FILED JUN 4 2019 NOT FOR PUBLICATION SUSAN M. SPRAUL, CLERK U.S. BKCY. APP. PANEL OF THE NINTH CIRCUIT
UNITED STATES BANKRUPTCY APPELLATE PANEL OF THE NINTH CIRCUIT
In re: BAP No. SC-18-1269-KuFB BAP No. SC-18-1278-KuFB JORDON WALLACE SCHULTZ, (cross-appeals)
Debtor. Bk. No. 17-01568-LA7
JORDON WALLACE SCHULTZ, Adv. No. 17-90126-LA
Appellant/Cross-Appellee, v. MEMORANDUM*
KEYWORD ROCKSTAR, INC.; JON SHUGART; LUKE SAMPLE,
Appellees/Cross-Appellants.
Argued and Submitted on May 23, 2019 at Pasadena, California
Filed – June 4, 2019
Appeal from the United States Bankruptcy Court Southern District of California
* This disposition is not appropriate for publication. Although it may be cited for whatever persuasive value it may have, see Fed. R. App. P. 32.1, it has no precedential value, see 9th Cir. BAP Rule 8024-1. Honorable Louise DeCarl Adler, Bankruptcy Judge, Presiding
Appearances: J. Edward Switzer, Jr. argued for appellant/cross-appellee Jordon Wallace Schultz; Patrick N. Downes of Loeb & Loeb LLP argued for appellees/cross-appellants Keyword Rockstar, Inc., Jon Shugart, and Luke Sample.
Before: KURTZ, FARIS, and BRAND, Bankruptcy Judges.
Keyword Rockstar, Inc., Jon Shugart and Luke Sample (collectively,
Plaintiffs) filed an adversary complaint against debtor, Jordon Wallace
Schultz, objecting to his discharge under § 727(a)(3), (4), (5), and (7).1 After
a trial, the bankruptcy court found in favor of Mr. Schultz on the
§ 727(a)(3), (4), and (5) claims. However, the court denied his discharge
under § 727(a)(7), finding that Mr. Schultz committed a false oath under
§ 727(a)(4)(A) by undervaluing the customer and lead lists on the schedules
of his solely-owned company, chapter 7 debtor JWS Publishing, Inc. (JWS).
Mr. Schultz appeals from the bankruptcy court's judgment on the
§ 727(a)(7) claim. Plaintiffs cross-appeal on the § 727(a)(5) claim.
For the reasons explained below, we REVERSE the court's ruling on
the § 727(a)(7) claim and AFFIRM on the § 727(a)(5) claim.
1 Unless specified otherwise, all chapter and section references are to the Bankruptcy Code, 11 U.S.C. §§ 101-1532, and “Rule” references are to the Federal Rules of Bankruptcy Procedure.
2 FACTS
A. Prepetition Events2
Mr. Schultz, individually and later through JWS, developed
advertising webinars and educational videos marketed through the
internet, and conducted personal coaching of his customers.
Seeking to expand his customer base, Mr. Schultz contacted Mr. Shugart to
participate in a joint venture arrangement through JWS, where Mr. Shugart
would coordinate and manage the marketing of JWS’s products. Their oral
agreement and business dealings were facilitated through Skype and text
messaging.3 They agreed to split the profits 50-50 and create a mutually
accessible customer and sales database containing email addresses.
Initially, the joint efforts were highly successful. However, sometime
in February 2015, Mr. Schultz began having bouts of strange behavior
including paranoia, forgetfulness, and deep depression. After seeking
medical advice and testing, he was diagnosed with bi-polar disorder,
post-traumatic stress disorder (PTSD), and dissociative disorder.
Mr. Schultz obtained some relief from medication and by participating in
on-going psychiatric therapy. As Mr. Schultz's mental condition became
2 Most of the background facts are taken from the bankruptcy court's memorandum decision. 3 Mr. Shugart and Mr. Sample are located in Georgia. Keyword Rockstar, Inc. was formed and solely owned by Mr. Shugart.
3 worse, the partnership's amicability began to suffer.
Sometime in May 2015, Mr. Shugart sold copies of JWS's videos to
parties on the customer list without informing Mr. Schultz. Mr. Shugart
claimed that he was testing the strength of the customer list. When
Mr. Schultz discovered this "test," he reacted as though he had been
betrayed and encouraged those who purchased during Mr. Shugart's test to
request refunds or reverse purchases through the merchant accounts that
financed those purchases.
In a June 2015 face-to-face meeting, Mr. Schultz told Mr. Shugart he
was overwhelmed by providing customer service to JWS’s customers,
creating products (webinars and videos), personally coaching some
customers, and doing all the travel necessary to facilitate these activities.
He asked Mr. Shugart to take on more customer support responsibilities so
that he could focus on preparing and presenting video coaching sessions.
Mr. Shugart offered to bring in Mr. Sample, his longtime associate, to take
over customer service and other duties. Mr. Schultz agreed, and they set a
schedule for periodic accounting to each other and agreed to split the
profits three ways.
