Source: https://www.losangelesbankruptcylawyerblawg.com/category/exceptions-to-discharge/page/2/
Timestamp: 2019-04-20 07:16:23+00:00

Document:
Bankruptcy offers relief to people and businesses in financial distress, allowing them to pay down debts over a period of time, or pay them down quickly by liquidating assets. A court may then grant a discharge of some unpaid debts. The bankruptcy process is not, however, supposed to give people a way out of debts incurred because of dishonest or unlawful acts. Congress has placed provisions in the Bankruptcy Code that except certain types of debt from discharge. A California district court recently considered the appeal of creditors who alleged that their claim against a debtor was excepted from discharge because it involved false pretenses. In re De Long, No. 2:14-cv-02947, order (E.D. Cal., Jan. 7, 2016).
The Bankruptcy Code bars a wide range of debts from discharge. 11 U.S.C. § 523(a). In some cases, such as child support obligations and student loans, an entire class of debt is excepted from discharge. Other exceptions are based on the manner in which the debtor incurred the debt, including debts for something of value “to the extent obtained by…false pretenses, a false representation, or actual fraud…” Id. at § 523(a)(2)(A). Creditors may ask a bankruptcy court to find that a debt is not subject to discharge under this section, after providing notice to all parties and conducting a hearing. Id. at § 523(c)(1).
The debtor in the De Long case owned and operated a construction company in Sacramento, California. The creditors, a married couple, hired the company to work on their home. The original contract between the parties, signed in June 2010, included a total project cost of $246,000 and a payment schedule. The creditors eventually paid the construction company a total of $189,400, but they hired another contractor in late 2011 to complete the job.
A bankruptcy court may grant a discharge of remaining debts at the end of a case, allowing a fresh start for the debtor. Certain debts, however, are not eligible for discharge. A bankruptcy judge in California recently considered a creditor’s argument that an alleged debt was nondischargeable on one or more fault-based grounds, since it was incurred as a result of fraud or false pretenses, fraud by a fiduciary, or willful and malicious acts resulting in injury. 11 U.S.C. §§ 523(a)(2)(A), (a)(4), (a)(6). The judge reviewed the standard of proof for each alleged ground and ruled that the creditor failed to provide sufficient evidence to support her claims. In re Ogilvie, No. 13-bk-31179, Adv. Proc. No. 13-ap-03221, mem. dec. (N.D. Cal., Feb. 23, 2015).
A debt involving something of value obtained through “false pretenses, a false representation, or actual fraud” is not dischargeable. 11 U.S.C. § 523(a)(2)(A). The Ninth Circuit, which includes California, uses a five-part test in this sort of claim: (1) the debtor made statements or representations to the creditor, (2) which they knew at the time were false, (3) with fraudulent intent, (4) and the creditor reasonably relied on these statements or representations in making the transaction and (5) suffered damages as a result. In re Eashai, 87 F.3d 1082, 1086 (9th Cir. 1996). A creditor must establish each element by a preponderance of the evidence.
Debts incurred through fraud while acting in a fiduciary capacity are not dischargeable. 11 U.S.C. § 523(a)(4). A creditor has to prove, by a preponderance of the evidence, the existence of an express trust, the actual act of fraud, and the fiduciary relationship. In re Stanifer, 236 B.R. 709 (B.A.P. 9th Cir. 1999). Proving a trust requires evidence of a trust agreement, including “sufficient words to create a trust.” Ogilvie, mem. dec. at 9.
Child support, spousal support, and any other “domestic support obligation” (DSO), as defined by the Bankruptcy Code, are treated differently in a bankruptcy case from most other types of debt. DSOs have the highest priority for payment of any unsecured claim. 11 U.S.C. § 507(a)(1). They are excepted from discharge. Id. at § 523(a)(5). Property claimed as exempt under bankruptcy law could still be liable for DSO debts. Id. at § 522(c)(1). The bankruptcy trustee has additional duties when a creditor files a claim for amounts owed under a DSO.
