Walking the Balance Beam of the Bankruptcy Code's Discharge Injunction
| Publication year | 2018 |
| Pages | 38 |
Walking the Balance Beam of the Bankruptcy Code's Discharge Injunction
Teresa M. Schreffler and The Honorable Janice Miller Karlin, Chief Judge U.S. Bankruptcy Court, District of Kansas
When a debtor files bankruptcy, whether represented by counsel or not, the debtor understands that the automatic stay and the discharge injunction are the "good" parts of bankruptcy. Debtors certainly may not understand the exact contours of these legalities, but they know that filing bankruptcy brings them a stay of collection from their creditors and ultimately a discharge of most of their debts. Those are the payoffs.
There is plenty of "bad" that goes along with bankruptcy as well, of course, but practitioners can rest assured that these "good" parts, perhaps the most important benefits, are fiercely protected by the courts. In fact, one local bankruptcy judge has called the discharge injunction "the backbone of an honest but unfortunate debtor's fresh start."[1]Obviously, you do what you can to protect your backbone.
For non-bankruptcy practitioners, seeing a notice of bankruptcy can (and should) cause you to immediately freeze. When an attorney is not well versed on the nuances of the automatic stay and the discharge injunction, the contours of the Bankruptcy Code can seem daunting. Especially regarding the discharge injunction, there is a common misconception about what a bankruptcy discharge means for creditor clients. What avenues, if any, remain for communication or even collection? What is prohibited? What is permitted? Two mistakes are often made at opposite ends of the spectrum: 1) the attorney does nothing when he or she could have actually proceeded, or 2) the attorney proceeds and runs afoul of the Bankruptcy Code. And there are a lot of situations in between these extremes as well. This article attempts to provide general practitioners who do not regularly practice in bankruptcy court an overview of the discharge injunction, a review of some recent discharge injunction violations, and the status of the law in the Tenth Circuit on what relief can be granted for violations and which court(s) have jurisdiction to grant the relief. It then provides tips for attorneys representing either debtors or creditors.
I. Bankruptcy's Discharge Injunction versus the Automatic Stay
A. A Review of the Automatic Stay
As noted above, bankruptcy can seem like a statutory maze and both the discharge injunction and the automatic stay are statutory creatures at heart. This article is focused on the intricacies of the discharge injunction, but to understand the discharge injunction, a practitioner must first understand how it is different from the automatic stay.
Bankruptcy's automatic stay is governed by 11 U.S.C. § 362. Section 362 "automatically stays the commencement or continuation of a judicial proceeding against the debtor that was or could have been initiated before the filing of a bankruptcy petition."2 The stay protects against a host of other things, in addition, and those are listed in the subsections of § 362(a). Essentially, any effort to recover on a claim against a debtor is stayed once the bankruptcy petition is filed.[3]
Section 362, which establishes the automatic stay, is the central provision of the Bankruptcy Code. When a debtor files for bankruptcy, section 362 prevents creditors from taking further action against him except through the bankruptcy court. The stay protects debtors from harassment and also ensures that the debtor's assets can be distributed in an orderly fashion, thus preserving the interests of the creditors as a group.[4]
"Actions taken in violation of the automatic stay are void ab initio; that is, they are without legal effect. 5
The automatic stay, however, does not "extinguish or discharge any debts;" it merely protects the "debtor from various collections efforts"[6] while it is in effect. The "while it is in effect" language is important, as the automatic stay is in effect only for a statutorily prescribed time period. The automatic stay terminates upon the occurrence of any of a number of listed items in subsection (c) of § 362. Highly simplified, the most generally applicable are case closure, case dismissal, or the entry of discharge. But even this general rule is not universal because "entry of discharge" does not terminate the stay for actions against debtor's non-exempt assets, as explained below. So it is admittedly complicated.
