Tag Archives: discharge

June 21, 2016

Supreme Court Expands Creditors’ by Allowing Denial of a Discharge Under Sec. 523(a)(2)(A) if Debtor Transfers Assets in Violation of State Fraudulent Transfer Statute

Section 523(a)(2)(A) of the Bankruptcy Code allows a creditor to obtain a judgment denying its debtor a discharge of debts incurred by false pretenses or actual fraud. However, if the debt itself was not incurred by actual fraud, but the debtor subsequently transfers his assets with the intent prevent its creditors from obtaining payment, may the creditor still obtain a judgment denying the debtor’s discharge under § 523(a)(2)(A)? The United States Supreme Court answered that question in the affirmative in its recent decision in Husky International Electronics, Inc. v. Ritz, 2016 WL 2842452 (2016).

Chrysalis Manufacturing Corp. incurred a debt to Husky International arising from Chrysalis’s purchase from Husky of components used in electronic devices. Over a period of four years, Chrysalis incurred a debt to Husky totaling over $160,000. There was no contention that this debt was incurred as the result of false representations or actual fraud. However, during the latter part of this same period, Daniel Ritz, a director and owner of Chrysalis, caused Chrysalis to transfer virtually all its assets to other companies Ritz also controlled. Husky sued Ritz under a Texas statute which allows creditors to hold shareholders responsible for corporate debts under circumstances involving actual fraud. After Ritz filed a personal bankruptcy petition under chapter 7, Husky brought an adversary proceeding against him seeking denial of the dischargeability of its debt under § 523(a)(2)(A). The District Court concluded the Ritz was liable under the Texas statute but also concluded that the debt was not obtained by actual fraud could be discharged. The Fifth Circuit affirmed, agreeing the debt could be discharged since it was not incurred by actual fraud as required by § 523(a)(2)(A).

The Supreme Court reversed, holding the term “actual fraud” in § 523(a)(2)(A) “encompasses forms of fraud, like fraudulent conveyance schemes, that can be effected without a false representation.”

The Court commenced its analysis by first looking to the prior Bankruptcy Act, which prohibiting debtors from discharging debts obtained by false pretenses or false representations, but contained no provisions relating to situations which might constitute “actual fraud” but not fall within the meaning of false pretenses or false representations. Congress added the term “actual fraud” when it enacted the Bankruptcy Code in 1978. The addition of the words “actual fraud” were presumed by the Court to have “real and substantial effect.” The Court believed the words “actual fraud” were intended to mean something other than “false representation.” The Court then analyzed the historical meaning of the terms “actual fraud” and concluded the words have long included the type of fraudulent transfer scheme in which Ritz engaged. First, the Court noted the word “actual” has a simple meaning in the common law, and denotes any fraud that “involves moral turpitude or intentional wrong,” and stands in contrast to implied fraud or fraud in law. The Court stated “Thus, anything that counts as ‘fraud’ and is done with wrongful intent is ‘actual fraud.’”

The Court found analyzing the history of the word “fraud” to be more challenging, and although it “connotes deception or trickery generally,” was more difficult to precisely define. However, the Court noted the term “fraud” had long been used by courts to describe a debtor’s transfer of assets which impairs a creditor’s ability to collect a debt. The Court further noted that fraudulent conveyances at common law did not require a misrepresentation by a debtor to his creditor. The fraudulent conduct was not in inducing the creditor to extend credit but rather was in the act of concealment and hindrance. As a result, the Court determined the actual fraud need not be present at the inception of a credit transaction.

March 15, 2016

Secured Creditors Beware: Ninth Circuit Holds a Chapter 13 Debtor may Avoid Liens Even if not Entitled to a Discharge

Congress enacted § 1328(f) of the Bankruptcy Code when its passed BAPCPA. This section prohibits the granting of a chapter 13 discharge if the debtor received a chapter 7 discharge within four years prior to the commencement of his chapter 13 case. The Ninth Circuit in In the Matter of Blendheim, 803 F.3d 477 (9th Cir. 2015) held a chapter 20 debtor may in his chapter 13 case avoid a lien under § 506(d) even if § 1328(f) precludes him from receiving a discharge.

The creditor in Blendheim was HSBC Bank, which held a deed of trust lien on the debtors’ home. The debtors filed a chapter 7 case and received a discharge. Soon thereafter, they filed a chapter 13 case, mainly to restructure debts relating to their primary residence. HSBC timely filed a secured proof of claim based on its deed of trust against the debtors’ residence. The debtors objected to the claim, substantively objecting on the grounds that the note which formed the basis for the claim bore a forged signature. For some unknown reason, HSBC never responded to the debtors’ objection, and the bankruptcy court entered an order disallowing HSBC’s secured claim. In fact, after receiving notice that its secured claim had been disallowed, HSBC withdrew its proof of claim and requested the court to no longer send it electronic notifications in the case.

