The Chapter 7 Trustee and the Bankruptcy Administrator filed a complaint requesting that the Debtors’ discharges be denied under 11 U.S.C. § 727(a) for multiple misstatements and omissions, in both the schedules and at the § 341 meeting, regarding the validity and amount of a secured debt owed to the probate estate of the male Debtor’s deceased mother. The mother had loaned $144,723 to the Debtors to put towards the purchase of their residence and obtained a third-priority deed of trust securing that debt. The Debtors did not list the debt as disputed in their bankruptcy schedules; they also indicated that the Debtor’s mother had intended to forgive the obligation but was unable to do so prior to her death. After the Trustee marketed and sold the property, however, and shortly before payment of the obligation owing to the probate estate, the Debtors produced, for the first time, a purported loan forgiveness document executed by the mother. The Trustee and the Bankruptcy Administrator argued that, by first admitting the validity of the debt owed to the probate estate, and then months later identifying and proffering the alleged forgiveness document, the Debtors knowingly and fraudulently made a false oath or account, warranting denial of discharge under § 727(a).
Based on the evidence offered at trial, including the testimony of the Trustee and the male Debtor, the Court found the Trustee and Bankruptcy Administrator met their burden and demonstrated the required elements necessary to deny the Debtors’ discharges under § 727(a)(4)(A), which provides that a court should not grant a debtor’s discharge if “the debtor knowingly and fraudulently, in or in connection with the case . . . made a false oath or account.” To prove a violation § 727(a)(4), the plaintiff must show a debtor “made a statement under oath which he knew to be false, must have made the statement willfully, with intent to defraud, and the statement must have related to a material matter.” Van Robinson v. Worley, 849 F.3d 577, 583 (4th Cir. 2017). A debtor’s intent may be established in one of two ways: first fraudulent intent may be established by circumstantial evidence, or by inferences drawn from a course of conduct; second, fraudulent intent can be shown through reckless indifference to the truth, which constitutes the functional equivalent of fraud. Id. at 585.
The Court found the Debtors’ statements in the schedules and at the § 341 meeting as to the amount and validity of the debt owed to the probate estate, as well as their omission of any reference to a forgiveness document, qualified as false statements for purposes of § 727(a)(4)(A). The Court found these statements were material and relevant to the bankruptcy estate. The Court also found it could reasonably infer the Debtors’ fraudulent intent based on several grounds. First, the Court found the male Debtor’s testimony at trial and his observable lack of candor strongly supported a finding of fraudulent intent. Second, the Court found the Debtors’ course of conduct in the bankruptcy proceeding further demonstrated fraudulent intent. Specifically, the Debtors’ decision to schedule the debt as valid and undisputed, combined with their asserted homestead exemptions and two senior mortgages, appeared to be an attempt to persuade the Trustee that it was a “no asset” bankruptcy case with no equity to administer on behalf of unsecured creditors. Only after the Trustee attempted to sell the Property and satisfy the debt owed to the Proctor Estate did the Debtors “rediscover” the forgiveness document and assert its validity. Third, the Debtors’ pattern of repeatedly making false statements and omissions bolstered a finding of fraudulent intent.
Based on the evidence presented, the Court entered judgment denying the Debtors’ discharges under § 727(a)(4)(A).
Opinions:
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(Judge: Lena M. James)
(Judge: Lena M. James)
Memorandum Opinion and Order Granting in Part and Denying in Part Defendant’s Motion for Summary Judgment and Denying Plaintiff’s Motion for Summary Judgment. The Court considered cross-motions for summary judgment in a dispute arising from the Defendant’s handling of insurance claims against the Debtor for his liability in a two-car automobile accident. The Plaintiff-Trustee sought damages for (1) violations of the North Carolina unfair and deceptive practices statute, N.C. Gen. Stat. § 75-1.1 (the “UDP”), (2) breach of contract, (3) breach of the implied covenant of good faith and fair dealing, (4) bad faith failure to settle, and (5) negligence and gross negligence.
