Here’s an example showing in a practical way what happens when a creditor objects to the legal write-off of a debt in bankruptcy.
The last three blog posts were about the procedure for litigating whether a debt gets discharged in bankruptcy. Let’s bring this to life with an example.
Marshall had spent 10 years learning everything he could learn as an auto mechanic at the local Ford dealership. He was 30 years old, and itched to open his own auto repair shop. So, five years ago, Marshall asked his financially well-off aunt, Heather, to lend him $35,000 to help him to start his business. She had her concerns, but agreed, only if they did it in a business-like manner. So she had her lawyer write up a loan application and promissory note.
Marshall completed the loan application, but not quite accurately. He was too embarrassed and afraid to include a $7,500 debt he already owed to another aunt. She was from the other side of the family so he knew Heather wouldn’t find out about that debt. Besides, he’d been paying on it perfectly for years, bringing the balance way down from its original amount. So he figured that, if anything, that loan was proof of his creditworthiness with family loans. But he didn’t want to risk Heather not seeing it that way and not giving him the business loan.
So Heather lent him the $35,000, Marshall signed a promissory note to pay it back at 6% annual interest, through monthly payments of $400 per month.
For four years Marshall paid the $400 monthly payments perfectly. His auto repair business was doing pretty well for a new business in a competitive market.
But then there was a fire in the building where his shop was located. The fire itself did not get into his shop but it did result in serious smoke and water damage. He had to shut down for a full month and replace some expensive equipment. He learned that his insurance did not cover nearly as much as he’d expected it would. He struggled to recover.
He stopped sending Heather the $400 payments because he simply did not have the money. She was understanding at first. But then, after a year of no payments as the business continued to falter, Heather became impatient. An unrelated family feud erupted between Heather and her brother, Marshall’s father, and Marshall got caught up in it. Heather had her lawyer sue Marshall for the $21,000 he still owed.
Marshall got an offer to go back to work at the Ford dealership he’d left five years earlier. So he decided to close his business, and filed a Chapter 7 bankruptcy case to discharge his accumulated debts and get a fresh financial start.
Heather was very angry that Marshall did not intend to pay her back the rest of the business loan. She saw that he was as irresponsible and undependable as his father, her brother, who she now couldn’t stand. She asked her lawyer what she could do about it. Heather told the lawyer that she knew that Marshall had not included his $7,500 debt to his other aunt when he’d filled out Heather’s loan application. She’d know about this for years but had never told Marshall. Heather learned that this might give her the grounds for stopping the debt from being discharged.
So Heather instructed her lawyer to start an adversary proceeding in Marshall’s bankruptcy case objecting to the discharge of the debt. The complaint alleged that Marshall had gotten the $35,000 business loan through a written application:
- that was “materially false”
- about his “financial condition”
- on which Heather had “reasonably relied,” and
- Marshall had not included the $7,500 owed to the other aunt “with intent to deceive” Heather
See Section 523(a)(2)(B) of the U.S. Bankruptcy Code. It’s about the potential exception to discharge for the use of a written false statement used to obtain credit.
After receiving the complaint in the mail, Marshall met with his bankruptcy lawyer. After talking the situation over thoroughly, his lawyer advised him to fight Heather’s adversary proceeding. In our next blog post we’ll tell you how they answered the complaint and what happened afterwards.