount of income
  2. while knowing that income amount was inaccurate
  3. with the purpose of fooling the creditor into making the loan
  4. resulting in the creditor relying on this income information in making the loan
  5. and losing money when the person didn’t pay back the loan

What Happens When a Creditor Alleges Fraud

Proving all five of these necessary elements often isn’t easy. So creditors tend not to object unless they believe they have a strong evidence of fraud. In the vast majority of consumer bankruptcy cases no creditors raise any fraud-based challenges.

When a creditor does raise such a challenge it does so in a specialized lawsuit in the bankruptcy court. This “adversary proceeding” usually focuses directly on whether the creditor can prove the five elements of fraud.

Such adversary proceedings almost always get settled. That’s because the amount of money at issue doesn’t justify the expense in attorney fees and other costs that can accrue quickly for both sides.  

Staying Allegedly Fraudulent Debts

The “automatic stay” imposed against virtually all creditor collection action also applies to allegedly fraudulent debts. If the creditor has alleged fraud prior to your bankruptcy filing, the filing will at least temporarily stop all collection on the debt. The “automatic stay” stops “any act to collect, assess, or recover a claim against the debtor.”  (Section 362(a)(6) of the U.S. Bankruptcy Code.)

Then, as mentioned above, the debt will either get discharged or not. If the creditor doesn’t file an adversary proceeding in time, the debt DOES get discharged. If the creditor files an adversary proceeding but then doesn’t prove fraud, the debt is discharged.

On the other hand, if the creditor does prove fraud the debt is not discharged and the creditor can then pursue the debt. It gets a judgment stating that the debt is not discharged and collectible. Then the creditor can use all the usual collection methods to collect the debt.  

However, because these matters are usually settled, the settlement usually includes an agreed payment plan. So in the unlikely event that a creditor DOES allege fraud against you, files a timely adversary proceeding, AND convinces the bankruptcy judge that all the elements of fraud were present, you would still very likely have a workable way to pay the debt without worrying about being hit by unexpected collection actions.

 

Two More Creditor Challenges to the Automatic Stay

February 23rd, 2018 at 8:00 am

A creditor might want to pay a claim through your insurance, or finish a lawsuit to establish that you got the debt through fraud.  

 

“Relief from the Automatic Stay”

Our last blog post got into some reasons that creditors ask for “relief from stay” other than to repossess collateral.

The “automatic stay” is one of the biggest benefits you get for filing bankruptcy. It “stays”—legally stops—virtually all creditor collection actions right away when you file a bankruptcy case. The automatic stay protects you, your assets, and your income from creditors. It does so permanently in many circumstances.

But there are exceptions, when creditors can ask for permission to pursue a debt, and may get that permission.  So it’s important to know the circumstances in which a creditor would be able to get “relief from stay.”

Last time we explained two of those circumstances, allowing a creditor to finish a legal proceeding against you to determine whether you are liable on a debt, and if so how much you owe. Now here are two other circumstances where creditors may get “relief from stay.”

1. Getting Paid Insurance Proceeds  

When you file bankruptcy you get protection from creditors to which you are personally liable on a debt. But what if your liability is completely covered by insurance, such as with a vehicle accident? Or what if insurance would at least partially cover the amount of your liability?  

The money to pay the claim is not coming from your pocket but that of your insurance company. Should your bankruptcy filing affect your insurance company’s obligation to pay your liability up to the coverage limits?  Arguably not. An injured person may understandably believe your insurance company should pay your liability regardless of your bankruptcy filing.

But the person allegedly damaged by you can’t pursue you, your assets, or your income because of the automatic stay. However, he or she could file a motion asking the bankruptcy court for permission to pursue ONLY the insurance proceeds. The motion would make clear that the debt would be pursued only against your insurance coverage.  Assuming that the court would agree, it would sign an order granting “relief from stay” for the person to go after your insurance proceeds, but not against you in any other way.

Note that your insurance company likely has a “duty to defend” you in such a situation. So the insurance company and the allegedly damaged person, or their respective lawyers, would likely negotiate the matter. Most likely there would be no lawsuit. Or, if there would be one it would get settled and not go to trial. In the unlikely event that it would go to trial, your insurance company would pay to defend the lawsuit, and would pay out any damages up to the coverage limit. Any damages beyond coverage limits would very likely be written off—discharged in bankruptcy.

2. Determining Dischargeability of the Debt

Most types of debts can be discharged in bankruptcy. But there are quite a few exceptions. Some examples of exceptions are criminal debts, unpaid spousal and child support, recent income taxes, and many student loans. See Subsections 523(a)(1),(5),(8), (13), and (15) of the U.S. Bankruptcy Code.

But more conventional debts may also not get discharged based on how you incurred them. A debt incurred through fraud or misrepresentation usually can’t be discharged. See Subsections 523(a)(2) and (4) of the Bankruptcy Code. However, unlike the above exceptions of criminal and support debt, fraud-based debt IS discharged unless the creditor proves the fraud. Then if the creditor would allege fraud, you’d have the opportunity to dispute it.

The bankruptcy court usually decides such fraud-related disputes. But what if at the time of your bankruptcy filing there’s already a state court lawsuit addressing that question?

Just as with the insurance-based circumstance above, your bankruptcy filing would stop that lawsuit from proceeding. But then the creditor could ask for relief from stay to allow the lawsuit to go ahead.

