I’ve been a bit busy lately, and haven’t posted anything for a while.  I plan to remedy this over the next couple of weeks.  This post begins that process of “blogging rehabilitation.”

Some time ago I posted an article discussing the consequences of omitting a creditor in a debtor’s bankruptcy papers.  Recently, I had an interesting email exchange with a colleague, that explored the question in a bit more depth.  This post gives you that email exchange.  I hope you find it interesting.  In the interests of privacy I have changed any personal identifiers.

I.        The Question My Fellow Attorney Posed

We all know that per In re Beezley that failure to schedule a creditor in a no-asset Chapter 7 case does not affect the dischargeability of any debts.  This works both ways, in that debts that would be dischargeable (but for failure to schedule) are discharged, but also that debts that would NOT be dischargeable (such as DSO’s, certain taxes, etc.) are not discharged.  My question regards those types of non-dischargeable debts which are not self-executing, namely fraud claims (523(a)(2)).  Since these aren’t really non-dischargeable unless and until a court makes a finding of the requisite fraud, is there any time limit for a creditor to reopen the bankruptcy case to litigate the fraud claim if they weren’t scheduled?

The specific facts I’m dealing with are:  Debtor filed Ch. 7 and got their discharge.  Debtor failed to list a certain creditor.   Debtor later seeks to reopen Chapter 7 case to amend schedules and add creditor.  Court allows it for some reason, and debtor amends.  Creditor files lawsuit in state court against debtor claiming breach of promise and fraud for prepetition debts.

My bigger question is:  Am I “safe” to file an OSC re: contempt for violating section 524 or, per Beezley, was this debt not discharged?

II.       My Response

I offer my thoughts with a suggestion on the OSC motion.

A.          In Re Staffer

In re Staffer, 306 F. 3d 967 (9th Cir. 2002), is interesting because the original debt in question was alleged to have been incurred through fraud.  This fact would appear to implicate § 523(a)(2), and thus, through § 523(c), the 60-day bar of Fed. R. Bankr. Proc. 4007(c).

However, the debtor’s failure to schedule the debt put it into § 523(a)(3), avoiding § 523(c) altogether, and making applicable Fed. R. Bankr. Proc. 4007(b)’s provision (with emphasis added):  “A complaint other than under §523(c) may be filed at any time.”

Moreover, the Ninth Circuit held that:  “[A] separate motion to reopen is not necessary when commencing an action for nondischargeability of a debt under Rule 4007(b) . . .” Staffer, at 969, so the creditor could have filed the adversary complaint without even reopening the case.

By the way, the Court didn’t reject the laches argument:  “[W]e agree with the BAP that the debtor may assert laches as a defense when Predovich’s complaint is filed.”  Id.  The Court’s focus on chronology dealt with the inapplicability of Fed. R. Bankr. Proc. 4007(c) rather than laches.

Next, to your question.

            B.         In Re Beezley

The Beezley Court held:  “If the debt is of a type covered by 11 U.S.C. § 523(a)(3)(B), it has not been discharged, and is non-dischargeable.”  In re Beezley, 994 F. 2d 1433, 1434 (9th Cir. 1993) (emphasis added).

Section 523(a)(3)(B) (with emphasis added) excepts from discharge any debt

neither listed nor scheduled under section 521 (a)(1) of this title, with the name, if known to the debtor, of the creditor to whom such debt is owed, in time to permit— . . . if such debt is of a kind specified in paragraph (2), (4), or (6) of this subsection, . . . timely request for a determination of dischargeability of such debt under one of such paragraphs, unless such creditor had notice or actual knowledge of the case in time for such timely filing and request . . .

The Beezley Court’s holding is expanded on in the concurrent opinion:

If the debt flows from an intentional tort “of a kind specified” in the relevant paragraphs [i.e., § 523(a)(2), (4), and (6)], the debtor’s failure to schedule in time to provide notice to the creditor of the need to seek an adjudication of dischargeability is conclusive (at least in the absence of actual knowledge of the bankruptcy on the part of the creditor).  The debt is not discharged.

Beezley, at 1437 (emphasis added).

In sum, an unscheduled fraud debt is not discharged, and amending the schedules after the 60-day bar date will not change that fact:

Reopening a case does not extend the time to file complaints to determine dischargeability.  Either the creditor had actual, timely notice of the [case] or he didn’t.  Amending the schedules will not change that.

Beezley, at 1437 (internal quotes omitted).

Therefore, your client’s amending of the schedules had no effect on the question of discharge.  If the debt was a fraud debt it was not discharged.

            C.       Limit Your OSC Motion To The Breach Of Promise Action

In light of the above discussion, I do not think that the creditor’s fraud action in state court is improper – though the breach of promise action clearly is – because the fraud portion of the debt was not discharged.  Therefore, the state court fraud action may be characterized as the legitimate vehicle for determining the liquidated value of the debt.  Consequently, I suggest that you limit your OSC motion to the impropriety of the breach of promise action and exclude the fraud action from its ambit.

III.     My Friend’s Follow Up Email

So if the debt on the fraud claim is not scheduled, then it is automatically non-dischargeable without ever filing a 523 action?

IV.     My Follow Up Response

If the unscheduled debt was incurred through fraud, then the holding in Beezley is that it was not discharged.  However, it seems to me that there are three options you should consider as a way to perhaps make the debt dischargeable, and therefore discharged.

First, the debtor could file a complaint under a combination of § 523(a)(3)(B) and Fed. R. Bankr. Proc. 4007(b) to get a determination of dischargeability.  Nothing in Rule 4007(b) restricts the filing of such a complaint to the creditor.  If you win, the debt is discharged.  Of course, you have to incur the costs and attorney’s fees to get the determination, so a cost/benefit analysis is necessary before proceeding down this path.  Moreover, there is no a priori guarantee of victory, so you might end up throwing money into the wind.

Second, you could fight the state court action.  If you win, then there is no debt to discharge.  Moreover, if the creditor’s action was genuinely without merit, after winning you could sue the creditor for filing a frivolous suit in the first place.  This approach also has the drawback of upfront costs and attorney’s fees, without any guarantee of recovering them if there is a subsequent suit for frivolous prosecution.  And once again, you might lose.  In addition, this approach may take much more time to resolve, as the state courts are very backed up these days.

Third, you could file the OSC motion without mentioning the specific state court causes of action – a sort of generic OSC motion – and hope that it dissuades the creditor from continuing the state court action.  Best case scenario:  you settle before the hearing on the OSC motion.  Worst case scenario:  the creditor correctly appeals to the holding in Beezley, or the judge, sua sponte, applies Beezley and sanctions you for filing a meritless OSC motion.

The success of this third approach obviously depends on the bankruptcy law sophistication, or lack thereof, of the state court action attorney.  The fact that the pending state court action has a breach of promise cause of action thrown in suggests that your opponent is unaware of Beezley, since under Beezley’s holding that debt was discharged.

I had a case a few years ago in which a state court attorney blew the 60-day bar (inapplicable in your case, of course) by staying a state court action without filing a § 523(c)  action in the bankruptcy court.  The attorney had a serious lack of bankruptcy law knowledge, which worked to my client’s advantage.