In many common nondischargeability claims, the plaintiff creditor must prove the debtor defendant’s intentional misconduct. A default judgment for an underlying breach of contract or tort is insufficient on its own to support nondischargeability. The creditor must put on specific evidence of the debtor’s intent. This constitutes black-letter law under the Bankruptcy Code.

Proving intent can be challenging in its own right, but the problem becomes more complex if the debtor cannot be located. It is not unheard of for a debtor to disappear after the completion of the core matters in a chapter 7 or 13 case. For example, a foreign national may decide to return to his or her home country, but the creditor’s nondischargeability action may still be pending, subject to proof of debtor’s intent in the underlying claim. If the debtor is not around, it may be difficult to prove the intent to support a nondischargeability judgment.

Fortunately for creditor counsel, the court’s procedural rules provide them with protections. The primary protection is under Federal Rule of Bankruptcy Procedure 7037, which provides a range of sanctions for failure to participate in discovery. Although entry of a dispositive order is an extreme sanction, courts recognize it as valid against a nonparticipating party in nondischargeability actions.

A Creditor Must Prove Debtor’s Intentional Conduct
One of the most common claims for nondischargeability arises when a debtor obtained money, services or credit by using a materially false statement of the debtor’s financial conditions. [1] The statute requires the plaintiff prove “that the debtor caused [the statement] to be made or published with [the] intent to deceive.” [2] Courts recognize that a plaintiff must prove the debtor’s intent as a necessary element before entering a nondischargeability judgment. [3]

Similarly, a denial of discharge may require a plaintiff creditor to establish the debtor’s intent. The discharge should be denied if the debtor, “with intent to hinder, delay or defraud a creditor or an officer of the estate,” has transferred, removed, destroyed, mutilated or concealed property of the debtor or the bankruptcy estate. [4] The discharge also should be denied if the debtor “knowingly of fraudulently” engaged in misconduct concerning the debtor’s assets and liabilities. [5] These provisions require a plaintiff to prove the debtor’s intent in order to obtain a denial of discharge. [6] A debt also is nondischargeable if it arises from a “willful and malicious injury by the debtor to another entity or to the property of another entity.” [7] Although the statutory language is not explicit, courts have held that a plaintiff must prove the debtor’s intent to cause an injury. [8]

A Creditor May Not Have Any Direct Proof of Intent When the Bankruptcy Starts
When a bankruptcy commences, a creditor may only know that debtor owes it money. The creditor may have even obtained a pre-petition default judgment without conducting any discovery. In either instance, the creditor may not have any evidence about debtor’s intent except for its own records of the debt. As a result, the creditor will need to conduct discovery in the bankruptcy proceeding to establish a debtor’s intentional misconduct and obtain a nondischargeability judgment.

A creditor can face additional challenges in chapter 7 and 13 cases. A chapter 7 debtor may receive a discharge before the nondischargeability action is resolved. Similarly, a chapter 13 debtor may have confirmed a plan during the pendency of the nondischargeability action. The debtor may decide that he or she already obtained the benefit of bankruptcy. As a result, the debtor may not participate in the nondischargeability action. This occurs with pro se debtors who may not understand the procedure. There also are numerous cases arising when defendants and their counsel have lost contact with each other.

If the debtor ignores the adversary proceeding or walks away from court entirely, the plaintiff may obtain a default judgment on the underlying substantive claim, but to obtain the nondischargeability judgment, the plaintiff still needs to develop the evidentiary record to establish the debtor’s intentional conduct. [9] “This practice is motivated by the risk that a creditor may obtain a default judgment, regardless of the merits of the complaint, against an honest debtor who is in such a precarious financial condition that the debtor cannot afford to defend a nondischargeability claim.” [10] If a debtor has disappeared, the creditor may not be able to conduct discovery and obtain evidence to prove the debtor’s intent. The creditor needs to consider alternative methods to obtain a nondischargeability judgment.

