Bankruptcy: Dischargeability of Debts - Company Funded & Controlled by Wife

     In the case of Old National Bank v. Reedy, Judge Tice of the United States Bankruptcy Court, Eastern District of Virginia, denied a complaint against dischargeability. In Reedy the debtor, a consultant on obtaining government contracts, had financial difficulties in his prior business operations. One year before he filed for bankruptcy, the debtor’s wife agreed to assist him from her own financial resources by capitalizing and operating a company in which she was the sole shareholder and through which husband could perform his consulting work. The creditor bank had argued that the establishment and operation of this business was a transfer with intent to defraud creditors. 

     The Court held that the case was devoid of any direct testimony by the debtor concerning specific intent to delay, hinder or defraud his creditors. Instead, there was credible evidence regarding the legitimate business purpose of setting up and operating the corporation in its present form. 

     In Reedy the debtor's wife completely capitalized the business and maintained the books and records while the debtor performed consulting services. Such control was a condition to the debtor's wife's capital contribution. Moreover, the debtor's wife initiated the incorporation of the business and had been the only stockholder since its inception. No transfer of stock ever occurred. 

     In summary, the Court denied the creditor's request for two reasons. First, there was no transfer of property by the debtor. Although the debtor had earned some consulting commissions, there was no evidence that he had an established business or that he transferred a business to the corporation. He merely went to work for and rendered services to a new employer. There was no basis in the trial record for the Court to ignore the business as a separate and independent entity. The business's receipts of consulting income did not constitute transfers by the debtor. Second, there was no intent by the debtor to hinder or delay his creditors. The formation of the business by the wife almost a full year before the debtor filed bankruptcy served a legitimate business purpose of enabling the debtor's wife to assist him in dealing with his financial problems. The Court found that the new arrangement removed the debtors' ability to make imprudent financial decisions and gave wife the reassurance she needed if she was to assist him from her own independent financial resources.

Foreclosure: Lost Notes

     Virginia Code §55-59.1(B) addresses the situation where the noteholder has lost the original note. With the frequency of sales of notes on the secondary market, the loss of the original note documents occurs more often than might be expected. The Code provides that if the note or other evidence of indebtedness secured by a deed of trust cannot be produced, and, the beneficiary submits to the trustee an affidavit to that effect, the trustee may proceed to foreclosure. However, the beneficiary must send written notice to the person required to pay the instrument stating that the instrument is unavailable and that a request for sale will be made of the trustee upon the expiration of fourteen days from the date of the mailing of the notice. The notice must be sent by certified mail, return receipt requested, to the last known address of the person required to pay the instrument, as reflected in the records of the beneficiary, and shall include the same and the mailing address of the trustee. The notice must also advise the borrower if the borrower believes that he may be subject to claim by a person other than the beneficiary to enforce the instrument, the debtor may petition the circuit court of the county or city whether the property lies for an order requiring the beneficiary to provide adequate protection against any such claim. Failure to give the notice does not affect the validity of the sale.

Bankruptcy: Collateral Estoppel - Default Judgment in State Court

     Two cases illustrate how courts will handle default judgments being argued as collateral estoppel in bankruptcy court. 

     The United States District Court at Norfolk, Virginia, in the case of L&R Assoc. v. Curtis, reviewed the question as to whether a creditor's default judgment in state court collaterally estopped a debtor from relitigating in Bankruptcy Court whether his debt was nondischargeable because of the debtor's alleged fraud. 

     In Curtis the Bankruptcy Court found that the creditor advanced funds to the debtor for the purchase of automobiles at auction. The debtor was to be compensated in the form of half of the profits from the subsequent sale of the automobiles. The creditor apparently charged in state court that the debtor had fraudulently converted some of the purchase money to his own personal use. 

