Category Archives: Discharge

Is Elder Abuse Dischargeable Under The Bankruptcy Code?

By Ryan C. Wood

Howdy humans.  Elder abuse?  Yes, elder abuse.  I tell humans repeatedly bankruptcy touches all of life one way or another.  Even elder abuse can become a bankruptcy issue.  Bankruptcy touches all of life given when life goes bad bankruptcy may ultimately be the only way to get relief from what is taking place in the real world, outside of the Bankruptcy Code.  The question is what human or entity is benefiting from the bankruptcy filing and is the human or entity allowed this benefit under the Bankruptcy Code? 

Can you determine who is the good guy or bad guy is?    Is it possible that the human or entity that is owed the money is the bad guy collecting from someone that should have to pay?  Or did the debtor filing bankruptcy and their bankruptcy attorney seek to get over on creditors and obtain results not allowed under the Bankruptcy Code?  Both can be true at the same time in the same case.

In a recent Ninth Circuit Bankruptcy Appellate Panel case elder abuse was the issue and why the human bankruptcy filers filed for relief under Chapter 7 of the Bankruptcy Code.  The bankruptcy filers were sued for elder abuse, did not defend the lawsuit, default judgment was entered against the bankruptcy filers in state court, and then the present Chapter 7 bankruptcy case was filed to discharge the default judgment entered against the bankruptcy filers for elder abuse.

Background Leading to 9th Circuit Bankruptcy Appellate Panel Appeal

To not name the precise humans involved we will call the court appointed fiduciary, appointed to take care of the older human, the Fiduciary, and the person being taken care of the Client.  Then we have the people alleged taking advantage of the Client and committing elder abuse.  Since a default judgment was entered against them, we will call them the Elder Abusers.

A court appointed the Fiduciary to take care of the Client and for some unknown reason.

The Elder Abuses are the victim’s daughter, daughter’s husband and daughters sister.  Three Elder Abusers.  The Elder Abusers are accused of misusing a durable power of attorney and taking money they should not have.

The Oregon State Court complaint filed against the Elder Abusers included three claims for relief:

(1) elder abuse under Oregon Revised Statutes (“ORS”) 124.110 against all defendants

(2) unjust enrichment against all defendants

(3) breach of fiduciary duty against the one daughter of the victim.

Pursuant to ORS 124.100, it awarded Van Loo treble damages totaling $1,069,606.86 against Kristine and Bryce and an additional judgment against Kristine for treble damages of $887,276.16 – exactly what Van Loo requested. It also issued a second limited judgment awarding Van Loo attorneys’ fees and costs and conservator fees

The Fiduciary was awarded a default judgment against the Elder Abusers totaling $1,069,606.86 and an additional judgment against the specific daughter totaling $887,276.16.  There was also another judgment awarding the Fiduciary attorneys’ fees and costs with conservator fees.

Will the default judgments be discharged or not in Chapter 7 Bankruptcy?

A Little Commentary First

So, you get sued for elder abuse and you ignore the lawsuit.  Please read your mail each day no matter what.  Will the bankruptcy filing be strike three given strikes one and two happened before any state court lawsuit was ever filed.  No doubt the issue of whether elder abuse took place in this case was hashed out prior to any state court lawsuit being filed and the bankruptcy filers/Elder Abusers and most likely had some opportunity to improve the circumstances or at least defend the allegations against them.  To allow a default judgment to be entered against yourself for elder abuse is highly questionable and concerning.  The bankruptcy filers/Elder Abusers allowed a default judgment be entered against for elder abuse against their own family member.  Begs the question why?  I will attempt to fill in that blank and then review the bankruptcy filers filed petition to know their circumstances. 

At first blush it is difficult to know why the state court lawsuit was not defended.  Did they have no money to pay attorneys to fight for them?  Was service of the state court lawsuit was defective or fraudulent so they never knew they were getting sued?  Hmm no.  Did they believe even if a default judgment was entered it would be dischargeable when filing Chapter 7 Bankruptcy so why spend the money defending the Oregon State Court lawsuit for elder abuse?   Did a bankruptcy attorney advise the Elder Abusers to not defend the lawsuit and if a default judgment is entered you can just file for bankruptcy protection? 

Generally a bankruptcy should be filed prior to a default judgment being entered so at least what happened in this recent Ninth Circuit Bankruptcy Appellate Panel case illustrates.

Oh, and there has to be money involved because no one cares if their loved one was abused unless money was lost in the process as well.  Just say’in.

Chapter 7 Bankruptcy and Discharge of Elder Abuse Default Judgment

The Elder Abusers filed for Chapter 7 bankruptcy to obtain a discharge of the elder abuse default judgment.  Pursuant to Section 523(a) of the Bankruptcy Code certain types of debts, or how the debt was incurred, make the debt or claims not dischargeable.  Section 523(a)(2) is generally fraud; Section 523(a)(4) breach of fiduciary duty, embezzlement, defalcation, larceny; Section 523(a)(6) willful and malicious injury.  An adversary lawsuit must be filed to prove the debt/claim should not be discharged.