Pursue Discovery Sanctions to Obtain a Default Judgment without Proving Debtor’s Intent
The creditor still may prevail in a nondischargeability action based on the discovery sanctions under Federal Rule of Bankruptcy Procedure 7037, which incorporates by reference the entirety of Federal Rule of Civil Procedure 37. The primary basis for relief arises if the debtor defendant fails to appear at his or her deposition under Rule 30, or fails to provide a written response to interrogatories or a request for inspection under Rules 33 and 34. [11] If a defendant fails to participate in discovery, the Rules authorize the court to enter a range of sanctions including default judgment against the disobedient party. [12]

Sanctions are appropriate for discovery violations in “extreme circumstances” when the violation is “due to willfulness, bad faith or fault of the party.” [13] To establish “willfulness, bad faith or fault,” the movant must show that the disobedient party’s conduct was not outside the party’s control. [14] The exact standards may vary by circuit. For example, the Ninth Circuit holds that the court should weigh five factors to determine whether default judgment is appropriate: “(1) the public’s interest in expeditious resolution of litigation; (2) the court’s need to manage its docket; (3) the risk of prejudice to the [moving party]; (4) the public policy favoring disposition of cases on their merits; and (5) the availability of less drastic sanctions.” [15] Courts generally are concerned that a party’s failure to cooperate with discovery prevents the opposing party from “ascertaining the truth of the issue.” [16]

In weighing those factors, courts have entered a dispositive sanction where a party has disappeared and failed to comply with discovery. Primarily, courts have held that a party’s location is within its control, and the party’s absence “demonstrate[s] the requisite willfulness and fault” that justifies a dispositive sanction under Rule 37(d). [17]
Default judgments have been entered specifically in nondischargeability actions as a sanction for failure to satisfy discovery obligations. [18] Sanctions have been repeatedly imposed based on a debtor’s absence from the adversary proceeding. The dispositive sanction is sometimes based on a debtor’s failure to participate in the proceeding. [19] Other times, the debtors have left the state. One decision reflected the fact that the debtors apparently were looking for work out of state, but based on the fact that the debtors had appeared once, claimed to be hiring counsel but had not, and had not otherwise participated in the case, the court entered a default judgment for nondischargeability. [20] In another case, the debtors claimed to have moved out of state, but when the debtors did not appear at depositions or in court for a motion hearing and trial set concurrently, the court entered a default judgment. [21]

The sanction is often imposed after fruitless efforts to compel the debtor to comply with their discovery obligations. For example, a default judgment was entered in a matter that consolidated the determination of debtors’ tax liability and the dischargeability of that debt. [22] The court ruled in the government’s favor of the tax liability. The debtors then objected to the court’s jurisdiction, refused to schedule a continued deposition and refused to accept the proposed pretrial order mailed to them. The court held that the debtor’s conduct “constituted willful discovery abuses” and entered a default judgment against them as a violation under Rule 37(d). [23]

It is not unusual for a debtor to stop participating in a case after a number of prior discovery disputes. The debtor’s counsel in one case advised the court that his client had stopped responding to him. [24] Between the debtor’s absence and earlier problems with discovery, the court entered a default judgment as a sanction in the nondischargeability proceeding. Alternatively, when the debtor defendant no longer can be located, a court may issue a warning order effectively to defendant’s counsel if the defendant is not in attendance. The court may order the defendant to comply with his or her discovery obligations, subject to the risk of default judgment for noncompliance. [25]

Conclusion
The disappearance of a defendant can be problematic in any case. It can be resolved in civil litigation with a default judgment on the substantive claim under Federal Rule of Civil Procedure 55, but when a defendant disappears in a nondischargeability proceeding, the plaintiff still needs to prove the defendant’s intentional misconduct in many claims. Proof of intent may be evasive if the defendant has disappeared. The dispositive discovery sanction is an important tool for creditor’s counsel that relieves the plaintiff of its burden of proving the defendant’s intent in the underlying claim. The debt remains nondischargeable, leaving the creditor free to resume its search for the defendant and seek repayment of its debt.

The manipulation of the current monthly income (CMI) schedule [Bankruptcy Form B22] by bankruptcy practitioners has been subject of many bankruptcy court opinions and, such concern culminated with a 2011 opinion by the U.S. Supreme Court—Ransom v. FIA Card Services NA [1]. One of the better expenses to include would be the car expenses of one or two or more vehicles, even when a debtor may own the vehicle free and clear of all liens. The majority of circuits ruled in favor of allowing a debtor to include such motor vehicle expenses, while the creditors persisted in arguing that the same was in violation of the language of the Bankruptcy Code and legislative intent of the Bankruptcy Abuse Prevention and Consumer Protection Actof 2005(BAPCPA). Those issues were reviewed by the Supreme Court in Ransom, which has now made the creditors’ view the law of all jurisdictions; but, with this decision some very important questions remain unanswered.

