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8th Cir. Affirms Denial of Discharge Due to Inadequate Records, Questionable Transactions

receivablesThe U.S. Court of Appeals for the Eighth Circuit recently affirmed the denial of bankruptcy discharge for a Chapter 7 debtor due to the debtor’s failure to keep adequate records.

In particular, the Eighth Circuit focused on a sudden and financially significant return of hundreds of thousands of dollars’ worth of high-end watches and jewelry that left significant unanswered questions as to the whereabouts of the assets and the legitimacy of the creditor jeweler’s claim.

A copy of the opinion in Snyder v. Dykes is available at:  Link to Opinion.

Husband and wife doctors (“debtors”) filed a voluntary petition for relief under Chapter 7 of the Bankruptcy Code.  In Schedule A/B of their Chapter 7 petition, they listed jewelry assets comprised only of a wedding ring worth $35, a wedding band and anniversary ring collectively worth $700, two sets of cufflinks collectively worth $1,250, and a watch winder worth $12,000, and no “other property of any kind [that they] did not already list.”

The debtors’ Schedule A/B also stated that they had no ongoing monthly expenses related to “childcare or children’s education costs,” while their Statement of Financial Affairs (SOFA) disclosed that in the 90 days before the petition, they paid amounts related to their son’s college tuition and rent. The SOFA also claimed that the debtors had no gifts above $600 or no transfer of any property within the last two years, “other than property transferred in the ordinary course of [their] business or financial affairs.”

Upon the trustee’s review of the filings, he notified the court that the case was “presumed to be an abuse” under 11 U.S.C. § 707(b).  The debtors subsequently filed Amended Schedules A/B and C and an Amended SOFA, which also now disclosed $108,473.77 of payments related to their son’s and daughter’s college expenses.

After a meeting of creditors, the trustee noted a “potential fraudulent transfer” concerning the return of “twenty to thirty valuable watches” to a Las Vegas jeweler, who filed an unsecured claim in the amount of $413,788. 

The trustee filed a complaint to deny the debtors a discharge: (i) under 11 U.S.C. § 727(a)(2)(A), for transferring thousands of dollars to their children in the year preceding the petition with the intent to hinder, delay or defraud a creditor; (ii) under § 727(a)(4), for failing to disclose numerous and substantial transfers to their adult children within two years prior to commencement of the bankruptcy case; and (iii) under § 727(a)(3), for failing to maintain adequate records regarding the transfer of “numerous and valuable watches.”

At trial on the trustee’s case, the debtors described their decline of fortunes during the national foreclosure crisis in 2008, which resulted in a $2.4 million claim against the Chapter 7 estate for failure to pay their mortgage and hundreds of thousands of dollars of goods that were auctioned from storage for failure to pay rent with no accounting of the forfeited property. 

The husband debtor testified he was an avid collector of expensive watches and jewelry, and while he was able to produce invoices recording deliveries there were few recorded payments, as his relationship with the jeweler resulted in a “running total” that charged and credited watches and jewelry received and returned until he was eventually unable to pay, and signed a confession of judgment in the amount of $390,700.  To partially satisfy that judgment, in February 2013, he returned 27 watches and a bridal collection ring to the jeweler’s attorney, which was documented with receipts but not the value of the items or balance due after the return.

Following trial, the bankruptcy court denied the discharge on three grounds. 

Primarily, discharge was denied under § 727(a)(3) for unjustifiably failing to keep adequate records regarding the purchase, sale and return of hundreds of thousands of dollars of jewelry, finding the husband debtor’s testimony regarding purchase without paperwork or receipts not credible and that it was impossible to ascertain their financial condition and material transactions. 

The bankruptcy court also found discharge improper under § 727(a)(4)(A) for failure to disclose substantial transfers for the benefit of the debtors’ adult children, and under § 727(a)(5) for failing to document what happened to five watches purchased in 2008 marked as “paid” and an accounting of assets allegedly lost in the storage containers. 

On appeal, the Bankruptcy Appellate Panel (BAP) affirmed the denial of discharge under § 727(a)(3), while declining to address the denial under §§ 727(a)(4)(A) and (a)(5).  The debtors appealed to the Eighth Circuit.

