Refinancing Loans Not Consumer Debts

Posted by NCBRC - July 27, 2022

The movant bears the burden of demonstrating by a preponderance of the evidence that the debtor’s debts were “consumer” rather than “business,” and the debtor’s subjective purpose in taking out the loans is a crucial factor where the debts do not fall neatly into either category. Centennial Bank v. Kane, No. 21-4597 (N.D. Cal. July 22, 2022).

The debtor, a professional hockey player, filed for chapter 7 bankruptcy listing $28,191,340 in total debt including several mortgages and a debt to the aptly-named “Lone Shark Holdings.” At issue in this case were three loans, one of which was for over $8 million owed to the movant, Centennial Bank. The debtor took out that loan and the other two loans in order to refinance other debts at a lower interest rate. In his schedules, the debtor categorized these and his other debts as primarily “business” rather than “consumer.” Centennial moved to dismiss under section 707(b) arguing that, in fact, his debts were primarily consumer.

Section 707(b)(1) provides that a court may dismiss a chapter 7 bankruptcy case if it finds that granting relief would be an abuse of the chapter 7 provisions, so long as the debts involved are primarily consumer debts. Section 101(8) defines consumer debt as “debt incurred by an individual primarily for a personal, family, or household purpose.” In In re Kelly, 841 F.2d 908, 913 (9th Cir. 1988), the Ninth Circuit held a debt is not “consumer” if it was “incurred for business ventures or other profit-seeking activities.” In analyzing the issue, a court is to look at the debtor’s purpose in incurring the debt.

Centennial argued that the bankruptcy court applied the wrong legal standard when it adopted the reasoning in In re Garcia, 606 B.R. 98 (Bankr. D.N.M. 2019). In that case, the court found there was a “gray area” where debts are neither plainly consumer nor plainly business, and that when a debt falls into that area, the court must examine the totality of circumstances. Such circumstances may include whether the debt was incurred for “consumption or profit motive, the debtor’s purpose, the voluntariness of the debt, whether the debtor obtained a financial advantage like a tax benefit, and whether the debt related to any guaranty obligations.” Centennial argued that this analysis ignored the debtor’s subjective purpose as required by Ninth Circuit precedent.

The district court found that even though the bankruptcy court relied on Garcia rather than Kelly, the standard it imposed mirrored the subjective purpose standard set forth in Kelly and the facts on which it relied went to the debtor’s purpose in taking out the loans. Therefore, the bankruptcy court applied the correct legal standard.

Centennial next argued that the bankruptcy court assigned the burden of proof incorrectly. Citing In re Ferreira, 549 B.R. 232, 237 (Bankr. E.D. Cal. 2016), Centennial acknowledged that it bore the initial burden to show by a preponderance of the evidence that the debts at issue were consumer, but that the debtor then bore the burden of countering that evidence by “demonstrating a profit motive.”

The district court found Ferreira unpersuasive as it relied on two dubious cases one of which was poorly reasoned and the other reversed on appeal. In fact, the court here found, once the moving party effectively challenged the nature of the debtor’s debts, the correct burden shifting paradigm gave the debtor only the “burden of persuasion” to counter that evidence. The ultimate burden remains with the moving party to show that the debts are primarily consumer. While the bankruptcy court stated that it was “unclear . . . how a debtor can have the burden of persuasion on an issue where the moving party still bears the burden of proof,” it nonetheless went on to properly hold Centennial to its burden of producing evidence that the debts were consumer. The district court found that the bankruptcy court properly assigned the burdens of proof.

The court turned next to whether Centennial established by a preponderance of the evidence that the three refinancing loans at issue were consumer.

The court found this to be a mixed question of fact and law and noted that under U.S. Bank Nat’l Ass’n v. Vill. at Lakeridge, LLC, 138 S.Ct. 960 (2018), the standard of review depends on the balance between fact and law in the underlying question. An appeal involving a highly fact-specific question will be reviewed for clear error while an appeal largely involving application of law will be reviewed de novo. Here, the court found that questions of fact dominated the bankruptcy court’s decision and the considerations on appeal. It therefore applied the clear error standard of review.

The three debts at issue here were incurred so the debtor could refinance higher interest loans. The money was distributed directly to the other lenders and the debtor received none of it personally. The bankruptcy court “determined that Kane effected a transaction that increased his economic value and did not consume a good or service in the process, and therefore that the Centennial debt was not incurred for a consumer purpose. The same holds true for the Zions and Professional Bank loans.”

Centennial argued that paying off higher-interest loans was the quintessential consumer debt as the benefit adheres to the debtor and his household. The court disagreed. The facts established that the debts were incurred not to allow the debtor to consume a good or service, but for increasing overall economic value, tipping the balance toward business rather than consumer debt.

The court also rejected Centennial’s argument that because the debtor did not use any of the three loans at issue for traditional business purposes such as buying business-related property, funding a business, or investing in business ventures, they were necessarily not business loans. But the court found it was not enough to show that the loans were not related to a business venture, the movant had the burden of showing that the loans were related to personal, family, or household purposes. It noted that the fact that a debt may not fall within the category of business debt does not necessarily relegate it to the category of consumer debt.

The court concluded that bankruptcy court did not commit clear error in categorizing the debts at issue as non-consumer debts.

It affirmed the bankruptcy court’s denial of the motion to dismiss.

Kane ND Cal July 2022





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