The Fiduciary filed the adversary lawsuit against the Elder Abusers in the Elder Abusers Chapter 7 bankruptcy case to have the Bankruptcy Court determine the default judgment against the Elder Abusers cannot be discharged.

The Elder Abusers defended the adversary proceeding of course and generally denied all of the allegations alleged in the Complaint to Determine Dischargeabillity of Oregon State Default Judgment for Elder Abuse against the Elder Abusers/bankruptcy filers.

Can The Oregon State Court Default Judgment Be Used to Prove Elder Abuse Claim is Not Dischargeable?

So, some states allow the preclusive effect of default judgments and other states do not.  The argument is if the lawsuit was not defended then nothing was actually litigated and should not and cannot be used in another legal matter to preclude the use of the default judgment.  Oregon happens to be a state that does allow default judgments to be used against the defendants in other matters; like a Chapter 7 bankruptcy case.  This is very controversial given the Oregon State Court lawsuit was not defended and the Fiduciary was awarded everything requested only because the Elder Abusers’ did not fight.  No actual litigation took place to make sure the allegations were true and damages are reasonable under the circumstances. 

Nevertheless, Oregon law says no problem.  So the Bankruptcy Court entered a judgment against the daughter Elder Abuser under Section 523(a)(4) ruling the $1,069,606.86 from the Oregon State Court default judgment is not dischargeable. 

The Elder Abuse daughter appealed the Bankruptcy Court’s entry of a judgment against her and here we are.  So do no defend the original Oregon State Court lawsuit, file for Chapter 7 bankruptcy, then defend adversary lawsuit objecting to the discharge of the default judgment and spend the money to appeal when the Bankruptcy Court entered judgment against Elder Abuse/bankruptcy filer.  Would it have been better to spend money and defend the original Oregon State Court lawsuit?  Or was there no hope and the only hope was to seek a discharge of the claim/elder abuse?  Hard to know.

Ninth Circuit Bankruptcy Appellate Panel Affirmed the Bankruptcy Courts Judgment

A little housekeeping regarding law.  Issue preclusion does apply in nondischargeability adversary proceedings pursuant to § 523(a) and See Grogan v. Garner, 498 U.S. 279, 284 n.11 (1991). Federal Bankruptcy Courts must also afford full faith and credit to state court judgments. 28 U.S.C. § 1738.  So the Bankruptcy Court in this adversary proceeding required to give the Oregon State Court’s default judgment against the Elder Abusers the same preclusive effect it would be given by other Oregon courts. See Far Out Prods., Inc. v. Oskar, 247 F.3d 986, 993 (9th Cir. 2001).

Generally the elements of issue preclusion are well settled.  If the Oregon State Court default judgments provides the following 5 elements, then the Bankruptcy Court in the dischargeability adversary proceeding is bound by the findings of fact and law in the Oregon State default judgment against the Elder Abusers.

1. The issue in the two proceedings is identical. 2. The issue was actually litigated and was essential to a final decision on the merits in the prior proceeding. 3. The party sought to be precluded has had a full and fair opportunity to be heard on that issue. 4. The party sought to be precluded was a party or was in privity with a party to the prior proceeding and, 5. The prior proceeding was the type of proceeding to which this court will give preclusive effect.

The Elder Abusers were part of both lawsuits whether the Elder Abusers participated in the Oregon State Court lawsuit or not. 

In this appeal the Elder Abusers disclose or argue why they did not defend the Oregon State Court lawsuit.  The inability to retain or hire an attorney, so the Elder Abusers were not given a full and fair opportunity to litigate the Oregon State Court lawsuit.  The problem is the Elder Abusers were in fact served and aware of the Oregon State Court lawsuit and their choice to not defend or have the ability to retain a bankruptcy attorney is not denial of a full and fair opportunity to be heard.  If the Elder Abusers could establish they were procedurally denied evidence or be heard then maybe no full or fair opportunity to be heard could be found in their favor.

Two of the issue preclusion elements need a more detailed analysis: (1) whether the issues in the two proceedings were identical; and (2) whether the issues were essential to the state court’s judgment.

The lower Bankruptcy Court said yes, and the Ninth Circuit Bankruptcy Appellate Panel agreed.

Oregon state courts have four elements regarding financial abuse of elders: (1) a taking or appropriation (2) of money or property (3) that belongs to an elderly or incapacitated person, and (4) the taking must be wrongful.

The Ninth Circuit Court of Appeals disagreed with the lower bankruptcy court’s decision but still affirmed the entry of the dischargeability judgment against the Elder Abusers for separate findings.

Oregon State’s elder abuse law does not specifically require a finding of a fiduciary relationship while Section 523(a)(4) of the Bankruptcy Code does.  This is a problem.  But the 9th Cir. BAP found the default judgment did include enough information to assume, or read into the default judgment, the elements for larceny and embezzlement pursuant to Section 523(a)(4).  What did the default judgment in Oregon State Court specifically find though? 

