Debtor’s slipshod records provide lesson for attorneys – Minnesota Lawyer
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BOSTON — The 1st U.S. Circuit Court of Appeals has ruled that a Chapter 7 debtor could be denied discharge of a judgment debt because of his failure to keep adequate records regarding rental properties he owned.
The case offers the bankruptcy bar a lesson on how to handle such clients, lawyers say.
“Every bankruptcy practitioner needs to give serious time to looking at the backup accounting and financial records of every debtor,” said Jordan L. Shapiro of Malden, Massachusetts.
Debtor Richard M. Shove operated a landscape company for 25 years until shuttering it in 2015. He also owned numerous rental properties. Before he filed for bankruptcy, one of his employees, Jose Hernandez, obtained a $965,201 Superior Court judgment against him for a severe on-the-job injury he suffered during a period that Shove did not carry workers’ compensation insurance.
Paper copies that Shove allegedly kept of his business records were destroyed in a December 2015 house fire, after which he and his wife apparently stopped keeping records of rental payments and instead kept cash at various locations in their home and car.
When Shove sought a discharge of the judgment debt, a U.S. Bankruptcy Court judge found the debt nondischargeable under 11 U.S.C. §727(a)(3), based on his failure to preserve records from which his financial condition could be ascertained.
On appeal, Shove argued that his practice of not keeping records was justified under the circumstances.
The 1st Circuit disagreed, affirming both the Bankruptcy Court and a subsequent ruling by the Bankruptcy Appellate Panel for the 1st Circuit.
“A reasonable individual who owned several income-producing properties would keep and preserve records related to those properties, and the bankruptcy court was within its province in concluding that Shove’s failure to do so was unreasonable and unjustified,” Judge Lara E. Montecalvo wrote for the 1st Circuit panel. “Shove previously operated a landscaping company for twenty-five years, owned ninety rental units over his career, and kept rental income and expense records in the past. Shove thus possessed the necessary expertise to contemporaneously record rental income and expenses.”
The 19-page decision is In Re: Shove, Richard M. Hernandez v. Shove. A link to the case is available with the story at minnlawyer.com.
‘Satisfying’ decision
The injured employee’s attorney, Cynthia A. Spinola of Pittsfield, Massachusetts, said it was “satisfying” that the Superior Court, U.S. Bankruptcy Court, BAP and 1st Circuit all rejected Shove’s attempts to evade responsibility to her client.
“Mr. Hernandez is an immigrant from El Salvador and is a hard-working man with family in El Salvador. Hopefully [through collection activities] he will receive the relief to which the jury and different judges have confirmed he is entitled,” she said.
Spinola also said the ruling sends a broader message to plaintiffs’ attorneys to pursue judgments persistently, even if it means in Bankruptcy Court.
Debtor’s counsel James P. Ehrhard of Worcester, Massachusetts, could not be reached for comment prior to deadline.
But John S. Simonian, a bankruptcy attorney in Providence, Rhode Island, said the debtor likely could have obtained a discharge had he waited two years to file the case while maintaining records in the interim.
“I have clients come to me all the time with sloppy recordkeeping, and I send them to a bookkeeper to get them into an acceptable format,” he said. “Many do not have bookkeeping skills on their own to produce records, so they need to get someone to do it for them. Otherwise, I don’t file the case.”
Shapiro represented the debtor in In re Schifano, a 2004 case cited in Shove. The 1st Circuit in Schifano denied his client a discharge for failing to maintain adequate financial records. He said as he read Shove, the importance of a creditor or trustee being able to determine the debtor’s financial condition “all sadly came back to me.”
“Unfortunately, even the ‘reasonably prudent debtor’ argument, which has worked for me on occasion, fell on deaf ears,” said Shapiro, referencing the argument, also advanced by Shove, that failure to maintain records should be excused because they acted like a reasonable person in their position.
Boston attorney Jonathan M. Horne said in most cases in which a debtor has not maintained contemporaneous records, the debtor can obtain bank statements to document past transactions and satisfy disclosure obligations.