First, the Plaintiff argued that the Defendant violated the UDP by engaging in unfair claim settlement practices as defined by N.C. Gen. Stat. § 58-63-15(11) and intentionally concealing its bad faith failure to settle the claims. See Guessford v. Pa. Nat’l Mut. Cas. Ins. Co., 983 F. Supp. 2d 652, 660 (M.D.N.C. 2013). Among other things, the Plaintiff alleged that the Defendant failed to timely respond to a time-limited demand and misrepresented to the Debtor that it had a continuing duty to defend him—even after all claims had been resolved and the Debtor’s interests no longer aligned with those of the Defendant. The Plaintiff also argued that the Defendant intentionally sought to conceal its bad faith failure to settle the claims. The Court denied both summary judgment motions on the majority of the Plaintiff’s bases under N.C. Gen. Stat. § 58-63-15(11), allowing the claims to proceed to trial. However, the Court granted summary judgment to the Defendant with respect to the Plaintiff’s allegations that it misrepresented (1) that it would timely inform the Debtor of settlement demands and (2) the insurance policy’s applicable coverages.
Second, the Plaintiff asserted that the Defendant breached the express provisions of the insurance policy. However, the Court found the undisputed facts demonstrated the Defendant ultimately complied with its contractual obligations to pay damages for bodily injury or property damage and paid compensatory damages for which the Debtor was legally entitled. Accordingly, the Court granted summary judgment for the Defendant on this claim.
Third, the Court considered the Plaintiff’s two claims for breach of the implied covenant of good faith and fair dealing and bad faith failure to settle together, as they share the same elements. See Michael Borovsky Goldsmith LLC v. Jewelers Mut. Ins. Co., 359 F. Supp. 3d 306, 315 (E.D.N.C. 2019). The Court found the Plaintiff forecasted sufficient evidence that the Defendant refused in bad faith to settle claims against the Debtor for the policy limit when presented with the opportunity to do so, but the evidence could also support a finding that there was a reasonable, good-faith basis for not accepting certain settlement offers. The Court found there were also genuine issues of material fact as to the aggravated conduct element of the claims. Thus, the Court denied both summary judgment motions with respect to these claims.
Fourth, the Court granted summary judgment for the Defendant on the negligence and gross negligence claims, determining that the negligent conduct cited by the Plaintiff related entirely to the Defendant’s performance under the Policy and, under the “economic loss rule,” could not support the claim. See Wilkie Amica Mut. Ins. Co., No. 1:17CV314, 2018 WL 2326130, at *3 (W.D.N.C. Apr. 30, 2018).
Lastly, the Court determined that the Plaintiff’s claims were non-core proceedings related to the underlying bankruptcy case under 28 U.S.C. § 157(c) and that the Court had authority to issue a final order because of the Defendant’s implied consent. The Court found that the Defendant’s post-judgment conduct and that of the counsel it retained on the Debtor’s behalf, including facilitating the Debtor’s bankruptcy filing, was indicative of the knowing and voluntary consent described in Wellness Int’l Network Ltd. v. Sharif, 575 U.S. 665, 686 (2015).
(Judge: Lena M. James)
Order Granting Bankruptcy Administrator’s Motion to Dismiss. The Bankruptcy Administrator filed a motion to dismiss the Debtor’s case or convert to chapter 7 under 11 U.S.C. § 1112(b)(1). The Debtor did not object to the motion. First, the Court determined that cause existed to dismiss or convert under each of the § 1112(b)(4) grounds asserted by the BA. For example, there was continuing and substantial loss to the estate based on the uncontested allegations that the Debtor operated at break-even level since the petition date and failed to pay required expenses. There was also evidence of gross mismanagement of the estate, as the Debtor’s management failed to fix operational problems and was unable to reasonably estimate revenues or adequately identify expenses.
Second, although the BA announced that he had reached an agreement with the Debtor to dismiss the case with conditions, the Court conducted its own analysis to determine whether dismissal or conversion was in the best interest of creditors and the estate under § 1112(b)(1). The Court exercised its discretion to consider various “best interest” factors, such as: the low likelihood that a chapter 7 trustee could reach the Debtor’s assets; the small benefit of pursuing avoidable transfers due to potentially high administrative costs; and the support for dismissal from the Debtor’s biggest secured creditor. In exercising its discretion, the Court determined that dismissal, rather than conversion, was appropriate.
