Consumer Bankruptcy

Published on: August 13, 2013

BAP Finding Affirms that a Spouse does Not need to be Directly Engaged in Fraud to have their Bankruptcy Discharge denied if the Fraudulent Conduct of the other Spouse can be Imputed to them

By Binder Malter Harris & Rome-Banks LLP

In In re: John Shart and Elke Gordon Shardt, an unpublished decision by the United States Bankruptcy Appellate Panel (BAP) for the Ninth Circuit, the BAP affirmed the bankruptcy court’s ruling that chapter 7 co-debtor’s spouse did not directly engage in fraudulent conduct, but remanded the action back to bankruptcy court for consideration and findings as to whether the co-debtor spouse had a partnership or agency relationship with her co-debtor husband such that his fraudulent behavior should be imputed to her for purposes of exception to discharge under §523(a)(2)(4).

Factual Background and Procedural History

Husband entered into various real and personal property transactions with creditors with whom the husband had a personal and business relationship. Creditors sued husband, his wife, and husband’s business in state court.

Husband and wife then filed a chapter 11 bankruptcy, which was converted to a chapter 7 bankruptcy. Creditors filed an adversary proceeding against the husband and wife debtors alleging the debtors: a) made misrepresentations to creditors with the intent to deceive them, b) had engaged in fraud or defalcations as fiduciaries, and c) willfully, maliciously and intentionally injured the creditors and converted their property. The creditors argued that the resulting debt should therefore be excepted from discharge under §523(a)(2)(A), §523(a)(4) and §523 (a)(6). Debtors filed an answer denying the allegations.

The bankruptcy court entered a judgment in favor of creditors against husband and declared that creditors’ claims against wife were discharged. A timely appeal was filed by creditors on September 27, 2012, challenging the part of the judgment holding that the claims against wife were not excepted from discharge.
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Published on: June 18, 2013

United States Supreme Court Protects Innocent Trustees by Holding that “Defalcation” under Bankruptcy Code § 523(a)(4) Requires a Culpable State of Mind

By Binder Malter Harris & Rome-Banks LLP

In Bullock v. Bankchampaign, N.A., 569 U.S. ___ (2013), the United State Supreme Court held that the term “defalcation” in the Bankruptcy Code includes a culpable state of mind requirement involving knowledge of, or gross recklessness in respect to, the improper nature of the fiduciary behavior giving rise to liability.

Factual Background and Procedural History

In 1978, Petitioner’s father established a trust for the benefit of his five children. He made Petitioner the trustee and transferred to the trust a single asset, a life insurance policy. The trust instrument permitted Petitioner, as trustee, to borrow funds from the insurer that issued the life insurance policy against the policy’s value. Initially at his father’s request, and later on his own, Petitioner borrowed money from the trust. All of the money borrowed by Petitioner was repaid with interest.

In 1999, Petitioner’s brothers sued Petitioner in Illinois state court. The state court held that Petitioner had committed a breach of fiduciary duty, stating that Petitioner “does not appear to have had a malicious motive in borrowing the funds from the trust” but was nonetheless “clearly involved in self-dealing.” After Petitioner tried unsuccessfully to liquidate certain assets to make court-ordered payments, Petitioner filed for bankruptcy. BankChampaign, as trustee for the constructive trust imposed by the state court on Petitioner’s assets in order to secure Petitioner’s payment of the judgment against him, opposed Petitioner’s effort to obtain a bankruptcy discharge of his debts to the trust. The bankruptcy court granted summary judgment in BankChampaign’s favor, holding that Petitioner’s debts were non-dischargeable under Bankruptcy Code § 523(a)(4) “as a debt for defalcation while acting in a fiduciary capacity.” The Federal District Court and the Court of Appeals both affirmed, with the Court of Appeals finding that “defalcation requires a known breach of fiduciary duty, such that the conduct can be characterized as objectively reckless.”

Petitioner sought certiorari, asking the Supreme Court to decide whether the bankruptcy term “defalcation” applies “in the absence of any specific finding of ill intent or evidence of an ultimate loss of trust principal.” Noting lower courts’ disagreement over whether “defalcation” includes a scienter (intent) requirement and, if so, what kind of scienter it requires, the Supreme Court granted certiorari.
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Published on: June 4, 2013

Bankruptcy Appellate Panel Affirms Bankruptcy Court’s Finding that ‘Cause’ Existed under Bankruptcy Code Section 707(a) to Dismiss Corporate Contractor’s Chapter 7 Case

By Binder Malter Harris & Rome-Banks LLP

In re: M.P. Construction Company, Inc., an unpublished decision by the United States Bankruptcy Appellate Panel (BAP) for the Ninth Circuit, the BAP affirmed the bankruptcy court’s ruling that ’cause’ existed to dismiss a corporate debtor’s chapter 7 bankruptcy under Bankruptcy Code Section 707(a) and to impose sanctions on debtor and its counsel under Bankruptcy Rule 9011 when the debtor contractor filed a chapter 7 bankruptcy petition to try to enable it to transfer its suspended contractor’s license to a new entity formed and owned by the adult children of debtor’s principals and the debtor was not eligible for a discharge and had no assets to distribute to creditors.

Factual Background and Procedural History

In 2005, the Wongs contracted with debtor contractor, M.P. Construction Company, Inc., to remodel their home. After being paid over $1.6 million for services originally estimated to cost $995,000, debtor sued to collect approximately $75,000 in unpaid invoices. The Wongs countersued. Following a week-long arbitration, a $601,322 judgment was entered in the Superior Court in favor of the Wongs in January 2010. The unsatisfied judgment resulted in debtor’s contractor’s license being suspended by operation of law.

In July 2009, prior to the judgment being entered, a new entity named Avenue 35 Construction Co., Inc. (“Avenue 35”) was incorporated by the three adult children of debtor’s owners, Mario and Ana Piumetti. In August 2009, Avenue 35 acquired debtor’s assets for $120,000. To facilitate this transaction, Mr. Piumetti loaned each child $40,000. The $120,000 paid to debtor was then used to repay undocumented loans that Mr. Piumetti asserted he made to debtor. Mr. Piumetti then attempted to transfer debtor’s contractor’s license to Avenue 35.
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