KSB

13-22232 Rock (Doc. # 43)

In Re Rock, 13-22232 (Bankr. D. Kan. Oct. 7, 2014) Doc. # 43

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SO ORDERED.
SIGNED this 6th day of October, 2014.

 

Opinion Designated for Electronic Use, But Not for Print Publication
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS


In re:
AMELIA LUE ROCK,
DEBTOR.
CASE NO. 13-22232-13
CHAPTER 13

OPINION DENYING DEBTOR’S REQUEST FOR ATTORNEY FEES

This matter is before the Court for a ruling following a hearing on August 28,
2014, on the Debtor’s request for sanctions against UnitedHealthcare Specialty Benefits,
LLC (UHCSB), for alleged violations of the automatic stay. The Debtor appears by
counsel Sarah A. Sypher of Sypher Law Group, LLC. UHCSB appears by counsel
Michael D. Fielding of Husch Blackwell LLP and Eric S. Goldstein of Shipman &
Goodwin LLP. The Court has reviewed the relevant pleadings and heard the arguments
of counsel, and is now ready to rule. At this point, the question is whether the doctrine of

Case 13-22232 Doc# 43 Filed 10/06/14 Page 1 of 11


recoupment provides UHCSB a defense to actions it took that would otherwise constitute
violations of the automatic stay imposed by § 362(a) of the Bankruptcy Code. As
explained below, the Court concludes UHCSB properly withheld money from
postpetition disability benefits it owed the Debtor in order to recoup an overpayment of
the benefits that had been made to the Debtor before she filed bankruptcy. Consequently,
UHCSB did not violate the automatic stay, and is not liable to the Debtor for attorney fees
she incurred in trying to get UHCSB to stop the withholding and refund the money it
withheld postpetition.

Facts

Before April 2010, the Debtor was working as a nurse for the State of Kansas in
the psychiatric ward of a hospital. In 2010, she was injured by a patient in a way that led
to back surgery. By April 2010, she was no longer able to work and began receiving
long-term disability benefits under a plan sponsored by the Kansas Public Employees
Retirement System. UHCSB administers the plan for KPERS. The plan called for the
Debtor’s benefits to be reduced to the extent she received income from certain other
sources, including workers’ compensation benefits. The plan gave the administrator the
right to recover any overpayments, and to determine the method by which repayment
would be made. In 2011, the Debtor received a workers’ compensation award of $7,300.
Under the plan, that amount was treated as an overpayment of her disability benefits, and
in accordance with the plan, UHCSB reduced the Debtor’s future benefits by $100 per
month in order to recoup that overpayment from her.

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Between 2011 and 2013, the Debtor developed additional health problems that she
attributes to her work injury, including diabetes and a heart condition. She needs several
medications in order to stay alive. The monthly withholding from her disability benefits
has made it more difficult for her to pay her rent and purchase her necessary medicine.
By August 2014, she was approximately 60 years old.

In August 2013, the Debtor filed a Chapter 13 bankruptcy petition. Her attorney
assumed UHCSB would stop the $100 per month withholding, and included that
assumption in drafting the Debtor’s Chapter 13 plan. The plan was confirmed in October
2013. Despite receiving actual notice of the Debtor’s bankruptcy filing, UHCSB
continued to withhold $100 per month from her disability payments to continue
recovering the overpayment from her.

The Debtor’s attorney contacted UHCSB and at first was advised the withholding
would stop, but later was told it would continue. Eventually, an attorney for UHCSB
advised her that the company believed the monthly withholding was in the nature of
recoupment and therefore not prohibited by the automatic stay, providing citations to a
number of cases concerning recoupment. On June 11, 2014, the Debtor filed a motion
asking the Court to compel UHCSB to turn over to the Debtor all the money it had
withheld postpetition, to impose a sanction against UHCSB for violating the automatic
stay by continuing to withhold $100 per month from her benefits after she filed
bankruptcy, and to require UHCSB to pay her $1,500 in attorney fees as an additional
sanction under § 362(k)(1). In a response filed on July 11, 2014, UHCSB continued to

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assert the monthly withholding was a permissible recoupment that did not violate the stay.
Nevertheless, it advised that KPERS had voluntarily agreed to stop withholding any
money from the Debtor’s future disability benefits, to waive the remaining balance owed
on the prepetition overpayment (approximately $4,120), and to refund the $800 that had
been withheld since the Debtor filed bankruptcy.

A hearing on the Debtor’s motion was held on August 28, 2014. In light of
KPERS’s decision to waive the balance of the overpayment and to refund the money that
had been withheld postpetition, the only outstanding relief the Debtor was seeking was
for UHCSB to pay her attorney fees. The Court told the parties the only issue it had to
decide was whether UHCSB had violated the automatic stay. There was no question that
the company thought it had the absolute right to continue the monthly withholding
without getting stay relief. If that was wrong, the Court stated that a reasonable attorney
fee was the only sanction the Court would impose.
Discussion

Ordinarily, any postpetition efforts a creditor takes to recover a prepetition
obligation from a debtor are violations of the automatic stay imposed by § 362(a) unless
the creditor first obtains relief from the stay. The Debtor sensibly suggests that even if
UHCSB’s actions were proper recoupment, the company should at least have asked this
Court to confirm that fact by asking for stay relief, instead of relying solely on its own
determination. A leading bankruptcy treatise says that courts are split on the question

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whether the automatic stay applies to bar or restrain a legitimate right of recoupment.1
However, assuming for the moment that UHCSB had a valid right to recoup the
overpayment, binding Tenth Circuit precedent prohibits this Court from ruling that
UHCSB was required to seek stay relief before it continued to withhold the $100 from the
Debtor’s monthly benefit payment.2

At least within the Tenth Circuit, the doctrine of recoupment is a well-established
exception to the automatic stay, as well as to the discharge injunction imposed by
§ 524(a).3 Recoupment originated as an equitable rule of joinder, allowing adjudication
in one suit of two claims that the common law had required to be brought separately.4
“Under recoupment, a defendant could meet a plaintiff’s claim with a countervailing
claim that arose ‘out of the same transaction.’”5 In bankruptcy, “‘[r]ecoupment’ is an
equitable doctrine . . . that allows one party to a transaction to withhold funds due another

15 Collier on Bankruptcy, ¶ 553.10 at 553-93 (Alan N. Resnick & Henry J. Sommer, eds.-inchief,
16th ed. 2014).

2Beaumont v. Dept. of Veteran Affairs (In re Beaumont), 586 F.3d 776, 781 (10th Cir. 2009) (“If
the recoupment doctrine applies, then there is no ‘debt’ or ‘claim’ here as defined in the Bankruptcy
Code, and [the party who exercised recoupment rights] has not violated the automatic stay nor the
discharge injunction”).

3See id., 586 F.3d at 781; In re Lunt, 477 B.R. 812, 818-19 (Bankr. D. Kan. 2012), aff’d 500 B.R.
9 (D. Kan. 2013); see also Ahsland Petroleum Co. v. Appel (In re B&L Oil Co.), 782 F.2d 155, 159 (10th
Cir. 1986) (“The general principle is that a petition for bankruptcy operates as a ‘cleavage’ in time; but
the recoupment doctrine has traditionally operated as an exception to the rule that applies to other
debts.”).

4Ashland Petroleum Co. v. Appel (In re B & L Oil Co.), 782 F.2d 155, 157 (10th Cir. 1986).

5Id. (citing J. Moore, 3 Moore’s Federal Practice, ¶ 13.02 at 13-13, n. 1 (2d ed. 1985) and 20 Am.
Jur. 2d Counterclaim, Recoupment, and Setoff, §§ 16-18 (1965)).

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party where the debts arise out of the same transaction. In other words, the doctrine
‘allows a creditor to recover a pre-petition debt out of payments owed to the debtor postpetition.’”
6

Whether UHCSB’s postpetition withholding from the Debtor’s disability benefits
was protected by the recoupment doctrine depends on whether the Debtor’s obligation to
repay the benefits overpayment arose out of the “same transaction” as her right to receive
continuing disability benefits.7 This means that “both debts must arise out of a single
integrated transaction so that it would be inequitable for the debtor to enjoy the benefits
of that transaction without also meeting [the debtor’s] obligations.”8 The Court must
examine the equities of the case, and determine whether the Debtor’s claim for ongoing
disability benefits and UHCSB’s claim to recover the prepetition overpayment of benefits
“are so closely intertwined that allowing the debtor to escape [her] obligation would be
inequitable notwithstanding the Bankruptcy Code’s tenet that all unsecured creditors
share equally in the debtor’s estate.”9

After considering the equities here, the Court concludes it must agree with

6Beaumont, 586 F.3d at 780 (quoting Conoco, Inc., v. Styler (In re Peterson Distributing, Inc.),
82 F.3d 956, 959 (10th Cir. 1996), and City of Fort Collins v. Gonzales (In re Gonzales), 298 B.R. 771
(Bankr. D. Colo. 2003)).

7See Beaumont, 586 F.3d at 781.
8Peterson Distributing, 82 F.3d at 960 (quoting University Medical Ctr. v. Sullivan (In re
University Medical Ctr.), 973 F.2d 1065, 1081 (3d Cir.1992)).
9Peterson Distributing, 82 F.3d at 960.
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UHCSB that this case cannot be distinguished from In re Beaumont10 on any relevant
basis. In Beaumont, the Tenth Circuit held that the Department of Veteran Affairs (VA)
did not violate either the automatic stay or the discharge injunction by reducing the
debtor’s ongoing benefits under a VA disability program in order to recover a prepetition
overpayment of benefits, even though it continued with the reduction after the debtor filed
bankruptcy and after he received a discharge. The debtor was a disabled veteran who had
been receiving disability benefits for eight years when he was given a large probate
distribution. Pursuant to federal statutes, the debtor’s VA benefits were subject to being
reduced if he received any payments from any other source, including an inheritance.
After learning of the inheritance, the VA advised the debtor that it had determined the
probate distribution had made him ineligible for his VA benefits for a period of time,
which meant he had received an overpayment of $18,448 in benefits, and that the VA
intended to collect that amount by offsetting his future disability payments, as was
expressly permitted by statute. The debtor responded by filing for bankruptcy relief, and
the VA continued to offset his benefits during the bankruptcy proceeding and after he
received a discharge. The debtor contended this conduct violated the automatic stay and
the discharge injunction. The Tenth Circuit disagreed.

This Court finds that the obligations of both parties did
arise from the “same transaction.” [Plaintiff-debtor’s] claim
for and award of pension benefits generated the [Defendant
VA’s] obligation to pay those benefits. The Defendant’s

10586 F.3d 776.
7


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obligation to pay benefits was and is contingent upon
Plaintiff’s financial situation, his annual income, and his
responsibility to keep the Defendant informed of his financial
situation. Plaintiff’s inheritance had the effect of reducing the
amount of benefits he could receive from the Defendant.
Therefore, Plaintiff’s inheritance was directly related to or
intertwined with the amount of benefits Defendant was
obligated to pay to him, and the resulting overpayment of
benefits. It is unlawful for Plaintiff to keep any overpayments
so long as the Defendant, through its own administrative
procedures, has properly determined the amount of
overpayment and properly considered Plaintiff’s disagreement
with that determination. The Court believes that it would be
inequitable for the Plaintiff to receive his inheritance,
continue to receive benefits as if his income was zero, then be
able to discharge in bankruptcy the overpayments once it was
determined that he had been overpaid.11

The same can be said in this case: It would be inequitable for the Debtor to receive her

workers’ compensation award, continue to receive disability benefits as if she had not

received the award, then be able to discharge in bankruptcy the overpayment once it was

determined she had been overpaid.

Pointing to the equitable nature of the recoupment doctrine, the Debtor argues her

unfortunate ongoing health problems and financial condition should convince the Court

not to condone UHCSB’s efforts to recoup the overpayment of disability benefits she

received. But the Court does not understand the 10th Circuit and other courts applying

recoupment to mean the availability of the doctrine ever depends on its impact on the

debtor based on anything about the debtor other than the direct relationship between the

11 Id. at 781.

8

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prepetition obligation the creditor wants to recoup and the postpetition benefit the creditor
will be providing to the debtor. Instead, the equities to be considered are whether the
debtor’s postpetition benefits are so intertwined with the overpayment or other obligation
the debtor incurred that allowing the debtor to continue to receive those benefits without
meeting the obligation would be inequitable, or whether it would be unfair for the party
providing the postpetition benefits to recover on the related prepetition obligation when
the debtor’s other creditors are not being made whole.12 The Debtor has cited no case
where a court ruled that anything else about the debtor’s circumstances precluded a party
from exercising an otherwise proper right to recoup an obligation the debtor incurred
before filing bankruptcy, and this Court has found none. While the Court feels sympathy
for the Debtor’s health and financial problems, the recoupment doctrine allows no room
for such considerations to affect its application.

The Court did find one case relying on an equitable consideration that might be
viewed as involving the debtor’s unfortunate financial circumstances, the Third Circuit’s
decision in Lee v. Schweiker. 13 In that case, after the debtor filed bankruptcy, the Social
Security Administration continued to reduce her monthly old-age benefits in order to
recover a prepetition overpayment of those benefits. The Third Circuit ruled the SSA’s

12See, e.g., Conoco v. Styler (In re Peterson Distributing, Inc.), 82 F.3d 956, 959-63 (10th Cir.
1996) (denying recoupment); Davidovich v. Welton (In re Davidovich), 901 F.3d 1533, 1537 (10th Cir.
1990) (allowing recoupment of one obligation but not another); B&L Oil, 782 F.2d at 159 (allowing
recoupment).

13739 F.2d 870 (1984).

9

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action violated the automatic stay, saying,

Social welfare payments, such as social security, are statutory

“entitlements” rather than contractual rights. The purpose of these

payments is to provide income to qualifying individuals. Although the

paying agency can ordinarily recover overpayments, just as creditors can

ordinarily obtain payment from a debtor’s future income, the Bankruptcy

Code protects a debtor’s future income from such claims once a petition has

been filed, and the SSA violated the automatic stay in continuing to

withhold part of [the debtor’s] benefits after she had filed her petition.14
Benefits paid to a debtor based on being unable to work could similarly be viewed as
social welfare payments, which suggests the Third Circuit might apply a similar rule to
disability payments like those the Debtor is receiving in this case. But the Tenth Circuit’s
Beaumont decision, dealing with VA disability benefits, makes clear this Court cannot
rely on the social welfare aspect of the benefits involved in this case to conclude that the
recoupment doctrine did not protect UHCSB’s postpetition recovery of the prepetition
overpayment the Debtor received.

Under the circumstances of this case, the Court concludes UHCSB was entitled to
recoup the prepetition overpayment that resulted when the Debtor received her workers’
compensation award from the postpetition payments it owed the Debtor under the KPERS
long-term disability plan. Consequently, UHCSB did not violate the automatic stay by
deducting $100 per month from the postpetition benefits it paid the Debtor, and is
therefore cannot be liable to her for the attorney fees she incurred trying to get the
deductions stopped.

14Id. at 876.
10


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Conclusion

For the reasons stated, the Court denies the Debtor’s request that UHCSB be
ordered to pay her attorney fees.
# # #

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10-06225 Redmond, Brooke Trustee v. Brooke Holdings, Inc. et al (Doc. # 230)

Redmond, Brooke Trustee v. Brooke Holdings, Inc. et al, 10-06225 (Bankr. D. Kan. Sep. 12, 2014) Doc. # 230

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SO ORDERED.
SIGNED this 12th day of September, 2014.

