Exceptions to Discharge

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The 6th Circuit To Determine Whether the Debtors’ Post-Petition Application of Their Tax Refund to Future Tax Liabilities is Per Se Intent to Hinder a Trustee Justifying a Denial of Discharge

The Sixth Circuit in Wylie v Miller is reviewing the decision of the District Court for the Eastern District of Michigan. The district court reversed the bankruptcy court’s decision, holding that the bankruptcy court erred in applying a per se rule that the debtors’ post-petition application of their tax overpayment to future tax liabilities constituted an intent to hinder the trustee.

Facts

Jason and Leah Wylie filed for Chapter 7 bankruptcy and were denied discharge under 11 U.S.C. § 727(a)(2)(B) by the bankruptcy court. The denial was based on the Wylies’ post-petition election to apply a $20,736 tax overpayment from their 2019 tax return to their 2020 tax liabilities, which the bankruptcy court interpreted as an intent to hinder the trustee.

Analysis

The court’s analysis centered on the bankruptcy court’s application of a per se rule regarding the debtors’ intent. The bankruptcy court found that the Wylies’ election to apply their 2019 tax overpayment to their 2020 tax liabilities was sufficient to establish an intent to hinder the trustee. This conclusion was drawn without direct evidence of the Wylies’ intent but rather inferred from the action itself, effectively applying a per se rule that such an action always constitutes intent to hinder.

The court found this application problematic because it did not consider the specific circumstances or the debtors’ actual intent. The court highlighted that intent to hinder, delay, or defraud must be supported by concrete evidence and not merely inferred from the action of applying tax overpayments. The Wylies had consistently made similar elections pre-petition, which the bankruptcy court had previously found were made without intent to hinder, delay, or defraud. The court emphasized that exceptions to discharge must be narrowly construed, and a broad per se rule undermines this principle by potentially denying a fresh start without sufficient evidence.

The court also noted that the bankruptcy court failed to account for the Wylies’ testimony, which consistently stated that their intent was to ensure payment of future tax liabilities, not to hinder the trustee. The bankruptcy court’s failure to distinguish between intent to prefer one creditor over another and intent to hinder the trustee further weakened its position. Therefore, the application of a per se rule was inappropriate, and the court reversed the decision, remanding for entry of a discharge.

NCBRC and NACBA filed an amicus brief in support of the Debtor/Appellee.

Wylie v Miller – Amici Brief

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4th Circuit Holds a Deferred Entry of Conviction by Probation Before Judgment is Non-Dischargeable as a “Conviction” Under Section 1328(a)(3)

In In re Feyijinmi, the 4th Circuit held that a debt for restitution ordered as part of a criminal conviction is nondischargeable under 11 U.S.C. § 1328(a)(3), even if the conviction was expunged or the restitution was later converted to a civil matter. Additionally, the State’s characterization of the debt on its proof of claim as “court fees” did not change its nondischargeable nature.

Facts

Dedre Feyijinmi was found guilty of welfare fraud in Maryland state court and ordered to pay $14,487 in restitution. The court deferred the entry of her conviction and placed her on probation before judgment. After completing her probation, the state expunged her criminal records but her restitution obligation remained, and it was later transferred to the State’s Central Collection Unit. Feyijinmi filed for Chapter 13 bankruptcy, and the State filed a proof of claim for the restitution debt, labeling it as “court fees.”

Analysis

The court’s legal analysis began with the interpretation of “conviction” under 11 U.S.C. § 1328(a)(3). The court applied federal law, relying on the Supreme Court’s decision in Dickerson v. New Banner Institute, Inc., which held that a guilty plea followed by probation qualifies as a conviction, even if no formal judgment is entered. The court determined that Feyijinmi’s probation before judgment, which required a guilty finding, constituted a conviction under federal law. This interpretation promotes national uniformity and prevents anomalous results that could arise from varying state definitions.