Third, the Court considered whether it would allow the parties’ agreement to dismiss the case with the condition that the Debtor pay the subchapter V trustee’s fees, including fees incurred in preparing a report under § 1183(b)(2), and income-based taxes that had accrued post-petition. The Court classified this agreement as a structured dismissal, which cannot be approved unless, at a minimum, any required distributions are made in accordance with the Bankruptcy Code’s priority scheme. See Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973, 978 (2017). The Court did not approve the structured dismissal because it was not shown that the contemplated payments complied with the priority rules of § 507.
(Judge: Lena M. James)
Order Denying Trustee’s Motion for Public Auction Sales of Real Property. The chapter 7 trustee moved under 11 U.S.C. § 363(f) to conduct online public auctions of five parcels of real property and sell them free and clear of all liens, encumbrances, and other claims of interest. Although the Debtor agreed in principle that the properties could be sold, he objected to the proposed procedures for the sale. Donald Green, a co-owner and the Debtor’s brother, also objected to the sale, arguing that one of the properties should be sold to a family member and that the benefit to the estate of any sale of that property would not outweigh the detriment to Mr. Green, in contravention of § 363(h)(3).
The Court overruled the Debtor’s objection for lack of standing, as the record indicates that he would not have a pecuniary interest in the distribution of assets; there was no possibility of a surplus returning to the Debtor because he did not claim a homestead exemption on any of the properties and there was little chance they would be sold for a price higher than the value of the liens. See In re Hamilton Road Realty, Inc., No. 8-19-72596, 2021 WL 1620046, at *3 (Bankr. E.D.N.Y. Apr. 26, 2021). The Court also overruled Mr. Green’s objection with respect to the comparative determination of benefit to the estate vs. detriment to the co-owner under principles of res judicata, because the Court had already found in a related adversary proceeding that the benefit to the estate of a sale of the property would outweigh any detriment to Mr. Green.
On the merits of the motion, the Court found that the overwhelming weight of authority holds that courts, in exercising their independent duty to review proposed sales, should not authorize a trustee’s sale of fully encumbered assets. See, e.g., In re Bird, 577 B.R. 365, 377-78 (B.A.P. 10th Cir. 2017). Here, the parties conceded that the properties were overencumbered by Palm Avenue Hialeah Trust’s claim and none of the proceeds would be available to pay general unsecured creditors. The only carve-outs allowed by Palm Avenue were for expenses related to the proposed sale, including compensation to the trustee and his professionals. Payment of these priority unsecured claims did not justify sale of the properties by the trustee.
Accordingly, the Court determined that the motion should not be granted because the trustee failed to demonstrate that sale of the properties would have a discernible benefit to general unsecured creditors.
(Judge: Benjamin A. Kahn)
Memorandum Opinion Denying Plaintiff’s Motion for Temporary Restraining Order, or in the Alternative, for a Preliminary Injunction. The Court found that Plaintiff-Creditor (“Creditor”) did not carry its burden with respect to the standard for preliminary injunction and the standards for constructive trust and other theories of equitable title. Creditor did not become an owner of certain goods in possession of Debtor on a pre-petition contract theory. The earmarking doctrine did not apply. Plaintiff did not stablish that it was entitled to imposition of a resulting or constructive trust. The doctrines of equitable lien and equitable title did not apply. Creditor did not meet the standards for a preliminary injunction at that stage of the litigation: likelihood of success on the merits, balance of equities, irreparable harm in the absence of an injunction, and public interest.
(Judge: Lena M. James)
Order Granting Debtor’s Motion to Convert Case and Denying Joint Motion to Vacate Discharge. The Debtor filed a motion to convert her chapter 7 case to one under chapter 13 of the Bankruptcy Code. Over the course of the case, and through the chapter 7 trustee’s investigation, the Debtor learned her residence had a higher-than-expected value beyond what was listed in the schedules, which could in turn result in substantial non-exempt equity to be administered by the trustee. The Debtor sought to convert the case to chapter 13 to retain the residence and pay any non-exempt equity over time through a confirmed plan. The Bankruptcy Administrator objected to the motion to convert, asserting that a number of courts, including the Bankruptcy Court for the Middle District of North Carolina, see In re Godwin, No. 06-50150, 2007 WL 4191729 (Bankr. M.D.N.C. Nov. 21, 2007), have refused to allow post-discharge conversion absent a debtor seeking to vacate the prior discharge order. Based on that reasoning, the Debtor and the Bankruptcy Administrator jointly filed a motion to vacate the discharge.
