VI.Creditors' Rights and Restrictions in Bankruptcy
A. Dismissal or Conversion of Case
Sections 348, 349, 706, 707,1307(c), 1112
Conversion and dismissal are delineated in each of the three major forms
of bankruptcy (Chapters 7, 11 and 13).The general effect of a dismissal
or conversion is found in Sections 348 and 349 of Title 11 of the United
States Code of Laws (the "Bankruptcy Code"). Hereinafter, references
to a Section shall be a reference to a section within the Bankruptcy Code
unless otherwise specified.
A.1.1 From Chapter 7 to Another Chapter
Section 706(a)provides that the debtor may convert a Chapter 7 case to
a Chapter 11, 12, or 13 as long as the case has not been previously converted
from another chapter.Waivers that prohibit the conversion of bankruptcy
cases to or from a Chapter 7 are unenforceable.As it relates to creditors
or other parties in interest, they may make a motion to convert a case
under Chapter 7 to only Chapter 11.See Section 706(b) (allowing for conversion
to Chapter 11); Section 706(c) (prohibiting conversion to Chapter 12 or
13 without debtor's consent).The creditor bears the burden of showing
conversion to Chapter 11 will benefit all of the parties in interest and
the decision on whether to convert is left to the sound discretion of
the trial court.See 124 Cong. Rec. H11,098 (September 28, 1978); S.17414
(October 6, 1978).Conversion is contingent on the eligibility of the debtor
to be a proper debtor under the new chapter. Section 706(d).
A.1.2. From Chapter 7 to Chapter 13
A Chapter 7 Debtor may convert his case to a Chapter 13 even after the
debtor has received a Chapter 7 discharge.
In re Young, 237 F.3d 1168 (10th Cir. 2001);
In re Mosby, 244 B.R. 79 (Bankr. E.D. Va. 2000);
but see In re Hauswirth, 242 B.R. 95 (Bankr. N.D. Ga. 1999) (debtor can only receive one discharge
and Chapter 7 discharge must first be vacated or Chapter13 case must be
filed in a separate case).
For plan purposes, under 706(a) the conversion date from a Chapter 7 to
a Chapter 13 is the date of the order providing for the conversion, not
the date the motion is filed.
In re Calder, 973 F.2d 862 (10
th Cir. 1992).
A.1.3. Creditors Rights in Motion to Convert.
In the case of
In re Finney, 992 F.2d 43 (4
th Cir. 1993), the Fourth Circuit had before it a debtor that had refused
to cooperate with the Chapter 7 Trustee and had engaged in post-petition
undisclosed transfers of his assets.This activity cost the debtor his
Chapter 7 discharge.The debtor moved to convert the case to a Chapter
11.The Fourth Circuit held that the court could dismiss the Chapter 11
case or reconvert the case to a Chapter 7 if it found subjective bad faith
or that the Chapter 11 was objectively futile.However, the Fourth Circuit
also held that the debtor was entitled to a hearing on the issue of objective futility.
A.1.4. From Chapter 13 to another Chapter
Section 1307(a) gives the debtor an absolute right to convert a Chapter
13 into a Chapter 7. Also, Section 1307(b) gives the debtor the absolute
right to dismiss his Chapter 13 case.The only time this right is restricted
is when the debtor had previously converted the case from another Chapter
to Chapter 13.Since the debtor has the absolute right to dismiss, most
creditors do not seek to convert the case to another Chapter.Nevertheless,
Section 1307(c) does provide certain enumerated reasons for converting
the case to Chapter 7 or dismissing the case in the best interests of
the creditors if the moving part can show (1) unreasonable delay (2) nonpayment
of the required fees and charges (3) failure to timely file a plan; (4)
failure to commence making payments; (5) denial of confirmation; (6) a
material default; (7) revocation of the order of confirmation; (8) termination
of the current plan pursuant to its own terms; or (9) if the U.S. Trustee's
office requests conversion because of the debtor failure to provide certain
required information. Section 1307(c). Similarly, the case can be converted
to Chapter 11.Section 1307(d).If the debtor is a farmer, the case cannot
be converted without the debtor's consent.Section 1307(e).
A.1.5. From Chapter 11 to another Chapter.
Section 1112(a) also gives the debtor the ability to convert a Chapter
11 to a chapter 7 unless
- The debtor is no longer the debtor in possession,
- The case was commenced as an involuntary case, or
- The case was converted on someone else's request.
Section 1112(b) states that the court, the Trustee or any party in interest
can move to convert the case to a Chapter 7 and the Court may so convert
the case after notice and hearing. The moving party bears the burden of
showing cause for the conversion.
A court may convert a case from a Chapter 11 to a Chapter 7 if the debtor
seeks Chapter 11 protection for subjective bad faith or if the case is
Finney v. Smith, 141 B.R. 94 (E.D. Va. 1192)
aff'd and modified 992 F.2d 43 (4
th Cir. 1993).
In the case of
In re Phoenix Medical Technology, Inc., C/A No. 00-07253-W (Bankr. D.S.C. 3/30/2001), the South Carolina Bankruptcy
Court, the Court found that sufficient cause existed to convert the Chapter
11 case to a Chapter 7 through a two-step process: (1) the Court examined
whether "cause" exists to dismiss the Chapter 11 proceeding
or convert it to a Chapter 7 and (2) the Court examined whether to dismiss
or convert was in "the best interest of creditors and the estate."
The Court found the following facts supported conversion (1) there had
never been any prospect of rehabilitation of Debtor's business, (2)
during the bankruptcy case, Debtor had continued to borrow substantial
sums of money beyond its revenues from its primary secured creditor and
post-petition lender for the stated purpose of preserving and eventually
selling its assets for the benefit of all of its creditors, (3) the format
of borrowing was approved based upon the assurances of counsel and the
representation that the liquidation would be quick, to minimize expense,
and produce a dividend to unsecured creditors; however, the delay in the
case was overall unreasonable and while Debtor had incurred a significant
post-petition debt, only limited sales had taken place; (4) debtor failed
to timely act in regards to the motions filed in the case requesting the
Court's approval of the post-petition financing agreement and borrowed
funds prior to court approval and (5) the Court was further concerned
that the arrangement involving the payment of Debtor counsel's fees
tainted his independence in the case.
In the case of
In re Carowinds Boulevard Homes, Inc., C/A No. 00-10572-W (Bankr. D.S.C. 12/20/2000)(JW), the Court denied the
creditors' Motion to Convert the Chapter 11 case to a Chapter 7 even
though (1) the Debtor improperly used a secured parties collateral, (2)
the debtor was significantly out-of-trust, (3) the Debtor made untruthful
statements regarding the location of the collateral, and (4) the present
management's failed to distance itself from the pre-petition management.
In so denying, the Court recognized that conversion is a drastic remedy
and noted that the case was only 21 days old at the time of the hearing
on the Motion to Convert. Even though the Court refused to convert the
case, the Court did order the appointment of a Chapter 11 Trustee.
However, in the case of
In re Long Bay Dunes Homeowners Association, Inc., C-99-06930-W (Bankr. D.S.C. 11/8/1999), the South Carolina Bankruptcy
Court granted the Motion to Dismiss the Chapter 11 Bankruptcy. The Court
applied the two-pronged test set forth by the Fourth Circuit in
Carolin and considered whether the reorganization was objectively futile and whether
the case was filed in subjective bad faith. The Court concluded that there
was no valuable ongoing business activity to protect by filing a Chapter
11 and that a confirmation of the plan could not be met pursuant to §1129
because the only unimpaired class had indicated their objection to the plan.
Timing seems to have a great deal to do with the success of a motion to
dismiss or convert. Local Rule 2081-1(c) of the South Carolina Bankruptcy
Court provides that a debtor has 180 days from the date of the petition
to file a plan and disclosure statement.If the debtor fails to meet this
deadline, this alone justifies the conversion or dismissal of a case.
After the Chapter 11 plan has been confirmed the debtor is no longer a
debtor in possession and cannot convert the case into a Chapter 7.
In re T.S.P. Indus., Inc., 120 B.R. 107 (Bankr. N.D. Ill. 1990).
1.A.6. Effect of Conversion
The effect of Conversion is governed by Section 348.A conversion constitutes
a new order for relief, but does not change the petition's filing
date. A claim arising after the original order for relief but after conversion
is treated as a pre-petition claim (that still may be entitled to priority
status as an administrative claim).
Conversion of a case does not reset the period for objecting to the debtor's
In re Bell, 225 F.3d 203 (2d Cir. 2000).However, the conversion from a Chapter 11
to a Chapter 7 generates a new period for filing complaints objecting
the discharge of a debt.
F & M Marquette Nat'l Bank v. Ritchards, 780 F.2d 24 (8
th Cir. 1985).
Conversion of the case does not change rulings made during the previous
chapter proceeding and would not revive a lien set aside during the previous
In re Cooke, 169 B.R. 662 (Bankr. W.D. Mo. 19994).Also, some case law holds that a
confirmed plans of reorganization bind creditors, not just in cases that
are converted but also in state court proceedings.
See McNaughton-McKay Electric Co., Inc. v. Andrich, 482 S.E.2d 564 (S.C. Ct. App. 1997) (creditor had to adjust amount claimed
by the amount agreed to in confirmed plan of reorganization).
Lastly, under 348 (f) if a debtor converts a chapter 13 into a chapter
7 the property's valuations and allowed secured claims will apply
in the converted case (reduced by the amount paid in the Chapter 13).
A.2.1. Creditors Rights to Seek to Dismiss Chapter 7.
Under Section 707(a) a Court may dismiss a Chapter 7, only after notice
and a hearing and after a finding of cause (such as unreasonable delay
and nonpayment of any fees). Under Section 707(a), Courts often differ
on what is cause (lack of good faith , bad faith, etc.) to dismiss a case.Cases
often show that dismissal may not be always appropriate where the debtor
acted in bad faith or is abusing the bankruptcy system and the dismissal
will only serve to injure creditors.
See generally In re Turpen, 244 B.R. 431 (B.A.P. 8
th Cir. 2000);
In re Simmons, 200 F.3d 738 (11
th Cir. 2000).
A.2.2. The Court and U.S. Trustee Substantial Abuse Determination in Chapter 7.
Under Section 707(b), the Court or an United States Trustee (not a creditor)
can move to dismiss the case if the debtor's debts are primarily consumer
debts and the petition is a substantial abuse of Chapter 7.Primarily consumer
debt has been defined as more than 50% of the total debt.
In re Stewart, 175 F.3d796 (10
Determining if substantial abuse exists under the circumstances include
evaluating factors such as: (1)sudden illness, calamity, disability, or
unemployment; (2) cash advances for consumer purchases in excess of the
ability to pay; (3) excessive family budget; (4) accurate reflection of
the debtor's true financial status in the debtor's schedules and
statement of income and expenses; (5) the debtor's good faith; (6)
if the debtor enjoys a stable source of future income; (7) if the debtor
is elligible for a chapter 13; (8) if state remedies exist to ease the
financial troubles; (9) the degree of relief available through private
negotiation; and (10) if the debtor's expenses are able to be reduced
without depriving him of necessities.
In re Stewart, 175 F.3d 796 (10
2.A.3. Dismissal in Chapter 13.
Under Section 1307, after notice and hearing a party in interest or the
United States Trustee may dismiss a chapter 13 case for cause if the dismissal
is in the best interest of the creditors and the estate.Section 1307(c)
provides ten (10) examples of cause for dismissal or conversion. The last
two can only be exercised by the United States Trustee.
2.A.4. Dismissal in Chapter 11.
Section 1112 also allows a party in interest or the United States Trustee
to dismiss the case after notice, and a hearing wherecause is established.
A dismissal under 349(a) is normally without prejudice and the debtor
can refile and obtain discharge from those debts that were previously
filed in first case.The court can dismiss the case with prejudice which
forbids the debtor from freely discharging her debts for a specified period
of time. A dismissal "revests the property of the estate in the entity
in which such property was vested immediately before the commencement
of the case." 349(b)(3).
In the case of
In re Hartley, 187 B.R. 506 (Bkrtcy. D.S.C. 1995), the Court dismissed Debtor's
Chapter 13 based upon debtors and debtor's spouses previous filings.
However, in the case of
In re Heath, 188 B.R. 17 (Bkrtcy. D.S.C. 1995), the Chapter 13 debtor's case was
not dismissed for lack of good faith, just because the husband had filed
a previous Chapter 13. The court did not impute this filing to this debtor
because of a divorce and general animosity towards each other.
As it relates to dismissals with prejudice, in the case of
In re Marett, 96-72959-W (Bkrtcy.D.S.C. 11/13/96), the court dismissed Chapter 13 with
prejudice for 180 days and sanctioned debtor for repetitive filing and
for lack of feasibility, failure to pay and failure to file documents
and provide information.
If the original bankruptcy is dismissed, the creditor in a subsequent case,
can recalculate hisclaim and interest on that original claim.
In re Whitmore, 154 B.R. 314 (Bankr. D. Nev. 1993).The dismissal of a case reinstates
a void lien unless the court orders otherwise.
In re Sadler, 935 F.2d 918 (7th Cir. 1991).
Dismissal of a case does not immediately strip the bankruptcy court of
jurisdiction over a related adversary proceeding.
In re Porgis, 44 F.3d 159 (2
nd Cir. 1995).
If a confirmed Chapter 13 case is dismissed, then the funds must still
be dispersed pursuant to the plan and not returned to the debtor.
In re Bell, 248 B.R. 236 (Bankr. W.D. N.Y. 2000).
Creditors should note that they can move for dismissal under 1307 or 1112.Also
that they can move that the case be dismissed with prejudice.Furthermore,
a dismissal frees up all property encumbered by the bankruptcy.
B. Appointment of a Trustee or Examiner
Section 321 dictates who may serve as a trustee while 322 governs the Trustee's
qualifications and bonds.Section 323 provides that the Trustee is the
representative of the estate and thathe has the capacity to both sue and be sued.
B.1. The Trustee's Ability to Waive the Debtor's Attorney-Client Privilege
The Trustee can waive a corporate debtor's attorney client privilege
for prepetition communications.
Commodity Futures Trading Comm,n v. Weintraub, 471 U.S. 343 (1983).Whether he can waive an individual debtor's attorney
client privilege for prepetition communications is presently uncertain.
The decision by the United States Supreme Court in
Commodity Futures Trading Comm'n v. Weintraub, 471 U.S. 343, 105 S.Ct. 1986, 85 L.Ed. 2d 372 (1985) is recognized as
a seminal case in the area of attorney-client privilege. In
Weintraub, the Supreme Court held that the attorney-client privilege was available
to a corporation, that the privilege passed from the corporation management
to a Chapter 7 Trustee, and that the privilege could be waived by the
Chapter 7 trustee for pre-petition attorney-client communication.The Supreme
Court left the issue of an individual debtor's assertion of a privilege
to the courts to decide on a case-by-case basis.That Court noted that:
Our holding today has no bearing on the problem of individual bankruptcy,
which we have no reason to address in this case. . . . An individual .
. . can act for himself; there is no 'management' that controls
a solvent individual's attorney-client privilege.If control over that
privilege passes to a trustee, it must be under some theory different
from the one we embrace in this case.
Weintraub, 471-U.S. at 356-357, 105 S. Ct. at 1995.
Several courts since
Weintraub have considered the issue of the Trustee's rights to waive the individuals'
attorney client privilege.The Bankruptcy Court for the District of Colorado in
In Re Foster, 217 B.R. 631 (Bankr. Colo. 1997) provides the most thoroughly reasoned
case on the issue of passage of attorney-client information in an individual
chapter 7 case.That court held:
The right to assert an attorney-client privilege is acquired by the trustee
in bankruptcy in a situation where. . .the trustee has become entitled
to and the estate is owner of assets in the nature of a debtor's pre-petition
causes of action against third parties.
Id. at 635. In
Foster, the trustee was requesting the turnover of recorded information relating
to the debtor's property and financial affairs in order to pursue
causes of actions for breach of promissory note, breach of consulting
agreement, breach of personal guarantee, fraud in the inducement and general
fraud.The Court found that neither the attorney-client privilege, the
work-product doctrine nor the constitutional rights asserted by the debtor,
bar the production of documents requested by the trustee from debtors'
counsel.The Court concluded that "the right to assert, or to waive,
the attorney-client privilege, passes from the debtor to a bankruptcy
trustee where . . . it involves recovery of assets of the estate in the
nature of pre-petition civil action."
Id. at 638.
Similarly, in the case of
In Re Bazemore, 216 B.R. 1020 (Bankr. S.D.Ga. 1998), the Court confronted the issue of
whether or not the trustee in a Chapter 7 individual bankruptcy has the
authority to waive the attorney-client privilege of the debtor and require
the debtor's insurance company appointed attorney to be deposed regarding
his representation of the debtor in the state court action.The Court concluded
that the examination would aid the trustee in determining whether the
bankruptcy estate of the debtor had a cause of action against the attorney
and the insurance company for malpractice or bad faith.The Court concluding
that the trustee could waive the privilege and held:
when the trustee seeks to determine whether the bankruptcy estate holds
a cause of action against an insurance company and the attorney it appointed
for potential bad faith in settlement and malpractice during a state court
case, which judgment precipitated the debtors' bankruptcy, the trustee
holds the right to waive the attorney-client privilege.
Id. at 1025.
In Re Smith, 24 B.R. 3 (Bankr. S.D. Fla. 1982) is also a case with facts similar to
this case. In
Smith, a wrongful death state judgment caused the debtor to file for bankruptcy.
The trustee was attempting to depose the debtor to determine if the estate
might have a cause of action for bad faith refusal to settle and malpractice
against the liability insurance carrier and appointed attorney of the
debtor.The Court held that "any attorney-client privilege which the
debtor had passes by operation of the law to the bankruptcy trustee."
Smith, 24 B.R. at 5. (Citing
O.P.M. Leasing Services, Inc., 13 B.R. 64 (S.D.N.Y. 1981);
Citibank, N.A. v. Andros, 666 F.2d 1192 (8th Cir. 1981); and
In re Blier Cedar Co., Inc., 10 B.R. 993 (Bankr. Me. 1981). In
Smith, the debtor refused to answer a number of questions at his 2004 examination
invoking his privilege through his attorney. The Court noted in
Smith that the debtor's position was argued primarily by the insurance company
lawyers who defended the debtor in the wrongful death action.
Nevertheless, there is a line of cases finding that a trustee does not
have the power to waive the attorney-client privilege of the individual
debtor and these cases focus on personal harm to or control over the debtor. See
e.g. In Re Silivio, 27 B.R. 28 (Bankr. S.D. Fla. 1982)(Where an individual owner of the stock
of a bankruptcy corporation also filed for bankruptcy, the trustee could
not waive the privilege for the individual because the disclosure could
involve criminal conduct and thus, loss of personal freedom).
B.2. The Appointment of a Trustee
B.2.1.The Chapter 7 Trustee
Section 701 provides for the immediate appointment of a Chapter 7 interim
trustee.In South Carolina, this Trustee is appointed from a panel of private
trustees.If a creditor is uncomfortable with the appointed trustee, the
creditor can then call for the election of a new trustee under Section
702.This creditor must be a fixed unsecured creditor entitled to a distribution
of property of the estate.The creditor cannot be an insider.This election
is held at the 341 first meeting of creditors.A candidate is elected the
new trustee if 20% of those unsecured creditors vote for him and he receives
a majority of votes of the creditors who hold a majority of the claims.If
a vacancy occurs, a new trustee will be elected or appointed under 703.
The Trustee in a Chapter 7 case has the authority to bring law suits under
state law or federal law and may, with court order, continue the conduct
of the debtor's business.Further, the Court may allow a Chapter 7
Trustee to transfer an avoiding power to a creditor if the creditor is
pursuing interests common to the benefit of all creditors.
In re P.R.T.C., 177 F.3d 774(9
th Cir. 1999).
B.2.2. Chapter 11 Trustee
Section 1104 governs the appointment of a trustee or examiner in chapter
11 cases.The trustee replaces the debtor in possession to operate the
business and manage the reorganization efforts.An examiner investigates
the business without replacing the debtor in possession. Upon request
of a party in interest and after notice and a hearing the court must order
the appointment of a trustee for a showing of cause or if the appointment
is in the best interest of creditors, equity holders, and the estate.An
examiner may also be appointed in the same way for the same basic circumstances.An
examiner MUST be appointed if the unsecured debts exceed 5 million dollars.The
Court can terminate the trustee or examiner pursuant to Section 1105.Section
1106 provides the specific duties of the trustee or examiner, which incorporates
many of the applicable provisions of the Chapter 7 trustee, including
investigating the debtor in possession and the business and filing reports,
etc.The Court may appoint an examiner
In re First Am. Health Care of Georgia Inc., 208 B.R. 992 (Bankr. S.D. Ga. 1996).
Factors in determining if there is cause to appoint a Trustee include:
(1) the existence andmateriality of any misconduct on the part of the
debtor-in-possession; (2) the evenhandedness in dealings with insiders
or affiliates; (3) the existence of preferences or fraudulent transfers;
(4) the unwillingness or inability of management to pursue the estate's
causes of action; (5) conflicts of interest on the part of management
of the debtor-in-possession; and (6) self-dealing by management or waste
of corporate assets.
In re Intercat, Inc. 247 B.R. 911 (Bankr. S.D. Ga. 2000).Even though the code specifically
enumerates these reasons, a court need not find any of the enumerated
subsections in 1104(a)(1) to appoint a trustee.It is sufficient that the
appointment be in the best interest of creditors.
In re Oklahoma Refining Co., 838 F.2d 1133 (10
th Cir. 1988).
Neither a debtor nor a debtor's principal have standing to bring an
adversary proceeding after a chapter 11 trustee has been appointed.
In re Dawnwood Properties,209 F.3d 114 (2d Cir. 2000).
B.2.3. The Chapter 13 Trustee
Section 1302 governs both the standing trustee and Chapter 13 trustee appointed
to particular cases. Section 1302(b) delineates the trustee's responsibilities
and incorporates many of the duties of a chapter 7 and/or 11 debtor in
possession.The trustee is required to appear before the court at the Chapter
13 confirmation hearing and upon any modification. The trustee must also
monitor payments under the plan.
Creditors should be aware of the trustee's responsibilities under the
appropriate bankruptcychapter.If the creditor is unhappy with the trustee,
then that creditor may be able to get the trustee removed or later take
legal action against the trustee.
C. Determination of Secured Status and Valuation of Security Interest
C.1. Amount of Secured Claim
Section 506 determines the amount of a secured claim.Section 506(a) provides
that a creditor with a right of setoff or a lien has a secured claim ONLY
to the amount subject to setoff or the value of the collateral.Section
506(b) states that if the collateral's value is greater than the amount
of the claim, thenthe amount of the secured claim is the amount of the
setoff or that amount of the collateral along with any interest or expenses
of the creditor.Under Section 506(c) the trustee may recover from the
collateral the reasonable and necessary costs of securing the estate,
like insurance.Finally, Section 506(d) voids liens that are secured by
claims that are not properly allowed in bankruptcy proceedings. But see
In re Virello, 98-03751-W (Bkrtcy.D.S.C. 3/31/99) (a Chapter 7 debtor does not have
standing to use 506(d) to void a lien on real property which is abandoned
or likely to be abandoned and therefore of no benefit to the estate).
C.2. Valuation Hearing or Confirmation Hearing
Creditors can call for a section 506(a) valuation hearing or the hearing
may accompany the confirmation hearing as long as Bankruptcy Rule 3012
is properly followed.If amount in collateral is greater than amount on
lien, then creditor is in good shape and is oversecured.If the value of
the collateral is less then amount of the debt, the creditor is undersecured.
For oversecured creditors, under 506(b) post petition interest is permitted
and the recovery of fees and costs may be permitted when they are reasonable
and are provided for in the agreement under which the claim arose.
See Rake v. Wade, 508 U.S. 464, 113 S.ct. 2187, 124 L.ed. 2d 424 (1993) (Chapter 13 debtor
required to pay postpetition, preconfirmation interest to oversecured
creditor holding mortgage on principal residence regardless of whether
mortgage provides for such interest).
C.3. Value is the Replacement Value
The value used by the Courts is the replacement value.
Associates Commercial Corp. v. Rash, 520 U.S. 953, 117 S.Ct. 1879, 138 L.Ed. 2d 148 (1997).Valuation of collateral
securing a creditor's claim is flexible and is not limited to a single
point in time for purposes of determining whether a creditor is entitled
to accrue interest under 506(b).
In re T-H New Orleans Ltd. Partnership, 116 F.3d 790 (5
th Cir. 1987).
C.4. Attorney Fees are Reasonable Attorney Fees
As it relates to attorney fees awarded in a foreclosure action, in the case of
In re Epps, 99-00026-W (Bkrtcy. D.S.C. 7/9/99), the Court held that the debtor was
precluded from challenging a pre-petition state court award of attorney's
fees pursuant to the Rooker-Feldman Doctrine. Nevertheless, Court allowed
the Chapter 13 Trustee to challenge the reasonableness of the attorney's fees.
D. Adequate Protection of Secured Creditor's Interests
D.1. Secured Creditors are entitled to Adequate Protection
Adequate protection is protection afforded to the holders of secured claims.
The concept of adequate protection preserves the secured creditors position
at the time of bankruptcy.Section 361 provides three ways to provide adequate
protection over a property interest.Adequate protection may be achieved
by using cash payments, replacement liens, or any other method that provide
an equivalent of the entity's interest in property.
D.2. Relief from the Automatic Stay for Lack of Adequate Protection.
Section 362(d)(1) states that a party in interest (a creditor) can move
to lift the stay for cause, including a lack of adequate protection in
the property.Section 506 is intertwined with 361 as the valuation of the
collateral is very important in determining if the creditor is adequately
protected.363(e) provides that the court will stop the sale/lease of property
to maintain adequate protection.Finally 364(d) allows a second lien to
be given to obtainadditional credit as long as adequate protection is
given to the existing lien holder.
D.3. What constitutes adequate protection?
The following could provide adequate protection: a large equity cushion,
requirement of payments to the creditor, or a interest in a stream of
future rents. Section 361 protects a broad range of creditor interestsand
will depend on the factual situation in each case concerning both the
nature and the use of the collateral.
A substantial equity cushion can obviate the need for any other adequate
In re Mellor, 734 F.2d 1396 (9
th Cir. 1984).
The statutory scheme of Section 361 indicates that adequate protection
is intended to encompass a broad range of creditor interests and does
not mandate an interpretation of the creditor's interest as a whole
of the economic bargain. It is clearly susceptible to differing applications
over a wide range of fact situations and will depend on the nature of
the collateral and the proposed use of the collateral.
In re Briggs Transp. Co., 780 F.2d 1339 (8
th Cir. 1985).
E. Obtaining relief from the Automatic Stay
Relief from the automatic stay is governed by 362(d).A party in interest
may move for relief of the stay, which the court will properly grant after
notice and a hearing. To get relief from the stay the creditor must satisfy
both parts of the 362(d) test. First, the stay can be lifted for cause,
including a lack of adequate protection and second, if the debtor does
not have equity in the property and the property is not needed for an
effective reorganization.362(d)(3) then provides specific rules when the
bankruptcy concerns a single asset real estate case.362(e) provides that
thirty days after the motion for relief, the stay shall be lifted unless
the court after both notice and a hearing orders thestay to continue in
effect pending the conclusion of or as a result of a final determination
The bankruptcy court may properly lift the automatic stay in an equitable
distribution suit if(1) the state court has special expertise in handling
domestic matters, (2) judicial economy is promoted because the state proceedings
may be completed quickly and inexpensively, and (3) theentry of the judgment
in state court does not harm the estate or the interests of other creditors
because the bankruptcy court retains jurisdiction to determine the amount
the former spouse is to be paid on the claim.
In re Robbins, 964 F.2d 342 (4
th Cir. 1992).
All liens including, including those senior and junior to the movant's
lien, are considered in determining whether the debtor has equity in the property.
In re Indian Palms Assoc., 61 F.3d 197 (3d Cir. 1995).
For property to be necessary for an effective reorganization, there must
be reasonable possibility of a successful reorganization within a reasonable time.
