Most debtors believe that once they receive a discharge in bankruptcy and their case is closed they can put their troubles behind them. While that’s true almost all the time the bankruptcy code does leave the door open for creditors to complain that the discharge was obtained as a result of fraud. Like many other provisions of the bankruptcy code the timeframe for bringing these actions is somewhat compressed.
The procedure for debtors obtaining a discharge in bankruptcy is fairly straightforward. At the beginning of the bankruptcy case the debtor submits schedules of assets and liabilities and a statement of financial affairs. These documents attempt to accurately and completely portray the debtor’s financial condition. The debtor signs these documents under penalty of perjury and they become open to the public.
Approximately 30 to 40 days after filing a case the debtor meets with a Chapter 7 trustee. (Although this meeting is technically called the “first meeting of creditors” creditors almost never attend.) Creditors and the trustee then have 60 days after the first meeting of creditors to complain to the bankruptcy court that the debtor should not receive a discharge or that individual claims should not be discharged and should survive the bankruptcy case. This 60 day period is strictly enforced and if no complaints are filed during that time the bankruptcy court will promptly award the debtor a discharge.
Almost every chapter 7 case results in the debtor receiving a discharge. At the same time, almost every chapter 7 case is a “no asset case” where the trustee does not identify any assets to be liquidated to cash for distribution to creditors. If the case is a “no asset” case, the bankruptcy will be closed promptly after the debtor receives a discharge. However, this is not always the end of the story.
Within one year after entry of the discharge the trustee, a creditor, or the United States trustee may request a revocation of that discharge “if it was obtained through the fraud of the debtor, and the requesting party did not know of the fraud until after the granting of such discharge.” In those situations, the objecting creditor will likely need to ask the bankruptcy court to reopen the case and at the same time file a motion to revoke the debtor’s discharge.
Other grounds to cause the revocation of the debtor’s discharge also address the debtor who is dishonest or refuses to cooperate in the bankruptcy process. For example, a debtor may obtain property by inheritance within 180 days after filing a bankruptcy case. When that happens, the debtor is supposed to report that inheritance to the Chapter 7 trustee, even if the bankruptcy case has been closed. If the debtor “knowingly and fraudulently” fails to report this inheritance then the trustee or other creditor may file a motion to revoke the discharge. The timeframe for bringing this action is one year after the later of closing the case or entry of the discharge order. If the trustee identifies assets for distribution then the debtor’s exposure to a discharge revocation could be considerably longer then one year after the discharge: trustees frequently keep a Chapter 7 case open for several years as they identify assets for liquidation and distribution to creditors. This longer timeframe also applies if the grounds for the motion to revoke the discharge are that a debtor has refused to obey an lawful order of the court or to respond to a material question approved by the court or otherwise to testify as to a material fact in the bankruptcy case.
Finally, grounds to revoke a debtor’s discharge may arise when a debtor fails to cooperate during an audit conducted by the United States trustee. Although these audits are rare, the United States trustee does have the right to conduct audits of debtors, their assets, debts, income and expenses. These audits serve the function of policing the “honor system” that is at the heart of the bankruptcy disclosure process. Specifically, the bankruptcy code provides the United States trustee with the right to ask for revocation of discharge if the debtor “fails to explain satisfactorily a material misstatement” or “make available for inspection all necessary accounts, papers, documents, financial records, file and all other papers, things, or property belonging to the debtor that are requested for an audit.”
The bankruptcy code is silent as to the timeframe for the United States trustee to ask a bankruptcy court to revoke the debtor’s discharge upon the debtor’s misbehavior during an audit. While the United States trustee should not have an unlimited amount of time to bring this action a debtor should expect that a bankruptcy court will grant the United States trustee longer than the one year after discharge imposed upon other creditors.
Creditors almost never file motions to revoke a debtor’s discharge. Nevertheless, the threat exists that a dishonest debtor may have his ill-gotten fresh start taken away. This “escape hatch” for creditors is an important component to preserve the integrity of the bankruptcy system.