Next, the court addressed whether restitution ordered as part of a probation before judgment constitutes a “sentence” under § 1328(a)(3). The court concluded that “sentence” includes any penal consequences resulting from a determination of guilt, such as probation and restitution. The court found that Congress intended to except criminal restitution from discharge in bankruptcy to prevent federal proceedings from invalidating state-ordered restitution.

Finally, the court rejected Feyijinmi’s argument that the State’s labeling of the debt as “court fees” on its proof of claim affected its dischargeability. The court held that restitution debts are nondischargeable without any action by the creditor and that the State’s proof of claim and its characterization of the debt did not change its nature. The court also found no evidence of bad faith or unreasonable delay that could have prejudiced Feyijinmi.

NACBA filed an amicus brief in support of the Debtor/Appellant.

In re Feyijinmi – 4th Circuit

In re Feyijinmi – Appellants Brief

In re Feyijinmi – NACBAs Amicus Brief In Support of Appellant

In re Feyijinmi – Appellees Brief

Tips

  1. Accurately Characterize Claims: Ensure that proofs of claim accurately reflect the nature of the debt to avoid confusion and potential disputes in bankruptcy proceedings.
  2. Understand Federal Definitions: Be aware that federal law, not state law, governs definitions such as “conviction” and “sentence” in the context of bankruptcy dischargeability.
  3. Advising Clients on Restitution: Advise clients that restitution debts are generally nondischargeable in bankruptcy, even if labeled differently on proofs of claim or converted to civil matters.

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Ex-Wife’s Interest in Home Not Property of Debtor’s Bankruptcy Estate

Under Colorado law,  spouses in dissolution proceedings own marital property as co-owners. Therefore the debtor’s ex-wife had a vested equitable interest in an up-front sum plus 50% of the proceeds from the sale of their marital residence as ordered by the divorce court, and that interest did not enter the debtor’s chapter 13 estate. Williams v. Goodman (In re Williams), No. 22-1067 (10th Cir. Dec. 13, 2022) (non-precedential).

The debtor and his wife, Ms. Williams, lived with their children in a home titled only in the debtor’s name. When they divorced, they agreed to sell the home. Ms. Williams was to receive $24,800 from the proceeds and the remaining proceeds were to be divided evenly between the two of them. Instead of selling the home, though, the debtor filed for chapter 13 bankruptcy.

The debtor’s confirmed plan listed general unsecured creditors as “class four,” with their payments to be made on a pro rata basis after all prior classes of debts were fully paid. Beyond describing class four claims as allowed and timely filed, the plan did not address any individual unsecured claims.

Ms. Williams filed an adversary complaint seeking a ruling that her interest in the house did not become part of the bankruptcy estate under section 541(a), and seeking an order of nondischargeability of other claims under section 523(a). The debtor filed counterclaims including a request for attorney’s fees under section 523(d). The bankruptcy court ruled in favor of Ms. Williams on the section 541(a) claim and against her on the section 523 claims. The court ruled against the debtor on his counterclaims. It failed to address his claim under section 523.

The debtor moved for reconsideration based on the court’s failure to address the attorney’s fee claim, and at the same time, appealed the court’s decision in favor of Ms. Williams to the Tenth Circuit BAP. The bankruptcy court denied the motion for reconsideration, expressly rejecting his section 523 claim for attorney’s fees at that time. The debtor did not amend his BAP appeal to include the reconsideration order.

In the meantime, the trustee asked the court what she should do with the distributions earmarked for Ms. Williams. If Ms. William’s interest in the house was determined on appeal to be estate property she would be entitled to her pro rata share of the distributions representing only a fraction of the claim. But if it was outside the estate, she would be entitled to the entire amount as ordered by the divorce court. The bankruptcy court ordered the trustee to retain Ms. Williams’ share in a separate trust to await a ruling by the BAP as to the legal question. The debtor appealed that order to the BAP.

In two separate orders, the BAP affirmed the orders of the bankruptcy court. It did not consider the debtor’s arguments related to the bankruptcy court’s order denying reconsideration because the debtor failed to file a notice of appeal of that order.

