Consumer Bankruptcy
Proposal #4: 11 U.S.C. § 523 Exceptions to Discharge
a) Scope of 11 U.S.C. § 523(a)(4)
Section 523(a)(4) excepts from discharge debts arising from "fraud or defalcation
while acting in a fiduciary capacity, embezzlement, or larceny." This provision is partly
redundant of other exceptions to discharge covering fraud, embezzlement, and larceny. It also is
ambiguous as to the scope of the trusts to which it applies and the mental state that is required,
and thus has created confusion among the courts and conflicts in the case law.
The Recommendation
Section 523(a)(4) should be clarified to limit its application to negligence with
respect to property held under an express trust or pursuant to a fiduciary relationship.
Reasons for the Change
Bankruptcy laws have used the term "defalcation" since The Bankruptcy Act of
1841. [ FN: Meyer v. Rigdon, 36 F.3d 1375,
1382 (7th Cir.1994), citing Central Hanover Bank & Trust Co. v. Herbst, 93 F.2d 510, 511
(2d Cir.1937).] Defalcation generally is defined as a fiduciary’s
failure to account for property held in trust, [
FN: See, e.g., Quaif v. Johnson, 4 F.3d 950, 955 (11th Cir. 1993) ( " `defalcation ’
refers to a failure to produce funds entrusted to a fiduci ary ").] but courts
have been divided as to the debtor’s level of intent that will give rise to a nondischargeable
debt. Some courts require proof of intentional misconduct, others negligence, and some have
found that even innocent failures to account may give rise to liability for defalcation. [ FN: For collection and discussion of conflicting
decisions, see Meyer v. Rigdon, 36 F.3d 1375, 1382-85 (7th Cir.1994).]
This proposal recommends a negligence standard for defalcation under section 523(a)(4). This
standard would require the trustee to take reasonable care to protect trust property. If the trustee
failed to do so and the trust property were lost, the resulting debt would be nondischargeable.
Because nondischargeability generally is premised on personal culpability, nondischargeability
should not result from a purely innocent failure to account for trust property (e.g., if property was
stolen despite reasonable safeguards by the trustee). [
FN: See Central Hanover Bank & Trust Co. v. Herbst, 93 F.2d 510, 512 (2d
Cir.1937), in which Judge Learned Hand stated that " ‘ defalcation ’ may demand some
portion of misconduct; we will assume arguendo that it does. " ]
However, trustees traditionally have beenheld to a higher standard than other persons dealing with
property. [ FN: See Meinhard v. Salmon, 164
NE 545, 546 (1928), in which Justice Cardozo made the famous remark that the standard of
behavior for a trustee is "the punctilio of an honor the most sensitive. "] It
would be equally inappropriate to raise the nondischargeability threshold any higher by requiring
that the trustee intentionally or recklessly dealt with trust property before a failure to account
created a nondischargeable debt.
Another ambiguity concerns the nature of the "trusts" as to which duties may be
enforced under section 523(a)(4). Although this provision was intended to apply only to express
trusts, [ FN: In interpreting the predecessors to
section 523(a)(4), "[t]he Supreme Court has consistently held that the term "fiduciary" is not to be
construed expansively, but instead is intended to refer to ‘technical ’ trusts. " Quaif v.
Johnson, 4 F.3d 950, 953 (11th Cir. 1993), citing Chapman v. Forsyth, 43 U.S. (2 How.) 202
(1844); Upshur v. Briscoe, 138 U.S. 365 (1891); Davis v. Aetna Acceptance Co., 293 U.S. 328
(1934).] section 523(a)(4) might be construed to apply to at least four
different situations: (1) formal trusts, in which a settlor creates a res under the control of a trustee,
with named beneficiaries; (2) relationships not involving formal trusts, but in which one party
reposes such special trust or confidence in another that the high standards of behavior applicable
to formal trusts have been applied (e.g., the attorney/client relationship); (3) situations in which
statutes or financing documents have imposed trustee duties on a debtor-creditor relationship; and
(4) situations in which the law has used trust concepts to fashion remedies, such as constructive
trusts imposed for misconduct or resulting trusts to effectuate a transferor’s actual intent.
