UNITED STATES BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
In re: Case No. 00-54315-ASWSA
Willie T. Gray and Sandra M. Gray, Chapter 7
Franco Intagliata, Adv. Pro. No. 00-5294
Steve Mendoza, and
Willie T. Gray and Sandra M. Gray,
Before the Court is a complaint by Plaintiffs Franco Intagliata, Steve Mendoza, and Katia Mendoza (“Creditors”), against Defendants Willie Gray (“Mr. Gray”) and Sandra Gray (“Mrs. Gray”), the Debtors in this Chapter 7 case (“Debtors”). [Unless otherwise noted, all statutory references are to Title 11, United States Codes (“Bankruptcy Code”), as amended in 1994.]. Creditors seek to have Debtors’ discharge denied. The complaint alleges that Debtors transferred and concealed property with the intent to defraud creditors, failed to keep records, and knowingly and fraudulently made a false oath, in violation of, respectively, §727(a)(2), §727(a)(3), and §727(a)(4) of the Bankruptcy Code. Creditor’s trial brief further alleges that Debtors violated Bankruptcy Code §727(a)(5) by failing to explain a loss or deficiency in assets.
This matter has been tried and submitted for decision. Creditor is represented by Andrew Lauderdale, Esq. (“Mr. Lauderdale”) and Debtors are represented by Richard D. Gorman, Esq. (“Mr. Gorman”). At trial, Creditors called the Debtors as witnesses; Debtors called Mrs. Gray.
This Memorandum Decision constitutes the Court’s findings of fact and conclusions of law, pursuant to Rule 7052 of the Federal Rules of Bankruptcy Procedure (“FRBP”).
DENYING OBJECTION TO DISCHARGE
I. The heart of the Bankruptcy Code’s fresh start provisions is §727. Subsection (a) requires the court to grant a debtor a discharge unless the debtor has committed any one of eight prohibited acts prior to or during the bankruptcy case. Four of those acts are at issue in this case. The relevant Code sections are:
1/ §727(a)(2), which provides, in pertinent part, that discharge shall not be granted if
... the debtor, with intent to hinder, delay, or defraud a creditor or an officer of the estate charged with custody of property under this title, has transferred, removed, destroyed, mutilated, or concealed, or has permitted to be transferred, removed, destroyed, mutilated, or concealed –-
(A) property of the debtor within one year before the date of the filing of the petition; or (B) property of the estate, after the date of the filing of the petition....
2/ §727(a)(3), which provides, in pertinent part, that discharge shall not be granted if
... the debtor has concealed, destroyed, mutilated, falsified, or failed to keep or preserve any recorded information, including books, documents, records and papers from which the debtor’s financial condition or business transactions might be ascertained, unless such act or failure to act was justified under all of the circumstances of the case.
3/ §727(a)(4), which provides, in pertinent part, that discharge shall not be granted if
(4)the debtor knowingly and fraudulently, in or in connection with the case -- (A)made a false oath or account ....
4/ §727(a)(5), which provides, in pertinent part, that discharge shall not be granted if
(5) the debtor has failed to explain satisfactorily, before determination of denial of discharge under this paragraph any loss of assets or deficiency of assets to meet the debtor’s liabilities.
With the exception of §727(a)(5), Creditors’ complaint alleges violation of each of the foregoing sections. An argument under §727(a)(5) is made in Creditor’s trial brief, but Creditors never moved to amend the complaint to include a claim for relief based on that subsection. Generally, a party cannot assert a claim for relief that is not stated in the complaint. However,
Rule 15(b) FRCP 15(b) provides that:
Amendments to Conform to the Evidence. When issues not raised by the pleadings are tried by express or implied consent of the parties, they shall be treated in all respects as if they had been raised in the pleadings. Such amendment of the pleadings as may be necessary to cause them to conform to the evidence and to these issues may be made upon motion of any party at any time, even after judgment; but failure to so amend does not affect the result of the trial of these issues....
