CRASHING THROUGH THE DEBTOR’S BANKRUPTCY Spring TRMG Conference April 16, 2012

1. CRASHING THROUGH THE DEBTOR’S BANKRUPTCY Spring TRMG Conference April 16, 2012 Paul D. Keenan, Esq. and Jeffrey D. Cohen, Esq. Keenan Cohen & Howard PC jcohen@freightlaw.net 215-609-1104

2. Bankruptcy Court and Its Judges • Bankruptcy courts are units of the district court in the jurisdiction where the bankruptcy court sits. Bankruptcy judges are classified as “judicial officers” of the district court and are appointed by the United States Court of Appeals for each circuit. • Appointments are for a term of 14 years.

3. Jury Trials • The Bankruptcy Code is silent on the issue of whether a litigant is entitled to a jury trial on matters litigated in bankruptcy court. • Courts have generally found that litigants are entitled to a jury trial when the matter at issue is legal in nature and is analogous, historically, to a suit seeking monetary compensation. • On the other hand, a litigant cannot obtain a jury trial for suits in bankruptcy court which are equitable in nature.

4. Equitable or Legal • Courts have found the following types of cases to be equitable versus legal: • Disgorgement of excessive fees by counsel (equitable); • A trustee’s claim for turnover of property of the estate (equitable); • A fraudulent transfer action when asserted against a defendant that has not filed a proof of claim (legal); and • A preference action initiated by a trustee in response to a proof of claim filed by a creditor in a pending bankruptcy matter (equitable).

5. Standard of Review • Bankruptcy courts apply a “preponderance of the evidence” standard when ruling upon whether an exception to discharge should be granted. • Following a bankruptcy court determination, the losing party can seek appellate review first at the district court level. On appeal, a district court or an appellate court reviews a bankruptcy court’s factual determinations under the clearly erroneous standard and its conclusions of law denovo (anew). In re: Fegley, 118 F.3d 979, 982 (3rd Cir. 1997).

6. Adversary Complaint • When an issue arises in a bankruptcy case that can’t be resolved by negotiation or by motion, it becomes necessary to file an adversary complaint. The adversary complaint initiates a matter, (“adversary proceeding”), in bankruptcy court similar to the typical civil action brought in local district court.

7. Litigants will commonly initiate an adversary proceeding to address the following issues: • The debtor wishes to pursue a creditor for violating the bankruptcy automatic stay; • A creditor seeks an exception to discharge for his or her individual debt; and/or • The US trustee’s office objects to the debtor obtaining a discharge altogether.

8. Types of Attorneys Handling Adversary Proceedings • Attorneys who specialize exclusively in bankruptcy matters many times, have limited actual trial experience. We have found that many times bankruptcy attorneys will avoid the formal adversary environment of an adversary proceeding. This can be detrimental to client goals particularly when a debtor is not playing by the rules and is perpetrating a fraud. Because many bankruptcy attorneys spend little if any time calling witnesses, conducting cross examination, ensuring the admissibility of documentary evidence and applying the rigid Federal Rules of Evidence they may not be accustomed to, and not comfortable with these proceedings. • This puts certain counsel at a disadvantage when faced with an experienced litigator. The question to be asked when determining which type of counsel to engage to recover assets when a debtor files for bankruptcy is whether or not fraud or self dealing of the debtor is likely, if it is – this will likely lead to an adversary proceeding in which a litigator is your better choice. If fraud is not likely and the technical mechanics of the bankruptcy process are primary – a bankruptcy attorney is more suited to this type of work.

9. A VERY BRIEF PICTORIAL HISTORY OF THEFT FROM CARRIERS OVER THE COURSE OF HISTORY

10. THEN

11. THEN

12. NOW

14. DISCHARGE OF DEBT • A bankruptcy discharge releases the debtor from personal liability for certain specified types of debts. In other words, the debtor is no longer legally required to pay any debts that are discharged. The discharge is a permanent order prohibiting the creditors of the debtor from taking any form of collection action on discharged debts, including legal action and communications with the debtor, such as telephone calls, letters, and personal contacts. • Although a debtor is not personally liable for discharged debts, a valid lien (i.e., a charge upon specific property to secure payment of a debt) that has not been avoided (i.e., made unenforceable) in the bankruptcy case will remain after the bankruptcy case. Therefore, a secured creditor may enforce the lien to recover the property secured by the lien.

15. Automatic Exceptions to Discharge • Certain exceptions to discharge apply automatically • The most common types of nondischargeable debts are: • certain types of tax claims, • debts not set forth by the debtor on the lists and schedules the debtor must file with the court, • debts for spousal or child support or alimony, • debts for willful and malicious injuries to person or property, • debts to governmental units for fines and penalties, debts for most government funded or guaranteed educational loans or benefit overpayments, • debts for personal injury caused by the debtor's operation of a motor vehicle while intoxicated, • debts owed to certain tax-advantaged retirement plans, • and debts for certain condominium or cooperative housing fees.

