Non-Dischargeable Debts – Sections 523/727

Lamar, Archer and Cofrin vs Appling, 16-1215 (Sup. Ct. June 4, 2018)  The Supreme Court resolved a split of circuits by holding that a false statement about one asset must be in writing to provide grounds for rendering a debt nondischargeable under Section 523(a)(2).  In this case a debtor lied to his attorney about the intended use of his tax refunds – to pay his attorney’s fees.

Supreme Court: The Court holds that a statement about a single asset can be a “statement respecting the debtor’s financial condition” under §523(a)(2) of the Bankruptcy Code. The judgment of the Court of Appeals for the Eleventh Circuit is affirmed. Pp. 4–15.

Lower courts: The Bankruptcy Court found that Appling (the debtor) knowingly made two false representations on which Lamar (the law firm) justifiably relied and that Lamar incurred damages as a result, the court concluded that Appling’s debt to Lamar was nondischargeable under §523(a)(2)(A). The District Court affirmed, but the Eleventh Circuit reversed, holding that a “statement respecting the debtor’s financial condition” may include a statement about a single asset. Because Appling’s statements were not in writing, the court held, §523(a)(2)(B) did not bar him from discharging his debt to Lamar.

The case pitted courts’ aversion to those who lie against the statutory language and its history.  This decision is similar to the result in Law v. Siegel, 134 S. Ct. 1188 (2014), where the Supreme Court ruled that the bankruptcy court does not have a “roving commission” to do equity. In Law, the high court barred the imposition of sanctions by invading property made exempt by statute, even though the debtor persistently committed fraud.

While courts may not be favorably inclined toward debtors who lie orally to obtain credit, Congress made a decision in Section 523(a)(2)(B) that a materially false statement “respecting the debtor’s . . . financing condition” must be in writing to provide grounds for nondischargeability of the related debt.

In re Stewart, Stewart v. DeWitt, 18-9007 (1st Cir. 2/3/20) This opinion lays out everything you need to know about the standards for nondischargeability under Section 523(a)(2)(A). In terms of appellate practice, the opinion recommends that cases be remanded for further findings or explanations if the appeals court is tempted to make findings of fact different from those in the trial court.

Carrillo v. Su, No. 01-55656 (9th Cir. May 20, 2002) In determining nondischargeability of a debt under 11 U.S.C. section 523(a)(6), the proper inquiry is whether the injury underlying the judgment involved either a subjective intent to harm, or a subjective belief that harm was substantially certain.

In re Wilson, __ B.R. __ (E.D.Va. 2003) (E.D.Va 2003) Debtor, who disposed of a motor vehicle that was subject to a lien, was charged with a felony under Virginia law. Prior to debtor’s trial on this charge, he entered into a plea agreement under which he pled guilty to the misdemeanor crime of fraud as an accessory after the fact. The Richmond Circuit Court found debtor guilty and additionally entered an order on April 30, 2002, requiring debtor to pay criminal restitution to plaintiff.

Plaintiff, a secured creditor, objected to discharge. The Court looked at split in authority on this issue, and opted for the plain language of the Bankruptcy Code, which makes restitution “payable to or for the benefit of a governmental unit” is nondischargeable.

Note: while criminal restitution is non-dischargeable under section 523, it is not one of the listed priority debts in section 507 (the same problem as with educational loans). Therefore, any attempt to pay that unsecured debt in full in the plan without the same percentage payback to other unsecured creditors would likely cause the trustee to object. Instead, try to get the agency to whom the restitution is owed to agree to a long term payback of the restitution–longer than the Ch 13 plan’s duration. Then, using section 1322(b)(5), pay the restitution outside the plan as a budget expense.

Banks v. Gill Distribution CTRS., Inc. (08/15/01 – No. 00-55339) (9th Cir. Ct App) A valid state law claim need not be reduced to a pre-petition judgment to be nondischargeable in bankruptcy.