The 9th Cir. BAP found that the elements of the Oregon State elder abuse law are exact as to larceny and embezzlement when compared to Section 523(a)(4) even if the Oregon State court default judgment did not go into detail as to findings of fact.  It must be assumed the entry of the default judgment incorporates the elements of Oregon State law regarding elder abuse or the default judgment would not be entered period. 

The 9th Circuit Bankruptcy Appellate Panel therefore conducted the analysis for the Oregon State court providing the Oregon Court had to make finding that the Elder Abusers:  (1) took or appropriated (2) money or property (3) that belongs to the victim, who was incapacitated, and (4) the taking was wrongful.  They held there was no need to find the Elder Abusers were acting in fiduciary capacity given the elements for larceny and embezzlement pursuant to Section 523(a)(4) were satisfied.

Do Not Let A Default Judgment Be Entered Against You At All Costs

This is a cautionary tale of allowing a default judgment entered against you.  Even if the default judgment does not include detailed findings of fact and law a court may look to the elements of the law in support of the default judgment to determine if the elements for dischargeability of a debt are satisfied.  The entry of the default judgment itself is probative in jurisdictions that allow the preclusive effect of default judgments in Bankruptcy Court cases.

Benefit Overpayments Are Dischargeable In Bankruptcy

By Ryan C. Wood

Time and time again I hear various government overpayments are not dischargeable when filing for bankruptcy protection. This is wrong. Government overpayments and overpayments are general unsecured debts that are eligible to be discharged when filing bankruptcy. I dedicated an entire section of a bankruptcy attorney website to hopefully dispel this myth over seven years ago. Overpayments from various government entities such as the California EDD (Employment Development Department), welfare overpayments, food stamp overpayments, social security overpayments and even retirement benefit overpayments are eligible to be discharged when filing for bankruptcy protection given they are general unsecured debts.

Do Not Forget About Recoupment Though

What is even more unknown is what equitable recoupment is. This article discusses the difference between a setoff and equitable recoupment. Equitable recoupment is not a violation of the automatic stay or order of discharge resulting from filing for bankruptcy and that is what is at issue in the case described and listed below.

Ninth Circuit Bankruptcy Appellate Panel No. CC-17-1375-LSF

The Ninth Circuit Bankruptcy Appellate Panel recently had an appeal that dealt with these issues as it pertained to a former city council member who also served on the planning commission for a city for around 17 years, a long time. Upon retirement she applied to supplement her retirement income by obtaining retirement income from the State of California via CalPers (she was apparently a State of California employee) and the also applied in her city for their Retirement Enhancement Plan benefits given her “:public service” as a member of the city council and planning commission. The 9th Circuit BAP memorandum of decision specifically added a footnote to the memorandum of decision to highlight that this person was on the city council at the time this Retirement Enhancement Plan was approved and that she voted in favor of the Retirement Enhancement Plan.

The Retirement Enhancement Plan is supposed to provide a small supplement to the California Public Employees’ Retirement System (CalPers) benefits for only certain eligible city employees. Public Agency Retirement System (PARS) is a private corporation that manages this Retirement Enhancement Plan. When there is an overpayment of some sort of benefit the question is always why was the person overpaid? In this case there seemingly are mistakes by all parties involved. The Retirement Enhancement Plan enrollee and bankruptcy filer in this case provided PARS with her income correctly as $14,938.04 annually or a year, which should have resulted in a monthly plan benefit of only $99.87 from the Retirement Enhancement Plan. Then PARS sent her an enrollment packet that mistakenly had the income listed as $14,938.04 per month, not annually, and resulted in a monthly benefit payment of $1,198.84 or a 1,100% increase……. The enrollee just signed the enrollment documents and returned them to PARS with the mistake. The overpayment of $1,098.97 continued for about 19 months before PARS realized the mistake and requested the $21,972.20 in overpayments be immediately returned.

Four months later in December 2014 the enrollee and overpayment receiver filed for bankruptcy protection under Chapter 13 of the Bankruptcy Code. Again, the PARS overpayment is a general unsecured debt that is eligible be discharged when filing for protection under the Bankruptcy Code. In Chapter 13 it becomes a little more complicated given a bankruptcy filer may have an obligation to pay all or part of their unsecured debt back and have the unpaid portion discharged upon completion of the Chapter 13 Plan. Almost three years after filing the Chapter 13 bankruptcy case the bankruptcy filer and overpayment receiver filed a motion for sanctions against PARS for violating the automatic stay in the chapter 13 case for withholding benefits to recoup the overpayment she received before the chapter 13 bankruptcy case was filed.

As I have told potential clients and clients for years that the underlying overpayment is eligible to be discharged, but the entity that the overpayment is owed the money has the right to recoup from any future benefits you made receive. This is what PARS is doing in this case. PARS reduced the bankruptcy filers/overpayment receivers’ current benefit to recoup the overpayment or funds the bankruptcy filer should not have received. The bankruptcy filer and her bankruptcy attorneys filed a motion for sanctions saying PARS is violating the automatic stay in the bankruptcy case by continuing to collect on a debt that is part of the bankruptcy filing and eligible to be discharged. This is called equitable recoupment.

