What the Bankruptcy Discharge Does and Does Not Do.
Updated: Feb 25
A bankruptcy discharge is a permanent injunction that bars creditors from seeking to enforce personal liability of a debtor for a discharged debt. 11 U.S.C. § 524(a). More specifically, the discharge: (1) voids any judgment to the extent it seeks to impose personal liability on the debtor; and (2) bars any action to collect a discharged debt from the debtor.
Barred collection actions may be judicial and non-judicial in nature. Judicial collection activity include filing lawsuits against the debtor after the discharge, or continuing an existing lawsuit that commenced against the debtor before bankruptcy. Nonjudicial collection actions include phone calls or collection letters (note, however, if this occurs the debtor may have a claim against the offending creditor for damages under the Bankruptcy Code and the Fair Debt Collection Practices Act).
Does a Discharge Wipe Out All Debts?
Practically speaking, the answer is yes as to unsecured debt. While personal liability on secured debt is also wiped out, the creditor of a secured debt may still enforce its lien against collateral securing the discharged debt. To understand how this process works, you need to understand the meaning of bankruptcy discharge, secured and unsecured debt.
Unsecured debt is any debt that is not secured by property of the debtor as collateral for the debt. Examples of common types of unsecured debt include credit card debt and medical bills, A secured debt is secured by collateral. Examples of common types of secured debt include home mortgages and financed car loans.
As to unsecured debt, the creditor holds a claim against the debtor for personal liability that is personal in nature or “in personam” (i.e., a promise to pay under the credit agreement). If the debtor breaches this agreement the creditor’s sole recourse is to sue the debtor to get a money judgment against the debtor. This claim for personal liability does not attach to any assets of the debtor. Because the discharge voids all judgments for personal liability and bars collection actions seeking to impose personal liability of the debtor, for all intents and purposes, the bankruptcy discharge does wipe out these unsecured debts (although in the technical sense these debts are not legally extinguished).
As to secured debt, the creditor holds the in personam claim described above plus a claim against the debtor’s property, or “in rem” claim that attaches to assets of the debtor (i.e., the creditor’s lien against debtor’s property that comprises its collateral). Although the bankruptcy discharge may “wipe out” the secured creditor’s claim against the debtor for personal liability, because the discharge order is an in personam injunction that precludes imposing personal liability, it does not prevent the creditor from seeking to enforce its in rem claim against its collateral by foreclosing on its lien against the collateral.
This does not necessarily mean a debtor that has received its discharge will lose all assets encumbered by a lien in favor of a secured creditor. All this means is that the discharge injunction imposed by the bankruptcy code does not extend to in rem creditor remedies. To enforce such remedies the creditor will still have to comply with applicable state law and the underlying security agreement. If conditions for enforcement of the lien have not been met per the agreement (for example, the debtor is current on its installment payments), then the creditor cannot foreclose its lien and the debtor will be able to keep its asset.
Debtors with secured creditor and not enough money to keep current will all financed assets must budget monthly debt service payments accordingly.