Peklar v. Ikerd (08/09/01 – No. 00-55464) (9th Cir. Ct App) A California state civil court judgment for conversion may be discharged in bankruptcy because it does not involve “willful and malicious injury” under 11 USC 523(a)(6).

Baldwin v. Kilpatrick (05/09/01 – No. 00-15332) Under 11 USC 523(a)(6), a prior state court proceeding that granted default judgment in a battery lawsuit that was previously arbitrated will have preclusive effect on whether judgment is nondischargeable as a “willful and malicious injury”. Default judgment entered in lower court acts as collateral estoppel and granted Movant’s summary judgment in Movant’s nondischargeability action (plaintiff in superior court case).

NOTE: Most Complaints objecting to dischargeability of a debt includes 523(a)(6) include a “catchall” count. Regarding intent and how to prove it, the best advice is to use Kawaauhau v. Geiger, 523 U.S. 57, 140 L.Ed.2d 90, 118 S.Ct. 974 (1998) as your guide. The Supreme Court held that the actor needed to be aware that the conduct was not only wrongful, but also would necessarily cause the injury in question to rise to the “willful and malicious” standard. Since Geiger, most courts have used a subjective approach to determine the intention required for “willfulness.” In re Moore, 357 F.3d 1125 (10th Cir. 2004); In re Su, 290 F.3d 1140 (9th Cir. 2002); In re Markowitz, 190 F.3d 455 (6th Cir. 1999).

Can a debtor discharge a debt arising out of a deliberate or intentional act that causes injury to you?

A recent article addressed the general issue of discharging debts in bankruptcy and various grounds for excepting debts from discharge in Chapter 7. This article focuses on the discharge exception for debts arising out of willful and malicious injuries by the debtor. The United States Court of Appeals for the Fourth Circuit recently reiterated in TKC Aerospace Inc. v. Muhs that such debts may be dischargeable it the debtor did not intend to cause injury.

Markus v. Gschwend (12/17/02 – No. 01-17279) (9th Cir Ct App) An untimely complaint objecting to discharge of a judgment creditor did not relate-back to a timely motion objecting to debtor’s discharge, and that motion did not comply with the pleading requirements under Bankruptcy Rule 7008(a) or FRCP 8(a). Litigation expenses cannot be shifted when sanctions are imposed under Bankruptcy Rule 9011, on the court’s initiative.

Staffer v. Predovich, No. 01-56093 (9th Cir. September 27, 2002) A separate motion to reopen is not necessary when commencing an action for nondischargeability of a debt under Bankruptcy Rule 4007(b). Moving party may simply file a nondischargeability complaint.

Beaty v. Selinger, No. 01-56576 (9th Cir. September 26, 2002) The doctrine of laches may apply as an affirmative defense to nondischargeability complaints brought under 11 U.S.C. section 523(a)(3)(B), where defendant shows extraordinary circumstances and sets forth a compelling reason why the action should be barred.

Issue of preclusion:

In re Zuckerman, BAP No. CC-19-1200-TaFS (9th Circ. 4/10/20) Debtor Robert E. Zuckerman appeals from the bankruptcy court’s summary judgment order (“Order”) excepting from discharge under
§ 523(a)(2)(A) a debt for fraud and elder abuse reduced to judgment in state court. We agree with the bankruptcy court’s determination that Appellees were entitled to summary judgment based on the preclusive effect of the state court’s judgment. Therefore, we AFFIRM.  This involved lengthy litigation dealing with serious fraudulent actions.  The Debtor (Zuckerman) used excessive delay tactics and failed to respond and/or appear in court.  Default entered in State court.  BAP agreed with BK court that it was bound by state court’s finding of fraud, et al.

RULING: Ninth Circuit Bankruptcy Appellate Panel affirmed order from bankruptcy court finding debt non dischargeable under § 523(a)(2)(A) and (a)(4). Bankruptcy court did not err when it granted creditors’ motion for summary judgment based on the preclusive effect of the state court judgment, which found the Debtor had committed fraud.

