Opinion
MEMORANDUM DECISION
PETER W. BOIE, Chief Judge
This matter came on regularly for trial on creditor Schacher's complaint objecting to debtor's discharge under 11 U.S.C. § 727(a)(4)(A). The LLC, A. Schacher & V. Brennan, was also a named plaintiff, but not authorized to appear without counsel. Mr. Schacher ably presented the position of the plaintiff, while debtor was well represented by Mr. Hood.
The Court has subject matter jurisdiction over the proceedings pursuant to 28 U.S.C. § 1334 and General Order No. 312-D of the United States District Court for the Southern District of California. This is a core proceeding under 28 U.S.C. § 157(b)(2)(J).
Section 727(a)(4)(A) provides:
(a) The court shall grant the debtor a discharge, unless -
...
(4) The debtor knowingly and fraudulently, in or in connection with the case -
(A) made a false oath or account;
....
In In re Coombs , 193 B.R. 557 (Bankr. S.D. CA 1996) this Court reviewed the applicable law of § 727(a) (4) (A). That analysis is repeated herein. Courts generally agree:
[T]he plaintiff must prove by a preponderance of evidence that: (1) debtors made a statement under oath; (2) the statement was false; (3) debtor knew the statement was false; (4) debtor made the statement with fraudulent intent, and (5) the statement related materially to the bankruptcy case.
In re Bailey , 147 B.R. 157, 162 (Bankr. N.D. Ill. 1992); In re Metz , 150 B.R. 821, 824 (Bankr. M.D. Fla. 1993); In re Maletta , 159 B.R. 108, 112 (Bankr. D.Conn. 1993).
As one court put it:
The purpose of these requirements is to insure that those interested in the case, in particular the trustee, have accurate information upon which they can rely without having to dig out the true facts or conduct examinations. (Citations omitted.) A debtor has an uncompromising duty to disclose whatever ownership interest he holds in property. It is the debtor's role to simply consider the question carefully and answer it completely and accurately. (Citation omitted.) Even if the debtor thinks the assets are worthless he must nonetheless make full disclosure. (Citation omitted.) In completing the schedules it is not for the debtor to pick and choose [sic] which questions to answer and which not to. Indeed, the debtor has no discretion--the schedules are to be complete, thorough and accurate in order that creditors may judge for themselves the nature of the debtor's estate. (Citation omitted.)
In re Lundav , 100 B.R. 502, 508 (Bankr. D.N.D. 1989); In re Haverland , 150 B.R. 768, 770 (Bankr. S.D. Cal. 1993); In re Maletta , 159 B.R. 108, 112 (Bankr. D. Conn. 1993).
Two of the indispensable elements of a cause of action under § 727(a)(4)(A) are fraudulent intent and materiality. It is generally recognized that:
A plaintiff can rarely produce direct evidence of fraudulent intent; the requisite actual intent to defraud may therefore be established through proof of sufficient "badges of fraud." (Citation omitted.) Such badges of fraud include reservation of rights in or the beneficial use of the transferred assets; inadequate consideration; close friendship or relation to the transferee; the financial condition of the transferor both before and after the transfer; and "'the existence or cumulative effect of a pattern or series of transactions or course of conduct after the incurring of debt, onset of financial difficulties, or pendency or threat of suits by creditors.'" (Citation omitted.)
[W]here there has been a "pattern of falsity, or a "cumulative effect" of falsehoods, a court may find that [fraudulent] intent has been established.
Likewise, a court may infer fraudulent intent under Code § 727(a)(4)(A) from a debtor's reckless indifference to or cavalier disregard of the truth.
In re Maletta , 159 B.R. 108, 112 (Bankr. D. Conn. 1993); In re Gipe , 157 B.R. 171, 176-77 (Bankr. M.D. Fla. 1993); In re Metz , 150 B.R. 821, 824 (Bankr. M.D. Fla. 1993). However:
The denial of a discharge under 11 U.S.C. § 727 (a)(4)(A) cannot be imposed where the false statement was the result of a simple or honest mistake or inadvertence. (Citations omitted.) Rather, to sustain an objection to discharge under 11 U.S.C. § 727(a)(4)(A), the debtor must have willfully made a false statement with intent to defraud his creditors. (Citation omitted.)
