Bankruptcy: Dischargeability of Debt - False Financial Statement

     In the case of Chopp & Co. v. Luria, the United States Bankruptcy Court at Alexandria, Virginia, concluded that a bankrupt builder's omission from a supplier's credit application of a bank's earlier consent judgment against the builder was not made with the "intent to deceive" and the builder's debt to the supplier was not exempt from discharge pursuant to Bankruptcy Code §523 (a)(2)(B). 

     The Court found as fact that the debtor signed a credit application which he knew was being submitted to the creditor. The Court further found as fact that the credit application incorrectly represented that the debtor had no judgments entered against him within the last five years when, in fact, there had been a substantial judgment docketed against the debtor within one year of the credit application. The Court also found as fact that the consent order was entered under a workout agreement on a separate loan. The Court further found as fact that the debt had been fully paid off, the judgment did not show up on the builder's credit report, and there was no evidence that the builder knew that the consent order had ever been entered. The Court noted that the judgment at issue arose from a financial workout agreement between the bank, the debtor and other related parties on a large mortgage loan. As part of the agreement, under which the bank was to be paid in full, the debtor and his related entities executed the judgment order by consent. Under the agreement the loan was to be paid by new financing and by sales of property. The consent judgment essentially served as backup protection to the bank if its loan was not fully paid by a set date. This deadline passed without full payment because of delays in settlement under contracts for sale of realty by the debtor's business entities. The contemplated settlement eventually took place, and the bank's judgment had been paid in full six months before the debtor made the credit application at issue.

     Considering all of these facts in light of the applicable law, the Court had to determine, in order to find that the debt was nondischargeable, that the debtor's statement was materially false, that the creditor reasonably relied on the statement, and that the debtor had the intent to deceive the creditor.

     In regard to the "materially false requirement", the Court ruled that "..the omission of such a substantial judgment from debtor's credit application was plainly a materially false statement..".

     Upon considering reasonable reliance, the Court ruled that "...the evidence demonstrates that plaintiff had a very conservative policy on extending credit and that its policy has resulted in lower than average bad debts. Based upon plaintiff's unrefuted evidence, it seems likely that plaintiff would have denied open account credit to debtor's corporation if the judgment had been disclosed...". "..plaintiff's reliance on debtor's credit application was objectively reasonable and was actually relied upon by plaintiff in extending credit...".

     In regard to the "intent to deceive" requirement, however, the Court found that the evidence failed to establish that debtor actually knew that the judgment had been docketed. The Court then looked to see if the intent could be imputed through reckless indifference. Given the workout arrangements, given the fact that the judgment was paid within three months of entry, given the fact that no adverse information appeared on the debtor's credit report, and given the fact that there was no evidence that the debtor had been informed of the bank's entry of the judgment, the Court stated that it was unwilling to infer from the circumstantial evidence that the debtor recklessly failed to disclose the judgment. Accordingly the Court concluded that the debtor did not publish the financial statement with intent to deceive plaintiff.

Bankruptcy: Prior Bankruptcy Petition - Dismissal "With Prejudice"

     In the case of Colonial Auto Ctr. Inc. v. Tomlin, the United States District Court at Charlottesville, Virginia, reviewed a Bankruptcy Court's decision denying a creditor summary judgment against the debtor in a motion to determine if the creditor's debtor was nondischargeable due to the debtor's prior bankruptcy case being dismissed "with prejudice". 

     In Tomlin the Bankruptcy Court had ruled that the words "dismissed with prejudice" meant only that the debtor could not file another bankruptcy petition for 180 days. The creditor, however, argued that the language meant that the debtor could not discharge pending debts in a later bankruptcy petition; the creditor asserted that dischargeability had a res judicata effect. 

     The District Court ascertained that the question before it was does an order stating only that a case is "dismissed with prejudice," which in the general legal context, the effect of precluding the subsequent litigation based upon the same claim, have, in the bankruptcy context, the effect of precluding the subsequent discharge of pending debts? 

