One of the main reasons people and entities file for bankruptcy is to get their debts discharged. The Bankruptcy Code (USC §§ 101, et. sequence) provides honest debtors with a fresh start by imposing an injunction against creditors to take any action to recover canceled debts.
Given this powerful weapon in the debtors’ arsenal, creditors would naturally like their claims to be exempt from the scope of that discharge. There are four specific provisions in the Bankruptcy Code that allow creditors to mitigate the effect of a discharge.
First, 11 USC § 523 lists debts that are not dischargeable. A non-exhaustive list of such claims includes:
(1) certain tax claims;
(2) money, property, services, or an extension, renewal, or refinancing of credit to the extent obtained by false pretense, misrepresentation, or actual fraud;
(3) fraud or embezzlement by a debtor who is a fiduciary;
(4) domestic support obligations and other debts arising from divorce or separation proceedings;
(5) willful and malicious damage to an entity or that entity’s property;
(6) certain fines, penalties, and forfeitures payable to and for the benefit of a governmental unit; Y
(7) violations of federal or state securities laws.
Second and third, pursuant to 11 USC §§ 727 and 1141, the Bankruptcy Court may approve a written waiver of all debts that the debtor discharges after filing for Chapter 7 or Chapter 11 bankruptcy.
Fourth, pursuant to 11 USC 524, the Bankruptcy Court may approve a written reaffirmation agreement whereby a debtor agrees, after filing bankruptcy, to pay a specific debt if the debtor meets an extensive set of criteria that are found in that section.
Some creditors have tried to get around these specific provisions that allow a debtor to give up some or all of the benefits of a discharge by having the debtor agree, before filing bankruptcy, that the debtor is giving up the benefit of a discharge in bankruptcy for a debt to that creditor or agree not to file for bankruptcy. These pre-release waivers may be inserted into a promissory note, contract, transaction agreement, or any number of other documents. For enterprising creditors who have included pre-release waivers in various agreements, the goal is clear: to protect their debts early in a transaction or in connection with collection efforts against the debtor who owes them money. Such a creditor may pat himself on the back and feel confident that his position is protected should the debtor do the unthinkable and file for bankruptcy, but is that trust justified?
It is not.
The vast majority of courts have held that pre-petition discharge exemptions are unenforceable because they are illegal, void due to public policy concerns, and violate the Code provisions discussed above that establish specific means for debts to be exempt from discharge. cancellation. Pre-petition dismissal exemptions are ipso facto (“by the very fact”) clauses that have long been considered in violation of the Bankruptcy Code.
another well spent ipso facto clause is a provision in a contract or promissory note that creates a default on a debt by the very act of filing for bankruptcy.
In the Eastern District of Virginia, the main case on pre-petition dismissal exemption clauses is Property of McCoy vs. McCoy (In re McCoy), 2016 banker. LEXIS 2952 (2016)(Bankr.EDVa.). In that case, a woman gave the property on which she resided to her son and daughter-in-law, and the son-in-law and daughter-in-law subsequently used that property to secure a bank loan. The son died and the woman finally paid off the debt secured by the residence after the daughter-in-law defaulted on the debt to the bank. As a result, the daughter-in-law executed a confession judgment note in favor of the woman. The confessed sentence contained a provision by which the daughter-in-law allegedly waived “the benefit of any law or rule of law intended to release or exempt liability hereunder…”. When the daughter-in-law defaulted on the woman’s debt, the woman initiated collection activities and the daughter-in-law filed for bankruptcy.
In addressing that clause, the Bankruptcy Court first noted that it was a type of ipso facto clause that would punish the debtor for declaring bankruptcy. ID. in 66. The Court indicated that it would not enforce ipso facto clauses because they were rendered inapplicable as a matter of law by the passage of the Bankruptcy Code, particularly Sections 541(c) and 365(e)(1), because they are null and void contrary to public policy in favor of giving debtors a “ new start”, because they violate the Bankruptcy Code’s legislative history which prohibits “against the enforcement of clauses that ‘hinder rehabilitation efforts’ in bankruptcy”, and because many other courts have reached the same conclusion. In 66-69. If pre-petition discharge waivers were allowed, all “astute creditors would routinely require debtors to waive” potential discharge. ID. If that were to happen, the debtors would lose one of the most important weapons, if not the most important, in their arsenal. Enforcing such “agreements would render the protections of the Bankruptcy Code obsolete.” ID.
As such, pre-petition discharge waivers are unenforceable and, unfortunately for creditors, a waste of ink in a settlement.