PARS filed an opposition to the motion for sanctions providing the bankruptcy filer or overpayment receiver should have known she was receiving too much each month given she had approved the Retirement Enhancement Plan when she was on the city council and she knew the Retirement Enhancement Plan was intended only to provide a minimal supplement to CalPers retirement payments. She actually received $1,198.84 each month and that is a lot higher than the intent of the Retirement Enhancement Plan. Also PARS argued that she had signed the forms that included the calculation error and should have noticed the calculation error at that point too. If the cashier is supposed to give you a dollar in change and gives you $1,000 19 times in a row instead you will notice right? The bankruptcy court held PARS had the right to equitable recoupment and the bankruptcy filer and overpayment receiver appealed the order denying her motion for sanctions to the 9th Cir. BAP. So here we are now.

Equitable Recoupment

Equitable recoupment is not a violation of the automatic stay when filing for bankruptcy protection. Equitable recoupment is also not provided for in the Bankruptcy Code, but is a common law equitable doctrine, a fairness doctrine, that provides the setting up of a demand arising from the same transaction as a plaintiff’s claim or cause of action for the purposes of abatement or reduction. See Newbery Corp. v. Fireman’s Fund Ins. Co., 95 F.3d 1392, 1399 (9th Cir. 1996). Recoupment is not subject to or limited to claims that exist before a bankruptcy case is filed and can be recovered after the bankruptcy case is filed. This is what is going on in this case by PARS. PARS setup a demand for return of the overpayment for the purpose of abatement or reduction of the bankruptcy filer’s current and future benefits under the Retirement Enhancement Plan. If the bankruptcy filer was no longer receiving benefits under the Retirement Enhancement Plan from PARS, then there is no way for the abatement or reduction to take place on current and future received benefits.

Here comes the more complicated part and a detailed analysis of if a party has the right to recoupment. There is a two part test used by the Ninth Circuit….. the events need to be part of the same transaction and must be sufficiently interconnected so that it would be unjust to insist that one party fulfills its obligation without requiring the same of the other party. The Ninth Circuit uses a logical relationship test regarding if the events are part of the same transaction. See Aetna U.S. Healthcare, Inc. v. Madigan (In re Madigan), 270 B.R. 749, 753 (9th Cir. BAP 2001). Transaction is defined liberally and in a flexible construction or broadly.
The original Bankruptcy Court found that the logical relationship test was satisfied given the debt owed to PARS and future benefits owed to the bankruptcy filer/overpayment receiver were from the same facts. The Ninth Circuit Bankruptcy Appellate Panel did not have too much to add to the analysis and agreed that the overpayment owed to PARS and the current benefits received by the bankruptcy filer/overpayment receiver are from the identical transaction and retirement plan.

The bankruptcy filer/overpayment receiver in the appeal attempts to argue that equitable recoupment is not part of the Bankruptcy Code, if Congress intended for equitable recoupment to be an exception to the automatic stay Congress would have included it in Section 362(b) of the Bankruptcy Code and California law prohibits the offset of retirement benefits. The Ninth Circuit Bankruptcy Appellate Panel explained that it is bound by Ninth Circuit precedent unless overturned by the Supreme Court and equitable recoupment is a doctrine in the Ninth Circuit. The Ninth Circuit Bankruptcy Appellate Panel further noted that the bankruptcy filer/overpayment receiver did not make these arguments in her opening brief so the panel does not have to consider them regardless. Ouch. Regarding California law prohibiting the recoupment of retirement benefits the appellate court equally slams the door and provides multiples cases in which California courts treat pension benefits the same as wages for purposes of recoupment. See Krolikowski v. San Diego City Emps.’ Ret. Sys., 24 Cal. App. 5th 537, 557 (2018) (holding that recoupment of state pension benefit overpayment was not barred by statutes of limitations; exemptions for levy and attachment of public retirement benefits; equitable estoppel; or laches).

What Happens Most of The Time Regarding Overpayments When Filing Bankruptcy

What happens with overpayments most of the time when filing bankruptcy is after receiving a discharge that is the end. Someone receives an overpayment for whatever reason and they do not need future benefits from the program or entity they received the overpayment from. There is no way for the discharged overpayment to be collected on given there are no current or future benefits paid out that can be reduced for recoupment purposes.

Do Not Mistake Setoff With Equitable Recoupment

Unlike equitable recoupment setoff is codified in Section 553 of the Bankruptcy Code. Setoff allows a creditor to deduct amounts owed to it by the bankruptcy filer from amounts the creditor owes to the person or entity filing for bankruptcy protection. A creditor must request and receive relief from the automatic stay before doing any sort of setoff. Also a distinguishing difference is setoff does not allow claims from before the bankruptcy case was filed to be setoff with claims after the bankruptcy case was filed.

Should I File Bankruptcy Jointly With My Spouse?