United Savings Ass'n of Texas v. Timbers of Inwood Forest Assoc., Ltd. 484 U.S. 365(1988).
re Darrell Creek Associates, L.P., 187 B.R. 908 (Bkrtcy. D.S.C. 1995)(JW)
Section 362; Stay Waiver Agreement; A waiver-of-stay agreement executed
prepetition by a Chapter 11 debtor provided cause for lifting the automatic
stay to allow the mortgagee to foreclose.
In re Dole, 96-77677-W (Bkrtcy.D.S.C. 2/21/97)(JW)
Section 362(d)(1) and state family court concurrent jurisdiction; Court
modified automatic stay to allow the state family court to decide issues
related to support, equitably division of marital property and to allow
the debtor to obtain a divorce decree.
In re Drawdy, No. 01-04844-W (Bankr. D.S.C. 09/20/01)(JW)
Section 362(d), Pre-Petition Waiver Agreements, and Res Judicata. Creditor
sought to enforce a pre-petition waiver agreement whereby Debtors waived
their right to object in the event Creditor sought relief from the automatic
stay. The parties entered an agreement as a consent order in a state court
claim and delivery action. Debtors argued that the parties modified the
agreement and that Debtors performed according to these new terms. The
Court first decided that neither res judicata nor the Rooker-Feldman doctrine
barred the Court from determining the case. The Court reasoned it was
not barred because (1) the waiver provision was operative only in the
event of Debtors'' default of the agreement and the Court found
that Debtors complied with the agreement; (2) the state court did not
determine the issue of the automatic stay''s applicability; and
(3) the waiver agreement is not self-executing but is only one factor
a court considers when determining whether relief from stay is appropriate.
The Court then examined the waiver agreement to determine whether it was
enforceable and, citing In re Riley, ruled that it was not because Debtors
had performed according to its modified terms. Finally, the Court ruled
that Creditor, who failed to prosecute an earlier objection to confirmation,
was not barred from relief from stay because the plan had not yet been
confirmed; however, the Court denied Creditor''s motion for relief
In re Gregory, 97-10052-W (Bkrtcy. D.S.C. 1/12/98)(JW)
Section 362; The Court denied a creditors motion for relief from the stay
in a Chapter 13 case even though the case was a second filing.
In re Holmes, 99-08796-B (Bankr. D.S.C. 11/23/1999)(JW)
Sections 362(d) and 541. A mortgage creditor filed a motion for relief
from the automatic stay. Prior to the filing of the Chapter 13 petition,
a foreclosure action had terminated, with the mortgage creditor as the
successful bidder at the foreclosure sale. Even though the Master's
Deed was signed, it had yet to be recorded. The Court relied on precedent
to conclude that upon foreclosure on the property, the debtor is divested
of any interest, including the equity of redemption; thus, the property
in question was no longer property of the bankruptcy estate. As a result,
the Court concluded that such facts constituted sufficient "cause"
to grant relief from the stay pursuant to §§362(d)(1). However,
the Court recognized that the debtor had raised a significant question
regarding whether the service of the Summons and Complaint in the foreclosure
action was effective. In applying the Rooker-Feldman doctrine, the Court
concluded that the determination of proper service was left to the state
courts; however, to provide an opportunity for the debtor to address the
issue of proper service with the state court, the Court granted the Motion
but made it effective at a later date.
Jennings v. R & R Cars and Trucks (In re Jennings), No. 01-02330-W;
Adv. No. 01-80044-W (Bankr. D.S.C. 9/17/01)(JW)
Section 542(a), Turnover; and Section 362, Violation of Automatic Stay.
Order determined damages for turnover and violation of the automatic stay.
Previously, in an adversary proceeding, the Court ordered Creditor to
return the vehicle, lawfully repossessed prepetition, to Debtors. By the
time the Order was entered, Debtors'' case had been dismissed,
but the Court later vacated the dismissal order. Afterward, Debtors brought
a contempt action against Creditor claiming it failed to comply with the
turnover order. The Court found Creditor in contempt and again ordered
it to return the vehicle immediately to Debtors. In determining damages,
the Court considered the effect of the dismissal of the case and held
that the vacation of the dismissal did not retroactively reinstate the
automatic stay during the period when the case was dismissed; however,
by reinstating the case, the automatic stay was simultaneously reimposed
from the date of reinstatement. Consequently, Creditor is liable for damages
for violating the automatic stay after the case was reinstated as well
as during the time before the dismissal when the evidence proved that
Creditor knew about the turnover action. The Court also considered whether
damages might be negated because Creditor orally notified Debtors that
the vehicle was available for Debtors to take possession. After examining
prior cases in this District and in rejecting this argument, the Court
held that §§542(a) placed an affirmative duty on creditors in
possession of estate property to deliver it to the estate. Regarding the
issue of when turnover is required, the Court held that the duty to turn
over is triggered upon a debtor''s notification to the creditor
of the bankruptcy filing, written demand for turnover, and proof of insurance.
In re Kinard, C/A No. 01-03621-W (Bankr. D. S.C. Nov. 21, 2001)(JW)
Section 362(d)(1), (d)(2), and (d)(3), Relief From Automatic Stay. Creditor
motioned for relief from the automatic stay with respect to Debtor's
collateral, a 5.7 acre vacant parcel of land generating no income, as
well as collateral pledged by a third party who had not filed for bankruptcy
protection. Debtor objected to the motion and sought an injunction protecting
the third party. The Court first decided that Debtor's automatic stay
does not extend to the third party or its collateral; consequently, the
foreclosure process could continue against the third party's collateral.
In addition, the Court declined to grant the extraordinary relief of issuing
an injunction to protect the third party because Debtor failed to demonstrate
irreparable injury to the movant, lack of substantial harm to others if
the injunction were granted, the promotion of public interest by issuing
the injunction, and a reasonable likelihood of successful reorganization.
Next, the Court granted relief from the automatic stay pursuant to §§362(d)(2).
Debtor argued that the real property collateral will appreciate in the
future and that its later sale will be the only way for him to reorganize.
The Court ruled that, in order for property to be necessary for reorganization,
a debtor must show a reasonable possibility of a successful reorganization
and this possibility must be based on more than speculation. The Court
found that the potential sale of the real property was too speculative.
In addition, the court ruled that Creditor is entitled to relief from
the stay pursuant to §§362(d)(3) because the real property collateral
is single asset real estate and Debtor failed to file a plan of reorganization
or make monthly payments to secured creditors within the ninety day period
prescribed by the code section. Debtor argued the real property is not
single asset real estate because it is vacant land that does not presently
generate income. The Court disagreed, ruling that raw land generating
no income falls within the definition of single asset real estate. Finally,
the Court ruled that relief from the stay was appropriate pursuant to
§§362(d)(1) because Debtor's reorganization is objectively
futile and because the case was filed in subjective bad faith, evidenced
by repeat filings intended to stave off foreclosure sales.
In re Koenig, C/A No. 00-11188-W (Bankr. D. S.C. Dec. 7, 2001)(JW)
Section 362(d), Relief from Automatic Stay. Creditor having a claim against
Debtor's estranged husband secured by a note on which Debtor is not
liable sought relief from stay to pursue foreclosure of the collateral
in Debtor's possession. In Debtor's Chapter 13 plan, she treats
the debt by providing that it will be paid outside of the plan by her
estranged husband. The estranged husband failed to make payments for several
months. When Creditor sought relief from the stay, Debtor objected because
Creditor failed to file an objection to its treatment in the plan. The
Court rejected the argument, finding that a line of cases Debtor cited
were inapposite to the circumstances of this case and that there is no
res judicata effect of the plan because its language is insufficient to
extinguish Creditor's lien nor does it clearly prohibit Creditor from
foreclosing its lien. Moreover, the Court determined Creditor is not adequately
protected, no payments are being made to Creditor, and there is no equity cushion.
In re Madden, 99-08282-W (Bankr. D.S.C. 12/21/1999)(JW)
Section 362(d). The Court denied Creditor's Motion for Relief from
the Automatic Stay. Debtor filed a Chapter 13 bankruptcy proceeding approximately
two months after purchasing a truck. Debtors made no payments on the vehicle.
The Court found that the truck was necessary for an effective reorganization,
thus precluding relief from the stay pursuant to §§362(d)(2)
because Debtors worked separate shifts and needed the vehicle for transportation.
Furthermore, the Court found that even though the time between the purchase
of the truck and the filing of the bankruptcy case was short, there were
no indications that the bankruptcy was filed in bad faith thus precluding
relief from the stay pursuant to §§362(d)(1).
In re Ragin, C/A No. 99-11323-D (Bankr. D.S.C. 3/3/2000)(JW).
Sections 362(d) and 1301(c). The Court granted the Motion for Relief from
the Automatic Stay and the Motion for Relief from Co-Debtor Stay filed
by the Bank. The Bank was the holder of a second mortgage lien on a parcel
of real property. The Note was signed by both Debtor and a third party,
but the property that secured the Note was solely owned by the third party.
The Court held that because the Note clearly showed that the third party
was the real owner of the property, and Debtor was in reality the cosigner
on the obligation, the Bank should be granted leave to seek recovery from
the party who received the benefit of the transactions. Furthermore, the
Court held that, in addition to the relief granted under §§1301(c),
the Bank was also entitled to a modification of the automatic stay for
purposes of completing its Foreclosure Action.
In re Remington Forest, 194 B.R. 384 (Bkrtcy.D.S.C. 1995)(JW)
Section 362, Equity and Successful Reorganization; A mortgagee was entitled
to relief from the automatic stay to complete its foreclosure proceedings
against the Chapter 11 debtor-mortgagor over a single asset debtor in
which there was clearly no equity.
(appeal affirmed by Judge Traxler. Summatyme Corporation v. Remington Forest,
a South Carolina Partnership, Case No. 2:96-425-21 (D. S.C. 7/15/96))
In re Riley, 188 B.R. 191 (Bkrtcy. D.S.C. 1995)(JW)
Section 362; Waiver of Stay; A prepetition forbearance agreement that was
executed by a Chapter 13 debtor-mortgagor and a mortgagee and which contained
a waiver of stay provision did not continue beyond the cure of default
that existed when the agreement was entered.
In re Scott, C/A No. 00-07468-W (Bankr. D.S.C. 1/1/2001)(JW)
Section 544 and 362(d) (Annulment of the Automatic Stay). Creditor filed
a Motion seeking the annulment of the automatic stay to validate the post-petition
perfection of a mortgage on Debtor's home. Debtor had mortgaged his
property and subsequent to the execution of the mortgage, the creditor
forwarded the mortgage for filing in the proper office, but failed to
include necessary information; therefore, the mortgage was never properly
recorded pre-petition. Debtor argued that if the automatic stay was annulled
in this case, the creditor would be permitted to better its position post-petition
in that its lien would be perfected against third parties. Debtor also
argued that the post-petition validation of the recording would prevent
Debtor of his ability to file an avoidance action under §§544.
The Court found that in Chapter 7 cases a debtor does not ordinarily have
standing under the strong-arm provision of §§544(a). Having
decided that Debtor could not have brought a §§544 action in
this case, the Court next addressed the issue of whether the stay could
have been retroactively annulled. The Court found that "cause"
existed as required by §§361(d)(1) to annul the stay retroactively
to allow the perfection of the creditors' mortgage and further found
that there was no equity in the property and it was not necessary for
reorganization, thus warranting retroactive relief from the automatic
stay also pursuant to §§362(d)(2).
In re Thomas, 211 B.R. 838 (Bkrtcy.D.S.C. 1997)(JW)
Section 362,; Court granted 362 relief to state court personal injury plaintiffs
to allow state court proceedings to continue as this court without subject
matter jurisdiction to determine merits pursuant to 28 U.S.C. §§
In re Trapp, C/A No. 00-09987-W (Bankr. D.S.C. 1/5/2001)(JW)
Section 1322 and 362(d). The mortgagee had entered into a Mortgage and
Note with the Brewers, who subsequently sold the mortgaged property to
Debtor, without the Mortgagee's consent nor knowledge. Debtor then
filed for relief under Chapter 13 and proposed to cure the arrears on
the debt and recommence monthly payments to the Mortgagee. The Mortgagee
filed a Motion to Modify Stay and Objection to Plan of Reorganization
asserting that it was entitled to relief from the automatic stay pursuant
to 11 U.S.C. §§362(d)(1) and (2) to permit it to proceed in
State Court with foreclosure and eviction proceedings and further objecting
to any treatment in Debtor's Chapter 13 Plan on the grounds that there
is no debtor-creditor relationship between Debtor and Mortgagee and that
therefore the mortgage debt was not a "claim". Furthermore,
the mortgagee argued that the Plan may not cure and reinstate Mortgagee's
claim, which was accelerated upon the expiration of the right to cure.
The Court first concluded that a Chapter 13 debtor who is not in contractual
privity with the mortgagee can repay a mortgage lien through the plan
because the mortgagee holds a "claim" against the debtor's
estate, even though there is no privity between the mortgagee and the
debtor. Furthermore, the Court concluded that the fact that the debt to
the Mortgagee was accelerated due to debtors' default did not prohibit
the curing of such default through the Chapter 13 Plan.
In re Watts, C/A No. 00-06791-W (Bankr. D.S.C. 10/27/2000)(JW).
Sections 362(d), 542 and 1322(c)(1). The United States of America, on behalf
of the Rural Development, filed a Motion to Terminate Automatic Stay.
Prior to the filing of the Motion, a judgment of foreclosure and sale
had been entered in the United States District Court and the property
had been sold at the foreclosure sale. Debtor objected to the Motion arguing
that the sale was not fully completed and further asserting that, pursuant
to §§1322(c)(1), she had the right to cure the mortgage arrears
owed to the Creditor because the sale was yet to be completed under applicable
non-bankruptcy law. First, the Court followed precedent in this district
to hold that the property no longer constituted property of the estate
and Debtor possessed neither a legal nor an equitable interest in the
property once the auctioneer''s hammer fell. Furthermore, as it
related to §§1322(c)(1), the Court recognized that courts interpreting
this section were split in their decisions, but it ultimately adopted
the reasoning of the courts that have held that the language of §§1322(c)(1)
is clear and unambiguous in establishing the date of the actual foreclosure
sale as the cut-off date for curing mortgage defaults. The Court once
again emphasized that upon the falling of the gavel, the debtor was left
with bare legal title and "''[t]he additional steps of obtaining
court approval, awaiting the expiration of any cure period . . . , paying
the purchase price, and recording the deed may be necessary to consummate
the sale, but that does not alter the fact that the purchaser''s
right to acquire the property has intervened." The Court ultimately
found that relief from the automatic stay pursuant to §§362(d)
F. Unexpired Leases and Executory Contracts
Unexpired Leases and Executory Contracts are governed by Section 363 and
365. Section 363 governs the postpetition use, lease and sale of estate
property. This section also governs "cash collateral." Section
363(b) provides the Trustee with the ability to "use, sell or lease"
estate property outside the ordinary course of the estate.Section 363(c)
provides the trustee with instances when the property can be sold, leased
or used pursuant to the ordinary course of business.The Trustee must also
lease all property pursuant to any relief granted from the stay.
Section 365(a) specifically provides the Trustee with the ability to assume,
or reject any debtor's executory contract or unexpired lease. Note
that neither "executory contract" nor "unexpired lease"
is defined in the Bankruptcy Code. Subsections (b), (c) and (d) state
limitations on the Trustee's power to assign or assume a lease or
executory contract.If the executory contract or lease is in default, the
Trustee still may assume the contract or lease, but the trustee must either
cure, compensate, or provide adequate assurance of future performance
under the lease.The Court must usually approve these assignments.
The court uses a business judgment standard in determining whether to approve
a rejection, assumption or assignment.
In re G.I. Indus., 204 F.3d 1276 (9
th Cir. 2000).
An executory contract or unexpired lease becomes property of the estate
when it is assumed by the trustee.
A creditor with an interest in the lease does not have standing to raise
a section 365(d)(4) contention that the property covered in the lease
is not part of the bankruptcy estate.
In re James Wilson Assoc., 965 F.2d 160 (7
th Cir. 1992).
Section 365(b)(1)(B) does not create an independent right to a fee award.
To recover fees the lessor must demonstrate that the lease contains a
clear contractual provision allocating the right to collect fees, the
provision is lawful, and that the lossess are for actual pecuniary lossess
resulting from the defaults under the lease - attorneys actions were taken
primarily to collect sums due under the lease or to enforce an obligation
of the leasee.
In re Shangri-La, Inc., 167 F.3d 843 (4
th Cir. 1999).
Priorities are governed by Section 507. 507(a) delineates the categories
of claims that are entitled to priority in bankruptcy cases.Pursuant to
104(b) the dollar cap on some priority claims increases every 3 years
to correspond to the Consumer Price Index.507 mandates the order of payment
of these (unsecured/partially secured) creditors.Practice dictates that
each subsection of 507(a) is to be fully paid to the creditors before
moving on to the next subsection.If the debtor delineates all of his funds,
then that last subsection's creditors are paid pro-rata. All later
creditors receive nothing. The 9 priority subsections are as follows:
Priorities should be given a narrow, strict interpretation.
In re Birmingham-Nashville Express Inc., 224 F.3d 511 (6
th Cir. 2000).
4. Administrative expenses under Section 503(b) - These expenses include
the "actual, necessary costs and expenses of preserving the estate,
including wages, salaries or commissions, certain fines and taxes. Administrative
expenses also may include bank charges, insurance, assumed lease obligations,
leases, executory contracts.Such things as a prepetition pension plan,
lump sum employment contracts and criminal fines or environmental penalties
are not administrative expenses.
Once a lease is assumed, even if later rejected, its an administrative expense.
In re Klein Sleep Prods, Inc. 78 F.3d 18 (2d Cir. 1996).
A broker's commission is a proper administrative expense after the
broker has delivered a ready and willing buyer pursuant to the brokerage contract.
Inre Ferncrest Court Partners Ltd., 66 F.3d 778 (6
th Cir. 1995).
"Creditors may not claim lump sum payments, as administrative expenses,
due upon termination pursuant to their employment contracts with the debtor
because (1) the claims did not arise from a transaction with the debtor
possession; (2) the consideration supporting the right to payment was
neither supplied nor beneficial to debtor in possession; and (3) the payments
were not actual and necessary costs and expenses of preserving the estate."
In re Comm. Fin. Servs. , 246 F.3d 1291 (10
th Cir. 2001).
5. Unsecured Claims under 502(f) - in involuntary cases claims that arise
after commencement but before the order of relief that arise in the ordinary
course of the debtor's business or financial affairs receive priority
status. These are known as involuntary gap creditors.
6. Unsecured claims for wages, salaries and commissions- Up to $4,650.00
per individual or corporation for salaries, wages and commissions earned
within 90 days of filing the petition or the end of the debtor's business
(whichever occurs first) receive 3
rdpriority.These claims arise with all types of employees from the traditional
to home nursing care workers.
7. Unsecured claims for contributing to an employee benefit plan -These
claims must arise from services given within 180 days before the filing
of the petition or the end of the debtor's business. The total amount
allowed is now $4,650.00 (the maximum amount allowed under subsection
3) multiplied by the number of employees covered under the plan less the
actual distributions these employees previously received under subsection (a)(3).
8. Unsecured claims of those who raise/store grain or are fishermen -Each
such individual may have a priority claim of up to $4, 650.00.
9. Consumer Creditors priority -This priority is for consumers who have
deposited money for the purchase, lease or rental of property or services.The
property or services must be for personal, household or family use.Each
individual may have a claim of up to $2,100.00.This priority is to cover
the debtor's inexpensive couch or microwave on lay-a-way.
10. Alimony and Child Support debts - All "support" debts receive 7
th priority.These debts are also nondischargeable.Note that this priority
may not encompass debts incurred with property settlements.507(a)(7)(B)
specifically provides for priority only for "alimony, maintenance
or support." Guardian ad litem fees and expenses are also given priority
under this subsection.
11. Unsecured Governmental Claims/Tax Claims - Income taxes for which a
return is due within 3 years before the filing of the case are given priority
under subsection 8.To receive priority, the tax assessment must also be
within 240 days before the filing date.All property taxes due in the year
before the commencement of the case also receive 8
The question of when a tax is assessed is a matter of federal law, so that
when federal taxes are in dispute, the Court must look to the definition
of the Internal Revenue Code, which provides that assessment is the notation
in the Secretary of the Treasury's records.State law assessment occurs
when the liability becomes final under state law.
In re Lewis, 199 F.3d 249 (5
th Cir. 2000).
12. Unsecured Claims to the FDIC - Any unsecured claim to the FDIC or related
entity for failing to maintain capital receive 9
Section 507(b) gives a "superpriorty" status to secured claims
that have received adequate protection but still incur a claim.Finally,
507(d) provides that any subrogated entity does not receive the priority
rights of the official holder.
Reaffirmation is an agreement provided for under Section 524(c) where the
debtor and the creditor consensually agree that the debtor is going to
reaffirm the debt. So even though the debtorreceives a discharge, the
debtor is still bound to the pay the total debt. A Reaffirmation agreement
should involve a renegotiation of the debt and the terms and/or total
debt may be different from the original debt. Reaffirmations should contain
an attorney affidavit whereby the attorney states that he examined and
investigated the reaffirmation to his client. Reaffirmations are not supposed
to pose an undue hardship on the debtor.If the reaffirmation is not evidenced
by the proper paperwork, the reaffirmation can be annulled. Reaffirmations
are related to Redemptions and the concept of "Ride Through".Section
722 allows a debtor to "redeem tangible personal property intended
primarily for personal, household, or family use."Redemption permits
the debtor to "pay off" the loan or the collateral.The amount
needed for a redemption may be reduced if a debtor can use some of his
state or Section 506 exemptions. A reaffirmation or a redemption agreementwill
not be approved if the agreement will cause "undue hardship"
on the debtor pursuant to 524(a)(6)(A)(i).521(2)(A) provides that a creditor
and debtor may agree to "ride through" the bankruptcy for a
particular debt.Ride-through is not very advantageous to the creditor
and is also not permitted in all circuits.
If the code requirements of 524(c) and (d), including the requirement that
it be entered into prior to discharge are not met, even if it is signed
by the parties, a reaffirmation agreement is unenforceable.
In re Kinion, 207 F.3d 751 (5
th Cir. 2000).
A reaffirmation agreement should involve a renegotiation of the debt and
the terms may be different than the original contract terms.
In re Strong, 232 B.R. 921 (Bankr. E.D. Tenn. 1999).
I. Discharge and Objection to Discharge
Generally, one of the primary purposes of the United States Bankruptcy
Code (Title 11 of the United States Code of Laws) is to provide individual
debtors with a "fresh start." The fresh start is provided by
(1) allowing the debtor to keep certain minimal assets and (2) discharging
the debtor from his obligations to pay his debts. Generally, courts construe
objections to the debtor's discharge against the objector and liberally
in favor of the debtor.
In re Scarlata, 979 F.2d 521 (7th Cir.1992);
In re Hunter,780 F.2d 1577 (11th Cir. Fla.1986);
Rosen v. Bezner, 996 F.2d 1527 (3d Cir.1993) (Section 727 is construed liberally in favor
of the debtor);
Insurance Co. of N. Am. v. Cohn (In re Cohn), 54 F.3d 1108 (3d Cir. 1995) (same).
However, discharge is a privilege granted to the honest debtor and not
a right accorded to all bankrupts and as the Supreme Court once said discharge
is only for the "honest but unfortunate debtor."
Grogan v. Garner, 498 U.S. 279, 112 L. Ed. 2d 755, 111 S. Ct. 654 (1991);
In re Burgess, 955 F.2d 134 (1st Cir. Mass. 1992);
In re Horridge, 127 B.R. 798 (S.D. Tex.1991) (discharge not a matter of right);
In re Pimpinella, 133 B.R. 694 (Bankr. E.D.N.Y.1991) (same). While some have suggested
that the debtor should use pre-exemption planning to "go as far as
you can," this attitude does not comport well with the idea of the
honest but unfortunate debtor. Cristol, A., Cassidy, W. and Walden, A.
Exemption Planning: How Far May You Go?, 48 S.C.Law. R. 715,742 (1997).
With the recent change relating to the Individual Retirement Account (an
"IRA"), providing for an unlimited exemption for IRA's under
South Carolina law, we may see an increase in pre-petition planning by debtor.
See In re Outen, 97-08675-W, (March 18, 1998) (IRA is included as exempt under South Carolina
but see Rowland v. Strickland, 362 S.E.2d 892 (Ct App. 1987) (judgment creditor may attach IRA account
as not exempt from alienation). With this increase in pre-petition planning,
we may see an increase in complaints objecting to the discharge of the
Section 727 provides for the denial of the debtor's discharge in Chapter
7 cases. Section 1328 provides for the denial of the debtor's discharge
in Chapter 13 cases.Section 523 provides for the non-discharge of certain
obligations under certain conditions. In the materials that follow, Richard
R. Gleissner discusses the denial of discharge of certain obligations
and gives certain practice pointers for practitioners to keep in mind.
Däna Wilkenson discusses the denial of discharge under Chapter 7
and Chapter 13.
Objections to Discharge under Section 523
By Richard R. Gleissner
Section 523 provides that certain specific obligations of the debtor may
be excepted from discharge under two conditions. The first condition is
that the debt must be determined to be not subject to a discharge. The
second condition is that the obligation must meet certain criteria. This
paper will first discuss the practical aspects of the trial of issues
relating to the discharge and then will discuss the substantive criteria
used to determine whether the debt will be discharged.
I.The Practical Aspects of Objecting to Discharge
1. Bring a Law Suit.
Under Section 523(a), a creditor, or someone standing in the creditor's
shoes, must object to the discharge of a particular debt through an adversary
proceeding. Rule 7001, Fed.R. Bankr. P.
See also In re Kennerley, 995 F.2d 145, 146-47 (9th Cir. Cal.1993)
(A motion to lift the automatic stay is not either a valid complaint to
determine dischargeabilityor a motion to extend the deadline under Bankr.
To obtain standing to bring a complaint objecting to discharge, the plaintiff
must show (1) it is a creditor, (2) it is the assignee of a creditor,(
See Westbank v. Grossman (In re Grossman), 174 B.R. 972 (Bankr. N.D. Ill. 1994) (assignment of judgment rights))
or (3) it is subrogated to the claims of a creditor. Subrogation may occur
in relation to nondischargeable taxes, as discussed below and when the
debts ordinarily would not be dischargeable but they are paid by some
insurance company or surety.
Old Republic Sur. Co. v. Richardson (In re Richardson), 178 B.R. 19 (Bankr. D.D.C.1995) (public policy behind exceptions to discharge
for breach of fiduciary duty is punitive in nature and intended to discourage
improper conduct; public policy would be frustrated if debtor could avoid
liability by allowing surety to cover a debt and then discharge the debt
to the surety in bankruptcy; whether plaintiff had fiduciary relationship
with the debtor irrelevant). See
In re Snellgrove, 15 B.R. 149 (Bankr. S.D.Fla. 1981) (debt to surety nondischargeable to
extent of debtor's embezzlement of creditor's funds).
1.2 Class Actions.
Although not seen in the District of South Carolina, Bankruptcy Courts
have permitted class action suits to challenge the dischargeability of
similarly situated debts.
Santa v. Lebner (In re Lebner), 197 B.R. 180 (Bankr. D. Mass. 1996)
. In so finding, the Bankruptcy Court for the District of Massachusetts
indicated that a majority of the bankruptcy courts addressing the issue
agreed to allowing the suits through class actions.
Objections to discharge are core proceedings. 28 USC §158(b)(2)(I)
and (J).In South Carolina, these core proceedings have been referred to
the Bankruptcy Court for determination.28 USC §157 (on allowing referrals).
Under Code § 523(c), the Bankruptcy Court has exclusive jurisdiction
to determine the dischargeability of debts for: (1) Section 523(a)(2)
(debts created by false pretenses, false representation, actual fraud,
or by use of a false financial statement); (2) Section 523(a)(4) (debts
for fraud or defalcation while acting in a fiduciary capacity, or for
embezzlement, or larceny); (3) Section 523(a)(6) (debts for willful and
malicious injury by the debtor to another entity or to the property of
another entity); and (4) Section 523(a)(15) (certain debts arising from
divorce or separation which are not excepted under Code § 523(a)(5)).
