Debtors Entitled to Discharge Despite Bad Faith Conduct

Posted by NCBRC - November 9, 2018

The debtors were entitled to discharge once they completed their payments under the plan notwithstanding the fact that they “gamed the system” and conducted their bankruptcy in bad faith. Davis v. Holman (In re Holman), No. 17-1118 (D. Kans. Oct. 31, 2018).

During the course of their chapter 13 bankruptcy, debtors, Shala and Nathan Holman, failed to disclose assets and debts, employment status, post-petition debts, and other relevant information. They modified their chapter 13 plan numerous times and responded to challenges by the trustee based on bad faith. In one challenge, addressing the entirety of their misconduct to date, the court held a hearing and the parties reached a stipulated agreement resolving the issues. In July, 2016, the trustee again sought dismissal of their case based on bad faith. While that litigation was pending, the debtors successfully completed their payments in accordance with their confirmed plan. After trial on the motion, the bankruptcy court found that while the debtors’ conduct indeed constituted bad faith, the court was precluded from dismissing the case because the debtors’ successful completion of their plan payments entitled them to discharge.

On appeal, the district court addressed the question of whether the mandatory language of section 1328(a), which provides that upon completion of all payments under the plan, a “court shall grant the debtor a discharge,” trumps the discretionary language of section 1307(c), which provides that a court may dismiss a case for cause upon motion by a party in interest. The court reviewed cases falling on both sides of the equation and found that those cases allowing dismissal after the debtor completed her plan, did not address the impact of section 1328(a)’s mandatory language and were, therefore, unpersuasive.

On the other hand, while courts finding to the contrary differed in some instances on the issue of what constituted “payments under the plan,” they did not disagree on the ultimate question of the significance of a debtor’s having completed those payments. Those courts found that “shall means shall” and thus the mandatory language of section 1328(a) deprived the bankruptcy court of discretion to dismiss under section 1307(c).

The district court agreed with those cases finding that the mandatory language of the discharge provision prevails, and on that basis, concluded that despite the fact that debtors had, in fact, conducted their bankruptcy in bad faith, the bankruptcy court was powerless to do anything other than discharge once the Holmans completed their payments under the plan.

The court rejected the trustee’s argument based on the may/shall dichotomy raised by the interplay between the discretionary language of section 1307(c) and the mandatory language of section 1307(b), which provides that “[o]n request of the debtor at any time, . . . the court shall dismiss a case under this chapter.” The court found the trustee’s argument unpersuasive because, while the issue had never been addressed by the Tenth Circuit or any of its district courts, a bankruptcy court in Kansas found that even within section 1307, the mandatory language of paragraph (b) trumps the discretionary language of paragraph (c).

The court therefore affirmed the order of the bankruptcy court and dismissed the appeal.

Holman D Kan Oct 2018

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