This case came before the court on the debtor’s complaint to strip-off a wholly unsecured deed of trust and tax lien against her property in a Chapter 13 bankruptcy.

The debtor was the only obligor on the two deeds of trust.  The Debtor was on the title as joint tenants with right of survivorship. The non-debtor had the tax liability.

After the debtor met with her bankruptcy attorney, the debtor decided to have the non-debtor convey her one-half interest in their home to her, file a chapter 13 bankruptcy petition herself, and strip-off the second deed of trust. The debtor argues that she is entitled to strip-off the second trust and tax lien simply because the value of the property is less than the balance due to the first trustholder.

The IRS claimed two defenses that the court addressed, first that it was entitled to sovereign immunity and, second, that the debtor is acting in bad faith.

1. Sovereign Immunity:  Judge Mayer disposes of this defense by citing 11 USC 106 which abrogates sovereign immunity for a governmental unit for certain sections, including section 506.

2. Debtor’s good faith:  Judge Mayer took issue with the transfer of the non-debtor’s one-half interest for no value right before the filing of the Chapter 13.  The court examined Philips v. Krakower, 46 F.2d 764 (4^th Cir. 1931), in which the husband and wife structured their filings to achieve a result that they would not have been able to accomplish on their own. The Court in the Phillips case called this a “legal fraud,” but Judge Mayer noted that today, this is simply called “abuse.”

Discussing abuse, Judge Mayer noted that “bankruptcy courts have traditionally drawn upon their powers of equity to prevent abuse of the bankruptcy process and to ensure that a “case be commenced in ‘good faith’ to reflect the intended policies of the Code.”  2 L. King, Collier on Bankruptcy, 301.05[1], at 301-5 to 301-7(1996). Continuing, Judge Mayer noted that such good faith requirement prevents abuse of the bankruptcy process by debtors whose overriding notice is to delay creditors without benefiting them in any way or to achieve reprehensible purposes.  Moreover, a good faith standard protest the jurisdictional integrity of the bankruptcy court by rendering their powerful equitable weapons (i.e., avoidance of liens, discharge of debtors, marshaling and turnover of assets) available only to those debtors and creditors with “clean hands.” In re Little Creek Development Co., 779 F.2d. 1068 (5^th Cir. 1986).

Judge Mayer look to the factors applied in In re Lilley, 91 F.3d 491 (3^rd Cir. 1996) , which were restated in In re Folotico, 231 B.R. 35 (Bankr.D.N.J. 1999), where the bankruptcy court refused to strip off a wholly unsecured lien on equitable grounds.  In applying the Lilly factors, the court stated: The factors which may be considered in an examination of the totality of circumstances include:  (i) the nature of the debt; (ii) the timing of the petition; (iii) how the debt arose; (iv) the debtors notice in filing the petition; (v) how the debtor’s actions affected creditors; (vi) the debtor’s treatment of creditor’s both before and after the petition was filed; and (vii) whether the debtor has been forthcoming with the bankruptcy court and creditors.

Judge Mayer decided that the debtor seeks to achieve indirectly what the debtor is not able to achieve directly: “The manner in which this transaction was structured allowed the debtor to file bankruptcy and was intended to achieve the discharge of the IRS’s lien from the property by the debtor, but not Ms. Fagan, filing bankruptcy. The result of this bankruptcy case is that the debtor and Ms. Fagan working together seek to achieve a result that Ms. Fagan, the obligor of the tax debt, could not achieve directly.

Judge Mayer ultimately decided that the absence of good faith prevented the court from allowing the strip off of the IRS lien.

In this case, the debtor proposed a plan that proposed to pay approximately 7% of the allowed unsecured claims, but the plan provided that the debtor would keep the payment on her student loan current. Section 1322(b)(1) of the Code allows for the designation of one or more classes of unsecured claims, but provides that the Chapter 13 Plan “may not discriminate unfairly against any class so designated.” 11U.S.C. 1322(b)(1).

Courts around the country have applied a number of different tests to determine if any classification discriminates unfairly.  The Eighth Circuit articulated a four-part test, in In re Leser, 939 F.2d 669, 672 (8^th Cir. 1991), which is as follows:

1. whether the discrimination has a reasonable basis;

2. whether the debtor can carry out a plan without discrimination;

3. whether the discrimination is proposed in good faith; and

4. whether the degree of discrimination is directly related to the basis or rationale for the discrimination.

