In re Johnson 387 B.R. 728 (S.D. Ohio 2008)
Two for the Money: Embezzlement and Bankruptcy
General rule: Fraud is one of the most common reasons the court will deny a bankruptcy discharge, however, failure to keep accurate records can jeopardize the discharge as well.
Mr. and Mrs. Johnson drove a Land Rover, wore the latest designer fashions, and took regular exotic vacations. They lived in the lap of luxury. How did they manage this lavish lifestyle? Were they movie stars, investment bankers, or plastic surgeons? Well, Mrs. Johnson worked for a bank and Mr. Johnson worked in various industries, including computer repair and real estate. They earned a combined income of about $90,000. No, we’re not missing a zero. They made $90,000 a year and lived like rock stars. Did they discover the secret to the American dream?
Not quite. As it turns out, Mrs. Johnson was using her position at the bank to create phantom accounts and phantom lines of credit; she embezzled a grand total of more than $5,000,000. Eventually, the long arm of the law caught up with Mrs. Johnson. She pled guilty to criminal bank fraud, money laundering, and false statements on a tax return. In re Johnson, 387 B.R. 728 (S.D. Ohio 2008). She and Mr. Johnson consented to judgment against them to the tune of $2,000,000. As a part of her plea agreement, Mrs. Johnson waived her right to discharge her debt through bankruptcy. Mr. Johnson, however, made no such agreement. When the illicit funds stopped flowing, he declared bankruptcy. Id.
Mr. Johnson claimed to have no knowledge of his wife’s criminal misdeeds. He told the court he was under the impression that the bank had given them a loan so that he could flip real estate. Could his debts be discharged in bankruptcy?
The Bankruptcy Discharge is Only Available to Those Who Act in Good Faith
Bankruptcy law may “grant the honest debtor a discharge of his or her pre-petition debts.” Id. at 736. Its protection does not extend to those “who play fast and loose with their assets and the reality of their affairs.” Id. The bankruptcy trustee accused Mr. Johnson of destroying financial records, making false statements, failing to account for his assets, and intentionally transferring property that should have gone to the care of the trustee. If these allegations were true, Mr. Johnson would be denied discharge. The court recognized the severity of total denial of discharge and so construed the law and the facts in Mr. Johnson’s favor in determining whether to grant or deny the discharge of his debts.
11 U.S.C.A. § 727(a)(3)
Under 11 U.S.C.A. § 727(a)(3), discharge should be denied to a debtor who destroys or conceals financial records. The law is meant to guarantee fair treatment to creditors and prevent debtors from hiding assets. Mr. Johnson “had a reasonable grasp of practical and business matters” and “a working understanding of lines of credit, mortgages, leases, and real estate transactions.” Johnson, 387 B.R. at 738. So, he would be expected to have reasonable records of his personal and business-related finances.
When his wife was charged with embezzlement, Mr. Johnson claimed in his deposition to have just that sort of record. However, when his bankruptcy case commenced, the records were nowhere to be found – he claimed to have “disposed of” them. Id. at 739.
During the four-year course of Mrs. Johnson’s phantom-account joyride, Mr. Johnson purchased more than $1,000,000 in real estate, gambled heavily, and apparently spent almost $600,000 in cash. Id. Of course, without his records of any of these transactions, the court couldn’t tell precisely where that cash had gone. They could, of course, still determine how much cash the Johnsons had brought in. During the trial, the lawyer questioned Mr. Johnson about the checks he had written, some of which were for more than $40,000. He claimed that he simply couldn’t remember where he had spent the money. He suggested that he had spent it on construction workers on any number of his properties but couldn’t name a single project or a single worker. Many of his expenditures predated his real estate ventures completely. Id.
The court points out that Mr. Johnson must not have been completely ignorant of the fresh cash flows. He and Mrs. Johnson paid cash for a Land Rover, bought twelve parcels of real estate (some of which were also paid in cash), and took luxurious vacations. The court felt that as a businessperson, Mr. Johnson should have known to keep records of his expenditures and income, both for his business and himself. Unable to name a single specific business expense or gambling loss, he also “misplaced” a $4,000 leather suit and failed to mention $15,000 worth of expensive Italian furniture to the trustee. In the end, “his failure to keep and preserve records [was] fatal to his discharge.” Id. at 742.
