Because bankruptcy doesn’t necessarily wipe out all debts, if a jury awards money to someone as compensation for embezzlement (a type of fraud), or you’ve been criminally prosecuted and ordered to pay fines or restitution, filing for bankruptcy might not offer you much comfort. How bankruptcy will affect embezzlement-related obligations will depend on the type of debt—whether it’s a criminal fine or a civil award—and the action the creditor takes after you file your bankruptcy matter.
Some debts never get wiped out (discharged) in bankruptcy—and restitution and criminal fines for embezzlement fall into the category of “nondischargeable” debt. Therefore, you won’t be able to get rid of any obligation arising out of a criminal conviction for embezzlement.
(Learn more by reading Nondischargeable Debts in Chapter 7 Bankruptcy.)
Before some debts are declared nondischargeable, the creditor—the person owed the debt—must take certain steps to prevent the debt from being wiped out. Specifically, the creditor must ask the court to declare the debt nondischargeable. If the creditor doesn't do so or is unsuccessful, the obligation gets discharged with all other qualifying debt.
Civil debts arising from embezzlement fall into this category because it’s a debt “for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.” Unlike criminal restitution, a civil embezzlement-related debt will only survive the bankruptcy discharge if the creditor takes action early in the bankruptcy case. The creditor must obtain a determination from the bankruptcy judge that the debtor’s actions fit within that code section.
To start the process of determining dischargeability, the creditor must file an adversary proceeding (lawsuit) in the bankruptcy case within 60 days of the first date set for the 341 meeting of creditors—the one appearance all bankruptcy filers must make.
The meeting of creditors usually occurs about 30 days after the debtor files the case, giving the creditor approximately 90 days to file the complaint. The creditor can request an extension of time to file the adversary proceeding, but after the passing of the initial 60 days, that right disappears.
The bankruptcy court will decide on its own whether the debtor’s action comes within the meaning of the embezzlement statute. To be held nondischargeable, the creditor will have to prove three elements in the bankruptcy adversary case:
Once the court declares the embezzlement debt nondischargeable, it will never get wiped out in any future bankruptcy case.