 

Opinion Designated for Print and On-Line Publication
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS


In Re:

BROOKE CORPORATION, et al.,
DEBTORS.

CHRISTOPHER J. REDMOND,
Chapter 7 Trustee of Brooke
Corporation, Brooke Capital
Corporation, and Brooke Investments,
Inc.,

PLAINTIFF,

v.
BROOKE HOLDINGS, INC., et al.,

DEFENDANTS.

CASE NO. 08-22786
CHAPTER 7

ADV. NO. 10-6225

MEMORANDUM OPINION AND ORDER
DENYING THE TRUSTEE’S MOTION FOR SUMMARY JUDGMENT
AGAINST DEFENDANTS STEVEN AND WANDA SCHMIDT


Case 10-06225 Doc# 230 Filed 09/12/14 Page 1 of 19


In this action, the Trustee seeks to avoid allegedly preferential transfers and
constructively fraudulent conveyances made by Debtor Brooke Corporation (Brooke
Corp) to Defendant Brooke Holdings, Inc. (BHI), and to recover part of those avoided
transfers from Defendants Steven and Wanda Schmidt (the Schmidts)1 under 11 U.S.C.
§ 550,2 as subsequent transferees of BHI. The Trustee moved for summary judgment
against BHI and the Schmidts.3 BHI did not respond to the motion, and a default judgment
was entered finding that $5,100,800 in loan payments Brooke Corp made to BHI are
avoidable as preferential transfers under § 547(b) and that $13,143,980.77 in dividend
payments Brooke Corp made to BHI after December 31, 2004, are avoidable as
constructively fraudulent conveyances under §§ 544 and 548.4 This opinion therefore
addresses only the motion for summary judgment against the Schmidts.5 For the reasons
discussed below, the Court finds the Trustee is not entitled to judgment as a matter of law
based upon the uncontroverted facts presented and therefore denies the motion as to the

1 The Complaint also seeks recovery from other individuals, but the Trustee’s actions against
them have been dismissed.


2 All subsequent references to title 11 in the text shall be to the section number only.

3 Doc. 176.

4 Doc. 215.

5 This Court has jurisdiction pursuant to 28 U.S.C. §§ 157(a) and 1334(a) and (b), and the
Amended Standing Order of Reference of the United States District Court for the District of Kansas that
exercised authority conferred by § 157(a) to refer to the District’s bankruptcy judges all matters under the
Bankruptcy Code and all proceedings arising under the Code or arising in or related to a case under the
Code, effective June 24, 2013. D. Kan. Standing Order 13-1, printed in D. Kan. Rules of Practice and
Procedure at 168 (March 2014). Efforts to avoid or recover preferences and fraudulent conveyances are
core proceedings which this Court may hear and determine as provided in 28 U.S.C. § 157(b)(2)(F) and
(H). There is no objection to venue or jurisdiction over the parties.

2

Case 10-06225 Doc# 230 Filed 09/12/14 Page 2 of 19


Schmidts.

UNCONTROVERTED FACTS.
Procedural History.

Brooke Corp and Brooke Capital filed for bankruptcy on October 28, 2008. On
October 6, 2010, the Trustee filed his Complaint against the defendants in this adversary
action. The Complaint sought avoidance of preferential transfers under § 547 (Count I);
avoidance of constructively fraudulent conveyances under § 548 and K.S.A. 33-204 and
33-205 (Count II); recovery of avoided transfers under § 550 (Count III); and disallowance
of several proofs of claim under § 502(d) (Count IV). Initially, there were 13 defendants.
Of these, eight have been dismissed with prejudice, and the claims against two more were
terminated. This leaves BHI and the Schmidts, the parties against whom the Trustee
moved for summary judgment. Defendant BHI failed to respond to the motion for
summary judgment, and the order granting the Trustee a default judgment was entered on
July 10, 2014.

The pretrial order set deadlines for discovery, including the production of reports
from expert witnesses. The Trustee retained experts and provided three reports: Expert
Report of R. Larry Johnson Regarding Insolvency of Brooke Corporation; Expert Report
of R. Larry Johnson Regarding Insolvency of Brooke Holdings, Inc.; and Expert Report of
Kent E. Barrett Regarding Brooke Holdings, Inc. Cash Flows (BHI Cash Flow Report).
The Schmidts did not serve any expert reports and did not request any documents relied
upon by the Trustee’s experts. Discovery closed on April 3, 2014. April 21, 2014, was set

3

Case 10-06225 Doc# 230 Filed 09/12/14 Page 3 of 19


as the deadline for filing dispositive motions.

Relationship of Defendants.

Defendant BHI was incorporated in the State of Kansas as a privately-owned
company used primarily to hold stock of Brooke Corp.6 BHI is an insider of the Debtors.
Approximately 74% of BHI was owned by Robert Orr, 22% by his brother, Leland Orr,
and 4% by other Orr family members.7 Robert Orr always held himself out as the person
in charge of BHI. Robert Orr also served as the CEO of Brooke Corp from 1986 through
October 1, 2007. Robert Orr served as the Chairman of Brooke Corp’s Board of Directors
from 1991 through September 17, 2008, and resigned from that Board in October 2008. In
2007 and 2008, Robert Orr held various officer positions with Brooke Capital. Defendant
Wanda R. Schmidt is Robert Orr’s mother-in-law. Defendant Steven Schmidt is Wanda
Schmidt’s son and the brother-in-law of Robert Orr.

Brooke Corp Loan Repayments and Dividend Payments to BHI.

In May 2007, BHI began borrowing from First United Bank of Frankfort, Illinois,
and loaning the proceeds to Brooke Corp. From December 18, 2007, through July 16,
2008, BHI loaned Brooke Corp a total of $6.1 million. Brooke Corp repaid BHI a total of

6 Doc. 176-4 at 4.

7 Doc. 176-1 at 6, ¶ 10 (supported by BHI Cash Flow Report, Doc. 176-6 at 3, which relied on
SEC complaint filed May 4, 2011, in District of Kansas). The Schmidts controverted this statement by
referring to a 1992 document which shows Robert Orr’s ownership to be approximately 39%. The Court
finds that the Schmidts’ have not effectively controverted the Trustee’s statement of fact, since the date of
the Schmidts’ document is almost 19 years before the SEC complaint was filed, and fifteen years before
the events at issue in this proceeding took place. Further, the exact percentages of ownership are not
material to the issues before the Court.

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Case 10-06225 Doc# 230 Filed 09/12/14 Page 4 of 19


$5,100,800 between February 14, 2008, and September 4, 2008.

From November 24, 2004, to the date that Brooke Corp filed for bankruptcy relief,
Brooke Corp paid dividends to BHI totaling $13,737,194. In this proceeding, BHI has not
contended that the dividends were paid on account of any antecedent debt.

BHI Transfers to the Schmidts.

Wanda Schmidt received two checks from BHI: one for $87,168.50, dated
December 26, 2007, and one for $75,300, dated December 31, 2007. Of this $162,468.50
paid to Wanda Schmidt, $75,300 was for the redemption of her BHI common stock, and
the remainder was for the redemption of her BHI preferred stock. The two checks did not
clear the BHI bank account until February 26, 2008. Steven Schmidt received two checks
from BHI: one for $180,000, dated December 31, 2007, and one for $180,000, dated
February 22, 2008. This $360,000 paid to Steven Schmidt was for the repurchase of his
BHI stock. Steven Schmidt deposited both checks into his bank account on February 22,
2008, and they cleared BHI’s bank account on February 25, 2008. The Schmidts do not
controvert the conclusions of the BHI Cash Flow Report that of the $162,468.50 paid by
BHI to Wanda Schmidt, $115,840 (71.3%) came from Brooke Corp dividends, and that of
the $360,000 paid by BHI to Steven Schmidt, $252,000 (70%) came from Brooke Corp
dividends.

Avoidance of Transfers from Brooke to BHI.

On July 10, 2014, an Order Granting Trustee’s Motion for Default Judgment

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Case 10-06225 Doc# 230 Filed 09/12/14 Page 5 of 19


Against Defendant Brooke Holdings, Inc. was entered.8 The judgment holds:

(1) $5,100,800 in loan payments that Brooke Corp made to BHI are avoidable as
preferential transfers under § 547(b); (2) $13,143,980.77 in dividend payments that
Brooke Corp made to BHI are avoidable as constructively fraudulent conveyances under
§ 544 of the Bankruptcy Code (through K.S.A. 33-204(a)(2) and 33-205(a)) and
§ 548(a)(1)(B); and (3) pursuant to § 550 and K.S.A. 33-207, the Trustee may recover the
$5,100,800 and $13,143,980.77 in avoidable transfers from BHI.
DISCUSSION

The Schmidts Have Not Effectively Controverted the Trustee’s Statement of Facts
Regarding the Insolvency of Brooke Corp and BHI (Paragraphs 16-20).

The Trustee’s memorandum in support of his motion includes the following
statements regarding the insolvency of Brooke Corp and BHI. The statements are
supported by reference to expert reports, copies of which are attached to the memorandum.

16. Brooke Corp’s assets consisted primarily of its
investments in its operating subsidiaries, approximately 8090%
of which was its investments in Brooke Capital and
Aleritas. Brooke Capital was continuously insolvent from
November 1, 2004 through the Petition Date. . . .
17. After establishing liabilities for loan impairments
and writing off intangible assets, Aleritas had substantial
negative equity and was continuously insolvent since at least
December 31, 2004.
18. Given the insolvency of Aleritas and Brooke
Capital, coupled with Brooke Corp’s numerous unrecorded
8 Doc. 215.
6


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liabilities, Brooke Corp was insolvent since at least December
31, 2004.

19. Defendant BHI’s solvency was dependent on the
value of its investment in Brooke Corp common stock, since
its other assets and liabilities consisted primarily of amounts
borrowed from third parties to fund loans to Brooke Corp and
other related parties.
20. As noted above, Brooke Corp was insolvent since
at least December 31, 2004. Thus, after eliminating the value
of BHI’s investment in Brooke Corp stock and amounts
receivable from Brooke Corp due to Brooke Corp’s
insolvency, BHI had substantial negative equity. Accordingly,
BHI was also insolvent since at least December 31, 2004.9
When responding to the Trustee’s motion, the Schmidts state:

4. ¶s 16-18 are contested. The Schmidts have no
information as to Brooke Corp’s solvency at any given time.
They also have no information as to the methodology
employed by the trustee’s expert. The report, as attached to
the summary judgment motion, is for the most part no more
than conclusions. The report also contradicts the market, as
Brooke Corp. was a publicly traded company during the
applicable time period with a positive per share price.
Moreover, given the amount involved in this adversary action,
as to the Schmidts, they simply cannot afford to independently
hire their own experts. However, they understand that there
are other actions pending in which Brooke Corp.’s solvency is
at issue and will be/are contested with countering experts. See
Argument, Part 1, below. Also, the Claimholder’s Response
includes significant materials contesting the trustee’s experts
as to insolvency.
5. ¶s 19-20 are contested. Again, the premise for these
¶s is that BHI was insolvent because Brooke Corp. was
9 Doc. 176-1 at 7-8.

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insolvent. See Response to ¶s 16-18 above.10

The Schmidts’ response to ¶¶ 16-20 of the Trustee’s statement of facts is not
sufficient to show a genuine dispute as to the facts stated. Rule 56(c)(1) provides that a
party asserting that a fact is “genuinely disputed must support the assertion by: (A) citing
to particular parts of materials in the record.” A local rule applicable to proceedings
before this Court states, “All facts on which a motion or opposition is based must be
presented by affidavit, declaration under penalty of perjury, and/or relevant portions of
pleadings, depositions, answers to interrogatories, and responses to requests for
admissions.”11 The Schmidts cite no particular portions of the record in support of their
assertions. The Schmidts’ refer to the “Claimholder’s Response,” but that response has
been stricken from the record.12 Rather than providing facts which would be admissible in
evidence to controvert the Trustee’s statements, the Schmidts state they “have no
information as to Brooke Corp’s solvency at any given time.”13

The matters stated in the Trustee’s ¶¶ 16-20 will be considered uncontroverted for
purposes of the motion for summary judgment. As noted by the Trustee, these facts have
reduced relevancy since BHI failed to respond to the motion for summary judgment and a

10 Doc. 189 at 2.
11 D. Kan. Rule 56.1(d).
12 The Claimholder’s Response is Doc. 186. It is a response to the Trustee’s motion for summary


judgment that was filed by a nonparty, Robert D. Orr, who purchased BHI’s claim against Brooke Corp.
The response was stricken from the record by Doc. 208.
13 Doc. 189 at 2.
8

Case 10-06225 Doc# 230 Filed 09/12/14 Page 8 of 19


default judgment avoiding the challenged transfers to it has been entered. The insolvency
of neither Brooke Corp nor BHI is an element of the Trustee’s claims against the
Schmidts. Nevertheless, BHI’s insolvency is not totally irrelevant, as it is a factor in the
Trustee’s argument that the Schmidts did not give value for the funds in issue.

The Court Will Not Delay Ruling on the Summary Judgment Motion Based on the
Schmidts’ Assertion that Facts to Controvert Paragraphs 16-20 of the Trustee’s
Statement of Facts Are Unavailable to Them.

The Schmidts argue that their inability to controvert the Trustee’s statement of facts
regarding the solvency of Brooke Corp and BHI provides grounds to delay ruling on the
motion under Rule 56(d), which provides:

(d) When Facts are Unavailable to the Nonmovant.
If a nonmovant shows by affidavit or declaration that, for
specified reasons, it cannot present facts essential to justify its
opposition, the court may:

(1) defer considering the motion or deny it;
(2) allow time to obtain affidavits or declarations or to
take discovery; or
(3) issue any other appropriate order.
The rule was amended in 2010 and subdivision (d) “carrie[d] forward without substantial
change the provisions of former subdivision (f),”14 so earlier authorities referring to
subdivision (f) now apply to subdivision (d). “The purpose of subdivision (f) is to provide
an additional safeguard against improvident or premature grant of summary judgment.”15
“One of the most common reasons offered under Rule 56(f) for being unable to present
14 Fed. R. Civ. P. 56, Advisory Committee Notes to 2010 Amendments.
15 10B Charles Alan Wright, Arthur R. Miller & Mary Jane Kane, Federal Practice and
Procedure, § 2740 at 402 (3rd ed. 1998).
9


Case 10-06225 Doc# 230 Filed 09/12/14 Page 9 of 19


specific facts in opposition to a summary-judgment motion is insufficient time or
opportunity to engage in discovery.”16 In the Tenth Circuit, “a party seeking to defer a
ruling on summary judgment under Rule 56(f) must provide an affidavit ‘explain[ing] why
facts precluding summary judgment cannot be presented.’”17 The affidavit should identify
“(1) ‘the probable facts not available,’ (2) why those facts cannot be presented currently,

(3) ‘what steps have been taken to obtain these facts,’ and (4) ‘how additional time will
enable [the party] to’ obtain those facts and rebut the motion for summary judgment.”18
Justifications for not taking discovery based on a lack of funds have not been successful.19
In this case, discovery has been closed. The Schmidts have not designated any
experts or conducted any discovery to determine the details of the expert opinions offered
by the Trustee. The Schmidts describe no steps which they have taken to refute the
allegations of insolvency and do not explain how additional time will enable them to
obtain the needed facts. The declaration submitted to support the Rule 56(d) defense
states merely that neither the declarant, Steven Schmidt, nor his mother, Wanda Schmidt,
can afford to pay significantly more to defend against the Trustee’s Complaint, and that
the fees of a forensic accountant would be substantial and beyond their ability to pay. The

16 Id., § 2741 at 412.

17 Valley Forge Ins. Co. v. Health Care Mgmt. Partners, Ltd., 616 F.3d 1086, 1096 (10th Cir.
2010) (quoting Comm. for the First Amendment v. Campbell, 962 F.2d 1517, 1522 (10th Cir. 1992)).