In July 2015, Mr. Schultz discovered information that he believed
showed that either Mr. Shugart or Mr. Sample were marketing copies of his
product without permission or accounting for sales. He also discovered
that Mr. Sample was not performing any customer services. Thereafter, the
4 parties were unable to do a mutually agreeable accounting and the
partnership terminated.
In August 2015, Plaintiffs filed a civil lawsuit against Mr. Schultz,
JWS, and others, in the United States District Court, Central District of
California (Case No. 2:15-cv-06167-DDP-RAO). Both sides in that lawsuit
alleged that the other must provide an accounting, and that the other side
breached the contract, violated fiduciary duties, and misappropriated trade
secrets. In addition, the ownership of JWS’s customer list was disputed.
The matter was stayed pending the outcome of this appeal and cross-
appeal.
In addition to this litigation, Mr. Schultz became involved in a
protracted child custody lawsuit with the mother of his infant son. Then, in
October 2016, Mr. Schultz lost virtually everything he owned in a house
fire. Combined, these events pushed him into bankruptcy.
B. Bankruptcy Events
Mr. Schultz filed a chapter 7 petition on March 22, 2017. Seven days
later, he filed JWS’s chapter 7 petition. Based on comparable sales,
Mr. Schultz valued JWS’s customer list at $348.60 ($0.10 per lead) and its
lead list at $430.00 ($0.02 per lead) for a total of $778.60.
Plaintiffs filed an adversary complaint objecting to Mr. Schultz’s
discharge under § 727(a)(3), (4)(A) and (B), (5), and (7), and § 523(a)(4) and
5 (6).4 Plaintiffs alleged that in Mr. Schultz’s personal bankruptcy, he made
false oaths under § 727(a)(4)(A) by failing to disclose jewelry (a Rolex
watch) with a value of more than $100, and by failing to schedule his
Bitcoin account which contained about $30,000. In the § 727(a)(5) claim,
Plaintiffs alleged that had a net worth in excess of $4 million during the
later stages of the partnership but supposedly became insolvent in March
2017. Plaintiffs maintained that Mr. Schultz failed to satisfactorily explain
the loss of his net worth.
Plaintiffs also alleged that Mr. Schultz had made a false oath under
§ 727(a)(4)(A) in JWS’s bankruptcy case by undervaluing its customer list.
According to Plaintiffs, the list generated millions in income. Using a
revenue-based valuation methodology, Plaintiffs alleged that the list was
worth a six or seven figure number. On this basis, Plaintiffs sought denial
of Mr. Schultz’s discharge under § 727(a)(7).
1. The Trial
The bankruptcy court conducted a four-day trial on the § 727 claims.
Five witnesses testified: Mr. Shugart, Mr. Schultz, Benjamin Rucker
(Mr. Schultz’s accountant), Susanne Morgan (Mr. Schultz’s therapist), and
Joanna Morales (a paralegal in Mr. Switzer's office who assisted
Mr. Schultz with his bankruptcy petitions). Relevant trial testimony is
4 The bankruptcy court deferred ruling on the § 523 claims pending the outcome on the § 727 claims.
6 summarized below.
Summary of Mr. Shugart's Testimony
Mr. Shugart, who had worked in the affiliate marketing space since
2008, testified about how sales are made through a webinar. He explained
that the webinar is about a one-hour sales presentation of a product and
customers are invited to participate by email. According to Mr. Shugart,
either the advertiser of the product or an affiliate would send out the email
invite. If a customer registered for the webinar, they were consenting to be
on the email list, and the sender would know what the consumer was
interested in. Mr. Shugart opined that knowing the purchase behavior of
the consumers on your list is always "really, really good." He also testified
that the customer list contained not only email addresses, but phone
numbers and "that kind of thing."
Mr. Shugart then testified about the value of JWS’s customer list.
Mr. Shugart testified that he was aware of a list that recently sold for
$12,000. According to Mr. Shugart, this list was not as "curated" as the JWS
list because it did not generate as much income (his understanding was
that the list that sold for $12,000 generated $200,000 in sales). Mr. Shugart
explained that the JWS list was "curated," meaning that the people on the
list spent a lot of money to learn the information Mr. Schultz was selling.
Mr. Shugart testified that at least $4 to $5 million was sold to people on
JWS’s list. By using a revenue based methodology rather than the sales
7 comparison used by Mr. Schultz in JWS’s schedules, Mr. Shugart opined
that JWS’s customer list was worth at least $1 million.
During Mr. Shugart's testimony, his attorney played a video showing
Mr. Schultz at a webinar. There, Mr. Schultz told his customers that if they
followed his instructions, they, too, could create a customer email list (as he
had done) that generated over $4 million in gross sales, and was worth $1
million.
At another point, when asked if he had any understanding as to how
Mr. Schultz could have come up with a valuation of $700, Mr. Shugart
testified that there were valuation methods on a per email basis, but he did
not know how Mr. Schultz came up with the $700 valuation.
