No Shortcut to Non-Dischargeability

No Shortcut to Non-Dischargeability

shortcutBankruptcy is almost like a civil death and resurrection.  It puts an end to debts, judgments, lawsuits, and yet the debtor – if an individual – will live on.  More than one plaintiff has been frustrated by obtaining a large judgment against a former business partner only to encounter bankruptcy.  As a general principle, when a person files for bankruptcy protection under Chapter 7 of the bankruptcy code, the result will be a discharge of all debts without further obligation to pay.  This includes all money judgments.  The exceptions are limited: taxes, debts to the government, child or spousal support, student loans, and debts that result from fraud or embezzlement.  The fraud nondischargeability rule is a mainstay of action in bankruptcy courts under 11 U.S.C. 523(a)(2)(A).

It has long been the rule that a debtor cannot simply consent by contract to make a debt nondischargeable.  The reasoning is sound: if it were possible for creditors to ask debtors to sign contracts making debts nondischargeable, the practice would soon cover all debts.  Perversely, the practice might result in a scheme that only permits discharge of judgments and other involuntary (non-contractual) debts.    Creditors have long looked for ways around this problem.

In the case of Wank v. Gordon (9th Cir. BAP Jan 31, 2014), Gordon had brought suit in state court alleging 20 causes of action against Wank, among them false promise and fraud in connection with lost investments.  The parties entered into a settlement agreement for the payment of $750,000.   If Wank failed to pay, he stipulated to entry of judgment against him in the amount of $1,100,000.  As part of the settlement agreement, Gordon required Wank (the Court’s term for what happened) to sign a declaration reciting the facts of the case and attesting to fraud.  The declaration was explicit that its purpose was to ensure that the judgment would be declared nondischargeable.  Based on that declaration, the trial court granted summary judgment in the adversary proceeding.

The Bankruptcy Appellate Panel (“BAP”) reversed, holding that the declaration was effectively a pre-petition waiver of discharge, and re-iterated the existing law that such waivers were unenforceable under strong public policy rules.   The BAP was plainly concerned that this sort of declaration might be routinely drafted and signed as part of settlement agreements, making the “fresh start” in bankruptcy impossible and creating a de facto exemption from discharge for large numbers of debts.  The Court also was concerned that, given a subsequent contrary declaration by Wank, the former declaration was untrustworthy and conclusory.

So what is a practitioner to do?  The answer is not to be afraid of an adversary proceeding.  Expect that to be the price of a nondischargeability determination.  Above all, do not include such declarations by rote.  If there really is a set of facts supporting fraud, get a good declaration – not a pro forma one – that carefully recites the facts that form the basis for a fraud/non-dischargeability determination under 11 U.S.C. 523(a)(2)(A) so that the debtor will not be able to credibly deny them later.  Summary judgment is possible, but it will take more than just a prebankruptcy declaration.

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