Transcript Crashing Through Bankruptcy - Cohen

CRASHING THROUGH THE DEBTOR’S
BANKRUPTCY
Spring TRMG Conference
April 16, 2012
Paul D. Keenan, Esq.
and
Jeffrey D. Cohen, Esq.
Keenan Cohen & Howard PC
[email protected]
215-609-1104
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Bankruptcy courts are units of the district
court in the jurisdiction where the bankruptcy
court sits. Bankruptcy judges are classified as
“judicial officers” of the district court and are
appointed by the United States Court of
Appeals for each circuit.
Appointments are for a term of 14 years.
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The Bankruptcy Code is silent on the issue of
whether a litigant is entitled to a jury trial on
matters litigated in bankruptcy court.
Courts have generally found that litigants are
entitled to a jury trial when the matter at
issue is legal in nature and is analogous,
historically, to a suit seeking monetary
compensation.
On the other hand, a litigant cannot obtain a
jury trial for suits in bankruptcy court which
are equitable in nature.
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Courts have found the following types of cases to
be equitable versus legal:
Disgorgement of excessive fees by counsel
(equitable);
A trustee’s claim for turnover of property of the
estate (equitable);
A fraudulent transfer action when asserted
against a defendant that has not filed a proof of
claim (legal); and
A preference action initiated by a trustee in
response to a proof of claim filed by a creditor in
a pending bankruptcy matter (equitable).
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Bankruptcy courts apply a “preponderance of the
evidence” standard when ruling upon whether an
exception to discharge should be granted.
Following a bankruptcy court determination, the
losing party can seek appellate review first at the
district court level. On appeal, a district court or
an appellate court reviews a bankruptcy court’s
factual determinations under the clearly
erroneous standard and its conclusions of law de
novo (anew). In re: Fegley, 118 F.3d 979, 982 (3rd
Cir. 1997).
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When an issue arises in a bankruptcy case
that can’t be resolved by negotiation or by
motion, it becomes necessary to file an
adversary complaint. The adversary complaint
initiates a matter, (“adversary proceeding”), in
bankruptcy court similar to the typical civil
action brought in local district court.
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Litigants will commonly initiate an adversary
proceeding to address the following issues:
The debtor wishes to pursue a creditor for
violating the bankruptcy automatic stay;
A creditor seeks an exception to discharge
for his or her individual debt; and/or
The US trustee’s office objects to the debtor
obtaining a discharge altogether.
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Attorneys who specialize exclusively in bankruptcy matters many times,
have limited actual trial experience. We have found that many times
bankruptcy attorneys will avoid the formal adversary environment of an
adversary proceeding. This can be detrimental to client goals
particularly when a debtor is not playing by the rules and is perpetrating
a fraud. Because many bankruptcy attorneys spend little if any time
calling witnesses, conducting cross examination, ensuring the
admissibility of documentary evidence and applying the rigid Federal
Rules of Evidence they may not be accustomed to, and not comfortable
with these proceedings.
This puts certain counsel at a disadvantage when faced with an
experienced litigator. The question to be asked when determining which
type of counsel to engage to recover assets when a debtor files for
bankruptcy is whether or not fraud or self dealing of the debtor is likely,
if it is – this will likely lead to an adversary proceeding in which a
litigator is your better choice. If fraud is not likely and the technical
mechanics of the bankruptcy process are primary – a bankruptcy
attorney is more suited to this type of work.
A VERY BRIEF PICTORIAL HISTORY OF THEFT
FROM CARRIERS OVER THE COURSE OF
HISTORY
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A bankruptcy discharge releases the debtor from personal liability for certain
specified types of debts. In other words, the debtor is no longer legally
required to pay any debts that are discharged. The discharge is a permanent
order prohibiting the creditors of the debtor from taking any form of
collection action on discharged debts, including legal action and
communications with the debtor, such as telephone calls, letters, and
personal contacts.
Although a debtor is not personally liable for discharged debts, a valid lien
(i.e., a charge upon specific property to secure payment of a debt) that has
not been avoided (i.e., made unenforceable) in the bankruptcy case will
remain after the bankruptcy case. Therefore, a secured creditor may enforce
the lien to recover the property secured by the lien.
