National Consumer Bankruptcy Rights Center

Protecting The Rights Of Consumer Debtors In Bankruptcy

§ 523 – Exceptions to discharge

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The Ninth Circuit Considers Whether Appellate Rights are Property of the Estate

In In re Lopez, Case No. 23-55682 (9th Cir. 2023), the Ninth Circuit is considering whether the bankruptcy court erred in (1) ruling that the Chapter 7 debtor’s right to appeal a prepetition personal injury judgment against her was property of the estate, (2) denying the debtor’s motion for the Chapter 7 trustee’s abandonment of the appeal rights, and (3) denying the debtor’s motion for reconsideration.

NCBRC filed an amicus brief requesting that the court narrowly confine its ruling to the specific facts of the case.  The concern is that a broad ruling will have a significant impact in other factual situations.

The fact that something has monetary value is not sufficient, by itself, to make it property of the estate. Just as no one would argue that a debtor’s kidneys should be property of the estate because they could have monetary value, it is not difficult to find many examples of situations in which classifying a right to appeal as property, simply because a trustee could sell it, would be extremely problematic. A debtor could be involved in a hotly-contested custody case, where a very questionable decision was appealed. The opposing party, perhaps far wealthier than the debtor, could offer to buy from the trustee the debtor’s right to appeal for more than the debtor could afford, thus ending the appeal. Similarly, a debtor could be involved in a contested divorce, in which a clearly erroneous support order for $100,000, which would not be dischargeable in bankruptcy, 11 U.S.C. § 523(a)(5), was entered against the debtor. In that situation, too, the opposing party could offer the trustee $10,000 for the right to appeal, cutting off any review of the support order and leaving the debtor with a $100,000 debt after bankruptcy.

And such situations are not limited to family law matters. A debtor could be appealing an erroneous criminal conviction. The alleged crime victim, or even a prosecutor trying to save the costs of appeal, could purchase the debtor’s right to appeal from a bankruptcy trustee, perhaps causing the debtor to be imprisoned for years.  Or the debtor might be appealing an erroneous judgment or other decision that would lead to loss of a professional license, which would severely impair the debtor’s fresh start.

The loss of a debtor’s right to appeal could also lead to large debts becoming nondischargeable in bankruptcy when, in fact, they should be discharged. For example, a debtor could erroneously be found liable for a large amount in a fraud judgment that, if not reversed, would result in a nondischargeability determination under 11 U.S.C. § 523(a)(2). See Grogan v. Garner, 498 U.S. 279, 111 S. Ct. 654 (1991) (collateral estoppel applies in dischargeability determination). If the plaintiff could pay the bankruptcy trustee for the debtor’s right to appeal, and then dismiss the appeal, the debt would not be discharged.

In all these situations, and undoubtedly many others, the fact that a right may have monetary value to the bankruptcy estate, and could be sold by the trustee, should not, by itself, make that right property.

The amicus brief for NCBRC and NACBA is here:  Lopez amicus brief v4

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The Fourth Circuit Rules That Parties in an Adversary Proceeding Cannot Manufacture a Final Judgment

In Kiviti v. Bhatt, No. 22-1216, 2023 U.S. App. LEXIS 24415 (4th Cir. Sep. 14, 2023), the court ruled that the parties in an adversary proceeding cannot manufacture a final judgment to appeal an otherwise interlocutory order.  Further, the mootness doctrine employed by Article III courts to determine whether a case or controversy exists does not apply to bankruptcy courts as non-Article III courts.

Before filing the bankruptcy, the Chapter 7 Debtor (Bhatt) was contracted to renovate the creditor’s (Kiviti) home.  Upon finding the Debtor was unlicensed, the creditor filed suit in state court to recover all funds paid ($58,770).  Before judgment, the Debtor filed a Chapter 7 bankruptcy.

The creditors then filed an adversary proceeding with two counts.  The first count asked the court to enter a judgment against the Debtor for the amount paid.  The second count asked the court to find the debt non-dischargeable under 11 U.S.C. § 523(a)(2)(A).  The creditors also filed a proof of claim despite the small bankruptcy estate.

The bankruptcy court granted the Debtor’s motion for summary judgment on the non-dischargeability count leaving only the first count asking for a money judgment.  The creditors wished to appeal but needed a final judgment.  Therefore, the parties agreed to dismiss the first count without prejudice.

