Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca7-15-03200/USCOURTS-ca7-15-03200-0/pdf.json

Parties Involved:
Brian K. Farley
Appellant
Margaret Kempff
Appellee

Document Text:

In the

United States Court of Appeals

For the Seventh Circuit ____________________

No. 15-3200

IN RE: MARGARET KEMPFF,

Debtor-Appellee.

APPEAL OF: BRIAN K. FARLEY.

____________________

Appeal from the United States District Court

for the Northern District of Illinois, Eastern Division.

No. 14 C 9810 — Thomas M. Durkin, Judge.

____________________

ARGUED FEBRUARY 23, 2016 — DECIDED JANUARY 30, 2017

____________________

Before WOOD, Chief Judge, and SYKES and HAMILTON,

Circuit Judges.

SYKES, Circuit Judge. Margaret Kempff’s ex-husband Bart 

embezzled more than $1 million from his employer while 

the two were still married. To evade detection, he attempted

to replenish the stolen funds, borrowing $400,000 from his 

friend Brian Farley on the ruse that the money would be 

used for a real-estate development. As security for the loan, 

Bart gave Farley a third-priority lien on the couple’s home, 

forging Margaret’s signature on the note and mortgage.

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Bart’s effort to cover his tracks did not succeed. His employer discovered the embezzlement and reported it to 

police; he was eventually convicted of felony theft. In the 

meantime, Margaret divorced him and the couple’s home

went into foreclosure. Farley filed a cross-claim in the foreclosure action seeking to enforce his lien, but the sale of the 

home did not yield nearly enough to cover even the first 

mortgage. Margaret filed for bankruptcy while the foreclosure was pending, which stayed Farley’s claim. 

Farley then filed an adversary complaint challenging

Margaret’s eligibility for a Chapter 7 discharge. He claimed 

that she made a fraudulent transfer after filing her bankruptcy petition and made multiple false statements in her bankruptcy schedules. Margaret testified at trial that these were 

innocent mistakes. The bankruptcy judge credited her

testimony and rejected each of Farley’s contentions, and the 

district court affirmed that decision. We do the same. 

Farley’s arguments for overturning the bankruptcy judge’s 

ruling are most charitably described as ill-considered. The 

decision rests on the judge’s acceptance of Margaret’s testimony as credible. Credibility determinations are almost 

never disturbed on appeal. Farley gives us no good reason to 

do so here.

I. Background

Bart Kempff, an attorney, was general counsel for a luxury home builder in suburban Chicago. Over time he embezzled approximately $1.2 million from his employer. In early 

August 2007, he launched a desperate scheme to avoid 

detection by surreptitiously replenishing the stolen money. 

To that end he asked Brian Farley, also an attorney, to lend 

him $400,000, ostensibly for a real-estate development. In 

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No. 15-3200 3

exchange Bart offered Farley a security interest on the realestate project and a second mortgage on the home he and 

Margaret owned. Farley agreed.

On August 8 Bart signed a note and mortgage, and Farley 

wrote him a check for $400,000. Bart had concealed his 

fraudulent activity from his wife, so Margaret wasn’t present 

for this transaction. Bart assured Farley that she was willing 

to sign and promised to obtain her signature on the loan 

documents. He then used the money to partially restore the 

stolen funds. On August 21 Bart and Margaret closed on a 

bank loan secured by a second mortgage on their home. Two 

days later, Bart forged Margaret’s signature on the Farley 

loan documents and sent them back to Farley, clearing the 

way for him to record the mortgage. Farley did so, but by

then it was third in order of priority.