Thereafter, the debtors filed an adversary proceeding against HSBC seeking to void HSBC’s lien under § 506(d) which provides “to the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.” The debtors contended they were entitled to avoid the lien because the plain language of the statute says a lien securing a debt which is not an allowed secured claim is void. HSBC defended, asserting the debtors were not entitled to avoid the bank’s lien because the debtors were precluded from receiving a discharge by § 1328(f), which provides that a debtor may not receive chapter 13 discharge if he has received a chapter 7 discharge within four years prior to the commencement of his chapter 13 case.

The Ninth Circuit agreed the debtors could avoid HSBC’s liens even though they could not receive a chapter 13 discharge. First, the court concluded the plain language of § 506(d) entitled the debtors to avoid HSBC’s lien. Because this section provides that a lien is void if it secured a debt which is not an allowed secured claim, the court concluded that Congress’ intent was manifest, and held the purpose of § 506(d) was to nullify a creditor’s legal rights in a debtor’s property if the creditor’s claim is disallowed. The court stated its belief that the Supreme Court’s decision in Dewsnup v. Timm, 502 U.S. 410 (1992) confirmed its interpretation. In Dewsnup, the debtors argued that the creditor’s claim was not an allowed secured claim because it was undersecured, and therefore they could avoid it under § 506(d). The Supreme Court rejected this argument, holding “§ 506(d) did not void the lien on his property because the creditor’s claim has been fully ‘allowed.’”

HSBC argued that such a conclusion would be inconsistent with decisions from the Eighth,[1] Fourth[2] and Seventh[3] Circuits, all of which held that avoiding liens for claims which were disallowed because they were untimely filed violated the long-standing principle that valid liens pass through bankruptcy unaffected. Viewing these decisions as holding that filing an untimely claim is akin to not filing a claim at all, the court determined the reasoning of these cases to be inapplicable since HSBC’s claim was disallowed on the merits. The court also noted that the Eleventh[4] and Fourth[5] Circuits have held that a chapter 13 debtor who cannot receive a discharge because of § 1328(f) may still void liens under § 506(d).

Finally, the court rejected HSBC’s argument that allowing avoidance of its lien in these circumstances would effectively grant the debtors on a de facto basis, the discharge to which they were not entitled. The court stated this argument ignored the difference between in personam and in rem liability. By enacting § 1328(f), Congress affected only the debtor’s in personam liability: “We take Congress at its word when it said in § 1328(f) that Chapter 20 debtors are ineligible for a discharge, and only a discharge.” The court further noted there is no language in the Bankruptcy Code which prevents Chapter 20 debtors from receiving the other benefits chapter 13 has to offer, and had Congress intended to prevent these debtors from avoiding liens, it would have included specific language when it enacted BAPCPA.

 

[1] In re Shelton, 735 F.3d 747 (8th Cir. 2013)

[2] In re Hamlett, 322 F.3d 342 (4th Cir. 2003)

[3] In re Tarnow, 749 F.2d 464 (7th Cir. 1984)

[4] In re Scantling, 754 F.3d 1323 (11th Cir. 2014)

[5] In re Davis, 716 F.3d 331 (4th Cir. 2013)

March 1, 2016

Tenth Circuit Holds Default Judgments for Violations of Securities Laws Must be Given Preclusive Effect in Non-dischargeability Actions Under Section 523(a)(19)

The Tenth Circuit has in the past refused to give preclusive effect in bankruptcy non-dischargeability actions brought under § 523(a)(2) to pre-petition default judgments arising from claims of actual fraud. In re Jordana, 216 F.3d 1087 (10th Cir. 2000). However, the Tenth Circuit recently held that this refusal does not extend to pre-petition default judgments based on violations of securities laws where the claim for non-dischargeability is brought under § 523(a)(19), and that such judgments must be given preclusive effect for purposes of denying the dischargeability of the debt. Tripoldi v. Welch et al, 810 F.3d 761 (10th Cir. 2016).

Robert Tripoldi brought an action in the U.S. District Court for the District of Utah against Nathan Welch and others alleging violations of state and federal securities laws. Welch answered the complaint, but during the course of the litigation, his attorneys withdrew and Welch never retained new counsel. Eventually, the trial court issued a default judgment against Welch. Welch subsequently filed a chapter 7 bankruptcy petition, and then filed motions with the district court to set aside the default judgment and grant judgment on the pleadings in Welch’s favor. Tripoldi filed a motion with the district court to declare the pre-petition default judgment non-dischargeable under § 523(a)(19). The district court denied Welch’s motions and granted Tripoldi’s.

