Case No. 00-70868, Adversary No. 00-7091United States Bankruptcy Court, C.D. Illinois
September 28, 2000
OPINION
LARRY LESSEN, United States Bankruptcy Judge.
The issue before the Court is whether the Defendants should be denied a discharge pursuant to 11 U.S.C. § 727(a)(2)(A), 727(a)(2)(B) and/ or 727(a)(4)(A). The Defendants, Curtis and Stephanie Thomas, purchased a bicycle business in Decatur, Illinois, from Curtis’ father, Robert Thomas, in 1996. The Defendants renamed the business Velocity Cycle Fitness. Robert Thomas maintained ownership of the real estate where the business was located, and the Defendants paid rent to Robert Thomas.
The business did not go well. Robert Thomas pumped money into the business over the next few years by way of loans. Many of these loans were disguised as credit card sales wherein a charge would be run up on Robert Thomas’ credit card, a sales slip would be prepared to show certain bicycles sold, but Robert Thomas would not take possession of the bicycles.
In December, 1999, the Defendants needed $15,000 to pay their federal withholding taxes. Robert Thomas borrowed $10,000 from The State Bank of Blue Mound and $5,000 from Decatur Earthmovers Credit Union and put the money into Velocity Cycle Fitness. No documents were drawn up to evidence this transaction at this time. Robert Thomas did not take any bicycles with him as security in December, 1999. He may have pointed out a few bikes at this time, but nothing was written down and no bicycles were ever tagged with his name. All of the bicycles were left on the floor and were free to be sold because Robert Thomas wanted to maximize the Defendants’ opportunity to pay their creditors.
According to the manager of Velocity Cycle Fitness, the close of the business was imminent in all of 1999. In January, 2000, the Defendants met with an attorney for the purpose of discussing the filing of a bankruptcy petition. Robert Thomas was aware of the Defendants’ plans to file bankruptcy because the Defendants told him of their plans.
Robert Thomas was by far the Defendants’ largest creditor. They owed him for three months back rent, for the inventory and fixtures which they purchased in 1996, and for the various cash infusions which Robert Thomas made to the business. In all, the Defendants owed Robert Thomas around $46,000.
On February 1, 2000, Robert Thomas went to Velocity Cycle Fitness with a truck and took $15, 322 worth of bicycles out the back door. An invoice prepared at this time indicated that the bicycles were purchased on February 1, 2000, and paid for with a check. Robert Thomas did not give the Defendants a check on this date. The prices on the invoice are 10% over wholesale plus tax. The bicycles were picked out so that the total price would match the $15,000 that Robert Thomas had put into the business in December, 1999. Robert Thomas stored the bicycles in his garage. He sold 11 bicycles before he was instructed to stop by the Trustee. He is now selling the bicycles as the agent for the Trustee.
On March 20, 2000, the Defendants filed a petition pursuant to Chapter 7 of the Bankruptcy Code. Paragraph 3 of the Statement of Financial Affairs requires debtors to “[l]ist all payments on loans, installment purchases of goods or services, and all debts, aggregating more than $600 to any creditor, made within 90 days immediately preceding the commencement of this case.” The Defendants responded that they paid Robert [ Polly] Thomas a total of $4,346.55 on “01-18-00, 12-23-99, 11-29-99, 12-3-99”. The Defendants further indicated that no payments were made within one year immediately preceding the commencement of the case to or for the benefit of creditors who were insiders. Paragraph 10 of the Statement of Financial Affairs requires debtors to “[l]ist all other property, other than property transferred in the ordinary course of the business or financial affairs of the debtor, transferred either absolutely or as security within one year immediately preceding the commencement of this case.” The Defendants marked “None” on their petition. There are no references in any part of the Statement of Financial Affairs to Robert Thomas removing over $15,000 of bicycles from Velocity Cycle Fitness on February 1, 2000. Both Defendants signed the Statement of Financial Affairs.
A meeting of creditors was held on May 9, 2000, pursuant to 11 U.S.C. § 341, at which time the following colloquy took place between Mr. Richardson, the attorney for the Plaintiff, and the Defendants:
J. Richardson: Yes, Mr. and Mrs. Thomas, Mr. Cox asked you what happened to your equipment and inventory. Mr. Thomas you responded “still there”. Where is there? What’s the location . . .
Mr. Thomas: 518 E. Prairie.
J. Richardson: Is that the . . .
Mr. Thomas: That’s the ? location.
