The purpose of filing a bankruptcy, either Chapter 7 or Chapter 13, is to obtain a bankruptcy court order discharging the debtor of liability on debts. The bankruptcy court usually issues a discharge order about two months after the debtor first meets with the bankruptcy trustee.
What debts are discharged in bankruptcy? Section 523 of the Bankruptcy Code lists debts that are excepted from discharge. Unless a debt is excepted, it is discharged.
NEVER DISCHARGED: Some debts are never discharged in bankruptcy; the creditor is not obligated to take any action in bankruptcy to make the debt survive the discharge. The most common are:
- Recent income taxes: a complicated area, but taxes where the April 15 tax return deadline was less than three years ago are definitely not dischargeable. Also, loans used to pay a non-dischargeable tax are also non-dischargeable.
- Trust taxes: usually a business situation, where a debtor collects taxes from another party (such as sales tax or employee withholding) and fails to turn it over to the government. Trust taxes are never discharged, no matter how old they are.
- Alimony, maintenance or child support: never discharged; neither are property settlement claims arising out of a separation agreement or divorce decree.
- Penalties or fines owed to the government: non-dischargeable, but penalties that reimburse the government for an actual financial loss are discharged. As a personal example, I once slid off a highway in a snow storm and knocked over a light post. I got a traffic ticket for the accident, and a bill from the county for repairing the light. If I had filed bankruptcy, the traffic ticket fine would not have been discharged, but the repair bill would have been discharged.
- Student loans: Both government-backed and private student loans, except in cases of extreme hardships, are not discharged. For more information on student loan dis-chargeability, see my December 3, 2009 bankruptcy blog, describing student loans dis-chargeability in greater detail. See also my student loan blogs of April 11, 2011 and August 5, 2011
- Debts that existed where discharge was denied or revoked in a previous bankruptcy case: never discharged in future bankruptcy cases.
DEBTS DISCHARGED UNLESS CREDITOR TAKES ACTION:
Other debts are excepted from bankruptcy ONLY if the creditor files a lawsuit with the bankruptcy court asking that the debt be excepted from discharged. The creditor must file this lawsuit within 60 days of the debtor's first meeting with the trustee (or the creditor must file a motion asking the deadline to be extended.) These lawsuits, called adversary proceedings, costs creditors a lot of money, and so they are not filed unless the amount of the debt is significant.
These exception-to-discharge lawsuits basically involve allegations that the debtor intentionally or recklessly harmed the creditor. They include:
- Lying to a creditor about the debtor's financial condition: obtaining money or credit by false pretenses, false representation or actual fraud, or by a credit application that is materially false and intended to deceive the creditor.
- Stealing from a creditor: Fraud, embezzlement or larceny. Some credit card banks believe that charging on a credit card when the debtor has no capacity to repay the debt is credit card fraud, and should not be discharged.
- Stealing or diverting money held in trust for someone else: Defalcation while in control of the financial affairs of another (that is, acting in a fiduciary capacity) This includes diverting funds from a trust account, and in New York, contractors run into this problem all the time. Under New York Lien Law, Article 3A, a contractor is suppose to hold all funds received on a project and pay the laborers and suppliers on that contract before paying anything else, such as overhead. As these funds are considered a 'trust fund', diverting the funds to some other purpose is grounds to deny discharge of unpaid debts to laborers and suppliers of the project. See my blog posting Feb. 21, 2010 on the Henderson case This issue can also come up if a bank has a security interest in a business debtor's cash, and the debtor spends the money after filing bankruptcy (see my November 16, 2009 blog "Cash Collateral agreements needed in business Chap. 13: In re Kjoller
- Intentional (willful and malicious) harming another person or entity, or their property. For an example, see my case note in a 2008 Buffalo case "Dischargeability of a bar fight claim: In re Donald L. Wright" under Bankruptcy News - Recent Cases'
I have extensive experience and knowledge of debt discharge issues in Western New York bankruptcy courts.
I have analyzed every dischargeability lawsuit (adversary proceeding) filed by a creditor in Rochester and Buffalo since 2007, and have identified those creditors most likely to ask for a debt to be excepted from discharge see my blog January 2, 2011.
In both consumer bankruptcy and business bankruptcy cases, the dischargeability of debts is one of the major issues that must be reviewed. Debtors should know, before filing bankruptcy, what debts are dischargeable, which are not, and which might possibly be excepted from discharge. Debt dischargeability issues should never be a surprise.
Contact me to learn more about ways I can help you get the fresh start your family is looking for.