No. 03-07748-PCW13, Adv. No. A03-00172-PCW.United States Bankruptcy Court, E.D. Washington.
November 22, 2004
MEMORANDUM DECISION RE: ADVERSARY A03-00172 AND CONFIRMATION OF PLAN IN MAIN CASE 03-07748.
PATRICIA WILLIAMS, Chief Judge, Bankruptcy
THIS MATTER came on for hearing and trial before the Honorable Patricia C. Williams on September 29, 2004 through October 4, 2004. Plaintiff was represented by Richard Hayden; Defendants were represented by Timothy Durkop; and Joseph Harkrader represented the Chapter 13 Trustee. The court reviewed the files and records herein, heard
testimony of the witnesses, heard argument of the parties, and was fully advised in the premises. The court now enters its Memorandum Decision.
The trial in this adversary proceeding occurred simultaneously with the evidentiary hearing on the Trustee’s and the plaintiff creditor’s objections to confirmation of the Chapter 13 plan and motions to dismiss the Chapter 13 proceeding. The prior summary judgment decision which is currently on appeal determined that the obligation owed to plaintiff ex-wife by debtor ex-husband is in the nature of property settlement and not spousal maintenance or support. Before trial, the parties resolved the issue of the classification of certain obligations to plaintiff as not subject to discharge pursuant to 11 U.S.C. § 523(a)(15). The only issue remaining in the adversary is whether the corporate veil protecting the corporation, Kreyssler, Inc., should be pierced rendering the corporation liable for the obligations of the debtor. The issues relating to confirmation of the Chapter 13 plan are the debtor’s lack of good faith and his failure to devote all projected disposable income to the plan. At trial the plaintiff also argued that the plan fails to pay creditors as much as they would receive in a Chapter 7 liquidation as the value of the corporate stock has been understated.
The underlying cause of these disputes is that the debtor and plaintiff negotiated a stream of payments to the plaintiff as part of the marital dissolution proceeding in September, 2002, and within six months, the debtor attempted to modify the payment stream on the basis he could not pay. When that effort failed, he filed bankruptcy. The plaintiff simply does not believe that the debtor and his new wife
cannot and should not pay as he agreed. Nor does the Trustee.
The extensive facts will be more fully described, but it is clear that in early 2003 the debtor’s income, or more accurately, the income of his wholly owned corporation, was reduced to slightly more than half of recent historical levels by factors beyond the debtor’s control. The debtor in 2003 began reducing expenses by selling a motorcycle and time share which required monthly payments. He also attempted to renegotiate the payment stream to plaintiff. When that failed, the plaintiff filed contempt charges in state court for failure to pay under the decree. In response, the debtor commenced a Chapter 13. The plaintiff argues that although those facts are true, the defendant regularly pays personal expenses through the corporation, thus artificially reducing his personal income in an attempt to avoid payments to her and only her as she is the only creditor in the bankruptcy. She argues that the inaccuracy of his schedules are a continuation of his attempts to minimize income and that his attempt to renegotiate the dissolution decree was improper as the decree stated it could not be modified. This proceeding involves emotional issues as much as it does legal issues but the court is concerned only with the latter.
In support of the arguments regarding lack of good faith and corporate liability, the plaintiff argues that the Sub-Chapter S corporation wholly owned by the debtor pays many of the personal expenses of the debtor which means that the debtor has more disposable income than is demonstrated on Schedules “I” and “J”. The debtor formed this corporation many years ago to avail himself of the tax advantages of a Sub-Chapter S corporation. He is the only employee of the
corporation and it is his only source of income. He acts as sales representative for 6 to 8 manufacturers who produce window and door components. He is an independent contractor terminable on thirty (30) days notice and his assigned territory varies from manufacturer to manufacturer, but generally is Eastern Washington, Idaho, Western Montana, and part of Oregon.
The personal expenses which are paid by the corporation fall into four categories. The first category is the medical insurance on the plaintiff which the debtor is required to maintain under the terms of the dissolution decree. Prior to the dissolution, the insurance was provided by the corporation with the premiums paid by it, and the defendant has continued this arrangement. Plaintiff argues this is a personal expense which should be paid by the debtor. Since the plaintiff is the beneficiary of this corporate expense and it is not known whether the debtor, as an individual, could even procure medical insurance coverage for his ex-wife, this category is of no significance. Such payment, whether made by the corporation or the debtor is reasonably necessary under § 1325(b)(2)(A).