Diamond v. Kolcum, No. 00-16280 (9th Cir. April 04, 2002) Defendants are entitled to a declaration of discharge-ability under 11 U.S.C. section 523(a)(2)(A) and (a)(6) because the state court judgment to which they asked the bankruptcy court to give preclusive effect necessarily implicated issues identical to those implicated in the nondischargeability proceeding, and those issues were therefore actually litigated in the state court proceeding.

Bankruptcy can discharge an overpayment of SSA and other

Filing a bankruptcy can discharge the overpayment of SSA or insurance benefits, unless there is fraud.  SSA or the insurance company has the burden to prove that the recipient committed fraud or misrepresentation in obtaining the benefit, but rarely does so.

But – see exceptions: Recoupment – SSA versus Long term disability insurance

However, although the person’s personal liability to the overpayment is discharged, depending on if it is the SSA or insurance and whether or not there is a right to continue to receive such benefits, the ability for “recoupment” may become an option.  Recoupment is an “equitable defense” theory that is excluded from the limitations of the bankruptcy laws. As a result the payor has the right to off-set the amount owed from any new benefits received.

The right of recoupment does not apply to overpayments of SSA funds, therefore the recipient will continue to receive the regular payment.

There is a difference result if the overpayment was made by a long-term disability insurance policy.  In that case the insurance company has a right to “recoup/off-set”  the amount that was overpaid from on-going future payments.   End result – the insured is no longer personally liable as a result of the discharge, but the insurance company can off-set the overpayment from future benefits.

Some Case Law:

In re DeLotto, 2015 Bankr. LEXIS 3846 (Bankr. D.R.I. November 9, 2015) Reduction of Social Security disability benefits to reimburse overpayments did not violate the automatic stay. Conclusion: Liberty Life’s post-petition reduction of Mr. DeLotto’s benefits to recover its pre-petition overpayment in accordance with the Policy terms constitutes permissible recoupment that is an exception to the automatic stay.

In re Terry, No. 08-43123, Adv. No. 09-3031 (Bankr. W.D. Mo 2010)  (affirming In re Caldwell, theory of recoupment applies to long-term disability)

In re Beaumont, No. 09-7006 (10^th Cir. 2009) (Theory of recoupment does apply to VA overpayment)

In re Caldwell, 350 B.R. 182 (Bankr. E.D. Pa. 2006)(distinguishing Lee v. Schweiker, 739 F.2d 870 (3d. Cir. 1984))(SSA is a govern by a “social welfare” statute that is an “entitlement” compared to the case in hand where the benefit is governed by a “contract” between the parties”)) (note – pre-BAPCPA)

Kozlowski v. Michigan Unemployment Insurance Agency Dockets: 16-2680, 16-2383 (US Court of Appeals for the Sixth Circuit, May 29, 2018)

Two individuals obtained unemployment benefits from the Michigan Unemployment Insurance Agency to which they were not entitled because they were being paid wages. Each was ordered to pay restitution and a penalty; each subsequently filed for Chapter 13 bankruptcy. The debtors argued that the penalties assessed were dischargeable in a Chapter 13 bankruptcy. Each district court disagreed. The Sixth Circuit affirmed, finding the penalties nondischargeable under 11 U.S.C. 523(a)(2). That section reflects a congressional decision that those who commit fraud are not to be given the same “fresh start” as “honest but unfortunate debtor[s].” A finding that the debt here arises from fraud perpetrated against the Agency makes section 523(a)(2) applicable, regardless of whether the debt could also fit under section 523(a)(7), which applies to government penalties.