Still other courts have added a fifth factor “the difference between what the creditors discriminated against will receive as the plan is proposed, and the amount they would receive if there were no separate classification.”  In re Husted, 142 B.R. 72, 74 (Bankr. W.D.N.Y. 1992).

Judge Kenney decided that his test would substitute the fifth Husted factor for the fourth Leser factor making the test for his court the following:

Judge Kenney Test for unfair discrimination:

1. whether the discrimination has a reasonable basis;

2. whether the debtor can carry out a plan without discrimination;

3. whether the discrimination is proposed in good faith; and

4. the difference between what the creditors discriminated against will receive as the plan is proposed, and the amount they would receive if there were no separate classification

Applying this test to student loan classification, Judge Kenney, citing the Fourth Circuit, found that there is “a strong public policy” that exists “in favor of the federal student loan program,” Educ. Credit Mgmt. Corp. v. Frushour (In re Frushour), 433 F.3d 393, 399 (4^th Cir. 2005), and that there is a reasonable basis for their separate classification.

As to the second factor, Judge Kenney thought that, while the debtor could carry out the plan without the separate classification, that she would be saddled with all of her student loan debt at the end of the plan and actually encourage her NOT to complete her plan and convert to a Chapter 7.

Third factor:  no allegation of bad faith.

Fourth factor:  difference to other unsecured creditors:  total of $92.17 per month.  Not so great a difference as to compel a denial of confirmation though the court points out that this is a case-by-case determination and that a greater disparity could compel a denial of confirmation.

Chapter 7 Debtor convinced Plaintiffs to make an investment of $500,000.00 in an oil and gas concern that came to be known as Whistler, LLC. (not Whistler, BC, as pictured below).  Whistler, LLC was purported to own oil and gas leases in the Gulf of Mexico.  However, the Debtor deposited all of the funds in the bank account of another company, which used the funds to pay business expenses.

The Plaintiffs became increasingly concerned about their investments and eventually demanded their money back.  As of the filing date of the bankruptcy, none of the $500,000.00 has been repaid.

The Plaintiffs filed this suit to determine the dischargeability of the debt pursuant to 11 USC 523(a)(2)(A).

Under 523(a)(2)(A), in order to prove “false pretenses, a false representation, or actual fraud,” the Plaintiffs must prove that the Debtor “made a representation; [that] the debtor knew the representation was false at the time the representation was made; [that] the debtor made the false representation with the intention of deceiving the creditor; [that] the [Plaintiffs] justifiably relied on the representation; and [that]the [Plaintiffs] sustained the alleged loss and damage as the proximate result of the false representation.”  Fowler v. Gary (In re Gary), 258 B.R. 356, 361 (Bankr. E.D. Va. 2000).  The standard of proof is preponderance of the evidence. Id.

In the Supreme Court case of Field v. Mans, the Court decided that, in order to prove a case of actual fraud under Section 523(a)(2)(A), the Plaintiffs needed only prove “justifiable reliance,” not the more demanding standard of “reasonable reliance.”  The Court explained the standard of justifiable reliance as follows:

“. . . a person is justified in relying on a representation of fact “although he might have ascertained the falsity of the representation had he made an investigation.” Significantly for our purposes, the illustration is given of a seller of land who says it is free and clear of encumbrances; according to the Restatement, a buyer’s reliance on this factual representation is justifiable; even if he could have “walked across the street to the office of the register of deeds in the courthouse” and easily have learned of an unsatisfied mortgage.  The point is otherwise made in a later section noting that contributory negligence is no bar to recovery because fraudulent misrepresentation is an intentional tort.  Here a contrast between justifiable and reasonable is clear:  “Although the plaintiff’s reliance on the misrepresentation must be justifiable. .  . this does not mean that his conduct must conform to the standard of a reasonable man.  Justification is a matter of the qualities and characteristics of the particular plaintiff, and the circumstances of the particular case, rather than of the application of a community standard of conduct in all cases.”  W. Prosser, Law of Torts, (4^th Ed. 1971).