The second category is the family cable bill which is paid by the corporation. The evidence is that in 2003 while seeking ways to reduce corporate expenses, the debtor reviewed his internet and telephone services. Eventually, the corporation obtained internet access, which is necessary for the day-to-day operation of the business, from Comcast. For a charge of $91 per month, Comcast also provides television cable
coverage for the family. The debtor testified this was the “best deal.” This category is of little importance in reaching the ultimate determination of whether significant personal expenses are paid by the corporation, but it is relevant when considering the accuracy of the Schedules. Schedule “J” lists as a personal expense, a monthly cable charge of $40.00.
The third category is the 1999 Dodge Ram pickup truck owned and insured and maintained by the corporation, which is the vehicle used by the debtor for all purposes. Debtor testified that he drives about 30,000 miles a year of which perhaps 2,000 are personal rather than business-purpose miles. There is no reimbursement by the debtor to the corporation for the personal miles. Again, this category is of little significance. It is not untypical in a wholly owned corporation to have such an arrangement and indeed this is one of the advantages of forming a Sub-Chapter S corporation. The personal use is only about eight percent (8%) a year and would be reasonaly necessary under 1325 (b)(2)(A).
The corporation incurs substantial travel expenses most of which are charged on its credit cards. The debtor’s only personal credit card is a gasoline credit card. Charges on the corporation credit cards also include office supplies, postage, and other items. According to the 2001 federal corporate tax return, corporate income was $194,023, with travel expenses of $47,000. At that time, the debtor was living in and operating the corporation from Missoula, Montana. The 2002 corporate tax return lists income of $215,161 and travel expenses of $44,000. The debtor moved to Spokane some time in 2002. The 2003 corporate return
lists income of $128,752 and travel expenses of $28,000.
Plaintiff’s expert testified that from an accounting tax preparation or compliance viewpoint this amount of travel expense, when compared to income, would constitute a “red flag” necessitating further inquiry. It is this category of corporate expense which lends the only significant credence to plaintiff’s theory that the corporation is paying the personal expenses of the debtor. The plaintiff introduced no evidence indicating that the supporting documentation for these expenses was requested from the debtor or his corporate tax preparer.
MUST DEBTOR PAY PLAINTIFF AS CONTINUING CLAIM UNDER 11 U.S.C. § 1322(b) (5)?
During the course of the trial and the hearing on confirmation, an issue arose as to the treatment of the property settlement obligation as a continuing claim under 11 U.S.C. § 1322(b)(5). A continuing claim is one which matures after completion of the plan. The plan proposes to pay this obligation as a general unsecured claim, although the decree required the property distribution monthly payments to be made over a 12 year period. The Code does not mandate that any claim be treated as a continuing claim, but states that the plan “may” do so.
11 U.S.C. § 1328 (a) (1) states that the court shall grant the debtor a discharge of all debts except any debt “provided for under section 1322(b)(5) . . .” If a court requires a debtor or a debtor voluntarily proposes to pay a continuing claims under § 1322(b)(5), a discharge of that obligation does not occur upon successful completion of the plan. Although the language of § 1322(b)(5) does not limit continuing claims to those which are not subject to discharge under the Code, when read in
connection with § 1328(a)(1), § 1322(b)(5) must be interpreted as only applying to obligations not otherwise subject to discharge under the Code. To find otherwise would lead to results not contemplated by the Code. For example, an unsecured promissory note payable monthly over a 10 year payment is a continuing claim as it would mature after completion of the plan. Requiring or allowing payment of the note under § 1322 (b) (5) would result in making that an otherwise dischargeable claim, not subject to discharge.
