Business Law

Jonathan Dabbieri’s e-Bulletin re Jones v. United States Trustee

Dear constituency list members of the Insolvency Law Committee, the following is a case update on a recent decision of interest:

SUMMARY

The United States Court of Appeals for the Ninth Circuit held that fraud which would have justified the bankruptcy court denying a discharge under 11 U.S.C. §727(a)(4)(A) will support an action to revoke a discharge under 11 U.S.C. §727(d)(1).  Jones v. U.S. TrusteeEugene, ___ F.3d ___, 2013 WL 6224330 (9th Cir. 2013 Dec. 2, 2013 Dkt. no. 12-35665) (“Jones”).  To read the opinion, click here: 
 http://cdn.ca9.uscourts.gov/datastore/opinions/2013/12/02/12-35665.pdf.

FACTS

In his initially filed bankruptcy schedules and in his testimony at the meeting of creditors under 11 U.S.C. §341(a), Jerry Jones (debtor) omitted a number of assets and undervalued other assets, largely valuing them at zero.  The debtor received his discharge in due course.  Within a year of the date the discharge was granted, the United States Trustee discovered the debtor had omitted and undervalued assets in his bankruptcy schedules, and brought an adversary action to revoke the discharge.  After two days of hearings, the bankruptcy court ruled that the debtor’s omissions and undervaluations violated 11 U.S.C. §727(a)(4) and revoked the discharge.  On appeal, the Ninth Circuit affirmed.

REASONING

Before the bankruptcy court the debtor argued that his omissions and undervaluations had been inadvertent or on advice of counsel, and that several were corrected through schedule amendments.  The bankruptcy court rejected these defenses, found the omissions and undervaluations had been made knowingly and fraudulently, and determined they constituted a violation of 11 U.S.C. §727(a)(4), justifying revocation of the discharge pursuant to 11 U.S.C. §727(d)(1).

On appeal, the debtor argued that it was error to revoke a discharge under 11 U.S.C. §727(d)(1) based on a violation of 11 U.S.C. §727(a)(4).  Quoting Nielsen v. White (In re Nielsen), 383 F.3d 922, 925 (9th Cir. 2004) that to revoke a discharge due to the debtor’s fraud it had to be shown that “but for the fraud, the discharge would not have been granted” the debtor argued that some fraud other than his fraudulent schedules had to be proven, and it had to be proven that but for the additional fraud, the discharge would not have been granted.  The debtor argued that since he would have received his discharge even without the fraud, that is, he would have received a discharge had he filed accurate schedules, it could not be said he would not have obtained a discharge  “but for” his fraud.  The debtor further argued, citing Nielsen, 383 F.3d at 925-26, that to revoke the discharge it had to be proven the outcome of the case would have been different had the fraud not occurred.  According to the debtor, the alleged fraud did not affect the outcome of his case.  The chapter 7 trustee investigated all the assets on the debtor’s schedules and was liquidating them for the benefit of creditors.  As a result, the debtor believed that creditors would get paid and there was no harm caused by his actions.

The Ninth Circuit rejected these arguments.  The Ninth Circuit cited two Ninth Circuit Bankruptcy Appellate Panel cases, In re Gilliam, 2012 WL 1191854 (9th Cir. BAP 2012, Dkt. no. 11-1248) and In re Wahl, 2009 WL 7751412 (9th Cir. BAP 2009, Dkt. no. 08-1218), and a district court case, In re Guadarrama, 284 B.R. 463 (C.D. Cal. 2002), all holding that pre-discharge fraud which would have justified denial of a discharge had it been discovered prior to the grant of a discharge, will justify revocation of the discharge when it is discovered post-discharge.  Jones at *2.  As for the requirement in Nielsen that “but-for” the fraud the discharge would not have been granted, the Ninth Circuit stated this is “properly read as establishing the rule that the fraud must be material, i.e., must have been sufficient to cause the discharge to be refused if it were known at the time of discharge.”  Here, the Ninth Circuit concluded that had the fraud been discovered prior to issuance of the discharge, the debtor could have been denied a discharge, satisfying the suggestion in Nielsen that the fraud must have affected the outcome of the bankruptcy.