The Bankruptcy Code broadly defines a DSO as any debt “owed to or recoverable by” a debtor’s spouse, ex-spouse, child, child’s parent or guardian, or governmental agency that is “in the nature of alimony, maintenance, or support,” and that is part of a court order or court-approved agreement. 11 U.S.C. § 101(14A). This includes orders for child support and spousal support under California law. See Cal. Fam. Code §§ 4000 et seq., 4330 et seq.
Courts around the country have found that other debts may meet the Bankruptcy Code’s definition of a DRO. These include an award of attorney’s fees in a proceeding for a modification of child support, In re Johnson, 445 B.R. 50 (Bankr. D. Mass. 2011); a duty to make mortgage payments on a former spouse’s residence, In re Westerfield, 403 B.R. 545 (Bankr. E.D. Tenn. 2009); and juvenile detention costs payable by a parent under state law, In re Rivera, 511 B.R. 643 (BAP 9th Cir. 2014). Courts found that each of these debts was excepted from discharge under § 523(a)(5). A monetary award that was part of the property division in a pre-bankruptcy divorce decree, however, was not a DRO, and therefore it was discharged at the end of the ex-husband’s Chapter 13 case. In re Mooney, 532 B.R. 313 (Bankr. D. Id. 2015).
A California federal district court ruled that fines assessed under a California law that allows employees to enforce state labor law as “private attorneys general” are not dischargeable in a Chapter 7 bankruptcy proceeding. Medina v. Poel, No. 1:14-cv-01302, order (E.D. Cal., Jan. 20, 2015). Federal bankruptcy law excepts certain fines and other penalties payable to a government entity from discharge. 11 U.S.C. § 523(a)(7). The debtor argued that any damages awarded in a lawsuit brought by an individual under the California Private Attorney General Act (PAGA), Cal. Labor Code § 2698 et seq., do not fit the definitions established in § 523(a)(7) and therefore should be subject to discharge. While the bankruptcy court agreed with the debtor, the district court reversed that holding, finding that PAGA provides for civil penalties that are excepted from discharge.
The creditor filed suit under PAGA against the debtor in state court in 2010 for alleged wage and hour law violations. PAGA allows employees to sue an employer for civil penalties for violations of state labor laws. The California legislature enacted PAGA in recognition of state officials’ inability to “keep pace with the sprawling and often ‘underground’ economy.” Medina, order at 5, citing Iskanian v. CLS Transp. Los Angeles, LLC, 59 Cal.4th 348, 379 (2014). It therefore decided to “deputize and incentivize employees uniquely positioned to detect and prosecute violations.” Id.
The state PAGA lawsuit was still pending when the debtor filed for Chapter 7 bankruptcy in August 2012. The debtor filed an adversary proceeding against the creditor. In a motion for summary judgment, the debtor claimed that any liability under the PAGA lawsuit was not excepted from discharge under § 523(a)(7), and that any liability had already been discharged by the general discharge issued by the bankruptcy court in June 2013. The bankruptcy court granted the debtor’s motion, and the creditor appealed to the district court. The two questions presented to the district court on appeal were whether the bankruptcy court erred in ruling that civil penalties under PAGA do not fall under the exception to discharge in § 523(a)(7), and whether the court erred in ruling that the creditor’s claims were already discharged.
A bankruptcy court reopened a Chapter 7 case after granting a discharge on the debtor’s motion, although not for the reason stated by the debtor. In re Sullivan, No. 11-38246-A-7, memorandum (Bankr. E.D. Cal., Feb. 23, 2015). The debtor asked the court to reopen the case in order to amend the schedules to include one or more creditors who had not been included at the beginning of the case. The court held that amending the schedules was not necessary under the circumstances, but it also noted that the creditors may be able to claim an exception to discharge under 11 U.S.C. § 523. The court reopened the case in order to allow the creditors the opportunity to challenge the discharge of their debts.
