What are the debtor’s duties to disclose fully payments from a divorce in a subsequent bankruptcy case?

What are the debtor’s duties to disclose fully payments from a divorce in a subsequent bankruptcy case?

In bankruptcy, the debtor has a duty to disclose information with his lawyer, the Trustee and his creditors.  In return for the benefit of receiving a bankruptcy discharge, a debtor must disclose all of his assets, liabilities and financial affairs.  This obligation extends to the debtor’s conduct regarding payments received under divorce settlements with former spouses. The United States Court of Appeals for the First Circuit affirmed the U.S. District Court affirming a bankruptcy court’s order revoking the discharge of Bruce E. Thunberg in his Chapter 7 bankruptcy case in Thunberg v. Wallick (In re Thunberg) 641 F.3d 559 (1st Cir. 2011).

In that case, the debtor was involved in a divorce settlement with his former wife prior to the filing of his bankruptcy petition. The debtor’s treatment of the payments he received under that settlement became an issue in his subsequent bankruptcy proceeding.  Although he was granted a discharge administratively, the Trustee filed a complaint requesting that the bankruptcy court revoke his discharge on the grounds that it had been obtained fraudulently. See 11 U.S.C. § 727(d)(2) (which provides that upon request of a trustee, the court shall revoke a discharge if, “the debtor acquired property that is property of the estate, or became entitled to acquire property that would be property of the estate, and knowingly and fraudulently failed to report the acquisition of or entitlement to such property, or to deliver or surrender such property to the trustee . . . .”).

Pursuant to the 1997 divorce agreement, the debtor’s former spouse agreed to make annual payments of $30,000 to the debtor. Each $30,000 payment included $16,666 in alimony, and the remaining $13,333 was in the form of a property settlement. The debtor’s questionable conduct began in November of 2000, when he received one of these $30,000 payments from his former spouse and deposited the entire amount in a business account. See Wallick v. Thunberg (In re Thunberg), 413 B.R. 20, 22 (Bankr. D.R.I. 2009).

The debtor and the Trustee provided differing accounts of which portions of the payments were to be paid to secured creditors. The debtor claimed that he believed he could keep the alimony portion of the payment. The Trustee, meanwhile, argued that he was led to believe, by information provided at the 341 meeting and by the contents of a letter from the debtor’s attorney, that the entire payment was subject to the liens of secured creditors. Although the debtor claims the letter only refers to the property settlement portion of the payment, the bankruptcy court found that the record, including the letter, suggested that the entire payment from the ex-spouse was subject to security interests. Wallick v. Thunberg (In re Thunberg), 413 B.R. at 23 (Bankr. D.R.I. 2009).

The debtor also defended his retention of the payment by arguing that his attorney at one point advised him that he may keep the alimony portion of the payment. The bankruptcy court noted that his arguments regarding the alimony portion of the payment did not explain his actions in retaining the non-alimony portion. Id. The District Court noted, on appeal, that the debtor tried to explain his retention of the funds by testifying that he was paying funds to the creditors according to a separate schedule. Thunberg v. Wallick (In re Thunberg), No. 09-419 S (D.R.I. May 4, 2010). The court, in its decision affirming the bankruptcy court’s ruling, stated that there was nothing to corroborate the debtor’s claims. Id.

Additionally, to the debtor’s discredit, the debtor made a side agreement with his former spouse to accelerate several of the payments, without informing the Trustee or his own lawyer. When he received these funds, he deposited them in various personal and business accounts, before eventually paying some of the funds to the banks. Although the debtor claimed he told his lawyer about the agreement prior to receiving the payments, the bankruptcy court accepted the testimony of the debtor’s attorney who testified that he had not received any notice of the agreement until after the fact, and that he wouldn’t have approved of such an agreement. Finally, the trustee discovered that the liens in question had not been perfected, and thus, no portion of the payment was subject to any security interest. These circumstances only further clouded the credibility of the debtor.

The bankruptcy court found that Thunberg violated his duty to be “straightforward” in three ways: by remaining silent while his lawyer “mistakenly and incorrectly” informed the Trustee that the payments the Debtor received from his former spouse would be paid to secured creditors, by engaging in “secret negotiations” with his former spouse over funds that were property of the estate, and finally, by “hurriedly dispersing” the payments made under the unauthorized agreement with his former spouse without informing his lawyer. The bankruptcy court, convinced that these violations fell within the category of deceptive behavior that is prohibited by 11 U.S.C. § 727(d)(2), revoked the debtor’s discharge.

Ultimately on appeal to the U.S. Court of Appeals for the First Circuit, Thunberg argued that his actions “were at worst honest mistakes.” Thunberg v. Wallick (In re Thunberg) 641 F.3d 559 (1st Cir. 2011). However, the appellate court noted that while Thunberg “largely avoided explicit false statements,” his fraudulent intent could be inferred from a “pattern of evasion and silence in the face of culpable knowledge.” Id.  Importantly, the court notes that although he eventually turned over payments to the estate before trial, it was not enough to undo his earlier actions and avoid the revoking of his discharge. Id.

In this case, the bankruptcy court relied on the reasoning in Boroff v. Tully (In re Tully), 818 F. 2d 106 (1st Cir. 1987), which provided a standard for litigation under §727 of the Bankruptcy Code. See. Although Tully involved litigation concerning the denial of a discharge pursuant to § 727(a)(4)(A), and not a revocation of a discharge pursuant to § 727(d)(2), the bankruptcy court found that the analysis and discussion in Tully was relevant in addressing the facts of Thunberg’s case. Similarly, the District Court for the Eastern District of Virginia, in a case involving an objection to discharge under § 727(a), has cited Tully’s language, stating that a debtor may not “play fast and loose with their assets” and still receive a discharge under § 727.  Hatton v. Spencer (In re Hatton), 204 B.R. 477, 482 ( E.D. Va. 1997).  In determining whether a debtor’s actions were carried out with requisite fraudulent intent, the District Court has found proof of fraudulent intent where the pattern of conduct of the debtor suggests a “reckless indifference for the truth.” See Dean v. McDow, 299 B.R. 133, 140 (E.D. Va. 2003).  In handling the proceeds of a divorce settlement, a debtor in the Eastern District of Virginia may similarly find themselves in peril of losing the benefit of a discharge in bankruptcy if they fail to fully disclose the circumstances of their receipt of payments from an former spouse.

You should consult with your Virginia bankruptcy law lawyer and divorce lawyer, or Richmond bankruptcy law and divorce attorney James H. Wilson, Jr., concerning how your divorce settlement should be handled when filing a bankruptcy petition.

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