While all this was unfolding, Bart’s employer learned of 

the embezzlement. On August 21—the same day he and 

Margaret closed on the bank loan—Bart was fired. Things 

unraveled quickly after that. Several of Margaret’s relatives 

loaned the couple sizable sums in the hope that Bart could 

repay his employer and avoid prosecution. To no avail; the 

State’s Attorney charged him with felony theft, and he was 

eventually convicted and disbarred. Meanwhile, the lender 

holding the first mortgage on the couple’s home initiated 

foreclosure proceedings. Farley filed a cross-claim against 

Bart and Margaret in the foreclosure action, but the proceeds 

of the home sale were insufficient to cover even the first 

mortgage. The nonpriority lienholders received nothing.1

 1 Farley obtained an $840,000 judgment against Bart for breach of 

contract and fraud.

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While the foreclosure action was pending, Margaret filed 

a petition for bankruptcy, which automatically stayed 

Farley’s claim against her. Farley turned to the bankruptcy 

court for relief, filing an adversary action challenging 

Margaret’s eligibility for a Chapter 7 discharge. He raised

many grounds; only two remain relevant here. Farley accused Margaret of transferring property “with intent to 

hinder, delay, or defraud a creditor” after the date of her 

bankruptcy petition. 11 U.S.C. § 727(a)(2). He also alleged 

that she “knowingly and fraudulently” made false statements in her bankruptcy filings. Id. § 727(a)(4).

The bankruptcy judge held a three-day bench trial on 

Farley’s claims. Margaret testified that she did not authorize 

the postpetition transfer and that the inaccurate statements 

in her bankruptcy filings were innocent mistakes or misunderstandings. The judge credited her testimony, found that 

she lacked fraudulent intent, and rejected Farley’s claims. 

The district court upheld this ruling, and Farley has appealed.

II. Discussion

Discharge under Chapter 7 of the Bankruptcy Code “is 

reserved for the ‘honest but unfortunate debtor.’” Stamat v. 

Neary, 635 F.3d 974, 978 (7th Cir. 2011) (quoting Grogan v. 

Garner, 498 U.S. 279, 286–87 (1991)). Section 727(a) enforces 

this reservation by “deny[ing] the privilege of discharge to 

dishonest debtors.” Id. The statute lists 12 grounds for 

denying a discharge. 11 U.S.C. § 727(a)(1)–(12). The challenger must establish the debtor’s ineligibility by a preponderance of the evidence. Stamat, 635 F.3d at 978.

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No. 15-3200 5

On appeal from a district court’s review of a bankruptcy 

judge’s ruling, “we apply the same standard as the district 

court, reviewing the bankruptcy court’s factual findings for 

clear error and the legal conclusions of both the bankruptcy 

court and the district court de novo.” In re Marcus-Rehtmeyer, 

784 F.3d 430, 436 (7th Cir. 2015). A factual finding is clearly 

erroneous if “although there is evidence to support it, the 

reviewing court on the entire evidence is left with the definite and firm conviction that a mistake has been committed.”

Kovacs v. United States, 614 F.3d 666, 672 (7th Cir. 2010)

(quotation marks omitted).

A. Fraudulent Transfer

A bankruptcy judge may deny a discharge if, after the 

date of the bankruptcy petition, the debtor transferred or 

permitted to be transferred any property of the bankruptcy 

estate “with intent to hinder, delay, or defraud a creditor.”

§ 727(a)(2). Farley alleged that Margaret fraudulently permitted her accountant to transfer funds to the Illinois 

Department of Revenue for unpaid taxes.

The tax payment concerned shares Margaret owned in 

Steel Investment Company, a closely held company controlled primarily by relatives on her mother’s side. Prior to 

her bankruptcy filing, the Illinois Department of Revenue

issued a $7,288.22 levy for unpaid taxes on income from 

these shares. By the time of the levy, Margaret had pledged 

the shares to her uncle as security for a loan; she had also 

ceded control over any income generated by the shares to 

her father in return for the financial support her parents 

were providing to her and her children. After she filed her 

Chapter 7 petition, her bankruptcy attorney prepared a letter 

informing interested parties that the automatic stay preventCase: 15-3200 Document: 25 Filed: 01/30/2017 Pages: 13
6 No. 15-3200

ed the Department of Revenue from enforcing the levy. The 

letter was sent to the Department and to Richard Schoon, 

Margaret’s accountant, who was also the accountant for Steel 

Investment Company. When Steel Investment later approved a distribution to stockholders, Schoon consulted with 

the company’s attorney and, despite the contrary instructions from Margaret’s attorney, transferred a $7,200 distribution on Margaret’s stock to the Illinois Department of 

Revenue.

