The different sections of the Bankruptcy Code should all work together for a common purpose. Sometimes a situation arises which looks like a disconnect. I had this happen in a dischargeability case I am defending. The creditor filed an action under Section 523, based on a suit pending in another state, and asked to have the stay lifted to allow the case to go forward. While the motion was pending, the debtor received his general discharge. The court asked the parties to address the impact of Section 362(c)(2)(C), which states that the automatic stay for an individual in Chapter 7 terminates upon entry of the general discharge.
By way of background, Section 523 provides that the discharge under Section 727 “does not discharge an individual from any debt” covered by the next nineteen subsections.
In the case of an individual debtor, the automatic stay under Section 362(a) operates like a preliminary injunction, enjoining suits against the debtor pending entry of the discharge. The discharge acts like a permanent injunction and bars the pursuit of actions against the discharge. With respect to lawsuits and collection actions, the protection of the discharge takes over from the automatic stay. In theory, the transition should be seamless. However, what happens in the situation where the stay has expired under Section 362(c)(2)(C), but the debt has not been determined to be dischargeable or non-dischargeable?
The problem, as it first appeared to me, was that if the stay terminated due to the discharge and the debt had not been discharged, didn’t that leave the creditor free to continue the litigation? My solution was to say that when the debt has not been determined to be dischargeable or not, the discharge had not taken effect as to that debt and therefore that Section 362(c)(2)(C) did not apply.
The judge had a different analysis, although it essentially arrived at the same result. The Court ruled that entry of the discharge did in fact terminate the stay, rendering the motion to lift stay moot. However, the discharge took over at that point. Section 524(a)(2) states that the discharge “operates as an injunction against the commencement or continuation, the employment of process, or an act, to collect, recover or offset any such debt as a personal liability of the debtor….” Thus, the court found that even though dischargeability had not yet been determined, the discharge blocked pursuit of the state court action. The court further ruled that if the creditor wanted to continue in the state court forum, it could ask the bankruptcy court to abstain in favor of the state court action.
The court’s solution reconciles Sections 362(c)(2)(C), 523(a) and 524(a)(2). The discharge is the discharge. Thus, for an individual in a chapter 7 case, entry of the discharge terminates the stay. However, the automatic stay is replaced by the injunction of Section 524(a)(2). If the debt is later found to be nondischargeable, then Section 523(a) excludes it from operation of the discharge. That being said, during that period when the debt is neither dischargeable nor nondischargeable, the discharge applies.
The problem that I had in my thinking was that I assumed that the discharge did not take effect until the debt was found to be dischargeable. However, the opposite is true. The debt is not excluded from the discharge until the court so finds.
The problem is more difficult for debts that are automatically deemed nondischargeable. Recently I wrote that certain educational loans did not fall within the language of Section 523(a)(8). Thus, these debts would be immediately discharged. However, if the debtor misunderstands the nature of the debt and it really is nondischargeable, then the discharge would never take effect. For these automatically nondischargeable debts, there is a binary outcome. Either the discharge applies immediately, or it is excluded from discharge immediately. Despite this certainty, there may be ambiguity as to whether the discharge applies or not. This leads to the possibility that a creditor may be violating the discharge, even if it has a good faith belief that the discharge does not apply. In this case, a prudent creditor will stop trying to collect and seek a determination that the discharge does not apply. However, in far too many cases, I see the creditor continue trying to collect until the court finds the debt to be subject to the discharge. At that point, the discharge has clearly been violated and there may be consequences for the creditor.
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