Homeowners in foreclosure who suspects fraud in their mortgage loan transaction may opt to use the Bankruptcy Adversary Proceeding to pursue their pretender lenders.

An adversary proceeding is filed and prosecuted by a plaintiff against a responding defendant. The procedural rules and requirements for adversary proceedings are set forth in the Federal Rules of Bankruptcy Procedure. Local rules of court may provide additional sources of guidance and instruction.

Procedurally, an adversary proceeding commences through filing of a complaint by the plaintiff. The complaint is served upon the defendant, who must respond to allegations of the complaint by filing an answer. There are filing and service fees required of the plaintiff to initiate an adversary proceeding. A case number is assigned to the matter once the court receives the plaintiff’s filed complaint. The parties often engage in written and other types of discovery, such as depositions prior to the adversary proceeding being set for trial.

Adversary proceedings may be filed by the debtor, creditors, trustee (standing or panel), or U.S. Trustee’s Office. A creditor might file an adversary proceeding to lodge an objection to a debtor receiving a discharge. Creditors may also bring adversary proceedings to seek an exemption of the debt owed to them by the debtor from a debtor’s pending discharge because the debt was the by-product of fraud, hindering conduct, malfeasance, willful injury, malicious injury, or personal injury. Creditors may seek a dismissal of the bankruptcy or loss of discharge for debtor due to bad faith in the conduct of debtor.

There are many Reasons Homeowners May Wish to File Adversary Proceeding

Debtors bring adversary proceedings against creditors for violations of automatic stay protections when creditors pursue collection remedies against debtors despite bankruptcy code’s prohibitions. Debtors bring adversary proceedings to seek hardship discharges from student loans and to attempt to strip, avoid, or extinguish liens

Trustees file adversary proceedings to protect their interests. A standing trustee might file an adversary proceeding against a debtor to expose inaccurate bankruptcy filings or fraudulent records. Trustees file adversary proceedings against creditors to avoid preferences or fraudulent transfers in instances where a creditor received funds or property from debtor inappropriately, and the trustee seeks to undo the transaction and recoup funds. The U.S. Trustee files adversary proceedings to compel debtors in Chapter 7 to convert to Chapter 13 if there is bad faith in the filing, ineligibility for liquidation, and/or an ability to repay creditors through a plan. U.S Trustees also bring suits to dismiss debtor cases filed in abuse of the bankruptcy system

In many ways, adversary proceedings are like other civil lawsuits. It is the trustee’s job to make sure all assets are collected and creditors are treated equally and fairly. There are many situations that may give rise to an adversary proceeding, but some of the more serious reasons are accusations of fraud by an administrator or creditor or violations of the bankruptcy rights by creditors.

Because adversary proceedings are unusual and require a significant amount of legal work, the client’s attorney fees are not included in the normal price of a bankruptcy. As a result, homeowners can either hire an Attorney that will handle the Adversary Proceeding side of the Bankruptcy who will then be included in the Bankruptcy plan for payment of his fees, or the homeowner may represent themselves in the Adversary Proceeding.

The most common use of adversary proceedings is where the Debtor sues one of their creditors for violating their bankruptcy protection. Examples include wage garnishments or repossessions after the case is filed or continued debt-collection efforts by the creditor after becoming aware of the bankruptcy. While the debtor generally does not have an obligation to pay attorney fees out-of-pocket, the damages received in the case are usually given over to the Trustee for the benefit of the creditors and the violating creditor pays the attorney fees. It is not like “winning the lottery” but adversary proceedings are effective in penalizing creditors who trample on the rights of our clients.

While rare, the Trustee of your bankruptcy case may wish to file a fraudulent transfer proceeding if you transferred money or property within the two years before you filed for bankruptcy. Or, the Trustee can file a preferential transfer adversary complaint if you repaid any creditor to whom you were not related more than $600 during the 90 days before bankruptcy. Similarly, this type of complaint may be filed if you repaid a relative more than $600 during the year before filing for bankruptcy.

A trustee or a creditor may file a complaint to initiate adversary proceedings to deny your discharge if there is an allegation that you incurred a debt fraudulently or filed for bankruptcy fraudulently. Examples of fraud include lying in the information on your bankruptcy petition or lying to the trustee or judge during hearings. Someone who does these things can be convicted of fraud, have his or her discharge denied, or be sentenced to prison. The administrator also can ask the court to deny your discharge if they allege you did not comply with court orders.

