To what extent are “child tax credits” from a debtor’s income tax refund considered exempt in a bankruptcy case as a “public assistance benefit”? This was the question considered by the Eighth Circuit Bankruptcy Appellate Panel (B.A.P.) in the 2013 case of In Re Pepper Hardy (B.A.P. No. 13-6029). The answer was: not at all. The appeal involved a Chapter 13 bankruptcy case coming from the Kansas City-based Chapter 13 Trustee, Richard V. Fink.
Adversary proceedings objecting to the discharge of certain debts sometimes arise in the context of bankruptcy cases. One such type of adversary proceeding, one based on “fraud or defalcation while acting in a fiduciary capacity,” is based on Section 523(a)(4) of the Bankruptcy Code. But to prevail under this section requires that certain conditions must exist. A recent case illustrated how such conditions may in fact exist. The case was a 10th Circuit B.A.P. case, NM-12-017, Hawks Holding LLC v. Kalinowski, decided in 2012.
In 2008, Hawks Holdings, LLC (“Hawks”) contracted with K2 Construction Company, LLC (“K2”) to build three homes on property Hawks owned near Santa Fe, New Mexico, for a contract price of more than $3.6 million. K2 was formed in 2007 as a New Mexico limited liability company, and held a general contractor’s license issued under the New Mexico Construction Industries Licensing Act (the “Contractors Act”). K2 neither completed the construction 1 called for by the Hawks contract, nor paid all of the subcontractors and material suppliers that had contributed to the project.
The bankruptcy “head of household” exemption in Missouri applies to your children, and not someone else’s children. The children have to be related to the head of the family (either a man or a woman) either biologically or by adoption. That was the gist of a ruling by the Eighth Circuit B.A.P. in a recent Missouri case. The case was In Re Mark Turpen (B.A.P. 12-6039), from the Western District of Missouri.
Turpen was single and lived with his two minor children, an unrelated woman, and the woman’s three minor children. He filed a voluntary Chapter 7 petition in 2011. He then filed amended schedules B and C on February 20, 2012. The amended schedule B listed a 2011 tax refund of $8,491.00. The amended schedule C listed claimed exemptions in that refund totaling $3,600.00: $600.00 under § 513.430.1(3) and $3,000.00 under § 513.440, $1,250.00 for Turpen as head of the family, and $350.00 each for his two minor children and the woman’s three minor children.
Under what circumstances are life insurance policies exempt in bankruptcy? Can the exemption ever be forfeited? These were some of the questions considered by the 10th Circuit Bankruptcy Appellate Panel in the case of In Re Larry Erickson and Betty Moore, filed in August 2011 (KS-11-005). Life insurance proceeds are normally exempt in bankruptcy provided certain conditions are met, but this case had an unusual set of facts.
Husband and wife Larry J. Erickson and Betty L. Moore filed a petition for Chapter 7 relief on March 30, 2010. At the time the petition was filed, Erickson owned several insurance policies on his life with respect to which Moore was the designated beneficiary. Debtors neither scheduled the life insurance policies as assets, nor claimed them as exempt.
What is a “core proceeding” arising from a bankruptcy case? What standard is used to evaluate this issue? These were the questions asked by the Eighth Circuit case of In Re Schmidt, decided in 2011 (11-6028 to 11-6030). In this case, Klein Bank appealed the bankruptcy court’s order denying its motions to remand its replevin actions which had been removed from the state court to the bankruptcy court.
In denying the motions, the bankruptcy court had originally concluded that the replevin actions were core proceedings. The Eighth Circuit B.A.P. disagreed, stating that core proceedings are limited to those “arising under or arising in” a bankruptcy case.
How much charity should a person in bankruptcy be able to contribute? At some point, can donations become excessive? These issues often come up in bankruptcy cases. Some debtors need to tithe as part of their religious obligations.
Some debtors have a need to contribute as part of their work obligations. These were the questions under consideration in a recent 10th Circuit bankruptcy appellate case from 2012. The case was In Re McGough (B.A.P. No. CO-11-038).
Can a bankruptcy debtor’s copyright violation ever rise to the level of a willful and malicious injury, such that it would be excepted from a bankruptcy discharge under 11 U.S.C. §523(a)(6)? The answer is yes, according to the Bankruptcy Appellate Panel for the 8th Circuit (which includes Missouri). The case here is In Re Walker, decided in August 2014 by the 8th Circuit B.A.P. (No. 14-6012).
