A Perpetrator of Fraud Cannot Hide Behind the Skirts of Bankruptcy

By:  James M. Hoffman and Joseph J. Bellinger

An honest person who seeks bankruptcy protection is relieved of most of his or her debts at the conclusion of the proceedings, which is known as a “discharge” of debts.  The discharge is a cornerstone of the Bankruptcy Code and is intended to provide what the Supreme Court has referred to as the “honest but unfortunate” debtor with a fresh start. However, not all debts are discharged in bankruptcy. The Bankruptcy Code automatically excludes certain types of debts from discharge, and provides creditors with the opportunity to object to the discharge of their debts if they can prove to the bankruptcy court that their debt was incurred by the debtor under limited and specific circumstances, usually involving some form of misconduct or dishonesty on the part of the debtor.

Joseph Bellinger and William Erskine of Offit Kurman, P.A. successfully represented a husband and wife (the couple) in an objection to their debt owed by a debtor in a three-day trial before the bankruptcy court in Baltimore, Maryland.  Specifically, the couple objected to the discharge of substantial sums of money advanced by them to the debtor prior to her bankruptcy filing in connection with the purchase of real property based on three exceptions to discharge under the Bankruptcy Code: fraud, larceny, and willful and malicious injury.

The couple alleged that the debtor induced them to advance the funds toward the purchase of the property by misrepresenting that the purchase price was $1.7 million (it was actually $1.2 million), that the wife would be an equal owner of the property, and that the funds advanced by them would be secured by a mortgage against the property.  The couple also alleged that the debtor misrepresented that she had invested more than $400,000 of her own money toward the purchase of the property.  The couple alleged that through her scheme, the debtor acquired sole ownership of the property, and the monies they advanced to her were not secured by a mortgage lien against the property.  Simply put, the debtor induced them to provide her with the funds she needed to purchase the property without investing any of her own money.

After considering the evidence presented at trial, including conflicting testimony of numerous witnesses, the bankruptcy court determined that the debtor was not entitled to a discharge of a debt in the amount of $695,000 owed to the couple.  The court found that Mr. Bellinger and Mr. Erskine met the burden of proof on all three grounds upon which the couple alleged that the debt was nondischargeable.  First, the court noted that “perpetrators of fraud were not allowed to hide behind the skirts of the Bankruptcy Code” under Section §523(a)(2)(A) of the Bankruptcy Code.  The court also concluded that the acts of the debtor constituted larceny as a knowing theft of money under Section §523(a)(4) of the Bankruptcy Code.  Finally, the debt owed by the debtor to the couple constituted a willful and malicious injury to the couple’s property excepted from discharge under §523(a)(6) of the Bankruptcy Code.

Bankruptcy may not be the end to creditors’ claims against a person who has filed for bankruptcy protection.   Too often creditors do not take steps to protect their interests because they mistakenly believe that their debt is uncollectible when the debtor files for bankruptcy protection.  While it is true that bankruptcy offers protections for the “honest but unfortunate” debtor, the bankruptcy process also affords creditors with an opportunity to object to the discharge of a debt owed to them if they can show that the debtor incurred the debt through false pretenses, fraud, larceny, or other grounds.  By seeking the advice of experienced bankruptcy counsel, creditors and debtors can best protect their interests in the bankruptcy process.

The Court’s Order and Memorandum is dated January 23, 2018, in Allison v. Lee (In re Lee), Case No. 16-24339-MMH; Adv. Proc. No. 17-00071-MMH.

Questions about discharging debts or other bankruptcy law issues?
Please contact James Hoffman at [email protected] or Joseph Bellinger at [email protected].

Read more of our blogs from the CRRAB Group (Creditors Rights, Reorganizations and Bankruptcy) at Offit Kurman.