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What does “discharge” mean? Individual DR is freed from legal obligation to pay pre- bankruptcy debts So, the Dr can enjoy her future (post-bankruptcy)

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Presentation on theme: "What does “discharge” mean? Individual DR is freed from legal obligation to pay pre- bankruptcy debts So, the Dr can enjoy her future (post-bankruptcy)"— Presentation transcript:

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2 What does “discharge” mean? Individual DR is freed from legal obligation to pay pre- bankruptcy debts So, the Dr can enjoy her future (post-bankruptcy) earnings free from the claims of her discharged creditors

3 history Original 1543 law – no discharge – solely a creditors’ remedy Discharge introduced 1706 Statute of Anne Still designed to aid CRs – induce Dr to cooperate And if did not got death penalty CRs had to vote to allow Dr discharge Remember bankruptcy purely involuntary, so Dr could not just file and get discharge Enforce: “certificate of conformity,” affirmative defense

4 History in America 1800: Followed English law Involuntary, only against merchants, CRs vote 1841: Watershed Voluntary bankruptcy Any person whatsoever owing debts Today: generous discharge for individuals debtors, but limit eligibility for chapter 7 relief (means test)

5 Local Loan Facts: Individual (Hunt) borrowed $300 from Local Loan Co., executed assignment of future wages as security Under Illinois state law, wage assignment created lien effective immediately, attaching to wages as earned, and not disturbed by a discharge in bankruptcy Hunt filed bankruptcy and discharged Local Loan’s debt After bankruptcy, Local Loan brought action in Illinois state court against Hunt’s employer seeking to enforce the wage assignment as to post-bankruptcy wages

6 Local Loan Held: creditor’s pre-bankruptcy lien against post- bankruptcy wages is ineffective and unenforceable

7 Why not defer to state law? 1) he Illinois wage assignment created an enforceable lien under state law, and Illinois courts construed it as enforceable even after a bankruptcy discharge 2) In Long v Bullard, SCOTUS held that liens survive bankruptcy 3) In Butner, SCOTUS held should defer to state law re creation & nature of property interests  so why didn’t SCOTUS in Local Loan defer to the Illinois law?

8 Why have a discharge? According to Justice Sutherland, why do we have a discharge?

9 The quote “ it gives to the honest but unfortunate debtor who surrenders for distribution the property which he owns at the time of bankruptcy, a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preëxisting debt ”

10 What does it mean? What is Court’s point when it says Dr has “a new opportunity in life and a clear field for future effort”?

11 Public interest Justice Sutherland emphasizes it is of public interest, not just the debtor’s private interest, to give the debtor a discharge WHY?

12 Fair to creditors? Is it fair to private creditors to compel them to finance indirectly the “public interest” via the discharge of a debtor’s debts? If it’s a public interest, why don’t we impose a tax burden on all citizens and just have the government give the insolvent Dr a grubstake to move forward?

13 Freebie?? Should the debtor have to do anything to earn a discharge?

14 Other justifications Apart from the iconic “fresh start” policy, why else might we, as a policy matter, offer a discharge of debts to individual debtors? Why was the discharge originally offered back in bonnie old England in 1706?

15 What if no discharge? What would happen if the discharge were not widely available?

16 Other countries? Why don’t other developed economies have as generous a discharge policy as does the United States? Do they not care about “fresh starts”? Are they just mean?

17 Any limits on discharge? Given the justifications for the discharge, what limits (if any) should be placed on which debtors can qualify, or on what conditions must be satisfied in order to earn a discharge?

18 Exceptions? Even if a discharge is generally available to a debtor, are there any debts that should NOT be discharged, no matter what? Why? And how do you reconcile the decision to exclude those debts from the discharge with the justification that a discharge serves the public interest by giving a debtor a “fresh start”?

19 Scope & availability of discharge 1) “Debt” only 2) pre-bankruptcy 3) denial of discharge (727(a)) 4) excepted debts (523(a)) 5) liens survive 6) reaffirm ok (524(c)) 7) defer in chapter 11 or chapter 13 cases until Dr completes performance under planAnd Dr who flunks “abuse” test of 707(b) can only go under 13 or 11 8) only Dr is discharged – not co-Drs (524(e))

20 Problem 10.1(a) DR owes Cr $8K, and debt is secured by a perfected security interest in a car worth $6K  discharge the DR’s personal liability on the $8K note, but  do not discharge the security interest (in rem) So, unless the bankruptcy trustee has dealt with the collateral in some way (and remember CR has right to the $6K collateral value if so), Cr is free to enforce the security interest against the collateral after bankruptcy