“But where a debtor has been dealing almost exclusively in cash, the absence of contemporaneous records makes satisfying the disclosure requirement more difficult,” Horne said.
Dmitry Lev of Watertown, Massachusetts, said he found the outcome unsurprising.
“The ‘price’ of a bankruptcy discharge comes down to two things: honesty and documents. And in most cases, one needs the latter to substantiate the former,” Lev said. “Unfortunately for the debtor in this case, where the decision of the Bankruptcy Court was based in large part on assessments of credibility, in light of the applicable standard of review and great deference given to lower courts, prevailing on appeal here would have been extremely challenging.”
Denial of discharge
Shove operated Rick’s Complete Lawn Care, his landscaping business for 25 years, in addition to owning approximately 90 rental units over the years. He shut down the landscaping business following the 2014-2015 season.
In December 2015, a fire damaged Shove’s home, forcing his family to relocate for a year.
According to the record from the Bankruptcy Court, before the house fire Shove kept paper copies of business records related to his rental properties in boxes stored in his basement. Fire and related water and ice damage destroyed the records.
Shove and his wife, Kathleen, did not keep records of rental payments after the fire, using instead what they described as a “partial cash system” in which many of their tenants paid cash. For those who paid by check, Kathleen would cash the check at the tenant’s bank to ensure they did not bounce.
According to Kathleen, they kept cash from rental payments locked in the car, in a kitchen drawer, and in a living room hutch.
They did not retain records of the rental payments, the cashing of rental checks, or cash payments for bills related to their rental properties.
In February 2015, before Shove wound down his landscaping business, Hernandez fell from a snow-covered roof during the course of his employment. Because Shove did not have a workers’ comp policy at the time, Hernandez sued him for his injuries in Superior Court, where, in September 2017, he recorded a $965,201 judgment against Shove.
Three months later, the Shoves filed for Chapter 7 bankruptcy, requesting a discharge from the judgment.
As part of their filings, the Shoves disclosed that they owned nine properties in Berkshire County, several of which were income-producing at the time.
They also indicated that they received approximately $1,000 in monthly net rental income, but despite the form’s instructions, they did not attach a statement for each rental property showing gross receipts, ordinary and necessary business expenses, and total monthly net income.
The trustee requested additional documentation of their financial affairs, including rent rolls and bank statements so that he could try and ascertain their financial position.
In response, the Shoves produced a single-page document for each month listing rent received from each property, along with a statement that the information represented their “best recollection” as of March 2018 because they no longer kept records.
In March 2018, Hernandez began an adversary proceeding to prevent discharge of his judgment under §727(a)(3).
After a trial, the Bankruptcy Court denied the discharge and the BAP affirmed. Shove then appealed to the 1st Circuit.
Ruling affirmed
The 1st Circuit rejected Shove’s argument that the post-hoc rent rolls he created for the trustee fulfilled his duty to keep records.
“Shove’s post-hoc rent rolls … do not move the needle,” Judge Montecalvo responded. “At the end of the day, the Trustee testified that he was ‘having great difficulty determining the status of [the Shoves’] financial affairs’ and that he never fully ‘satisf[ied] [himself] that [he] had a complete handle on the status of their financial affairs from the records’ provided. Accordingly, given the Trustee’s testimony and the lack of contemporaneous records, we would be hard pressed to find that the court erred in finding that Shove failed to keep adequate records after the house fire.”
Shove also failed to convince the court that his practices were reasonable under the circumstances because it is not customary to maintain financial records with a small number of rental units and because the fire created extenuating circumstances for his family.
“[The Bankruptcy Court] reasoned that in light of Shove’s ‘lengthy history as a business and rental property owner,’ the change in recordkeeping practice pre- and post-fire, the relatively light burden involved in recording rent-related transactions, and Shove’s demeanor at trial, Shove’s failure to keep records was unreasonable and unjustified,” Montecalvo said. “We see no error in the bankruptcy court’s well-reasoned assessment.”
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