of the Federal Rules of Civil Procedure (“FRCP”) permits the parties to consent implicitly to amendments to the pleadings based on the actual trial. FRCP 15(b) is to be construed liberally, see In re Jodin, 209 B.R. 132 (9th Cir. BAP 1997). At trial, issues regarding §727(a)(2), §727(a)(3), and §727(a)(4) were raised, as were issues concerning §727(a)(5). The evidence Debtors introduced to defend against the allegations made under §727(a)(2), §727(a)(3), and §727(a)(4) is likely the same evidence that would be introduced to defend against allegations made under §727(a)(5). Debtors’ counsel did not object to the §727(a)(5) argument in Creditor’s trial brief. Accordingly, the Court finds that the pleadings were implicitly amended pursuant to FRCP 15(b).
DENYING OBJECTION TO DISCHARGE
UNITED STATES BANKRUPTCY COURT
For The Northern District Of California
Pursuant to FRBP 4005, an objector to discharge bears the burden of proving grounds for denial of discharge. The burden may be met by a preponderance of the evidence, see Grogan v. Garner, 498 U.S. 279 (1991). Once an objecting party makes a prima facie case against a debtor, the burden shifts and a debtor cannot prevail if no credible evidence is offered after a creditor has established a prima facie case, see In re Aubrey, 111 B.R. 268 (9th Cir. BAP 1990) (“Aubrey”). Creditors need only prove that Debtors violated one subsection of §727(a) in order to prevent Debtors’ discharge from being granted.
Under both §727(a)(2) (concealment) and §727(a)(4)(A) (false oath), it is actual, not merely constructive, intent to defraud that must be shown, see In re Adeeb, 787 F.2d 1339 (9th Cir. 1986); In re Devers, 759 F.2d 751 (9th Cir. 1985) (“Devers”). Such actual intent may, however, be inferred from circumstances, surrounding acts, or transactions, see In re Woodfield, 978 F.2d 516 (9th Cir. 1992). Although even property of little or no value or apparent significance is capable of being concealed under §727(a)(2), and is capable of being the subject of a false oath under §727(a)(4), the nature of undisclosed property can be a factor in inferring the absence or presence of fraudulent intent: see generally, 4 Collier on Bankruptcy (15th ed. 1995) § 727.02 and cases cited therein at note 24, page 727-17; § 727.04 and cases cited therein at notes 2 and 3, pages 727-55 - 727; In re Coombs, 193 B.R. 557 (Bkrtcy. S.D.Cal. 1996) (“Coombs”).
For example, in In re Swanson, 36 B.R. 99 (9th Cir. BAP 1984) (“Swanson”), an accountant who failed to schedule his professional practice among his assets appealed the bankruptcy court’s ruling that such omission constituted concealment under §727(a)(2) and a false oath under §727(a)(4)(A). The bankruptcy court was reversed on appeal, due to the fact that, as a practical matter, the omitted asset represented no value to anyone but the accountant, and its omission was therefore not indicative of a fraudulent intent on the part of the debtor:
To have any significant value an account-
ancy practice, or for that matter any pro-
fessional practice, would have to be sold
and the seller would have to agree not to
compete for a reasonable time in future.
If there were no covenant not to compete
the professional’s clients would be free
to follow him and not deal with the buyer.
There would be little value to the buyer
in the future earnings of the seller’s
practice. Value would be paid to the
seller only to the extent the buyer would
be willing to risk competition from the seller.
For similar reasons, a practice has value
upon the death of its principal because
there can be no competition with the buyer.
[§] Debtor fully disclosed his entire employ-
ment history including his previous account-
ancy practice. There was no intent to hinder,
delay, or defraud his creditors and he had
no intent to hide an asset.
Swanson, at 100.
Under §727(a)(3) (failure to keep books and records), a debtor is required to keep books and records in a manner that is reasonable under the circumstances. The records need not be in any particular form; however, they must be sufficient to “enable his creditors reasonably to ascertain his present financial condition and to follow his business transactions for a reasonable period in the past.” see In re Cox, 904 F.2d 1399 (9th Cir. 1990).