On appeal, after determining the district court did not abuse its discretion in entering the default judgment or in denying the motion to vacate it, the Tenth Circuit then turned to the issue of whether the default judgment could be the basis for a denial of discharge under § 523(a)(19). Welch argued that a default judgment should not be the basis for the denial of a discharge, relying on the Tenth Circuit’s prior opinion in Jordana. The Tenth Circuit disagreed, and noted what it considered to be significant differences between § 523(a)(2) and § 523(a)(19). The court stated that it declined to extend its reasoning in Jordana to default judgments based on violations of securities laws because § 523(a)(2) and § 523(a)(19) “have different requirements and different purposes.” The court placed great importance on the fact that § 523(a)(19) contains the specific requirement that the debt be memorialized in a “judgment, order, decree or settlement agreement” stemming from a violation of securities laws, whereas § 523(a)(2) contains no such requirement. The court also that Congress, in enacting § 523(a)(19) to include the requirement of a judgment, intended to close what it perceived to be a “loophole in the law.” The noted its decision was consistent with those of two other courts to rule on the issue: In re Pujdak, 462 B.R. 560 (Bankr. D. S.C. 2011) and Meyer v. Rigdon, 36 F.3d 1375 (7th Cir. 1994) (interpreting § 523(a)(11) which contained a similar requirement).

January 12, 2016

Ninth Circuit BAP Holds That a Wholly Unsecured Junior Lien, Discharged in Chapter 7, is not Included in Calculating Chapter 13 Eligibility Under Sec. 109(e)

Section 109(e) of the Bankruptcy Code limits eligibility for chapter 13 relief to those individual debtors whose noncontingent, liquidated unsecured debts do not exceed statutory limits. In calculating eligibility to file chapter 13, should a court consider debts which have been discharged in a prior chapter 7 case and which are “out of the money” because, while secured by a trust deed against the debtor’s residence, the value of the debtor’s residence is insufficient to cover the debt relating to the first trust deed? The Ninth Circuit Bankruptcy Appellate Panel answered this question in the negative, holding in Free v. Malaier (In re Free), 2015 WL 9252592 (9th Cir. BAP 2015) that such debts are not to be included in determining eligibility for chapter 13 relief.

In Free the debtors owned a home which they valued in their chapter 7 schedules at $425,000. The home secured three debts totaling over $900,000, with the first lien holder owed more than the value of the home. The debtors received a chapter 7 discharge and shortly thereafter commenced a chapter 13 case in which they sought to strip off the two subordinate liens. The chapter 13 trustee filed a motion to dismiss the case, arguing that these two wholly unsecured subordinate liens should be included in determining eligibility, and doing so rendered the debtors ineligible for chapter 13 relief. While noting that there was no Ninth Circuit controlling case directly on point, the bankruptcy court relied on several opinions in the Ninth Circuit in chapter 12 cases to conclude the subordinate liens should be included in the calculation and finding the debtors were not eligible for chapter 13 relief.

The BAP reversed, concluding that the discharged debts reflected by the wholly unsecured subordinate liens, should not be considered in determining chapter 13 eligibility. The court began its analysis with the definitions of “debt” and “claim” in section 101 of the Code. Because “claim” is defined as a right to payment and “debt” is defined as liability on a claim, the court held “there is no ‘unsecured debt’ unless the creditor has a ‘right to payment’ on an unsecured basis.” The court next concluded that the result of the debtors’ chapter 7 discharge resulted in their having no personal liability to pay the debts relating to the subordinate liens.

Because the bankruptcy court based its ruling in part on the U.S. Supreme Court’s decision in Johnson v. Home State Bank, 501 U.S. 78 (1991), the BAP addressed its perceived distinctions between the facts in Johnson and the facts in the present case.   In Johnson, the debtor obtained a chapter 7 discharge of a judgment in a foreclosure action and then filed a chapter 13 case with the intent to pay the in rem judgment through his chapter 13 plan. In addressing the question of whether an in rem claim for which personal liability has been discharged can properly be included in a chapter 13 plan, the Supreme Court held that such a claim can be treated in a chapter 13 plan because the claim was enforceable against the debtor’s property even though it was not enforceable against the debtor himself.

