Jul. 28, 2021

A New Tool To Deal With Misbehaving Bankruptcy Debtors

While most individual bankruptcy debtors are honest and seek to rehabilitate themselves following financial distress, there are situations, which appear to be occurring more frequently, where the debtors, either with or without advice of counsel, abuse the bankruptcy process, ignore deadlines, ignore court orders, and seek to use the bankruptcy process for improper purposes in order to hinder and delay creditors. On April 27, 2021, the United States Court of Appeals for the First Circuit issued an opinion in the case of In re Paul Francis (No. 19-9011) that provides great ammunition to creditors and judges in the bankruptcy court to appropriately impose punitive sanctions for such misbehavior.

The facts are relatively simple. The individual debtor owned several parcels of real estate with substantial secured debt. His first Chapter 13 petition was dismissed within a month after filing based upon his failure to file required documents. Approximately two months later, the debtor filed a new Chapter 13 case, which the debtor then converted to a case under Chapter 11. Approximately four months later, the US Trustee obtained an order converting the case to Chapter 7 because of the debtor’s failure to file a Chapter 11 plan by the deadline. Subsequently, the debtor failed to comply with orders to file documents and to appear at hearings. Finally, following the bankruptcy judge’s issuance of warnings which were ignored, the bankruptcy judge dismissed the Chapter 7 case, but the dismissal was ordered only after the bankruptcy judge sua sponte denied the debtor’s discharge.

In so doing, the bankruptcy judge stated “my problem is that it’s like pulling teeth with Mr. Francis and this has been going on since March 2017, not this March…. This is the poster child for someone who has ignored what the Court has required from him….” The bankruptcy judge concluded that the debtor had “repeatedly ignored lawful orders of the Court” and had exhibited a “conscious practice of ignoring mail, addressed to [him] and marked with the seal of this Court”.

This sequence of orders is significant because of the preclusive effect of the denial of the discharge entered before the case was dismissed will have long-lasting effects on any attempt by the debtor to attempt to use the bankruptcy process for many years to come. Additionally, the denial of discharge no longer precludes the creditors from pursuing their appropriate remedies.

The debtor appealed first to the Bankruptcy Appellate Panel which affirmed the bankruptcy court and then appealed to the U.S. Court of Appeals which also affirmed the bankruptcy court decision. The appellate opinion authored by Judge Bruce Selya is a blueprint and model for language that can be used by practitioners as precedent in supporting similar relief in cases where the facts support drastic action by the court.

The appellate court found that the language contained in section 521(i)(1) of the Bankruptcy Code does not mandate an automatic dismissal if the debtor fails to file all of the information required, and the court rejected a mechanical approach, which enabled the bankruptcy court to explore all options in order to grant the appropriate relief.

Significantly, the appellate court found that the bankruptcy court had the authority to sua sponte enter a denial of discharge and/or dismiss the case even without motion filed by a party in interest. Circuit Judge Selya, in reviewing section 105 of the Bankruptcy Code and the legislative history, stated “[T]his unambiguous language makes it nose-on-the-face plain that the bankruptcy court, acting sua sponte, possesses the authority to deny at debtor a discharge in consequence of, say, his flagrant disregard of the bankruptcy court’s lawful orders”. Judge Selya refused to “handcuff” the bankruptcy court in a manner inconsistent with congressional intent. 

The debtor had argued that a “mere failure” to comply with the bankruptcy court’s orders within the prescribed time frame did not constitute a refusal which would give rise under section 727 of the Bankruptcy Code to the denial of a discharge, since the failure to file was not willful. While a majority of appellate courts have required a showing of willful or intentional disobedience in order to justify the denial of the discharge, the appellate court found that “even if we assume, favorably to the debtor, that a showing of willfulness is required, evidence of willfulness is abundant here. The debtor stonewalled no fewer than three lawful orders of the bankruptcy court without any legitimate justification – and he did so despite receiving pointed warnings from the court that his discharge hung in the balance”. 

Finally, and this is a refrain that is often heard emanating from misbehaving debtors, that the bankruptcy court had denied the debtor due process. In what may be described as the “quote of the month”, Judge Selya stated that the due process argument was “the same old whine in new bottles” - a great and appropriate pun.

Hopefully, the extensive supporting language and case citations in this case will work to deter inappropriate conduct by debtors and their attorneys and arm the bankruptcy judges with great ammunition to shoot down such inappropriate behavior.

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