Tags: Subchapter V

Gambling wins/losses sometimes provide for entertaining reading when combined with the Bankruptcy Code. Recently, the Kansas Bankruptcy Court considered a Small Business Reorganization Act/Subchapter V Debtor’s use of funds to gamble during the pendency of a Subchapter V case.[1]

In the matter of In re Robinson, Debtor’s Subchapter V was precipitated by a prior Chapter 11 of a business he owned and operated, which left Debtor with an approximate $1.9 million obligation resulting from his personal guarantee of the business’ debts as well as other tax obligations. During the Subchapter V case, Debtor, apparently, frequented a casino in Oklahoma and lost $4,000 post-petition.

The U.S. Trustee became aware of the Debtor’s use of post-petition funds to gamble upon review of Debtor’s monthly operating report and supporting bank statements that showed post-petition withdrawals totaling $8,000 related to gambling. Upon inquiry, the Debtor stated he played slot machines with the $8,000, lost $4,000, and deposited the remaining $4,000 back into his checking account. Debtor’s 2018 and 2019 tax returns showed gambling income and equal losses of $250,234 and $185,674.27, respectively. The Debtor further provided that his 2020 tax return would show $95,930.50 gambling income and offset expenses. Debtor’s Statement of Financial Affairs was later amended to include this information.

The U.S. Trustee then moved to dismiss the Debtor’s Subchapter V citing Debtor’s “gross mismanagement” related to his loss of $4,000 as a result of gambling post-petition. The Bankruptcy Court denied the U.S. Trustee’s Motion to Dismiss finding Debtor’s gambling did not constitute gross mismanagement given the facts of the case.

“Gross mismanagement” qualifies as “cause” for dismissal if the alleged mismanagement occurred post-petition and the Court finds the action(s) in question is material. Therefore, the Court looked solely to the Debtor’s alleged, post-petition mismanagement resulting from one trip to the casino in question in December 2020—i.e. the Court did not look specifically at other, pre-petition gambling.

In denying the Motion to Dismiss, the Court noted, in part, gambling is lawful in Kansas and is not forbidden by the Bankruptcy Code. The Debtor had not violated an agreement with the U.S. Trustee or Case Trustee or otherwise been admonished not to gamble prior to the trip in question. Additionally, the Court found the Debtor’s testimony to be “credible and forthcoming” as to his pre- and post-petition gambling finding no concealment of the same. The Court further noted the Tax Code does not allow for a person to deduct losses over the amount of winnings, therefore, there seemed to be no improprieties with the Debtor’s reporting of the same. The Court further found Debtor’s post-petition but pre-plan confirmation earnings were not property of the Subchapter V bankruptcy estate. Further, the Debtor pledged not to gamble further while in Chapter 11 and offered to increase payments to unsecured creditors by $4,000 to cover the post-petition gambling losses.

In terms of the Debtor’s use of post-petition but pre-confirmation funds to support his gambling, under traditional Chapter 11 “property of the estate” is defined by § 1115 of the Code and includes earnings from a debtor’s services performed post-petition. However, §1181(a) makes §1115 inapplicable in Subchapter V. Accordingly, a Subchapter V debtor’s post-petition earnings are not property of the bankruptcy estate, and, therefore, the Debtor’s use of non-estate assets to gamble could not constitute gross mismanagement of the “Estate.”

If you need help understanding your rights in the complicated bankruptcy process, contact the experienced bankruptcy attorneys at Goosmann Law in our Sioux City, Sioux Falls, and Omaha offices.

[1] In re Robinson, 20-11471 (Bankr., KS August 20, 2021).

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