Obligations which are not subject to discharge under § 523 such as student loan obligations are often treated as continuing claims. No cases arising in the Ninth Circuit have been cited in which a court has required an otherwise dischargeable claim to be paid under § 1322 (b) (5) thus continuing the duty to pay after completion of the plan. Requiring an otherwise dischargeable claim to be treated as a continuing claim would preclude discharge of the claim pursuant to § 1328 (a) (1), thus nullifying the spirit and language of § 523 which defines claims which are not subject to discharge. Exceptions to discharge are to be narrowly construed as the discharge of claims is favored in the Code. As the plaintiff’s claim is subject to discharge, it would not be appropriate to treat it as a continuing claim under § 1322(b)(5).
LIQUIDATION TEST UNDER § 1325(a)(4)
The property of the estate is the stock of Kreyssler, Inc. To satisfy the liquidation test of § 1325(a)(4), the debtor must demonstrate that a willing buyer would pay less for the stock to a willing seller than the debtor proposes to pay under his plan. The base amount of his plan is $19,200.00. In his schedules, the debtor valued
his corporate stock at $15,000 which he believes is the value of Kreyssler, Inc. He based his value on the corporation’s “hard assets” which consist of the 1999 Dodge Ram truck and some computer equipment. The NADA value on the truck at the time was $12,000 to $14,000. The debtor did not know the value of the computer and related items, but believed it was minimal. When pressed, he opined it was not more than $1,000. At the time of the bankruptcy filing, the corporation had a bank balance of approximately $8,000 which he did not include in valuing the stock. Nor did the debtor include any accounts receivables as he normally does not know of their existence. The purchasers submit orders to the manufacturer without any involvement of the debtor and the manufacturer simply calculates the debtor’s commission on the sale and sends him a check. He generates and pays an invoice on the day the check is received. Although it was apparent from the testimony and only to be expected that an on-going business would have liabilities, the debtor was not asked any questions regarding the liabilities of the corporation or how they were factored into his valuation. Based on the federal corporate returns and monthly operating statements which reflect to some extent the operation of the corporation after the filing, the liabilities may have equaled the amount in the bank account at the time of filing.
The debtor did not include in the value of the stock any goodwill as he does not believe that the corporation has goodwill. He only represents about 8 to 9 manufacturers whose agreements are terminable at
will with thirty (30) days notice. Mr. Strickland, a former employee of one of the manufacturers, testified that he was not aware of any situation in which these manufacturer’s representative agreements had been sold or assigned. He did know of situations where third parties attempted to purchase the agreements, but the manufacturer would simply terminate the agreement. Mr. Strickland did know of situations where a representative had brought a family member into the business and the manufacturer had agreed to allow the relationship to continue, but it was solely the manufacturer’s discretion based upon the specific situation. Mr. Strickland stated that he would not be interested in purchasing such a business as it is a highly personal relationship and “there is nothing to sell.”
The plaintiff’s expert Mr. Dubois valued the Kreyssler, Inc. at between $240,000-$263,000. At the time of the valuation, he was not aware that the two largest accounts had been terminated. Mr. Dubois stated that he did not know how difficult it would be to find a willing buyer for the business, but based his valuation upon what a willing buyer would pay a willing seller. He did concede that some businesses do not, in fact, have any goodwill. Mr. Dubois reiterated several times that he was not provided sufficient financial and accounting information with supporting documentation to fully analyze the financial affairs of the debtor and the financial strength of the corporation.
Mr. Dubois’ valuation was based upon a sophisticated point system analyzed by a computer program. His basic premise was that the debtor would continue to be employed in the business. They is not likely in a Chapter 7 liquidation. Mr. Dubois concluded that the corporation was capable of distributing significantly greater amounts to the debtor than the current salary and distributions of $3,775 per month net. He opined that the corporation, if it reduced its discretionary spending, would distribute an additional $6,000 to the debtor each month for total wages and owner distributions of roughly $10,000 per month before taxes. It is not credible that a corporation with $128,000 of income in 2003 and the same projected through the end of 2004 would be able to annually distribute $120,000 to its owner. Mr. Dubois’ opinion was based upon his belief that the corporation could generate an additional $95,000 annually, thus distributing up to an additional $95,000 before tax income to debtor. This belief arose from the lack of knowledge of the loss of the two largest accounts. The debtor’s valuation is more credible. Based upon that valuation, the liquidation test has been met.