18 Id.

19 10B Fed. Prac. & Pro., § 2741 at 436 (citing Grimm v. Westinghouse Elec. Corp., 300 F.
Supp. 984, 991 (N.D. Cal. 1969); Dale Hilton, Inc., v. Triangle Publ’ns, Inc., 27 F.R.D. 468, 476


(S.D.N.Y. 1961)).
10
Case 10-06225 Doc# 230 Filed 09/12/14 Page 10 of 19


Schmidts ask for a delay in ruling on the summary judgment motion not for the purpose of
conducting their own discovery, but because there are other adversary proceedings “where
the Brooke Corp. insolvency will be contested with the assistance of expert testimony.”20

For several reasons, the Court rejects the Schmidts’ argument as a basis for
delaying a ruling on the summary judgment motion. First, the Schmidts recite no efforts
on their part to join with the defendants in the cited cases in the retention of experts.
Second, it is highly possible that the other proceedings will be settled and not proceed to
trial. Third, because judgment has been entered on the avoidance claims against BHI, the
insolvency of Brooke Corp and BHI are not elements of the remaining claims. Fourth, the
Schmidts have made no argument that a ruling on the solvency of Brooke Corp in the
other cases would have a preclusive effect in this case.

The Court declines to delay resolution of the Trustee’s summary judgment motion
until after a determination is made in other adversary proceedings of Brooke Corp’s
solvency.
The Trustee’s Summary Judgment Motion Is Denied.

Section 550(a)(1) allows the Trustee to recover for the benefit of the estate any
transfer which is avoidable under §§ 544, 547, and 548 from the initial transferee.
Judgment was entered under this subsection against BHI as the initial transferee of the
Brooke Corp loan repayments of $5,100,800 and dividend payments of $13,143,980.77.

20 Doc. 189 at 5.
11


Case 10-06225 Doc# 230 Filed 09/12/14 Page 11 of 19


But that judgment has not been satisfied, and the Trustee has no expectation of recovering
from BHI. The Trustee therefore seeks a judgment against the Schmidts under
§ 550(a)(2), which allows the Trustee to recover the avoided transfers from “any
immediate or mediate transferee of such initial transferee.”

The uncontroverted facts establish that in February 2008, BHI transferred $360,000
to Steven Schmidt and $162,468.50 to Wanda Schmidt in order to redeem their stock in
BHI. Of the monies paid to Steven Schmidt, $252,000 is traceable to the avoidable
transfers that BHI received from Brooke Corp. Of the monies paid to Wanda Schmidt,
$115,840 is traceable to the avoided transfers that BHI received from Brooke Corp. As to
the traceable funds, the Schmidts are transferees of BHI, the initial transferee from Brooke
Corp. They are therefore liable to the Trustee under § 550(a)(2), unless they are within the
protection afforded by § 550(b). That subsection provides:

(b) The Trustee may not recover under section (a)(2) of
this section from —
(1) a transferee that takes for value, including
satisfaction or securing of a present or antecedent debt, in good
faith, and without knowledge of the voidability of the transfer
avoided; or
(2) any immediate or mediate good faith transferee of
such transfer.
“The policy underlying the ‘good faith’ defense . . . is to protect certain innocent
purchasers from challenges to the underlying transfer.”21 The focus is on the transaction

21 Enron Corp. v. Avenue Special Situations Fund II, LP, (In re Enron), 333 B.R. 205, 233
(Bankr. S.D.N.Y. 2005); see also Bonded Financial Servs., Inc., v. European Amer. Bank, 838 F.2d 890,
897 (7th Cir. 1988) (Transferees covered by § 550(b) receive protection because requiring them to

12

Case 10-06225 Doc# 230 Filed 09/12/14 Page 12 of 19


between the initial and the subsequent transferee.22 The subsection provides an affirmative
defense, and the transferee relying on the defense has the burden of proof.23

The Trustee asserts that the Schmidts are not protected by § 550(b)(1) for two
reasons: (1) they did not allege the defense in their answer; and (2) they did not give value
for the transfers from BHI. When the Trustee raised the first of these objections in his
memorandum in support of summary judgment, the Schmidts responded with a motion to
amend their answer to add the defense, to which the Trustee objected. By separate order,
the Court has allowed the Schmidts to amend their answer. The Trustee’s first assertion is
therefore rejected.

The Trustee’s second assertion presents a difficult legal question — does the fact
that BHI was insolvent when the transfers were made to the Schmidts in exchange for their
stock in BHI establish as a matter of law that the Schmidts did not give value for the
transfers? Courts disagree about the meaning of “value” as used in § 550(b)(1). Some
courts hold that “value” is consideration sufficient to support a contract24 — that there is
no requirement for the value of the property received from the earlier transferee to be

monitor how their transferors obtained the property transferred would be impractical, and exposing them
to risk on account of earlier problems affecting the property would make commerce harder to conduct.).

22 Bonded Financial, 838 F.2d at 897; Lewis v. Zermano (In re Stevinson), 194 B.R. 509, 512-13,

D. Colo. 1996); Bakst v. Sawran (In re Sawran), 359 B.R. 348, 354-55 (Bankr. S.D. Fla. 2007).
23 Rodgers v. Monaghan Co. (In re Laguna Beach Motors, Inc.), 159 B.R. 562, 566 (Bankr. C.D.
Cal. 1993).
24 In re Enron, 333 B.R. at 236; Baldi v. Lynch (In re McCook Metals, L.L.C.), 319 B.R. 570, 590

n. 15 (Bankr. N.D. Ill. 2005).
13
Case 10-06225 Doc# 230 Filed 09/12/14 Page 13 of 19


reasonably equivalent to the value of the property given by the subsequent transferee.25
Other courts find that “value” requires a measure of equivalence, such as fair market value
or reasonably equivalent value.26 The Schmidts argue the Court should adopt the first
view, and the Trustee urges the adoption of the second view.

The Court finds those cases not requiring a measure of equivalence are better
reasoned. Section 550(b) contains no equivalence language; it requires only “value.” If
Congress intended to require equivalence, one would expect it to have said so, as it did in
other Code sections. As stated by one court,

[The omission of equivalence language in § 550(b)(1)] is
significant because Congress knows how to impose an
equivalence standard when it wants to. Section 549(c) of the
Code, for example, requires a transferee to have paid “present
fair equivalent value” to sustain a defense to an action to
recover a post-petition transfer. Similarly, section
548(a)(1)(B) renders fraudulent certain transfers received for
“less than a reasonably equivalent value.” When Congress
uses language in one part of a statute and omits it in another,
the omission is presumed to be intentional.27

This analysis is supported by the legislative history. The 1973 Report of the Commission
on the Bankruptcy Laws of the United States explained the proposal which became

25 Anderson v. SunTrust Mortgage, Inc. (In re Judd), 471 B.R. 830, 847 (D.S.C. 2012); CLC
Creditors’ Grantor Trust v. Howard Savings Bank (In re Commercial Loan Corp.), 396 B.R. 730, 743-44
(Bankr. N.D. Ill. 2008); Williams v. Mortillaro (In re Resource, Recycling & Remediation, Inc.), 314 B.R.
62, 70 (Bankr. W.D. Pa. 2004); Coleman v. Home Savings Ass’n (In re Coleman), 21 B.R. 832, 836
(Bankr. S.D. Tex. 1982).

26 Brown v. Harris (In re Auxano, Inc.), 96 B.R. 957, 965 (Bankr. W.D. Mo. 1989) (fair market
value); In re Laguna Beach Motors, 159 B.R. at 568 (reasonably equivalent value).


27 In re Commercial Loan Corp., 396 B.R. at 744.

14

Case 10-06225 Doc# 230 Filed 09/12/14 Page 14 of 19


§ 550(b) in part as follows: “Subdivision (b) states the liability, if any, of subsequent
transferees. If the subsequent transferee gives value in good faith, regardless of the
amount or whether present or past consideration, he is protected.”28 The cases relied upon
by the Trustee that interpret “value” to mean “fair market value” or “reasonably equivalent
value” are contrary to the legislative intent.

The absence of an equivalence standard is also supported by the purpose of
§ 550(b).29 It provides a defense similar to one available to purchasers of goods. Under
Article 2 of the Uniform Commercial Code, “a person with voidable title has power to
transfer a good title to a good faith purchaser for value.”30 The definition of “value”
includes “any consideration sufficient to support a simple contract”;31 there is no
equivalence requirement. Under Kansas law, a similar rule also applies to certain real
property transactions: in order for a grantee under a quitclaim deed to take advantage of
the recording laws and be considered a good faith purchaser for value, the consideration

28 Report of the Commission on the Bankruptcy Laws of the United States, H.R. Doc. No. 93-137,
93rd Cong. 1st Sess., Part II, Proposed Statutory Changes, § 4-609, n. 4 (1973), reprinted in App., Vol. B,
Collier on Bankruptcy, App. Pt 4(c) at p. App. Pt. 4-753.

29 The case relied upon by the Trustee for the proposition that “value” in § 550(b)(1) means “fair
market value” does so based upon the rationale that the purpose of § 550 is to preserve the assets of the
estate. In re Auxano, Inc., 96 B.R. at 965. But in this Court’s opinion, that rationale is misdirected.
Although the purpose of § 550 in general is preserving assets of the estate, the purpose of § 550(b)(1),
which imposes the requirement of “value,” is to provide protection to subsequent transferees of avoided
transfers. That protective purpose is fulfilled by construing “value” in subsection (b)(1) not to impose an
equivalence standard.

30 K.S.A. 84-2-403(1).

31 K.S.A. 2013 Supp. 84-1-204(4).

15

Case 10-06225 Doc# 230 Filed 09/12/14 Page 15 of 19


paid must have been valuable (not nominal), but it need not have been full or adequate.32
Furthermore, the Restatement (Third) of Restitution and Unjust Enrichment, which has
been followed by the Kansas appellate courts,33 recognizes being a purchaser for value
without notice as an affirmative defense to liability on restitution claims against the
property that would have been valid if the property had remained in the hands of the
grantor.34 When defining “value,” the Restatement says, in part: “Except as otherwise
provided by statue, a purchaser gives value for rights if they are acquired (a) in exchange
for present value, excluding nominal consideration.”35

The Trustee contends that because BHI was insolvent when the Schmidts received
the funds from BHI that are traceable to the avoided transfers from Brooke Corp to BHI,
summary judgment should be granted in his favor. The Schmidts respond by asserting that
stock of even an insolvent company may have value. They cite Commercial Loan36 in
support. In that case, four banks were stockholders of the debtor, Commercial Loan
Corporation (CLC), which was controlled by Hueser. Starting in 2001, Hueser began
purchasing all of the stock of CLC from the banks using CLC funds that had been
transferred to WK Financial, a corporation controlled by Hueser. CLC filed for Chapter

32 Morris v. Wicks, 81 Kan. 790, 791-94, 106 P.1048 (1910) (consideration of $1 was nominal).

33 Uhlmann v. Richardson, 48 Kan. App.2d 1, 7-12, 287 P.3d 287 (2012).

34 Restatement (Third) of Restitution and Unjust Enrichment, § 66 (2011).

35 Id., § 68.

36 In re Commercial Loan Corp., 396 B.R. 730.

16

Case 10-06225 Doc# 230 Filed 09/12/14 Page 16 of 19


11 bankruptcy relief in 2004, and a liquidating plan proposed by creditors was confirmed.
A liquidating trust created by the plan sued to recover the funds used to purchase the stock
from the banks. The banks moved for summary judgment. As to the value element of the
banks’ good-faith-transferee defense under § 550(b)(1), the court held that “value” did not
include any equivalence element and that the stock purchased by Hueser had value even
though CLC was insolvent. The court stated:

The stock was “value” because it constituted consideration
sufficient to support a simple contract. The Trust argues that
the stock had no value because CLC was insolvent at the time
of the sales, but stock in a corporation may have value even
though the corporation is insolvent (in the “balance sheet”
sense that its liabilities exceed its assets). The banks
established a prima facie case on the “value” element by
showing they gave up their stock. If CLC’s insolvency meant
the stock had no value, it was the Trust’s obligation to adduce
evidence showing as much. No evidence has been offered.37

The Commercial Loan court therefore found for the transferees on the value issue because
of the trust’s failure to provide evidence other than the fact of CLC’s insolvency.

The question in this case is whether “value” was given when the Schmidts
surrendered their BHI stock for redemption even though it has now been established that
BHI was insolvent at the time of the redemption. The Court finds Commercial Loan to be
instructive and rejects the Trustee’s argument that the statement in Commercial Loan that
the stock of an insolvent entity may have value is not good law. It is true, as argued by the

37 Id. at 743-44.

17

Case 10-06225 Doc# 230 Filed 09/12/14 Page 17 of 19


Trustee, that Commercial Loan relied upon Wabash Valley Power, 38 a 1995 Seventh
Circuit decision which that circuit recently noted has been abrogated in part by subsequent
Supreme Court decisions.39 But Wabash Valley addressed the value of the stock of an
insolvent corporation for purposes of the absolute priority rule, not § 550(b)(1). The Court
finds the general proposition that it is possible for the stock of an insolvent corporation to
have value for purposes of § 550(b)(1) to be reasonable. Nothing in § 550 requires the
adoption of a balance-sheet test for the value of stock transferred to the issuer for
redemption. For example, such stock could have value because of control issues or
because solvency is on the horizon.

The Court also finds the rationale of the bona-fide-payee defense of the
Restatement (Third) of Restitution and Unjust Enrichment to be helpful. It defines the
innocent-cash-payee defense by providing, in part, that “[a] payee without notice takes
payment free of a restitution claim to which it would otherwise be subject, but only to the
extent that (a) the payee accepts the funds in satisfaction or reduction of the payee’s valid
claim as creditor of the payor or of another person.”40 Under this definition, the defense is
not available to the recipient of a gift or a payment on an illegal contract, such as a

38 In re Wabash Valley Power Assoc., 72 F.3d 1305, 1318 (7th Cir. 1995).

39 In re Castleton Plaza, LP, 707 F.3d 821, 823-24 (7th Cir. 2013) (Wabash Valley abrogated to
extent it suggested that despite absolute priority rule, equity owners of Chapter 11 debtor could retain
their interests by contributing new value to debtor pursuant to reorganization plan without engaging in
competitive bidding for those interests).


40 Restatement (Third) of Restitution and Unjust Enrichment, § 67.

18

Case 10-06225 Doc# 230 Filed 09/12/14 Page 18 of 19


gambling obligation, because they are not valid claims against the payor.41 The Trustee
has not presented facts or argument showing that the redemption of the Schmidts’ stock in
BHI was either a gift or an illegal contract.

In this case, as in Commercial Loan, the Trustee has proven that BHI was insolvent,
not that the Schmidts gave no value for the transfers. The Trustee may ultimately prove
that the Schmidts gave no value, but at the summary judgment phase of this litigation, the
Court is unwilling to conclude that the Schmidts cannot prevail on the good-faithtransferee
defense premised solely on the fact of BHI’s insolvency. Although this fact will
undoubtedly make it more difficult for the Schmidts to prove the stock had value at the
time their stock was redeemed, it does not conclusively establish that the stock had no
value at that time.
CONCLUSION.

