Case No. 02-01327-rjh7, Adv. Pro. 02-20132-als.United States Bankruptcy Court, S.D. Iowa.
March 21, 2011
MEMORANDUM OF DECISION
ANITA SHODEEN, Bankruptcy Judge
COURSE OF PROCEEDING
The Defendant, Michael William Pohle (“Pohle”) filed a voluntary chapter 7 proceeding on March 15, 2002. A complaint objecting to discharge pursuant to 11 U.S.C. section 727 and dischargeability of a particular debt pursuant to 11 U.S.C. section 523[1] was timely filed by the Plaintiffs (“Dickinsons”). The Honorable Russell J. Hill heard the matters on April 19 and 20, 2004. At the conclusion of trial the matter was taken under advisement, along with the Defendant’s request that Counts III, IV, V, VI, and VII be dismissed.
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This proceeding was transferred to the undersigned on March 9, 2010.[2] Familiarity with the proceeding was certified on July 14, 2010 as required by Bankruptcy Rule 9028. As discussed in more detail below, the Debtor’s discharge is denied based upon 11 U.S.C. sections 727(a)(3) and 727(a)(5).
BACKGROUND
Diamond Dave’s Taco Company (DDTC) is the franchisor of approximately 26 Mexican restaurants located throughout the Midwest. The Defendant was employed by DDTC from 1993-1998. In 1994, a group of investors purchased a restaurant located in Marshalltown, Iowa and created Marshalltown Diamond Dave’s, Inc. (“MDD”). As a result of his employment relationship with DDTC, Pohle was a shareholder in this corporation and acted as its president for a period of time.[3] At the time of his separation from DDTC the Defendant held the position of corporate vice president.[4]
The Defendant entered into a Buy-Sell Agreement to obtain the stock in MDD and in a free standing franchise located in Newton, Iowa (“Newton”).[5] In August 1999 the Defendant executed an offer to purchase the remaining 6,080 shares of stock in MDD and 1,155 shares in Newton from the Plaintiffs.[6] The purchase price was $152,000 for the shares of MDD and $1,155 for Newton[7] which represented a grand total of $153,155.[8] The purchase required a down payment of $30,000 with the balance to be financed through monthly payments. Pohle obtained funds from his father in the amount of
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$50,000 to close on the stock sale.[9] Pohle executed a promissory note in the amount of $123,155 and pledged his shares in MDD as collateral under a security agreement in favor of the Dickinsons for the balance of the purchase price.[10] As a result of this transaction, the Defendant became the sole shareholder, director and officer of MDD.[11] Pohle made payments under the Agreement on a regular basis until May 2001.[12] With a balance owing of $90,764.38 the Defendant informed Ronald Dickinson that he did not intend to pay the remaining amount.[13] Prior to the Defendant’s bankruptcy filing, the Plaintiffs initiated action to collect the balance owing under the promissory note.[14]
Pursuant to a franchise agreement, monthly payments representing four percent of the restaurant’s sales were to be made by MDD to DDTC. Pohle believed that due to his experience he did not require operational support and wanted to pay a lower franchise percentage to DDTC.[15] Shortly after the Defendant’s acquisition of MDD it ceased making franchise payments.[16] DDTC sued to enforce the contractual obligations. On September 4, 2001 the Iowa District Court, Johnston County, entered judgment against MDD in the amount of $48,425.93 for delinquent royalty payments.[17]
DISCUSSION
The Dickinsons allege seven Counts under the first amended complaint to deny discharge or dischargeability of the obligation owing to them under the Agreement. To
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prevail, the Plaintiff must prove the elements of at least one of their claim(s) by a preponderance of the evidence. The claims arising under 11 U.S.C. section 727 will be addressed first.
11 U.S.C. section 727(a)(2)(A) (Count IV)
This Code provision provides that a discharge shall not be granted if:
the debtor, with intent to hinder, delay, or defraud a creditor or an officer of the estate charged with custody of property under this title, has transferred, removed, destroyed, mutilated, or concealed, or has permitted to be transferred, removed, destroyed, mutilated or concealed — property of the debtor, within one year before the date of the filing of the petition.
