Debtors who have filed for bankruptcy and received their Discharge often continue to receive collection letters and phone calls from their creditors. Some creditors even go so far as to sue on these discharged debts or garnish wages and bank accounts. Such actions may result in severe penalties, sanctions and damages. This article goes over the basics of the Bankruptcy Discharge and the importance of having measures in place to avoid violations.
What is the Bankruptcy Discharge?
After a Debtor receives the Order of Discharge in a bankruptcy proceeding, the Automatic Stay provisions of the Bankruptcy Code prohibiting all acts directed at collecting pre-bankruptcy petition debt come to an end. This, however, does not mean that the discharged debtor is without any defense from those seeking to collect pre-petition debts. The Bankruptcy Code provides continuing protection from creditors in the form of a discharge injunction. The discharge injunction is authorized by section 524(a)(2) of the Bankruptcy Code. It provides that a bankruptcy discharge “operates as an injunction against… an act, to collect, recover or offset any such debt as a personal liability of the debtor, whether or not discharge of such debt is waived….” 11 USC § 524.
The discharge injunction is permanent, survives the bankruptcy case and is always applicable with respect to every debt that was discharged. This injunction is to give complete effect to the discharge and acts to eliminate any doubt concerning the effect of the discharge as a total prohibition on debt collection efforts. This protection is so broad that even creditors who are not noticed in the bankruptcy proceeding, whether inadvertently or otherwise, will also be unable to escape liability (subject to very limited instances).
Elimination of Personal Liability Only
While the Automatic Stay prohibits any act to enforce a lien against property of the estate, there is no comparable provision in the discharge injunction. Thus the bankruptcy discharge eliminates the personal liability of the debtors on the debt, and converts the loan into a non-recourse loan. The lien on the property, however, remains, and the creditor may proceed to enforce the lien in rem to the extent authorized by state law. Once the bankruptcy discharged is entered, the case is dismissed or relief from the Automatic Stay is granted.
When does the Discharge Occur?
The timing of the discharge varies, depending on the chapter under which the case is filed. In a chapter 7 (liquidation) case, for example, the court usually grants the discharge promptly on expiration of the time fixed for filing a complaint objecting to discharge and the time fixed for filing a motion to dismiss the case for substantial abuse (60 days following the first date set for the 341 meeting). Typically, this occurs about four months after the date the debtor files the petition with the clerk of the bankruptcy court. In individual chapter 11 cases, and in cases under 13 (adjustment of debts of an individual with regular income), the court generally grants the discharge as soon as practicable after the debtor completes all payments under the plan. Since a chapter 12 or chapter 13 plan may provide for payments to be made over three to five years, the discharge typically occurs about four years after the date of filing.
As to corporate debtors that reorganize under Chapter 11 and will not liquidate and end operations, the Bankruptcy Code provides that confirmation of a reorganization plan discharges a debtor from any debt that arose before the date of confirmation. After the plan is confirmed, the debtor is required to make plan payments and both the debtor and its creditors and other parties in interest are bound by the provisions of the reorganization plan. The confirmed plan also creates new contractual rights, replacing or superseding pre-bankruptcy contracts.
What Actions from Creditors Are Prohibited?
The injunction provides ample and permanent protection against virtually all collection activity. Some common examples include:
- The sale of a discharged debt to a collection agency.
- Phone calls, collection letters and public announcements of default.
- Refusing to modify a loan unless the debtor reaffirms the mortgage loan.
- Moving to perfect a lien, such as a mortgage, over discharged debt.
Consequences of Violation
Bankruptcy courts frown upon improper collection activity and use their broad contempt powers under 11 U.S.C. § 105 of the Bankruptcy Code to award actual damages, attorney’s fees and costs, damages for emotional distress, and, in extreme cases, punitive damages. The same action in attempting to collect a discharged debt may also violate the Fair Debt Collection Practices Act and other state and federal consumer protection laws. In addition, Sections 524 and 362 of the Bankruptcy Code also provide causes of action to aggrieved debtors.
Measures to Take to Avoid Violation
Creditors have a duty under the law to maintain adequate procedures to prevent a violation of the discharge injunction. Internal best practices should be formalized so that adequate protocols are in place prior to commencing any debt collection activity. Some good initial measures include placing broad waiver language in all letters and correspondence sent to debtors at any point in time (although some courts have held that this is still not enough). Also, having access to PACER, i.e., Public Access to Court Electronic Records, which is the sophisticated electronic search index in place for all U.S. federal courts and bankruptcy courts, and conducting searches of debtors by name, is recommended. This way, creditors may ensure that the debtors are not currently under bankruptcy protection prior to taking collection action.