Neal v. Oak Brook Management Corporation

No. 2--06--0549 Filed: 4-27-07
______________________________________________________________________________
IN THE
APPELLATE COURT OF ILLINOIS
SECOND DISTRICT
______________________________________________________________________________
LAWRENCE P. NEAL and DAWN ) Appeal from the Circuit Court
LUEBERS NEAL, ) of Lake County.
)
Plaintiffs-Appellants, )
)
v. ) No. 02--L--907
)
OAK BROOK MANAGEMENT )
CORPORATION, )
)
Defendant ) Honorable
) Margaret J. Mullen,
(Robert F. Smith, Defendant-Appellee). ) Judge, Presiding.
______________________________________________________________________________
JUSTICE O'MALLEY delivered the opinion of the court:
Plaintiffs, Lawrence P. Neal and Dawn Luebers Neal, appeal from an order of the circuit
court of Lake County, granting the motion of Robert F. Smith to be dismissed as a defendant because
the relevant debt was discharged in bankruptcy. We hold that the trial court erred in ruling that the
debt was discharged, and we therefore reverse and remand.
Plaintiffs sued Oak Brook Management Corp. (OBMC) and Smith for common-law fraud,
consumer fraud, and breach of contract. They filed their complaint on November 8, 2002. On
March 12, 2003, the trial court entered an order staying the case against Smith because he had filed
No. 2--06--0549
for protection under chapter 11 (11 U.S.C. §1101 et seq. (2000)) of the United States Bankruptcy
Code (11 U.S.C. §101 et seq. (2000)).1 OBMC answered the complaint on March 27, 2003.
On February 17, 2004, Smith moved to be dismissed from the case under section 2--619(a)(6)
of the Code of Civil Procedure (735 ILCS 5/2--619(a)(6) (West 2004)). That section allows the
dismissal of an action when the claim involved is barred by a discharge in bankruptcy. He stated that
he filed for bankruptcy protection on April 25, 2002, and had "amended the schedules attached to
his bankruptcy petition to include Plaintiffs' pre-petition claim." The schedules attached as an
exhibit show a filing date of December 12, 2002. He received a discharge. Another exhibit is a copy
of a discharge order entered on August 11, 2003, under section 1141(d) of the Bankruptcy Code (11
U.S.C. §1141(d) (2000))--a chapter 11 discharge. Smith asserted that "[s]ince Plaintiffs' claim
against Smith was listed in Smith's schedules and since Plaintiffs did not object to the discharge of
Smith, Plaintiffs' claims against Smith have been discharged and Plaintiffs are enjoined from
continuing the instant action against Smith."
Plaintiffs responded, arguing that the debt was excepted from discharge under section
523(a)(3)(B) of the Bankruptcy Code (11 U.S.C. §523(a)(3)(B) (2000)). They asserted that the court
should take judicial notice that Smith's meeting of creditors took place on May 30, 2002. They noted
that, under Rule 4007(c) of the Federal Rules of Bankruptcy Procedure (Fed. R. Bankr. P. 4007(c)),
in bankruptcy proceedings the deadline for filing a complaint to determine the dischargeability of
a debt is 60 days after the meeting of creditors. Thus, they argued, the last day for filing a complaint
1
The Bankruptcy Code as a whole (11 U.S.C. §101 et seq. (2000)), is Title 11 of the United
States Code. Smith's case, although he is an individual, was under chapter 11 (11 U.S.C. §1101 et
seq. (2000)), familiar as the provision governing business reorganizations.
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No. 2--06--0549
was July 30, 2002. Further, because Smith did not add their claims to the schedule until December
12, 2002, they did not have an opportunity to object to the dischargeability of the debt, and it became
nondischargeable under section 523(a)(3)(B).
Smith replied that, when a creditor is added to a petition, the creditor then has a "reasonable
time" to object to dischargeability and that, if he or she does not, the debt is discharged. He noted
that "some courts" have held that 60 days is a reasonable time.
The court granted Smith's motion to dismiss on March 8, 2005, and plaintiffs timely
appealed.
