Non-Dischargeable Debts in Bankruptcy

When the U.S. Bankruptcy Code was enacted, its primary goal was debtor rehabilitation.  Rehabilitation refers to providing a fresh start for "honest but unfortunate debtors."   A bankruptcy filing gives debtors the opportunity to wipe out certain debts.  There are specific exceptions relating to the dischargeability of debts. Confirmation of a Plan of Reorganization discharges the debtor from most types of pre-petition debts.   Confirmation of the Plan of Reorganization does not discharge a debt made nondischargeable by Section 523 of the Bankruptcy Code.

Debts are broadly divided under the U.S. Bankruptcy Code into two categories -- those that are dischargeable and those debts that are non-dischargeable. If a debt is dischargeable, the debt can be eliminated in the course of a bankruptcy filing. Certain debts cannot be discharged through a bankruptcy proceeding. Currently, the bankruptcy code defines eighteen specific categories of debt that are non-dischargeable. These include certain types of taxes, alimony and child support, student loans and some property settlements.  Of special interest to credit professionals is the provision of the Code relating to non-dischargeability based on deceit or fraud. A scheduled debt may be found by the Court to be non-dischargeable to the extent that:

• It is obtained by use of materially false written financial statements respecting the debtor or an insider on which the creditor reasonably relied, and that the debtor presented with the intent to deceive the creditor into extending credit. 
• The debt was obtained under false pretenses, by a false representation, or through actual fraud.

From the trade creditor's point of view, debts incurred when the debtor had no reasonable expectation or ability to repay would be non-dischargeable if the creditor can prove to the Court that the credit was extended based on fraud, or based on materially false representations. For example, if a debtor provided financial statements in support of a request to increase its credit limit, but those statements were fraudulent or deliberately and materially misleading, the creditor could petition the Court to have the debt declared non-dischargeable. 

The decision about whether to ask the U.S. Bankruptcy Court to declare a debt non-dischargeable is complex. A trade creditor will require the assistance of an attorney decide whether or not enough evidence exists to make it cost effective to petition the Court to block the discharge of a pre-petition debt. In the scenario described above, the petitioning creditor would need to prove to the Court that the debtor knowingly and intentionally made fraudulent or materially false representations as to its financial condition and ability to pay the creditor in order to obtain the goods or services it received.

Edited by Michael C. Dennis.  Mr. Dennis is a consultant and can be reached by email at mcdennis13@yahoo.com