Bankruptcy Code 523: Exceptions to Discharge

A primary goal of filing for personal bankruptcy is to obtain a discharge, a court order that formally releases an individual from the legal obligation to pay certain debts. This discharge provides a financial “fresh start” for honest but unfortunate debtors. However, this fresh start is not absolute. Federal law, specifically Section 523 of the U.S. Bankruptcy Code, identifies numerous categories of debts that are not eligible for discharge due to public policy reasons. These exceptions are based on the nature of the debt itself or on improper conduct by the person filing for bankruptcy.

Automatically Non-Dischargeable Debts

Certain debts are considered non-dischargeable by law, meaning they survive the bankruptcy process without any required action from the creditor. These exceptions are automatic and rooted in public policy, which deems some obligations too important to be erased. The Bankruptcy Code lists these exceptions to ensure that a debtor’s fresh start does not come at the expense of these specific societal interests.

Domestic Support Obligations

Among the most prominent automatic exceptions are domestic support obligations. This category includes debts for alimony, maintenance, or child support. These financial duties are considered a priority and are not eliminated by a bankruptcy discharge, reflecting a strong public policy to ensure the continued support of former spouses and children.

Certain Tax Debts

The treatment of tax debts in bankruptcy is complex, but some are automatically non-dischargeable. This includes recent income taxes, typically those for which the tax return was due within three years before the bankruptcy filing. It also covers payroll taxes and other trust fund taxes, which are monies held by an employer “in trust” for a government agency. If a tax return was never filed or was filed fraudulently, the related tax debt cannot be discharged.

Government Fines and Penalties

Fines, penalties, and forfeitures payable to a governmental unit are generally not dischargeable. This exception applies as long as the penalty is not compensation for an actual monetary loss. This means punitive penalties, such as traffic fines or criminal restitution, will remain owed by the debtor after the bankruptcy case concludes.

Student Loans

Federally guaranteed and private student loans receive special treatment and are a significant category of non-dischargeable debt. These educational loans cannot be discharged unless the debtor can prove in a separate legal action that repaying the loan would impose an “undue hardship.” This is a difficult standard to meet, often requiring a showing of a certainty of hopelessness regarding the debtor’s financial future.

Debts from Death or Injury Caused by Drunk Driving

Debts for death or personal injury caused by the debtor’s operation of a motor vehicle, vessel, or aircraft while legally intoxicated are not dischargeable. This rule ensures that victims of such acts are not left without recourse due to the offender’s bankruptcy filing.

Debts Unlisted in the Bankruptcy Filing

A debtor is required to list all their debts on the bankruptcy schedules filed with the court. If a debt is not listed or scheduled in time for the creditor to file a proof of claim and participate in the bankruptcy case, that debt is not discharged. This exception only applies if the creditor did not have notice or actual knowledge of the bankruptcy case in time to act.

Debts Requiring Creditor Action to Prevent Discharge

Unlike the automatic exceptions, some debts are discharged unless the creditor takes timely legal action to prevent it. These exceptions typically involve some form of misconduct by the debtor in how the debt was incurred. For these specific types of debts, the creditor must file a formal lawsuit within the bankruptcy case to have the debt declared non-dischargeable. If the creditor fails to act, the debt will be erased.

Debt Obtained by Fraud or False Pretenses

A significant category of debt that requires creditor action is for money, property, or services obtained through fraudulent means. This includes debts incurred by “false pretenses, a false representation, or actual fraud.” This can involve a direct lie or a deceptive act intended to mislead a creditor. The statute also specifically addresses the use of a written statement about the debtor’s financial condition that is materially false and on which the creditor reasonably relied.

Debt for Fraud While Acting as a Fiduciary, Embezzlement, or Larceny

This provision makes debts non-dischargeable for fraud or “defalcation” (a failure to account for funds) while acting in a fiduciary capacity. The term “fiduciary capacity” is narrowly defined in bankruptcy law and often requires the existence of an express trust. This section also covers debts arising from embezzlement, which is the fraudulent appropriation of property by someone to whom it was entrusted, and larceny.

Debt for Willful and Malicious Injury

Debts for “willful and malicious injury by the debtor to another entity or to the property of another entity” can be excepted from discharge. This requires more than just negligent or reckless behavior. The creditor must prove that the debtor intended to cause the injury, not just that they intended to perform the act that resulted in injury. This means the action must have been both deliberate and targeted to cause harm.

The Adversary Proceeding

For a creditor to challenge the discharge of debts related to fraud or willful injury, they must initiate a lawsuit known as an adversary proceeding. This formal legal action functions as a separate case filed within the main bankruptcy proceeding to resolve the dispute over the dischargeability of a particular debt.

A creditor must file their adversary proceeding complaint no later than 60 days after the first date set for the meeting of creditors. This meeting, also known as the 341 meeting, typically occurs about a month after the bankruptcy case is filed. This deadline is rigidly enforced, and missing it means the creditor loses the right to object.

Once the complaint is filed, the process resembles a standard federal lawsuit. The debtor must file an answer responding to the creditor’s allegations. The parties may then engage in discovery, which can include exchanging documents and taking depositions. If the case is not settled, it will proceed to a trial before the bankruptcy judge.

Distinctions Between Chapter 7 and Chapter 13

The rules for which debts can be discharged differ significantly between Chapter 7 and Chapter 13 bankruptcy. A Chapter 7 bankruptcy involves the liquidation of non-exempt assets to pay creditors, while a Chapter 13 involves a three- to five-year repayment plan.

A key difference is the Chapter 13 “superdischarge,” which is broader than the discharge available in Chapter 7. This means that certain debts that are non-dischargeable in a Chapter 7 case can be eliminated upon the successful completion of a Chapter 13 plan. This broader discharge was designed to create an incentive for debtors to choose the repayment plan structure of Chapter 13.

For example, a debt for willful and malicious injury to property is non-dischargeable under Chapter 7 but can be discharged in Chapter 13. Similarly, certain debts arising from divorce property settlements (but not domestic support obligations) are non-dischargeable in Chapter 7 but can be discharged through a completed Chapter 13 plan.