Willard v. Lockhart-Johnson (In re Lockhart-Johnson)

• Decision Date: 28 July 2021
• Docket Number: Bk. No. 2:20-bk-10969-BB,BAP No. CC-20-1161-GKT,Adv. No. 2:20-ap-1073-BB
• Citation: 631 B.R. 38
• Parties: IN RE: Sherrie Nicole LOCKHART-JOHNSON, Debtor. Sharlene Willard, Appellant, v. Sherrie Nicole Lockhart-johnson, Appellee.
• Court: U.S. Bankruptcy Appellate Panel, Ninth Circuit

631 B.R. 38

IN RE: Sherrie Nicole LOCKHART-JOHNSON, Debtor.

Sharlene Willard, Appellant,

v.Sherrie Nicole Lockhart-johnson, Appellee.

BAP No. CC-20-1161-GKT

Bk. No. 2:20-bk-10969-BB

Adv. No. 2:20-ap-1073-BB

United States Bankruptcy Appellate Panel of the Ninth Circuit.

JULY 28, 2021

Appellant Sharlene Willard, pro se, on brief;

Appellee Sherrie Nicole Lockhart-Johnson, pro se, on brief.

Before: GAN, KLEIN,^* and TAYLOR, Bankruptcy Judges.

GAN, Bankruptcy Judge:

INTRODUCTION

In a community property state, the fresh start afforded to a debtor extends to the marital community and prevents collection against all after-acquired community property, including the postpetition wages of both spouses. Thus, it has been said that "the Devil himself could effectively receive a discharge in bankruptcy if he were married to Snow White." Alan Pedlar, Community Property and the Bankruptcy Reform Act of 1978 , 11 St. Mary's L.J. 349 (1979). This case requires us to confront the question of what a creditor must to do to avoid the consequence of the community property discharge where the debt is allegedly caused by the fraudulent conduct of a nondebtor spouse.

Appellant Sharlene Willard ("Willard") holds a state court judgment against Steve Johnson arising from a contract for home repairs. After Steve's wife Sherrie Lockhart-Johnson ("Debtor") filed a chapter 7¹ bankruptcy petition, Willard filed a complaint to except the debt from discharge under § 523(a)(2)(A) based on Steve's conduct. But Willard made no allegations of any fraudulent conduct by Debtor, and she did not allege that the debt was a community debt. Consequently, the bankruptcy court granted Debtor's motion to dismiss. Realizing that her complaint was insufficient, Willard sought leave to amend, but because the allegations of fraud were against a nondebtor, the bankruptcy court denied leave and dismissed the complaint with prejudice.

We agree that Willard did not state a claim for relief, but we determine that the complaint could be saved by amendment to assert claims that the community property discharge provision should not apply. Because amendment is not futile, the bankruptcy court erred by denying leave to amend. Accordingly, we VACATE the order dismissing the case with prejudice and REMAND with instructions to grant the motion with leave to amend. We publish to clarify the procedure involved in a creditor's attempt to preclude the community property discharge where the alleged wrongdoing spouse is not the debtor.

FACTS

In 2017, Willard filed a complaint in state court against Debtor's husband, Steve Johnson, and others, based on an agreement for home repairs.² Willard asserts that after an initial failed settlement, she obtained a default judgment against Steve Johnson in excess of $10,000. In June 2019, Willard sought to garnish Debtor's wages; she asserted that they were community property under California law and thus liable for the debt. After Willard filed the garnishment action, but prior to the hearing in state court, Debtor filed her chapter 7 petition.³

Debtor indicated in her Statement of Current Monthly Income, Official Form 122A, that she was married, but either legally separated or living separately from her spouse. She averred in her Schedule H that she had lived in a community property state in the past eight years but that her spouse did not reside with her during that time.

Debtor did not initially list Willard as a creditor, but in February 2020, she filed an amended list of creditors and an amended Schedule E/F which listed the debt owed to Willard in the amount of $9,873. Debtor indicated that the obligation to Willard was a community debt.

In March 2020, Willard filed an adversary complaint seeking a determination that the debt was nondischargeable under § 523(a)(2)(A). She alleged that Steve Johnson obtained funds from her through false pretenses, false representation, and actual fraud and, as a result, the debt was nondischargeable. Willard asserted that the state court had ruled that Debtor was not liable for the debt but, by listing the debt as a community obligation, Debtor was attempting to discharge it.

In response, Debtor filed a motion to dismiss and argued that Willard failed to plead fraud with particularity as required by Civil Rule 9(b), made applicable by Rule 7009. Debtor also argued that she was living separately from Steve Johnson at the time of the contract and never owed any money to Willard. Debtor maintained that she never made any false material representations to Willard and, even if Willard had a claim against the estate, the complaint failed to state a claim for fraud against Debtor. Finally, she argued that Willard expressly admitted the state court had ruled that Debtor was not liable for the debt.