We hold that the trial court erred in granting Smith's motion. It misinterpreted the applicable
bankruptcy law. The Bankruptcy Code and the Federal Rules of Bankruptcy Procedure provide that
amendments to schedules do not alter the deadlines for filing bankruptcy court complaints to
determine the dischargeability of fraud debt. The cases Smith has cited do not alter this rule.
Consequently, plaintiffs' failure to file a complaint to determine dischargeability in bankruptcy court
did not render the debt dischargeable.
Initially, we note that, although the issues in this appeal are almost entirely ones of
bankruptcy law, this court and the trial court have subject matter jurisdiction. Principally at issue
is whether the discharge exception of section 523(a)(3)(B) allows plaintiffs' suit to proceed in the
face of Smith's discharge. Whether state courts have jurisdiction concurrent with that of the
bankruptcy courts to decide whether debts are excepted from discharge under section 523(a)(3)(B)
has been in contention in the bankruptcy courts. Compare In re Padilla, 84 B.R. 194, 196-97 (Bankr.
D. Colo. 1987) (holding that jurisdiction to decide whether a debt belongs to one of the classes that
would bring it within the scope of section 523(a)(3)(B) lies exclusively in the bankruptcy courts),
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No. 2--06--0549
with In re Strano, 248 B.R. 493, 501-03 (Bankr. D.N.J. 2000) (holding that, although the bankruptcy
court is the preferred forum because of its greater expertise, state courts have concurrent
jurisdiction). We find persuasive In re Strano's careful analysis of the relevant statutory provisions
concluding that the provisions that give bankruptcy courts exclusive jurisdiction over closely related
issues do not apply to section 523(a)(3)(B). Adopting that analysis, we find that this court and the
trial court have subject matter jurisdiction.
Smith asserts that plaintiffs' claims were discharged because plaintiff's did not seek a
determination of dischargeability in bankruptcy court. More specifically, he asserts that his
amendment to his schedules forced plaintiffs to file a complaint in bankruptcy court to preserve their
claims. That is not the law. As we discuss, debts due to fraud, akin to that alleged here,2 usually fall
within a group of restricted exceptions to discharge--exceptions that require the creditor to file a
timely complaint in bankruptcy court to determine dischargeability or else have those debts
automatically discharged. Ordinarily, for the required complaint to be timely, a creditor must file
it within 60 days of the date originally set for the meeting of creditors. Plaintiffs never filed a
complaint in bankruptcy court. However, bankruptcy law creates an exception to that requirement
in cases where the creditor does not have notice of the bankruptcy in time to file a timely complaint,
thus creating an exception to an exception to an exception. Smith does not deny that plaintiffs
lacked notice of the bankruptcy in time to file a complaint within the 60-day period. Nevertheless,
he asserts that bankruptcy law required plaintiffs to file a complaint within a reasonable time after
he amended his schedules to list plaintiffs as creditors. In support of his position, Smith points to
2
We do not resolve whether plaintiffs' claims are within bankruptcy law's definition of fraud
debt.
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certain cases that hold that bankruptcy courts may set a time limit for the filing of the required
complaints when they reopen a case to allow a debtor to amend his or her schedules to include
omitted creditors. As we will explain, these cases are inapposite. Although the cases may be correct
that courts can set such limits, the law is clear that new limits do not automatically arise when a
debtor amends his or her schedules. Thus, plaintiffs' failure to file a complaint when Smith amended
his schedules did not cause their claims to be discharged.
We start our consideration of the applicable bankruptcy law by considering the scope of the
section 523(a)(3)(B) exception to discharge. Section 523(a) limits the dischargeability of an
individual's debts under all chapters of the Bankruptcy Code. 11 U.S.C. §523(a) (2000). When
Smith filed for protection, section 523(a) contained 18 subsections describing the types of
nondischargeable debt. Three of these subsections describe debt arising from certain kinds of
intentional torts, including some frauds and misrepresentations; we will call this "fraud debt." Fraud
debts are the restrictedly dischargeable debts--the debts for which a creditor must generally file a
complaint to avoid their discharge.3
The sections describing fraud debts are 523(a)(2), (a)(4), and (a)(6). 11 U.S.C. §523(a)(2),
(a)(4), (a)(6) (2000). The restriction on their dischargeability arises from section 523(c)(1). The
effect of that section is to require a creditor to file an adversary complaint in bankruptcy court to
preserve their nondischargeability. See 11 U.S.C. §523(c)(1) (2000). (We will thus refer to the
complaints this section requires as "section 523(c)(1) complaints.") Section 523(c)(1) itself contains
an exception: it provides for the discharge of fraud debt absent a proper complaint "[e]xcept as
3
We ignore the existence of section 523(a)(15) (11 U.S.C. §523(a)(15) (2000)), concerning
certain debts arising out of divorce or separation, as that section is irrelevant here.
