Inadequate Recordkeeping by Debtor Leads to Denial of Discharge
by Sam Ott, Esq.
The Seventh Circuit U.S. Court of Appeals in Union Planters Bank, N.A. vs. Connors recently upheld the decisions of the bankruptcy court and the district court to grant a bank's motion objecting to a debtor's discharge for failure to keep adequate records.
The debtors, husband and wife, filed for Chapter 7 relief and listed aggregate debts of over $19 million including more than $12 million owed to the bank. The basis of the bank's objection was 11 U.S.C. section 727(a)(3), which provides in part that a the bankruptcy court can deny the discharge of a debt if the debtor has concealed, mutilated, falsified, or failed to keep or preserve any recorded information.
At one time the debtors had two lines of credit and other loans from the bank totaling $28 million. The loans were secured with shares of stock in a gaming corporation that the bank believed more than adequately secured the lines of credit and the loans. The bank did not place any restriction on the application of loan proceeds and did not inquire as to the use of the funds. The funds were used to build a $4 million home, the construction of two sports facilities and the purchase of two casinos. The stock that was valued at one time at over $36 per share declined in value to under $3 per share. After selling the stock the bank obtained a lien on most of the debtor's assets. Demand for repayment of the outstanding loans was made and the debtors commenced the bankruptcy proceeding.
The debtors testified that they did not keep many records of their financial transactions and that some records were disposed of when they moved from their home. They provided the bankruptcy court with bank statements and cancelled checks that indicated in the four year preceding the bankruptcy over $16 million flowed through their accounts. The bankruptcy court denied the discharge and held that the above referencec section of the Bankruptcy Code requires the debtors to produce records that provide enough information to ascertain the debtor's financial condition and track their financial dealings with substantial completeness and accuracy for a reasonable period. The district court affirmed the decision that the statements did not provide a satisfactory record of accounting of the financial condition of the debtors.
The Court of Appeals, in affirming the decisions of the lower courts, noted that neither the court nor a creditor is required to reconstruct a debtor's financial situation by sifting through a morass of checks and bank statements. It is the debtor's duty to maintain and provide the court the organized records of its financial dealings. In addition, the court observed that the debtors conducted multiple large-scale transactions in running their businesses, and stated, "Where debtors are sophisticated in business, and carry on a business involving significant assets, creditors have an expectation of greater and better record keeping."
The debtors argued that the granting of the bank's motion to deny the discharge would result in the debtors facing a non-discharged debt of over $15 million and since there was no evidence of intent to defraud their creditors, the equities favored a discharge. The Court of Appeals found that the bankruptcy court did not abuse its discretion in denying the discharge. It observed that it would have been in the discretion of the bankruptcy court to grant the discharge, however after considering the failure of the debtors to keep primary records, and the fact the debtors had disposed of significant documents that they may have had, warranted a denial of the discharge.
The Court of Appeals cited previous cases that held that "although the denial of discharge in bankruptcy should be construed strictly against the creditor and liberally in the favor of the debtor, such discharge is a not a right, but a privilege", and "the intent to defraud is not a required element of a section 727(a)(3) violation".
Summary
The Court of Appeals upheld the decisions of the bankruptcy court and the district court that a debtor may not be granted a discharge if adequate records that account for the financial condition of the debtor prior to bankruptcy are not maintained and presented to the bankruptcy court. The court and any creditor are not required to reconstruct the debtor's financial condition by sorting through poorly maintained records. The more sophisticated the debtor, the higher the expectation of better bookkeeping. A discharge can be denied even if there is no evidence of fraud or intentional misconduct.
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