Law Advisor Blog


A Settlement Agreement Related to a Non-dischargeable Debt is Non-dischargeable

Kevin R. Feig

Under the bankruptcy code, certain types of debt are excepted from discharge (these “non-dischargeable” debts will still be owed after the bankruptcy case is over). Section 523 of the bankruptcy code lists a panoply of debts that are excepted from discharge. Some better-known examples of non-dischargeable debts include domestic support obligations, tax liabilities, student loan debt, and debt obtained by fraud.

What happens if a debtor, prior to filing bankruptcy, enters an agreement to settle a lawsuit with an underlying fraud claim? (The classic occurrence that gives rise to a fraud claim is when a borrower makes a false statement to obtain a loan.) Fraud claims are excepted from discharge under 11 U.S.C. § 523(a)(2)(A). Will the settlement agreement change the nature of the debt from a non-dischargeable fraud claim to a dischargeable breach of contract claim?

Fortunately, we have an answer to this question. The United States Supreme Court addressed this issue in 2003 when it took up a case with this fact pattern. The Supreme Court found, that for purposes of determining the dischargeability of a claim for fraud, money promised in a settlement agreement retains the character of the underlying debt and is therefore non-dischargeable. Archer v. Warner, 538 U.S. 314, 123 S.Ct. 1462, 155 L.Ed.2d 454 (2003).

Recently, the United States Bankruptcy Court, for the Eastern District of Virginia was presented with a case with a similar fact pattern to Archer, but it included an additional issue – are the collection charges (the interest related to the unpaid settlement agreement, and attorney fees incurred in collecting the unpaid settlement agreement) dischargeable?

First, the bankruptcy court had to decide if a pre-suit settlement agreement itself, arising from a claim “for willful and malicious injury” was dischargeable. Claims arising from a willful and malicious injury are excepted from discharge under 11 U.S.C. § 523(a)(6). The bankruptcy court applied the precedent established in Archer, looked to the character of the underlying debt, a willful and malicious injury, and concluded that the debt owed for settled amounts was non-dischargeable. In re Hilgartner, 2020 WL 6875960.

The bankruptcy court then turned its attention to the question of the dischargeability of the collection charges (interest and attorney fees). The bankruptcy court concluded that the collection charges were dischargeable reasoning that, unlike the principal debt, these debts “d[id] not flow from the injuries sustained” creating a separation between the injury and the liability. Id.

On appeal, the United States District Court, for the Eastern District of Virginia, affirmed in part and reversed in part the bankruptcy court’s decision. It agreed with the bankruptcy court, that the settlement agreement had not converted the non-dischargeable tort claim into a dischargeable contract claim. However, the district court reversed the bankruptcy court’s ruling on the non-dischargeability of the collection charges. The District Court saw no reason to differentiate, for purposes of dischargeability “a settlement award flowing from tortious conduct” and “ancillary costs meant to enforce and collect on” that settlement award. Hilgartner v. Yagi, 643 B.R. 107, 125 (E.D. Va. 2022).

On further appeal, the United States Court of Appeals for the Fourth Circuit affirmed the judgment of the district court. The Fourth Circuit reasoned that the settlement agreement “simply formalized a bargain that envisioned compensation for injury and collection alike – to resolve claims arising from willful and malicious injury,” and therefore, the collection fees and interest were non-dischargeable under 11 U.S.C. § 523(a)(6). In re Hilgartner, 91 F.4th 186, 194 (4th Cir. 2024).

So, the result of this set of legal rulings is that neither the amounts owed pursuant to the settlement agreement, “for willful and malicious injury” nor the interest related to the delayed payment and the attorney fees related to collecting the amounts owed, were dischargeable in bankruptcy.