6.2 Chapter 7 Discharge

• Library: Bankruptcy Practice in Virginia (Virginia CLE) (2017 Ed.)

6.2 CHAPTER 7 DISCHARGE

6.201 In General. Section 727(a) of the Bankruptcy Code provides that an individual Chapter 7 debtor must receive a discharge unless one or more of the twelve grounds for denying a discharge exist. Section 727(b) describes the scope of the discharge and specifically excepts any debts determined to be non-dischargeable under section 523. Federal Rule of Bankruptcy Procedure 4004 is the primary rule addressing the procedural aspects of a Chapter 7 discharge.

6.202 Grounds for Objecting to Discharge.

A. Debtor Is Not an Individual. Only individuals are entitled to a Chapter 7 discharge. ¹⁵ Although corporations, partnerships, and limited liability companies are not entitled to Chapter 7 discharges, these entities often use Chapter 7 bankruptcies to wind up their affairs and obtain a liquidation of their assets even without receiving the benefit of a discharge. If these entities seek a discharge, they may file under Chapter 11.

B. Intent to Hinder, Delay, or Defraud a Creditor. Section 727(a)(2) of the Bankruptcy Code prohibits a discharge where it is proven that the debtor, with intent to hinder, delay, or defraud a creditor or an officer of the estate charged with custody of property under the Bankruptcy Code, transferred, removed, destroyed, mutilated, or concealed or permitted to be transferred, removed, destroyed, mutilated, or concealed property of the debtor within one year before the date of the filing of the petition or property of the estate after the date of the filing of the petition.

1. Evidence Needed. To prevail on the objection, the plaintiff must show the actual intent of the debtor to hinder, delay, or

[Page 270]

defraud. ¹⁶ To establish the debtor's actual intent, courts typically must rely on circumstantial evidence established through "badges of fraud." ¹⁷ These badges of fraud include such things as the relationship between the debtor and the transferee, inadequate consideration, the debtor's insolvency, whether all or substantially all of the debtor's assets were transferred, retention of some interest by the debtor in the property transferred, the pendency or threat of litigation at the time of the transfer, and any secrecy or concealment. ¹⁸ It is not necessary that a court find any specific badge of fraud as one badge alone may be sufficient. ¹⁹

2. Converting Assets to Exempt. Although a debtor may sometimes convert property from nonexempt items into exempt assets to maximize exemptions available under state law, if the transfers occur within one year of the filing of a Chapter 7 petition, a court will examine carefully the circumstances to determine if there are extrinsic facts constituting an intent to hinder, delay, or defraud. ²⁰ Also, section 34-26 of the Virginia Code, which sets forth the poor debtor's exemptions, specifically provides that the purchase of items claimed as exempt under this section with nonexempt property in contemplation of bankruptcy or creditor process should not be deemed to be in fraud of creditors.

3. Preference. The intent to prefer one creditor over another does not constitute an intent to hinder, delay, or defraud creditors in most instances. ²¹ Courts have held that grounds for objecting to discharge should be liberally construed in favor of the debtor. ²²

C. Failure to Maintain Records. Section 727(a)(3) of the Bankruptcy Code provides that a debtor should be denied a discharge where it has

[Page 271]

"concealed, destroyed, mutilated, falsified, or failed to keep or preserve any recorded information, including books, documents, records, and papers, from which the debtor's financial condition or business transactions may be ascertained, unless such act or failure to act was justified under all of the circumstances of the case." The purpose of this section is to ensure that creditors have sufficient information from which they can assess the debtor's estate and its general financial condition. ²³ The debtor's failure to maintain sufficient records is not an absolute bar to a discharge. Instead, evidence must establish that the failure to maintain records prevented creditors from determining the financial condition and transactions of the debtor. ²⁴ The test for determining the justification for a debtor's failure to maintain records is an objective one and does not require intent to conceal its financial condition. ²⁵

D. False Oath or Account, False Claim, and Other Matters. Section 727(a)(4) provides that a debtor will be denied a discharge where it knowingly and fraudulently in or in connection with the case:

1.	Made a false oath or account;
2.	Presented or used a false claim;
3.	Gave, offered, received, or attempted to obtain money, property, or advantage or a promise of money, property, or advantage for acting or forbearing to act; or
4.	Withheld from an officer of the estate entitled to possession under the Bankruptcy Code any recorded information including books, documents, records, and papers relating to the debtor's property or financial affairs.

For a Chapter 7 debtor to be denied a discharge for having made a false oath, the debtor must have intentionally made a false statement under oath. A false statement or omission in a debtor's schedule or statement of financial affairs is sufficient, ²⁶ but the statement must have been made willfully with intent to defraud, and the false oath must have related to a

[Page 272]

material matter. ²⁷ A finding of reckless indifference to the truth is adequate to establish fraud. ²⁸ A false oath is "material" where it maintains a relationship to the debtor's business transactions or estate or concerns discovery of assets, business transactions, or the existence and disposition of the debtor's property. ²⁹ The asset in question does not require a particular value for the debtor's false statement or omission to be material. ³⁰

E. Failure to Explain Loss of Assets. Section 727(a)(5) provides that a debtor shall not be granted a discharge where it "has failed to explain satisfactorily, before the determination of denial of discharge under this paragraph, any loss of assets or deficiency of assets to meet the debtor's liabilities." The scope of section 727(a)(5) is broad and includes any unexplained disappearance or failure to account for assets. ³¹ To prevent a denial of a discharge for a loss of assets, the debtor must provide an explanation that...