Exception to Discharge in Bankruptcy for Intentional Torts

EXCEPTION TO DISCHARGE IN BANKRUPTCY FOR INTENTIONAL TORTSBankruptcy Code Section 523(a)(6) prevents a debtor from obtaining the discharge of any debt for “willful and malicious injury by the debtor to another entity or to the property of another entity”.  There are two prominent interpretations as to how this provision is to be construed.  The Ninth Circuit interpretation is that the debtor’s actions “must be accompanied by some form of tortious conduct which gives rise to the willful and malicious injury.”  The Fifth Circuit maintains that tortious conduct is not required and that the creditor must only prove that the debtor intended to injury the other party or if the injury to the other party was substantially certain from the conduct of the debtor.  The salient cases that addressed this issue were In re Jercish in the Ninth Circuit and In re Williams in the Fifth Circuit.

The differing treatment among these Jurisdictions is at least partly created by the US Supreme Court decision in Kawaauhau v Geiger, which addressed the issue of whether reckless or negligent conduct could prevent the discharge ability of a debt, but did not address the matter of what kind of intentional conduct was necessary to maintain a creditor objection to Discharge under 523(a)(6).

Bankruptcy Code Section 523(a)(6) excepts from discharge any debt “for willful and malicious injury by the debtor to another entity or the property of another entity.”  From 1904 to 1998 the United States Supreme Court broadly interpreted “willful and malicious”.  To prevent the discharge of a debt, the claimant needed only to prove that the debtor’s action was an intentional and necessarily caused injury.  Malice was assumed based upon the argument that an intentional act caused the injury.  This standard can be found in the Supreme Court case of Tinker v Colwell in 1904.  This nearly century-long interpretation changed in the Geiger decision.

In the Geiger decision, the Court entertained whether  “a debt arising from a medical malpractice judgment, attributable to negligent or reckless conduct”, would be dischargeable under 523(a)(6) when there was no attendant willful or malicious injury.

In Geiger, the patient suffered the amputation of her right leg, below the knee, after receiving treatment from a foot injury.  The patient brought suit for malpractice, and the jury subsequently decided that the doctor committed malpractice in his treatment of the patient.  Following the verdict of the jury, the doctor filed Chapter 7 Bankruptcy, hoping to Discharge the debt presented by the verdict.

The bankruptcy court determined that the debtor’s behavior was willful and malicious because the “treatment fell far below the appropriate standard of care.”  The district court affirmed the bankruptcy court decision but the appellate court reversed the lower court holdings and held that the debt presented by the malpractice claim was dischargeable.

The US Supreme Court affirmed the decision of the appellate court, holding that the willful conduct requires a “deliberate or intentional injury, not merely a deliberate or intentional act that leads to injury.”  Furthermore, if Congress intended to “exempt debts resulting from intentionally inflicted injuries” it would have included such language in 523(a)(6).  Such unintentional inflicted injuries, as in the case of an automobile accident or a knowing breach of contract, are not addressed in the bankruptcy code, and specifically, Section 523(a)(6).

Such a construction, according to the Supreme Court, was not contemplated by Congress.  For example, Section 523(a)(9) which prevents the discharge of debts arising from injuries arising from the drunk or intoxicated operation of a motor vehicle, would be essentially duplicative or unnecessary, if the unintentionally inflicted injuries were included in the purview of 523(a)(6).

The clear ruling of Geiger is that 523(a)(6) only exempts deliberate or intentional injuries, but not intentional acts that result in injury.  Yet, the Court did not decide whether the conduct of the debtor must be not only willful and malicious but also tortious, to prevent Discharge.  This lack of attention by the Supreme Court to the issue of whether tortious conduct must be present arguably may be the cause of the differing opinions of the Fifth and Ninth Circuits.

Subsequent to the Geiger decision, the Ninth Circuit rendered a ruling in Petralia v Jercich.  Jercich, a real estate company owner, did not pay one of his employees, Petralia, under an employment contract.  Petralia brought suit in the state court.  The state court found in favor of Petralia, and Jercich thereafter filed bankruptcy.  Petralia brought an adversary proceeding to determine that the debt should not be discharged pursuant to Section 523(a)(6).