CORPORATE DISREGARD UNDER STATE LAW
The only issue remaining in the adversary proceeding is plaintiff’s request to hold the corporation, Kreyssler, Inc., responsible for the obligations of the debtor. The plaintiff argues that the debtor has
merged his identity with that of the corporation and that reverse piercing of the corporate veil should occur, i.e., that the corporation should be held liable for the obligations of the sole shareholder. Washington law describes such theories as “corporate disregard.”
Kreyssler, Inc. is a Montana corporation with its principal place of business in Washington. It elected Sub-Chapter S status under the Internal Revenue Code. A Sub-Chapter S election results in the corporation being treated for tax purposes as a partnership so that net corporate profits pass through the corporation free of tax to the stockholders who receive the tax benefits or tax liabilities which would otherwise be available to the corporation. In re Weaver, 219 B.R. 890 (Bankr. D. Mont. 1998). The debtor is the single stockholder and officer of Kreyssler, Inc. Operating any business in the corporate form rather than a sole proprietorship not only confers tax benefits but also protects the individual stockholder from personal liability for the acts of the corporation. Indeed the protection from personal liability for corporate acts is one of the cornerstones of corporate law and the fact that a single individual owns all stock and is the sole director and employer does not destroy that protection.
The doctrine of corporate disregard is an exception to the general principle that stockholders are not liable for acts of the corporation. Washington courts take a conservative approach to application of that exception and only apply it under exceptional circumstances. See 17 Stewart M. Landefeld, et al., Wn. Crop. Law: Corporations and LLC’s, § 17.2 (2004). In those exceptional circumstances, the court, in effect, extends the scope of the duty initially owed by the corporation
and does so to avoid manifest injustice or to remedy fraud. The Washington courts have done so when they have concluded that a violation of duty will result if the corporate entity is not disregarded. Morgan v. Burks, 93 Wn.2d 580 (1980). Corporate disregard is an equitable remedy imposed to correct an abuse of the privilege of maintaining a corporate entity.
There are two theories of corporate disregard, but they are rarely distinguished in the case law. The first theory is referred to as “alter ego.” It rests upon a determination that the corporation is the alter ego of the individual. This occurs when the identity of the individual and corporation have merged or become so confused that they cannot be severed. There is no corporate veil to be pierced. Generally, this theory arises in situations involving the imputation of knowledge from the individual to the corporation. Standard Fire Ins. Co. v. Blakeslee, 54 Wn. App. 1 (1989). Case law concluding that the individual and the corporate identities have merged rely upon such facts as confusing names, failure to maintain separate books and records, commingling of assets and failure to comply with corporate licensing requirements. In the situation of Kreyssler, Inc., there is no issue concerning the imputation of knowledge. The corporation does maintain separate books and records, files corporate tax returns, is an active corporation properly formed. There is no evidence that any third-party was confused as to whether it was dealing with a corporate entity or an individual.
The other theory of corporate disregard is referred to as “piercing the corporate veil.” The creation of a corporation creates a veil
through which liabilities of the corporation do not pass. The stockholders receive the benefit of that veil. “Reverse piercing” occurs when liabilities of the stockholders pass through the veil and attach to the corporation. The fact a corporation is unable to pay creditors or the fact a stockholder is unable to meet his personal obligations is not sufficient to pierce the corporate veil. The fact that a single individual owns the corporation neither lessens its legal status nor weighs in favor of corporate disregard nor does the fact that one corporation is wholly owned by another. Minton v. Ralston Purina Co., 146 Wn. 2d 385
(2002). There must be some exceptional circumstances present to justify such relief.
The court in Truckweld Equipment Co., Inc. v. Olson, 26 Wn. App. 638 (1980) stated at page 643:
The doctrine of disregarding the corporate entity or piercing the corporate veil is an equitable remedy imposed to rectify an abuse of the corporate privilege. 1 W. Fletcher, §§ 41 et seq. Typically the corporation is considered an entity separate and distinct from its officers or stockholders even where they are only one in number. Grayson v. Nordic Constr. Co., supra. In exceptional circumstances, however, the corporate entity will be disregarded where its recognition would aid in perpetrating a fraud or result in a manifest injustice. Harrison v. Puga, 4 Wn. App. 52, 480 P.2d 247, 46 A.L.R.3d 415 (1971).