For the foregoing reasons, the Court denies the Trustee’s motion for summary
judgment against Defendants Steven and Wanda Schmidt.

IT IS SO ORDERED.
# # #


41 Id., Illustrations 2 & 11.
19
Case 10-06225 Doc# 230 Filed 09/12/14 Page 19 of 19

13-06094 Rajala, Chapter 7 Trustee v. National Association of Postal Supervisors Branch (Doc. # 46)

13-06094 Rajala, Chapter 7 Trustee v. National Association of Postal Supervisors Branch (Bankr. D. Kan. Jul. 11, 2014) Doc. # 46

PDFClick here for the pdf document.


 

SO ORDERED.
SIGNED this 11th day of July, 2014.

 

Opinion Designated for Print and On-Line Publication
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS


In Re:

ROSEMARY ANN KROUSE,
DEBTOR.

ERIC C. RAJALA, Chapter 7 Trustee,
PLAINTIFF,

v.
NATIONAL ASSOCIATION OF
POSTAL SUPERVISORS BRANCH 458,
DEFENDANT.

CASE NO. 13-20356
CHAPTER 7

ADV. NO. 13-6094

MEMORANDUM OPINION AND ORDER
GRANTING THE PLAINTIFF'S MOTION FOR SUMMARY JUDGMENT AND
DENYING THE DEFENDANT'S MOTION FOR SUMMARY JUDGMENT


In this adversary proceeding, Plaintiff Eric C. Rajala, Chapter 7 Trustee (Trustee),
seeks to avoid under 11 U.S.C. § 548(a)(1)(B) and recover under § 550(a) a transfer of

Case 13-06094 Doc# 46 Filed 07/11/14 Page 1 of 13


$15,000 made by Debtor to Defendant National Association of Postal Supervisors Branch
458 (NAPS) immediately before the filing of Debtor’s bankruptcy petition. Both the
Trustee and NAPS have moved for summary judgment. The relevant facts are
uncontroverted. The motions present the legal question whether the Trustee may avoid as
a fraudulent transfer a prepetition payment of funds which Debtor could have claimed as
exempt if the transfer had not been made. For the reasons examined below, the Court
concludes that the Trustee may avoid such a transfer. The Court has jurisdiction.1

UNCONTROVERTED FACTS.

Debtor signed her voluntary petition under Chapter 7 on February 15, 2013, and
her counsel filed it on February 20, 2013, at 3:03 pm. One of the assets listed on Debtor’s
Schedule B is “life insurance proceeds US Bank” valued at $147,000.

On February 8, 2013, Debtor received a check from the Office of Federal
Employee’s Group Life Insurance for $147,670.77, representing the proceeds of Debtor’s
claim for life insurance arising from the death of her husband on December 31, 2012. On
February 8, 2013, Debtor deposited the check into her US Bank savings account. On the
morning of February 20, 2013, before the petition was filed, Debtor purchased two

1 This Court has jurisdiction over the parties and the subject matter pursuant to 28 U.S.C.
§§ 157(a) and 1334(a) and (b), and the Amended Standing Order of Reference of the United States
District Court for the District of Kansas that exercised authority conferred by § 157(a) to refer to the
District’s bankruptcy judges all matters under the Bankruptcy Code and all proceedings arising under the
Code or arising in or related to a case under the Code, effective June 24, 2013. D. Kan. Standing Order
13-1, printed in D. Kan. Rules of Practice and Procedure at 168 (March 2014). Furthermore, this Court
may hear and finally adjudicate this matter because it is a core proceeding pursuant to 28 U.S.C.
§ 157(b)(2)(H). There is no objection to venue or jurisdiction over the parties.

2

Case 13-06094 Doc# 46 Filed 07/11/14 Page 2 of 13


cashier’s checks from US Bank for a total of $67,350. One cashier’s check, in the
amount of $51,750, was made payable to Wanda O’Brien for payment of Debtor’s
husband’s debt to Ms. O’Brien. Debtor delivered the check to Ms. O’Brien, who
deposited it into her US Bank checking account on February 20, 2013, at 11:45 a.m.,
several hours before Debtor’s petition was filed. The second cashier’s check, in the
amount of $15,600, was made payable to NAPS for payment of Debtor’s husband’s debt
to NAPS. Debtor delivered the check to NAPS, which deposited it into its Brotherhood
Bank checking account on February 20, 2013, at 2:30 p.m., approximately one-half hour
before Debtor’s petition was filed. Neither the transfer to Wanda O’Brien nor the transfer
to NAPS was disclosed by Debtor in her schedules or statement of financial affairs filed
on February 20, 2013. As a result of the purchases of the cashiers’ checks, when
Debtor’s petition was filed at 3:03 p.m. on February 20, 2013, she had in her US Bank
account net life insurance proceeds of $80,320.77.

On her Schedule C, Debtor claimed $147,000 to be exempt under K.S.A. 602313(
a)(7). The Trustee objected to the exemption of the portion of the life insurance
proceeds which had been transferred prepetition. The Court sustained the objection and
ruled that the exemption is limited to $80,320.77, the amount of the life insurance
proceeds in Debtor’s possession when the Chapter 7 petition was filed.

Debtor’s schedules showed $153,301 owed to creditors, real property valued at

3


Case 13-06094 Doc# 46 Filed 07/11/14 Page 3 of 13


$60,690 (subject to a secured claim of $52,514),2 and personal property valued at
$152,556, comprised primarily of the $147,000 life insurance proceeds,3 only $80,320.77
of which was in her possession. After investigation, the Trustee determined that as of the
filing date, Debtor’s nonexempt property consisted of nonexempt funds in her bank
accounts of $1,219.26 and a 1994 Ford Van 150 Econoline having a fair value of $750.4
In its reply brief filed out of time,5 NAPS states that the amount owed to Debtor’s
creditors and the value of Debtor’s nonexempt assets are controverted, but provides
nothing of evidentiary value in support. The Court will therefore regard as
uncontroverted that on the date Debtor filed her petition, she owed her creditors $153,301
and had non-exempt property valued at $1,969.26.

DISCUSSION.

The Trustee seeks to avoid the payment to NAPS under § 548(a)(1)(B). It

provides:

(a)(1) The trustee may avoid any transfer . . . of an

interest of the debtor in property . . . that was made . . . on or

within 2 years before the date of filing of the petition, if the

debtor voluntarily or involuntarily —

. . .

(B)(i) received less than a reasonably equivalent value

in exchange for such transfer . . . ; and

2 Case no. 13-20356, Doc. 1 at 7, Schedule A.
3 Id. at 8-12, Schedule B.
4 Doc. 37 at 5.
5 Doc. 38 (filed on May 29, 2014, more than 21 days after the Trustee filed a memorandum in


support of his motion for summary judgment on April 25, 2014).
4

Case 13-06094 Doc# 46 Filed 07/11/14 Page 4 of 13


(ii) (I) was insolvent on the date that such transfer was
made . . . , or became insolvent as a result of such transfer.
This subsection allows a bankruptcy trustee to set aside constructively fraudulent
transfers — transfers which are not “infected by actual fraud”6 but are made by insolvent
debtors.
It permits avoidance if the trustee can establish (1) that the
debtor had an interest in property; (2) that a transfer of that
interest occurred within [two years] of the filing of the
bankruptcy petition; (3) that the debtor was insolvent at the
time of the transfer or became insolvent as a result thereof;
and (4) that the debtor received ‘less than a reasonably
equivalent value in exchange for such transfer.’7

The uncontroverted facts establish these elements. On February 20, 2013, Debtor
delivered a cashier’s check in the amount of $15,600 to NAPS to pay the debt of her late
husband to NAPS. The funds used to purchase the cashier’s check were proceeds of life
insurance paid to Debtor which had been deposited in a segregated account. NAPS
deposited the check into its checking account on February 20, 2013, at 2:30 pm,
approximately one-half hour before Debtor’s petition was filed. The facts therefore
establish that Debtor made a transfer of an interest in her property to NAPS, that the
transfer occurred less than two years prepetition, and that Debtor received less than a
reasonably equivalent value in exchange, since the debt was owed by Debtor’s late
husband, not by Debtor. Further, the facts establish that Debtor was insolvent on the date

6 BFP v. Resolution Trust Corp., 511 U.S. 531, 535 (1994).
7 Id.


5

Case 13-06094 Doc# 46 Filed 07/11/14 Page 5 of 13


of the transfer because Debtor’s debts then exceeded the value of all her nonexempt
property.

Even though all the elements of a constructively fraudulent transfer are present,
NAPS contends that the Trustee may not avoid the transfer because the funds transferred
were exempt proceeds of life insurance. NAPS argues, “Because the life insurance
proceeds received by the Debtor were exemptible property and not subject to the attacks
of creditors, the payment to NAPS could not be fraudulent as a matter of law under
§ 548(a).”8 NAPS relies on cases holding that a trustee cannot avoid such a transfer under
§ 548(a)(1)(A) because a transfer of exempt property cannot be made with the actual
intent to hinder, delay, or defraud creditors,9 and cases reasoning that to permit avoidance
“would allow the Debtor’s creditors to indirectly, through the trustee, defeat the Debtor’s
state law exemption . . . when they could not do this acting on their own.”10

The Trustee’s response is two fold.11 First, he contends that NAPS is in effect

8 Doc. 35 at 5.

9 Kepler v. Weis (In re Weis), 92 B.R. 816, 822-23 (Bankr. W.D. Wis. 1988) (transfer of exempt
property could not be avoided under § 548(a)(1) as a matter of law because transfer could not have been
made with actual intent to hinder, delay, or defraud creditors); Malone v. Short (In re Short), 188 B.R.
857 (Bankr. M.D. Fla. 1995) (transfer of homestead that was exempt at the time of transfer cannot be
avoided under § 548(a)(1) as having been made with the intent to hinder, delay, or defraud creditors).
After these cases were decided, § 548(a) was amended and § 548(a)(1) was redesignated as
§ 548(a)(1)(A). See Religious Liberty and Charitable Donation Protection Act of 1998, Pub. L. No. 105183,
§ 3(a), 112 Stat. 517 (1998), reprinted in App. F, Pt. 41(o), Collier on Bankruptcy, App. Pt. 41(o)(ii)
at App. Pt. 41-255 (Alan N. Resnick & Henry J. Sommer, eds.-in-chief, 16th ed. 2012).

10 Doc. 35 at 6 (citing Jarboe v. Treiber (In re Treiber), 92 B.R. 930, 933-34 (Bankr. N.D. Okl.
1988), Silagy v. Marzilli (In re Hunter), 2008 WL 2076750, *2 (Bankr. N.D. Ohio May 15, 2008); and
Rutledge v. Johansen, 270 F.2d 881, 882-83 (10th Cir. 1959)).

11 See doc. 37.

6

Case 13-06094 Doc# 46 Filed 07/11/14 Page 6 of 13


asserting Debtor’s exemption rights, that such rights are personal to Debtor, and NAPS is
therefore precluded from asserting that the exempt nature of the transferred funds bars the
Trustee’s complaint. For this position, the Trustee relies upon an unpublished decision of
the Tenth Circuit BAP.12 Second, the Trustee argues that the Court should reject those
decisions holding that Debtor’s prepetition transfer of exemptible property cannot be
avoided. The Trustee relies on case law13 and §§ 522(g)(1), 541(a)(1), and 522(b)(1) and
(b)(3).

NAPS has failed to address the Trustee’s first argument,14 but both parties have
fully briefed the question whether prepetition transfers of exemptible property are
amenable to avoidance and recovery actions by bankruptcy trustees. The Court will
resolve this case on its merits by ruling on this issue, rather than on the issue of NAPS’s
standing to assert Debtor’s exemption rights.

One of the cases cited by NAPS in support of its position that transfers of
exemptible property cannot be the object of avoidance actions is Rutledge, 15 a 1959
decision of the Tenth Circuit Court of Appeals, which would be very persuasive in this

12 Morris v. First Nat’l Bank and Trust (In re Taylor), 1998 WL 123027 (10th Cir. BAP March
19, 1998).

13 Id.; Tavenner v. Smoot, 257 F.3d 401 (4th Cir. 2001).

14 NAPS filed its own motion for summary judgment and brief in support (doc. 35) but failed to
timely reply to the Trustee’s response to NAPS’s motion and cross-motion for summary judgment (doc.
37). NAPS’s out-of-time reply (doc. 38) does not address Taylor, the case relied upon by the Trustee for
the proposition that NAPS is precluded from asserting the exempt nature of the funds.

15 270 F.2d 881.

7

Case 13-06094 Doc# 46 Filed 07/11/14 Page 7 of 13


case if it were still good law. In Rutledge, the bankruptcy trustee brought an action to
recover exempt homestead property that the debtor had transferred to a creditor for an
antecedent debt within four months preceding bankruptcy. The trial court found that all
elements of a voidable preference were present but held the transfer could not be avoided
because the property transferred was exempt under Oklahoma law. On appeal by the
trustee, the Tenth Circuit affirmed, applying the “textbook law . . . that ‘a transfer of
exempt property of a debtor, though it is to a creditor and to apply to an antecedent
indebtedness, does not give rise to a voidable preference.’”16 The Circuit noted that the
rule was “grounded in the legal concept that property exempt by law remains in the
bankrupt, does not pass to the trustee, and the bankrupt’s disposition of it prior to
bankruptcy is therefore of no concern to the trustee or the creditors he represents.”17 To
allow the avoidance of the preferential payment “would deny to the bankrupt the right to
accomplish before bankruptcy that which he could clearly do after bankruptcy. Surely, if
a bankrupt is entitled to have exempt property of which he is seized at the time of filing of
the bankruptcy set apart from the bankruptcy estate, he is entitled to make a valid transfer
of it prior to the date of the filing.”18 The Rutledge view has been referred to as the “no
harm, no foul” doctrine.19 Courts have applied the doctrine not only in preference actions

16 Id. at 882 (quoting Remington on Bankruptcy, Vol. 4, § 1678).
17 Id.
18 Id.
19 E.g., Tavenner v. Smoot, 257 F.3d at 406.


8

Case 13-06094 Doc# 46 Filed 07/11/14 Page 8 of 13


but also in actions to recover fraudulent conveyances of exempt property.20

This Court finds Rutledge not to be applicable. Since 1959, when Rutledge was
decided, the Bankruptcy Act that was then in effect has been repealed, and replaced with
the current Bankruptcy Code, enacted in 1978. An analysis of the Code shows the
invalidity of the “no harm, no foul” doctrine under current law. Contrary to the rationale
of Rutledge, § 541 now defines property of the estate to include all property of the debtor,
including property which the debtor may exempt. The estate also includes any interest in
property which the trustee recovers under § 550, which provides that to the extent a
transfer is avoided under §§ 544, 545, 547, 548, 553(b) or 724(a), the trustee may recover
such property or its value for the benefit of the estate. Section 522(g) allows the debtor to
exempt property so recovered by the trustee to the extent such property could have been
exempted if it had not been transferred, providing that the transfer was not a voluntary
transfer by the debtor and the debtor did not conceal such property. If transfers of
potentially exempt property could not be recovered by the trustee, no purpose would be
served by § 522(g). Under the Code, the avoidance of a debtor’s voluntary transfer of
property which the debtor could have exempted now augments the estate for the benefit
of all creditors. A voluntary transfer is in effect a waiver of the right to exempt the
property. In addition, under the Code, potentially exempt property may become available

20 Malone v. Short (In re Short), 188 B.R. 857, 859-60 (Bankr. M.D. Fla. 1995) (transfer of
homestead that was exempt at the time of transfer cannot be avoided as having been made with the intent
to hinder, delay, or defraud creditors); Kapila v. Fornabaio (In re Fornabaio), 187 B.R. 780, 782 (Bankr.

