First Commercial Financial Group, Inc. v. Hermanson (In Re Hermanson)First Commercial Financial Group, Inc. v. Hermanson (In Re Hermanson)
MEMORANDUM OPINION
First Commercial Financial Group, Inc., (“First Commercial”) objects to the discharge of John A. Hermanson (“Herman-son”), alleging as grounds that he failed to keep adequate records and failed to explain satisfactorily the loss of assets he once owned. These are reasons to deny a discharge under 11 U.S.C. § 727(a)(3)
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and (a)(5).
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First Commercial has moved
I. Background
In December 1992, Hermanson’s net worth exceeded $4,000,000, and in August 1993 he was the first or second largest shareholder in thirteen companies. At other times during 1993, Hermanson estimated his personal net worth to be 9.5 million dollars and 8.5 million dollars. From 1993 through 1995, Hermanson’s income tax returns show that his adjusted gross incomes for these three years reflect an aggregate loss of $435,675 before his adjusted gross income climbed to a positive $222,359 for the year 1996. On the bankruptcy schedules filed with his chapter 7 case in May 1998, Hermanson reported a negative net worth of approximately 4.3 million dollars. The only ownership interest in business entities he reported on his Schedule B listings was stock in John Hermanson Associates, Inc. and Vantage Capital Management — each being valued at zero dollars.
The two parties to this adversary proceeding have an extensive history with one another. In 1994, First Commercial and Hermanson became embroiled in litigation in the Circuit Court of Cook County concerning First Commercial’s alleged misappropriation of First Trading Group, a corporation owned by Hermanson, resulting from its merger into First Commercial. First Commercial and Hermanson were also co-defendants in additional litigation that Burling Bank commenced in 1994. Then, in 1995, First Commercial and Her-manson both appeared before the Commodity Futures Trading Commission as well as the National Futures Association as a result of alleged violations of federal law. The two parties have been engaged in discovery since long before Hermanson filed his 1998 bankruptcy petition.
First Commercial contends that Her-manson is not entitled to a discharge for two reasons. First, he has failed to keep records of transactions involving millions of dollars — transactions such as investing hundreds of thousands of dollars in over a dozen business entities, loaning money to individuals and businesses, and receiving loans from individuals and banks; furthermore, Hermanson has not been able to set forth specific dates, transfers, and losses concerning these transactions, supported by bank-account statements, general ledgers, or other documentation. Second, he has failed to satisfactorily account for a reduction in his net assets from $8.5 to $9.5 million in 1993 to $723,935 in 1998 ($700,000 of which is an unliquidated, potentially uncollectible claim against Vantage Capital Management, Inc.).
Hermanson defends by contending that his failure to keep adequate records is justified under all of the circumstances, that other people and entities have documents that could be used to account for his asset depletion, that three specific events satisfactorily explain his financial demise, and that genuine disputes of material facts prevent the entry of summary judgment.
II. Jurisdiction
This Court has core jurisdiction to render a final judgment in this proceeding because it arises under § 727(a) of the Bankruptcy Code. See 28 U.S.C. § 157(b)(2)(J).
In order for First Commercial to prevail on its motion for summary judgment, it must demonstrate both that “the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that [it] is entitled to a judgment as a matter of law.” Fed. R. Civ. Pro. 56(c). Since First Commercial bears the burden of proof on the § 727(a) cause of action, it cannot rest on the pleadings but has an initial duty to affirmatively reveal an absence of a genuine issue of material fact on every element essential to its case.
See Banner Oil Co. v. Bryson (In re Bryson),
If First Commercial accomplishes these two tasks, Hermanson (as the nonmoving party) is “required to go beyond the pleadings and by [his] own affidavits, or by the depositions, answers to interrogatories, and admissions on file, designate specific facts showing that there is a genuine issue for trial,”
Gilbert,
IV. Discussion and Analysis
A. First Commercial’s Standing
As a preliminary defense, Her-manson argues that First Commercial does not have standing to object to his discharge under 11 U.S.C. § 727(c) because First Commercial has not yet established that it has a legitimate claim against Hermanson. 5 Hermanson contends that because he listed his debt to First Commercial as disputed, and because he himself lists a claim of unknown value against First Commercial, he may ultimately not owe anything to First Commercial, which would then not be a creditor with standing to object.
