Wednesday, August 05, 2020

Some Debts Are Not Dischargeable in Bankruptcy

By Sim Israeloff

 

It’s a common misconception that if someone files bankruptcy, all claims against them will be discharged leaving few assets to be split between creditors.  In fact, several kinds of debts are not eligible for a discharge.  A creditor or other party can file a complaint under Bankruptcy Rule 4007 to contest the dischargeability of a particular claim.  If successful, that debt will remain enforceable after bankruptcy, a valuable right.  Here are some of the more common nondischargeable debts:

 

Debts for Money or Property Obtained by Fraud

11 U.S.C. Section 523(a)(2)(A) provides that a discharge is not allowed for 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.”  Thus, a party may not be able to avoid a fraudulent debt by filing bankruptcy.

The elements of actual fraud under Section 523(a)(2)(A) generally correspond with the elements of common-law fraud in Texas and include: (1) the debtor made a representation; (2) the debtor knew the representation was false; (3) the representation was made with intent to deceive the creditor; (4) the creditor actually and justifiably relied on the representation; and (5) the creditor sustained a loss as a proximate result. Saenz v. Gomez (In re Saenz), 899 F.3d 384, 403 (5th Cir. 2018). 

 

Debts Incurred Through a Breach of Fiduciary Duty

Section 523(a)(4) bars discharge of a debt for “fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny."  The section was intended to reach those debts incurred through abuses of fiduciary positions and through the acquisition or use of property that is not the debtor's.  Powers v. Caremark Inc. (In re Powers), 261 F. App'x 719, 723 (5th Cir. 2008).

As used in Section 523(a)(4), “fiduciary” is limited to express or technical trusts.  Miller v. J.D. Abrams, Inc. (In re Miller), 156 F.3d 598, 602 (5th Cir. 1998).  A technical trust may be imposed by law.  In re Grisham, 245 B.R. 65, 70 (Bankr. N.D. Tex. 2000).  The fiduciary duties owed by corporate officers and directors to the corporation meet the standard for a technical trust.  Assurance Systems Corp. v. Jackson (In re Jackson), 141 B.R. 909, 915-16 (Bankr. N.D. Tex. 1992).

 

Debts for Willful and Malicious Injuries.

Section 523(a)(6) bars dismissal of any debt “for willful and malicious injury by the debtor to another entity or to the property of another entity.”   The test for willful and malicious injury is condensed into a single inquiry of “whether there exists either an objective substantial certainty of harm or a subjective motive to cause harm on the part of the debtor."  Goaz v. Rolex Watch U.S.A., Inc. (In re Goaz), 559 F. App'x 377, 380 (5th Cir. 2014).

Intent to cause injury may be inferred.  Arguello v. Lafavers, No. 3:18-cv-00449, 2020 U.S. Dist. LEXIS 50505, at *10-11 (S.D. Tex. Mar. 24, 2020).  When a debtor’s actions, viewed from a reasonable person's perspective, were substantially certain to result in harm to the Plaintiff, a court can infer the debtor’s subjective intent to inflict a willful and malicious injury to the Plaintiff.  Id. at *19.

In Chapter 13 bankruptcies, debts for willful and malicious injury can still be discharged by satisfying the terms of 11 U.S.C. Section 1328.  But a discharge is not available for restitution or damages awarded in a civil action as a result of willful or malicious injury causing personal injury or death.

 

Judgments and Settlements for Securities Fraud

Section 523(a)(19) bars discharge of any debt that is for the violation of any of federal or state securities laws; or common-law fraud, deceit, or manipulation in connection with the purchase or sale of any security; and results from any judgment, order, consent order, or decree entered in any Federal or State judicial or administrative proceeding; any settlement agreement entered into by the debtor; or any court or administrative order for any damages, fine, penalty, citation, restitutionary payment, disgorgement payment, attorney fee, cost, or other payment owed by the debtor.

For a debt to be non-dischargeable under Section 523(a)(19), the creditor must prove that: (1) the debt is for violation of securities laws or for common-law fraud in connection with the sale of a security; and (2) the debt must be memorialized in a judicial or administrative order, or in a settlement agreement.  Jenkins v. Jones (In re Jones), 600 B.R. 561, 568 (Bankr. W.D. Tex. 2019).

In Chapter 13 bankruptcies, Section 1328 may allow discharge of debts from securities violations, with the exception of debts for restitution and damages awards discussed above.

 

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