While Judge Kenney was careful to note that the misrepresentation must be of an existing fact with present intention not to perform, Structured Invs. Co., LLC v. Dunlap, 458 B.R. 301, 329 (Bankr. E.D. Va. 2011), he nonetheless found that the Plaintiffs justifiably relied on misrepresentations of present fact and that $500,000.00, plus interest, was non-dischargeable.

This suit was brought by Wells Fargo against Chapter 7 debtor, Maryam Nawroz, to determine the dischargeability of a debt owed by the debtor to Wells Fargo.

The debt arose out of a mistake by Wells Fargo when the debtor transferred money out CD’s held by Wells Fargo into a retirement account.  Wells Fargo mistakenly credited the Debtors retirement account twice.  Before Wells Fargo realized the mistake, the Debtor transferred the money out of her retirement account into a checking account with Union Bank.  The Debtor then wrote a check on the amount. This check would not have cleared but for the mistaken transfer by Wells Fargo.

The Debtor testified that she was severely depressed at the time of the transfers, she was not keeping close tabs of her finances of business affairs.  The Debtor testified that she did not know about the mistaken transfer and used the money for a family emergency.

In this action to determine nondischargeability of debt, Wells Fargo has the burden of proof.  Section 523(a)(6) excepts from a debtor’s discharge debts that are the result of “willful and malicious injury by the debtor to another entity of the property of another entity.”  Judge Kenny recognized that the Supreme Court held that “willfulness” requires more than just a negligent, or even reckless, injury; rather, the term “willful” requires a deliberate or intentional act that leads to injury.”  Kawaauhau v. Geiger, 523 U.S. 57, 61 (1998).  An injury is only willful and malicious “if the actor purposefully inflicted the injury or acted with substantial certainty that injury would result,” however, “a debtor may be assumed to intend the natural and consequence of his acts.”

The Court decided that the Debtor’s use of the funds was both deliberate and intentional because the debtor intended to deprive Wells Fargo of the rightful use of its funds, which was the natural consequences of her acts.  This satisfies the willful element.

The Fourth Circuit has held that a debtor may act with malice even though he or she bears no subjective ill will toward, and does not specifically intend to injure, his or her creditor.  Further elaborating, the Fourth Circuit stated that the Debtor’s subjective state of mind is relevant . . .and that a particular debtor’s knowledge may be proved by circumstantial evidence:  Implied malice may be shown by the acts and conduct of the debtor in the context of the surrounding circumstances.

A Debtor’s injurious act done deliberately and intentionally in knowing disregard of the rights of another is sufficiently willful and malicious and will prevent discharge of the debt.  Here the Debtor made a conscious choice to use the funds rather than alert Wells Fargo of the mistake.  Because the Fourth Circuit has stated that the proper focus is not on the Debtor’s good intentions, but simply on her exercise of dominion and control over funds that she knew belonged to another, Judge Kenney felt constrained to find the actions were malicious and that the debt was non-dischargeable.

The Debtor filed a motion for contempt based on the confirmation order based and how Capital One reported the debtors account to the credit rating agency.  The Chapter 13 plan contained a provision that “if a creditor reports to the consumer reporting agencies the receipt and timeliness of the payments on any debt dealt with in this plan, then the claim as altered by the confirmed plan, rather than the original loan agreement, should form the basis for the report.”  Further, the debtor argued that the reporting of the debt violates the Consumer Data Industry Association’s Credit Reporting Resource Guide.

Since the confirmation of the plan, Capital One has continued to report the original loan balance to the credit reporting agencies.  Capital One argued that (a) it did not have adequate notice of the Confirmation Order pursuant to Bankruptcy Rule 2002(c)(3), (b) the credit reporting resource guide does not constitute a national standard, and (c) the confirmation order does not reference or incorporate the CDIA guide.  Further, Capital One’s view is that plan only required that it update the balance as payments are received under the Plan.

The Court decided that it was unable to conclude that the resource guide constitutes a national, legally enforceable standard for the reporting of debts in a Chapter 13 case. The Court held that “a violation of a confirmation order is an act of contempt, which may be remedied by the Court pursuant to 11 U.S.C. § 105.  In order to be found in contempt of a Court order, the movant must show: “(1) the existence of a valid decree of which the alleged contemnor had actual or constructive knowledge; (2) that the decree was in the movant’s ‘favor’; (3) that the alleged contemnor by its conduct violated the terms of the decree, and had knowledge (at least constructive knowledge) of such violations; and (4) that the movant suffered harm as a result.”  United States v. Under Seal (In re Grand Jury Subpoena), 597 F. 3d 189, 292 (4^th Cir. 2010).