The Court first denied the motion to vacate on three grounds. First, because the Code expressly provides the bases and time limits for seeking to revoke a discharge, the Court could not use the equity provisions under 11 USC § 105(a) to bypass or override those mandates. Second, the erroneous value of the property listed in the schedules was not the type of “mistake,” “inadvertence,” or “newly discovered evidence” that would warrant relief under Rule 60(b). Third, the Court found the BA offered no factual support to revoke the discharge under 11 USC § 727(d).
In turning to the motion to convert, the Court found the language of § 706 provided that a debtor may convert the case “at any time” provided the debtor was eligible and the case had not been previously converted. The Court found no blanket prohibition on a debtor who has received a chapter 7 discharge from exercising the right to convert contained in § 706(a). The Court was also not persuaded by the Bankruptcy Administrator’s argument that leaving the discharge intact leaves a debtor with no debts to be repaid in chapter 13. Nothing in the Bankruptcy Code suggests that a discharge eliminates a creditor’s claim against the bankruptcy estate; rather, the Court observed that conversion does not constitute the commencement of a new case, but merely represents a change in the statutory chapter pursuant to which the case could proceed. Creditors would still have the ability to file claims against the estate and there were numerous protections in place to prevent any attempts at manipulation or potential prejudice to creditors. The Court, therefore, granted the Debtor’s motion to convert the case to chapter 13.
(Judge: Benjamin A. Kahn)
Order Granting Plaintiff’s Motion to Amend Complaint as to All Defendants. Overall, finding that Plaintiff-Debtor should be granted leave from the Court under Fed. R. Civ. P. 15(a)(2) to amend his complaint. Defendants would not be prejudiced by the amendment.
(Judge: Fourth Circuit Court of Appeals)
On appeal, the Fourth Circuit Court of Appeals (Per Curiam) affirmed the rulings of the Bankruptcy Court and the District Court for the Middle District of North Carolina granting First Citizen Bank & Trust Co.'s and Mortgage Electronic Registration Systems, Inc.'s motions to dismiss the chapter 7 trustee's adversary complaint under Federal Rule of Civil Procedure 12(b)(6). The Fourth Circuit concluded "that the bankruptcy court correctly applied North Carolina law to determine that the notarial certificate at issue substantially complied with the law, the [chapter 7 trustee] failed to overcome the presumption of regularity, and thus [the trustee] could not avoid the lien." As such, it affirmed the rulings of the lower courts that dismissed the chapter 7 trustee's complaint.
(Judge: District Court)
On appeal, the District Court for the Middle District of North Carolina (Biggs, J.) affirmed the ruling of the Bankruptcy Court sustaining the Chapter 7 Trustee’s objection to the Debtor’s claimed exemptions. The question presented on appeal was whether the Debtor may exempt entireties property from the bankruptcy estate with respect to a debt owed solely by the Debtor to the Internal Revenue Service (“IRS”) where the IRS is a priority and general unsecured claimant in the Debtor’s bankruptcy case. The District Court reviewed the Bankruptcy Court’s application of the law de novo and its findings of fact for clear error.
In adopting and affirming the Bankruptcy Court’s order, the District Court agreed that, while North Carolina law exempts entireties property from the claims of non-joint creditors, such property is not exempt under the U.S. Tax Code. The District Court found that, absent bankruptcy, the IRS would have been able to obtain a lien against the Debtor’s interest in the entireties property under applicable nonbankruptcy law and, therefore, the Bankruptcy Court was correct to disallow the exemption under 11 U.S.C. § 522(b)(3)(b) with respect to the IRS debt. While there was no evidence in the record that the IRS issued the demand necessary to establish a lien, Section 522(b)(3)(B) does not require a creditor to have established a lien in order to prevent a debtor from exempting the property from the bankruptcy estate. The District Court also rejected the Debtor’s contention that the Trustee lacked authority to assume the collection powers of the IRS under 11 U.S.C. § 544(a), noting that nothing in Section 544(a) exempts otherwise nonexempt property from the bankruptcy estate or limits the power of a trustee to collect and reduce to money the nonexempt property of the estate to pay actual creditors.