Other courts are given concurrent jurisdiction for the remaining objections
In those situations where another court has jurisdiction, the Bankruptcy
Court could abstain from hearing a dischargeability issue.
See 28 USC § 1334 (discussing both discretionary and mandatory abstention).I
n a practical sense this abstention is most often used in questions dealing
with the dischargeability of claims involving multiple personal injury
In re Robbins, 964 F.2d 342 (4th Cir. N.C.1992);
Wood v. Fiedler, 548 F.2d 216 (8th Cir. Minn.1977);
Austin v. Wendell-West Co., 539 F.2d 71 (9th Cir. Wash. 1976)) or in family support obligations where
state courts are more familiar with the criteria for measuring support
Brothers v. Tremaine (In re Tremaine), 188 B.R. 380 (Bankr. S.D. Ohio 1995) (abstaining from dischargeability
proceeding under Code § 523(a)(5) with respect to alleged alimony).
Sometimes it is used relating to tax claims but the abstention in tax
claims seems to be limited to situations involving no asset chapter 7 cases.
In re Gossman, 206 B.R. 264 (Bankr. N.D. Ga.1997);
Shapiro v. United States (In re Shapiro), 188 B.R. 140 (Bankr. E.D. Pa. 1995) (Court abstained from hearing debtor's
adversary proceeding to determine amount of nondischargeable debt where
such determination would have no effect on creditors in the no-asset bankruptcy
case which had been fully administered). If another court renders a determination
on dischargeability, that determination is given preclusive effect in
the bankruptcy court.
In re Galbreath, 83 B.R. 549 (Bankr. S.D. Ill.1988)
2. Bring the Suit Timely.
2.1 Within 60 days after the first date set for the meeting of creditors.
For causes of action within the exclusive jurisdiction of the bankruptcy
court, the complaint objecting to discharge must be filed "not later
than 60 days following the first date set for the meeting of creditors
held pursuant to § 341(a)." Fed.R. Bankr. P. 4007(c). A motion
to extend the 60-day period must be made prior to the end of the period
and must be made by the creditor. Fed. R. Bankr. P. 9006(b)(3) permits
an enlargement of time.If you don't bring the complaint, no amount
of excusable neglect will save the creditor and unless the creditor relies
upon an incorrect bar date being provided by the court, the bankruptcy
court will not allow the late filing of a claim objecting to discharge.
Neeley v. Murchison, 815 F.2d 345 (5th Cir. 1987);
In re Alton,837 F.2d 457 (11th Cir. 1988);
In re Anwiler, 958 F.2d 925 (9th Cir. 1992)
cert. denied, 121 L. Ed. 2d 171, 113 S. Ct. 236 (1992) (court has equitable power to
permit untimely filing where the clerk gave an incorrect bar date);
Themy v. Yu (In re Themy), 6 F.3d 688 (10th Cir. 1993) (courts have "almost uniformly allowed
an out-of-time filing when the creditor relies upon a bankruptcy court
notice setting an incorrect deadline"). Some courts have held that
a late filed complaint denies the court of jurisdiction and the case is
dismissed even if the defense of failure to timely file is not raised
by the debtor.
Dollinger v. Poskanzer, 146 B.R. 125 (D.N.J.1992) (bar date for filing dischargeability complaint
is jurisdictional, and thus debtor's failure to plead untimeliness
in answer is not a waiver of time bar);
But see In re Santos, 112 B.R. 1001 (Bankr. 9th Cir.1990) (dischargeability complaint bar date
is not jurisdictional, and thus debtor can waive defense of untimeliness).Still
other courts have found other exceptional circumstances to allow them
to accept late-filed objections to discharge.
See In re Dewalt, 961 F.2d 848 (9th Cir.1992) (unscheduled creditor's late-filed complaint
acceptable because notice of bankruptcy filing only 7 days before the
bar date was insufficient under Code § 523(a)(3)(B), the court required
at least 30 days' notice or knowledge of the bankruptcy to satisfy
In re Crumley, 73 B.R. 996 (Bankr. E.D. Tenn.1987) (due process required acceptance of
creditor's late filed Section 523(a)(2), (4) or (6) objection because
creditor was without notice of bar date);
Shaheen v. Penrose (In re Shaheen), 174 B.R. 424 (E.D. Va. 1994) (30-day notice required by Bankruptcy Rule
applied to objections to discharge and thus late filed complaint was timely
where creditor received notice of bankruptcy only 12 days before bar date).
For dischargeability issues not within the exclusive jurisdiction of the
bankruptcy court, under Rule 4007(b), these complaints may be filed at
any time. There is no bar date for filing complaints based on alimony
and child support, driving while intoxicated, student loans, and taxes.
These types of debts are not automatically discharged. Thus, in these
instances, a debtor may have an incentive to bring the complaint in the
form of a declaratory judgment action.
Under Bankruptcy Rule 1019(2), if a Chapter 11 case is converted to Chapter
7, a new filing period commences. If the Chapter 11 case partially concluded
by way of a confirmed plan, that confirmed plan discharged the debt and
the new time period can be used only for post confirmation issues of discharge.
In re Pavlovich, 952 F.2d 114 (5th Cir. La.1992) (conversion to Chapter 7 after confirmation
of individual debtor's Chapter 11 plan precludes creditors whose claims
were dealt with under the plan from challenging discharge or dischargeability;
however, creditor may challenge discharge based on post-confirmation conduct).
Further, if a case started as a Chapter 7, converts to a Chapter 11 and
then is converted back to a Chapter 7, there is some authority that the
reconversion will not start a new period.
F & M Marquette Nat. Bank v. Richards, 780 F.2d 24 (8th Cir. Minn.1985) (reconversion did not start new period)
In re Jones, 966 F.2d 169 (5th Cir. Tex.1992) (reconversion did start a new period
for filing objections to discharge pursuant to Fed. R. Bankr. P. 1019(2)
2.2. If you don't know the bar date, find it out.
A creditor with actual notice of the bankruptcy but not the bar date must
take reasonable steps to ascertain the bar date or lose the right to object.
In re Sam, 894 F.2d 778 (5th Cir. 1990)
In re Rhodes, 61 B.R. 626 (Bankr. 9th Cir.Cal. 1986)
2.2. File the Complaint or File the Extension.
On the bar date, the creditor must file the complaint or the extension.
Some courts have held that the motion is made upon filing.
In re Miller, 188 B.R. 1021 (Bankr. S.D. Fla. 1995) (motion to extend bar date pursuant
to Bankruptcy Rule 4007(c) is "made" when filed with court,
not when served on debtor). However other courts hold that a motion is
"made" when it is served on the debtor as long as the motion
is filed within a reasonable time after service.
In re Friscia, 123 B.R. 9 (Bankr. E.D.N.Y. 1991)
.The Eleventh Circuit has adopted the former approach and requires the filing
of the motion.
Coggin v. Coggin (In re Coggin), 30 F.3d 1443 (11th Cir. Ala. 1994).
2.3. Others can't obtain an extension for the creditor.
The Chapter 7 panel trustee and the Chapter 13 panel trustee doesn't
have the ability to get an extension on behalf of creditors to object
In re Farmer, 786 F.2d 618 (4th Cir.1986)
Vaccariello v. Lagrotteria, 43 B.R. 1007 (N.D. Ill.1984);
but see Marshall v. Demos (In re Demos), 57 F.3d 1037 (11th Cir. 1995) (the court "validly entered" order
granting motion by Chapter 7 trustee to extend the time for all creditors
to file objections to discharge).
3. Allege the entire factual basis for the creditor's claim.
An amendment to a complaint objecting to discharge that changes the legal
theory or adds another claim arising out of the same transaction or occurrence
relates back to the original complaint.
In re Tester, 56 B.R. 208 (W.D. Va. 1985) ( Code § 523(a)(4) complaint permitted
to be amended to add § 523(a)(6) claim). Thus, if the creditor hasalleged
all of the factual basis for asserting an objection to discharge, the
creditor stands a better chance of the court determining in its favor
that "the amended pleading arose out of the conduct, transaction,
or occurrence set forth or attempted to be set forth in the original pleading.
"Fed. R. Civ. P. 15(c)(2). For a discussion of the application of
Bankruptcy Rule 7015 (which incorporates Fed.R. Civ. P. 15 ); see also
Flexi-Van v. Perez (In re Perez), 172 B.R. 284 (Bankr. E.D.N.Y.1994)(amendment in discharge context);
In re Gunn, 111 B.R. 291 (Bankr. 9th Cir.Cal. 1990) (complaint alleging §§
523(a)(2)(A) and (B) and 727(a)(5) causes of action amended after two
years of discovery to allege § 727(a)(3) and (4) because all claims
arose out of same transaction);
CIT Group/Factoring Mfrs. Hanover, Inc. v. Srour, 138 B.R. 413 (Bankr. S.D.N.Y.1992) (action under Code § 727(a)(2)
and (4) amended to seek relief under § 523(a)(4), because claims
arose out of the same conduct, transaction or occurrence);
Bank of Chester County v. Cohen, 139 B.R. 327 (Bankr. E.D. Pa.1992) (complaint originally filed under §
523(a)(2)(A) amended to assert Section 523(a)(2)(B) and 727(a)(2)(A) where
actions in the amended complaint were based on the same conduct, transaction
and occurrence as the original); but see
In re Union Bank of Middle East, Ltd., 127 B.R. 514 (E.D.N.Y. 1991) (amendment of Code § 523(a)(2)(A) complaint
to include § 523(a)(4) claim not allowed);
In re Harrison, 71 B.R. 457 (Bankr. D. Minn. 1987) (§ 727(a) claim was not sufficiently
similar to § 523(a)(6));
Rufenacht, Bromagen, & Hertz, Inc. v. Russell, 69 B.R. 394 (D. Kan. 1987) (§ 727 complaints may be timely amended
to assert a § 523 claim);
In re McClellan, 60 B.R. 719 (Bankr. E.D. Va.1986) (amendment from § 727(a)(2) relief
to action under § 523(a)(2) was not allowed);
In re Grant, 45 B.R. 262 (Bankr. D. Me.1984) (§ 727 complaint could not be amended
to allege § 523 cause of action because of "insufficient identity"
4. Don't ask for a jury trial
Discharge proceedings are equitable actions tried without juries.
In re Hallahan, 936 F.2d 1496 (7th Cir.1991)
In re Johnson, 110 B.R. 433 (Bankr. W.D. Mo.1990)
; but seeIn re Jensen, 946 F.2d 369 (5th Cir. 1991) (in dicta suggesting that debtor did not
waive the right to a jury trial but denying debtor jury trial because
creditor filed a proof of claim regarding the debt);
Longo v. McLaren (In re McLaren), 3 F.3d 958 (6th Cir. Ohio 1993)
.Even when the creditor seeks a money judgment, the bankruptcy court gets
to make the determination.
In re McLaren, 3 F.3d 958 (6th Cir. 1993);
In re Hallahan, 936 F.2d 1496 (7th Cir. 1991);
Harris v. U.S. Fire Ins. Co., 162 B.R. 466 (E.D. Va. 1994);
Citibank (South Dakota) N.A. v. Fisher (In re Fisher), 186 B.R. 70 (Bankr. W.D. Ky. 1995).
In situations involving personal injury torts, the claim must be determined
by the District Court and the parties are still entitled to a jury trial
on the claim itself.See 28 U.S.C. §1411.Nevertheless, the question
of discharge is determined by the court.
SeeIn re Thompson, 140 B.R. 979 (N.D. Ill. 1992).
5. The Creditor has the burden of proof.
The creditor has the burden to prove that the claim is not subject to discharge
by a preponderance of the evidence.
Grogan v. Garner, 498 U.S. 279, 111 S.Ct. 654, 112 L. Ed. 2d 755 (1991)
5.1. Collateral Estoppel.
If a state court has already made a determination, the Creditor may be
benefitted by the doctrine of collateral estoppel or issue preclusion.
Grogan v. Garner, 498 U.S. 279,111 S. Ct. 654, 112 L. Ed. 2d 755 (1991).But you still need
to show that the elements of the claim made in state court are the same
elements associated with the Bankruptcy Court's determination of dischargeability.
In re Tsamasfyros, 940 F.2d 605 (6th Cir. Ohio 1981). The elements of issue preclusion are
(1) the issue to be decided by the bankruptcy court is identical to that
involved in the prior litigation, (2) the issue was actually litigated,
(3) the issue was determined by a valid and final judgment, (4) the determination
of the issue was essential to the judgment, and (5) the standard of proof
in the prior litigation was at least as high as the standard in the present
Spilman v. Harley, 656 F.2d 224 (6th Cir. Ohio 1981). The application of issue preclusion
will be discussed with the substantive aspects of the suit below.
6. Use caution when settling nondischargeable obligations.
It has been held that where an obligation was created from embezzlement
and this obligation is settled through a promissory note to repay and
release, the debt has been held to be dischargeable absent fraud surrounding the note.
In re West, 22 F.3d 775 (7th Cir. 1994);
United States v. Spicer, 57 F.3d 1152 (D.C. Cir. 1995),
cert. denied, 116 S.Ct. 701, 133 L. Ed. 2d 658 (1996) (type of debt is not altered
through settlement agreement as settlement "makes the dishonest debtor
no more honest, and no more entitled to relief").
II.The Substantive Aspects of Objecting to Discharge
Section 523(a) provides that the following debts are not discharged: (1)
certain kinds of taxes, (2) claims created by certain wrongful acts of
the debtor, (3) unlisted and unscheduled claims; (4)claims resulting from
the fraud or defalcation by a fiduciary, (5) alimony, maintenance and
support for a spouse or child, (6) willful and malicious injury, (7) fines,
penalties and forfeitures to a governmental unit, (8) student loans, (9)
claims of wrongful death or personal injury resulting from the operation
of a motor vehicle while intoxicated, (10) claims surviving prior bankruptcies,
(11 and 12) claims relating to federally insured depository institutions,
(13) restitution orders, (14) debts incurred to pay a tax that wasn't
dischargeable, (15) claims associated with a divorce degree or settlement
agreement not provide for in Section 523(5), (16) post petition fees or
assessments by homeowners associations, (17) fees for filing cases, motions,
complaints or appeals, and (18) funds owed to a state or state agency
for support.This paper will discuss each of these sections in turn.
1. Certain taxes.
The following taxes and customs duty are excepted discharge:
(A) Taxes and duties entitled to priority;
(B) Taxes for which a return was never filed or was late-filed less than
two years before the bankruptcy case commenced; and
(C) Taxes associated with the debtor's filing of a fraudulent return
or willful attempt to evade or defeat a tax.
11 U.S.C. §523(a)(1). Other than these specifically enumerated exceptions,
taxes are generally discharged in bankruptcy. If the underlying tax obligation
is not dischargeable, pre-petition interest, post petition interest and
penalties on these taxes are not dischargeable.
In re Larson, 862 F.2d 112 (7th Cir. 1988) (pre-petition interest);
In re Hanna, 872 F.2d 829 (8th Cir. 1989)(post petition interest);
In re Burns, 887 F.2d 1541 (11th Cir. 1989) (post petition interest); 11 USC §
523(a)(7) (fines, penalties, and forfeitures payable to a governmental
unit are exempt from discharge);
In re Woodward, 113 B.R. 680 (Bankr. D. Or.1990) (citing cases holding that post-petition
interest is dischargeable).Non compensatory tax penalties are generally
1.1 Priority Taxes.
Section 523(a)(1)(A) excepts from discharge the debtor's obligation
to pay: (1) withholding taxes, (2) recently incurred taxes, and (3) taxes
incurred during the period of time between an involuntary petition and
the court's appointment of a trustee or order for relief. 11 USC §
507(a)(2), incorporating 11 USC § 502(f). This section incorporates
Sections 507(a)(2) and 507(a)(8) in determining the dischargeability of
the taxes. Both secured tax claims and unsecured tax claims are not discharged.
In re Latulippe, 13 B.R. 526 (Bankr. D. Vt.1981) (the legislative history expresses an
intent to make secured, as well as unsecured, tax claims nondischargeable).
To get the bankruptcy court to make a determination of whether certain
taxes are dischargable, the debtor may desire to bring the action.
See §523(c).Further, the provision in this section that provides for
the continuing of the debt beyond bankruptcy "whether or not a claim"
has been filed appears to be quite ominous. Specifically, the Tenth Circuit
has found that the Internal Revenue Service may make a claim for taxes
for a particular year, accept thedistribution provided by the Bankruptcy
Court, and then audit the records to make additional claims for that same year.
DePaolo v. United States ex rel. IRS (In re DePaolo), 45 F.3d 373 (10th Cir. Wyo.1995).
Generally, the taxes and customs duties excepted from discharge fall within
the following categories:
- taxes on or measured by income or gross receipts; 11 USC §507(a)(8)(A)
assessed property taxes; 11 USC § 507(a)(8)(B). See also
In re Davis, 11 B.R. 621 (Bankr. N.D. Tex.1981) (the term "assessed" includes
the procedure by which the property is listed, valued, and the pro rata
tax claim determined).
taxes required to be collected or withheld and for which the debtor is
liable in any capacity ("trust fund taxes"); 11 USC § 507(a)(8)(C). See
In re King, 117 B.R. 339 (Bankr. W.D. Tenn.1990) (state sales taxes are nondischargeable
trust fund taxes);
In re Fernandez, 130 B.R. 757 (Bankr. W.D.Mich. 1991) (100% penalty for failure of responsible
party to pay withholding taxes is included in this section rather than
Section 523(a)(7) on penalties);
United States v. Sotelo, 436 U.S. 268, 98 S. Ct. 1795, 56 L. Ed. 2d 275 (1978) (under Bankruptcy
Act 100% penalty on this section and not under penalty section).
- certain employment taxes; 11 USC § 507(a)(8)(D).
certain excise taxes; 11 USC § 507(a)(8)(E). See
In re Payne, 27 B.R. 809 (Bankr. D. Kan.1983) (excise tax is a tax "imposed on
the performance of an act, the engaging in an occupation or the enjoyment
of a privilege");
In re Grynberg, 986 F.2d 367 (10th Cir.Colo. 1993),
cert. denied, 114 S.Ct. 57, 126 L. Ed. 2d 27 (1993) (excise taxes include gift taxes);
In re Beaman, 9 B.R. 539 (Bankr. D. Or. 1980) (excise tax includes amount to be paid
to State in repayment for uninsured debtor's employee's injuries);
Yoder v. Ohio Bureau of Workers' Compensation (In re Suburban Motor Freight), 998 F.2d 338 (6th Cir. 1993) (unpaid workers' compensation premiums
are excise taxes).
- customs duties on certain imported merchandise; 11 U.S.C. §507(a)(8)(F).
- any penalty in compensation for actual pecuniary loss. 11 U.S.C. §507(a)(8)(G).
The only type these taxes that aren't limited to a specific period
of time (either two years pre-petition or three years prepetition) are
"trust fund taxes".
Rosenow v. Illinois, Dept. of Revenue, 715 F.2d 277 (7th Cir. Ill.1983). Most of the taxes are given priority
only for a limited time. This temporal aspect also affects the payment
of the tax claims. If necessary for an effective reorganization, the court
may instruct the taxing authority to apply payments to non-dischargeable
taxes prior to applying payments to dischargeable taxes claims.
United States v. Energy Resources Co., 495 U.S. 545, 110 S.Ct. 2139, 109 L. Ed. 2d 580 (1990). However, courts
have rejected the debtor's request to instruct the taxing authority
as to the application of the payments in a Chapter 7 or liquidating Chapter
See In re Schilling, 177 B.R. 862 (Bankr. N.D. Ohio 1995) (declining to instruct Internal Revenue
Service as to allocation of tax payments between dischargeable and nondischargeable
tax obligations in a Chapter 7 case);
In re Suburban Motor Freight, 161 B.R. 640 (S.D. Ohio 1993) (not applicable to Chapter 7 corporate debtor);
In re Deer Park, 136 B.R. 815(Bankr. 9th Cir.Cal. 1992) (debtor can direct application
in liquidating Chapter 11 plan),
aff'd, 10 F.3d 1478 (9th Cir.1993).
If a surety pays the claim, under some cases, that surety is subrogated
to the rights of the taxing authority to the extent that the surety's
claim is rendered not dischargeable.
In re Fields, 926 F.2d 501 (5th Cir. 1991)
cert. denied, 112 S.Ct. 371, 116 L. Ed. 2d 323 (1991);
In re Waite, 698 F.2d 1177 (11th Cir. 1983)
reh'g denied, 703 F.2d 582 (11th Cir. 1983)
reh'g denied, 703 F.2d 582 (11th Cir. Ga.1983)
but see National Collection Agency, Inc. v. Trahan, 624 F.2d 906 (9th Cir. 1980) (decided under the bankruptcy act).
1.2 Late Filed Taxes.
If the Debtor fails to file a return or filed a late return within the
two years immediately preceeding the bankruptcy case, Section 523(a)(1)(B)
excepts from discharge debts the debts relating to the return. The debtor's
intent or lack of knowledge concerning the requirement to pay the tax
is not a defense to an objection to discharge under this section.
Spain v. United States (In re Spain), 182 B.R. 233 (Bankr. S.D. Ill. 1995). Similarly, even though 26 U.S.C.
§602(b)(1) allows the Secretary of the Treasury to prepare a substitute
return, this substitute return is not equivelent to the tax payer filing a return.
In re Bergstrom, 949 F.2d 341 (10th Cir. Wyo.1991);
In re Pruitt, 107 B.R. 764 (Bankr. D. Wyo.1989);
In re Hofmann, 76 B.R. 853 (Bankr. S.D. Fla.1987);
Delaney v. United States (In re Delaney), 177 B.R. 251 (Bankr. E.D. La.1994);
but seeGless v. USA/IRS (In re Gless), 181 B.R. 414 (Bankr. D. Neb. 1993) (where debtor cooperated with the Secretary
of the Treasury in preparing and filing the return).
If the return is filed but the filing is late the government is afforded
at least two years to effect collection before the debtor can discharge
the debt. At the same time, if the debtor completely fails to file a tax
return, taxes for years ending within three years are also excepted from
discharge. 11 USC § 507(a)(8)(A)(i) (incorporated into 11 USC §
523 by subsection (a)(1)(A)). The three-year period begins on the date
the return is originally due.
Pan American Van Lines v. United States, 607 F.2d 1299 (9th Cir. Cal.1979);
In re Wood, 866 F.2d 1367 (11th Cir. Fla. 1989).
1.3 Fraudulent Return or Willful Attempt to Evade Tax.
Section 523(a)(1)(C) provides that debts for taxes relating to fraudulent
returns or for which the debtor "willfully attempted in any manner
to evade or defeat such tax" are nondischargeable.
Cassidy v. Commissioner, 814 F.2d 477 (7th Cir.1987)
.Acts such as (1) claiming an imaginary child as a dependent have been determined
to fall within this exception to discharge (
In re Harris, 59 B.R. 545 (Bankr. W.D. Va.1986)); (2) using false W-2 Forms
(In re Gilder, 122 B.R. 593 (Bankr. M.D.Fla. 1990)
; Ketchum v. United States, 177 B.R. 628 (E.D. Mo. 1995); and (3) titling real property in the names
of others to evade the taxes
(In re Jones, 116 B.R. 810 (Bankr. D. Kan.1990).
The Internal Revenue Service has the burden of proof to establish: (1)
debtor's knowledge of the falsehood; (2) debtor's intent to evade
the taxes; and (3) an underpayment of taxes.
Brackin v. United States, IRS, 148 B.R. 953 (N.D. Ala.1992);
In re Kirk, 98 B.R. 51 (Bankr. M.D. Fla.1989);
In re Hopkins, 133 B.R. 102 (Bankr. N.D.Ohio 1991).The court applies a the totality of
circumstances test in determing each of these three elements.
Berzon v. United States, 145 B.R. 247 (Bankr. N.D.Ill. 1992);
In re Kirk, 98 B.R. 51 (Bankr. M.D. Fla.1989)
. Intent is inferred from such factors as significant understatements, failure
to file returns, habitual late filings, failure to cooperate with the
IRS, and implausible or inconsistent behavior.
Toti v. United States,149 B.R. 829 (E.D. Mich. 1993)
aff'd, 24 F.3d 806 (6th Cir. Mich. 1994)
cert. denied, 115 S.Ct. 482, 130 L. Ed. 2d 395 (1994);
In re Jones, 116 B.R. 810 (Bankr. D. Kan.1990).
The courts hold that any attempt to evade or defeat a tax, including omissions
and commisions, and any willful attempt to avoid paying a tax fall within
Toti v. United States (In re Toti), 24 F.3d 806 (6th Cir. Mich. 1994),
cert. denied, 115 S.Ct. 482, 130 L. Ed. 2d 395 (1994) (acts of omission and comission
fall within Section 523(a)(1)(C));
Bruner v. United States (In re Bruner), 55 F.3d 195 (5th Cir. La. 1995) (following Toti);
Internal Revenue Code. Haas v. IRS (In re Haas), 48 F.3d 1153 (11th Cir. Ala. 1995) (Congress, which knew how to distinguish
between evasion of tax and evasion of payment and this section does not
apply to evasion of payment);
Ketchum v. United States, 177 B.R. 628 (E.D. Mo. 1995) (a good discussion of the case law).
2. For Claims When the Debtor made False Representations.
The dischargeability of claims based upon false representations made by
the debtor fall within two categories (1) false representations other
than a statement respecting financial condition and (2) false statements
relating to financial conditions.
2.1. Not relating to financial condition.
The distinction between "false pretenses, a false representation,
or actual fraud" appears to be the level of intentional conduct.
"The 'fraud' referred to . . . means positive fraud, or fraud
in fact, involving moral turpitude or intentional wrong . . .".
Neal v. Clark, 95 U.S. 704, 24 L. Ed. 586 (1878);
In re Black, 787 F.2d 503 (10th Cir. 1986);
Stanley H. Silverblatt Electrical Contractor, Inc. v. Marino, 139 B.R. 380 (Bankr. D. Md.1992). Actual fraud may also form the basis
for an objection to discharge under Section 523(a)(6) for willful and
See Printy v. Dean Witter Reynolds, Inc., 110 F.3d 853 (1st Cir. 1997) (surveying circuit court opinions from the
Third, Fourth, Fifth, Sixth, Eighth, Ninth, and Eleventh circuits interpreting
The elements of a cause of action under this portion Section 523(a)(1)(A),
appear to be:
A present material misrepresentation, either oral or in writing.
See In re Buttendorf, 11 B.R. 558 (Bankr. D. Vt.1981) (promises of future performance are insufficient);
In re Bogstad, 779 F.2d 370 (7th Cir. 1985) (an important or substantial misrepresenation
Engler v. Van Steinburg, 744 F.2d 1060 (4th Cir. 1984) (representation may be made orally or in
In re Van Horne, 823 F.2d 1285 (8th Cir. Iowa 1987) (silence or concealment may constitute
the false representation).
Knowledge that the representation is false.
In re Colvin, 117 B.R. 484 (Bankr. E.D. Mo.1990) (discharge granted where mentally challenged
debtor did not know the falsity of her statements); see also
Morimura, Arai & Co. v. Taback,279 U.S. 24, 73 L. Ed. 586, 49 S. Ct. 212 (1929) ("reckless indifference
to actual facts" is equivalent to intentional misrepresentation).
Intent to defraud or deceive.
In re Devers, 759 F.2d 751 (9th Cir. 1985);
FDIC v. Reisman, 149 B.R. 31 (Bankr. S.D.N.Y. 1993) (intent to deceive may be inferred
from surrounding circumstances).This intention is usually determined by
the totality of the circumstances surrounding the representation.
Sinclair Oil Corp. v. Jones (In re Jones), 31 F.3d 659, (8th Cir. 1994).
Justifiable Reliance by the creditor.