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No. 2--06--0549
provided in subsection (a)(3)(B) of this section." 11 U.S.C. §523(c)(1) (2000). As we explain,
sections 523(a)(3)(B) and 523(c)(1), read together, limit the dischargeability of fraud debt, even
when a creditor has not filed a section 523(c)(1) complaint, to cases where the creditor has received
acceptable notice of the bankruptcy. Debts falling into the other categories excepted from discharge
are not discharged despite a creditor's inaction in the bankruptcy proceedings, and a creditor can raise
the nondischargeability of those debts for the first time in a state court action to collect them. See,
e.g., In re Walker, 195 B.R. 187, 203-04 (Bankr. D.N.H. 1996).
Section 523(a)(3) limits the dischargeability of all debts the debtor did not properly list on
his or her bankruptcy schedules.4 It contains two very similar subsections. Section 523(a)(3)(A)
applies to debt other than fraud debt. It bars discharge of a debt unless the debt was scheduled in
time for the creditor to file a timely proof of claim, or unless the creditor had actual notice of the
bankruptcy in time to file a timely proof of claim. The last day to file a timely proof of claim--the
claims bar date--is thus the sole date critical to determining dischargeability under section
523(a)(3)(A). Section 523(a)(3)(B) applies to fraud debt. It bars discharge of such debts on the same
conditions as section 523(a)(3)(A), but adds a further condition on which debt is nondischargeable:
that the creditor be scheduled in time, or receive actual notice in time, to file a timely section
4
The debt must have been "known to the debtor" for this section to apply. 11 U.S.C.
§523(a)(3) (2000). However, Smith has never asserted that he did not know of plaintiffs' claims.
Instead, he asserts that his initial failure to schedule them was inadvertent.
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No. 2--06--0549
523(c)(1) complaint.5 Thus, section 523(a)(3)(B) creates two critical dates for determining the
dischargeability of fraud debt: the claims bar date and the deadline for section 523(c)(1) complaints.
Rule 4007(c) sets a deadline for section 523(c)(1) complaints: 60 days after the first date set
for the meeting of creditors required by section 341 (11 U.S.C. §341 (2000)). Fed. R. Bankr. P.
4007(c). (The trustee must set a date for a meeting of creditors 20 to 40 days after the debtor files
his or her petition. Fed. R. Bankr. P. 2003(a), Advisory Committee Note, subsection(a).) The court,
on a motion, may extend the deadline for filing such complaints, but the movant must file the motion
before the deadline. Fed. R. Bankr. P. 4007(c). Rule 9006(b)(3) emphasizes this limitation on
extensions of the deadline; it allows retroactive extensions of some deadlines, but provides that the
"court may enlarge the time for taking action under Rule[] *** 4007(c) *** only to the extent and
under the conditions stated in [that] rule[]" (Fed. R. Bankr. P. 9006(b)(3)). Nevertheless, as we will
discuss in more detail, a conflict of authorities exists regarding the power of the court to set new
deadlines for section 523(c)(1) complaints after the original deadline has expired.
5
As should be clear, section 523(a)(3) as a whole excepts from discharge all debts where the
creditor did not have acceptable notice before the claims bar date. Section 523(a)(3)(A) and claims
bar dates have less overall significance than they initially suggest. The most common cases, no-asset
chapter 7 cases (see In re Walker, 195 B.R. at 196 n.11; Federal Judiciary, Bankruptcy Statistics,
www.uscourts.gov/bnkrpctystats/statistics.htm), usually do not have claims bar dates, such that
claims never become nondischargeable under section 523(a)(3)(A). E.g., In re Mendiola, 99 B.R.