The bankruptcy judge accepted Margaret’s testimony 

that this transfer occurred without her knowledge, input, or 

approval. Because § 727(a)(2) requires a knowing fraudulent

transfer, the judge held that this payment did not disqualify 

Margaret from receiving a discharge.

Farley doesn’t challenge the judge’s factual findings; he 

argues instead that § 727(a)(2) contains no requirement that

the complaining creditor actually suffer harm. In re Krehl, 

86 F.3d 737, 744 n.4 (7th Cir. 1996) (A “discharge may be 

denied even if creditors did not suffer any harm.”). That’s 

true, but irrelevant. Discharge is not denied unless the 

complaining creditor “demonstrates by a preponderance of 

the evidence that the debtor actually intended to hinder, 

delay, or defraud a creditor, ... [and] intent to defraud must 

be actual and cannot be constructive.” Village of San Jose v. 

McWilliams, 284 F.3d 785, 790 (7th Cir. 2002) (citations omitted). Farley has not argued that Margaret purposely kept 

herself in the dark while suspecting that her accountant 

would transfer assets to a favored creditor. Nor could he; the

uncontested facts tell a different story. Margaret notified 

Schoon of the bankruptcy stay and informed him that the 

Department of Revenue could not enforce the levy. After she 

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No. 15-3200 7

did so, she had no reason to think that he would transfer

assets to pay the tax debt. Farley has given us no reason to 

upset the judge’s ruling.

B. Fraudulent Filings

Farley’s other challenges fall under the rubric of 

§ 727(a)(4), which withdraws discharge eligibility if the 

debtor “knowingly and fraudulently” makes “a false oath or 

account” in connection with the bankruptcy proceeding. A 

party who opposes discharge under this provision must 

prove the following: “(1) the debtor made a statement under 

oath; (2) the statement was false; (3) the debtor knew the 

statement was false; (4) the debtor made the statement with 

fraudulent intent; and (5) the statement related materially to 

the bankruptcy case.” Stamat, 635 F.3d at 978. Although 

Margaret’s bankruptcy filings contained several misstatements, the bankruptcy judge found that Margaret lacked

fraudulent intent.2

Fraudulent intent “includes intending to deceive, which 

need not connote intending to obtain a pecuniary benefit.” In 

re Katsman, 771 F.3d 1048, 1050 (7th Cir. 2014) (internal 

quotation marks and alteration omitted). Evidence of “reckless disregard for the truth is sufficient to prove fraudulent 

intent.” Stamat, 635 F.3d at 982. “Whether a debtor possessed 

the requisite intent to defraud is a question of fact, which is 

subject to the ‘clearly erroneous’ standard of review.” In re 

Marcus-Rehtmeyer, 784 F.3d at 436. And because an “intent 

determination often will depend upon a bankruptcy court’s 

 2 The bankruptcy judge also concluded that some of the inaccuracies 

were immaterial. Farley challenges this ruling, but we do not need to 

address it.

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assessment of the debtor’s credibility,” the reviewing court’s 

deference to the bankruptcy judge’s ruling is particularly 

strong in this context. In re Krehl, 86 F.3d at 743 (addressing a 

challenge to discharge under § 727(a)(2)).

Margaret testified that each misstatement in her bankruptcy filings was an innocent mistake. The judge found her 

testimony “very credible” and concluded that the errors 

resulted from either a misunderstanding or the “utter incompetence” of Margaret’s attorney, not any fraudulent 

intent on her part. Farley carries a heavy burden to convince 

us otherwise.