An initial determination must be made as to whether the Plaintiffs have established that the Defendant has engaged in any of the enumerated actions with regard to his property within one year prior to the filing of the bankruptcy. Property is not a defined term under the Code. However, property of the estate is broadly defined as a debtor’s legal or equitable interest in various assets, whether tangible or intangible. 11 U.S.C. § 541(a) (2011). In general terms, property represents an interest that embodies: “[t]he right to possess, use and enjoy a determinate thing (either a tract of land or a chattel).” Black’sLaw Dictionary (9th ed. 2009). Property can also be synonymous with the term asset which infers that the item can be the subject of monetary value. See William C. Burton, Burton’s LegalThesaurus 414 (3rd ed. 1998).
In the first amended complaint, the Plaintiffs allege that within one year prior to the filing, Pohle engaged in deliberate action related to his business and personal financial records.[18]
There is no evidence in the record, and the briefs do not contain an
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argument, that such financial records constitute “property” for purposes of applying this exception to discharge. As a practical matter, the financial records may relate to property or assets, but standing alone they would have no intrinsic or independent monetary value.
The majority of transfers identified at trial related to property of MDD that was transferred to Pohle within the one year time period.[19] Notwithstanding the fact that MDD was a closely held entity, such transfers fall outside of the statute because the corporation is a separate entity and its assets are not “property of the debtor.” The only transaction identified that involved a transfer of the Defendant’s assets within the one year period occurred on November 20, 2001 and is represented by an unexplained withdrawal from his personal checking account in the amount of $9,500.[20] The fact of this transfer, standing alone, without additional evidence, does not meet the element of intent required under the statute. Based upon a plain reading of 11 U.S.C. section 727(a)(2)(A) the Plaintiffs have not sustained their burden of proof as to this claim. Accordingly, the Defendant’s request that Count IV of the complaint be dismissed is granted.
11 U.S.C. section 727(a)(3) (Count V)
This provision precludes entry of discharge if:
the debtor has concealed, destroyed, mutilated, falsified, or failed to keep or preserve any recorded information, including books, documents, records, and papers, from which the debtor’s financial condition or business transactions might be ascertained, unless such act or failure to act was justified under all of the circumstances of the case.
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11 U.S.C. § 727(a)(3) (2011). An affirmative duty is imposed upon debtors to create and maintain records which reasonably detail financial activity. See Zapata v. McCormick (In re McCormick), Adv. No. A09-08014-TJM, 2010 WL 3037758, at *3 (Bankr. D. Neb. July 27, 2010). Creditors are entitled to written evidence of the debtor’s financial situation and past transactions because “[t]he privilege of discharge is hinged on disclosure.” Broad Nat’l Bankv. Kadison, 26 B.R. 1015, 1018 (D.N.J. 1983). Impeccable records are not required to obtain a discharge, but information must be kept in an “intelligent fashion.” See Cadle Co. v. Hughes (In reHughes), 354 B.R. 801, 810 (Bankr. N.D. Tex. 2006); Christy v.Kowalski (In re Kowalski), 316 B.R. 596, 601 (Bankr. E.D.N.Y. 2004); FDIC v. Kottwitz (In re Kottwitz), 42 B.R. 566, 569
(Bankr. W.D. Mo. 1984). Adequate record keeping is subject to an evaluation of “ordinary fair dealing and common caution.” Davisv. Wolfe (In re Wolfe), 232 B.R. 741, 745 (B.A.P. 8th Cir. 1999) (quoting First State Bank of Newport v. Beshears (In reBeshears), 196 B.R. 468, 474 (Bankr. E.D. Ark. 1996). These standards are imposed to enable creditors and trustees to track a debtor’s financial condition and transactions with “substantial completeness and accuracy” from some time past to present. SeeUnion Planters Bank, N.A. v. Connors (In re Connors), 254 B.R. 230, 235 (Bankr. S.D. Ill. 2000) (quoting In re Martin, 141 B.R. 986, 995 (Bankr. N.D. Ill. 1992)).