S.D. Fla. 1995) (although debtor transferred exempt property for less than reasonably equivalent value
when insolvent, the transfer could not be avoided by trustee).
9

Case 13-06094 Doc# 46 Filed 07/11/14 Page 9 of 13


to creditors if the debtor fails to assert the exemption. The label “no harm, no foul” is
now a misnomer; to disallow avoidance may result in the diminution of the estate and be
contrary to the goal of making an equitable distribution to creditors.

The legislative history of the Code fully supports the rejection of the “no harm, no
foul” doctrine. In 1970, Congress created the Commission on the Bankruptcy Laws of
the United States to “study, analyze, evaluate, and recommend changes to the [1898
Bankruptcy] Act.”21 The Commission’s recommendations provided the basic structure of
the new Code that was enacted in 1978. Whereas under the Act, exempt property was not
included in the estate,22 the Commission recommended that the Code should provide for
the estate to include all property of the debtor on the date of filing, including property
which the debtor claims is exempt, and also include property which the trustee recovers
under § 550.23 One of the Commission’s recommendations was to overrule the cases
holding that “a transfer of exempt property cannot be a preference.”24 The report stated:

There is no valid reason supporting the case law that is being
overruled; the mere fact that the property used to prefer a
creditor may be claimed as exempt does not establish a reason
why preference attack is not appropriate. The goals of
equality and avoidance of unwise extensions of credit would
be furthered by allowing preference attack. The only rationale

21 Joint Resolution, Pub. L. 91-354, 84 Stat. 468-469 (July 24, 1970).
22 See Rutledge, 270 F.2d at 882.
23 11 U.S.C. § 541(a)(1) and (3).
24 Report of the Commission on the Bankruptcy Laws of the United States, July 1973, 93d Cong.,


1st Sess., H.R. Doc. 93-137, pt. I, at Ch. 8(E)(3)(c), reprinted in App. B, Pt. 4(c) Collier on Bankruptcy,
at App. Pt. 4-465.
10

Case 13-06094 Doc# 46 Filed 07/11/14 Page 10 of 13


for the cases is that other creditors are not hurt since they are
not entitled to expect payment or security from exempt
property.25

Although cases decided since the adoption of the Code have not uniformly rejected
the “no harm, no foul” doctrine, the majority of cases has done so.26 In Tavenner 27 the
Fourth Circuit Court of Appeals noted the split of authority but found the “majority
position — that transfers of exemptible property are amenable to avoidance and recovery
actions by bankruptcy trustees — is better reasoned.”28 It did so for two reasons. First,
§ 522(g) anticipates this result, since it permits the debtor under certain circumstances to
exempt property recovered by the trustee. Second, the “no harm, no foul” approach is
misguided. “Under a statutory scheme in which all property is presumed to be part of the
bankruptcy estate, and no property is exempt until such time as the debtor claims an
exemption for it, creditors can be harmed by transfers of potentially exempt property
because it is not a foregone conclusion that such property will be exempt from the
estate.”29 The Tenth Circuit BAP, in an unpublished decision, held that the fact that the

25 Id.

26 Maxwell v. Barounis (In re Swiontek), 376 B.R. 851, 865 n. 8 (Bankr. N.D. Ill. 2007)
(collecting cases). One of the cases cited as adopting the majority view is Redmond v. Tuttle, 698 F.2d
414 (10th Cir. 1983), in which, without mentioning the “no harm, no foul” doctrine, the Tenth Circuit
ruled the debtors’ attempted exemption of property the trustee recovered that they had transferred
prepetition must be denied under § 522(g) because the transfer had been voluntary.

27 257 F.3d 401.

28 Id. at 406.

29 Id. at 407.

11

Case 13-06094 Doc# 46 Filed 07/11/14 Page 11 of 13


debtors claimed a vehicle as exempt “did not affect the Trustee’s right to avoid the
Bank’s [unperfected] lien under section 544(a).”30 It relied upon §§ 541 and 522b) but
did not cite Rutledge or any cases either accepting or rejecting the “no harm, no foul”
doctrine.

This Court is persuaded that the majority is correct, and prepetition transfers of
property which the debtor could have claimed as exempt are avoidable by the trustee if
the elements of constructively fraudulent transfers under § 548(a)(1)(B) are satisfied. The
construction of §§ 541 and 522(g), together with the accompanying legislative history,
compel this result.

For the foregoing reasons, the Court declines to apply the “no harm, no foul”
doctrine to this action under § 548(a)(1)(B) and holds that the Trustee’s avoidance of
Debtor’s constructively fraudulent transfer to NAPS of $15,000 before she filed her
bankruptcy petition is not precluded because the funds transferred could have been
claimed as exempt if the transfer had not been made. The Trustee’s motion for summary
judgment is therefore granted, and NAPS’s motion for summary judgment is denied. The
Trustee may avoid the transfer to NAPS under § 548(a)(1)(B) and recover the same from
NAPS for the benefit of the estate under § 550(a).

The foregoing constitute Findings of Fact and Conclusions of Law under Rule
7052 of the Federal Rules of Bankruptcy Procedure, which makes Rule 52(a) of the

30 In re Taylor, 1998 WL 123027 at *2.
12


Case 13-06094 Doc# 46 Filed 07/11/14 Page 12 of 13


Federal Rules of Civil Procedure applicable to this proceeding. A judgment based upon
this ruling will be entered on a separate document as required by Federal Rule of
Bankruptcy Procedure 7058, which makes Federal Rule of Civil Procedure 58 applicable
to this proceeding.

IT IS SO ORDERED.
# # #


13

Case 13-06094 Doc# 46 Filed 07/11/14 Page 13 of 13



10-06225 Redmond, Brooke Trustee v. Brooke Holdings, Inc. et al (Doc. # 228)

Redmond, Brooke Trustee v. Brooke Holdings, Inc. et al, 10-06225 (Bankr. D. Kan. Sep. 12, 2014) Doc. # 228

PDFClick here for the pdf document.


SO ORDERED.
SIGNED this 12th day of September, 2014.

 

Opinion Designated for Electronic Use, But Not for Print Publication
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS


In Re:

BROOKE CORPORATION, et al.,
DEBTORS.

CHRISTOPHER J. REDMOND,
Chapter 7 Trustee of Brooke
Corporation, Brooke Capital
Corporation, and Brooke Investments,
Inc.,

PLAINTIFF,

v.
BROOKE HOLDINGS, INC., et al.,

 DEFENDANTS.

CASE NO. 08-22786
CHAPTER 7

ADV. NO. 10-6225

MEMORANDUM OPINION AND ORDER GRANTING
DEFENDANTS STEVEN AND WANDA SCHMIDT’S MOTION TO
FILE AMENDED (SUPPLEMENTAL) ANSWER TO COMPLAINT,
AND ALLOWING THE TRUSTEE ADDITIONAL TIME FOR DISCOVERY


Case 10-06225 Doc# 228 Filed 09/12/14 Page 1 of 6


In this action, the Trustee seeks to avoid allegedly preferential transfers and
constructively fraudulent conveyances made by Debtor Brooke Corporation (Brooke
Corp) to Defendant Brooke Holdings, Inc. (BHI) and to recover part of those avoided
transfers from Defendants Steven and Wanda Schmidt (the Schmidts) under 11 U.S.C.
§ 550 as subsequent transferees of BHI. The Schmidts request leave of the Court under
Federal Rule of Bankruptcy Procedure 7015 to file an amended answer asserting the goodfaith-
transferee defense of § 550(b)(1).1 The Trustee opposes the motion.2 Argument was
held on June 18, 2014. For the reasons stated below, the Court grants the motion.3

PROCEDURAL BACKGROUND.

The complaint was filed on October 26, 2010. The Schmidts’ original answer was
filed on May 2, 2011. It did not assert a defense under § 550(b)(1). On August 13, 2013,
the Schmidts’ present counsel entered his appearance. Pursuant to the scheduling order,
the deadline for the parties to amend their pleadings expired two days later. After several
extensions of time, discovery closed on April 3, 2014, and on the same day, the Trustee
filed his motion for summary judgment against the Schmidts and BHI. On May 16, 2014,

1 The Schmidts appear by J. Michael Morris of Klenda Austerman LLC.

2 The Trustee appears by Michael D. Fielding of Husch Blackwell LLP.

3 This Court has jurisdiction pursuant to 28 U.S.C. §§ 157(a) and 1334(a) and (b), and the
Amended Standing Order of Reference of the United States District Court for the District of Kansas that
exercised authority conferred by § 157(a) to refer to the District’s bankruptcy judges all matters under the
Bankruptcy Code and all proceedings arising under the Code or arising in or related to a case under the
Code, effective June 24, 2013. D. Kan. Standing Order 13-1, printed in D. Kan. Rules of Practice and
Procedure at 168 (March 2014). Efforts to avoid or recover preferences and fraudulent conveyances are
core proceedings which this Court may hear and determine as provided in 28 U.S.C. § 157(b)(2)(F) and
(H). There is no objection to venue or jurisdiction over the parties.

2

Case 10-06225 Doc# 228 Filed 09/12/14 Page 2 of 6


the due date for the Schmidts to respond to the motion for summary judgment, the
Schmidts filed their motion for leave to amend their answer.

The Schmidts seek to amend their answer to add the following paragraph:

115. Steven R. and Wanda R. Schmidt further assert
that they are immediate or mediate transferees of the initial
transferee (BHI), and that any funds transferred to them from
BHI as alleged in the Complaint were taken for value, in good
faith, and without knowledge of the voidability of any transfer
avoided. The trustee may, therefore, have no recovery from
them pursuant to 11 USC § 550(b)(1).
The Schmidts argue that no prejudice will result to the Trustee by the amendment since he
had actual notice of the defense and has conducted discovery on it. The Trustee opposes
the motion. He responds that the Schmidts have not shown any cause to amend the
scheduling order that set the deadline to amend pleadings. He also argues that the
Schmidts unduly delayed in seeking the amendment, that he would be prejudiced by the
amendment, and that the amendment, if allowed, would be futile.

DISCUSSION.
Two bankruptcy procedural rules are applicable, Rule 7016 and Rule 7015. Rule
7016 adopts Civil Rule 16, Pretrial Conferences; Scheduling; Management. Subsection

(b) of Rule 16 addresses scheduling, and subsection (b)(4) addresses modification of a
scheduling order. It provides: “(4) Modifying a Schedule. A schedule may be modified
only for good cause and with the judge’s consent.” Rule 7015 adopts Civil Rule 15,
Amended and Supplemental Pleadings. Subsection (a) of Rule 15 provides:
(a) Amendments Before Trial.
3

Case 10-06225 Doc# 228 Filed 09/12/14 Page 3 of 6


(1) Amending as a Matter of Course. A party may amend its
pleadings once as a matter of course within:
(A) 21 days after serving it, or
(B) if the pleading is one to which a responsive pleading is
required, 21 days after service of a responsive pleading or 21
days after service of a motion under Rule 12(b), (e), or (f),
whichever is earlier.
(2) Other Amendments. In all other cases, a party may amend its
pleading only with the opposing party’s written consent or the court’s
leave. The court should freely give leave when justice so requires.
Of the two rules, Rule 16 sets the more stringent standard, authorizing amendment of the
scheduling order only for “good cause.” Rule 15 provides that leave to amend pleadings
should be freely given when justice so requires. “Refusing leave to amend is generally
only justified upon a showing of undue delay, undue prejudice to the opposing party, bad
faith or dilatory motive, failure to cure deficiencies by amendments previously allowed, or
futility of amendment.”4

Three factors combine to convince the Court that the amendment should be allowed
under these standards. First, the affirmative defense of § 550(b)(1) is essential to the
Schmidts’ defense. Absent the ability to assert the defense, the Schmidts will be strictly
liable to the Trustee if they are subsequent transferees of funds BHI received in an avoided
transfer from Brooke Corp. Second, the Court finds that the Trustee had notice that the
Schmidts intended to rely upon the defense, even though it was not alleged in their answer.
At argument on the Schmidts’ motion, although the Trustee stated he could find no

4 Frank v. U.S. West, Inc., 3 F.3d 1357, 1365 (10th Cir.1993).
4


Case 10-06225 Doc# 228 Filed 09/12/14 Page 4 of 6


correspondence regarding the defense, he did not dispute having notice that the Schmidts
would assert the defense. Questions posed to the Schmidts in depositions taken by the
Trustee include those relevant to the defense. Third, the deadlines established in the
scheduling order in this case for matters other than the filing of amended pleadings have
been extended numerous times upon the request of the Trustee.

The Court therefore finds that there is cause to amend the scheduling order as
requested by the Schmidts. The Court finds no bad faith or dilatory conduct of the
Schmidts. The assertion of the Schmidts’ counsel, who did not prepare the initial answer,
that he believed the defense had been alleged until he received and reviewed the Trustee’s
motion for summary judgment is credible. As set forth in the Court’s separate
memorandum opinion and order denying the Trustee’s motion for summary judgment, the
Court finds that allowing the amendment will not be futile.

Any prejudice to the Trustee that might result from the amendment can be avoided
by allowing the Trustee to engage in any additional discovery which he deems appropriate
in light of this ruling allowing the § 550(b)(1) defense. The Court therefore extends the
discovery deadline for the Trustee to 60 days after the entry of this memorandum opinion
and order for the sole purpose of developing facts related to the §550(b)(1) defense. The
Schmidts may not conduct additional discovery.

The Schmidts’ motion for leave to amend their answer to add the paragraph as
stated in their motion is granted. The Trustee is granted 60 days from the entry of this
order to conduct additional discovery relevant to the newly-added affirmative defense.

5

Case 10-06225 Doc# 228 Filed 09/12/14 Page 5 of 6


IT IS SO ORDERED.

# # #

6

Case 10-06225 Doc# 228 Filed 09/12/14 Page 6 of 6

09-06043 Posl-Bendsen et al v. Leonard et al (Doc. # 229)

Posl-Bendsen et al v. Leonard et al, 09-06043 (Bankr. D. Kan. Jun. 13, 2014) Doc. # 229

PDFClick here for the pdf document.


 

________________________________________________________________________________________________________________________________________________________
SO ORDERED.
SIGNED this 12th day of June, 2014.


For on-line use but not print publication
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS


In Re:
DAVID TODD LEONARD and
MICHELLE LEIGH LEONARD,
DEBTORS.

JANICE POSL-BENDSEN, by John R.
Kurth, guardian and conservator; and
JOHN R. KURTH, Trustee of the Janice
Posl-Bendsen Revocable Living Trust,

PLAINTIFFS

v.
DAVID TODD LEONARD and
MICHELLE LEIGH LEONARD,
DEFENDANTS.