16. Non-Automatic Exceptions to Discharge • The types of debts described in sections 523(a)(2), (4), and (6), obligations affected by fraud or maliciousness are not automatically excepted from discharge. • Creditors must ask the court to determine that these debts are excepted from discharge. In the absence of an affirmative request by the creditor and the granting of the request by the court, the types of debts set out in sections 523(a)(2), (4), and (6) will be discharged.

17. Section 523(a) of the Code specifically excepts various categories of debts from the discharge granted to individual debtors. Therefore, the debtor must still repay those debts after bankruptcy.

18. OBJECTING TO A DISCHARGE • Creditors receive a notice shortly after the case is filed that sets forth much important information, including the deadline for objecting to the discharge. To object to the debtor's discharge, a creditor must file a complaint in the bankruptcy court before the deadline set out in the notice. Filing a complaint starts a lawsuit referred to in bankruptcy as an "adversary proceeding."

19. Code Provisions That Permit Survival of Debt After Bankruptcy

20. The types of debts described in sections 523(a)(2), (4), and (6) (obligations affected by fraud or maliciousness) are not automatically excepted from discharge. Creditors must ask the court to determine that these debts are excepted from discharge. In the absence of an affirmative request by the creditor and the granting of the request by the court, the types of debts set out in sections 523(a)(2), (4), and (6) will be discharged.

21. § 523 (a)(2)(A) - FraudException To Discharge • (A) - Misrepresentations or Fraud Used to Obtain Money or Services • (a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title [11 USCS § 727, 1141, 1228(a), 1228(b), or 1328(b)] does not discharge an individual debtor from any debt-- • (2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained, by— • (A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor's or an insider's financial condition.

22. To prove an exception to discharge under this Code section, a creditor must establish the following: • (1) The debtor made a false representation of fact; • (2) The debtor knew the representation to be false; • (3) The debtor made the representation with the intent and purpose of deceiving the creditor; • (4) The creditor justifiably relied on the debtor’s representation; and • (5) The creditor sustained the alleged injury as the proximate result of the representation.

23. Statement • The debtor made a false representation of fact • Direct Evidence

24. Knowledge • The debtor knew the representation to be false • Circumstantial Evidence

25. Intent • The debtor made the representation with the intent and purpose of deceiving the creditor • Circumstantial Evidence

26. Intent • Because actual intent is difficult to decipher, courts have adopted a multiple-factor test used to prove actual intent to defraud through circumstantial evidence, including the following factors: • (1) Number of charges made; • (2) The amount of charges; • (3) The financial condition of the debtor at the time the charges were made; • (4) Whether the debtor made multiple charges on the same day; and • (5) The financial sophistication of the debtor

27. Justifiable Reliance • The creditor justifiably relied on the debtor’s representation • A creditor must establish that the falsity of the debtor’s representation would not be patent upon cursory examination.

28. Justifiable vs. Reasonable • Justifiably relied • Reasonably relied

29. Proximate Cause • The creditor sustained the alleged injury as the proximate result of the representation • Not as a result of other factors (business operations)

30. § 523 (a)(2)(B) - Exception To Discharge • (B) Written Misrepresentations about Financial Condition • A debtor is not entitled to a discharge of a debt incurred because of false statements made about the debtor’s financial condition in writing. 11 U.S.C. § 523(a)(2)(B). To establish this exception to discharge, a creditor must prove: • (1) The use of a written statement; • (2) That is materially false; • (3) Respecting the debtor's or an insider's financial condition; • (4) On which the creditor reasonably relied; and • (5) That the debtor caused to be made or published with the intent to deceive.

31. 523(a)(2)(A) Compared To 523(a)(2)(B) • 11 U.S.C. § 523(a)(2)(B) differs from 11 U.S.C. § 523(a)(2)(A) because a creditor must establish “reasonable reliance.” • In other words, a creditor must establish that its conduct in extending credit to the debtor was objectively reasonable. • Additionally, this exception is limited to statements about financial condition, which must be in writing. Oral misrepresentations about financial condition are not excepted from discharge.

32. 523(a)(3) - Omitted Debts • A debt will be excepted from discharge if the debtor fails to schedule that debt on his or her bankruptcy petition in sufficient time for the creditor to file a proof of claim. • The only exception to this rule is that a debt will be discharged if the creditor had notice or actual knowledge of the case in time to file a proof of claim, even though the debtor failed to list that creditor on his or her schedules. 11 U.S.C. § 523(a)(3)(A). • In applying this Code section, courts typically rely upon the plain language of this statutory section and hold that, if there is a claims bar date, a creditor must have notice of the bankruptcy before that date for the creditor’s debt to be discharged.

33. § 523 (a)(4)-Fiduciary Fraud • (a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title [11 USCS § 727, 1141, 1228(a), 1228(b), or 1328(b)] does not discharge an individual debtor from any debt— • (4) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.

34. § 523 (a)(4) • In order for a creditor to prevail under this section, he or she must prove that a debtor committed: • (1) Fraud or defalcation while acting as a fiduciary; or • (2) Embezzlement; or • (3) Larceny.

35. Fraud or Defalcation • Step One – Fiduciary Relationship • Step Two – Fraud or Defalcation • "Fraud" for purposes of this exception has generally been interpreted as involving intentional deceit, rather than implied or constructive fraud. • Most courts agree that "Defalcation" requires something more than mere negligence or mistake.