When asked about whether he was aware of any other sales that
would be comparable to a sale of JWS’s list, Mr. Shugart explained that
normally lists like JWS’s were not for sale because they are so curated and
are proven producers for sales. Therefore, most people do not sell the lists,
but give third parties a representative share, typically 50% when sales are
made. Mr. Shugart continued: "I can't give you a value on that [JWS] list,
because the value is so high. Would someone actually pay for it versus. . .
generally they just do a rep share on it and that way it's safer for both
parties. It is an expensive purchase if you were to pay what it's really
worth."
On cross examination, Mr. Shugart testified further about the $12,000
8 sale that he had previously mentioned. He said he knew the owner of the
email list that was sold for $12,000, but did not know the buyer.
Mr. Shugart also testified that the broker had told him the list sold for
$12,000 after he had turned down the sale. According to Mr. Shugart, the
seller of that list owned a company that sends emails.
Other testimony showed that Mr. Shugart had told Mr. Schultz he
was fine with him controlling and having the say on the customers, "they
will be yours in terms of listening to you." When asked what he meant by
that, he replied that whatever emails he would send on behalf of
Mr. Schultz would come from Mr. Schultz’s voice. Further, Mr. Schultz’s
face was on the registration page of the webinars. Mr. Shugart thought that
in terms of listening to Mr. Schultz, consumers would be more responsive
if the emails were coming from his name or voice.
Mr. Shugart also testified that Mr. Schultz "has very erratic behavior,"
which he saw in May 2015.
On recross, Mr. Shugart testified that in his opinion the value of the
list was definitely closer to $1 million than $700. Last, Mr. Shugart testified
that he was not an expert on the sale of email lists, but more of a purchaser.
Summary of Mr. Schultz’s Testimony
With respect to the § 727(a)(5) claim and alleged loss of assets,
Mr. Schultz testified as to line items on the tax returns for JWS. Most of his
answers were "I don't know" and "you'll have to talk to my accountant."
9 Mr. Schultz further testified that his assistant, Sarah, helped him
prepare his bankruptcy filing, and that at the time he was on many
medications. He answered many of the questions about his bankruptcy
filing and the disposition of assets with "I don't remember."
Later, Mr. Schultz testified that he did not understand specific
transactions and hundreds of pages of accounting from two to three years
ago. He explained that he did not know the difference between a ledger
and an income statement and similar concepts. "So again, ask my
accountant."
With respect to JWS’s schedules, when asked why he listed the
internet domain and website of JWS with a value of zero, he replied that he
had "abandoned it, no one bought it; and you can still buy it if you want to,
and it's sitting out there." When asked "you picked revenue-based"
(methodology for the valuation), Mr. Schultz replied: "I don't understand."
Later, he again said that he did not know why he picked a revenue-based
methodology for the domain. When asked about how he came up with the
value for the customer and lead lists using a comparable sale methodology,
Mr. Schultz testified that he asked his "buddy," a fellow affiliated marketer,
Precious Ngwu, about the value. The testimony further shows that in
Mr. Schultz’s previous deposition about how he came up with the value, he
had responded that he "did not know." Evidently, his discussion with
Mr. Ngwu came to him later, but he could not remember when he spoke to
10 Mr. Ngwu.
When shown the exhibit about his video when he valued his email
list at $1 million, Mr. Schultz replied that he thought the statement was true
"only to me" because he had a relationship with his customers to sell them
his products. Mr. Schultz also testified that Virticode, a company which he
partially owned, was using the list now and making money.
Finally, Mr. Schultz testified that he did not have a clear memory of
filling out the JWS petition paperwork because he was "like a zombie" and
it "was a really bad time for [him]."
Summary of Mr. Rucker's Testimony
Mr. Rucker, a former tax examiner and forensic accountant for the
IRS, kept Mr. Schultz’s books and had prepared his personal and business
tax returns since 2015. Mr. Rucker explained his customs and practices with
Mr. Schultz. Mr. Rucker had access to all of Mr. Schultz’s bank statements
so that he could enter each transaction into Quick Books and then reconcile
the accounts. During the entry process into Quick Books, if Mr. Rucker
could not tell from the context of the bank statement how to properly
classify a transaction, he would ask Mr. Schultz the purpose of the
transaction. Any transaction that did not have a known business purpose
was booked as a shareholder distribution and not a business transaction.
These distributions, which were personal items, did not show up on the
income statement and were not deducted on the tax return.
11 Mr. Rucker also explained that a $250,000 transaction on February 4,
2016, was a cashier's check and was for advertising. He testified that he
knew this since he would have called Mr. Schultz as part of the
classification process to ask him what the transaction was for and he would
have booked it based on Mr. Schultz’s explanation.
Finally, Mr. Rucker testified that based on his experience as an
account and fraud investigator with the IRS, he was extremely confident
that Mr. Schultz’s books and tax returns were an accurate accounting of his
business transactions since January 2015 and, if he had any doubt, he
would not have Mr. Schultz as a client. He also opined that compared to
the other books and records that he reviewed in his tax practice and cases
he reviewed while with the IRS, it was rare that he saw records as
meticulous and detailed as Mr. Schultz’s and he felt that if Mr. Schultz
were ever audited, there would be no tax change involved.