With respect to any violation of Bankruptcy Rule 2002(c)(3), the court held that even if there were a violation, the confirmation order is res judicata citing the Supreme Court in United States Aid Funds v. Espinoza.

Continuing in its analysis of debts reported to credit rating agencies, the court noted that other “Courts have held that the failure to correct the pre-discharge reporting of a debt on the debtor’s credit report, without additional evidence of some coercive efforts to collect the debt (phone calls, letters, etc.), does not rise to the level of a discharge injunction violation for which the creditor may be held in contempt.”  Citing In re Dendy, 396 B.R. 171, 182 (Bankr. D.S.C. 2008), the Court denied the violation, stating “[t]he mere existence of a discharged debt on a debtor’s credit report, when reported prior to the discharge injunction and not combined with evidence of actions by a creditor to collect the debt after the injunction arose, does not rise to the level of action that violates a discharge injunction.”

It is important to note that the balance should be reported as zero upon receipt of the discharge even though there will not be an action in bankruptcy court for failure to report the balance as zero during the life of the Chapter 13 plan.

The Trustee objected to the the chapter 13 plan on the grounds that the plan or petition was not filed in good faith under 11 USC 1325(a)(5) and (a)(7).

The Trustee alleged that the petition and plan were not filed in good faith because the only debt being dealt with in the proposed plan was previously excepted from discharge in the debtor’s 2010 chapter 7 case.  In that case, the debtor entered into a consent judgment excepting from discharge indebtedness of amounts owed to a creditor pursuant to the fraud exceptions of sections 523(a)(2)(A) and (a)(4).

Before a court can approve a chapter 13, the court must find that the plan was “proposed in good faith.”  11 U.S.C. 1325(a)(3).  The burden is on the debtor and the factors to be considered are as followed:

(1) percentage of the proposed repayment;

(2) debtor’s financial situation;

(3) the period of time payment will be made;

(4) debtor’s employment history and prospects;

(5) that nature and amount of unsecured claims;

(6) debtor’s past bankruptcy filings;

(7) debtor’s honesty in representing facts; and

(8) any unusual or exceptional problems facing the particular debtor.

Deans v. O’Donnell, 692 F.2d 968, 973 (4th Cir. 1982).

The 4th Circuit has also held that pre-filing conduct and whether a claim is non-dischargeable under chapter 7 are also factors in evaluating a debtor’s good faith.  Neufeld v. Freeman, 794 F.2d 149, 152 (4th Cir. 1986).  Using these factors, the court must examine the “totality of circumstances” in each case to determine if the proposed plan violates the purpose or spirit of chapter 13.

The Trustee argued that the sole purpose of the plan was to delay payment of the nondischargeable debt.  The debtor admitted that the purpose of the filing is to relieve him from the “garnishment and other judgment collection methods.”  The court noted that it had previously examined similar circumstances and found that bad faith existed when a debtor proposed a low percentage repayment on a debt that was found to be nondischargeable under section 523(a)(2).

The Court noted the presence of several indicia of bad faith, including a low payout percentage, nondischargeable debt incurred by fraud, and a pending chapter 7 case that does not relieve him of that debt.  The court found that nothing about this plan served to give the debtor a fresh start, which is the primary goal of bankruptcy laws but instead, only reduced payments to which the creditor was entitled to under his judgment and garnishment, the only function of which is to frustrate Roberts’ collection efforts.

The Trustee also raised the issue of good faith under section 1325(a)(7) to which the court found that the same good faith criteria found in Deans v. O’Donnell and, likewise, reached the same conclusion:  neither the plan nor the petition were filed in good faith.

This case involved a credit card account and a deed of trust at SunTrust bank.

The first legal issue the court addressed was whether or not the debtor would be allowed to amend their complaint  against the bank. To this the court decided that “Under the notice pleading approach adopted in Federal Rule of Bankruptcy Procedure 7008, the bank had sufficient notice both of the claim (violation of the discharge injunction) and the remedy (attorney’s fees) sought by the debtors as well as supporting allegations of fact. See Fed.R.Civ.P. 8(a)(2), made applicable by Fed.R.Bankr.P. 7008(a); Erickson v. Pardus, 127 S.Ct. 2197, 2200 (2007) (“Specific facts are not necessary; the statement need only ‘give the defendant fair notice of what the . . . claim is and the grounds upon which it rests.’”) (internal quotation marks and citations omitted).”

