Chapter 17 Discharge and Dischargeability

• Jurisdiction: United States

Chapter 17 Discharge and Dischargeability

§ 17.1 ~ Not What You Might Hope

The basic rule is that if an individual debtor plays by the rules — files his schedules, discloses all his property, appears at the meeting of creditors, and so forth — then at the end of the case, the debtor gets a discharge. His remaining liability on his unpaid debts is canceled. Far and away, the majority of all bankruptcy cases are filed by individuals who seek the discharge, and most of them get it.¹ But the discharge may not provide all of the comfort it seems to offer at first glance.

For the debtor, part of the problem is practical. If the creditor holds a security interest in, say, the automobile the debtor needs to drive to work, then the debtor may have to keep paying the secured creditor to retain the automobile.² If the creditor is the debtor's father-in-law, then he may have to repay the debt just to keep peace in the family. If the debtor wants the creditor to continue to extend credit to it after bankruptcy, then he may have to pay the debt off even if it is legally dischargeable. And some people still cannot bear the thought of not paying their debts; discharge or no discharge, they will insist on following through.

The Code also provides its own catalog of debts that will remain nondischargeable even though the debtor receives a discharge overall.³ On a day-to-day basis, this matter of nondischargeability is probably a lot more important than the matter of the discharge overall. There are plenty of cases where the debtor will have an undisputed right to the general discharge but where some exception or other will threaten to carve so large a hole in the protection as to make the bankruptcy scarcely worth the bother.

One reason why this is so is the matter of creditor incentive. Consider the problem of your client, CreditCo, holder of a claim against Dawson Debtor for $100,000, secured by the "Barbarelli Messenger," an exquisite little gold statue last seen in Debtor's possession. Debtor says it was stolen. You do not believe him. You believe he melted it down and hid the gold inside a souvenir model of the Eiffel Tower. Debtor has other liabilities totaling $1 million and no other assets. He does, however, have the capacity to earn money in the future.

A review of the law persuades you that you might have a cause of action to deny Debtor's discharge, perhaps under § 727(a)(2) ("removed, destroyed, mutilated, or concealed" property), (a)(4) (false oath), or (a)(5) (failure to explain loss of assets). But you also have a respectable shot at an exception to discharge under § 523(a) (2) (obtaining property by actual fraud) or perhaps (a)(6) (willful and malicious injury).

As a matter of litigation strategy, between your § 727 action and your § 523 action, which one do you prefer? After a moment's reflection, the question almost answers itself. Assuming that your goal is to get paid, then you would usually rather have the § 523 action — because if the debtor gets his (general) discharge while your claim alone survives, you are in the best of all possible worlds. You are in the ironic position of being the debtor's ally with regard to his § 727 case, just as you want to win under § 523.

There are limits to this reasoning. Sometimes, you may have grounds for a § 727 case, but not for a § 523. And of course, sometimes the debtor's future prospects are so slim that neither case is worth the time and effort.

§ 17.2 ~ Discharge vs. Priority

It is also useful to distinguish the denial of (or exception to) discharge from the matter of a priority claim. The short point is that there is no relation between the two. Consider the various kinds of "debtor wrongdoing" that are grounds for an exception to discharge under § 523(a)(2), (4) or (6). There is no corresponding priority for any of these claims. By contrast, wages and employee benefits are entitled to priority under § 507(a)(4) and (5), but there is no corresponding exception to discharge. On the other hand, in other limited cases, a debt can be both nondischargeable and subject to priority treatment. For example, § 523(a)(1)(A) declares to be nondis-chargeable debts for taxes of the kind specified in § 507(a)(3) or 507(a)(8).

Indeed, the relationship can be trickier than it appears to be. Under § 523(a)(7), there is an exception to discharge for "a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit." But under § 726(a)(4), claims for fines or penalties (and also claims for punitive damages) are subordinated to general unsecured claims. This presents an interesting strategic choice. Counsel who seeks to persuade the court that his client's claim is a fine or penalty (for purposes of enjoying the exception to discharge) may find that he has talked himself out of a distribution under § 726(a).