However, few consumer debtors maintain anything more than, at most, a collection of bills, receipts, and canceled checks; in the absence of a sudden and large dissipation of assets, a discharge should not be denied in a typical consumer bankruptcy case due to a lack of books or records. 6 Collier on Bankruptcy (15th ed. 1995)
§ 727.03, pages 727-33. For example, a consumer debtor’s discharge was not denied when he could not produce a passbook from a closed savings account, see In re Haugen, 9 B.R. 4 (Bktcy.S.D.Fla. 1980). The discharge was denied in another case when the debtor’s records did not account for a loss of half a million dollars, see In re Resnick, 4 B.R. 602 (Bktcy.S.D.Fla. 1980).
Under §727(a)(5)(satisfactorily explain any loss of assets), a debtor must explain losses or deficiencies in such manner as to convince the court of good faith and business-like conduct. The test is subjective, see Devers. In Devers, the debtor testified that the tractor in his possession “just vanished” and the court denied discharge because the debtor could not offer credible evidence to rebut the creditor’s prima facie case. Whether a loss has been satisfactorily explained is a question of fact, see In re Mereshian, 200 B.R. 342 (9th Cir. BAP 1996) (“Mareshian”). A debtor received his discharge over a §727(a)(5) objection even when the debtor’s expenditures were extravagant and irresponsible because the amounts unaccounted for were relatively small in relation to the total for which the debtor had accounted, and discharge would not be denied simply because the debtor was unable to produce receipts for certain expenditures, see In re Buck, 75 B.R. 417 (Bktcy.N.D.Cal. 1987) (“Buck”).
The Bankruptcy Code provisions denying a discharge are generally construed liberally in favor of the debtor and strictly against the creditor, see In re Klapp, 24 B.R. 598 (9th Cir. BAP 1982.); Rosen v. Bezner, 996 F.2d 1527 (3d Cir. 1993). A total bar to discharge is an extreme penalty, id. at 1530. The reasons for denial of the discharge must be real and substantial rather than technical and conjectural, see Commerce Bank v. Burgess, 955 F.2d 134 (1st Cir. 1992).
II. Creditors and Mr. Gray entered into a construction contract in January of 1999. The contract was not entered into evidence. There was no testimony regarding the terms of the contract or any breach. In or about June of 1999, Creditors filed an action in State Court against Mr. Gray concerning that contract, and Mr. Gray filed a cross complaint. There was no testimony regarding the outcome of the litigation.
The evidence did show that Creditors had a hearing on June 30, 2000 for a writ of attachment against Mr. Gray, so it appears that Creditors obtained a judgment against Mr. Gray through litigation or settlement. The writ of attachment to secure $16,779.21 (Trial Exhibit 2) The writ of attachment was file-stamped by the State Court on June 30, 2000. There is no reference to show when it was served on Mr. Gray or Mr. Gorman. was served on Mr. Gorman as Mr. Gray’s attorney and returned “no assets”. Debtors’ Schedule F in the bankruptcy case (“Creditors Holding Unsecured Nonpriority Claims”) reflects a claim owed to Creditor Franco Intagliata in the amount of $12,000.00, incurred in 1999, and shows the consideration for that claim as Monterey County Superior Court Case No. M45134. Debtors live in Seaside, California, with their two dependent children. Mr. Gray has not worked since the aforementioned construction contract with Creditors. He attempted a contracting job in 1999-2000 for a party named Galloway. Mrs. Gray testified that the job did not work out and that Mr. Gray “earned nothing.” Mr. Gray is retired and receives disability; he has a problem with his knee that affects his back.
Mrs. Gray testified that three years ago, Mr. Gray was also diagnosed with a bipolar disorder by a Dr. Liebowitz. Mrs. Gray testified that, because of the bipolar disorder, Mr. Gray has long and short term memory problems, insomnia, panic attacks, agitated spells, strong mood swings, depression, difficulty in concentrating, and periods when his behavior is inappropriate.