Field v. Mans, 133 L. Ed. 2d 351, 116 S. Ct. 437 (1995);
See Greenfield State Bank v. Copeland, 330 F.2d 767 (9th Cir. Cal.1964)
(no reliance in fact because the loan was granted before the representation);
In re Geyen, 11 B.R. 70 (Bankr. W.D. La. 1981) (after the fact representations were
not relied upon);
City Bank & Trust Co. v. Vann (In re Vann), 67 F.3d 277 (11th Cir. 1995) (justifiable reliance means a creditor's
conduct should be determined by the creditor's own capacity and knowledge);
In re Kirsh, 973 F.2d 1454 (9th Cir. Cal.1992) ("justifiable reliance" is
required not "actual reliance" or "reasonable reliance").
In re Collins, 946 F.2d 815 (11th Cir. 1991);
In re Siriani, 967 F.2d 302 (9th Cir. 1992).
As to these elements it should be understood that the courts are continually
developing the concept of common law fraud and this area will incorporate
Wingate v. Attalla (In re Attalla), 176 B.R. 650 (Bankr. D.N.H.1994) (Section 523(a)(2)(A) "has always
been understood to incorporate common law development" of the concept).
2.2. Relating to Financial Conditions.
Section 523(a)(2)(B) requires that these representations be: (1) in writing,
(2) material, (3) reasonably relied upon, and (4) made with the intention
to deceive. The second and fourth elements are the same as the elements
provided for under Section 523(a)(2)(A).
The first element is that representations relating to financial condition
must be in writing. Oral statements relating to financial condition do
not form the basis for an objection to discharge.
Engler v. Van Steinburg, 744 F.2d 1060 (4th Cir. 1984) (oral statement that property not subject
to liens insufficient).
The third element, reasonable reliance, is a higher burden and requires
more than just "justifiable reliance."Some courts require the
creditor to show that it engaged in further investigation of the written
financial statement of the debtor.
Kentile Floors, Inc. v. Winham, 440 F.2d 1128 (9th Cir. Ariz.1971) (creditor "acted unreasonably
if it acted upon the . . . statement in extending credit without any further
see alsoIn re Smith, 424 F. Supp. 858 (M.D. La.1976);
Sweet v. Ritter Finance Co., 263 F. Supp. 540 (W.D. Va. 1967). The further investigation requirement
appears to require the creditor to merely follow industry practices in
relying upon the financial statement.
SeeIn re Patch, 24 B.R. 563 (D. Md.1982);
In re Ardelean, 28 B.R. 299 (Bankr. N.D. Ill.1983).
In renewal situations, when the false documentation is only part of the
renewal, the courts are split on whether a creditor must provide "new
money" as a necessary element.
In re Gerlach, 897 F.2d 1048 (10th Cir. Colo.1990) (new money not required);
Cho Hung Bank v. Kim (In re Kim), 62 F.3d 1511 (9th Cir. Cal. 1995) (although no additional money was provided,
the court required an extension of repayment due date to form consideration
associated with nondischargeability under Code § 523(a)(2)). For
the courts requiring consideration, some hold that only the amount of
the "new money" is except from discharge.
In re Barnacle, 44 B.R. 50 (Bankr. D. Minn.1984);
In re Wright, 52 B.R. 27 (Bankr. W.D. Pa.1985);
In re Curl, 64 B.R. 14 (Bankr. W.D. Mo. 1986). Other courts except the debt represented
by both the previous obligation and new money.
In re Carter, 11 B.R. 992 (Bankr. M.D.Tenn. 1981);
In re Greenidge, 75 B.R. 245 (Bankr. M.D. Ga. 1987);
In re Duncan, 123 B.R. 383 (Bankr. C.D. Cal.1991).
When the documentation is part of the original loan procedure, the debt
arising from a renewal of the loan is should also be nondischargeable.
In re Liming, 797 F.2d 895 (10th Cir. Okla. 1986) (creditor should not be forced to
call loan after discovering falsity of financial statement in order to
maintain rights). The idea is that a debtor shouldn't be able to benefit
from a renewal because the renewal"makes the dishonest debtor no
more honest, and no more entitled to relief Congress intended to reserve
for the honest debtor."
United States v. Spicer, 57 F.3d 1152 (D.C. Cir. 1995)
cert. denied, 116 S.Ct. 701, 133 L. Ed. 2d 658 (1996)
; see also
Fuller v. Johannessen (In re Johannessen), 76 F.3d 347 (11th Cir. Fla. 1996) ("the debtor's fraud should
not be discharged simply because the debtor entered into a settlement
2.3 Purchasing of luxury goods on the eve of bankruptcy
It is generally thought that when a debtor makes a purchase using a credit
card, the debtor is impliedly representing that he intends to pay the
credit card company for that purchase.
American Express Travel Related Servs. Co. v. Mc Kinnon (In re Mc Kinnon),192 B.R. 768 (Bankr. N.D. Ala. 1996) (majority of courts have adopted the
implied representation theory);
Colonial Nat'l Bank USA v. Leventhal (In re Leventhal), 194 B.R. 26 (Bankr. S.D.N.Y. 1996) (same). Because of this general theory,
in the Bankruptcy Amendments and Federal Judgship Act of 1984, Congress
adopted an subsection (C) to Section 523(a)(2).Basically, Section 523(a)(2)(C)
excepts from discharge luxury purchases.
The Bankruptcy Reform Act of 1994 amended Section 523(a)(2)(C) by increasing
the monetary values associated with luxury purchases. Specifically, consumer
debts of more than $1,000 owing to a single creditor for luxury goods
or services which are incurred within 60 days of the bankruptcy petition
are now presumed to be excepted from discharge. In addition, if the debtor
received aggregate cash advances during the 60 days immediately preceding
the bankruptcy of more than $1,000, these advances are presumed to be
excepted from discharge.Advances for goods and services reasonably necessary
to support the debtor or the debtor's dependents are not "luxury
goods and services."
In re Koch, 83 B.R. 898 (Bankr. E.D. Pa.1988);
In re Claar, 72 B.R. 319 (Bankr. M.D. Fla.1987);
In re Smith, 54 B.R. 299 (Bankr. S.D.Iowa 1985).
3. Unscheduled and Unlisted Creditors.
Section 523(a)(3) divides creditors into two categories: (1) those creditors
that have claims against the debtor because of the debtor's wrongful
acts under Section 523(a)(2), Section 523(a)(4) and Section 523(a)(6),
and (2) all other creditors.
3.1 Creditors having claims "of the kind" specified under 523(a)(2),
(4) and (6).
If the creditor is not scheduled and doesn't have knowledge of the
bankruptcy in time to file a dischargeability complaint, the creditor's
claim is not discharged under this section. Courts have not yet determined
the extent to which a creditor must show that his claim is "of the
kind" specificed under Section 523(a)(2), (4) and (6).Some require
a full trial of the claim others require a lesser degree of proof. See
Fidelity Nat'l Title Ins. Co. v. Franklin (In re Franklin), 179 B.R. 913 (Bankr. E.D. Cal. 1995) (full trial with applicable substatnive
law and proof for unscheduled fraud claim);
In re Haga, 131 B.R. 320 (Bankr. W.D. Tex. 1991) (creditor need only show it has "a
viable or colorable claim");
In re Thompson, 177 B.R. 443 (Bankr. E.D.N.Y.1995) (debtor has burden of proof to show
not a claim under Section 523(a)(2), (4) or (6)).
3.2 For creditors with claims not "of the kind" specified under
523(a)(2), (4) and (6).
For the second set of creditors, if the debtor knows of the creditor and
fails to list and schedule the creditor, the claim is not discharged by
the bankruptcy proceeding, unless the creditor receives notice or has
actual knowledge of the filing of the bankruptcy in time to file a proof
of claim. If the debtor knows of the creditor and knows the correct address
of the creditor, the claim is similarly not discharged if the debtor fails
to correctly list the creditor.
In re Gelman, 5 B.R. 230 (Bankr. S.D. Fla.1980) (exception applies where, knowing correct
address, debtor gave wrong address and creditor had no actual knowledge of case);
Beverly Lumber Co. v. Nicholson (In re Nicholson), 170 B.R. 153 (Bankr. W.D. Mo.1994) (proper list includes viable addresses);
In re Faden,170 B.R. 304 (Bankr. S.D. Tex.1994) (notice to subsidiary of creditor insufficient).
3.3 Notice of Knowledge requirement.
If the creditor has notice or knowledge of the bankruptcy, even though
unscheduled and unlist, the creditor bears the burden of finding out the
bar dates and filing a proof of claim.
In re Price, 79 B.R. 888 (Bankr. 9th Cir. 1987),
aff'd, 871 F.2d 97 (9th Cir. 1989). However, the creditor must receive the information
by more than rumor.
In re Stratton, 29 B.R. 93 (Bankr. W.D. Ky.1983) (unsubstantiated rumor of bankruptcy
is not sufficient);
In re Bosse, 122 B.R. 410 (Bankr. C.D. Cal. 1990) (mere statement of intent to file
made by debtor insufficient). The knowledge has to be (1) that the case
was actually filed and (2) the location of the bankruptcy.
In re Layman, 131 B.R. 495 (M.D. Fla.1991).
If no bar debt for filing proofs of claims is set, such as a no-asset Chapter
7 case, the Bankruptcy Court for the District of South Carolina has held
that it is technically never too late to file a timely proof of claim.
Thus, the Bankruptcy Court for the District of South Carolina has concluded
that an unscheduled creditor in a no-asset Chapter 7 case cannot take
advantage of the exception provided by Code § 523(a)(3)(A) and the
claim is discharged.In re Gardner, 194 B.R. 576 (Bankr. D.S.C. 1996).
The Bankruptcy Court for the District of South Carolina has not addressed
the issue of whether the Court should reopen a bankruptcy case where an
unscheduled debt was the result of an intentional design, fraud, or improper
motive rather than due solely to negligence or inadvertence.
Stone v. Caplan (In re Stone), 10 F.3d 285, 291 (5th Cir. 1994) (if part of an intentional design, fraud
or improper motive, failure to include claim in no asset bankruptcy would
render claim not subject to discharge).
4. Fraud and defalcation by a Fiduciary, embezzlement or larceny.
If the debtor acted in a fiduciary capacity, Section 523(a)(4) provides
that the claims of fraud and defalcation against the fiduciary are not
subject to discharge. In addition, all acts of embezzelment and larceny
are exempted from discharge whether or not the debtor was acting in a
4.1 Fraud by a fiduciary.
The fraud associated with a fiduciary's actions appears to be similar
to the fraud found in Section 523(a)(2), however, the burden upon the
creditor is lessened by the fiduciary's duty of good faith, loyalty
and full disclosure.In addition, the creditor appears to have the right
to rely upon the fiduciary as a matter of law.
The definition of "fiduciary" includes persons acting under an
objectively manifested, pre-existing, and binding relationship.
Davis v. Aetna Acceptance Co., 293 U.S. 328, 55 S.Ct. 151, 79 L. Ed. 393 (1934);
LSP Investment v. Bennett, 989 F.2d 779 (5th Cir.Tex. 1993);
Lewis v. Scott (In re Lewis), 97 F.3d 1182 (9th Cir. 1996). The express trust may arise from contract,
from statute, or may be inferred from conduct but some courts have required
an identifiable trust corpus.
Evans v. Pollard (In re Evans), 161 B.R. 474 (9th Cir.1992) (breach of general fiduciary obligations are
insufficient and claim must involve money or property entrusted to the
fiduciary). Even though the trust may be inferred, this exception has
been held not to apply to equitable, implied or constructive trusts.
In re Stone, 91 B.R. 589 (D. Utah 1988);
In re Freeman, 101 B.R. 698 (Bankr. E.D. Okla.1989).
4.2 Defalcation by a fiduciary.
Defalcation is the "misappropriation of trust funds or money held
in a fiduciary capacity; failure to properly account for such funds."
Black's Law Dictionary, (5th Ed. 1961);
see also In re Matheson, 10 B.R. 652 (Bankr. S.D. Ala.1981) (using trust fund for any purpose other
than the intended purpose constitutes defalcation);
In re Duttenhofer, 12 B.R. 926 (Bankr. C.D. Cal.1981) (inability to account for use of trust
funds is defalcation);
In re Beach, 13 B.R. 759 (Bankr. M.D.Ala. 1981) (failure to account for and turn over
money collected is defalcation);
In re Gonzales, 22 B.R. 58 (Bankr. 9th Cir. Cal.1982) (misapplying construction funds
is defalcation). Defalcation does not require an international conduct
and may simply be a willful neglect of duty.
In re Moreno, 892 F.2d 417 (5th Cir. 1990).
Upon insolvency, corporate officers and directors are fiduciaries of the
creditors of the corporation.
In re Bernard, 87 F.2d 705 (2d Cir. N.Y.1937) (based on common law and statute, the Honorable
Learned Hand found a fiducirary relationship between corporate officers
In re Long, 774 F.2d 875 (8th Cir. 1985) (upon insolvency, director has a fiduciary
duty owing to creditors);
In re Chavez, 140 B.R. 413 (Bankr. W.D.Tex. 1992) (complaint filed against former president
and chief executive officer of bank for defalcation);
Berres v. Bruning, 143 B.R. 253 (D. Colo. 1992) (common law creates a fiduciary relationship
upon insolvency). In this context, defalcation occurs when "a payment
by an officer of his own claim, or that of another officer, . . . when
he knew that the corporation was insolvent and that the interests of other
creditors would be sacrificed for the benefit of its fiduciaries."
In re Bernard, 87 F.2d 705 (2d Cir. N.Y.1937). Defalcation may also occur when the director
or officer transfers property to himself or herself.
Lawrence T. Lasagna, Inc. v. Foster, 609 F.2d 392 (9th Cir.1979),
cert. denied, 446 U.S. 919, 100 S.Ct. 1853, 64 L. Ed. 2d 273 (1980);
In re Metz, 6 F.2d 962 (2d Cir. N.Y.1925).
Also, general partners of a limited partnership and managing partners are
often found to be fiduciaries of the partnership.
Bennett v. Bennett (In re Bennett), 989 F.2d 779 (5th Cir. 1993),
en banc, denied, 993 F.2d 1545 (5th Cir. 1993) (managing partner of limited partnership
is a fiduciary);
In re Short, 818 F.2d 693 (9th Cir. 1987) (managing joint venturer was a fiduciary);
Cundy v. Woods (In re Woods), 175 B.R. 78 (Bankr. D. Colo.1994) (joint venturers and management committee
members have fiduciary obligations). The law is less clear on general
partners of a general partnership.
See LSP Investment v. Bennett, 989 F.2d 779 (5th Cir.Tex. 1993),
reh'g, en banc, denied, 993 F.2d 1545 (5th Cir. Tex. 1993) (citing cases finding the general
partner is a fiduciary in footnote 6 and citing cases finding that the
general partner is not a fiduciary in footnote 7).
"Embezzlement" is defined as "the fraudulent appropriation
of property by a person to whom such property has been entrusted or into
whose hands it has lawfully come."
Chrysler First Commercial Corp. v. Nobel (In re Nobel), 179 B.R. 313 (Bankr. M.D. Fla. 1995);
In re Jardula, 122 B.R. 649 (Bankr. E.D.N.Y.1990) (quoting
Moore v. United States, 160 U.S. 268, 16 S.Ct. 294, 40 L. Ed. 422 (1895))
.The establish embezzlement the creditor must show: (1) theappropriation
of money or property; (2) for the debtor's use or benefit; and (3)
done with fraudulent intent.
In re Patton, 129 B.R. 113 (Bankr. W.D. Tex.1991)
. For embezzelment, the fraudulent intent is established by a showing of
dishonesty in fact.
In re Black, 787 F.2d 503 (10th Cir. Utah 1986). This section has been applied to a
wide variety of property, not just the embezzlement of money.
In re Mastrangelo, 34 B.R. 399 (Bankr. D. Mass.1983) (diamonds);
In re Berkemeier,51 B.R. 5 (Bankr. S.D. Ind.1983) (fertilizer).As with fraud, the intent
is usually inferred from the debtor's actions and the totality of
Hall v. Blanton, 149 B.R. 393 (Bankr. E.D. Va.1992);
In re Beasley, 62 B.R. 653 (Bankr. W.D.Mo. 1986);
Savonarola v. Beran, 79 B.R. 493 (Bankr. N.D. Fla.1987);
In re Bevilacqua, 53 B.R. 331 (Bankr. S.D.N.Y.1985).
"Larceny" is defined as the wrongful taking of the property of
another with fraudulent intent.
In re Rose, 934 F.2d 901 (7th Cir. Ill. 1991). The fraudulent intent in larceny is
merely the intent to convert the property to one's own use without consent.
In re Shinew, 33 B.R. 588 (Bankr. N.D. Ohio 1983). With Larceny, the wrongful conduct
is in the initial taking of the property. With embezzelment, the wrongful
conduct is after the property comes into the possession of the debtor.
In re Weber, 892 F.2d 534 (7th Cir. Wis.1989).
In this regard, embezzelment and larceny are similar to the South Carolina
criminal acts of breach of trust and larceny at common law. Breach of
trust is part of the criminal statutes found at S. C. Code Ann. §16-13-230(1997)
("S.C. Code"). Basically, breach of trust is larceny after trust,
which includes all of the elements of larceny (stealing), except the unlawful
taking in the beginning.
See State v. Owings, 205 S.C. 314, 31 S.E.2d 906 (1944). In the case of
State v. Jordan, 255 S.C. 86, 177 S.E.2d 464 (1970), the defendant was given money to
purchase stock for the victim. The defendant used some of the money to
purchase groceries for himself, rather than to purchase the stock. Thus,
he breached the trust and was guilty of the crime of breach of trust.Larceny
occurs when the possession of the property is obtained through artifice,
trick, or other fraud.
State v. McCann, 167 S.C. 393, 166 S.E. 411 (1932).
5. Alimony, Maintenance and Support
Under Section 523(a)(5), to be exempt from discharge, the obligation to
pay support must have some legal basis, such as the obligation of one
spouse to pay another.
Audubon v. Shufeldt, 181 U.S. 575, 21 S.Ct. 735, 45 L. Ed. 1009 (1901) ("on the natural
and legal duty of a husband to support the wife" )
Wetmore v. Markoe, 196 U.S. 68, 25 S.Ct. 172, 49 L. Ed. 390 (1904)
. If there is no legal duty to support, the obligation may be found to be
Norris v. Norris, 324 F.2d 826 (9th Cir. Cal.1963) (annuled marriage does not form legal
basis for support);
In re Doyle, 70 B.R. 106 (Bankr. 9th Cir.1986) (payments to non-spouse companion may
. The obligation of a parent to support the child is always found to be
In re Magee, 111 B.R. 359 (M.D. Fla.1990);
Mullally v. Carter, 67 B.R. 535 (N.D. Ill. 1986) (obligation from paternity action);
In re Seibert, 914 F.2d 102 (7th Cir. 1990) (paternity can be determined as part of the
The issue of whether the obligation is nondischargeable support is determined
by federal law.
Sylvester v. Sylvester, 865 F.2d 1164 (10th Cir. 1989);
In re Harrell, 754 F.2d 902 (11th Cir. 1985);
In re Calhoun, 715 F.2d 1103 (6th Cir. 1983);
In re Williams,703 F.2d 1055 (8th Cir. 1983);
In re Spong, 661 F.2d 6 (2d Cir. N.Y.1981);
In re Long,794 F.2d 928 (4th Cir. 1986);
Shaver v. Shaver, 736 F.2d 1314 (9th Cir. 1984). Even if state law does not provide for
alimony and support, some obligation may still be found non-dischargable
under this provision.
See In re Nunnally, 506 F.2d 1024 (5th Cir. 1975),
reh'g denied, 509 F.2d 576 (5th Cir. Tex. 1975),
reh'g denied, 509 F.2d 576 (5th Cir. Tex.1975) (Texas law does not allow alimony or
support, nevertheless obligation held to be non-dischargeable under this
In re Biggs, 907 F.2d 503 (5th Cir. 1990) (although no alimony allowed, there are alimony
substitutes for dischargeability issues).
The Honorable Learned Hand suggested that the courts are to examine the
underlying duty that created the obligation and not the written terms
of the obligation in determining whether an obligation is for support.
In re Adams, 25 F.2d 640 (2d Cir. N.Y.1928).Since that opinion, the federal courts
have generally examined whether there is an underlying obligation to support
and whether the intent of the parties was to fulfill that obligation through
the mechanism at issue. However, some courts ignore the underlying obligation
and focus on the form or mechanism in an effort to determine whether the
mechanism provides for support.
See In re Fox, 5 B.R. 317 (Bankr. N.D. Tex.1980) (if obligation terminates on death or
remarriage, it is alimony or support); see also
In re Maitlen, 658 F.2d 466 (7th Cir. Ind. 1981);
In re Taff, 10 B.R. 101 (Bankr. D. Conn.1981);
In re Snyder, 7 B.R. 147 (W.D. Va.1980).
The primary objective in examining either the nature of the obligation
or the mechanism used to provide for the obligation is to determine the
true intent of the parties. In the absence of clear intent as manifested
in some writing, the courts examine various factors present at the time
the debt was incurred. The factors examined are usually the same as those
that a divorce court might consider in deciding whether to award support
or alimony. Under this test, even obligations to pay third parties may
In re Stranathan, 15 B.R. 223 (Bankr. D. Neb.1981);
In re Harrell, 754 F.2d 902 (11th Cir. 1985) (educational expense for 19-year-old child);
In re Crawford, 8 B.R. 552 (Bankr. D. Kan.1981) (moving expenses are non-dischargeable
when intended for support);
In re Maitlen, 658 F.2d 466 (7th Cir. Ind.1981) (mortgage payments are non-dischargeable
when intended for support).
Different courts use a different list of factors in determining the intent
of the obligation.
In re Singer, 787 F.2d 1033 (6th Cir. Ohio 1986) (eleven factors);
In re Stone, 79 B.R. 633 (Bankr. D. Md.1987) (the eighteen factors);
In re Goin, 808 F.2d 1391 (10th Cir. Kan.1987) (four factors). These factors usually include:
(1) whether the obligation terminates on the death or remarriage; (2) the
written characterization of the payment; (3) whether the payments appear
to balance disparate income; (4) whether the payments are to be made directly
to the spouse or to a third party; (5) whether the obligation is payable
in lump sum or installments; (6) whether an assumption of a debt has the
effect of providing the support necessary to insure that the daily needs
of the former spouse and children; and (7) whether an assumption of debt
has the effect of providing the support necessary to insure a home for
the spouse and children.
Friedman v. Silberfein, 138 B.R. 778 (Bankr. S.D.N.Y.1992).Some courts also examine such things
as whether the spouse has declared the obligation as a support obligation
for tax purposes as indicia of the intent of the parties.
Robb-Fulton v. Robb (In re Robb), 23 F.3d 895 (4th Cir. 1994);
Nowak v. Nowak (In re Nowak), 183 B.R. 568 (Bankr. D. Neb. 1995) (debtor's income taxes that claimed
past payments as alimony used to support finding).
As previsously discussed, claims for support are not discharged and under
Section 523(c), the creditor is not required to bring a suit to make this
determination. The determination of dischargeabilty can be made at any
time and in other courts.However, if the claim has been assigned to another
entity or includes a liability designated as alimony, maintenance or support,
then the claim may be non-dischargeable under Section 523(a)(15). As previsously
discussed, the creditor does have to bring a suit for a determination
of whether the claim is dischargeable under Section 523(a)(15).
6. Willful and malicious injury.
Section 523(a)(6) has received recent attention in the case of
Kawaauhau v. Geiger, 118 S. Ct. 974; 140 L. Ed. 2d 90; 66 U.S.L.W. 4167 (March 3, 1998).
Kawaauhau dealt with a medical malpractice action and whether the malpractice claim
was a willful and malicious inury. The Supreme Court held that it was
not willful and malicious and therefore it was subject to being discharged.
The facts of this case are a bit different than the ordinary malpractice
case. The case didn't involve an honest negligent mistake by a physician,
instead, the case involved an intentional act of providing a lesser degree
of care. In this case,
The Kawaauhaus urge that the malpractice award fits within this exception
because Dr. Geiger intentionally rendered inadequate medical care to Margaret
Kawaauhau that necessarily led to her injury. According to the Kawaauhaus,
Geiger deliberately chose less effective treatment because he wanted to
cut costs, all the while knowing that he was providing substandard care.
Such conduct, the Kawaauhaus assert, meets the "willful and malicious"
specification of § 523(a)(6).
The Supreme Court held that:
The word "willful" in (a)(6) modifies the word "injury,"
indicating that nondischargeability takes a deliberate or intentional
injury, not merely a deliberate or intentional act that leads to injury.
Had Congress meant to exempt debts resulting from unintentionally inflicted
injuries, it might have described instead "willful acts that cause
injury." Or, Congress might have selected an additional word or words,
i.e., "reckless" or "negligent," to modify "injury."
The Court went further in also describing the claims covered by Section
523(a)(6) as follows:
the (a)(6) formulation triggers in the lawyer's mind the category "intentional
torts," as distinguished from negligent or reckless torts. Intentional
torts generally require that the actor intend "the consequences of
an act," not simply "the act itself." Restatement (Second)
of Torts § 8A, comment a, p. 15 (1964) (emphasis omitted).
Thus, it appears that the Supreme Court has defined "willful and malicious"
as "intentional." A copy of this opinion is attached to this
outline for your viewing pleasure.
6.1 Willful means intentional
Prior to this Supreme Court ruling, several courts found that "willful"
meant intentional and that the intent required under the willful element
was the intent to do the act which resulted in harm, not the intent to
injure the creditor.
In re Britton, 950 F.2d 602 (9th Cir. 1991);
In re Posta, 866 F.2d 364 (10th Cir. 1989). Under
Kawaauhau, the debtor must intend not just the act but the consequences of the act.
6.2 Malicious means done without just cause.
Kawaauhau, most courts examined Section 523(a)(6) as requiring a showing both intentional
and malicious. Malicious required a showing that the act was done without
just cause or excuse.
Seven Elves, Inc. v. Eskenazi, 704 F.2d 241 (5th Cir. Tex. 1983).The malicious action did not require
a showing of hatred or ill will.
In re Wooten, 30 B.R. 357 (Bankr. N.D.Ala. 1983);
In re Chambers, 23 B.R. 206 (Bankr. W.D. Wis.1982);
First Nat'l Bank v. Stanley (In re Stanley), 66 F.3d 664 (4th Cir. Md. 1995). Although not stated, it could be suspected that the
Kawaauhau court did not want to get into the question of whether saving money by
providing substandard care was "just cause or excuse."
Kawaauhau, some secured creditors attempted to use this section to object to the
discharge of debtors that sold the collateral and then used the proceeds
of the sale for purposes other than payment to the secured creditors.
Even prior to
Kawaauhau, the rule appeared to be that the mere conversion of collateral and diverting
of funds for other uses did not constitute a willful and malicious injury
required under Section 523(a)(6).
In re Long, 774 F.2d 875 (8th Cir.1985);
First Nat'l Bank v. Zinke (In re Zinke), 174 B.R. 1017 (Bankr. D.N.D.1994) (finding willful and malicious injury
resulting from repeated and unauthorized disposition of collateral in
contravention of the security agreement). Other courts have required a
showing that the debtor made personal use of the diverted funds.
Taubert v. Walsh, 143 B.R. 691 (Bankr. N.D.Ohio 1992);
See also C.J. Tabb,
The Scope of Fresh Start in Bankruptcy: Collateral Conversions and the
Dischargeability Debate, 59 George Washington L. Rev. 56 (1990).
6.3 Punitive Damages.
Kaawauhau also places into question the issue of punitive damages. Prior
to Kaawauhau, applied Section 523(a)(6) in deciding whether punitive damages
In re Miera, 926 F.2d 741 (8th Cir. 1991);
In re Levy, 951 F.2d 196 (9th Cir. 1991),
cert. denied, 112 S.Ct. 2965, 119 L. Ed. 2d 586 (1992);
Gober v. Terra+Corp. (In re Gober), 100 F.3d 1195 (5th Cir. Tex. 1996);
Grogan v. Garner, 498 U.S. 279, 111 S.Ct. 654, 112 L. Ed. 2d 755 (1991) ("Arguably,
fraud judgments in cases in which the defendant did not obtain money,
property, or services from the plaintiffs and those judgments that include
punitive damages awards are more properly governed by § 523(a)(6) .");
Brown v. Benson (In re Benson), 180 B.R. 796 (Bankr. W.D. Pa. 1995) ("The vast majority of courts
to address the issue have held that punitive damages are nondischargeable
under § 523(a)(6).") Punitive damages may be awarded in cases
where the conduct is far less culpable than the intentional standard set
At least one circuit has taken the position that if the underlying actual
damages are non-dischargeable, the punitive damages associated with the
claim are non-dischargeable.
