Even if an individual DR receives a discharge, some of her debts may be excluded from that general discharge.

34: Discharge exceptions© Charles Tabb 2010

Not ALL debts are discharged

Even if an individual DR receives a discharge, some of her debts may be excluded from that general discharge

Effect of exclusion from discharge

The CR owed a debt that is excluded from discharge is able to try to collect that debt from the Dr after bankruptcy

i.e., no “fresh start” for the Dr as to the excepted debt

The statutory list

523(a) contains an exclusive list of debts excepted from discharge

Number of excepted debts has continued to grow – now have 21 excluded types of debts in 523(a)

Category 1 – Bad DR

Several of the excepted debts are ones in which the Dr acted “wrongfully” in creating the debt in the 1st place fraud willful and malicious injury DUI embezzlement

Category 2 – Worthy Cr

Other excepted debts are explainable as favoring what are deemed to be creditors who are particularly worthy taxes alimony and child support

Politics?

Other debts excepted from discharge are more difficult to explain -- except by reference to political pressure student loans▪ could argue is a PRO-human capital rule, b/c

incentivizes CRs to extend student loans to DRs that will then enable DR to have more productive human capital

By chapter

All of 523(a) exceptions apply to individual DRs who otherwise receive a discharge in: chapter 7 (§ 727(b)) or chapter 11 (§ 1141(d)(2))

13?

Code originally contained “superdischarge” (1328(a)) for DR who completed plan performance in chapter 13 case

The idea was to provide an incentive for debtors to elect chapter 13 voluntarily

Most of 523(a) debts discharged, including: taxes (523(a)(1)) fraud (523(a)(2)) willful and malicious injury (523(a)(6))

Super no more

Over time, Congress has cut back on the scope of the superdischarge, making more and more 523(a) debts nondischargeable even in full-performance chapter 13

Today, the only common debts still left as part of the “super” discharge are for: (i) stale income taxes – i.e., due more than three

years before bankruptcy, and no other funny business (e.g., fraudulent return, etc.)(§ 523(a)(1)(A)) and

(ii) debts arising from property settlements in divorce or separation proceedings (§ 523(a)(15))

Ties in with means test

Change from carrot to stick in 2005

Before, idea was to offer consumer debtors a carrot (e.g., superdischarge) to file 13

Now, just use the means test stick to deny chapter 7 to them, so only “choice” left is chapter 13

Procedure?

Where are exceptions litigated? for three types of nondischargeable debts, the

creditor may only challenge dischargeability in an adversary proceeding in the bankruptcy court during the bankruptcy case. § 523(c)(1). ▪ Fraud 523(a)(2)▪ Larceny, embezzlement, fiduciary defalcation (a)(4) ▪ Willful and malicious injury (a)(6)

For everything else – can bring action to collect in state court after bankruptcy▪ i.e., exception is “automatic”

Timing?

CR complaint objecting to discharge of one of the types of debts that has to be litigated in bankruptcy must be filed in the bankruptcy court within 60 days of the first date set for the creditors’ meeting (unless court extends time) Rule 4007(c).

Creditors are notified of this bar date in the initial bankruptcy notice

Same as for discharge denial Discharge objection must be filed as

adversary proceeding in bankruptcy court. Rules 4004(a), 7001(4)

Complaint must be filed within 60 days after the first date set for the meeting of creditors (unless court extends). Rule 4004(a)

The trustee and creditors will be notified of bar date in initial notice of bankruptcy case

proof

Creditor has burden of proof in discharge exception action (and in discharge denial)

Supreme Court has held that the standard of proof is preponderance of the evidence in discharge exception cases Grogan v. Garner, 398 U.S. 279 (1991)

Collateral estoppel

Standard if proof as “preponderance” is very important b/c means CR can get collateral estoppel to prove a discharge exception.

Example: CR obtained final judgment against DR prior to

bankruptcy, and as part of that judgment court made a necessary finding of fraud

CR could bring a discharge exception action in bankruptcy under § 523(a)(2) and invoke that prior fraud finding through collateral estoppel

No res judicata

Procedural bar does not run the other way

Res judicata is not applied to bar a creditor from raising a discharge exception claim for the first time in bankruptcy. Brown v. Felsen, 442 U.S. 127 (1979).