The BAP also distinguished the decision of the Ninth Circuit in Quintana v. Commissioner, 915 F.2d 513 (9th Cir. 1990) and the Ninth Circuit BAP in Davis v. Bank of America (In re Davis), 2012 WL 3205431 (9th Cir. BAP 2012), both of which involved chapter 12 proceedings. In Quintana, a judgment creditor agreed to waive any deficiency judgment following the sale of the debtor’s real property securing the judgment. Because the real property had not yet been sold, making a determination of the relative amounts of the secured and unsecured debts uncertain, the Ninth Circuit held it appropriate to include the full amount of the judgment debt in determining the debtor’s eligibility for chapter 12 relief. The BAP also noted the differences between § 109(e), which segregates secured and unsecured debts in determining eligibility, and § 101(18), which determines who is a family farmer by looking to the individual’s aggregate debts. The BAP distinguished its prior decision in Davis on similar grounds.

The BAP then distinguished the Ninth Circuit’s decision in Scovis v. Henrichsen (In re Scovis), 249 F.3d 975 (9th Cir. 2001) and the Ninth Circuit BAP’s decision in Smith v. Rojas (In re Smith), 435 B.R. 637 (9th Cir. BAP 2010) both of which held that the unsecured portion of partially secured debts are to be included in determining chapter 13 eligibility on the grounds that both Scovis and Smith dealt with cases where the chapter 13 proceeding was not preceded by a chapter 7 discharge of the debtor’s personal liability on the debt in question.

Finally, the BAP addressed the U.S. Supreme Courts’ decisions in Dewsnup v. Timm, 502 U.S. 410 (1992) and Bank of America v. Caulkett, 135 S. Ct. 1995 (2015) in connection with lien stripping efforts by chapter 13 debtors. The Court in Dewsnup held that a chapter 7 debtor cannot strip down a partially unsecured lien under § 506(d) to the value of the collateral. Subsequently in Caulkett the Court extended its holding in Dewsnup to situations involving wholly unsecured junior liens. The BAP noted that, following Dewsnup and Caulkett, litigants have argued that debtors who first file a chapter 7 case and obtain a personal discharge and then file a chapter 13 case seeking to strip the remaining in rem claim are acting in bad faith. The BAP refused to reach this issue as it had not been brought forward in the appeal but did state that this argument must be raised by filing a motion to dismiss the chapter 13 case as a bad faith filing and not in the context of whether the debtor is eligible under § 109(e) to file a chapter 13 case.

July 7, 2015

Ninth Circuit BAP Holds that Denial of a Student Loan Debt under Sec. 523(a)(8)(A)(ii) Requires Actual Receipt of Funds by the Debtor

In a case of first impression for the Ninth Circuit BAP, the court held that student loan debts can be denied a discharge under § 523(a)(8)(A)(ii) only if the debtor actually received funds from the plaintiff.  Institute of Imaginal Studies dba Meridian University v. Tarra Nichole Christoff (In re Christoff), 2015 WL 1396630.  The court reached its conclusion based on the plain language of the statute.

In Christoff, the debtor enrolled in Meridian University and received in her first year a financial aid package which provided her with a tuition credit but under which she did not receive any actual funds.  The debtor signed a promissory note to repay the tuition credit in monthly installments after she completed her coursework or withdrew from the institution.  She received a similar financial aid package for her second of study.  The debtor failed to make all payments required under her promissory notes and eventually filed a chapter 7 bankruptcy petition.  Meridian filed an adversary proceeding seeking denial of the discharge of its debt under 11 U.S.C. § 523(a)(8)(A)(ii). 

Sec. 523(a)(8)(A)(ii) provides that, unless for hardship, a debt is not dischargeable if it constitutes “an obligation to repay funds received as an educational benefit, scholarship, or stipend.”  The dispute in Christoff centered on the “funds received” language of the statute.  Without question, the debtor received no funds from Meridian.  The transaction involved the granting of a tuition credit in the debtor’s two years of study with the debtor signing promissory notes to repay the amount of those credits after she completed her coursework or withdrew from the university. The bankruptcy court held the debt was dischargeable because the plain language of the statute required the debtor to receive funds, and the debtor had not received any funds from Meridian.  The BAP affirmed.