St. Laurent v. Ambrose (In re St. Laurent), 991 F.2d 672 (11th Cir. 1993) (under Section 523(a)(2)(A), punitive damages
are nondischargeable because they flow from the same course of conduct).It
is unclear the extent to which punitive damages will continue to be exempt
7. Fines, penalties and forfietures.
Section 523(a)(7) which excepts from discharge penalties:
Other than a tax penalty
(A) relating to a tax of a kind not specified in paragraph (1) of this
(B) imposed with respect to a transaction or event that occurred before
three years before the date of the filing of the petition.
Both subsections (A) and (B) must exist before the tax penalty is excepted
McKay v. United States, 957 F.2d 689 (9th Cir. Cal.1992);
In re Roberts, 906 F.2d 1440 (10th Cir.Okla. 1990);
In re Burns, 887 F.2d 1541 (11th Cir. Ga.1989).
It should be noted that in Chapter 13 the result is different. Taxes are
dischargeable under a Chapter 13 plan if the plan is fully consummated.
11 U.S.C. §1328(a). Only priority taxes must be paid in full in Chapter
13.11 U.S.C. §1322(a)(2). Thus, a tax penalty whose nondischargeability
is based on 11 USC § 523(a)(7)(A) and (B) is discharged under 11
USC § 1328(a) and need not be paid in full in a Chapter 13 case.
Section 101(27) defines a "governmental unit" to include all
departments, agencies, and instrumentalities of states and the United
States. The term is construed in the broadest sense.
See In re Haberman, 137 B.R. 292 (Bankr. E.D.Wis. 1992) (extending application to state attorney
disciplinary boards created by a state supreme court)
Attorney Registration & Disciplinary Comm'n v. Betts, 149 B.R. 891 (Bankr. N.D. Ill.1993) (same). The fines, penalties, and
forfeitures imposed by these various entities are nondischargeable to
the extent they do not represent "compensation for actual pecuniary
loss." These fines would include traffic fines and parking tickets.
In re Young, 10 B.R. 17, (Bankr. S.D.Cal. 1980) (traffic citations are criminal fines
which are nondischargeable);
In re Marini, 28 B.R. 262 (Bankr. E.D.N.Y.1983) (contempt fine is nondischargeable).
Some penalties issued by administrative agencies such as environmental
agencies are also held to fall within this section's scope. See
In re Daugherty, 25 B.R. 158 (Bankr. E.D.Tenn. 1982) (monetary penalty for environmental
In re Tauscher, 7 B.R. 918 (Bankr. E.D. Wis.1981) (civil money penalties for violations
of Fair Labor Standards Act).Lastly, court sanctions, such are Rule 9011,
are not dischargeable.
In re McIntyre, 96 B.R. 70 (Bankr. S.D. Miss. 1989) (nondischargeable under either Code
§ 523(a)(7) and Code § 523(a)(6)).
In South Carolina, the SC Department of Transportation requires the payment
of certain funds in order to reinstate a debtor's driver's license.
These required payments may be dischargeable.
See Williams v. Motley, 925 F.2d 741 (4th Cir. Va.1991) (service fees to reinstate vehicle registration
and driving privileges are compensatory and not excepted from discharge).
Because of certain limiting language in Section 523(a)(13) (declaring federally
ordered restitution orders non-dischargeable), State Court-ordered restitution
may still be found nondischargeable under Section 523(a)(7) and court-ordered
restitution imposed as a condition of probation is nondischargeable because
it is viewed as part of the state's interest in rehabilitation and
Kelly v. Robinson, 479 U.S. 36, 107 S.Ct. 353, 93 L. Ed. 2d 216 (1986) (State Court ordered
restitution excepted from discharge under Section 523(a)(7)). If the purpose
of the restitution order is to compensate, the obligation may be discharged.
In re Car Renovators, 946 F.2d 780 (11th Cir. 1991),
cert. denied, 112 S.Ct. 1949, 118 L. Ed. 2d 553 (1992).
The Fourth Circuit disctinguishes between restitution orders that seek
to compensate the government from restitution orders that seek to compensate
the victim. The Fourth Circuit held that the governments purpose was penal
when it required the criminal to compensate the victims and therefore,
found the obligations to the victims to be non-dishargeable.
United States Dep't of Hous. & Urban Dev. v. Cost Control Mktg.
& Sales Management, 64 F.3d 920 (4th Cir. Va. 1995).
It should be noted that in the Crime Control Act of 1990, Congress amended
the discharge provisions of Chapter 13. Section 1328no longer discharges
restitution orders. The restitition order mentioned in Section 1328 does
not distinguish between federal restitution orders and state restitution
orders. Thus, if state restitution orders are not found to be included
under Section 527(a)(7), debtors could face the anamoulous situation where
a state court restitution order is not dischargeable in a Chapter 13,
but is dischargeable in a Chapter 7 and Chapter 11.
8. Student Loans.
Section 523(8) provides that student loans are not dischargeable if (1)
made, insured, or guaranteed by a governmental unit or (2) made under
any program funded in whole or part by a governmental unit or a nonprofit
institution. This section does not require the creditor to bring a complaint
objecting to the discharge, thus the burden is on the debtor if he seeks
a determination from the bankruptcy court.
Buford v. Higher Education Assistance Foundation, 85 B.R. 579 (D. Kan. 1988);
United States v. Bradburn, 75 B.R. 108 (S.D. Ind.1987);
In re Frech, 62 B.R. 235 (Bankr. D. Minn.1986).Nevertheless, the creditor bears the
burden of establishing the existence of the debt and its qualification
for the debt under Code § 523(a)(8).
In re Webb, 132 B.R. 199 (Bankr. M.D. Fla.1991).
This exception to discharge contains two exceptions (1) an exception for
loans that first came due more than seven years before bankruptcy and
(2) cases where not discharging the loan would work an "undue hardship"
upon the debtor. In 1990, the discharge provided under Chapter 13, Section
1328, was amended to prevent the discharge of otherwise non-dischargeable
student loans under Section 523(a)(8). The debtor should also be aware
that outside of Section 523(a)(8) there are other statutes that relate
to specific types of student loans.
8.1 Made, insured or guaranteed by a governmental unit
Section 101(27) define "governmental unit," to include the United
States, states, municipalities, foreign states, and their departments,
agencies and instrumentalities. An educational loan is "made"
by a governmental unit regardless of the immediate source of the money
for the loan.
In re Shore, 707 F.2d 1337 (11th Cir. 1983) (immediate source was a trust with the
beneficiary as the educational institution);
In re Hammarstrom, 95 B.R. 160 (Bankr. N.D. Cal.1989) (loan made with the intention of selling
it to a nonprofit institution with the debtor's knowledge). While
not considering the source of the money for the loan, the courts will
consider the source of repayment and if that source is specifically identified,
the court may determine the obligation to be something other than a student loan.
See In re Shipman, 33 B.R. 80 (Bankr. W.D.Mo. 1983) (when obligation was to be paid back
by labor in work-study program, court determined the obligation was not a loan);
but see In re Merchant, 958 F2d 738, (6th Cir. 1992) (even though creditor had recourse against
educational institution, loan was still excepted from discharge).
8.2. Made pursuant to a program funded by a governmental unit or nonprofit
Unlike governmental unit, the term "nonprofit institution" is
not defined. Thus, even though some institutions are clearly nonprofit,
the case law is split on whether these nonprofit instutions are allowed
to claim the benefit of Section 523(a)(8).
In re Sinclair-Ganos, 133 B.R. 382 (Bankr. W.D. Mich. 1991) (credit unions do not deserve to
claim benefit of exception);
but see In re Roberts, 149 B.R. 547 (C.D. Ill.1993) (credit unions are nonprofit institutions);
see also, T I Fed. Credit Union v. DelBonis, 72 F.3d 921 (1st Cir. Mass. 1995) (federal credit unions are governmental
units).In deciding whether the nonprofit institution is allowed standing
to object to a discharge the court will examine the corporate structure,
whether dividends are paid and whether the institution competes with "for
Navy Fed. Credit Union v. Simmons (In re Simmons), 175 B.R. 624 (Bankr. E.D. Va.1994).
8.3 First became due more than seven years before the bankruptcy petition.
The first exception to the exception provided under Section 523(a)(8) relates
to loans that first became due more than seven years before the filing
of the bankruptcy petition. The burden of proof is on the creditor to
show that the loan first became due within the seven years.
In re Webb, 132 B.R. 199 (Bankr. M.D. Fla.1991);
In re Norman, 25 B.R. 545 (Bankr. S.D. Cal.1982). The date on which the loan "first
became due" is the date on which the first installment is due under
the promissory note as interpreted under state law.
Woodcock v. Chemical Bank, NYSHESC (In re Woodcock),45 F.3d 363, (10th Cir. Colo.1995)
petition for cert. filed, 45 F.3d 363 (1995);
In re Nunn, 788 F.2d 617 (9th Cir. Wash.1986)
. The date the loan "first became due" is extended by any suspension
period in the creditors ability to seek collection, such as a forbearance
in whole or in part or a prior bankruptcy.
In re Eckles, 52 B.R. 433 (E.D. Wis.1985) (forebearance agreement);
In re Shryock, 102 B.R. 217 (Bankr. D. Kan.1989) (forebearance agreement);
In re Saburah, 136 B.R. 246 (Bankr. C.D. Cal.1992) (automatic stay);
State Educ. Assistance Auth. v. Gibson (In re Gibson), 184 B.R. 716 (E.D. Va. 1995) (automatic stay). The forebearance has to
be agreed upon by the debtor and cannot be unilaterally decided by the creditor.
In re Crumley, 21 B.R. 170 (Bankr. E.D. Tenn.1982) (deferment beyond requested time did
In re Keenan, 53 B.R. 913 (Bankr. D.Conn. 1985) (unilateral suspension was invalid).
If student loans are consolidated, the new loan may restart the seven-year period.
United States v. McGrath, 143 B.R. 820 (D. Md.1992);
In re Saburah, 136 B.R. 246 (Bankr. C.D. Cal.1992);
Martin v. Great Lakes Higher Educ. Corp., 137 B.R. 770 (Bankr. W.D. Mo.1992);
In re Brown, 4 B.R. 745 (Bankr. E.D.Va. 1980) (consolidation does not restart running
of statutory period);
Hiatt v. Indiana State Student Assistance Comm'n, 36 F.3d 21 (7th Cir.Ind. 1994),
cert. denied, 115 S.Ct. 1109, 130 L. Ed. 2d 1074 (1995) (same)
.In situations involving consolidated loans, the courts examine the current
creditor to determine whether the loan is still a student loan.
See Santa Fe Medical Servs. v. Segal (In re Segal), 57 F.3d 342 (3d Cir. Pa. 1995) (money loand by prospective employer to
repay National Health Services Corp. service obligation was not a student
loan) (in dicta, the court suggests that consolidated loans are educational loans).
8.4. Undue Hardship.
Section 523(a)(8) provides for an exception to the exception to discharge
if the continuation of the obligation would result in an undue hardship.
"Undue hardship" is not defined in the bankruptcy code. Nevertheless,
some courts have found this issue to be a question of law, reviewable
de novo on appeal.
Cheesman v. Tennessee Student Assistance Corp. (In re Cheesman), 25 F.3d 356 (6th Cir. 1994);
In re Roberson, 999 F.2d 1132 (7th Cir. Ill.1993)
.Undue hardship is more than current financial difficulties and must include
a long-term detriment.
In re Berthiaume, 138 B.R. 516 (Bankr. W.D. Ky.1992)
. In one instance, undue hardship was described "as a result of unique
factors" which make the "expectation of repayment . . . virtually
non-existent unless by the effort the bankrupt strips himself of all that
makes life worth living."
United States v. Russo, 708 F.2d 209 (6th Cir. 1983),
cert. denied, 464 U.S. 993, 104 S.Ct. 487, 78 L. Ed. 2d 682 (1983).
The debtor has the burden to show undue hardship by a preponderance of
the evidence and each case involving a student loan must be examined on
the facts and circumstances surrounding that particular bankruptcy.
In re Betz, 31 B.R. 565 (Bankr. W.D.N.Y.1983) (debtor has burden);
In re Keenan, 53 B.R. 913 (Bankr. D.Conn. 1985) (debtor has burden);
In re Garneau, 122 B.R. 178 (Bankr. W.D.N.Y. 1990) (debtor has burden by the preponderance
of the evidence);
In re Connolly, 29 B.R. 978 (Bankr. M.D. Fla.1983) (facts and circumstance of particular case);
In re Ford, 22 B.R. 442 (Bankr. W.D.N.Y.1982) (court must examine facts and circumstance
of particular case);
In re Diaz, 5 B.R. 253 (Bankr.W.D.N.Y. 1980) (good factual discussion ofhardship).
In determining undue hardship, the courts generally examine three factors
that were first discussed in the case of
In re Johnson, 5 Bankr. Ct. Dec. (CRR) 532 (Bankr. E.D. Pa.1979). The first factor is
known as the "mechanical" test. The court examines whether the
debtor's financial resources will be insufficient to enable the debtor
(and any dependents of the debtor) to live at or above a subsistence level.
The court examines numerous indicia including: the number of the debtor's
dependents, and their ages and needs; health of the debtor and his or
her dependents; access to transportation; level of education attained
by the debtor; the reasonable and necessary day-to-day living expenses;
marketability of the debtor's job skills; current income; and other
sources of wealth.
In re Andrews, 661 F.2d 702 (8th Cir. S.D.1981);
Koch v. Pennsylvania Higher Educ. Assistance Agency, 144 B.R. 959 (Bankr. W.D.Pa. 1992);
In re Armijo, 13 B.R. 175 (Bankr. D.N.M.1981);
In re Rice, 13 B.R. 614 (Bankr. D.S.D.1981);
In re Clay, 12 B.R. 251 (Bankr. N.D. Iowa 1981);
In re Perkins, 11 B.R. 160 (Bankr. D. Vt.1980);
In re Conard, 6 B.R. 151 (Bankr. W.D. Ky.1980);
but see In re Fischer, 23 B.R. 432 (Bankr. W.D. Ky.1982) (motherhood is not an "undue hardship"
but voluntarily assumed). If the debtor fails to establish that his financial
resources are insufficient to live at or above a subsistence level, the
court denies the discharge. If the debtor meets this test, the court proceeds
to the second factor.
Woodcock v. Chemical Bank, NYSHESC (In re Woodcock), 45 F.3d 363 (10th Cir. Colo. 1995),
cert. denied, 116 S.Ct. 97, 133 L. Ed. 2d 52 (1995);
In re Johnson, 5 Bankr. Ct. Dec. (CRR) 532 (Bankr. E.D. Pa.1979).
The second factor is the "good faith" test. The debtor must demonstrate
that he or she has made a good faith attempt to make payments on the loan.
Koch v. Pennsylvania Higher Educ. Assistance Agency, 144 B.R. 959 (Bankr. W.D.Pa. 1992);
In re Love, 28 B.R. 475 (Bankr. S.D. Ind.1983);
In re Lezer, 21 B.R. 783 (Bankr. N.D.N.Y.1982);
In re Armijo, 13 B.R. 175 (Bankr. D.N.M.1981);
In re Rice, 13 B.R. 614 (Bankr. D.S.D. 1981);
In re Clay, 12 B.R. 251 (Bankr. N.D. Iowa 1981);
In re Archie, 7 B.R. 715 (Bankr. E.D. Va.1980).In addition to examining the payment
history of the loan, the court will examine such factors as: efforts to
get and keep a job;present employment; job history; whether the debtor's
education and skills are being used to the best advantage; and attempts
by the debtor to live within his or her means.If the debtor fails to meet
his burden on this factor, the debt is excepted from discharge. If the
debtor meets his burden, the court examines the third factor.
The third factor is referred to as the "policy test" and appears
to be a category for the court to examine an any other potential reason
not to allow the debtor to discharge the student loan. Some Circuit Courts
have abandoned the "policy test" but employ a modified version
of the remaining factors. See
Brunner v. New York State Higher Education Services Corp., 831 F.2d 395 (2d Cir. 1987);
In re Roberson, 999 F.2d 1132, 1137 (7th Cir. Ill.1993). These courts require the debtor to prove:
(1) that the debtor cannot maintain, based on current income and expenses,
a "minimal" standard of living for [himself] and [his] dependents
if forced to repay the loans;
(2) that additional circumstances exist indicating that this state of affairs
is likely to persist for a significant portion of the repayment period
of the student loans; and
(3) that the debtor has made good faith efforts to repay the loans.
999 F.2d at 1137.
Except for the Johnson test and the modified Johnson test, the courts seem
to provide a divergent group of tests to determine whether the debtor
has met his burden of showing an undue hardship.
In re Craig, 64 B.R. 854 (Bankr. W.D. Pa. 1986),
appeal dismissed, 64 B.R. 857 (W.D. Pa.1986) (debtor must rebut presumption on nondischargeability
with a showing of severe and uniquely difficult circumstances);
Mathews v. Higher Educ. Assistance Found. (In re Mathews), 166 B.R. 940 (Bankr. D.Kan.1994) (presumption must be rebutted);
In re Ford, 151 B.R. 135, 139 (Bankr. M.D.Tenn.1993) (same);
In re Bryant, 72 B.R. 913 (Bankr. E.D.Pa. 1987) (Federal Poverty Income Guidelines established
by the Department of Health and Human Services).
In addition to determining whether a debt is dischargeable, some courts
have examined the issue of undue hardship and revised payment schedule
or to reduced the amount of the nondischargeable debt.
In re Webb, 132 B.R. 199 (Bankr. M.D. Fla.1991) (revised payment schedule);
In re Littell, 6 B.R. 85 (Bankr. D. Or.1980) (reduced amount);
Silliman v. Nebraska Higher Educ. Loan Program, 144 B.R. 748 (Bankr. N.D. Ohio 1992) (reduced amount);
Raimondo v. New York State Higher Educ. Servs. Corp. (In re Raimondo), 183 B.R. 677 (Bankr. W.D.N.Y. 1995) (finding debtor could repay $5,000
of student loan obligations (20% of total outstanding) over ten years
without undue hardship).
But see Rice v. United States (In re Rice), 78 F.3d 1144 (6th Cir. Ohio 1996) (Bankruptcy Court may not reduce an
otherwise nondischargeable debt on the basis of perceived undue hardship).
In South Carolina, the amount of the obligation may be reduced.
See Ammirati v. Nellie Mae, Inc. (In re Ammirati), 187 B.R. 902 (D.S.C. 1995),
aff'd without op., 85 F.3d 615 (4th Cir. S.C. 1996).
8.5. Non Bankruptcy Exceptions to Discharge of Student Loans.
Outside of Section 523(a)(8), the debtor should be aware of the following
possible exceptions, depending upon the student loan itself.
42 U.S.C. §254o(d)(3). Under the National Health Service Corps ("NHSC")
medical training is funded as part of a program to redistribute physicians
to areas in need of medical care providers. Discharge is permitted only
if (1) five years has passed since the first date that payment of damages
for breach of the scholarship contract is required and (2) the Bankruptcy
Court finds that failure to discharge the obligation would be unconscionable.
In re Hines, 63 B.R. 731 (Bankr. D.S.D.1986); Pub. L. 100-177, 101 Stat. 992 (1987)
(adding unconscionable requirement);
Matthews v. United States, Nat. Health Service Corps., 150 B.R. 11 (Bankr. W.D. Pa.1992);
42 U.S.C. §292f(g). Under the Health Education Assistance Loan ("HEAL")
obligations cannot be discharged unless (1) the passage of seven years
from the first date repayment was to begin; (2) a finding that nondischarge
of the debt be "unconscionable"; and (3) the Secretary of Health
and Human Services has not waived certain rights.
Matthews v. Pineo, 19 F.3d 121, 124(3d Cir. 1994),
cert. denied, 130 L. Ed. 2d 35, 115 S. Ct. 82 (1994) (defining unconscionable as "excessive,
exorbitant," "lying outside the limits of what is reasonable
or acceptable," "shocking, unfair, harsh, or unjust," or
);Barrows v. Illinois Student Assistance Comm'n (In re Bush Barrows), 182 B.R. 640 (Bankr. D.N.H. 1994) (to determine "unconscionability"
the court should examine the totality of the circumstances including the
debtor's age, health, educational background, employment history,
financial condition, earning ability and current income).
- 37 U.S.C. §301d(c)(3). This section provides for an exception to discharge
for the obligation of a medical officer in the military to pay back the
retention bonus if the discharge is entered less than five years after
the termination of the officer's agreement to complete a term of active
duty.Pub. L. 101-510, § 611, Nov. 5, 1990.
This list is not meant to be exhaustive. If the debtor has a particular
type of student loan, funded under a particular legislative program, it
is recommended that the legislation associated with that particular loan
is examined for any possible discharge issues.
9. For death and personal injury caused while driving under the influence.
Section 523(a)(9) has three objectives: (1) deter drunk driving; (2) ensure
that those who caused injury by driving drunk do not escape liability;
and (3) protect victims of drunk driving.
Lugo v. Paulsen, 886 F.2d 602 (3d Cir. N.J. 1989);
In re Hudson, 859 F.2d 1418 (9th Cir. Wash. 1988)). Under Section 523(a)(9), the creditor
must show:(1) the debtor was legally intoxicated under state (or other
applicable) law and (2) liability resulted from the operation of a motor vehicle.
Whitson v. Middleton, 898 F.2d 950 (4th Cir. Va.1990);
In re Phalen, 145 B.R. 551 (Bankr. N.D. Ohio 1992).The definition of motor vehicle may
be broad enough to include boats.
Willison v. Race, 192 B.R. 949 (W.D. Mo. 1995) (term "motor vehicle" is broad
enough to include motorboats);
In re Williams, 101 B.R. 356 (Bankr. S.D. Fla. 1989),
aff'd, 111 B.R. 361 (S.D. Fla. 1989) (motorboat is a motor vehicle);
Schwartz v. Dunn (In re Dunn), 203 B.R. 414 (E.D. Mich. 1996) (snowmobile a "motor vehicle");
but see Boyce v. Greenway (In re Greenway), 71 F.3d (5th Cir. 1996),
cert. denied, 116 S. Ct. 2499, 135 L. Ed. 2d 191 (1996) (boat not a motor vehicle);
Schachter v. Fall (In re Fall), 192 B.R. 16 (Bankr. D.N.H. 1995) (boat not a motor vehicle).
10. Debts from a prior case
If the debtor was previously involved in a Chapter 7 proceeding and the
debtor either waived his discharge or was denied his discharge, Section
523(a)(10) excepts these same claims from discharge. Debts existing at
the commencement of a case in which the debtor is denied discharge can
never be discharged in a subsequent bankruptcy.
Four subsections of Section 727(a) are not listed in 523(a)(10), including
subsection (a)(1) (debtor not an individual), subsection (a)(8) (discharge
barred where debtor received a discharge in a previous Chapter 7 or Chapter
11 case within six years), and subsection (a)(9) (Chapter 7 discharge
denied where debtor received discharge in a Chapter 12 or 13 case within
six years before a subsequent Chapter 7 case and debtor failed to pay
specified percentages of unsecured claims in the Chapter 12 or 13).Of
these (a)(8) provides an exception to the general rule relating to prior
bankruptcy debts.If the debtor didn't receive a discharge because
of (a)(8), then those claims do not fall within the exception of Section
Reaffirmation of a debt is not waiver of discharge.
In re Lones, 50 B.R. 801 (Bankr. W.D.Ky. 1985). Dismissal of a case is not a bar to
discharge in a subsequent case. 11 U.S.C. § 349(a).
Britt v. Logan, 145 B.R. 324 (Bankr. D. Kan.1992).
As to previous determinations under Section 523(a), if a debt is determined
to be non-dischargeable in one bankruptcy, this determination is res judicata
in subsequent cases.
Royal American Oil & Gas Co. v. Szafranski, 147 B.R. 976 (Bankr. N.D. Okla.1992);
In re Sobh, 61 B.R. 576 (E.D. Mich. 1986) (debtor reopened bankruptcy to relitigate
student loans based on new circumstances to show undue hardship). A subsequent
Chapter 13 filing could get a different result.
In re Lilley, 185 B.R. 489 (E.D. Pa. 1995) ("Congress did not intend to foreclose
categorically the benefit of Chapter 13 reorganization to a debtor who
previously has filed unsuccessfully for Chapter 7 relief");
In re Harlan, 179 B.R. 133 (Bankr. W.D. Ark. 1995) (requiring Chapter 13 plan be proposed
in good faith);
In re Chaffin, 816 F.2d 1070 (5th Cir. 1987) (debtor converted case to Chapter 13 from
Chapter 7 after a debt was found nondischargeable).
11. and 12. Insiders of Federal Depository Institutions
Sections 523(a)(11) and (a)(12) affect insiders within bank and thrift
institutions who were involved in wrongful acts. These provisions do not
overrule previous case law regarding honest debtors but does attempt to
punish those who were in charge of failed insured depository institutions.
136 Cong Rec H13,289 (daily ed. Oct. 27, 1990).
Section 523(a)(11) excepts from discharge any final judgment, order or
consent decree issued by a federal depository institutions regulatory
agency or any obligation contained in any settlement agreement to which
the debtor was a party that arose from any act of fraud or defalcation
by the debtor while acting in a fiduciary capacity with respect to any
insured depository institution or insured credit union.
In re Harris, 135 B.R. 434 (Bankr. S.D.Fla. 1992) (creditor may choose to seek judgment
in forum other than bankruptcy court)
Section 523(a)(12) excepts from discharge those claims arising from malicious
or reckless actions or omissions by a debtor in fulfilling any commitment
to maintain minimum capital at an insured depository institution. The
act need only be reckless and as we have seen under Section 523(a)(6),
this standard is lower than the intentional standard found in Section
The regulatory agency seeking a determination of dischargeablity must bring
suit by the bar date unless it was not appointed in time to reasonably
comply with the deadlines. 11 USC § 523(c)(2).
13. Federal Court Ordered Restitution.
In the Violent Crime Control and Law Enforcement Act of 1994,Pub. L. 103-322,
§ 320934 (Sept. 13, 1994),Section 523(a)(13) was added to address
federal restitution orders.This Section excepts from discharge restitution
ordered in cases arising under Title 18 of the United States Code.No provision
is made to except restitution ordered by state courts. As previously discussed,
the exception to the discharge in Chapter 13 cases under Section 1328(a),
however, applies to all restitution orders. Thus, if Section 523(a)(6)
or (7) is not applied for restitution orders of a state court the debtor
could receive a discharge in Chapter 7 or 11 but not in Chapter 13.
Sometimes, an award of costs is included in a restitution order to compensate
for "a pecuniary loss." These awards are not included in Section
523(a)(7). However, this type of award may be viewed as nondischargeable
under Section 523(a)(13).
14. Loans to pay a tax
The Bankruptcy Reform Act of 1994 added Section 523(a)(14). This section
excepts from discharge loans made to pay a tax "to the United States
that would be nondischargeable" under Code § 523(a)(1). According
to the House Report accompanying the bill, the purpose of this section
is to encourage the use of credit cards in paying federal taxes.H.R. Rep.
No. 103-835, 103d Cong., 2d Sess.(1994). The idea of subrogation for tax
claims has been previously discussed. This section merely codified previous
case law on subrogation.
15. Support Obligations not included in 523(a)(5)
In the Bankruptcy Reform Act of 1994, Section 523(a)(15) was added to address
concerns over certain limiting rulings relating to Section 523(a)(5) and
its requirement that the obligation be "to a spouse, former spouse
or child." Section 523(a)(15) applies to all obligations found in
a divorce or separation decree and is limited in only two respects. First,
the exception does not apply when the debtor does not have an ability
to pay the debt. Second, the exception does not apply when "discharging
such debt would result in a benefit to the debtor that outweighs the detrimental
consequences to a spouse, former spouse, or child of the debtor."
