For more than 100 years, Virginia has been misled with the fib: “Yes, Virginia, there is a Santa Claus.” But you can tell her: “Yes, Virginia, there is a bankruptcy-proof promissory note” and be telling the truth.
Ordinarily, a promissory note or settlement agreement requiring payment(s) cannot be eliminated (discharged) in bankruptcy. A Bankruptcy Court will not enforce language saying the agreement to repay is nondischargeable unless there is legal support. The legal support is that the obligation relates to a debt that is not dischargeable in bankruptcy.
Exceptions to discharge are found in 11 U.S.C. §523. With exceptions noted below, all of these debts are nondischargeable in Chapters 7, 11 and 13 for the following debts:
- A domestic support obligation, such as an agreement to repay accrued alimony, maintenance or support;
- To a spouse, former spouse or child that is not a domestic support obligation but arises in the course of a divorce or separation agreement, divorce decree or other order of a court in such proceeding (unless the debtor files Chapter 13 and is found to be filing in good faith).
- For money, property, services or credit to the extent obtained by false pretenses, false representations or actual fraud but not relating to financial condition;
- Arising from a false writing respecting a financial condition upon which the creditor relied and that the debtor caused to be made with the intent to deceive;
- For willful and malicious injury to another or the property of another (unless the debtor files Chapter 13 and is found to be filing in good faith);
- Arising from fraud or defalcation while acting in a fiduciary capacity, embezzlement or larceny;
- Arising from death or person injury while operating a motor vehicle if the operation was unlawful because of intoxication;
- For payment of an order of restitution issued for a crime under Federal law; and
- Certain tax obligations.
If the Code says that the preceding debts are nondischargeable, then a promissory note evidencing such wrongful actions are not dischargeable. Will a court agree? Yes, Virginia, the promissory note may be bankruptcy proof.
We can rely on the rationale of Archer v. Warner, 538 U.S. 314 (2003). In Archer, business owners sued the seller of the business for fraud. The parties settled the lawsuit with Warner executing a promissory note for $100,000. The Archers dismissed the lawsuit. Warner found the quickest way he could file in the Bankruptcy Court, arguing that the promissory note replaced the original claim of fraud under 11 U.S.C. §523. Since the note was a new debt, it was dischargeable. The Supreme Court concluded that the trial court may look beyond the state-court record and documents to decide whether the debt was a nondischargeable debt for money obtained by fraud.
Using Archer, you can prepare a promissory note that may not be dischargeable in bankruptcy by referring to the type of nondischargeable debt in the note, including a reference to the particular section of 11 U.S.C. §523 and cite to Archer v. Warner in the note. If the debt resulted from a nondischargeable obligation, the likelihood of your promissory note surviving discharge in bankruptcy increases dramatically.
If you have any questions on this topic, please contact James Hoffman at
ABOUT JAMES HOFFMAN
James Hoffman is a corporate, bankruptcy and litigation attorney and the Chair of the Creditors Rights, Restructuring and Bankruptcy Practice. Mr. Hoffman focuses his practice in the areas of representing various business types, particularly closely held businesses and has a broad base of experience representing creditors, trustees and debtors in bankruptcy cases and litigation. In his business practice, Mr. Hoffman represents businesses through their life cycles from creation, to formulating employment and shareholders agreements, creating contracts, collecting debts and closing the business through sale or liquidation. Mr. Hoffman has represented nine different Chapter 7 trustees, and several Chapter 11 trustees and receivers. Thus, he is “a lawyer’s lawyer.” He has been involved in handling a broad range of litigation before state courts, including disputes involving complex commercial litigation, breach of contract actions, and collection actions.
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