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Certain exceptions to discharge apply automatically
The most common types of nondischargeable debts are:
certain types of tax claims,
debts not set forth by the debtor on the lists and schedules the
debtor must file with the court,
debts for spousal or child support or alimony,
debts for willful and malicious injuries to person or property,
debts to governmental units for fines and penalties, debts for
most government funded or guaranteed educational loans or
benefit overpayments,
debts for personal injury caused by the debtor's operation of a
motor vehicle while intoxicated,
debts owed to certain tax-advantaged retirement plans,
and debts for certain condominium or cooperative housing fees.
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The types of debts described in sections
523(a)(2), (4), and (6), obligations affected by
fraud or maliciousness are not automatically
excepted from discharge.
Creditors must ask the court to determine that
these debts are excepted from discharge. In the
absence of an affirmative request by the creditor
and the granting of the request by the court, the
types of debts set out in sections 523(a)(2), (4),
and (6) will be discharged.
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Section 523(a) of the Code specifically
excepts various categories of debts from
the discharge granted to individual debtors.
Therefore, the debtor must still repay those
debts after bankruptcy.
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Creditors receive a notice shortly after the
case is filed that sets forth much important
information, including the deadline for
objecting to the discharge. To object to the
debtor's discharge, a creditor must file a
complaint in the bankruptcy court before
the deadline set out in the notice. Filing a
complaint starts a lawsuit referred to in
bankruptcy as an "adversary proceeding."
Code Provisions That Permit
Survival of Debt After Bankruptcy
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The types of debts described in sections
523(a)(2), (4), and (6) (obligations affected by
fraud or maliciousness) are not automatically
excepted from discharge. Creditors must ask
the court to determine that these debts are
excepted from discharge. In the absence of
an affirmative request by the creditor and the
granting of the request by the court, the
types of debts set out in sections 523(a)(2),
(4), and (6) will be discharged.
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(A) - Misrepresentations or Fraud Used to Obtain Money or
Services
(a) A discharge under section 727, 1141, 1228(a), 1228(b),
or 1328(b) of this title [11 USCS § 727, 1141, 1228(a),
1228(b), or 1328(b)] does not discharge an individual
debtor from any debt-(2) for money, property, services, or an extension, renewal,
or refinancing of credit, to the extent obtained, by—
(A) false pretenses, a false representation, or actual fraud ,
other than a statement respecting the debtor's or an
insider's financial condition.
◦ To prove an exception to discharge under this
Code section, a creditor must establish the
following:
◦ (1) The debtor made a false representation of fact;
◦ (2) The debtor knew the representation to be false;
◦ (3) The debtor made the representation with the intent and
purpose of deceiving the creditor;
◦ (4) The creditor justifiably relied on the debtor’s
representation; and
◦ (5) The creditor sustained the alleged injury as the
proximate result of the representation.
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The debtor made a false representation of
fact
◦ Direct Evidence
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The debtor knew the representation to be
false
◦ Circumstantial Evidence
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The debtor made the representation with
the intent and purpose of deceiving the
creditor
◦ Circumstantial Evidence
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Because actual intent is difficult to decipher, courts
have adopted a multiple-factor test used to prove actual
intent to defraud through circumstantial evidence,
including the following factors:
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(1) Number of charges made;
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(2) The amount of charges;
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(3) The financial condition of the debtor at the time the
charges were made;
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(4) Whether the debtor made multiple charges on the
same day; and
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(5) The financial sophistication of the debtor
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The creditor justifiably relied on the
debtor’s representation
A creditor must establish that the falsity of
the debtor’s representation would not be
patent upon cursory examination.
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Justifiably relied
Reasonably relied
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The creditor sustained the alleged injury as
the proximate result of the representation
Not as a result of other factors (business
operations)
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(B) Written Misrepresentations about Financial
Condition
A debtor is not entitled to a discharge of a debt
incurred because of false statements made about
the debtor’s financial condition in writing. 11
U.S.C. § 523(a)(2)(B). To establish this exception to
discharge, a creditor must prove:
(1) The use of a written statement;
(2) That is materially false;
(3) Respecting the debtor's or an insider's financial
condition;
(4) On which the creditor reasonably relied; and
(5) That the debtor caused to be made or
published with the intent to deceive.