AUTHOR’S COMMENT

There were two strands to the debtor’s argument, neither of which was accepted by the Ninth Circuit.  First, by noting that he would have received a discharge had he properly disclosed the assets, the debtor argued that his fraud did not procurethe discharge; he would have received the discharge had he properly disclosed and valued the assets.  The Ninth Circuit rejected interpreting the “but-for” language of Nielsen as a requirement that the fraud must have directly procured the discharge, instead interpreting it as a materiality requirement, that the fraud must have been sufficient to justify denying a discharge had it been known at the time of the discharge.  Jones at *2.  The Ninth Circuit implicitly adopted the holding of Guadarrama and the other cited cases that the fraud need only have occurred “in the procurement” of the discharge.  It is not required to be the direct cause of the debtor obtaining a discharge.

The second strand of the debtor’s argument was that since the debtor was not questioned about the omissions and undervaluations on his schedules. He therefore did not engage in a second fraud to conceal the first to procure a discharge. The Ninth Circuit rejected a requirement there be two frauds, the second consisting of concealing the first.  Only the initial fraud need be shown.

Although not addressed by the Ninth Circuit, the debtor also argued that because 11 U.S.C. §727(d)(3) explicitly makes a violation of 11 U.S.C. §727(a)(6) a ground for revocation of a discharge, it is error to revoke a discharge under 11 U.S.C. §727(d) by reason of a violation of any other subsection of 11 U.S.C. §727(a).  The debtor argued that by explicitly making a violation of 11 U.S.C. §727(a)(6) a ground for discharge under 11 U.S.C. §727(d)(1), Congress implicitly rejected making the violation of any other subsection of 11 U.S.C. §727(a) a basis for revocation of the discharge. If any violation of 11 U.S.C. §727(a) justified revocation under 11 U.S.C. §727(d)(1), the debtor argued, there was no need for 11 U.S.C. §727(d)(3), rendering the subsection superfluous.  Presumably, however, because 11 U.S.C. §727(d)(1) requires a showing of fraud, only those violations of 11 U.S.C. §727(a) which implicate fraud, e.g., 11 U.S.C. §727(a)(2), would be the basis for an action to revoke a discharge under 11 U.S.C. §727(d)(1).  Section §727(a) is not wholly incorporated into 11 U.S.C. §727(d).

The case establishes that a debtor who has committed pre-discharge fraud is not safe once the discharge is obtained.  The debtor remains exposed to possible revocation proceedings under 11 U.S.C. §727(d)(1) for one year from the date of discharge.  11 U.S.C. §727(e)(1).

Interestingly, the opinion did not address the debtor’s materiality argument.  The debtor did not dispute that he listed many of his assets as having no value.  However, according to the debtor, the bankruptcy court never made a finding as to the specific value of his assets.  Because the bankruptcy court did not determine the value of his assets, the bankruptcy court could not find that the debtor’s undervaluation was material, i.e. sufficient to cause the discharge to be refused if it were known at the time of the discharge. 

Finally, the opinion did not address the debtor’s argument that even if the debtor undervalued his assets, the chapter 7 trustee investigated each asset and determined that he could liquidate them.  Because the chapter 7 trustee was liquidating the assets, the debtor’s non-disclosure or undervaluation had no impact on the case.  Perhaps the Ninth Circuit did not want to lessen the debtor’s burden to be truthful regarding the information reported in the schedules.

These materials were prepared by Jonathan Dabbieri of Sullivan, Hill, Lewin, Rez & Engel.  Editorial contributions were provided by Everett L. Green, United States Department of Justice, Office of the United States Trustee.

Thank you for your continued support of the Committee.

Best regards,

Insolvency Law Committee

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