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I will give you my opinion right now and say yes, if possible. If your spouse and you do not own any separate property then please file bankruptcy jointly and receive an order of discharge with both of your names and social security numbers listed. Doing this makes it black and white to your creditors. All debts are discharged as to both spouses. If only one spouse files for bankruptcy and receives a discharge you have entered the gray as to the non-filing spouse. While bankruptcy is governed by Federal Law to determine certain asset issues the Bankruptcy Court has to look to state property marital law to determine separate property and community property.

The Community Discharge

So in a community property state only the community assets are liable for community debts. If there are no separate property assets brought into the marriage by the spouses then there is nothing other than community assets at the time of filing and then post-discharge. 11 U.S.C. § 524(a)(3). “[Section] 524(a)(3) treats the effect on the nondebtor spouse of a discharge of a debtor in a community property state when the nondebtor spouse is liable on the community claim, but has not filed a bankruptcy petition.” In re Karber, 25 B.R. 9, 12 (Bankr. N.D. Tex. 1982). In summary, all actions to collect a “community claim” from section 541(a)(2) property acquired after the petition date is permanently enjoined unless timely objected to. A creditor is still free to seek collection against the non-filing spouse’s separate assets.

So What Is The Problem?

So you the issue is some of the debts are under one spouses name and social security number while some debts were incurred by the other spouse. Who files for bankruptcy then? All of the debts were incurred during their marriage too. If one spouse files for bankruptcy and receives a discharge will that discharge protect the spouse that did not file? Yes and no. This is the gray of only one spouse filing. What can a creditor do or not do to collect their debt against the non-filing spouse’s separate property? What is property of the bankruptcy estate or community assets after the spouse received a discharge? Can a judgment creditor suspend the non-filing spouses driver’s license? Is a driver’s license a community asset?

File Jointly If Possible To Avoid Confusion

As bankruptcy attorneys that have filed and been involved in thousands of b bankruptcy cases, if it is possible, we recommend spouses file jointly so that it is black and white post-discharge. Each spouse receives a discharge of all debts whether in their name and social security number or not. A creditor with a judgment can renew the judgment and then wait to collect. The entire time the judgment is also accruing interest. Also, once the judgment is renewed the total amount of the renewal will accrue interest. This accrual of interest will make the judgment increase significantly plus the cost of collection added in also. What is the judgment creditor waiting for? They are waiting for some separate property assets to be obtained by the non-filing spouse. If the non-filing spouse inherits assets from someone the inherited assets are arguably separate property of that spouse and now there are separate assets to collect from. Or the judgment creditor is waiting for the community to end via divorce or death. Once the community is terminated then the protection of the discharge of the filing spouse is also terminated.

We had a judgment creditor write us a letter once to explain their position and right to collect from the non-filing spouse. The judgment creditor argued that the community discharge pursuant to Section 524 is a “phantom discharge” since it only bars collection from community assets. Again, if there are no separate assets then how is the discharge merely a phantom discharge? If there are no separate assets then all assets are community assets and therefore protected. What procedure is there to make the determination that there are no separate assets? There really is none. If a creditor allegedly violates the order of discharge the only recourse is to seek sanctions from the bankruptcy court that signed the order of discharge. Litigating this issue will most likely cost more than what it cost to file the initial Chapter 7 bankruptcy case. No one really wants to have to deal with this after receiving a discharge and moving on. If you are married and do not file jointly this is a potential issue you will be creating by filing alone.

Prevent Possible Litigation

Again, the theme of this article is if you can file jointly then file jointly and eliminate the possibility of litigating whether a creditor is violating the order of discharge or not. It may not be possible though depending upon the circumstances. Bankruptcy attorneys have to look at all of the assets of clients and make a determination as to the best course of action. There are also circumstances in which a spouse refused to file for bankruptcy protection no matter what. The point of filing for bankruptcy is to discharge eligible debts or reorganize debts without causing additional stress or problems for the bankruptcy filer. Most bankruptcy filers do not have the means to litigate issues that sometimes arise. Like a creditor going after a non-filing spouse post-discharge. If you filed for bankruptcy protection you probably do not have thousands of dollars to litigate anything. In the event a creditor goes after a non-filing spouse and we are successful in obtaining sanctions there is no guarantee that the bankruptcy court will award attorneys’ fees and costs for seeking sanctions. It is usually a tough position to be in after the bankruptcy is long over and then a creditor decides to do some sort of collection activity against the non-filing spouse. So what then? To take this issue off the table completely and just file jointly.

What Should I Do If I Have Unfiled Tax Returns?

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You must file the late or unfiled tax return as soon as possible no matter how difficult and unpleasant going through that process is for you. I will be providing a number of reasons below for why it is so important to file tax returns on time, or as soon as humanly possible if you miss the deadline to file the tax return. Filing for an extension kicks the can down the road, but at least you will not miss the deadline or be considered to have an unfiled tax return.