J. Richardson: Is that the one owned by your parents?
Mr. Thomas: Uh huh.
J. Richardson: You said you closed the business February of 2000. You are saying you didn’t remove any of the equipment or inventory from the premises?
Mr. Thomas: Not after that time, no.
J. Richardson: Well, okay. That is kind of a fine answer. Is there any equipment or inventory that is in that business that is not at 518 E. Prairie right now?
Mr. Thomas: No.
J. Richardson: Okay. I was contacted by an attorney in California for Specialized Bicycle Components and here is the statement and I will give Mr. Cox a copy of this. On February 4, 2000, Michael Barr, the manager of Velocity, unbeknownst to the debtor, called Specialized, that’s the company in California, on the telephone to advise that the Debtor was loading inventory onto a truck, and moving out. Specialized immediately requested that its area sales representative visit the store. The sales representative, stopped by the store later that day, and was told by the debtor that he had filed for bankruptcy. Now, was anything removed on February 4? Did you in fact load up inventory
Mr. Thomas: No
J. Richardson: To take it someplace else?
Mr. Thomas: Absolutely not.
J. Richardson: Okay. So everything that was in the operation of that business is still there at 518 E. Prairie?
Mr. Thomas: Other than since that date we still continued business for a few more days and we did sell some stuff.
J. Richardson: I’m not talking about anything you sold in the ordinary course of business. I’m talking about anything you might have taken home, put in your garage or put on somebody else’s property?
Mr. Thomas: No.
J. Richardson: And the answer is no?
Mr. Thomas: No.
J. Richardson: Is that you answer too Mam? You got to say yes or no.
Mrs. Thomas: Yes.
Curtis Thomas was active in the business of Velocity Cycle Fitness. He was at the store on February 1, 2000, when his father was taking a truck full of bicycles from the store, and he was fully aware of what his father was doing. He instructed the store manager to prepare the February 1, 2000, invoice, and they tried to pick out bicycles that would add up to $15,000. Stephanie Thomas was not as active in the business. Although not involved in the day-to-day operation of the business, she did do some of the accounting for the business. She testified that she knew that Robert Thomas had taken a whole bunch of bicycles from the store, and that they were being stored in Robert Thomas’ garage. She was aware of these facts before she signed her bankruptcy petition on March 9, 2000, and before she testified at the meeting of creditors.
The discharge provided by the Bankruptcy Code is to effectuate the “fresh start” goal of bankruptcy relief. In exchange for that fresh start, the Bankruptcy Code requires debtors to accurately and truthfully present themselves before the Court. A discharge is only for the honest debtor. In re Garman, 643 F.2d 1252, 1257 (7 th Cir. 1980), cert. denied, 450 U.S. 910, 101 S. Ct. 1347 (1981). Exceptions to discharge are construed strictly against objectors and liberally in favor of debtors. In re Johnson, 98 B.R. 359, 364 (Bankr. N. D. Ill. 1988). The objector must establish all elements of his objection by a preponderance of the evidence. In re Scott, 172 F.3d 959, 966-67 (7 th Cir. 1999).
11 U.S.C. § 727 provides in pertinent part as follows:
(a) The court shall grant the debtor a discharge, unless —
. . . .
(2) 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 —
(A) property of the debtor, within one year before the date of the filing of the petition; or
(B) property of the estate, after the date of the filing of the petition;
. . . .
(4) the debtor knowingly and fraudulently, in or in connection with the case —
(A) made a false oath or account(.)
The Plaintiff argues that the pre-petition transfer of $15,000 worth of bicycles to Robert Thomas and the post-petition concealment of the transfer constitute grounds to deny the Defendants a discharge pursuant to 11 U.S.C. § 727(a)(2)(A) and (B). Denial of discharge under this section requires proof of actual intent to hinder, delay or defraud a creditor. In re Snyder, 152 F.3d 596, 601 (7 th Cir. 1998). “Proof of harm is not a required element of a cause of action under Section 727.” In re Smiley, 864 F.2d 562, 569 (7 th Cir. 1989). In determining whether a debtor has acted with intent to defraud under § 727, the Court should consider the debtor’s “whole pattern of conduct.” In re Ratner, 132 B.R. 728, 731 (N. D. Ill. 1991). Actual fraudulent intent can be inferred from extrinsic evidence. In re Krehl, 86 F.3d 737, 743 (7 th Cir. 1996).