Courts have taken different approaches to the burden of proof: (1) debtor
has burden of proof after creditor establishes the debt arose from divorce
proceeding; (2) creditor has burden of proof but debtor has burden of
going forward once creditor has established the debt arose from divorce
proceeding; (3) once established that debt arose from divorce proceeding,
burden is on debtor under Section 523(a)(15)(A) but remains on creditor
under Section 523(a)(15)(B); and (4) creditor has burden throughout the
Willey v. Willey (In re Willey), 198 B.R. 1007 (Bankr. S.D. Fla. 1996) (citing cases for each approach).
In the first limitation, courts generally examine the debtor's "ability
to pay" based upon the "disposable income test."
Hill v. Hill (In re Hill), 184 B.R. 750 (Bankr. N.D. Ill. 1995) (discussing different approaches
to determining when expenses are "reasonably necessary");
Carroll v. Carroll (In re Carroll), 187 B.R. 197 (Bankr. S.D. Ohio 1995) (using disposable income test);
McGinnis v. McGinnis (In re McGinnis), 194 B.R. 917 (Bankr. N.D. Ala. 1996) (citing cases) (reviewing debtor's
Belcher v. Owens (In re Owens), 191 B.R. 669 (Bankr. E.D. Ky. 1996) (adopting "disposable income
test" of Code § 1325(b));
Taylor v. Taylor (In re Taylor), 191 B.R. 760 (Bankr. N.D. Ill. 1996).
In reviewing the second limitation, the Courts apply a totality of the
circumstances test including consideration of (1) the income and expenses
of both parties, (2) the nature of the debt, and (3) the former spouse's
ability to pay the debt.
See Florio v. Florio (In re Florio), 187 B.R. 654 (Bankr. W.D. Mo. 1995);
Phillips v. Phillips (In re Phillips), 187 B.R. 363 (Bankr. M.D. Fla. 1995) (the court exercises its equitable
powers to make a value judgment).
16. Condominium and Homeowners Association Fees
The Bankruptcy Reform Act of 1994 added Section 523(a)(16) which excepts
from the discharge condominium and cooperative housing corporation fees
and assessments which are due and payable after the order for relief.
Section 523(a)(16) has two limitations. First, the exception does not
affect the dischargeability of fees and assessments arising before the
order for relief.Second, the exception applies only to fees and assessments
payable during the period the debtor physically occupies the dwelling
or the period during which the debtor rents the dwelling and receives
rental payments.Section 523(a)(16) specifically references condominium
associations and cooperative housing corporation fees and assessments.
The legislative history of Section 523(a)(16) suggests that the exception
is intended to affect "condominiums, cooperatives, or similar membership
associations." H.R. Rep. No. 103-835, 103d Cong., 2d Sess.(1994).
I haven't found any case law on this section.
17. Court Costs.
Section 523(a)(17) excepts from discharge a debt" for a fee imposed
by a court for the filing of a case, motion, complaint, or appeal, or
for other costs and expenses assessed with respect to such filing"
regardless of an assertion of poverty by the debtor under 28 U.S.C. §
1915(b) or (f) or the debtor's status as a prisoner as defined in
28 U.S.C. § 1915(h). Section 523(a)(17) applies to all "fees
. . . others costs and expenses" imposed or assessed by the court
irrespective of the status of the debtor as a prisoner. Code § 523(a)(17)
could also be read to render non-dischargeable fines and sanctions imposed
in civil matters under Rule 11, Fed. R. Civ.P., Rule 9011, Fed. R. Bankr.
P. or even the related state court sanction.
18.Support Enforceable Under the Social Security Act.
The "Personal Responsibility and Work Opportunity Reconciliation Act
of 1996" added Section 523(a)(18). This Section excepts from discharge
an obligation owed to a state or municipality that is in the nature of
support and enforceable under Part D of title IV of the Social Security
Act. The Act also amended the Social Security Act to provide that a debt
owed under state law to the state or a municipality "that is in the
nature of support and that is enforceable under this part is not released
by a discharge in bankruptcy under title 11 of the United States Code."
The amendments apply to bankruptcy cases filed only after August 22, 1996.P.L.
104-193, 110 Stat. 2105 (1996).
Section 553 recognizes a right to set-off established by nonbankruptcy
law. Set-off is when the debtor debt is used to offset a creditor debt.Set-off
is used as a tool for creditors to eliminate its debt to debtor and the
debtor simultaneously eliminates its debt back to the creditor. However,
certain set-offs may be avoided, such as if the right to set-off accrued
within 90 days of filing the petition. Even if a creditor has a right
of set-off , the set-off is stayed under 362(a)(7). The creditor must
file for relief from the stay. The amount subject to the set-off is a
secured claim pursuant to 506 and also may be used as cash collateral
under 363. If a creditor is ordered to turnover the property under 542,
the creditor may properly use set-off as a defense to the turnover action.
Preference Rules under 547 do not apply to amounts subject to set-off.
Three requirements must be met in order to effect the right of set-off:
(1) the party must make a decision to set off the debt (2) action must
be taken; and (3) the set-off must be recorded.
Citizens Bank of Maryland v. Strumpf, 516 U.S. 16 (1995).
To protect its right to a set-off a creditor may temporarily withhold payment
of a debt it owes to a debtor without violating the automatic stay.
The mutuality requirement of set-off requires that each party pay its own
claim, with the right to collect in its own name.
Matter of United Sciences of America, Inc., 893 F.2d 720 95
th Cir. 1990).
Section 554(a) gives the Trustee the power (after notice and a hearing)
to abandon burdensome property or property that is ofinconsequential value/benefit
to the estate. After the request of a party in interest (such as a creditor)
and notice and hearing, the Court may order the Trustee to abandon burdensome
or inconsequential property of the estate. Any property scheduled but
not administered at the time of closing is abandoned to the debtor. If
property is not abandoned to the debtor, it remains property of the estate.
Abandoned property is not protected by the automatic stay. Sections 725
provides that a Trustee may dispose of any other property which an entity
other than the estate has an interest, such as a lien, that has not been
disposed of under another section of title 11.Section 1107 gives the debtor
in possession the rights of the trustee, so that the debtor in possession
has the right to abandon property.
VII. Problems for Secured Creditors in Bankruptcy
A. Use of Cash Collateral
Section 363(a) defines cash collateral as "cash, negotiable instruments,
documents of title,securities, deposit accounts, or other cash equivalents
whenever acquired in which the estate and an entity other than the estate
have an interest." It also includes the proceeds. The use of cash
collateral usually arises in a Chapter 11 proceeding. In a Chapter 11
the Debtor in Possession both needs cashand could destroy the business
with the misuse of such cash. The Code allows the Debtor in Possession
free use of cash , not subject to a lien, so long that the cash is used
"in the ordinary course of business." Encumbered cash (subject
to a lien) is cash collateral.Cash collateral cannot be used without the
permission of the bankruptcy court. Section 363 also governs the post
petition use, lease and sale of estate property. Section 363(b) provides
the Trustee with the ability to "use, sell or lease" estate
property outside the ordinary course of the estate. To sell, lease or
use property outside of the normal course of business, the Trustee give
notice and have a proper hearing at the Bankruptcy Court.Section 363(c)
provides the trustee with instances when the property can be sold, leased
or used pursuant to the ordinary course of business. As long as its in
the ordinary course of business, no notice or hearing is needed.
The priority extended to a cash collateral lender under section 363 is
not affected by the dismissal of the bankruptcy case, and cash collateral
lender's lien may prevail over suppliers who fail to secure bankruptcy
court approval for their advances.In re TNT farms, 226 B.R. 436 (Bankr.
D. Idaho 1998).
B. Use Sale or Lease of Property
The use, sale and lease of estate property is governed by Section 363.
It is related to cash collateral.Section 363(b) provides the Trustee with
the ability to "use, sell or lease" estate property outside
the ordinary course of the estate. To sell, lease or use property outside
of the normal course of business, the Trustee give notice and have a proper
hearing at the Bankruptcy Court. Section 363(c) provides the trustee with
instances when the property can be sold, leased or used pursuant to the
ordinary course of business. As long as its in the ordinary course of
business, no notice or hearing is needed. While the Trustee can sell,
lease, use estate property, it must do so pursuant tothe automatic stay
in Section 362.363(f) states that in some instances the Trustee may even
sell the property free and clear of certain liens.363(e) however, gives
parties the opportunity to demand "adequate protection" for
their property if the property is to be leased or sold.
A two step test may be used to determine whether a postpetition transaction
is in the debtor's ordinary course of business. The "horizontal
dimension" test determines whether the transaction is of the sort
commonly undertaken by companies in the debtor's industry. The "vertical
dimension test" determines whether the transaction subjects the creditors
to economic risk different from therisk they accepted and could reasonably
expect when they extended credit.
Advo-System, Inc. v. Maxway Corp., 37 F.3d 1044 (4
th Cir. 1994).
C. Fraudulent Conveyances
Fraudulent conveyance law presents a unique blend of federal and state
law. Statutes allowing for the avoidance or revocation of fraudulent transfers
are found at 11 U.S.C. § 548 and, for South Carolina, S.C. Code Ann.
§ 27-23-10 et seq. The two collectively cover a multitude of situations
and deceptive behavior. Much of the case law suggests that the fraudulent
conveyance statutes are overlapping to the point of being redundant.A
general review of the two statutes would seem to support this proposition.
In re Hoffman Associates, Inc., 194 B.R. 943 (Bankr. D.S.C. 1995) (analyzing South Carolina Fraudulent
Conveyance Statute simultaneously with the Federal Fraudulent Conveyance
Statute). However, there are subtle differences between the two that may
prove to be useful, especially in light of the fact that a debtor is entitled
to a jury trial on the state based claim, whereas, no such right exists
as to the federal claim.
Granfinanciera, S.A. v. Nordberg, 109 S. Ct. 2782, 492 U.S. 33, 106 L. Ed. 26 (1989).
Another major difference is the applicable statute of limitations. Under
federal law, as is discussed later, the trustee is relegated to actions
that took place within a year of the filing. An action under the Statute
of Elizabeth is governed by the limitations period applicable to fraud actions.
Walter J. Klein Company, Inc. v. Kneece, 239 S.C. 478, 123 S.E. 2d 870 (1962);
Tucker v. Weathersbee, 98 S.C. 402, 82 S.E. 870 (1893). The applicable period is three years
from the time the aggrieved creditor discovers facts that reveal the fraudulent
conveyance.S.C. Code Ann. § 15-3-530(7) (Law. Co-op. Supp.). The
mere recording of a deed or mortgage is insufficient to place creditors
on notice of the fraudulent transfer for purposes of starting the limitations period.
Tucker v. Weathersbee, supra.
Together, the two statutes provide a body of law that give the trustee
or creditor a great deal of flexibility and allows him or her to reach
a wide variety of activities. The following discussion is an analysis
of each body of law, and it was drafted with the purpose of helping a
trustee or creditor choose a line of attack that is most suitable to him or her.
III.Federal Fraudulent Conveyance Law:
A. One Year Limit:
Section 548 of the Bankruptcy Code provides the federal rule available
to trustees and debtors-in-possession. The section provides that a trustee
may avoid any transfer of an interest of the debtor that was made or incurred
on or within one year before the date of the filing of the petition, if
procured through fraudulent means of the debtor. Bankruptcy Code § 548.
The timing of the transfer, therefore, becomes exceedingly important. Obviously,
from the language found in the statute, the object of section 548 was
to prevent prepetition transfers, not postpetition transfers.
See Consolidated Partners Inv. Co. v. Lake, 152 B.R. 485 (N.D. Ohio 1993). Therefore, a transfer that occurs after
the bankruptcy petition is filed is not covered under this statute.
Consolidated Partners Inc. Co. v. Lake, 152 B.R. 485 (Bankr. N.D. Ohio 1993); Matter of Fisher, 80 B.R. 58 (Bankr.
In re Sattler's Inc., 73 B.R. 780 (Bankr. S.D.N.Y. 1987).
In complex transactions, the specific date of the transfer could prove
to be important. Generally, where a lien of some sort is granted as part
of the transaction, the transfer is deemed to take place on the date the
lien is perfected, provided it is done prior to the bankruptcy filing.
In re Tucker Oil Co., Inc., 55 B.R. 78,
appeal decided 64 B.R. 183 (Bankr. W.D. Ark. 1985). At the same time, a granting of a
security interest to a preexisting creditor during the one year period,
without receiving new consideration, will alter the entire transfer or
debt to the latest transaction date.
In re Kelley, 7 B.R. 384 (Bankr. D.S.D. 1980). In deed questions, the operative date
is when the deed is recorded.
In re Levy, 185 B.R. 378 (Bankr. S.D. Fla. 1995). The obvious pattern is that the
court will usually look to the date that actual title vests or the date
on which the last significant part of the transfer took place. In other
words, the transfer date is liberally construed to find coverage under
B. Elements required:
The term transfer, includes every method of disposing of or parting with
property or possessions.
Hoecker v. United Bank of Boulder, 476 F.2d 838 (10th Cir. 1973). The transfer does not have to be made
directly by the debtor, as long as one can connect the transfer to the
debtor, either directly or indirectly.
In re FBN Food Services, Inc., 185 B.R. 265,
affirmed and remanded 82 F. 3d 1387,
rehearing denied (N.D.Ill 1995);
Matter of Clover Donut of White Plains Corp., 14 B.R. 205 (Bankr. S.D.N.Y. 1981). Nevertheless, a transfer needs to
be made. Therefore, a change in form or substance of the asset does not
necessarily constitute a transfer.
E.g. In re Levine, 139 B.R. 551 (Bankr. M.D. Fla. 1992) (Conversion of non-exempt property
into exempt property did not constitute a transfer.).
a. Acts constituting transfers
(i) Consignment of goods --
In re Factory Tire Distributors, Inc., 64 B.R. 335 (W.D. Pa. 1986).
(ii) Church contributions --
In re Young, 82 F.3d 1407 (8th Cir. 1996)
rehearing and suggestion for rehearing en banc denied 89 F. 3d 494.
(iii) Judgments barring debtors from reasserting claims --
Matter of Besing, 981 F. 2d 1488 (5th Cir. 1993) (Prejudicial dismissal was for debtor's
(iv) Transfers according to divorce decree, separation agreement, or marital
property settlement --
In re Lange, 35 B.R. 579 (Bankr. E.D. Mo. 1983).
(v) Foreclosures --
In re Littleton, 888 F.2d 90
rehearing denied 890 F.2d 1167 (11 Cir. 1989).
(vi) Termination of lease -- see II,B,2,a,ii,(b) below.
(vii) Leveraged buyouts --
In re Oxford Homes, Inc., 180 B.R. 1 (Bankr. D. Me. 1995).
(viii) Mortgage modifications --
Matter of Venice Western Motel, Ltd., 67 B.R. 777 (Bankr. M.D. Fla. 1986) (transfer where net effect of modification
increased principle amount of loan.).
(ix) Down payments on real property --
In re McConnell, 934 F.2d 662 (5th Cir. 1991);
but see Matter of Wey, 854 F.2d 196 (7th Cir. 1988).
b. Acts not constituting transfers
(i) Conversion of non-exempt property into exempt property -
- In re Levine, 139 B.R. 551 (Bankr. M.D. Fla. 1992);
but see In re Beckman, 104 B.R. 866 (Bankr. S.D. Ohio 1989);
In re Breuer, 68 B.R. 48 (Bankr. N.D. Iowa 1985);
In re O'Brien, 67 B.R. 317 (N.D. Iowa).
(ii) Franchisor's termination of debtor's franchise-dealership
contracts pursuant to terms of agreement --
Matter of Jermoo's Inc., 38 B.R. 197 (Bankr. W.D. Wis. 1984); but see cases involving termination
of lease by a lessor for breach of covenant contained therein, which is
a transfer --
In re Ferris, 415 F. Supp. 33 (D.C. Okl. 1976);
In re Queen Ciry Grain, Inc., 51 B.R. 722 (Bankr. S.D. Ohio 1985).
2. Interest of the debtor in property, or any obligation incurred by the debtor
An essential element of an action under this section is that the debtor
must have had an interest in the property transferred.
In re Jackson, 105 B.R. 15 (Bankr. S.D. Ohio 1989). Because the interest of the debtor
in the property is an undefined term in the bankruptcy code, the court
will generally look to state law to help define its parameters.
In re Hulm, 738 F.2d 323, (C.A.N.D. 1984),
cert. denied 469 U.S. 990, 83 L. Ed. 2d 331, 105 S. Ct. 398,
on remand 45 B.R. 523;
Matter of Simpson, 36 F.3d 450 (5th Cir. 1994);
In re Dews, 152 B.R. 982 (D. Colo. 1993);
In re Reynolds, 151 B.R. 974 (Bankr. S.D. Fla. 1993);
In re Brajkovic, 151 B.R. 402 (Bankr. W.D. Tex. 1993).
The battles are fought in two areas: (1) where the debtor owns legal title
to a piece of property, and (2) where they do not possess legal title
but some equitable interest. When the former is the case, it is often
the debtor who must sustain the burden of proof that while legal title
may be vested in his or her name, de facto or equitable title belongs
to the alleged transferee.For example, in
In re Reynolds, 151 B.R. 974 (Bankr. S.D. Fla. 1993), the debtor was the legal title
holder to real estate. The court found however, that no fraudulent conveyance
had taken place because the debtor did not have an interest in the property
beyond the face of the document. The debtor successfully proved that he
was the legal title holder of the property for the benefit of his son
to allow him to obtain financing for the property, and that neither the
debtor, nor the son, had ever considered the debtor to be the legal title holder.
Other times, the creditor is on the attack and is attempting to prove that
the debtor had an equitable interest that was conveyed. Typically, a possessory
interest in property is sufficient to trigger the provisions of § 548.
See e.g. In re Ocean Line of North Florida, 137 B.R. 540 (Bankr. M.D. Fla. 1992).
3. incurred within one year before the date of the filing -- [see supra].
4.voluntarily or involuntarily
Fraud, as a general rule, requires some type of intent on the part of the
actor. The common law, however, does recognize constructive fraud. However,
constructive fraud is just another way of proving intent, as mental intent
is often very difficult to prove. The fact that involuntary actions can
be grounds for a fraudulent act seems contrary to common sense and the
common law. Nevertheless, Congress added this interesting twist to the
types of activities that constitute fraudulent conveyances, and the question
must be answered whether these words serve any purpose or modify in any
way the listed actions that can constitute fraudulent behavior.
Courts have held that subjective intent to commit a fraud is not required
under bankruptcy code § 548.
In re Nance, 26 B.R. 105 (Bankr. S.D. Ohio 1982);
In re Checkmate Sterio and Electronics, 9 B.R. 585, aff'd 21 B.R. 402 (Bankr. E.D.N.Y. 1981). In both of
these cases, a trustee was applying the second method of proving fraudulent
behavior. Bankruptcy Code § 548 is split into two sections. The first
is discussed at i below; the second is discussed at ii. The second section
of 548 is admittedly much more objective, and requires little testing
of the debtor's motivations or mental state. Therefore, these cases
do not answer the question of whether the involuntariness referred to
in the primary paragraph of § 548 can be coupled with "actual
intent," found in the first subparagraph, to create a much more relaxed
standard of proof. The practical standard of proof in showing actual intent
is discussed below.
a. actual intent to hinder, delay or defraud a creditor
Actual intent does not need to be proven by direct evidence or by an admission.
In re Sergio, Inc., 16 B.R. 898 (Bankr. D. Hawaii 1981).There exists common circumstantial
indicia of a fraudulent intent that can be used to prove actual intent:
(1) actual or threatened litigation against the debtor; (2) purported
transfers of all or substantially all of the debtor's property; (3)
insolvency or other unmanageable indebtedness on the part of the debtor;
(4) a special relationship between the debtor and the transferee; and
(5) retention by the debtor of property involved in putative transfer
(i.e., reservation of benefits, control or dominion by the debtor --
In re Warner, 87 B.R. 199,
appeal dismissed 94 B.R. 734 (M.D. Fla. 1988)).
Max Sugarman Funeral Home, Inc. v. A.D.B. Investors, 926 F.2d 1248 (1st Cir. 1991), on remand 149 B.R. 274. Other badges of
fraud that have been noted in categorical form include:(1) absconding
with the proceeds of the transfer immediately after their receipt; (2)
absence of consideration when the transferor and transferee know that
outstanding creditors will not be paid; (3) a huge disparity in value
between the property transferred and the consideration received; and (4)
the fact that the debtor was the officer, agent, or creditor of the transferor.
In re FNB Food Services, Inc., 185 B.R. 265 (N.D. Ill. 1995),
affirmed after remanded 82 F.3d 1387,
rehearing denied.Still other cases have sited additional badges of fraud: (1) the conveyance
is concealed; (2) the transferee takes property in trust for the transferor
and transferor remains in possession; and (3) debtor deals with property
as his own.
In re Sergio, Inc., 16 B.R. 898 (Bankr. D. Hawaii 1981).
These badges of fraud and other suspicious behavior must be considered
as a whole. A trustee does not have to prove any one of these factors
with any degree of certainty. The facts, as taken together, only needs
to lead to the conclusion that actual fraud existed.
In re Jeffry Bigelow Design Group, Inc., 956 F.2d 479 (4th Cir. 1992). The test requires a subjective determination
of the debtor's motivation.Id. The standard is that fraudulent intent
exists where the trustee shows that the transferor acted under circumstances
precluding any reasonable conclusion other than that the purpose of the
transfer was fraudulent as to his creditors.
Matter of Life Science Church of River Park, 34 B.R. 529 (Bankr. N.D. Ind. 1983).
Which parties must be shown to have intent to defraud is unclear. Certainly,
the debtor/transferor must have the requisite intent, but some courts
hold that the transferee must have the intent as well.
Stratton v. Equitable Bank, 104 B.R. 713 (D. Md. 1989),
aff'd 912 F.2d 464 (4th Cir. 1989);
Business Systems, Inc., 642 F.2d 200 (C.A. Tenn 1981) (Transferee does not have to return payments
if transferee entered transaction in good faith without knowledge of intent
to defraud creditors.);
Presbrey v. Noble, 505 F.2d 170 (C.A. Utah 1974) (Transferee had bonafide purchaser status
which trumped rights of trustee.). The apparent logic for this rule is
simple. If a bona fide purchaser, without knowledge or intent to defraud,
takes the property for a value, then he or she has paid what he or she
believes to be fair consideration for the item, or, at the very least,
the debtor has no hope of gaining a return on the transfer after the bankruptcy
has passed.In these cases, the transferee must still show that the consideration
paid was in an amount that he or she believed to be reasonable.
Id. In truth, the rule appears to be that once the badges of fraud have been
proven against the debtor, then the transferee is presumed to have a similar
intent, and this intent can be overcome by showing that the transferee
was a bona fide purchaser for value. If proven, then the transfer cannot
be undone. The policy reasons for this rule are obvious, and an adoption
of this rule would benefit public policy, particularly under economic
efficiency arguments (the arguments are the same justifications for a
bona fide purchaser rule under the Uniform Commercial Code).
There is, however, a middle ground between the two rules. Some cases have
held that a transferee is protected from the fraudulent conveyance statute
to the extent of the consideration given. Of course, which of the three
positions taken will depend upon the party asserting the argument.
In re Mesa, 48 B.R. 208 (Bankr. S.D. Fla. 1985). Under the presumption that the transferred
item is always more valuable than the consideration paid, trustees will
inevitably always argue that only the debtor's intent needs to be
proven, as this test will grant the trustee the return of the entire item
with no refund to the transferee; the transferee will always argue that
both party's intent needs to be proven, because by keeping the property,
the transferee retains his benefit of the bargain; and finally, the most
logical remedy, the one in the middle, will go unargued, but will be the
source of many judicial opinions, and has been termed the good faith rule.
See In re Maddalena, 176 B.R. 551 (Bankr. C.D. Cal. 1995) (If transferee neither knew nor
should have known of the fraudulent nature of the transfer, then transferee
is entitled to retain the fraudulent transfer to the extent of the value
given in the exchange; if transferee knowingly or recklessly participates
in the fraudulent scheme, then he or she is not protected.);
Matter of Laughlin, 18 B.R. 778 (Bankr. W.D. Mo. 1982). In cases where the transferee's
"good faith" is an issue or the subject of discussion, courts
generally look for earmarks of an arms-length transaction, or whether
there are gross departures, to determine whether the transferee is entitled
to any special treatment.
Bullard v. Aluminum Co. of America, 468 F.2d 11 (C.A. Ind. 1972);
In re Browning Tufters, Inc., 3 B.R. 487 (Bankr. N.D. Ga. 1980).
This added twist on the law makes the adequacy of consideration all that
much more important, and in some cases, a necessary factor in proving
a fraudulent conveyance case.
See In re Pinto Trucking Service, Inc., 93 B.R. 379 (Bankr. E.D. Pa. 1988) (even where debtor did become insolvent
as a result of transfer, court would not conclude fraudulent conveyance
where debtor received adequate and fair compensation for sale.);
In re 18th Ave. Development Corp., 18 B.R. 904 (Bankr. S.D. Fla. 1982) (Evidence that transfer received
a fair value was sufficient to show not a fraudulent conveyance.). However,
in most cases, unequal consideration will not in itself prove a fraudulent
See e.g., In re Gutierrez, 160 B.R. 788 (Bankr. W.D. Tex. 1993) (Purchase at 70% of value is insufficient,
without other badges of fraud, to prove fraudulent conveyance.). And there
are cases that hold that valuable consideration is not an affirmative
defense to a fraudulent conveyance.
Matter of Beechwood Medicenter of Flint, 23 B.R. 939 (Bankr. E.D. Mich. 1982);
Matter of Montanino, 15 B.R. 307 (Bankr. D.N.J. 1981) (Sale to parents living in same home
was perceived to be effort to defraud creditors, and therefore, revocable,
regardless of adequacy of consideration.). Upon review of the
Beechwood case, the court had the facts of a preference case, and because of time
limitations, it was trying to fit it into the fraudulent conveyance statute.
The case does however stand for the proposition that, even if fair consideration
is received, the transaction will be unwound where it is determined that
the debtor was attempting to either prevent certain creditors for receiving
what they would receive without the transfer, or the debtor was attempting
to make the eventual receipt of those payments or property more difficult
for one or more creditors.
One of the highly litigated issues and one of the acts that angers trustees
and creditors alike is where a debtor transfers non-exempt assets into
exempt assets. While some courts hold that these internal transfers are
not transfers at all, the majority of the courts do.
Supra. Those courts that get past the initial question are inevitably faced
with the question of whether the transfer to exempt property is a badge
of fraud in and of itself. Creditors and trustees are often disappointed
to find that the answer is no. The overwhelming number of cases state
that the trustee must go one step further and prove that the transfer
was made to prevent hinder or delay creditors from reaching the assets.
In re Holt, 894 F.2d 1005 (8th Cir. 1990);
In re Breuer, 68 B.R. 48 (Bankr. N.D. Iowa 1985);
In re O'Brien, 67 B.R. 317 (N.D. Iowa 1986);
In re Levine, 40 B.R. 76 (Bankr. S.D. Fla. 1984);
In re Oliver, 38 B.R. 407 (Bankr. D. Mass. 1984).However, the additional proof necessary
does to appear to minimal.
In re Barker, 168 B.R. 773 (Bankr. M.D. Fla. 1994) (Even though placing funds into
annuities was sound investment strategy, evidence appeared to show that
transfer was made in attempt to hinder creditor's attempt to obtain
b. the Second Method of Proving Fraudulent Conveyance under § 548
(i) received less than equal consideration; and
Obviously, in this phase of the test, the court is comparing what left
the estate to what entered into the estate.
In re Southmark Corp., 138 B.R. 820 (Bankr. N.D. Tex. 1992). Generally, the litmus test in
this case is -- as long as the unsecured creditors are no worse off because
of the transfer, then the debtor received a reasonably equivalent value
to that which left the estate because of the transfer.
