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In re Sears

United States Bankruptcy Appellate Panel of the Tenth Circuit

March 24, 2017

RICHARD K. SEARS, Defendant - Appellant. LYNN MARTINEZ, Chapter 7 Trustee, Plaintiff - Appellee, Adv. No. 15-1257

         Appeal from the United States Bankruptcy Court for the District of Colorado

         Submitted on the briefs.[*]

          John A. Berman, Esq. of Denver, Colorado, for Defendant - Appellant.

          Maria J. Flora, of Maria J. Flora, P.C., Denver, Colorado, for Plaintiff - Appellee.

          Before CORNISH, MICHAEL, and HALL, Bankruptcy Judges.


         Financial transparency is an integral component of our bankruptcy system. A debtor seeking a discharge in a Chapter 7 bankruptcy case has a duty to fully disclose all of her assets and liabilities, to provide sufficient records to explain her business affairs, and to explain where her money went prior to the filing of the bankruptcy case. If a debtor cannot tell her trustee or creditors what happened to her money, or provide records to show where the money went, and a party in interest objects, she does not get a discharge.

         In this case, Richard Sears ("Debtor") ran several businesses and chose not to utilize business accounts. He took over $2.2 million in cash draws from his businesses for personal use. Debtor could not tell his bankruptcy trustee what happened to the $2.2 million, other than to say, "I spent it." The trustee filed an action to deny the Debtor his discharge. After a trial, the bankruptcy court sided with the trustee. Debtor appeals. Finding no reversible error, we affirm.


         In 1983, the Debtor began leasing land for hunting and grazing cattle. Beginning in 2004, the Debtor operated his hunting and cattle businesses through five companies (the "Companies").[2] The Companies generated $9, 294, 429 in income from 2008-2015.[3] From 2011 through 2013, the Debtor suffered unexpected losses and increased operating costs.[4]The Debtor sought Chapter 7 relief on April 2, 2015 (the "Petition Date"). Lynn Martinez was appointed as Chapter 7 Trustee (the "Trustee"). The Debtor's Schedule F listed a total of $6, 375, 996.80 in unsecured debt primarily owed in connection with his cattle and hunting businesses.[5]

         The Debtor had no personal bank accounts prior to April 21, 2014, when he opened a checking account at Wells Fargo Bank (the "Personal Account").[6] The Debtor's reported income and expenses could not be traced through the Personal Account, because the Companies paid the Debtor's personal expenses. The Debtor had separate checking accounts for each of the Companies, as well as copies of checks with written notes (the "Original Records").[7] The Debtor brought to trial a large stack of boxes he alleged contained the Original Records. Those documents were not offered into evidence. Debtor's accountant, Patricia Woods, used the Original Records to create Quickbooks records (the "Reconstructed Records"). The Reconstructed Records were admitted into evidence.

         Debtor's records were not adequate to identify transactions or allow the Trustee to make inquiry into them. The Debtor's strategy of using "cashier's checks for draws or intercompany transfers, so the funds would clear the bank more quickly" made money difficult to trace.[8] The Trustee identified over $2.2 million in disbursements from the Companies to the Debtor, his wife, and son between 2009-2015 (the "Owner Draws"). She could not determine the ultimate disposition of those funds. The Debtor failed to produce evidence of the intercompany transfers or to explain the disposition of the Owner Draws, other than to offer a vague explanation that the funds were used for personal or business expenses, for which he offered no documentary support.

         On July 6, 2015, the Trustee filed her Complaint for Denial of Discharge Pursuant to 11 U.S.C. §§ 727(a)(3) and (a)(5) (the "Complaint").[9] Debtor filed an answer contesting the Complaint. On September 8, 2016, after a two-day trial, the bankruptcy court entered its Order on Adversary Complaint (the "Order"), denying the Debtor's discharge pursuant to 11 U.S.C. §§ 727(a)(3) and (a)(5). The bankruptcy court concluded the Trustee met her burden under both §§ 727(a)(3) and (a)(5), ruling that the Debtor "failed to provide the court with information to justify the lack of adequate business records under the circumstances of this case"[10] and "failed to offer an adequate explanation of the disposition of very substantial funds."[11] This appeal followed.