The Defendants’ business, Velocity Cycle Fitness, was failing throughout 1999 and bankruptcy was imminent. In January, 2000, the Defendants met with a bankruptcy attorney. In February 2000, the Defendants’ largest creditor, Robert Thomas, removed $15,000 worth of bicycles from the business. This constituted about one-third of the inventory of the business. The business shut down soon after the transfer. In March, 2000, the Defendants filed for bankruptcy relief. The Defendants continued to conceal the existence of the bicycles in Robert Thomas’ garage following the filing of the bankruptcy petition.
It is clear from the foregoing that the Defendants transferred the bicycles to Robert Thomas with the intent to hinder, delay and defraud creditors. The Defendants made the transfer after talking to their bankruptcy attorney. Robert Thomas knew that the Defendants were going to file bankruptcy. It is certainly understandable that the Defendants wanted to prefer Robert Thomas, the father of Curtis Thomas and father-in-law of Stephanie Thomas, over their other creditors. Although such a preference may be natural, it is not permitted by the Bankruptcy Code.
The Defendants’ argument that the February 1, 2000, transfer was a true sale was not supported by the evidence. Robert Thomas wrote the $15,000 check in December, 1999. No sales slip was prepared, no bicycles were tagged with his name or removed from the floor, and no bicycles were removed from the business. The Defendants were free to sell any bicycle from their inventory to any customer that walked in off of the street. The invoice prepared on February 1, 2000, was a “dummy” invoice; the bicycles were picked out in order to make the total add up to $15,000.
It is clear that the parties intended for Robert Thomas to have some sort of security interest in the Defendants’ inventory. However, the necessary documents to evidence a secured transaction were not prepared. Instead, Robert Thomas was simply an unsecured creditor.
The transfer of $15,000 worth of bicycles to Robert Thomas on February 1, 2000, and the continuing concealment of the transfer were attempts by the Defendants to hinder, delay, and defraud their creditors. Therefore, their discharge should be denied pursuant to 11 U.S.C. § 727(a)(2)(A) and (B).
The Plaintiff further argues that the Defendants should be denied pursuant to 11 U.S.C. § 727(a)(4) because the Defendants failed to disclose the transfer of $15,000 of bicycles to Robert Thomas in their Statement of Financial Affairs. In addition, they lied about the transfer at their meeting of creditors.
The purpose of § 727(a)(4) is to enforce a debtor’s duty of disclosure and to ensure that the debtor provides reliable information to those who have an interest in the administration of the estate. In re Carlson, 231 B.R. 640, 655 (Bankr. N. D. Ill. 1999), aff’d 250 B.R. 366
(N. D. Ill. 2000). In order to prevail under § 727(a)(4), the Plaintiff must establish five elements: (1) the Defendants made a statement under oath; (2) the statement was false; (3) the Defendants knew that the statement was false; (4) the Defendants made the statement with intent to deceive, and (5) the statement related materially to the bankruptcy case. In re Bailey, 147 B.R. 157, 163
(Bankr. N. D. Ill. 1992). If made with the requisite fraudulent intent, a false statement, whether made in the schedules or orally at a § 341 creditors’ meeting, is sufficient grounds for denying a discharge provided it was knowingly made and is material. In re Lunday, 100 B.R. 502, 508 (Bankr. D. N. D. 1989). It is a debtor’s role to consider the questions posed on the schedules and at the creditors’ meeting carefully and answer them accurately and completely. Id.
A debtor’s petition and schedules constitute a statement under oath for purposes of a discharge objection under § 727(a)(4). In re Gannon, 173 B.R. 313, 320 (Bankr. S. D. N. Y. 1994). In addition, a debtor’s testimony at the meeting of creditors is under oath. Thus, the Plaintiff has established that the Defendants made a statement under oath.
Whether the Defendants made a false oath within the meaning of § 727(a)(4)(A) is a question of fact. In re Bernard, 99 B.R. 563, 570
(Bankr. S.D.N.Y. 1989). “Filing of false schedules with material omissions or misrepresentations with an intent to mislead creditors and the trustee as to a debtor’s actual financial condition constitutes a false oath under § 727(a)(4)(A).” In re Krich, 97 B.R. 919, 923 (Bankr. N. D. Ill. 1988). This element has been satisfied because the Statement of Financial Affairs and the Defendants’ testimony at the § 341 meeting completely omitted any reference to Robert Thomas’ removal of $15,000 of bicycles from Velocity Cycle Fitness on February 1, 2000.