As a bankruptcy attorney I have been part of thousands of bankruptcy cases in one shape or form at this point I am of the opinion that most people do not timely file returns because they will owe a significant amount of taxes. A little known fact is that most of our bankruptcy cases whether Chapter 7, Chapter 13 or Chapter 11 involve taxes that are owed to either the Internal Revenue Service or here in California the Franchise Tax Board. TAXES CAN BE DISCHARGED IN BANKRUPTCY. Almost every celebrity bankruptcy involves unpaid taxes. Read some of my other articles about celebrity bankruptcy cases like actress Teri Polo or actor Gary Busey and on and on. Just Google celebrity bankruptcy and Ryan C. Wood. Not filing a tax return for a year you owe taxes is the single worst thing you can do even if you know you are going to owe taxes that you cannot pay immediately. Even if you are going to owe so much you cannot possibly pay the taxes you still need to file your tax returns on time every time to get the best treatment for repayment. When you do not file a tax return on time it starts a chain of events that are designed to make it extremely difficult to get rid of the taxes owed. Please note there is a statute of limitations for taxes owed to the IRS, but that statute of limitations can be suspended or altered depending upon your circumstances and this article is not addressing issues related to the statute of limitations.

Do not wait to for the IRS to take action. File your unfiled returns.

Do not wait to for the IRS to take action. File your unfiled returns.

Do Not Ignore Notices From The IRS

First off, yes, life is not easy and for whatever reason you did not file your tax return on time. The IRS will give you notice after notice to file your return on your own. If you ignore these notices this will be a big factor in what I will be wrapping this article up with about Substitute File Returns or an SFR. You will be given all kinds of chances to file a tax return even after the deadline to file the return and pay any taxes owed has long passed. Do not ignore the notices you receive in the mail. You will not get a phone call. You will get notices in the mail that you must read and respond to. I tell client after client that you do not want to be in the pile of files that is for people who are not communicating with the IRS. You want to be in the pile of files for people who are communicating with the IRS and working the problem. I know it is not easy. You have to address the problem sooner than later for someone like me to someday make it all go away forever.

So, Have You Ever Heard of a Substitute Filed Return?

I hope for your sake this is the first time you have heard of this. You do not want this period. A Substitute Filed Return (SFR) is what the IRS puts together as best they can with the information they have to file a tax return on your behalf for a tax year you did not file a tax return for. The IRS will only file a SFR when you have ignored them over and over again. The IRS even knows the numbers they use are not completely accurate. The IRS knows certain deductions will not be made and potentially income not counted. The result is a SFR filed by the IRS on your behalf that everyone knows is not completely accurate, but nonetheless you get assessed the amount of taxes they say you owe in the SFR. Once the taxes on the SFR have been assessed you will then be given more notices about your rights to object to the assessed taxes and correct any errors. Again, do not ignore notices in the mail you receive from the IRS. If you again do nothing you have more or less sealed your fate

Why Substitute Filed Returns Are So Dangerous

In my bankruptcy attorney world SFR’s are very dangerous given the current interpretation of the law and whether the taxes owed and assessed from a SFR are ever dischargeable when filing for bankruptcy protection. You have to understand that when all else fails, us bankruptcy attorneys ultimately clean up the mess once and for all, if the law allows. Long story short you should file a tax return for a year the IRS already filed a SFR on your behalf. You must correct their numbers, add income, add deductions and more or less make the return accurate and the amount of taxes you owe accurate. This could lead to the amount of taxes owed to decrease or increase. But what happens to the taxes owed and assessed from a SFR if you file bankruptcy? As mentioned before taxes absolutely can be discharged when filing bankruptcy if the taxes meet certain requirements. The problem right now is that the Ninth Circuit Court of Appeals agreed with the Internal Revenue Service’s interpretation of what the definition of a “return” is when you file your own return after the IRS files a SFR on your behalf. Let me back up a little. The Bankruptcy Code addresses late filed returns and this is part of the issue I am discussing. Taxes owed for a late filed return can in theory be discharged under the Bankruptcy Code, but the requirements are even more narrow or stringent than when a return is filed on time and there are taxes owed. That is the short of it. So, the definition of what constitutes a “return” under the Bankruptcy Code is the issue. The Ninth Circuit Court of Appeals held that the tax return you file with the correct income, correct deductions and therefore correct amount of taxes actually owed may not be a “return” for bankruptcy purposes given this filed return is not an honest and reasonable attempt to comply with the tax laws since the return was late filed . . . . . . Well, that is unfortunately one way to interpret the law and right now that is it. Let me back up again. So you did not file a return, the IRS filed a SFR on your behalf and assessed you some made up amount of taxes, then you file an accurate return to correct the numbers in the SFR and if and when you seek to discharge these taxes owed according to the accurate return you just filed you may not be able to because the fact that the return was late filed and filed after the SFR has been interpreted that your accurate filed return is not an honest and reasonable attempt to comply with applicable tax laws and therefore not a “return” under the bankruptcy code so the taxes owed for that year cannot be discharged. Did that make sense to you? Let me try again. To allow taxes owed for a late filed return to be discharged when filing bankruptcy there has to be a “return” filed. See Bankruptcy Code §523(a)(1)(B)(i).
All this mess of analysis will take place because you did not timely file your tax return. If you had timely filed that tax return the taxes could easily be discharged when filing for bankruptcy protection, assuming the taxes owed meet the normal requirements to be discharged. The IRS will argue that the SFR assessed taxes will not be part of the “return” you later file that actually has the accurate information. You will forever be in the category of a SFR was filed and now there is an issue as to whether your return filed after the SFR is an honest and reasonable attempt to comply with the applicable tax laws. So far convincing the appellate courts that the later filed return is a “return” under the bankruptcy code has not been very successful. It is truly a fact based analysis on a case by case basis. So, again, file your tax returns on time even if you will owe a lot of taxes and if you miss the deadline to file the return or extended deadline to file the return file your return as soon as you can. Do not let the IRS file a Substitute Filed Return on your behalf.