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11 U.S.C. § 523(a)(2)(B) differs from 11 U.S.C. §
523(a)(2)(A) because a creditor must establish
“reasonable reliance.”
In other words, a creditor must establish that its
conduct in extending credit to the debtor was
objectively reasonable.
Additionally, this exception is limited to
statements about financial condition, which must
be in writing. Oral misrepresentations about
financial condition are not excepted from
discharge.
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A debt will be excepted from discharge if the debtor
fails to schedule that debt on his or her bankruptcy
petition in sufficient time for the creditor to file a proof
of claim.
The only exception to this rule is that a debt will be
discharged if the creditor had notice or actual
knowledge of the case in time to file a proof of claim,
even though the debtor failed to list that creditor on his
or her schedules. 11 U.S.C. § 523(a)(3)(A).
In applying this Code section, courts typically rely upon
the plain language of this statutory section and hold
that, if there is a claims bar date, a creditor must have
notice of the bankruptcy before that date for the
creditor’s debt to be discharged.
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(a) A discharge under section 727, 1141,
1228(a), 1228(b), or 1328(b) of this title [11
USCS § 727, 1141, 1228(a), 1228(b), or
1328(b)] does not discharge an individual
debtor from any debt—
(4) for fraud or defalcation while acting in a
fiduciary capacity, embezzlement, or larceny.
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In order for a creditor to prevail under this section,
he or she must prove that a debtor committed:
(1) Fraud or defalcation while acting as a fiduciary;
or
(2) Embezzlement; or
(3) Larceny.
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Step One – Fiduciary Relationship
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Step Two – Fraud or Defalcation
◦ "Fraud" for purposes of this exception has
generally been interpreted as involving
intentional deceit, rather than implied or
constructive fraud.
◦ Most courts agree that "Defalcation" requires
something more than mere negligence or
mistake.
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the act or an instance of embezzling
a failure to meet a promise or an expectation
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Embezzlement, under § 523(a)(4), has been defined as the
"'fraudulent appropriation of property by a person to whom
such property has been entrusted or into whose hands it has
lawfully come.'" In re Weber, 892 F.2d 534, 538 (7th Cir.
1989).
To prove embezzlement, the creditor must establish that:
◦ (1) The debtor appropriated the subject funds for his own benefit;
and
◦ (2) The debtor did so with fraudulent intent or deceit.
To demonstrate fraudulent intent, the creditor must show intent on
the debtor's part to deprive him of his property.
A fiduciary relationship or trust relationship need not be established
in order to find a debt non-dischargeable by an act of
embezzlement.
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Larceny under § 523(a)(4) necessitates a
showing that a debtor wrongfully took
property from its rightful owner with
fraudulent intent to convert such property to
his own use without the owner's consent.
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a) A discharge under section 727, 1141,
1228(a), 1228(b), or 1328(b) of this title [11
USCS § 727, 1141, 1228(a), 1228(b), or
1328(b)] does not discharge an individual
debtor from any debt—
(6) for willful and malicious injury by the
debtor to another entity or to the property of
another entity.
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Willful
Intentional
Knowing
Malicious
Purposeful
Recklessly
Negligently
Deliberate
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In this context, “Willful” means intentional or
deliberate (actual intent) or acts which have a
substantial certainty of causing harm.
“Malicious” means wrongful and without just cause
or excuse. Lee v. Ikner (In re: Ikner), 883 F.2d 986,
989 (11th Cir. 1989).
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(a)(1) - Corporation Does not Get Discharge
in a Chapter 7 (Liquidation)
A bankrupt corporation, unlike a bankrupt
natural person, has virtually no prospect of
future property accumulation. For that
reason, a determination whether the
corporation should be discharged is a
purely academic exercise with no practical
or economic purpose. It is for this reason
that the Bankruptcy Code provides a
discharge only for individuals in Chapter 7
cases. 11 U.S.C. § 727(a)(1); In re:
Gulfstream Marina, Restaurant & Motel, Inc.,
2 B.R. 26 (Bankr. S.D. Fla. 1979).
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Creditors may find it beneficial to pursue a
denial of discharge, under 11 U.S.C. § 727, in
addition to, or instead of, an exception to
discharge, under 11 U.S.C. § 523, for two
significant reasons.
