The settlement agreement, fully executed, provided explicitly that the obligation was not dischargeable in bankruptcy.
So how come the successful resolution stood to go up in flames when the defendant filed bankruptcy?
Because the terms of the settlement agreement didn’t track the elements of the bankruptcy code’s elements for non dischargeable debts.
With agreed facts, the agreement would have been entitled to collateral estoppel, making the debt nondischargeable in bankruptcy. Little more than the filing of the nondischargeability complaint would have been required to preserve the claim from discharge.
But just reciting the result you want doesn’t get the job done in bankruptcy court.
Three exceptions to discharge
The bankruptcy code lists a long string of debts that simply can’t be wiped out in bankruptcy.
But in that list of debts that are not dischargeable in bankruptcy, three categories are called out for special treatment.
- Debts incurred by fraud or other forms of rank dishonesty
- Debts for breach of fiduciary duty, larceny or embezzlement
- Debts for willful and malicious injury
To be excepted from discharge, the creditor asserting a claim based in one of these theories must file a timely adversary complaint, challenging the discharge of the debt. 11 USC 523(c). Then the creditor has to prove that the debt is really what he claims.
Labels don’t carry the day
Plaintiff bears the burden to show that the facts surrounding the debt fit the bankruptcy definition of the exception. The fact that state law denominated it as fraud, breach of fiduciary duty, or a willful tort isn’t sufficient.
The first judge before whom I appeared as a newly fledged bankruptcy lawyer used to complain that, under our state law, everyone was a fiduciary to those around him. However, the bankruptcy exception to discharge covered only express trusts and defalcation. So a state law judgment for breach of fiduciary duty may not spare the claimant from proving up his case in bankruptcy court.
We saw that play out when the Supreme Court recently held that “defalcation” required an intentional wrong. The creditor held a state court judgment for breach of fiduciary duty grounded, not in any financial loss to the trust, but for self dealing.
So, you are not home free as plaintiff’s counsel by getting a judgment that calls the challenged behavior fraud, etc.
Make it truly non dischargeable in bankruptcy
Nor, as I said at the top, is it sufficient to get an agreement in writing that the debt will not be dischargeable in bankruptcy. That doesn’t prove that the conduct in question squares with the bankruptcy definition of a non dischargeable debt.
You need to establish the operative facts, by agreement or in judicial findings of fact, to be spared a trial in bankruptcy court.
If you are alleging non dischargeable fraud, you’ll need facts adding up to the following:
- the debtor made a representation;
- the debtor knew at the time the representation was false;
- the debtor made the representation with the intention and purpose of deceiving the creditor;
- the creditor relied on the representation; and
- the creditor sustained damage as the proximate result of the representation.
In re Apte, 96 F.3d 1319, 1322 (9th Cir. 1996); In re Kirsh, 973 F.2d 1454, 1457 (9th Cir. 1992).
Your settlement agreement must then have the defendant admit that he made a representation to induce the behavior; that he knew at the time it was false, etc.
Then you have undisputed facts entitling you to summary judgment in your non dischargeability action.
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