The bankruptcy court might allow the state court to finish deciding whether the debt was incurred through fraud. Or the bankruptcy court might want to decide that issue itself.  Likely it would focus is which court would be more efficient than deciding this issue. And that would likely turn mostly on whether the state court was actually deciding the fraud issue (and not just whether you were merely liable in the debt) and on how close the state court was to a resolution.

 

Exceptions to the Discharge of Debts in Chapter 7

December 15th, 2017 at 8:00 am

Often all your debts are discharged—legally written off—in Chapter 7. But some you might want to pay, or might not be able to discharge. 

 

Two blog posts ago we ended by saying that most general unsecured debts get legally written off—“discharged”—in a Chapter 7 bankruptcy case, but that there are some exceptions. We’ll get into those exceptions now. These exceptions include all types of debts—general unsecured, secured, and priority debts.

Definitely Not Discharged vs. Might Not Get Discharged

When you file a Chapter 7 “straight bankruptcy” likely your main objective is to discharge your debts and move on.  The point is to get a fresh financial start. So when you’re considering your options you need to know whether you will still owe any of your debts after finishing bankruptcy.

Debts Definitely Not Discharged

You might still owe debts afterwards that you’ll know in advance you’ll owe. These include two types—those you’ll still owe voluntarily and those you’ll owe whether you want to or not.

Voluntarily Not Discharged

Why would you voluntarily agree to owe a debt after bankruptcy when the main point of Chapter 7 is to wipe out all the debts you can?  You’d do it to get something worthwhile in return.

What would you get in return? The debts most commonly retained are debts secured by collateral, such as a home, vehicle, or something else worth keeping. In return for continuing to make payments and owe the debt, you get to keep the collateral. And you get the sometimes important benefit of being able to quickly start rebuilding your credit record.

In these situations you’d usually formally “reaffirm” the debt. You’d sign a “reaffirmation agreement” to remain legally liable on the debt in return for keeping the collateral. See Section 524(c) of the U.S. Bankruptcy Code.

Or, rarely, you might just want to keep paying a debt, simply because you want to. This is usually done with special, usually more personal debts, such as one owed to a relative. It’s usually based on a moral or family obligation, not a binding legal one. As the Bankruptcy Code says, “[n]othing… prevents a debtor from voluntarily repaying any debt.” Section 522(f).

Not Discharged by Force of Law

There are also debts you simply can’t discharge in a Chapter 7 case because the law says you can’t. Here are the most common ones:

  • Child and spousal support can never be discharged, and most other divorce-related obligations can’t be under Chapter 7. Section 523(a)(5) and Section 523(a)(15).
  • Income tax debts can’t be discharged, unless they meet a list of conditions (mostly related to how old the tax is). Section 523(a)(1)
  • Most (but not all) student loans can’t be discharged unless imposing an “undue hardship” on the debtor. Section 523(a)(8)
  • You can never discharge criminal fines and restitution (except sometimes minor traffic infractions that are not considered “criminal.” Section 523(a)(7) and (13)

Debts that Might, or Might Not Get Discharged

There’s one more set of debts that WILL get discharged in a Chapter 7 case, UNLESS all three of these happens:

1. The creditor files a formal objection to the discharge at the bankruptcy court

2. That objection is filed on time—within 60 days after the “First Meeting of Creditors”

3. The court determines that the debt should not be discharged

As long as the creditor was included on your schedules of creditors and the creditor does not object in time, the debt is discharged just like any other debt.

The bankruptcy court determines whether the debt gets discharged based on whether the creditor convinces the court that the debt meets one of 3 sets of conditions. These conditions include whether you obtained the debt through:

1. Misrepresentation or fraud on the creditor (Section 523(a)(2))

2. Fraud while acting as a fiduciary (such as an executor of a decedent’s estate), embezzlement, or larceny (theft) (Section 523(a)(4))

3. “Willful and malicious injury” against someone or something (Section 523(a)(6))

Again, if the creditor does object on time but does not show that one of these conditions apply, the debt still gets discharged.

Because you don’t know for sure whether a creditor will object, and if one does how the judge will decide, this is a debt that you won’t know in advance whether it will get discharged. But of course you’d usually know if there is a risk that any of your creditors have a basis for raising such an objection. If you have any inkling that one does, talk with your bankruptcy lawyer about it. You’ll find out whether you or not you should be concerned. Often you’ll learn that your risk that the creditor would object is actually quite low. However, sometimes you’ll just have to wait to see if the creditor objects by the deadline.

 

This is just an outline of debts that don’t or may not get discharged. We’ll look more closely at these in the upcoming blog posts.

 

Timing: Writing Off Recent Credit Card Debt

September 25th, 2017 at 7:00 am

Using a credit card shortly before filing bankruptcy doesn’t seem right. The law agrees. Writing off this kind of debt can be a problem. 


Our last blog post was about writing off—“discharging”—income taxes.  The conditions you have to meet to discharge a tax debt are mostly very clear. These conditions are based on rather straightforward calculations of time. If you don’t meet those time-based conditions the tax does not get discharged; you still owe it.

Credit card debts are completely different. First, they’re almost always discharged. Second, there are some timing rules but those rules don’t necessarily decide whether or not the credit card debt is discharged or not. We’ll explain all this in today’s blog post.