The debtor filed a Chapter 7 petition on July 26, 2011. The case was determined to be a “no asset” case, so no proofs of claim were requested from the creditors. The trustee was not able to find any nonexempt assets to liquidate and filed a “no distribution” report with the court. No creditor objected to the trustee’s report. The court ordered a discharge and closed the case. Since the case was a “no-asset, no-bar-date-case,” Sullivan, mem. at 1, any dischargeable debt was discharged by the court’s order, whether or not the debt was included in the schedules or the creditor received notice of the case. See 11 U.S.C. § 727(b).
At some point after the discharge and closing of the case, the debtor moved to reopen on the grounds that the schedules did not include one or more creditors and needed to be amended. Since the discharge affected all creditors, not just the ones listed on the schedules, the court held that amending the schedules was not necessary. The court noted that a procedure exists for creditors who did not have the opportunity to object to discharge, but it held that amending the schedules would not address that issue.
The story of a film producer who finds himself in a range of financial difficulties after poor performance at the box office is not unique to Los Angeles, but Hollywood probably gives this region more examples of this tale than most cities. One producer’s story, recently covered by the Los Angeles Times, describes just how difficult the entertainment business usually is, how easy it can be to lose money, and how many ways the personal bankruptcy process can become involved in the process. Bankruptcy can be helpful to the parties involved in these types of situations, but just like the movie business, it can also get very complicated.
The debtor in this case has what the Los Angeles Times calls a “showbiz pedigree.” His uncle was a well-known Hollywood producer, and his father-in-law was part of the production company that bought Miramax from Disney in 2010. He had some successes in the early- to mid-2000’s, such as the 2005 film Lord of War starring Nicolas Cage and Ethan Hawke. By 2008, however, he had amassed several “flops,” as well as films that were never released in theaters. His production company, which he formed with a former executive of the William Morris Agency, folded that year.
In early 2009, the debtor filed for Chapter 7 bankruptcy protection. In re Eberts, No. 2:09-bk-12534, petition (Bankr. C.D. Cal., Feb. 5, 2009). His Schedule F, the list of creditors with unsecured nonpriority claims, identified more than $7.7 million in debts. These included loans for both personal and business purposes, and personal guarantys of business loans. He received a discharge of debt from the court on March 15, 2013, although that was far from the end of the legal issues.
A creditor objected to the discharge of a judgment for damages against the debtor in a Chapter 7 bankruptcy case under 11 U.S.C. § 523(a)(6), which prohibits discharge of debts resulting from “willful and malicious injury by the debtor.” The bankruptcy court granted partial summary judgment for the creditor, finding part of the damage award nondischargeable. The creditor appealed to the Bankruptcy Appellate Panel (BAP), arguing that the entire damage award should be excepted from discharge. The BAP vacated the bankruptcy court’s order and remanded the matter for further proceedings regarding how much of the judgment involved tortious action. In re Lawson, No. NC-14-1153, memorandum (B.A.P. 9th Cir., Mar. 23, 2015).
The debtor operates a winery in California’s Napa Valley under an assumed business name. He entered into a two-year master distribution agreement (MDA) with the creditor in May 2011, which gave the creditor the exclusive right to distribute the debtor’s wine in China. The BAP states that “signs of strain in the business relationship” soon became apparent. Lawson, mem. at 3. In May 2012, the creditor placed an order for Merlot and paid in full. It also placed an order for Cabernet, but the debtor canceled this order and, according to the BAP, refused to release the Merlot to the creditor unless it paid additional money for expenses related to the cancelled Cabernet order and underpayment for earlier orders.
The creditor filed suit against the debtor in California state court after it lost two major contracts in China. An arbitrator found that the debtor was liable for conversion of the Merlot order, breach of the MDA, and breach of the covenant of good faith and fair dealing. The court confirmed the arbitrator’s award of over $222,000 in compensatory and punitive damages, attorney’s fees, and costs.

References: § 523
 § 523
 § 523
 § 523
 § 523
 § 507
 § 523
 § 522
 § 101
 § 523
 v. 
in fine
 § 523
 § 2698
 § 523
 v. 
 § 523
 § 523
 § 523
 § 727
 § 523