Empowerment of Creditor Rights Section 727 Denial of Discharge and the BAPCPA of 2005
This article will discuss how it has perhaps become easier in obtaining a denial of discharge by the U.S. Trustee, chapter 7 trustee or creditors under §727(a)(3) when "the debtor has concealed, destroyed, mutilated, falsified or failed to keep or preserve any recorded information, including books, documents, records and papers, from which the debtor's financial condition or business transactions might be ascertained, unless such act or failure to act was justified under all of the circumstances of the case."
Property of the Estate
Bankruptcy professionals understand the debtor has the duty, under §521(4), to "surrender to the trustee all property of the estate and any recorded information, including books, documents, records and papers relating to property of the estate, whether or not immunity is granted under §344 of this title."
BAPCPA of 2005
While the BAPCPA was not an attempt to quicken the proposed changes to the Federal Rules of Civil Procedure (FRCP)2 related to electronic data discovery, it was most pleasurable to see the addition of §101(40B). The term "patient records" means any written document relating to a patient or a record recorded in a magnetic, optical or other form of electronic medium.
The BAPCPA provides several provisions for the denial of discharge for the benefit of creditors. Section 727(a)11 applies when the debtor fails to complete the required personal financial management course described in §111. Section 727(a)12 relates to the provision found in §522(q)(1) when exempt property under state or local law exceeds the federal exemption, and unless the property is reasonably necessary for the support of the debtor and any dependent as defined under §522(q)(2), the provisions of §522(q)(1) shall apply to the extent the debtor has been convicted under §522(q)(1)(A) and/or when the debtor owes a debt arising from the provisions found in §522(q)(1)(B). Section 727(d)(4) applies when the debtor has failed under §§727(d)(4)(A) and (B) to explain satisfactorily a material misstatement under §586(f) of Title 28 and/or failed to make available documents, records, things or property belonging to the debtor under §586(f) of Title 28.
Challenge of the e-Times
Regardless, by now bankruptcy professionals should understand that few debtors have books and records, documents and papers that were not made and stored in digital, electronic or optical media. Keeping up with the e-times in bankruptcy will not be easy, yet it must be done because "the greatest obstacle to discovery is not ignorance—it is the illusion of knowledge."3 Manifestly, in any business bankruptcy case today, computers and digital devices4 contain the decisive information necessary to eliminate abuses of the Code.
Professionals involved in bankruptcy need to move forward rapidly, investing in technical staff, providing training, and purchasing the necessary hardware and software technologies to adequately manage bankruptcy cases. Today, debtor's computers, servers, PDAs and digital devices, including digital, electronic and optical media, need to be examined using established digital/computer forensics "best practices"5 for acquisition, examination, presentation and preservation by the digital forensic accounting technologist. The discovery and recovery of computer information, including the debtor's electronic books and records and financial information, is not an option for the chapter 7 trustee.
Caution to Professionals
We are not talking about the proposed changes to the FRCP for electronic data discovery (EDD) because this is property of the estate. Debtors have the implicit duty to produce computers, including digital, electronic and optical information, to the trustee. Creditors and trustees would not want to learn after a case is closed that insiders or employees of an unscrupulous debtor slipped out the front door with the intellectual property and the debtor's electronic books and records on a laptop, USB drive or perhaps any of the other digital devices and methods available to hide digital, electronic and optical information that is property of the estate.
The denial of discharge under §727 may be the last resort as it is not always favorable to creditors, since it means other creditors are standing in line to collect after the case is closed. Section 727 was created for the benefit of all creditors, and therefore a fiduciary duty exists for the interests of all creditors. After all, for the trustee and creditors, it becomes just a matter of asking the debtor the right questions (see below) about the electronic books and records. If the questions are not being asked by the trustee at the §341 exam, then perhaps creditors and their attorneys need to become involved. Waiting until the §341 exam to take possession of the computers and understanding the existence of digital, electronic and optical information is perhaps already late, as it needs to be done as soon as possible.
That said, a debtor engaged in business most likely did not conduct business without the aid of computers and digital devices, including perhaps several computers, servers, laptops, PDAs, e-mail, electronic books and records and financial information, and the possibility of that second set of electronic books or hidden information should never be overlooked.6
Computer-related Questions:§341 Exam
- If the trustee did not ask the debtor questions about the electronic books and records, concerned creditors may want to ask the debtor if the books and records were kept on a computer.
- If the debtor answered "No," then perhaps someone should ask: "How many computers, servers, laptops, PDAs and other digital devices were used, and where are they now?"
