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California Federal Court Reviews Whether Debtor Had Capacity to Sign Bankruptcy Petition

By Heinrich Klaffs [CC-BY-SA-2.0 (http://creativecommons.org/licenses/by-sa/2.0)], via Wikimedia CommonsIn order to pursue a bankruptcy case, a debtor must have the legal capacity to understand the contents and meaning of the bankruptcy petition at the time of filing. The same general rules that govern a person’s capacity to enter into a contract apply in bankruptcy cases. A U.S. district court in California recently considered whether a debtor, who was known to have multiple health problems, including drug addiction, was incapacitated at the time that his bankruptcy petition was filed. In re Preston, No. 8:14-cv-00163, prop. findings of fact (C.D. Cal., Feb. 5, 2014). The trustee of a revocable trust established by the debtor claimed that the debtor was incapacitated. The court held that the trust had the burden of establishing lack of capacity, and that it failed to do so.

The court applied California law in assessing capacity. A “rebuttable presumption” that all people have the capacity to make their own decisions, and take responsibility for them, exists under California law. Cal. Prob. Code § 810(a). A “mental or physical disorder,” by itself, does not preclude entering into contracts and other major decisions. Id. at § 810(b). For a court to rule that a person is incapacitated, it must find a specific deficit in one or more mental functions, from a list provided by the Legislature, affecting a specific action or decision. Id. at §§ 810(c), 811(a). The party contesting capacity has the burden of proof to overcome the statutory presumption. Estate of Mann, 184 Cal.App.3d 593 (1986).

The debtor in the Preston case, musician Billy Preston, filed a petition for Chapter 11 bankruptcy on October 21, 2005. The case was converted to Chapter 7 in July 2006. Preston fell into a coma on November 21, 2005, from which he never awoke. He died on June 6, 2006. A conflict emerged between the Chapter 7 trustee (the bankruptcy trustee) and the trustee of the William Preston Trust (the Preston trustee), with the Preston trustee alleging that Preston lacked capacity to agree to the bankruptcy petition on the day it was filed. The bankruptcy trustee filed an adversary proceeding, seeking a declaratory judgment that Preston was not incapacitated, that the trust therefore remained revocable, and that its assets are part of the bankruptcy estate.

The court conducted a thorough review of the evidence of the events surrounding the filing of the petition on October 21. Preston required dialysis on a regular basis and suffered from depression and anxiety. He was addicted to cocaine, but his personal assistant testified that she was not concerned that his safety was at risk from his drug use until his health sharply declined on October 22, the day after the petition was filed. The court held that the Preston trustee and the trust had failed to produce evidence to overcome the presumption that Preston had the capacity to agree to the bankruptcy petition on October 21.

Bankruptcy attorney Devin Sawdayi has represented clients in the Los Angeles area for over sixteen years, guiding them through Chapter 7 or Chapter 13 bankruptcies and helping them repair their finances with dignity and respect. To schedule a free and confidential consultation to see how we may can help you, please contact us today online or at (310) 475-9399.

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Photo credit: By Heinrich Klaffs [CC-BY-SA-2.0], via Wikimedia Commons.