Example: CR in prebankruptcy suit could have but did not raise

fraud as a ground for relief CR will not be precluded from contesting discharge of

the judgment debt in bankruptcy on the ground of fraud

Fraud exception

Most important and most litigated discharge exception – BY FAR -- is for debts incurred by fraud. § 523(a)(2).

The fraud exception has two mutually exclusive alternatives: First: all fraud-based debts other than those

obtained by the use of a false financial statement (subsection (A))

Second: fraud debts that arise from the use of a false financial statement (subsection (B)).

presumption

For purpose of proving fraud under (A), a rebuttable presumption of fraud arises under § 523(a)(2)(C) if:

DR incurred a consumer debt of $550 or more for “luxury goods or services” within 90 days of bankruptcy, or

Obtained cash advances aggregating more than $825 in the 70 days prior to bankruptcy.

procedure

Fraud exception complaint has to be filed by Cr in the bankruptcy court

Within 60 days of 1st meeting of Crs

Sanction vs Cr?

Cr who loses a 523(a)(2) fraud action to consumer Dr could be sanctioned for costs and attorneys' fees incurred Idea is to keep Crs from bringing fraud objection

just to pressure Dr to settle with Reaff agreement

Liable if CR’s position "was not substantially justified"

Unless the court finds that "special circumstances would make the award unjust"

Elements of fraud?

Statute specifies fraud elements under the “false financial statement” rule of (B): Statement in writing Materially false Respecting Dr’s or an insider’s financial

condition On which Cr reasonably relied Dr had intent to deceive

What about elements under (A)?

Statute does not specify elements under (A)

Supreme Court held in Field v Mans, 516 U.S. 59 (1995), that Congress intended to incorporate in 523(a)(2)(A) the common law fraud elements as of date of Code (1978)

Common law fraud elements (A) Dr made false representation of fact Dr knew representation was false Dr made representation with intent to

deceive Cr Cr justifiably relied on Dr’s representation Cr sustained injury as proximate result of

representation

-> main difference is justifiable vs reasonable reliance

Actual fraud required

Note that Cr must prove actual fraud, with DR’s bad intent, to prevail under (a)(2)

“constructive” fraud not enough

Credit card fraud

Biggest fight under fraud exception – DR uses credit card in months before bankruptcy when in bad financial condition, not pay, file chapter 7

CR argues: Fraud for Dr who knows she’s in terrible financial

situation to go ahead and incur credit card charges right before files bankruptcy

When incurs charges, is impliedly misrepresenting her ability and intent to repay the debt incurred ▪ b/c she knows she is about to file and discharge debt

Fraud if never meant to pay

Intuitively, seems fraudulent if DR gets credit by using card but never intended to pay

For example, DR stops at ATM on way

to courthouse to file bankruptcy and gets a cash advance, spends cash buying presents for her friends

The trip abroad …

Or the DR who took his family on a 6-week trip to Europe, put it all on his credit card, and upon returning to the States filed bankruptcy

But what about Janet Marie Stearns?

But Janet Marie Stearns did not go on a trip to Europe on Amex’s dime

And she did not stop and get a large cash advance on her way to the courthouse to file bankruptcy

Janet the poor gambler

Instead, she had a gambling problem, and kept getting cash advances at the ATM at the Mystic Lake Casino ($7800 in 2 months Aug-October)

and not surprisingly, she kept losing made some small payments on the card, but

$7800+ balance left when she filed she didn’t make much $ in her job ($1382/mo) No charges for gambling last month before filed

What false representation of fact?

CR must prove that DR made a false representation of fact

Threshold problem – is the use of a credit card a representation of ANYTHING?

Williams & bad checks

Consider non-bankruptcy Supreme Court case of Williams v. United States, 458 U.S. 279 (1982): "a check is not a factual assertion at all, and therefore cannot be characterized as 'true' or 'false.'“

Id. at 284-85.