     The Bankruptcy Court found in Curtis that the issue of fraud, as alleged by the creditor, was not the subject of actual litigation in the state court action which resulted in the entry of the default judgment. The Bankruptcy Court held that because it had no evidence before it that the state court had decided this issue of fraud with "particular care", the doctrine of collateral estoppel did not apply to the judgment. Subsequently, the Bankruptcy Court dismissed the complaint upon a full trial on the merits. The United States District Court, upon appeal, agreed with the result of the Bankruptcy Court's decision, but stated that the emphasis for reaching the decision should have been on whether the state court had actually litigated the issue of fraud. The District Court recognized that counsel for the creditor represented to the Bankruptcy Court that it had presented witnesses and evidence before the state court. The judgment order indicated that the plaintiff/creditor and witnesses for the plaintiff appeared before the state trial court. Yet the creditor presented no other information to the Bankruptcy Court to indicate that the issue actually had been litigated and was necessary to the decision. 

     The Bankruptcy Court gave the creditor in Curtis more than one opportunity at the hearing on its motion for summary judgment and at trial to present evidence concerning prior litigation. The creditor presented no transcript of the proceeding before the state court or anything else to suggest that the state court entered more than a standard default judgment. 

     The District Court agreed with the Bankruptcy Court in Curtis that more had to be submitted than the state court default judgment by testimony at trial to establish that the issue was actually litigated and that the determination of the issue was necessary to the judgment of the state court. The District Court found that the Bankruptcy Court determined "with particular care" that the state court's default judgment should not collaterally estop debtor from relitigating the issue of fraud as it relates to the dischargeability of this debt.

     In Neese the creditor, a video store, had obtained a default judgment in state court against a husband and wife, who had contracted to use store material and services in a nightclub. The wife filed a bankruptcy petition. The Creditor filed a proof of claim in order to collect from the debtor's bankruptcy estate.

     The District Court in Neese found that the Bankruptcy Court evaluated the validity of the State Court judgment for reasons other than fraud. Accordingly, the District Court found that this was an error. The District Court ruled that under Bankruptcy Code §502, a creditor's proof of claim is deemed allowed unless a party in interest objects to that claim. The validity of a creditor's claim that is based on a State Court judgment may be attacked in Bankruptcy Court by an objection to a proof of claim only upon the grounds that there was a lack of jurisdiction over the parties or subject matter of the suit (which was not alleged in this case) or that the judgment was the product of fraud (which was initially raised but not pursued). The trial conducted in the Bankruptcy Court, however, focused upon whether judgment was proper against the debtor individually.

     In regard to the facts in Neese, the District Court found that the debtor had properly been served with the State Court suit, that she failed to respond to that claim, and that she failed to contest the claim on appeal even after judgment was entered. Nothing in the record indicated that the judgment was obtained fraudulently, and it was clear that the default judgment was fully enforceable in State Court.

     Accordingly, the District Court ruled that the Bankruptcy Court did not have the authority to look beyond the validity of the State Court judgment. The doctrine of res judicata applied. The creditor's claim should have been allowed.

Bankruptcy: Dischargeability - False Oath

     In the case of Federal Deposit Insurance Corp. v. McFarland, the United States Bankruptcy Court, sitting in Arlington, Virginia, Judge Tice, denied the debtor, a real estate developer, a discharge in bankruptcy because of false testimony.

     The creditor had brought a complaint objecting to dischargeability because of allegedly false testimony given by the debtor in examinations under oath after the filing of the debtor's bankruptcy petition.
     The Court found as fact that the debtor gave false testimony under oath 1) that he did not receive from a closely held corporation any proceeds of a $440.00 certificate of deposit, when in fact he and his co-shareholder each received $220,000 and 2) that he had no bank accounts in nor made any deposits to offshore banks, when in fact he drew checks in amounts in excess of $300,000 payable to a Cayman Island bank.
     Although the debtor denied that he had any fraudulent intent when he testified, the Court found it "highly implausible" that the debtor forgot about the withdrawal of the $220,000. The debtor also failed to produce any credible evidence refuting the natural presumption that some $300,000 worth of checks admittedly drawn by debtor payable to an offshore bank were transfers of funds to the bank or to an account in the bank.
     Accordingly, Judge Tice found the evidence sufficient to warrant denial of the debtor's discharge.

