Mistakes Happen, But…


Two recent opinions from the 7th Circuit this past week show how mistakes can happen, but you can’t always fix them. And there are consequences.

In Katsman, the 7th Circuit found that a debtor’s intentional actions in leaving certain creditors out of her bankruptcy paperwork was not immaterial and sufficient to deny her a bankruptcy discharge.

In Duckworththe 7th Circuit found that a lender’s mistaken identification of its security (specifically that the date of the note identified in the security agreement was wrong by two days) could not be corrected with parol evidence against the bankruptcy trustee who, as other creditors, was entitled to rely on the 4 corners of the agreement.

One might think that such mistakes are trivial, but as Judge Posner notes in Katsman:

It is true that even a deception must be material to the bankruptcy proceeding to be a ground for refusal to discharge the debtor. Stamat v. Neary, supra, 635 F.3d at 978. And it might seem that Katsman’s deceptive omission of certain creditors from her Schedule F was immaterial because, had she listed on the schedule the family-and-friend creditors whom she wanted to repay, her debts would still have been discharged in bankruptcy and having thus received her “fresh start” she would be free to repay those creditors from new earnings. But such an argument if accepted would mean that a no-asset debtor wouldn’t have to so much as submit a Schedule F, because the creditors he would list on it could recover nothing from the estate in bankruptcy—there would be no estate. That can’t be right. A bankruptcy proceeding can’t be concluded without knowledge of who the debtor’s creditors are, unless omitting to mention them would be immaterial, United States v. Key, 859 F.2d 1257, 1260–61 (7th Cir. 1988); United States v. Lindholm, 24 F.3d 1078, 1083–84 (9th Cir. 1994), which it would be only if the amount owed them was utterly trivial. Collier on Bankruptcy, supra, ¶ 727.04[1][b]. That was not the case here.

In Duckworth, Judge Hamilton recognizes the harsh results that may need to follow on account of the rights of a bankruptcy estate and its creditors:

A bankruptcy trustee is in a different position, however. A bankruptcy trustee is tasked with maximizing the recovery of unsecured creditors. See In re Vic Supply Co., 227 F.3d
928, 931 (7th Cir. 2000). To assist in this task, trustees may exercise the so-called strong-arm power: the trustee is deemed to be in the privileged position of a hypothetical subsequent creditor and can avoid any interests that a hypothetical subsequent creditor could avoid “without regard to any knowledge of the trustee or of any creditor.” See 11 U.S.C. § 544(a). The strong-arm power is a “blunt information-generating tool” that encourages lenders to give public notice of their security interests by harshly penalizing those who fail to do so. Jonathan C. Lipson, Secrets and Liens: the End of Notice in Commercial Finance Law, 21 Emory Bankr. Dev. J. 421, 450-51 (2005) (criticizing the strong-arm power, “a necessary evil,” as perhaps “more troublesome for its over- and under-inclusiveness than for its basic goals”); see also Barkley Clark & Barbara Clark, The Law of Secured Transactions Under the Uniform Commercial Code § 6.02(1)(a) (3d ed.2011) (“The strong-arm clause is the ultimate Article 9 enforcer.”); id., § 6.02(1)(b) (“As a matter of public policy, the [strong-arm] rules penalize secret liens and encourage lenders to give public notice of their security interests.”).



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