Iowa Bankruptcy Court Refuses to Bar Debt from Discharge

March 30, 2015
Kristine A. Tidgren

The United States Bankruptcy Court for the Northern District of Iowa recently ruled in favor of the debtors in an adversary action brought by their bank. The bank argued that the debtors’ obligations under a promissory note and an agricultural security agreement should be excepted from discharge in their Chapter 7 bankruptcy under 11 U.S.C. § 523(a)(6). Under that provision, debt is excepted from discharge for “willful and malicious injury by the debtor to another entity or to the property of another entity.” The facts in this case were sympathetic to the debtors, and the court denied the relief.

In 2006, the debtors (a farmer and his wife) borrowed $150,000 from the bank to finance the farmer’s operation. They issued a security agreement to secure the note. The security agreement required the debtors to make all proceeds from the sale of collateral available immediately to the bank by depositing the proceeds in their account with the bank. The bank was at first lax in enforcing that policy.

In July of 2011, the farmer suffered a serious brain injury in a farming accident. His relatives took over his farming business for the rest of the year. They did not deposit all of the proceeds from the 2011 farm products into the farmer’s account with the bank. In fact, only $21,785 of the $83,277 reported on the farmer’s income tax return was deposited in the account. The farmer testified that the remaining money was used to pay his medical bills.

The farmer’s son started his own farming operation in 2012. He used his father’s and his uncle’s farming equipment, and his father helped him locate buyers for his crops. The farmer, however, was still unable to farm for the first half of 2012, and he did not contribute financially to his son’s business.  

During this time, the son provided the farmer with financial assistance. He would frequently write checks to the farmer and his wife. He also had some of his buyers do the same.

The debtors filed for Chapter 7 bankruptcy protection on March 12, 2013. In its adversary action, the bank alleged that $74,889 in debt should not be discharged because the debtors willfully and maliciously injured the bank by failing to deposit farm proceeds into the debtors’ bank account.

Specifically, the bank argued that the 2012 farming operation actually belonged to the farmer and not his son. The bank alleged that the debtors devised the ownership story to avoid the deposit requirement and to intentionally injure the bank.

The court disagreed. The court found that the bank did not prove that the 2012 operation was the farmer’s. Instead, the court believed that the son ran the operation and that the farmer merely assisted him when his health would allow.

The court stated that the bank had to prove the necessary three elements to prevail in its action to except the debt from discharge under 11 U.S.C. § 523(a)(6): (1) injury, (2) willfulness, and (3) malice. The court found that the bank had only established injury. As such, the debt was not excepted.

The court clarified that to prove willfulness, the bank had to show that the debtors intended to injure the bank, not just that they intended the actions that led to the injury. The court found that although the bank proved that the debtors intended to process checks from proceeds outside of their account with the bank, the bank did not prove that the debtors were trying to injure the bank. The farmer was recovering from a serious injury, and the bank had in the past allowed some checks to be deposited elsewhere, despite the language of the security agreement. 

The court also found that the bank had failed to prove malice. This, the court stated, would require a “knowing wrongfulness or knowing disregard of the rights of another.” Evidence of a cover up might, for example, be sufficient to prove malice. In this case, the court found the bank failed to show that the debtors were "substantially certain" that their actions would injure the bank.

Although the debtors violated the legal rights of the bank, there were no “aggravating circumstances.” As such, the court stated that it would not bar the debt from discharge.

This case provides a good overview of the high level of proof a creditor must submit to except a debt from discharge under 11 U.S.C. § 523(a)(6). These cases rely heavily on the testimony of the debtors. The court stated, "This case could have been, and probably would have been, different if the Court did not find Debtors to be credible."

In re Jacobson, No. 13-00331, 2015 Bankr. LEXIS 964 (Mar. 27, 2015)

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