≠ “factual assertion”

Bad check ≠ factual assertion

Williams Court held that bad-check writer could not be convicted of the “false statement” crime based solely on the issuance of a bad check

b/c no factual assertion

Analogy of check to credit card

By analogy to Williams, some bankruptcy courts have concluded that the DR does not make any representation at all when she uses a credit card – like presentation of a check, is simply an authorization to charge the credit card account

=

Not “true or false”

Use of a credit card, on this line of reasoning, is no more able to be “true or false” than is the delivery of a check

But most courts find “representation”

Notwithstanding the powerful logic of the “no representation” view, most courts in credit card discharge cases DO find that use of a card = representation

At the very least, the clear “never intended to pay” cases are captured this way

Representation of WHAT?

Even if decide (notwithstanding Williams) that use of a credit card can be “true or false” and thus is a representation – is critical to identify representation of what?

CR argues: ABILITY to pay Janet Marie Stearns, with a monthly

income of $1382, simply was not ABLE to pay back monthly cash advances of $3900!!

Ability? -- NO

Some courts have agreed with CR and if DR does not appear to have means to repay the credit card debt, say Dr made an implied rep of ability to pay, that could support fraud 523(a)(2)

WRONG!! If concerns Dr ability to pay, that deals with

Dr’s financial condition – so must go under (a)(2)(B) – not (A) ▪ And, must then be in WRITING – not implied

Intent to pay? perhaps

Instead, the only possible implied representation that a DR can be making when she uses a credit card is that she has an INTENT to repay the debt

Thus, the possible false representation of fact that a DR might get caught with in credit card cases is whether she did or did not have a present intent (when she used the card) of paying it back

Ability relevant to intent?

Could a DR’s apparent objective inability to repay a credit card debt ever be relevant to the issue of her intent to repay?

Applied to Stearns?

In Stearns, did the court find that the Cr had carried its burden of showing that Janet made a false representation of her intent to pay the credit card charges?

Explain

So, is it okay to be “fatuous”?

Dfn: “completely or inanely foolish; silly; devoid of intelligence”

“Her persistent belief in the salvation of the "big win" was fatuous, but there is nothing to indicate that it was not genuine. Throughout, the Defendant maintained a subjective intent to pay back everything she was borrowing from the Plaintiff”

Footnote 21

“This formulation probably will limit success for credit card issuers under § 523(a)(2)(A) to situations where they can prove an actual, consciously-conceived plan or scheme on the part of the cardholder-debtor, contemporaneous with the charges in question – the scheme being to knowingly abuse the inherent impersonality of a credit card facility.”

“That is not inappropriate – given the likelihood that much more credit card overcharging is generated by stupidity and self-deception than by avarice and chicanery.”

“Bankruptcy under American law is not a hideout for the malefactor, but it still is a refuge for the irresponsible – and not inappropriately so.”

Intent to deceive

What about proving that DR had an intent to deceive the CR when she used the card, accompanied by an intent not to repay?

Obviously, closely linked to proof of implied intent to pay, or not

Laundry list of factors

See in note 23 an illustrative list of a dozen factors of circumstantial evidence that are relevant to proving whether the DR had a subjective intent to deceive

The factors

1. The length of time between the charges made and the filing of the bankruptcy;

2. Whether or not an attorney has been consulted concerning the filing of bankruptcy before the charges were made;

3. Number of charges made;

4. The amount of charges;

5. The financial condition of the debtor at the time the charges were made;

6. Whether the charges were above the credit limit of the account;

7. Whether the debtor made multiple charges on the same day;

8. Whether or not the debtor was employed;

9. The debtor's prospects for employment;

10. Financial sophistication of the debtor;

11. Whether there is a sudden change in the debtor's buying habits;

12. Whether the purchases were made for luxuries or necessities.

Court’s holding on intent to deceive?

What did the Stearns court hold, and why, on the intent to deceive question?

What facts were good for Janet?

What facts were bad for her?

Proof of actual & justifiable reliance

Cr also must prove both actual and justifiable reliance on Dr’s misrepresentation of fact

What problems did Stearns court find with the creditor’s proof of reliance?

Are these problems peculiar to this creditor or endemic in credit card cases generally?