In determining whether the corporate veil should be pierced, Washington courts have developed a two part test. Firstly, the corporate form must intentionally be used to violate or evade a duty and that evasion must constitute fraud or an improper manipulation of the corporation. Secondly, the remedy must be necessary to prevent injustice and loss to the injured party which loss was caused by abuse of the corporate form. Meisel v. M N Modern Hydraulic Press Co.,
97 Wn.2d 403 (1982). If some other remedy is available to the injured party or if the party could have avoided the harm by use of ordinary business practices, it is not appropriate to resort to the exceptional remedy of piercing the corporate veil. Morgan v. Burks, supra; Molander v. Raugust-Mathwig, Inc., 44 Wn. App. 53 (1986).
The plaintiff has cited state court decisions for the proposition that reverse piercing may occur in marital dissolution proceedings. If exceptional circumstances exist and the required elements can be met, state courts may and do utilize reverse piercing in marital dissolution proceedings. This is not a marital dissolution proceeding. This is a bankruptcy proceeding where the plaintiff and debtor were divorced months before any bankruptcy was commenced, and the state court did not impose any liability on Kreyssler, Inc.
The issue here is whether, in the context of this Chapter 13 proceeding, the corporation should be held liable for all the personal obligations of the debtor. Setting aside any question of the standing of a creditor to raise that issue, piercing the veil to hold the corporation liable would result in benefit to all creditors and not just the former wife. In this case, however, the plaintiff is the only significant creditor.
The corporate form must have been utilized in an improper or fraudulent manner to the detriment of creditor for this remedy to be applicable. Only if the debtor’s inability to pay personal obligations has been caused by, or is related to, improper or fraudulent use of the corporate form would state law allow a piercing of the veil. In this case, the argument is that the debtor has improperly or fraudulently
used the corporate form to avoid paying creditors by paying many living expense with corporate funds thus reducing the corporation’s distributions to him which results in less disposable income available to pay creditors.
Although at first glance this may seem to be a recitation of the disposable income test under § 1325(b), the review of the state law indicates that the state law and bankruptcy law require quite dissimilar analysis. Different standards must be met to reverse pierce the corporate veil than those utilized in determining disposable income. Under state law, plaintiff must demonstrate that fraudulent or immoral acts occurred in the utilization of the corporate form. Fraudulent or immoral conduct is irrelevant to the application of § 1325(b). Unlike § 1325(b) which places the burden of proof on the debtor, the plaintiff has the burden of proof when seeking to pierce the corporate veil Critzer v. Oban, 52 Wn.2d 446 (1958).
In this case, the plaintiff certainly presented evidence that raises questions regarding the corporation’s travel expense category. The plaintiff did not produce evidence that, in fact, personal living expenses were being paid from that account nor any evidence from which the court could quantify the amount of any such personal living expenses. From the evidence, it is not possible to determine if those living expenses would be considered “necessary” and thus have no effect on debtor’s disposable income. The amount paid by the corporation for cable TV is insignificant and not evidence of fraud or abuse. The defendant was questioned regarding some fragmentary internal records from 2001 which showed that while married, the plaintiff and the
defendant vacationed in the Carribean and to some undetermined extent used the corporate credit cards. Contemporaneously, there was also the purchase of an $800 watch for plaintiff on the corporate credit card. The personal trip and gift funded by the corporation during the marriage of the parties occurred some years before the bankruptcy filing when the debtor was not insolvent. The plaintiff has not demonstrated an abuse of the corporate form. Plaintiff’s burden of proof cannot be met solely by the fact that the corporate travel expenses would cause a tax preparer to make further inquiry as to the composition of that category of expenses.