Summary of Ms. Morgan's Testimony
Ms. Morgan is a licensed marriage and family therapist who had
been treating Mr. Schultz since September 2016. She explained that
Mr. Schultz was formally diagnosed with bi-polar disorder, PTSD, and
dissociative disorder, and that she coordinated his care with his treating
psychiatrist.
Ms. Morgan testified that his bi-polar disorder was severe and made
worse by stress. She further opined that in both the manic and depressive
12 state, Mr. Schultz’s ability to think in a logical fashion and to attend to
details was impaired, albeit in different ways.
Ms. Morgan explained that Mr. Schultz qualified for PTSD based on
multiple traumas beginning with being abused from a young age in his
family of origin, severe bullying as a young child in social settings, and
even abuse outside the home. According to Ms. Morgan, the trauma of the
house fire and all the events that followed also qualified Mr. Schultz for
PTSD. Ms. Morgan opined that for Mr. Schultz, in particular, it affected his
memory in that he did not have clear memories of the events themselves.
Ms. Morgan also testified that Mr. Schultz’s dissociative disorder
complicated things in an "elaborate way." In a nutshell, due to his traumas,
Mr. Schultz had distinct differences as to which part of him was in charge
and running the show. She testified that Mr. Schultz exhibited eight
different personalities.
Ms. Morgan further explained that Mr. Schultz had difficulty filling
out forms. It was difficult for him to get through the standard intake forms
at her office and, therefore, he needed help from another therapist. Even
then, she opined, it was unclear if they were correct. She testified that
Mr. Schultz fills out a mood survey every time he has an appointment with
her and, sometimes, it looks as though it was filled out by a child. She also
testified that he does not always connect the dots, and although she could
not speak to every decision, Mr. Schultz had difficulty with concentrating
13 and cognition, and thinking logically.
She also explained that Mr. Schultz’s logic was severely impaired
when he had taken some of his medications. One medication prohibits
driving and another medication impairs cognition. She testified that his
medications have been adjusted frequently throughout his care.
Summary of Ms. Morales' Testimony
Ms. Morales, Mr. Switzer's legal assistant, testified that on a scale of
1 to 10, Mr. Schultz’s bankruptcy filings were a 10 with respect to difficulty
and accuracy. According to Ms. Morales, this was due to the voluminous
information and Mr. Schultz’s state of mind. She further explained that
Mr. Schultz had lost many of his papers in the fire. Ms. Morales testified
that the numerous amendments made to the schedules were due to
mistakes and Mr. Schultz’s forgetfulness. Ms. Morales also opined that
Mr. Schultz was confused a lot and that his assistant, Sarah, could keep
Mr. Schultz on schedule, but he definitely needed help.
C. Summary of the Bankruptcy Court's Findings
1. Section 727(a)(5)
On this claim, the bankruptcy court found that either Plaintiffs had
failed to carry their burden, or that Mr. Schultz had offered credible
evidence and explanation. The court noted that the Plaintiffs took issue
with Mr. Schultz’s ability to explain a number of entries in, for example, the
Quick Books for 2016, a document that is some 194 pages in length with 33
14 lines of entries on each page and over 6,402 entries. The court found that it
was true that Mr. Schultz could not explain some of the withdrawal entries.
However Mr. Schultz testified that he left a lot of the categorization to his
accountant. The court observed that Mr. Rucker corroborated Mr. Schultz’s
testimony, explaining how he sorted various deposits and withdrawals
from JWS’s accounts. The court concluded that there was nothing
unsatisfactory in Mr. Rucker's explanation.
2. Section 727(a)(4)(A) via § 727(a)(7)
The bankruptcy court found that Mr. Schultz grossly undervalued
JWS’s customer list which constituted a false oath. In reaching this
conclusion, the court found that Mr. Schultz’s testimony for the low value
was not credible. Although Mr. Schultz testified that he asked his "buddy,"
a fellow affiliated marketer, Mr. Ngwu, about the value, the court observed
that there was no information on whether Mr. Ngwu was qualified to
opine on value.
Further, although the bankruptcy court had found that the false oaths
in Mr. Schultz’s personal bankruptcy schedules (the omission of the Rolex
watch and the Bitcoin account) were a result of his mental disabilities (e.g.
forgetfulness, lack of focus, inability to connect the dots), the court decided
that Mr. Schultz deliberately placed a low value on the customer list,
purportedly in consultation with his friend. The court decided that
Mr. Schultz’s conduct in JWS’s bankruptcy case was the result of an
15 intentional act and differentiated its findings as to the false oaths in his
personal bankruptcy based on "a commission rather than an omission." The
court noted that Mr. Schultz did not claim the valuation of the list was the
result of a mistake or inadvertence.
The bankruptcy court also considered Mr. Schultz’s previous claim in
the webinar that his list was worth $1 million. According to the court,
Mr. Schultz could have chosen the $1 million valuation but, instead, he
chose the $778.60 value from Mr. Ngwu. The court noted that he did not
choose a mid-range value, nor did he state the value was unknown.