Mrs. Gray testified that, on June 29, 2000, Debtors went to Mr. Gorman’s office. Mr. Gorman had assisted the Grays in probate proceedings for the estate of Mr. Gray’s mother. According to a letter from Mr. Gorman to Creditors’ attorney Mr. Lauderdale (Exhibit L), the Grays received from the probate estate approximately $25,141.00, consisting of executor’s commissions of $5,710.00, expense reimbursement of $10,000.00, and Mr. Gray’s (12.5% of the estate) of $15,056.72; from those amounts were deducted “advances and unallowed expenses” totalling $5,625.15, leaving $25,141.00.
Mrs. Gray testified that, when Debtors met with Mr. Gorman on June 29, 2000, they were in severe financial distress. By the end of the meeting, Debtors had decided to file for bankruptcy. Mr. Gorman advised them that, in light of the bankruptcy, there might be interest in how they spent the funds received from the probate estate. He further advised them that they were allowed to spend the money on household expenses, clothes, school supplies for the children, and food.
Debtors paid Mr. Gorman $8,500 at the time of the meeting, $2,500 of which was to represent them in a Chapter 7 bankruptcy. The other $6,000 (which amount was later renegotiated and reduced to $5,000) was a “non-refundable retainer”, intended to compensate Mr. Gorman for services required to defend Mr. Gray’s contractor’s license, plus litigation expenses contemplated in the bankruptcy case. At the request of the Trustee appointed in Debtors’
bankruptcy case, Mr. Gorman later turned the $6,000 over to the Trustee for the benefit of the bankruptcy estate (Exhibit E). There was no litigation to defend Mr. Gray’s Contractor’s license, and the license was revoked by stipulation on October 6, 2000 (Exhibit 3).
Debtors left Mr. Gorman’s office on June 29, 2000 with a check for approximately $16,640.00, representing the $25,141.57 from the probate estate less the $8,500 paid to Mr. Gorman.
Mrs. Gray testified that Debtors immediately went to the bank upon which the check was drawn and cashed it. Mrs. Gray then explained, and corroborated most of her testimony with documentation, that Debtors made the following payments:
PURPOSE OF PAYMENT AMOUNT EVIDENCE
Deposit for future
for Debtors' daughter $2,000.00 Exhibit V,
Pay Monterey County District
Attorney for bad checks $1,002.14 Exhibit R,
of two money
orders with the
Release car from Sheriff's
impound $50.00 Exhibit Q,
paid by Mrs.
Release car from storage $720.00 Exhibit Q,
paid with Mrs.
Stereo for car $277.11 Exhibit Q,
Bicycle $440.48 Exhibit S,
with Mr. Gray's
Car repairs $340.18 Exhibit U, car
Food $662.00 Exhibit T,
Market made out
to Mr. Gray.
Purchase of bed $674.60 Exhibit O,
and delivery of
of a bed to Mr.
Purchase of mattress $579.04 Exhibit P,
purchase of a
Purchase of washer and dryer $669.00 Exhibit N,
Clothing, school supplies for
children, household goods $1,554.10 Exhibit M
per child, with
First payment to Dr. Eisner
for orthodontia services for
daughter $160.00 No documentation
she did make
this payment and
Three mortgage payments
on Debtors' home $5,124.00 No documentation
she made three
$1708.00 each at
one time, and
Repairs to Debtors' home
(bathroom repairs and
replacement of a
bedroom window) $2,374.00 No documentation
she made this
payment and Mr.
Total amount spent: $25,126.65
CANB DocumentsNorthern District of California
All but three of the above-listed categories of expenditures are documented with copies of checks, money order stubs, receipts and/or invoices from merchants. The dates on the receipts correspond with the period (June 29, 2000 to August 29, 2000) in which Debtors claim to have spent the money. There was no documentation entered into evidence to prove that the mortgage payments and home repairs were made. Mrs. Gray testified that after she made the payments, she gave the receipts to her attorney. Mr. Gray confirmed this testimony and nothing was presented to contradict either Debtors’ testimony. Debtors did not provide a receipt for a payment of $160.00 to the orthodontist. Mrs. Gray testified that this receipt was at home in another file.