The statute identifies two alternatives that may be relevant to a determination of this issue. First, whether records are adequate to ascertain a debtor’s financial condition, and second, whether records are adequate to trace a debtor’s business transactions. Pohle’s sole ownership and control of MDD requires a careful examination of both of these issues. A debtor’s failure to maintain records for a closely-held business entity is
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sufficient to deny discharge to the individual debtor pursuant to 11 U.S.C. section 727(a)(3). See id.; WTHW Inv. Builders v.Dias (In re Dias), 95 B.R. 419, 422-23 (Bankr. N.D. Tex. 1988). This result is based upon the extreme significance of the business entity to an individual debtor’s bankruptcy, as well as activity that may involve the commingling of personal and business income and expenses. See Pher Partners v. Womble, (In reWomble), 289 B.R. 836, 857 (Bankr. N.D. Tex. 2003). Such circumstances are clearly present in this case. Pohle testified: “I always felt that the restaurant was — I was financially responsible for it, so it made no difference whether the money was in the corporate checking account or my own account.”[21]
Deposits of proceeds from the restaurant were routinely made into Pohle’s personal accounts, and in many instances he was unable to recall the source of the funds.[22] This disregard for the separation of corporate and personal transactions resulted in various payments of personal expenses and obligations from MDD funds.[23]
The record is clear that adequate records were not maintained to enable either personal financial or business transactions to be traced.[24] Pohle testified that he utilized cash in many instances to purchase supplies and product for the business operation. Although purchases of this nature are not prohibited, documentation to substantiate such transactions is required. SeeNeary v. Hughes (In re Hughes), 353 B.R. 486, 500
(Bankr. N.D. Tex. 2006). The Defendant’s conduct in failing to retain even minimum documentation to verify his cash transactions resulted in a “due from owner account” on
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the corporation’s financial reports. This account[25] was used to accumulate all amounts withdrawn from the business by the Defendant which could not be properly substantiated.[26] As of December 31, 2001, this accounting entry indicated that Pohle owed MDD $182,405.66.[27]
A debtor may rebut an allegation related to a failure to maintain records if such action is “justified under all of the circumstances of the case.” See 11 U.S.C. § 727(a)(3). To properly analyze whether a failure is justified a court must determine what records would be kept by individuals under circumstances similar to those of the Defendant. See Riley v.Riley (In re Riley), 305 B.R. 873, 883 (Bankr. W.D. Mo. 2004). It is most plausible to expect that at least some written document, invoice or receipt, be retained to verify the details of business purchases, cash transfers, and the disposition of funds. In evaluating justification for failure to keep or preserve records, a debtor’s educational background, business acumen, sophistication, and experience may be considered. See Leibowitzv. Tanglis (In re Tanglis), 344 B.R. 563, 569 (Bankr. N.D. Ill. 2006). None of these factors weigh in favor of the Defendant in this case. Pohle had worked in the restaurant business for “most of his adult life” and he had been associated with Diamond Dave’s in one capacity or another beginning in 1993.[28] The Defendant was not only experienced, generally, in the restaurant business, according to his testimony, he was specifically knowledgeable of the operations of DDTC and MDD.
The Defendant also did not adequately explain his failure to retain source documents to verify amounts he utilized to prepare financial reports for the business. He
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explained that his procedure was to enter sale information onto a daily or monthly report that he provided to the accountant. After entering numbers on the daily or month-to-date sheet he deemed the source documents “useless”[29] and did not retain them or provide them to his accountant.[30] Without source documents there is no ability to verify the accuracy of the Defendant’s reporting. Due to the inability of his accountant to reconcile bank deposits with Pohle’s reports the balance reflected in the due from owner account was further increased.[31]
Pohle stated that he relied upon his accountant[32] and that he had no intent to misrepresent his financial transactions.[33] His reliance on his accountant to produce financial reports does not explain, or excuse, his failure to provide adequate recorded information to support his financial transactions. The Debtor’s reliance, or intent, is neither persuasive nor relevant to the issue of justification under the statute. S. Bancorp S. v.Richmond (In re Richmond), 430 B.R. 846, 871 (Bankr. E.D. Ark. 2010). Pohle cannot satisfactorily explain his failure to maintain adequate records, and consequently his discharge must be denied under 11 U.S.C. section 727(a)(3).
