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Non-Dischargeable Debts in Bankruptcy
By Michael C. Dennis, MBA, CBF

Bankruptcy Articles
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Wrongful conduct on the part of the debtor

When the U.S. Bankruptcy Code was enacted, its primary goal was debtor rehabilitation, to provide a fresh start to "honest but unfortunate debtors." The gives debtors the opportunity to wipe out debts, but there are exceptions. These exceptions are based on public policy issues, or wrongful conduct on the part of the debtor.

Debts are divided into two categories -- dischargeable and non-dischargeable. If the debt is dischargeable, the debt can be wiped out by going through bankruptcy. 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 taxes, alimony and child support, student loans and some property settlements, as well as certain other obligations.

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 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 Court to declare a debt to be non-dischargeable is complex. A trade creditor will require the assistance of an attorney decide whether or not enough evidence exists to petition the Court to block the discharge of a pre-petition debt. The creditor must 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 debt in order to obtain the goods, or services or money it wanted.

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