The debtor appealed both decisions to the Tenth Circuit and that court consolidated the appeals.

The court began with the debtor’s argument that the bankruptcy court’s distribution order contravened the terms of the confirmed plan. The court disagreed, finding that the provision in the plan and in the confirmation order concerning class four claims was general in its applicability. The court held that where neither the plan nor the confirmation order addressed the timing of distributions or whether specific claims like Ms. Williams’ were allowed, “the confirmation order did not have preclusive effect regarding the allowance of that claim or the timing of distributions based on that claim.” Therefore, the trustee was not required to adhere to the plan’s treatment of her claim in the event her interest in the house was determined not to be part of the bankruptcy estate. The court also rejected the debtor’s argument that the trustee’s motion for an order of distribution was actually merely an untimely appeal of the confirmation order.

The court next affirmed the BAP’s refusal to address the debtor’s motion for reconsideration. The court found that when a judgment or order under appeal is amended or added to while the appeal is pending, the appellant must file a new appeal or amend the pending appeal to encompass the new judgment or order. The debtor failed to do so.

The court then turned to the issue of whether Ms. Williams’ equitable interest in the house was not part of the bankruptcy estate under section 541. Section 541(d) states, “[p]roperty in which the debtor holds . . . only legal title and not an equitable interest, . . . becomes property of the estate . . . only to the extent of the debtor’s legal title to such property, but not to the extent of any equitable interest in such property that the debtor does not hold.”

Looking to state law to determine the nature of Ms. Williams’ property interest, the court reasoned that at the time of the bankruptcy petition, Ms. Williams “had a vested interest in the house protected by ‘an encumbrance of record,’ created via ‘filing the lis pendens.’” Based on this finding, the circuit court agreed that Ms. Williams had an equitable interest in the property valued at 50% plus $24,800, that the debtor did not hold. Therefore, that interest did not become part of the debtor’s estate.

In answer to the debtor’s argument that Ms. Williams’ interest was not in the home itself, but in a sum of money representing a divorce settlement, the court turned again to state law. Colorado law states that upon filing a dissolution of marriage, marital property “the wife has an interest in the marital property in the nature of a co-owner, rather than as a mere creditor of her husband,” and that interest vests automatically.

The court concluded that Ms. Williams’ equitable interest in the property did not enter the debtor’s bankruptcy estate and affirmed the decisions of the BAP.

Williams 10th Cir Dec 2022

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Debt Owed to Trust is DSO

Where the debtor’s payments to his ex-wife’s Trust were in lieu of alimony and were understood by both the debtor and his ex-wife to be for her future support, the payments were in the nature of a domestic support obligation not dischargeable in bankruptcy. Hundt v. Ventrone (In re Ventrone), No. 21-11643, Adv. Proc. Nos. 22-00005, 22-00026 (Bankr. E.D. Pa. Jan. 2023).

In order to buy a house, the plaintiff and her then-husband, the debtor, withdrew $415,000 from a Trust established for the plaintiff’s benefit. They then entered into a post-nuptial agreement providing that in the event of divorce, “the original Distribution invested in the Property of $415,000, . . . shall be returned to the Trust at the time of sale, free and clear from any and all claims by [Debtor].”

Three years later, the debtor and the plaintiff divorced. They entered into a property settlement agreement (PSA) which incorporated the post-nuptial agreement and PSA further provided that:

“The parties agree that in the event that the sale of the Marital Residence does not satisfy their $415,000.00 obligation to the Trust, that they shall divide the deficiency between the net sale proceeds returned to the Trust and the $415,000.00 liability with [Debtor] being responsible for 37.5% of the deficiency and [Plaintiff] being responsible for 62.5% of the deficiency.”

