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Foley, Inc. v. Fevco, Inc.

379 N.J. Super. 574, 879 A.2d 1242 (App. Div. 2005)

LIENS; BANKRUPTCY; DISCHARGE—It is possible that theft or conversion of collateral in which a creditor has a secured interest constitutes fraud or an intentional tort that would bar discharge of the secured debt in a bankruptcy and bar removal of the lien on that property despite a discharge.

A lender argued “that both its security interest in [a] corporate debtor’s property and [the guarantors’] individual liability as guarantors of the corporate debt were erroneously determined to have been discharged in bankruptcy, because [the lender] had no notice of the bankruptcy proceedings and its claim was omitted from each” list of creditors. In response, one of the guarantors claimed that “the omission was inadvertent, and irrespective of the omission, the discharge applied both to listed and unlisted creditors.” In one of the guarantor’s Chapter 7 bankruptcy, a vehicle securing one of the loans was deemed to be of “inconsequential value,” and abandoned by the trustee. It was found to be a no asset case and that guarantor’s debts were discharged. The other guarantor filed a similar Chapter 7 petition, also omitting the debt owed to the lender, and the second guarantor’s debts were similarly discharged.

Unaware of the bankruptcy proceedings, the lender proceeded in state court and obtained a default judgment against the corporate borrower and the individual guarantors as well as obtaining a judgment of possession for the vehicle. Three years passed without any activity, and the guarantor with the vehicle sought to have the default judgment vacated. New Jersey law provides that if a judgment creditor does not proceed within one year after a bankruptcy discharge of a dischargeable debt, the lien of that judgment could be discharged by the state court. The lower court found that ordinarily “debts not listed in the bankruptcy petition and which the creditor has no notice are not dischargeable.” It believed that an exception existed “for debts not listed in no-asset cases.” Each of the two bankruptcy filings had been classified as no asset cases. It also found that the creditor could have moved to reopen the bankruptcy cases but failed to do so. Consequently, the lower court vacated the judgment as to both guarantors.

An appeal was filed and the Appellate Division remanded the matter to the lower court for additional findings. When the lower court again ruled that the judgments should be discharged, the matter returned to the Appellate Division. Here, the lender argued “that its security interest was not subject to the discharge in bankruptcy,” but the Court found that argument to have no relevance. It determined that the corporate borrower “was a party to the security agreement, and the individual [guarantors] not [the corporate borrower], [were] the debtors in bankruptcy whose discharge [was] in issue.” Consequently, the lender was not a secured creditor as to the individual debtors. Nonetheless, the New Jersey statute that would discharge a bankruptcy lien “applies only in circumstances where the judgment that created the lien against the property was entered before the bankruptcy petition was filed. ... In this case, [the lender’s] judgment was not entered until after the bankruptcy court orders discharging [the guarantors’] debt to [the lender].” Thus, “if the debt was dischargeable, enforcement of the judgment lien was barred [the bankruptcy code] as well as by [New Jersey statute].”

This set of facts raised the question before the Appellate Division as to whether the guarantors’ “liability as personal guarantors of [the corporation’s] debt was discharged by their respective bankruptcies.” If those obligations were dischargeable, then the judgments against the guarantors were void ab initio and was properly vacated. Under the bankruptcy code, a discharge in bankruptcy “operates as injunction against the commencement or continuation of an action,” such as obtaining a judgment on discharged debt. According to Bankruptcy Code Section 727(b), “a discharge under sub-section (a) of this section discharges the debtor from all debts that arose before the date of the order for relief under this chapter.” Because section 727(b), “on its face, does not create an exception for unlisted or unscheduled debts, every prepetition debt is discharged under section 727(b) subject to the provisions of section 523(a)(3).” There is one exception to the rule and that is that a debt that “is not dischargeable if it was incurred through ‘false pretenses, false representation, or actual fraud, ... fraud or defalcation, while acting in a fiduciary capacity. ..., or willful malicious injury by the debtor.” Here, the lender argued that this exception barred discharge of the debt and the lower court should not have vacated the judgment. A particular allegation was that a theft or conversion of collateral in which a creditor has a secured interest should satisfy the exception to discharge. In particular, it claimed that “the failure to include the secured debt of [the lender], which was known to [the guarantor] and/or for defalcation of the secured collateral, constitute[d] an exception to discharge.” For that reason, the Appellate Division believed that a hearing should have been held to determine the lender’s allegation of fraud as an “intentional tort” to establish “the non-dischargeability of the debt in issue here.”

The Appellate Division also struggled with the question as to whether the Bankruptcy Court has exclusive jurisdiction of dischargeability issues. It was unquestionable that the Bankruptcy Court had exclusive jurisdiction over scheduled debts, but the Court found many contrary decisions as to whether it had “exclusive jurisdiction over unscheduled intentional tort debts.” For that reason, the Appellate Division looked at a bankruptcy decision in the District of New Jersey and, relying on that decision, concluded that the Law Division had jurisdiction to determine the dischargeability of the debt.

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