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When is a failure to disclose income sufficient basis to deny discharge? The answer to this question was determined by the U.S. Bankruptcy Appellate Panel of the 9th Circuit in In re Kenneth R. Roberts, Appellant, v. James F. Erhard, Appellee. The matter came before the appellate panel from an appeal from the U.S. Bankruptcy Court for the District of Idaho In re Kenneth and Laura Roberts, Debtors, decided Sept. 29. The facts of the case are as follows: The debtor, Kenneth R. Roberts, filed a Chapter 7 Jan. 30, 2002, and filed his schedules and statement of financial affairs Feb. 11, 2002. In his statement of financial affairs, Roberts stated that his 2001 income was “$0.00.” He also indicated he did not finish preparing his income tax returns for the year 2001 and his “income figures were being done.” He failed to disclose $9,964 in rental income and $2,800 received from the sale of a registered American Quarter Horse within the year prior to the filing of the petition. In addition, he also failed to disclose several items of personal property, totaling approximately $1,000. Two years after the initial filing, Roberts amended his schedules and disclosed the missing information, including his 2001 income he received of approximately $19,000. James F. Erhard, a creditor, filed a complaint April 30, 2002, objecting to Roberts’ discharge based on these errors and omissions, and further charging that his statement of financial affairs contained false oaths that required the denial of a discharge under Section 727(a)(4)(A). From the period April 20, 2002, until Sept. 3, 2003 – almost 16 months – after the filing of the original complaint and after many extensions, Roberts answered the complaint but failed to raise any timeliness issues. The adversary proceeding then was litigated and tried by the bankruptcy court July 15, 2004. The bankruptcy court found Roberts did not explain the necessary income and that he failed to disclose approximately $12,000 in proceeds from a horse sale and rentals in the year prior to the filing of his statement of financial affairs. The court specifically found Roberts’ conduct indicated “a careless reckless approach to the important duty of disclosure in sworn bankruptcy filings.” The court further stated, “case law places a serious duty of care and candor” on debtors and “defendant’s conduct herein was insufficient to meet that duty.” The bankruptcy court denied discharge bases solely on the Section 727 (a)(4)(A) cause of action and dismissed the other causes of action. In reviewing decisions of the bankruptcy court, the appellate panel reviewed legal conclusions de novo, factual findings for clear error, and mixed questions of law and fact de novo. The court also reviewed de novo a bankruptcy court’s selection of the applicable legal rules under Section 727, Searles v. Riley (In re Searles). Roberts challenged the denial of his discharge. First, he argued that bankruptcy court had an obligation to dismiss the adversary proceeding sua sponte because of Erhard’s delay in prosecuting it. Second, he challenged the court’s application of Section 727 (a)(4)(A) in this case. The appellate panel rejected the issue of dismissal on the timely service of the complaint on basis that is has not been raised in the court below and therefore they are not subject to review. The decision therefore is based upon Section 727 (a)(4)(A). The court pointed out this section of the bankruptcy code denies a discharge to a debtor who “knowingly and fraudulently” made a false oath or account in the course of the bankruptcy proceedings. The court pointed out that in order to bring a successful claim for false oath, the plaintiff must show the following; the debtor made a false oath in connection with the case; the oath related to a material fact; the oath was made knowingly; and the oath was made fraudulently. The court further pointed out that denial of discharge under Section 727 is construed liberally in favor of the discharge and strictly against a person objecting to the discharge, according to First Beverly Bank v. Adeeb (In re Adeeb). The court held that a false oath may involve a false statement or omission in the debtor’s schedules. In the present case, the bankruptcy court determined Roberts omitted from his statement of financial affairs the rent received from the rental property and the proceeds from the sale of the horse. The appellate panel determined that the bankruptcy court was not clearly erroneous in finding the debtor made a false oath as to these nondisclosures. However, the appellate panel determined such false oath did not pass the test of materiality. The panel stated that materiality is broadly defined: “A false statement is material if it bears a relationship to the debtor’s business transactions or estate, or concerns the discovery of