Real Estate: Homeowner Associations - Damages Caused by Common Area Tree

     Townes at Grand Oaks Townhouse Association, Inc. v. Baxter is a recent case from Richmond Circuit Court that illustrates the importance of carefully drafted HOA agreements. The HOA sought to recover expenses for removing a tree that fell from a common area onto a homeowner’s condo. The Richmond Circuit Court held that the HOA agreement did not exempt the HOA from paying removal costs because a portion of the tree remained on the common area. The court noted that there was no Virginia authority for these facts, but stated that the Supreme Court of Virginia ruled that in cases of fallen trees between adjoining properties in the absence of negligence, there is no liability for property damages on the landowner from where the tree fell. However, the HOA agreement is a contract that created the obligation for the HOA. The agreement had a provision requiring the HOA to maintain and replace trees, and another provision exempting the HOA from liability to an owner for repairing or replacing any portion of the lot or the improvements provided the homeowner has insurance as required by the agreement. The HOA relied on the first provision, but the court determined that that reliance was misplaced as it did not cover this situation. The HOA relied on the second provision because the homeowner did not have the required insurance for “the structure of each lot”, but only insurance for the inside of the home. However, the court heard evidence from the homeowner that he understood the language to only require internal insurance. The court noted three primary reasons for holding for the homeowner:
     (1) “Removal of the tree from the lot is not a repair or replacement, but merely something necessary before the physical work of restoration of the damaged structure can begin.”
     (2) “The exemption from liability applies when the homeowner has 'fire and extended coverage insurance' with applicable coverage. Considering the varying types of insurance that the market may provide, there is no evidence that the insurance required under the contract terminology must cover tree removal. Whether such a policy would is left to speculation.”
     (3) “The tree removal would necessarily involve removal of a portion of the tree from the common area as well as from Defendant's lot and home. I question whether, in any event, the total removal cost should be assigned to the defendant rather than some prorated amount.”
     It is important to ensure that HOA agreements include provisions that would govern a broad spectrum of potential issues and disputes. The law firm of Lafayette, Ayers & Whitlock, PLC has experience in drafting, reviewing, and amending HOA documents, as well as, representing HOAs in court.

Bankruptcy: An Examination of the Dischargeability of Debts Regarding Property Damage-Malice

     In a previous blog I began a multi-issue review of cases that address the dischargeability of debts regarding property damage-malice. The relevant bankruptcy code provision is §523(a)(6). I briefly established the standard used by courts to determine dischargeability of debts involving property damage. The standard is very fact specific so reviewing cases will shed light on how the standard is applied.
     In Appalachian Equipment & Supply Co. v. McDaniel, the United States Bankruptcy Court at Harrisonburg, Virginia, determined that the creditor/plaintiff, a rental company, had satisfied all of the elements necessary to prove its case under Bankruptcy Code §523(a)(6), and thus, its claim for damages from the improper use of the forklift was declared exempt from discharge.
     The Court in McDaniel ruled that the physical evidence was the most reliable evidence offered. That evidence showed that the forklift was delivered to the debtor in normal operable condition. It also showed that when the creditor picked up the forklift, it was damaged and displayed light blue paint on the bottom of the carriage. The debtor's evidence showed that one of the vehicles which was placed on the tractor trailer was a light-blue car. To the Court, it appeared more likely than not that the bottom portion of the carriage of the forklift was used in conjunction with attempting to crush the light-blue car such that paint flecks from the car attached themselves to the underside of the carriage. The Court indicated that it was satisfied that the expert testimony of the witness for the creditor established that more likely than not that the carriage of the forklift was used to apply hydraulic pressure in a downward direction with such force that the carriage boon and forks of the forklift were damaged. In conclusion, the Court found that the debtor used the carriage to accomplish his intent to crush cars, such use was inconsistent with the normal usage of the forklift, and such usage led to the damage of the forklift. The Court further found that the creditor proved by a preponderance of the evidence that the debtor's actions in using the forklift were intentional.
     The Court in McDaniel found that the debtor knew that a forklift should not be used to crush cars. The physical evidence and the expert evidence offered by the creditor were more persuasive than the debtor's attempts to deflect blame to another person. It showed that the debtor applied the boon portion of the forklift to employ downward hydraulic pressure to the crush the cars. The Court ruled that it was satisfied that the debtor used the forklift in an improper manner to crush the cars in order to load them onto his flatbed trailer. The Court found that the debtor was an experienced forklift operator. He brought equipment to the site which could have been used to safely crush the cars. He used the forklift in a manner inconsistent with the generally accepted practice for the usage of this type of forklift. In light of these surrounding circumstances, the Court ruled that the debtor knew, or should have known, that his acts would cause damage to the forklift and resulting harm to the creditor. Thus, the Court ruled that the debtor's actions fit the definition of malice as set forth in the case of St. Paul Fire & Marine Ins. Co. v. Vaughn, the standard for denial of discharge.
     In a future blog I will apply the standard used by courts to determine dischargeability of debts involving property damage to a case involving withheld payments.