- Ask, "did the debtor lease, rent, use or borrow computers and any digital devices?" This may be worthwhile for creditors, because you do not want to have the electronic information overlooked or simply destroyed by neglect for failing to ask the right questions.
- Do not allow the trustee or creditors to be duped; an insider or others could own the computers and digital devices. Simply asking the debtor "do you own a computer?" may get you the correct answer (no) from the debtor's perspective, but may allow the electronic evidence to escape examination by the trustee.
- Be sure to ask the debtor for e-mail and web site addresses both current and used in the past. A debtor could easily cancel the e-mail service and answer "none" if the question is not exacting. Also, remember that e-mail is the electronic envelope, and you also want the electronic contents.
- Ask the debtor, "when and where were the computers and digital devices bought?"
- Ask, "how did the debtor pay for the computers?" Be sure to examine the schedule of assets and liabilities and statement of financial affairs (SOFA) before the §341 exam for computers and related issues.
- Ask the debtor, "exactly how many computers, PDA, laptops and other digital devices were used, and where are they now?" Remember, old computers may never die, and hard drives may provide a wealth of information about the debtor's business, including the trail of transfers going back 10 years.
- Ask the debtor, "were any computers, electronic media or digital devices sold, lost, stolen, discarded or disposed of?" Then, if suitable, quip back, "was that before or after filing the petition? Who helped you? What was the reason you did that?" Based on those answers, expand the questions as may be necessary.
- If the trustee did not take possession of the debtor's computers before the §341 exam, when does the trustee plan to do that? Perhaps you need to talk with the U.S. Trustee's office.
- Ask, "did the debtor turn over any computers and electronic information covered under a UCC and security agreement to secured creditors?" Trustees and creditors should jump on this issue if warranted.
- Ask, "did the debtor return computers and digital devices to any leasing companies?" It should become obvious what is necessary if that did take place.
- Secured creditors should beware of debtors bearing gifts in the form of "return of collateral." Translated, that means ask the creditor "if the return of collateral, the computers and digital devices, could perhaps be a method to discard the debtor's electronic books and records."
- Do not be duped by a UCC and security agreement purporting to have rights in the debtor's "books and records." Ask "did the debtor turn over the computers and electronic books and records and financial information to any party?" Perhaps the insiders or others received the collateral, the computers with the electronic books and records and financial information, after becoming the "holder in due course."
- Computers and other digital devices are property of the estate, and before the trustee sells them, ask the trustees "when are the 'forensic images' of the hard disk drives going to be made to examine the debtor, including the discovery and recovery of the electronic books and records and financial information under §704?" Until the electronic hard disk drives are fully examined, including laptops, servers, PDAs and any other digital devices, the trustee should not sell the computers.
- Ask the debtor, "if digital, electronic or optical copies have been made in the past of the computers and related media, where are those copies today?"
- Ask the debtor "does the debtor's attorney have the computers and electronic books and records and financial information?" That is not a privilege or work-product issue (so the debtor will have no problem answering it).
Dividends for Creditors
Persistence pays off with dividends for the creditors, but the lack of persistence provides excuses for the debtor when a §727 action is pursued. Should the trustee or creditors detect a "weak answer" to any of the questions about use of computers and electronic media, just be prepared to ask more questions.7
The above questions are simply suggestions designed to bring to the forefront information technologies used by debtors. One of my favorite quotations used to keep focused during a digital forensic accounting technology investigation in bankruptcy is "speak clearly if you speak at all; carve every word before you let it fall" (Oliver Wendell Holmes).
This series of questions is directed to attorneys considering §727 actions. Does your client have evidence to believe the debtor has not complied with §727(a)(3)? For example, computer records and reports documenting the existence of computers used in the debtor's business would go a long way to that end. Computer reports from the debtor, including financial statements, detailed accounts receivable, inventory lists, sales backlog and customer lists are good starters. Did the debtor provide financial projections? Debtors no longer prepare those by hand, and they have not been typed for more than 20 years. Did your client receive e-mail from the debtor or professionals showing the debtor's e-mail addresses? Did the debtor place orders for goods or services using e-mail or other forms of electronic communications, such as instant messaging? Did your client review electronic files for business addresses of the debtor? Did the debtor make agreements with the creditor using e-mail, instant messaging or collaborating technologies?
Opportunity for Creditors: §727(a)(3)
Section 727(a)(3) may be overlooked because of claims the debtor concealed property or committed any of the other many exceptions that are grounds for denial of discharge and are more visible. Regardless, §727(a)(3) is ripe for the denial of discharge because the trustee does not have a duty to re-create a set of electronic books and records for the debtor to discover what happened to the assets. Often the digital forensic accounting technologist will discover and recover "deleted" and "altered" electronic books and records, financial information and databases of the debtor and insiders. Debtors and insiders are often unable to offer any viable explanation for such actions.
