MIAMI BUSINESS LITIGATION: BANKRUPTCY CONSIDERATIONS IN LITIGATION STRATEGY

Florida companies should always consider the risk that a business litigation defendant will attempt to avoid paying an adverse money judgment through bankruptcy proceedings. While bankruptcy protection is usually invoked by people and companies that are genuinely insolvent, bankruptcy protection can also be abused by cunning defendants to avoid paying adverse judgments. Claims which are discharged in bankruptcy are not collectable. Accordingly, a money judgment against a defendant for a claim discharged in bankruptcy is not worth the paper it is printed on. A savvy plaintiff can strategically plan to limit the possibility that a nefarious defendant will avoid his or her liability through bankruptcy. Peter Mavrick is a Miami business litigation lawyer, and also represents clients in business litigation in Fort Lauderdale, Boca Raton, and Palm Beach. The Mavrick Law Firm represents clients in breach of contract litigation, non-compete agreement litigation, trade secret litigation, trademark infringement litigation, and other legal disputes in federal and state courts and in arbitration.

Bankruptcy permits a debtor to discharge certain debts to give the debtor a fresh start. A discharge of a debt in bankruptcy “voids any judgment at any time obtained, to the extent that such judgment is a determination of the personal liability of the debtor.” 11 U.S.C. § 524(a)(1). It also bars a plaintiff from pursuing such a claim. 11 U.S.C. § 524(a)(2) (“A discharge in a case under this title […] operates as an injunction against the commencement or continuation of an action, the employment of process, or an act, to collect, recover[,] or offset any such debt as a personal liability …”). Because of this, bankruptcy protection can be a powerful tool for defendants to avoid their obligations to pay money judgments.

Sometimes, however, a cunning defendant in business litigation will invoke bankruptcy protection even though he or she has the money to pay a judgment. A plaintiff who expects a defendant to attempt such a scam can preemptively strategize to avoid this result. This is accomplished by ensuring that the causes of action brought against a party are exempt from bankruptcy discharge.

There are certain types of claims which are not subject to discharge. Generally, the bankruptcy code prevents the discharge of actions taken purposefully to harm another person. These are described in 11 U.S.C. § 523(a), which in pertinent part states:

(a) A discharge […] does not discharge an individual debtor from any debt:[…]

(2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by–false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition; […]

(4) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny; […]

(6) for willful and malicious injury by the debtor to another entity or to the property of another entity; […]

(19) that–is for– the violation of any of the Federal securities laws […] or common law fraud, deceit, or manipulation in connection with the purchase or sale of any security.

“Recklessly or negligently inflicted injuries are not excepted from discharge under § 523(a)(6)” In re Jennings, 670 F.3d 1329 (11th Cir. 2012). Instead, “[a] debtor is responsible for a ‘willful’ injury when he or she commits an intentional act the purpose of which is to cause injury or which is substantially certain to cause injury.” Kane v. Stewart Tilghman Fox & Bianchi, P.A. (In re Kane), 755 F.3d 1285 (11th Cir. 2014). A debtor must intend the harm which was caused. In re Walker, 48 F.3d 1161 (11th Cir. 1995) (“We follow our sister courts in concluding that, in order to be “willful” under section 523(a)(6), the debtor must have intended more than merely the act that results in injury. Congress has been very clear in expressing its intention in section 523(a)(6). The plain language of section 523(a)(6) excepts from discharge debts arising from ‘willful and malicious injury’ rather than ‘willful and malicious acts which cause an injury’”).

Similarly, “‘malicious’ means ‘wrongful and without just cause or excessive even in the absence of personal hatred, spite or ill-will.’” In re Walker, 48 F.3d 1161 (11th Cir. 1995). “Malice can be implied when a debtor commits an act that is ‘wrongful and without just cause or excessive even in the absence of personal hatred, spite or ill-will.’” In re Thomas, 288 Fed. Appx. 547 (11th Cir. 2008).

In the recent case, In Re Gaddy, 19-11699, 2020 WL 5793082 (11th Cir. Sept. 29, 2020), the Eleventh Circuit Court of Appeals affirmed the trial court in an adversarial action. The debtor was a personal guarantor for a $12.5 million dollar loan which the debtor’s company borrowed to fund a construction project. As it became clear to the debtor that the loan was in default, he distributed much of his property to various family members. The lender filed a lawsuit to collect on the money. After judgment was entered in favor of the plaintiff, the debtor filed for Chapter 7 bankruptcy. The lender sought to avoid its judgment from being discharged under 11 U.S.C. § 523 (a)(2)(A) and (a)(6). The Gaddy trial court held that the basis for the lender’s theory of exemption was not proper. The Gaddy appellate court agreed, holding that a prior debt cannot become exempt from discharge through subsequent conduct. Essentially, the reason for the existence of the debt must be one of the listed exemptions from discharge, subsequent fraudulent conduct cannot cause a debt to become exempt.

The Gaddy lender’s claim in its lawsuit could have been a strategic error. Had the Gaddy lender in the original business litigation case been able to show that the loan was provided to the defendant based upon defendant’s fraudulent statement, the underlying debt might not have been dischargeable. However, because the Gaddy lender had only sought to collect on a breach of a personal guarantee, the subject debt was discharged in bankruptcy. Of course, the Gaddy lender should not make a claim which was not supported by the facts. However, it would probably have been a strategic error had there been evidence of fraud at the time of the loan and the Gaddy lender simply pursued a breach of a personal guarantee because it was easier to win. In this way, the Gaddy lender could have avoided the eventual discharge of its loan.

Companies pursuing claims against individuals should consider the possibility that the defendant may fraudulently seek bankruptcy protection. By considering a defendant’s potential bankruptcy strategies, a plaintiff can reduce the likelihood that a debt will be discharged in bankruptcy. Peter Mavrick is a Miami-Dade business litigation attorney who also practices business litigation in Fort Lauderdale and Palm Beach. This article does not serve as a substitute for legal advice tailored to a particular situation.