Undisclosed Debt Discharged In No-Asset Chapter 7

Where an undisclosed debt was automatically discharged in the debtor’s chapter 7 bankruptcy, the court declined to reopen to permit the debtor to add the debt to her schedules. In re Mohammed, No. 13-73191 (Bankr. E.D. N.Y. Sept. 4, 2015). In February, 2013, a state court entered a default judgment of over $430,000.00 against Mir Mohammed and other co-defendants. Ms. Mohammed filed a no-asset chapter 7 case in June, 2013, but did not list the judgment creditor in her bankruptcy petition and related documents. Ms. Mohammed obtained her discharge in September, 2013, and the trustee issued his report of no distribution.

One year later, Ms. Mohammed moved to reopen to schedule the debt and have it discharged. She argued that her failure to include the debt was inadvertent because she did not realize that she was a co-defendant responsible for its payment. The court held a hearing on the motion.

In its order, the court began with the general finding that it has discretion to reopen a case for good cause and within a reasonable time “to administer assets, to accord relief to the debtor, or for other cause” under Bankruptcy Rule 5010 and section 350(b). A court will look to the merits of the relief sought when deciding whether to reopen and will not reopen if doing so would serve no purpose.

In considering Ms. Mohammed’s motion, the court began with the issue of whether an undisclosed debt is discharged in chapter 7 bankruptcy. It found that circuit courts are split between applying a “mechanical approach” and an “equitable approach” to this question.

The mechanical approach follows section 727(b), which provides that discharge applies to debts without regard to whether a claim was filed, and section 523(a)(3) which describes conditions under which an undisclosed debt is not discharged. Unless the debt falls under one of section 523(a)’s exceptions to discharge the mechanical approach automatically discharges the undisclosed debt. [Watson v. Parker (In re Parker), 313 F.3d 1267 (10th Cir. 2002) (so long as debt is not non-dischargeable under section 523(a)(2), (4) or (6), and the creditor had notice of the bankruptcy in time to protect his rights, section 727(b) acts to discharge the undisclosed debt)].

With respect to the notice component of section 523(a)(3), the court, quoting In re Haemmerle, 529 B.R. 17, 24 (Bankr. E.D. N.Y. 2015), found “where there is no deadline set to file a claim in a no asset chapter 7 case, if the debt at issue does not fall within the category of non-dischargeable debts listed in Sections 523(a)(2), (4) or (6), there is no deadline for the creditor to file a timely claim, and, therefore, the creditor could not have notice or actual knowledge of a deadline to file a claim that has not been set.” The court pointed to the Third, Sixth, Ninth and Tenth Circuit Courts of Appeals as having adopted the mechanical approach.

Under the equitable approach courts look at the circumstances surrounding the omission of the debt and may allow a case to be reopened to allow the creditor to challenge discharge. [Matter of Stone, 10 F.3d 285 (5th Cir. 1994) (In determining whether failure to list creditor prevents discharge: “Courts must examine 1) the reasons the debtor failed to list the creditor, 2) the amount of disruption which would likely occur, and 3) any prejudice suffered by the listed creditors and the unlisted creditor in question.”)].The court found this approach adopted by the First, Fifth, Seventh and Eleventh Circuits.

Noting that the Second Circuit has not ruled on the issue, the Court adopted the mechanical approach. Under that approach, it held that the debt at issue was discharged in Ms. Mohammed’s chapter 7 bankruptcy.

The court then turned to whether reopening the case would serve a purpose. It applied a three-part test under which it looked at whether: “(i) the debtor or creditor can state a plausible basis for seeking a determination that the debt at issue does or does not fall within the category of non-dischargeable debts listed in Sections 523(a)(2), (4) or (6); or (ii) the creditor can state a plausible basis for the court to determine that assets may become available to distribute to creditors; or (iii) prejudice to either party which can be remedied by reopening the case has been demonstrated.”

Applying this test, the court found that there was no evidence of bad faith on the part of the debtor, and the creditor had “not suggested that the Judgment, which sounded in contract, is a debt that falls within Sections 523(a)(2), (4) or (6), nor has he suggested that assets may be available for creditors; further, neither side has demonstrated any prejudice that will result which can be remedied by reopening the case; therefore, this case will not be reopened.” The deprivation of the creditor’s right to elect the trustee, question the debtor at the creditor’s meeting or object to exemptions or discharge, without any showing that he suffered prejudice by reason of those deprivations, did not meet the requirements of the test for reopening.

Thus, the court denied the motion because “no purpose would be served by reopening this case.”

Mohammed Bankr ED NY opinion