§ 17.3 ~ Discharge Timing

Congress tightened the basic discharge rule in 2005: For a debtor filing under chapter 7, it increased the waiting time from six years to eight if the debtor had previously been granted a discharge under chapter 7 or 11.⁴ Congress also tightened up a number of the chapter 13 discharge rules and added one glaring ambiguity, which concerns the filing of a chapter 13 case following a prior bankruptcy. The relevant language provides that a court shall not grant a discharge if the debtor has received a discharge "in a case filed under chapter 7, 11, or 12 of this title during the 4-year period preceding the date of the order for relief under this chapter" or "in a case filed under chapter 13 of this title during the 2-year period preceding the date of such order."⁵ Under this provision, if a debtor files a case under chapter 7 or 11, or chapter 13, and receives a discharge under that same chapter, the statute is clear. However, what about a case that is filed under chapter 13 and then converts to a chapter 7 case? Do we look to the chapter under which the case was originally filed or to the chapter under which the debtor ultimately received his discharge?⁶ The following chart attempts to make sense out of the rules.⁷

Discharge Waiting Period	Current Case Chapter 7	Chapter 11	Chapter 13
Prior Case Chapter 7	8 years from prior case filing	None	4 years from prior case filing (or prior case discharge)
Chapter 11	8 years from prior case filing	None	4 years from prior case filing (or prior case discharge)
Chapter 13	6 years from prior case filing (none with defined payout)	None	2 years from prior case filing (or prior case discharge)

§ 17.4 ~ Discharge

There are separate discharge rules for each chapter. We begin by considering the discharge in chapter 7.

§ 17.5 ~ Chapter 7: Discharge for "Individuals" Only

Section 727(a)(1) bars the discharge if "the debtor is not an individual." This means, among other things, that there is no discharge for partnerships or corporations (note that this is for chapter 7 only; the chapter 11 rule is different).

The case of a partnership is not problematic. At least with respect to general partners, the point of partnership is unlimited liability, so you cannot really give a discharge to the partnership independent of the (general) partners. On the other hand, nothing bars the individual partners from getting their own individual discharges in their own bankruptcy proceedings.

The case of a corporate discharge is more puzzling. The legislative history says that the bar "will avoid trafficking in corporate shells,"⁸ although it is far from clear that there was ever a market for corporate shells, or if so, that it needed to be discouraged, or if so, that the Bankruptcy Code was the proper place to do it. But on the other side of the coin, there is probably no point to a discharge in a corporate chapter 7 liquidation. The corporation's assets will be sold or abandoned, so all that will remain, in the usual case, will be the corporate shell. A limited liability entity, with no assets and no ongoing business, has no need for a discharge. The usual course will be to either dissolve the corporation under state law or, perhaps more commonly, just let it languish.

§ 17.6 ~ Chapter 7: wrongdoing, Fraudulent Transfer

Section 727(a)(2) bars the discharge when the debtor, with intent to hinder, delay, or defraud a creditor or an officer of the estate charged with custody of property under this title, has transferred, removed, destroyed, mutilated or concealed, or has permitted to be transferred, removed, destroyed, mutilated, or concealed:

- (A) property of the debtor, within one year before the date of the filing of the petition; or
- (B) property of the estate, after the date of the filing of the petition.

This is a kind of fraudulent transfer rule, but note that it is limited to intentional fraud and does not bar the discharge in the case of constructive fraudulent transfers. Intentional concealment of this sort may also be a crime,⁹ so on appropriate facts, a debtor may (a) see the transfer avoided and the property recaptured for the estate, (b) lose his discharge, and (c) suffer a criminal penalty.

Note that § 727(a)(2) does not say anything about harm to the estate. Consider this case:

Example: Dawson owns Mona Lisa, a famous painting. Fearing that his creditors may get it, he transfers it to his cousin Ted. Later, as his troubles get worse, he seeks advice from Leonard, a lawyer. Leonard asks him if he has made any transfers by gift. Dawson freely tells Leonard about the transfer of the Mona Lisa.

What is Dawson's next move? If Dawson files for bankruptcy leaving the transfer undisturbed, he almost certainly will lose his discharge under § 727(a)(2). On the other hand, if he gets the painting back from Ted, it is not clear that he has improved his lot. After all, the statute speaks about transfer, not repentance, and the transfer remains a fact even after the return. Plausible as this may sound, the Ninth Circuit was able to read a no-harm-no-foul rule into...