CASE NO. 09-20190
CHAPTER 7

ADV. NO. 09-6043

MEMORANDUM OPINION AND ORDER
DENYING PLAINTIFFS’ COMPLAINT


Case 09-06043 Doc# 229 Filed 06/12/14 Page 1 of 33


In this adversary proceeding, creditors Janice Posl-Bendsen, by John R. Kurth, her
guardian and conservator, and John R. Kurth as the Trustee of the Janice Posl-Bendsen
Revocable Living Trust object to the discharge of their claim against Defendants David
Todd Leonard and Michelle Leigh Leonard (Debtors or Defendants) under 11 U.S.C.
§ 523(a)(2)(A) and (a)(4), and also seek an order denying Debtors’ discharges under
§ 727(a)(4).1 Trial was held on February 28, 2014. Plaintiffs appeared by Patrick E.
Henderson, and Defendants appeared pro se. The parties stipulated to the jurisdiction of
the Court, and consented to the trial and entry of a final order by the bankruptcy court.2
For the reasons discussed below, the Court rules in favor of Defendants on all counts.
FINDINGS OF FACT.

The Court makes its findings of fact based on the stipulations in the pretrial order,
the exhibits of both Plaintiffs and Defendants which were admitted without objection, and
the testimony of John Kurth and David Leonard. The Court has also considered the posttrial
brief filed by Plaintiffs arguing their contentions.3 Defendants’ brief in response has

1 Additional claims alleged in the complaint were withdrawn by Plaintiffs in the pretrial order.
Doc. 218.

2 Doc. 218. Further, this Court has jurisdiction over the parties and the subject matter pursuant to
28 U.S.C. §§ 157(a) and 1334(a) and (b), and the Amended Standing Order of Reference of the United
States District Court for the District of Kansas that exercised authority conferred by § 157(a) to refer to
the District’s bankruptcy judges all matters under the Bankruptcy Code and all proceedings arising under
the Code or arising in or related to a case under the Code, effective June 24, 2013. D. Kan. Standing
Order 13-1, printed in D. Kan. Rules of Practice and Procedure at 168 (March 2014). Furthermore, this
Court may hear and finally adjudicate this matter because it is a core proceeding pursuant to 28 U.S.C.
§ 157(b)(2)(I) and (J).

3 Doc. 222.

2

Case 09-06043 Doc# 229 Filed 06/12/14 Page 2 of 33


largely been disregarded because it is a recitation of facts not in the trial record.4 The
Court finds the testimony of both witnesses to be credible. Janice Posl-Bendsen (Janice)
was not available to testify, either in person or by deposition, because she suffers from
advanced cognitive impairment secondary to dementia, and also has medical conditions
which require 24-hour supervision and monitoring. She is residing in a care facility in
Las Vegas, Nevada. Janice’s unavailability created significant impediments to the
presentation of both Plaintiffs’ and Defendants’ cases. On January 30, 2009, after the
events which gave rise to this litigation occurred, John R. Kurth, Janice’s son, was
appointed as her guardian and conservator by order of the District Court of Atchison
County, Kansas.5

Debtor David Todd Leonard (David) is Janice’s second cousin.6 He was employed
by Countrywide as a branch manager from 2002 until May 2007. David and his wife
Michelle Leigh Leonard (Michelle) have four children. Michelle was not employed
outside the home. David and Janice had occasional contact while they were children. In
2000, the relationship was re-established, and Janice began visiting Debtors and spending
time with them and their children.

In 2004 or earlier, Janice inherited over $6 million in Bank of America stock.
Also in 2004, Janice started the practice of annually giving each member of the Leonard

4 Doc. 227.

5 Doc. 1, ¶¶ 8-11.

6 Janice referred to David Todd Leonard as Todd Leonard.

3

Case 09-06043 Doc# 229 Filed 06/12/14 Page 3 of 33


family $10,000, the maximum annual gift tax exclusion at that time. On May 12, 2004,
Janice wrote a letter to Michelle and Todd, stating, “I am so lucky to have all of you in
my life. I’ve needed to be an Auntie Janice for a long time. The kids are such fun and I
do enjoy them. Michelle, you were a delight to have on the trip.”7

John Kurth has not had a good relationship with his mother. During 2003 through
2005, he probably communicated with her quarterly. He did not recall discussing
Janice’s relationship with Debtors with her. John was afraid that Janice would quickly
spend her inheritance because she was not thrifty and had been waiting a long time for the
inheritance. Although John suggested she control her spending, he never directly
suggested what she should do and did not want to be involved in the management of her
property.

In correspondence, Janice referred to herself as “Eccentric Janice.”8 David
testified that Janice was very eccentric, demanding, and volatile. John testified that she
was determined and headstrong. According to John, Janice has exhibited a pattern
throughout her life of befriending people, then getting angry at them and excluding them
from her life, only to bring them back into the picture after a year or two as if nothing had
happened. Those in Janice’s favor experienced her generosity, while those she did not
favor were the object of her vindictiveness. John testified that Janice’s relationship with
Lynda Leonard, David’s mother, exhibited the pattern of abrupt changes in relationships.

7 Exh. 56.

8 Exh. 52.

4

Case 09-06043 Doc# 229 Filed 06/12/14 Page 4 of 33


In 2001, Janice executed a Last Will and Testament granting the residue of her estate to
Lynda, but in her Revocable Living Trust Agreement, executed in May 2006, she directed
that the residue should go to David and Michelle, and expressly stated that none of it
should be used for the benefit of Lynda.9

Leonard & Bendsen, LLC, a Nevada limited liability company, was formed on
September 29, 2005, for the purpose of holding and trading Janice’s assets. The articles
of organization list Janice as the only member,10 but a corporation details sheet from the
Nevada Secretary of State obtained on April 30, 2007, includes David as a member.11
David testified that Janice was the 100% owner. A MasterTrader.com account was
opened in the name of Leonard & Bendsen, LLC. David also established Fit Trade, LLC,
for the purpose of trading stocks; he was the only member of this company.

On May 31, 2006, Janice executed a Revocable Living Trust Agreement,
establishing her Trust.12 Janice was the sole trustee. Janice’s controlling and vindictive
nature is evidenced by the unusual terms in the Trust concerning John. Upon Janice’s
death, the only gift to John is accomplished by a direction to the trustee to purchase a new
bass boat for John for a total price not to exceed $40,000, reduced by the fair market
value of any bass boat owned by John at the time of Janice’s death. The Trust further

9 Exh. A at Article VII(B).

10 Exh. G at 2.

11 Id. at 5.

12 Exh. 1.

5

Case 09-06043 Doc# 229 Filed 06/12/14 Page 5 of 33


directs that the funds be paid directly to the boat dealer and that before delivery of the
boat, the trustee name the boat “The Endora” and have the name professionally painted
on the boat. The Trust provides that upon Janice’s death, the balance of the tangible
personal property remaining after the payment of Trust obligations and taxes shall be
distributed to “Todd Leonard and Michelle Leonard, or the survivor of the two of them if
one of them dies before” Janice, and the residue of any real and personal property not
otherwise disposed of shall go into an education trust for Debtors’ descendants, up to
$200,000, and the balance shall be distributed to “Todd Leonard and Michelle Leonard,
or the survivor of them if one of them dies before” Janice.13 Also on May 31, 2006,
Janice executed her Last Will and Testament.14 It provides for the residue of her estate to
be transferred to her Trust, names David as the personal representative of the will, and
provides that under no circumstances shall John or any of his descendants take any assets
as a result of Janice’s death. Also on May 31, 2006, Janice executed a General Durable
Power of Attorney naming David as her attorney-in-fact.15

Janice’s inheritance was initially placed into an account with Merrill Lynch. In
2006, about one-and-one-half years after the opening of the account, the account was
frozen by Merrill Lynch. On August 1, 2006, Janice responded by letter to her Merrill
Lynch financial advisor asserting that the account was frozen because of her alleged

13 Id. at 3 & 6.

14 Exh. 57.

15 Exh. 59.

6

Case 09-06043 Doc# 229 Filed 06/12/14 Page 6 of 33


“‘bad behavior’ vacillating on decisions.”16 Merrill Lynch had apparently questioned
David’s involvement in Janice’s affairs, Janice’s expenses, and her mental state. For
2004, her expenses were $416,785.39, for 2005, they were $1,487,013.10, and for 2006,
they were $436,490.28.17 On August 11, 2006, Janice executed a Durable Power of
Attorney naming David as her attorney-in-fact for the Merrill Lynch account, authorizing
him to exercise various powers with respect to the account.18

On December 14, 2006, Janice and David executed documents to open a
MasterTrader.com account in the name of the “Janice Posl-Bendsen Revocable Living
Trust” (the MasterTrader Trust account).19 David testified that the purpose of the
MasterTrader Trust account was for the investment of the funds which were initially in
the Merrill Lynch account. The application states that the initial deposit would be
$3,200,000. Janice as Trustee, Janice individually, and David are all named in the
account documentation. The first document, which appears to be the application to open
the account, names the Trust as the customer, and David as “Joint Customer (or
Additional Authorized Person).”20 The second document, labeled “New Account
Approval Form,” states the Trust is the “Primary Account Holder or Title of Account”

16 Exh. M at 5.

17 Exh. N.

18 Exh. 55.

19 Exh. O.

20 Id. at 1-10.

7

Case 09-06043 Doc# 229 Filed 06/12/14 Page 7 of 33


and David is the “Secondary Acct. Holder.”21 The third document, labeled “Customer
Account, Margin and Short Account Agreement,” identifies Janice Posl-Bendsen as the
“Full Name . . . on Account,” and David signed the document as the “Second Party, If
Joint Account.”22 The fourth document, labeled “Trustee Certification,” states it applies
to the “Janice Posl-Bendsen Revocable Living Trust” and lists both Janice and David as
individuals authorized to give orders and other instructions relative to the trust account.23
Janice signed the certification as the only trustee of the trust. The fifth document, labeled
“Customer Option Agreement,” states that the account name is the “Janice Posl-Bendson
Revocable Liv.” Janice signed this document as “Trustee” in a block labeled “For use by
entity customers only,” but both Janice and David signed in a block labeled “For use by
individual.”24 Account statements were addressed as follows:

Janice Posl-Bendsen
Janice Posl-Bendsen Rev Living Trust
D/T/D 05/31/2005
Janice Posl-Bendsen & Todd Leonard TTEES.25

Checks for the account were imprinted:

Janice Posl-Bendsen Rev Lvg Tr

Janice Posl-Bendsen &

21 Id. at 11-12.

22 Id. at 13-15.

23 Id. at 16.

24 Id. at 17.

25 E.g., exh. 24.

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Todd Leonard TTEES.26

David testified that as to the MasterTrader Trust account, he was a joint customer,
not a trustee, that Janice wanted him to be on the account, that Janice had on-line access
to the account, that account statements were e-mailed to Janice, that Janice very
frequently monitored the account, and that he talked with Janice 2 or 3 times a day. In
addition, Janice frequently stayed with the Leonards, once for a couple of months. The
MasterTrader Trust account statement for the period ending January 31, 2007, shows a
portfolio value of $2,941,248.76.27 One year later, the statement for the period ending
January 31, 2008, shows the portfolio value was $147,001.55.28 There is no evidence
explaining the loss of value.

The MasterTrader Trust account agreement provided for the writing of checks on
the cash portion of the balance. David was authorized to sign the checks. Plaintiffs’
allegation that the Trust’s claim of $586,00029 against David and Michelle should be
excepted from discharge arises solely from MasterTrader Trust account withdrawals

26 E.g., exh. 41.

27 Exh. 24.

28 Exh. 46 at 10. The portfolio value stayed above $2 million from April through October 2007,
but on November 30, 2007, it was $655,464.22.

29 Doc. 222-2. The adversary complaint alleges the following transfers of Janice’s assets to
Debtors by checks signed by David or by wire transfers: Checks to David and Michelle totaling at least
$227,000; checks totaling at least $60,000 to Fitness Quest; checks totaling $195,000 and a wire transfer
of $55,000 to Fit Trade, LLC; checks totaling $48,000 to Debtors’ four children; checks totaling $500 to
Lynda Leonard; checks totaling $2,500 to Anthony Wilson; checks totaling $36,754.82 to Lori Larson;
and checks totaling $18,039.92 to various vendors. These transfers total $642,794.74. Because $586,000
is the amount of damages stated in Plaintiffs’ post-trial brief, the Court finds that to be the actual amount
sought to be excepted from discharge.

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which were authorized by David and were payable to David, David’s businesses, or
members of David’s family, or are otherwise questioned as not having been for Janice’s
benefit. The exhibit number, check date, payee, check memo, and amount of the transfers

which were the subject of the trial are as follows:
Exh. Payee Memo Amount
21 1/24/07 Michelle Leonard Admin. Fees $ 5,000.00
22 1/24/07 Fitness Quest $ 50,000.00
26 2/10/07 Michelle Leonard Admin. Fees $ 2,500.00
27 2/20/07 Michelle Leonard Admin. Fees $ 5,000.00
29 3/7/07 Fitness Quest $ 10,000.00
30 3/8/07 Michelle Leonard Admin. fees $ 5,000.00
31 3/28/07 Michelle Leonard admin. fees $ 5,000.00
33 4/14/07 Michelle Leonard 1st Qtr. Bonus $ 10,000.00
34 5/3/07 Todd Leonard 1st Qtr. Bonus $ 10,000.00
35 5/20/07 Lynda Leonard $ 500.00
36 5/22/07 Michelle Leonard Admin. Services $ 5,500.00
37 5/29/07 Michelle Leonard 07 Gift $ 12,000.00
38 5/29/07 Todd Leonard 07 Gift $ 12,000.00
39 6/6/07 Tate Leonard 07 Gift $ 12,000.00
39 6/6/07 Trey Leonard 07 Gift $ 12,000.00
39 6/6/07 Alyssa Leonard 07 Gift $ 12,000.00
39 6/6/07 Alec Leonard 07 Gift $ 12,000.00
40 6/7/07 Lori Larson $ 500.00
44 8/5/07 Michelle Leonard Admin fees $ 10,000.00
43 8/5/07 Todd Leonard 2nd Qtr. '07 Mg $ 25,000.00
43 8/24/07 Todd Leonard July Bonus $ 25,000.00
45 9/7/07 Fit Trade $ 90,000.00
44 9/12/07 Michelle Leonard special projects $ 10,000.00
47 9/14/07 WIRE Fit Trade LLC $ 55,000.00
45 9/18/07 Fit Trade, LLC $ 95,000.00
43 10/1/07 Todd Leonard Sept. bonus $ 35,000.00
43 11/12/07 Todd Leonard $ 10,000.00
44 11/21/07 Michelle Leonard $ 10,000.00
43 12/12/07 Todd Leonard $ 25,000.00
45 1/4/08 Fit Trade $ 10,000.00
43 1/28/08 Todd Leonard $ 5,000.00
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$ 586,000.0030

Of the many checks payable to him, David testified that only the check dated May
3, 2007, for $10,000 bearing the notation “1st Qtr. Bonus”31 was intended as compensation
for services. Thereafter, it was David’s understanding that the transfers to him were gifts,
since Janice wanted to fully utilize the lifetime gift tax exemption. Under his agreement
with Janice, David was voluntarily working for Janice without payment and Janice was
voluntarily giving David money not because of his work, but because of her affection for
him. David testified that the notations on the checks stating they were for “admin.
services” or “bonuses” were mischaracterizations written by David at Janice’s direction.
The payments were not regular and were not related to performance, as one would expect
if there were a compensation-for-services arrangement. Further, some checks written to
Michelle bear the “admin. services” notation, even though there is no evidence that she
was providing investment services to Janice.