Foreclosure: Lost Notes

     Virginia Code §55-59.1(B) addresses the situation where the noteholder has lost the original note. With the frequency of sales of notes on the secondary market, the loss of the original note documents occurs more often than might be expected. The Code provides that if the note or other evidence of indebtedness secured by a deed of trust cannot be produced, and, the beneficiary submits to the trustee an affidavit to that effect, the trustee may proceed to foreclosure. However, the beneficiary must send written notice to the person required to pay the instrument stating that the instrument is unavailable and that a request for sale will be made of the trustee upon the expiration of fourteen days from the date of the mailing of the notice. The notice must be sent by certified mail, return receipt requested, to the last known address of the person required to pay the instrument, as reflected in the records of the beneficiary, and shall include the same and the mailing address of the trustee. The notice must also advise the borrower if the borrower believes that he may be subject to claim by a person other than the beneficiary to enforce the instrument, the debtor may petition the circuit court of the county or city whether the property lies for an order requiring the beneficiary to provide adequate protection against any such claim. Failure to give the notice does not affect the validity of the sale.

Bankruptcy: "Tools of the Trade" Exemption

     Virginia Code §34-26, the "Poor Debtor's Exemption" section, allows a debtor to claim tools used in the course of his trade or occupation and keep them from creditors in bankruptcy cases. This exemption also applies to collection cases, as the debtor may use this exemption to prohibit post judgment collection by execution on the asset.
     In the case of Monticello Arcade L. P. v. Lyall, the United States Bankruptcy Court at Newport News reviewed §34-26 in regard to an architect's Acura automobile. The Bankruptcy Court denied the exemption based upon the classification of the car as a "luxury" car. The Appeals Court reversed and remanded the case with instructions that the Bankruptcy Court focus not upon whether the car is a "luxury" car, but upon whether the car is an "absolute requirement for [debtor] to efficiently and competently perform his work as an architect." Upon the Bankruptcy Court’s review, the Court ruled that the architect had demonstrated with his daily calendar and his testimony that the car was used to visit clients, job sites and government offices. The debtor was a self-employed architect in Hampton Roads, had practiced architecture on his own for six years as owner and president of his company. The debtor testified that although he used the vehicle to commute to and from work, the vast majority of the time he used the vehicle for non-commuting business purposes. The debtor also testified that he had to visit job sites in order to interpret plans and in order to understand the scope of the project. The Court noted that there was no evidence that there were alternate means of transportation available for the debtor to accomplish these requirements. Accordingly, the Court, this time around, found that the vehicle was "necessary", and therefor was exempt under Virginia Code §34-26(7).
     In the case of White v. Central Fidelity Bank the United States Bankruptcy Court at Roanoke, Virginia, reviewed the language of Virginia Code §34-26 and held that the plain meaning is that property which is "necessary for use in the course of the householder's occupation or trade" qualifies as a "tool" for purposes of exemption. In White the Court noted that in regard to automobiles, the particular facts surrounding the occupation and the necessity of the automobile must be examined. In White, the debtor had both a day and an evening job as a nursing assistant providing home health care in patients' homes, and whose employment contract required that she have an auto as a condition of her employment. Based upon these facts, proof that the creditor's lien was a nonpossessory, non-purchase money lien, and the fact that the creditor's lien impaired the debtor's exemption, the Court held that the lien was avoidable under Bankruptcy Code §522(f).
     In the civil/collection case of Hunn v. Zettel the Fairfax County Circuit Court had occasion to review a debtor's claim for an exemption for his BMW car as a "tool of the trade". Unlike the evidence obtained in Lyall which demonstrated the "absolute requirement", in Zettel, no such evidence was presented. Accordingly, the Court denied the debtor's exemption claim in Zettel.
     Looking at another case involving tools of the trade, the United States Bankruptcy Court at Newport News, in the case of In re Aldrich, upheld the debtors' motion to exempt various items of property, including an inoperable photo enlarger and two photo processors, as "tools of the trade" under Virginia Code §34-26. The Court concluded that these items were exempt under Virginia Code §34-26 and under Bankruptcy Code §522. The Court in Aldrich stated that it reached its conclusion from the plain meaning of Virginia Code §34-26, and from the obvious intention of the Virginia legislature, which substantially broadened the scope of the relevant definitions when it amended Virginia Code §34-26 in 1990. The Court in Aldrich found from the unrebutted testimony that the photo processing equipment was necessary for use in the debtors' occupation involving the family photo processing lab. There was no doubt that the debtors had been in the photo processing business for some time and, in the case of the husband, almost continuously since his retirement from the Air Force. It was likewise absolutely clear from the evidence that the wife was engaged in the photo processing business of a third party at the time of the filing of the petition, and that she too awaited the startup of the family business in order to utilize the exempted tools of the trade, which she was currently utilizing on a part-time basis. Therefore the Court found that both debtors were, or intended to be engaged, in an occupation and trade at the time of the filing of the petition. The Court found it to be sufficient that the husband had the intention of returning to his occupation as a photo processor at the time of the bankruptcy filing, even though he had been precluded from doing so by the contractual relationship with the objecting creditor, who bought out the debtor's earlier photo processing business and implemented a non compete agreement.