The Point of the Timing Rules

With income tax debts, they’re NOT discharged unless you meet the timing rules. With credit card debts they ARE discharged unless you meet the timing rules.

With income taxes the debt is not discharged unless it’s been long enough since the pertinent tax return was due and since that tax return was actually submitted to the IRS/state. The point of the rules is the give the IRS/state a chunk of time to try to collect the tax.

With credit cards the debt is discharged unless it’s been too short of a time since the credit card charge. The point of the rules is to make it harder to discharge a charge incurred after deciding to file bankruptcy.

A Mere Presumption

As we just said, the timing rules with credit cards merely make it harder to discharge a credit card debt.  If you run afoul of the timing rules with income taxes, you absolutely still owe the tax. With credit cards, if you run afoul of the timing rule there’s only a bigger chance that you would owe it. It just gives the creditor an easier time of making you pay it—a presumption that it can’t be discharged. But that creditor still needs to act or else it loses that advantage. The entire credit card debt could still get discharged.

For example, if you owed $7,500 on a credit card, of which you incurred $1,000 recently, the entire debt would be discharged in bankruptcy if the creditor did not timely object.

 Only a Portion of the Credit Card Debt is at Risk

With income taxes the entire tax is either discharged or it’s not. With credit card debts, most of the debt could be discharged while only the portion that violates the timing rules is not.

In the above example, only the $1,000 incurred recently, in violation of the timing rules, would usually be at risk of not being discharged.

In Rare Circumstances the Entire Credit Card Debt Could Be at Risk

The following may be confusing in light of what we said so far. If a creditor has evidence that you incurred the entire credit card debt without the intent to pay it, the creditor can challenge the discharge of the entire debt. The timing rules do not need to apply (although if they would that may make the creditor’s argument easier).

In the above example, if the creditor somehow had evidence that you didn’t intend to repay any of the $7,500 at the time you incurred the debt, the creditor could object to any of the $7,500 debt being discharged. It doesn’t matter how long ago that $7,500 debt was incurred.

The Timing Rules

So here are the timing rules.

If you buy more than $675 in “luxury goods or services” (essentially, any non-necessity) from any single creditor during the 90-day period before your bankruptcy is filed, that specific debt is presumed not to be discharged. Also, if you make a cash advance of more than $950 from any single creditor during the 70-day period before your bankruptcy is filed, the debt from that cash advance is presumed not to be discharged.  See Section 523(a)(2)(C) of the U.S. Bankruptcy Code.

The Presumption Is Only a Presumption

Just because a purchase/cash advance meets these conditions do not necessarily mean you can’t discharge that part of the debt. You can defeat the presumption with evidence that you did actually intend to pay the debt when you incurred it. You can still win by persuading the court of your honest intent. You and your bankruptcy lawyer can do this through your own testimony. You can also provide evidence of other relevant facts, such as of you making payments after incurring the debt, or the subsequent event(s) in your life that induced you to file bankruptcy (and not pay the debt after all).

The Judge’s Ruling in a Dischargeability Proceeding: an Example

April 7th, 2017 at 7:00 am

In our example of the adversary proceeding about whether a debt gets discharged, here is the bankruptcy court’s ruling on the matter. 


This is the last of six blog posts in a series showing how a dischargeability dispute gets resolved in bankruptcy court. Check out the last five posts about all the steps in the “adversary proceeding” so far, including the trial itself. In the last one, lawyers for the creditor and the debtor gave their closing arguments. Today the judge announces and explains her ruling.

The Judge’s Opening Remarks

At issue in this adversary proceeding is whether the debtor, Marshall, can discharge his debt to the creditor, Heather. The loan was made five years ago for $35,000; its current balance is about $21,000. The purpose of the loan was for Marshall to start a car repair business. Heather is Marshall’s aunt. At Heather’s request, Marshall completed a loan application and signed a promissory note. As she instructed, after completing and signing these documents Marshall delivered them to Heather’s lawyer. The loan was not secured by any collateral.

For four years Marshall paid the monthly payments on time. But about a year ago there was a fire in the building where his shop was located. He had to shut down his business for a month and replace some of the shop’s equipment. This deeply hurt his business. He stopped the monthly payments to Heather and was eventually forced to close down his shop.

A few weeks ago Marshall filed a Chapter 7 case. Heather responded by filing a complaint asking this court to declare that her debt not be discharged.

Her complaint was based on the allegation that Marshall obtained the loan through fraud. Specifically, she alleged that Marshall lied on his loan application by not listing a $7,500 debt that he owed at the time to another aunt. She argued that under  Section 523(a)(2)(B) of the Bankruptcy Code this omission constituted 1) the “use of a statement in writing” 2) that was “materially false” 3) about his “financial condition” 4) on which Heather had “reasonably relied,” and 5) which Marshall had prepared “with intent to deceive” her.

Marshall admitted allegations #1 and #3. He disputed allegations #2, 4, and 5. Heather had the burden of presenting evidence establishing that that all of these three disputed allegations were more likely true than not true in order for her to prevail.

The Ruling

After carefully listening to and reviewing all of the evidence admitted at trial, I have determined s follows.

First, Marshall prepared the loan application “with intent to deceive” her.