Meridian argued that the phrase “funds received” should be construed as the equivalent of the word “loan” as described in the other two subsections of 523(a)(8).  The debtor argued that, by using the phrase “funds received” in § 523(a)(8)(A)(ii), Congress intended to restrict the denial of a discharge for student debts to for-profit universities to those instances where the debtor receives actual funds.  The BAP agreed.  The court began its analysis by noting that any construction begins with the language of the statute, stating that the words of the Bankruptcy Code “must be read in their context and with a view to their place in the overall statutory scheme.”   Further, the provisions of § 523 are to be strictly construed in favor of debtors.  The BAP relied heavily on the Ninth Circuit’s decision in Hawkins v. Franchise Tax Bd. Of Cal., 769 F.3d 622 (9th Cir. 2014) and its interpretation of the pre-BAPCPA provisions on student loan debt.  In Hawkins, the debtor entered into an agreement with Ohio University agreeing to practice medicine for five years after licensure in exchange for admittance to the university’s medical school.  The agreement contained a liquidated damages provision in the event she breached the requirement that she practice medicine in Ohio for five years.  The debtor promptly moved to California following her graduation. After the university sued her to obtain a judgment on the liquidated damages provision, the debtor filed a chapter 7 petition.  The Ninth Circuit concluded the liquidated damages was not an educational loan stating “while an educational loan need not include an actual transfer of money . . . to [the] debtor, in order for it to fall within the definition of . . . § 523(a)(8), the loan instrument must sufficiently articulate definite repayment terms and the repayment obligation must reflect the value of the benefit actually received [by the debtor] rather than some other ill-defined measure of damages or penalty.”  More importantly, the BAP relied on the Ninth Circuit’s language in Hawkins that the liquidated damages were dischargeable “because the plain language of this prong of the statute requires that a debtor receive actual funds in order to obtain a nondischargeable educational benefit.” 

As a result, since the provisions of the statute are to be construed narrowly, and because the plain language of the statute refers to “funds received” by the debtor, the BAP affirmed the ruling of the lower court that the debtor was dischargeable because the tuition credits were not “funds received” by the debtor.

June 9, 2015

Seventh Circuit Holds that a Debt Created by Fraud may be Discharged if the Fraud was Perpetrated by the Debtor’s Agent, so long as the Debtor was not Complicit in the Fraud

In the case of Sullivan v. Glenn (In re Glenn), No 14-3213 (7th Cir. 2015), the Seventh Circuit Court of Appeals held that a debt which was incurred as a result of fraud perpetrated by the debtor’s agent is dischargeable, so long as the debtor was not complicit in the agent’s fraudulent conduct.  The facts involved a loan made by Brian Sullivan to the Glenns through the actions of a loan broker by the name of Karen Chung.  Chung and Sullivan knew each other.  In fact, Sullivan, an attorney, had represented Chung on more than one occasion.  In this transaction, however, Chung acted as the agent of the Glenns in seeking a bridge loan of $250,000 pending the closing of a bank loan for $1,000,000.  Chung convinced Sullivan to loan the Glenns $250,000 on a short-term basis at a high interest rate, representing to Sullivan that a bank had agreed to give the Glenns a loan of $1,000,000.  Chung represented to the Glenns that she had negotiated the bank loan and that it had been approved.  Based on Chung’s representations, Sullivan made the loan to the Glenns, and the Glenns signed promissory notes to Sullivan.  As it turned out, there was no bank loan at all.  After the Glenns filed bankruptcy, Sullivan filed an adversary proceeding seeking denial of the discharge of his loan based on fraud.

Sullivan raised two arguments to justify denial of the debtors’ discharge, both of which were rejected by the Seventh Circuit.  First, Sullivan argued that a debtor’s complete innocence in connection with the fraud should not be a defense to nondischargeability.  The court rejected this “debt not the debtor” theory for denying a discharge, even though it agreed the theory was consistent with the language of § 523, stating this argument “just illustrates the limitations of literal interpretation of statutory language.”  The court illustrated this limitation by taking Sullivan’s argument to its logical conclusion:  if Chung, who was jointly liable with the Glenns on the loan, had assigned the debt to an innocent third party who agreed to assume it, and that third party later filed bankruptcy, Sullivan under his theory could obtain a judgment denying the discharge of the debt in that innocent third party’s bankruptcy case.  The court concluded the intent of § 523 did not go that far, and rejected the “debt not the debtor” argument advanced by Sullivan.

The court then addressed Sullivan’s agency argument, contending that Chung’s fraud should be charged to the Glenns.  Sullivan contended that an agent’s fraudulent conduct must always be binding on his principal, even if the principal had not knowledge of the fraud.  The court rejected this argument, and agreed with the Eighth Circuit’s opinion in In re Walker, 726 F.2d 452, 454 (8th Cir. 1984) that denial of a discharge of a debt based on an agent’s fraudulent conduct requires “proof which demonstrates or justifies an inference that the debtor knew or should have known of the fraud.”  On the facts before it, the Seventh Circuit determined that, as between the Glenns and Sullivan, the Glenns were the more innocent party, and Sullivan was in the better position to protect himself.  As a result, the court affirmed the judgment in favor of the Glenns.