B. Overvieiv of Substantive Law Governing § 727(a)(5) Causes of Action
Section 727(a) authorizes the denial of a bankruptcy discharge to a debtor who did not adequately explain a disappearance of assets prior to bankruptcy.
See First Federated Life Insurance Co. v. Martin (In re Martin),
The intent behind § 727(a) is to deter abuse of the bankruptcy system.
See Nof v. Gannon (In re Gannon),
First Commercial has the burden of proof on its complaint objecting to discharge under § 727(a). Fed. R. Bankr.P. 4005. In actions brought under § 727(a)(5), the plaintiff has a preliminary burden of adducing, evidence that demonstrates that the debtor formerly owned substantial, identifiable assets that are now unavailable to distribute to creditors.
See Banner Oil Co. v. Bryson (In re Bryson),
Though the explanation does not necessarily need to be comprehensive, it must meet two criteria in order to be deemed “satisfactory.”
See In re Bryson,
C. First Commercial’s Prima Facie Case Under § 727(a)(5): Disappearance of Substantial Prepetition Assets
First Commercial has established that in December 1992, Hermanson had a net worth of approximately $4,067,000, (Pl.’s Ex. 2 ¶ 121; Ex. 3 at 148-51 & Attach. 11.), and, in 1993, a net worth of at least $4,000,000. (Pl.’s Ex. 5 at 100.) There is no genuine dispute that Herman-son owned substantial assets within six years before filing for bankruptcy. Moreover, in the same time frame, Hermanson received proceeds from at least six different loans in the total amount of $1,940,160. (Pl.’s Ex. 3 at 72-75, 77-78; Ex. 7 Sched. F; Ex. 8 at 19, 47-50.)
In his amended Schedule B, filed on July 31, 1998, Hermanson claimed a negative net worth of approximately 4.3 million dollars, and aside from two unliquidated and potentially uncollectible claims against other entities (including First Commercial), his reported assets consisted only of personal property totaling $23,935 in value. (Pl.’s Ex. 7.)
This disappearance of substantial and identifiable assets establishes First Commercial’s prima facie case.
Cf. Soft Sheen Products, Inc. v. Johnson (In re Johnson),
D. Hermanson’s Response to First Commercial’s Summary Judgment Motion
1. Hermanson’s Rebuttal: The Disappearance Is Satisfactorily Explained as a Factual Matter
To explain this substantial reduction in assets over six years, Hermanson offered interrogatory answers as evidence of three events: 1) First Commercial’s alleged 1994 misappropriation of First Trading Group;
The explanatory evidence offered by Hermanson takes the form of an interrogatory answer executed and signed by Hermanson’s attorney. (Pl.’s Ex. 9.) It clearly consists of statements which in turn are based on the statements of another person with personal knowledge, and as such it is hearsay excluded from admission into evidence under Federal Rule of Evidence 802. Hence, it is not the type of evidence a court may consider in opposition to a motion for summary judgment.
See Garside v. Osco Drug,
Even if the Court considered this evidence, however, it would not be able to conclude that it provided a satisfactory explanation of the proven asset depletion. First Commercial has demonstrated the disappearance of numerous specific assets not explained at all by the above three explanations. Hermanson was the first or second largest shareholder in eleven different corporations, 7 and in 1997 he was the first or second largest shareholder in a twelfth company. 8 During 1993, Herman-son had at least some type of ownership interest in other business entities, as well. 9 In addition, Hermanson once owned valuable personal property including jewelry worth between $3000 and $4000 and a wardrobe worth $10,000 in May 1996.