The bankruptcy court found in favor of Jercich, holding that the debt was discharged.  The bankruptcy appellate decision affirmed the bankruptcy court decision, holding “where a debtor’s conduct constitutes both a breach of conduct and a tort, the debt resulting from that conduct does not fit within 523(a)(6) unless the liability for the tort is independent of the liability on the contract” and because “there was not a tort independent from the contract, the debt was not exempt from discharge under 523(a)(6).”

The Ninth Circuit reversed the lower court ruling based on its determination that tortious conduct did exist, but essentially applied the same standard in determining whether a debt may be discharged, irrespective of a 523(a)(6) challenge.  The Ninth Circuit wrote, “breach of contract must be accompanied by some form of tortious conduct that gives rise to willful and malicious injury”.  The court found that tortious conduct was present because of the defendant’s nonpayment of the wages of the employee when he had the financial means to pay such wages, was a violation of California law.  The Ninth Circuit interpretation of 523(a)(6) is “the deliberate or intentional injury” standard determined by the Geiger decision which requires tortious conduct and willful and malicious injury, for a finding of a debt to be exempt from discharge.  Tortious conduct is a necessary element, along with willful and malicious injury, according to the Ninth Circuit interpretation.

The Fifth Circuit in Williams v International Brotherhood Of Electrical Workers Local 520 crafted its own interpretation of 523(a)(6), holding that tortious conduct was unnecessary, that the sole determination required for the exception to bankruptcy is that the conduct of the debtor was willful and malicious.

In Williams, the dispute arose from a purported violation of a collective bargaining agreement, and a later agreement between an electrical contractor and a union representing electrician who performed labor on a construction project.  Williams hired electricians who did not reveal their union membership and subsequently went on strike.

Purportedly, unable to hire nonunion electricians, Williams entered a collective bargaining agreement with the union.  Unsatisfied with the work performance of the union electricians, Williams hired nonunion electricians.  William’s action was a violation of the collective bargaining agreement.

The bankruptcy court held that debt arising from the violation of the collective bargaining agreement was not dischargeable because the debt “arose from willful and malicious injury.”  The district court affirmed the bankruptcy court.

The Fifth Circuit Court agreed with the lower courts, also rejecting the requirement of tortious conduct.  The Fifth Circuit held that there must be a single inquiry into “whether there exists either an objective substantial certainty of harm or a subjective motive to cause harm on the part of the debtor.”  The “debtor must commit an intentional or substantially certain injury in order to be deprived of a discharge.”  The Fifth Circuit decision interprets Geiger to only require conduct that was intentional or substantially certain to cause injury.

The 11th Circuit Court addressed Bankruptcy Code Section 523(a)(6) in Hope v Walker (1995).  The court has presented the issue of whether an employer’s failure to obtain statutorily required workers’ compensation insurance constitutes a willful and malicious injury under 523(a)(6).

Walker, the debtor, hired Hope to perform construction work on a house.  Hope fell approximately eight feet and broke his elbow and forearm, resulting in medical expenses, lost wages, and a permanent and partial disability.  Although state law requires that general contractors in Georgia obtain workers’ compensation insurance coverage for subcontractors, Walker did not have such coverage.  Walker claimed that he did not secure such coverage because he did not consider himself to be the general contractor, and believed that Hope was responsible for obtaining his own insurance for himself and his employees.

Hope sued Walker and the State Board of Workers’ Compensation awarded Hope disability benefits, medical costs, and other damages.  Walker paid a portion of the award and then filed Chapter 7 bankruptcy.  Hope filed an adversary complaint against Walker, arguing that 523(a)(6) prevented the discharge of the debt because such debt resulted from the willful and malicious injury.

The court found that Walker’s failure to secure insurance was a willful act in “that it was not the result of an accident or inadvertence, but was founded upon a putatively mistaken belief.”  The court concluded that “in order for the act to be willful under 523(a)(6), the debtor must have intended more than merely the act that results in injury.”  The plain language of 523(a)(6) “excepts from discharge debts arising from willful and malicious injury rather than willful and malicious acts which cause an injury.”  Furthermore, 523(a)(6) does not except discharge intentional acts which cause injury; it requires an intentional or deliberate injury.

