Ninth Circuit Bankruptcy Law Changes Course - Embezzler Prevented from Evading Repayment – BAP and bankruptcy court overruled

In re Laizure, --- F.3d ---, (9th Cir. Nov 17, 2008) (NO. 06-16857, BAP EC-06-1112-BMOS)

The Ninth Circuit Court of Appeals has been a sanctuary for fraudsters who wish to use the bankruptcy laws to escape justice. In re Scovis, 249 F.3d 975 (2001), allowed Chapter 13 debtors to omit creditors from their filing to stay under the jurisdictional limits so long as the creditor could not prove the omission was not in good faith. This is rarely possible because the debtor always has a reason that she “forgot” or “did not understand.” At the time In re Scovis was decided, fraud was dischargeable in Chapter 13 so fraudsters were able to use Chapter 13 to discharge debts when in reality they were not eligible to file a petition in Chapter 13. This was done over vigorous dissent. The 2005 amendments made fraud nondischargeable in Chapter 13 but left many of the loopholes in place.

Now it seems that the Ninth Circuit has changed course.

In Laizure, the debtor had embezzled money from his employer but agreed to repay the money after he was caught. The last payment to the employer was made within 90 days of the embezzler (Laizure) filing bankruptcy. The trustee demanded repayment of the money as a preferential payment made within 90 days of bankruptcy. The employer repaid the money and filed an adversary proceeding in bankruptcy to recover the embezzled money as a nondischargeable debt. The bankruptcy court and the Bankruptcy Appeals Panel dismissed the case. These dismissals required a narrow reading of the bankruptcy statute. The courts decided that since the debt had been paid as of the date of the filing, it did not exist as of the date of filing. Therefore the employer could not bring the adversary action and the embezzler could avoid repaying the money.

The Ninth Circuit reversed, holding that if the claim meets certain requirements the claimant can bring the claim as if it had arisen before filing the petition. In this case, the trustee avoided Laizure's final transfer to Busseto under 11 U.S.C. § 547 and recovered the $34,000 under § 550. According to the language of § 502(h), the trustee, through using this § 550 recovery ability, revived Busseto's claim to prepetition status. Consequently, Busseto has a claim against Laizure “the same as if ... [it] had arisen before the date of the filing of the petition.” 11 U.S.C. § 502(h).

We were encouraged by the following quote in Laizure:

. . . , this conclusion best advances the policies of our bankruptcy laws. As the Supreme Court has explained, “the Act limits the opportunity for a completely unencumbered new beginning to the honest but unfortunate debtor.” Grogan v. Garner, 498 U.S. 279, 286-87, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991) (citations and internal quotations omitted). The Court later stated that these “statutory provisions governing nondischargeability reflect a congressional decision to exclude from the general policy of discharge certain categories of
debts ... [including] liabilities for fraud.” Id. at 287. Here, allowing Laizure to avoid repaying the funds he embezzled from Busseto would contravene Congress' intent. A contrary conclusion would only encourage debtors to pay outstanding debts that are nondischargeable and later file for bankruptcy protection, thus avoiding the nondischargeability of their debt under the veil of our bankruptcy
laws.

Finally, the Ninth Circuit seems to be on course to assist rather than obstruct the fight against fraud.