Exhibit Q documented expenditures the Debtors made with regard to a 1985 Lincoln Continental. The Debtors paid substantial vehicle release fees and storage fees to the Sheriff and impound lot. Debtors also purchased a stereo for the car. The automobile was registered to Buffone Richard Angelo. Mrs. Gray testified that the reason Debtors incurred expenses for a car that was not registered to them was that Debtors had purchased the car for a very nominal amount of money, “they practically gave it to us.” In
order to see if the bargain car was “workable”, the Debtors first had to obtain possession of it from the Sheriff’s impound. It turned out that the car was not “workable” and the Debtors never registered it in their own names. The car is listed on Debtors’ Schedule C (“Property Claimed Exempt”), and valued at $500.00.
Exhibit S documents a bicycle that Debtors purchased. Mrs. Gray testified that the bicycle, in addition to being Mr. Gray’s transportation, was also a form of therapy for him. She explained that, “the bicycle was easier on him because of the low impact.”
On August 29, 2000, two months after the meeting with Mr. Gorman, the Debtors filed their Chapter 7 petition. When questioned about the two month period between the date on which Debtors paid Mr. Gorman for the bankruptcy and the date on which the bankruptcy petition was filed, Mrs. Gray replied, ”We had to wait a long time to get the money from the house” (i.e., the largest asset in the aforementioned probate estate) and “I didn’t question the time for filing the bankruptcy.” This testimony implies that Mrs. Gray was relying on guidance from Mr. Gorman to file the bankruptcy, just as she had relied on him to handle the probate proceedings for her mother-in-law’s estate. Apparently, the timing of the filing was not an issue over which Mrs. Gray understood that she had control.
Debtors’ inheritance was not listed in their bankruptcy schedules or Statement of Affairs, nor was $5,710 fee that Mr. Gray received for acting as executor listed as earned income in the Statement of Affairs. Debtors listed three home mortgage payments and nothing else where the Statement of Affairs asks what payments were made to creditors within 90 days pre-petition. An amended
Statement of Affairs disclosed that Mr. Gorman’s “non-refundable” retainer was turned over to the Trustee of the bankruptcy estate.
Neither the original nor amended Statement of Affairs disclosed the payment that Debtors made to the Monterey County District Attorney for bad checks. Mrs. Gray testified that the payment was not listed as a payment to creditors because she “didn’t realize that the Sheriff was a creditor.”
Both Debtors testified that, just prior to filing their Chapter 7 petition, they had “a couple hundred dollars” left from their bequest.
III. Creditors allege that Debtors concealed the receipt of the inheritance and went on a spending spree shortly before filing Bankruptcy, in violation of §727(a)(2). In the Ninth Circuit, a prima facie case under §727(a)(2) must show:
A. §727(a)(2) (Transfer/Concealment)
1. The debtor transferred or concealed property;
2. The property belonged to the debtor;
3. The transfer occurred within one year of the filing; and
4. The debtor made the transfer with the intent to hinder, delay or defraud a creditor.
Elements two and three are undisputed in this case. The Debtors received funds from the probate estate of Mr. Gray’s mother, It is not clear whether the inheritance was actually property of both Debtors, since the bequest appears to have been made to Mr. Gray alone and property that a spouse receives by inheritance is not community property, pursuant to California Family Code §§760 and 761. Creditors’ complaint seeks to deny discharge to both Debtors, and Debtors have not argued that the inheritance funds were not property of Mrs. Gray. and spent most of them during the two months immediately prior to filing their Chapter 7 petition.