The court then went through the different facts that showed the bank was a notice of the claim for the discharge violation.

The debtor’s claim six different actions by the bank that could have resulted in a discharge violation. “The court need not find that all six actions taken by the bank were willful and intentional violations of the discharge junction. One violation isn’t enough.” What the court found most disturbing was the letter reiterating the payoff figure and threatening the debtor’s that further action might be taken. Suntrust cites the court’s opinion in Helmes v Wachovia Bank, N.A., 336 B.R. 105, 109 (Bankr.E.D.Va. 2005) which found that “it was not a per se violation and that there was no intentional violation of the discharge junction because the debtors file was mistakenly not flagged as a bankruptcy case.”  The court pointed out that in Helmes the creditor properly corrected the error when it was brought to its attention. There was no pattern of discharge violations. The court, in that case, concluded from the totality of the circumstances that the errant credit report was not an act intended to collect a debt, but rather an excusable mistake.

Unlike the mistake in credit reporting in Helmes, which was not on its face and act to collect a discharge debt; the phone call in this case cannot be characterized as anything but attempts to collect a discharged debt.

Importantly “the bank is charged with the knowledge of the contents of its own records.” The failure to properly review the bank’s own records is not excusable mistake. If it were there would be no violations of the discharge junction, only “mistakes.” While prompt action by the court in Helmes was consistent with an innocent violation, promptness of correction of an error is not the determining factor finding willfulness or the lack of willfulness, it is a factor.

Not every action that offends discharge junction is action. An honest mistake may be a legitimate defense. However, merely showing where the bank system and wrong is not enough. Here, the summary judgment record shows that the bank knew of the bankruptcy discharge and that information was easily and readily available to the bank employees working on the account.

The court noted the bank accounting practice to “charge-off” and account and noted that and account charged off to profit and losses merely removes it from the bank’s balance sheet. It is not an acknowledgement that the debtor has been discharged.  The court also noted that he discharged creditors acceptance of the voluntary payment from the debtor does not, without more, violate the discharge junction. If a debtor seeks to voluntarily repay the debt question Month creditor, the creditor does not violate discharge junction simply by responding to the request. However, if the bank knew that the request arose because of the erroneous credit bureau report or the title search or that the debtor’s asserted that the debt was discharged but were only requesting payoff out of compulsion, then the act of providing payoff may be a violation of the discharge stay. Further, “the bank is charged with all the facts known to its collection divisions even if they are geographically or operationally separated.”

The debtor in this case filed a Chapter 13 without yet having the necessary credit counseling certificate.  Instead of this certificate, she filed a certification of exigent circumstances stating that she will be evicted without the court’s protection.

The court cites Bankruptcy Code §109(h)(3)(A) which allows the credit counseling requirement to be waived if the debtor submits to the court a certification that (1) “describes exigent circumstances that merit a waiver” of the credit counseling requirement; (2) “states that the debtor requested credit counseling services from an approved nonprofit budget and credit counseling agency, but was unable to obtain the services . . . during the 5-day period beginning on the date on which the debtor made that request,” and (3)”is satisfactory to the court.” Id.

The court reasons that though an impending eviction would generally qualify as an exigent circumstance, the debtor has not certified that sh requested and did not receive credit counseling within the five day period before the filing.  The court states that a debtor who waits until the last minute to seek counseling will not be exempt unless the agency is so backed up that it cannot provide the counseling within five days of the request.  In the absence of a request for counseling services and the inability to receive it within five days of the request, the court cannot grant a deferment no matter how compelling the circumstances might otherwise be and has no choice but to dismiss the case.  In re Watson, 332 B.R. 740 (Bankr. E.D. Va. 2005).

The court grants the dismissal without prejudice, but warns the debtor regarding the need to file a motion to extend the stay under §362(c)(3) and quickly highlights the requirements for a debtor to stop an eviction if the landlord already has a judgment for possession under §362(f).  Onerous requirements, indeed.