Second, Marshall’s omission of the prior $7,500 debt from Heather’s loan application was clearly false but, under the evidence presented, was not “materially false.”

And third, Heather did not “reasonably rely” on the loan application in deciding whether to make the loan.

The Rationale for “Intent to Deceive”

Marshall rationalized his omission of the outstanding $7,500 debt two ways:

  •  
    • He wanted to avoid Heather potentially deciding not to make the loan to him for what he saw as an irrelevant and irrational reason. He knew Heather could be erratic and unreasonable. He’d heard she was having a personal dispute with his other aunt who had made the earlier loan to him. He understandably didn’t want what he considered totally unrelated to the loan clouding her judgment.
    • Marshall guessed that Heather’s decision about making the loan was based on factors not connected to the loan application. It turns out that he guessed correctly. But at the time he completed the application this was nothing but wishful thinking on his part.  

These rationales may have been understandable and seemingly justifiable. But they do not change the clear fact that Marshall omitted the $7,500 loan with the intent to deceive Heather. And, importantly, his specific intent was to deceive her into making the loan.

The nuance that he was trying to prevent her from being irrational does not matter. The nuance that he hoped she wasn’t actually going to rely on the loan application also does not matter. His entire purpose in making the omission was deceit, deceit calculated to induce her into giving him the money.

So, this court finds that Heather has met her burden of proof as to Marshall’s “intent to deceive” her.

The Rationale for “Material Falsity”

Marshall’s omission on the loan application was clearly false.

The question is whether the omission was materially false. Given that the prior loan was a family loan just like the one Heather was considering may make omitting it more relevant. Given that the $7,500 loan balance was not an insignificant amount also makes its omission appear to be a material one.

However, what determines materiality in this statutory context is a specific objective standard. What is crucial under the law is whether Heather would have still made the loan to Marshall had he listed the prior loan in Heather’s loan application. Whether a falsity is material turns on whether it affected the creditor’s loan-making decision.

Based the evidence (as discussed in more detail in the next section), Heather would clearly have still made the loan if the prior debt had been accurately listed in the application. Since Marshall’s omission would not have made a difference in Heather’s decision, that omission was not materially false.

So, this court finds that Heather has not met her burden of proof as to the “material falsity” of Marshall’s omission.

The Rationale for “Reasonably Rely”

Heather admitted she never looked at the loan application after Marshall completed it. She asked him to deliver it and the signed promissory note to her lawyer without her looking at them beforehand. She did not instruct the lawyer to review the application, inquire into Marshall’s credit record, or do anything else to determine his financial condition. She did not discuss the content of the loan application with her lawyer. She did not rely on the loan application whatsoever. So she could not have reasonably relied on it either.

Heather also affirmatively testified that she based her loan decision on matters of family connection and loyalty. She clearly did not rely, reasonably or not, on the completed loan application.

So, this court finds that Heather has not met her burden of proof as to her “reasonable reliance” on Marshall’s application and the omission contained in it.

Conclusion

Therefore, since Heather has not met her burden of proof as to these last two allegations as required under Section 523(a)(2)(B) of the Bankruptcy Code, Marshall’s debt to her will be discharged in his Chapter 7 case.

 

The Closing Arguments in a Dischargeability Proceeding: an Example

April 5th, 2017 at 7:00 am

In our example about the adversary proceeding about whether a debt gets discharged, here are the creditor’s and debtor’s closing arguments. 

 

Here’s the fifth blog post in a series showing how a dischargeability dispute gets resolved in bankruptcy court. Check out the last four posts about the different steps in the “adversary proceeding” so far, including the trial itself. Now it’s time for the two sides to give their closing arguments to the bankruptcy judge.

The Creditor’s Closing Argument

The lawyer for the creditor says the following to the bankruptcy judge:

As the U.S. Supreme Court said way back in 1934, bankruptcy law “gives to the honest but unfortunate debtor… a new opportunity in life… unhampered by the pressure and discouragement of preexisting debt.”

As the debtor here fully admits, he was NOT honest with his creditor, Heather, his aunt. Marshall admitted that he purposely did not include his debt to another aunt on his loan application to Heather. He admitted that he did this because he was afraid that otherwise Heather would not give him the loan. He desperately wanted that loan. It was the only way he could start his business. So he stooped to lying, and put his lie in writing. He then signed the loan application, dishonestly asserting that what he wrote was truthful.

Marshall’s omission was not insignificant or immaterial.

The outstanding loan balance was $7,500. This amount was enough that, had Heather known about it, that outstanding loan likely would have given Heather pause about providing her own loan.

The existence of the prior loan was a material fact and his omission of it was a material omission. That prior loan was another family loan. Had Heather known about it, she could well have figured that if money got tight for Marshall down the line and he had to choose, he’d pay the earlier loan ahead of hers. So Heather definitely deserved to know about that loan balance before she made her decision about giving Marshall a new loan.

The Creditor Lawyer’s Conclusion

Marshall says now that he believed at the time that Heather would not base her decision on the loan application. He tells us his impression at the time was that this documents wasn’t all that important. And yet Heather told him directly that she had her lawyer prepare the application and other loan documents because she wanted the loan to be legally enforceable. He had every reason to know that the loan application was a meaningful document. He knew he needed to take it seriously, that he had every obligation to complete it truthfully. He can’t now use the excuse that he didn’t have to be honest because Heather wouldn’t treat the application seriously in making her decision.

