Commercial Division Blog

Posted: June 12, 2016 / Categories Commercial, Bankruptcy

State Court Can Determine Dischargeability of Debt Not Scheduled in Bankruptcy Case

On May 31, 2016, Justice Ostrager of the New York County Commercial Division issued a decision in Gleeson v. Phelan, 2016 NY Slip Op. 30993(U), regarding the determination of whether a debt had been discharged in bankruptcy.

In Gleeson, the plaintiffs sought to have the defendant reimburse them for monies they paid under a Guaranty Agreement after the Defendant . . . defaulted on a Promissory Note." The defendant moved to dismiss, arguing "that his 2010 "No Asset" Chapter 7 Bankruptcy discharged all of his prior debts, including the Note and the underlying Guaranty." The court denied the motion, explaining:

A state court is a judicial tribunal with concurrent jurisdiction to determine the dischargeability of debt not scheduled in bankruptcy cases. Typically, when a discharge order is granted under §727(b) of the Code, all of a debtor's prior debts are automatically discharged. However, a debt that meets one of the 19 exceptions listed in § 523(a) of the Code is not automatically discharged. Three exceptions - namely §523(a)(2), (4), and (6) - encompass claims arising out of actual fraud, false pretenses, false representations, embezzlement, larceny, or willful or malicious injury to person or property, collectively referred to as "Intentional Tort Debts. Section 523(a)(2) of the Code specifically addresses "money, property, services . . . obtained by . . . false pretenses, a false representation, or actual fraud.

Typically, creditors must file a complaint in a Bankruptcy court within 60 days from the date first set for the meeting of creditors during Bankruptcy proceedings when allegations of Intentional Tort Debts are involved. However, when debtors fail to list or schedule debt, creditors are given the right to litigate the dischargeability of alleged Intentional Tort Debts outside of the prescribed time limits. The statute treats intentional tort debts differently and thus
permits creditors to request that a court determine whether or not these debts are, in fact, dischargeable-i.e., whether or not the creditor actually committed an intentional tort. In such an action, a court must determine whether a particular debt is an Intentional Tort Debt within the rubric of § 523(a)(3)(B)4.

Thus, the debtor would have the burden of proving, by a preponderance of evidence, that the debt was not a fraud class debt under §523(a)(2), (4), or (6) of the Code. If the debtor prevails, the debt is not of the fraud class. A separate issue that may be determined is whether the creditor had notice or actual knowledge of the debtor's bankruptcy case. If the creditor had notice or actual knowledge of the case, and did not timely act to preserve its rights, then §523(a)(3) does not except the debt from discharge even if unscheduled.

(Internal quotations and citations omitted) (emphasis added).