Dischargeability Issues in Serial Bankruptcy Cases

A finding that a particular debt is excepted from a debtor’s discharge is not necessarily the end of the struggles between the debtor and creditor in bankruptcy court. Creditors holding debts that were once held to be nondischargeable are not necessarily able to rest on the prior judgment in a subsequent bankruptcy case, and debtors may wish to use chapter 13 to obtain a broader discharge than they received in chapter 7. The Bankruptcy Code offers some guidance on how to handle these situations, but statutory ambiguity has led to unexpected or anomalous results. This article discusses the circumstances in which these serial dischargeability issues arise and offer potential solutions to protect debtors’ and creditors’ statutory rights.

Prior Judgments and Preclusion

Before turning to the discharge exceptions themselves, it is important to discuss the preclusion doctrines that play a role in determining what may or may not be relitigated. Unfortunately, there is a great deal of confusion regarding proper terminology.[1] The term “res judicata” can refer either to the entire body of preclusion doctrines or specifically to claim preclusion, which is contrasted with issue preclusion, also known as collateral estoppel.[2] For clarity, this article uses the unambiguous terms “claim preclusion” and “issue preclusion.”

Claim preclusion generally bars a party from raising any claim based on the same cause of action that was previously decided on the merits in prior litigation, even if different issues are involved.[3] Although precise definitions are “elusive,” claim preclusion usually turns on “the essential similarity of the underlying events giving rise to the various legal claims.”[4]

On the other hand, issue preclusion prevents parties from relitigating factual or legal issues that have already been resolved in prior litigation.[5] These issues need not be relitigated if “(1) the issue sought to be precluded is the same as that involved in the prior action; (2) the issue was actually litigated; (3) the determination of the issue was essential to the final judgment; and (4) the party against whom [issue preclusion] is invoked was fully represented in the prior action.”[6]

In either case, the preclusive effect of a prior judgment will be governed by the law of the jurisdiction in which the judgment was entered. Thus, each state’s preclusion principles apply to judgments entered by the courts of that state while federal law applies to federal judgments.[7]

Both preclusion doctrines are applicable in dischargeability proceedings. Claim-preclusion principles prevent the bankruptcy court from revisiting the validity of a prior valid judgment. However, because the existence of a debt and its dischargeability are separate claims, the court may still look beyond the judgment to determine whether the debt is dischargeable.[8] Likewise, issue-preclusion principles prevent litigants from asking the bankruptcy court to revisit previously resolved issues, such as whether a debt was created through fraud.[9]

Section 523(b) Exceptions to Discharge

Some discharge exceptions are expressly excluded from claim-preclusion principles. “[A] debt that was excepted from discharge under subsection (a)‌(1), (a)‌(3), or (a)‌(8) ... in a prior case concerning the debtor under this title ... is dischargeable in a case under this title unless, by the terms of subsection (a) of this section, such debt is not dischargeable in the case under this title.”[10]

The dischargeability of many tax debts depends, in part, on the time between the tax assessment and the bankruptcy filing.[11] If these debts were nondischargeable in one bankruptcy case solely because they were incurred too close to the petition date, they should naturally be able to be discharged in a subsequent bankruptcy if they otherwise meet the terms of §§ 523‌(a)‌(1) and 507‌(a)‌(8).

Unscheduled debts under § 523‌(a)‌(3) are also, in part, time-dependent. Their dischargeability depends on whether the creditor receives notice in time to file a dischargeability complaint (in the case of a debt under § 523‌(a)‌(2), (4) or (6)), or to file a proof of claim (in the case of all other debts).[12]

Regarding student loans under § 523‌(a)‌(8), the debtor’s circumstances may have changed significantly between one bankruptcy and the next. The Brunner test, which most courts use to ascertain whether student loans should be discharged, takes into account the debtor’s financial condition at the time of the bankruptcy, including any conditions that would hinder the debtor’s ability to earn a living in the future.[13]

For these three types of debts, the result should be the same — even without § 523‌(b). Excepting these debts from discharge requires analyzing some circumstances as they exist at the time of the bankruptcy case. They do not merely involve looking back at past conduct and determining the legal impact, as would ordinarily justify application of claim preclusion. Thus, an attempt to preserve the nondischargeable status of such debts in future bankruptcy cases should be considered a new “claim” for preclusion purposes.

Negative Implications and the Need to Relitigate

Although § 523‌(b) makes it clear that some discharge exceptions must be relitigated in subsequent bankruptcy cases, the Bankruptcy Code does not specify how to handle other types of potentially nondischargeable debts. One theory embraced by some courts is that “[b]‌y negative implication, the general rule is that all other debts held to be nondischargeable are always thereafter nondischargeable.”[14] However, this interpretation is difficult to square with other Bankruptcy Code provisions, and the “negative implication” should not be applied where circumstances do not justify it.[15]

Like the discharge exceptions specified in § 523‌(b), § 523‌(a)‌(7) (excepting certain debts payable to government entities) contains a temporal element by referring to § 523‌(a)‌(1). It would make little sense if such debts were “always thereafter nondischargeable” simply because Congress — perhaps inadvertently — did not mention them in § 523‌(b).[16]

Likewise, it should go without saying that some debts that are not discharged in chapter 7 can be discharged in a chapter 13 case.[17] Some frequently litigated debts included in the chapter 13 “superdischarge,” but not in a chapter 7 discharge, are debts for nonsupport divorce obligations and many debts for willful and malicious injuries.[18]

Finally, harmonizing § 523‌(c)‌(1) with § 523‌(b) also presents challenges. Under § 523‌(c)‌(1), “the debtor shall be discharged from a debt of a kind specified in [§ 523‌(a)‌(2), (4) or (6)] unless, on request of the creditor to whom such debt is owed, and after notice and hearing, the court determines such debt to be excepted from discharge.”[19] As discussed later, this provision is considered to be ambiguous as to whether any new action is required when the debts at issue have already been held to be nondischargeable in a prior bankruptcy.[20]

Exceptions under § 523(c)(1)

On its face, § 523‌(c)‌(1) permits the discharge of debts that fall under § 523‌(a)‌(2), (4) or (6) unless the creditor acts to obtain a judgment that the debt is not dischargeable.[21] However, some courts question whether § 523‌(c)‌(1) even applies when the debts was previously held to be nondischargeable.

