Debtor's Attorney Commended in Case Denying Objection to Discharge

 No attorney wants to see his name mentioned prominently in an opinion. However, if it has to happen, it's better if its something like this:  "Chance McGhee is an experienced and competent attorney that has practiced consumer bankruptcy law for many years." Adv. No. 21-5036; Wilson v. Silva (In re Silva) (Bankr. W.D. Tex. 5/19/2022).  The opinion can be found here. As the opinion lays out, Mr. McGhee demonstrated how an experienced and competent attorney should handle a potentially difficult case.

What Happened

Danny Wilson, the Plaintiff, took out a loan to help the Defendant, Arthur Silva, acquire an insurance agency. Part of their deal was that commission checks would be deposited into an account controlled by Wilson. This was important because Wilson had pledged the commissions on a loan that he took out to fund Silva's acquisition of the agency.

About eight months into the deal, Silva stopped depositing the commissions into the Wilson account. Wilson sued for breach of contract and eventually recovered a judgment for over $616,000. Silva filed a Chapter 13 petition in 2020 which was dismissed and then a Chapter 7 case in 2021. 

Wilson filed a complaint under 11 U.S.C. Sec. 523(a)(6) and Sec. 727(a)(4). 

The parties did not submit a joint pre-trial order which meant that there were not any stipulated facts.  (Practice tip: Always submit a joint pre-trial order). The Plaintiff submitted 149 exhibits. Three witnesses testified: Wilson, Silva and attorney Chance McGhee. The Debtor waived attorney-client privilege to allow Mr. McGhee to testify.

The Willful and Malicious Ruling

On the willful and malicious injury claim, the Plaintiff was required to show that Silva's actions in diverting the commission checks created either "an objective substantial certainty of harm" or "a subjective motive to cause harm." Williams v. International Brotherhood of Electrical Workers Local 520 (In re Williams), 337 F.3d 504, 509 (5th Cir. 2003). At trial, Wilson's counsel failed to ask Silva any questions about his intent. Mr. McGhee, recognizing that Wilson had the burden of proof, wisely refrained from asking any questions of his own. This is the first lesson from this case. If your opponent doesn't meet his burden of proof, don't provide the evidence for him.  

The Court stated:

The Court recognizes that Silva breached the agreement and was liable for damages caused to Wilson. What is unclear to the Court is whether Silva acted objectively or subjectively to cause harm to Wilson. The Court notes that the breach of a contract gives rise to damages, but there is insufficient evidence to find that Silva’s breach of the agreement demonstrates subjectively or objectively an intent to harm Wilson. Based on the evidence provided, the Court cannot find that Silva had a subjective motive by acting deliberately and intentionally in knowing disregard of Wilson. There is insufficient evidence on subjective intent to cause harm. Additionally, the Court cannot find that Silva’s actions were objectively substantially certain to cause injury. Wilson did discuss how the diversion of Allstate payments impacted him, but there is insufficient evidence that Silva’s actions were certain to cause harm. As such, the Court finds that Wilson has not met his burden by a preponderance of the evidence that Silva’s liability to Wilson is nondischargeable under § 523(a)(6).

Opinion, at 13-14.

The Objection to Discharge

The Plaintiff seized upon a number of inconsistencies between the Debtor's two bankruptcy filings as well as amendments to the schedules to assert that the Debtor had made a false oath in his bankruptcy case. However, the Plaintiff failed to meet the five-part test for denial of discharge and some of his allegations left the Court scratching its head. The test for denial of discharge under 11 U.S.C. Sec. 727(a)(4) is:   "(1) [the debtor] made a statement under oath; (2) the statement was false; (3) [the debtor] knew the statement was false; (4) [the debtor] made the statement with fraudulent intent; and (5) the statement related materially to the bankruptcy case.’” Cadle Co. v. Pratt (In re Pratt), 411 F.3d 561, 566 (5th Cir. 2005). Thus, a false statement standing alone is not sufficient to deny discharge. 

Notably, “Bankruptcy Courts have not construed § 727(a)(4) generally to impose strict liability for the schedules and false statements.” (citations omitted). Innocent mistakes and inadvertence are generally not sufficient to result in denial of a discharge.

Opinion, p. 14. The Court went on to note that “[i]t may be close to impossible to produce Schedules and SOFAs that contain no mistaken information.” Opinion, p. 16.

The creditor alleged ten supposedly false statements. 

 1.    Failure to list a non-profit corporation that was formed post-petition. The Court found that the omission was not intentionally false. Indeed, since the Schedules and SOFA are a snapshot as of the petition date, the entity need not have been listed at all.