March 31, 2015

Ninth Circuit Holds Discharged Debts are Still Debts for Purposes of Determining Eligibility to File under Chapter 12

In a case of first impression, the Ninth Circuit held that the unsecured portion of a secured debt, for which the debtor’s liability has been discharged in a prior chapter 7 proceeding, is still a debt for determining the debtor’s eligibility to be a debtor under chapter 12 of the Bankruptcy Code.  Davis v. U.S. Bank (In re Carolyn Davis), 2015 WL 662001 (9th Cir. 2015).  Carolyn Davis owned three parcels of real property on which she created a vineyard.  The appraised value of the three parcels totaled $1,600,000, and Davis owed debts secured by the properties totaling $4,100,000.  When her vineyard venture failed, Davis filed a personal chapter 7 case and received a discharge of her liability on the three loans.  She then filed a chapter 12 petition seeking to restructure the secured debt.  At the time, the statutory limit for debt in order to be eligible to file a chapter 12 petition was $3,792,650.  Although the loans secured by her real property totaled $4,100,000, Davis contended she was eligible to file a chapter 12 petition because the value of the collateral securing these loans was below the statutory limit and she had received a discharge of her liability on these loans in her chapter 7 case.

The bankruptcy court dismissed her chapter 12 petition concluding her “aggregate debts” exceeded the statutory limit of $3,792,650 in effect at the time under 11 U.S.C. § 101(18)(A).  The Ninth Circuit BAP affirmed, holding that the term “aggregate debts” in § 101(18)(A) included the unsecured portion of the debts secured by her real property even though her personal liability for the debts had been discharged.  The Ninth Circuit affirmed.

In concluding the bankruptcy court and BAP had reached the correct conclusion, the Ninth Circuit began with viewing the plain language of the statute.  First it noted that a “debt” is a “liability on a claim.”  11 U.S.C. § 101(12).  Next, it noted that the Code defined the term “claim” as a “right to payment . . . or right to an equitable remedy for breach of performance.”  11 U.S.C. § 101(5).  Citing the U.S. Supreme Court’s opinion in Pa. Dept. of Pub. Welfare v. Davenport, 495 U.S. 552 (1990), the Ninth Circuit stated “the plain meaning of a ‘right to payment’ is nothing more nor less than an enforceable obligation, regardless of the objectives [sought] in imposing the obligation,” and that “the meanings of ‘debt’ and ‘claim’ [were intended by Congress to] be coextensive.”  Further, the Ninth Circuit noted the opinion of the U.S. Supreme Court in Johnson v. Home State Bank, 501 U.S. 78 (1991), where the Court held that a debtor must include a mortgage lien in a chapter 13 plan even though the obligation secured by the mortgage was discharged in an earlier chapter case.  As a result, the Ninth Circuit concluded that the word “claim” in § 101(5) is to be given the “broadest definition available.” 

The Ninth Circuit held that the creditors’ right to foreclose in rem against the debtor’s properties constituted a “debt” and a “claim” even though the debtor’s personal liability had been previously discharged.  As a result, the debtor’s “aggregate debts” for purposes of determining eligibility exceeded the statutory limit, and the dismissal of the debtor’s chapter 12 case was affirmed.

March 14, 2014

Ninth Circuit B.A.P. Holds That Principal Can Discharge Debts Caused By His Agent’s Fraud

The BAP held that “more than a principal/agent relationship is required to establish a fraud exception to discharge . . . The creditor must show that the debtor knew, or should have known, of the agent’s fraud.”

A central purpose of bankruptcy is to grant debtors a fresh start – in bankruptcy terms, a “discharge” of existing debts.  But not all debts are dischargeable.  Bankruptcy Code § 523(a)(2)(A), for example, prevents the discharge of debts resulting from “false pretenses, a false representation, or actual fraud . . . .”  What if a principal incurs a large debt based not on his own fraud, but on the fraud of his agent?  Is that debt dischargeable?  That was the question addressed recently by the Ninth Circuit Bankruptcy Appellate Panel in In re Huh, BAP No. CC-12-1633, 2014 WL 936803 (9th Cir. B.A.P. March 11, 2014). Download In re Huh 2014 WL 936803 9th Cir BAP 2014.

Benjamin Huh was a real estate broker who ran a real estate and business brokerage business as a sole proprietor.  He hired an agent, Jay Kim, who did not hold a brokerage license of his own and so relied on Huh’s brokerage license.  Kim sold a shopping market (the “Market”) to an out-of-country investor looking for a profitable investment that required minimal personal involvement.  It turned out that the Market was quite unprofitable and required substantial personal involvement.  Its gross sales were significantly lower than Kim represented, and it was subject to so many code violations that its business license was revoked. 

The investor sued Kim for fraud in state court and prevailed.  The investor then successfully moved the state court to add Huh to the judgment.  Huh thereby became jointly and severally liable on the judgment of approximately $1 million, based upon his agent’s fraud.