With regard to element one, the Debtors transferred the proceeds from their inheritance as outlined in the facts section of this Memorandum Decision. The expenditures can be broken down into roughly three categories, with some overlap:
1/ Acquisition/enhancement of exempt property. These expenditures include: three mortgage payments Debtors’ home; releasing a car from custody and storage; buying a stereo for the car; buying a bicycle for Mr. Gray; buying a bed and mattress; buying a washer and dryer; and repairs to a car and the home. The payments Debtors made on account of exempt property are a form of pre-bankruptcy planning that has long been recognized as permissible in the Ninth Circuit under both the former Bankruptcy Act and the current Bankruptcy Code, see: Love v. Menick, 341 F.2d 680 (9th Cir. 1965); Wudrick v. Clements, 451 F.2d 988 (9th Cir. 1971); Matter of Jackson, 472 F.2d 589 (9th Cir. 1973) (“Jackson”); In re Roosevelt, 176 B.R. 200 (9th Cir. BAP 1994); In re Cataldo, 224 B.R. 426 (9th Cir. BAP 1998). Evidence of actual intent to defraud creditors is required to support a finding sufficient to deny discharge. Pre-bankruptcy conversion of non-exempt assets into exempt assets is frequently done to put those assets beyond the control of creditors, but that is the effect of an exemption rather than evidence of an intent to hinder and delay. No testimony was given as to whether the stereo Debtors purchased was actually installed in the car -- if it was, it became part of the car, and the car was claimed exempt; a purposeful conversion of non-exempt assets into exempt assets immediately prior to bankruptcy is not fraudulent per se, see Jackson -- if the stereo was not installed in the car, it is nevertheless exempt as part of the household goods that were claimed exempt.
2/ Necessities. These expenditures include: payment to Monterey County District Attorney; car release and repair; food; clothing; school supplies for children; household goods (bed, mattress, washer, dryer, etc.); first payment to the orthodontist; and home repairs. The money Debtors spent on necessities will not support a finding of intent to hinder or delay creditors unless the expenditures were outrageously large. Debtors’ expenditures were not outrageously large and they were reasonable. Debtors bought food, school supplies and clothing for their children, household goods, and a bicycle for Mr. Gray’s transportation and therapy; paid to release and repair cars; and made a payment toward orthodontia work.
3/ Prepaid services. These expenditures include the deposit for the orthodontia work and the amounts paid to Mr. Gorman for future legal services. The money Debtors spent on prepaid services does not support a finding of intent to hinder, delay or defraud creditors. If a debtor is merely providing for his future well_being, the discharge will be granted, see In re Oberst, 91 B.R. 97 (Bktcy.C.D.Cal. 1988). The Court finds that the money Debtors prepaid for orthodontia work and for legal services was to ensure their future well-being.
Element four requires that the aforementioned transfers be made with the intent to hinder, delay or defraud a creditor. Because a debtor is unlikely to testify directly that his intent was fraudulent, the courts may deduce fraudulent intent from all the facts and circumstances of the case, see Devers. Toward that end, Creditors assert that Debtors’ alleged spending spree on the eve of bankruptcy is analogous to the facts and circumstances of a case where discharge was denied, In re Rice, 109 B.R. 405 (Bktcy.E.D.Cal 1989). The debtor in Rice was advised by counsel that he had more cash than could be exempted in Chapter 7; he said that his lawyer advised him simply to spend the money before he filed his bankruptcy case, so he did (by transferring $3,486.28 to his mother, which transfer was not disclosed in his bankruptcy papers). The court found that:
A debtor who, intending to file bankruptcy, deliberately spends money for the sake of spending it lest the funds otherwise fall into the hands of the bankruptcy trustee and
creditors is, a fortiori, committing waste that has the ineluctable effect of hindering or delaying creditors.
Rice at 407.
As discussed above, the evidence in this case (including Exhibits V, R, Q, S, U, T, O, P, N, and M 1-7) substantially documents that debtors were spending money on exempt property, necessities, and future services. As the court in Rice points out:
Legal advice to go spend money without regard to the use of the money is far removed from the type of prebankruptcy exemption planning that is designed to transform nonexempt assets into exempt assets. There is a policy argument in favor of permitting such planning, at least within limits: it implements the “fresh start” policy by permitting honest debtors to emerge from bankruptcy with the grubstake of exemptions that are permitted by the applicable law.
No evidence has been presented to the Court that suggests that Debtors acted with a fraudulent intent. The testimony and physical evidence demonstrate that Debtors were engaging in permissible pre-bankruptcy planning.