The facts of the case were these. The debtor (Walker) was a managing member of an establishment called Twister’s Iron Horse Saloon. Twister’s often played music and hosted musical performances. Some of the music played or performed was included in the repertoire of the American Society of Composers, Authors and Publishers. ASCAP is a professional membership organization of song writers, composers and music publishers. In accordance with Federal copyright law, ASCAP licenses and promotes the music of its members. It also obtains compensation for the public performances of their works and distributes the royalties based upon on those performances. Several music companies granted ASCAP a nonexclusive right to license public performance rights of their works.
Twister’s did not hold a public performance license. ASCAP became aware of this and promptly contacted the debtor to offer him a license. The debtor did not respond to ASCAP’s offer. ASCAP unsuccessfully attempted to contact the debtor an incredible 44 times: twice in person, 14 times by mail and 28 times by telephone. None of the mail was returned as undeliverable. The phone calls were made on various days and at various times. The debtor was often on the Twister’s premises but refused to acknowledge the communications. An investigator from ASCAP visited Twister’s and noted that unauthorized musical performances were taking place.
ASCAP in 2009 informed the debtor of the violations and offered to settle for a monetary amount. The letter was delivered to Twister’s return receipt requested. The receipt was signed by the debtor and confirmed that delivery was made on September 23, 2009. The debtor signed for the letter but claimed not to have read it.
In June 2010, the music companies brought an action for copyright infringement against the debtor in the Eastern District of Missouri. The debtor did not contest the case and lost by default. A judgment of $41,231 was entered against him. When the debtor filed a Chapter 7 bankruptcy, the music companies filed an adversary proceeding against him under §523(a)(6), which prevents the discharge of debts incurred through “willful or malicious” injury. The trial court found that the debtor had willfully failed to obtain an ASCAP license and maliciously disregarded the rights of ASCAP’s members and Federal copyright law. The debtor appealed.
The case is an interesting one, since adversary proceedings under §523(a)(6) are rare. Proving “malice” and a “willful injury” is not an easy matter. An intentional tort must be inflicted on some opposing party. The B.A.P.’s analysis focused on the meaning of the words “willful,” “malicious,” and “injury.” Under case law in the Eighth Circuit, the terms must be separately analyzed. Furthermore:
Malice requires more than just reckless behavior by the debtor. Scarborough, 171 F.3d at 641 (citing In re Miera, 926 F.2d at 743). The defendant must have acted with the intent to harm, rather than merely acting intentionally in a way that resulted in harm…
If the debtor was aware of the plaintiff-creditor’s right under law to be free of the invasive conduct of others (conduct of the sort redressed by the law on the underlying tort) and nonetheless proceeded to act to effect the invasion with particular reference to the plaintiff, willfulness is established. If in so doing the debtor intended to bring about a loss in fact that would be detrimental to the plaintiff, whether specific sort of loss the plaintiff actually suffered or not, malice is established. Sells v. Porter (In re Porter), 375 B.R. 822, 828 (B.A.P. 8th Cir. 2007) aff’d, 539 F.3d 889 (8th Cir. 2008) (quoting KYMN, Inc. v. Langeslag (In re Langeslag), 366 B.R. 51, 59 (Bankr. D. Minn 2007)).
The debtor made the rather unconvincing argument that he did not “intentionally” injure the music companies because he was not aware he needed an ASCAP license. He claimed he was not aware of the violations until suit was filed against him in court. The court was not persuaded, noting that he had been contacted 44 times, and never responded. Furthermore, the court found that Walker (the debtor) failed to distinguish between the concepts of injury and harm:
The Supreme Court [has] analyzed willfulness in terms of injury. Injury is the “invasion of any legally protected interest of another.” Restatement (Second) of Torts § 7(1). Under § 523(a)(6), a judgment debt cannot be exempt from discharge unless it is based on an intentional tort, which requires the actor to intend “the consequences of the act rather than the act itself.” Restatement (Second) of Torts § 8A, comment a, at 15; Geiger, 523 U.S. at 61. In effect, Geiger requires that the debtor intend the injury.