 2.    Failure to list a dba of his insurance agency. The Court found that this statement was not false because the Debtor had listed the actual insurance agency.

3.    Undervaluing his homestead. Mr. McGhee testified that consumer lawyers often use the appraisal district valuation for valuing property. However, when the valuation was challenged, the Debtor obtained an appraisal and amended. Based on the amendment, the Debtor switched from federal to state exemptions, which the court described as  "good lawyering to protect assets from liquidation in a chapter 7 case." Neither relying on the appraisal district value initially, amending to disclose the value stated in an appraisal or switching from federal to state exemptions was a false oath.

 4.    The Debtor initially valued his electronics at $0. Mr. McGhee testified that this was his error. He later amended the schedules to value the electronics at $2,000. The court found that the misstatement was not material since the trustee did not seek turnover of the electronics (presumably because they were exempt). 

5.    Undervaluing his Allstate franchise agreement. Although the court did not say so, questions are valuation are difficult to use for a false oath. Valuation is a matter of opinion and while a debtor may have an opinion as to value, that opinion would only be false if the debtor had actual knowledge of a higher value from a source that could not be disputed. In this case, the Debtor initially gave his estimate of the going concern value of the franchise and then amended when he was able to obtain a definitive valuation from Allstate. Amending to provide a better value is not the type of amendment that could constitute a false oath in most cases.

 6.    Claiming federal exemptions in Silva's cash and investment accounts. "The Court fails to understand how asserting federal exemptions somehow qualifies as an omission or false statement under § 727(a)(4)(A)." 

7.     “Amending Silva’s Schedule C to claim both the monetary value of the majority of his exempt assets as well as claiming 100% of fair market value”  "(T)he Court is perplexed by this assertion. Maximizing exemptions is precisely what a debtor’s counsel should do to achieve the broadest discharge possible for a debtor. The Supreme Court’s holding in Schwab v. Reilly permits using 100% of the fair market value to exempt assets. 560 U.S. 770 (2010)." Opinion, p. 18.

8.     Increasing the amount of the IRS's secured claim on the Debtor's homestead.  Mr. McGhee testified as to the reason for this amendment which the Court found was neither false nor material due to the unlimited Texas homestead exemption.

9.    Decreasing the value of the secured claim on the Debtor's insurance agency. The secured value was dependent on the value of the asset. As explained above, when the Debtor obtained a better valuation, it necessarily affected the value. The Court found that this was "not attributable to any manipulation by Silva, but an independent valuation."   

10.    Failure to list certain unsecured creditors who later filed claims. Mr. McGhee testified that sometimes debts are sold or transferred so that the original creditor listed on a credit report was not the creditor at the time for claims to be filed. The Court noted that there was no benefit to the debtor in omitting unsecured creditors since these claims might be excluded from discharge under 11 U.S.C. Sec. 523(a)(3). 

The Court found that the creditor did not establish that the statements were made with fraudulent intent. 

As to the fourth element—whether the debtor made the statement with fraudulent intent—Silva did not make any statements suggesting the omissions or false statements were made with fraudulent intent. The Court finds Silva’s explanations credible as to why he originally listed his liabilities the way he did. Further, the Court cannot discern any attempt to prevent any creditor from learning about Silva’s assets and liabilities. Silva repeatedly testified he disclosed his assets and liabilities to McGhee to the best of his knowledge and relied on McGhee’s expertise to list the liabilities and assets appropriately. The Court also finds credible McGhee’s explanations and rationale for the how the schedules were originally prepared and subsequently amended. The Court cannot find any basis to conclude that Silva purposely omitted any of his assets or liabilities.

Opinion, p. 19.  The Court also found that none of the statements were material.

What this section shows is that Mr. McGhee helped his client by getting him to waive attorney-client privilege and by allowing Mr. McGhee to testify as to rationale for the changes. While many of the objections were spurious (or at a minimum not very well thought out), the expert testimony of an experienced consumer bankruptcy lawyer provided valuable context to the court. Amendments that the creditor perceived to be fraudulent were, in fact, just good lawyering. The fact that Mr. McGhee was willing to testify, and in one instance, admit to his error, showed that he was willing to place his client's interest ahead of his own (since after all, no lawyer wants to be cross-examined by his adversary. 

This opinion provides a wealth of good case law and good observations that will be useful in defending an objection to discharge. The opinion should also be required reading for a creditor wanting to pursue a false oath case. While the various amendments and omissions may have looked shady, someone should have asked whether they made a difference before filing the complaint.  It also shows the wisdom in consulting with an experienced bankruptcy lawyer before filing an adversary proceeding.