In Szafranski, a creditor had brought a complaint to determine the dischargeability of a debt that had already been held to be nondischargeable under § 523‌(a)‌(2) and (a)‌(4).[22] The complaint had not been brought within the time period specified in Bankruptcy Rule 4007‌(c), which otherwise would have formed the basis for the dismissal. Rather than dismiss the complaint, the court construed the complaint as a request for declaratory judgment that the debt remained excepted from discharge and accordingly entered summary judgment for the creditor.

The court believed that § 523‌(c) is ambiguous as to whether it applies when a debt has already been held as nondischargeable. Ultimately, the court concluded that it does not apply; therefore, the “continuing exception to discharge might be established in the normal manner — i.e., either by reply to affirmative defense of discharge on a suit in non-bankruptcy court; or by adversary proceeding, not subject to deadlines under [Bankruptcy Rules] 4007‌(c) [and] 9006‌(b)‌(3), in Bankruptcy Court.”[23] In Pacher, the court similarly believed that even if an adversary proceeding were required, there would be no purpose on “insisting on technically correct procedures” under the presented set of circumstances.[24]

Absent from these decisions was discussion of the aspect of § 523‌(c)‌(1) requiring “the court” to adjudicate exceptions to discharge governed by that subsection. This provision could easily be construed to refer to the bankruptcy court in the current bankruptcy case. However, the panel in Moncur concluded that the phrase “the court” merely deprives nonbankruptcy courts of the jurisdiction to resolve these dischargeability issues; it does not require the specific bankruptcy court presiding over the current case to enter a new judgment of nondischargeability.[25] Thus, as long as some bankruptcy court held these types of debts to be nondischargeable, they remain nondischargeable thereafter.

Nevertheless, not all courts would necessarily come to the same conclusions as the courts in the aforementioned cases. Therefore, prudence suggests that the creditor holding a debt of a type specified in § 523‌(c)‌(1) should timely file an adversary proceeding to maintain the nondischargeable status of their debt. This should be a simple matter.

A motion for summary judgment could be filed shortly after the filing of the adversary proceeding, raising claim and issue preclusion as the basis for judgment.[26] Absent unusual circumstances, the court would likely be compelled to enter a judgment as a matter of law based on preclusion without the need to wait for any significant discovery. Further, the creditor would be entitled to an award of litigation costs, reducing the overall burden of prosecuting the subsequent dischargeability action.[27]

Litigation in Chapter 13 After a Chapter 7 Discharge

Different issues arise when a debtor who once received a chapter 7 discharge subsequently seeks a chapter 13 discharge. For example, Pacher involved a chapter 13 debtor’s efforts to discharge debts that were held to be nondischargeable “pursuant to § 523 and § 727 of the Bankruptcy Code” in a prior chapter 7 case.[28] The creditor filed an objection to the debtor’s motion for entry of chapter 13 discharge, noting that the debt at issue was previously held to be nondischargeable.[29] Although the debtor argued that the broader chapter 13 provisions could result in a discharge of the debt, the court refused to consider the distinction between chapter 7 and 13 discharges. The court stated that the “negative implication” described in Blackmore instead requires a debt that was held nondischargeable in a chapter 7 case to remain nondischargeable in a subsequent chapter 13 case.[30] This aspect of the Pacher decision is inconsistent with both the structure of the Bankruptcy Code and cases holding that a finding of nondischargeability in a chapter 7 case is not a per se bar to discharging the same debt in a subsequent chapter 13 case.[31]

The need to relitigate may also arise where the prior judgment is unclear as to the basis for the exception to discharge. For example, in a prior chapter 7 case, the creditor may have brought a complaint seeking an exception to discharge under § 523‌(a)‌(5) and (15) for divorce-related debts, and the judgment does not specify the extent to which either provision is applicable. In a subsequent chapter 13 case, it might become necessary to determine whether the debt is in the nature of support or a property settlement for the purpose of ascertaining either priority or dischargeability.[32] Although issue preclusion would likely prevent relitigation of issues that were actually decided, such as the fact that the obligation is divorce-related, it would not prevent the court from allocating the support and nonsupport portions of the debt.

In either case, given that the debtor is attempting to obtain a broader discharge, it could be wise to take affirmative action to secure a judgment from a bankruptcy court. That way, the debtor can benefit from the bankruptcy court’s expertise on dischargeability issues and its understanding of the difference between chapters 7 and 13 to establish that a debt that was once excepted from discharge can ultimately be discharged.

Conclusion

Serial bankruptcy cases can cause unwanted hassles for creditors holding potentially nondischargeable debts and debtors seeking a “superdischarge.” For certain debts, the Bankruptcy Code makes it clear that preclusion doctrines are no barrier to discharge in a subsequent case. Some courts believe that by “negative implication,” all other debts are forever thereafter nondischargeable. This implication is clearly inapplicable to certain types of debts and in certain circumstances.

In light of this legal uncertainty, both debtors and creditors can protect their rights by timely bringing dischargeability issues before the bankruptcy court. Claim and issue preclusion will prevent relitigation of matters that were actually previously decided, but should not stand in the way of obtaining a legally appropriate outcome.