Marshall materially lied on the one and only document that he presented to Heather to have her decide whether or not to give him a loan. He cannot now claim to be an “honest but unfortunate debtor” deserving to write off his debt to Heather. This court must therefore exclude this one debt from the discharge Marshall is getting of his other debts.

The Debtor’s Closing Argument

Then the lawyer for Marshall, the debtor, says the following to the judge:

The creditor here, Heather, has failed to establish three different elements of her case. If she fails to establish even JUST ONE of these elements, the debt must be discharged.

First, while Marshall’s omission was admittedly false, it was not materially false. What’s crucial to the omission being material is not the amount of the prior loan. Nor is it that this prior loan was a family loan like Heather’s. What is crucial under the law is whether Heather would have made the loan to Marshall if he would have included the other aunt’s prior loan in Heather’s loan application. An omission is material if it would have made a difference in the creditor’s decision to make the loan.

The evidence is quite clear that not including the prior loan was not a material omission. Heather admitted she didn’t even look at the completed loan application, nor discuss its contents with her lawyer.  Heather testified here that she based her lending decision on family considerations, not on Marshall’s finances. Whether one particular debt was or was not included in the loan application had no bearing on Heather’s decision. The omission was immaterial.

Second, Marshall did not omit the prior debt “with intent to deceive” Heather. He completed the application with the understanding that what he wrote on it was not important to Heather. He was reasonable in this understanding because that was what he had heard, albeit indirectly, from Heather. She signaled strongly to him that her decision was being made primarily or even exclusively because of their relationship. This included both their family and personal relationship.

Marshall admitted that he intentionally did not include the prior debt, but for a very specific reason. He knew that at the time Heather was having a quarrel with his other aunt who’d made that prior loan. Marshall knew Heather could be impulsive, erratic, and even irrational. So Marshall was justifiably concerned that Heather would somehow let some irrelevant irritation cause her to deny him the loan. He imagined her telling him to instead just go back to that other aunt for more money. He already knew the other aunt was unable to lend him what he needed. His only intent in not listing the prior loan on the application was to avoid having Heather hit an emotional tripwire that would distract her from her decision to make the loan.

The Debtor Lawyer’s Conclusion

Third and most clearly, Heather did not rely on, much less reasonably rely on, on the loan application in her decision. She particularly didn’t rely on Marshall’s omission of the other loan. She never read the application, didn’t discuss the contents with her lawyer, and nothing about the application entered into her loan-making decision.

This creditor bases her entire argument on Section 523(a)(2)(B) of the Bankruptcy Code. That requires the use of a materially false “statement in writing” on which the creditor “reasonably relied.” It’s perfectly clear from the evidence presented at this trial that the creditor here does not meet this element of reasonable reliance. So just as perfectly clearly the debt at issue here should be discharged in this bankruptcy case.

The Judge’s Decision

Our next blog post in a couple days will give, and then explain, the judge’s decision about whether or not this debt will be discharged in bankruptcy.

 

The Trial in a Dischargeability Proceeding: an Example

April 3rd, 2017 at 7:00 am

In our example about the process about whether a debt gets discharged, here’s what happens at the bankruptcy court trial itself. 

This is the fourth blog post in a series showing how a legal dispute gets resolved in bankruptcy court. The process is called an “adversary proceeding”—essentially, a lawsuit in bankruptcy. The dispute at issue is whether a debtor’s Chapter 7 “straight bankruptcy” will discharge—permanently write off—a particular debt.

The Story So Far

The creditor, Heather, has formally objected to the discharge in a complaint—see our blog post of a week ago. Essentially, she alleged that the debtor, Marshall, her nephew, lied in the credit application she asked him to complete. He did not include a $7,500 debt that he owed to another aunt. Because of this fraud on her, Heather has now argued that Marshall should not be able to discharge the $21,000 that he still owes her.

Marshall, through his bankruptcy lawyer, filed an answer to Heather’s complaint—see two posts ago. He admitted that he had not included the $7,500 debt in Heather’s loan application. But he argued that his omission wasn’t significant enough to make his application “materially false.” Also, he figured that Heather had already heard about his prior debt through family gossip. So she couldn’t “reasonably rely” on his omission in making the loan when she already knew about that prior debt. Finally, Marshall didn’t omit the prior loan from the application with “intent to deceive” Heather, again since she already likely knew about it.

See our last blog post for what happened when we got into the next stage of the litigation—“discovery.” That’s the step where both Marshall and Heather tried to get at the relevant facts. In this case they each sent the other a formal list of questions to answer—interrogatories. Their sworn answers indicate how they would testify at a trial, if the case didn’t settle before then.

Settlement

After a debtor and creditor finish “discovery,” they usually settle their dispute. That’s because at this point it tends to become much clearer who would likely prevail at a trial.

Also, a trial is very expensive. A lot of time goes into preparing for a trial, and for the trial itself. So even a relatively straightforward trial costs a few thousand dollars in lawyer time. That encourages settlement, especially after the facts are more clearly on the table.

Sometimes the adversary proceeding ends at this point with a slam dunk for one of the two sides. A creditor sees that it is going to lose and simply dismisses the adversary proceeding. Or the debtor sees that the creditor has strong grounds against the discharge of the debt and agrees to pay it all.

