What Happens to Debt Resulting from Fraud in Bankruptcy?

By Cara O'Neill, Attorney
Debts resulting from fraud are nondischargeable and don’t go away in bankruptcy.

Filing for bankruptcy doesn’t guarantee that all of your debt will go away. Certain kinds of debt—called nondischargeable debts—remain your responsibility even after your bankruptcy is over. Debts resulting from fraud fall into this category.

However, for a debt to be declared nondischargeable, a creditor must ask a court for a fraud determination. If the creditor doesn’t, the debt is wiped out.

What Is Fraud?

Fraud happens when someone lies or manipulates. In bankruptcy, fraud usually occurs at the expense of a creditor.

Suppose, for example, you aren’t completely honest about your income when you apply for a credit card. Or maybe you hid money from your business partner. Or perhaps when you closed your restaurant, you sold off all the tables, commercial ovens, and the like. Then, instead of dividing the proceeds fairly between the landlord, the guy who sold you wholesale food, and the business’s other creditors, you pocketed the money. All of these situations involve deception that might rise to the level of fraud.

A common type of fraud is presumptive credit card abuse. Using your credit cards for luxury items—such as expensive purses, jewelry, or going to the theater—during the 90 days before you file for bankruptcy is presumed fraudulent. You can, however, use credit for necessities of life, such as food and car repairs.

Other types of fraud also exist—for example, fiduciary fraud (such as fraud between business partners), larceny, and embezzlement .

A Creditor Needs a Judgment

On its own, a creditor’s claim that you committed fraud doesn’t do anything. A creditor must file a lawsuit and get a fraud judgment against you. Creditors can do so in a couple ways.

Fraud Lawsuit Filed in State Court Before Bankruptcy

Sometimes a creditor files a complaint (the first legal paper filed in a lawsuit) alleging fraud before you even file for bankruptcy. (Being served with a complaint is often what starts people thinking about bankruptcy.) Here are the two types of judgement creditors can get:

  • Default judgment. The court will grant a judgment by default if you fail to respond within the time required.
  • Trial judgment. A creditor receives a trial judgment by winning at trial.

Once a creditor has a fraud judgment against you, the debt becomes nondischargeable. This potential outcome makes it important to speak with an attorney as soon as you’re served with a lawsuit. Quick action allows you and your attorney time to take steps to prevent the issuance of a judgment.

Adversary Proceeding Filed in Bankruptcy Court

A creditor who doesn’t already have a fraud judgment against you can file an adversary proceeding—a lawsuit in bankruptcy court—within 60 days of the first meeting of creditors. If the creditor doesn’t file the proceeding on time, the debt remains dischargeable and eventually goes away.

The debt becoming dischargeable assumes, however, that you properly listed the creditor in your bankruptcy petition. If you didn’t, the omitted creditor can file a fraud lawsuit against you even after your bankruptcy case is over.

Proving Fraud at Trial

Proving fraud at trial isn’t easy. Your creditor must prove that:

  • you knowingly made a fraudulent representation (you lied or were misleading about something, like the amount of your income or what you did with company profits)
  • the creditor relied on the misrepresentation (they believed your misrepresentation), and
  • the creditor lost money as a result.

Matters involving fraud are serious. A bankruptcy attorney can review your case and help you determine your best course of action.

Questions for Your Attorney

  • Should I file bankruptcy if I think that one of my creditors might claim I committed fraud?
  • How long does someone have to file a fraud-related lawsuit against me in my jurisdiction?
  • If admit I committed fraud, can you—and will you—still continue to represent me?
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