Decisions applying section 523(a)(4) have held uniformly that formal trusts are within its scope,
[ FN:In re Niles, 106 F.3d 1456, 1459
(9th Cir. 1997).] and that constructive and resulting trusts are not. [ FN:In re Marchiando, 13 F.3d 1111, 1115-16
(7th Cir. 1994) (outlining approaches and holding that lottery ticket seller not fiduciary). "The
trust giving rise to the fiduciary relationship must be imposed prior to any wrongdoing; the
Debtor must have been a ‘trustee ’ before the wrong and without reference to it. "In
re Young, 208 B.R. 189 , 204 (Bankr. S.D. Cal. 1997).] However,
decisions conflict on the application of the provision to fiduciary duties and trusts created by
statute.
Consistent with the historically-narrow construction of the defalcation exception to
discharge, [ FN: See infra note 6. See
alsoIn re Cantrell, 88 F.3d 344, 347 (5th Cir. 1996) (section 523(a)(4) inapplicable in
absence of express trust), citing Davis v. Aetna Acceptance Co., 293 U.S. 328, 333
(1934).] this proposal recommends that the exception be limited to express
or technical trusts and property held by the debtor for the benefit of a person who has reposed
special trust or confidence in the debtor. In these situations, a debtor should be aware of the
importance of exercising care over trust property, and negligence in doing so is sufficiently
culpable to make the resulting debt nondischargeable. However, negligence in carrying out duties
imposed by statute or financing documents does not imply such culpability. As one bankruptcy
court has noted, "most contracts involve a degree of the factors indicative of reposed trust
and confidence. For example, all contracts ultimately involve mutual intent, and many involve
disparate bargainingpower; however, only those instances which involve a veritable
‘substitution of the will of the defendant for that of the plaintiff in material matters involved
in the transaction’ will give rise to fiduciary duties." [ FN:In re Turner, 134 B.R. 646, 649 (Bankr.
N.D. Okla. 1991) (providing detailed history of exception to discharge for defalcation), citing
Sellers v. Sellers, 428 P.2d 230, 236 (Okla.1967), citing Derdyn v. Low, 220 P. 945
(Okla.1922).] Intentional misconduct relating to secured credit agreements
and statutory duties will be nondischargeable under other exceptions to discharge. In summary,
section 523(a)(4) should provide an exception to a chapter 7 discharge only when a debt arises
from the debtor's failure to exercise reasonable care over property that is subject to a formal trust
or that was held by the debtor for the benefit of a person who reposed special trust or confidence
in the debtor.
Section 523(a)(4) also contains redundancies. It excepts from discharge the fraud of
fiduciaries, which already is covered by section 523(a)(2)). [ FN: The Supreme Court made clear in Field v. Mans,
116 S.Ct. 437, 443, 133 L.Ed.2d 351 (1995), that section 523(a)(2)(A) incorporates the common
law understanding of fraud, and this understanding is fully applicable to fraud by
fiduciaries.] Likewise, the provision refers to embezzlement and larceny,
which are intentional torts respecting property. These torts are handled under section 523(a)(6).
[ FN: See Transamerica Commercial Fin. Corp.
v. Littleton, 942 F.2d 551, 555 (9th Cir.1991) (defining "embezzlement " as fraudulent
misappropri ation of property by someone who lawfully obtained possession of property); Kay v.
Rose (In re Rose), 934 F.2d 901, 903 (7th Cir.1991) (defining "larceny " as wrongfully taking
property of another with fraudulent intent). See also Printy v. Dean Witter Reynolds Inc., 110
F.3d 853, 858 (1st Cir. 1997) (conversion included within scope of section
523(a)(6)).] The scope of section 523(a)(4) should be limited to
defalcation in a fiduciary capacity, which would be more clearly defined under this proposal.