Creditors further allege that Debtors did not disclose the inheritance in their bankruptcy schedules. Creditors cite In re Aboukhater, 165 B.R. 904 (9th Circ. BAP 1994) for the proposition that mere failure to disclose assets of substantial value in bankruptcy papers is sufficient to support a finding of intent to hinder, delay, or defraud creditors under §727(a)(2). The Court finds that, when Debtors filed their Chapter 7 petition, the inheritance was no longer property of the Debtors because they had spent it. As a result, they were not required to list it as an asset in their schedules.
B. §727(a)(3) (Failure to Maintain Records) Creditors allege that Debtors violated §727(a)(3) by failing to maintain adequate records of how the inheritance was spent.
However, at trial Debtors admitted a great many records into evidence (documentation for all but three of the expenditures). The Court finds these copies of checks, stubs from money orders, invoices, and copies of invoices to be reliable. They are for the dates between June 29 and August 29, 2000 when the Debtors testified that they spent the inheritance. The records correspond with Debtors’ testimony as to how the money was spent.
There are two relatively large receipts missing: one for three mortgage payments totalling $5,124.00, and the other for
repairs to the Debtors’ home in the amount of $2,374.00; a third missing receipt is for $160 paid to the orthodontist. Mrs. Gray testified that, after she made the mortgage and home repair payments, she gave the documentation to her attorney. Mrs. Gray’s testimony was very credible and no evidence was introduced to contradict it. Her testimony was also logically consistent as it pertained to the mortgage payments; in order for Debtors to keep their home, they had to make the payments that they said they made. Debtors presented substantially all of their records and offered credible explanations for the missing documents. The Court finds that Debtors did in fact keep adequate records, given all of the circumstances. Mrs. Gray was articulate and struck the Court as organized and responsible. The Court had the impression during trial that Debtors could and would have provided Mr. Gorman with copies of all of their receipts (including those for the mortgage payments, home repair payments, and single orthodontia payment) had they been asked to do so. Even at trial, Debtors’ counsel seemed almost reluctant to take the time to go through Debtors’ many receipts and seek their admission into evidence.
C. Knowingly Making a False Oath -- §727(a)(4) Creditors allege that, by not listing the inheritance in their bankruptcy schedules, Debtors knowingly made a false oath in connection with this bankruptcy case. The Court addressed this issue in Section A of this Memorandum Decision and, for the reasons therein described, finds no merit to this allegation.
Creditors further allege that two incorrect statements were made in papers filed in this bankruptcy case: Mr. Gray’s $5,710.00 executor fee was not disclosed as earned income in the Statement of Affairs; and the payment made to the Monterey County District Attorney was not disclosed in the Statement of Affairs as a payment to creditors exceeding $600 made within 90 days pre-petition.
To obtain a denial of discharge for making false oaths, a creditor must prove by preponderance of the evidence that:
1) debtor made the statement under oath;
2) the statement was false;
3) debtor knew the statement was false;
4) debtor made the statement with fraudulent intent;
5) the statement related materially to the bankruptcy case.
Coombs. Creditors have the burden of proving each of these elements, id.
Assuming arguendo that Creditors had proven Debtors’ actions satisfied the first two elements, Creditors provided no evidence that Debtors actions satisfied the third, fourth, and fifth requirements.
Debtors paid their attorney to advise them and file this bankruptcy; they probably trusted that their professional representative was competent, and deferred to his expertise when they signed the Statement of Affairs. Debtors’ attorney knew about the executor’s fee because he had assisted Debtors in handling the probate proceedings. Although no evidence was introduced on this point, Debtors’ attorney, Mr. Gorman, states in the Debtors’ trial brief that he is at fault for the omission: “I failed to think of those commissions as earnings.” It is reasonable for Debtors to have relied on their attorney to advise them, once he received information about their assets, how to fill the bankruptcy forms out accurately. The Court believes that Debtors actually intended to submit a Statement of Affairs that was both truthful and correct. Mrs. Gray also credibly testified that she did not consider the Monterey County District Attorney to be a creditor. Her explanation is extremely plausible because, as a lay person, she might reasonably think of the District Attorney as an arm of law enforcement (indeed, had the Debtors had not paid the District Attorney, Mr. Gray might have found himself in jail). Debtors did not realize that payment should have been included in the list of payments to creditors, and did not deliberately exclude that payment from their bankruptcy papers with fraudulent intent.