In 2018, the parties sold the property but the proceeds were not sufficient to fully repay the trust. The debtor failed to make the payments required by the PSA to make up his share of the deficiency. After the Family Court issued a couple of contempt orders and held a contempt hearing, it ordered the debtor to make a one-time payment to the court for $30,625, and to make three other payments in the amount of $1,225 each. All the payments represented amounts owed to the Trust. The debtor complied with the order except that each of the checks he submitted to the Family Court contained conditional language that ultimately prevented the plaintiff from depositing them. The debtor refused to submit acceptable replacement checks.

The Family Court issued a bench warrant and after a hearing on that warrant, the court ordered the debtor to liquidate his 401K accounts and pay the proceeds to the plaintiff to satisfy Marital Obligations. The court also ordered the debtor to pay $4,500 in attorney’s fees.

The debtor filed for chapter 13 bankruptcy. The Trust filed a claim for $174,451.79 plus the attorney’s fees as awarded by the Family Court. “Out of an abundance of caution,” the plaintiff filed the identical claim. The debtor objected to the claim on the bases that the contempt order was for only $113,913.28, that attorney’s fees should not have been included, and that the claim was not for a domestic support obligation. The debtor and the plaintiff (along with the Trust) filed opposing adversary complaints relating to whether the plaintiff’s claims were nondischargeable domestic support obligations under various paragraphs in section 523(a).

The case came before the court on the plaintiff’s motion for summary judgment. Though the plaintiff cited several provisions of section 523(a), the court rested its decision on section 523(a)(5) which excepts domestic support obligations (DSO) from discharge in chapter 13.

The court began its analysis with the question of whether the plaintiff’s claim was for a DSO, finding that to qualify as such the debt must be, “(i) ‘owed to or recoverable by’ a governmental unit or a person with a specific relationship to the Debtor such as a spouse, former spouse, or child of the Debtor; (ii) the underlying obligation [must be] in the nature of alimony, maintenance, or support of such person; (iii) the obligation [must arise] from an agreement, court order, or as otherwise defined; and (iv) the debt [must not be] assigned to a non-governmental entity unless voluntarily done by the spouse, former spouse, or child of the Debtor.”

The court rejected the debtor’s argument that the claim was not a DSO because it was payable to the Trust rather than to the plaintiff herself. The court found that where the obligation is in the nature of support for a spouse or child, it qualifies as a DSO even though it may be payable to another entity.

The court looked to three factors to determine whether the payments were intended for support: “(i) the language and substance of the agreement; (ii) the parties’ financial circumstances; and (iii) the function of the obligation.”

Here, under the terms of the PSA, the debtor was obligated to make payments to the Trust “in lieu of alimony” for the plaintiff’s support. The court noted that the plaintiff’s income was substantially less than the debtor’s and the plaintiff had the responsibility of paying her own and their children’s expenses. In testimony in the Family Court the debtor acknowledged that the Trust constituted the plaintiff’s future support and that his payment into it was in furtherance of that end. That the obligation was for support was reinforced by the fact that the plaintiff sought and received enforcement by the Family Court.

Having found the plaintiff’s claim was a nondischargeable DSO, the court turned to whether the plaintiff’s claim for $4,500.00 in attorney’s fees was also nondischargeable as a DSO. It found the law well-settled that an award of attorney’s fees in connection with a divorce proceeding are in the nature of a DSO.

The court concluded that the claim in the modified amount of $118,413.28, as well as the $4,500 attorney’s fee award and any additional legal fees awarded by the Family Court, were nondischargeable under section 523(a)(5). It granted summary judgment to Plaintiffs. The debtor filed a motion to reconsider on March 7.

Ventrone Bankr ED Pa Jan 2023

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Passive Voice and 1885 Case Sink Debt Discharge

SCOTUS determined that section 523(a)(2)(A), which excludes from discharge debts incurred by fraud, applies to innocent partners of the fraudulent actor where the statute does not draw any connection between the individual debtor and the fraudulent conduct but instead is written in passive tense saying merely that a debt owed by an individual and procured by fraud is nondischargeable. Bartenwerfer v. Buckley, No. 21-908,  __ U.S. __ (Feb. 22, 2023). The decision was unanimous with a concurring opinion by Justice Sotomayor adding that the decision turned on the fact that the debtor had an agency relationship with the fraudulent actor.  