     The District Court ruled that there was no reason to depart from the traditional effect of an order dismissing a case "with prejudice", and that the Bankruptcy Court erred in determining that the prior order as effecting something less than res judicata. The District Court further ruled that the debtor failed to identify any portion of the Bankruptcy Code in which Congress indicated an intention that a dismissal "with prejudice," once ordered, does not effect claim preclusion in relation to a pending debt. Accordingly, the District Court vacated the Bankruptcy Court's order denying the creditor summary judgment. 

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: Bankruptcy Exemptions - Intentional Tort

    The United States Bankruptcy Court at Alexandria, Virginia, in the case of In Re: Scott, entered a judgment in favor of the creditor in the amount of $12,735 on a theory of conversion. In doing so, the Bankruptcy Court determined that the judgment was nondischargeable under Bankruptcy Code §523(a)(6). In Scott the Bankruptcy Court found that the creditor hired the debtor to look after the creditor's elderly mother, paying the debtor $28,000 in advance wages. The debtor quit the job six weeks later and refused to return the unused funds. The debtor subsequently filed for bankruptcy and the creditor filed a nondischargeability complaint. In the debtor's bankruptcy schedules she listed exemptions of a car, clothing, household goods, jewelry and a savings account. The creditor challenged both the specific items claimed as well as the debtor's right to claim any exemptions at all against a claim for an intentional tort. 

    In regard to the creditor's challenge for specific items, the Bankruptcy Court found that Virginia state law exemptions include the homestead exemption under Virginia Code §34-4 and the poor debtor's exemption under Virginia Code §34-26. The Court ruled that the debtor was entitled to claim a "poor debtor's" exemption on the car, and that the debtor's interest in the vehicle was less than $2,000. The Court also found that the debtor's claim for $5,400 in exemptions for the household goods did not exceed the amount allowed under Virginia Code §34-4. The Bankruptcy Court denied the debtor's "poor debtor's" claim for exemption for a herringbone gold necklace, as there was no evidence that the necklace was a family heirloom. The Bankruptcy Court also denied the debtor's claim for an exemption in a $300 savings account as tenants by the entirety property.

    In regard to the creditor's claim that the debtor was not entitled to any exemptions because Virginia law does not allow for the assertion of Virginia exemptions against a claim based on an intentional tort, the Bankruptcy Court examined the bankruptcy statutes and the results that other courts had reached on similar questions. The Bankruptcy Court noted that other courts had reached different opinions. However, the Bankruptcy Court decided that since Congress had specifically legislated as to the type of claims that could be enforced against exempt property, and since the creditor's claim in this case did not fall within any of the enumerated exceptions, in this case, the debtor was entitled to her exemptions notwithstanding the fact that the creditor held a nondischargeable claim based upon an intentional tort.

