Aggressive bankruptcy planning won’t necessarily result in a denial of discharge, as shown by a Sixth Circuit opinion reversing the bankruptcy court and directing the entry of discharge.

The Sixth Circuit’s opinion dealt with a couple who didn’t want their creditors to attach 2018 and 2019 federal tax refunds that amounted to about $60,000. Believing they would have tax liability for 2020, they filed their tax returns with elections for the refunds to be applied to their 2020 taxes.

The IRS Overpayment Elections

The couple were facing problems because the husband’s health was deteriorating from cancer, forcing him to stop working and sell business assets to satisfy creditors’ claims.

The couple’s tax returns were complex because it was unclear how much they would owe in capital gains taxes from the sale of business assets that had depreciated for years. Their accountant completed and filed their returns almost one year after the April 15 deadline for tax year 2018. The tax return showed that they had overpaid their 2018 taxes by about $40,000. In the return that was filed five months before they filed their chapter 7 petition, the couple elected to have the 2018 refund applied to their 2019 taxes.

The couple testified that they applied the overpayment to 2019, believing they would owe taxes in 2019 but that creditors would garnish a 2018 refund before they could pay 2019 taxes.

The couple filed their 2019 tax return three weeks after filing their chapter 7 petition. Again, they elected for the $21,000 refund to be applied to their 2020 taxes.

The chapter 7 trustee filed a complaint to deny the debtors’ discharges. With regard to the election made before bankruptcy, the trustee alleged under Section 727(a)(2)(A) that the debtors made a transfer within a year before bankruptcy with intent to hinder, delay or defraud a creditor or the trustee. Regarding the election made after filing, the complaint sought to deny the debtors’ discharges under Section 727(a)(2)(B) for having made a post-petition transfer of estate property with intent to hinder, delay or defraud the trustee.

The bankruptcy court dismissed the Section 727(a)(2)(A) claim based on the pre-bankruptcy election. Finding that the couple intended to hinder the trustee by making the post-petition election, the bankruptcy court denied the couple’s discharges under Section 727(a)(2)(B). See Miller v. Wylie (In re Wylie), 649 B.R. 852 (Bankr. E.D. Mich. April 17, 2023). To read ABI’s report, click here.

On the debtors’ appeal, the district court reversed and remanded with instructions to grant discharges, because he was “left with the ‘definite and firm conviction’ that the bankruptcy court erred in finding that the debtors intended to hinder the trustee.” Wylie v. Miller, 657 B.R. 602 (E.D. Mich. March 29, 2024). To read ABI’s report, click here.

The trustee appealed to the circuit.

Intent to Prefer One Creditor Is Ok

In his October 23 opinion affirming the district court, Circuit Judge Richard Allen Griffin said that the “sole issue on appeal concerns the bankruptcy court’s finding that the [debtors] transferred their anticipated 2019 tax refund ‘with intent to hinder’ the trustee,” referring to Section 727(a)(2). The subsection provides that the court will deny a discharge 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 (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.

To affirm the district court, Judge Griffin said he must be “left with . . . a definite and firm conviction” that the bankruptcy court’s finding of intent was “clear error.”

Citing the Collier treatise, Judge Griffin said that Section 727(a)(2) “requires culpable, specific intent to trigger the denial of discharge.” Citing the Supreme Court addressing Section 523(a)(6), he said a debt will be “nondischargeable only if there was ‘a deliberate or intentional injury, not merely a deliberate or intentional act that leads to injury.’ In other words, ‘actual intent’ requires that the debtor intend “the consequences of an act, not simply the act itself.” Kawaauhau v. Geiger, 523 U.S. 57, 61-62 (1998). [Emphasis in original.]

To deny discharges, Judge Griffin summarized the standards to mean there must be “a factual finding that the debtor acted ‘with intent to hinder’ a trustee under § 727(a)(2)(B)” along with “evidence that the debtor acted with the specific intent to make it more difficult for the trustee to facilitate creditors’ collection of debts from the estate.”

Judge Griffin devoted the remainder of his opinion to explaining why “the bankruptcy court’s findings on credibility and intent for two similar counts under § 727(a)(2) are irreconcilable.”

For the election made before bankruptcy, the bankruptcy court found no specific intent because the bankruptcy court found that the debtors only intended for their state and local taxes to be paid. Judge Griffin said that the bankruptcy court correctly decided, as a matter of law, that intending to prefer one creditor over another is not intent to defraud. As authority, he cited 6 Collier on Bankruptcy ¶ 727.02[3][c] (“The intent to prefer creditors is not equivalent to the intent to hinder, delay or defraud creditors.”).

On the other hand, the bankruptcy court had denied discharges arising from the election made after bankruptcy, based on a finding of intent to hinder, delay or defraud the trustee.

Comparing the two findings, Judge Griffin saw “no meaningful factual differences between the 2018 and 2019 tax elections to support this different finding.”

Judge Griffin cited “the bankruptcy court’s own reasoning and findings, that evidence [of specific intent] was lacking,” when the bankruptcy court found that the debtors were “not intimately familiar” with a trustee’s duties and the Bankruptcy Code’s pattern of distributions. He therefore saw “no basis to conclude that the [the debtors] even knew, let alone intended, that by trying to make sure their 2020 taxes were paid they would be hindering the trustee.”

Judge Griffin affirmed the district court and remanded with instruction for the bankruptcy court to grant the debtors their discharges.

Observations

The opinion does not mean that aggressive bankruptcy planning will never result in the denial of discharge. The denial of discharge might have been upheld on appeal had there been different findings of fact based on the same evidence.

However, the case deals with debtors who made transfers designed to prefer one creditor over another. Based on the idea that intention to prefer one is not intent to defraud, the opinion could be cited for the principle that prepetition payment of a creditor with a nondischargeable claim will not result in the denial of discharge.

Note: The National Consumer Bankruptcy Rights Center and the National Association of Consumer Bankruptcy Attorneys filed an amicus brief in support of the debtors. The brief was submitted by attorneys from Kirkland & Ellis LLP.