Disch v. Rasmussen

Decision Date09 August 2005
Docket NumberNo. 03-3363.,03-3363.
Citation417 F.3d 769
PartiesRobert E. DISCH, Plaintiff-Appellee, v. Faye F. RASMUSSEN, Defendant-Appellant.
CourtU.S. Court of Appeals — Seventh Circuit

Charles W. Giesen (argued), Madison, WI, for Plaintiff-Appellee.

Michael E. Kepler (argued), Kepler & Peyton, Madison, WI, for Defendant-Appellant.

Before RIPPLE, WOOD, and EVANS, Circuit Judges.

WOOD, Circuit Judge.

While many observers have touted Congress's recent amendments to the Bankruptcy Code as a major overhaul of the law in this area, the changes leave intact one primary purpose of the Code: to provide only honest debtors with relief. Under that standard, Faye Rasmussen should not have received a discharge of her debts, but the bankruptcy court initially ordered one. Later, the court revoked the discharge on grounds that Rasmussen contests. We hold that the bankruptcy court was authorized to take the action that it did, and we therefore affirm.

I

In January 2000, Rasmussen, the proprietor of a café and catering business called Faval, Inc., sought financial assistance from her friend, Robert Disch, when the business ran into difficulties. Among the business's woes were the inability to obtain credit and a pending default on two bank loans due at the end of the month. Disch agreed to provide assistance to Faval; he gave Rasmussen a check for $20,000 to stave off default and pledged to extend credit to the business. True to his word, between January 2000 and May 2001, Disch loaned more than $810,000 to Rasmussen to use in Faval. Approximately $590,000 of this amount was obtained through loans and lines of credit that Disch secured with his own collateral and personal guarantees. The remainder consisted of cash and checks from Disch to Rasmussen to cover Faval's operating expenses. The parties agreed that Rasmussen would make all payments due on the bank loans, but would not begin to pay Disch back for his personal loans until Faval became "profitable."

Notwithstanding the infusion of this considerable sum, Faval closed its doors in October 2001. Soon thereafter, Disch filed an action in the Wisconsin courts to recover his investments. On February 12, 2002, Rasmussen filed a Chapter 7 bankruptcy petition. As required by 11 U.S.C. § 341(a), the first scheduled meeting with her creditors took place on March 18; her creditors then had 60 days from that date to file objections to the discharge of all debts (11 U.S.C. § 727) or to seek to exclude particular debts from discharge (11 U.S.C. § 523). See FED. R. BANKR. P. 4004(a), (c) (cited hereafter as "Bankruptcy Rule X"). On May 15, Disch filed a complaint seeking to exempt from discharge the debt owed to him. The complaint alleged that the debt was based on Rasmussen's dishonesty in obtaining the loans, her defalcation or embezzlement, and her willful and malicious injury to him through embezzlement and conversion, actions that prevent dischargeability under Code § 523(a)(2), (a)(4), and (a)(6) respectively. Because no creditors filed an objection under § 727 to contest the overall discharge, the bankruptcy court granted a general discharge to Rasmussen on August 19, reserving the determination of Disch's § 523(a) claims until after an adversary hearing was conducted.

Troubling facts regarding the manner in which Rasmussen handled the funds in connection with the debts she sought to discharge first came to light during the adversary proceeding. Although Rasmussen worked as a bookkeeper for 18 years at a large corporation with over 100 employees and $26 million in annual sales prior to purchasing Faval, she adopted a number of unusual (if not highly suspicious) bookkeeping methods for the business. She did not keep a general ledger for Faval or accurate records of her personal and business transactions; instead, she generally relied on her memory instead of books. As a result, she could not explain a large number of transactions, many of which involved the commingling of personal and business funds. For example, she claimed that she made a number of short-term loans to Faval, and though she was certain that she paid herself back, she could not remember the amount of these alleged loans, the source of the funds, when she paid herself back, or from which funds she did so. She could not track large sums from her many investors or recall how she used much of the money Disch lent. While she could account for the allocation of some funds, she was unable to explain what she did with the funds in excess of the allocation. In one instance, she used funds from Disch to pay off a personal debt. In 2001, after examining Faval's records, Disch's accountant discovered that despite Rasmussen's complaints about Faval's financial difficulties, the business's assets, including Disch's investments, exceeded its liabilities by approximately $550,000.

