Thursday, January 8, 2009

Ch. 7 Case Dismissed Under Sect. 727(a(3) Because Debtor Failed to Keep or Preserve Adequate Business & Financial Records on $800,000 in Bank Deposits

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys,

U.S. Trustee v. Caron (In re Caron)
Bankruptcy Court, District of Oregon
Adversary Proceeding 08-0365-rld; Case No. 07-33796-rld7

December 2, 2008 ((NOTE: this opinion was just uploaded to the Court's website although it is dated a month earlier.)
Unpublished opinion by Judge Randall Dunn

This opinion, although unpublished, presents good guidance on the standards for dismissal under § 727(a)(3).

Recent Ninth Circuit Opinion: Caneva
In his opinion Judge Dunn cites and relies on a very recent Ninth Circuit opinion, Caneva v. Sun Communities Operating Limited Partnership (In re Caneva), __ F.3d __, 2008 WL 4791680 (9th Cir. Nov. 5, 2008), which was the subject of this website's Bankruptcy Bulletin published on the day following its filing, titled Ninth Circuit Affirms Denial of Discharge under Section 727(a)(3) for Chapter 7 Debtor's Failure to Keep Financial Records.

The holding in Caneva was that under § 727(a)(3) the party moving for dismissal has the burden of:
establishing a prima facie case (1) that [debtor] had failed to keep or preserve records and (2) that such failure made it impossible to ascertain his financial condition and material business transactions. The prima facie case shifted to [debtor] the burden to avoid summary judgment by showing that a genuine issue of material fact existed with respect to whether his failure was justified under the circumstances of his case.
. . . .
[T]he statute imposes an affirmative duty on the debtor to keep and preserve recorded information that will allow his creditors to ascertain his financial condition and business transactions. A debtor who has admitted to owning businesses for which he kept no recorded information and to transferring a substantial sum of money without retaining any documentation has not kept or preserved information within the meaning of the statute, and must provide a justification for this failure that goes beyond a conclusory statement in an affidavit that he is entitled to discharge.
Summary of the Opinion
This Oregon Caron opinion largely mirrors Caneva but adds some additional important nuances. In this Chapter 7 case the United States Trustee (“UST”) filed an adversary proceeding to deny debtor’s discharge on various
§ 727 grounds in addition to subsection (a)(3), including §§ 727(a)(2)(B), (a)(4)(A), and (a)(5), but Judge Dunn did not have to address those because he found the (a)(3) grounds to be sufficient for dismissal. The judge entered a judgment denying "discharge for failing to keep and preserve adequate business and financial records to allow creditors and the chapter 7 trustee to ascertain and evaluate [the debtor] Mr. Caron’s financial condition and material business transactions." Specifically, during the two years before filing the case, debtor deposited a total of more than $800,000 in a number of different bank accounts without any accounting, "commingled indiscriminately," leaving the UST and the court unable to "determine what Mr. Caron’s income and expenses were for 2006 and 2007. The UST having met its burden of proof under section 727(a)(3), Judge Dunn further concluded "that Mr. Caron has not met his burden of proof to justify the lack of adequate business and financial records."

Standard of Proof

This opinion makes clear that while the "party seeking to deny a discharge to the debtor generally bears the burden of proof, "[s]ince the Supreme Court’s decision in Grogan v. Garner, 498 U.S. 279 (1991), the burden of proof standard for denial of discharge actions under § 727 is preponderance of the evidence." So:
ultimately, in spite of whatever weight on the scale favors the debtor’s discharge, a party seeking to deny the debtor a discharge under § 727 likely will prevail if the evidence establishes that it is more likely than not that the objecting party’s case is justified.
Section 727(a)(3)
Section 727(a)(3) denies a discharge to a debtor who “has concealed, destroyed, mutilated, falsified, or failed to keep or preserve any recorded information, including books, documents, records, and papers, from which the debtor’s financial condition or business transactions might be ascertained, unless such act or failure to act was justified under all of the circumstances of the case.”

Very importantly:
Unlike many of the other discharge denial provisions of § 727, § 727(a)(3) does NOT require that the party seeking to deny the debtor a discharge establish that the failure to keep or maintain adequate financial records was “knowing” or “fraudulent.” “What constitutes adequate books, documents, and records must be decided on a case-by-case basis, depending on the Debtors’ business operations and sophistication."
§ 727(a)(3) is not appropriately used as a trap to deny a discharge to consumer debtors or business operators who through inadvertence, lack of competence, or both, maintain less than pristine business records. However, the Bankruptcy Code does not condone a complete default in maintaining and preserving records from which basic information regarding a debtor’s business and financial affairs can be obtained.
Burden of Proof, Initially with Proponent, then Shifts to Debtor
The plaintiff in a § 727(a)(3) action bears the initial burden of proof to establish “(1) that the debtor failed to maintain and preserve adequate records, and (2) that such failure makes it impossible to ascertain the debtor’s financial condition and material business transactions.” [Citation excluded.] Once plaintiff makes such a prima facie case, the burden shifts to the debtor defendant to justify the
inadequacy or nonexistence of the records.
Debtor's Justifications
After the UST met its burden of proof, debtor, through his counsel Michael Day, made the following arguments to justify the insufficient records:

1) Lack of access to one set of financial records: The opinion appears to be sympathetic to the realities that. as to one set of the debtor's businesses, the business records were maintained by a partner's wife on her computer, and that when the partner and his wife and the computer disappeared a number of months before the bankruptcy was filed, he had no access to those records. So although Judge Dunn was troubled by the lack of records maintained by debtor after the partner's disappearance, he said he "might be inclined to find that adequate justification for Mr. Caron’s lack of records for the Royal Air Cargo business was provided from the uncontradicted evidence of the absconding of his business partner . . . and his record-keeping wife," but the debtor's other other major business and financial activities "cry out for further justification."

2) Debtor is "not an accountant": While acknowledging that a § 727(a)(3) analysis "is fact dependent in each case and focuses in large part on the relative business sophistication of the debtor whose discharge is challenged," Judge Dunn was adamant about the limits of this excuse:
One does not have to be an accountant to be able to prepare and maintain a ledger, showing 1) when and how much money was received from a particular customer, 2) how the funds were handled or invested, 3) when and how much money was repaid to each customer, and 4) how much compensation Mr. Caron received for his services.
He found "the virtually complete lack of such records to be astonishing and ultimately not credible."

3) In his closing argument Mr. Day raised the argument that the debtor's lack of record-keeping could be "cultural." Although noting that no evidence was presented at trial on this argument, Judge Dunn could not resist addressing it, with a flash of his wry humor, by saying:
I am unaware generally of any culture that conducts commerce without some means of recording business transactions. The practice of keeping records of business transactions goes back at least to pre-cuneiform script on clay tablets in ancient Sumer. See the entry on “Sumer” in Wikipedia.
He found "that Mr. Caron’s cultural background as a Kazakh emigrant to the United States does not justify his failure to keep and preserve adequate financial and business records in this case."

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
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