In re Jeffrey Bigelow Design Group, Inc., 956 F.2d 479 (4th Cir. 1992). This does not mean that the debtor needs
to receive a dollar for dollar exchange in order to have been paid a "reasonably
Matter of Fairchild Aircraft Corp., 6 F.3d 1119 (5th Cir. 1993);
In re Southmark Corp., 138 B.R. 820 (Bankr. N.D. Tex. 1992). There is no magic percentage of
fair market value that needs to be achieved in order to constitute reasonably
In re Fargo Biltmore Motor Hotel Corp., 49 B.R. 782 (Bankr. D.N.D. 1985) (Flat percentage basis approach is inappropriate,
however, a good starting point with which to gauge a transfer's reasonableness.).
However, one line of cases holds that anything less than 70% of the value
is not reasonably equal.
Durrett v. Washington Nat'l Ins. Co., 621 F.2d 201 (5th Cir. 1980);
In re Thrifty Dutchman, Inc., 97 B.R. 101 (Bankr. S.D. Fla. 1988). In another case,
Misty Management Corp. v. Lockwood, 539 F.2d 1205 (C.A. Nev. 1976), the court held that a transfer that was
for over 70% of the collateral's value was unreasonable, where the
difference amounted to $276,000. One court has stated that the relative
percentage of fair market value
is but one factor to be compared along with good faith and the relative
difference in amount paid compared to the fair market value.
In re Smith, 24 B.R. 19 (Bankr. W.D.N.C. 1982). Other courts follow the 70% rule only
in cases of private sales.
Madrid v. Lawyers Title Ins. Corp., 725 F.2d 1197 (9th Cir. 1984). A final line of cases holds that courts
must determine reasonably equivalent value on a case by case basis.
First Federal Savings & Loan Assn. of Bismark v. Hulm, 738 F.2d 323 (8th Cir.),
cert denied, 469 U.S. 990 (1984).
While the court generally must look to the surrounding circumstances of
the transaction to determine value,
Matter of Fairchild Aircraft Corp., 6 F.3d 1119 (5th Cir. 1993), it is improper for a court to consider sentimental
value of the debtor or other similarly subjective criteria.
In re First Capital Holdings Corp., 179 B.R. 902 (Bankr. C.D. Cal. 1995). At the same time, a completely
objective, mathematical standard does not apply either; a court must consider
things such as whether indicia of an arms length transaction are present
and other factors showing the actual fair market value of the property sold.
In re Morris Communications NC, Inc., 914 F.2d 458 (4th Cir. 1990) (appearing to side with the
First Federal v. Hulm,
supra, line of cases).
The operative date is the value of property and consideration as of the
date of transfer.
In re Robinson, 80 B.R. 455 (1987).
(ii) insolvent/small capital remaining/ debt incurred beyond ability to pay
Some courts hold that if the party attacking the transfer as being fraudulent
meets the burden of proving that the consideration given was inadequate,
the burden of the defense of the transferor's solvency, or the proof
that one of the three subsections of § 548(a)(2)(B) exists, passes
to the party seeking to uphold the transfer.
See e.g., In re Joshua Sloam, Ltd., 103 B.R. 610 (Bankr. E.D. Pa. 1989).However, most cases place this burden
on the trustee.
See e.g., In re Vadnais Lumber Supply, Inc., 100 B.R. 127 (Bankr. D. Mass. 1989).
Courts look to see whether a debtor is either insolvent at the time of
the transfer or rendered insolvent as a result of the transfer, and either
one will be sufficient to pass this portion of the analysis.
In re Newtowne, Inc., 157 B.R. 374 (Bankr. S.D. Ohio 1993). To decide whether a debtor is insolvent,
courts generally ask -- what would the buyer be willing to pay for the
debtor's entire package of assets and liabilities? If the price is
positive, the debtor is solvent; if the price is negative, the debtor
Covey v. Commercial National Bank of Peoria, 960 F.2d 675 (7th Cir. 1992). Courts look to the debtors balance sheet.
Mellon Bank, N.A. v. Metro. Communications, Inc., 945 F.2d 635 (3d Cir. 1991),
cert. denied 112 S. Ct. 1476, 117 L. Ed. 2d 620 (1992). However phrased, this method
is a review of the assets and liabilities of the debtor, and a comparison
between the two.
When looking at assets, the court must assign to those assets that are
readily susceptible to liquidation,
In re Joshua Sloam, 103 B.R. 610 (Bankr. E.D. Pa. 1987), their fair market value. In re Davis,
169 B.R. 285 (E.D.N.Y. 1994);
In re Pioneer Home Builders, Inc., 147 B.R. 889 (Bankr. W.D. Tex. 1992) (Fair market value price at time
of transfer is most equitable standard.). Therefore, assets are best valued
by determining what price they would bring on the open market. An open
market value has been further defined as that value that a prudent business
person could obtain from the sale of an asset when there is a willing
buyer and a willing seller.
supra. Under this approach it is inappropriate to add costs and expenses associated
with the sale of the assets.
Id. The method of market price valuation focuses on what a willing buyer
would pay, not necessarily what a willing seller would ultimately receive.
Id. However, the value can be reduced by factors regarding the difficulty
of the sale of the asset, but only if they affect the market price and
do not relate to the costs of sale.
Id. The value may be further adjusted by the net costs of making the asset
Id. The court cannot take into consideration the debtor's subjective
sentimental value placed upon the item.
Id. The court can value doubtful or contingent claims at less than face value.
In re Join-In Inern. (USA) Ltd., 56 B.R. 555 (Bankr. S.D.N.Y. 1986). If a debtor is a guarantor on a liability,
courts will generally multiply the total debt by the percent chance that
the guarantee will be exercised to determine the liability to be included
in the balance sheet.
Covey v. Commercial Nat'l Bank of Peoria, 960 F.2d 657 (7th Cir. 1992) (cited in 26 Collier Bankr. Cas.2d 1046).
Goodwill can be considered an asset, and can be determined by average
high earnings over a period of years, valuable customer lists, and/or
by trade names.
In re Roco Corp., 701 F.2d 978 (2d Cir. 1983).
The assets are to be reduced by liabilities. Courts can refer to 11 U.S.C.
§ 101(4) to determine what is a liability.
See In re: Joshua Slocum, Ltd., 103 B.R. 610 (Bankr. E.D. Pa. 1989) (finding that shareholders stock
redemptions were not liabilities under Bankruptcy Code § 101(4).
At least one court has allowed the use of the retrojection method to prove
In re R. Purbeck & Assocs., Ltd. 27 B.R. 953 (Bankr. D. Conn. 1983) (analyzing insolvency in a preference
action). Since insolvency at a given point in time is often difficult
to demonstrate by direct proof, courts permit the trustee to show that
the debtor was insolvent at one point in time and then prove that the
same condition existed at the time of the subject transfer. "This
method ... applies equally to situations in which the trustee starts at
a point in time prior to the transfer....[to use this method, the trustee
must] show the absence of any substantive or radical charges in the assets
or liabilities of the bankruptcy between the retrojection dates. Possibly
another burden would be to show that the evidence relating to solvency
at the time of the transfer was scant."
Id. (Evidence was scant.)
(b)Unreasonably small capital remaining
The Bankruptcy Code does not define unreasonably small capital. However,
most courts hold that the definition indicates a financial condition short
E.g., Murphy v. Meriton Sav. Bank (
In Re: O'Day Corp.), 126 B.R. 370, 407 (Bankr. D. Mass. 1991). However, the condition must
be severe enough that it soon turns to, or severely threatens, insolvency;
otherwise, the statute is overly broad.In re
Badnais Lumber Supply, Inc., 100 B.R. 127 (Bankr. D. Mass. 1989). Some cases have confused unreasonably
small capital remaining with the third subsection, dealing with ability
to pay expenses as they become due.
See Pioneer Home Builders, Inc., 147 B.R. 889 (Bankr. W.D. Tex. 1972). While it is one method of reviewing
capital, the method renders this provision meaningless, in light of its
cousin, § 548(a)(2)(13)(iii). However, determining whether enough
capital exists to continue the business would not be inappropriate or
In re Joshua Slocum, Ltd., 103 B.R. 60 (Bankr. E.D. Pa. 1989);
In re Vadnais Lumber Supply, Inc., 100 B.R. 127 (Bankr. D. Mass. 1989).
In Vadnais, the Court held that the analysis must somehow be tied to insolvency.
Since the standard is something less than insolvency, then it must somehow
be tied to causing or inevitably leading to insolvency.
Id.. Delving into the courts logic, one is faced with the conclusion that
subparts ii and iii are strikingly similar.
(c) Incurred debt beyond ability to pay
There is scant authority specifically referring to 548(a)(2)(B)(iii). The
language of this provision requires that the debtor intended to incur,
or believe he would incur, debts that would be beyond his ability to pay.
Bankruptcy Code § 548(a)(2)(B)(iii). Therefore, a fundamental issue
is whether this provision applies at all in cases where the transfer is
involuntary, especially when the debtor is admittedly solvent.All cases
that do discuss the provision examine the intent of the debtor when the
transfer was made. The provision requires an affirmative act by the debtor.
The court in
In Re Hall, 131 B.R. 213 (Bankr. N.D. Fla. 1991), has held that involuntary transfers
were not contemplated by 548(a)(2)(B)(iii).
Id. (Reconciling with general "involuntary" language of 548).
Who may bring claim:
The statute grants the federal fraudulent conveyance cause of action to
trustees and debtors-in-possession, and therefore, a creditor generally
does not have standing to prosecute an action for fraudulent conveyance.
In re Auxano, Inc., 87 B.R. 72 (Bankr. W.D. Mo. 1988);
In re Grell, 83 B.R. 652 (Bankr. W.D. Mo. 1988);
In re Hess, 21 B.R. 465 (Bankr. W.D. Va. 1982).However, courts hold that an individual
creditor can bring an action for recovery of an alleged fraudulent transfer
provided they can show that the trustee or creditor's committee failed
to zealously prosecute the action on behalf of estate.
In re Gibson Group, Inc., 66 F.3d 1436 (6th Cir. 1995);
In re v. Savings Oil & Heating Co., Inc., 91 B.R. 655 (Bankr. E.D.N.Y. 1988);
In re Conley, 159 B.R. 323 (Bankr. D. Idaho 1993).
In one case,
Glinka v. Abraham and Rose Co, Ltd., 199 B.R. 484 (D. Vt. 1996), the court allowed a creditor and the trustee
to jointly pursue a fraudulent conveyance action. The court found that
by itself, the estate lacked the funds to pursue the claim, and that allowing
the creditor to join the trustee imposed no net financial burden on the
IV. South Carolina Fraudulent Conveyances/Statute of Elizabeth.
South Carolina Code § 27-23-10 et seq, known as the Statute of Elizabeth,
states, essentially, that "any transaction which may be had or made
to or for any intent or purpose to delay, hinder or defraud creditors
and others of their just and lawful rights to that property shall be deemed
and taken to be clearly and utterly void, frustrate and of no effect."
This is qualified by § 27-23-40, which states:
Nothing contained in § 27-23-10 to 27-23-30 shall extend or be construed
to impeach, defeat, make void or fraustrate any [transfer] made upon or
for good consideration and bonafide to any person or body politic or corporate.
Although the statute of Elizabeth's protection extends to any and all
parties who are defrauded in connection with the conveyance of property,
Mathis v. Barton, 460 S.E. 2d 406 (S.C. App. 1995) (citing
Lebovitz v. Mudd, 2293 S.C. 49, 358 S.E.2d 698 (1987), when a creditor actually becomes
a creditor can prove to be important. South Carolina case law makes a
distinction between existing creditors and subsequent creditors. The applicable
date of reference is the date of the challenged transfer. A creditor whose
claim straddles the transfer date shall be treated according to when the
majority of the claim accrued.
Creditors who were creditors at the time the transfer took place -- i.e.,
existing creditors -- can set aside a fraudulent conveyance upon a showing that:
(a) where the transfer was made for valuable consideration --
(1) the transfer was made by the grantor with actual intent of defrauding
(2) the grantor was indebted at the time of the transfer; and
(3) the grantor's intent is imputed to the grantee; or
(b) where the transfer is made without valuable consideration --
(1) the grantor was indebted to the creditor at the time of the transfer;
(2) the conveyance was voluntary; and
(3) the grantor failed to retain sufficient property to pay the indebtedness
to the plaintiff in full, not merely at the time of the transfer, but
in the final analysis when the creditor seeks to collect his debt.
Id.[structure of text altered for clarification].
Subsequent creditors, those creditors where at least fifty percent of the
claim accrued after the allegedly fraudulent transfer, may set aside a
transfer if they show (1) the conveyance was without consideration and
(2) it was made with a view to future indebtedness or with actual fraudulent
intent on the part of the grantor to defraud creditors. The obvious difference
between the two is that an existing creditor can choose between proving
lack of consideration and actual fraud whereas a subsequent creditor must
always prove lack of consideration, and some type of intent.
Id. With the exception of the elements requiring a creditor to prove that
the debtor was indebted to him at the time of the transfer, all of the
aforementioned elements are discussed below in order. As for proof that
the grantor was indebted to the creditor at the time of the transfer,
it has never been flushed out, but it would seem fairly obvious that if
one is able to prove that he is an existing creditor -- fifty percent
of debt owed prior to transfer -- then these elements are self actualizing,
provided a creditor remembers that part of his proof is to show when the
debt occurred and the amount.
A. Valuable consideration.
Obviously, for an existing creditor, the first question that must be answered
is whether or not the transfer was for valuable consideration. Valuable
consideration means something more than nominal.
Matthews v. Matthews, 35 S.E. 2d 157, 207 S.C. 170 (S.C. 1945). Generally, in South Carolina,
a contract need only mention consideration for it to be considered a bonafide
exchange for value.However, under fraudulent conveyance law, the standard
is higher, and courts will look past the four corners of the document
to discern whether the exchange amounted to an arms length transaction.
See First Citizens Bank and Trust Co. of South Carolina v. Scofield, 335 S.E. 2D 248, 286 S.C. 520 (S.C. app. 1985) (for $5.00 and "Love
and Affection" insufficient language to circumvent Statute of Elizabeth).
Valuable consideration is the fair equivalent of the property conveyed.
Additionally, any value given must inure to the benefit of the debtor
in order to be considered.
Dufresne v. Regency Realty, Inc.of Hilton Head Island, 366 S.E. 2d 256, 295 S.C. (S.C. App. 1987) (Value given to someone other
than the debtor does not county as consideration for fraudulent conveyance
B. Fraudulent Intent
If valuable consideration was given, the creditor is forced to prove fraudulent
intent. In usual circumstances,
fraudulent intent . . . can be shown only by a consideration of the attendant
facts and circumstances, a resort to which must usually be had in order
to distinguish between transactions which are bona fide, and those which
are not. The Courts frequently must resort to evidence or circumstances
which are not properly explained, when such circumstances lead to the
belief that a fraudulent intent was present. . . . For fraud is not to
be expected to seek the glare of day, or the presence of witnesses for
its consummation. It is usually effected in secret, and it is only from
circumstances [that it may be presumed].
Certain circumstances so frequently attend conveyances to defraud creditors
that they are recognized and referred to as "badges of fraud."
These badges tend to excite suspicions as to the bondfides of a challenged
conveyance. Unexplained, they may warrant an inference of fraud. Whether
the inference is warranted depends in large measure on whether a satisfactory
explanation is presented.
. . . Among the generally recognized badges of fraud are:
 insolvency or indebtedness of the transferor;
 lack of consideration for the conveyance;
 relationship between the transferor and the transferee;
 the pendency or threat of litigation;
 secrecy or concealment;
 departure from the usual method of business;
 the transfer of the debtor's entire state;
 the reservation of benefit to the transferor;
 retention by the debtor of possession of the property.
Although it has been said that a single badge of fraud may stamp a transaction
as fraudulent, it is more generally held that one circumstance recognized
as a badge of fraud may not alone prove fraud; where there is a concurrence
of several such badges of fraud an inference of fraud may be warranted.
Coleman v. Daniel, 199 S.E.2d 74, 261, S.C. 198 (S.C. 1973).
C. Knowledge of Grantee.
In order to set aside a fraudulent conveyance made where value is given,
the creditor must show that the fraudulent intent of the debtor is imputable
to the grantee.
Sumner v. Janicare, Inc., 366 S.E. 2D 20, 294 S.C. 483 (S.C. App. 1988). This requires that the
transferee have knowledge or participate in the scheme, which can be proven
by circumstantial evidence.
SCNB v. Halter, 359 S.E. 2D. 74, 293 S.C. 121 (S.C. App. 1987). Actual knowledge of,
or participation in, the debtor's fraudulent intention on the part
of the transferee need not be established in order to justify a conclusion
that the transaction was fraudulent. The transaction is subject to attack
if at the time of the transfer the transferee had notice of circumstances
which would arouse the suspicion of any ordinary prudent man and cause
him to make inquiry as to the purpose for which the transfer was being
made, which would disclose the fraudulent intent of the maker.
Coleman v. Daniel, 199 S.E. 2D 74, 261 S.C. 198 (S.C. 1973). Knowledge on the part of a
purchaser that the seller is indebted or insolvent has frequently been
held sufficient to place a purchaser on notice and to require him to investigate.
Id. The purchaser need not know of the specific debt that the creditor asserts
is being hindered or prejudiced as a result of the transfer.
Id. Perhaps the most ambiguous element is the requirement that an existing
creditor must prove that a transfer without consideration was voluntary.
A voluntary conveyance is a transfer made without consideration or for
a mere nominal consideration.
Durham v. Blanchard, 438 S.E. 2D 259 (S.C. App. 1993).Where nominal or some amount of consideration
is paid, the transfer is considered voluntary to the extent the value
of the property is more than the consideration paid.
Kirby v. Horne Motor Co., 366 S.E. 2D 259 (S.C. App. 1988).
D. Voluntariness of transfer
A voluntary conveyance is a transfer made in good faith without consideration
or for a mere nominal consideration.
Durham v. Blackard, 438 S.E. 2d 259 (S.C. App. 1993). "A voluntary conveyance which
violates the statute [of Elizabeth] will be set aside to the extent of
the value of the property transferred less any consideration received
in exchange therefore."Id. at 263.
When an existing creditor is showing that the grantor failed to retain
sufficient property to pay the indebtedness to the plaintiff in full,
they are in essence attempting to prove insolvency. The court in
Gardner v. Kirven, 191 S.E. 814, 816 (1937) seems to suggest that the plaintiff needs to
show that "[i]f in the final event the property of the debtor is
not sufficient to pay his debts existing at the time of this voluntary
conveyance, then such conveyance is null and void as to such debts."
Id. Clearly, the
Garvin holding suggest that a creditor may show insolvency at the time the debt
is sought to be collected.
Garvin supports the position that in conveying property, debtor's must retain
sufficient property to satisfy their debts when they become due. The amount
of property that must be retained "means a sufficient amount of property
not merely at the time of the transfer, but an amount from which in the
final analysis the creditors are able to collect their indebtedness in
Id. at 816.
No South Carolina Court has held that this element is presumed or abandoned
when the debtor/grantor has filed bankruptcy. Nevertheless, it would seem
that a creditor's or trustee's duties in proving this element
go beyond simple proof that the debtor filed bankruptcy. The creditor
or the trustee must show that the debtor is infact insolvent. The mere
filing of a petition is insufficient because one can file bankruptcy for
one of two reasons -- (1) the inability to pay ones debts as they become
due, and (2) not having enough assets to pay ones debts. According to
Durham v. Blackard, 438 S.E. 2d 259 (S.C. App. 1993), a creditor may have to prove that the
debtor has insufficient assets to pay the debt, after the transfer.
See Durham, 438 S.E. 2d at 263 ("McMillan failed to retain sufficient property
to pay his debt to Blackard."). Additionally, in
Dufresne v. Regency, Inc., 366 S.E. 2d 256 (S.C. App. 1987), the court focused on the assets of
the debtor versus the liabilities, further evidencing that the a creditor
must prove insolvency.
See also, Garvin v. Kirven, 191 S.E. 814 (1937) (The grantor must reserve a sufficient amount of
property to pay his creditors.). A debtor may have filed for bankruptcy
using only the first condition. However, it seems almost tautological
to state that if the debtor has enough assets to pay his debts without
the necessity of recovering the fraudulent conveyance, the trustee would
be hard pressed to justify the suit. Therefore, while the burden to show
insolvence is more than showing that a petition was filed, the burden
is met once the Trustee establishes that without the recovery of the fraudulent
conveyance, the estate will not distribute a 100% payout to creditors.
F. Was made with a view to future indebtedness
It appears that the court in
Matthews v. Burton, and in
Parker Peanut Co. v. Felder, 20 S.E. 2D 716 (S.C. 1942), was referring to some proof that the debtor
knew of the impending indebtedness at the time of the transfer. Although
the court in
Gentry v. Lanneau, 32 S.E. 523 (1899) was even more relaxed and suggested that the creditor
need only prove that the transfer was made in anticipation of some future
V. South Carolina Uniform Commercial Code Bulk Sales Act Fraudulent ConveyanceStatute.
Under the South Carolina version of the Uniform Commercial Code, the legislature
has implanted a fraudulent conveyance statute to help protect creditors.
The Bulk Transfer Act, found at South Carolina Code § 36-6-100 et
seq., seeks to protect creditors from two possible events: from an enterprise
that may sell its stock to an insider for less than what it is worth and
from an enterprise that sells its stock only to distribute the proceeds
to an individual who disappears. The act seeks to accomplish this purpose
solely by providing notice to the creditors of the selling enterprise.See
Official Comment 4 to S.C. Code Ann. § 36-6-101 (S.C. Code Ann.).
The provision that gives the Bulk Transfers act its teeth is S.C. Code
§§ 36-6-104 and 105, which essentially states that transfers
in bulk of all or a major part of a business's inventory is not effective
against existing creditors of that business unless the transferee gives
notice to the creditor at least ten days before the transferee takes possession
of or pays for the goods, whichever is first.S.C. Code § 36-6-104.
If the creditors are not given the statutory notice neither good faith
nor fair consideration are defenses for the transferee.
See In re Pritchard, 8 B.R. 88 (Bankr. Cal. 1981) (good faith is immaterial);
Darby v. Ewing's Home Furnishings, 278 F. Supp. 917 (D.C. Ok. 1967) (fair consideration is no defense).
D.1. Elements of a Preference Cause of Action
Pursuant to section 547(b) of the United States Bankruptcy Code, a trustee
may avoid any transfer of an interest of the debtor in property:
(1) to or for the benefit of the creditor;
(2) for or on account of an antecedent debt owed by the debtor before such
transfer was made;
(3) made while the debtors was insolvent;
(4) made --
(a) on or within 90 days before the date of the filing of the petition; or
(b) between ninety days and one year before the date of the filing of the
petition, if such creditor at the time of such transfer was an insider; and
(5) that enables such creditor to receive more than such creditor would
(a) the case were under chapter 7 of this title;
(b) the transfer had not been made; and
(c) such creditor received payment of such debt to the extent provided
by the provisions of this title.
11 U.S.C. § 547(b).It is the trustee's burden to prove each and
every one of these elements.
Id. at § 547(f);
Danning v. Bozek, 836 F.2d 1214 (9th Cir. 1988).Failure to meet this burden on any one
element precludes a finding that a transfer is a preference.
In re Hood, 118 B.R. 417 (Bkrtcy.D.S.C. 1990);
In re Cockreham, 84 B.R. 757 (D.Wyo. 1988).Further, because the elements above are objective,
the intent of the debtor is
Marathon Oil Co. v. Flatau, 785 F.2d 1563 (11th Cir. 1986).Accordingly, it is the
effect of the transfer which is controlling.
Barash v. Public Fin. Corp., 658 F.2d 504 (7th Cir. 1981).
B. Transfer of an Interest of the Debtor in Property
Section 101 of the Bankruptcy Code defines a "transfer" as "every
mode, direct or indirect, absolute or conditional, voluntary or involuntary,
of disposing of or parting with property or with an interest in property,
including retention of title as a security interest and foreclosure of
a debtor's equity of redemption." 11 U.S.C. § 101(54). This
definition is exceptionally broad, and therefore includes virtually every
conceivable transfer, including the creation or fixing of judicial liens.
Precisely because this definition is so broad, the true test is not whether
a transfer occurred, but whether the debtor had an actual or constructive
ownership interest in the transferred property.
In re Hood, 118 B.R. 417 (Bkrtcy.D.S.C. 1990);
In re Flooring Concepts, Inc., 37 B.R. 957 (9th Cir. 1984).
 In this regard, ownership is determined by the debtor's ability to
control the disposition of the property.
For example, in
In re Cybermech, Inc., 13 F.3d 818 (4th Cir. 1994), the Fourth Circuit Court of Appeals addressed
the question of whether a debtor corporation's return of another corporation's
down payment on the purchase of office machines constituted an avoidable
preference. In the court held that the debtor did have an interest in the
payment funds because the debtor, upon receipt of the funds, could deposit
it, commingle it with other funds, withdraw from it, transfer it or otherwise
use the payment funds in anyway it so desired.
Id. at 820. Therefore, the debtor's "ability to exercise complete
'dominion and control over the funds' was sufficient to 'demonstrate
an interest in property' under the preferential transfer provision
. . . the [money] transferred . . . was a transfer of an 'interest
of the debtor in property.'"
Id. at 821 (quoting
In re Smith, 966 F.2d 1527 (7th Cir. 1992)).
Another illustrative case is
In re Hood, 118 B.R. 417 (Bkrtcy.D.S.C. 1990). There, the debtor was facing an imminent
sheriff's levy when a friend of the debtor's intervened by offering
to personally pay the debtor's debts. The debtor's creditors,
however, refused to accept her checks. The debtor then took his friend's
personal checks to the bank where they were exchanged for cashier checks
and used to pay off the creditors. After finding that the transfer satisfied
the other elements of a preference, the court turned to the ultimate question
of whether or not the debtor possessed an interest in the transferred
funds. Accordingly, the court held that the debtor did not have an interest
in the funds because the debtor did not and could not control the disposition
of the funds.In so holding, the court adopted and applied the "earmark"
doctrine. This doctrine essentially states that funds loaned to a debtor
by a third party that are "earmarked" for a particular creditor
do not belong to the debtor.Its application requires:
- The existence of an agreement between the new lender and the debtor that
the new funds will be used to pay a specified antecedent debt. Where the
payment is made directly by the third party to the creditor, this requirement
- Performance of that agreement according to its terms; and
- Transaction, when viewed as a whole, including the transfer of new funds
out to the old creditor, does not result in the diminution of the estate.
Id. at 420 (citing
In re Bohlen Enter., 859 F.2d 561 (8th Cir. 1988)). Applying the doctrine, the court found
that (1) the debtor and his friend entered an agreement that earmarked
the funds for the payment of the debtor's creditors; (2) the debtor's
friend directly paid the creditors; (3) the agreement was performed according
to its terms; (4) the funds transferred were never property of the debtor
nor did they become property of the debtor; and (5) the transfer did not
diminish the debtor's bankruptcy estate.
Id. Therefore, the court concluded that the transfer was not an interest
of the debtor in property simply because the debtor did not and could
not control the disposition of the property.
Id. at 421.
C. To or For the Benefit of a Creditor . . .
Section 101 of the Bankruptcy Code defines a "creditor," in relevant
part, as an"entity that has a claim against the debtor that arose
at the time of or before the order for relief concerning the debtor."
11 U.S.C. § 101(10)(A).Further, a "claim" means:
(A) right to payment, whether or not such right is reduced to judgment,
liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed,
undisputed, legal, equitable, secured, or unsecured; or
(B) right to an equitable remedy for breach of performance if such breach
gives rise to a right to payment, whether or not such right to an equitable
remedy is reduced to judgment, fixed, contingent, matured, unmatured,
disputed, undisputed, secured, or unsecured.