21 10.1(b) May 1: DR, distracted while talking on cell phone, crashes into Cr’s truck and causes $4K damage May 2: Dr files chapter 7; Cr has not reduced claim to judgment  discharge the $4k debt = “debt” even though not reduced to judgment Arose pre-bankruptcy At most = negligence, not excepted from discharge

22 10.1(c) Same facts as question b, but DR swears light was green and accident was Cr’s fault  not change outcome – still a “debt” and discharge it Only possible difference is that trustee might object to Cr’s proof of claim, and if successful objection, Cr won’t even get paid anything in the bk distribution (if any)

23 10.1(d) Same except Dr intentionally smashes into Cr’s truck  not discharge Exception – “willful and malicious injury”, 523(a)(6) An intentional tort

24 10.1(e) Same facts, except accident occurs on May 3 Recall Dr filed chapter 7 on May 2  not discharge Arose after the bankruptcy filing, 727(b) And recall Dr can’t voluntarily dismiss and refile

25 10.1(f) Dr agrees to reaffirm the debt to Cr  Not discharge but only if meets all of the requirements for an enforceable reaffirmation agreement in 524(c) Those requirements seek to protect Dr from doing something stupid – paternalistic (e.g., warnings, independent review, Dr right to change her mind, formal reqmts, etc) Can only reaffirm during the case itself – not before, not after

26 10.1(g) Dr intentionally falsifies his bankruptcy schedules, not listing a valuable property he owns  deny discharge entirely under 727(a) Not cooperate in the bankruptcy case Falsified information re financial condition, (a)(3) False oath – fraudulent schedules, (a)(4) Concealed property with intent to defraud, (a)(2)

27 enforcement Automatic and self-executing Statutory injunction (524(a)) against discharged creditors trying to collect debts as a personal liability of DR Changed law (in 1970) from old approach of discharge as affirmative defense

28 Anti-discrimination provision 525 prohibits various forms of discrimination against a Dr solely b/c she has filed bankruptcy First, a governmental unit may not discriminate with respect to the grant of a license, permit, charter, franchise or the like or discriminate in employment, solely because of the debtor’s bankruptcy. § 525(a).

29 Anti-discrimination, cont. Second, private employers may not fire an employee or discriminate in employment solely because of a debtor’s bankruptcy. § 525(b). Note, though, that unlike the governmental employment anti-discrimination rule in subsection (a), private employers are not barred from discriminating in hiring because of bankruptcy

30 Anti-discrimination, cont. Third, a debtor may not be denied a student loan because of the debtor’s bankruptcy. § 525(c).

31 Denial of discharge 727(a) has 11 exclusive grounds for complete denial of discharge in a chapter 7 case Note do not apply directly in a chapter 13 or 11 case Some provisions in those chapter are similar E.g., time bar (1328(f)), personal financial management course (1328(g)) Also, some of the “bad acts” in 727(a) might lead to dismissal or conversion to ch 7 of the 11 or 13, and then no discharge  Common theme underlying 727(a): DR did not cooperate in the bankruptcy case

32 Only for humans Only individual debtors get discharge. § 727(a)(1). neither a corporate nor a partnership debtor may receive a chapter 7 discharge but they are discharged by confirmation of a plan in chapter 11 Non-human entities do not need a “fresh start”!

33 Actual fraudulent transfer Dr, acting with actual fraudulent intent, transfers or conceals his property Not apply if only constructive fraud Time: within one year of bankruptcy Or, does so as to property of the estate after the filing Note does not go back 2 years, as does the avoiding power for FT in 548(a) § 727(a)(2)

34 Bad books Unjustified failure to keep proper books and records. § 727(a)(3). Creditors and the trustee need to be able to figure out what happened to the debtor financially – so if DR’s books are hopeless, not get a discharge Exception -- even DR did not maintain adequate records, she still may be discharged if failure was “justified”

35 Bankruptcy crime Commission of a bankruptcy crime. § 727(a)(4). Most common example – DR knowingly and fraudulently filed false schedules in the bankruptcy case

36 What in the heck happened?? Failure to explain satisfactorily any loss of assets. § 727(a)(5).

37 Disobey court order Refusal to obey a lawful court order or to testify § 727(a)(6) Exception: take the 5 th – Dr may invoke Fifth Amendment privilege against self-incrimination and refuse to testify and still get discharge Change in law in 1978 – under prior Act, Dr had to choose

38 Insider Commission of a prohibited act (i.e., any of # 2-6) in the prior year in the bankruptcy of an insider § 727(a)(7)

39 Time limit: ch 7 then another 7 Time period between discharges: DR may receive a chapter 7 discharge only once every eight years. § 727(a)(8). time bar was extended from 6 to 8 six years by BAPCPA How count? The eight-year period is computed from petition filing to petition filing (not from when discharge entered)

40 Time limits: 13 then 7 If Dr’s first case was under chapter 12 or chapter 13, and the second case is under chapter 7, do not have an 8-year bar (that is only for a 7 followed by a 7) § 727(a)(9). Instead, when is 13->7, have conditional six-year bar in the chapter 7. Condition -- EITHER: ( i) payout on unsecured claims in the original chapter 12 or 13 case was 100% or, (ii) payout at least 70%, the plan was proposed in good faith, and was the debtor’s best effort.