People often file an adversary proceeding related to a home during bankruptcy. For example, a landlord may file a complaint asking to lift a stay so that he can evict a tenant if the tenant is using illegal drugs on the property or otherwise endangering it.

People seeking Chapter 13 bankruptcy also can file an adversary proceeding related to mortgages on a home. If you have multiple mortgages, of which one or more junior mortgages are not fully secured by the property, you can ask the court to strip the mortgages that are not secured. To qualify, the home must be worth less than the senior mortgage. For example, if a debtor has a house worth $150,000 and owes $151,000 on their first mortgage and $30,000 on their second mortgage, the second mortgage may be stripped because there is no equity in the house for it to attach to. On the other hand, it is all-or-nothing. If a $150,000 home has a $149,000 first mortgage, then there is some equity for the second mortgage to attach to so it will not be stripped. If the court agrees, it will strip the junior mortgages and treat them as unsecured claims, like medical or consumer debt.

If you own a nonexempt property with somebody else, and a trustee needs to sell it to pay off creditors, the trustee can file an adversary complaint to sever your interests. This action can force the co-owner of your property to sell the property.

If it is true that you are looking to file a bankruptcy eventually then it might be the time now to move forward with it. If your home continues to rise in price you will eventually have equity in your home again. But this equity in your home could create problems for your bankruptcy filing. If the equity rises past your ability to protect it with the allowable bankruptcy exemptions then your home may be in jeopardy if you file bankruptcy.  This is because the trustee could take it and sell it for the equity in it.  If you move quickly before this happens then you can usually protect your equity.

Now, Let’s Look at How Adversary Proceedings are Handled in Various Chapters of Bankruptcy

1)     Adversary Proceedings In Chapter 13

Most adversary proceedings in a personal bankruptcy filed under any chapter of the Bankruptcy Code involve questions of dischargeability. Most adversary complaints are filed by creditors challenging the discharge of a specific debt or the entire discharge. A few are filed by debtors, usually to obtain a determination of the dischargeability of tax debts or student loans.

11 U.S.C. § 523(a) contains the complete list of nondischargeable debts in personal Chapter 7, 11, and 12 bankruptcies. However, the list does not apply to debtors that are not individuals, typically businesses.

Chapter 13, which is only available to individual debtors because of § 109(e), has an interesting complication because there are two ways to get a Chapter 13 discharge(1): under § 1328(a) after plan completion, and under § 1328(b) if the debtor successfully moves the court for a hardship discharge without having completed the plan.

The list of exceptions to discharge in §523(a) applies to the § 1328(b) hardship discharge because of §1328(c)(1). However, the list of nondischargeable debts in a § 1328(a) discharge is found in § 1328(a), and does not include some of the § 523(a) exceptions.

For example, debts for willful and malicious harm to property are dischargeable in a § 1328(a) discharge (cp. § 523(a)(6) and § 1328(a)(4)). There is another important difference between the wording of § 523(a)(6) and § 1328(a)(4): § 523(a)(6) refers to “willful and malicious” whereas §1328(a)(4) refers to “willful or malicious.” Therefore, while the object of the harm is narrower in § 1328(a)(4), the burden of proof is less stringent.

Other types of debts that are dischargeable under § 1328(a) are noncriminal fines (cp. § 523(a)(7) and § 1328(a)(3); e.g., in California parking penalties are civil rather than criminal penalties pursuant to Cal. Veh. Code § 40203.5), and the kinds of debts listed in § 523(a)(10)-(19).

In particular, debts incurred as part of a separation agreement or divorce decree that are not domestic support obligations are dischargeable in a § 1328(a) discharge. This fact alone leads to acrimonious Chapter 13 litigation— though not always in the form of an adversary proceeding.

One final note on dischargeability: if a debtor is in a Chapter 13 and then converts to Chapter 7, any debts incurred during the pendency of the Chapter 13 case are dischargeable in the Chapter 7 — subject, of course, to § 523(a) — because of § 348(b) combined with § 727(b)

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II. Debtor Initiated Adversary Proceedings

Fed. R. Bankr. Proc. 4007(a) states: “A debtor or any creditor may file a complaint to obtain a determination of the dischargeability of any debt.”

