Gambling in Bankruptcy (In re Robinson)

A casino (photo by Marilyn Swanson)

By: Donald L Swanson

The opinion is In re Robinson, Case No. 20-11471, Kansas Bankruptcy Court (issued August 20, 2021, Doc. 72).

The issue involves gambling by the Debtor while in a Subchapter V bankruptcy case.

The U.S. Trustee moves to dismiss Debtor’s Subchapter V case for “gross mismanagement,” because Debtor played slot machines and lost $4,000 during the month after he filed bankruptcy.

The Bankruptcy Court denies the dismissal motion—but with strong words of caution to the Debtor.  Grounds for the Court’s denial are:

  1. Debtor’s gambling did not constitute gross mismanagement under the evidence presented; and  
  2. Debtor gambled with post-petition earnings, before plan confirmation—such earnings are, technically, not property of the Subchapter V bankruptcy estate.

Facts

Debtor owns and operates a funeral home business, called Countryside Funeral Home, and personally guarantees a Bank loan to Countryside.

Debtor is single with no dependents and considers himself a recreational gambler.  For several years, he’s frequented a casino in Ramona, Oklahoma, (about an hour drive from his home) to play quarter slots, using his salary from Countryside to gamble.

Countryside expands its operations too quickly, incurs substantial withholding tax liabilities, and files Chapter 11 bankruptcy.  A reorganization plan is confirmed for Countryside, which leaves $1.9 million of the guaranteed obligation unpaid.

So, Debtor files his own bankruptcy—under Subchapter V—to deal with the guarantee and the tax obligations.

Debtor files a Subchapter V plan.  No creditor objects to confirmation—or even votes on it. 

However, the U.S. Trustee discovers that Debtor has a gambling issue—from Debtor’s first monthly operating report.  That report attaches Debtor’s checking account statement, showing a series of post-petition withdrawals totaling $8,000 for the “Ramona Casino.”  Debtor testifies that he played slot machines with the $8,000, lost $4,000, and deposited the remaining $4,000 back into his checking account.

Additionally, Debtor provides his 2018 and 2019 tax returns to the U.S. Trustee, showing gambling income and “expenses” and indicates that, despite declaring no gambling losses in his Statement of Financial Affairs, his 2020 tax return “will show $95,930.50 gambling income and offset expenses.”  Then, Debtor amends his Statement of Financial Affairs accordingly.

Debtor objects to the U.S. Trustee’s dismissal motion:

  • pledging not to gamble while in Chapter 11; and
  • noting that he will not have income to gamble, due to substantial plan payments he will have to make under his proposed Subchapter V plan.

None of Debtor’s creditors join the U.S. Trustee’s motion to dismiss, and no creditor appears for the evidentiary hearing on dismissal.

Debtor denies filing bankruptcy because of gambling.

Debtor’s 2018 federal tax return reports gambling income of $250,234 and the same number for gambling losses. His 2019 federal tax return reports gambling income of $185,674.27 and the same number for gambling losses.

Such tax reporting (that actual losses exactly equal winnings in all three years) “is not credible.”  But the Court is not overly concerned by this because:

  • such reporting merely recognizes that the Tax Code does not allow Debtor to deduct gambling losses in excess of gambling winnings;
  • in all other respects, the Court finds Debtor’s testimony to be “credible and forthcoming”;
  • the salient point, regarding concealment allegations, is that Debtor reported gambling on his 2018 and 2019 tax returns and provided those returns to the U.S. Trustee;
  • at trial, Debtor testifies that he did not intend to hide his gambling and had not been aware that he could not gamble during bankruptcy, until the issue arose following his initial operating report;
  • Debtor pledges not to gamble while in Chapter 11 and offers to increase payments to unsecured creditors by $4,000 to cover the post-petition gambling losses; and
  • Debtor testifies that he has not been to the Ramona casino or gambled since learning of the gambling prohibition.

The Subchapter V Trustee expresses concern about “significant risks” for the proposed plan from Debtor’s gambling, because gambling can be addictive. However, the Subchapter V Trustee admits, on cross examination, that Debtor’s plan is feasible and that Debtor deserves a chance to try to perform the plan.