Competing Considerations
Although fraud and intentional torts are covered by other provisions, some people might
argue that creditors should be able to look to a single provision with respect to nondischargeable
debts of a fiduciary. However, because the requirements for sections (a)(2), (a)(4), and (a)(6) are
not greatly dissimilar (e.g., all require adversary proceedings and determinations by the
bankruptcy court), this duplication is not necessarily helpful to creditors.
Others might believe that defalcation should apply to any arrangement in which a statute or
financing arrangement deems to impose the duties of a trustee.
b) Exceptions to Discharge Relating Specifically to Failure of Financial Institutions
Congress introduced sections 523(a)(11) [
FN: Section 523(a)(11) provides that a discharge under section 727, et. al does not
discharge any debt "provided in any final judgment, unreviewable order, or consent order or
decree entered in any court of the United States or of any State, issued by a Federal depository
institutions regulatory agency, or contained in any settlement agreement entered into by the
debtor, arising from any act of fraud or defalcation while acting in a fiduciary capacity committed
with respect to any depository institution or insured credit union. "] and
(a)(12) [ FN: Section 523(a)(12) provides that
a discharge under section 727, et. al does not discharge any debt "for malicious or reckless failure
to fulfill any commitment by the debtor to a Federal depository institutions regulatory agency to
maintain the capital of an insured depository institution, except that this paragraph shall not
extend to any such commitment which would otherwise be terminated due to any act of such
agency. "] to the Bankruptcy Code in 1990. [ FN: Crime Control Act of 1990, Pub.L. No. 101 -
647, S 2522(a), 104 Stat. 4789, 4866 (1990). ] These provisions were
added in response to a series of failures of financial institutions for which the United States
provided deposit insurance, presumably to help maintain public confidence in the banking system;
"[i]ts obvious aim, coming as it did in the midst of a national banking crisis, is to streamline
litigation against the scoundrel bankers, and prevent the use of the Bankruptcy Court as a shield
against such litigation." [ FN: In
re Harris, 135 B.R. 434, 436 (Bankr. S.D. Fla. 1992).] However, the
activities that make debts nondischargeable under sections 523(a)(11) and (a)(12) already make
debts nondischargeable under other subsections of section 523(a): section 523(a)(11) renders
nondischargeable certain debts incurred by fraud or defalcation while acting in a fiduciary
capacity, already covered by sections 523(a)(2) and (a)(4), respectively. Section 523(a)(12) deals
with malicious or reckless failure to fulfill certain obligations, which could fall within section
523(a)(6).
The Recommendation
The exceptions to discharge relating to the FDIC in sections 523(a)(11) and (12) should
be eliminated and section 523(e) [
FN: Under section 523(e), "[a]ny institution-affiliated party of a [sic.]insured depository
institution shall be considered to be acting in a fiduciary capacity with respect to the purposes of
subsection (a)(4) or (a)(11). " The Bankruptcy Code has adopted the banking law definition of
institution - affiliated party. 11 U.S.C. S 101(33)(a). The Federal Deposit Insurance Act defines
institution - affiliated party as: (1) any director, officer, employee, or controlling stockholder
(other than a bank holding company) of, or agent for, an insured depository institution. 12 U.S.C.
S 1813(u) (emphasis added). ] and section should be amended
accordingly [ FN: Likewise, section
523(c)(2) would have to be amended to eliminate the reference to subsection (a)(11). This
provision addresses the requirement that nondischargeability actions under subsections (a)(2), (4),
(6), or (11) be brought and determined when the federal depository institution regulatory agency
was not appointed in time to reasonably comply with the timing for bringing such
actions.] .
Reasons for the Change
As stated above, the debts covered by these exceptions to discharge already are
nondischargeable under sections 523(a)(2), (4) or (6). [
FN: See, e.g., Meyer v. Rigdon, 36 F.3d 1375, 1382 (7th Cir.1994)(holding that
defalcation means same thing in section 523(a)(11) as it does in section
523(a)(4)).] "Arguably, 523(a)(11) adds little to the existing state of
the law regarding nondischargability. Since fraud can be determined to be nondischargeable
pursuant to 523(a)(2) and (4), the fraudulent banker would in most cases be prevented from
receiving a discharge of the resulting debt." [
FN:In re Harris, 135 B.R. 434, 436 (Bankr. S.D. Fla.
