Penalties for fraudulently obtaining government benefits are nondischargeable despite the so-called superdischarge in chapter 13, according a May 29 opinion from the Sixth Circuit.
The circuit court was reviewing two cases with nearly identical facts. In both cases, an individual fraudulently obtained unemployment benefits by failing to disclose employment income. After discovering fraud, the state imposed orders of restitution and penalties for fraudulently obtaining unemployment benefits.
The restitution and penalties for one debtor were approximately $6,900 and $27,000, respectively, and $4,300 and $16,700 for the other. In other words, the penalties were about four times larger than the benefits that were fraudulently obtained.
In the debtors’ chapter 13 cases, the state objected to the dischargeability of both the restitution awards and the penalties. The debtors conceded that the restitution awards were nondischargeable under Section 523(a)(2)(A) as money obtained by “false pretenses, a false representation, or actual fraud.”
However, the debtors argued that the penalties were dischargeable in chapter 13 because they fell under Section 523(a)(7) as a “fine, penalty, or forfeiture payable” to a governmental unit that “is not compensation for actual pecuniary loss.”
Although debts covered by Section 523(a)(7) are ordinarily nondischargeable, the superdischarge in Section 1328(a)(2) makes (a)(7) penalties dischargeable once chapter 13 debtors complete their plan payments. (Section 523(a)(2) debts are not covered by the superdischarge in Section 1328(a)(2) and remain nondischargeable in chapter 13.)
One bankruptcy judge ruled that the penalties were dischargeable, and the other held that they were not. On appeal in district court, the penalties were held nondischargeable.
Circuit Judge Eugene E. Siler, Jr. concluded that the penalties were nondischargeable.
Judge Siler was most persuaded by Cohen v. de la Cruz, 523 U.S. 213 (1998), where the Supreme Court held that treble damages for fraud are nondischargeable under Section 523(a)(2). He described Cohen as holding that “penalties associated with fraud should be regarded as essentially the same as the fraud itself.”
Judge Siler rejected several arguments offered by the debtors. To the contention that exceptions to discharge are construed strictly against the creditor, he said that bankruptcy benefits the “honest but unfortunate” debtor.
The debtors relied on the rule of construction that a more specific statute, like Section 523(a)(7), should control over the more general provision in Section 523(a)(2). However, Judge Siler found no authority for the proposition that a debt may not be covered by two subsections in Section 523(a). Indeed, he said the subsections are not mutually exclusive.
Significantly, Judge Siler read the Supreme Court’s recent decision in Husky International Electronics Inc. v. Ritz, 136 S. Ct. 1581 (2016), to mean that a debt can be nondischargeable under both subsections (a)(2) and (a)(7).
Judge Siler held that the penalties arose “from fraud perpetrated against the Agency,” thus making the penalties nondischargeable under subsection (a)(2).
In Husky, the Supreme Court held that a debt can be nondischargeable for “actual fraud” under Section 523(a)(2)(A) even if the debtor made no misrepresentation to the creditor. To read ABI’s discussion of Husky, click here.