Did A Creditor Violate The Bankruptcy Discharge By Suing The Debtors After Discharge?

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Apparently it depends upon the terminology used in the lawsuit and a demand for attorney fees and costs. A recent Ninth Circuit Bankruptcy Appellate Panel published opinion discusses this issue. Desert Pine Villas Homeowners vs. Gil Kabiling; Linda Kabiling (BAP No. NV-15-1380-BDF) Discrimination happens for all kinds of reasons unfortunately. One reason discrimination is not supposed to happen is when you seek bankruptcy protection and obtain a discharge of eligible debts. There are a number of issues in this case, but the outcome of the case is creditors should not use language in lawsuits or other documents post-discharge that disparage a debtor or do not accurately communicate the legal relationship post-discharge. A creditor cannot try and obtain attorneys’ fees and costs post-discharge for a claim that arose before the bankruptcy petition was filed. In this case it all started when the Kabiling’s defaulted on paying their homeowner association assessments for a property located in Las Vegas, Nevada. The Kabilings’ obtained a discharge of their debts in Chapter 7 after the defaults and therefore their personal liability no longer exists for the defaulted homeowner association dues. Generally in most states a homeowner association can attach a lien for the unpaid homeowner association dues and then enforce that lien post-discharge since the lien is not discharged, just the personal liability for paying the pre-petition unpaid homeowner association dues. A homeowner association can also foreclose on the home under state law for unpaid homeowner association dues. Each state has different laws about homeowner association dues and the legal rights involved with collecting unpaid dues. The is not a huge issue in this case, but you need to know your state law in this area as it relates to Section 523(a)(16) of the Bankruptcy Code. Section 513(a)(16) makes post-discharge unpaid homeowner association dues not dischargeable.

The Desert Pine Villas Lawsuit Against Kabiling

On February 1, 2011, the Kabilings’ bankruptcy attorney filed a voluntary chapter 7 petition on their behalf along with a statement of intention asserting that they would abandon the Property. Notice of the Kabilings discharge was mailed to creditors on June 30, 2011. Desert Pines nonjudicially foreclosed on its homeowner association liens in 2013 and thereby acquired title to the Kabilings property. On December 15, 2014, in the District Court for Clark County Nevada, Desert Pines, through its counsel, Alessi & Koenig, filed a complaint against the Kabilings and three additional named defendants seeking to quiet title to the foreclosed property and confirm that Desert Pines held good title to the Kabiling property based on its nonjudicial foreclosure in 2013. Just to be clear, Desert Pine Villas already foreclosed on the Kabiling property under Nevada state law, so why did they need to file an additional lawsuit to quiet title to the already foreclosed property? There could be facts regarding the other named parties in the lawsuit that are not included in the record of this case.

The Kabilings were served with the lawsuit and then retained counsel to inform Desert Pine Villas they violated the discharge injunction by filing the lawsuit against them. Attorneys for Desert Pine Villas of course denied violating the discharge injunction so the Kabilings attorney reopened their Chapter 7 bankruptcy case and filed a motion for contempt against Desert Pine Villas. The bankruptcy court agreed with the Kabilings and found Desert Pine Villas in contempt of court and held Desert Pine Villas liable for the Kabilings’ compensatory damages in the amount of $8,928.00.

The Law In Desert Pine Villas Appeal

A violation of the discharge injunction is enforced through the court’s civil contempt authority under section 105(a). Renwick v. Bennett (In re Bennett), 298 F.3d 1059, 1069 (9th Cir. 2002). The debtor has the burden of proving, by clear and convincing evidence, that the offending creditor knowingly and willfully violated the discharge injunction. The offending creditor acts knowingly and willfully if (1) it knew the discharge injunction was applicable and (2) it intended the actions which violated the injunction. ZiLOG, Inc. v. Corning (In re ZiLOG, Inc.), 450 F.3d 996, 1007 (9th Cir. 2006). Actual knowledge of the discharge injunction does not end the inquiry, however, as the creditor also must be aware that its claim against the debtor was subject to the discharge injunction. Emmert v. Taggart (In re Taggart), 548 B.R. 275, 288 (9th Cir. BAP 2016). The focus is on whether the creditor’s conduct violated the injunction and whether that conduct was intentional; it does not require a specific intent to violate the injunction. Knupfer v. Lindblade (In re Dyer), 322 F.3d 1178, 1191 (9th Cir. 2003) (citing Hardy v. United States (In re Hardy), 97 F.3d 1384, 1390 (11th Cir.1996); and Havelock v. Taxel (In re Pace), 67 F.3d 187, 191 (9th Cir. 1995)).

