Denial of Discharge for Fraudulent Note

Posted by NCBRC - November 9, 2017

The chapter 7 debtor was denied discharge due to having presented a sham Note purporting to prove a debt taking priority over the debt owed to the creditor in this case. Sloan v. Allen (In re Allen), No. 16-23, Adv. Proc. No. 16-10027 (Bankr. D. D.C. Sept. 21, 2017).

In 2008, Carlos Allen borrowed $60,000 from his friend, Douglass Sloan, to apply toward improvements to real property that Allen anticipated selling for an amount that would bring him enough money to repay the loan within sixty days at $72,000. The agreement gave Mr. Sloan the option to convert the loan to an equity interest and take 14.5% of the proceeds when the property sold. Mr. Sloan never exercised this option. Mr. Allen used the money as planned to renovate the property but, when the bottom fell out of the housing market, the house did not sell. The downturn in the housing market also diminished Mr. Allen’s mortgage business which he had hoped to use as an alternative source of income to repay the loan. While Mr. Allen made some payments on the loan over the years, those payments amounted to approximately $18,000.00, and, when he finally did sell the property five years later, he did not give Mr. Sloan 14.5% of the proceeds.

Mr. Sloan filed an adversary complaint seeking an order denying discharge of the loan under section 523, or, alternatively, denying Mr. Allen a discharge altogether under section 727.

Mr. Sloan first argued that Mr. Allen obtained the loan with no intention of repaying it and should, therefore, be denied discharge under section 523(a)(2)(A). The court disagreed finding that, had all gone according to plan, Mr. Allen would have sold the property and repaid the debt, or used his income from his mortgage business to repay it. It was the drop in the housing market rather than misrepresentation of intentions that caused Mr. Allen’s failure to repay the debt in full.

The court also found that section 523(a)(6) did not render the debt nondischargeable. Mr. Sloan argued that Mr. Allen’s conduct caused “willful and malicious injury . . . to another entity or to the property of another entity[.]” The court found there must be a tort claim to support a finding of nondischargeability under this section and concluded that, because Mr. Sloan did not establish that he successfully converted the debt to a security interest by opting for the 14.5% equity option, he could not sustain a claim for conversion due to Mr. Allen’s failure to pay him out of the sale proceeds.

The court then turned to Mr. Sloan’s argument that Mr. Allen should be denied discharge under sections 727(a)(2)(A) and (B) due to his failure to reveal certain bank accounts, a Pay Pal account, proceeds from sales of merchandize, and his interest in AMG, a company ostensibly owned by his wife, Karen Brooks. The court found that any inaccuracies in Mr. Allen’s schedules with respect to various bank accounts were both insignificant and inadvertent and did not demonstrate an intent to conceal as required by section 727(a)(2)(A). As to his position with respect to AMG, the court found that any evidence of concealment took place outside the time limit in section 727(a)(2)(A) and that at the time of the petition, the business essentially had no significant assets to conceal.

But that did not mark the end of the AMG controversy. The court turned to the evidence surrounding distribution of the funds from the ultimate sale of the property. After paying off a mortgage and the contractors who had renovated the property, Mr. Allen noted a $270,000 payment to AMG. Mr. Allen claimed that the payment was in repayment of a loan (Brooks Loan) secured by the property in the amount of $102,000 that Ms. Brooks made to him prior to the loan from Mr. Sloan. As evidence of this debt, Mr. Allen produced a Note. The court concluded the Note was a sham for the following reasons:

  1. Allen failed to list the debt in his schedules in a previous bankruptcy.
  2. Allen’s mother, who was a “co-obligor” on the Note, did not list Ms. Brooks as a creditor in her own bankruptcy.
  3. There was no indication that Mr. Allen ever made any payments on the debt and, if the Note were genuine, he would have owed substantially more on the debt than $270,000 by the time the property sold.
  4. Allen’s testimony about his discussions and agreements with Mr. Sloan was illogical and incredible, as was his testimony and other evidence concerning the nature and origin of the Brooks Loan.
  5. Allen first brought the “Note” to the attention of the court in this case six months after the adversary complaint was filed and after he had filed a motion to dismiss and a motion for summary judgment with no mention of the Brooks Loan.

Based on these findings, the court concluded that Mr. Allen created the “Note” as a means of depriving Mr. Sloan of the benefit of the lending agreement and redirecting the money to himself in an effort to return to financial success.

The court then turned to Mr. Allen’s interest in AMG. At various times, for various reasons, Mr. Allen had listed himself AMG’s president, owner, and/or board member. To the extent Ms. Brooks had an interest in AMG it was as a “straw” owner. This evidence led the court to conclude that AMG was merely a shelter from creditors for the proceeds from the sale of the property.

Based on these findings, the court concluded that Mr. Allen should be denied discharge under sections 727(a)(3) and (4).

Section 727(a)(3) provides in part that a debtor may be denied discharge if he, “concealed, . . . falsified, or failed to keep or preserve any recorded information, . . . from which the debtor’s financial condition or business transactions might be ascertained,” The court found that Mr. Allen’s falsification of the Brooks Note fit within the meaning of this section.

The court also found denial of discharge appropriate under section 727(a)(4), which provides that a debtor may be denied discharge for knowingly making a “false oath or account” in connection with his bankruptcy case. Mr. Allen’s false assertion of the existence of the Brooks Loan to explain the transfer of funds to AMG sufficed to satisfy the requirements of this section.

As a final matter, the court declined to fix an amount owed by Mr. Allen to Mr. Sloan citing the fact that there were no assets to distribute from the bankruptcy and that Mr. Sloan had a pending civil case against Mr. Allen in the D.C. Superior Court.

Allen Bankr D DC opinion Sept 2017

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