Finally, according to Coombs, the false statements must materially relate to the bankruptcy case. Had Mr. Gray’s $5,710 executor’s fee been disclosed, nothing would have changed. Debtors still would have been permitted to spend money on necessities, future services, and exempt property for the reasons explained herein.
The Court finds that, though two incorrect statements were made in the bankruptcy case, Creditors have failed to prove that Debtors knew those statements were false, and have failed to prove that Debtors made the statements with fraudulent intent.
Creditors also allege that, by not initially disclosing in the Statement of Affairs the amount Debtors paid Mr. Gorman, they violated §727(a)(4). Mr. Gorman certainly knew about the payments made to him, and Debtors relied upon him to advise them regarding their schedules and Statement of Affairs; further, the Debtors filed an Amended Statement of Affairs in which they disclosed the amount they paid to their lawyer. If items were omitted by mistake or upon honest advice of counsel, to whom the debtor had disclosed all the relevant facts, the declaration will not be deemed
willfully false, and the discharge should not be denied because of it, Collier’s at §727.04.
In this instance, Debtors’ attorney had all the relevant information, had set the price and charged Debtors for his legal fees, and filled out (or advised his clients how to fill out) The record is not clear as to whether Mr. Gorman advised his clients how to fill out the forms or filled them out himself. the bankruptcy papers. Debtors did not do anything willfully false. They had nothing to gain by not disclosing the amount of their attorney’s fee. Creditors did not even attempt to establish that the “non-refundable retainer” would have been returned to the Debtors or that the Debtors would somehow have benefitted by the omission. Creditors have failed to meet their burden of proof to have Debtors’ discharge denied under §727(a)(4).
D. §727(a)(5) (Failure to Explain Loss/Deficiency of Assets) Creditors allege that Debtors are unable or unwilling to account for the inheritance that Debtors received shortly before filing their Chapter 7 petition. Accordingly, Creditors contend that Debtors have violated §727(a)(5) by failing to explain satisfactorily the loss of such assets.
The test is a subjective one -- a debtor must convince the court of good faith and business-like conduct, see Devers. Whether a loss has been satisfactorily explained is a question of fact, see Mereshian.
The Court finds that Debtors have “satisfactorily explained” how they spent their inheritance. (See the Facts section and Section B of this Memorandum Decision.) At trial, Debtors corroborated Mrs. Gray’s comprehensive explanation with most of the records pertaining to the inheritance. Debtors are consumers and are not particularly financially sophisticated. Mrs. Gray was organized and careful. Debtors have demonstrated good faith and business-like conduct appropriate to their level of sophistication and financial background. Further, the facts of this case are similar to those in Buck, where a debtor received her discharge over a §727 (a)(5) objection when the amounts unaccounted for were relatively small in relation to the total for which the debtor had accounted; here, too, the amounts unaccounted for were relatively small in relation to the total for which Debtors have accounted. The Debtors have not violated §727(a)(5) by failing to explain satisfactorily the loss of an asset.
IV. As discussed above, bankruptcy debtors are effectively presumed to be entitled to discharge of their debts, and the limited statutory bases upon which to deny discharge are to be construed liberally in favor of granting discharge and strictly against denial. Creditors have not met their burden of proof in establishing that Debtors: transferred property with the intent to hinder and delay a creditor; failed to maintain adequate records; knowingly and fraudulently made a false oath in connection with the case; and/or failed to explain satisfactorily any loss of assets.
Counsel for Debtors shall submit a form of judgment providing that Debtors’ discharge is not denied, after review by counsel for Creditors as to form.
ARTHUR S. WEISSBRODT
United States Bankruptcy Judge