The Supreme Court held that “collateral estoppel principles do indeed apply in discharge exception proceedings pursuant to §523(a).” Grogan v. Garner, 498 U.S. 279, 285 fn. 11, 111 S.Ct. 654 (1991). In the Ninth Circuit, collateral estoppel principles are applied in nondischargeability litigation to the extent that they would apply were the litigation being held in a court of the state where the original judgment was entered. In re Nourbakhsh, 67 F.3d 798, 800 (9th Cir. 1995), citing, Marrese v. American Academy of Orthopaedic Surgeons, 470 U.S. 373, 380 (1985) This is true, in the Ninth Circuit, even in default cases. Nourbaksh, supra, 67 F.3d at 800.

It appears that most states find collateral estoppel should be applied where (1) there is indentity of the parties, (2) the issues are identical, and (3) the matter has been litigated to final conclusion. See, e.g., Trucking Employees of North Jersey Welfare Fund, Inc. v. Romano, 450 So.2d 843, 845 (Fla. 1984); Mobil Oil Corp. v. Shevin, 354 So.2d 372, 374 (Fla. 1977). Other states sometimes add that the issue must be “necessarily” decided in the prior litigation, and also be “decisive.” See, e.g., Buechel v. Bain, 97 N.Y.2d 295, 303, 740 N.Y.S.2d 252, 766 N.E.2d 914 (2001).

Griffin v. Wardrobe, No. 07-16635 U.S. 9th Circuit Court of Appeals, March 16, 2009
In an action to declare a state judgment for fraud non-dischargeable in bankruptcy, summary judgment for Plaintiff is reversed, where the state court improperly allowed Plaintiff to amend her complaint in violation of the automatic stay under the Bankruptcy Code. The stay had been lifted for the sole purpose of the Movant pursuing the Debtor’s bond.

Lockerby v. Sierra, No. 06-15928 U.S. 9th Circuit Court of Appeals, August 07, 2008
In the bankruptcy context, an intentional breach of contract cannot give rise to nondischargeability under 11 U.S.C. section 523(a)(6) unless it is accompanied by conduct that constitutes a tort under state law.

In re Foster, ___ F.3d ___ (9th Cir. 2003) – Feb. 8, 2003 Debtor’s chapter 13 plan provided for full payment of delinquent non-dischargeable child support. Debtor completed the plan and was granted a discharge. Subsequently, Ventura County District Attorney went after debtor for the accumulated interest that was not paid through the plan. Held, plan could not provide for payment of interest, and creditor could collect unpaid interest following discharge. This is the majority rule.

A claim for post-petition interest on a debt not dischargeable in Chapter 13 under 11 U.S.C. § 1328(a) is not part of the bankruptcy estate because such unmatured interest was not part of the debt as of the date of filing the petition. Thus, a creditor cannot insist on interest being paid through the plan. And, the Code does not explicitly prohibit collection of post-petition interest after a debtor completes a confirmed chapter 13 plan.

Question: If a creditor files a non-dischargeability complaint against a debtor couple under 523(a)(2),(4),(6), but only the husband-debtor’s alleged wrongful conduct is at issue (the wife-debtor had nothing to do with the debt), can you dismiss the non-dischargeability complaint with respect to the wife?  Or does the wife still inherit liability from the husband’s potential fraud because of community property laws?

Answers: “The Arizona rule is that the community is liable for the intentional torts of either spouse if the tortious act was committed with the intent to benefit the community, regardless of whether in fact the community receives any benefit” Selby v. Savard, 134 Ariz. 222, 655 P.2d (1982).  Cited by J. Nielsen in In re LeSueur, 53 B.R. 414 (1985) and J. Case In re Oliphant, 221 B.R. 506 (1998).  See also In re Rollinson, 322 B.R. 879 (2004) issued by Judge Haines.

Fraud cannot be imputed to an individual spouse based on a theory of community liability.  See  In re LeSueur, 53 B.R. 414 (1985).  Rather, fraudulent conduct must be shown from an individual’s actions for the debt to be rendered non-dischargeable as to that individual.  Id.  In LeSueur, the court stated:

Fraud for purposes of a bankruptcy dischargeability complaint cannot be imputed to a spouse based on a theory of Arizona community property law. In re Norton, 34 B.R. 666, 668 (Bankr.Ariz.1983); In re Bursh, 14 B.R. 702, 705-06 (Bankr.Ariz.1981) (dismissing complaint and cause of action as to spouse).

