Wednesday, February 13, 2019

Non-Dischargeable Debts in Bankruptcy

Overview

Farm financial distress remains a big issue in the ag sector at the present time.  There has been an uptick in farm and ranch bankruptcy filings over the past few years.  This makes bankruptcy law, unfortunately, important to farmers and their legal counsel.

One of the particular rules of bankruptcy concerns the dischargeability of debts.  What debts can be erased?  What debts cannot?  Does a debtor’s conduct during the bankruptcy process matter when it comes to debt discharge?

Bankruptcy debt discharge rules – that’s the topic of today’s post.

Basic Principles of Bankruptcy

The U.S. bankruptcy system is governed by two objectives - (1) a “fresh start” for poor but honest debtors who can obtain a discharge for some (but not all) debts; and (2) a policy of fairness for the unsecured creditors.  The bankruptcy process attempts to provide secured creditors (in most instances) with the value of their collateral, and provides a procedure for unsecured creditors to share in the debtor’s assets on a basis of fairness and equality.

A major feature of bankruptcy in the United States, as noted above, is discharge of indebtedness.  This makes possible the “fresh start” for individual debtors.  While the basic rule is that only debts arising before bankruptcy filing are dischargeable, not all debts can discharged.

Debts Ineligible for Discharge

Categories.  Several categories of debts are not eligible for discharge:

  • Taxes entitled to a preference (normally those within the last three years), for which a return was not filed or was filed late, or for which a fraudulent return was filed or which the debtor tried to evade, are not dischargeable. Penalties on non-dischargeable taxes are likewise not dischargeable.  See, e.g., In re Zuhone, 88 F.3d 469 (7th Cir. 1996).
  • A federal income tax lien against exempt property is not discharged in bankruptcy although the debt for the taxes, penalties and interest secured by the lien may be discharged in bankruptcy. The exempt property may be subject to foreclosure and sale to pay the tax lien.
  • Debt incurred to pay state and local taxes is not discharged.
  • Fines, penalties and forfeitures payable to a governmental unit that are not compensation for pecuniary loss are not dischargeable, nor is debt incurred to pay fines and taxes.
  • Student loans that are insured, guaranteed or funded by a government unit, for-profit entity and non-governmental entity unless the loan was “due and payable” more than five years before the filing of bankruptcy are ineligible for discharge.
  • Claims neither listed nor scheduled by the debtor in time to permit the creditor to file a timely proof of claim cannot be discharged.
  • Alimony and child support is not dischargeable.
  • Nonsupport obligations incurred from divorce or separation is not dischargeable.
  • Claims based on fraud or defalcation while the debtor was acting in a fiduciary capacity or based on embezzlement or larceny are not eligible for discharge.
  • Claims based on willful or malicious injury are not dischargeable. For example, in In re Cantrell, 208 B.R. 498 (B.A.P. 10th Cir. 1997), the debtor's loan agreement required a bank’s prior consent for the sale of secured cattle and that payment for the cattle be by check made out jointly to the debtor and the bank.  The debtor sold much of cattle herd without remitting the sale proceeds to the bank.  This left much of the loan unpaid and unsecured at the time of bankruptcy filing.  The court held that the remaining debt was not dischargeable.
  • Debts that were (or could have been) listed in a prior bankruptcy proceeding and were not discharged in the earlier proceeding because of the debtor’s acts or conduct are not eligible for discharge.
  • Claims owed to a single creditor aggregating more than $600 for luxury goods and services incurred by an individual on or within 90 days of filing the bankruptcy petition cannot be discharged.
  • Cash advances aggregating more than $875 that are consumer credit under an open-end credit plan if incurred on or within 70 days before filing the bankruptcy petition (per line of credit) are not in line for discharge.
  • Claims arising from a judgment entered against the debtor for operating a motor vehicle, vessels or aircraft while legally intoxicated are not eligible for discharge.
  • Homeowner association, condominium and cooperative fees are not discharged.
  • Debt associated with pension and/or profit-sharing plans is not dischargeable.