  A.     Chapter 7

Chapter 7 debtors rarely have the resources to fund an adversary proceeding, so debtor – initiated adversary proceedings are rare. Therefore, unless the case is done on a pro bono basis, or a wealthy friend or relative pays the costs and fees, an adversary proceeding is unlikely, even if it is warranted. It is for this reason that there are not very many student loan or tax dischargeability actions filed.

Of course, if the debtor’s debts are not primarily consumer debts — for example, they may be mostly tax debts, which are not consumer debts (see, e.g., In re Westberry , 215 F.3d 589, 591 (6th Cir. 2000))— then § 707(b) is inapplicable to the case. This is what underlies the occasional high income Chapter 7 filings. Then the debtor may have the resources to fund the litigation.

High income Chapter 7 cases usually involve high tax liabilities. As the IRS and the Franchise Tax Board (or whatever taxing authority you have in your state) may assert that the tax is nondischargeable, a debtor – initiated dischargeability action may be in order. As trust fund tax liabilities are never dischargeable, the focus of such actions is on income tax and the three – part dischargeability test that follows:

1.    Due Date Of The Return

First, the debtor must file the bankruptcy papers more than three years after the date the tax return was due — with extensions. For example, if the tax year in question is 2007, then the date the tax return was due, with extension if the debtor took one, was October 15, 2008. Therefore, to satisfy this requirement the debtor cannot file the bankruptcy papers before October 16, 2011. Notice that this requirement does not focus on whether the debtor actually filed the return, just on when the return was due.

2.    Filing Date Of The Return

Second, the debtor must have actually filed a legitimate, non – fraudulent return for the tax year in question at least two years before filing the bankruptcy papers. Continuing with the previous example, for the debtor to be able to file bankruptcy papers on October 16, 2011, the debtor must have filed the return no later than October 15, 2009. It should be noted that if the IRS files a “substitute for return” on behalf of the taxpayer because the taxpayer never filed a return, then this requirement cannot be satisfied.

3.    Date Of Tax Assessment

Third, the IRS cannot have assessed the tax liability during the 240-day window immediately prior to filing the bankruptcy papers. Thus, in the previous example, for the debtor to file bankruptcy papers on October 16, 2011 the IRS cannot have assessed the tax after February 18, 2011. This particular requirement can be problematic because the 240 – day clock is tolled during an offer in – compromise, plus 30 days, and during any time in which a stay of proceedings against collections in a prior bankruptcy was in effect, plus 90 days. In applying this third requirement, one determines the applicable chronology by reviewing the tax transcript available from the IRS.

Other factors can come into play. For example, some years ago there was a debtor who had lived in a county in Texas that was declared a disaster area. As a result , the IRS granted a filing extension. Therefore, it is important to do a thorough analysis prior to filing the petition to ensure that a given tax is dischargeable

B.     Chapter 13

Chapter 13 debtor initiated dischargeability actions are also rare because the debtor’s disposable income is usually consumed by plan payments. However, in a 100% plan where the debtor still has money left over, a dischargeability action may be warranted.

  1.     Student Loan Dischargeability Actions

A Chapter 13 debtor will almost certainly fail the so – called Brunner test (see In re Brunner, 46 B.R. 752, 753 (S.D.N.Y., 1985) (Aff’d by 831 F.2d 395 (2d Cir.1987)), and applied by the Ninth Circuit in In re Pena, 155 F. 3d 1108 (9th Cir. 1998)), so a Chapter 13 student loan dischargeability action will probably result in sanctions under Fed. R. Bankr. Proc. 9011.

 2.     Income Tax Dischargeability Actions

The difference in income tax dischargeability between the § 1328(a) and § 1328(b) discharges lies in the first and third requirements listed above. These requirements do not have to be met in a § 1328(a) discharge because § 1328 (a)(2) does not include §523(a)(1)(A) within its ambit. This simplification in the analysis may make a debtor-initiated action worth filing, especially if the liability is large and the proof of claim asserts nondischargeability status. However, it’s probably best to use an objection to the proof of claim rather than an adversary proceeding.

When Homeowner’s good faith attempts to amicably work with the Bank in order to resolve the issue fails;

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