According to the bankruptcy court, it was unreasonable for Mr. Schultz to
have chosen the lowest valuation, given that he had touted the list was
worth $1 million.
In its findings on intent, the bankruptcy court also relied on
Mr. Schultz’s sophistication. The court found that Mr. Schultz was "well-
educated, experienced and [a] creative participant in the internet marketing
field." The court concluded: "He had to have known the list had far more
value than he scheduled."
As further evidence of value, the court observed that Mr. Schultz was
currently using the customer list to market products to potential customers
in his new business and was making money.
Finally, the court agreed with Mr. Shugart's testimony that a
customer list containing contact information is not virtually valueless. The
16 court explained that although Mr. Shugart hesitated to put an exact value
on Mr. Schultz’s list, he was aware of a "poorly-curated" list that had sold
recently for $12,000.
In the end, the bankruptcy court found that Mr. Schultz intentionally
undervalued the list to cause the chapter 7 trustee, who had no
independent knowledge of the potential value of the list, to abandon it.5
The court concluded that Plaintiffs carried their burden of establishing that
Mr. Schultz made a false oath under § 727(a)(4)(A) in connection with
JWS’s bankruptcy case and denied his discharge on that basis.
The court entered judgment in favor of Mr. Schultz on all claims,
except the § 727(a)(7) claim, which was based on a false oath in JWS’s
schedules.6 Mr. Schultz filed a timely appeal from the judgment denying
his discharge under § 727(a)(7). Plaintiffs filed a timely cross-appeal,
challenging the court's ruling in favor of Mr. Schultz on the § 727(a)(5)
claim.
5 The chapter 7 trustee filed her notice of abandonment over a month after JWS filed its petition. According to the notice, the trustee abandoned the customer and lead lists on the grounds that (1) the ownership of the lists was disputed in the on-going litigation between Plaintiffs and Mr. Schultz and (2) the lists contained confidential and proprietary information. 6 Since the court denied Mr. Schultz his discharge under § 727(a)(4)(A) via § 727(a)(7), the court dismissed the § 523 claims without prejudice in the event its judgment was reversed and the discharge restored.
17 JURISDICTION
The bankruptcy court had jurisdiction under 28 U.S.C. §§ 1334 and
157(b)(2)(J). We have jurisdiction under 28 U.S.C. § 158.
ISSUES
Did the bankruptcy court err by denying Mr. Schultz a discharge
under § 727(a)(4)(A) via § 727(a)(7) on the basis that he knowingly and
fraudulently made a false oath in JWS’s bankruptcy schedules by
undervaluing the customer and lead lists?
Did the bankruptcy court err when it found that Plaintiffs had not
met their burden of proof under § 727(a)(5) and that Mr. Schultz provided a
satisfactory explanation about any loss of assets ?
STANDARDS OF REVIEW
In objection to discharge appeals: "(1) the [bankruptcy] court's
determinations of the historical facts are reviewed for clear error; (2) the
selection of the applicable legal rules under § 727 is reviewed de novo; and
(3) the application of the facts to those rules requiring the exercise of
judgments about values animating the rules is reviewed de novo." Retz v.
Samson (In re Retz), 606 F.3d 1189, 1196 (9th Cir. 2010) (quoting Searles v.
Riley (In re Searles), 317 B.R. 368, 373 (9th Cir. BAP 2004) aff'd, 212 F. App’x
589 (9th Cir. 2006)).
Under § 727(a)(4)(A), whether a debtor made a false oath, whether
the false statements were material, and whether the debtor had the
18 requisite fraudulent intent are all questions of fact reviewed under the
clearly erroneous standard. Id. at 1197. Whether a debtor has satisfactorily
explained a loss of assets under § 727(a)(5) is also a question of fact that we
review for clear error. Id. at 1205.
A factual determination is clearly erroneous if the trial judge's
interpretation of the facts is "illogical, implausible, or without support in
the record.” United States v. Hinkson, 585 F.3d 1247, 1261–62 & n.21 (9th Cir.
2009) (en banc).
There are other basic tenets that guide us in application of the clearly
erroneous standard of review. A factual determination is clearly erroneous
if the appellate court, after reviewing the record, has a definite and firm
conviction that a mistake has been committed. Anderson v. Bessemer City,
470 U.S. 564, 573 (1985). Where two permissible views of the evidence exist,
the factfinder's choice between them cannot be clearly erroneous. Id. at 574.
In addition, our role in this appeal is not to reweigh the evidence presented
to the bankruptcy court and we give due regard to the trial court's
opportunity to judge the witnesses' credibility. Id. While we give great
deference to credibility determinations, they are still subject to our review.
We may find clear error if the witness' story is so internally inconsistent or
implausible on its face that a reasonable factfinder would not credit it. Id. at
575. We also give deference to inferences drawn by the trial court. Beech
Aircraft Corp. v. United States, 51 F.3d 834, 838 (9th Cir. 1995).