The Defendants knew that their statements were false. Curtis Thomas was in the bicycle shop when Robert Thomas removed the bicycles on February 1, 2000, and Curtis Thomas instructed his manager to prepare the dummy invoice. Curtis Thomas knew that the bicycles were taken to and stored in Robert Thomas’ garage. Stephanie Thomas admitted that she knew that Robert Thomas had taken a whole bunch of valuable bicycles from the shop and was storing them in his garage. The determinative issue is whether the Defendants made the statements with fraudulent intent. To find the requisite degree of fraudulent intent, the Court must find that the Defendants knowingly intended to defraud or engaged in behavior which displayed a reckless disregard for the truth. In re Yonikus, 974 F.2d 901, 905 (7 th Cir. 1992). If a debtor’s bankruptcy schedules or § 341 testimony reflect a “reckless indifference to the truth”, then the plaintiff seeking denial of discharge need not offer any further evidence of fraud. In re Calisoff, 92 B.R. 346, 355 (Bankr. N. D. Ill. 1988). The requisite intent under § 727(a)(4)(A) may be inferred from circumstantial evidence. In re Yonikus, supra, 974 F.2d at 955. When a debtor is in doubt concerning disclosure, it is unquestioned that he is obligated to disclose. In re Johnson, 189 B.R. 985, 994-95
(Bankr. N. D. Ala. 1995) (failure to disclose transferred assets warranted denial of discharge).
The Defendants contend that they did not have to disclose the transfer of $15,000 of bicycles to Robert Thomas on February 1, 2000, on their Statement of Financial Affairs because it was a sale in the ordinary course of business for Velocity Cycle Fitness. The evidence, however, clearly demonstrated that the transaction was neither a sale nor ordinary. The Court has explained, supra, why the transaction was not a sale. Even if it was a sale, it was certainly not ordinary. It is true that Robert Thomas had purchased various items, including two bicycles, from Velocity Cycle Fitness after 1996 for 10% over cost. However, at no time did Robert Thomas, or any other creditor, purchase the number of bicycles evidenced by the February 1, 2000, invoice. When Robert Thomas took over $15,000 of bicycles out of the back door of Velocity Cycle Fitness on February 1, 2000, this constituted onethird of the store’s inventory. Indeed, the transaction was so extraordinary that Robert Thomas had to rent a truck because he could not fit the bicycles into the vehicle that he had originally brought to the store. The Defendants omitted the transfer of bicycles to Robert Thomas on February 1, 2000, because they wanted to protect him.
The Defendants also testified with fraudulent intent at their meeting of creditors. The Defendants flatly denied that inventory was loaded onto a truck and moved out in February, 2000. They also denied that any of the store’s inventory was removed and taken to someone else’s property. The Defendants knew that the Plaintiff’s attorney was inquiring about Robert Thomas’ removal of $15,000 worth of bicycles, but their testimony was evasive at best. Their false testimony was not the result of mistake or inadvertence. The Defendants were given every opportunity at their meeting of creditors to come clean about the transfer to Robert Thomas, but they decided to stick to their fraudulent story, and this decision as proven to be fatal to their discharge.
The Defendants’ false statements clearly related materially to the bankruptcy case. The test for materiality of the subject matter of a false oath is whether it “bears a relationship to the bankrupt’s business transactions or estate, or concerns the discovery of assets, business dealings, or the existence of dispositions of his property. In re Bailey, 147 B.R. 157, 162 (Bankr. N. D. Ill. 1992). The $15,000 worth of bicycles, which constituted one-third of the Defendants’ inventory was an important asset. The test for materiality has been met.
For the foregoing reasons, judgment is granted in favor of the Plaintiff and against the Defendants. The Defendants’ discharge is denied pursuant to 11 U.S.C. § 727(a)(2)(A), 727(a)(2)(B), and 727(a)(4)(A).
This Opinion is to serve as Findings of Fact and Conclusions of Law pursuant to Rule 7052 of the Rules of Bankruptcy Procedure.
ORDER
For the reasons set forth in an Opinion entered this day, IT IS HEREBY ORDERED that the Defendants’ discharge be and is hereby denied pursuant to 11 U.S.C. § 727(a)(2)(A).
IT IS FURTHER ORDERED that the Defendants’ discharge be and is hereby denied pursuant to 11 U.S.C. § 727(a)(2)(B).
IT IS FURTHER ORDERED that the Defendants’ discharge be and is hereby denied pursuant to 11 U.S.C. § 727(a)(4)(A).