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Michigan Bankruptcy Court Judge Rules that Unemployment Insurance Agency Quadruple Damage Penalties are Dischargeable in Chapter 13!

Eastern District of Michigan Bankruptcy Court Judge Mark Randon ruled that the “super discharge” provisions of Chapter 13 operate to discharge the quadruple damage penalty assessed by the Michigan Unemployment Insurance Agency.

The Michigan Unemployment Insurance Agency (“the Agency”) determined that the debtor was overpaid $6,897.00 in unemployment benefits because she intentionally failed to report wages from two jobs. After a quadruple-damage statutory penalty and interest were added, the Agency demanded payment of more than $34,000.00; the debtor filed Chapter 13 bankruptcy.

The Court held that:

A debtor who successfully completes a Chapter 13 bankruptcy receives a broader discharge of debts than she would under Chapter 7. Among the debts dischargeable under Chapter 13, but not Chapter 7, are penalties payable to and for the benefit of a governmental unit. Andrews says the quadruple-damage penalty is, therefore, dischargeable; the Agency claims that under 11 U.S.C. § 523(a)(2)(A), the entire debt, including the penalty, is nondischargeable–if it arises from fraud. Because the Court finds that–in Chapter 13–Congress intended to exclude section 523(a)(7) penalties from “any debt” obtained by fraud under section 523(a)(2)(A), Andrews’ motion is CONDITIONALLY GRANTED.  The quadruple-damage penalty is dischargeable.

In 2005, Congress significantly narrowed the so-called Chapter 13 “super discharge”: it revised 11 U.S.C. § 1328(a)(2) to provide that any debt “of the kind specified . . . in paragraph (1)(B), (1)(C), (2), (3), (4), (5), (8), or (9) of section 523(a)” is nondischargeable. Importantly, Congress omitted section 523(a)(7) debts from the list.

Section 523(a) lists 19 types of debt that are “not discharged” under specific provisions of the Bankruptcy Code.3   Subsection (7) addresses any debt for a “penalty . . . payable to and for the benefit of a governmental unit, and [] not compensation for actual pecuniary loss[.]” In McKay v. United States, the Ninth Circuit cogently explained section 523(a)(7)’s meaning:

Carefully parsed, the section initially makes nondischargeable a “debt that is for a fine, penalty or forfeiture payable to and for the benefit of a governmental unit.” Withdrawn from this class, however, are any such fines, penalties, or forfeitures that are “compensation for actual pecuniary loss.” These are dischargeable. The double negative, “does not discharge” and “ not compensation for actual pecuniary loss,” accomplishes this end.

 McKay v. United States, 957 F.2d 689, 693 (9th Cir. 1992).

Penalty debts are nondischargeable under Chapter 7. 11 U.S.C. § 523(a). But, by omitting penalty debts from section 1328(a)(2), Congress intended that they remain dischargeable under Chapter 13–a vestige of the super discharge. On this issue, Pennsylvania Dep’t of Public Welfare v. Davenport, 495 U.S. 552 (1990), superseded by statute on other grounds, is instructive.

In Davenport, the debtor (Davenport) pleaded guilty to welfare fraud, and as a condition of her probation, was ordered to make monthly restitution payments. Before completing her payments, Davenport and her husband filed Chapter 13 bankruptcy and listed the restitution obligation as an unsecured debt payable to the Pennsylvania Department of Public Welfare. Id. at 556. After Davenport stopped making restitution payments, the probation department initiated a violation proceeding. In response, the Davenports filed an adversary proceeding to have the Bankruptcy Court determine the dischargeability of the restitution obligation. Id.

The Bankruptcy Court ruled that the restitution was dischargeable in a Chapter 13. On appeal, and relying heavily on Kelly v. Robinson, 479 U.S. 36 (1986), the District Court reversed. The Third Circuit reversed the District Court, and the Pennsylvania Department of Public Welfare appealed to the United States Supreme Court.

In Kelly, the United States Supreme Court held that “restitution obligations imposed as conditions of probation in state criminal actions are nondischargeable in proceedings under Chapter 7 of the Bankruptcy Code,” because they fall within the ambit of a fine, penalty or forfeiture under section 523(a)(7). Davenport, 495 U.S. at 555 (emphasis added). But Davenport filed Chapter 13 bankruptcy. Recognizing, as here, that Congress chose to omit section 523(a)(7) from the list of nondischargeable debts in Chapter 13, the Supreme Court affirmed the Third Circuit’s decision:

In Kelly, the Court examined pre-Code practice and identified a general reluctance “to interpret federal bankruptcy statutes to remit state criminal judgments.” This pre-Code practice informed the Court’s conclusion that §523(a)(7) broadly applies to all penal sanctions, including criminal fines. Here, on the other hand, the statutory language plainly reveals Congress’ intent not to except restitution orders from discharge in certain Chapter 13 proceedings. This intent is clear from Congress’ decision to limit the exceptions to discharge applicable to Chapter 13, § 1328(a), as well as its adoption of the “broadest possible” definition of “debt” in § 101(11).



(Internal citations omitted). The criminal restitution debt was, therefore, held dischargeable.

In response to Davenport, Congress acted. It amended the Bankruptcy Code and overruled the Supreme Court’s decision: specifically making debts “for restitution, or a criminal fine, included in a sentence on the debtor’s conviction of a crime” nondischargeable. 11 U.S.C. § 1328(a)(3). But while Davenport has been superceded by statue, its import remains apt: Congress’ decision to omit a debt from section 1328(a) is akin to a clear congressional mandate that the debt remain dischargeable in Chapter 13. See Hardenberg v. Commonwealth of Virginia, Dep’t of Motor Vehicles (In re Hardenberg), 42 F.3d 986, 992 (6th Cir. 1994) (“[W]e believe that Congress . . . has indicated that state criminal fines are ‘debts,’ which cannot be discharged in a Chapter 7 proceeding, pursuant to 11 U.S.C. § 523(a)(7), but which can be discharged in a Chapter 13 proceeding, pursuant to 11 U.S.C. § 1328(a)”). Despite this congressional mandate, the Agency insists that if the penalty also arises from a debtor’s fraudulent conduct, section 523(a)(2)(A) trumps section 523(a)(7), and the debt is nondischargeable in Chapter 13.

In Chapter 7 cases, the Agency has also made this very distinction. See e.g., In re Williams, Case No. BT 14-01038, 2014 WL 6774252, at *1 (Bankr. W.D. Mich. Nov. 26, 2014) (“The [Agency] further alleges that the debt for restitution and interest is nondischargeable under § 523(a)(2)(A) because the Debtor obtained the overpayments by fraud, and that the statutory penalties are nondischargeable under § 523(a)(7) as penalties payable to a governmental unit.”).