The debtor had a duty, the court found, the obtain the required license. He also signed for a settlement letter from the plaintiffs, but later claimed he had not read it. These types of arguments did little to win the debtor friends among the judges. The court then turned its attention to the concept of harm:
The Eighth Circuit analyzed maliciousness in terms of harm…Harm is the “existence of loss or detriment in fact of any kind to a person resulting from any case.” Restatement (Second) of Torts § 7(2). In this case, the debtor’s actions were malicious because he intended to harm the appellees. The debtor did not obtain a public performance license yet he continued to play music covered by the license. The district court for the Eastern District of Missouri found the debtor to be in violation of Federal copyright law and entered judgment against him. The Eighth Circuit has held that the bankruptcy court may consider a violation of a statute as evidence of malicious intent. In re Fors, 259 B.R. at 139. And, one court has held that the debtor’s intentional violation of a Federal copyright law was an aggravating feature which evinces a voluntary willingness to inflict injury. Knight Kitchen Music v. Pineau (In re Pineau), 149 B.R. 239 (D. Me. 1993).
The debtor admitted he had a general knowledge of federal copyright law. When all was said and done, the court plainly could see that the debtor knew he needed to obtain a license, and deliberately avoided doing so because then he would have to pay royalties. Thus, he intended the financial harm which was the logical consequence of his actions. Thus, the B.A.P. had no trouble in upholding the ruling of the lower bankruptcy court on making the debt nondischargeable. Presumably, what irked the court most was the repeated and deliberate evasions of the plaintiff creditor’s communications. At some point, willfulness can be inferred from this sort of extrinsic evidence.
A recent decision by the Bankruptcy Appellate Panel for the 10th Circuit (which covers the state of Kansas) dealt with an interesting issue of statutory interpretation. The case was In Re Miller, (BAP No. WY-14-002), on appeal from a bankruptcy court in Wyoming, and decided in October 2014. The question in the case involved the calculation of the income figures for the “means test.” When a bankruptcy case is filed, there is normally a requirement to submit financial data (on Form B22A) showing the average monthly income and expenses in the six months preceding the month of the filing of the case.
The issue was whether a debtor’s wages need to be both earned and received during the applicable six-month “look-back” period in order to be included as part of his “current monthly income” (called “CMI”) under 11 U.S.C. § 101(10A). In Miller’s case, the Wyoming bankruptcy court concluded that his CMI figures were high enough to disqualify him from proceeding under Chapter 7. The Trustee felt he should convert his case to Chapter 13. When this did not happen, the case was dismissed. Miller then appealed.
The critical issue was the dispute on the interpretation of what should be considered “income.” The United States Trustee (UST) contested Miller’s CMI calculations, which Miller based on his understanding of the term “current monthly income,” as defined in § 101(10A). That definition includes, “income from all sources that the debtor receives . . . without regard to whether such income is taxable income, derived during the 6-month period.” Miller argued that the “derived during” language means “earned during,” such that his CMI only need include income he both received and earned during the look-back period. The UST read the definition to include all money received during the six month look-back period, regardless when it was earned.
The bankruptcy court agreed with the UST interpretation, holding that all income received by a debtor in the look-back period must be included in the calculation of CMI “without relation to when that income was earned.” The bankruptcy court dismissed Miller’s case pursuant to § 707(b)(2) when he declined to convert to a Chapter 13 proceeding.
The BAP first noted that the 10th Circuit had not previously ruled on this issue. The court, applying principles of statutory construction, then proceeded to look at the plain language meanings of the words “derived from.” While the interpretations of “received” and “derived” were a bit ambiguous, normal meanings should be applied. After reviewing the accepted definitions for the term “derived,” in the context of the phrase “derived during,” the Court concluded that the phrase “income derived during the look-back period” had the plain meaning “income received during the look-back period.” In other words, all income received during the look-back period should be included.
The Court found that this interpretation also was in accord with the original purpose of the statute (Sect. 101(10A)), which was to evaluate the debtor’s income level. The court said “Finally, the doctrine that we should be guided by the underlying public policy of the statute reinforces our interpretation of CMI as requiring inclusion of all income received by a debtor during the look-back period….Although both parties present persuasive arguments on this difficult issue of statutory interpretation, we conclude that the plain meaning of § 101(10A) is that the term ‘current monthly income’ includes all income a debtor receives in the look-back period, regardless when it was earned.”
Readers should note that this ruling is not as harsh as it might appear. There are times when a debtor receives an atypical amount of money during the means test period, that is not representative of his or her normal “income.” For example, sometimes people cash in retirement plans, receive personal gifts, or income from the sale of an asset. In these situations, all a debtor has to do is to file a rebuttal of the presumption of abuse, and explain why this atypical amount should not be factored into the CMI calculation. In the present case, the court might have been influenced by a perception that the debtor was artificially understating his normal salary figures.
