When Can the Bankruptcy Court Order a Revocation of Discharge Under Chapter 11?

When a company files for bankruptcy under Chapter 11, the primary goal is to achieve a final, legally-binding resolution that allows the company to move forward with a reorganized debt load that it can effectively manage while still focusing on growing its operations and maximizing its long-term profitability. While this is the ultimate outcome in most cases, creditors and U.S. trustees can file to revoke Chapter 11 discharges in certain circumstances.

If a creditor or U.S. trustee successfully files for revocation following a Chapter 11 bankruptcy, the outcome will be just as it sounds—the company’s reorganization plan will be set aside, and the company will resume its pre-bankruptcy debt obligations. Not only will this reintroduce the company’s financial concerns, but it will also mean that the resources that the company devoted to the bankruptcy process were for naught. As a result, the risk of revocation is one that companies seeking protection under Chapter 11 should seek to avoid—and it is one that they can avoid in most cases.

When Can Creditors and U.S. Trustees Request Revocation of Discharge?

Creditors’ and U.S. trustees’ ability to request revocation of discharge under Chapter 11 is established in Section 727(d) of the U.S. Bankruptcy Code. Under Section 727(d), revocation of discharge is warranted in four primary circumstances:

1. Revocation of Discharge Obtained Through Fraud

Within one year of the date of discharge, a creditor or U.S. trustee can file for revocation based on a claim that “discharge was obtained through the fraud of the debtor, and the requesting party did not know of such fraud until after the granting of such discharge.”

2. Revocation of Discharge Based On Failure to Report the Acquisition of Property  

Within one year of the date of discharge or prior to the date that the debtor’s bankruptcy case is closed, whichever comes later, a creditor or U.S. trustee can file for revocation based on a claim that “the debtor acquired property that is property of the estate, or became entitled to acquire property that would be property of the estate, and knowingly and fraudulently failed to report the acquisition of or entitlement to such property, or to deliver or surrender such property to the trustee.”

3. Revocation of Discharge Based on Refusal to Obey Court Order or Testify

Within one year of the date of discharge or prior to the date that the debtor’s bankruptcy case is closed, whichever comes later, a creditor or U.S. trustee can file for revocation based on a claim that the debtor has refused either:

• “[T]obey any lawful order of the court, other than an order to respond to a material question or to testify;”
• “[O]n the ground of privilege against self-incrimination, to respond to a material question approved by the court or to testify, after the debtor has been granted immunity with respect to the matter concerning which such privilege was invoked;” or,
• “[O]n a ground other than the properly invoked privilege against self-incrimination, to respond to a material question approved by the court or to testify.”

4. Revocation of Discharge Based on Failure to Provide a Satisfactory Explanation

Finally, Section 727(d) also provides that the bankruptcy court “shall revoke a discharge” if the debtor “has failed to explain satisfactorily” either of the following:

• A material misstatement in an audit requested by the U.S. trustee under 28 U.S.C. Section 586; or,
• Any “failure to make available for inspection all necessary accounts, papers, documents, financial records, files, and all other papers, things, or property belonging to the debtor,” as requested by the U.S. trustee during an audit under Section 586.

Most requests to revoke Chapter 11 discharges are based on debtors’ alleged fraudulent misrepresentations and omissions—although actions for revocation are relatively rare overall. To avoid (or at least minimize) the risk of facing a request for revocation, Chapter 11 debtors should work closely with their counsel throughout the bankruptcy process. By following their bankruptcy counsel’s recommendations regarding the collection and disclosure of information and by following their counsel’s general advice regarding compliance with the U.S. Bankruptcy Code, companies can move on from the Chapter 11 business bankruptcy process with relative certainty.

Companies Have the Right to Notice and a Hearing Prior to Revocation of Discharge Under Chapter 11

When a creditor or U.S. trustee requests revocation under Section 727(d), the debtor is entitled to notice and a hearing. Presenting an effective defense during a revocation hearing is essential, as failure to do so can have significant financial consequences as discussed above.

As also discussed above, Section 727(d) provides that the court “shall revoke a discharge” if it determines that adequate grounds exist. This means that whether to issue an order revoking a Chapter 11 discharge generally is not within the court’s discretion. If a creditor or U.S. trustee adequately establishes grounds for revocation under Section 727(d), then the court must revoke the debtor’s discharge in accordance with the law.

With this in mind, when faced with a request for revocation, a company that has reorganized its debts under Chapter 11 must take the request seriously. It must thoroughly evaluate the merits of the request, and it must prepare to defend its discharge with the help of its legal counsel. Depending on the circumstances involved, it may be possible to defeat the request for revocation entirely, or if the circumstances warrant, it may make sense to negotiate a resolution that avoids complete revocation. Presenting an effective defense requires informed decision-making, and companies facing revocation requests under Chapter 11 should consult with experienced counsel as soon as possible.

Speak with a Chapter 11 Bankruptcy Lawyer at Edelboim Lieberman

The Chapter 11 bankruptcy lawyers at Edelboim Lieberman represent debtors and creditors in all bankruptcy-related matters. With offices in Miami and Fort Lauderdale, we handle Chapter 11 bankruptcy proceedings across Florida. If you have questions about seeking or defending against a revocation of discharge, we invite you to call 305-768-9909 or contact us online to arrange a confidential initial consultation.