In addition to her unorthodox bookkeeping methods, Rasmussen engaged in a number of unscrupulous business practices. She testified that she dealt in cash as much as possible in order to avoid a Wisconsin Department of Revenue levy for unpaid income taxes. To achieve this end, she frequently converted checks from Disch into cash or cashier's checks in her name instead of depositing them into a Faval account. She paid her suppliers with cashier's checks or cash and half the time, she paid her employees in cash. In addition to concealing assets from the State, this lack of a paper trail also made it difficult for creditors to trace the money that went into the business.

Rasmussen also attempted to engage in a number of transactions involving Disch's financial information without his knowledge, including unauthorized purchases on Disch's credit line. At one point, Rasmussen contacted one of the banks with whom Disch obtained a loan for the business to request that the address on file be changed from Disch's address to Faval's so that Disch would not be notified when she was late in making a payment on the loan.

At the adversary hearing, Disch argued that the particular debts Rasmussen owed to him should not be included within the general discharge she had received, relying on the various subsections of § 523 mentioned above. In addition, for the first time, he made the broader argument that Rasmussen was not entitled even to a general discharge of her debts, because she was disqualified under several of the provisions of § 727(a). Section 727 requires the bankruptcy court to grant a discharge unless it finds that certain specified kinds of misconduct or fraud disentitle the debtor to this relief. Rasmussen objected to the bankruptcy court's consideration of Disch's new argument on the ground that Disch had not properly raised this theory in the adversary proceeding.

The court decided against Disch on his claim that his particular debts should be found nondischargeable, and Disch has not taken a cross-appeal from this determination. Nevertheless, it allowed Disch to amend the pleadings to add the § 727 theory and then found that Rasmussen had no right to a discharge under § 727. The problem, as the court recognized, was that Rasmussen's conduct did not appear to meet the grounds for revocation enumerated in § 727(d), which specifically addresses the court's power to revoke a discharge. It found, however, that § 727(d) did not exhaust the grounds for revocation. Relying on its equitable authority under 11 U.S.C. § 105(a), it found that revocation was necessary and authorized in this situation to prevent manifest injustice. It also held in the alternative that it had authority to revoke the order of discharge under Bankruptcy Rule 9024, on the theory that the discharge resulted from the court's own mistake. The net result of all this was a judgment in favor of Disch for $657,700. The district court affirmed the decision in all respects, although it did not address the alternate ground for revocation under Bankruptcy Rule 9024.

II

On appeal, Rasmussen challenges the revocation of her discharge on a variety of procedural grounds. She first takes issue with the bankruptcy court's consideration of the § 727 claim. She argues that it was improper and futile because her discharge had already been granted in conformity with § 727 and Bankruptcy Rule 4004. She also argues that it was an abuse of the court's discretion to allow the amendment of the pleadings when it did, because she had no opportunity to defend against the claim. Finally, Rasmussen challenges the court's authority to revoke her discharge and argues that it was an impermissible exercise of the court's equitable powers under § 105(a) and Bankruptcy Rule 9024.

We have stated that "the Bankruptcy Code was meant to discharge only an honest debtor from his or her debts," and that "the Code `should be liberally applied to protect the [debtor] only in those cases where there is no intent to violate its provisions.'" In re Suttles, 819 F.2d 764, 766 (7th Cir.1987) (quoting Matter of Garman, 643 F.2d 1252, 1257 (7th Cir.1980)). A debtor in a Chapter 7 liquidation case qualifies for an order discharging her nonexempt debts if she satisfies the conditions stated in § 727(a) of the Bankruptcy Code. 11 U.S.C. § 727(a) (grounds for entitlement to a discharge); see Kontrick v. Ryan, 540 U.S. 443, 447, 124 S.Ct. 906, 157 L.Ed.2d 867 (2004). The debtor cannot obtain a discharge, however, if one of the conditions specified by the statute exists, such as where the debtor had transferred, removed or concealed property within a year prior to the filing of the petition, see 11 U.S.C. § 727(a)(2), failed to keep or preserve any recorded information from which her financial condition or business transactions might be ascertained, see 11 U.S.C. § 727(a)(3), or failed to provide a satisfactory explanation for any loss of assets or deficiency of assets preventing the satisfaction of liabilities, see 11 U.S.C. § 727(a)(5).

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