The debtor, Kate Bartenwerfer and her husband David Bartenwerfer, bought property in San Francisco which they planned to remodel and sell at a profit. David handled the project and the debtor was not actively involved. After they sold the property, the buyer discovered a number of undisclosed problems. He sued both Kate and David in state court for breach of contract, negligence, and nondisclosure of material facts, and won a judgment against them jointly in the amount of $200,000. The Bartenwerfers then filed for chapter 7 bankruptcy. The purchaser filed an adversary complaint seeking a finding that his claim was nondischargeable as having been incurred by false pretenses or fraud. The bankruptcy court found that the debt was nondischargable as to both David and Kate.

The Bankruptcy Appellate Panel for the Ninth Circuit reversed the finding as to Kate, finding that the debt was nondischargeable as to her only if she knew, or had reason to know of David’s fraud. On remand, the bankruptcy court found that Kate’s liability on the debt was discharged. The BAP affirmed. The Ninth Circuit reversed, finding that, under Strang v. Bradner, 114 U. S. 555 (1885), a debtor is liable for her partner’s fraud and cannot discharge that debt in bankruptcy, regardless of her own culpability. The Supreme Court granted certiorari.

Writing for the Court, Justice Barrett began with section 523(a)(2)(A), which provides that a discharge does not discharge an individual debtor for a debt “obtained by false pretenses, a false representation, or actual fraud . . .” The Court found all requirements for exclusion from discharge were met. Kate Bartenwerfer was an individual, the state court judgment created a debt, and the debt was based on fraud. The fact that the individual debtor was not the one who committed the fraud was irrelevant in light of Congress’s use of the passive tense referring only to fraud with respect to the debt rather than the actor.

The Court observed that its conclusion was supported by the common law understanding that fraud is not limited to the wrongdoer but extends to principals liable for the fraud of their agents, or to partners liable for the acts of other partners.

The Court was unpersuaded by the debtor’s argument that the context of section 523(a)(2) lends credence to her position. Specifically, the debtor maintained that sections 523(a)(2)(B) and (C) both refer to acts of misconduct actually carried out by the individual debtor. The debtor extrapolated that Congress intended nondischargeability in section 523(a)(2)(A) also to be based on actual culpability by the debtor.

The Court reached the opposite conclusion, finding that the express reference to the individual actor in paragraphs 523(a)(2)(B) and (C) suggested that the absence of a similar reference in section 523(a)(2)(A) indicated Congress’s intent to broaden nondischargeability under that section to non-culpable actors. The Court was satisfied that the difference between section 523(a)(2)(A) and the similarly fraud-based, but individually targeted, nondischargeability of section 523(a)(2)(B) supported the view that Congress intended different levels of culpability.

The Court referred to its 1885 decision in Strang, where it held that two innocent business partners of the third partner who committed fraud were equally liable because they benefitted from the fraud to the same extent the culpable partner did. They could not discharge the debt in bankruptcy even though the Code at that time specifically referred to nondischargeability of debts incurred by the fraud “of the bankrupt.” The nineteenth century Court established that the fraud of one partner was the fraud of all. Congress’s removal of the phrase “of the bankrupt” in later iterations of the provision reinforced the Court’s finding that Congress intended to extend nondischargeability to non-culpable parties.

The Court observed that the underlying state law judgment applied to both Kate and David and that the debtor’s arguments related to general unfairness of making an innocent party liable for the fraud of another would have been better directed to that court.

The Court affirmed the Ninth Circuit decision finding the debt nondischargeable as to Kate Bartenwerfer.

Justice Sotomayor filed a concurring opinion joined by Justice Jackson. Crucial to her concurrence was Kate Bartenwerfer’s concession that she and David were partners in the remodeling and sale endeavor. Justice Sotomayor noted that had there been no agency or partnership relationship between the two, she would have reached the opposite conclusion.

Bartenwerfer SCt Feb 2023