1992).] As a consequence of removing subsections (a)(11) and (a)(12), the
agency holding these claims would have to bring a nondischargeability action in the bankruptcy
court, which will assure prompt resolution of any dischargeability disputes. Absent evidence that
these provisions have a deterrent effect beyond that provided by other nondischargeability
provisions, there is little need for separate exceptions. The reported case law indicates that these
provisions are used extremely infrequently and even then only in combination with other
overlapping exceptions to discharge. [ FN: See,
e.g.,In re Pancake, 106 F.3d 1242 (5th Cir. 1997) (alleging nondischargeability of debt of
bank loan officer under sections (a)(2), (a)(4), and (a)(11)).]
The recommended removal of these provisions also is based on the fact that these provisions
protect only a single class of creditors: depository institutions and the agencies that regulate and
insure them. While this group of creditors may be worthy of protection, narrowly tailored
legislation can lead to negative consequences for overall bankruptcy policy, especially when those
claims are already nondischargeable under other provisions. This creates overlapping and
conflicting provisions, which yields uncertainty. Including provisions such as sections 523(a)(11)
and (12) enables other groups to seek similar specialized protection through legislative
endorsement of their particular interests, often to the detriment of other creditors.
Delineating specific results for one type of debt leads courts to find ways to distinguish
between the special rule and the default rule. Continually expanding the list of nondischargeable
debts weakens the effects of generic and policy-based exceptions to discharge that articulate the
same principle. With increasing numbers of provisions that refer to only one type of creditor,
some courts may be more inclined to find claims dischargeable that do not fit a creditor-specific
exception, even if the debt was culpably incurred.
Competing Considerations
Some have argued that the class of debtors affected by these provisions is so narrow that it is
not harmful, per se, to leave them in the Code.
Because sections 523(a)(2), (4), and (6) impose a greater burden on the creditor byrequiring
an action be brought in the bankruptcy court, others might suggest that the creditors in such
actions relating to depository institutions should not have to take this extra step. However, these
actions typically are not brought independently, thus creditors already are taking this extra step.
c) Nondischargeability of Debts for Support, Maintenance, & Alimony
Overarching bankruptcy policy reflects the critical societal importance of family support
obligations. When these obligations are not honored, the people requiring support, who are
non-adjusting and involuntary creditors, may suffer catastrophic consequences and ultimately may
need governmental assistance to compensate for the lack of support. The Bankruptcy Reform Act
of 1994 introduced a new exception to discharge, section 523(a)(15), for debts arising out of
divorce decrees or separation agreements to ensure that negotiated "hold harmless"
and property settlement obligations that are for support -- but are not labeled as
"support" -- are nonetheless nondischargeable. [ FN: "In some instances, divorcing spouses have
agreed to make payments of marital debts, holding the other spouse harmless from those debts, in
exchange for a reduction in alimony payments. In other cases, spouses have agreed to lower
alimony payments based on a larger property settlement. If such "hold harmless " and property
settlement obliga tions are not found to be in the nature of alimony, maintenance, or support, they
are dischargeable under current law. The nondebtor spouse may be saddled with substantial debt
and little or no alimony or support. This subsection will make such obligations nondischargeable
in cases where the debtor has the ability to pay them and the detriment to the nondebtor spouse
from their nonpayment outweighs the benefit to the debtor of discharging such debts. " 140
Cong. Rec. H 10, 762 (daily ed. Oct. 4, 1994).] To be operative, a former
spouse must file an adversary proceeding seeking to except such obligations from discharge,
which in most cases must occur no later than sixty days after the first date set for the section 341
meeting of creditors. [ FN: See 11 U.S.C.