36. Defalcation • the act or an instance of embezzling • a failure to meet a promise or an expectation

37. Embezzlement • Embezzlement, under § 523(a)(4), has been 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.'" In re Weber, 892 F.2d 534, 538 (7th Cir. 1989). • To prove embezzlement, the creditor must establish that: • (1) The debtor appropriated the subject funds for his own benefit; and • (2) The debtor did so with fraudulent intent or deceit.

38. Embezzlement To demonstrate fraudulent intent, the creditor must show intent on the debtor's part to deprive him of his property. A fiduciary relationship or trust relationship need not be established in order to find a debt non-dischargeable by an act of embezzlement.

39. Larceny • Larceny under § 523(a)(4) necessitates a showing that a debtor wrongfully took property from its rightful owner with fraudulent intent to convert such property to his own use without the owner's consent.

40. § 523 (a)(6) - Willful and Malicious Exception To Discharge • a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title [11 USCS § 727, 1141, 1228(a), 1228(b), or 1328(b)] does not discharge an individual debtor from any debt— • (6) for willful and malicious injury by the debtor to another entity or to the property of another entity.

41. Semantics of Intent • Willful • Intentional • Knowing • Malicious • Purposeful • Recklessly • Negligently • Deliberate

42. § 523 (a)(6) - Willful and Malicious Exception To Discharge • In this context, “Willful” means intentional or deliberate (actual intent) or acts which have a substantial certainty of causing harm. • “Malicious” means wrongful and without just cause or excuse. Lee v. Ikner (In re: Ikner), 883 F.2d 986, 989 (11th Cir. 1989).

43. § 727 Denial of Discharge (Applies to All Debts) • (a)(1) - Corporation Does not Get Discharge in a Chapter 7 (Liquidation) • A bankrupt corporation, unlike a bankrupt natural person, has virtually no prospect of future property accumulation. For that reason, a determination whether the corporation should be discharged is a purely academic exercise with no practical or economic purpose. It is for this reason that the Bankruptcy Code provides a discharge only for individuals in Chapter 7 cases. 11 U.S.C. § 727(a)(1); In re: Gulfstream Marina, Restaurant & Motel, Inc., 2 B.R. 26 (Bankr. S.D. Fla. 1979).

44. Benefits of Seeking Denial of Discharge (11 U.S.C. § 727) versus Exception to Discharge (11 U.S.C. § 523) • Creditors may find it beneficial to pursue a denial of discharge, under 11 U.S.C. § 727, in addition to, or instead of, an exception to discharge, under 11 U.S.C. § 523, for two significant reasons.

45. First, a creditor may pursue a denial of discharge under 11 U.S.C. § 727 because that Code section is its only option. The Bankruptcy Code specifically limits the exceptions to discharge contained in 11 U.S.C. § 523(a) to “individual” debtors, not corporations. Thus, for those creditors who are pursuing a corporate debtor involved in a Chapter 11 (reorganization), Section 727 may be the only method available to prevent a discharge of its debt in a liquidation context.

46. Second, a creditor, asserting a cause of action under 11 U.S.C. § 727, may find that it has additional negotiating leverage and the potential threat of maintaining the complete status quo as powerful bargaining tools. Naturally, a debtor filing a bankruptcy petition is seeking a “fresh start.” To the extent that an individual creditor can “scare” the debtor into thinking that this “fresh start” will be denied, the creditor may force the debtor to forgo efforts defending discharge or dischargeability litigation and seek a resolution of that particular creditor’s claim as quietly as possible.

47. Noteworthy Transportation Related Cases In Which Section 523 Discharge Considered by Court • Wheels Unlimited, Inc. v. Sharp (In re Sharp), 2009 Bankr. LEXIS 481, 2-3 (Bankr. D. Idaho Jan. 14, 2009).

48. Wheels Unlimited, Inc. v. Sharp • Defendant/Debtor Sharp was a motor carrier which brokered loads to Wheels, another motor carrier, to transport a number of trailers from locations out West to Hurricane Katrina relief sites in Mississippi and Louisiana.  • Sharp, retained Wheels to transport its freight through its agent Tompkins. • Tompkins on behalf of Sharp made and oral agreement with Wheels for Wheels to transport the trailers for a rate of $1 per mile

49. Wheels Unlimited, Inc. v. Sharp • After moving 35 trailers Sharp and Thompkins did not pay Wheels the 75K it determined was due • Wheels learned that Sharp was identified as the carrier on bills of lading. • Wheels called Sharp and demanded payment • Sharp confirmed Thompkins was their representative and said not sure of payment terms. • Sharp sent check for about 18K – indicating rate that there was an agreement for a flat rate per load • Wheels sued Sharp for the difference and received a default judgment

50. Wheels Unlimited, Inc. v. Sharp • Sharp, an individual, filed for Chapter 7 Bankruptcy and included the Wheels debt on his schedules. • Wheels initiated an adversary complaint to have the debt declared non-dischargeable eventually proceeding under 523(a)(2) and 523(a)(6). • SHIPPER >SHARPE > THOMPKINS > WHEELS