On appeal, the court reviewed whether the case was final to review the bankruptcy court’s decision to dismiss the non-dischargeability count.  The creditors argued that the adversary proceeding was moot because if they were unsuccessful in challenging the dismissal of the non-dischargeability count, their debt would be discharged and uncollectable.  The court held that the parties can’t manufacture finality.  Furthermore, the court held that mootness is a limitation on Article III courts (stemming from the case or controversy requirement) but not bankruptcy courts as non-Article III courts.  Instead, bankruptcy courts can rule on moot proceedings

“The parties cannot manufacture finality

“The parties will be unsurprised by our holding that the bankruptcy court’s order was not final—and so not appealable—when entered. After all, that is why they agreed to dismiss Count I. They thought that, by doing so, they would make the order final because there would no longer be anything left to adjudicate in the adversary proceeding. J.A. 63 (agreeing to dismiss Count I “so as to give rise to a final order from which an appeal . . . may be taken”); J.A. 73 (“The instant appeal is from an interlocutory  order that became a final order upon dispensation of the remaining cause of action below.”).

“They were wrong. They cannot “use voluntary dismissals as a subterfuge to manufacture jurisdiction for reviewing otherwise non-appealable, interlocutory orders.” See Waugh Chapel S., 728 F.3d at 359. When Congress requires finality, we must ensure that “every matter in the controversy . . . [is] decided in a single appeal.” Microsoft Corp. v. Baker, 582 U.S. 23, 36, 137 S. Ct. 1702, 198 L. Ed. 2d 132 (2017) (quoting McLish v. Roff, 141 U.S. 661, 665-66, 12 S. Ct. 118, 35 L. Ed. 893 (1891)). Yet, if we allowed the parties to appeal Count II now, there would be nothing to stop them from reinstating—and then separately appealing—Count I down the line. See J.A. 63 (agreeing that the dismissal is “without prejudice to the [Kivitis’] right to amend their pleadings to seek a finding of liability should there be an appellate remand”). Such tactics impermissibly “erode the finality principle” Congress enacted. See Microsoft, 582 U.S. at 37; see also In re AroChem Corp., 176 F.3d at 619 (explaining that the “flexible” nature of bankruptcy finality does not “overcome the general aversion to piecemeal appeals” (cleaned up)). So the voluntary dismissal did not make the bankruptcy court’s earlier, partial dismissal final.

“True, some partial dismissals are final and appealable after the parties voluntarily dismiss the remaining claims. See Affinity Living Grp., LLC v. StarStone Specialty Ins. Co., 959 F.3d 634, 638-39 (4th Cir. 2020). But that’s only when the district court dismisses some claims and, in the process, makes it legally impossible to prevail on the remaining claims, even while allowing them to limp on. Id. In this sense, the litigants do not impermissibly create finality by voluntarily dismissing the doomed claims; they merely recognize that it already effectively exists. See id. at 639 (hearing an appeal from a case that was “legally over” even before the voluntary dismissal).

“That is not what happened here. These parties set out to create finality, not recognize it. The adversary proceeding was not “legally over” after the bankruptcy court’s partial dismissal. See id. Count II’s dismissal did not mean the Kivitis could not prevail on Count I. Count I asked whether Bhatt was in debt to the Kivitis—i.e., whether Bhatt violated D.C. law by renovating the Kivitis’ house without a license and thus owed them money. Count II asked whether any such debt was dischargeable—i.e., whether Bhatt obtained such a debt through “false pretenses, a false representation, or actual fraud.” See 11 U.S.C. § 523(a)(2)(A). Just because the bankruptcy court found that Bhatt had obtained $=P13 no debt through fraud did not mean the Kivitis were wrong that he violated D.C. law. Count I was still very much alive.

“The parties agree that the Kivitis could have prevailed on Count I’s merits even after Count II’s dismissal. They maintained their proof of claim which sought the same monies. Yet the Kivitis still argue that their voluntary dismissal recognized rather than created finality because, they say, their Count II loss rendered the adversarial proceeding moot. According to them, a moot proceeding is “legally over” and so this appeal falls within Affinity Living Group‘s safe harbor.