Under the approach of the Stearns court, how would a credit card issuer establish reliance? Can CR argue PRESUMED reliance on other party’s

implied promise to keep its bargain?

Proving reliance?

What many courts do is infer reliance unless the creditor has reason to know otherwise:

“the credit card issuer justifiably relies on a representation of intent to repay as long as the account is not in default and any initial investigations into a credit report do not raise red flags that would make reliance unjustifiable.”

Anastas, 94 F.3d at 1286.

Willful & malicious injury

Ever since the passage of the Bankruptcy Act of 1898, Congress has excepted from discharge debts stemming from “willful and malicious” injuries by the debtor

The current exception is 523(a)(6)

procedure

Just like fraud exception – e.g.: The bankruptcy court has exclusive

jurisdiction to determine dischargeability issues under 523(a)(6), 523(c)(1)

Cr must file complaint within 60 days of 1st CR’s meeting

candidate for application of collateral estoppel

structure

prevents the discharge of debts based on intentional torts (“willful”) that contain some aggravating features (“malicious”)

Exactly how aggravating has proven to be difficult to pin down

“willful”

Two elements must be proved to establish the 523(a)(6) exception

1st, DR's actions must have been "willful“

legislative history ▪ means "deliberate or intentional." ▪ Cases allowing a "reckless disregard" standard to

suffice were intended to be overruled by the 1978 Code

▪ Behavior that is merely negligent (or even reckless) would NOT give rise to a nondischargeable debt under the sixth exception

“malicious”

2nd -- Dr's actions must have been "malicious"

Until 1998, courts differed widely on the proper meaning of malice

As well as on the proper interaction between parts 1 (willful) and 2 (malicious)

3 tough cases

Problems have arisen most often in three types of cases: (1) DR converts secured creditor’s

collateral for DR’s own benefit and dissipates proceeds

(2) DR inflicts an injury driving drunk

(3) Dr-physician commits particularly egregious medical malpractice

Issue

Question is whether section requires proof of: “special malice” – i.e., that the debtor

intended to injure the creditor – or

whether it is sufficient to prove “implied malice” – that the debtor intentionally committed an act knowing that the act was wrongful and was likely to harm the creditor, without just cause or excuse

Some history of the exception Tinker v Colwell (1904):

Implied malice Charles Tinker unable to discharge $50K judgment based on

"criminal conversation" (adultery) with Frederick Colwell's wife

Not matter whether Tinker was driven by malevolence toward Frederick or just passion for Frederick's wife

“Malice, in common acceptation, means ill will against a person; but in its legal sense it means a wrongful act, done intentionally, without just cause or excuse.”

Tinker Court concluded: a “wilful disregard of what one knows to be his duty, an act which is against good morals, and wrongful in and of itself, and which necessarily causes injury and is done intentionally, may be said to be done wilfully and maliciously, so as to come within the exception.”

History, cont.

Davis v Aetna Acceptance (1934): not every intentional tort falls within the exception. Cr objected to discharge of debt when Dr converted

Cr’s collateral. ▪ lower courts had found that Dr’s act did constitute a legal

conversion, which is an intentional tort ▪ Supreme Court held that not every conversion was

excluded from discharge, but that aggravating features were required.

▪ DR mistakenly but innocently believed that he had authority to sell the collateral and use the proceeds

▪ Such a technical conversion, while done intentionally, is not “malicious,” the Court held, and the resulting debt was held to be dischargeable.

More history

under 1898 Act, many lower courts found a nondischargeable debt for willful and malicious injury in cases involving gross or wanton negligence that caused personal injury or death

leading case: Den Haerynck v. Thompson, 228 F.2d 72 (10th Cir. 1955), in which DR negligently ran over and killed a child while drunk

History, cont.

1978 Code & legislative history: “‘willful’ means deliberate or intentional.

To the extent that Tinker v. Colwell, 139 U.S. 473 (1902), held that a looser standard is intended, and to the extent that other cases have relied on Tinker to apply a ‘reckless disregard’ standard, they are overruled.”