The first misstatement relates to the Kempffs’ divorce settlement. In her original Schedule B, which listed her personal 

property, Margaret checked “None” next to the space reserved for “[a]limony, maintenance, support, and property 

settlements to which the debtor is or may be entitled.” In an 

examination conducted under Rule 2004 of the Federal Rules 

of Bankruptcy Procedure, Margaret admitted that this 

statement was wrong: Bart technically owes her more than

$300,000 under various provisions of their divorce settlement agreement.3 She filed an amended Schedule B about a 

week after this examination. Again she checked “None” in 

this box. But in the space reserved for “[o]ther contingent 

and unliquidated claims,” she explained that she had

“[c]laims against ex-husband Bart Kempff, pursuant to 

Judgment of Marriage Dissolution” and estimated that these

claims were worth “0.00.”

 3 The settlement also requires Bart to indemnify Margaret for marital 

debts, including debts to her parents.

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At trial Margaret testified that she did not include the divorce settlement in her original filing because Bart hadn’t 

paid her anything and she had no expectation that he would 

ever do so. The judge credited this testimony, considering it 

eminently reasonable for Margaret to believe that the settlement agreement with her ex-husband—a disbarred, felonious fraudster who has yet to pay her “one cent” of the 

amount he owes—was essentially worthless. The judge

concluded that although Margaret should have disclosed the 

settlement in her original filing, she did not omit this information with fraudulent intent.

The second misstatement was a line item in Margaret’s 

amended Schedule F listing her creditors. On this form she 

listed her parents as creditors in the amount of $1.4 million.

Farley claims this statement was willfully false because

Margaret knew that her parents didn’t have the legal authority to collect on this debt; it was at most a moral obligation, 

not a legal debt. The bankruptcy judge discerned no fraudulent intent on Margaret’s part, concluding instead that this 

line item was the result of “the inexplicable and I will say 

incompetent advice of [her bankruptcy attorney].”

The third misstatement relates to Margaret’s estimates of

the value of her clothing and jewelry. In her original and 

amended Schedule B, she valued this property at $500. At

trial Farley tried to prove—largely via Bart’s testimony—that 

Margaret’s clothing and jewelry were worth much more 

than $500. The bankruptcy judge rejected Bart’s testimony as 

self-serving, unreliable, and generally incredible; the rest of 

Farley’s evidence was unsubstantiated or irrelevant. With no 

credible evidence about the actual value of Margaret’s 

clothing and jewelry, the judge found that Farley had failed 

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to prove that her estimate was false, much less intentionally

and fraudulently so.

The fourth misstatement pertains to Margaret’s estimate 

of her current income in Schedule I. She originally reported 

$2,000 in monthly income in the form of gifts from her 

parents, who were supporting Margaret and her children 

during this period. The bankruptcy judge concluded that the 

actual amount was closer to $4,500 per month. But again the 

judge concluded that Margaret’s lower estimate was an 

innocent mistake. The difference ($2,500 per month) reflected charges Margaret made on her parents’ credit cards, and 

a reasonable layperson “would not necessarily think that 

charges made on somebody else’s charge card should be 

included as income.” The judge also noted that Margaret 

would have no motive to intentionally understate the gifts 

from her parents because the accurate $4,500-per-month 

figure “would not have put her anywhere close to the level 

at which ... there could be even a potential argument that 

she should not get a discharge.”

On this point Farley lodged a further objection: Margaret 

never filed an amended Schedule I correcting this misstatement. The judge attributed the omission to Margaret’s

attorney, whose “failure to suggest the amendments ...

reflect[ed] a misunderstanding by him of what should be 

included ... or utter incompetence in not realizing that any 

errors in the schedules should be corrected.” Once again, the 

judge found that Margaret lacked fraudulent intent.