41 Time limit: 2 nd case a ch 13 BAPCPA instituted for 1 st time a time bar when the second case is chapter 13 § 1328(f) Previously, there was no time bar for a case under any chapter except chapter 7 Rule: if 2 nd case is a chapter 13, discharge is denied – EVEN IF DR MAKES ALL PAYMENTS (!) - if DR got discharge: (i) in a prior chapter 7, 11, or 12 case filed within four years before the current chapter 13 case, or (ii) in a prior chapter 13 case filed within two years before the current chapter 13 * this just shows the meanness of BAPCPA!

42 Waiver Waiver: Dr waives discharge in writing and after the filing of the bankruptcy case § 727(a)(10) Crucial that DR may not waive the discharge in advance of bankruptcy prevents creditors from obtaining enforceable boilerplate discharge waivers at the time credit is extended

43 DR education Failure to complete debtor education BAPCPA added provision denying discharge to DR who fails to complete an instructional course concerning personal financial management after filing the petition Applicable in both chapter 7 and chapter 13 cases § 727(a)(11); § 1328(g). This post-filing debtor education rule is in addition to the debtor eligibility rule of § 109(h), which requires a debtor to receive credit counseling within 180 days prior to filing a petition in order to be eligible for bankruptcy relief

44 The Enron rule – delay discharge BAPCPA added § 522(q), a $136,875 cap, to the homestead exemption in certain limited circumstances (is often called the “Enron rule”) if: DR is convicted of felony which demonstrates that filing of bankruptcy was abuse, or DR owes a debt arising from securities law violation, racketeering, fiduciary fraud, or crimes or intentional or reckless torts that caused death or personal injury in past 5 years. Discharge implications:  court must delay entry of discharge if it finds reasonable cause to believe that a proceeding under § 522(q)(1) is pending Applies in all chapters: chapter 7 (§727(a)(12)), chapter 11 (§ 1141(d)(5)(C)), chapter 12 (§ 1228(f)), and chapter 13 (§ 1328(h)). Rule does not effect permanent denial of discharge -- only postpones the discharge until the § 522(q) proceeding is completed.

45 Problem 10.2 Facts: Three months before filing chapter 7, DR made a fraudulent transfer of his ranch, Blackacre, to his son One month before filing, DR consulted an attorney for first time, and the attorney advised DR that the fraudulent transfer would defeat his discharge Acting on attorney’s advice, DR persuaded his son to reconvey Blackacre back to DR Two weeks after reconveyance, DR filed chapter 7 DR listed the transfers of Blackacre to and from his son on his statement of financial affairs and listed Blackacre as an asset on his schedules Trustee objected to DR’s discharge under § 727(a)(2)

46 Analysis of 10.2 Question -- can a DR “unwind” a FT and still receive his discharge? Arguments for discharge? Arguments against discharge?

47 Problem 10.3(a) DR filed chapter 7 on May 1, 1998 discharged on August 1, 1998 May 15, 2006, DR filed a second chapter 7 case His discharge hearing is scheduled for July 31, 2006. May Debtor be discharged? Answer: DISCHARGE  8-year time bar computed from filing to filing – so here, 8 years and 14 days, so ok * not matter when gets discharges

48 Problem 10.3(b) DR filed chapter 7 on May 1, 2002 Discharged on August 1, 2002 April 30, 2006, Debtor filed chapter 13. Will Debtor be able to discharge his debts in the subsequent chapter 13 case? Answer: NO DISCHARGE DR runs afoul of the new 4-year bar in chapter 13 cases DR received discharge in prior ch. 7 case that was filed within 4 years before filing of current chapter 13 case. § 1328(f)(1) Should have waited two days!

49 10.3(b), cont. What if the first case had been filed under chapter 13 instead of chapter 7? Answer: DISCHARGE DR would receive discharge in ch 13 if first case is also a chapter 13. In that event, time bar is only two years, not four. § 1328(f)(2).