In re Bodenstein , 168 B.R. 23, 32 (Bankr. E.D.N.Y. 1994). Similarly, "material misstatements, absent fraudulent intent, do not warrant denial of a discharge under § 727(a) (4) (A)...." In re Parsell , 172 B.R. 226, 231 (Bankr. N.D. Ohio 1994).
In reviewing the many published decisions which have considered whether the debtor should be denied a discharge, this Court has been troubled by some which conclude a discharge should be denied but do not explain how they found the requisite fraudulent intent. It bears repeating that an essential element under § 727(a) (4) (A) is that debtor acted with an actual intent to defraud. To be sure, that intent may be proven by circumstantial evidence. In re Devers , 759 F.2d 751, 753-54 (9th Cir. 1985); In re Schroff , 156 B.R. 250, 254 (Bankr. W.D. Mo. 1993). And it may be inferred from all the surrounding circumstances. Ibid. But there must be specific facts or circumstances which point toward fraud. The court, in In re Smith , 161 B.R. 989, 991 (Bankr. E.D. Ark. 1993) observed:
First, the debtor's actual intent must be found as a matter of fact from the evidence presented. Of course, the objecting party must generally rely on a combination of circumstances which suggest that the debtor harbored the necessary intent. The Court may then draw an inference from this evidence. (Emphasis added.)
Some courts have stated: "The fact that numerous major assets were omitted will alone satisfy the requirement that such omissions be knowing and fraudulent."
In re Schroff , 156 B.R. 250, 256 (Bankr. W.D. Mo. 1993); In re Shah , 169 B.R. 17, 21 (Bankr. E.D.N.Y. 1994). More than one court has opined:
The Debtor's numerous omissions in his Statement of Financial Affairs and Schedules, taken together may constitute a pattern demonstrating a reckless disregard for the truth. (Citation omitted.) This reckless disregard for the truth is widely recognized as the equivalent to fraudulent intent. (Citation omitted.)
In re Metz , 150 B.R. 821, 824 (Bankr. M.D. Fla. 1993). Such conclusory statements are of little use to a court trying to i determine whether the requisite fraudulent intent exists in a particular case. Competent facts placed in evidence must point toward that fraudulent intent. If no facts point toward fraudulent intent, it cannot be found simply by cumulating the number of omissions. Neither sloppiness nor an absence of effort by the debtor supports, by itself, an inference of fraud. Courts which hold otherwise are simply devising a court-made prophylactic rule that the debtor must make substantial effort to provide accurate and complete schedules. Had the Congress intended to make such a rule, it could have done so easily, as it did with § 727(a)(3) (failure to keep adequate books and records), and (a)(5) (failure to adequately explain the loss of assets), neither of which have an express element of fraudulent intent. In re Bodenstein , 168 B.R. 23, 33 (Bankr. E.D.N.Y. 1994). But the Congress did not do so, and it is not for the courts to create new bars to discharge under § 727 (a), or to so distort a requisite element as to make it no element at all.
The essential point is that there must be something about the adduced facts and circumstances which suggest that the debtor intended to defraud creditors or the estate. For instance, multiple omissions of material assets or information may well support an inference of fraud if the nature of the assets or transactions suggests that the debtor was aware of them at the time of preparing the schedules and that there was something about the assets or transactions which, because of their size; or nature, a debtor might want to conceal. For instance, in In re Chalik , 748 F.2d 616, 618-19 (11th Cir. 1984), the debtor failed to disclose dealings with twelve corporations of which he was) the sole or controlling shareholder and which had $2.1 million in assets and $250,000 per month in income. The court in In re Aboukhater , 165 B.R. 904, 910 (9th Cir. BAP 1994) looked to the substantiality of the omission to support an inference of an intent to defraud. In other words, is there something about (the omitted asset or transaction which a debtor might want to avoid disclosing. That is why the so-called badges of fraud are utilized to discern intent. In re Woodfield , 978 F.2d 516, 518 (9th Cir. 1992); In re Gipe , 157 B.R. 171, 176-77 (Bankr. M.D. Fla. 1993). Another court has called them "factors to consider". In re Schroff , 156 B.R. 250, 254-55 (Bankr. W.D. Mo. 1993).