LACK OF GOOD FAITH UNDER § 1325(a)(3)
The burden is on the debtor to prove that his plan was proposed in good faith. In re Leavitt, 209 B.R. 935 (9th Cir. B.A.P. 1997). To determine good faith, the totality of the circumstances must be examined and no fraud or evil motive need be demonstrated. The question is whether the debtor is using the Code inequitably or contrary to the purposes for which it was intended. Chinichian, 784 F.2d 1440 (9th Cir. 1986). Decisions have enumerated various factors to be examined in determining good faith, for example, In re Gonzales, 172 B.R. 320 (E.D. Wash. 1994), but no list of factors can reflect the myriad individual circumstances in which Chapter 13 proceedings arise and the breadth of human conduct.
On April 28, 2003, the debtor commenced his first Chapter 13 (03-0633) which gave rise to this adversary proceeding. At that time, the plaintiff had brought contempt charges against the debtor in Montana
for failure to make the property settlement payments. The debtor had been in default in those payments and had informed plaintiff that the loss of income rendered him unable to repay. The parties attempted to renegotiate the dissolution decree and when that was not successful, the plaintiff filed contempt charges. At the time the charges were filed, the debtor was not in default. The Trustee criticizes the debtor for commencing a bankruptcy proceeding when not in default in the property settlement payment and for failing to “deal with the issues in the Montana state court.” The plaintiff argues that the debtor, in bad faith, “threatened” bankruptcy in the negotiations and the bankruptcy is an improper effort to avoid payment of the property settlement agreement which, by the terms of the dissolution decree, could not be modified. The court does not agree. In light of the fact that the debtor’s income had been substantially reduced and contempt charges had been brought, bankruptcy may have been the only realistic option for the debtor.
On July 28, 2003, this adversary was commenced. Also that month, a hearing was held in the first Chapter 13 which resulted in an order requiring the debtor to provide certain information to the Trustee and file a Liquidation Analysis and a BR 2016 Disclosure of Compensation of Attorney for Debtor. On August 5, 2003, the Trustee filed a certificate stating that some information had been provided but some had not and that the pleadings had not been filed. Based on the certificate, the court entered an ex-parte order dismissing the case on August 15, 2003. The debtor promptly filed a motion to vacate with a declaration from counsel stating that all information had been provided to the Trustee albeit not in the form anticipated. Admittedly, the BR
2016 Disclosure of Compensation of Attorney for Debtor by counsel and the Liquidation Analysis had not been filed.
On September 18, 2003, the second Chapter 13 (03-07748) was commenced. The explanation for the second filing was that before the hearing on the motion to vacate the order of dismissal could occur, another contempt hearing was requested by the plaintiff in state court. The commencement of the second proceeding is, at most, an indication that counsel was remiss in filing the Liquidation Analysis and BR 2016 Statement of Attorney Compensation, but is not an indication of inequitable or improper conduct on the part of the debtor.
Although there are a few small creditors who will be effected by this second Chapter 13 proceeding, the only significant creditor is the plaintiff. Confirmation of the plan will result in discharge of all but a small percentage of the financial obligation to the ex-wife. Such obligations are inherently different than obligations to commercial institutions, credit card holders and other types of consumer debt. Often, the motivation for a discharge of such obligations is not financial. When the sole significant claim to be discharged is held by a former spouse, strict examination of the debtor’s affairs is not only predictable, but required.
The former wife was employed as a para-professional librarian during the marriage but voluntarily terminated her employment sometime before the dissolution at the urging of the debtor. In the 2002 decree, the state court awarded her the family home which had about $52,000 of equity and it was sold post-dissolution. Since the dissolution, she has
been a student with small student loans being her only source of income. She regularly borrows from family members to meet her minimal monthly living expenses.
One of the reasons the plaintiff is the only significant creditor in this case is that the debtor voluntarily took steps pre-petition to reduce both personal expenses and corporate expenses. His motorcycle was sold alleviating the need for monthly payments and the timeshare was assigned to the plaintiff’s brother for the same reason. Although it is certainly a factor in examining bad faith that there is only one meaningful creditor and that creditor is a former spouse, that alone is not determinative of bad faith.
Substantial Distribution to Creditors
The debtor proposes to pay $400 per month for 48 month for a base amount of $19,200. Although the Proof of Claim filed by the plaintiff is in the amount of $293,000, from previous hearings and this trial it has been concluded that the actual amount owed is between $241,000 and $250,000. The proposed plan would distribute about $17,000 to the plaintiff or about 7% of her claim. Nominal distribution to unsecured creditors is not necessarily a demonstration of bad faith but a factor to be considered. In re Warren, 89 B.R. 87 (9th Cir. B.A.P. 1988).
