92 F.3d 1300 (2nd Cir. 1996), 1189, In re Chalasani
|Docket Nº:||1189, Docket 95-5071.|
|Citation:||92 F.3d 1300|
|Party Name:||In re Prasad CHALASANI, Debtor. STATE BANK OF INDIA, New York Branch, Plaintiff-Appellee, v. Prasad CHALASANI, Defendant-Appellant, Allen Mendelsohn, Trustee, Society For Savings, Creditor-Appellee.|
|Case Date:||August 13, 1996|
|Court:||United States Courts of Appeals, Court of Appeals for the Second Circuit|
Argued March 14, 1996.
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Kenneth Cooperstein, Centerport, New York, for Defendant-Appellant Prasad Chalasani.
Richard S. Last, New York City (Opton Handler Gottlieb Feiler & Katz, LLP, of counsel), for Plaintiff-Appellee State Bank of India.
Aaron R. Cahn, New York City (Olshan Grundman Frome & Rosenzweig, of counsel), for Creditor-Appellee Society for Savings.
Before: CARDAMONE, WALKER, and McLAUGHLIN, Circuit Judges.
CARDAMONE, Circuit Judge:
This bankruptcy appeal poses two questions. The first--when a defendant in an adversary proceeding may undo a default judgment--is readily resolvable; the second--whether another interested creditor may enter an action seeking a denial of discharge under 11 U.S.C. § 727 and prosecute that claim itself, where the plaintiff has voluntarily dismissed the complaint--requires more analysis.
We set forth briefly what occurred. In order to justify reopening and amending a judgment that had discharged a Chapter 7 debtor and to provide § 727 relief to all creditors, the bankruptcy court made two assumptions, neither of which was in fact true. The bankruptcy court assumed that a plaintiff bank, which had already obtained a judgment granting it § 523 relief against the debtor, was a trustee for all other creditors for the purpose of obtaining § 727 relief. It also assumed that another bank benefitted from a transfer of interest and could be substituted for the plaintiff bank in the now-closed bankruptcy.
A legal fiction assumes as fact, for purposes of justice, that which does not exist. Black's Law Dictionary 751 (rev. 4th ed.1968). We need not condemn the bankruptcy court's action out of hand as adopting improbable fictions because the use of legal fictions has an ancient lineage. In the sixteenth century, for example, the English common law courts asserted jurisdiction over mercantile transactions that occurred abroad by fictiously describing the place where the transaction took place as "being in the parish of St. Mary-le-Bow in the ward of Cheap." The allegation was not traversable. See Theodore F.T. Plucknett, A Concise History of the Common Law 593 (2d ed.1936). Nor do we disapprove the trial court's action because it was obliged to rely on two--instead of simply one--legal fictions to justify its
decision. Our condemnation of the use of legal fictions here--despite the established pedigree of one of them--is that this action effectively nullified one of the principal purposes of the Bankruptcy Code: allowing the debtor to begin a new life free from debt, see Bank of Pennsylvania v. Adlman (In Re Adlman), 541 F.2d 999, 1003 (2d Cir.1976).
Chalasani and the State Bank of India
Dr. Prasad Chalasani (debtor or appellant) is a New York resident and the owner of various parcels of real property. In February 1986 he asked the New York branch of the State Bank of India (plaintiff or State Bank) for a short-term loan of $1.65 million to invest in the Sri Vishnu Cement Ltd. Company of Hyderabad, an enterprise he described as "the most profitable company ... in India." To persuade State Bank to make the loan, he provided it with a personal financial statement representing his net worth as roughly $5.5 million.
Based on the financial statement, State Bank extended appellant a credit line of $500,000 "[f]or meeting the working capital requirements for real estate and other commercial operations." He was required to guarantee the $500,000 loan personally and to pledge 2,272 shares in Hempstead Gardens Owners Corp. (Hempstead Gardens), which operated the Country Club Estate, a cooperative complex in West Hempstead, New York. These shares were then held by 125 Gardens Corp., an entity controlled (like Hempstead Gardens) by the debtor. On December 26, 1986 Chalasani agreed to these terms and entered into a credit arrangement with plaintiff. In a separate pledge agreement executed the same day, he transferred to State Bank the 2,272 shares and original proprietary leases for ten cooperative apartments. Later, in June and August 1987, plaintiff perfected its lien on the debtor's property through possession of the Hempstead Garden stock certificates and by filing a UCC-1 financing statement with both the New York Secretary of State and the Nassau County Clerk.