…

“(F)raud, which is never presumed, was not shown as to her.” Id, citing Matter of Benedict, 15 B.R. 671, 675 (Bankr.W.D.Mo.1981) (finding fraud as to husband, dismissing as to wife); Matter of Curry, 12 B.R. 421, 424-25 (Bankr. M.D. Fla.1981).

…

In re LeSueur, 53 B.R. at 415.

A nondischargeability judgment should only be entered against a marital community’s community property where the evidence presented proves that both the husband and wife were involved in the transactions or occurences which lead to the nondischargeability judgment.  See In re Clark, 179 B.R. 898, 902 (Bankr.D.Ariz. 1995); see also In re Bursh, 14 B.R. 702 (Bankr.D.Ariz 1981) (granting summary judgment where there was no evidence that wife participated in or had knowledge of husband’s fraud); In re Norton, 34 B.R. 666 (Bankr.D.Ariz. 1983) (dismissing nondischargeability complaint as to wife in absence of showing that she made misrepresentations to plaintiff).

In Clark, the court found that no evidence was presented to demonstrate that the wife took part in the acts which gave rise to the nondischargeability complaint.   In re Clark, 179 B.R. at 902.  Accordingly, the court found that the wife was an innocent spouse and that the debtors’ community property was not liable for the nondischargeabilty judgment entered against the husband.  Id.

The Ninth Circuit has held that the proper test is a partnership or business relationship, not a spousal relationship.  See In re Tsurukawa I, 258 B.R. 192, 198 (9^th Cir. BAP 2001) (“we hold that a marital union alone, without a finding of a partnership or other agency relationship between spouses, cannot serve as a basis for imputing fraud from one spouse to the other.”); see also In re Carbray, 2006 WL 2559849 (Bankr.D.Ariz. 2006) (“Where no agency relationship exists, courts do not generally impute the wrongdoing of one spouse to an ‘innocent’ spouse in holding a debt nondischargeable.  The marital status alone does not create an agency relationship.”).

Daily v. Garrett EC-16-1265-HKuB (9th Circuit, Aug 24,2018)

FACTS: Chapter 71 debtor Garrett agreed to build a new home for Plaintiffs Daily, and executed a written agreement with Garrett who began building Dailys’ home but did not complete the home, and Dailys sued for breach of contract, negligence and fraud. Dailys filed an adversary under § 523(a)(2)(A), alleging that Garrett induced them to enter the agreement with a series of false and fraudulent representations. RULING:Ninth Circuit BAP affirmed order from bankruptcy court finding Plaintiffs did not prove a claim under § 523(a)(2)(A) when they failed to provide evidence supporting allegations that the Debtor made a misrepresentation, fraudulent omission, or engaged in deceptive conduct. Evidence only showed Plaintiffs may have had a breach of contract action, but nothing more.

In re Albert-Sheridan BAP No. CC-18-1222-LSF (9th Circuit, Apr 11, 2019) Not Published

Ruling : Debtor’s sanctions and costs ordered paid by the California Supreme Court as a condition of reinstatement of her law license were nondischargeable.

Discovery sanctions to be paid as part of state bar disciplinary proceedings are nondischargeable under Section 523(a)(7), even though the debtor-attorney was directed to pay the sanctions to the adversary, according to the Ninth Circuit Bankruptcy Appellate Panel.

The BAP also ruled that costs incurred by the state bar are similarly nondischargeable.

In re Wlodarczyk, 19 cv-00062 (District Court, S.D. Cal 7/7/19) Stipulated state court judgment, including not dischargeable in bankruptcy.  Default, then debtor filed chapter 7.  Creditor filed adversary alleging not dischargeable under Section 523(a)(2)(A) – ‘false pretenses, false representation or actual fraud’.  Bankruptcy court denied creditor’s motion, appealed and lost again in 9th Cir. District court.

