Case digest

The case implicates section 727 of the U.S. Bankruptcy Code, which concerns a Chapter 7 debtor’s request for discharge. Objections to discharge are challenging to prove because the denial of discharge is the “death penalty” in bankruptcy. The objector has the burden of proving the debtor failed to disclose property, including a customer list, with the intent to defraud a creditor or trustee. Here, the court found the plaintiff/creditor could not meet the burden of proof on any of her objections.

Findings of fact

Background and sale of the accounting business.

The debtor/defendant was the sole proprietor of an accounting business. She was not a CPA but a public accountant. She had bought the practice from the plaintiff (also not a CPA), for whom she had worked full-time for about ten years. The defendant claimed she was the one who “cultivated” the clients. She bought the practice for over $255,000, most of which, for tax purposes, was allocated to the “client base.” Ultimately, the defendant defaulted on her payments, and the plaintiff sued for breach of contract. The parties settled the dispute with a consent decree of over $174,500 against the defendant. The decree was not secured. The parties’ sale contract mentioned a“client base,” which was comprised of a computer database with historical client information. According to the plaintiff, the client base was the most valuable asset of the business. In contrast, the defendant/debtor contended it had no value because it lies in the clients’ services. The plaintiff had agreed to a non-compete in the sale contract. 

The bankruptcy filing and objection to discharge.

In October 2019, the debtor filed for Chapter 7 bankruptcy. A few months later, the plaintiff filed an unsecured claim relating to the consent judgment. The debtor listed her accounting licenses and the business website or internet domain name ($0 value) in the schedule. She stated she had no “customer lists, mailing lists, or other compilations.” In a Chapter 7 liquidation, the client list or database would be sold free of a noncompete. The court stated that “[t]his proceeding boils down to the issue of whether [the debtor’s] discharge should be denied for failing to disclose the existence of a ‘customer list’ on line43 of Schedule A/B.” However, the Bankruptcy Court noted that, even if the client list had been disclosed, the plaintiff would have to show that the defendant/debtor omitted the list with the intent to hinder, delay, or defraud creditors, i.e.,,, “knowingly or fraudulently” omitted them. 

Trustee

The trustee marshaled the assets of the debtor’s estate, which were minimal, and found there was about $10,000 available to distribute to the creditors. The trustee said the debtor cooperated with him and did not hide or conceal property of the estate, nor did she impede the trustee’s ability to administer the estate. The trustee also believed disclosing the client list would not have changed anything he had done, nor would it have resulted in a more significant recovery.

Not surprisingly, most of the testimony, in this case, focused on the value of the client list. Each sides’ expert filed a report, but neither directly addressed the fact that the allocation of the value of the client list in the agreement was for tax purposes. The plaintiff’s expert was not a CPA, and his education and training were in areas other than financial matters. He held a senior tax preparer’s certificate from H&R Block. His opinions were based on his experience in acquiring accounting businesses and franchises. He testified that the client list or database was the most valuable asset of the debtor’s business. He said that he obtained a noncompete in one case in the two accounting businesses he had purchased. The other, the company was purchased from the estate of the accountant/owner and, therefore, a non-compete was not necessary. He also testified that he would not buy an accounting business without the total transfer of the client list and a non-compete. He said he could not place a value on the client list at issue because he lacked sufficient information, including the business’s historical and forecasted revenue generated from the client list, goodwill, and the likelihood that clients would be retained in the future. The debtor’s expert, an experienced CPA and business valuator, served as a rebuttal witness. She agreed that a client list could be sold to a third party but said that a client list sold without a non-compete agreement from the previous provider had no value. She also testified that the practice was overvalued by nearly double due to a high multiplier of revenue used to calculate the purchase price. Bankers and the SBA told her the business was overvalued and did not finance the purchase. It was seller-financed. She also testified that the value of the intangibles in the sale agreement likely resulted from the transfer of “personal goodwill” from the plaintiff to the defendant due to the noncompete and not because of the inherent value of the client list.

Analysis

The plaintiff had to show the debtor acted with intent to hinder, delay, or defraud the creditors or the trustee. The plaintiff’s claims required proof that the debtor acted “knowingly and fraudulently.” The plaintiff’s claims alleged the debtor concealed the customer list by omitting it from the schedule. They were not based on any fraudulent transfer or conveyance. Based on the facts and applicable law, the Bankruptcy Court did not find any fraudulent concealment of the customer list in this case.

The court discussed other Kansas cases dealing with these issues. It noted that those cases concluded that the client list does not have intrinsic value, “separate from the services provided by the professional practice.” The instant case, the court here found, required the same result. Testimony from both the defendant’s expert and the trustee showed that the client list had no value and would be difficult to sell to a third party. The trustee noted that the debtor could not be forced to sell her business. As such, she could continue her business without the client list but with her current clients. The debtor’s expert also stated that the client list or database had no value by itself, without a non-compete, which the court could not impose. The court also found the plaintiff failed to meet the burden of proof as to her claim that the defendant had made a false oath as to the client list.

Moreover, there was no evidence that the debtor withheld any documents or information from the trustee. The Bankruptcy Court denied the plaintiff’s objection to discharge under the applicable bankruptcy law. In contrast, the court granted the defendant/debtor’s request for discharge.