The scope and extent of debts that may be discharged is an often litigated issue in bankruptcy. In a recent Chapter 13 case in the U.S. Bankruptcy Court for the Eastern District of Michigan, the bankruptcy court considered whether an otherwise dischargeable government penalty debt is nondischargeable if the debt arises from fraud.[1]

The Michigan Unemployment Insurance Agency (the “Agency”) alleged that the debtor was overpaid $6,897 in unemployment benefits because she intentionally failed to report wages from two jobs. The Agency imposed a quadruple-damage statutory penalty with interest, and demanded payment of more than $34,000.

The debtor subsequently filed for Chapter 13 bankruptcy. The Agency filed an adversary complaint to determine the dischargeability of the overpayment, penalty and interest. The debtor filed a motion to dismiss the penalty portion of the complaint.

The bankruptcy court granted the debtor’s motion, holding that the quadruple-damage penalty is dischargeable. The bankruptcy court’s analysis focused on two particular sections of the Bankruptcy Code, 11 U.S.C. §§ 523(a)(2)(A) and 523(a)(7).

Chapter 13 offers a debtor a broader discharge of debts than Chapter 7. Penalties payable to and for the benefit of a governmental unit are dischargeable under Chapter 13 (11 U.S.C. § 523(a)(7)), but not Chapter 7.

The bankruptcy court explained that, in 2005, Congress significantly narrowed the so-called Chapter 13 “super discharge” by limiting the debts specified in 11 U.S.C. § 1328(a)(2) by specifically noting the number of subsections of section 523(a) that are non-dischargeable. Congress omitted section 523(a)(7) debts - governmental penalties - from the list in section 1328(a)(2). The bankruptcy court reasoned that, by omitting penalty debts from the winnowing of the super discharge, “Congress intended that they remain dischargeable under Chapter 13.” This is true even if the penalty debt arises from fraud.