Do you have electronic evidence the debtor may have committed exceptions to discharge found in §523(a) during the dealings with your client? Section 523(a) provides several exceptions to the debtor's discharge for just the debt of your client. Bankruptcy counsel is able to decide the best method to settle the claim with the debtor, subject to court approval under §523. Perhaps that creditor may be the only one in line after the debtor's discharge.
A detailed discussion of the discovery and recovery of computer information found on the debtor's computers is beyond the scope of this article.8 In cases under §727 where the debtor has destroyed the electronic books and records and financial information, including altering and back-dating of electronic files, the creditors' position has only improved. Attorneys representing debtors should be advised that digital/computer forensic evidence that is properly acquired, investigated, presented and preserved is practically indisputable when considering the cost of the defense of §727 actions.
Today, courts are in a better position to rule on the need for the debtor to produce computers, electronic books and records, and financial information. To the digital forensic accounting technologist, the failure to turn over the debtor's computers and electronic media that contained or should have contained "any recorded information, including books, documents, records and papers, from which the debtor's financial condition or business transactions might be ascertained" under §521(4), just made that §727 action nearly a prima facie case. Any successful §727 denial of discharge action will be determined by the evidence and the debtor's failure to perform the requirements necessary to obtain a discharge.
1 Jack Seward is a consultant and digital forensic accounting technologist in New York and veteran of many years of forensic accounting and electronic data sleuthing. He provides litigation support, including e-discovery for bankruptcy, insolvency, judgment enforcement and the discovery and recovery using computer forensics for digital forensic accounting technology for attorneys, corporations, creditors, trustees, stockholders and other interested parties. He may be contacted at firstname.lastname@example.org or (917) 450-9328, fax (212) 656-1486. Return to article
2 See the following articles for an analysis on the subject of electronic data discovery and the proposed amendments to the FRCP: Seward, J. "Back to the Future: FRCP and Electronic Discovery in Bankruptcy," ABI Journal (February 2005), and Seward, J. "Protecting Yourself Against E-illiteracy: Avoid Being Duped," ABI Journal (September 2004). Return to article
4 Digital devices include, but are not limited to, removable media, PDAs, hand-held devices, CD, DVD, Microdrive, CompactFlash, SmartMedia, SecureDigital, Memory Stick and MultiMediaCard, optical devices, floppy disks, USB drives and devices, FireWire devices, PCMCIA hard disk drives, Zip disks, Jazz Disks, internal and external hard disk drives, tape archival and backup recovery systems, and telephone and messaging systems. Return to article
5 Contact the author and request a copy of his comprehensive list of "best practices" for the forensic acquisition, examination, presentation and preservation of computers and related media in bankruptcy cases. Return to article
6 See the following articles for an analysis on the subject of discovery and recovery using computer forensic for digital forensic accounting technology, including electronic books and records and financial information in bankruptcy: Seward, J., "The Debtor's Digital Reckonings," International Journal of Digital Evidence (Fall 2003) (http://www.ijde.org/docs/03_fall_seward.pdf); Seward, J., "Rejecting E-illiteracy and Adopting the Best Practices to Protect the Debtor's Confidential Information and Estate Asset," NABTalk (Fall 2004); Brighton, Jo Ann, and Seward, J., "Is it a Capital Contribution or a Loan, and How Can Electronic Data Assist in the Analysis or Defense of a Claim for Recharacterization? Parts I and II" AIRA News (June/July 2004 and August/September 2004); "How Digital Forensics Can Give You an Edge," Bankruptcy Law & Litigation Report, (April 2004); Seward, J., "The Debtor's Survival in the Digital Age," ABI Journal (June 2004); Seward, J., "Digital Stealth Secrets and the Act," The Corporate Compliance & Regulatory Newsletter, Law Journal Newsletters (March 2004) (http://www.ljnonline.com); Seward, J. and Austin, D., "E-sleuthing and the Art of Electronic Data Retrieval: Uncovering Hidden Assets in the Digital Age: Parts I, II and III" ABI Journal, (February March and April 2004); Seward, J., "The Debtor's Digital Autopsy, or Where's the Money!" NABTalk (Summer 2003). Return to article
7 Contact the author and request a copy of his computer questions for the §341 exam that have been designed for use in specific information technologies, industries and services, including debtor, insider and creditor issues. Return to article