‘Bankruptcy Planning,’ Alone, Doesn’t Equal Fraudulent Intent to Evade Creditors – IL ND

A Northern District of Illinois bankruptcy judge recently rejected a creditor’s attempt to nix a debtor’s discharge for fraud.  The creditor alleged the debtor tried to escape his creditors by shedding assets before his bankruptcy filing and by not disclosing estate assets in his papers.  Finding for the debtor after a bench trial, the Court in Monty Titling Trust I v. Granrath, 15 AP 00826 illustrates the heavy burden a creditor must meet to successfully challenge a debtor’s discharge based on fraud.

The Court specifically examines the contours of the fraudulent conduct exception to discharge under Code Section 727(a)(2) and Code Section 727(a)(4)’s discharge exception for false statements under oath.

Vehicle Trade-In and Lease

The court found that the debtor’s conduct in trading in his old vehicle and leasing two new ones in his wife’s name in the weeks leading up to the bankruptcy filing was permissible bankruptcy planning (and not fraud).  Since bankruptcy aims to provide a fresh start to a debtor, a challenge to a discharge is construed strictly against the creditor opposing the discharge.  Under the Code, a court should grant a debtor’s discharge unless the debtor “with intent to hinder, delay or defraud a creditor” transfers, hides or destroys estate property.

Under the Code, a court should grant a debtor’s discharge unless the debtor “with intent to hinder, delay or defraud a creditor” transfers, hides or destroys property of the debtor within one year of its bankruptcy filing. 11 U.S.C. s. 727(a)(2)(A).  Another basis for the court to deny a discharge is Code Section 727(a)(4) which prevents a discharge where a debtor knowingly and fraudulently makes a false oath or account.

To defeat a discharge under Code Section 727(a)(2), a creditor must show (1) debtor transferred property belonging to the estate, (2) within one year of the filing of the petition, and (3) did so with the intent to hinder, delay or defraud a creditor of the estate.  A debtor’s intent is a question of fact and when deciding if a debtor had the requisite intent to defraud a creditor, the court should consider the debtor’s whole pattern of conduct.

To win on a discharge denial under Code Section 727(a)(4)’s false statement rule, the creditor must show (1) the debtor made a false statement under oath, (2) that debtor knew the statement was false, (3) the statement was made with fraudulent intent, and (4) the statement materially related to the bankruptcy case.

Rejecting the creditor’s arguments, the Court found that the debtor and his wife testified in a forthright manner and were credible witnesses.  The court also credited the debtor’s contributing his 401(k) funds in efforts to save his business as further evidence of his good faith conduct.  Looking to Seventh Circuit precedent for support, the Court found that “bankruptcy planning does not alone” satisfy Section 727’s requirement of intent.  As a result, the creditor failed to meet its burden of showing fraudulent conduct by a preponderance of the evidence.

Opening Bank Account Pre-Petition

The Court also rejected the creditor’s assertion that the debtor engaged in fraudulent conduct by opening a bank account in his wife’s name and then transferring his paychecks to that account in violation of a state court citation to discover assets.  

The court noted that the total amount of the challenged transfers was less than $2,000 (since the most that can be attached is 15% gross wages under Illinois’ wage deduction statute) and the debtor’s scheduled assets exceeded $4 million.  Such a disparity between the amount transferred and the estate assets coupled with the debtor’s plausible explanation for why he opened a new bank account in his wife’s name led the Court to find there was no fraudulent intent.

Lastly, the court found that the debtor’s omission of the bank account from his bankruptcy schedules didn’t rise to the level of fraudulent intent.  Where a debtor fails to include a possible asset (here, a bank account) in his bankruptcy papers, the creditor must show the debtor acted with specific intent to harm the bankruptcy estate.  Here, the debtor testified that his purpose in opening the bank account was at the suggestion of his bankruptcy lawyer and not done to thwart creditors.  The court found these bankruptcy planning efforts did not equal fraud.

Afterwords:

1/ Bankruptcy planning does not equate to fraudulent intent to avoid creditors.

2/ Where the amount of debtor’s challenged transfers is dwarfed by scheduled assets and liabilities, the Court is more likely to find that a debtor did not have a devious intent in pre-bankruptcy efforts to insulate debtor assets.

 

The Third-Party Citation: How Long Does It Last?

Shipley v. Hoke, 2014 IL App (4th) 130810 provides an exhaustive discussion of Illinois’ post-judgment enforcement rules in the context of a judgment creditor trying to reach debtor assets held by third parties.

It’s key points concerning a citation’s life span include:

– Code Section 2-1402 allows a judgment creditor to prosecute supplementary proceedings for the purposes of examining a judgment debtor and to compel the application of non-exempt assets or income discovered toward the payment of a judgment;

– Section 2-1402(f)(1) contains a “restraining provision” that prohibits any person served with a citation from allowing a transfer of property belonging to a judgment debtor that may be applied to the outstanding judgment amount;

– If someone violates the restraining provision, the Court can punish the violator by holding him in contempt or entering a money judgment against him in the amount of the property he transferred; 

– A third-party citation must be served in the same manner a (“first party”) citation is served (e.g. either by personal service or certified mail);

– Supreme Court Rule 277(f) provides that a citation proceeding automatically terminates six months from the date of the respondent’s first personal appearance unless the court grants an extension of the citation;

– This six-month rule is an affirmative defense that must be raised by a citation respondent or else it’s waived;

-Rule 277(f)’s purpose is to prevent a creditor from harassing a judgment debtor or a third party subject to a citation proceeding and is designed to provide an incentive for creditor’s to diligently work to discover debtor assets;

– While a court can retain jurisdiction over a turnover order entered before but not complied with until after the expiration of the six-months, the court does not maintain jurisdiction to enforce any restraining provision violations past that six-month mark.

– Rule 277 does permit a creditor to request an extension of the six-month limitation period indefinitely to fit the needs of a given case.

(¶¶ 78-81, 92-93).

Take-away: While I often serve bank respondents with third-party citations by certified mail (since banks usually aren’t motivated to evade service),  a judgment creditor should serve any non-bank respondent by personal service; either via county sheriff or a special process server.

In addition, the creditor should keep track of when a judgment debtor first appears in response to a citation.  If it looks like the creditor’s post-judgment case isn’t going to be finished at the six-month mark, he should move to extend the citation for as long as necessary to complete his examination of the debtor and any third-party(ies).