Intentional Wrongdoing as the Basis for Nondischargeability in Bankruptcy

A debtor who files a petition for bankruptcy expects that certain debts will be discharged at the conclusion of the process. However, complex provisions of the U.S. Bankruptcy Code provide numerous exceptions to dischargeability. Several of those exceptions relate to nondischargeability of a bankruptcy debt based on intentional wrongdoing.

Nondischargeability in the Bankruptcy Code

Section 523 of the United States Bankruptcy Code is entitled Exceptions to Discharge. Several subsections provide for nondischargeability due to intentional wrongdoing. Those subsections frequently relate to fraud and misrepresentation and include certain criminal actions or torts (wrongdoing under civil law).

For a debt to be ruled by the bankruptcy court as nondischargeable under the section, the creditor may initiate an adversary proceeding in the case. In the proceeding, the burden of proof is on the creditor to establish the intentional wrongdoing.

The subsections of Section 523 that relate to nondischargeability for intentional wrongdoing include:

• Section 523(a)(2)(A), a debt obtained by false pretenses, false representation, or fraud
• Section 523(a)(4), fraud or defalcation while acting in a fiduciary capacity, or embezzlement or larceny
• Section 523(a)(6), willful or malicious injury to property of another person or entity

A brief summary of each of those subsections follows. If an issue relating to one of the provisions arises in a bankruptcy case for a debtor or creditor, consultation with a bankruptcy litigation attorney is strongly recommended.

Fraudulent Conduct

For intentional wrongdoing based on fraud, the relevant part of Section 523(a)(2)(A) provides:

(a) A discharge under section 727, 1141, 1192 [1] 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt—

…

(2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by—

(A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition

This subsection requires the creditor to show actual fraud, false pretenses, or a misrepresentation. To make that showing, the creditor must prove that the debtor made a representation that they knew was false at the time, with the intention of deceiving the creditor. If the creditor relied on the misrepresentation and sustained damage as a result of the fraud, the creditor can make a nondischargeability claim.

Numerous court decisions interpret the requirements for establishing nondischargeability under these provisions. A creditor who believes there was debtor fraud under this subsection should consult with an experienced bankruptcy litigation lawyer before initiating an adversary proceeding in the bankruptcy case. A debtor who faces a nondischargeability claim under this section should also seek counsel from a lawyer who handles bankruptcy nondischargeability proceedings.

Wrongdoing of a Fiduciary or Embezzlement

Section 523(a)(4) establishes an exception from discharge of a debt due to fraud or defalcation of a debtor acting in a fiduciary capacity, or based on embezzlement or larceny. The relevant provisions state:

(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt—

…

(4) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny

For a creditor to establish nondischargeability under the first part of this provision, the creditor must show that the debtor was acting in a fiduciary capacity at the time the debt was created. The creditor also must establish actual fraud or defalcation. The term defalcation generally includes innocent, negligent, and intentional conduct that constitutes misappropriation of funds.

A fiduciary relationship only matters for a claim based on fraud or defalcation. If a nondischargeability claim under this section involves embezzlement or larceny under the second part of this subsection, it does not matter whether the debtor was acting in a fiduciary capacity.

As with all Bankruptcy Code provisions, court interpretations of the statute apply to any action brought under this section. As such, if an issue arises under this subsection in a bankruptcy case, the creditor and debtor should each secure representation by a knowledgeable bankruptcy litigation lawyer.

Willful and Malicious Injury

Bankruptcy Code Section 523(a)(6) establishes a basis for nondischargeability due to willful and malicious injury to property by the debtor. The section provides:

(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt—

…

(6) for willful and malicious injury by the debtor to another entity or to the property of another entity

A creditor who claims nondischargeability under this provision must prove willfulness, which means that the debtor had the intention to cause the damage. Willfulness and maliciousness are two different requirements, so the creditor also must prove the malicious motivation of the debtor. Reckless or negligent injury does not fall within the scope of this provision.

Whether the facts support a conclusion of willful and malicious conduct is determined by the bankruptcy court, which applies past court decisions interpreting the meaning of those terms in the bankruptcy context. For that reason — and because a claim under this section likely involves an adversary proceeding — a debtor and creditor should consult with a bankruptcy litigation attorney if a claim arises under this subsection.

Adversary Proceedings in a Bankruptcy Case

Any claim made under the intentional wrongdoing provisions of Section 523 may result in a creditor filing an objection to discharge or challenge to dischargeability action. These actions are adversary proceedings within the bankruptcy case, also known as bankruptcy litigation. The court action involves a trial on the issue by the bankruptcy court. For both the creditor and debtor, representation by an experienced bankruptcy litigation attorney is essential.

Schedule a Consultation with a Minnesota Bankruptcy Litigation Attorney

At Dave Burns Law Office, I represent clients in all types of adversary proceedings in the United States Bankruptcy Courts in Minneapolis and St. Paul, including actions relating to intentional wrongdoing and dischargeability of debts. Bankruptcy litigation is a primary focus of my practice. If you are a debtor or creditor in a bankruptcy case involving issues under Bankruptcy Code Section 523, I welcome you to contact me at (612) 677-8351 or by sending an email to me at dave@daveburnslaw.com. I am available to meet with clients in both Minneapolis and St. Paul and welcome inquiries from clients and referring attorneys throughout the State of Minnesota.