Huh filed for chapter 7 bankruptcy relief.  The investor filed a complaint under Bankruptcy Code § 523(a)(2)(A), asking the court to except his state court judgment from discharge.  The investor argued that under basic agency principals, a principal is liable for the torts of his agents, and therefore Kim’s liability should be imputed to Huh for purpose of discharge.  Notably, the state court findings of fact were not binding on the bankruptcy court, which made its own findings.  It found that Huh had no involvement with Kim’s sale of the Market, and was totally unaware of the Market until after the sale closed.  In short, he had not personally engaged in any culpable conduct.  Thus, the judgment debt would be dischargeable in Huh’s bankruptcy unless Kim’s fraud was imputed to Huh for purposes of § 523(a)(2)(A). 

The bankruptcy court dismissed the investor’s nondischargeability complaint, and the BAP, sitting en banc, affirmed.  The BAP held that “more than a principal/agent relationship is required to establish a fraud exception to discharge . . .  The creditor must show that the debtor knew, or should have known, of the agent’s fraud.”  In reaching this result, the BAP examined various approaches taken by circuit courts, and a recent United States Supreme Court case that granted a discharge exception under another subsection only if the creditor could establish a debtor’s “culpable state of mind.”  See  Bullock v. BankChampaign, N.A., 133 S.Ct. 526 (2013). 

Because Huh was not aware of the Market sale or of his agent’s false representations until after the sale closed, Huh’s liability on the state court judgment was dischargeable in his chapter 7 case.

January 7, 2014

Tenth Circuit Holds that a Claim for Overpayment of Spousal Support is Dischargeable Under Sec. 523(a)(5) but Non-Dischargeable Under Sec. 523(a)(15)

The Tenth Circuit recently analyzed the interplay between sections 523(a)(5) and 523(a)(15) of the Bankruptcy Code in connection with a judgment obtained by a former husband for overpayment of his spousal support obligations.  Eloisa Taylor, the debtor in In re Taylor, 2013 WL 6404952 (10th Cir. 2013) had divorced Matthew Taylow and was awarded spousal support, with the divorce decree providing that Matthew’s obligation to pay spousal support would terminate on Eloisa’s remarriage.  Several years later, Matthew moved to terminate his spousal support obligations on the ground that Eloisa was cohabiting with another man in a marriage-like relationship.  Applicable Virginia law provided that cohabitation for one year in a relation analogous to marriage constitutes grounds for termination of spousal support under a decree that provides for termination on remarriage.  Not only did the Virginia state court terminate Matthew’s obligation to pay spousal support, it did so retroactively and awarded him a judgment of $40,660 against Eloisa for overpaid spousal support.

Eloisa filed bankruptcy in the District of New Mexico seeking to discharge the judgment.  Matthew filed an adversary proceeding asserting the judgment was non-dischargeable under either section 523(a)(5) or 523(a)(15).  The bankruptcy court held that the judgment was not “spousal support” and, therefore, did not qualify for denial of discharge under section 523(a)(5).  However, the bankruptcy court further held that the judgment was an obligation in connection with a divorce proceeding within the plain language of section 523(a)(15) and denied a discharge of the judgment.  The BAP affirmed, and the appeal was then brought to the Tenth Circuit, which also affirmed.

The Tenth Circuit first analyzed whether the judgment in Matthew’s favor was “spousal support” within the meaning of section 523(a)(5).  The court first noted that, while the Bankruptcy Code favors a debtor’s “fresh start,” it does not do so over the policy of enforcing familial support obligations.  First, the court looked to the statutory definition of “domestic support obligation” as a debt “owed to. . . . a spouse. . . in the nature of alimony, maintenance or support.”  11 U.S.C. sec. 101(14A).  The court affirmed the conclusion of the bankruptcy court and the BAP that the judgment did not qualify under section 523(a)(5) for a denial of discharge, because it did not create a support obligation as to Matthew as the creditor spouse.  The Tenth Circuit held that, to be non-dischargeable under section 523(a)(5), the spousal support obligation had to be owed to the creditor spouse.  In this case, Matthew was the one who owed spousal support.  The judgment in question was not one where Eloisa was ordered to pay spousal support to Matthew, but instead to compensate Matthew for his overpayment of spousal support to Eloisa.  Consequently, the court held that Matthew could not obtain a denial of discharge of the judgment under section 523(a)(5).

The Tenth Circuit, however, held that Matthew’s judgment was non-dischargeable under section 523(a)(15).  Section 523(a)(15) provides that debts owed to a former spouse incurred in the course of a divorce decree or other court of record, which are not of the kind described in section 523(a)(5), are not dischargeable.  There was no dispute in this instance that Matthew was Eloisa’s former spouse, and the Tenth Circuit held the debt did not constitute spousal support for purposes of section 523(a)(5).  The state court retained jurisdiction over the parties under the divorce decree and entered the judgment in connection with the prior divorce decree.  Thus, under the plain language of section 523(a)(15), the judgment was not dischargeable. 