“The root of their mootness argument is that, without Count II, any judgment they won via Count I could not be collected outside bankruptcy and their $58,770 would be recovered—if at all—only through the bankruptcy’s proof-of-claims process. So once Count II failed, they argued, Count I became legally moot. A case is moot when “a court can’t grant any effectual relief whatever” to the complaining party.5 Mission Prod. Holdings, Inc. v. Tempnology, LLC., 139 S. Ct. 1652, 1660, 203 L. Ed. 2d 876 (2019) (quoting Chafin v. Chafin, 568 U.S. 165, 172, 133 S. Ct. 1017, 185 L. Ed. 2d 1 (2013)). Recall that if a debt is discharged, it cannot be collected outside the bankruptcy proceedings. So if the bankruptcy court agreed Bhatt owed the Kivitis money (success on Count I), but determined that debt dischargeable (failure on Count II), the Kivitis could not directly use the judgment they won from Count I to force Bhatt to pay them outside of bankruptcy. Their only means of recovery would be within bankruptcy, via their already filed proof of claim. The Kivitis thus contend that they could not get “any effectual relief” from the adversary proceeding, rendering it moot. Appellant’s Supp. Br. at 10 (“[T]he Bankruptcy Court’s dismissal of Messrs. Kiviti’s claim . . . caused the remaining case to become moot, and to accordingly strip the Bankruptcy Court of Article III jurisdiction.”).

“The Kivitis’ argument is clever, but it misses at least one critical link: Mootness is an Article III doctrine, and bankruptcy courts are not Article III courts. Mootness arises out of Article III’s “case-or-controversy” requirement. The United States’s judicial Power extends only to cases or controversies. U.S. Const. art. III, § 2. To be a case or controversy, parties must have a “‘personal stake in the outcome’ of the lawsuit,” at each stage of the litigation. Lewis v. Cont’l Bank Corp., 494 U.S. 472, 478, 110 S. Ct. 1249, 108 L. Ed. 2d 400 (1990) (quoting Los Angeles v. Lyons, 461 U.S. 95, 101, 103 S. Ct. 1660, 75 L. Ed. 2d 675 (1983)); Campbell-Ewald Co. v. Gomez, 577 U.S. 153, 161, 136 S. Ct. 663, 193 L. Ed. 2d 571 (2016). If they lose that stake, their case drifts beyond the judicial Power and becomes moot. See United States v. Payne, 54 F.4th 748, 751 (4th Cir. 2022). But since bankruptcy courts are not Article III courts, [*17]  they do not wield the United States’s judicial Power. Stern v. Marshall, 564 U.S. 462, 503, 131 S. Ct. 2594, 180 L. Ed. 2d 475 (2011). So they can constitutionally adjudicate cases that would be moot if heard in an Article III court.

“To be sure, a bankruptcy case must—at the start—be within the judicial Power. Section 1334 grants near-exclusive jurisdiction over bankruptcy matters to federal district courts. 28 U.S.C. § 1334(a). The district court may then refer a bankruptcy case to a bankruptcy judge (who serves as a unit of the district court). 28 U.S.C. §§ 157(a), 151.9 But, of course, a district court can only refer a case that it has jurisdiction over. See Ex parte McCardle, 74 U.S. 506, 514, 19 L. Ed. 264 (1868) (“Without jurisdiction the court cannot proceed at all in any cause.”). So before a bankruptcy case is referred to a bankruptcy court, the case must satisfy Article III. See In re Curtis, 571 B.R. 441, 447 (B.A.P. 9th Cir. 2017) (“[T]he bankruptcy court’s power to hear, or to hear and determine, as the case may be, bankruptcy cases and proceedings is entirely dependent upon the referral by the district court.”)

.“So too must Article III be satisfied after the bankruptcy court acts and the case is returned to the district court from the bankruptcy court. Every action by a district court is constrained by Article III, including reviewing a bankruptcy court order. So a district court has no authority to act without an existing constitutional case or controversy. See In re Thorpe Insulation Co., 677 F.3d 869, 880 (9th Cir. 2012); In re Croniser, No. 22-1227, 2022 U.S. App. LEXIS 28563, 2022 WL 7935991, at *1 (4th Cir. Oct. 14, 2022) (unpublished).

“But that limit on the district court’s authority does not constrain the bankruptcy court. Once a case is validly referred to the bankruptcy court, the Constitution does not require it be an Article III case or controversy for the bankruptcy court to act. See In re Technicool Sys., Inc., 896 F.3d 382, 385 (5th Cir. 2018) (“Bankruptcy courts are not Article III creatures bound by traditional standing requirements.”). That requirement comes from the Constitution’s limits on the judicial Power. Bankruptcy courts do not wield judicial Power. End of story

.“At least that is the end of the constitutional story. The statutory story—i.e., whether bankruptcy courts have statutory authority to decide a constitutionally moot matter—is more complex. Still, the tale concludes the same way: a bankruptcy court can adjudicate a constitutionally moot matter.