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First, a creditor may pursue a denial of
discharge under 11 U.S.C. § 727 because
that Code section is its only option. The
Bankruptcy Code specifically limits the
exceptions to discharge contained in 11
U.S.C. § 523(a) to “individual” debtors, not
corporations. Thus, for those creditors who
are pursuing a corporate debtor involved in
a Chapter 11 (reorganization), Section 727
may be the only method available to
prevent a discharge of its debt in a
liquidation context.
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Second, a creditor, asserting a cause of action
under 11 U.S.C. § 727, may find that it has
additional negotiating leverage and the potential
threat of maintaining the complete status quo as
powerful bargaining tools. Naturally, a debtor
filing a bankruptcy petition is seeking a “fresh
start.” To the extent that an individual creditor
can “scare” the debtor into thinking that this
“fresh start” will be denied, the creditor may force
the debtor to forgo efforts defending discharge
or dischargeability litigation and seek a
resolution of that particular creditor’s claim as
quietly as possible.
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Wheels Unlimited, Inc. v. Sharp (In re Sharp), 2009 Bankr. LEXIS 481,
2-3 (Bankr. D. Idaho Jan. 14, 2009).
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Defendant/Debtor Sharp was a motor carrier which
brokered loads to Wheels, another motor carrier, to
transport a number of trailers from locations out
West to Hurricane Katrina relief sites in Mississippi
and Louisiana.
Sharp, retained Wheels to transport its freight
through its agent Tompkins.
Tompkins on behalf of Sharp made and oral
agreement with Wheels for Wheels to transport the
trailers for a rate of $1 per mile
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After moving 35 trailers Sharp and Thompkins did
not pay Wheels the 75K it determined was due
Wheels learned that Sharp was identified as the
carrier on bills of lading.
Wheels called Sharp and demanded payment
Sharp confirmed Thompkins was their
representative and said not sure of payment terms.
Sharp sent check for about 18K – indicating rate
that there was an agreement for a flat rate per load
Wheels sued Sharp for the difference and received
a default judgment
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Sharp, an individual, filed for Chapter 7 Bankruptcy
and included the Wheels debt on his schedules.
Wheels initiated an adversary complaint to have the
debt declared non-dischargeable eventually
proceeding under 523(a)(2) and 523(a)(6).
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SHIPPER >SHARPE > THOMPKINS > WHEELS
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The Court first conducted an analysis of whether or
not the representations of Tompkins could be
attributable to Sharp – and determined that they
could be under an agency theory.
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Next the court analyzed if the elements of
Section 523(a)(2) were met
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Representations– yes
Knew was false – no
Made with intent to deceive – no
Justifiable reliance of creditor – barely
Loss as a result of the representation (proximate
result of fraud) – no
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Next the court analyzed if the elements of
Section 523(a)(6) were met
◦ “willful and malicious” injury – no
◦ Lower court default was for breach of contract
◦ No state court fraud established – clear and
convincing
◦ In fact fraud not established for lesser
preponderance level of proof
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LESSONS:
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Have a Written Contract,
Conduct Due Diligence,
Cap Credit and
Monitor
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A prior judgment may have preclusive effect
in bankruptcy court under the doctrine of
issue preclusion. Issue preclusion prevents
the relitigation of a particular issue that was
necessarily adjudicated in rendering a prior
judgment. The United States Supreme
Court has recognized that issue preclusion
applies in dischargeability litigation.
Grogan v. Garner, 498 U.S. 279 (1991).
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The application of issue preclusion in
dischargeability litigation requires the existence
of three elements, including:
1) The issue at stake must be identical to the one
involved in the prior litigation;
2) The issue must have been actually litigated in
the prior litigation;
3) The determination of the issue in the prior
litigation must have been a critical and necessary
part of the judgment in the earlier action.
