by The Bankruptcy Appellate Panel for the Tenth Circuit found that the bankruptcy court erred when it declined to exercise its exclusive jurisdiction to determine whether state causes of action raised by investors in the debtor’s pre-bankruptcy Ponzi scheme belonged to the Debtor’s bankruptcy estate: an issue which the panel found was “central to whether the investors had standing to pursue those claims and whether they violated the discharge injunction” by doing so. Hafen v. Adams (In re Hafen), No. 19-31 (B.A.P. 10th Cir. July 30, 2020).
When the debtor filed for chapter 7 bankruptcy, he scheduled over $5,000,000 in unsecured debt and listed investors in his pre-bankruptcy Ponzi scheme (Investors) as unsecured creditors with claims ranging from $250,000 to $500,000. He disclosed assets with the total value of $11,560. Though they knew of the debtor’s bankruptcy filing, the Investors did not take part in the case. The bankruptcy trustee paid $5,000 to unsecured creditors, and the debtor received his discharge. Thirteen years later, the Investors moved to reopen the bankruptcy case alleging that the debtor had fraudulently conveyed or otherwise concealed assets that should have been administered by the chapter 7 trustee.
Shortly after they moved to reopen, the Investors initiated a state court action based on the Ponzi scheme and seeking to recover from the property the debtor had allegedly concealed from the bankruptcy court. Specifically, the Investors alleged that the debtor, through a variety of machinations, had fraudulently transferred property to the C.A.R. Trust for which he and his wife were the sole beneficiaries and that the debtor concealed ownership of the business entity, Daniel Roy Hafen, Ltd, which owned real property and water rights. The complaint named as defendants the debtor, his wife, C.A.R. Trust and its trustees, Daniel Roy Hafen, LTD, and other parties allegedly in possession of the Debtor’s assets. The bankruptcy court granted the motion to reopen and appointed a trustee.
The debtor sought sanctions against the Investors alleging that the state court action violated the discharge injunction. Additionally, the debtor argued that the Investors lacked standing to file the state court complaint because the causes of action belonged to the bankruptcy estate.
At a hearing on the motion for sanctions, the Investors assured the bankruptcy court that they did not intend to collect from the debtor himself, but were seeking to recover property solely in the possession of third parties. Relying on this assertion, the bankruptcy court denied the motion for sanctions under the exception in section 524(e) which permits post-discharge actions against debtors in order to collect from non-debtors. As to the issue of standing, the bankruptcy court stated: “A question was raised about the standing of the [Investors] to pursue these claims in the state court proceeding. This Court does not decide whether or not the [Investors] have standing to pursue these claims or whether the reappointed Chapter 7 Trustee would have standing. The parties have stated that the standing issues will be brought before the state court. To the Court’s knowledge, the chapter 7 Trustee has not made an appearance in the Lawsuit.” The court denied the debtor’s motion to alter or amend the order, and the debtor appealed.
Addressing whether the bankruptcy court erred in declining to decide the issue of standing, the Bankruptcy Appellate Panel for the Tenth Circuit broke the Investor’s state court complaint into two theories: the fraudulent conveyance claim and the concealment claim.
Fraudulent Conveyance Claim
Under this theory, the Investors sought to recover property that the debtor had transferred through fraudulent means to a trust for which he and his wife were the sole beneficiaries. The panel began its analysis with the finding that, if the property at issue belonged to the bankruptcy estate, only the chapter 7 trustee would have standing to pursue the fraudulent transfer claim. The panel found, therefore, that standing was “totally dependent upon and inescapably intertwined with” the question of whether the property at issue was property of the estate. Furthermore, whether property is part of the bankruptcy estate is a question over which the bankruptcy court has exclusive subject-matter jurisdiction. Pursuant to this reasoning, the panel concluded that the bankruptcy court erred when it left the question of standing to the state court to decide.
Undisclosed Property Claim
Here, the Investors alleged that the debtor concealed from the bankruptcy trustee his interest in Daniel Roy Hafen, LTD. The panel noted that undisclosed property may nonetheless enter the bankruptcy estate and, under 521(a)(1), discharge does not result in abandonment of such property without an order to that effect. As with the claims for fraudulent conveyance, if the property belonged to the estate, only the chapter 7 trustee would have standing to seek turnover. Because the bankruptcy court had exclusive jurisdiction over the question of what property belonged to the bankruptcy estate and the issue of standing relied on that determination, the bankruptcy court erred in declining to reach that issue.
Discharge Injunction Violation
The debtor challenged the bankruptcy court’s finding that, under section 524(e), the Investors did not violate the discharge injunction. In In re Walker, 927 F.2d 1138, 1142 (10th Cir. 1991), the Tenth Circuit held that section 524(e) permits a creditor to pursue a post-discharge action against the debtor if a finding of debtor liability is a prerequisite to allowing the creditor to recover from a person or entity other than the debtor.
In their state court complaint, the Investors sought to recover concealed or fraudulently transferred property under the theory that there was a “unity of interest and ownership” between the debtor, his wife, and the entities possessing such property such that “the separate personalities of the entities and individual no longer exist.”
The panel found that, “[t]o the extent this is true, the claims and assets at issue may be property of the bankruptcy estate, the Investors may not have standing in the State Court lawsuit, and the § 524(e) safe harbor applicable to claims against entities separate from the Debtor may not apply. Accordingly, absent a record determining whether the claims and assets at issue constitute property of the bankruptcy estate, we cannot review the Bankruptcy Court’s decision to apply § 524(e).”
The panel reversed and remanded to allow the bankruptcy court to reach findings as to whether the Investors’ state court claims were property of the bankruptcy estate and whether the Investors had standing to bring the claims.
Bankruptcy Judge Somers filed a concurring opinion adding that the Walker prerequisite test for application of section 524(e)’s exception to the discharge injunction should be applied to the state court complaint on a claim-by-claim basis in accordance with the method set out in In re Robben, 562 B.R. 469 (Bankr. D Kan. 2017).