Mere recklessness is not sufficient to establish intent.  The court stated, “An act is the reckless disregard of the rights of others is insufficient to constitute willful and malicious conduct for purposes of 11 USC 523(a)(6).”

Another 11th Circuit decision was the matter of Monson v Galaz.  Monson and Galaz met in federal prison in 2003, and after their release decided to partner in opening an internet café in Hillsborough County, in Florida.  According to their agreement, Galaz, through his company Segundo Suenos LLC, would loan $130,000 to Monson for the funding, creation, and management of an internet café.  The agreement further provided that in the event that the café was not profitable or the parties agreed to terminate the business, all material assets would be liquidated and first used to pay back any unrecouped portion of the loan.  Finally, the agreement provided that neither party would open any additional cafes without the consent of the opposite party.

In 2008, law enforcement raided the café and seized almost all of its assets, based upon the allegation that the café was engaged in an illegal online gambling operation.  While the equipment was still in the possession of the law enforcement authorities, Segundo sent notice to Monson that it wished to terminate the agreement and sought the liquidation of the assets of the café in order to at least partially, satisfy the loan.

Subsequently, Monson entered an agreement with law enforcement that enabled him to retrieve the assets of the café.  Thereafter, Monson and a new partner entered an agreement to open a new internet café in Jacksonville, Florida.  Monson used the equipment that he purchased pursuant to the agreement with Segundo, to operate the new café in Jacksonville.

After Monson filed Chapter 7 bankruptcy, Galaz filed an adversary proceeding, claiming that the debt incurred by Monson should not be discharged in bankruptcy.  Galaz brought the adversary based upon three legal theories.  First, Monson obtained money and property from Segundo-based upon false pretenses, false representation, and fraud, and therefore such debt was excepted from discharge under bankruptcy code section 523(a)(2).  Secondly, Monson’s actions constituted fraud or defalcation while acting in a fiduciary capacity.  Third, Monson’s actions maliciously and willfully injured Segundo by converting the café assets for his own personal and financial advantage, and therefore such debt was excepted from discharge under 523(a)(6).

In reference to only the court’s interpretation of bankruptcy code section 523(a)(6), the court held that while the chapter 7 debtor is usually entitled to discharge of all debts that arose before the filing of the bankruptcy, this fresh start policy is only available to an honest but unfortunate debtor.  The court held that the debtor commits a willful injury when he commits an intentional act the purpose of which is to cause injury or which is substantially certain to cause injury.  523(a)(6) requires the actor to intend the injury and not just the act that leads to the injury.  Malicious means wrongful and without just cause or excessive even in the absence of personal hatred, spite or ill-will.”  Constructive or implied malice can be found if the nature of the act itself implies a sufficient degree of malice.

The court concluded that Monson committed a willful injury because his action of absconding with the equipment and using such equipment to open a new café was an “intentional act the purpose of which was to cause injury or which was substantially certain to cause injury.”  Monson knew that his actions were at least substantially certain to cause injury to Segundo’s ability to obtain repayment of its loan.

In evaluating the Fifth and Ninth Circuit decisions, it appears that the Ninth Circuit interpretation is more protective of debtors and supportive of the purpose of the bankruptcy code to enable a fresh start to the debtor.    The Ninth Circuit only prevents debts from discharge when the debtor has both intentionally and maliciously caused injury to the creditor through tortious conduct.  The Ninth Circuit interpretation also aligns more closely with legislative intent and the rules of statutory construction, which relies firstly, upon the plain language of the statute.

Other issues are relevant to this article, including the application of local or common law versus federal law, in determining the meaning of 523(a)(6).  Such issues are important but are better left the subject of another discussion.  One can easily write a short book on that subject alone.  The purpose of this article is to present the differing interpretations of 523(a)(6), as determined by the US Supreme Court and the more prominent Circuit Court decisions.

Picture Credit: Luca Bertolli