By: Donald L Swanson
Under 11 U.S.C. § 727(a)(2), an individual debtor may be denied a discharge, in its entirely, for making a transfer “with intent to hinder, delay, or defraud” a creditor or the trustee.
On April 17, 2023, the Bankruptcy Court for Eastern Michigan ruled:
- an “intent to hinder” the bankruptcy trustee is sufficient to be denied a discharge under § 727(a)(2), because the phrase “hinder, delay, or defraud” is in the disjunctive; and
- the Debtors intended to “hinder” the bankruptcy Trustee by electing, post-petition, to apply their tax refund to their next year’s taxes.
Nearly a year later, on March 29, 2024, the U.S. District Court for Eastern Michigan reverses on appeal and remands the case “for entry of a discharge,” declaring:
- the bankruptcy court “erred” because “it did not adequately support its finding”; and
- “this Court is left with the ‘definite and firm conviction’ that the bankruptcy court erred in finding that the debtors intended to hinder the trustee.”
Facts
Here’s what happened.
About a year before filing bankruptcy, Debtors elect to apply their tax refund to their next year’s tax bill.
A year later, and several weeks after filing Chapter 7 bankruptcy, Debtor’s elect to apply their tax refund to their next year’s tax bill.
For such post-petition action, Debtor’s should be denied their discharge, in its entirety, under § 727(a)(2). That’s what the Chapter 7 Trustee contends and what the Bankruptcy Court rules.
Neither the bankruptcy Trustee nor the Bankruptcy Court are impressed by this additional fact:
- during the bankruptcy, Debtors direct that their next year’s tax refund (in about the same amount) be paid to the bankruptcy trustee.
District Court’s Reversal Rationale
The only issue on appeal is Debtor’s intent.
The only evidence cited by the Bankruptcy Court for its intent-to-hinder finding is the Debtors’ trial testimony.
At trial, Debtors testified that their purpose in their post-petition election to apply their tax overpayment to their next year’s tax liability was to make sure that their next-year’s taxes would be paid.
From this, the bankruptcy court inferred an intent to hinder the trustee:
- “In the post-petition context,” the Debtors making such a transfer with such a purpose is wholly inconsistent with the duties of the Chapter 7 Trustee; and
- this means the Debtors had, at minimum, an intent to hinder the trustee.
However, Debtors gave an identical explanation for why they made the same election the year before filing bankruptcy. But the Bankruptcy Court found nothing wrong with that:
- “Debtors’ only intent in making their [pre-petition] tax refund elections” was to assure that “their taxing authority creditors would be paid in full” for the next year’s taxes: and
- “Debtors’ intent in taking this [pre-petition] action was not to hinder, delay, or defraud creditors, but rather merely to prefer the two tax creditors over their other creditors.”
The Bankruptcy Court did not explain why its conclusion regarding intent was different in the post-petition context.
The Bankruptcy Court explained in detail how Debtors’ post-petition election could have hindered the Trustee, but the Bankruptcy Court:
- did not find that Debtors were aware of this potential effect;
- even assumed that Debtors “were not intimately familiar with the foregoing legal principles about bankruptcy distributions and priorities”; and
- noted that Debtors’ attorney was “no doubt” familiar with the legal principles of bankruptcy; but
- such a finding has no bearing on Debtors’ familiarity or intent; and
- there is no evidence that Debtors discussed the tax election with their attorney.
In sum:
- the Bankruptcy Court pointed to no evidence that the Debtors intended to hinder the Trustee—or were even aware that their actions might have that effect; yet
- the Bankruptcy Court still found that “Debtors’ actual subjective intent . . . was, in substance, an intent to ‘hinder’ the Trustee” and denied Debtors a discharge;
- such a finding is improper because:
- exceptions to discharge “are narrowly construed in furtherance of the Bankruptcy Code’s fresh start policy”;
- Courts have repeatedly held that a total bar to discharge is an “extreme step”; and
- § 727 is to be “construed liberally in favor of the debtor.”
So, the District Court is left with the “definite and firm conviction” that the bankruptcy court erred in finding that Debtors intended to hinder the trustee.
Further Appeal
On April 12, 2024, the Trustee appealed the District Court’s ruling to the U.S. Court of Appeals for the Sixth Circuit.
Conclusion
It will be interesting to see what the Sixth Circuit does with this case on appeal!
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