864, 868 (Bankr. N.D. Ill. 1989). However, this being a chapter 11 case, we presume the bankruptcy
court set a claims bar date. See Fed. R. Bankr. P. 3003(c)(3). Nevertheless, the court may have set
it too late to have any significance here; we have no evidence of what date it set.
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Smith has not suggested that plaintiffs had notice such that they could have acted before the
original deadline or that the bankruptcy court extended that deadline. Instead, he argues that, when
he amended his schedules of creditors (and plaintiffs received notice), plaintiffs then had a
reasonable amount of time to file a nondischargeability complaint in bankruptcy court.
The general rule is that, when creditors allege that debts are nondischargeable under section
523(a)(3)(B), they may litigate that issue in either state or bankruptcy court at any time. Courts have
typically held that Rule 4007(c) does not limit the time for filing such complaints. For instance, the
Ninth Circuit Court of Appeals, in In re Staffer, 306 F.3d 967, 971-72 (9th Cir. 2002), held that
bankruptcy proceedings under section 523(a)(3)(B) are governed by Rule 4007(b) (Fed. R. Bankr.
P. 4007(b)), which allows a creditor to file a complaint at any time. Further, parties can litigate
whether a debt falls within the scope of section 523(a)(3)(B) in state court, without bankruptcy court
involvement. E.g., In re Mendiola, 99 B.R. at 868 n.6; see also L. Helbling & C. Klein, The
Emerging Harmless Innocent Omission Defense to Nondischargeability under Bankruptcy Code
§523(a)(3)(A): Making Sense of the Confusion over Reopening Cases and Amending Schedules to
Add Omitted Debts, 69 Am. Bankr. L.J. 33, 43-44 (1995).
Section 523 and the bankruptcy rules make clear that a debtor's late amendment to his or her
schedules of creditors cannot by itself make the debts dischargeable if they are already
nondischargeable under section 523(a)(3). First, section 523(a)(3) states that debts are not
discharged unless they are "scheduled *** in time" to permit filing of a proof of claim or complaint.
11 U.S.C. §523(a)(3) (2000). The inescapable implication is that a debt can be scheduled too late
to be discharged. This conclusion is further confirmed by the comments to the bankruptcy rules.
Rule 1009 allows a debtor to amend a voluntary schedule "as a matter of course at any time before
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the case is closed." Fed. R. Bankr. P. 1009(a). However, an Advisory Committee Note following
the rule states that "[i]f a list or schedule is amended to include an additional creditor, the effect on
the dischargeability of the creditor's claim is governed by the provisions of §523(a)(3) of the Code."
Fed. R. Bankr. P. 1009(a), Advisory Committee Note. The liberal allowance for amendment thus
does not allow a debtor to evade the requirement of timely notice to a creditor.
Smith asserts that a group of cases, of which In re Thompson, 152 B.R. 24 (E.D.N.Y. 1993),
is the most important, requires us to conclude that, if a creditor does not file a section 523(c)(1)
complaint within a "reasonable time" after a debtor has scheduled that creditor, the debt is
discharged. These cases do not create an exception to the rule regarding amendments. They address
a wholly different situation: the reopening of a no-asset case under chapter 7 of the Bankruptcy
Code. E.g., In re Thompson, 152 B.R. at 26.
The conclusion that these cases have no application here is a straightforward consequence
of bankruptcy law. Nevertheless, to explain why this is so, we must describe the context in which
the courts decided those cases.
Many, perhaps now all, bankruptcy courts agree that, in typical no-asset chapter 7 cases,
claims cannot become nondischargeable under section 523(a)(3)(A) (the section for which the claims
bar date is critical) even if the debts remain unscheduled. See In re Walker, 195 B.R. at 198-200;
L. Helbling & C. Klein, The Emerging Harmless Innocent Omission Defense to Nondischargeability
under Bankruptcy Code § 523(a)(3)(A): Making Sense of the Confusion over Reopening Cases and
Amending Schedules to Add Omitted Debts, 69 Am. Bankr. L.J. 33, 51-54 (1995). This is so
because, when the trustee finds that no assets are available, the clerk can (and usually does) notify
creditors that no claims bar date will be set unless the trustee later discovers distributable assets.
