## Facts

- Hugh D. Reed operated a retail clothing business financed by loans from a bank, with the primary loan guaranteed by the Small Business Administration.
- By early 1979, Reed knew the business was insolvent; the business continued to deteriorate despite efforts to restructure and delay creditor collection.
- Reed formed a wholly owned corporation to receive sales commissions, pay him a salary, and retain earnings.
- In the months immediately preceding bankruptcy, Reed engaged in transactions involving valuable guns, antiques, and stocks, including purchases funded through a corporate borrowing.
- Reed used a concealed bank account into which he deposited business receipts without creditor knowledge, and used funds to repay the corporation.
- Shortly before filing bankruptcy, Reed sold the guns, antiques, and stocks at significant discounts and applied the proceeds to reduce the mortgage on his Texas homestead, increasing exempt equity.
- Reed failed to provide a satisfactory explanation for an approximately $20,000 cash deficiency reflected in the record.
- The bankruptcy court denied Reed a discharge; the district court affirmed.

## Issues

1. Whether a debtor who converts nonexempt assets into an exempt homestead immediately before bankruptcy, with actual intent to hinder, delay, or defraud creditors, must be denied a discharge under 11 U.S.C. § 727.
2. Whether the evidence supported findings of (a) actual fraudulent intent in the conversion transactions and (b) failure to satisfactorily explain a substantial loss or deficiency of assets.

## Decision

- The Fifth Circuit affirmed the denial of discharge.
- The court held that converting nonexempt assets into exempt homestead property is not per se improper, but discharge must be denied when the conversion is done with actual intent to hinder, delay, or defraud creditors under § 727.
- The court held the bankruptcy court’s findings of fraudulent intent were supported by the timing, concealment, undervalue sales, and use of a controlled entity and hidden account.
- The court held Reed’s inability to satisfactorily explain the cash deficiency independently supported denial of discharge under § 727.

## Legal Principles

- A debtor may convert nonexempt property into exempt property on the eve of bankruptcy, but § 727 bars discharge when the conversion is accompanied by actual intent to hinder, delay, or defraud creditors.
- Intent to hinder, delay, or defraud may be inferred from circumstantial evidence, including concealment of accounts, transfers through related entities, undervalue sales, and transactions clustered immediately before filing.
- Under § 727(a)(5), a debtor must satisfactorily explain losses or deficiencies of assets; vague, indefinite, or uncorroborated explanations may be insufficient.
- Factual findings on intent and credibility in bankruptcy proceedings are reviewed for clear error; appellate courts generally defer when supported by the record.

## Conclusion

The Fifth Circuit affirmed denial of discharge because the debtor’s last-minute conversion of nonexempt personal property into exempt homestead equity was found to be undertaken with actual intent to hinder, delay, or defraud creditors, and the debtor also failed to satisfactorily explain a substantial cash deficiency.


In re Reed, 700 F.2d 986 (5th Cir. 1983)