19 DISCUSSION
A. General Considerations
The party objecting to discharge bears the burden of proof, which
under § 727 is a preponderance of the evidence. Rule 4005; In re Retz, 606
F.3d at 1196. "The burden of showing something by a 'preponderance of the
evidence,' . . . 'simply requires the trier of fact to believe that the existence
of a fact is more probable than its nonexistence before [he] may find in
favor of the party who has the burden to persuade the [judge] of the fact's
existence.'" Concrete Pipe & Prods. of Cal., Inc. v. Constr. Laborers Pension
Trust for So. Cal., 508 U.S. 602, 622 (1993) (citations omitted). "Before any
such burden can be satisfied in the first instance, the factfinder must
evaluate the raw evidence, finding it to be sufficiently reliable and
sufficiently probative to prove the truth of the asserted proposition with
the requisite degree of certainty." Id.
When considering this standard of proof, we are guided by certain
general principles governing denial of discharge claims. To effectuate the
fresh start policy, a claim for denial of a discharge under § 727 is construed
liberally in favor of the discharge and strictly against a person objecting to
the discharge. First Beverly Bank v. Adeeb (In re Adeeb), 787 F.2d 1339, 1342
(9th Cir. 1986). However, the bankruptcy discharge and its opportunity for
a fresh start is limited to the "honest but unfortunate" debtor. Grogan v.
Garner, 498 U.S. 279, 286–87 (1991).
20 B. The bankruptcy court erred in denying Mr. Schultz’s discharge under § 727(a)(4)(A) via § 727(a)(7).
Section 727 states in relevant part:
(a) The court shall grant the debtor a discharge, unless— .... (4) the debtor knowingly and fraudulently, in or in connection with the case– (A) made a false oath or account; .... (7) the debtor has committed any act specified in paragraph . . . , (4), . . . of this subsection, on or within one year before the date of the filing of the petition, or during the case, in connection with another case, under this title or under the Bankruptcy Act, concerning an insider . . . .
A plaintiff bringing a claim under § 727(a)(4)(A) must prove that:
"(1) the debtor made a false oath in connection with the case; (2) the oath
related to a material fact; (3) the oath was made knowingly; and (4) the
oath was made fraudulently." In re Retz, 606 F.3d at 1197 (quoting Roberts v.
Erhard (In re Roberts), 331 B.R. 876, 882 (9th Cir. BAP 2005)). "To establish a
§ 727(a)(7) claim based on the same type of conduct, the same elements
logically are required, albeit the 'false oath' must be made in another
bankruptcy case."7 Trainor v. Evans (In re Evans), BAP No. CC-16-1356-
7 There is no dispute that Mr. Schultz was an "insider" of JWS and that he caused JWS to value the customer list at $348.60 and the leads list at $430.00, for a total of $778.60.
21 KuFTa, 2017 WL 3429023, at *4 (9th Cir. BAP Aug. 9, 2017).
To meet their burden of proof, Plaintiffs must first show that
Mr. Schultz made a false statement in connection with JWS’s bankruptcy
case. The undervaluation of an asset on the schedules or statement of
financial affairs can constitute a false oath. Weiner v. Perry, Settles & Lawson,
Inc. (In re Weiner), 208 B.R. 69, 71–72 (9th Cir. BAP 1997) (denying discharge
on the basis of undervalued jewelry), rev'd on other grounds, 161 F.3d 1216
(9th Cir. 1998).
The bankruptcy court considered several pieces of evidence when
determining that the value of JWS’s customer list was greater than $700.
First, the court emphasized Mr. Schultz’s previous claim in the webinar
that the list was worth $1 million. Indeed, Plaintiffs' counsel waived the
trial exhibit on the webinar like a flag at oral argument before the Panel.
However, the court's reliance on this evidence for its determination of
"undervaluation" for purposes of a false oath is problematic. Mr. Schultz’s
opinion about the $1 million value was made at a different time and in a
different context. At the webinar where he made this claim, he was selling
a product, which included helping his customers build a profitable
customer email list. In this context, it was an estimate of how much he
could earn from his own list over time because of his relationship with his
list customers. Placed in context, if the customer list were offered for sale
by the chapter 7 trustee to a third party, it is not obvious from the record
22 what value it would have without Mr. Schultz’s involvement.8
Mr. Schultz’s opinion of value at the webinar is not plausible evidence of
the list's value in the hands of the chapter 7 trustee.
Next, the bankruptcy court agreed with Mr. Shugart's testimony that
a customer list containing contact information is not virtually valueless.
The court considered Mr. Shugart's testimony about the "poorly curated"
list that had sold for $12,000 as an indicator of value for JWS’s customer
list. However, Mr. Shugart offered few, if any, details about this sale: he
had turned down the offer to buy the list, the list generated about $200,000
in sales, and he "heard" that the list was sold, although he did not know
who had bought it.9 Compared to this list, Mr. Shugart opined that JWS’s
customer list was worth $1 million or had a "high value" because it
generated between $4 and $5 million in sales.
Plainly, the $12,000 sale was not a comparable sale. Indeed,
Mr. Shugart testified that he was unaware of any comparable sales.
