Summary of a Recent
Judicial
Development in
Bankruptcy
Court Considers Extrinsic Signs of Fraud
Walt McCarterNational AgLaw Center Research Associate
Summary of Decision
In In re Przybylski, 340 B.R. 624 (Bankr. E.D. Wis. 2006), the United States Bankruptcy Court for the Eastern District of Wisconsin held that certain exemptions purchased prior to filing a Chapter 12 plan were not allowed, and thus denied confirmation of the plan because it failed to meet the "best interest of creditors" test and there was evidence of lack of good faith in filing.
Background
The Debtors began having financial problems with their dairy operation in 2000, and eventually decided to sell their farm in 2003. Id. at 626. They attempted to negotiate an out-of-court settlement with their unsecured creditors, and when that failed they did engaged in pre-bankruptcy planning and filed for Chapter 7 bankruptcy in November 2004. Id. Nutrition Service Company (NSC) was their largest unsecured creditor, and was owed over $230,000. Id. NSC was in the process of obtaining a state court judgment against the Debtors when they filed their bankruptcy petition. Id. at 627. After the Trustee filed a complaint objecting to the discharge of certain debts, the Debtors converted to Chapter 12 and filed a plan. Id. at 626. The Debtors then took out a home equity loan and purchased exempt property prior to filing their Chapter 12 plan. Id. at 629. NSC objected to confirmation of the plan, alleging lack of good faith and failure of the "best interest of creditors" test of § 1225(a)(4) of the Bankruptcy Code. Id.
Arguments
Debtors argued that their residence was fully exempt. Id. at 627. They also argued that in creating certain exemptions on the eve of bankruptcy, they were only trying to take advantage of all available exemptions. Id. at 629.
NSC argued that the Debtors undervalued their residence and six items of farm equipment, and that if the correct values were used, the plan would fail the best interest test because a Chapter 7 trustee would have been able to liquidate the assets for more than the Debtors were proposing to pay under the plan. Id. at 627. NSC also objected to certain exemptions created on the eve of bankruptcy, alleging they were created with the intent to hinder, delay or defraud creditors. Id. at 629. NSC also argued that the plan was not proposed in good faith due to the Debtors' aggressive pre-bankruptcy planning. Id.
Analysis and Holdings
After reviewing the evidence and testimony, the court determined the proper valuation of the Debtors' assets. Id. at 629. The Seventh Circuit has found the following to be extrinsic signs of fraud: "(1) that the debtor obtained credit in order to purchase exempt property; (2) that the conversion occurred after the entry of a large judgment against the debtor; (3) that the debtor had engaged in a pattern of sharp dealing prior to bankruptcy"; and "(4) that the conversion rendered the debtor insolvent." Id. at 629 (quoting Smiley v. First Nat'l Bank of Belleville, 864 F.2d 562, 567 (7th Cir.1989)). The court noted that in this case, the Debtors used credit to purchase some exempt property, and a large judgment was about to be taken by NSC. Id. at 630. The court also considered: (1) the amount of the exemption; (2) the proximity of time of conversion to the time of filing for bankruptcy; (3) the source of funds used to acquire the exempt property; (4) misleading contacts with creditors; (5) the purpose of conversion of assets; and (6) conveyances for less than fair consideration. Id. at 630-31. After applying those factors to this case, the court concluded that the Debtors' exemptions created with borrowed funds should be denied. Id. at 631. The court further held that the totality of the circumstances pointed to a lack of good faith in filing, and that the plan also failed the best interest of creditors test after considering the potentially avoidable transfers and undervalued assets. Id. at 632. Therefore, the court denied confirmation of the Chapter 12 plan. Id. at 633.
The case was decided on April 14, 2006.