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Wednesday, July 23, 2014

Jam that bankruptcy! The power of a 523 exception.

When the case you are pursuing get's booted by a bankruptcy -- fight back!

Folks, there are few things more frustrating to civil attorneys than watching a great case get all the way to trial stage...and then poof! Bankruptcy is filed by the defendant and the case flops like a fish on dry land.

11 U.S. Code §362, frequently called the "automatic stay provision", stops all legal action against a debtor. This article deals only with legal action -- not collections or judgments entered against a debtor. Those are interesting topics, too, but not nearly as diabolical and placing a wilely debtor over the proverbial barrel of pain when he/she thought escape was theirs!

Alright, so your case is stayed. Not the operative word -- "stayed" -- not "terminated." It is really important that the you pay special attention to bankruptcy procedures. After being notified that your case has been stumped by a bankruptcy filing, you can expect to receive a "Notice of Creditor Meeting". Go to that meeting. At that time, you will have a chance to inquire of the debtor anything you wish under oath (related to assets, naturally), and through those questions, you can alert the bankruptcy trusty to potentially damning evidence of hiding or evasive conduct. Also, be sure to review the tax returns! Fraudulent tax returns, or a material incorrect filing of the bankruptcy case can result in a dismissal of the entire bankruptcy. Any assets (other than direct wages, and certain exempted payments such as child support) received by the debtor within 90 days of the filing of the bankruptcy is automatically given to the trustee to be distributed to the creditors.

An interesting example of this occurred during a recent Creditor Meeting I had in DC. After examining the tax return, it was clear the debtor had received $19,000 in mid-March as a result of tax returns. He filed for bankruptcy in the middle of June. Uh-oh. Trustee busted him for missing the 90 day cut-off, and the 19K must not be disgorged by the debtor (paid by the debtor) to the trustee. Point for the good-guys!

However, debtor errors aside, I would draw your attention to 11 USC §523. This section of the code details exceptions to the bankruptcy filing. If the a debtor's situation falls within a discharge exception, he/she is barred from discharging the debt. Great news for the creditor (that's you!) and very bad news indeed for the debtor (the person who was running like heck from you).

The most common exceptions are:
Exception Code
523(a)(2)False pretenses, false representations, actual fraud
523(a)(4)Breach of fiduciary duty, embezzlement, larceny
523(a)(5)Domestic support obligations
523(a)(6)Willful and malicious injury
523(a)(15)Divorce or separation obligations (other than 5 above)

Without a doubt, (a)(1), (a)(4), and (a)(6) are the most common form of attack on dischargability. For business litigation, (a)(4) is a killer. If there is even a remote chance a court action (currently underway) could result in a judgment that is excepted, the bankruptcy court will often lift the stay on the state court suit and allow a trial on the merits. Only then, depending on the verdict of the bench or the jury, with the bankruptcy court decide whether a final discharge is appropriate or not.

Experienced bankruptcy attorneys rarely advise bankrupting during litigation, as the debtor usually ends up paying for two actions -- a 523 action in bankruptcy court, and the underlying state case.

If you are concerned about an opponent going belly-up and bankrupting during a contract breach case, be certain to include an element of fraud. Again, as in the previous paragraph, where the outcome is uncertain, the bankruptcy court will often lift the stay to allow a final determination on the state case, and only then issue a ruling on dischargability if appropriate.

Plan your cases carefully! If you need help with a bankruptcy matter, or you need assistance planning a civil action (suing for tort or breach), contact us first! It could save you a fortune in bankruptcy headaches.

Hanover Law, PC
Offices in Fairfax, VA and Washington, DC
888 16th St., NW Ste 800
Washington, DC 20006
2751 Prosperity Ave, Ste 580
Fairfax, VA 22031
Sean R. Hanover, Esq.
Stephen Salwierak, Esq.
1-800-579-9864 Charles Hatley, Esq.
Leigh Snyder, Esq.


Anonymous said...

Is there case law that prevents a creditor from using §523(a)(7) after §523(a)(19) and §523(a)(19)(b)(iii) have been ruled discharged?

Is there case law that clearly states a court cannot make one provision of the bankruptcy code meaningless by first ruling one penalty provision §523(a)(19)(b)(iii) inapplicable and then using another penalty provision (a)(7) to be non-dischargeable

Sean Hanover said...

Need further clarification on this question. If the debt is discharged from bankruptcy, why would the creditor seek to discharge it again?

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