Eloisa attempted to avoid this result by asserting the “absurdity doctrine,” under which the plain language of a statute is to “yield to the legislative intent of the Bankruptcy Code drafter,” and where enforcement of a statute’s plain language will yield a result demonstrably at odds with the drafters’ intent.  See United States v. Ron Pair Enterprises, 489 U.S. 235, 242-43 (1989).  However, the Tenth Circuit noted that the absurdity doctrine applies “in only the most extreme of circumstances,” where the result of enforcing the statute’s plan language will lead to “results so gross as to shock the general moral or common sense.”  (citing United States v. Husted, 545 F.3d 1240, 1245 (10th Cir. 2008)).  The court concluded that the bankruptcy court’s determination that Matthew’s judgment was not dischargeable under section 523(a)(15) did not shock the general moral or common sense, and was not at odds with the intent of the Bankruptcy Code’s drafters.  Congress amended section 523(a)(15) in 2005 to remove the provisions which required a court to balance the debtor spouse’s ability to pay the debt in question against the merits of the creditor spouse’s needs, leaving the court to conclude that Congress intended such debts to be non-dischargeable regardless of the debtor spouse’s ability to pay.  In addition, nothing in the statute indicated Congressional intent that the statute was enacted solely for the protection of the dependent spouse.  Based on this reasoning, the Tenth Circuit held the judgment non-dischargeable under section 523(a)(15).

April 24, 2013

Ninth Circuit BAP Clarifies Standard of Review for Undue Hardship Determination

Under 11 U.S.C. § 523(a)(8), student loans are excepted from a debtor’s discharge unless paying those loans would “impose an undue hardship on the debtor and the debtor’s dependents.”  In the Ninth Circuit, a debtor must prove three elements to obtain a discharge of student loans—(1) that the debtor cannot maintain, based on current income and expenses, a minimal standard of living for him/herself and his/her dependents if forced to repay the loans; (2) that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and (3) that the debtor has made good faith efforts to repay the loans.  See United Student Aid Funds v. Pena (In re Pena), 155 F.3d 1108, 1111 (9th Cir. 1998).

In Roth v. Education Credit Management Corp., BAP No. AZ-11-1233-RnPaKi (B.A.P. 9th Cir. filed Apr. 16, 2013) the Bankruptcy Appellate Panel for the Ninth Circuit was faced with the determination of whether the bankruptcy court erred in concluding that the debtor failed to make a good faith effort to repay her student loans.  However, a threshold question the court had to resolve before deciding whether the bankruptcy court erred was what standard should be applied in reviewing that determination as Ninth Circuit precedent contains contradictory language regarding the appropriate standard of review.

First, the court found that it is clear from existing case law that the ultimate undue hardship determination is reviewed de novo even though the undue hardship determination is a mixed question of fact and law as it requires a determination of the legal effect of the bankruptcy court’s findings regarding the student’s circumstances.  The court explained that mixed questions of fact and law are reviewed de novo because they “require consideration of legal concepts and the exercise of judgment about the values that animate legal principals.”  Roth, 11:2-4.  De novo review is of course, independent and gives no deference to the bankruptcy court’s conclusion.

Second, the court went on to state that the bankruptcy court’s determinations of facts underlying its undue hardship determination are reviewed for clear error.  Review for clear error is significantly deferential to the bankruptcy court and an appellate court should not reverse a bankruptcy court’s factual findings unless it is left with a “definite and firm conviction that a mistake has been committed.”  Id. at 11:17-18.

However, what was not so clear is the standard of review to be applied to the three individual elements that a debtor must establish to obtain a discharge of student loans because Ninth Circuit case law at times acknowledges that the ultimate undue hardship determination is a question of law reviewed de novo but nevertheless, uses clear error language in its analysis.  The court held that the three hardship elements are subject to do novo review because they are stand-alone requirements and failure to prove any one precludes discharge.  The court reasoned that “if the ultimate undue hardship determination is reviewed de novo…, it must then follow that the three independent prongs are also mixed questions requiring de novo review.  If not, and they instead are simply factual determinations, the reviewing court, upon finding no clear error as to each prong, would be bound to uphold the bankruptcy court as to the ultimate hardship determination.  Such a mechanical application…would negate the reviewing court’s ability to ‘exercise judgment’.”  Id. at 14:4-14. 

Therefore, in sum, the court held that appellate courts in the Ninth Circuit should review: (1) the ultimate undue hardship determination de novo; (2) the bankruptcy court’s factual findings for clear error; and (3) the three hardship elements de novo.