Furthermore, First Commercial’s evidence is- that Hermanson owned the entities in 1993 directly; they were not owned by Vantage Capital Management, and Vantage Capital Management’s value loss, therefore, does not account for their disappearance (nor the disappearance of the valuable personal property).
Additionally, First Commercial notes that Hermanson can point to nothing in the record that connects his misfortunes with Checkers Double Drive-Thru and First Trading Group with his loss of interests in these fifteen entities and valuable personal property prior to bankruptcy. In fact, Hermanson dissolved First Trading Group way back in October 31, 1990, yet had a $4,000.000 net worth three years later. (Pl.’s Ex. 3 at 167-69.)
Hermanson has shown some explanation for the loss of his interests in six other
Baum v. Millikin, Inc., (In the Matter of Baum),
Although First Commercial has not offered past values for most of Hermanson’s shares in the fifteen entities, that lack is not significant. The record indicates that Hermanson was undoubtedly the first or second largest shareholder in twelve of the fifteen entities, that his investment in one of them totaled at least $200,000, and that he held at least 1.5 million shares in another one. Whatever their values, Herman-son has simply failed to explain what happened to his equity interests or to his valuable personal property.
Cf. In re Reed,
Additionally, of the $1,940,160 in loan proceeds listed in Part IV. C, the record contains verbal explanations for what became of two of the six loans. Hermanson used a loan for $480,000 to pay expenses incurred while moving from company to company, (Pl.’s Ex. 3 at 74), and he invested the proceeds of a $100,000 loan from Burling Bank in the now-bankrupt Chicago (Checkers) Double Drive Thru, (Pl.’s Ex. 8 at 17). Hermanson, however, has not accounted for the proceeds of the other four loans totaling $1,360,160, apart from his general reliance on the three circumstances listed in his attorney’s interrogatory answers. In
Chalik v. Moorefield (In re Chalik),
2. Hermanson’s Rebuttal: There Are Genuine Issues of Material Fact
Hermanson further counters by trying to create a genuine issue of material fact concerning the history of the lost assets. He claims that other individuals — including First Commercial, relatives, former
It is not enough to overcome a § 727(a)(5) objection to offer a general oral explanation for the disappearance of substantial assets without documentary corroboration.
See D’Agnese,
Under Rule 56(e) as interpreted by the Seventh Circuit, Hermanson cannot create a genuine issue of material fact by submitting affidavits with conclusions contradicting prior sworn testimony or documentary evidence.
See Kalis v. Colgate-Palmolive Co.,
Furthermore, Hermanson’s attempt to create a genuine issue of material fact essentially attempts to place the burden of constructing a satisfactory explanation for asset disappearance on First Commercial. In trying to create a material factual dispute by using affidavits and interrogatory answers that indicate that explanatory documents are in the possession of attorneys for First Commercial, former accountants, the Internal Revenue Service, and other entities, Hermanson fails to acknowledge his shifted burden to produce evidence to support a satisfactory explanation under 11 U.S.C. § 727(a)(5).
See Chusid v. First Union National Bank,
Even if the documents are currently in the possession of others, the burden of sifting through them, organizing them, and constructing this explanation remains at all times on Hermanson, once First Commercial has laid out a prima facie case. In complex cases involving substantial assets and funds, even producing for creditors a ream of potentially relevant documents — including evidence such as checking account ledgers,
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canceled checks,
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deposit slips, bank statements, and income tax returns' — will not by itself create a satisfactory explanation for the disappearance of assets, unless an accountant transforms them into a complete and credible explanation, obtains missing information, explains discrepancies, and does whatever else is necessary to make the explanation intelligible.
Cf. In the Matter of Juzwiak,
Hermanson is not claiming that he has been given insufficient access to necessary files or insufficient time to review them. In fact, Hermanson’s own exhibits reveal that his attorney had access to the 42 boxes of potentially relevant documents at the offices of First Commercial’s attorneys in prior litigation. The time to take discovery in this proceeding was from June 20, 1999, until March 2, 2001. Hermanson did not make any effort under either Rule 37 or Rule 56(f) to show an insufficient access to documentary evidence necessary to rebut a prima facie case under § 727(a)(5) and defeat First Commercial’s motion for summary judgment.
