Claims for Non-Dischargeability in Business Bankruptcy Cases Under Section 727

When preparing to file for bankruptcy under Chapter 7 or 11, business owners must carefully assess their risk of facing claims for non-dischargeability. This includes not only claims for non-dischargeability of individual debts but also claims for non-dischargeability in the entirety.

Both creditors and trustees can object to discharge during the bankruptcy process. While Section 523 of the U.S. Bankruptcy Code allows creditors to object to the discharge of their individual debts, Section 727 allows creditors and trustees to object to discharge in general. Section 727 establishes several grounds for non-dischargeability, and if a creditor or the U.S. Trustee asserts one of these grounds successfully, this can lead to the dismissal of the business’s Chapter 7 or Chapter 11 bankruptcy petition.

Grounds for Non-Dischargeability Under Section 727 of the U.S. Bankruptcy Code

Section 727 lists several grounds for non-dischargeability. While many of these are substantive in nature, many are more technical and procedural, and, as a result, it isn’t always easy to discern whether a defense to dischargeability may apply. Before filing for bankruptcy, business owners and executives should work with their bankruptcy counsel to assess the applicability of all potential defenses, including (but not limited to):

1. Fraudulent Transfers

Under Section 727(a)(2), a business that files for bankruptcy under Chapter 7 or 11 is not eligible for discharge if the business “with intent to hinder, delay, or defraud a creditor or an officer of the estate . . . has transferred, removed, destroyed, mutilated, or concealed, or has permitted to be transferred, removed, destroyed, mutilated, or concealed . . . property of the debtor, within one year before the date of the filing of the petition.” This is what is commonly referred to as a “fraudulent transfer.”

When contemplating bankruptcy, businesses cannot lawfully transfer assets to affiliates, subsidiaries, owners, owners’ family members or other parties in an effort to shield these assets from the bankruptcy process. If a business seeks to improperly shield assets from the process and secure a discharge, this can lead to a claim for non-dischargeability under Section 727(a)(2).

2. Destruction or Falsification of Records

Destruction or falsification of records can also serve as grounds for a defense to discharge in a business bankruptcy case under Chapter 7 or 11. Section 727(a)(3) provides for non-dischargeability if a creditor or trustee shows that the business “concealed, destroyed, mutilated, falsified, or failed to keep or preserve any recorded information, including books, documents, records, and papers, from which the debtor’s financial condition or business transactions might be ascertained.”

The law provides an exception for cases in which a business’s destruction of records or failure to preserve records “was justified under all of the circumstances of the case.” This requires a good-faith reason for the business’s conduct, such as purging records in the ordinary course of business prior to commencing bankruptcy preparations.

3. Knowing and Fraudulent Conduct In Connection with the Bankruptcy Case

Section 727 also provides for non-dischargeability in circumstances involving knowing and fraudulent conduct in connection with the business’s Chapter 7 or 11 bankruptcy case. Specifically, under Section 727(a)(4), a denial of discharge is warranted if the business:

• Makes a false statement or submits a false account under oath;
• Makes a false claim;
• Solicits, receives, offers or provides “a promise of money, property, or advantage, for acting or forbearing to act;” or,
• Withholds books, records or information from the bankruptcy trustee or any other officer of the bankruptcy estate.

4. Refusal to Comply with a Court Order

Creditors and trustees can seek to prevent discharge in a business bankruptcy case under Chapter 7 or 11 if the business refuses to obey any lawful court order issued during the bankruptcy proceeding. They can also file claims for non-dischargeability based on the business’s refusal to testify or respond to a material question approved by the court.

5. Violations Involving Insiders’ Prior Bankruptcy Filings

If a business has committed any of the violations discussed above in connection with an insider’s (i.e., corporate owner’s or executive’s) bankruptcy filing within the past year, this can also constitute grounds for non-discharge in the business’s Chapter 7 or 11 bankruptcy case. As a result, when preparing for a business bankruptcy following (or during) an insider’s bankruptcy case, the business’s bankruptcy counsel must carefully examine the business’s conduct in connection with the insider’s case as well.

Other Potential Roadblocks in Chapter 7 and 11 Business Bankruptcies

While these are among the most common grounds for denial of discharge under Section 727, they are by no means the only issues that can trigger a claim for non-dischargeability. Along with the additional grounds for non-dischargeability under Section 727, other potential defenses in Chapter 7 and 11 business bankruptcy cases include:

• Lack of Standing, Judicial Estoppel and Res Judicata – These judicial doctrines can provide creditors and trustees with procedural defenses to Chapter 7 and 11 bankruptcy filings in some cases. Depending on the circumstances, these defenses may apply to individual debts (i.e., lack of standing to seek discharge of a debt transferred to a third party) or to the business’s entire bankruptcy filing.
• Preferential Transfers – In addition to fraudulent transfers, preferential transfers (i.e., those that unlawfully advantage certain creditors to the disadvantage of others) can also serve as defenses to discharge in Chapter 7 and 11 bankruptcy proceedings.
• Section 523 Defenses to Discharge – As referenced above, while Section 727 of the U.S. Bankruptcy Code establishes grounds for non-dischargeability of a business’s bankruptcy case in its entirety, Section 523 establishes additional grounds for creditors to seek non-discharge of their individual claims against the business’s bankruptcy estate.

Speak with a Business Bankruptcy Lawyer in Miami or Fort Lauderdale

If you are considering a business bankruptcy filing under Chapter 7 or Chapter 11, it will be important for you to work with experienced bankruptcy counsel as you move forward. To discuss your options with a business bankruptcy lawyer at our Miami or Fort Lauderdale law offices in confidence, please call 305-768-9909 or tell us how we can contact you online today.