         The bankruptcy court's factual findings, which underpin its legal conclusions, are reviewed for clear error.[12] A factual finding is "clearly erroneous" when "it is without factual support in the record, or if the appellate court, after reviewing all the evidence, is left with the definite and firm conviction that a mistake has been made."[13]

         Counsel for the Debtor has striven valiantly to cast this case in a light that would require de novo review, arguing that the bankruptcy court failed to hold the Trustee to the proper standard of proof, and that, as a result, the entire decision should be, in effect, retried in this Court. We are not persuaded. The bankruptcy court correctly stated the applicable burdens of proof in actions brought under both § 727(a)(3) and § 727(a)(5).[14]


         A prima facie case under § 727(a)(3) requires a showing that a debtor "failed to maintain and preserve adequate records and that the failure made it impossible to ascertain his [or her] financial condition and material business transactions."[15] If a creditor or trustee meets this initial burden, "the burden then shifts to the debtor to justify his or her failure to maintain the records."[16] A party objecting to a debtor's discharge under § 727(a)(5) has the burden of proving facts establishing that a loss of assets occurred.[17] The burden then shifts to the debtor to explain the loss of assets in a satisfactory manner.[18] The ultimate burden under § 727 rests with the plaintiff and must be proven by a preponderance of the evidence.[19]

         The fact that the bankruptcy court used proposed findings of fact and conclusions of law is not properly before this Court and, in any event, does not constitute reversible error. The Debtor argues that the Order is "virtually a verbatim adoption" of the Trustee's Proposed Findings of Fact and Conclusions of Law and such adoption is reversible error.[20]The Debtor did not list this issue in his statement of issues, and has therefore waived this argument.[21] Accordingly, we decline to consider it. Even if the argument had been preserved on appeal, it is not persuasive. A bankruptcy judge's verbatim adoption of proposed findings become those of the court and may be reversed only if clearly erroneous.[22]

         The bankruptcy court did not err in determining the Debtor's records were inadequate to ascertain his financial condition.

         The bankruptcy court determined the Debtor failed to maintain adequate records and that such failure made it impossible to ascertain his financial condition under § 727(a)(3), warranting denial of the Debtor's discharge. "The scope of the debtor's duty to maintain records depends on the nature of the debtor's business and the facts and circumstances of each case."[23] When a debtor carries on a business involving substantial assets, "greater and better record keeping" is warranted.[24] Other circuit courts and bankruptcy courts hold that records are inadequate where the debtor failed to separate personal and business accounts, [25]failed to substantiate expenses, [26] or failed to explain dispositions of cash.[27]

         The bankruptcy court found all of these factors present in this case. The record supports the findings. The Reconstructed Records commingled personal and business expenses.[28] The Reconstructed Records were neither accurate nor complete.[29] The Debtor and the Trustee were unable to identify the disposition of the Owner Draws or the sources of certain expenses using the Reconstructed Records.[30] We hold that the bankruptcy court did not err in determining the Debtor failed to maintain adequate records, such failure made it impossible to ascertain his financial condition, and denial of Debtor's discharge was warranted under § 727(a)(3).

         The Debtor makes another rather unique argument in support of his position that the requirements of § 727(a)(3) have not been met. Debtor argues that, under § 704(a)(4), a Chapter 7 trustee has a duty to "investigate the financial affairs of the debtor."[31] Debtor contends that this duty required the Trustee to undertake a detailed review of all of the Debtor's records, depose the Debtor, the Debtor's bookkeeper, and the Debtor's accountant, and, finally, hire an expert should she deem it necessary in order to fully understand the financial affairs of the Debtor. Debtor argues that the Trustee's failure to undertake such herculean tasks precludes the filing of a complaint under § 727(a)(3) and the resultant denial of his discharge. The Debtor offers no viable legal precedent in support of this argument.[32] Perhaps it is because none exists.

         The bankruptcy court did not err in determining the Debtor's inadequate records were not justified ...

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