Understand the complexities and nuances of the Bankruptcy Code to better advise clients and prepare for court.
By Diane Davis
Jan. 7 — A creditor can't take advantage of an “innocent mistake” made by a debtor who listed an incorrect address for the creditor on his schedule of debts in his bankruptcy case because it wouldn't serve the Bankruptcy Code's purpose of giving the “honest but unfortunate debtor” a fresh start, a district court in Virginia held Jan. 4.
Judge James P. Jones of the U.S. District Court for the Western District of Virginia vacated the judgment of the bankruptcy court and remanded the case, directing the bankruptcy court to consider the three-part equitable test articulated in Stone v. Caplan (In re Stone), 10 F.3d 285 (5th Cir. 1994).
The equitable approach taken by Stone, which has been adopted by the Fifth, Seventh, and Eleventh Circuits, achieves Congress's purpose and balances the interests of the debtor and creditors, the court said. The Fourth Circuit has yet to consider the issue of whether to discharge an innocently omitted debt, but the district court said that on remand, the bankruptcy court should consider:
Creditor/appellee Marc Bougie made an unsecured loan of $100,000 to debtor/appellant Jeffery R. Livingston. Under the loan agreement, Bougie could demand repayment any time and the amount owed would be $150,000.
Bougie demanded repayment and when payment wasn't made, he filed suit in a state court seeking damages for breach of contract and punitive damages.
While the state court case was pending, Livingston filed for Chapter 7 protection in which a debtor's nonexempt assets are liquidated and the proceeds are distributed to creditors.
Livingston included the $150,000 debt to Bougie on his schedule of debts but he listed the wrong address for Bougie. As a result, he did not receive notice of the bankruptcy prior to the deadline for filing a proof of claim — the claims bar date. After the claims bar date had passed, Bougie's counsel in the state court case received communication from the debtor's counsel that he would no longer respond to any discovery requests because Livingston had filed for bankruptcy.
Bougie then filed an adversary proceeding in the bankruptcy court seeking a declaration that the debt Livingston owed to Bougie was nondischargeable.
The bankruptcy court issued an oral ruling in favor of Bougie, concluding that he had a nondischargeable debt in the amount of $150,000.
Livingston appealed, urging the district court to use its equitable powers and “consider his reasons for failing to list Bougie's correct address, the extent to which fixing the problem would disrupt the bankruptcy proceedings, and whether correcting the error would prejudice Bougie or other creditors.”
Bougie contended that Bankruptcy Code Section 523(a) is unambiguous and should be given its plain meaning.
Section 523(a), the court said, “appears to create a general rule that a debt isn't dischargeable in bankruptcy if the debtor failed to list the creditor, with his correct address, in time to permit the creditor to timely file a proof of claim.”
Livingston argued that “timely” doesn't necessarily mean by the claims bar date, but rather means in time for the creditor to protect his right to share in any distribution.
The bankruptcy court adopted Bougie's interpretation of Section 523(a), the court said.
The district court, however, rejected the mechanical application of Section 523(a)(3)(A) because it produces a result that is contrary to the expressed intent of Congress. Congress meant to overrule Birkett v. Columbia Bank, 195 U.S. 345 (1904), when it passed the 1978 Bankruptcy Reform Act, the court said, and a strictly literal reading of Section 523(a) leads to the same “inflexible, creditor-focused analysis” applied in Birkett.
The equitable approach adopted by the Fifth, Seventh, and Eleventh Circuits achieves Congress's purpose and balances the interests of the debtor and creditors, the court said.
The court also rejected the debtor's argument interpreting “timely” as used in Section 523(a) to mean in time to participate in distribution of the estate and not by the claims bar date. This approach was taken by the Sixth circuit, the court said.
Section 726(a)(2)(C), the court said, which governs distribution of the estate in a Chapter 7 case, provides that an allowed unsecured claim that is “tardily filed” by the creditor has the same priority as an allowed unsecured claim that is “timely filed under § 501,” as long as the creditor didn't have notice or actual knowledge of the bankruptcy “in time for timely filing of a proof of such claim under section 501(a) of this title” and the proof of claim is filed “in time to permit payment of such claim.”
The court distinguished between “timely filed” and “tardily filed.” Rule 3002(c) of the Federal Rules of Bankruptcy Procedure states that “a proof of claim is timely filed if it is filed not later than 90 days after the first date set for the meeting of creditors called under § 341(a) of the Code,” the court said. Thus, “timely filed” is defined by reference to the claims bar date, the court said.
Interpreting “timely filed” as used in Section 523(a)(3)(A) to include tardily filed proofs of claim under Section 726(a)(2)(C) is a “strained interpretation of statutory text,” the court said.
A better approach, the court said, is to consider Section 726(a)(2)(C) as part of the prejudice analysis that makes up the third prong of the Stone equitable text. Where the outcome for the omitted creditor and other creditors would be the same regardless of whether the omitted creditor had received notice before or after the claims bar date, the third prong of Stone weighs heavily in favor of finding the debt dischargeable, the court said.
Andrew S. Goldstein and Garren R. Laymon, Magee Goldstein Laskey & Sayers, P.C., Roanoke, Va., represented appellant/debtor Jeffery and Nancy Livingston; David O. Williamson, Brumberg Mackey Wall P.L.C., Roanoke, Va., represented appellee/creditor Marc Bougie.
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