One of the main reasons people and entities declare bankruptcy is to obtain discharge from their debts. The Bankruptcy Code (USC §§ 101, and. after) gives a fresh start to honest debtors by imposing an injunction on creditors to take any action to recover debts paid.
Given this potent weapon in debtors’ arsenal, creditors would naturally want their claims excluded from the scope of this release. 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, goods, services or extension, renewal or refinancing of credit to the extent obtained by false pretense, misrepresentation or actual fraud;
(3) fraud or misappropriation by a debtor who is a fiduciary;
(4) household maintenance obligations and other debts arising from divorce or separation proceedings;
(5) willful and malicious injury to an entity or to that entity’s property;
(6) certain fines, penalties and forfeitures payable to and for the benefit of a government unit; and
(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 the debtor executes 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 for bankruptcy, to repay a specific debt if the debtor meets a long set of criteria listed in that section.
Some creditors have attempted to circumvent these special provisions which allow a debtor to waive all or part of the benefits of a discharge by having the debtor accept, before declaring bankruptcy, that he waives the benefit of a discharge. bankruptcy for a debt to that creditor or undertakes not to declare bankruptcy. These pre-discharge waivers may be embodied in a promissory note, contract, settlement agreement or any other number of documents. For enterprising creditors who have included pre-petition waivers of discharge in various agreements, the objective is clear: to protect their debts in advance of a transaction or in collection efforts against the debtor who owes money. Such a creditor can congratulate themselves and be sure that their position is protected in case the debtor does the unthinkable and files for bankruptcy, but is this confidence justified?
The vast majority of courts have ruled pre-petition discharge waivers unenforceable because they are illegal, void due to public policy concerns, and violate the previously discussed Code provisions that provide specific means for debts to be discharged. exempt from release. Waivers of discharge before the request are ipso facto (“by the same token”) clauses long considered contrary to the Bankruptcy Code.
Another well worn ipso facto clause is a provision in a contract or note that creates a default of a debt by the very act of filing for bankruptcy.
In the Eastern District of Virginia, the main case on pre-petition waiver of discharge clauses is Domain of McCoy c. McCoy (In re McCoy), 2016 Banker. LEXIS 2952 (2016)(Bank.EDVa.). In this case, a woman transferred the property in which she resided to her son and daughter-in-law, and the son and daughter-in-law then used this property to obtain a bank loan. The son died and the wife eventually paid the debt secured by the residence after the daughter-in-law defaulted on her debt to the bank. As a result, the daughter-in-law executed a note of avowed judgment in favor of the woman. The avowed judgment contained a provision by which the daughter-in-law would have waived “the benefit of any law or rule of law intended to release or discharge from any liability hereunder…”. When the daughter-in-law defaulted on the debt to the wife, the wife initiated collection activities and the daughter-in-law filed for bankruptcy.
In reviewing this clause, the bankruptcy court first noted that it was a type of ipso facto clause that would punish the debtor for filing for bankruptcy. ID. to 66. The Court noted that it would not apply ipso facto clauses because they have been rendered unenforceable at law by the enactment of the Bankruptcy Code, in particular sections 541(c) and 365(e)(1), because they are void against the public order in favor of giving debtors a “fresh start”, because they violate the legislative history of the Bankruptcy Code which prohibits “objecting to the execution of clauses which “impede the efforts of recovery” in bankruptcy”, and because many other courts have come to the same conclusion. To 66-69. If pre-petition waivers of discharge were permitted, all “sophisticated creditors would routinely demand that debtors waive” a potential discharge. ID. If that were to happen, debtors would lose one of the most, if not the most important, weapons in their arsenal. The application of such “agreements would render obsolete the protections of the Bankruptcy Code”. ID.
As such, pre-petition waivers of discharge are unenforceable and, unfortunately for creditors, a waste of ink in an agreement.