David testified that he wrote each check because he was directed to so by Janice.
According to David, not only the checks payable to him, but also the transfers payable to
his family and to his companies, Fitness Quest and Fit Trade, were intended by Janice as
gifts. David testified that a check for $10,000 payable to Michelle bearing the notation
“special projects” was drawn at Janice’s direction to pay for Michelle’s cosmetic surgery,
which Janice promoted, and that he wrote the notation “special projects” because that

30 Doc. 222-1.

31 Exh. 34.

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was the phrase Janice used. David testified the transfers to Fitness Quest, the fitness club
partially owned by David, were made because Janice wanted to help David with his
business. David testified that transfers to Fit Trade from Janice’s assets were intended by
Janice as gifts. David had established Fit Trade for the purpose of trading stocks. David
was the only member. David testified that the checks payable to Lori Larson, a person
who had formerly worked with David at Countrywide, were for administrative services
she performed in organizing Janice’s financial affairs.

By August 2008, Janice’s relationship with David and his family had disintegrated.
In a letter to her counsel dated August 5, 2008, she stated:
It seems I have been supporting the Leonard family since
2005. I’m in Vegas now seeing my Drs. & trying to get my
head straight. The more I dig the deeper it gets . . . Guess I
know what all those cash withdrawals are that went into their
private account which I was unaware of.
. . . I want you to throw the book at them criminal &

civil & fraud too if we can.32
Janice filed an unverified petition against David and Michelle in the District Court of
Johnson County, Kansas, on August 8, 2008.33 It alleges that on May 31, 2006, David
was granted a general durable power of attorney and pursuant to that power took control
of Janice’s funds for the alleged purpose of investing and reinvesting the funds for
Janice’s benefit but misused that power for his own benefit. Causes of action are alleged
against David for breach of fiduciary duty and gross negligence, and against David and

32 Exh. 52.

33 Exh. 103.

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Michelle for civil conspiracy and conversion. The prayer is for damages in the amount of
$582,377.00 and other relief. A default judgment was signed on October 8, 2008.34
Debtors were held jointly and severally liable for $582,377.00, plus interest and costs. In
addition, judgment was entered in favor of Janice against David for $550.00 plus interest,
and David was ordered to provide an accounting of his transactions regarding Janice’s
accounts from January 1, 2007, to the date of the judgment. In this action, Plaintiffs do
not rely upon any collateral estoppel effect of this default judgment.

In October 2008, John Kurth received a phone call that his mother was
hospitalized in Las Vegas. On November 5, 2008, John Kurth agreed to serve as a
successor trustee of Janice’s Trust.35 On November 9, 2008, David executed a declination
of appointment as a successor trustee of the Trust.36 Thomas Kolbremer, the other
potential successor trustee, executed a similar declination. John Kurth is now serving as
the Trustee, but the dispositive provisions of the Trust, including those providing that the
assets shall pass to David and Michelle Leonard on the death of Janice, have not been
amended. On January 30, 2009, John Kurth was appointed as the guardian and
conservator of Janice.37

Debtors filed for relief under Chapter 7 on January 29, 2009. David met with their

34 Exh. 50.

35 Exh. X.

36 Exh. Z.

37 Exh. 101.

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counsel three times before the petition was filed and provided materials concerning
Debtors’ financial affairs. The schedules were presented to David and Michelle for
signing during a meeting with the attorney’s wife in the attorney’s office in the afternoon
of the day before the day they were to be filed. David skimmed the documents, but did
not read them because he trusted his attorney to have properly prepared them.

As the basis for the denial of discharge under § 727, Plaintiffs rely upon the
following alleged inaccuracies and omissions in Debtors’ bankruptcy papers: (1) the
failure to include the receipt of funds from the Trust as income in the Statement of
Financial Affairs (SOFA); (2) the omission of personal property from Schedule B and the
SOFA; and (3) the failure to disclose on the SOFA a distribution from a pension or
annuity that was allegedly reported on Debtors’ 2007 federal income tax return.38

 In response to question 1 of the SOFA, which asks about income from
employment, trade, or business, Debtors listed $361,191 for 2007 and approximately
$300,000 for 2008. David testified that the 2007 income represented primarily the gross
income of his business, Fit Quest, and included the May 3, 2007, check for $10,000 from
Janice’s Trust for “1st Qtr, bonus.” For the same year, Debtors’ federal tax return shows
income from wages of $36,191 and other income totaling less than $25,000.39 There was

38 Following trial, Plaintiffs’ counsel was directed to file a post-trial brief addressing, among other
things, what is in the record to warrant the denial of discharge under § 727. Only these three items were
relied on in the brief, so the Court regards any additional contentions made at trial to have been
abandoned.

39 Exh. 54.

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no income reported in response to SOFA question 2, which asks about income from other
sources. SOFA question 18 requests information about the nature, location and names of
businesses in which the debtor was an officer, manager, partner, or owner for the six
years preceding the bankruptcy filing. Debtors’ SOFA lists Fitness Quest at question 18,
and states at question 21 that David holds a 48% interest and two other individuals own
51% and 1% respectively. The SOFA does not mention Fit Trade, LLC, which David
testified was his business, the assets of which were given to him by Janice. Computer
equipment purchased using Janice’s trust funds was in Debtors’ possession on the date of
filing of the petition, but was not included in response to SOFA question 14, which asks
about property held for another person, or on Schedule B, which requires debtors to list
all their personal property. David testified that as of the date of filing, the computers had
minimal value since they were no longer functional. In addition, although there was
testimony that funds provided by Janice were used to buy one bicycle and that David
owned an additional bicycle, the bicycles were not included in Schedule B. David
estimated that their value was $400 to $500.

PLAINTIFFS’ CLAIMS.

Plaintiffs seek to except their claim of $586,000 from discharge under
§ 523(a)(2)(A) and (4). Plaintiffs also seek to deny Debtors discharges under
§ 727(a)(4).40 Defendants respond that Plaintiffs have not sustained their burden of proof

40 The additional claims asserted in the complaint were withdrawn in the pretrial order.
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as to any of their claims. Plaintiffs also contend that David’s testimony included
statements made by Janice and that they should be excluded from consideration because
they were inadmissable hearsay.

DISCUSSION.

A. The Court has not relied upon any inadmissible hearsay evidence.
As mentioned above, an important factor in this litigation is that Janice was not
available to testify. At various times, counsel for Plaintiffs objected to David’s
statements concerning his interactions with Janice on the ground they were hearsay. Of
the four objections during David’s direct testimony, one was granted and the answers to
three questions were reformulated to not include hearsay. Thereafter, during David’s
cross-examination, the Court allowed Plaintiffs’ counsel to have a standing hearsay
objection, stating admissibility would be ruled on later. In their post-trial brief, Plaintiffs
argue that David’s testimony of statements alleged to have been made by Janice should
not be admitted into evidence, but fail to identify any specific testimony which should be
stricken under their standing objection.

Hearsay is a statement made by a declarant other than while testifying at trial
which is offered in evidence by a party to prove the truth of the matter asserted in the
statement.41 But when the statement is offered other than to prove the truth of the
statement, it is not hearsay. “[V]erbal conduct which is assertive but offered as a basis for

41 Fed. R. Evid. 801(c).
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inferring something other than the matter asserted [is] . . . excluded from the definition of
hearsay.”42 Hearsay also does not include “a statement made by one person which
becomes known to another . . . [when] offered as a circumstance under which the latter
acted and as bearing on his conduct.”43 Also, documents which would be excluded from
evidence as hearsay if offered to prove the truth of their content are admissible as non-
hearsay bearing upon the motivation of the person testifying.44

The Court has examined the transcript of David’s testimony and finds that it does
not contain hearsay which should be stricken under Plaintiffs’ standing objection. The
testimony which gave rise to the standing objection was not hearsay. David was asked,
“[W]hy did you write the checks that you wrote?”45 He answered, “Because it was
discussed with Janice”;46 and “I wrote the checks as directed by Mrs. Posl-Bendsen.”47
The Court understands this to be evidence of David’s motivation, not testimony about the
truth of what Janice may have said. Similarly, in response to the question, “[W]hen you
wrote the admin fees or anything else in the memo line on the checks . . . , were you
writing those on your own or from the guidance of Janice,” David answered “I was

42Advisory Committee Notes to 1972 proposed Fed. R. of Evid. 801, reprinted in Fed. Civ.
Judicial Pro. and Rules at 437-74 (2014 ed., Thomson Reuters).
43 2 Barry Russell, Bankruptcy Evidence Manual, § 801:5 at 898 (Thomson Reuters 2013).
44 Moore v. Sears, Roebuck and Co., 683 F.2d 1321, 1322-23 (11th Cir. 1982).
45 Doc. 224, Partial transcript (part 2) at 2, ll. 17-18.
46 Id. at 2, l. 19.
47 Id. at 3, ll. 21-22.
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directed by Janice.”48 This is not hearsay.

This is a trial to the Court where Debtors’ motivation and intent are at issue, not
the truth of Janice’s statements as recalled by David. The Court is capable of admitting
the testimony and not regarding it as having been offered to establish the truth of what
Janice said. The Court declines to strike the questioned portions of David’s testimony as
inadmissible hearsay.

B. Plaintiffs have not proven the elements required for excepting a debt from
discharge under § 523(a)(2)(A).
Section 523(a)(2)(A) excepts from discharge debts for money or property to the
extent obtained by “false pretenses, a false representation, or actual fraud, other than a
statement respecting the debtor’s or an insider’s financial condition.” Exceptions to
discharge are construed liberally in favor of the debtor.49 In the Tenth Circuit, to establish
a claim is nondischargeable under this subsection, the creditor must prove by a
preponderance of the evidence50 the following elements: “[1] The debtor made a false
representation; [2] the debtor made the representation with the intent to deceive the
creditor; [3] the creditor relied on the representation; [4] the creditor’s reliance was
[justifiable];51 and [5] the debtor’s representation caused the creditor to sustain a loss.”52

48 Id. at 15, ll. 4-8.
49 4 Collier on Bankruptcy, ¶ 523.05 at 523-21 (Alan N. Resnick & Henry J. Sommer, eds.-in


chief, 16th ed. 2014).

50 Grogan v. Garner, 498 U.S. 279, 286-91 (1991).

51 The Court has substituted “justifiable” for “reasonable” in the Tenth Circuit’s original language

because of the United States Supreme Court’s opinion Field v. Mans, 516 U.S. 59, 70-76 (1995), which

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“If there is a duty to disclose, nondisclosure may amount to a misrepresentation.”53 “In
order to give full effect to the plain meaning of the disjunctive ‘or’ in § 523(a)(2)(A), . . .
‘actual fraud’ is an independent basis for nondischargeability under that subsection.”54
State law controls whether fraud occurred.55 Under Kansas law, the elements of an action
for fraud are: “(1) false statements were made as a statement of existing and material
fact; (2) the representations were known to be false by the party making them or were
recklessly made without knowledge concerning them; (3) the representations were
intentionally made for the purpose of inducing another party to act upon them; (4) the
other party reasonably relied and acted upon the representations made; and (5) the other
party sustained damage by relying upon them.”56

Plaintiffs’ theory of recovery under § 523(a)(2)(A) is that Janice was not aware
that Debtors made withdrawals from her checking account for their own use, that Debtors
failed to inform Janice of the withdrawals, and that Janice was justified in relying upon
Debtors to inform her of the withdrawals.

Plaintiffs’ evidence in support of their theory is scant. Plaintiffs proved that the

held that the reliance must be justifiable, but need not be reasonable.

52 Fowler Bros. v. Young (In re Young), 91 F.3d 1367, 1373 (10th Cir. 1996).

53 3 William L. Norton, Jr., and William L. Norton III, Norton Bankruptcy Law & Practice 3d,

§ 57:16 at 57-39 (Thomson Reuters 2014).

54 Diamond v. Vickery (In re Vickery), 488 B.R. 680, 691 (10th Cir. BAP 2013).

55 Id. at n. 63.

56 Kelly v. VinZant, 287 Kan. 509, 515, 197 P.3d 803, 808 (2008).

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checks were drawn by David and were payable to him, his family, and his businesses.
But the writing of the checks is a neutral fact; what matters is whether Janice authorized
the withdrawals or otherwise knew or should have known about them. The only evidence
offered by Plaintiffs that Janice was not aware of the withdrawals for the benefit of
Debtors was her letter to her attorney dated August 6, 2008, in which she stated, “Guess I
know what all those cash withdrawals are that went into their private account which I was
unaware of” and the allegations in the state court petition. Given Janice’s personality, the
Court ascribes little credibility to this evidence as a basis to determine Janice’s
knowledge at the time the withdrawals were made.

The evidence that Janice knew, or should have known, of the withdrawals is
extensive. David testified that Janice talked with Debtors several times a day, visited
their home, and once stayed with them for several months. He further testified that
account statements were regularly sent to her, that he made the withdrawals upon
directions from Janice, that he agreed with her that she would make gifts to Debtors and
their children, and that Janice directed David to make the entries on the check notation
lines, such as “07 gift” and “admin fees.” Janice’s practice of making gifts to Debtors
and their children began in 2004 and continued through 2007. There is no evidence that
David made any attempt to conceal the transfers, which one would expect if they were
unauthorized. Rather, David testified that the transfers were made pursuant to Janice’s
desire to make gifts to fully utilize the lifetime gift tax exemption. Janice’s conduct of
being extremely close and generous to Debtors and their children, followed by an abrupt

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change to excluding them from her life and accusing them of taking her money is
consistent with the evidence about Janice’s personality and pattern of conduct.

The Court finds that Plaintiffs have not sustained their burden of proof for their
§ 523(a)(2)(A) claim. They have not proven that Debtors made any false representations
or failed to inform Janice of facts when they had a duty to do so; that Debtors acted with
the intent to deceive Janice; or that Janice relied on the alleged misrepresentations or
concealments. The elements of fraud under Kansas law likewise have not been proven.

C. The evidence does not prove the elements required to except a debt from
discharge under § 523(a)(4).
Section 523(a)(4) excepts from discharge a debt “for fraud or defalcation while
acting in a fiduciary capacity, embezzlement, or larceny.” Plaintiffs rely upon both the
fiduciary relationship and the embezzlement and larceny arms of the subsection.

 “The existence of a fiduciary relationship under § 523(a)(4) is determined under
federal law. . . . However, state law is relevant to this inquiry.”57 “For purposes of section
523(a)(4), the definition of ‘fiduciary’ is narrowly construed, meaning that the applicable
nonbankruptcy law that creates a fiduciary relationship must clearly outline the fiduciary
duties and identify the trust property.”58 “[A]n express or technical trust must be present
for a fiduciary relationship to exist under § 523(a)(4).”59 Therefore, not all fiduciary

57 Young, 91 F.3d at 1371.
58 4 Collier on Bankruptcy, ¶ 523.10[1][d] at 523-73.
59 Young, 91 F.3d at 1371.


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relationships which exist under common law or state law rise to the level that is
actionable under § 523(a)(4).

“‘Under Kansas law, the elements necessary to create an express trust are: (1) an
explicit declaration and intention to create a trust; (2) the transfer of lawful and definite
property made by a person capable of making transfer thereof; and (3) a requirement to
hold the property as trustee for the benefit of a cestui que trust with directions as to the
manner in which the trust funds are to be applied.’”60 “Neither a general fiduciary duty of
confidence, trust, loyalty, and good faith, nor an inequality between the parties’
knowledge or bargaining power is sufficient to establish a fiduciary relationship for
purposes of dischargeability.”61 “A technical trust differs from an express trust in that the
intention of the parties is not relevant, and the parties’ fiduciary obligations are imposed
by law, not implied by law.”62

The Court finds that Plaintiffs have not sustained their burden of proof to show a
fiduciary relationship. Although on May 31, 2006, Janice executed a General Durable
Power of Attorney naming David as her attorney-in-fact, there is no evidence that David
was acting pursuant to that power when he signed the checks which are alleged to have
been unauthorized. Likewise, although on August 11, 2006, Janice designated David as

60 Jenkins v. IBD, Inc., 489 B.R. 587, 597 (D. Kan. 2013) (quoting In re Foy, 2010 WL 2584193,
*3 (Bankr. D. Kan. June 21, 2010)).
61 Young, 91 F.3d at 1372 (citations omitted).
62 Jenkins v. IBD, 489 B.R. at 597.
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her attorney-in-fact with respect to the Merrill Lynch account, David was not exercising
powers under this agreement when he signed checks drawing on cash in the MasterTrader
Trust account.

