Economy, Pandemic Drove Up Bankruptcy Filings in 2023 With No Abatement Expected This Year

A look back at bankruptcy trends and litigation in 2023 reveals a spike in bankruptcy filings driven by economic factors and fallout from the pandemic while in upper courts several interesting cases were decided involving proofs of claim, stay violations, and discharge issues.

Bankruptcy filings in 2023 were up significantly, although the long-awaited tsunami that was anticipated did not arrive. In 2022, there were 383,000 total bankruptcy filings in the United States. In 2023, there were 445,186 filings for the year, which is an increase of approximately 5,000 cases a month. Chapter 7 filings, which include both consumer and business cases, increased by 17 percent. Chapter 13 consumer cases increased by 18 percent and Chapter 11 cases increased by 19 percent.

However, those increases are a far cry from the record-high filings in the early 2000’s. It is important to note that the numbers at times become skewed as some businesses that file bankruptcy have numerous subsidiaries, and each entity is filed as a separate bankruptcy action, with the cases ultimately being administratively consolidated.

Interest Rates, Inflation, Covid Lead to More Bankruptcies 

What are the causes of the increase in bankruptcies?

First and foremost, there were the Federal Reserve interest rate hikes, which caused variable-rate loans, credit card interest rates, and mortgage rates to increase. The rate increases coupled with the end of any state or federal government subsidies due to Covid-19 has made it more difficult for consumers and businesses to meet their obligations. Inflation has also been on the rise, which has caused consumers to cut back on discretionary spending.

In addition, with the lack of a return to the office and as more individuals continue to work at home, small businesses and restaurants in downtown locations are facing a rough business environment. Many landlords, both commercial and residential, are seeing increased defaults leading to vacancies that have not been re-let. As a result, we are seeing subsequent defaults with their mortgage lenders.

Student Loans Did Not Play a Role 

Student loans have not played a major role in the increase in bankruptcy filings. The White House signed an executive order setting forth procedures on how to handle adversary proceedings for hardship discharges of student loan debt. However, United States Attorneys have been instructed to accept the facts pleaded by a debtor to be true, which should allow for more summary judgments or judgments on the pleadings.

Although this initiative has been in place for approximately six months, we have not seen a large increase in complaints to discharge student loan debt due to hardship. This is mainly because only a small number of student loan obligations fall under this order. The standard to prove hardship student loan dischargeability has not changed from the well-established case law.

Bankruptcy Litigation in 2023 

There has been increased litigation of bankruptcy issues and the U.S. Supreme Court continues to address those issues. The appellate system saw various other bankruptcy litigation including proof of claim and stay violation issues.

LVNV Funding, LLC v. Myers (In re Meyers)

A case that could have had a major effect on creditors and debt buyers was recently decided by the U.S. Court of Appeals for the Ninth Circuit. In LVNV Funding, LLC v. Myers (In re Myers), No. 22-16615 (9th Cir. Nov. 21, 2023), the court held that a proof of claim is valid if it complies with the Federal Rules of Bankruptcy Procedure, rejecting the argument that a proof of claim needs to comply with Nevada judgment documentation requirements.

The court found that compliance with the Federal Rule of Bankruptcy Procedure 3001 substantiates a claim, and the bankruptcy court should not look at state law, following the Supreme Court’s 1938 decisions in Erie R.R. Co. v. Tompkins. The Ninth Circuit held that Nevada laws conflict with the Federal Rules of Bankruptcy Procedure and that the Nevada laws are not “applicable laws” that can render a claim unenforceable under Section 502(b)(1) of the bankruptcy code.

Golden One Credit Union v. Fielder (In re Fiedler)

The U.S. Bankruptcy Court of the Eastern District of California addressed the issue of filing complaints to determine dischargeability without conducting due diligence. Although Section 524 of the Bankruptcy Code provides a remedy for fees if such a complaint is not filed in good faith, the court in Golden One Credit Union v. Fiedler (In re Fiedler), No. 23-20862 (Bankr. E.D. Cal. Nov. 2, 2023), took it one step further.

In Golden, the credit union filed a complaint to determine dischargeability of debt due under Bankruptcy Code Section 523(a)(2) based on the incurrence of a $9,000 loan within 45 days of filing of the bankruptcy petition. The creditor’s counsel filed what the judge described as a boilerplate complaint. Counsel for the creditor did not conduct any thorough due diligence before the filing of the complaint. Further, before filing the complaint, the creditor did not attend the First Meeting of Creditors, have the debtor sit for a Rule 2004(a) examination, or reach out to the debtor’s counsel to discuss the potential of filing the complaint and learn more about the facts.

The court found that the filing of the complaint without reasonable inquiry constituted a violation of Rule 9011(b)(1). The court viewed the complaint as a tactic designed only to force the consumer into a non-dischargeable judgment. The court held that the complaint did not have a reasonable basis in law or fact. Since Rule 9011 (c)(2)(B) prevents the issuance of monetary damages, the judge created his own sanction to deter future behavior and required that for 19 months, any complaint to determine dischargeability of debt due filed by counsel in the district must be reviewed by the judge who issued the decision.

