In a bankruptcy case, many debts are discharged. There are certain debts that will be discharged unless a creditor files an action called an objection to the discharge. These creditor actions are referred to as Section 523 adversary proceedings, because they are filed under Section 523 of the U.S. Bankruptcy Code and constitute a separate proceeding within the bankruptcy case. While most bankruptcies do not involve this type of claim, there are some specific situations in which they can arise.
Section 523 objections to discharge fall into several different categories. If you are considering filing for bankruptcy, it's important to understand the basis for creditor objections to discharge and know what you should do if a creditor files one in your bankruptcy case.
Under Section 523(a) of the Bankruptcy Code, a creditor can file an action asking the bankruptcy court to declare that a certain debt will not be discharged in the bankruptcy case. The debt can be in the form of money, property, or services, or an extension, renewal, or refinancing credit.
Individual subsections of the Bankruptcy Code specify the different types of situations in which an objection can be filed by a creditor. The most common objections are filed under Section 523(a)(2)(A) or (B), but Sections 523(a)(4) and 523(a)(6) also allow a creditor to object to discharge under certain circumstances detailed in those subsections.
Section 523(a)(2)(A) permits a creditor to object to discharge of a debt that was obtained by “false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition.”
The Code does not define the terms false pretenses, false representation, or actual fraud. In a case filed under this section, the bankruptcy court will apply rules and guidelines developed in previous court decisions about what kind of statements or conduct meets those requirements.
Generally, if a creditor requests an exception to discharge under this subsection, the creditor must prove that the debtor’s actions or statements were intentionally deceitful or misleading and that the creditor relied on the debtor’s representations in advancing money, property, or credit. The fraud can occur by a debtor making a misrepresentation through statements or conduct. The U.S. Supreme Court has held that “actual fraud” includes claims based on intentional fraudulent transfers, regardless of whether the debtor made a false misrepresentation to the creditor.
Under this subsection, there are two types of transactions that are presumed to nondischargeable, so the debtor has the burden of proving that no fraud or misrepresentation was intended if the creditor files an objection to discharge:
If a creditor files an objection to discharge under this subsection, the creditor has the burden of proving the allegations, unless the claim is one of the two situations where nondischargeability is presumed. Even if there is a presumption of nondischargeability, the creditor must investigate the facts to make sure there is a basis for filing the objection and present evidence in court. In either case, your attorney in the adversary proceeding will present evidence on your behalf, as well as cross examine the creditor’s evidence, in defending against the claim.
Section 523(a)(2)(B) gives a creditor the ability to object to discharge if the debtor provided a materially false written statement about the debtor’s or an insider’s financial condition. Under the Code provisions, the creditor must prove that:
Whether a debt meets the four statutory requirements is a determination made by the court based on evidence introduced at a hearing on the creditor’s petition.
This subsection permits a creditor to file an objection to discharge if a debtor was acting in a fiduciary capacity and committed fraud or misappropriated funds while acting in that capacity. It also includes circumstances involving embezzlement or larceny.
A fiduciary is a person who has special legal responsibilities on account of a specific relationship of trust to another person. Fiduciaries include individuals who serve as the trustee of trust, a guardian or conservator, or a person acting as agent under a power of attorney.
As in the case of other objections to discharge, the creditor has the burden of proving to the court all the elements of the claim, including the fact that the debtor was acting in a fiduciary capacity.
A claim brought under Section 523(a)(6) is based on a debtor causing willful or malicious injury to another entity or person. The injury can be either to a person or to property.
Generally, a creditor has to prove that the debtor intentionally targeted the creditor and inflicted actual harm. The burden of proof in this type of claim is on the creditor.
A Section 523 objection is an adversary proceeding within your bankruptcy case. Adversary proceedings are also referred to as bankruptcy litigation. Each action is a separate, formal court proceeding that is heard before the bankruptcy court, rather than the bankruptcy trustee.
If you have a bankruptcy case pending, and a creditor files a Section 523 objection to discharge, the worst thing you can do is ignore it. Defending against an objection to discharge is critical.
If you have a lawyer handling your bankruptcy case, your lawyer will either represent you in the Section 523 proceeding or recommend a lawyer who specifically handles bankruptcy litigation. If you do not have an attorney handling your bankruptcy case, you should find one as soon as possible to represent you in the Section 523 action. You have a limited amount of time to respond to the creditor's petition. Failing to do so could result in having the court rule that a debt is nondischargeable.
When a creditor files an objection to discharge, both sides will be able to gather evidence about the creditor’s claim. Your attorney will file a response to the creditor’s petition. Then, the bankruptcy court will hold a hearing on the creditor’s petition. At the hearing, the creditor (who is usually represented by an attorney) and your attorney will present evidence. Both sides can cross examine witnesses. The proceeding and the hearing are conducted according to the Federal Rules of Civil Procedure.
Having a lawyer represent you and defend against the claim could result in a court ruling that the debt is discharged, contrary to the creditor's request. In addition, while the proceeding is pending, your lawyer likely will negotiate on your behalf with the creditor’s attorney to try to find a solution satisfactory to both sides, so that the bankruptcy court does not have to decide the issue.
A creditor who files certain claims under Section 523 can be liable for attorney’s fees if the claim is not justified. Section 523(d) is a specific provision in the Bankruptcy Code designed to discourage creditors from filing unwarranted objections to discharge based on fraud or false pretenses or statements. That section gives the bankruptcy court the authority to award reasonable attorney’s fees to the debtor in cases where a creditor files an action under Section 523(a)(2) if the court finds that the action not substantially justified.
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