Overview
The applicable provision of the Bankruptcy Code reads as follows:

The debtor's monthly expenses shall be the debtor's applicable monthly expense amounts specified under the National Standards and Local Standards, and the debtor's actual monthly expenses for the categories specified as Other Necessary Expenses issued by the Internal Revenue Service [IRS] for the area in which the debtor resides. [2]

 

Section 707(b)(2)(A)(ii)(I)’s reference to the “the National Standards and Local Standards issued” by the IRS requires debtors to comply with the IRS-established standards in calculating taxpayers’ ability to pay delinquent taxes. The Collection Financial Standards provide that taxpayers are allowed the total National Standards amount for their family size and income level, without questioning amounts actually spent. The local standards cover two categories of expenses: (1) housing and utilities, and (2) transportation. The “allowable living expenses for transportation” are broken down into “ownership costs” and “operating costs and public transportation.” It is the former costs that were at issue in Ransom.

The Ransom ruling disallowed monthly expenses if the debtor owned the vehicle free and clear of all liens. We now know that in bankruptcy, a debtor without a car payment does not receive the ownership cost deduction described by the IRS Financial Analysis Handbook. Ransom made bankruptcy akin to the world of collection by the taxing authority whose rulebook states that “[i]f a taxpayer has a car payment, the allowable ownership cost added to the allowable operating cost equals the allowable transportation expense. If a taxpayer has no car payment only the operating cost portion of the transportation standard is used to figure the allowable transportation expense.” [3]

In bankruptcy, calculating the CMI is done with a form B22, which is a document delivered by computer software. It asks questions, and practitioners merely plug answers into the boxes. Ultimately, a tabulated answer is delivered stating one of two things: (1) presumption arises or (2) presumption does not arise. The term “presumption” calls for “presumption of abuse,” which describes if the debtor may continue in chapter 7 (and pay nothing to creditors) or must convert to either chapter 11 or 13 (and make a payment plan to creditors).

To illustrate how the software is not identical to the Bankruptcy Code or the IRS Manual, one merely needs to see how the questions are posed. In TopForm, the applicable question for costs appears as follows:

22A. Local Standards: transportation; vehicle operation/public transportation expense

Number of Vehicles


Census Region

23. Local Standards: transportation ownership/lease expense; Vehicle 1

Number of Vehicles

a. IRS Transportation Standards, Ownership costs

b. (-)Avg Monthly Payment for
 debts secured by Vehicle 1 (if any)

24. Local Standards: transportation ownership/lease expense; Vehicle 2

Number of Vehicles

a. IRS Transportation Standards, Ownership costs

b. (-)Avg Monthly Payment for debts secured by Vehicle 1 (if any)

In Ransom, the Court did something that the programmers understandably did not—it looked deeply into the language of the Bankruptcy Code. “Our interpretation…starts ‘where all such inquiries must begin: with the language of the statute itself.’” Upon reviewing § 707(b)(2)(A)(ii)(I), the court determined that the issue is about the definitions and congressional inclusion of the terms “applicable,” “monthly” and “expense.”
 

“Because the Code does not define ‘applicable,’ we look to the ordinary meaning of the term. See, e.g., Hamilton v. Lanning, 560 U.S. ___, ___, 130 S. Ct. 2464, 177 L. Ed. 2d 23, 33 (2010). ‘Applicable’ means ‘capable of being applied: having relevance’ or ‘fit, suitable, or right to be applied: appropriate.’ Webster's Third New International Dictionary 105 (2002). See also New Oxford American Dictionary 74 (2d ed. 2005) (‘relevant or appropriate’); 1 Oxford English Dictionary 575 (2d ed. 1989) (‘[c]apable of being applied’ or ‘[f]it or suitable for its purpose, appropriate’). So an expense amount is ‘applicable’ within the plain meaning of the statute when it is appropriate, relevant, suitable, or fit.” [5]

The term “expense” was merely synonymous with car payment, and the court concluded that “[b]ecause Ransom owns his vehicle free and clear of any encumbrance, he incurs no expense in the ‘Ownership Costs’ category of the Local Standards. Accordingly, the car-ownership expense amount is not ‘applicable’ to him, and the Ninth Circuit correctly denied that deduction.” [6]

The differences between the texts of the Bankruptcy Code and the text of the forms are probably a derivative of users’ request for simplicity. The computer program asks for “ownership” of motor vehicles, and then has the user input the amount of the monthly payment from the federally allowed amount. Therefore, if one does not have an expense for ownership, the user puts nothing in the box and the computer will deliver the default amount for the first or second vehicle ($496), which will not be excluded. The result of such programming is to grant a $496 credit against income in favor of the debtor. This particular inclusion of an expense when no actual lien payment exists was the issue in Ransom.