According to Mr. Shugart, purchasers do not buy a list such as JWS’s due to
the risk of putting up significant cash for a list that may not return the
8 Although Mr. Schultz continues to use the list after it was abandoned by the chapter 7 trustee, we are similarly unable to tell from this record what value the list would have without his involvement. 9 This testimony, strictly speaking, was "hearsay" within the meaning of Fed. R. Evid. 801, although Mr. Schultz’s attorney did not object to its admission on this or any other grounds.
23 investment, especially when a 50-50 profit sharing arrangement is
available. Mr. Shugart does not explain the risks associated with
purchasing an email list and it is not apparent that he applied any discount
to the value he assigned Mr. Schultz’s customer list considering its
illiquidity.
In the end, Mr. Shugart's testimony about the value of JWS’s
customer list was conclusory, implausible, and inconsistent. There were no
comparable sales, he was unaware of any lists such as JWS’s for sale, and
his testimony was that purchasers do not buy a customer list such as JWS’s
for $1 million because the risk may be greater than the return on
investment. In other words, there is little, if any, market for these lists due
to risks that he did not fully explain. Furthermore, the chapter 7 trustee's
reasons for abandonment — the on going litigation over ownership of the
list and the personal and confidential nature of the content of the list —
were neither mentioned nor considered in the valuation testimony. The
record also shows that Plaintiffs did not attempt to purchase the list from
the chapter 7 trustee prior to abandonment, despite their litigation and
contention of high value.
In sum, the record contains no competent or plausible evidence that
JWS’s customer list was worth more in the hands of the chapter 7 trustee
than the value scheduled by Mr. Schultz on JWS’s schedules. Since we
liberally construe a claim for denial of a discharge under § 727 in favor of
24 the discharge and strictly against a person objecting to the discharge, we
are left with a definite and firm conviction that a mistake has been
committed. Anderson, 470 U.S. at 573. Since Plaintiffs failed to prove a false
oath, the burden of proof never shifted to Mr. Schultz to show that his
valuation was "more likely than not" correct.
Furthermore, on this record, even if there was a false oath (which was
not proven), we conclude that the bankruptcy court's finding that
Mr. Schultz knowingly and fraudulently undervalued JWS’s customer list
was clearly erroneous. In connection with the § 727(a)(4)(A) claim in
Mr. Schultz’s personal bankruptcy, the bankruptcy court found that
Mr. Schultz did not knowingly and fraudulently omit the Rolex watch and
Bitcoin account from his schedules due to his mental disabilities. But based
upon the same record, the court found that Mr. Schultz’s undervaluation of
the customer list was knowing and fraudulent. Although the court
explained its latter decision was based on Mr. Schultz’s commission versus
an omission, there is no evidence in the record that allows us to reconcile
the bankruptcy court's inconsistent findings.
The record shows that Mr. Schultz’s personal bankruptcy and that of
JWS were filed within a week of each other. There is no evidence that
shows Mr. Schultz had a different state of mind when he filed JWS’s
petition or that he was acting with any greater clarity at the time he valued
JWS’s customer list. Rather, there is ample undisputed evidence of
25 Mr. Schultz’s mental disorders in the record and their impact on his
memory and day-to-day functioning. The record shows that he had trouble
filling out simple forms. His personal bankruptcy petition and that of JWS
were complex. He had trouble with remembering — a significant portion of
answers during trial was that he did not remember. The record also shows
that he relied heavily on other people to help him — Mr. Rucker, his
accountant for his books; Sarah, his assistant for help with his filing and
that of JWS; Ms. Morales for help with his bankruptcy filings; and
ultimately his friend Mr. Ngwu for help with valuing his customer and
lead lists. These facts are consistent with the testimony of Mr. Schultz,
Ms. Morales, and Ms. Morgan.
Moreover, Mr. Schultz’s undisputed testimony was that he initially
had no memory of valuing the customer and lead lists. Only later did he
remember contacting Mr. Ngwu. Even then, he did not remember when or
any of the details, but his testimony showed that he relied on Mr. Ngwu's
opinion of the $0.10 per-email value. While we do not know whether
Mr. Ngwu's opinion was correct or incorrect based on the evidence in this
record, generally, "[a] false statement resulting from ignorance or
carelessness does not rise to the level of 'knowing and fraudulent.'" In re
Roberts, 331 B.R. at 884.
In sum, the bankruptcy court's finding of a knowing and fraudulent
intent was implausible and clearly erroneous.
26 C. The bankruptcy court did not err in finding that Plaintiffs failed to meet their burden of proof for denial of discharge under § 727(a)(5).
Section 727(a)(5) provides the court shall grant the debtor a
discharge, unless—
(5) 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 debtor's liabilities . . . .
The objecting party bears the burden of proof under § 727(a)(5) and
"must demonstrate: (1) debtor at one time, not too remote from the
bankruptcy petition date, owned identifiable assets; (2) on the date the
bankruptcy petition was filed or order of relief granted, the debtor no
longer owned the assets; and (3) the bankruptcy pleadings or statement of
affairs do not reflect an adequate explanation for the disposition of assets."