But most of the time a settlement is needed because it’s not a slam dunk for either side. Usually the debtor must agree to pay something to get the creditor to not chase the rest of the debt.

If there is no settlement, the case goes to trial.

Marshall’s Testimony at Trial

After opening statements by their lawyers, Marshall testified under oath as follows:

  • He omitted the prior $7,500 loan in the application because he figured that Heather had already heard about it.
  • In his conversations with Heather as she was considering lending him the money, she told him she was doing out of their family connection instead of conventional economic issues like his creditworthiness and capacity to pay it back. He got the strong impression from her that the content of the loan application was not important.
  • He was not trying to trick her about anything, such as the amount of his debts. He just didn’t think that the application had much bearing in her decision whether to lend to him.

On cross-examination by Heather’s lawyer, Marshall admitted:

  • He also omitted the prior loan from the application because Heather had a reputation for being unpredictable. He’d heard she was having a feud with the other aunt to whom he owed that other loan. He was desperate to have her give him the money. He didn’t want to give her any excuse for not going ahead with it.
  • Heather did tell him that her lawyer was preparing loan documents because she wanted to “make it all legal.” He did not really know how much she was going to rely on the content of the loan application in making her decision.
  • He may have been engaging in “wishful thinking” to guess that Heather was not putting much weight on the content of the loan application. Again, the truth was he simply didn’t know how she was deciding. He had been very relieved that she gave him the loan.

Heather’s Testimony at Trial

Heather then testified under questioning by Marshall’s lawyer as follows:

  • She had known about Marshall’s earlier loan from the other aunt. It was made years before Marshall approached her about the business loan. She’d heard that loan had been for him get a community college degree in auto repair without needing to work at the same time. Its amount was less what he needed from her for the business loan.
  • She did not review the loan application after Marshall had completed it. She talked with her lawyer about it very generally—mostly just confirming that Marshall sent it to the lawyer. She did not discuss any of its details with her.
  • Heather based her decision on whether to make the loan to Marshall on family considerations—on her sense of connection and obligation to him. Not having had kids herself, she felt closest to him of all her nieces and nephews. She definitely had the financial means to help him. She believed that he would do his very best at making the business successful. From conversations with him, she became convinced that he had the talents and drive needed. So she decided she wanted to help him achieve his dream of creating his own car repair business. But now she wanted him to repay her loyalty to him with the return loyalty of repaying the loan. 

Closing Arguments and the Bankruptcy Judge’s Determination

Next time (this coming Wednesday morning) we finish this series with the two lawyers’ closing arguments and the judge’s ruling.

 

Discovering the Facts in a Dischargeability Proceeding: an Example

March 31st, 2017 at 7:00 am

Here’s how the debtor and creditor get at the facts in an adversary proceeding about whether a debt gets discharged. 

 

We’re going through a series of blog posts showing by example how a creditor’s formal objection to discharge goes in bankruptcy court.

Here are the facts, briefly. Five years ago Marshall got a $35,000 loan from his aunt, Heather. But he wasn’t completely upfront with her at the time, neglecting to list in his loan application a $7,500 debt to another aunt. So now, after Marshall filed bankruptcy, Heather filed a formal complaint accusing him of fraud for this lying by omission. Specifically, she alleged that his omission about the other loan was “materially false,” Heather “reasonably relied” on that omission in making the loan, and Marshall made the omission “with intent to deceive” her. (There are other elements of fraud but these are the ones that are at issue in this example.)

Marshall filed an answer by denying that this omission was “materially false.” That’s because he thought that Heather would have made the $35,000 loan even if she had known about the $7,500 balance on the earlier loan. He also denied that Heather had “reasonably relied” on his omission because he didn’t think that she had relied on the application at all. Finally, Marshall denied that he’d excluded the prior $7,500 “with intent to deceive” Heather. He hadn’t thought she’d care one way or the other.

He felt he hadn’t set out to cheat her at all. Since he hadn’t, he understood the law gave him the right to legally write off the now-$21,000 debt in bankruptcy.

Burden of Proof

Debts like Marshall’s get discharged unless the creditor finds legally valid grounds for the bankruptcy court to deny discharge. The burden is on the creditor to find facts supporting those grounds.

Here in our example Heather has to bring evidence establishing ALL of the following:

  • Marshall’s omission was “materially false.” That is, the omission not only made his application false. It was so false that Heather would not have made the loan had Marshall included the $7,500 debt.
  • Heather had “reasonably relied” on the omission in making the loan. That is, Heather had at the time not only relied on the lack of a $7,500 loan. She had relied on that omission reasonably. Under all the circumstances it made sense for her to rely on the accuracy of Marshall’s application.
  • Marshall acted with “intent to deceive” Heather. He had not included any reference in the loan application to the $7,500 he owed to the other aunt because he purposely wanted to fool Heather into giving him the loan.

“Discovery” Methods

“Discovery” is the formal procedure for discovering the relevant facts in a lawsuit. In our context it’s the way that Marshall and Heather get at the facts relevant to their discharge dispute.

The facts are “discovered” mostly through these four methods:

“Discovery” in Our Example

The lawyers for Marshall and Heather wanted to try to keep litigation costs down for their clients. So they agreed to avoid depositions if they could get the facts they needed without them. Depositions can be time-consuming and expensive.