Congress apparently had in mind cases such as Thompson

Drunk driving rule

drunk driving problem addressed specifically in 1984, with the addition of § 523(a)(9)

bars discharge of debt “for death or personal injury caused by the debtor’s operation of a motor vehicle ... if such operation was unlawful because the debtor was intoxicated from using alcohol, a drug, or another substance.”

Still had collateral & bad doc cases

left unresolved were the (i) collateral conversion and (ii) horrible doctor cases

Special vs implied malice was the focus – literally hundreds of lower court opinions

Geiger

Facts: Dr. Paul Geiger, had committed particularly

egregious malpractice He knowingly and admittedly prescribed a course of

antibiotic treatment for an infection that he knew to be less effective than a viable alternative

When she got good help (he was out of town), he canceled that treatment when he got back

Caused Margaret Kawaauhau to have her leg amputated

And of course he had no malpractice insurance She got $355K judgment, he filed bankruptcy

Victim argued

Margaret argued that Geiger’s actions = “willful and malicious injury” because he knowingly and intentionally administered substandard medical care, which necessarily led to her amputation, without just cause or excuse

And thus squarely within Tinker

More than just “malpractice”

Was critical for Margaret to establish more than simple malpractice, which is plainly just = negligence and indisputably dischargeable

How did she argue this? Said Geiger KNEW he was giving her

inadequate care, but went ahead and did it anyway

Similar to the case where Doc knowingly used a nonsterile needle

SCOTUS – only if intent to injure!

SCOTUS misleadingly framed the question:

“We confront this pivotal question concerning the scope of the “willful and malicious injury” exception: Does § 523(a)(6)'s compass cover acts, done intentionally, that cause injury (as the [debtors] urge), or only acts done with the actual intent to cause injury?”

And chose the 2nd option

Any other choices?

Geiger Court omitted a third interpretation:

that the debtor intentionally committed an act that caused injury, knowing that the act was wrongful and substantially certain to cause injury, without justification or excuse

Come on, no straw man… The important additions of this

preferred interpretation to the Court’s straw man first alternative – “acts, done intentionally, that cause injury” – are: (1) Dr knew the act it committed was

wrongful, (2) Dr knew the act was substantially

certain to cause injury, and (3) in so acting Dr had no justification or

excuse

Geiger holding

Having framed the issue as a false choice between the alternatives of (i) encompassing every act done intentionally by a debtor that causes injury or (ii) only acts done with the intent to cause injury, the Court chose the latter.

Held that “nondischargeability takes a deliberate or intentional injury, not merely a deliberate or intentional act that leads to injury.”

basis

Court relied heavily on statutory text – noted that “[t]he word ‘willful’ in (a)(6) modifies the word ‘injury.’”

Thus, held “that debts arising from recklessly or negligently inflicted injuries do not fall within the compass of § 523(a)(6).” This last holding, standing alone, might not

work mischief, but the earlier statement, that a “deliberate or intentional injury” is required, could

critique

Geiger Court sought to limit subsection (6) to intentional torts this is a defensible interpretation of the

section

However -- the way they did so – by also requiring proof of an intent to injure – went too far, and much farther than needed to decide the case

Too far

Supreme Court could have decided against Margaret simply by saying that Geiger did not commit a “willful” (or “intentional”) tort, but at most acted with gross negligence (or even a “reckless disregard”). 1978 legislative history, reacting to drunk

driving cases that had gone against Dr, made clear that Congress thought that the section required an intentional tort.

too far, cont.

The way the Court in Geiger read subsection not only requires an intentional tort, but an intentional tort in which the debtor also intends to injure the victim.

Whither “malicious”?

Geiger opinion seems to conflate the separate elements of willfulness and malice into a single unitary test of “intent to injure.”

Unclear what the word “malicious” adds It is difficult to think of many (any?) cases in

which a debtor who inflicted a “willful … injury” (meaning, as the Geiger Court asserts, an “actual intent to cause injury”) would not also have acted with malice!

What about Tinker now?

under Geiger standard, Tinker’s chances of receiving a discharge for his debt to the cuckolded husband would be much greater

Colwell would have to show that Tinker intended to injure him by having an affair with his wife

Facts that Tinker knew that what he was doing was wrong, knew that by doing so he was substantially certain to cause injury to Colwell, and that he had no justification for doing so, would not seem to suffice under Geiger!

