Defending Against the Discharge of Claims in Bankruptcy

The bankruptcy process can present significant risks for creditors. Even in Chapter 11 proceedings in which corporate debtors reorganize their debts, creditors can still end up collecting just a fraction of the funds they are rightfully owed.

As a result, when a debtor files for bankruptcy, its creditors must work with their counsel to determine if they have grounds to defend against the discharge of their claims. In many cases, they will.

Grounds to Object to a Discharge of a Creditor’s Claims in a Business Bankruptcy

Creditors have several potential grounds to object to a discharge of their claims in bankruptcy proceedings. Most of these potential grounds fall into three broad categories: (i) the debt is not eligible for discharge; (ii) the debt is non-dischargeable under Section 523 of the U.S. Bankruptcy Code (the “Code”); or (iii) the debt is non-dischargeable under Section 727 of the Code.

1. The Debt is Not Eligible for Discharge

In some cases, debts simply aren’t eligible for discharge. While the code allows individual and corporate debtors to obtain relief from many types of debts, relief is not available across the board. If a creditor’s claim relates to a debt that is not eligible for discharge, this alone should be enough to preserve the creditor’s claim in full.

With that said, determining whether a debt is eligible for discharge is not always a straightforward process. Many types of debts will blur the line, and determining whether a creditor’s claim is insulated from the debtor’s bankruptcy often requires a careful assessment of the nature of the debt, the circumstances under which it was incurred and a variety of other factors.

While many of the debts that fall into this category are consumer debts, certain commercial debts can be ineligible for discharge as well. For example, in business bankruptcy proceedings, debts omitted from the business’s bankruptcy petition can be ineligible for discharge unless the creditor has actual knowledge of the business’s bankruptcy filing.

2. The Debt is Non-Dischargeable Under Section 523 of the Code

Section 523 of the U.S. Bankruptcy Code establishes several defenses to discharge that creditors can use to protect their claims in business bankruptcy proceedings. Debts omitted from a business bankruptcy petition fall under Section 523, though we’ve included them in the previous section because these are among the easier claims (relatively speaking) to preserve. Absent evidence of actual knowledge, an undisclosed debt is ineligible for discharge. In contrast, the following grounds under Section 523 place a greater onus on the creditor to establish non-dischargeability:

• Credit Secured Through False Pretenses – Under Section 523(a)(2)(A), creditors can avoid the discharge of debts obtained by “false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition.”
• Credit Secured Through Fraud – Under Section 523(a)(2)(B), creditors can avoid discharge of debts obtained through “use of a statement in writing—(i) that is materially false; (ii) respecting the debtor’s or an insider’s financial condition; (iii) on which the creditor . . . reasonably relied; and (iv) that the debtor . . . made or published with the intent to deceive.”
• Debts Owed for Funds Obtained by Embezzlement or Larceny – Under Section 523(a)(4), creditors can avoid the discharge of debts obtained by “fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.”
• Debts Owed for “Willful and Malicious” Injury – Under Section 523(a)(6), creditors can avoid discharge of debts owed “for willful and malicious injury by the debtor to another entity or to the property of another entity.”

3. The Debt is Non-Dischargeable Under Section 727 of the Code

Along with Section 523, Section 727 of the U.S. Bankruptcy Code also establishes several defenses to discharge. Some examples of defenses to discharge under Section 727 include:

• Fraudulent Transfers – If a business executes a fraudulent transfer in connection with its bankruptcy filing, this can constitute cause to deny bankruptcy protection in full. A fraudulent transfer is a transaction executed “with intent to hinder, delay, or defraud a creditor or an officer of the [bankruptcy] estate.”
• Destruction or Falsification of Records – Destroying or falsifying records in connection with a debtor’s bankruptcy filing also constitutes cause for denial of bankruptcy protection.
• Additional Forms of Fraud – Along with fraudulent inducement under Section 523(a)(2)(A), various other forms of fraud can serve as defenses to discharge under Section 727. These include making false statements under oath and withholding records from the bankruptcy estate, among others.
• Refusals to Comply with Court Orders – If a business debtor refuses to comply with any court order issued during the business’s bankruptcy proceeding, this can serve as a defense to discharge under Section 727 as well.  

These three categories represent the majority of the grounds creditors can use to defend against discharge in business bankruptcy proceedings. However, they are not exclusive. For example, creditors can assert various procedural defenses as well. Jurisdictional issues, standing issues, and debtors being precluded from relief based on prior bankruptcy filings can all provide additional grounds for protecting a creditor’s claim during a Chapter 7 or Chapter 11 bankruptcy.

Objecting to a Discharge is Not the Only Way to Protect a Creditor’s Rights During a Business Bankruptcy

While objecting to the discharge of a creditor’s claim is one way to protect the creditor’s rights during a business bankruptcy proceeding, it is not the only option that is available. For example, in some cases, creditors can ask the court to lift the automatic stay and allow them to pursue collection. In others, creditors may be able to claw back assets into the debtor’s bankruptcy estate through a preference claim. There are other options as well, and when facing debtor bankruptcy proceedings, creditors should engage experienced legal counsel to assess all of the options they have available.

Speak with a Creditors’ Rights Attorney in Miami or Fort Lauderdale

If you need to know more about defending against a discharge in a business bankruptcy proceeding in Florida, we invite you to get in touch. To speak with a creditors’ rights attorney in Miami or Fort Lauderdale, please call 305-768-9909 or inquire online today.