The Trustee Moves For Dismissal Based on Fraud
The trustee also moved for the dismissal of Mr. Johnson’s case based on alleged fraud. A case merits dismissal if the debtor makes false statements under oath. 11 U.S.C.A. § 727(a)(4). Bankruptcy schedules are prepared under oath and meetings are held under oath – if Mr. Johnson knowingly made a false statement in either of those instances, his case could be dismissed. Because of his claimed cash usage, no outbound paper trail existed for the court to track and no one could tell if Mr. Johnson was intentionally lying or hiding his tracks. However, the court decided that “the aggregation of falsehoods and evasions as to the existence and status of assets and liabilities paint[ed] a picture of knowing falsehood and fraudulent intent.” Johnson, 387 B.R. at 750. In other words, the court would have forgiven an honest error, but there was “no credible defense” for Mr. Johnson’s egregious misstatements of his and his wife’s assets and expenditures. Id. The court simply didn’t believe (and who can blame them?) that you could spend several million dollars and have no idea what you spent it on.
As if Mr. Johnson’s utter disregard for recordkeeping and his false statements regarding his finances weren’t enough, he was also sufficiently brazen to transfer a piece of property into his own father’s name in order to protect it from foreclosure. Id. at 733. He didn’t report either the property or the transfer to the court – or to his father. In fact, he had asked his father if he could transfer the property and his father had said no. Id. Mr. Johnson did it anyway. In combination, all of Mr. Johnson’s omissions about his properties, assets, and expenditures, his blatantly false statements, and his vague excuses “paint a comprehensive picture of evasiveness and prevarication.” Id. at 734.
As damning as his lack of bookkeeping was, Mr. Johnson’s attitude was the final nail in the proverbial coffin. The court illustrates his “blatant obstructionism and contempt for the truth” with an excerpt from the transcript of the meeting of creditors (Mr. Beyer is the attorney for the bank):
MR. BEYER: You filed a 2005 income tax return, correct?
MR. JOHNSON: Are we done?
THE TRUSTEE: You have to answer his questions.
MR. JOHNSON: Well, I’ll plead the Fifth on everything he’s asking me.
THE TRUSTEE: I can’t make rulings because I’m not a judicial official.
MR. BEYER: I understand. Who filed your — who signed your 2005 income tax returns for you?
MR. JOHNSON: You have it right there. You tell us.
MR. BEYER: No, I’m asking you to tell me.
MR. JOHNSON: I don’t recall. I don’t recall.
* * *
MR. BEYER: Mr. Johnson, how much do you make at [your current job]?
MR. JOHNSON: I plead the Fifth, man.
MR. BEYER: The Fifth Amendment’s not implicated by how much money you’re earning today.
MR. JOHNSON: I’m not answering your question.
MRS. JOHNSON: Fifth.
MR. BEYER: When did you start working at [your current job]?
MR. JOHNSON: I’m not answering your questions.
MR. BEYER: Who’s your boss?
MR. JOHNSON: [Mrs.] Johnson.
MR. BEYER: Who’s your boss at [your current job]?
THE TRUSTEE: I’m going to instruct you — this is not funny.
MR. JOHNSON: I’m not being funny.
MRS. JOHNSON: Oh, he’s the one being funny.
MR. JOHNSON: He asked me who my boss was.
* * *
MR. BEYER: Do you – do they give you a check on Fridays?
MR. JOHNSON: Give it to her.
MR. BEYER: What?
MR. JOHNSON: They give it to her. They mail it to her.
MR. BEYER: They mail it to her. To your house?
MR. JOHNSON: No, man, a tree house. Come on, these crazy questions you’re asking me, man. Jesus man, come on.
Id. at 754-59. Every transcript read like that; he consistently refused to give information and cooperate with the trustee and counsel. The court doesn’t appreciate that sort of attitude, and decided that:
“his specific false statements and nondisclosures in the schedules, evasive and misleading testimony, and blatant attempts to thwart rather than cooperate with the discovery process are more than sufficient to justify denial of Mr. Johnson’s discharge.”
Id. at 760.
This is an example of what not to do in bankruptcy
Mr. Johnson serves as an excellent example of how not to handle your bankruptcy. He destroyed and concealed records, lied and omitted important material during his proceeding, and was rude to boot. Bankruptcy is intended to help honest debtors get their financial lives back on track. It’s not a way to clean your books when you’ve behaved badly. If Mr. Johnson had cooperated with the court and given honest answers, he might have been able to discharge some of his debts. Instead, he had to face his creditors outside of the protection of bankruptcy.
So, keep records of your financial history. Don’t try to hide anything from the court – money always leaves some sort of trail. And please, no matter why you’re in court, mind your p’s and q’s.