Case sets out a step by step analysis of facts and factors for non-dischargeability.

ISSUE PRECLUSION:

“Issue preclusion `bars successive litigation of an issue of fact or law actually litigated and resolved in a valid court determination essential to the prior judgment, even if the issue recurs in the context of a different claim.'” ReadyLink Healthcare, Inc. v. State Compensation Ins. Fund, 754 F.3d 754, 760 (9th Cir. 2014) (quoting Taylor v. Sturgell, 553 U.S. 880, 892 (2008)). A federal court applies the forum state’s law of issue preclusion. Harmon v. Kobrin (In re Harmon), 250 F.3d 1240, 1245 (9th Cir. 2001). California’s test for issue preclusion has five threshold requirements:

First, the issue sought to be precluded from relitigation must be identical to that decided in a former proceeding. Second, this issue must have been actually litigated in the former proceeding. Third, it must have been necessarily decided in the former proceeding. Fourth, the decision in the former proceeding must be final and on the merits. Finally, the party against whom preclusion is sought must be the same as, or in privity with, the party to the former proceeding.

Section 523(a)(2)(A)

The record shows that the guarantee itself does not include any representation of Appellee’s financial condition. The bankruptcy court concluded that Appellee intended to perform on the guarantee. On the second element for § 523(a)(2)(A), the bankruptcy court concluded that there was no falsity with respect to Appellee’s agreement to the guarantee and even assuming any falsity, there was no evidence that Appellee knew of such falsity. On review of the record, the Court concludes that the bankruptcy court’s factual findings in support of its conclusion that Appellee had no intent to deceive with respect to agreeing to the guarantee are logical, plausible, and supported by the record.

If It’s Consensual, a Plan Can Discharge a Nondischargeable Debt

Dragnea v. Dragnea (In re Dragnea), 17-02248 (Bankr. E.D. Cal. Oct. 29, 2019) By consent, a chapter 11 plan can discharge an individual’s nondischargeable debt, even a matrimonial debt that is excepted from discharge under Section 523(a)(15). The husband contended that parties may not override Section 523(a)(15). Judge Klein responded by saying that chapter 11 can be used “as a vehicle contractually to modify otherwise nondischargeable debt.” He said, “Nothing is remarkable about an agreement compromising nondischargeable debt.” Likewise, he said, there is nothing “untoward about including a settlement in a chapter 11 plan.”

Does a false financial statement make it impossible for a borrower to discharge debt under Section 523(a)(2)(B)(iii)?

Not according to In re Brown, 17-21719, E.D. CA, Bankr Court). “A bank’s blind reliance on financial ratios does not qualify as “reasonable reliance” on a false financial statement for purposes of excepting a debt from discharge under 11 U.S.C. § 523(a) (2) (B) (iii) when it has information inconsistent with the credit application presented through an automobile dealer.”

Oregon v. Mcharo (In re Mcharo), 19-1010 (B.A.P. 9th Cir. Feb. 7, 2020) A husband and wife applied for public assistance cash benefits in Oregon. They signed an agreement under oath stating that they would report changes in income. Later husband became employed, but failed to report the income.  In the Ninth Circuit, a fraudulent omission in the face of a duty to disclose may constitute a false representation, thus potentially bringing the husband’s nondisclosure within the rubric of Section 523(a)(2)(A). But the question remained whether silence was a “statement.”

Judge Lafferty adopted the ordinary, common meaning of “statement” because the Bankruptcy Code does not define the term. He turned to the dictionary, where, he said, the definition of “statement” “does not contemplate silence or even nonverbal communication.”

Judge Lafferty cited bankruptcy courts in Idaho and Arkansas for holding in 2015 that “a debt incurred by overpayment of government benefits because a debtor failed to disclose a change in employment status was nondischargeable under § 523(a)(2)(A).”