Creditors can also seek relief from the automatic stay to prosecute their claims, under § 362(d) if they can show cause or a lack of equity in property that is not necessary to the debtor's "effective reorganization." Creditors must be careful to seek relief for any action prohibited by the automatic stay, however. A party who is willfully injured by a violation of the automatic stay can recover "actual damages, including costs and attorneys' fees, and, in appropriate circumstances, may recover punitive damages."7
B. How is the Discharge Injunction Different from the Automatic Stay?
The discharge injunction, found statutorily in 11 U.S.C. § 524, "eventually replaces the automatic stay."8 It applies only after the debtor has received a discharge. A bankruptcy discharge "voids any judgment at any time obtained, to the extent that such judgment is a determination of the personal liability of the debtor with respect to any debt discharged under" the applicable chapter.[9] The discharge injunction also "operates as an injunction against the commencement or continuation of an action, the employment of process, or an act, to collect, recover or offset any such debt as a personal liability of the debtor, whether or not discharge of such debt is waived[.]" [10]
The discharge injunction is, therefore, broad. It applies to "any action to collect a discharged debt '[11] against the debtor personally. It is unequivocal: the injunction "unambiguously voids past and future in personam judgments on discharged debts at any time obtained."[12] Small nuances exist, of course. For example, claims that are the subject of a pending adversary proceeding that seeks to have a debt declared nondischarge-able are still ""˜presumptively discharged' until the bankruptcy court makes a determination regarding dischargeability."[13]This means the creditor should take no steps to collect a debt, even after the debtor has received a general discharge, if there is a pending adversary concerning that debt.
At the same time, because a discharge does not eliminate the right of a creditor to recover on a claim in rem, in other words, to enforce the security instrument that makes its claim secured up to the value of the collateral, the discharge injunction is precise in its application. It applies only to a debtor's personal liability on a debt; it does not eliminate the underlying debt.[14] Generally stated, the discharge injunction "bars efforts to collect personal debts from debtors after they have been discharged in bankruptcy," but it does not impact a creditor's in rem rights.[15] For example, an action to foreclose a mortgage is not prohibited by the discharge injunction so long as the creditor makes no effort to collect its remaining debt directly against the debtor.[16]
The discharge injunction also only applies to debts that are statutorily eligible for discharge, and not all debts are dischargeable. For example, 11 U.S.C. § 523(a)(4) prohibits the discharge of debt "for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny."[17] Another example is student loans that fall within 11 U.S.C. § 523(a) (8)"”which excludes many student loans from the automatic discharge unless the debtor can show "undue hardship."[18] In addition, any debt that arises after the date a bankruptcy petition is filed"”a post petition liability"”is not discharged.[19]
Creditors must also be aware of the type of discharge a debtor has received, as some debts are dischargeable in a Chapter 13 case but not in a Chapter 7 case. In a Chapter 13 case, a debtor is entitled to a discharge "after full compliance," meaning the debtor has completed making the payments required by a confirmed plan.[20] The full compliance discharge includes the discharge of non-support debts owed in relation to a divorce or property settlement, although these debts would be nondischargeable in a Chapter 7 case.[21] Similarly, a full compliance Chapter 13 discharge could discharge a debt under 11 U.S.C. § 523(a)(6) for willful and malicious injury by the debtor to the property of another entity, whereas a debtor who obtains a different type of discharge under Chapter 13"”a hardship discharge under 11 U.S.C. § 1328(b)"”could still have to repay that debt if the creditor timely filed and prevailed on an adversary proceeding brought after it was notified that the debtor was seeking a hardship discharge.[22]
And even if an underlying debt is discharged, a creditor may in limited circumstances still proceed with an action where the debtor is nominally involved. For example, "suits"”even those brought to collect on debts a debtor has discharged"”that formally name the debtor as a defendant but are brought to collect from a third party" are permitted.[23] In addition, even if a debtor has been discharged, that will not prevent a party issuing a subpoena to that debtor to testify at a trial or to participate in discovery as a witness. Neither of those actions are prohibited by the discharge in-junction.[24] Simply put, "requiring a debtor to bear such collateral burdens of litigation as those relating to discovery (as opposed to the actual defense of the action and potential liability for the judgment), does not run afoul of" the discharge injunction.[25]
Other subsections of11 U.S.C. § 524 also merit discussion...
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