Court’s Analysis

–“Gross mismanagement” has not been shown

“Gross mismanagement” qualifies as “cause” for dismissal of a bankruptcy, but the alleged mismanagement must occur post-petition and must be material. Therefore, the U.S. Trustee’s mismanagement claim must be based, exclusively, on Debtor’s excursion to the Ramona Casino in late December 2020, where he lost $4,000—it cannot be based on pre-petition gambling.

Cases where gross mismanagement exists are very different from this case. Three examples are:

  • a debtor’s chief operating officer is uninvolved in debtor’s business, does not have a grasp of its day-to-day operations, and delegates his duties without following up;
  • a debtor’s principal uses debtor’s funds to pay personal expenses, and the nature of debtor’s business and the source of his income remain “elusive”; and
  • a debtor knowingly violates express instructions against gambling during the bankruptcy—and then perjures herself to cover up the violations.  

No such evidence exists in this case.  Instead, evidence shows that Debtor has conducted himself properly in this bankruptcy, except for the $4,000 gambling loss,.

Gambling in itself is not forbidden by the Bankruptcy Code and is a lawful activity in Kansas.

Neither the U.S. Trustee nor the Subchapter V trustee ever admonished Debtor to cease further gambling, despite being aware of his gambling activity through Debtor’s initial operating report and his 2018 and 2019 tax returns.  Nor has either moved to removed Debtor as a debtor in possession, and both are willing to have Debtor serve as post-confirmation disbursing agent.

Accordingly, the U.S. Trustee has not met the burden of proving gross mismanagement.

–A technicality: “property of the estate”

“Property of the estate,” in an individual’s Subchapter V case, differs from “property of the estate” in a regular Chapter 11 case.

In regular Chapter 11, “property of the estate” is defined by § 1115 and includes earnings from a debtor’s services performed post-petition. [Fn. 1] However, § 1181(a)) makes § 1115 inapplicable in Subchapter V: that means, an individual Subchapter V debtor’s post-petition earnings are not property of the estate.

So, when Debtor gambled with post-petition earnings (i.e., a non-estate asset), such gambling could not constitute gross mismanagement of the estate.

Moreover, there is no evidence that Debtor’s gambling loss rendered him unable to perform his plan or make plan payments.

–A warning

But the Court warns Debtor:

  • If the plan is confirmed as a nonconsensual plan under § 1191(b), then § 1186(a) provides that property of the estate includes property acquired post-petition and earnings from services performed by the debtor post-petition [fn. 2];
  • Such rule does not yet apply, since plan confirmation has not yet occurred; but
  • Any post-confirmation gambling will be with property of the bankruptcy estate—and can qualify as gross mismanagement.

Court’s Conclusion and Caution

For all of the foregoing reasons, the Bankruptcy Court concludes:

  • Debtor’s post-petition, pre-confirmation gambling did not constitute gross mismanagement of the estate;
  • The U.S. Trustee has not met the burden of proving cause for dismissal; and
  • The motion to dismiss is therefore DENIED.

However, Debtor should note and take caution:

  • Had even a few facts here proven to be different, the dismissal motion could have been decided in a different way;
  • While gambling may be legal in some circumstances, it can be both offensive to the integrity of the bankruptcy system and inconsistent with the duties owed by any fiduciary of the bankruptcy estate; and
  • If the amended plan is confirmed, Debtor’s promise to abstain from gambling will almost certainly be carefully monitored by the Subchapter V Trustee and the U.S. Trustee, with potentially serious consequences for any failure to keep his word.

——————–

Footnote 1: 11 U.S.C. § 1115(a) provides, “(a) In a case in which the debtor is an individual, property of the estate includes, in addition to the property specified in section 541—(1) . . . . ; and (2) earnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed or converted” to another chapter of the Bankruptcy Code.

Footnote 2: 11 U.S.C. § 1186(a) provides, “If a plan is confirmed under section 1191(b) of this title, property of the estate includes, in addition to the property specified in section 541 of this title—(1) . . . ; and (2) earnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed or converted” to another chapter of the Bankruptcy Code.

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