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E.g., In re Mendiola, 99 B.R. at 867. With no claims bar date, a proof of claim cannot be untimely,
and section 523(a)(3)(A) cannot apply.
More controversial is what action a bankruptcy court should take when a debtor has failed
to schedule a creditor in a no-asset chapter 7 case. In re Mendiola represents one position. It held
that reopening the case serves no purpose; the dischargeability of all claims is already fixed. If the
court has set no claims bar date, section 523(a)(3)(A) cannot make claims nondischargeable.
Further, because under Rule 4007(b) a court cannot reset the time to file a section 523(c)(1)
complaint, reopening the case cannot change the nondischargeability of claims under section
523(a)(3)(B). In re Mendiola, 99 B.R. at 868 n.6. Thus, cases in this line hold that, where the
creditor lacked the required notice, once the complaint deadline passes without extension, a court
can do nothing to alter the nondischargeability of a bona fide fraud claim. The other line of
decisions, which includes In re Thompson, has favored allowing the debtor to reopen the case (In
re Thompson, 152 B.R. at 26), at least when the debtor has acted in good faith and the creditors will
not be prejudiced. See, e.g., In re Candelaria, 121 B.R. 140, 142, 144 (E.D.N.Y. 1990). Although
one reason cited for allowing this is the desire for accuracy in the debtor's schedules (In re
Candelaria, 121 B.R. at 142), the idea that newly scheduled creditors should have a limited time to
file section 523(c)(1) complaints is a common thread in these cases. See In re Walker, 195 B.R. at
208 (holding that it had the power to set a 90-day deadline for the filing of section 523(c)(1)
complaints in reopened cases); In re Maddox, 62 B.R. 510, 514 (Bankr. E.D.N.Y. 1986) (holding
that a creditor added after the court reopens a case "must be accorded a reasonable period of time
within which to object to the dischargeability of the debt owed it under 523(a)(2), (4) and (6)").
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Of the cases in this line, only one that we have located, In re Walker, gives an explanation
of the source of the court's power to set a new deadline. In re Walker, 195 B.R. at 205-08. That
decision finds the source primarily in the court's power to equitably toll Rule 4007(c)'s time limit for
the filing of section 523(c)(1) complaints. At the risk of oversimplification, we summarize the
reasoning: if the court can toll the Rule 4007(c) deadline, it can deem that the late receipt of notice
did not prevent a creditor from timely filing a complaint, meaning that section 523(a)(3)(B) will not
apply.
The position on Rule 4007(c) in In re Walker is on one side of a split of authority. The
bankruptcy courts are divided on whether a court can waive the time limit of Rule 4007(c) for
equitable reasons. See In re Rowland, 275 B.R. 209, 212-15 (Bankr. E.D. Pa. 2002) (reviewing the
conflicting authorities). If In re Walker is correct about the source of a court's power to set new
deadlines for section 523(c)(1) complaints, as we believe it is, then only those courts that hold that
the Rule 4007(c) time limit is waivable should allow new deadlines.
We need not attempt to resolve this conflict; regardless of the position we might take on Rule
4007(c), Smith has not identified anything that occurred in his bankruptcy case that extended the
time to file a section 523(c)(1) complaint. The cases Smith cites do not contradict the provisions that
make an amendment ineffective to change a debt's dischargeability. That a court may use its
equitable powers to set a new deadline does not mean that a debtor's act of amending a schedule of
creditors also sets a new deadline. The reopening of a case is a matter for the court's discretion (In
re Candelaria, 121 B.R. at 142), whereas the amending of schedules while the case is open is
something the debtor may do "as a matter of course" (Fed. R. Bankr. P. 1009(a)). The addition of
new creditors may be largely unproblematic in a no-asset chapter 7 case, such that the importance
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No. 2--06--0549
of the court's discretion is not obvious. In a chapter 11 case, such as the one at issue here, the
importance of discretion becomes obvious. When a creditor is scheduled late in such a case, he or
she can be irreversibly deprived of the critical rights to participate in negotiation of and to vote on
the debtor's plan of reorganization. In re Smith, 21 F.3d 660, 664-65 (5th Cir. 1994). When a
creditor has lost important rights, a court may have serious concerns about the equity of extending
a deadline for the debtor's benefit. (These concerns may be so serious that equity would preclude
a court from exercising its discretion to reset deadlines, even if it has that power. See In re Smith,
21 F.3d at 663-65 (discussing the disruptiveness of a late claim in a chapter 11 case ).) Thus, we
conclude that mere amendment of the schedules does not affect the deadline for a section 523(c)(1)
complaint.