Not taking the Court at its word

Would impose a substantial burden on tort victims, if took Geiger Court at its word, if had to prove that the DR intended to injure the victim

Lower courts have seized on Rest 2d of Torts definition of intent to circumvent dire consequences of Court’s loose language

Restatement – “intent”

In Geiger, the Court relied on definition of “intent” in § 8A of the Restatement of Torts, that the actor must “intend the consequences of an act.”

However, the Court omitted the alternative meaning, also in § 8A: “or that he believes that the consequences are substantially certain to result from it.”

Knowledge of subjective certainty of harm enough

Post-Geiger, many lower courts have adopted this alternative meaning of “intent” and have read Geiger as allowing exception to discharge if the creditor can prove that DR acted knowing that his actions entailed an “objective substantial certainty of harm,” even if CR could not prove that DR acted

with a subjective motive to cause harm

Rewriting Geiger

Under this alternative formulation, CR can prevail either by showing that: DR “willed or desired harm” or DR “believe[d] injury is substantially

certain to occur as a result of his behavior”

When it matters – collateral conversion

Problem 10.7: Dr (Smith) owned a retail business Dr financed inventory & receivables with Bank Security agreement requires DR to put proceeds

from receivables in collateral account And, DR can’t use monies in collateral account w/o

Bank’s express written permission Dr fully understands these limits DR decides to take $300K out of account to buy

equipment, w/o getting permission from Bank Motive – save the business, hopefully repay Bank But gamble fails, loses everything, files bankruptcy

Dr argue discharge, à la Geiger?

So, this is a classic knowing collateral conversion case

Under Geiger’s formulation, “nondischargeability takes a deliberate or intentional injury” And Smith says, “I meant Bank no harm. I

wanted to pay the Bank, in fact. It’s not like I took the money to go to Vegas. I only stole their money because I was trying to save my business, and if it had worked, I’d have paid Bank back.”

If take Court at its word, CR would lose

On facts like this, if take Geiger literally to mean what it says, that a CR must prove that a Dr acted with an actual intent to cause injury, then the Cr could easily lose a knowing collateral conversion case such as this b/c DR’s motive was not to harm Cr, but

to save his business

Go with “substantial certainty” However, CR has chance under alternative

formulation of “intent”

Recall, CR can prevail either by showing that the debtor “willed or desired harm” or “believe[d] injury is substantially certain to occur as a result of his behavior.”

This alternative reading gives Cr whose collateral has been knowingly (rather than innocently) converted much more hope of blocking the discharge of the resulting debt

But you KNEW!

The key issues will be: whether DR knew that the conversion was

unauthorized (which it did in 10.7), and whether DR believed that his conversion

was “substantially certain” to cause harm to the (formerly!) secured creditor ▪ How analyze that issue in 10.7?

Cr does not have to prove subjective personal malevolence by Dr toward it

Final thought – tough luck on those student loans

One last note on the discharge exceptions – that it’s very, very hard to discharge a student loan debt

See 523(a)(8)

Student loan exception

inclusive part – defines what loans qualify to be nondischargeable. Includes any of: an “educational loan” or an “educational benefit

overpayment” if made directly by or if insured or guaranteed by any governmental unit

any loan made under a "program" funded at all by a governmental unit or by a nonprofit institution

"an obligation to repay funds received as an educational benefit, scholarship, or stipend.“

any other educational loan that is a qualified educational loan”. A “qualified educational loan” means loan debt that is tax-deductible under § 221 of Internal Revenue Code

The undue hardship escape

IF the loan is of any of the types covered in the prior slide, then will NOT be discharged UNLESS the Dr can prove that:“excepting such debt from discharge … would impose an UNDUE HARDSHIP on the debtor and the debtor’s dependents”

All the action on undue hardship

The litigation is all with regard to what constitutes an “undue hardship”

Bottom line – almost impossible for student DR to win

Brunner test

Leading test is still Brunner’s 3-part test:

1. That the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for herself and her dependents if forced to repay the loans;

2. That additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and

3. That the debtor has made good faith efforts to repay the loans.