Consumer Bankruptcy

Proposal #3a: 11 U.S.C. § 727

(a) Effect of Lack of Notice on Time to Bring Objection to Discharge

Under 11 U.S.C. § 523, a potentially nondischargeable debt will not be discharged if the creditor did not receive notice of the bankruptcy until after the applicable filing deadline. [ FN: 11 U.S.C. §523(a)(3).] This rule prevents creditors from being prejudiced by a lack of notice and reduces a debtor’s incentive to omit certain creditors from her bankruptcy schedules. Creditors do not have parallel protection with respect to objections to the debtor’s general discharge under section 727(c); [ FN: Complaints objecting to a chapter 7 debtor ’s discharge must be filed no later than 60 days after the first date set for the section 341 meeting. Fed. R. Bankr. P. 4004(a). Lack of notice does not provide an exception, under current law, from the deadline to file an objection to discharge. Id.] if notice is not provided to a creditor with information that may provide grounds for the denial of the debtor’s discharge, that creditor may be time-barred in pursuing the objection. The Federal Rules of Bankruptcy Procedure authorize extensions of the time to object to discharge only if the creditor makes an extension motion within the allotted time itself, [ FN: Fed. R. Bankr. P. 4004(b).] thus a creditor omitted from the schedules and un-apprised of the bankruptcy until afterwards is unable to object to the discharge. Parties can seek revocation within a year after the discharge, but the grounds for revocation are somewhat more circumscribed, and again, no extensions to this period are provided for lack of notice. [ FN: 11 U.S.C. §727(e).]

The Recommendation

Creditors that did not receive notice of a bankruptcy should get an extension of time to file an objection to or seek revocation of a discharge.

Reasons for the Change

Section 727 is designed to discharge only debtors who have acted honestly. To this end, the statute expressly authorizes parties in interest to bring relevant information to the court’s attention that might indicate that the debtor’s discharge should be denied. Although their debts may be excepted from discharge if they did not receive notice of the bankruptcy, creditors with pertinent information cannot perform this broader monitoring function if they are not aware of the bankruptcy proceeding. A creditor omitted from the schedules should have a reasonable period of time after receiving notice of bankruptcy to file an objection to discharge or a motion to revokedischarge.

The legitimacy of the bankruptcy process is premised on adequate notice and disclosure. This recommendation should encourage debtors and their attorneys to be as forthright as possible in listing creditors and in providing accurate information.

Competing Consideration

Some people might argue that this amendment is unnecessary. The objection-filing deadline (sixty days after the first date scheduled for the section 341 meeting) surpasses the average tenure of chapter 7 individual bankruptcy cases. In addition, the statute already affords a one-year post-discharge period to seek revocation, which provides an adequate time frame in most cases.

(b) Settlement and Dismissal of Objections to Discharge

Debtors are presumptively eligible for a general discharge of debt under section 727 of the Bankruptcy Code. The Code authorizes creditors, as well as the U.S. trustee and case trustees, to file adversary complaints objecting to a debtor’s discharge. [ FN: "The trustee, a creditor, or the United States trustee may object to the granting of a discharge under subsection (a) of this section. " 11 U.S.C. §727(c)(1).] This serves a legitimate function to help ensure that only honest debtors discharge their debts. However, a troubling situation arises if a creditor brings an objection to discharge and then settles or dismisses the complaint in exchange for the debtor’s agreement to reaffirm a debt or to concede the nondischargeability of the debt on other grounds. This may indicate that the original objection was meritless and was brought only to yield a benefit to the creditor, or it may mean that a dishonest and undeserving debtor will get a general discharge by making a deal with the one creditor who discovered the dishonesty. [ FN: But see 18 U.S.C. §152 (criminalizing concealment of assets, false oaths and claims, and bribery).]

The Recommendation

Section 727 should be amended to provide that (a) any complaint objecting to discharge may be dismissed on motion of the plaintiff only after giving notice to the United States trustee, the case trustee and all creditors entitled to notice, advising them of an opportunity to substitute as plaintiff in the action; (b) any motion to dismiss a complaint objecting to discharge must be accompanied by an affidavit of the moving party disclosing all consideration given or promised to be given by the debtor in connection with dismissal of the complaint; and (c) if the debtor has given or promised to give consideration in connection with dismissal of the complaint, the complaint may not be dismissed unless the consideration benefits the estate generally.

