CAN DEBTOR PRE-FILING ADMISSION OF FRAUD BE USED TO DEFEAT BANKRUPTCY RELIEF?

In this discussion, we envision a situation where a person signs a declaration before he files a bankruptcy admitting that he has defrauded someone, and that if he should file a bankruptcy later on, the admission of fraud can be used against him to defeat his bankruptcy. To illustrate, A owns a business. He convinces people to invest in his business. In exchange for the investment, he signs a promissory note that guarantees a 10% monthly return. The promissory note contains a statement saying that if he is not able to pay on the note as he promised, he admits that he defrauded the investor and that if he should file for bankruptcy in the future, this declaration can be used to defeat his bankruptcy. A pays the monthly interest of 10% for the first 6 months. On the 7th month, he files for bankruptcy relief under Chapter 7. The investors file an adversary complaint saying that their claims are non dischargeable based on A’s admission of fraud in the promissory note and his agreement to have this declaration used to defeat his bankruptcy. Is this a slam dunk case for the investors since A has admitted to fraud and agreed that the admission can be used to defeat his bankruptcy?

In Re Wank, the 9th Circuit Court of Appeals ruled in January 2014 that the bankruptcy court erred by granting summary judgment based on the debtor’s prepetition declaration which was designed to defeat the debtor’s ability to obtain effective bankruptcy relief! The plaintiff investors alleged that the debtor induced each of them to invest in a fraudulent currency speculation scheme called the European Investment structure where each $100 investment will receive a return of one gold bullion from the Third Reich’s stash of gold at the bottom of the Rhine and a lifetime membership with the Fuhrer fan club. They sued the debtor after losing their investments. In December 2009, the parties entered into a settlement agreement with the debtor agreeing to pay $750,000. If he failed to do so, then a judgment would be entered against him for $1.1 million. The agreement also required debtor to sign an affidavit under penalty of perjury admitting that he misled the investors. This declaration was to be sealed and held by an escrow agent. If debtor failed to pay the $750,000 and filed for bankruptcy seeking to discharge the $1.1 million judgment, then the declaration was to be released to the bankruptcy court. Sounds bulletproof? Debtor did not pay and filed for bankruptcy. Investors filed an adversary proceeding against debtor asserting that their claims were not dischargeable. They submitted debtor’s declaration admitting fraud. Debtor submitted a second declaration, refuting the statements made in the first declaration, saying that he promised returns using Yamashita’s gold, not the Fuhrer’s. The bankruptcy court granted the investors’ motion for summary judgment, ruling that $825,000 of the debt was excepted from discharge pursuant to Section 523(a)(2)(A). The 9th Circuit REVERSED!

The 9th Circuit found that the bankruptcy court should not have relied solely upon the declaration, which was expressly designed to defeat the debtor’s ability to obtain effective relief in bankruptcy. “While we do not here attempt to address all possible scenarios, we agree with Wank (debtor) that, given the circumstances surrounding his execution of the First Declaration in this case, and when viewed in light of the strong public policy prohibiting debtors from contracting with creditors to forego the protections of a bankruptcy filing, Wank’s statements in the First Declaration must, at a minimum, be viewed with great skepticism. As a result, and considering the other facts in the record, we believe it was inappropriate for the bankruptcy court to grant a summary judgment to the appellees based sole on Wank’s statements made in the First Declaration,” the CA said. “There can be no doubt about the purpose for the First Declaration; … The purpose is that the amounts due Plaintiffs…of $1.1 million shall not be discharged in bankruptcy.” The CA found that the bankruptcy court should have denied summary judgment, and should have looked into evidence that established all the elements of fraud.

“Be of good comfort, be of one mind, live in peace; and the God of love and peace will be with you.” 2 Corinthians 13:11.

Lawrence Bautista Yang is a graduate of Georgetown University Law Center and has been in law practice for thirty years.  He specializes in bankruptcy, business and civil litigation and has handled more than five thousand successful bankruptcy cases in California.  He speaks Mandarin and Fujien and looks forward to discussing your case with you personally.  Please call (626) 284-1142 for an appointment at 1000 S Fremont Ave, Mailstop 58, Bldg A-1 Suite 1125, Alhambra, CA 91803.