§523(c).] This provision requires the bankruptcy court to assess the
present financial capabilities and needs of both debtor and nondebtor parties, and to balance the
hardship to the nondebtor against the benefit to the debtor of discharging the debt. Any debts that
are excepted from chapter 7 discharge under this provision are dischargeable in chapter 13.
Well before section 523(a)(15) was enacted, support, maintenance and alimony obligations
were nondischargeable in both chapter 7 and chapter 13 cases under section 523(a)(5). [ FN: 11 U.S.C. §§523(a)(5), 1328(a). The
Bankruptcy Reform Act of 1994 further advanced the policy of requiring payment of support
obligations by according them priority in payment over other unsecured claims. 11 U.S.C.
§507(a)(7).] Federal law governs whether an obligation is in the
nature of support and courts determining the issue are not bound by the description of the
obligation used in a particular divorce decree or settlement. [ FN: H.R.Rep. No. 595, 95th Cong. 1st Sess. 364
(1977) ( "What constitutes alimony, maintenance, or support, will be determined under the
bankruptcy laws, not State law. "); S. Rep. No. 989, 95th Cong., 2d Sess. 79 (1978)
(same).] Thus, if the obligation actually is a support obligation, it should
be excepted fromdischarge under section 523(a)(5) even if it has been characterized as a property
settlement. [ FN: See, e.g., Williams v.
Williams (In re Williams), 703 F.2d 1055, 1057 (8th Cir. 1983).] The new
section 523(a)(15) has introduced uncertainty into the protective scheme, thereby undermining the
impact of both sections.
The Recommendation
Sections 523(a)(5), (a)(15), and (a)(18) should be combined: under the revised section
523(a)(5), all debts actually in the nature of support, or debts owed under state law to a
state or municipality in the nature of support would be nondischargeable in both Chapters
7 and 13.
Reasons for the Change
Consolidating the three provisions would establish that all debts actually in the nature of
support, regardless of what they are labeled, would be nondischargeable under both Chapters 7
and 13 without a balancing test and without excessive bankruptcy court litigation. Obligations
that truly are not for support, and thus do not trigger a heightened societal need for repayment,
would be dischargeable like other debts.
Although "there is no indication that Congress intended to affect the liberal
interpretation [of support obligations] of section 523(a)(5)," [ FN: Macy v. Macy, 114 F.3d 1 (1st Cir. 1997)
(attorneys ’ fees nondischargeable under section 523(a)(5)).] the
present set of procedures in section 523(a)(15) for obligations that are not labeled as support
potentially weaken the protection of ex-spouses and children that Congress afforded them under
section 523(a)(5). Section 523(a)(15) only is operative with respect to debts "not of a kind
described in [section 523(a)(5);" when faced with a close question on whether a debt really
is for support, a court may find that the obligation is not support and proceed with the balancing
test and consider the relative needs of the parties under section 523(a)(15). The resulting
nondischargeable debt may be smaller than what the ex-spouse could have obtained through
section 523(a)(5). Moreover, a debt that fits the description of section 523(a)(15) is
dischargeable in chapter 13.
The primary problem that motivated the passage of section 523(a)(15) occurs when section
523(a)(5) is applied improperly. If section 523(a)(5) is applied correctly, prepetition support
awards, however denominated, will not be discharged. Section 523(a)(5) generally has
been held to make any debt nondischargeable, even if it arises from a "property
division" in a divorce decree or settlement, if it is actually in the nature of support. This
includes a nondebtor spouse’s agreement to accept lower alimony payments in exchange
for the debtor’s agreement to pay jointly owed debts. Section 523(a)(15) is not needed to
address needs for support that arise after entry of the original divorce or separation decree
because state courts should be available to consider modification of the divorce or separation
decree and are better equipped to assess the support needs of families involved in divorce and
separation proceedings.
A separate section 523(a)(15) is not necessary to protect ex-spouses in community property
states if bankruptcy courts in those states assess whether the obligation is actually a support
obligation for purposes of section 523(a)(5). [
FN: See, e.g., Kritt v. Kritt, 190 B.R. 382, 387 (Bankr. 9th Cir. 1995) (community
property division was in nature of support and thus nondischargeable under section 523(a)(5)).
