Revoking the Debtor’s Discharge under §727(d)(3)

A recent opinion from the U.S. District Court for the Eastern District of Virginia highlights the importance of counseling clients about their duties as debtors and clarifying for them what they can and cannot do with property of the estate, even after the discharge is entered. In Jordan v. Smith (In re Jordan), the District Court of Virginia clarified the standard for revoking a chapter 7 debtor’s discharge due to the debtor’s failure to obey a bankruptcy court order. In re Jordan, 2006 U.S. Dist. LEXIS 71077 (E.D. Va. Sept. 26, 2006) (Smith, J.). The opinion makes two things clear: (1) bankruptcy court orders can form the basis for revocation of a debtor’s discharge, even those that might be considered by many as administrative in nature, and (2) notice of such order and failure to comply is all that a trustee must prove to revoke the debtor’s discharge. Accordingly, trustees and attorneys for debtors and trustees should read and understand the implications of this opinion.

On Jan. 7, 2005, Allison Marie Jordan (the debtor) filed a voluntary petition under chapter 7. Id. at *2. On Jan. 13, 2005, the bankruptcy court entered the standard administrative order (the “order to debtor”),¹ which provided in pertinent part that the debtor must:

Safely care for, protect and preserve all of [the debtor’s] property; (2) not sell, transfer, remove, destroy, mutilate or conceal any of [the debtor’s] property; (3) make all or any part [of the debtor’s property] available to the trustee, when requested to do so; and (4) cooperate with the trustee as is necessary to enable the trustee to perform the trustee’s duties as required by law.

⁵Id. The order to debtor also stated “you shall obey all orders of the U.S. Bankruptcy Court, and your responsibility for doing so does not cease even after a discharge is granted. The discharge does not conclude your bankruptcy case. A discharge may be revoked, for cause.” In re Jordan, 2006 Bankr. LEXIS 2646 (Bankr. E.D. Va. June 12, 2006). This administrative order is generated by the clerk’s office and sent to every debtor. Id. 2006 Bankr. LEXIS 2646 *3, n.1.

When she filed for bankruptcy, the debtor listed an ownership interest in a parcel of real property (the “property”) on her schedules. In re Jordan, 2006 U.S. Dist. LEXIS 71077, *3. The chapter 7 trustee investigated the property’s value and concluded that the net proceeds from its immediate sale were unlikely to exceed the total of the liens against the property and debtor’s available exemptions. Id. Although the trustee decided against a sale of the property at that time, he sent out a notice to the creditors informing them that assets might be available for distribution and did not abandon the estate’s interest in the property. Id. The debtor received her discharge on June 24, 2005, but the case remained open. After receiving her discharge, and without court approval, the debtor refinanced the debt on the property. Id. The refinance created a new deed of trust, increased the debt on the property from $197,400 to $231,000 and yielded proceeds from equity to the debtor in the amount of $15,000. Id. Four months after the debtor’s refinance, the trustee received an offer to buy the real estate for an amount that would provide for distribution to the unsecured creditors. The trustee filed a motion to sell the property. Id. at *4. The debtor’s refinance came to light only when she objected to the motion claiming that the refinanced debt on the property would result in unsecured creditors receiving nothing from the proposed sale. Id. The trustee promptly withdrew the motion and shortly thereafter filed a complaint seeking to revoke the debtor’s discharge on the grounds that the debtor refused in the case to obey any lawful order of the court. See 11 U.S.C. §727(d)(3).²

In the complaint, the trustee asserted that the debtor refused to obey the order to debtor that expressly forbade the debtor from transferring any interest in her property, even after the discharge was entered. Id. at *5. The debtor argued that she had not failed to obey the order because nothing in the order required her to obtain permission from the bankruptcy court or the trustee to refinance her property once she received her discharge. Id. In affirming the bankruptcy court’s decision revoking the debtor’s discharge, the district court analyzed whether “refused” as applied to §727(a)(6) and §727(d)(3) requires proof of willfulness, rather than simply a mistake or inability to comply. Id. at pp. 6-9. After recognizing a split in authority, the district court followed the majority approach, holding that to revoke a discharge the trustee must establish that the debtor willfully and intentionally refused to obey the court’s order. Id. at * 9 (citing Gillman v. Green (In re Green)), 335 B.R. 181, 184 (Bankr. D. Utah 2005).³ To satisfy this standard, the district court concluded that the trustee must show that (1) the debtor had knowledge of the contents of the order to debtor and (2) the debtor failed to obey it. Id. at 11. Proof by the trustee that the debtor received the order to debtor and ignored it by acting contrary to its directives is sufficient to constitute a refusal to obey a court order warranting revocation of the discharge under §727(d)(3). Id.

The most important aspect of the Jordan opinion is that a chapter 7 debtor’s failure to comply with an administrative order led to the debtor’s discharge being revoked. Moreover, the standard of proof that must be met to justify revocation of discharge does not appear to be hard to satisfy; a trustee must simply show that a debtor received the order and failed to abide by its terms. Further, this standard also appears to govern regardless of whether there is any actual harm to the estate or loss of assets because §727(d)(3) does not provide that damage to the estate must be shown in order to revoke a debtor’s discharge under this section.

The implications for debtors and chapter 7 trustees are significant.⁴ Chapter 7 debtors often do not appreciate the significance of orders like the order to debtor, and thus, it is critical that clients be counseled as to the terms and potential consequences of any failure to obey them. Trustees often do not use these types of orders to force the debtor’s cooperation or as grounds for revoking a discharge. Rather, if the published opinions on the issue are representative of all cases, many trustees seek a turnover order by separate motion rather than relying on the administrative order, which is, in effect, an order of turnover. See, e.g., Marcus v. Jeffries (In re Jeffries), 2006 Bankr. LEXIS 2958 (Bankr. E.D. Va. 2006). Trustees would be wise to use this standard order as much as possible because it reduces delays and expense to the estate. Furthermore, the administrative order may form the basis for a revocation action if the debtor fails to comply with the trustee’s request founded on its terms. Thus, even though the orders are termed “administrative,” they are very substantive in nature and should be heeded.