At a status hearing in June 2020, Willard asked for a continuance to file a motion for leave to amend her complaint. The bankruptcy court advised Willard that a continuance was unnecessary because it would likely grant leave to amend if the complaint were dismissed but could be fixed by an amendment.

Prior to the hearing on the motion to dismiss, the court issued a tentative ruling indicating its intent to grant the motion without leave to amend. The court reasoned that the complaint itself asserted that Debtor did not owe the creditor any money, and the allegations of wrongful conduct were directed solely at Steve Johnson. The court noted that Willard alleged that state court already held that Debtor was not responsible for the debt.

At the hearing, Willard said that after obtaining transcripts of the state court hearing, she realized that she had made factual errors in her complaint and the state court did not actually rule that Debtor was not liable for the debt. She argued that the debt was a community obligation and "by discharging the debt, you're discharging a debt against community property and you'll make it impossible to collect because [Debtor] and her husband are married and living together. Even if you say I could still go after his individual assets, it's a community property debt." Hr'g Tr. , 13:18-23, June 16, 2020.

The bankruptcy court disagreed and granted the motion to dismiss because Willard failed to allege any misconduct by Debtor. The court entered an order granting the motion for the reasons stated on the record and in the tentative ruling. Willard timely appealed.

JURISDICTION

The bankruptcy court had jurisdiction under 28 U.S.C. §§ 1334 and 157(b)(2)(I). We have jurisdiction under 28 U.S.C. § 158.

ISSUES

Did the bankruptcy court err by dismissing Willard's complaint?

Did the bankruptcy court err by denying Willard leave to amend?

STANDARDS OF REVIEW

"We review de novo the [trial] court's grant of a motion to dismiss under [Civil] Rule 12(b)(6), accepting all factual allegations in the complaint as true and construing them in the light most favorable to the nonmoving party." Narayanan v. Brit. Airways , 747 F.3d 1125, 1127 (9th Cir. 2014) (citing Newdow v. Lefevre , 598 F.3d 638, 642 (9th Cir. 2010) ). Under de novo review we "consider a matter anew, as if no decision had been made previously." Francis v. Wallace (In re Francis) , 505 B.R. 914, 917 (9th Cir. BAP 2014).

We review a dismissal without leave to amend for abuse of discretion. Tracht Gut, LLC v. Cnty. of Los Angeles (In re Tracht Gut, LLC) , 503 B.R. 804, 810 (9th Cir. BAP 2014), aff'd , 836 F.3d 1146 (9th Cir. 2016) (citing AE ex rel. Hernandez v. Cnty. of Tulare, 666 F.3d 631, 636 (9th Cir. 2012) ).

A bankruptcy court abuses its discretion if it applies an incorrect legal standard or its factual findings are illogical, implausible, or without support in the record. TrafficSchool.com v. Edriver, Inc. , 653 F.3d 820, 832 (9th Cir. 2011).

DISCUSSION

On appeal, Willard argues that although Debtor was not involved in the original transaction, the debt is a community debt and, under state law, community property is liable for all debts incurred by either spouse during the marriage. She argues that the bankruptcy court erred by granting the motion to dismiss and by not allowing her to amend the complaint to correct errors and include tenets of § 524. To determine whether Willard stated a claim for relief or whether her complaint could be saved by amendment, we must consider the scope of the community property discharge and the procedure involved in seeking to except a claim from it.

A. The Community Property Discharge

Pursuant to § 524(a)(3),⁴ a bankruptcy discharge ordinarily applies to prevent collection of a "community claim"⁵ against community property acquired after the petition date. The bankruptcy court correctly stated that Debtor's discharge does not affect Steve Johnson's personal liability on the existing judgment debt. But, pursuant to § 524(a)(3), "a judgment creditor of the nondebtor spouse on a community claim loses the ability to collect from anything other than the judgment debtor's separate property." Rooz v. Kimmel (In re Kimmel) , 378 B.R. 630, 636 (9th Cir. BAP 2007), aff'd , 302 F. App'x 518 (9th Cir. 2008).

In other words, the Debtor's discharge enjoins Willard from collecting against all after-acquired community property, which could include the postpetition income of Debtor and of Steve Johnson. As we held in Kimmel , "[r]egardless of whether the community claim was attributable to the actions of the debtor spouse, the nondebtor spouse, or both, the effect of § 524(a)(3) is that all community property acquired postbankruptcy is protected by the discharge." Id. at 635-36.

The community property discharge has an important limitation: it applies only so long as a marital community continues to exist. Heilman v. Heilman (In re Heilman) , 430 B.R. 213, 219 (9th Cir. BAP 2010) (citing In re Kimmel , 378 B.R. at 636 ). The rules regarding the status of property, exceptions, and termination of the community vary greatly among community property jurisdictions. Because this appeal involves a putative California marital community, we look to...