Typically, the central purpose of filing a bankruptcy is to “discharge” all or most of the debtors’ debts. A bankruptcy “discharge” releases the debtor from personal liability for certain specified types of debts. In other words, the debtor is no longer legally required to pay any debts that are discharged. The discharge is a permanent order forever prohibiting the debtor’s creditors from taking any form of collection action on discharged debts, including legal action and communications with the debtor, such as telephone calls, letters, and personal contacts. Generally, excluding cases that are dismissed or converted, individual debtors receive a discharge in more than 99 percent of chapter 7 cases.
However, the Bankruptcy Code sets forth an extensive list of debts that are nondischargeable. Unfortunately, nondischargeability is not automatic – a creditor that holds such a debt must file a complaint with the Bankruptcy Court seeking to have the debt declared nondischargeable. A nondischargeability complaint must usually be filed within about sixty (60) to ninety (90) days after the debtor files his or her bankruptcy petition.
The largest category of nondischargable debts are those incurred through: 1) false pretenses, a false representation, or actual fraud; or 2) obtained through the use of a statement in writing, which is materially false regarding the debtor’s financial condition, and on which the creditor reasonably relied.
As one would imagine, the terms “false pretenses, false representations, or actual fraud” can encompass many types of dishonest behavior. An important consideration the court will make is whether the debtor intentionally and knowingly made the false/fraudulent representations. To except a debt from discharge under this section, the false representations giving rise to the debt must have been knowingly and fraudulently made. In other words, the failure to pay a debt is not sufficient, even if there is no excuse for the failure. The debtor has to incur the debt knowing that he will not be able to pay the debt, and knowing that the statements he is making to the creditor about his ability and intention to pay are untrue.
A creditor alleging fraud has the burden of proving that the debtor knew that any stated intention to repay was false and that the debtor nevertheless deliberately incurred the debt. The fact that the debtor was insolvent does not by itself provide a sufficient basis for inferring the debtor’s intent. A debtor’s honest belief that a debt would be repaid in the future, even if in hindsight found to have been very unrealistic, negates any fraudulent intent.
Use of a materially false writing concerning the debtor’s financial position comes up often in transactions that required the debtor to complete a credit application. On most credit applications, lenders will ask a debtor to list their monthly income and their current outstanding debts. Lenders then use this information to determine the debtor’s “debt-to-income” ratio. If the debtor falsely inflates their income, or omits certain debts, then the debt-to-income is inaccurate. If the court determines that the creditor reasonably relied upon the credit application in making the loan, then the debt is nondischargeable.