Finally, Hermanson points to several genuine factual disputes in the record of exhibits, but none of them are material to this adversary proceeding. Hermanson reveals a factual dispute over whether his accountant Victor DiMaggio actually returned the source documents used to prepare his income taxes from 1990 through 1996; however, as discussed above, the controlling issues would need to be access and availability rather than mere possession for this to be relevant. Furthermore, even if the Court adopts Hermanson’s version of the facts and finds that DiMaggio does possess these source documents, Hermanson still has not offered a satisfactory explanation of asset dissipation. Regarding a second genuine factual dispute, Hermanson has offered evidence that DiMaggio prepared his income tax returns for 1997 and 1998, not only for the time period from 1990-1996 as stated in DiMaggio’s affidavit. Again, this information in no way tends to explain a substantial loss of assets or establish a lack of access to information needed to do so. Hermanson also points to inconsistencies in First Commercial’s evidence concerning his gross income in both 1996 and 1998; to valid disputes over the ownership or loss of personal assets such as a watercraft, a camcorder, and recreational equipment; and to a valid dispute over his investment in Maxhght. But, First Commercial did not rely on this information to establish its underlying prima facie case described above or to provide examples of specific unexplained losses. Other true disputes— such as the documentation of Hermanson’s debt to Ron Firman — relate only to the § 727(a)(3) cause of action.
First Commercial has met its burden of affirmatively showing that there is no genuine issue of material fact concerning whether Hermanson has satisfactorily explained his asset reduction, and Herman-son has not proffered such an explanation.
3. Hermanson’s Rebuttal: First Commercial’s Period of Inquiry Is Unreasonably Long
Hermanson argues that, First Commercial’s focus on his ownership interests in 1992 and 1993 is unreasonable. He invites the Court to focus instead on the two years surrounding his May 1998 bankruptcy petition when he was unemployed and earning totals of $23,220 (1997) and $6066 (1998) in income.
The Court disagrees. As detailed above, the dissipation of assets during the six years prior to his petition was consider
4. Hermanson’s Rebuttal: A Debtor Need Only Make a Good-Faith Effort to Turn over Whatever Information He Himself Has
Hermanson submits that he has provided a good-faith explanation of his asset depletion, has consistently relied upon the same three events to explain the losses, has turned over all of the documentation he himself had after filing for bankruptcy, and has explained the possible whereabouts of the documents that he did not possess. He contends that this effort is sufficient as a matter of law to obtain a discharge and that he ought not be held responsible for the business records of the fifteen entities in which he held interests at one time. He also correctly points out that objections to discharge must be construed liberally in favor of the debtor and strictly against objecting creditors to further the Bankruptcy Code’s “fresh start” policy.
An explanation is not satisfactory, however, merely because it has been offered in good faith and relates to underlying events which were nonfraudulent in nature. The explanation must also be objectively adequate.
Hermanson relies on the unpublished decision of the Fourth Circuit,
Haskell v. Shigo (In re Shigo),
Hermanson’s reliance is inapt. The opinion distinguishes between business and personal assets. Finding that the debtor’s challenged losses concerned jewelry, automobiles, furniture, inheritance money, and funds withdrawn from a pension plan, the Fourth Circuit lowered the level of detail required for a satisfactory explanation.
Shigo,
Finally, Hermanson argues that he is not required to produce the records of the entities in which he owned equity interests. He is correct. But First Commercial, however, does not argue that Her-manson must produce the financial records of the fifteen entities themselves; rather, it complains that there is no satisfactory information about the history of Herman-son’s individual ownership interests in them. The court agrees.