“Bankruptcy courts, as statutory creatures, have whatever power Congress lawfully gives them. So to see if bankruptcy courts can decide matters outside the judicial Power, we check to see if Congress has given them that power. And Congress has said that bankruptcy courts “may hear and determine all [bankruptcy] cases . . . and all core proceedings . . . referred” to them by a district court. 28 U.S.C. § 157(b)(1) (emphasis added). Not just those that could be fully adjudicated in district court. Once a bankruptcy case lands in bankruptcy court, any number of things could happen before the estate’s distribution is settled. As relevant here, the parties could embroil themselves in an adversary proceeding. But whether that proceeding could itself be adjudicated in an Article III court is of no moment. By § 157’s text, a bankruptcy court’s jurisdiction requires only that the case or core proceeding arise under Title 11 and be referred to the bankruptcy court. § 157(b)(1). Section 157 does not require every “discrete dispute[ ],” see Ritzen, 140 S. Ct. at 587, arising post-referral to satisfy Article III. Nor does any other provision.

“Against this silence, Congress has elsewhere explicitly imported some Article III type requirements onto bankruptcy courts. For example, it created so-called “bankruptcy standing” by giving “parties in interest” a right to be heard, at least in Chapter 11 bankruptcies. See 11 U.S.C. § 1109(b); In re Capital Contracting Co., 924 F.3d 890, 895 (6th Cir. 2019) (discussing § 1109(b)).11 And it also codified some version of mootness for real-property cases. See 11 U.S.C. § 363(m); In re Rare Earth Mins., 445 F.3d 359, 363 (4th Cir. 2006) (explaining that § 363(m) “creates a rule of ‘statutory mootness’”). Yet these principles are not the same as Article III’s limits and Congress has never imported all [*20]  those limitations. We refuse to make that choice for it; indeed we cannot do so. See Antonin Scalia & Bryan A. Garner, Reading Law: The Interpretation of Legal Texts 96 (2012) (“[W]hat a text does not provide is unprovided.”).

“A few bankruptcy courts confronting this issue have disagreed. They point to a district court’s authority to “withdraw, in whole or in part, any case or proceeding” referred to a bankruptcy court. See 28 U.S.C. § 157(d). They also think it significant that Congress called bankruptcy courts “unit[s] of the district court,” with judges that are “judicial officer[s]” thereof. See § 151. Following these breadcrumbs, those courts have held that a bankruptcy court’s power depends on a district court’s power—and thus evaporates if the case strays outside of Article III’s bounds. See, e.g., In re Kilen, 129 B.R. 538, 542-43 (Bankr. N.D. Ill. 1991) (“In light of the derivative nature of the bankruptcy court’s power, it is obvious that the constitutional standards of Article III which bind the district court also bind the bankruptcy court.”); In re Interpictures, Inc., 86 B.R. 24, 28-29 (Bankr. E.D.N.Y. 1988); but cf. Stern, 564 U.S. at 500-01.12

“We are unconvinced. Congress requires bankruptcy courts to get cases from district courts and allows district courts to withdraw cases. And the Constitution limits the cases a district court can refer or withdraw. But these two facts do not add up to a limit on the types of matters a bankruptcy court can adjudicate after referral, nor a requirement that those matters be eligible for withdrawal. That could be how it works—if Congress said so. Yet Congress has not said so. So that is not how it works

.“In the same vein, we refuse to overread Congress’s designation of bankruptcy courts as “unit[s]” of the district court. See 28 U.S.C. § 151. Certainly, district courts oversee many aspects of bankruptcy courts. For example, when bankruptcy judges consider matters within the judicial Power, district courts can—indeed sometimes must—review those actions. § 157(a), (b)(1), (c)(1). But bankruptcy courts are not “mere adjuncts” of district courts. Stern, 564 U.S. at 487. They exercise “broad powers” under their own statutory grant of jurisdiction. See id. at 488. Congress did not impliedly limit that express grant through cryptic labelling in a separate provision

.“The argument to the contrary depends on finding something inherent about the words “cases” and “proceedings” in the bankruptcy jurisdictional provisions that brings them necessarily within the judicial Power. It assumes that when Congress gave federal courts (Article III and non-Article III alike) jurisdiction over bankruptcy “cases” and “proceedings,” it imbued those words with Article III’s limits. So that, even absent Article III, the statutes themselves would require the same level of adversariness.