So both parties prepared and delivered Interrogatories.

Heather’s Interrogatories to Marshall

Here are some of the most important interrogatories that Heather presented to Marshall, along with his sworn answers:

1. Were you aware of the $7,500 balance you owed your other aunt at the time you completed Heather’s loan application?

Yes.

2. If you were aware of this other loan balance, why did you not include it in the application?

I did not include it because I really didn’t think Heather would care one way or the other. I’d made payments on that personal loan perfectly, bringing it down from $20,000 to the $7,500 balance at the time. I figured that with this payment history that existing loan was more of a positive than a negative to Heather. It showed my creditworthiness on family loans. However, I’d heard that Heather was in an unpleasant dispute with the other aunt. Heather had a reputation for being unpredictable. So I was afraid of giving her any excuse to not give me the $35,000 business loan. I was pretty desperate to get it from her.

3. Did you intend to deceive Heather into making the loan by omitting the $7,500 debt you still owed to your other aunt?

No. First, I really didn’t think that Heather was basing her decision on the loan on financial and risk considerations. Based on my conversations with her, she seemed to be motivated mostly by family considerations. She was pretty well off, didn’t have kids of her own, and was excited about my business venture. She expressed a desire to help, out of affection and family connection. She acted like the application was a formality and wouldn’t be a major basis for her decision.

Second, I thought Heather may well already know about that other debt. I had borrowed the $20,000 years earlier from the other aunt to get a 2-year community college degree. I knew these two aunts were not very close, but that earlier loan wasn’t any big secret. I figured there was a good chance that Heather already knew about it.

I wasn’t trying to fool her into thinking I was debt-free so that she would make the loan.

Marshall’s Interrogatories to Heather

Here are some of the most important interrogatories that Marshall presented to Heather, along with her sworn answers:

1. Were you aware that Marshall had taken out a loan from his other aunt at the time you agreed to lend him the $35,000 for his new business?

No. I’d heard vaguely about it a few years before that. But it was not in my mind at the time I was considering whether to make the $35,000 loan. I did not know whether he’d paid it off, was making payments at the time, or any such details.

2. If you had been made aware of the $7,500 debt by Marshall including it on his application, would you have made the $35,000 loan to him?

I don’t know. Hard to tell now, more than five years later. It would have made it less likely, for sure. I WAS a little nervous about making the loan anyway. That could have pushed me to change my mind.

3. Did you review the application after Marshall had completed it?

I had my lawyer prepare the application form and I asked her to review it when he’d completed it. But no, I didn’t read it myself. I remember vaguely talking with my lawyer about it, but nothing specifically.

4. On what did you base your decision to make the loan to Marshall?

On whether he was worthy of getting the money. He’d always been a good guy. I don’t have any kids myself. I’d always liked him. He was always a hard worker, an honest young man. He had gotten some bad breaks earlier and I wanted to help. His business plan sounded sensible. He was family.

But now he needs to pay me back. Just because he can write off his other debts doesn’t mean he should write off this one. I was loyal to him. He should return the loyalty by paying back this debt to me.

Next, the Trial

With these facts on the table, this adversary proceeding is ready for trial. We’ll finish with that in our next blog post on Monday.

 

Answering a Creditor’s Dischargeability Complaint: an Example

March 29th, 2017 at 7:00 am

Here’s an example showing how to answer a creditor’s complaint objecting to the legal write-off of a debt in bankruptcy. 


The last blog post showed, through an example, how a creditor in a Chapter 7 bankruptcy case raises an objection to the discharge of its debt. Please check that out for the full facts of the dispute and what had happened so far. Today we pick up where we left off, after the creditor has formally filed its objection to discharge.

Summary of the Loan and the Complaint

Basically, the story is that five years ago Marshall persuaded his aunt to lend him $35,000 for a business loan. He completed the required loan application without referring to a $7,500 balance he already owned on a personal family loan. He’d made payments on that personal loan perfectly. So he rationalized his omission by figuring that this existing loan was more of a positive than a negative. It demonstrated his creditworthiness on family loans instead of being any kind of detriment. Nevertheless he didn’t want to give his unpredictable aunt, Heather, a reason to not give him the new $35,000 business loan.

But five years later, for reasons explained last time, Marshall closed his auto repair business and filed bankruptcy. Heather was enraged about Marshall not paying the debt. She had her lawyer file a complaint objecting to the discharge of the $21,000 remaining balance.

Under Chapter 7 bankruptcy most debts are discharged. To avoid discharge, a creditor has to show grounds that fit within the relatively few grounds that the law allows.

Heather’s complaint alleged that Marshall had gotten the $35,000 business loan by defrauding her. Consistent with what is required in bankruptcy law, her complaint alleged that Marshall obtained the loan through a written application:

  1. that was “materially false”
  2. about his “financial condition”
  3. on which Heather had “reasonably relied,” and
  4. Marshall had not included the $7,500 owed to the other aunt “with intent to deceive” Heather.

Section 523(a)(2)(B) of the U.S. Bankruptcy Code.

If Heather is able to convince the bankruptcy judge that the facts support these four elements, she’ll win the dispute. The $21,000 remaining balance would not be discharged in Marshall’s Chapter 7 case, and he’d remain liable on it.