Fraud.  A debtor in financial distress must be very careful not to engage in fraudulent conduct.  In general, a debtor is denied discharge for fraudulent conduct within one year of filing the bankruptcy petition or during the bankruptcy case or for failure to explain a loss of assets or preserve sufficient recorded information concerning the debtor's financial condition or business transactions.  In general, a creditor doesn’t have to prove that its reliance on the debtor’s misrepresentation was reasonable.  The creditor need only show that its reliance was justifiable.  See, e.g., In re Eccles, 407 B.R. 338 (B.A.P. 8th Cir. 2009).

Relatedly, claims based on the receipt of money, property or services by fraud, false pretenses or a materially false written statement concerning the debtor's (or an insider’s) financial condition intentionally made to deceive creditors are not in line for discharge.  11 U.S.C. §523(a)(2)(B)This point was illustrated recently by a bankruptcy case from Tennessee involving a farmer.

In In re Blankenship, No. 16-10839, 2019 Bankr. LEXIS 7 (Bankr. W.D. Tenn. Jan. 2, 2019), the defendant filed Chapter 11 bankruptcy in 2016. A month after filing, the defendant sought permission to obtain post-petition financing from the plaintiff (an ag lender) in the form of a crop loan to produce and harvest the debtor’s 2016 soybean crop.  To obtain the crop loan, the defendant completed a “Crop Loan Application,” and submitted a “Farm List” to the plaintiff.  The paperwork listed the acreage and yearly rent prices for each parcel of land the defendant planned on farming during that year.

The total acreage listed in the paperwork was well over 8,000 acres. Based on the documentation, the plaintiff approved and made a $1,949,880 crop loan to the defendant.  In 2017, the defendant converted the Chapter 11 case to a Chapter 7 case and subsequently defaulted on the crop loan, at a time when the outstanding balance was $355,012.  The plaintiff sued, claiming that outstanding balance was non-dischargeable under 11 U.S.C. §523(a)(2)(B).  As noted above, under that provision, a creditor seeking to have debt excepted from discharge must establish that the debtor, with intent to deceive, used a materially false written statement to obtain a loan from the creditor and that the creditor reasonably relied on the statement to loan funds to the debtor. 

The bankruptcy court determined that the Crop Loan Application and the Farm List constituted a written statement, and the fact that the Farm List was not attached to the Crop Loan Application was immaterial.  It was more than simply a projection of the acres to be farmed in 2016 - it was a concrete representation of the debtor’s need for $1.9 million.  While the documentation indicated that the debtor planned to farm about 8,000 acres, the debtor actually farmed about 5,000 acres and had profit of approximately $1.5 million less than projected in the documentation.  Consequently, the bankruptcy court regarded the projected acreage and profit numbers as “substantially untruthful” and “materially false.”  The bankruptcy court determined that the there was nothing in the documentation that would have alerted the creditor to the falsity of the information provided, and that the creditor reasonably relied on the information to loan the $1.9 million – an amount necessary for the debtor to plant 8,000 acres.  The bankruptcy court also concluded that the debtor had intent to deceive via the false documentation based on the totality of the circumstances including the fact that the debtor had attested that the Farm List was an accurate representation of the amount of land they were going to farm.  The bankruptcy court pointed out that the debtor knew that the amount of land actually farmed in the prior year was only 5,200 acres.  The bankruptcy court found it inconceivable that the defendant anticipated being able to increase row crop production by almost 50 percent from the previous year based on leasing additional land, while being in an active bankruptcy case. Consequently, the remaining balance of the loan was not dischargeable.   

Conclusion

There is no doubt that times are tough in agriculture.  When finances get strained, it can take an emotional toll on the parties involved.  Even the temptation to engage in conduct that could be construed as fraudulent should be avoided.  Legal, financial and tax counsel should be consulted and allowed to assist throughout the painful process of debt adjustment and, perhaps, reorganization of the farming or ranching operation for long-term success.  In the Tennessee bankruptcy case discussed above, the debtor was not represented by legal counsel.  That was a big mistake.  

https://lawprofessors.typepad.com/agriculturallaw/2019/02/non-dischargeable-debts-in-bankruptcy.html

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