Compare Johnson v. Arcelus, 162 B.R. 130 (Bankr. S.D. Tex. 1993) (because federal law
determines whether divorce related claims are "support obligations," community property division
was support obligation for nondischargeability purposes), and Semrow v. Robinson, 122 B.R. 502
(Bankr. W.D. Tex. (1990) (same), with Davidson v. Davidson, 133 B.R. 788 (N.D. Tex. 1990)
(certain payments not for support and thus not within 523(a)(5)) , reversed 947 F.2d 1294 (5th
Cir. 1991)(debtor estopped from claiming payments were division of property when he treated
them as alimony for tax purposes).] The published case law indicates that
section 523(a)(15) has been pivotal in only one Texas case since its enactment, in which the court
decided the balancing test against the debtor and held the property obligation nondischargeable.
[ FN: Gamble v. Gamble 196 B.R. 54 (Bankr.
N.D. Tex. 1996).]
This consolidation of related provisions would limit the extent to which bankruptcy courts
must intrude into family law issues. Such intrusion is minimal under section 523(a)(5) because the
bankruptcy court simply must characterize the prior state court judgment but does not adjudicate
support entitlements. Intrusion is exacerbated significantly by the requirements of section
523(a)(15). The administrative costs of divorce and bankruptcy are increased by adding another
step before the nonsupport obligations of a debtor are finally determined. The wide-ranging
determination required by section 523(a)(15)—including a complete review of the financial
condition of both parties—may be quite expensive for everyone and comes at a time when
resources already are strained. The balancing test entails a determination of the present financial
capabilities and needs of the parties, precisely the sort of inquiry that state courts, with greater
experience and expertise, undertake when a party seeks modification of a support order.
Beyond difficulties in the rationale of the balancing test in section 523(a)(15), the application
has been troubling. Courts have struggled to determine which party should have the burden of
proof on the balance of hardships and on the question of the debtor’s ability to pay
nonsupport obligations. [ FN: "The opinions
of the majority of reported cases - - approximately twenty - eight (Majority Group) - - reveal that
this group of courts allocate to the debtor the burdens of proof for section 523(a)(15)(A) and (B)
for Ability to Pay and Detriment. The second group (the Bifurcated Group), based on reported
decisions consists of only three courts, allocates the burden of proof for Detriment to the former
spouse/spouse and for the Ability to Pay to the debtor. The third category of courts (Minority
Group) - - five reported cases - - places the burden of proof for all of section 523(a)(15),
including Ability to Pay and Detriment, on the former spouse/spouse. " Stone v. Stone, 199 B.R.
753 (Bankr. N.D. Ala.1996) (citing authorities allocating burden of proving "ability to pay" and
"detriment" under section 523(a)(15)(A)). See also Jodoin v. Samayoa, 209 B.R. 132 (Bankr. 9th
Cir. 1997) (debtor had burdens of proof as to both inability to pay" and "detriment"
tests).] Also, should the court assess the debtor’s financial condition
at the time of the state court order, the time of the bankruptcy filing, the time of the
dischargeability proceeding, or the time of the hearing? In addition, because this provision is not
cross-referenced in section 523(a)(3), a lack of notice to an ex-spouse can be fatal to any attempt
to render the debt nondischargeable.
The nondischargeability of support obligations owed to states and municipalities is currently
set out in section 523(a)(18). As part of the Personal Responsibility and Work Opportunity
Reconciliation Act of 1996, Congress added this provision to ensure that a debt in the nature of
support owed to the State cannot be discharged in bankruptcy proceedings. Debts falling into
section 523(a)(18) are dischargeable in chapter 13. [
FN: 11 U.S.C. §1328(a).] Folding this provision into
section 523(a)(5) would provide clearer direction for all parties on the nondischargeability of
support obligations and would make them uniformly nondischargeable in both chapter 7 and
chapter 13.
Competing Considerations
Some might argue that many of the problems with section 523(a)(15) could be repaired.
