Sued for a deficiency judgment after your bankruptcy discharges doesn’t always need a motion to reopen the bankruptcy.

Here’s one situation that came up recently.   The borrower had a first and second mortgage (both were refinance loans – non-purchase money loans).  The borrower was not making loan payments and they received a notice of default.  Prior to the trustee sale date, the borrower filed for bankruptcy protection (Chapter 7 no asset case).  The senior lien holder sought to lift the automatic stay in bankruptcy and the motion was granted.  The house was thereafter sold at private foreclosure sale.  After the sale, the bankruptcy discharged (eliminating any personal liability on the first and second mortgage).  However, the junior mortgagee, believing itself to be a “sold out junior” (one action rule – we have talked about this on other posts) sought to collect on the second mortgage debt.  The borrower sought to reopen the bankruptcy case arguing the action to collect the debt violated the bankruptcy discharge.  The junior lien holder argued they were not scheduled on the bankruptcy petition so their debt was not discharged.  So what happens in this situation?   A similar situation arises where an unscheduled (omitted creditor) seeks to file a lawsuit after the chapter 7 no asset bankruptcy case was discharged.  Here is one argument to look at and some case law that supports the proposition that the debt was discharged even if it was not listed on the bankruptcy petition.

Here is a general look at two cases that address this point (In re Hicks and Beezley).  The following is general legal information only and should not be relied on as legal advice and may not be accurate or up to date.  Please consult a bankruptcy attorney to discuss your case.  This article is limited to the situation where  a creditor seeks to collect on an alleged debt after the debtor receives a discharge in a chapter 7 “no-asset” case.

In re Hicks, 184 B.R. 954, 27 Bankr.Ct.Dec. 676 (Bkrtcy.C.D.Cal., 1995).

This is a case that involved a chapter 7 no-asset bankruptcy case.  The debtor filed for bankruptcy protection and the bankruptcy petition omitted an alleged creditor who claimed liability on two promissory notes.  Eight months after the bankruptcy was discharged on February 1993, the alleged creditor filed a civil lawsuit seeking to collect on the notes.  The Plaintiff’s attorney was sent a copy of the Notice of Discharge, but ignored it and continued to proceed with the case.

The Plaintiff thereafter sought to reopen the bankruptcy to schedule the alleged debt, and then to discharge it.  The Court held that although it is permissible to reopen a bankruptcy to afford further relief to the debtor, there was no need to do so in this case as the alleged debt was already discharged.  The Court discussed 11 U.S.C. 524(a) discharge injunction which the court stated: “operates as an injunction against any post-discharge enforcement of any discharged claim as a matter of federal law.”  The court went on to state that: “reopening this case to permit determination of whether this creditor should be liable for a violation of the discharge injunction is appropriate.”

A similar case in the 9^th Circuit Court of Appeals reached a similar conclusion.  In the case of Beezley v. California Land Title Co. (In re Beezley), 994 F.2d 1433, 1434 (9th Cir. 1993) (per curiam), the court was faced with another no-asset Chapter 7 bankruptcy case and a subsequent action to collect on a debt following the bankruptcy discharge.  In Beezley, the alleged creditor (who had obtained a default judgment prior to the filing of the chapter 7 bankruptcy, but who was omitted on the schedule of creditors), sought to recover from the debtor and enforce the debt following the Chapter 7 discharge order.  The debtor raised the defense of discharge.  Ultimately the legal issue was whether or not the bankruptcy debt was discharged in the no-asset chapter 7.  The Court discussed the difference between debts that are automatically discharged in a chapter 7 no-asset case –whether scheduled or not, (11 U.S.C. 523(a)(3)(A)), from those that are not automatically discharged if unscheduled, (11 U.S.C. 523(a)(3)(B)).  Debts covered under Section “A” are automatically discharged whether they are scheduled or not in the no-asset chapter 7 case.  Debts that fall under Section “B” (basically debts that result from intentional fraud, willful injury, false statement or embezzlement) may arguably survive the discharge, but it is Plaintiff’s burden to prove such exemption, the failure of which results in a discharge violation.

Section 524 of the bankruptcy code is clear and unambiguous as to what is required to prove a violation of the discharge injunction order under section 727 of the Bankruptcy Code:

“A discharge “operates as an injunction against the commencement or continuation of an action . . . to collect, recover or offset any [discharged] debt as a personal liability of the debtor.” 11 U.S.C. § 524(a)(2). A party who knowingly violates the discharge injunction can be held in contempt under Section 105(a) of the Bankruptcy Code. See Renwick v. Bennett, (In re Bennett), 298 F.3d 1059, 1069 (9th Cir. 2002). The party “seeking contempt sanctions has the burden of proving, by clear and convincing evidence, that the sanctions are justified . . . ‘[T]he movant must prove that the creditor (1) knew the discharge injunction was applicable and (2) intended the actions which violated the injunction.’” ZiLOG, Inc. v. Corning (In re ZiLOG, Inc.), 450 F.3d 996 (9th Cir. 2006) (citations omitted).

This gives you a general idea of the way a California bankruptcy court might review these types of cases where a lawsuit is filed, or collection efforts are taken after the discharge in the no-asset Chapter 7 bankruptcy case.  If you are facing an aggressive creditor seeking to collect on a debt following your bankruptcy discharge, consider contacting our firm to discuss.  You may have legal rights to assert against the creditor.  We can be reached at (877) 276-5084.  Ask for “ATTORNEY STEVE” – More bankruptcy information can be found at Ultimate BK.