11 U.S.C. section 727(a)(4) Count VI
The Plaintiffs’ complaint also alleges that the following portions of this Code provision are applicable to deny Defendant’s discharge:
The debtor knowingly and fraudulently, in or in connection with the case — made a false oath or account; . . . or withheld from an officer of the estate entitled to possession under this title, any recorded information, including books,
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documents, records, and papers, relating to the debtor’s property or financial affairs.
11 U.S.C. § 727(a)(4)(A)(D) (2011). In support of this claim the Dickinsons identify Pohle’s failure to turnover books, records and documents in the course of a 2004 examination.[34]
The first alternative to except discharge pursuant to this statute requires a showing of intent and materiality. See Georgenv. Grimlie (In re Grimlie), 439 B.R. 710, 717 (B.A.P. 8th Cir. 2010).
Intent can be established by circumstantial evidence and statements made with reckless indifference to the truth are regarded as intentionally false. If a false oath `bears a relationship to the bankrupt’s business transactions or estate, or concerns the discovery of assets, business dealings, or the existence and disposition of his property,’ it is material.
Id. (quoting Korte v. United States (In re Korte), 262 B.R. 464, 474 (B.A.P. 8th Cir. 2001); Rasmussen v. Unruh, (In re Unruh), 278 B.R. 796, 803 (Bankr. D. Minn. 2002)) (internal citations omitted). It may be inferred that these items may have contained information relevant to the Defendant’s business transactions or dealings which would render them material. The record reveals that there is no evidence presented by the Plaintiffs which establishes Pohle’s intent in making a false oath by his alleged failure to provide the documents requested in the context of discovery. The grounds for establishing a false oath may be based upon the debtor’s signature on the petition and schedules which is given under penalty of perjury. Jordan v. Bren (In re Bren),
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303 B.R. 610, 613 (B.A.P. 8th Cir. 2004) (rev’d in part on other grounds). This argument was not fully developed by the Plaintiffs in support of Count VI.[35]
As to the second alternative set forth in the Code section, it must be shown that the Defendant withheld recorded information from an officer[36] of the bankruptcy estate. The record does not establish that the Defendant withheld information, rather Pohle testified that he did not have possession or retain copies of the requested documents. Failure to turnover books and records to a creditor in the context of a 2004 examination does not satisfy this required element to deny discharge.
Based upon a plain reading of the statute the Plaintiffs have not sustained their burden of proof as to this claim. Accordingly, the Defendant’s request that Count VI of the complaint be dismissed is granted.
11 U.S.C. section 727(a)(5) Count VII
Under this Code provision, discharge will be denied if:
The debtor has failed to explain satisfactorily, before determination of denial of discharge . . . any loss of assets or deficiency of assets to meet the debtor’s liabilities.
The Plaintiffs bear the burden to initially prove that there is a deficiency of assets for the Defendant to meet his obligations.See Floret, L.L.C. v. Sendecky (In re Sendecky), 283 B.R. 760, 765 (B.A.P. 8th Cir. 2002). Proof of intent is not required under this exception
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to discharge. See First State Bank of Munich v. Braathen, (In reBraathen), 364 B.R. 688, 698 (Bankr. D. N.D. 2006).