In bankruptcy, debts originating from fines or penalties in criminal cases are generally not dischargeable. A 2014 ruling by the 8th Circuit Bankruptcy Appellate Panel (B.A.P.) has restated this point. The case in question was Behrens v. United States (In Re Behrens, No. 13-6052, 2014 Bankr. LEXIS 565, Feb. 12, 2014).
Is an untimely 1040 Form, filed after the Internal Revenue Service has assessed a tax liability, a tax return for the purpose of the exceptions to discharge in § 523(a)(1)(B)(i) of the Bankruptcy Code? This was the question that the Tenth Circuit Court of Appeals recently decided in the case of In Re Mallo, decided on December 29, 2014 (Appeal from the United States District Court for the District of Colorado, (D.C. Nos. 1:13-CV-00098-LTB and 1:12-CV-03380-LTB).
The case was actually a consolidated appeal from two cases, In Re Mallo and In Re Martin. The appeal came out of Colorado. The background to the cases involved situations where bankruptcy debtors had not filed tax returns for certain years. Edson Mallo and Liana Mallo did not file timely federal income tax returns for 2000 and 2001 as required by the Internal Revenue Code. As a result, the IRS issued statutory notices of deficiency pursuant to 26 U.S.C. §§ 6212 and 6213 for those years. The Mallos did not challenge those determinations.
The Internal Revenue Service assessed taxes, including penalties and interest, against the Mallos for various years of delinquencies. The IRS began collection efforts in 2006. In 2007 the Mallos filed additional returns for past due years. The other appellant, Martin, had a similar history of delinquent returns. The IRS tried to make collection efforts against him as well.
The Mallos later filed a Chapter 13 bankruptcy case, which was eventually converted to a Chapter 7 case. They filed an adversary action against the IRS, seeking a determination that the income tax debts had been discharged. The IRS filed a motion for summary judgment in the case, claiming that because the Mallos had not filed a tax return for certain years at issue, the tax debts should not be discharged. The bankruptcy court agreed with the IRS and granted the motion. The Mallos appealed.
Mr. Martin, the other appellant, received a different result. He also filed an adversary action against the IRS seeking a determination that certain income tax debts were discharged. In his case, a bankruptcy court found that his delinquent filed Form 1040 did, in fact, qualify as a tax return. Thus, his tax debts were found to be discharged. The IRS appealed. Both the Martin case and the Mallo case were thus consolidated.
The Court of Appeals thus had to decide what actually constitutes a “tax return” for the purposes of dischargeability under Section 523. The Court found that:
The hanging paragraph [of Section 523] defines “return” as “a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements).” Id. § 523(a)(*). It then explains which tax forms prepared under § 6020 of the Bankruptcy Code fall within that definition. Thus, the plain language of the statute requires us to consult nonbankruptcy law, including any applicable filing requirements, in determining whether the tardy tax forms filed by the Mallos and Mr. Martin are returns for purposes of discharge.
The Court reviewed some decisions of other circuits on this issue. What was important to the Court was the idea that filing requirements for tax returns included “deadlines.” And because the applicable filing requirements include filing deadlines, § 523(a)(*) plainly excluded late-filed Form 1040s from the definition of a return. In other words, a delinquent Form 1040 did not constitute a “return” for the purposes of Section 523(a)(*). An untimely filed tax form cannot constitute a “tax return” for the purposes of dischargeability in bankruptcy. Why? Because a due date is an applicable filing requirement. Missing the due date means that a taxpayer has missed a filing requirement. In sum, the Court stated:
Having considered and rejected the arguments advanced by Taxpayers and the Commissioner, we agree with the Fifth Circuit’s decision in McCoy that the plain and unambiguous language of § 523(a) excludes from the definition of “return” all late-filed tax forms, except those prepared with the assistance of the IRS under § 6020(a).
The ruling of the Court makes sense from a policy perspective as well. If taxpayers simply file random forms out of time, without requesting extensions, then a burden would be placed on the IRS with regards to what is or is not a “return.” The lesson here is clear, and has been said before: always file your tax returns in a timely fashion, even if you cannot pay the tax. Unexpected adverse consequences can happen when returns are not filed.