Having clarified the applicable bankruptcy law, we turn to Illinois law and the sufficiency
of Smith's motion under section 2--619 of the Code of Civil Procedure. We review de novo a
dismissal of claims under section 2--619. Hartshorn v. State Farm Insurance Co., 361 Ill. App. 3d
731, 735 (2005). As noted, section 2--619(a)(6) provides for the dismissal of an action when the
defendant can show that the claims involved have been discharged in bankruptcy. 735 ILCS 5/2--
619(a)(6) (West 2004). Smith showed that he had a discharge; the question then becomes how the
burden lies to show that plaintiffs' claims fell within the section 523(a)(3)(B) exception to discharge.
The supreme court has discussed the parallel question with respect to section 2--619(a)(9) (735 ILCS
5/2--619(a)(9) (West 2004)) (concerning a claim barred by some other affirmative matter). "Once
a defendant satisfies [the] initial burden of going forward on the section 2--619(a)(9) motion to
dismiss, the burden then shifts to the plaintiff, who must establish that the affirmative defense
asserted either is 'unfounded or requires the resolution of an essential element of material fact before
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it is proven.' " Epstein v. Chicago Board of Education, 178 Ill. 2d 370, 383 (1997), quoting Kedzie
& 103rd Currency Exchange, Inc. v. Hodge, 156 Ill. 2d 112, 116 (1993). "The plaintiff may establish
this by presenting 'affidavits or other proof.' " Epstein, 178 Ill. 2d at 383, quoting 735 ILCS 5/2--
619(c) (West 1992). We conclude that Smith's showing that he received a discharge was sufficient
without his also showing that no exception to discharge applied. Given that there were 18 separate
exceptions, requiring him to show that none applied would be a daunting task that would undermine
the purpose of a discharge.
Nevertheless, adequate evidence existed to require the court to deny Smith's motion. The
motion itself gave the necessary support for the existence of a section 523(a)(3)(B) exception to
discharge, and thus Smith would need to prove new facts to avoid that exception applying. Smith
filed his bankruptcy petition on April 25, 2002. Under Rule 2003(a), the trustee must call the
meeting of creditors no more than 40 days after the debtor files the case. See Fed. R. Bankr. P.
2003(a). Thus, the meeting of creditors should have been scheduled for no later than June 4, 2002.
Under Rule 4007(c), absent an extension, section 523(c)(1) complaints were due no later than 60
days after the first date set for the meeting of creditors, or no later than August 5, 2002 (taking into
account the sixtieth day's falling on a weekend). Smith filed his amended schedules on December
12, 2002. Given that Smith's own motion shows that his amendments came too late to avoid section
523(a)(3)(B) nondischargeability under the default deadline, an issue of fact existed as to whether
the court had extended the deadline.
We recognize that a reasonable interpretation of Epstein and section 523(a)(3)(B) would
require plaintiffs to supply affidavits to show that their claims fall within the bankruptcy law
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definition of fraud debt,6 something they did not do. However, the parties have never raised the
point; indeed, Smith has actively pushed the argument in a different direction. Thus, we do not
further address this potential issue.
For the reasons we have stated, we reverse the order dismissing Smith as a defendant and
remand the matter for further proceedings on the action.
Reversed and remanded.
GROMETER, P.J., and CALLUM, J., concur.
6
"[T]o establish the §523(a)(3)(B) exception, a creditor must show that he actually had
grounds under §523(a)(2), (4) or (6) and that the debtor's failure to schedule him deprived him of the
opportunity to assert these grounds at the proper time." In re Zablocki, 36 B.R. 779, 782 (Bankr. D.
Conn. 1984).
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