BEST EFFORTS/PROJECTED DISPOSABLE INCOME House
The plaintiff argues that the debtor voluntarily impoverished himself by purchasing an expensive house in September of 2002. The purchase price was $196,000. The monthly payments are $1,529 which is high for the Spokane area. According to the debtor, the home has
appreciated and now has a value between $210,000 and $215,000. The mortgage balance is about $180,000. At the time of purchase, the debtor’s income was more than twice its current level. His taxable income in 2002 was $104,776 and in 2003 was $42,800. Debtor did not learn that his two largest accounts would be terminated until November or December of 2002, by which time he was obligated on the mortgage. Absent that loss of corporate income, the debtor would have been able to afford not only the payments required by the mortgage but payment of his other creditors.
The Schedules “I” and “J” in the two Chapter 13 cases are identical. They reflect net monthly income of $4,175 which includes $400 per month received by debtor’s new wife. They do not reflect the $428 per month received by her for child support. The $828 monthly income received by the current wife is used to pay household expenses. Although the current wife testified that the child support payments may have been disrupted and in default at the commencement of the first Chapter 13 proceeding, she was actively making attempts to collect. The Schedule I’s understates monthly income by $428.
The debtor offered to increase his plan payments by further reducing expenses. The expense he identified as subject to reduction was the tithing he states that he and his new wife have done for some time. The Schedule “J” does not show any amount for a tithing expense. The Trustee believes that the debtor’s current disposable income is
between $1,000 and $2,000 a month.
Because Kreyssler, Inc. is a wholly owned corporation, the debtor was required to file monthly operating statements reflecting its income and expenses. The debtor is an experienced businessman who historically has maintained books and records. His testimony and accounting records demonstrate an understanding of accounting principles. The monthly operating statements filed were not complete, were formatted inconsistently, and, in some months, did not reveal income and expenses of the corporation. Of the 12 monthly operating statements which should have been filed, seven meaningful monthly operating statements exist which reflect projected income of the corporation for 2004 in approximately the same amount as the 2003 income i.e. approximately $130,000. The debtor could provide no explanation for the inconsistent and incomplete monthly operating statements.
The debtor testified that he is attempting to generate additional business and develop new accounts with manufacturers. He believes he will be able to do so during the term of the plan. He states that if the corporate income increases, it will disburse additional funds to him thus allowing him to increase his plan payments. He stated that he is willing to periodically provide financial information to the Trustee during the term of the plan.
Corporate Travel Expense
The burden is on the debtor to demonstrate he is proposing to devote all projected disposable income to the plan. Although plaintiff failed to meet her burden of proof of corporate abuse, her allegation must be also analyzed in light of the debtor’s burden on the issue of
The debtor testified that he averages 6-7 days per month “on the road.” He normally flies once a month and on occasion, twice a month, to Boise, Idaho. Boise is not a great distance from Spokane which implies that the airfare would be modest, but the debtor stated that he was uncertain what portion of the travel expense would be attributed to airfare. Typically, the debtor attends one convention a year which is a few days in duration. There was no evidence whether he had done so in 2003 or 2004. Other travel is generally done by corporate vehicle. Annually, debtor averages 60-75 nights in lodging on business for an average cost of $60-$70 per night. The corporation purchases his meals, while traveling and he does not often entertain customers or take them to dinner but on occasion does take them to lunch. The incomplete nature of the monthly operating statements provided by the debtor has been addressed, but based upon the seven months of information provided, the average travel expenses since the filing of this bankruptcy would be about $3,100 per month or $37,000 for 2004. Travel expense was only $28,000 for 2003.