Collections: Bad Check Collection and the Fair Debt Practices Collection Act

     Those who actively engage in the collection of debts as a third party are cognizant of the fact that the Fair Debt Collection Practices Act (FDCPA) applies to their collection activities. However, does the FDCPA apply to notices given as a prerequisite to criminal prosecution for passing bad checks? The United States District Court at Charlottesville, Virginia, in the case of Shifflett v. Accelerated Recovery, examined the issue but did not give a definitive answer.
     Virginia Code §18.2-183 states that letters are required to be mailed to debtors to establish a prima facie case of fraud or knowledge of insufficient funds in order to pursue criminal prosecution. The creditor/defendant in Shifflett argued that it had never sought recovery through the civil process, it had always pursued a criminal warrant in cases where it was unable to collect an unpaid check.
     The debtors/plaintiffs, on the other hand, argued that the creditor was required to give notices pursuant to the FDCPA. The essence of the debtors' argument was that the notices sent by the creditor, regardless of the creditor's practice or intent, constituted a "communication" pursuant to the language of FDCPA §1692(a) and therefore trigger the notice requirements of FDCPA §1692(a).
     The Court did not rule as to whether the FDCPA applies to notices pursuant to Virginia Code §18.2-183. Instead, the Court focused on distinctions between the creditor's letters in Shifflett and that which is required by Virginia Code §18.2-183 for criminal prosecution. The Court found that the creditor's letters did not evidence the creditor's intent to pursue criminal remedies as opposed to civil remedies. The creditor claimed that the language of its letters referring to "the legal process" indicated its intent to use the criminal legal process not the civil legal process. The Court, however, stated that it was unable to discern precisely in what manner the phrase "legal process" objectively discriminates between the criminal legal process and the civil legal process.
     The Court also noted that the creditor's letters also advised the debtors that payment must be made within ten days from the date of the letter. Virginia Code §18.2-183 provides that notice mailed by certified mail or registered mail with evidence of returned receipt shall be deemed sufficient and equivalent to notice having been received by the maker or drawer. The creditor did not present evidence that it sent the letters by either certified or registered mail with the request of a returned receipt.
     The Court also noted that the creditor's letters stated explicitly that it is "attempting to collect a debt..." By contrast, the Court stated that it could not locate any language within the letters by which even vaguely suggest that the creditor had sent the notices in furtherance of pursuing a criminal proceeding.
     Accordingly, the Court found that the creditor failed to demonstrate that the letters were sent to the debtors pursuant to the requirements of Virginia Code §18.2-183, and therefore, found the creditor liable for its failure to comply with the notice requirements of §1692(a) of the FDCPA.
     The lesson from Shifflett - when contemplating pursuing legal measures for “bad checks” it is important to use counsel with experience in both criminal and civil law.