Further, the agreements establishing the MasterTrader Trust account did not create
an express or technical trust. Although the account statements and the imprint on the
checks identify David as a trustee, a review of the account documentation shows that he
was a co-signor, not a trustee. The account documents consistently identify the Trust as
the owner of the account, Janice as Trustee of the Trust, and David as either “Joint
Customer” or “Additional Authorized Person.” There is no document relating to the
MasterTrader Trust account which satisfies the requirements of Kansas law for the
creation of a fiduciary relationship.

In addition, assuming a fiduciary relationship existed between Janice and one or
both Debtors, the denial of discharge requires that the debt to be excepted from discharge
be damages for fraud or defalcation while acting as a fiduciary. Fraud, for purposes of
§ 523(a)(4) “has generally been interpreted as involving intentional deceit, rather than
implied or constructive fraud.”63 Plaintiffs provided no evidence of intentional deceit.
The United States Supreme Court, in Bullock v. BankChampaign, N.A., 64 recently held
that “defalcation” for purposes of § 523(a)(4) requires an intentional wrong. It stated:

Thus, where the conduct at issue does not involve bad

63 4 Collier on Bankruptcy, ¶ 523.10[1][a] at 523-71.

64 Bullock v. BankChampaign, N.A., __ U.S. __, 133 S.Ct. 1754, 185 L.Ed.2d 922 (2013).

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faith, moral turpitude, or other immoral conduct, the term
requires an intentional wrong. We include as intentional not
only conduct that the fiduciary knows is improper but also
reckless conduct of the kind that the criminal law often treats
as the equivalent.65

Plaintiffs have provided no evidence of defalcation.

Plaintiffs also have not proven the elements to except a debt from discharge under
the embezzlement or larceny arm of § 523(a)(4). “Embezzlement is the fraudulent
appropriation of property by a person to whom such property has been entrusted, or into
whose hands it has lawfully come.”66 The required elements include fraudulent intent or
deceit.67 “‘[F]raud in fact, involving moral turpitude or intentional wrong, rather than
implied or constructive fraud,’” is required.68

As discussed above, the Court finds that Janice knew or should have known of the
transfers made by David which are challenged by Plaintiffs. Further, even if Janice did
not have knowledge of each and every transfer, there is no evidence that David acted
fraudulently or deceitfully.

D. Plaintiffs’ complaint for denial of discharge under § 727(a)(4) must be
denied.
Section 727(a)(4)(A) provides that a debtor shall be granted a discharge unless

65 Id. at 1759.
66 4 Collier on Bankruptcy, ¶ 523.10[2] at 523-76.
67 Id. at 523-77.
68 Hill v. Putvin (In re Putvin), 332 B.R. 619, 627 (10th Cir. BAP 2005) (quoting Driggs v. Black


(In re Black), 787 F.2d 503, 507 (10th Cir. 1986)).
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“the debtor knowingly and fraudulently, in or in connection with the case — (A) made a
false oath or account.” A false statement or omission in a debtor’s schedules may be
sufficient for the denial of a discharge.69 Neither the complaint nor the pretrial order
identify the specific false statements or omissions Plaintiffs claim are grounds for the
denial of Debtors’ discharges. In their post-trial brief, Plaintiffs argue the discharges
should be denied because (1) Debtors’ receipt of funds from the Trust was not disclosed
in response to question 1 or 2 of the SOFA, (2) computers and bicycles in Debtors’
possession were omitted from Schedule B, (3) the only business listed in response to
question 18 of the SOFA was David’s 48% interest in Fitness Quest LLC, and (4) a
distribution from a pension or annuity allegedly shown on Debtors’ 2007 federal income
tax return was not shown on the SOFA.70 The Court has examined each of these
allegations and, for the reasons stated below, concludes that Debtors’ discharges should
not be denied.

One commentator summarizes the law applicable to the denial of discharge under
§ 727(a)(4) as follows:
Under current Official Bankruptcy Forms, the debtor is
required to verify the completeness and accuracy of any
schedule of assets, debts, or affairs filed in a case. However,
since the failure to list an asset must be both knowing and
fraudulent, mere inadvertence is not sufficient to establish an
objection. Where there is a knowing failure to list a
substantial asset, an inference of fraudulent intent may be

69 6 Collier on Bankruptcy, ¶727.04[1][c] at 727-38.

70 Doc. 222.

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drawn in the absence of mitigating circumstances. The failure
to amend schedules to include omitted information concerning
assets is a reckless indifference to the truth, which is
equivalent to fraud.

The false oath or account must relate to a material

matter. The failure to list a significant asset is the most

frequently established basis for denying discharge under this

section, and certainly satisfies the materiality element.

Materiality under Code § 727(a)(4)(A) means that the

statement must bear a relationship to the debtor’s financial

transactions or to the bankruptcy estate, concern the

disclosure of assets, or relate to the disposition of assets. If

there is a failure to list a valuable asset, materiality is

established.71

The purpose of § 727(a)(4)(A) “is to make certain that those who seek the shelter of the

bankruptcy code do not play fast and loose with their assets or with the reality of their

affairs.”72 “‘The reasons for denying a discharge must be real and substantial, not merely

technical and conjectural.’”73 The burden of proof in litigation under § 727(a)(2)(A) is on

the plaintiff to prove each element by a preponderance of the evidence.74

Once the objecting creditor establishes a prima facie

case for denying the debtor’s discharge under § 727, the

burden of going forward shifts to the debtor. The ultimate

burden, however, rests with the creditor. “Consistent with the

‘fresh start’ policy underlying the Code, [objections] to

discharge should be construed strictly against the creditor and

liberally in favor of the debtor.”75

71 4 Norton Bankruptcy Law & Practice, ¶ 86:11at 86-33 to 86-34.

72 Boroff v. Tully (In re Tully), 818 F.2d 106, 110 (1st Cir. 1987).

73 Id. (quoting Dilworth v. Boothe, 69 F.2d 621, 624 (5th Cir. 1934)).

74 Cadle Co. v. King (In re King), 272 B.R. 281, 288 (Bankr. N.D. Okla. 2002).

75 Id. (quoting In re Juzwiak, 89 F.3d 424, 427 (7th Cir. 1996) (other citations omitted)).

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1. Debtors’ discharges should not be denied for failure to include the receipt
of funds from the Trust in their SOFA.
Plaintiffs’ primary contention is that the Debtors should be denied a discharge
because they knowingly and fraudulently failed to disclose income from the Trust they
received during the two years preceding the filing of their bankruptcy petition under
either question 1 or 2 of the SOFA. Question 1 requires a statement of income from
employment or operation of a business, and question 2 requires a statement of income
other than from employment or operation of business. “Income” is not defined for
purposes of these questions.

There is no decision of the Tenth Circuit Court of Appeals defining the term
“income.” The Tenth Circuit BAP, when asked to determine the test for income when
examining a debtor’s income for the purpose of determining what percentage of that
income is from farming, noted there are two approaches, one using the definition of gross
income from the federal Tax Code, and a more flexible approach based upon the
circumstances to reach an equitable result.76 A bankruptcy court in this circuit has
concluded that the specificity and predictability of the Tax Code definition is preferable
when the issue concerns giving “guidance to debtors regarding which receipts they must
account for in their filing documents and which they may exclude.”77 This Court agrees.

The Tax Code provides as a general rule that “[g]ross income does not include the

76 In re Sharp, 361 B.R. 559, 564 (10th Cir. BAP 2007).

77 King, 272 B.R. at 293.

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value of property acquired by gift, bequest, devise, or inheritance.”78 “[T]he statute does
not use the term ‘gift’ in the common-law sense, but in a more colloquial
sense. . . . A gift . . . proceeds from a ‘detached and disinterested generosity; ‘out of
affection, respect, admiration, charity, or like impulses.’ And in this regard, the most
critical consideration . . . is the transferor’s ‘intention.’”79 Under this definition, gifts do
not need to be reported under either question 1 or 2 of the SOFA.

David testified that he included the $10,000 received from the Trust by a check
dated May 3, 2007 (for research conducted for Janice) in response to question 1 of the
SOFA but did not report any of the additional receipts. The testimony is unrefuted that
David understood these additional receipts to be gifts from Janice. If this understanding
is accurate, the gifts were not required to be disclosed in response to SOFA question 1 or

2.
If David’s understanding is not accurate and a portion of the receipts does not
qualify as a gift so that it should have been reported, Plaintiffs have not sustained their
burden to show that the omission was knowingly and fraudulently made. Plaintiffs
offered no evidence that David knew the receipts should have been included. Any
inference of fraud arising from the simple fact of omission is refuted by David’s credible
testimony that he relied upon his attorney when completing the SOFA. Assuming that
some of the receipts from the Trust should have been disclosed, Plaintiffs’ lack of

78 26 U.S.C. § 102.

79 Commissioner v. Duberstein, 363 U.S. 278, 285 (1960) (citations omitted).

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evidence that the omission was knowing and fraudulent is fatal to Plaintiffs’
contentions.80

2. Debtors should not be denied discharges because of the failure to disclose
personal property.
Plaintiffs also contend Debtors should be denied discharges because of their failure
to disclose in their bankruptcy filings their possession of computers purchased with Trust
funds, their ownership of two bicycles, and their interest in Fit Trade, LLC. The fact of
the omissions is established by the record. The crux of this denial of discharge claim is
therefore whether the omissions were material and whether Defendants’ omissions were
made knowingly and fraudulently.

David testified that the computers were not functional and therefore had little
value. David testified that the bicycles were valued at $400 to $500. The total value of
the assets listed on Debtors’ schedules was $260,200, which included $16,200 for
personal property. Given their insignificant value, the omission of the computers and
bicycles from the schedules was not sufficiently material to be the basis for the denial of
discharge. In addition, there is no record evidence to suggest that these omissions were
either knowing or fraudulent.

In response to question 18 of the SOFA, which asks the nature, location and name
of any business in which the debtor was involved during the 6 years before filing, Debtors

80 Plaintiffs’ arguments in their post-trial brief in support of denial of discharge based upon failure
to report the receipts from the Trust focus upon whether the receipts fall within the scope of questions 1
and 2. They fail to even acknowledge that the denial of discharge requires knowing and fraudulent
omissions, if the reporting was required.

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listed Fitness Quest. Plaintiffs allege that the failure to list Fit Trade, LLC, is grounds for
the denial of discharge. Fit Trade, LLC, was a trading entity owned by David “to trade
funds for Janice Posl-Bendsen’s trust account.”81 A separate MasterTrader.com account
was set up for Fit Trade.82 There is no evidence that Fit Trade engaged in any business
other than securities trading. As stated in the findings of fact, David made several
transfers of Trust funds to Fit Trade. But other than these transfers, there is no evidence
of the value of Fit Trade’s property during the period when David was managing Janice’s
assets or thereafter. David testified that he had no interest in Fit Trade when the
bankruptcy was filed and that Fit Trade was not disclosed because his counsel, on whom
he relied to prepare his schedules, wanted information only about ongoing entities. He
also testified that he intended to amend his schedules “once this is resolved, and I know
what happened in the situation.”83

The Court finds that Plaintiffs have not shown that the omission of FitTrade was
material or that the omission was knowing and fraudulent. “An oath or admission is
material when what is left out ‘bears a relationship to the debtor’s business transactions or
estate or concerns the discovery of assets, business dealings or the existence and
disposition of his property.”84 Although a debtor “cannot circumvent section

81 Doc. 218 at 7, ¶¶ 24 & 25.
82 Id. at ¶ 31.
83 Doc. 223, Partial transcript (part 1) at 53, ll. 2-4.
84 Grant v. Benjamin (In re Benjamin), 210 B.R. 203, 210 (Bankr. M.D. Fla. 1997) (quoting


Chalik v. Moorefield (In re Chalik), 748 F.2d 616, 618 (11th Cir. 1984)).
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727(a)(4)(A) by claiming that the omitted information has zero or little value,” value may
be considered by the Court when determining materiality and ascertaining the debtor’s
motivation and intent to deceive.85 The omission of FitTrade was not material to the
value of Debtors’ estate, since David had no interest in the company on the date of filing.
The omission was not material to Debtors’ affairs, other than being an aspect of their
relationship with Janice and her finances. But that relationship was otherwise disclosed
through the scheduling of Debtors’ liability for the judgment obtained by the Trust.

There is no evidence that the omission was knowing and fraudulent, and the record
provides no basis to infer such conduct. David testified that he relied upon his counsel
when the schedules were prepared. There is nothing from which the Court can infer that
Debtors acted otherwise than in good faith or that they had intent to conceal the existence
of Fit Trade. At trial, after having been read the directions for SOFA question 18, David
readily testified that Fit Trade should have been included in response to the question and
stated his intent to amend his schedules once this matter is resolved, when he will know
what should have been included.

The omissions of personal property from Defendants’ schedules on which
Plaintiffs rely when objecting to discharge are technical and conjectural, not real and
substantial. Creditors were not harmed. The Chapter 7 Trustee’s handling of the case
was not impaired by the omissions. The Chapter 7 trustee is not objecting to discharge.

85 Id.

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To deny discharges to Debtors would be draconian — their scheduled unsecured debts,
without consideration of Plaintiffs’ claim, are $332,945.79, comprised primarily of credit
card debt. As Debtors recognize in hindsight, by accepting Janice’s largess and engaging
in a lifestyle which they could not sustain with their earnings, Debtors made unfortunate
decisions.

3. Debtors should not be denied discharges because of the failure to report
pension or annuity distributions.
Finally, Plaintiffs assert as a basis for denial of discharge that Debtors reported
$31,927 of distributions from a pension or annuity on their 2007 federal income tax return
which was not disclosed in their bankruptcy schedules. Although Debtors’ 2007 federal
income tax return was admitted as an exhibit, there was no testimony regarding pension
or annuity income. The Court’s review of the exhibit shows that the $31,927 was listed
as “your total basis in traditional IRAs” on Form 8606. The Court finds no reporting of a
pension or annuity distribution. Objecting to discharge for the reason urged by Plaintiffs
has no merit.
CONCLUSION.

For the foregoing reasons, the Court denies Plaintiffs’ complaint seeking to except
Debtors’ obligation to them from discharge under § 524(a)(4) and (a)(6), and to deny the
Debtors discharges under § 727(a)(4)(A).

The foregoing constitutes Findings of Fact and Conclusions of Law under Rule
7052 of the Federal Rules of Bankruptcy Procedure, which makes Rule 52(a) of the

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Federal Rules of Civil Procedure applicable to this proceeding. A judgment based upon
this ruling will be entered on a separate document as required by Federal Rule of
Bankruptcy Procedure 7058, which makes Federal Rule of Civil Procedure 58(a)
applicable to this proceeding.

IT IS SO ORDERED.
# # #


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