50 Problem 10.3(c) DR borrowed $5K from CR Loan agreement provided: DR “hereby waives the right to receive a discharge under the Bankruptcy Code.” Two years later, DR filed chapter 7. Will the waiver preclude Debtor from receiving a discharge? Answer: DISCHARGE. Pre-bankruptcy waiver of right to receive bankruptcy discharge is invalid and unenforceable. §§ 524(a)(1)-(2), 727(a)(10)

51 Problem 10.3(d) DR incorporated his internet floral business as “Flowers.com Inc” Two years later, Flowers.com Inc. filed chapter 7 Will it receive a discharge? Answer: NO DISCHARGE § 727(a)(1) limits chapter 7 discharge to individual debtors.

52 Functional discharge, though Since all of a corporate debtor’s assets are liquidated in chapter 7, though, creditors have no further recourse against the debtor postbankruptcy This is the functional equivalent of receiving a discharge Corporate debtors essentially die in chapter 7

53 Cox The case of the bullying husband – or the “hear no evil, see no evil, speak no evil” wife?

54 Facts in Cox Stephen & Deborah Cox were married, she quit work and stayed home when 1 st child born Husband involved in myriad business activities, including diamond and bullion trading & real estate Wife signed numerous documents Became co-owner of 14 parcels real estate, partner in 2 partnerships, officer or director in 4 corporations Never asked Hubby any questions, or discussed business She did not keep any records of her own He came home one day and said they had to flee angry Crs She eventually turned herself into the FBI Hubby became a fugitive

55 Ground for discharge denial? Trustee in Deborah’s bankruptcy case objected to her discharge – inadequate books & records 727(a)(3): “the debtor has... failed to keep or preserve any recorded information, including books, documents, and papers, from which the debtor's financial condition or business transactions might be ascertained, unless such... failure to act was justified under all the circumstances of the case”

56 Step 1: adequate books? 1 st step under 727(a)(3) – does the DR have adequate books and records from which her financial condition can be ascertained? Trustee objecting to discharge has B/P Earlier decision – records not adequate

57 Step2 – failure justified? If trustee carries B/P that DR does not have adequate books, burden shifts to DR to prove justification Issue in case – was Deborah justified in relying on her husband to keep the books and records?

58 Factors in justification Six factors : (1) Ms. Cox's intelligence and educational background (2) her experience in business matters (3) the extent of her involvement in the businesses for which discharge is sought (4) her reliance on [her husband] to keep records, including what, if anything, Ms. Cox saw or was told that indicated her husband was keeping records (5) the nature of the marital relationship (6) any recordkeeping or inquiry duties imposed upon Ms. Cox by state law

59 Held was justified Court held that Deborah Cox was justified in relying on her husband to keep adequate books and records WHY?

60 Subjective or objective? Did court apply a subjective or an objective test of justification – or perhaps a little of both?

61 Narrow or liberal construction? Did the court construe 727(a)(3) narrowly or liberally? Why?

62 What arguments not justified? What arguments would you make that her reliance on the hubby was not justified? Recalling that question is whether she should be entitled to receive a bankruptcy discharge even though there were not adequate records by which the trustee or creditors could figure out her financial and business affairs Should a spouse have a duty of inquiry?

63 I relied on my accountant … Would the rationale of Cox allow a DR to obtain a discharge notwithstanding inadequate books & records if she could show that she relied on an accountant to do the heavy financial lifting? Any limits?

64 Tripp “So, tell me about the pot again”

65 Tripp Facts: George and Rose Tripp filed chapter 7 November 6 In their schedules, did not list “marijuana” as “property” December 22 – George stopped by police, had ¼ oz pot Search warrant – found 14-15 pounds at his home Had been growing for 2-3 years Sentenced to 5 years in prison Bankruptcy trustee objected to discharge under 727(a)(2) (concealment of property) and (4) (false schedules)

66 Defense? Not material There was no dispute that the Drs knowingly had not listed the marijuana on their bankruptcy schedules, so at 1 st blush, it would appear that they had both fraudulently concealed property (thus (2) met) and had falsified their schedules (thus (4) met) What was their defense, then?  Argued that their omission was not material – since it had no value to trustee – illegal to sell it!

67 Court held was material Court concluded that the debtors’ omission to list their marijuana was material 1 st – what was the TEST of materiality? 2 nd – why didn’t the “no value” defense work? Would the outcome have been different if Iowa did not impose a drug dealer tax?

68 Intent? Did the debtors have the necessary fraudulent intent? What is the test?

69 Double jeopardy? Why weren’t the debtors protected from denial of discharge for nondisclosure of the marijuana under the constitutional protection against double jeopardy? 5 years prison no discharge

70 Take the 5 th ? Could the Tripps have argued that they had a 5 th Amendment right not to incriminate themselves that would excuse them from listing the marijuana?


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