A chapter 7 discharge releases the debtor from personal liability for debts arising “before the date of the order for relief under this chapter.” § 727(b). A “debt” means a liability on a claim. § 101(12). Federal law determines whether such claim arose prepetition or postpetition. SNTL Corp. v. Centre Ins. Co. (In re SNTL Corp.), 571 F.3d 826, 839 (9th Cir. 2009); ZiLOG, 450 F.3d at 1000. The general rule in the Ninth Circuit is that “a claim arises, for purposes of discharge in bankruptcy, at the time of the events giving rise to the claim, not at the time the plaintiff is first able to file suit on the claim.” O’Loghlin v. Cty. of Orange, 229 F.3d 871, 874 (9th Cir. 2000).

9th Circuit Bankruptcy Appellant Panels Analysis

The Ninth Circuit BAP found the bankruptcy court applied and then held an evidentiary hearing to allow for testimony on the contempt motion properly. the bankruptcy court’s conclusion that The 9th Circuit BAP also found that Desert Pine Villas knew that the discharge order applied to its prepetition claims against the Kabilings is supported by the record and is neither illogical nor implausible. The Ninth Circuit BAP also found that during oral argument at the June 30, 2015 hearing on the motion for contempt, counsel for Desert Pines specifically admitted that Desert Pines filed the Complaint in the Quiet Title Action, that it named the Debtors as defendants, and that it sought recovery of attorneys’ fees and costs. Thus, the record supports the bankruptcy court’s conclusion that Desert Pine Villas intended to file the quiet title action and the only remaining question is whether the filing of the complaint violated the discharge order.

The mere filing of a complaint against a debtor by a prepetition creditor does not necessarily violate the discharge injunction. For example, pursuing a post-discharge lawsuit in which the debtor is named as a putative party to collect from a collateral source, such as an insurance policy or an uninsured employers’ fund, does not violate section 524 provided “the plaintiff makes it clear that it is not naming the debtor as a party for anything other than formal reasons.” Ruvacalba v. Munoz (In re Munoz), 287 B.R. 546, 550 (9th Cir. BAP 2002) (citing Patronite v. Beeney (In re Beeney), 142 B.R. 360, 363 (9th Cir. BAP 1992)).

Ninth Circuit Bankruptcy Appellate Panels Findings

The complaint filed by Desert Pines Villas did not provide anything about how the Kabilings failed to pay pre-petition HOA dues and that this default was discharged in their chapter 7 bankruptcy case. The 9th Circuit BAP also noted the Kabilings were not listed as just putative parties in the lawsuit and that the Kabilings were not being looked to for amounts listed in the complaint, such as attorneys’ fees and costs for bringing the lawsuit to quite title. The Ninth Circuit BAP continues to lambast Desert Pines Villas, “To the contrary, the Complaint alleges that Desert Pines was required to incur attorneys’ fees to file the action and prays for a fee award against each of the named defendants, including the Debtors.”

Desert Pine Villas tried to argue that there is no bar to seeking attorneys’ fees and costs in a post-discharge lawsuit. While potentially true see the above law regarding claims and when a claim arises under 9th Circuit law. The Ninth Cir. BAP clearly held that Desert Pine Villas made no distinction in their complaint between prepetition or post-petition claims they have or had against the Kabilings. The complaint reads like Desert Pine Villas is seeking redress for prepetition events or prepetition claims. The Desert Pine Villas complaint also did not identify any post-petition conduct by the Kabilings, a post-petition default by the Kabilings or any post-petition contract between Desert Villa Pines and the Kabilings in Desert Pine Villas quite title complaint.

Exception to Creditors Right to Post-Petition Attorneys’ Fees and Costs On a Pre-Petition Claim

There are a number of cases on this issue. The argument goes if a debtor starts the fight post-petition and returns to the fray, then a creditor has a right to seek attorneys’ fees and costs defending itself of dealing with the issue even though the issue arose about a pre-petition claim. Boeing N. Am., Inc., v. Ybarra (In re Ybarra), 424 F.3d 1018, 1026 (9th Cir. 2005).

Conclusion

Bankruptcy attorneys beware. If a creditor files some sort of post-petition or post-discharge complaint against your client and the facts of the complaint only include facts that are from pre-petition events and claims there could be a violation of Section 524. More time spent in drafting the complaint to quiet title could have solved this problem. It sounds like from the provided correspondence the attorney for the Kabilings did reach out to the Desert Pine Villas attorney about this issue to no avail. Desert Pine Villas could have just amended the complaint and changed the prayer or facts listed in the complaint and did not.