11th Circuit Holds Trustee’s Knowledge of Fraud Before Discharge Does Not Bar Trustee From Later Seeking Revocation of the Discharge

11th Circuit Holds Trustee’s Knowledge of Fraud Before Discharge Does Not Bar Trustee From Later Seeking Revocation of the Discharge

In 2011 the Debtors filed a voluntary chapter 13 bankruptcy which was converted later that year to a chapter 11. Several years later it was converted to a chapter 7 bankruptcy. At the same time of the Debtors conversion, one of Debtor’s companies Nattco, LLC (“Nattco”) filed a chapter 11 bankruptcy.

While the individual and corporate bankruptcy cases were pending, a former employee of Nattco submitted a fraud referral to the Trustee, alleging misconduct by the Debtors, including “stockpiling cash,” “taking trips to Hawaii, Puerto Rico, and Florida,” and undergoing plastic surgery. The Trustee received the referral and additional communications about alleged fraud between October 2013 and January 2014, and consequently initiated an investigation into the allegations.

In February 2014 the bankruptcy court granted the Debtors a discharge. In February 2015 the Trustee filed a motion to revoke the discharge based on 11 U.S.C. § 727(d)(1) and (d)(2). These sections state: part:

(d)On request of the trustee, a creditor, or the United States trustee, and after notice and a hearing, the court shall revoke a discharge granted under subsection (a) of this section if—

(1) such discharge was obtained through the fraud of the debtor, and the requesting party did not know of such fraud until after the granting of such discharge;

(2) the debtor acquired property that is property of the estate, or became entitled to acquire property that would be property of the estate, and knowingly and fraudulently failed to report the acquisition of or entitlement to such property, or to deliver or surrender such property to the trustee;

11 U.S.C. §§ 727(d)(1) & (2). The Debtors filed a motion for summary judgment arguing that the Trustee was on notice of the alleged fraud before discharge which barred a motion for revocation. The motion was partially granted and denied by the Bankruptcy Court. The Bankruptcy Court recognized that revocation of discharge under Section 727(d)(1) requires that the requesting party “did not know of such fraud until after the granting of the discharge.” Since the Trustee was aware of the fraudulent activity, no revocation could be granted under Section 727(d)(1) and that part of the complaint was dismissed.

However, the Court also found that Section 727(d)(2) does not contain the “lack-of-knowledge” requirement. Therefore, the Debtors’ motion for summary judgment under that section was denied. After a trial the Bankruptcy Court revoked the Debtors’ discharge. The Debtors appealed to the District Court which affirmed the Bankruptcy Court. The appeal was then brought before the 11th Circuit Court of Appeals.

On appeal, the Debtors argued that a Plaintiff seeking revocation of a discharge under Section 727(d)(2) should be required to prove lack of knowledge, the same standard as in Section 727(d)(1). The Debtors supported this argument by referring to the legislative history of this section. Next, Section 727(d)(2) must contain the lack-of-knowledge requirement to distinguish it from Section 727(a)(2). Further Debtors argued that the lack-of-knowledge requirement should be applied to Section 727(d)(2) in order for § 727 to comport with the disclosure obligations levied on the Trustee by § 704 of the Bankruptcy Code. In particular, the Debtors pointed to various disclosure requirements that § 704(a) places on a trustee, including furnishing the court with information about the debtor’s estate and other information material to the discharge decision. The Court addressed each argument.


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