Golden is not the first case where we have seen a bankruptcy judge raise Rule 9011 issues on his or her own initiative. This is an issue that impacts both debtors, creditors, and their counsel. The ramifications can be substantial and due diligence must be conducted before legal pleadings are filed to prevent the ramifications that could follow. Unfortunately, we expect to see more cases of this type brought before bankruptcy courts in 2024.

Skaggs v. Gooch (In re Skaggs)

Another case dealing with sanctions against a creditor for violating the discharge injunction is Skaggs v. Gooch (In re Skaggs), No. 17-50941 (Bankr. W.D. Va. Jan. 19, 2023). This case concerns a bankruptcy discharge violation and considers whether a discharge injunction violation warrants an award of remedial damages to the debtor.

In 2000, the defendants obtained a judgment against the debtors. At the time of the judgment, the debtors owned no real estate, meaning the judgment debt was unsecured. In 2017, the debtors filed for bankruptcy and obtained a bankruptcy discharge in 2019. This discharged the unsecured debt and rendered the judgment effectively uncollectable. Months after the bankruptcy discharge, the debtors inherited real estate and were erroneously advised that the judgment would have to be paid before selling their inherited real estate. When the debtors contacted the defendants, the defendants provided the debtors with a payoff statement and offered a discounted payment for the judgment debt. In doing this, the defendants violated the discharge injunction.

The main issue the court considered here was to what extent the defendants should pay damages for their violation of the bankruptcy discharge injunction. Ultimately, the court held the defendants in contempt of the discharge order and imposed a remedial sanction upon the defendants for $25,000, which represented the debtors’ attorney’s fees. However, the court declined to award punitive damages.

The court also considered whether the defendants acted in good faith, which could affect the amount and type of sanction award, and determined that the defendants did not act in good faith. The court reasoned that all the defendants’ actions were unjustified, unreasonable, and harmful. For example, when the defendants emailed the debtors with the payoff letter for the prior judgment, the defendants committed an intentional debt collection act in violation of the debtors’ discharge injunction. As such, the court found the debtors’ request for $25,000 in attorney’s fees to be reasonable and necessary to compensate the debtors for the harm caused by the defendants.

Bartenwerfer v. Buckley (In re Bartenwerfer)

In Bartenwerfer v. Buckley (In re Bartenwerfer), 143 S. Ct. 665 (2023) the Supreme Court determined that Bankruptcy Code section 11 U.S.C. § 523(a)(2)(A) exempts a fraudulently obtained debt from discharge, even when the detor was not the person who acted fraudulently.

The question presented to the Supreme Court was whether the debtor must be the party that conducted the fraud, or whether a debt obtained by fraud is exempt from discharge, regardless of the actor. The court affirmed the ruling of the Ninth Circuit in holding the latter. Justice Barrett delivered the opinion of the court on the unanimous decision.

In this case, Kate and David Bartenwerfer (who were not married at the relevant time) purchased and remodeled a home, then sold it for a profit. David took the lead on the project. He did not disclose defects in the property to the purchaser. The buyer obtained a state court judgment against both debtors. The debtors then filed for Chapter 7 bankruptcy. The purchaser initiated an adversary proceeding seeking a declaration that the state court judgment against the debtors should not be dischargeable to either debtor under Section 523(a)(2)(A) of the Bankruptcy Code.

The Ninth Circuit Bankruptcy Appellate Panel held that Kate’s debt was non-dischargeable only if she knew or had reason to know of David’s fraud. The Ninth Circuit reversed on that point. The Supreme Court affirmed. In so ruling, the Court found that the use of the passive voice in Section 523(a)(2)(A) shows that the actor conducting the fraud is not relevant to non-dischargeability.

It further reasoned that, in the legal context of common law fraud, liability is not limited to the party committing the fraud but can extend to other parties (e.g., agents and partners). The court juxtaposed the express references to the debtor in other exceptions from discharge provisions against the absence of the same here, which supported that any debt obtained by fraud would be non-dischargeable, regardless of the actor.

Looking Ahead to 2024 

As seen by recent court rulings, the world of sanctions and non-dischargeability of debts could be a very active area in 2024. Debtors, creditors, and their counsel need to make sure to review all aspects of a case carefully and do their due diligence before proceeding with any complaints to determine dischargeability of debt due.

As we move forward into 2024, we expect to see an increase in bankruptcy filings both on the consumer and commercial end. The Federal Reserve has indicated that they expect to cut interest rates throughout the year. However, it will still be difficult for consumers and will require many to look for a fresh start. It seems that counsel has also become more litigious, so we expect to see increased litigation on claim and stay violation issues.