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Cases of Interest

Denial of Discharge
Bankruptcy Code 727 and Its Importance to Creditors

It is well known that the basic premise of the bankruptcy system is that of the "fresh start." Every debtor's goal in filing a Chapter 7 bankruptcy petition is to be relieved of debts when the bankruptcy court grants the "discharge". However, in order to receive a discharge, the debtor must be honest and make truthful disclosures as to all of his assets and property, otherwise known as the "bankruptcy estate". If the debtor fails to do so, there may be serious consequences to the debtor, including a denial of discharge.

Section 727 of the Bankruptcy Code contains the provisions dealing with discharge, referred to by Congress as the "heart of the fresh start" concept. Under this code section, the bankruptcy court is required to grant the debtor's discharge so long as the debtor fulfills all of his responsibilities to the court, the trustee and the creditors. The debtor must provide accurate information about all income, assets, liabilities, and any transfers of property made in a certain time period. To further help ensure the integrity of the system, the debtor must sign the bankruptcy petition and documents subject to the penalty of perjury. The debtor is also required to testify as to the accuracy of the information in the documents at the Meeting of Creditors, which is held in every bankruptcy case.

All of these disclosures help the trustee and the court to evaluate the estate of the debtor and determine whether there are any non-exempt assets that could be liquidated and distributed to the creditors. The only way the estate can truly be evaluated is through the full and honest disclosures of the debtor. However, if the debtor fails to live up to his end of the bargain, the Bankruptcy Code specifically delineates a suitable punishment. Under Section 727(c)(1), the Chapter 7 Trustee, United States Trustee or a creditor may file a complaint to determine whether grounds exist for the bankruptcy judge to deny the debtor a discharge. While there are several reasons that the debtor's discharge could be denied, the most commonly litigated by creditors are the transferring and hiding of assets or information, failing to keep proper financial records, and making false statements with regard to the debtor's case.

The first ground upon which to request a denial of discharge is any action by the debtor which intends to "hinder, delay or defraud the creditors or an officer of the estate and transfers or conceals property within one year prior to filing bankruptcy." An obvious example would be the pre-petition transfer of real estate to a family member for $1.00 or the intentional failure to list a bank account or personal property in the bankruptcy documents. Unsecured creditors are most likely to discover this type of fraud when reviewing the debtor's use of its credit. Presumably, if a debtor charges $10,000 worth of jewelry and then files bankruptcy a short time later, the debtor should still be in possession of this property unless he has transferred it away. Bankruptcy schedules require disclosures of both personal property and a list of property given away as gifts. If the jewelry is not listed anywhere in the schedules, a creditor may have grounds to file a complaint against the debtor, since it would appear that the debtor was intentionally concealing the property or its transfer from the trustee and court.

A second reason that a creditor might file a complaint seeking a denial of discharge is if the debtor has concealed, destroyed or falsified books and records from which the debtor's financial condition might be ascertained. For example, if a debtor owns and operates a business, but fails to produce, or even alters, the financial records to intentionally mislead the trustee, that debtor can be denied a discharge.

The third most common reason a debtor could be denied discharge is for making "false oaths or accounts," that is, lying to the trustee and creditors. These misrepresentations and falsehoods can be contained in the debtor's petition and/or schedules, or can be made at the Meeting of Creditors. It is important to note that this also is a crime under federal law, thereby subjecting a lying debtor to jail time. If a creditor has sufficient information to demonstrate the debtor is not being truthful, that creditor may decide to initiate a suit within the bankruptcy seeking to have the debtor's discharge denied. The deadline for filing such a lawsuit is 60 days after the first date set for the Meeting of Creditors, which is the same deadline as for filing a complaint to determine dischargeability of debt pursuant to Bankruptcy Code Section 523 (the fraud exception to discharge). However, it is important to note the difference between a complaint under Section 523 and one under Section 727. In the former, a creditor is seeking a judgment that its debt should not be discharged, while in the latter, a creditor seeks to have the debtor's entire discharge denied. These remedies are not mutually exclusive, however; a creditor may file either or both types of complaints.

Assuming the creditor has timely filed its complaint Objecting to Discharge, the matter will proceed like other litigation in that the debtor must file an answer, discovery may be conducted, and the case will be set for trial. If the court rules in favor of the objecting creditor, the debtor will not receive a discharge. This means that none of the debtor's debts will be wiped out and the debtor will owe each of his creditors the debts that were due when the bankruptcy petition was filed.

One final point of interest to creditors is that it is possible for a debtor to receive a discharge, but later have it revoked. This can happen when a creditor or a trustee comes across information after the court has entered a discharge order. If information is later discovered that would have resulted in the denial of discharge, the discharge can be revoked by the bankruptcy judge. Section 727(d) allows for revocation if the discharge was obtained by the fraud of the debtor, and the creditor did not know of the fraud until after the discharge date. Note, however, that the creditor must seek to revoke discharge within 1 year after discharge is granted, or before the case is closed, whichever is later.

In any event, a creditor should be mindful that once the bankruptcy court enters the appropriate order denying discharge and the case is closed, that creditor, and all creditors, may begin to attempt to collect their debts from the debtor. The automatic stay that starts as soon as the debtor files the bankruptcy petition is terminated upon denial of discharge, and creditors may take appropriate collection actions. Denial of discharge is a very drastic remedy and, when warranted, should be used to its full benefit so that a fraudulent debtor cannot abuse the system to discharge his debts.

Bankruptcy Report is produced by Becket & Lee LLP, Attorneys at Law, as a service to our clients. Copyright 2004 by Becket & Lee LLP, except as otherwise noted. Reproduction of this newsletter is strictly prohibited without written permission from the publisher.

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