A number of courts have considered the concept of materiality. Most cited is In re Chalik , 748 F.2d 616, 618 (11th Cir. 1984). There, the court concluded:
The subject matter of a false oath is "material, " and thus sufficient to bar discharge, if it bears a relationship to the bankrupt's business transactions or estate, or concerns the discovery of assets, business dealings, or the existence and disposition of his property.... The recalcitrant debtor may not escape a section 727(a)(4)(A) denial of discharge by asserting that the admittedly omitted or falsely stated information concerned a worthless business relationship or holding; such a defense is specious. (Citation omitted.) It makes no difference that he does not intend to injure his creditors when he makes a false statement. Creditors are entitled to judge for themselves what will benefit, and what will prejudice, them. (Citations omitted.) The veracity of the bankrupt's statements is essential to the successful administration of the Bankruptcy Act. (Citation omitted.)
The court in In re Bailev , 147 B.R. 157, 162-63 (Bankr. N.D. Ill. 1992), reiterated the foregoing, and added several observations. Quoting from Matter of Yonikus , 974 F.2d 901 (7th Cir. 1992), the Bailey court stated "'[d]ebtors have an absolute duty to report whatever interests they hold in property, even if they believe their assets are worthless or unavailable to the bankruptcy estate.'" The Bailey court continued: "This is because [t]he bankruptcy court, not the debtor, decides what property is exempt from the bankruptcy estate.'"
The Bailey court then wrote at length:
10. Debtors in Chapter 7 proceedings have an affirmative duty to disclose on their schedules of assets whatever ownership interest they hold in any property, inclusive of all legal and equitable interest in said property, as of the commencement of a bankruptcy case. (Citations omitted.) The purpose behind 11 U.S.C. § 727(a)(4) is to enforce debtors' duty of disclosure and to ensure that the debtor provides reliable information to those who have an interest in the administration of the estate. (Citations omitted.) "Bankruptcy Trustees lack the time and resources to play detective and uncover all the assets and transactions of their debtors." Since § 727(a)(4) relates to the discovery of assets and enforces debtors' duty of disclosure, an omission can be material, even if the creditors were not prejudiced by the false statement. (Citations omitted.)
11. Allowing debtors the discretion to not report exempt or worthless property usurps the role of the trustee, creditors, and the court by denying them the opportunity to review the factual and legal basis of debtors' claims. It also permits dishonest debtors to shield questionable claims concerning an asset's value and status as an exemption from scrutiny. Therefore, the mere fact that unreported property is thought to be worthless or exempt is not a per se defense in a § 727(a)(4) action to bar discharge.
12. However, while the assertion that property is worthless or exempt is not a per se defense, it is a factor in determining materiality, and several courts have found minor omissions from debtors' schedules of assets to be immaterial.
See In re Cross , 156 B.R. 884, 889 (Bankr. D.R.I. 1993); In re Gipe , 157 B.R. 171, 178 (Bankr. M.D. Fla. 1993); In re Haverland , 150 B.R. 768, 771-72 (Bankr. S.D. Cal. 1993).
This Court holds the opinion that there is little that Will prove to be immaterial for purposes of required disclosure if it aids in understanding the debtor's financial affairs and transactions. However, the "size and status of the omitted assets" is directly relevant to determining the debtor's intent and whether it was fraudulent. The distinction between the prophylactic and inclusive concept of materiality in disclosure should not blur the separate requirement of an actual intent to defraud.
At the core of the dispute between Mr. Schacher and Ms. Nguyen is that they entered into an agreement pursuant to which Mr. Schacher sold a business called Xavier New York, Inc. to Ms. Nguyen. The sale included an inventory of hair pieced. Ms. Nguyen agreed to pay $75,000 total; she paid $3,000 up front, and $1,000 per month to December, 2007. In January, 2008 she filed bankruptcy under Chapter 7. In seeking to block her discharge, Mr. Schacher contends her bankruptcy schedules are inaccurate, overstating her debt to him, while significantly understating the value of the business Xavier New York, Inc..
