The Eleventh Circuit held that when a debtor knows of a lender's security interest and the debtor moves the lender's collateral for personal gain, the resulting debt is nondischargeable1 The decision represents a win for lenders when a debtor absconds with a lender's collateral, even when the lender's security interest may not have been properly perfected.
Background
In In re Monson, the debtor opened an internet café in Florida and borrowed $130,000 from his acquaintance's father to fund the café's operations. The parties entered into a letter agreement, whereby the lender would receive 40% of the café's profits after the debtor repaid the loan in full. If the café was not profitable or the parties agreed to close the business, the parties agreed that "all material assets [would] be liquidated and first used to pay back any unrecouped portion of the loan." The letter agreement allowed the lender to file "any documents necessary to preserve a lien upon all [of the café's] equipment, fixtures, and assets," and a UCC-1 form was filed but it did not have any signatures.
After operating for two months, law enforcement raided the café and seized the equipment under the belief that the debtor was operating an illegal gambling center. Shortly thereafter and while law enforcement still possessed the equipment, the lender notified the debtor that he was terminating his interest in the café and demanded that the café's assets be liquidated to repay the loan. Subsequently, the debtor successfully retrieved the equipment but did not turn the equipment over to the lender. Instead, the debtor moved to a different city and began leasing the equipment to an entity that he had formed for the operation of a new internet café.
The lender sued and obtained a $130,000 judgment against the debtor. The debtor then filed for Chapter 7 bankruptcy. After the lender obtained possession of the equipment (which was worth a fraction of its initial value), the lender filed an adversary proceeding, seeking a judgment that its debt was nondischargeable. The lender argued that its debt was nondischargeable because the debtor had committed a "willful and malicious injury" under Section 523(a)(6) of the Bankruptcy Code. To meet the "willful and malicious" standard, a creditor must prove: (i) that the injury was willful because the debtor committed an "intentional act the purpose of which is to cause injury or which is substantially certain to cause injury," and (ii) that the injury was "wrongful and without just cause or excessive even in the absence of personal hatred, spite or ill-will."
Here, the Eleventh Circuit affirmed the bankruptcy court's finding that the lender's debt was nondischargeable. First, the Eleventh Circuit held that the debtor committed a willful injury by taking the equipment and using it to open another internet café. The court cited with approval several bankruptcy court decisions that found that a lender's perfection of a security interest (or not) was irrelevant in a discharge action when the debtor knows of the claim and sells the property without notice to the lender. Second, the Eleventh Circuit found that the debtor's actions were malicious (excessive) because he knew that the lender was attempting to collect on the loan when he relocated the equipment for a new business. The mere fact that the business failed did not relieve the debtor of his contractual obligations or allow him to use the equipment for his own purpose.
Takeaway
This decision marks a victory for lenders when borrowers abscond or convert their collateral. The lender's alleged failure to perfect its interest in the collateral or the failure of the business will not, in and of themselves, protect the debtor from a nondischargability action.
Footnote
1 Monson v. Galaz (In re Monson), 2016 U.S. App. LEXIS 20793 (11th Cir. Nov. 21, 2016) (unpublished).
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