Case Summary:
The Debtor-Defendant owned and operated a business known at Faval, Inc. In late 1999, Faval was struggling financially. The Plaintiff owned and operated a restaurant and two rental buildings and maintained steady employment. Plaintiff had known the Debtor-Defendant for over 40 years. In January 2000 Debtor-Defendant and Plaintiff met to discuss the Faval business, culminating in a payment made to Debtor-Defendant with a promise for more money in the future. In the period January 2000 through May 2001 Plaintiff gave Debtor-Defendant in excess of $810,000 through loans, lines of credit, checks and cash to use in Faval. The parties agreed that Debtor-Defendant would make payments when due on Plaintiff’s bank loans and begin to pay plaintiff for his personal loans once Faval became profitable.

During this time, and unknown to Plaintiff, Debtor-Defendant adopted a number of unusual bookkeeping methods that made tracking Faval’s finances virtually impossible. Debtor-defendant did not keep a general ledger and generally relied on her memory instead of books and records. Debtor-Defendant is unable to explain how loans were disbursed and even admitted to losing track of large loans made by other investors. Debtor-Defendant also frequently dealt with cash in an effort to avoid a Wisconsin Department of Revenue levy for unpaid income taxes.

In January 2001 plaintiff gave Debtor-Defendant his employer’s credit card number so she could purchase approximately $3,000 worth of materials from a supplier that would only accept a credit card. Debtor-Defendant continued to use the credit card to purchase other supplies, incurring over $6,800 in charges.

In the spring of 2001 Debtor-Defendant contacted one of the banks with whom Plaintiff took out a loan for Faval’s benefit and requested that the address be changed from Plaintiff’s home address to Debtor-Defendant’s business address in an effort to save Plaintiff the hassle of being notified when Debtor-Defendant was late in making payment. Debtor-Defendant did not inform plaintiff of the request, instead, the bank contacted him seeking his authorization.

The Plaintiff became concerned about Debtor-Defendant’s management of Faval and sought the assistance of his personal accountant to examine the Faval records. The accountant was unable to trace funds beyond their initial payment and sought bank records from Debtor-Defendant. Those records were not provided. A disturbing pattern of misappropriation and uncertainty as to the proper allocation of Faval funds was discovered. Debtor-Defendant did not provide sufficient information to explain the many discrepancies.

In August 2001 plaintiff’s attorney demanded that Debtor-Defendant repay his client $120,000 of the personal loans by the end of the month. Debtor-Defendant failed to do so. In October 2001 plaintiff then changed the locks on the building. In response, Debtor-Defendant ceased operations of Faval.

In February 2002 Debtor-Defendant filed for Chapter 7 protection. At her first meeting of creditors Debtor-Defendant asserted her Fifth Amendment privilege as to her personal and business financial statements, dates on which she incurred debts to certain creditors, and the use to which she put those funds.

Plaintiff filed an adversary complaint arguing that the court should draw a negative inference from Debtor-Defendant’s use of the Fifth Amendment privilege and that the debt to him was non-dischargeable under 11 U.S.C. §§ 523(a)(2), (4), and (6). He also argued that Debtor-Defendant’s behavior warranted the denial of her discharge. In total he sought recovery of $657,700 of funds loaned to Debtor-Defendant.

The Court granted Debtor’s discharge before hearing plaintiff’s adversary proceeding. In the vast majority of cases, parties plead adequately in adversary proceedings and the clerk of court’s staff can determine whether a claim has been filed under § 727. If none has, the clerk follows the standard procedure of granting a debtor’s discharge 60 days after their first meeting of creditors as to all debts that are not the subject of a pending adversary proceeding brought under § 523. Plaintiff’s complaint alleged grounds for relief under § 523, not § 727. Thus, on August 19, 2002, following its standard procedure and without evaluating the substance of plaintiff’s claims, the court issued debtor-defendant’s discharge as to all debts not subject to a pending adversary proceeding. At trial it was then determined that the pleadings should be constructively amended to include the § 727 objections and that debtor-defendant should not have received her discharge.

Debtor-Defendant’s discharge was revoked and denied pursuant to §§ 727(a)(2), (3), and (5). A money judgment in the amount of $657,700 was entered in favor of Plaintiff.

Statute/Rule References:
11 U.S.C. § 105 -- Power of Court
11 U.S.C. § 523(a) -- Exceptions to Discharge
11 U.S.C. § 727 -- Discharge

Key Terms:
Fifth Amendment
Non-Dischargeable Debt
Revocation of Discharge