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A Debtor Who Intentionally Makes the Court a Party to a Fraudulent Scheme Has Perpetrated a “Fraud on the Court”

By: Stephen Van Doran

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

The Bankruptcy Court of the Eastern District of Texas held in In re Cardwell that reversal of a final judgement is appropriate where the debtor intentionally perpetrates a “fraud on the court.”).[1] Prior to Cardwell filing for bankruptcy, Cardwell’s business partner obtained a judgement from a Texas state court for $370,830.84 plus post judgment interest against Cardwell for a series of misrepresentations.[2] Thereafter, Cardwell filed for relief under chapter 7 of the Bankruptcy Code and a trustee was appointed.[3] In his bankruptcy schedules, Cardwell stated that he lived on 118 acres in Melissa, Texas, but that only 24 of those acres comprised his unencumbered homestead.[4] He claimed the remaining 94 acres were encumbered by a $600,000 lien in favor of “Barbara Marshall, LLP.”[5] Cardwell further represented that he had no equity in the non-exempt 94 acres.[6] The chapter 7 trustee filed a motion to sell the 94 acres to “North Ponderosa, LLP,” a company recently created by Cardwell’s financial advisor, for $25,000 plus the assumption of the $600,000 mortgage.[7] North Ponderosa, LLP then leased the land to Cardwell for $10 per year.[8] After the court approved the sale of the land, the court closed the bankruptcy case.[9] Later, Cardwell’s business partner initiated a post-judgment collections effort and during discovery, learned of the fraudulent nature of “North Ponderosa, LLP,” which led Cardwell’s business partner to assert a fraudulent transfer claim.[10] The court found that Cardwell and his advisor had perpetrated fraud by preparing fraudulent loan documents pertaining to the $600,000 loan from Barbara Marshall, LLP.[11] Ms. Marshall was an elderly woman who had no knowledge of the loan and the loan itself was not funded.[12]

A bankruptcy court has the inherent power to vacate a judgment based upon fraud.[13] Bankruptcy Rule of Civil Procedure 9024[14] adopts the rules regarding vacating a judgement as set out in Federal Rule of Civil Procedure 60.[15] Federal Rule of Civil Procedure 60(b)(3) allows the court to set aside a final judgment for “fraud (whether previously called intrinsic or extrinsic), misrepresentation, or misconduct by an opposing party.”[16] Federal Rule of Civil Procedure 60(d)(3) further affirms the court’s ability to reverse a judgment based on fraud by allowing the court to “set aside judgment for fraud on the court.”[17] Federal courts have typically refused to invoke the doctrine of fraud on the court, except in cases where there has been a direct assault on the integrity of the judicial process itself.[18] In order to establish fraud on the court, the party asserting fraud must show “an unconscionable plan or scheme which is designed to improperly influence the court in its decision.”[19] However, conduct such as nondisclosure to the court of facts pertinent to the matter at hand will not rise to the level of fraud on the court.[20]

Here, the court found that filing fraudulent bankruptcy schedules, misrepresenting liabilities in respect to owned land, falsely asserting that a valid lien was present, and including a co-conspirator was enough to prove a fraud on the court.[21] In bankruptcy proceedings, honesty is so important that bankruptcy fraud is punishable as a crime under 18 U.S.C. § 157 and the concealment of assets, false oaths, and false claims are punishable as crimes under 18 U.S.C. § 152.[22] Where a party commits those crimes and uses the court to further a conspiracy, the court will be able to make a finding of “fraud on the court” and vacate its prior orders.

 Before this decision, fraud on the court was typically limited to, “only the most egregious misconduct, such as bribery of a judge or members of a jury, or the fabrication of evidence in which an attorney is implicated.”[23] However, here, the conduct of the debtor fell well short of bribery or an attorney manufacturing evidence.[24] The Cardwell ruling relied primarily upon the dishonesty of the debtor.[25] The court noted that if a debtor does not file accurate bankruptcy schedules and statements of financial affairs, the entire bankruptcy system will cease to function.[26] If more courts follow this approach, there is the possibility that more courts will vacate their rulings.

 


[1] See In re Cardwell, No. 09-43121, 2017 WL 2304220, at *1, *5–*6 (Bankr. E.D. Tex. May 25, 2017).

[2] See id.

[3] See id.

[4] See id.

[5] See id.

[6] See id. at *2.

[7] See id.

[8] See id.

[9] See id.

[10] See id.

[11] See id.

[12] See id. at *3–*5.

[13] See In re Bennet, No. 09-36637, 2012 WL 2563854, at *4 (Bankr. S.D. Tex. June 28, 2012).

[14] Fed. R. Bankr. P. 9024.

[15] Fed. R. Civ. P. 60.

[16] Fed. R. Civ. P. 60(b)(3).

[17] Fed. R. Civ. P. 60(d)(3).

[18] See 11 Charles Alan Wright & Arthur Miller, Federal Practice and Procedure § 2870 at 578 (West 2012).

[19] See First Nat’l Bank of Louisville v. Lustig, 96 F.3d 1554, 1573 (5th Circ. 1996).

[20] See Rozier v. Ford Motor Co., 573 F.2d 1332, 1338 (5th Circ. 1978).

[21] See In re Cardwell, No. 09-43121, 2017 WL 2304220, at *5.

[22] 18 U.S.C. §§ 152, 157; See In re Cardwell, No. 09-43121, 2017 WL 2304220, at *5.

[23] See Rozier, 573 F.3d at 1338.

[24] See In re Cardwell, No. 09-43121, 2017 WL 2304220.

[25] Id. at *5.

[26] Id.