The alternatives that can be inputted in the same program include payments that are greater or less than the federally allotted amount. For instance, if a monthly car payment of $380 exists, the program would leave one with $116 at the first pertinent portion of the form with additional credit being given later in the form for $380 where secured creditor payments are allowed. If the payment exceeds the allotted amount of $496, the debtor is allowed full payment for the same. In short, if there were some type of payment, the debtor would receive credit either on line 23b or line 42 of form B22A. If the payment is less than the allowed amount, the debtor will receive credit on lines 23b and 42, which will total the $496. If the payment is greater than the federally gauged amount, the debtor will receive credit exceeding $496 on line 42 of form B22A. After the ruling in Ransom, if the debtor has no payments, he or she will not receive credit as to ownership, but will receive the deduction for operating costs.

This language-intensive review by the court may be correct on the letter of law, but it overlooked the practicality of bankruptcy practice. Quite simply, attorneys will be asked to engage in actions to circumvent the decision. The court, when delivered with this issue, had to contemplate the possibility of abusive or permitted practices that may occur in the future—any of which would defeat the decision. Justice Scalia wrote, “That is fairly matched by the imagined horrible that, under the Court's scheme, a debtor entering bankruptcy might purchase a junkyard car for a song plus a $ 10 promissory note payable over several years. He would get the full ownership expense deduction.” [7] Footnote 8 of the opinion addresses how various parties had briefed the court about this particular issue, but, this posed issue was only addressed in Scalia’s dissent.

The court’s decision not to rule on the issue of “whether or not a party with a junkyard heap would obtain a $496 credit” will be just one more reason why the Court may need to grant certiorari on a related and serious question: What “expense” is “reasonable” so as to permit the debtor to receive the full $496 credit? For instance, if a debtor has an insignificant payment of $10 a month for a vehicle, could that particular debtor be entitled to a credit of $486 on line 23b of form B22A and an additional $10 credit on line 43 of form B22A, which grants a total credit of $496? Why should a debtor who has no payments be disallowed any credit whatsoever while his neighbor with a $10 payment be allowed a credit of $496? It seems improper that a party who only makes a $10 payment would receive a full $496 credit while a debtor with no payments receives nothing. As important as this argument may be to some, it received no ruling by the court, and the allies on this issue were foes in the Ransom case. The U.S. Solicitor General, who sided with the creditor in Ransom, sided with the debtor in allowing the $496 credit to the hypothetical $10-per-month paying debtor described above. Not surprisingly, counsel for the credit card company disagreed on this unresolved issue—thereby awakening the author to conclude that this issue may be forthcoming.

The ridiculous result mentioned above is how the CMI becomes the topic of potential abuse. For instance, the debtor who has a motor vehicle owned free and clear of all liens, may choose to receive a motor vehicle loan from a relative prior to the filing to pay attorneys fees for the bankruptcy and make payments to that party for a period of 50 months so as to be entitled the full credit of $496 from the CMI’s B22 form. Counsel for the debtors, in making such arrangements, are often immunizing their clients from chapter 13 and permitting them to fully discharge the debt in chapter 7. Such planning would be beneficial to the clients, but may appear subject to suspicion by creditors and trustees.

Such planning cannot be disregarded. Finding loopholes in statutes or codes is definitional “good lawyering.” Positioning clients to comply with rulings or unambiguous language of code provisions requires attorneys, as skilled practitioners, to deliver methods or means to accommodate their clients’ best interests within the confines of the law. A decision such as Ransom may allow bankruptcy practitioners to have their clients enter into secured creditor arrangements prior to the filing, so as to avoid the draconian results of the Ransom decision.

Conclusion
A few main themes emerged from this decision. The lack of expense, which annulled the car credit in Ransom, may expand to disallow the board expenses to those living at home, or similar debtors who are protected souls of benevolent nondebtors. In short, Ransom may become a creditor’s weapon to be used for analogous concepts in the future. Alternatively, preparing for bankruptcy by buying junkyard cars or entering into de minimis loans should allow full credit of $496 for a worthless vehicle. In short, a debtor may be compelled to employ tactics to avoid the Ransom result. In either event, each interpretation will trigger more motions in the bankruptcy forum, deliver more appeals to district, appellate and circuit courts, and ultimately could well deliver a related certiorari request to the United States Supreme Court.

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