11 U.S.C. § 101(5)(A)(B). In construing these terms, the United States
Supreme Court stated in
Ohio v. Kovacs, 469 U.S. 274, 105 S.Ct. 705, 83 L.Ed.2d 649 (1985) that Congress intended
for them to be used in their broadest possible sense. The courts have
obliged by finding creditors in even the most contingent and remote cases.
e.g., In re Cybermech, 13 F.3d 818 (4th Cir. 1994) (buyer was a creditor of the seller because
the buyer had paid for the goods, and therefore had a claim against the
seller for a right to payment or a right to an equitable remedy for breach
In re Gold Coast Seed Co., 751 F.2d 1118 (9th Cir. 1985) (holding that a seller acquired a claim
against the buyer at the time the buyer received and accepted the goods).
The transfer, however, must also benefit the creditor.Accordingly, this
benefit can either be direct,
see, e.g., In re Cardon Realty Co., 146 B.R. 72 (Bkrtcy.W.D.N.Y. 1992) (holding that debtor's payment
to creditor/assignee of loan obligation benefitted the creditor/assignee,
regardless of what she did with the money after she received it, because
it paid off an antecedent debt), or indirect,
see, e.g., In re Conrad Corp., 806 F.2d 610 (5th Cir. 1987) (holding that the debtors' transfer
of restaurants in exchange for a simultaneous assumption of their debt
by a third party benefitted the creditor, and therefore, constituted a
voidable indirect transfer to the creditor).
D. Ninety Day Reachback Period; "Insider" Extension of the Preference
Period . . .
Subsection (b)(4) of section 547 provides that a transfer can only be avoided
where it was made on or within ninety days before the filing of the petition.
11 U.S.C. § 547(b)(4)(A). While this is generally an absolute rule,
subsection (b)(4)(B) immediately follows and provides that where the transfer
was made to an "insider," the time limit for avoidance is extended
to one year pre-petition.An "insider," in the conventional sense,
is simply someone who stands in a close relationship with the debtor and
who possesses the ability to control the debtor's actions.
In re Pineview Care Center, Inc., 152 B.R. 703 (D.N.J. 1993).
 The most common examples include a relative or general partner of thedebtor
in the cases where the debtor is an individual or a partnership, and the
director(s) or officers of the debtor in the cases where the debtor is
a corporation. 11 U.S.C. § 101(31).
One of the more interesting situations where these two elements play a
featured role occurs where the trustee attempts to recover a transfer
to an outside creditor that benefits an insider creditor. The most common
example of this scenario exists where the insider creditor guarantees
a loan and then directs its payment to the creditor advancing the loan.In
Levit v. IngersollRand Fin. Corp., 874 F.2d 1186 (7th Cir. 1989), the court examined such a situation and
set forth the "Deprizio" doctrine. This doctrine essentially
allows the trustee to recover from non-insider transferees for payments
made during the extended preference period which benefits insider creditors
or guarantors. While many courts have adopted the "Deprizio" doctrine,
see, e.g.,Ray v. City Bank & Trust Co., 899 F.2d 1490 (6th Cir. 1990), other courts have vehemently refused to
apply its reasoning. For example, in
In re Midwestern Co., Inc., 102 B.R. 169 (W.D.Mo. 1989), the court opposed the
Levit decision because it felt that section 547 unambiguously set forth two
distinct time limits for each type of creditor. In this regard, the
Midwestern court held that an outside creditor is only liable for a transfer made
within the ninety day limitation while an insider creditor is only liable
for a transfer made within the extended preference period of one year. While the
Midwestern court was attempting to give "full meaning" to section 547,
the court in
In re Mercon Indus., Inc., 37 B.R. 549 (Bkrtcy.E.D.Pa. 1984), reached an identical result by concluding
that a debtor's payment to an outside creditor for the benefit of
an insider creditor constituted two distinct and separate transfers --
one to the primary creditor (outsider) and one to the guarantor (insider).
While this dispute was eventually settled with the passing of the 1994
Bankruptcy Reform Act disposing of the Deprizio doctrine, it is still
relevant to any pre-1994 actions.More importantly, South Carolina bankruptcy
courtsfollow the Deprizio doctrine.
See In re Hoffman Assoc., 179 B.R. 797 (Bkrtcy.D.S.C. 1995).
E.For or on Account of an Antecedent Debt . . .
An antecedent debt is simply a debt that the debtor incurs before he makes
the alleged preferential transfer. 4 COLLIER ON BANKRUPTCY § 547.05
(15th Ed. 1991). This element is present to promote the central concept
governing the existence of a preference action -- the preservation of
the debtor's assets. Accordingly, any transfer to a creditor that
occurs during the preference period on account of an antecedent debt serves
only to deplete the debtor's bankruptcy estate, and therefore is in
derogation of this policy of preservation.
While the term "antecedent" is easy enough to grasp, the existence
of a "debt" depends upon the existence of a claim.In
In re Cybermech, the creditor, Royal Cake Co, Inc. (hereinafter "Royal") entered
a sales agreement with the debtor, Cybermech, Inc. (hereinafter "Cybermech")
whereby Royal paid Cybermech a substantial down payment for various equipment.
Due to financial troubles, however, Cybermech soon informed Royal that
it would be unable to perform the contract and returned the down payment.
Three weeks later, Cybermech filed a voluntary Chapter Seven petition.
The trustee quickly moved to have the returned down payment set aside
as a preference.Royal, however, challenged the trustee and alleged, among
other things, that the returned payment was not an antecedent debt because
(1) Cybermech never owed a debt to Royal; and (2) even if Cybermech did,
the debt was not antecedent to the transfer. The court disagreed and held
that because Royal possessed a claim against Cybermech for performance
under the contract, Royal was a creditor, and Cybermech owed Royal the
debt of performance.
 In so holding, the court stated that the terms "claim" and "debt"
were coextensive; where one exists then so does the other:
The Code defines "debt" as "liability on a claim."
11 U.S.C. § 101(12). By making "claim" the operative term
in the definition of debt, "Congress gave debt the same broad meaning
it gave claim." [Citation omitted]. Indeed, it is clear that "the
terms 'debt' and 'claim' are coextensive: a creditor has
a 'claim' against the debtor; the debtor owes a 'debt'
to the creditor." [Citations omitted]. By defining debt as "liability
on a claim," Congress did not impose an additional element, namely
that legal liability be established through litigation. "[W]hen a
claim exists, so does a debt." [Citation omitted]. They are but different
windows in the same room.
Id. at 822.Therefore, Cybermech did owe a debt to Royal and said debt was
antecedent to the transfer because Cybermech contracted the debt well
before it returned the money.
F. Made While the Debtor was Insolvent . . .
A debtor is essentially insolvent when his liabilities exceed his assets.
4COLLIER ON BANKRUPTCY § 547.06 (15th Ed. 1991).
 In this regard, there is a presumption of insolvency during the ninety
day reachback period.
Transit Homes, Inc. v. South Carolina Nat'l Bank, 57 B.R. 40 (Bkrtcy.D.S.C. 1985), however, the courtheld that the presumption
of insolvency can be rebutted by the introduction of the debtor's
G. That Enables the Creditor to Receive More Than Such Creditor Would Have
Received in a Hypothetical Chapter 7 Case.
Subsection (b)(5) is merely a codification of the United States Supreme
Court holding in
Palmer Clay Products Co. v. Brown, 297 U.S. 227, 56 S.Ct. 450, 80 L.Ed. 655 (1936). There, the court held
that whether a transfer is preferential should be determined "not
by what the situation would have been if the debtor's assets had been
liquidated and distributed among his creditors at the time the alleged
preferential payment was made,
but by the actual effect of the payment as determined when bankruptcy results." [Emphasis added]. In this regard, the court in
Elliot v. Frontier Prop./LP, 778 F.2d 1416, 1421 (9th Cir. 1985) stated:
This analysis requires that in determining the amount that the transfer
"enables the creditor to receive," 11 U.S.C. § 547(b)(5)
(1982), such creditor must be charged with the value of what was transferred
plus any additional amount that he would be entitled to receive from aChapter
7 liquidation. The net result is that, as long as the distribution in
bankruptcy is less than one-hundred percent,
any payment " on account" to an unsecured creditor during the preference
period will enable the creditor to receive more than he would have received
in liquidation had the payment not been made. [Emphasis theirs].
This section is also applicable to secured creditors.In
Smith v. Creative Fin. Management, Inc., 954 F.2d 193, 199 (4th Cir. 1992), the court stated:
While the bankruptcy code recognizes and respects the preeminent status
given to the secured creditor by state commercial codes, a creditor is
"secured" under the code only to the extent of the value of
his interest in the property of the estate . . . Section 547(b)(5) does
not, as Creative seems to argue, add any special protections for the secured
creditor.Indeed, the term "secured creditor" is not even included
in that section . . . As the plain language of [section] 547(b)(5) convey,
the court must focus, not on whether a creditor may have recovered all
of the monies owed by the debtor
from any source whatsoever, but instead upon whether the creditor would have received less than a
100% payout in a Chapter 7 liquidation.
See also 4 COLLIER ON BANKRUPTCY § 547.08 (15th Ed. 1991) ("The analysis
[for unsecured creditors] is similar for secured creditors . . . .").
H.Primary Defense -- The Ordinary Course of Business Exception
While section 547(c) sets forth a number of instances where a trustee cannot
avoid a preference transfer, the most important of these "defenses"
is the ordinary course of business exception.This exception is embodied
in the text of subsection (c)(2) which provides that a trustee cannot
avoid a transfer:
(A) in payment of a debt incurred by the debtor in the ordinary course
of business or financial affairs of the debtor and the transferee;
(B) made in the ordinary course of business or financial affairs of the
debtor or the transferee; and
(C) made according to ordinary business terms.
The essential purpose of this exception is "to leave undisturbed normal
financial relations because it does not detract from the general policy
of the section to discourage unusual action by either the debtor or its
creditors during the debtor's slide into bankruptcy."
Morrison v. Champion Credit Corp., 952 F.2d 795, 801 (4th Cir. 1991). In this regard, the creditor who claims
the exception also possesses the burden of proof.
Advo-System, Inc. v. Maxway Corp., 37 F.3d 1044, 1047 (4th Cir. 1995). Further, the creditor must satisfy
its burden by a preponderance of the evidence.
In re Jeffrey Bigelow Design Group, 956 F.2d 479 (4th Cir. 1992), the Fourth Circuit Court of Appeals held
that subsection (c)(2)(A) and (B) are analyzed pursuant to a subjective
test.There, the court stated that the "'focus of [the] inquiry
must be directed to an analysis of the business practices which were unique
to the particular parties under consideration.'"
Id. at 486 (quoting
Waldschmidt v. Ranier, 872 F.2d 739, 743 (6th Cir. 1989). This inquiry is "'peculiarly
factual, . . .'"
In re First Software Corp., 81 B.R. 211, 213 (Bkrtcy.D.Mass. 1988), and "[a]ttention should
be drawn to the reality of the situation and not the formal structure."
Id. at 488. In this regard, the court emphasized that "form must not
be elevated above substance."
The Fourth Circuit utilized a different approach, however, in examining
Advo-System, Inc. v. Maxway Corp., 37 F.3d 1044 (4th Cir. 1995), the creditor was a direct mail advertising
firm that required its customers to prepay for its services.One of these
customers was the debtor. In the ninety-day period preceding the debtor's
bankruptcy petition, the debtor made twelve payments to the creditor.
Two of the payments were prepayments while the remaining ten payments
were for services previously rendered. The creditor had waived the last
ten payments and had allowed the debtor to pay when able.Shortly after
the debtor filed for Chapter 11 protection, the trustee moved to avoid
the latter ten payments as preferences. The creditor countered that said
payments fell within the ordinary course of business exception, and therefore,
The court began its analysis by refusing to apply subsection (c)(2)(A)
and (B)' s subjective test for subsection (C).
Id. at 1048 ("[b]ecause subsection B and C are written in the conjunctive,
the use of subsection B's subjective approach under subsection C would
render subsection C superfluous . . . [w]e refuse to say that Congress
wrote a separate subsection for no reason at all."). The court then
held that subsection (C) should be analyzed under an objective test whereby
a court looks to the industry norms for the determination of "ordinary
Id. The court then explained the application of this test:
[T]he extent to which a preference payment's credit terms can stray
from the industry norm yet still satisfy [section] 547(c)(2)(C) depends on
the duration of the debtor-creditor relationship. "[T]he more cemented (as measured by its duration) the pre-insolvency
relationship between the debtor and the creditor, the more the creditor
will be allowed to vary its credit terms from the industry norm yet remain
in the safe harbor of [section] 547(c)(2)(C)."
Id. at 225. A "sliding-scale window" is thus placed around the
industry norm. On the one end of the spectrum, "[w]hen the relationship
between the parties is of recent origin, or formed only after or shortly
before the debtor sailed into financially troubled seas, the credit terms
will have to endure a rigorous comparison to credit terms used generally
in a relevant industry."
Id. In such a case, only those "departures from [the] relevant industry's
norms which are not so flagrant as to be 'unusual' remain within
subsection C's protection."
Id. at 226.
On the other end of the spectrum, "when the parties have had an enduring,
steady relationship, one whose terms have not significantly changed during
the pre-petition insolvency period, the creditor will be able to depart
substantially from the range of terms established under the objective
industry standard inquiry and still find a haven in subsection C."
Id. at 1049 (quoting
Fiber Lite Corp. v. Molded Acoustical Products, Inc., 18 F.3d 217 (3d Cir. 1994)). In so holding, the court also emphasized
that "subsection C never tolerates a gross departure from the industry
norm, not even when the parties have had an established and steady relationship."
Id. at 1050.
Applying their "newly adopted" sliding scale approach to subsection
(c)(2)(C), the court found that the creditor had failed to meet its burden
of satisfying subsection (c)(2)(C).Because the creditor's normal business
practice was to require prepayment, their waiving of the requirement for
the debtor constituted a gross departure from their industry norm. Therefore,
and despite their longstanding relationship with the debtor, the creditor
was held liable for the preference payment.
I. Defense -- The New Value Exception
Another defense worthy of mention is the new value exception.It is embodied
in section 547(c)(1)(A)(B) which provides:
(c) The trustee may not avoid under this section a transfer --
(1) to the extent that such transfer was --
(A) intended by the debtor and the creditor to or for whose benefit such
transfer was made to be a contemporaneous exchange for new value given
to the debtor; and
(B) in fact a substantially contemporaneous exchange.
The exception's existence and purpose is to protect transactions that
do not diminish the bankruptcy estate.
In re Martin, 188 B.R. 689 (M.D.Ala. 1995).In this regard, it is the intentof the parties
which constitutes the most critical element.
See In re Hersman, 20 B.R. 569 (Bkrtcy.N.D.Ohio 1982) ("The key inquiry, therefore,
is whether the parties at the outset intended the exchange to be contemporaneous.").
Legislative history reveals the type of transaction that this exception
was designed to cover:
However, for the purposes of this paragraph, a transfer involving a check
is considered to be "intended to be contemporaneous," and if
the check is presented for payment in the normal course of affairs . .
. that will amount to a transfer that is "in fact substantially contemporaneous.
H.R. Rep. No. 95-595, 95th Cong., 1st Sess. 373 (1977), U.S. Code Cong.
& Admin. News, p. 5787 (1978). A check, then, is the classic example.
See In re Davis, 22 B.R. 644 (Bkrtcy.M.D.Ga. 1982) (holding that the only type of credit
transaction which would resultin a transfer under the new value exception
is a check transaction, which is for all practical intents and purposes
really a cash transaction). Conversely, a credit card transaction is the
classic bad example.In
In re Hersman, the court explained:
Where goods are paid for by a check, the payor had funds in the banking
institution upon which the check is drawn when he makes the check payable
to the person furnishing the goods.The payee need only present the check
for payment . . . When using a credit card to pay for goods, a consumer
is generally seeking that which its name implies -- the extension and
receipt of credit.By using a credit card, the credit card consumer does
not intend a contemporaneous exchange for value.Instead, what is generally
intended is the receipt of goods or services presently and time to pay
for the same in the future . . . .
In re Hersman, 20 B.R. at 573.
A transaction, however, need not only be contemporaneous, but it must create
new value as well.While the question of new value is always a question of fact,
In re Spada, 903 F.2d 971 (3d Cir. 1990), its form can be virtually anything.
See In re Prescott, 805 F.2d 719 (7th Cir. 1986) (stating that new value includes new credit,
goods, services and property). In
In re Townsend-Robertson Lumber Co., 144 B.R. 407 (Bkrtcy.E.D.Ark. 1992), the courtfound new value in the
retention of fees for the storing of a Chapter 7 debtor's lumber.In
In re Mantelli, 149 B.R. 154 (9th Cir.BAP Cal. 1993), however, the court held that a
debtor's payment to his wife of a civil contempt sanction did not
create new value because the payment was not made for goods or services,
but in lieu of a five day jail sentence.
A. Turnover Orders
Section 542(a) generally provides that a third party noncustodian that
has custody or control over property of the estate that either the Trustee
may use, sell or lease or that the debtor may exemptmust turn that property
over to the Trustee, unless the property is of inconsequential value or
benefit to the estate. Section (b) provides that an individual that owes
a matured debt shall pay that debt to the order of the trustee, unless
the debt is being set-off under Section 553. Subsections 542(c) and(d)
provides specific instances where the third party does not have to turn
the property over to theTrustee.Specifically, if the party does not know
of the commencement of the case, or if the third party is transferring
life insurance benefits.542(e) also requires the turnover of books and
records from individuals such as attorneys and accountants to the Trustee.
Note that Section 542(e) does not waive or constitute any exception to
the attorney-client privilege.
The court will exceed its equitable power if it orders turnover of property
held by a creditor without first providing adequate protection for that property.
In re Empire for Him, Inc., 1 F.3d 1156 (11th Cir. 1993).
Exempted property is property that the debtor may keep. If a debtor owns
too expensive or too much property for a particular section, the debtor
must surrender the excess to the estate or sell the property and keep
the cash equivalent of the exempted property. Property that is fully liened
isnot subject to an exemption. Many of South Carolina's Exemptions
are located at S.C. Code Ann. 15-41-30:
- Up to 5,000.00 in a residence or burial plot owned by a debtor or a dependent
- Up to 1,200.00 in a motor vehicle (Ex. a debtor has a 6,000 car.The debtor
can sell the car for 6,000 and keep 1,200 in cash.)
- Up to 2,5000.00 in household goods, wearing apparel, furnishings, appliances,
books, animals, crops or musical instruments held primarily for personal,
family or household use.
- Up to 500.00 in jewelry
- Up to 1,000.00 in liquid assets (cash, drafts, securities, notes etc) This
exemption is only available if the debtor does not take a homestead exemption.
- Up to 750.00 in professional implements, tools of the trade and books
- Any interest that the debtor has in an unmatured life insurance contract,
but not a credit life insurance contract.
- Up to 4,000.00 in dividend, interest or loan value of any lie insurance contract.
- Any professionally prescribed health aids for the debtor or a dependent
of a debtor.
- The debtors right to receive: a social security benefit, a veteran's
benefit, a disability benefit, alimony, support or separate maintenance
and a payment of a stock, bonus, pension, sharing, annuity or similar
plan on account of age, disability, death or length of service.
- The debtor may also receive any property traceable to: an award under a
crime victim reparation law, a payment on account of bodily injury of
the debtor or of the wrongful death or bodily injury of another individual
of whom the debtor was or is a dependent, a payment under a life insurance
contract that insured a person to whom the debtor was s dependent on the
date of the insured's death.
- Any interest or right in an individual retirement account.
- The debtor's interest in an ERISA qualified employee pension plan.
- South Carolina has other exemptions:
a. Fraternal benefit association
b. Right to annuity or retirement allowance from the S.C. Retirement System,
the Retirement System for Judges and Solicitors, the Retirement System
for the General Assembly, the police Officers retirement System or any
private municipality retirement system.
c. Any pension fund held before or after the Fireman's pension funds
held by any municipality.
d. 50,000 in cash surrender value or proceeds from an individual life
insurance policy for the benefits of the debtors, spouse, children or
e. 50,000 in cash surrender value or proceeds from a group life insurance
policy for the benefits of the debtors, spouse, children or other dependents.
f. Workers Compensation pursuant to S.C. Code Ann. 42-9-360
g. Public Aid and Assistance pursuant to S.C. Code Ann. 43-5-190
h. Crime Victim's Compensation pursuant to S.C Code Ann. 16-3-1300
i. Partnership Property pursuant to S.C. Code Ann. 33-41-720.
15. Other Federal Exemptions include:
a. Social Security paid or payable 42 U.S.C. 407
b. Veteran's benefits 38 U.S.C. 3101
c. Disability or death compensation for government employees 5 U.S.C. 1830
d. Civil Service retirement annuity 5 U.S.C. 8346
e. Armed Services retirement or retainer pay annuity 10 U.S.C. 1440
f. Military survivor annuity, 10 U.S.C. 1450
g. Foreign service retirement and disability 22 U.S.C. 4060
h. Annuities for survivors of judicial officials 28 U.S.C. 376
i. Longshoremen's and harbor workers compensation and benefits, 33
j. Benefits from Servicemen's or veteran's Group Life Insurance
38 U.S.C. 770(g)
k. War risk hazard compensation benefits 42 U.S.C. 352(e)
l. Railroad retirement annuity for supplemental annuity 45 U.S.C. 231(m)
m.Railroad workers unemployment compensation 45 U.S.C. 352 (e)
n. The Clothing of seamen 46 U.S.C. 1110
o. CIA retirement 50 U.S.C. 403
G. Valuation of Security Interest
Section 506 determines the actual amount of a secured claim, but does not
govern if the claim itself is specifically allowed. A creditor is secured
if it has a lien on the property or if the property is subject to setoff
pursuant to Section 553. The creditor is secured to the value of the creditor's
interest in the property or the extent of the amount of setoff. If the
amount of the collateral is lessthan the claim, then the creditor is unsecured
for the remainder of the claim.506(b) states that if the value of the
collateral exceeds the amount of the creditor's claim, then the creditor's
claim can be increased by expenses and interest incurred by the creditor.506(c)
requires that the Trustee charge the secured creditors for certain necessary
expenses to preserve the property, 506(d) summarily voids liens secured
by claims that are not properly allowed claims.
A debtor's Chapter 13 property is valued according to the cost a debtor
would incur in obtaining a like asset for the same use. This is also known
as replacement value. Determining the replacement value requires deductions
for certain costs including warranties, storage and reconditioning.
Associates Commercial Corp v. Rash, 520 U.S. 953 (1997).
Replacement value for a vehicle may be calculated by averaging wholesale
values in the "blue book" and then by adjusting the value according
to other evidence introduced by the parties.
In re Getz, 242 B.R. 916 (B.A.P. 6th Cir. 2000).
Valuation of collateral securing a creditor's claim is flexible and
is not limited to a single point in time for purposes of determining whether
a creditor is entitled to accrue interest under 506(b). In re T-H New
Orleans Ltd. Partnership, 116 F.3d 790 (5th Cir. 1987).
Under 506(b) no recovery exists for postpetition interest on an oversecured
claim, but recovery of reasonable fees and costs are permitted.
United States v. Ron Pair Enterp. Inc., 489 U.S. 235 (1989).
The Chapter 11 debtor in possession may not surcharge an oversecured bank's
collateral to pay debtor's attorneys of the services are not necessary
and do not confer a benefit to the banks.
In re Compton Impressions, Ltd., 217 F.3d 1256 (9th Cir. 2000).
H. Treatment of Secured Claims in Chapter 11 Plans
In Chapter 11 Bankruptcy, The debtor usually files the plan pursuant to
Section 1121. The plan must place creditors into substantially similar
classes pursuant to 1122. Secured Creditors usually have their own class.Section
1123 provides that the plan may impair or leave unimpaired any class of
secured or unsecured claims, (1123(b)(1) but if the plan leaves a class
unimpaired, then the plan must specifically state it. (1123(a)(2).) Section
1124 defines an unimpaired class as a class that is completely protected
under the plan. Unimpaired classes are deemed to have protected the plan,
as those creditors will receive the full amount of their security interest.
For a plan to be confirmed each class must have accepted the plan under
1129(a)(7) or the class must be crammed down under 1129(b).A class has
accepted the plan if at least 2/3 in amount and more than ½ in
number of the creditors in the class have accepted the plan.1126(c). The
court may also "knock out"creditors whose acceptance or rejection
of the plan was not in good faith.1126(e). So as a class of secured creditors,
the plan can either leave them unimpaired so that the secured creditors
get the total amount of their lien and are deemed to have accepted the
plan. The secured creditors can accept the plan, or they can reject the
plan and the debtor can try to "cram" the plan down on them,
forcing them to accept the plan.Section 1129(b)(2) provides the mechanism
to "cram down" around a secured creditor. The plan must be fair
and equitable and provide that the holders retain the liens securing the
claims, that each holder receive deferred cash payments totaling at least
the allowed amount of such claim (or for the sale and proceeds of the
liened items) or the realization by the holders of the indubitable equivalent
of such claims. Thus, it is very hard to "cram down" on a secured
creditor, unless the creditor is getting what they would have gotten outside
of bankruptcy. Thus, it is smart for most Chapter 11 plans to go ahead
and set the secured creditors up as an unimpaired class, deemed to have
accepted the plan.
Claims may be classified separately if the claims are not substantially
similar, if there are good business reasons for doing so, or if in the
claimants have sufficiently different interests under the plan. Claims
may not be classified separately solely in order to gerrymander an affirmative
vote on reorganization.
Matter of Wabash Valley Power Assoc., 72 F.3d 1035 (7th Cir. 1995)
cert denied, 519 U.S. 965 (1996).
In determining whether a classification is reasonable, the court should
look to purposes that classification serves: (1) voting to determine whether
a plan can be confirmed; and (2) treatment of claims under the plan. Each
class must represent a voting interest that is sufficiently distinct to
merit and separate voice.John Hancock Mutual Life Ins. Co. v. Route 37
Bus. Park. Assocs., 987 F.2d 154 (3d Cir. 1993).
Any alteration of rights constitutes an impairment, even if the value of
the rights is enhanced.
Matter of Wabash Valley Power Assoc., 72 F.3d 1035 (7th Cir. 1995)
cert denied, 519 U.S. 965 (1996).
A claim is impaired unless the plan does not alter the legal, equitable,
and contractual rights to which a claim or interest entitles the holder.
In re Windsor on the River Assoc. Ltd., 7 F.3d 127 (8th Cir. 1993).
The purchase of claims for the purpose of securing the approval or rejection
of a plan is not per se bad faith.
In re 255 Park Plaza Assocs. L.P., 100 F.3d 1214 (6th Cir. 1996).
A postpetition secured lender is not entitled to vote on a plan of reorganization.
In re Kliegl Bros. Univ. Elec. Lighting Co., 149 B.R. 306 (E.D.N.Y. 1992).
When all requirements for a confirmation of a reorganization plan are met
except for 1129(a)(8), the bankruptcy court must confirm the plan despite
the objection of an impaired class or classes so long as the plan does
not discriminate unfairly and is fair and equitable with respect to the
In re Bonner Mall Partnership, 2 F.3d 889 (9th Cir. 1993).
 Note that fair market value is the standard barometer unless the property
is transferred under a forced sale environment, in which case the value
is liquidation value. In re Hollar, 184 B.R. 243 (Bankr. M.D.N.C. 1995).
See 4 COLLIER ON BANKRUPTCY § 547.03 (15th Ed. 1991) ("Any judicial
proceeding that creates or fixes a lien upon the debtor's property
will constitute a preference."). In South Carolina, a lien is created
when the judgment is enrolled. S.C. Code Ann. § 15-35-810 (1976).
 In determining whether a debtor has an interest in property, state law governs.
 A more exact definition of the term appears in 11 U.S.C. § 101(31).
 For a discussion of how the
Cybermech court determined that Royal was a creditor, and thus possessed a claim,
see supra. Section II(B).
 For a more extensive definition,
see 11 U.S.C. § 101(32).
 The Supreme Court demonstrated this principle in
Palmer with the following example:
[W]here the creditor's claim is $10,000, the payment on account of
$1,000, and the distribution in bankruptcy is 50%, the creditor to whom
the payment on account is made receives $5,500, while another creditor
to whom the same amount was owing and no payment on account was made will
receive only $5,000.
Palmer, 297 U.S. at 229, 56 S.Ct. at 451, 80 L.Ed. at 656.