The Trial in a Dischargeability Proceeding: an Example

 Posted on April 03, 2017 in Discharge of Debts

In our example about the process about whether a debt gets discharged, here’s what happens at the bankruptcy court trial itself.

This is the fourth blog post in a series showing how a legal dispute gets resolved in bankruptcy court. The process is called an “adversary proceeding”—essentially, a lawsuit in bankruptcy. The dispute at issue is whether a debtor’s Chapter 7 “straight bankruptcy” will discharge—permanently write off—a particular debt.

The Story So Far

The creditor, Heather, has formally objected to the discharge in a complaint—see our blog post of a week ago. Essentially, she alleged that the debtor, Marshall, her nephew, lied in the credit application she asked him to complete. He did not include a $7,500 debt that he owed to another aunt. Because of this fraud on her, Heather has now argued that Marshall should not be able to discharge the $21,000 that he still owes her.

Marshall, through his bankruptcy lawyer, filed an answer to Heather’s complaint—see two posts ago. He admitted that he had not included the $7,500 debt in Heather’s loan application. But he argued that his omission wasn’t significant enough to make his application “materially false.” Also, he figured that Heather had already heard about his prior debt through family gossip. So she couldn’t “reasonably rely” on his omission in making the loan when she already knew about that prior debt. Finally, Marshall didn’t omit the prior loan from the application with “intent to deceive” Heather, again since she already likely knew about it.

See our last blog post for what happened when we got into the next stage of the litigation—“discovery.” That’s the step where both Marshall and Heather tried to get at the relevant facts. In this case they each sent the other a formal list of questions to answer—interrogatories. Their sworn answers indicate how they would testify at a trial, if the case didn’t settle before then.

Settlement

After a debtor and creditor finish “discovery,” they usually settle their dispute. That’s because at this point it tends to become much clearer who would likely prevail at a trial.

Also, a trial is very expensive. A lot of time goes into preparing for a trial, and for the trial itself. So even a relatively straightforward trial costs a few thousand dollars in lawyer time. That encourages settlement, especially after the facts are more clearly on the table.

Sometimes the adversary proceeding ends at this point with a slam dunk for one of the two sides. A creditor sees that it is going to lose and simply dismisses the adversary proceeding. Or the debtor sees that the creditor has strong grounds against the discharge of the debt and agrees to pay it all.

But most of the time a settlement is needed because it’s not a slam dunk for either side. Usually the debtor must agree to pay something to get the creditor to not chase the rest of the debt.

If there is no settlement, the case goes to trial.

Marshall’s Testimony at Trial

After opening statements by their lawyers, Marshall testified under oath as follows:

• He omitted the prior $7,500 loan in the application because he figured that Heather had already heard about it.
• In his conversations with Heather as she was considering lending him the money, she told him she was doing out of their family connection instead of conventional economic issues like his creditworthiness and capacity to pay it back. He got the strong impression from her that the content of the loan application was not important.
• He was not trying to trick her about anything, such as the amount of his debts. He just didn’t think that the application had much bearing in her decision whether to lend to him.

On cross-examination by Heather’s lawyer, Marshall admitted:

• He also omitted the prior loan from the application because Heather had a reputation for being unpredictable. He’d heard she was having a feud with the other aunt to whom he owed that other loan. He was desperate to have her give him the money. He didn’t want to give her any excuse for not going ahead with it.
• Heather did tell him that her lawyer was preparing loan documents because she wanted to “make it all legal.” He did not really know how much she was going to rely on the content of the loan application in making her decision.
• He may have been engaging in “wishful thinking” to guess that Heather was not putting much weight on the content of the loan application. Again, the truth was he simply didn’t know how she was deciding. He had been very relieved that she gave him the loan.

Heather’s Testimony at Trial

Heather then testified under questioning by Marshall’s lawyer as follows:

• She had known about Marshall’s earlier loan from the other aunt. It was made years before Marshall approached her about the business loan. She’d heard that loan had been for him get a community college degree in auto repair without needing to work at the same time. Its amount was less what he needed from her for the business loan.
• She did not review the loan application after Marshall had completed it. She talked with her lawyer about it very generally—mostly just confirming that Marshall sent it to the lawyer. She did not discuss any of its details with her.
• Heather based her decision on whether to make the loan to Marshall on family considerations—on her sense of connection and obligation to him. Not having had kids herself, she felt closest to him of all her nieces and nephews. She definitely had the financial means to help him. She believed that he would do his very best at making the business successful. From conversations with him, she became convinced that he had the talents and drive needed. So she decided she wanted to help him achieve his dream of creating his own car repair business. But now she wanted him to repay her loyalty to him with the return loyalty of repaying the loan.

Closing Arguments and the Bankruptcy Judge’s Determination

Next time (this coming Wednesday morning) we finish this series with the two lawyers’ closing arguments and the judge’s ruling.