assets, business dealings, or the existence and disposition of the debtor’s property.” Therefore, a false statement or omission may be material even in the absence of direct financial prejudice to creditors. The bankruptcy court, in the present case, found that the omission of the rent and the horse sale was “a significant financial activity.” As to these issues, the appellate panel determined that the bankruptcy court was not persuaded that the court’s findings were erroneous in its determination that the nondisclosure of the rents and the quarter horse sale were material. The appellate panel, however, found difficulty with the bankruptcy court’s findings on two other elements of the Section 727(a)(4)(A) claim. The court pointed out that a person acts knowingly if he or she acts deliberately and consciously. In this case, the bankruptcy court did not make a finding that Roberts acted deliberately and consciously in failing to make these disclosures until he amended his statement of financial affairs. Instead, the court found the debtor exhibited “a careless and reckless approach to the important duty of disclosure in sworn bankruptcy filings.” The panel stated “careless and reckless” is a lower standard than “knowing.” The panel pointed out that “careless” is a negligent standard not a knowing misconduct standard. A false statement resulting from ignorance or carelessness does not rise to the level of “knowing and fraudulent,” according to Mondore v. Mondore (In re Mondore). Similarly, recklessness does not measure up to the statutory requirement of “knowing” misconduct. Therefore, since the bankruptcy court did not find Roberts made his nondisclosures “knowingly” in the required sense, it could not sustain the denial of his discharge. Finally, the court pointed out that to deny a discharge under Section 727(a)(4)(A), the trial court must find that the false oath was made “fraudulently.” The fraud provision of Section 727(a)(4)(A) is similar to common law fraud, which the 9th Circuit has described as follows: “The creditor must show that (1) the debtor made the representation; (2) that at the time he know they were false; (3) that he made them with the intention and purpose of deceiving the creditors; (4) that the creditors relied on such representation; (5) that the creditors sustained loss and damage as the proximate result of the representations having been made.” The appellate panel pointed out that the intent required for finding the debtor has acted fraudulently under Section 727(a)(4)(A) with respect to a false oath must be actual intent. Constructive fraudulent intent cannot be the basis for the denial of a discharge. The court stated a debtor’s fraudulent intent may be established by circumstantial evidence or by interferences. In examining this circumstance, a court may find “badges of fraud” including that there was a close relationship between the transferor and the transferee; that the transfer was in anticipation of a pending suit; that the transferor debtor was insolvent or in poor financial condition a the time debtor’s property was transferred; and that the transfer so completely depleted the debtor’s assets that the creditor has been hindered or delayed in recovering inadequate consideration for the transfer. These factors need to all be present in order to find that a debtor acted with requisite intent. The panel pointed out that the bankruptcy court specifically did not make a finding that the debtor has acted with actual fraudulent intent, and accordingly, the bankruptcy court applied a lower standard than that mandated by Section727(a)(4)(A) on the issue of whether the Roberts nondisclosure was fraudulent. Therefore, the appellate panel concluded that the bankruptcy court made insufficient findings in two respects to support its conclusion of denying discharge. First, the court did not find the material nondisclosures were made knowingly, and second, it did not make a specific finding that the debtor intended to defraud. The appellate panel reversed and granted the discharge. COMMENT With the underline philosophy that a discharge should not be denied unless there are specific findings, the objector to discharge must prepare the case to make sure all elements are present. Section 727(a)(4)(A) was drafted specifically by Congress to provide a basis for denial of discharge based upon fraud and misrepresentation. However, the creditor must prove all of the elements in order to overcome the presumption that a debtor should be granted a discharge. Whether or not the new amendments of the Bankruptcy Code will change this underline philosophy will await further judicial determination. CHARLES M. GOLDEN is a partner with Obermayer Rebmann Maxwell & Hippel. He is chairman of the firm’s creditors’ rights, bankruptcy and financial reorganization department.

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