The provision could establish the burden of proof for the balancing test and the relevant point in
time to measure the debtor’s financial condition. Section 523(a)(3) could be amended so
that lack of notice to an ex-spouse will not bar the nondischargeability of these debts. Of course,
these changes would not address the underlying conceptual problems with the provision.
Others might suggest that the provision is relatively new and requires additional time and
experience to assess its worth. However, judges, scholars, and members of the community
routinely have criticized this provision and its inherent unworkability since its inception.
d) Criminal Restitution Orders
Section 523(a)(13) makes nondischargeable "any payment of an order of restitution
issued under title 18, United States Code." Congress added this provision through The
Violent Crime Control and Law Enforcement Act of 1994. [ FN: Violent Crime Control and Law Enforcement Act
of 1994, Pub.L. No. 103 - 322, S 320934, 108 Stat. 1796, 2135 (1994). ]
This provision applies only to federal criminal restitution orders and excludes restitution orders
issued under state law.
The Recommendation
Section 523(a)(13) should be expanded to apply to all criminal restitution orders.
Reasons for the Change
For purposes of dischargeability, there appears to be no rational basis on which to distinguish
federal- and state- based restitution orders. Provisions that arbitrarily distinguish between debts
run counter to a policy-based approach to nondischargeability. Whether federal or non-federal,
criminal restitution orders are part of criminal convictions that reflect the penal andrehabilitative
interests of government entities. These debts reflect culpable conduct and generally should be
excepted from discharge.
Competing Considerations
Some have argued that section 523(a)(13) should be deleted because criminal restitution
debts already are nondischargeable under section 523(a)(7). [ FN: Section 523(a)(7) excepts from discharge a debt
"to the extent such debt is for a fine, penalty, or forfeiture payable to and for the benefit of a
governmental unit, and is not compensation for actual pecuniary loss, other than a tax penalty-(A)
relating to a tax of a kind not specified in paragraph (1) of this subsection; or (B) imposed with
respect to a transaction or event that occurred before three years before the date of the filing of
the petition.] The Supreme Court held in Kelly v.
Robinson that state law criminal restitution was nondischargeable under that subsection,
[ FN: Kelly v. Robinson, 479 U.S. 36, 49
(1986) (section "523(a)(7) preserves from discharge any condition a state criminal court imposes
as part of a criminal sentence "). See alsoIn re Gelb, 187 B.R. 87 (Bankr. E.D.N.Y.
1995) (finding restitution order nondischargeable under section 523(a)(7), noting that section
523(a)(13) is not retroactive and thus would not apply to the instant case).]
and subsequent courts uniformly have applied the holding and reasoning of Kelly to
federal restitution orders. [ FN: SeeIn
re Gelb, 187 B.R. 87, 90 (Bankr. E.D.N.Y. 1995) (collecting
citations).] Also, because many restitution orders involve conduct that
gives rise to a nondischargeable debt under section 523(a)(6) for willful and malicious injury or
section 523(a)(2) for fraud, section 523(a)(13) provision is even more duplicative in some
circumstances.
Consistent with the traditional mandate to construe exceptions to discharge narrowly, others
might argue that exceptions to discharge should not be expanded absent a compelling reason.
Because these restitution orders already appear to be nondischargeable under section 523(a)(7), it
may be imprudent to expand section 523(a)(13).
e) Debts Incurred to Pay Federal Taxes
As part of the Bankruptcy Reform Act of 1994, Congress introduced an exception to
discharge for a debt "incurred to pay a tax to the United States that would be
nondischargeable pursuant to paragraph (1)." [
FN: 11 U.S.C. §523(a)(14).] The only element a lender
must establish is that the debtor used the funds to pay a nondischargeable federal tax liability.
The Recommendation
Section 523(a)(14) should be deleted.
Reasons for the Change
According to Congress’ section by section analysis of the 1994 amendments, this
provision was intended to "facilitate individuals’ ability to use their credit cards to
pay their Federal taxes." The IRS does not allow direct payment of taxes with credit cards.