The debtor’s testimony regarding reimbursement to the corporation for personal expenses it paid was vague and at times contradictory. When asked about the 2001 personal charges, for the vacation with the Plaintiff, the debtor stated he would have broken out the personal charges from the corporate cards, but later said he did not know if he had done so. When asked why the corporate books do not reflect reimbursement from him, he stated that he would have written a personal check to the corporate credit card issuer for the personal portion of
the bill. He testified that there were few personal expenses paid by the corporation in the past couple of years. In later cross examination, he was asked what efforts he had made to reimburse the corporation for personal expenses and he indicated that he had not reimbursed the corporation. From his demeanor, it was apparent that he did not understand that last series of questions on cross examination. However, when the debtor’s counsel tried to rehabilitate the debtor’s testimony and asked similar questions, the debtor then stated that he did not know if he had ever written a check to the corporation but did not address his earlier testimony that he might have written checks payable to the credit card issuers. In total, the testimony regarding reimbursement to the corporation of any personal expenses was inconclusive.
In 2003, the debtor attempted to reduce travel expenses of the corporation as its income had been substantially reduced. According to the debtor, the 2004 corporate income is to date approximately the same as for 2003. No explanation was provided as to why the travel expenses increased dramatically from 2003 to the expenses reflected on the 2004 monthly operating statements. It is inexplicable how the travel described by the debtor, i.e., the monthly trips to Boise and annual convention, would result in expenses of this magnitude or how the 30,000 miles of driving relate to the travel category of expenses. Based upon his vague and at times inconsistent testimony regarding the travel expense category and the discomfort evidenced when examined about these expenses, the conclusion is that there are indeed some personal expenses contained in this category of corporate expense. The unease evidenced during testimony related, however, to the expenses that the court did
not consider as significant, i.e., the medical insurance premium, cable TV expense, etc. At other times during the debtor’s testimony, he appeared credible and sincere particularly when describing his attempts to reduce all expenses both personally and in the corporation. His discomfort on the topic of corporate travel was not of such magnitude to convince the court he was withholding information. The demeanor of all the individuals did convince the court that strong negative emotions exist and color all contact between the former spouses, even contact through counsel in litigation.
The incomplete monthly operating statements, the discrepancies in Schedules “I” and “J” and the various discovery disputes which occurred during the adversary proceeding demonstrate the debtor’s reluctance to provide full and frank disclosure of the corporate financial affairs to the plaintiff, his former wife. That reluctance created a cloud of suspicion not only on the part of his former wife but on the part of the Trustee and the court. Once the debtor was forced to reveal the information, it became apparent that there had been no substantive reason for the failure to readily disclose, such as a deliberate attempt to hide income. Mistakes were made in the bankruptcy information. Those mistakes increased the cloud of suspicion but unfortunately are the type of mistakes sometimes made by debtors and, once explained, not of sufficient magnitude to conclude or convince the court that they were attempts to mislead.
At trial, the debtor was forced to reveal more specifics of the interrelationship between his and the corporate affairs, but the evidence did not indicate impropriety in the relationship. The evidence
does not indicate that the debtor is utilizing the bankruptcy code contrary to the purposes for which it was intended. The evidence indicates that the personal expenses being paid by the corporation are minimal and to some extent necessary. Absent a request to produce by the plaintiff and no evidence of any such request was brought to the attention of the court, the debtor had no duty to produce the supporting documentation regarding the corporate travel expense category.
Although a close question, the court concludes that the debtor has met his burden of proof on the issue of good faith. He concedes that he has additional income and has not met his burden of proof on the issue of disposable income and “best efforts” but has stated that he is willing to increase his plan payments. Those payments must be increased to $868 per month (current plan payment of $400 plus the $428 child support and the $40 cable bill). The Chapter 13 Trustee shall submit an order confirming the plan, increasing the Plan payments and reflecting the new base amount. By December 15, 2004, the debtor is required to file complete monthly operating statements regarding the corporation evidencing the total income and expense throughout this proceeding. Due to the history of incomplete monthly operating statements and inaccurate Schedules “I” and “J” and the debtor’s anticipation of increasing corporate income, the debtor must provide to the Trustee and to the plaintiff by April 15, 2005 and each year thereafter prior to discharge, copy of the corporate and personal
federal income tax returns for the prior year.
As plaintiff did not prevail on the only issue remaining in the adversary proceeding, a separate order will be entered dismissing that action.