Retz, 606 F.3d at 1205. Once the creditor has established a prima facie case,
"the debtor must offer credible evidence regarding the disposition of the
missing assets." Id.
In their cross-appeal, Plaintiffs contend that they met their burden of
persuasion on their § 727(a)(5) claim and thus the bankruptcy court erred.
Plaintiffs explain that Mr. Rucker testified about a $250,000 withdrawal by
cashier's check from Mr. Schultz’s account on February 4, 2015 for
"advertising." According to Plaintiffs, this large withdrawal took place
about a year before the bankruptcy. They contend that Mr. Rucker testified
27 that he did not know who the cashier's check was written out to, and no
further explanation was provided about the amount. When questioned
about the $250,000 cashier's check, Mr. Schultz declined to answer and
deferred to his accountant "[a]gain my accountant can tell you that. I don't -
I don't do the books." Plaintiffs maintain that "[c]ulpability under Section
727(a)(5) is on a strict liability basis as, short of explaining where the assets
went, it contains no defense to an unexplained loss or deficiency." Grassman
v. Brown (In re Brown), 570 B.R. 98, 119 (Bankr. W.D. Okla. 2017).
We are not persuaded by Plaintiffs' arguments. Plaintiffs alleged "on
information and belief" that Mr. Schultz had a net worth in excess of $4
million during the later stages of the partnership, or July 2015, and then
allegedly became insolvent. The first step in prevailing under § 727(a)(5) is
to establish that the debtor owned identifiable assets of substantial value
which were not included in the bankruptcy estate.
Mr. Schultz provided all his 2014, 2015, and 2016 personal and
corporate tax returns, business financial records recorded in Quick Books,
and bank statements to the chapter 7 trustee in his individual case and that
of JWS, and to Plaintiffs. None of the documentation showed that he had a
positive net worth of $4 million dollars. Rather, as the bankruptcy court
noted, Plaintiffs’ primary evidence was that Mr. Schultz and JWS made a
lot of money in 2016 and 2017, yet wound up filing bankruptcy in 2017.
Although Mr. Schultz made a lot of money, his 2015 tax returns
28 showed he grossed $2.9 million, but had a net income of $372,992. In 2016,
Mr. Schultz grossed $2.8 million and had a net income of $268,632.
Moreover, the evidence shows that Mr. Schultz’s taxable income rose from
$275,699 in 2014 to $353,278 in 2015. The evidence also shows that his 2016
income from JWS was $268,632, but was offset by loss of another of his
subchapter S corporations, Brave Knight, which reported a loss of $517,264.
Mr. Rucker, who keeps Mr. Schultz’s books and does his personal
and business tax returns, testified extensively at trial. The bankruptcy court
acknowledged that Mr. Schultz could not explain some of the withdrawal
entries, but he testified that he left a lot of the categorization to his
accountant, Mr. Rucker. Mr. Rucker corroborated Mr. Schultz’s testimony,
explaining how he sorted various deposits and withdrawals from JWS’s
accounts.
Plaintiffs believe they met their burden of proof since neither
Mr. Schultz nor Mr. Rucker explained the $250,000 cashier's check, which
was categorized as an advertising expense, apparently since they do not
know who the check was made out to. Plaintiffs are mistaken as to what
constitutes a "satisfactory" explanation. "At a minimum, a 'satisfactory'
explanation must say what actually happened to the assets and must be
believable." Kane v. Chu (In re Chu), 511 B.R. 681, 687 (Bankr. D. Haw. 2014).
Here, not only was documentary evidence produced, but Mr. Rucker
corroborated Mr. Schultz’s testimony in great detail. Further, there is no
29 indication in the record that Mr. Rucker or Mr. Schultz withheld any
information about JWS or Mr. Schultz’s business dealings.
Section 727(a)(5) "does not require that the loss or other disposition of
the asset be proper; it requires only that the explanation satisfactorily
describe or account for the disposition." Ward v. Thompson (In re Thompson),
BAP No. CC-08-1265-MoMkH, 2009 WL 7751298, at *5 (9th Cir. BAP Apr.
20, 2009); see also In re Chu, 511 B.R. at 687 (§ "727(a)(5) does not require that
the explanation itself be meritorious, or that the loss or other disposition of
assets be proper; it only requires that the explanation satisfactorily account
for the disposition."). The Chu bankruptcy court explained: "[t]his
definition of 'satisfactory' is consistent with the basic principle that section
727 must be interpreted in favor of the debtor." In re Chu, 511 B.R. at 687.
Accordingly, even if the propriety of the $250,000 transaction could be
questioned, on this record, it is plausible that it was used for advertising.
Based on our review of the record, the bankruptcy court's decision to grant
Mr. Schultz a discharge under § 727(a)(5) was not clearly erroneous.
CONCLUSION
For the reasons stated, we REVERSE the bankruptcy court's denial of
Mr. Schultz’s discharge under § 727(a)(4)(A) via § 727(a)(7), and AFFIRM
its decision to grant Mr. Schultz a discharge under § 727(a)(5).