Lawsuit brought in bankruptcy case highlights core aspects of Virginia corporate law

Individual debtor filed a Chapter 11 under the bankruptcy code to reorganize her debts.  The debtor then brought an action for breach of contract arising from the sale of a business, a declaratory judgment that salary repayment and non-compete provisions in an employment agreement she signed are unenforceable, and damages for breach of fiduciary duty.

The court restated the standard for summary judgment that it was going to use.  Importantly, the court noted that “the Supreme Court has held that a plaintiff need not plead evidence sufficient to establish a prima facia case in order to survive a motion to dismiss, but under Rule 8(a), need only give the defendant fair notice of what the plaintiff’s claim is and the grounds upon which it rests.”  Swierkiewicz v. Sorena NA, 534 U.S. 506, 512 (2002).  At the same time, the plaintiff must provide grounds for entitlement to relief, which requires more than labels and conclusions or a formulaic recitation of the elements of a cause of action.  Bell Atlantic Corp. v. Twombly, — U.S. __ (2007).

The court went on to discuss the various Count alleged in the Complaint.  The Court summarily dealt with a few of the Counts based on the inclusion of an improper party in certain claims.  The court did spend some time addressing the veil piercing doctrine in Virginia and proper pleading of the same.  The court noted “the veil piercing doctrine has its origins in the “desire of courts to not permit investors to manipulate the statutory privilege of limited liability to the knowing disadvantage of those who deal with the corporation.”  AE Restaurants Associates, LLC v. Giampietro (In re Giampietro), 317 B.R. 841 (Bankr.D. Nev. 2004)(citing Robert B. Thompson, Piercing the Corporate Veil § 1:3(2004)).

Judge Mitchell goes on to articulate several different tests used by courts around to country to determine if the corporate veil should be disregarded.  Virginia’s veil piercing test is essentially an amalgamation of these [] tests, keeping as its principal focus the equitable considerations that undergird the veil piercing doctrine.  See C.F. Trust, Inc. v. First Flight Ltd Partnership, 266 Va. 3, 10 (2003)(stating that the corporate entity will be disregarded and the veil pierced only if the shareholder sought to be held personally liable has controlled or used the corporation to evade a personal obligation, to perpetrate fraud or a crime, to commit and injustice, or to gain an unfair advantage and when the unity of interest and ownership is such that the separate personalities of the corporation and the individual no longer exist and to adhere to that separateness would work and injustice.) The court decided that there was enough facts set forth in the complaint with sufficient particularity to survive a motion to dismiss.

The court then addressed the count alleging breach of fiduciary duty.  The court points out that Virginia does not recognize an individual shareholder’s right to claim damages for an officer or director’s breach of fiduciary duty, rather that right belongs to the corporation itself, on behalf of the entire shareholder body.  Simmons v. Miller, 261 Va. 561 (2001).  The court then notes that, at the very least, the individual shareholder needs to make demand on its board of directors and have them refuse to prosecute the claim, or prove that demand would be futile. Virginia Passenger & Power Co. v. Fisher, 104 Va. 121 (1905). Then, and only then, may a shareholder bring a derivative action on behalf of the corporation.

In a chapter 11 case, a debtor that continues in business following confirmation of a plan or reorganization is discharged from all debts arising prior to confirmation. 11 U.S.C. § 1141(d).  However, before such a claim can be discharged, creditors must be afforded adequate notice of the bankruptcy case, as well as of the deadline set for filing claims against the debtor.   Zurich American Ins. Co. v. Tessler (In re J.A. Jones, Inc.), 492 F.3d 242, 249(4^th Cir. 2007).

They type of notice that is required depends on whether a creditor is “known” or “unknown.”  Creditors whose identities are actually known to the debtor or are reasonably ascertainable by the debtor are deemed to be “known creditors” and are entitled to actual notice of the bankruptcy filing.  An “unknown creditor,” by contrast, is one whose identity or claim is wholly conjectural, or whose interests or whereabouts cannot be determined by the debtor after exercising reasonable diligence.  An unknown creditor need not be given actual notice, and constructive notice, such as by newspaper publication, will suffice.

“Reasonable diligence” by the debtor, in attempting to ascertain the identity of its creditors does not require a level of impracticality and does not require a vast, open-ended investigation; rather, the debtor’s search should be concentrated on its own books and records.