Even if the IRS changed its regulations to allow tax payment by credit card, it is not at all clear
how section 523(a)(14) "facilitates" that process.
Currently, this provision applies when an individual takes a cash advance on a credit card (or
uses a credit card check) and uses those funds to pay taxes. No culpability must be proven; rather,
the lender merely must establish that the advance was used to pay nondischargeable federal taxes,
which presents potential, although not insurmountable, tracing problems. [ FN: But seeIn re Chrusz, 196 B.R. 221
(Bankr. D.N.H. 1996) (access check that was first deposited into account and then used as part of
funds to pay IRS was nondischargeable debt).] Savvy debtors with careful
legal advice easily will circumvent this exception to discharge by commingling their cash advances
or using them to pay other expenses while saving their income to pay federal taxes. The debtors
who will get trapped by this provision are those who take a cash advance with every intention of
repaying the credit card obligation and who then suffer a catastrophic event and have to resort to
bankruptcy. For those unwary and honest debtors, this provision provides an overlapping and
much easier route for credit card debt nondischargeability that has no relation to their culpability.
[ FN: See MNBA America v. Parkhurst (In re
Parkhurst), 202 B.R. 816 (Bankr. N.D.N.Y. 1996), in which section 523(a)(14) provided
additional grounds for nondischarge abi lity to a credit card issuer already pursuing a section
523(a)(2) claim against a pro se debtor.]
The published case law indicates that the provision seldom has been used. An on-line search
reveals that this provision has been cited in only a few reported decisions and has provided the
basis for nondischargeability in one case. [ FN:
In re Chrusz, 196 B.R. 221 (Bankr. D.N.H. 1996).]
Competing Considerations
Because the provision was enacted three years ago, some might believe that it is premature
to recommend the provision’s repeal, especially if the IRS ultimately accepts payment by
credit card.
Others might argue that the provision should be extended to cover debts incurred to pay
state and local taxes.
f) Unpaid Court Fees and Costs
Under section 523(a)(17), unpaid filing fees and other filing costs assessed by a court are
nondischargeable in a subsequent bankruptcy proceeding, notwithstanding the debtor’s
status as an indigent or prisoner. [ FN: Section
523(a)(17) excepts from discharge "a fee imposed by a court for the filing of a case, motion,
complaint, or appeal, or for other costs and expenses assessed with respect to such filing,
regardless of an assertion of poverty by the debtor under section 1915(b) or (f) of title 28, or the
debtor ’s status as a prisoner, as defined in section 1915(h) of title 28.
"] In enacting this provision, it is readily acknowledged that Congress
sought to ensure that prisoners who engage in vexatious and frivolous litigation do not discharge
debts incurred in the course of that litigation. As written, the provision is not so limited.
The Recommendation
Section 523(a)(17) should be eliminated.
Reasons for the Change
While preventing the discharge of these costs arguably protects the integrity of the courts,
other measures are better tailored toward dealing with this behavior. For example, prisoners who
file frivolous litigation against the government are subject to sanctions under Fed.R.Civ.P. 11 and
similar provisions, and these sanctions are nondischargeable under section 523(a)(7), which
covers government fines and penalties.
As drafted, this provision casts a much wider net on court costs than costs incurred by
prisoners through vexatious litigation: all debts for filing fees and costs in all civil
cases are nondischargeable, including debts that would be dischargeable under any other
circumstances and involve no ill-intent. As such, the scope of section 523(a)(17) greatly exceeds
the problem it apparently sought to address and is inconsistent with the policies underlying the
nondischargeability provisions generally.
Competing Considerations
Some have argued that the provision should retained and clarified so that it applies only to
costs assessed against prisoners under the provisions of 28 U.S.C. 1915, and not generally to all
court costs. This view is premised on the belief that a prisoner who files any suit -- whether or not
frivolous -- ultimately is held to a higher level of responsibility to pay all costs and fees.
In addition, because this provision is new and does not seem to have been used in reported
decisions, some might suggest that recommending its elimination is premature.
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