V. Conclusion
For the foregoing reasons, the Court grants First Commercial’s motion for summary judgment on Count II of its complaint objecting to Hermanson’s discharge pursuant to § 727(a)(5). Because Hermanson’s bankruptcy discharge has been denied under § 727(a)(5), the Court need not address First Commercial’s objection pursuant to § 727(a)(3). 15
Notes
. "The court shall grant the debtor a discharge, unless 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.”
. "The court shall grant the debtor a discharge, unless the debtor has failed to explain satisfactorily, before determination of denial of discharge under this paragraph, any loss of assets or deficiency of assets to meet the debt- or’s liabilities.”
. Federal Rule of Bankruptcy Procedure 7056 ("Rule 56”) makes Federal Rule of Civil Procedure 56 applicable to adversary proceedings. To the extent First Commercial is not entitled to the complete relief sought, it seeks whatever partial summary judgment the Court deems appropriate under Rule 56(d).
. For § 727(a)(3), Hermanson would need to show at trial that his failure to keep or preserve records was justified under the totality of circumstances, and for § 727(a)(5), he would need to show that he can satisfactorily explain any loss of assets.
. Hermanson offers evidence tending to establish First Commercial’s dissolution in Defendant's Exhibit A, but he presents no argument based on this evidence in his memorandum of law, and the Court will not maintain one for him.
. The similarities between 11 U.S.C. § 727(a)(5) and § 14(c)(7) of the Bankruptcy Act are substantial enough so that cases decided under the Act continue to be pertinent under the Code.
See In re Martin,
.Stellar Corporation; Play It Again Sports, Europe; Once Upon a Child, Europe; Old Man River Casino; World Wide Technology; Swedes Corporation; Amber Limousine Service; Kidz Casting; Kingsland Commerce; ERSI, Inc. (an investment of at least $200,000); and Graphics Marketing Corporation (at least 1.5 million shares). (Pl.’s Ex. 3 at 136; Ex. 2 ¶¶ 6, 10, 12, 14, 27, 29, 33, 35, 39, 41, 57, 124.)
. Renaissance Building Corporation. (Pl.'s Ex. 2 ¶ 60.)
. Vantage Trading Partners, Catalyst, and Renaissance Partnership. (Pl.’s Ex. 2 ¶¶ 49, 51, & 53.)
. Magic Travel, Greystone Ventures I — III, Kids Play World, and Public Service Corporation of Colorado. (Pl.’s Ex. 2 ¶¶ 65, 106, 110; Ex. 3 at 89-97; Ex. 16 at 1997 Att. Seq. No. 12.)
. A nonmoving party may, however, effectively submit self-serving, contradictory affidavits after his opponent moves for summary judgment
if his opponent's version of material facts is also supported solely by selfserving assertions. See Szymanski v. Rite-Way Lawn Maintenance Co.,
.To prevent circumvention of the admission procedures in Federal Rule of Civil Procedure 36(a) intended to facilitate the narrowing of issues for trial, Rule 36(b) mandates that "[a]ny matter admitted under this rule is conclusively established unless the court on motion permits withdrawal or amendment of the admission.” Thus, in response to a summary judgment motion, a party cannot effectively submit affidavits, depositions, or other evidence to contradict a fact admitted pursuant to Rule 36(a). See
United States v. Kasuboski,
. See, e.g., Resp. of Def. to Stmnt. of Facts Not Subj. to Disp. ¶ 137.
. See, e.g., Resp. of Def. to Stmnt. of Facts Not Subj. to Disp. ¶ 150.
. The Court notes, however, that the second portion of a § 727(a)(5) cause of action— requiring a debtor to submit evidence which satisfactorily explains a substantial depletion of assets — is in many ways inextricably linked to a § 727(a)(3) cause of action — requiring a debtor to maintain and retain adequate records of his financial history. Both impose a duty on a debtor to submit reasonably complete and credible documentation accounting for his financial status as a precondition to obtaining the privilege of receiving a discharge. It would truly be a rare case in which a substantial disappearance of assets could be adequately explained without sufficient record keeping.