Bankruptcy: Dischargeability of Debt - False Financial Statement

     In the case of I. H. Mississippi Valley Credit Union v. O'Connor the United States Bankruptcy Court in Richmond, Virginia, reviewed the creditor's complaint objecting to dischargeability pursuant to two sections of Bankruptcy Code §523.
     In O'Connor the debtor was involved in a scheme with a car dealer to buy and sell "grey market" Mercedes Benz in Germany and then bring them to the United States to be refitted for sale at a profit, after which the dealer would pay off the credit union loan and split the profits with the debtor. During the conduct of this business, the debtor provided to the credit union an inaccurate vehicle identification number (VIN) on a loan application and also failed to list a loan from another credit union on an application.
     The Court found as fact that the debtor made misrepresentations as to the vehicle identification number and the existence of the Mercedes, and that the credit union relied on the existence of such an automobile in making the loan to the debtor. However, the Court found that the credit union did not meet its burden to show that the debtor knew that the representations were false when made. The debtor gave the loan officer the VIN appearing on the bill of sale from the car dealer, and although the insurance company requested from the debtor a corrected VIN for insurance purposes, the credit union presented no other relevant evidence that would show that the debtor knew that the VIN was false at the time he applied for the loan.
     The credit union argued that the debtor showed reckless disregard for the truth in not checking to verify that the VIN provided by the car dealer was accurate or that there existed a Mercedes Benz automobile. The Court, however, was not inclined to find reckless disregard for the truth. In regard to the VIN, the Court noted that in a majority of automobile purchases the buyer does not compare the VIN written on the bill of sale against the VIN on the automobile itself, nor does the buyer call the VIN in to the manufacturer's corporate headquarters for verification. In regard to the Mercedes, the Court found that there was no reason for the debtor to have doubted the existence of the vehicle. The debtor's only interest in the vehicle was that it could be refitted by the car dealer and then resold at a profit. Further, the debtor had already successfully conducted two such transactions with the credit union without seeing either of the cars involved in these transactions.
     The Court ruled that the debtor's representations regarding the VIN and the existence of the Mercedes Benz automobile were not made in reckless disregard to the truth. Further, the Court ruled that the credit union had failed to show any intent to deceive on the part of the debtor in making such representations. Accordingly, the Court ruled that Bankruptcy Code §523 (a)(2)(A) did not render the debt nondischargeable.
     The Credit Union also raised the issue on nondischargeability based upon material false financial statements pursuant to Bankruptcy Code §523 (a)(2)(B). The Court took evidence from the credit union regarding information written by a loan officer on the loan request form as well as the written deposition of that officer. The Court found as fact that a loan to another credit union was not included on the loan request forms to the plaintiff credit union. The Court noted that in deciding the issue of materiality the Court must determine whether the credit union would have made the loan knowing of the outstanding obligation to another credit union, considering what weight the plaintiff credit union gives to its debt-to-income ratio limit. The Court noted that the evidence by the credit union was not clear as to what debt-to-income ratio would have disqualified the debtor. The Court observed that a limit of 35 percent appeared on the form, but the debtor was approved with a debt-to-income ratio higher than 35 percent. The Court decided that it was more probable than not that under the totality of circumstances of this particular fact situation that the credit union relied not on the debt-to-income ratio, but instead on the debtor's high professional salary, low living expenses, and an established relationship in which during the past ten months two $20,000 "grey market" loans were paid off about the time of the due date of the first monthly installment. The Court concluded that the credit union's reliance on the debtor's false financial statement was not reasonable. Accordingly, the Court ruled that Bankruptcy Code §523 (a)(2)(B) did not render the debt nondischargeable.

Bankruptcy: Debt Declared Nondischargeable due to Debtors Knowledge of Error

     The U.S. District Court in Alexandria, in the case of Nawroz v. Wells Fargo Advisors LLC, in August, 2012, affirmed a bankruptcy court decision which held that a debtor cannot discharge in bankruptcy her obligation to repay a bank for the $28,029.99 that the bank mistakenly credited her IRA.
     Wells Fargo, after mistakenly transferring the funds into the debtor’s IRA, then transferred the balance of debtor’s account, $56,043, to a checking account at another bank, and then closed the debtor’s account with Wells Fargo.
     At trial, the debtor testified that during that time period, she was severely depressed, her home was in foreclose, she lost her business and she was not attending to her business affairs. She also testified that she did not know the funds not belonging to her had been mistakenly transferred to her new checking account. Shortly after the transfer of funds to the checking account, the debtor wrote a checking for $81,000 to Khalil Wadedi, allegedly to avert a family emergency arising from the kidnapping of a family member in Afghanistan. At the time, the checking account held less than $81,000.
     Wells Fargo won a default judgment against the debtor for $36,962.71, covering the funds mistakenly transferred, attorney’s fees, prejudgment interest and costs.
     During the debtor’s subsequent bankruptcy proceedings the bankruptcy court said the debt to Wells Fargo was nondischargeable pursuant to Bankruptcy Code Section 523 (a)(6). The debtor appealed this decision.
     The District Court noted that the debtor knew that her CD account with Wells Fargo held no more than $28,032 in April 2008, and therefore the amount transferred from Wells Fargo to the different checking account should not have exceeded this amount. The debtor subsequently used $81,000 from the checking account after the transfer of funds from Wells Fargo. But for the mistaken credit by Wells Fargo of $28,029, the checking account would have been no more than $56,000 and therefore debtor’s $81,000 check would not have cleared.
     The debtor admitted that she knew the balance of the CD account; therefore, the court reasoned that the debtor must have known that the amount transferred from Wells Fargo to the checking account should not have exceeded $28,032, regardless of what account held the funds prior to this transfer, and that the debtor was not the true owner of approximately $28,000 of the amount in her checking account in May, 2008.