ADVERSARY COMPLAINT TO CHALLENGE DISCHARGE CANNOT BE SETTLED BY PARTIES

Debtor filed for Chapter 7 bankruptcy relief to discharge $150,000 of unsecured debt.  Creditor who holds a state court judgment for $50,000 on a signature loan files an adversarial case asking the court to deny discharge to debtor on the ground that his bankruptcy schedules are grossly inaccurate with intent to defraud the court. After the trial date is set, creditor and debtor mutually agree on a settlement where the debtor agrees to pay creditor $25,000 at $500 a month without interest for 50 months. In exchange, creditor agrees to dismiss the adversary case. The settlement agreement is presented to the court by both parties. Will the court approve the settlement agreement and allow the dismissal of the adversary case and proceed to give debtor a discharge, or will the court deny the settlement agreement?

This is an interesting question because normally parties to a lawsuit are able to settle the dispute between them, while the court welcomes settlement agreements as matter of course.

In Re Bullis decided last month, a creditor holding judgments against the debtors filed a complaint against the court to deny the debtors a Chapter 7 discharge. The complaint raised serious questions about the accuracy of the debtors’ schedules and statement of financial affairs, the lack of financial records, and the debtors’ inability to explain the loss of assets. The creditor and debtors then filed a joint motion to settle the complaint. The motion, which provided no details of the settlement, called for the complaint to be dismissed, the debtors to receive their discharge, and the creditor’s claims to be excepted from discharge. It appears at this point that they don’t need a Judge to determine whether or not there is a legal ground to deny discharge, or if the claim is legally excepted from discharge. They’re asking the judge to take a hike.

The court noted that the ability of parties to settle discharge objections is limited by Fed.R.Bankr.7041, which recognizes that the dismissal of such actions raises concerns of abuse. In fact, some courts are so concerned about potential abuse that they do not allow the settlement of Section 727 objections. “The essential proposition is that as a matter of public policy the debtor is either entitled to discharge or is not. There is no middle ground. If he is entitled to a discharge, he ought not to be required to pay additional amounts to either a creditor or the estate for his entitlement. Payment for a discharge is inimical to his fresh start. If, on the other hand, he is not entitled to a discharge, he should not be permitted to purchase a discharge. This approach is appealing from a public policy perspective, however, it is difficult to reconcile with the absence of an express prohibition of settlement of Section 727 complaints in the Bankruptcy Code and the language of Rule 7041 which specifically permits dismissal of Section 727 complaints upon such ‘terms and conditions which the court deems proper,’, the court said. Where settlements are allowed, courts require full disclosure of the settlement terms. Some courts then require that other creditors, the Chapter 7 trustee, and the US Trustee be given the opportunity to become the plaintiff and continue the litigation. Other courts take a “cautious but pragmatic approach”, considering whether the proposed settlement is in the bankruptcy estate’s best interest. “All three tests endeavor to distinguish between appropriate and inappropriate settlements. The cautious but pragmatic approach is best suited to allow a careful consideration and inappropriate and appropriate settlements .The cautious but pragmatic approach is best suited to allow a consideration of the multitude of factors that may occur, particularly where a Section 727 complaint is joined with a Section 423 complaint brought by a creditor. It is particularly sensitive to a determination of whether the consideration for the settlement of the Section 727 count will go to the estate rather than an individual creditor even though the consideration may be attributed by the parties to the Section 423 count…” the court said.

“Jesus looked at them and said to them, “With men this is impossible, but with God all things are possible.” Mathew 19:26.

Lawrence Bautista Yang is a graduate of Georgetown University Law Center and has been in law practice for thirty years.  He specializes in bankruptcy, business and civil litigation and has handled more than five thousand successful bankruptcy cases in California.  He speaks Mandarin and Fujien and looks forward to discussing your case with you personally.  Please call (626) 284-1142 for an appointment at 1000 S Fremont Ave, Mailstop 58, Bldg A-1 Suite 1125, Alhambra, CA 91803.