In her Schedule B, debtor listed "100% Interest in Xavier N.Y. Corp. (Hair extensions)" and placed a value of $5,000 on it She also claimed it exempt on Schedule C, at the same value, Mr. Schacher asserts that "the value of the inventory, alone, when he transferred the business to Ms. Nguyen, was $53,587, (as reflected on Xavier's 2007 balance sheet (Ex. 5A). Moreover, on Xavier's 2007 year end tax return, the inventory balance was shown as $43,000, according to testimony of the accountant, Mr. Polley.
Mr. Schacher also pointed to Schedule F filed by Ms. Nguyen, in which she listed the debt to him at $72,000. His argument is that she gave no credit for the $1,000 monthly payments she made during the second half of 2007, which should have reduced the debt to around $66,000.
The accountant, Mr. Polley, testified that the inventory value listed on a tax return is not a market value number, but rather one drawn from a prior year's year-end number, plus inventory acquired, and minus inventory sold in the intervening year. It is a balance sheet number, not a value. Ms. Nguyen testified that the $5,000 value she ascribed to Xavier in her Schedule B came from her assessment of what someone would pay at a garage sale value for the hairpieces she had. She acknowledged that if she could find a buyer or buyers who would pay retail prices for the inventory, she could realize as much as $249 per item. (The Court notes that Ms. Nguyen's exhibit list included 416 bags of various sorts of hair extensions.) But, she testified, she had little success selling the hair extensions! in the roughly six months she operated Xavier, saying gross sale!s during that time were less than $6,000, in total. Moreover, she testified her attorney asked her to put a value on Xavier's inventory if it had to be liquidated.
One of Mr. Schacher's arguments, at least implicitly, was that she must have believed the inventory had value for her to agree to pay $75,000 for the business. However, she pointed lout in testimony that she was also paying for the "right of exclusivity" in distributing the product. On Ex. 5A, the balance sheet, Mr. Schacher had put a $50,000 value on that right. also there was goodwill and a customer list.
Another of Mr. Schacher's concerns is that in March of 2008, two months after filing the bankruptcy, Ms. Nguyen sold some hair extensions to a Cosmo Zappoli in New York. However, so far as the record reflects Xavier was a corporation and had not filed bankruptcy, although its owner, Ms. Nguyen had. Xavier, as at separate legal entity and a non-debtor, was not precluded from engaging in business. Moreover, the conduct was two months post-petition and did not implicate the debtor's oath.
It is unfortunate that Mr. Schacher did not timely perfect a security interest in the assets of Xavier or some other collateral put up by Ms. Nguyen. Indeed, Mr. Schacher has freely acknowledged that circumstance. Further, on the present record the Court could not conclude that when Ms. Nguyen first made the agreement to purchase Xavier she had no intention of performing her side of the bargain. To the contrary, she paid $3,000 up front, and $1,000 per month for about six months before filing.
During the trial, the Court was discomfitted by seeming inconsistencies between Ms. Nguyen's testimony at the First Meeting of Creditors and her testimony in court. Moreover, given her apparent financial sophistication as reflected in her Schedules A and B, it is hard to match that information against the person she portrayed in court. But those misgivings are not controlling.
Based on the testimony and the documentary evidence received at trial, the Court finds and concludes that plaintiff, although his case was presented well, has failed to carry his burden of establishing by a preponderance of evidence that Ms. Nguyen knowingly made false representations as to the value of Xavier or of her debt to Mr. Schacher. Nor has he established that she made any false representations with fraudulent intent.
Conclusion
For the foregoing reasons, Mr. Schacher's objection to debtor's discharge, asserted under 11 U.S.C. § 727(a)(4)(A), shall be, and hereby is overruled.
Counsel for debtor shall prepare and lodge, within thirty (30) days of the date of entry of this Memorandum Decision, a separate form of judgment.
IT IS SO ORDERED.