The fifth and final misstatement is an item in Margaret’s 

amended Statement of Financial Affairs reporting payments 

made to inside creditors in the year before the bankruptcy

petition. Margaret reported a $275.35 payment to her parCase: 15-3200 Document: 25 Filed: 01/30/2017 Pages: 13
No. 15-3200 11

ents; the correct figure was $3,275.35. The judge chalked this 

up to a simple typographical error, not a fraudulent falsification. The judge also noted that the payment was made more 

than a year before Margaret’s bankruptcy petition and thus 

did not need to be reported in the first place. 

Farley challenges each of these rulings as clear error but 

offers nothing to contradict the judge’s findings. Instead he 

points to several cases in which we upheld the denial of 

discharge where the bankruptcy judge made specific findings that the debtor fraudulently falsified submissions to the 

bankruptcy court. See, e.g., Stamat, 635 F.3d 974; In re Chavin, 

150 F.3d 726 (7th Cir. 1998); In re Krehl, 86 F.3d 737; In re 

Yonikus, 974 F.2d 901 (7th Cir. 1992). These decisions cannot 

possibly help his case; here the bankruptcy judge uniformly 

found that Margaret lacked fraudulent intent. Farley also 

relies on In re Katsman and In re Marcus-Rehtmeyer, but these 

cases are no more helpful to him; in both cases the bankruptcy judge committed legal not factual error.

Katsman involved a debtor who admitted that she deliberately omitted four creditors from her bankruptcy filings.

771 F.3d at 1049. The bankruptcy judge concluded that the 

debtor lacked fraudulent intent because she was not motivated by pecuniary interest. Id. at 1050. That was a legal 

mistake. Fraudulent intent in this context requires intent to 

deceive, but the particular reason for the deception is irrelevant. Id. The judge here did not make a similar legal mistake.

Marcus-Rehtmeyer is not merely irrelevant; it actually undercuts Farley’s position. In that case the bankruptcy judge 

accepted the debtor’s explanations for discrepancies in her 

filings. We expressed some doubt about this credibility 

finding but accorded it deference anyway. 784 F.3d at 436–

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37. In the end we reversed the bankruptcy court’s ruling, but 

not because we found clear error in the judge’s factual 

findings. Rather, we held that the judge misunderstood the 

debtor’s disclosure obligations under state law. Id. at 438.

Our willingness to give the benefit of the doubt to a questionable credibility determination in Marcus-Rehtmeyer

underscores the fatal flaw in Farley’s arguments. Farley 

insists that Margaret’s misstatements taken together evince 

reckless disregard for the truth. But her misstatements can 

just as easily be attributed to simple negligence or innocent 

misunderstandings—by Margaret herself or by her attorney. 

So the bankruptcy judge held. Margaret’s explanations were 

not so self-evidently absurd or in tension with other evidence as to call that credibility finding into question. 

C. “Advice of Counsel” Defense

Finally, Farley raises a single claim of legal error. He 

maintains that the bankruptcy judge should not have allowed Margaret to testify about the advice she received from 

her attorney. This argument rests on Rule 8(c) of the Federal 

Rules of Civil Procedure, which requires that a responsive 

pleading “affirmatively state any avoidance or affirmative 

defense.” Farley insists that Margaret’s testimony amounted 

to an “advice of counsel” affirmative defense in violation of 

Rule 8(c).

There’s absolutely no support for this argument. Farley 

had the burden of proof. Margaret was permitted to offer 

evidence to rebut his claim that she made a fraudulent 

transfer and filed false schedules in the bankruptcy proceeding with intent to defraud a creditor. A debtor’s testimony 

about advice from her bankruptcy attorney is one kind of 

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No. 15-3200 13

evidence that may tend to negate fraudulent intent. See In re 

Gotwald, 488 B.R. 854, 872 (Bankr. E.D. Pa. 2013). Margaret’s 

testimony about her attorney’s advice was not a disguised 

affirmative defense. Rule 8(c) does not apply.

AFFIRMED.

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