The Answer

Through his bankruptcy lawyer Marshall responded by filing a formal answer. In his answer he had to answer each one of Heather’s allegations directly.

1. He admitted that his omission of the $7,500 on his written application was a falsity. He lied by omission. But he denied that this omission was “materially false.”

For an inaccuracy on a financial statement to be “materially false,” courts have “examine[d] whether the lender would have made the loan had [s]he known of the debtor’s true financial condition.” Matter of Bogstag, p. 375. Marshall argued that Heather would have made the $35,000 loan even if she had known about the $7,500 balance on the earlier loan, given his perfect payment history on that loan.

2. Marshall admitted his omission about the prior loan was indeed about his “financial condition.”

3. He denied that Heather had “reasonably relied” on his omission. He believed that she had not relied on the application so much as on personal and family considerations. He didn’t know whether she’d even read the application before deciding to give him the loan. If she had read it, he suspected she hadn’t really focused on his debts or on the amounts stated. He denied this element of the complaint in the hopes of learning through the litigation process that Heather had not relied on the application at all, much less reasonable relied on it.

4. Marshall denied that he’d excluded the prior $7,500 “with intent to deceive” Heather. He hadn’t thought, or at least had hoped, that Heather wouldn’t care about that debt. In particular, he knew that Heather was having a quarrel with the other aunt who had made that prior loan. So Marshall was concerned that Heather would, out of spite, somehow use that to irrationally deny him the loan. He wasn’t trying to cheat her into making the loan. He was just trying to avoid having an irrelevant family feud mess things up.

“Discovery”

“Discovery” is the procedure for discovering the facts relevant to the dischargeability dispute. In our next blog post we’ll show how the facts were “discovered” here in this dispute between Marshall and Heather.

 

Resolving a Creditor’s Dischargeability Objection: an Example

March 27th, 2017 at 7:00 am

Here’s an example showing in a practical way what happens when a creditor objects to the legal write-off of a debt in bankruptcy. 

 

The last three blog posts were about the procedure for litigating whether a debt gets discharged in bankruptcy. Let’s bring this to life with an example.

The Loan

Marshall had spent 10 years learning everything he could learn as an auto mechanic at the local Ford dealership. He was 30 years old, and itched to open his own auto repair shop. So, five years ago, Marshall asked his financially well-off aunt, Heather, to lend him $35,000 to help him to start his business. She had her concerns, but agreed, only if they did it in a business-like manner. So she had her lawyer write up a loan application and promissory note.

Marshall completed the loan application, but not quite accurately. He was too embarrassed and afraid to include a $7,500 debt he already owed to another aunt. She was from the other side of the family so he knew Heather wouldn’t find out about that debt. Besides, he’d been paying on it perfectly for years, bringing the balance way down from its original amount. So he figured that, if anything, that loan was proof of his creditworthiness with family loans. But he didn’t want to risk Heather not seeing it that way and not giving him the business loan.

So Heather lent him the $35,000, Marshall signed a promissory note to pay it back at 6% annual interest, through monthly payments of $400 per month.

For four years Marshall paid the $400 monthly payments perfectly. His auto repair business was doing pretty well for a new business in a competitive market.

The Fire

But then there was a fire in the building where his shop was located. The fire itself did not get into his shop but it did result in serious smoke and water damage. He had to shut down for a full month and replace some expensive equipment. He learned that his insurance did not cover nearly as much as he’d expected it would. He struggled to recover.

He stopped sending Heather the $400 payments because he simply did not have the money. She was understanding at first. But then, after a year of no payments as the business continued to falter, Heather became impatient. An unrelated family feud erupted between Heather and her brother, Marshall’s father, and Marshall got caught up in it. Heather had her lawyer sue Marshall for the $21,000 he still owed.

Marshall got an offer to go back to work at the Ford dealership he’d left five years earlier. So he decided to close his business, and filed a Chapter 7 bankruptcy case to discharge his accumulated debts and get a fresh financial start.

The Complaint

Heather was very angry that Marshall did not intend to pay her back the rest of the business loan. She saw that he was as irresponsible and undependable as his father, her brother, who she now couldn’t stand. She asked her lawyer what she could do about it. Heather told the lawyer that she knew that Marshall had not included his $7,500 debt to his other aunt when he’d filled out Heather’s loan application. She’d know about this for years but had never told Marshall. Heather learned that this might give her the grounds for stopping the debt from being discharged.

So Heather instructed her lawyer to start an adversary proceeding in Marshall’s bankruptcy case objecting to the discharge of the debt. The complaint alleged that Marshall had gotten the $35,000 business loan through a written application:

  • that was “materially false”
  • about his “financial condition”
  • on which Heather had “reasonably relied,” and
  • Marshall had not included the $7,500 owed to the other aunt “with intent to deceive” Heather

See Section 523(a)(2)(B) of the U.S. Bankruptcy Code. It’s about the potential exception to discharge for the use of a written false statement used to obtain credit.

The Answer

After receiving the complaint in the mail, Marshall met with his bankruptcy lawyer. After talking the situation over thoroughly, his lawyer advised him to fight Heather’s adversary proceeding. In our next blog post we’ll tell you how they answered the complaint and what happened afterwards.

 

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