“But we do not ordinarily interpret a jurisdictional statute’s constraints to be the same as the Constitution’s. In fact, we often go out of our way to create differences and draw distinctions even where—unlike here—the statute uses Article III’s precise language. See Navy Fed. Credit Union v. LTD Fin. Servs., LP, 972 F.3d 344, 352 (4th Cir. 2020) (“Unlike the constitutionally permitted ‘minimal diversity’ jurisdiction, diversity must be ‘complete’ to satisfy this Congressional grant.” (citing Strawbridge v. Curtiss, 7 U.S. 267, 267, 2 L. Ed. 435 (1806)).

“If we did, our caselaw would look very different. The constitutional-jurisdiction inquiry would often collapse into the statutory one. Yet it doesn’t. For example, litigants can have statutory jurisdiction to sue States even if the Constitution forbids it. See, e.g., Hans v. Louisiana, 134 U.S. 1, 10, 10 S. Ct. 504, 33 L. Ed. 842 (1890). More to the point, we dismiss moot cases because they are no longer Article III cases, not because they fall outside the scope of a statute. See, e.g., Eden, LLC v. Justice, 36 F.4th 166, 169-72 (4th Cir. 2022). So we refuse to read in Article III’s limits.

“To recap, bankruptcy courts are not Article III courts. So Article III constraints— such as mootness—do not apply to them as a matter of constitutional aw. They only apply if Congress said so in a statute. But it hasn’t. And that means whether Count I was constitutionally moot is beside the point. The bankruptcy court could still adjudicate it.

“Since the Kivitis cannot argue that their adversary proceeding was constitutionally moot when Count II was dismissed, they have not shown the proceeding was legally doomed when they dismissed Count I. They are thus left arguing the order was final because Count I was practically over post-dismissal. See, e.g., Appellant’s Supp. Br. at 4 (claiming there was “no judicial economy” to pursuing Count I before appealing Count II). Yet the Supreme Court rejected this exact reasoning in Microsoft. The Microsoft plaintiffs also thought it “economically irrational” to litigate their still-legally-viable claims to final judgment. Microsoft Corp., 582 U.S. at 34. Still, the Court refused to let them create finality by voluntarily dismissing those claims. Id. at 36; see also Affinity Living Grp., 959 F.3d at 639 (distinguishing between claims that are “legally” and merely “practically” over). Here too, it is irrelevant that the parties think there is “no judicial economy” in litigating Count I to final judgment before they appeal the order dismissing only Count II. Count I is legally viable, and its dismissal was without prejudice, so that dismissal did not create a final order under § 158(a). And that means the district court lacked jurisdiction to review it.”

Kiviti v Bhatt

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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 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 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 like 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 $1,225 payments 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

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Debt Based on Breach of Pre-Divorce Stipulation Nondischargeable

A debt based on breach of a Stipulated Agreement that was incorporated but not merged into the final Judgment of Divorce was a debt “in connection with” a divorce decree within the meaning of section 523(a)(15) and was therefore nondischargeable in bankruptcy. Monassebian v. Monassebian, No. 21-41251, Adv. Proc. No. 21-1162 (Bankr. E.D.N.Y. Aug. 1, 2022). [Read more…] about Debt Based on Breach of Pre-Divorce Stipulation Nondischargeable

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Med School Loans Partially Discharged after Debtor Fails to Match for Residency

Finding that the debtor’s string of very bad luck unrelieved by his concerted efforts to increase his earnings, satisfied the Brunner test, a bankruptcy court granted him a partial discharge of his student loan, reducing the debt from $440,000 to $8,291.67. Koeut v. U.S. Dept. of Ed., No. 12-7242, Adv. Proc. No. 18-90130 (Bankr. S.D. Cal. Dec. 4, 2020). [Read more…] about Med School Loans Partially Discharged after Debtor Fails to Match for Residency

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Case Bites: Interesting Issues and Decisions from This Week’s Cases

  • In an adversary discharge proceeding, can the bankruptcy court treat a motion for summary judgment (that asserts a new affirmative defense) as a motion to amend an answer? (Bankr. S.D.N.Y.)
  • Can a chapter 7 trustee be awarded attorney’s fees incurred in defense of the trustee’s fee application? (Bankr. D.Colo.)
  • Does a bankruptcy court have the authority to extend the time to file a dischargeability complaint on a motion filed after the deadline? (Bankr. N.D.Ga.)
  • Does a pre-petition default judgment operate as collateral estoppel in a non-dischargeability complaint for fraud in bankruptcy? (Bankr. E.D.Mich.)
  • Post-filing, can a mortgage company postpone scheduled nonjudicial foreclosure sales (rather than dismiss the action) without violating the automatic stay? (Bankr. D.Ut.)

To read the case outlines and opinions click here