Reasons for the Change

The effects of an objection to the debtor's discharge goes beyond the plaintiff and the debtor; the ability of the complaining creditor to prove that the debtor is unworthy of a bankruptcy discharge significantly affects the rights of other creditors to pursue collection of their debts. For this reason, several courts have characterized a complaining creditor as a "trustee" of that action for the benefit of all creditors. [ FN:In re Lindsey 208 B.R. 169 (Bankr. E.D. Ark. 1997), citingIn re Taylor, 190 B.R. 413, 416 (Bankr. D. Colo.1995) and Hage v. Joseph (In re Joseph), 121 B.R. 679, 682 (Bankr. N.D.N.Y. 1990).] As such, the creditor "may not abdicate that responsibility or use that position to its own advantage by settling the litigation on terms which will allow it to receive a private benefit solely for itself." [ FN:In re Smith, 207 B.R. 177, 178 (Bankr. N.D. Ind. 1997) (regardless of lack of objections of other parties, if successful prosecution of section 727 proceeding will benefit entire creditor body, action may not be settled in return for private benefit). ]

The proposal would build upon the basic concept already set forth in the Bankruptcy Rules that "a complaint objecting to the debtor’s discharge shall not be dismissed at the plaintiff’s instance without notice to the trustee, the United States trustee, and such other persons as the court may direct, and only on order of the court containing terms and conditions which the court deems proper." [ FN: Fed. R. Bankr. P. 7041.] The 1983 Advisory Committee Note explains that the rule-makers intended to authorize the court to impose conditions on dismissal of a complaint objecting to a discharge, which "raises special concerns because the plaintiff may have been induced to dismiss by an advantage given or promised by the debtor or someone acting in his interest." [ FN: Fed. R. Bankr. P. 7041, Advisory Committee Note (1983). ] This rule works in conjunction with some courts’ local rules or orders that already require parties to file affidavits that nothing has been promised to the plaintiffs in consideration of the withdrawal of the objection. [ FN:In re Smith, 207 B.R. 177, 179 (Bankr. N.D. Ind. 1997) .]

A legitimate objection to discharge should not be dismissed on the basis of consideration flowing only to the creditor who filed the action, notwithstanding the interests of other creditors. Moreover, debtors should not be able to "purchase a repose from objections to discharge" given the severity of the charges that would support such an objection. [ FN:In re Moore, 50 B.R. 661 (Bankr. E.D. Tenn.1985).] This recommendation would permit creditors who did not institute a section 727 action within the 60-day limit to continue thetimely-brought action when the original plaintiff declines to go further. [ FN: SeeIn re Lindsey 208 B.R. 169 (Bankr. E.D. Ark. 1997); In re Nicolosi, 86 B.R. 882, 888 (Bankr. W.D. La. 1988) (questioning whether "there can ever be a compro mise of an objection to discharge that would involve receipt of compensation or remuneration by a creditor ").] Of course, not all settlements or dismissals of objections to discharge are problematic; [ FN:In re Mavrode, 205 B.R. 716, 719 (Bankr. D.N.J. 1997) (citing "majority view " that settlements of section 727 complaints are not prohibited per se, but should be settled in limited circumstances where there is no impropriety and there is no harm to other creditors).] this recommendation simply would help the court obtain the relevant facts to determine whether the settlement or dismissal should be approved and to allow other creditors to become substitute plaintiffs.

Competing Consideration

The Commission’s recommendation to prohibit reaffirmations would eliminate one of the ways in which an individual creditor could obtain a benefit by bringing and dismissing an objection to discharge. Thus, some might argue that the urgent need for this proposal is reduced. Likewise, with increasing frequency, courts are reviewing settlements of nondischargeability actions, and thus a debtor and creditor already are less likely to be able to establish the type of arrangement that motivates this proposal.