(Judge: Lena M. James)
Memorandum Opinion Granting in Part and Denying in Part Defendants’ Motion to Dismiss Complaint, and Granting Plaintiff’s Motion for Leave to Amend Complaint. The Defendants Moses H. Cone Memorial Hospital Operating Corp. (“Cone Health”) and Moses Cone Physician Services, Inc. (“MCPS”) filed a motion to dismiss numerous claims in the Plaintiff’s complaint regarding (1) the avoidance of transfers under provisions of the Bankruptcy Code and the North Carolina Uniform Voidable Transactions Act (“UVTA”) and (2) damages stemming from breach of fiduciary duty, constructive fraud by a fiduciary, and unfair and deceptive trade practices. The Plaintiff presented several arguments against dismissal of these claims and requested, in the alternative, that leave be granted to amend the Complaint.
In dismissing several claims for avoidance of preferential transfers and fraudulent conveyances, the Court found that the Plaintiff did not adequately plead that the debtor, Randolph Health, was insolvent at the time of the alleged transfers under the Bankruptcy Code or the UVTA. Under both regimes, a debtor is defined as insolvent when the sum of its debts is greater than all of its property, at a fair valuation (commonly referred to as the “balance sheet test”). See 11 U.S.C. § 101(32)(A); N.C. Gen. Stat. § 39-23.2(a). The Plaintiff’s allegations did not lead to an inference that Randolph Health was insolvent because he alleged that Randolph Health had net assets, according to book values, of at least $31 million at all applicable times.
Nevertheless, the Court granted the Plaintiff a presumption of insolvency under 11 U.S.C. § 547(f) for the 90-day period before the petition date and a presumption of insolvency for the two claims under N.C. Gen. Stat. § 39-23.5(a) for alleged transfers made on or before February 27, 2017. During this latter period, the Plaintiff sufficiently alleged that Randolph Health had defaulted and was unable to make payments on a substantial loan. See N.C. Gen. Stat. § 39-23.2(b) (presuming insolvency if debtor is generally not paying its debts as they become due other than as a result of a bona fide dispute). However, the Court dismissed the Eighth Cause of Action with respect to MCPS only because it was not sufficiently alleged that Randolph Health received less than reasonably equivalent value in exchange for the transfers it made to MCPS. Specifically, the Plaintiff made no factual allegations from which the Court could compare the value of the transfers to the value of the services rendered by MCPS.
The claims under N.C. Gen. Stat. § 39-23.4(a)(2) were dismissed because the Court found the Plaintiff failed to adequately plead the undercapitalization element. The Plaintiff’s allegations did not lead to an inference that Randolph Health was unable to sustain operations or pay debts as they became due within the 2-year lookback period of that provision.
The Court also dismissed the Plaintiff’s state law claims for breach of fiduciary duty and constructive fraud by a fiduciary because the Plaintiff failed to adequately plead that Cone Health had a fiduciary relationship with Randolph Health. Under North Carolina caselaw, the existence of such a relationship is successfully pleaded by alleging that a party had “control and domination” over another or the party “held all the cards.” Courts are especially reluctant to extend the protections of fiduciary obligations to parties whose relationship is established and defined by contract. Here, the Plaintiff relied solely on contractual obligations to allege that Cone Health had a fiduciary duty to Randolph Health. And the Plaintiff did not sufficiently allege that Cone Health held all the cards or was in a position of overwhelming superiority and influence over Randolph Health.
The Court did not dismiss the claim for unfair and deceptive trade practices because the Plaintiff alleged facts leading to a plausible inference that Cone Health used its managerial role and “position of power” to unfairly compete with Randolph Health from within. The Plaintiff sufficiently alleged that such competition adversely impacted the healthcare services provided to local patients.
Lastly, the Court granted the Plaintiff’s request for leave to amend the complaint because he had not amended before and amendment was not futile. The Court noted that the complaint’s issues were of a factual, rather than legal, nature and could potentially be cured with more adequate factual pleading.
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