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Thus, for the prior judgment to have preclusive
effect, the facts and elements necessary to satisfy
the prior judgment must match those necessary to
satisfy the showing to be made in bankruptcy
court, otherwise the prior judgment will have
limited preclusive effect.
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In District Court the Defendant Debtor Entered into a
Consent Judgment agreeing to the following:
(1) that Mr. Crook was the principal actor, principal
corporate officer, and sole director and shareholder of
Steal Your Money Collection Agency (“Steal”) and that they
provided collection services to Carrier (¶ 3(a));
(2) that he was Carrier’s collection agent and fiduciary with
the obligation to collect monies on Carrier’s behalf and
remit them to Carrier on a timely basis (¶ 3(b));
(3) that Mr. Crook and Steal, while acting as Carrier’s
collection agent, collected, retained, and never remitted at
least $1,000,000.00 in Carrier’s funds (¶ 3(c));
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(4) that final judgment was entered against Steal on Carrier’s claims for
breach of contract, breach of obligation of good faith and fair dealing,
breach of fiduciary duty, common law and statutory conversion,
statutory attorney’s fees, constructive trust, and accounting (¶ 3(d));
(5) that Mr. Crook exercised complete dominion and control over Steal,
commingled Steal’s funds with his own on a systematic and regular
basis, did not hold regular corporate meetings of Steal or observe other
corporate formalities, utilized Steal to collect and retain the Carrier
funds, and thereafter never remitted the Carrier funds to Carrier and
expended them for his own personal uses (¶ 3(e));
(6) that Mr. Crook wrongfully and knowingly converted and
misappropriated the CSX funds in violation of common law and O.C.G.A.
§ 51-10-6 (¶ 3(f)); and
(7) that Mr. Crook systematically and regularly exercised complete
dominion and control and abused the corporate forms of Steal with
respect to wrongfully retaining the Carrier funds such that the veil
between him and Steal is pierced (¶ 3(g)).
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These facts do not establish that Mr. Crook acted “willfully
and maliciously” within the meaning of § 523(a)(6). The
factual finding in paragraph 3(f) is that Mr. Crook
“wrongfully and knowingly converted and misappropriated
the Carrier Funds in violation of common law and O.C.G.A.
§ 51-10-6.” “Wrongfully and knowingly” is not the same as
“willful and malicious” within the meaning of 11 U.S.C. §
523(a)(6). As noted above, an essential element for a
determination that a debtor acted willfully and maliciously
is that he acted without just cause or excuse. E.g., Hope v.
Walker (In re Walker), 48 F.3d 1161, 1164 (11th Cir. 1995);
Miller v. Held (In re Held), 734 F.2d 628 (11th Cir. 1984);
see Britt’s Home Furnishing, Inc. v. Hollowell (In re
Hollowell), 242 B.R. 541 (Bankr. N.D. Ga. 1999). The
Consent Judgment does not include factual findings that
Mr. Crook acted without just cause or excuse.
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To establish the willful and malicious injury
exception to discharge mentioned above, a
creditor often times will attempt to utilize a
prior determination that the debtor converted
its property to support a finding of an
exception to discharge under 11 U.S.C. §
523(a)(6). Creditors may find difficulty to with
this strategy depending upon the language
contained in the prior judgment, because the
standards for common law conversion and a
willful and malicious exception to discharge
may differ.
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Therefore, a finding that a debtor "wrongfully and
knowingly converted” another’s property may not
be the same as a finding of a "willful and malicious"
because an essential element for a determination
that a debtor acted willfully and maliciously is that
he acted without just cause or excuse, which is
often not an element of a conversion cause of
action.
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Accordingly, unless a prior judgment
specifically states that the debtor converted
the creditor’s property without a just
excuse, a creditor may be required to
litigate a dischargeability issue in
bankruptcy court, even though it obtained a
prior judgment establishing that the debtor
engaged in wrongful conduct.
JEFFREY D. COHEN
KEENAN COHEN & HOWARD P.C.
ONE PITCAIRN PLACE
SUITE 2400
165 TOWNSHIP LINE ROAD
JENKINTOWN, PA 19046
(DIRECT) 215-609-1104
(FAX) 215-609-1117
[email protected]