As you may recall, Chapter 7 of the Bankruptcy Code allows debtors to discharge their debts by liquidating assets to pay creditors. See 11 U.S.C. §§ 704(a)(1), 726, 727.  Although objections to discharge “are strictly construed in favor of the debtor,” an objecting party need only establish one ground to support a discretionary denial of discharge by the bankruptcy court. See In re Korte, 262 B.R. 464, 471 (B.A.P. 8th Cir. 2001); Union Planters Bank, N.A. v. Connors, 283 F.3d 896, 901 (7th Cir. 2002).

Section 727(a)(3) authorizes denial of discharge 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.”

The objecting party (here, the trustee) must show “(1) that the debtor failed to maintain and preserve adequate records, and (2) that such failure makes it impossible to ascertain the debtor’s financial condition and material business transactions.” Meridian Bank v. Alten, 958 F.2d 1226, 1232 (3d Cir. 1992).  Upon meeting this initial burden, “the burden of production shifts to the debtor to offer a justification for his record keeping (or lack thereof); however, the objecting party bears the ultimate burden of proof with respect to all elements of this claim.” In re Swanson, 476 B.R. at 240.  No proof of intent is required for a denial of discharge under Section 727(a)(3). In re Wolfe, 232 B.R. at 745.

Here, the Eighth Circuit agreed with the BAP that the trustee met its initial burden because the debtors’ inadequate records left the bankruptcy court without a way to determine transactions between the debtors and jeweler. 

Although the debtors did not have the same “duty to create and preserve records” of these transactions as a Chapter 7 debtor operating as a business with substantial assets, the return of 27 valuable watches and bridal collection rings to the judgment creditor jeweler was such a “sudden and large dissipation of assets” that even a consumer bankruptcy debtor maintained a greater duty to keep records.  Alan N. Resnick & Henry J. Sommer, Collier on Bankruptcy ¶ 727.03[3][g] at 727-34 (16th ed. 2019); See, e.g., In re Buzzelli, 246 B.R. 75, 113-14 (W.D. Pa. 2000). 

Moreover, the husband debtor was a sophisticated collector of valuable watches and jewelry and the subject purchases and returns not only had a significant impact on the debtors’ financial condition, but also impacted the legitimacy of the jeweler’s bankruptcy claim for the complete confession of judgment.  The Eighth Circuit agreed that the lone receipt produced by the debtors failed to substantiate the transactions and shifted the burden of production to the debtors to justify their lack of adequate records.

To determine whether a debtor’s record keeping was justified, the Bankruptcy Code “requires the trier of fact to make a determination based on all the circumstances of the case.” Meridian Bank, 958 F.2d at 1231. Here, because creditors began asserting claims against the debtors and they were considering bankruptcy, the appellate court concluded that a reasonable person would insist on documenting the impact of this transaction on its financial condition.  Although the husband debtor may not have known the fair market value of the watches at the time of their return, the Eighth Circuit noted that he could have matched each watch to an invoice in his possession, noted the purchase price and demanded that the jeweler document the amount each returned watch would reduce the unpaid judgment. 

Instead, the Eighth Circuit held that his failure to do so “created serious, unanswered questions as to the whereabouts of these assets and the legitimacy of [the jeweler’s] bankruptcy claim.”

For these reasons, the Eighth Circuit agreed with the BAP that the bankruptcy court did not err in denying the debtors a discharge under section 727(a)(3) for failing to keep adequate records of the financially significant watch and jewelry transactions, and affirmed the bankruptcy court’s judgment, while declining to address the alternative denials of discharge under sections 727(a)(4) and (a)(5).

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The attorneys of Maurice Wutscher are seasoned business lawyers with substantial experience in business law, financial services litigation and regulatory compliance. They represent consumer and commercial financial services companies, including depository and non-depository mortgage lenders and servicers, as well as mortgage loan investors, financial asset buyers and sellers, loss mitigation companies, third-party debt collectors, and other financial services providers. They have defended scores of putative class actions, have substantial experience in federal appellate court litigation and bring substantial trial and complex bankruptcy experience. They are leaders and influencers in their highly specialized area of law. They serve in leadership positions in industry associations and regularly publish and speak before national audiences.

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