Numerous deposits were made to Pohle’s personal accounts that represented funds from his father, who resides in Wisconsin. These items were identified as rounded, even-numbered deposit transactions.[37] Amounts received from his father were in cash and had no card or writings associated with delivery to Pohle.[38]
Whether these proceeds were gifts or loans is the subject of inconsistent testimony by the Defendant.[39] During the time period of October 1999 through September 2000, funds identified as being received from his father exceeded $23,000.[40] This total is in addition to the $50,000 the Defendant received from his father to assist in his purchase of MDD.[41]
Transfers of MDD’s cash, sale proceeds and credit card receipts were routinely made to the Debtor. From January 2000 through October 2000 cash from MDD was deposited into Pohle’s personal account in the approximate amount of $23,000.[42] Other than the generic explanation that these deposits were related to his business he had “no [other] idea” as to the source of the funds.[43] Various explanations were given related to the use of his personal bank account for the deposit of business revenues. Pohle indicated that he used his personal account because it was more convenient, and that he utilized cash for purchases because he did not have the appropriate corporate checks.[44] The record also supports a finding that the Defendant used corporate funds to purchase assets
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for personal use.[45] Starting in January 2001 credit card proceeds were also deposited into Pohle’s personal account.[46]
Although his testimony indicates that these amounts would be reimbursed to MDD, there is no evidence that such reverse transactions were completed.
During calendar year 2001 the Defendant planned to transfer $82,000 from MDD to himself personally for salary that had not been paid for the prior two years. During the time period of October 2001 through December 2001 deposits in the form of “distributions” were made in excess of $40,000 into the Defendant’s personal bank account.[47] His explanation related to his disposition of these funds ranged from living expenses, buying product and keeping it “in [his] mattress.”[48] During August and September 2001 a total of $38,000 was received by the Defendant from MDD.[49] In June 2001 MDD shows a beginning balance in its savings account of $33,542.93.[50] Over the course of six days, Pohle made withdrawals from this account totaling $18,000.[51] Pohle withdrew the remaining balance in the account in the amount of $15,292.93 on June 20, 2001 which resulted in a zero balance and closed the account.[52] The Defendant claims that the funds were utilized to obtain supplies and liquor for the business, but he provides no documentation to substantiate such purchases.
The Defendant bears the burden to provide a satisfactory explanation of the loss or deficiency of assets. See Braathen, 364 B.R at 698. “Once the objector has introduced some evidence of the disappearance of substantial assets or of unusual transactions, the
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debtor must satisfactorily explain what happened.” 6-727 Collier on Bankruptcy ¶ 727.08 (2010) (emphasis added) (internal citations omitted). A debtor need only provide some explanation; it need not be meritorious. Riley, 305 B.R. at 885. However, the explanation must consist of more than estimates or vague, indefinite or undocumented explanations to rebut a prima facie case under this Code provision. See id.; Dolin v. NorthernPetrochemical Co. (In re Dolin), 799 F.2d 251, 253 (6th Cir. 1986); Chalik v. Moorefield (In re Chalik), 748 F.2d 616, 619
(11th Cir. 1984). Pohle’s attempts to explain the disposition of the funds he received and his lack of assets to meet his obligations were vague, undocumented, and based upon estimates. He has not met even the most minimum standard to rebut the Plaintiffs’ claim under Count VII.
An examination of this alleged exception to discharge is closely aligned with the facts considered under Count V of the Plaintiff’s Amended Complaint.[53] 6-727 Collier on Bankruptcy
¶ 727.08 (2010). As more fully set forth above, the Defendant’s failure to maintain appropriate records provides further support for a finding that he has not satisfactorily explained the loss, or deficiency, of his assets.
For the reasons stated it is hereby ORDERED:
1. That judgment will be entered in favor of the Plaintiffs on Counts V and VII and the Defendant’s discharge is denied based upon 11 U.S.C. sections 727(a)(3) and 727(a)(5).
2. That Counts IV and VI of the First Amended Complaint are dismissed.
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3. That Counts I, II, and III of the First Amended Complaint are moot due to the denial of discharge pursuant to 11 U.S.C. section 727.
4. That the parties shall bear their own costs.
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