On October 9, 1987 State Bank raised Chalasani's line of credit to $1 million, in return for which he executed additional guarantees and 125 Gardens pledged additional shares of stock in Hempstead Gardens. State Bank's lien now extended to 5,394 shares in Hempstead Gardens and covered 25 apartments. The original stock certificates and proprietary leases were delivered to it, and its security interest was again perfected.
Plaintiff also advanced loans to two other entities in which Chalasani had a financial interest. On February 22, 1988 it lent $150,000 (later increased to $250,000) to Abimex Holding, Inc. (Abimex), and on July 1, 1988, it loaned $350,000 to CBD Mechanical Components Manufacturing, Inc. (CBD). Chalasani personally guaranteed both loans.
The debtor later sought plaintiff's permission to release its security interest in two apartments in exchange for payment sufficient to cover the loss of its collateral. On November 9, 1988 and again on February 1, 1989 State Bank agreed and executed and filed the appropriate UCC-3 financing statements. After Chalasani sold those two apartments, it is alleged, he took additional steps to extinguish plaintiff's lien illegally. The UCC-3 releases prepared by State Bank were altered so that they appeared to discharge its entire lien rather than just its lien on the two apartments. Chalasani then proceeded to sell 12 of the remaining 23 apartments to third parties. He gave no notice of these sales to State Bank because, it is charged, he fraudulently issued new shares and leases to the purchasers. Chalasani denies these allegations.
In July 1989 the debtor defaulted. By December 31, 1990 the debtor owed plaintiff $856,000 in principal and $101,864 in interest, prompting plaintiff to sue him in New York State Supreme Court (New York County), an action which resulted in a judgment in favor of State Bank for $1,213,979.40 entered June 26, 1992. Earlier, plaintiff had won judgments against Chalasani enforcing his personal guarantees of the loans to Abimex and CBD.
Bankruptcy Filing and Adversary Proceeding
On September 9, 1992 (petition date) Chalasani filed for bankruptcy protection pursuant to Chapter 7 of the Bankruptcy Code in the Eastern District of New York (Hall, B.J.). According to his Statement of Financial Affairs, 13 lawsuits were pending against him in New York and New Jersey on the petition date. His petition listed State Bank as a creditor of his personal guarantees of $957,953, $310,000, and $120,000 respectively, totalling $1,387,953. He also listed two claims against State Bank that he valued at $50,739,600 and claimed, in all, total assets of $101,592,100 and total liabilities of $8,008,956. State Bank of India v. Chalasani (In Re Chalasani ), 187 B.R. 67, 68 (Bankr.E.D.N.Y.1995). The bankruptcy court scheduled the initial creditors' meeting for October 27, 1992, and set December 28, 1992 as the last day to oppose discharge.
On December 8, 1992 State Bank commenced an adversary proceeding against Chalasani, objecting to the dischargeability of the debt owed to it, pursuant to § 523(a)(2)(A) and (B) of the Code, and to the discharge of the debtor, pursuant to § 727(a)(3), (4), and (5). The complaint set forth five causes of action. The first count charged that the debtor obtained a loan from plaintiff by preparing a fraudulent personal financial statement that "grossly inflated" his assets, in violation of § 523(a)(2)(B); the second alleged that the debtor therefore received the loan under false pretenses, making the debt non-dischargeable pursuant to § 523(a)(2)(A).
State Bank claimed, third, that because the debtor's failure to keep accurate financial records prevented creditors from ascertaining his true financial condition, he should be denied discharge under § 727(a)(3), and, fourth, that his inability to explain his lack of assets also warranted denial of discharge under § 727(a)(5). Finally, fifth, plaintiff charged that by listing non-existent assets on his bankruptcy petition--such as a $50 million claim against State Bank--the debtor improperly inflated his actual assets, and should therefore be denied discharge under § 727(a)(4). Chalasani's motion to dismiss the complaint was denied, and he filed an answer on April 29, 1993 containing only general denials.
Less than a week after Chalasani filed his answer, on May 3, 1993, plaintiff sought discovery of his business records including tax returns, deeds, documents concerning personal property, account records, and financial statements submitted to other banks. Specifically, State Bank sought documents relating to the sale of the cooperative units at Hempstead Gardens that the debtor had earlier pledged as collateral and his records regarding the disposition of the proceeds of each loan received from plaintiff State Bank. Chalasani made no response to this notice.
On June 10, 1993 debtor's counsel moved to withdraw because of the debtor's unwillingness to comply with discovery and his failure to pay legal fees. Five days...
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