No Safe Harbor in “Ordinary Business” Spending: Fifth Circuit Remands § 523(a)(6) Collateral-Conversion Claim and Reaffirms Strict Debtor-Favorable Standards Under §§ 727(a)(2)(A), (a)(3), and 523(a)(2)(A)

No Safe Harbor in “Ordinary Business” Spending: Fifth Circuit Remands § 523(a)(6) Collateral-Conversion Claim and Reaffirms Strict Debtor-Favorable Standards Under §§ 727(a)(2)(A), (a)(3), and 523(a)(2)(A)

Introduction

In Triumphant Gold Limited v. Matloff, the Fifth Circuit affirmed in part and vacated and remanded in part a bankruptcy court’s judgment arising out of an adversary proceeding filed by secured lender Triumphant Gold Limited (TGL) against Chapter 7 debtor Darren Scott Matloff. The court upheld rulings that rejected TGL’s objections to discharge under 11 U.S.C. § 727(a)(2)(A) and § 727(a)(3) and its fraud claim under § 523(a)(2)(A). But the panel vacated and remanded TGL’s willful-and-malicious injury claim under § 523(a)(6) for a focused determination of whether (and in what amount) Matloff caused a non-dischargeable injury by diverting the proceeds of non-factored receivables that secured TGL’s loans.

The opinion delivers two headline takeaways:

  • There is no blanket “ordinary business expenses” safe harbor against § 523(a)(6). Using encumbered proceeds for payroll and vendors after default may still qualify as a willful and malicious injury if the debtor acted with a subjective motive to cause harm or objective substantial certainty of harm to the secured creditor’s collateral position.
  • Consistent with Fifth Circuit practice, actual fraudulent intent remains the operative benchmark for denying discharge under § 727(a)(2)(A); mere intent to “hinder or delay” without actual intent to defraud will not suffice—particularly given deference to the bankruptcy court’s credibility findings and the “harsh remedy” nature of total discharge denial.

The case arises from a complex cross-border drone business structure and financing stack, including “Charged Accounts” in Asia subject to a first fixed charge in favor of TGL, layered agency agreements, and later factoring to Star Funding. After default, collections that previously flowed into controlled, charged accounts were retained in a U.S. account outside TGL’s control and disbursed to keep the business afloat. Whether that decision created a non-dischargeable injury under § 523(a)(6) turns on collateral status, consent, tracing, and intent.

Background

Matloff founded and ran a family of “Rooftop” entities that designed, manufactured, and distributed Propel-branded drones through a Hong Kong manufacturing hub (Asian Express), a Singapore parent (Rooftop Singapore), and U.S. distribution companies (Rooftop Group USA; Rooftop Services). In 2016 and 2017, TGL extended secured credit to Rooftop Singapore. Security included:

  • A “first fixed charge” over deposits in designated Asian bank accounts (the “Charged Accounts”) and lender control over disbursements on default;
  • A pledge of purchase-order proceeds and accounts receivable; and
  • Stock pledges and other protections tightened via side letters.

In late 2017, Rooftop defaulted. On March 1, 2018, Matloff directed $846,919.82 from charged Asian accounts to a U.S. (non-charged) account, then ceased routing U.S. collections to the Charged Accounts. Funds were used to pay operations in hopes of preserving the enterprise and ultimately repaying creditors, including TGL. TGL protested the diversion in contemporaneous emails.

After failed refinancing and business deterioration, Rooftop entered insolvency proceedings; TGL obtained a Singapore judgment on Matloff’s guaranty; and Matloff filed Chapter 7 in the U.S. TGL’s adversary complaint sought to deny Matloff’s discharge under § 727 and to except TGL’s claim from discharge under § 523(a)(2)(A) and (a)(6). The bankruptcy court denied all relief. The district court twice affirmed (after a first remand for correct standard-of-review), leading to this second appeal.

Summary of the Opinion

  • Section 727(a)(2)(A) and (a)(7): Affirmed. TGL forfeited its “disjunctive” argument that “intent to hinder or delay” alone suffices; the bankruptcy court’s finding of no actual intent to defraud was not clearly erroneous given Matloff’s credible testimony that he moved funds to keep the company alive for the benefit of all creditors. The court reiterated the exceptional nature of § 727’s “harsh remedy.”
  • Section 727(a)(3): Affirmed. TGL failed to show inadequate personal recordkeeping; any gaps were justified under the circumstances.
  • Section 523(a)(2)(A): Affirmed. The bankruptcy court applied the correct “justifiable reliance” standard. TGL did not prove the alleged false representation about a “$1 million bonus” or justifiable reliance on that promise; the record did not credibly establish the bonus was actually paid.
  • Section 523(a)(6): Vacated and remanded in part. The court clarified that damages are measured by the value of the creditor’s collateral lost through willful and malicious conversion, not by contractual balances. “Ordinary business” use of proceeds is not a categorical defense. The case returns to determine whether, and in what amount, Matloff caused a willful and malicious injury by diverting non-factored receivable proceeds (roughly $6 million in dispute), while affirming that TGL failed to prove an enforceable interest in the specific $846,919.82 transfer on March 1, 2018.

Judge Oldham concurred in part and dissented in part, urging full affirmance based on the deferential clear-error standard and emphasizing that conversion does not automatically equal a willful and malicious injury.

Precedents Cited and Their Influence

  • Chastant; Reed; Dennis; Swift; Moreno; Duncan; Olivier: These Fifth Circuit decisions frame § 727’s narrow, debtor-favorable lens—denial of discharge is “harsh,” exceptions are narrowly construed, and “actual intent to defraud” is required under § 727(a)(2)(A). They also endorse deference to the bankruptcy court’s credibility determinations and the permissibility of inferring intent from circumstantial “badges of fraud.”
  • Bowyer (panel on rehearing) and Lee (W.D. Tex. Bankr.): Cited to show the Fifth Circuit has not embraced a standalone “hinder or delay” pathway under § 727(a)(2)(A) divorced from fraudulent intent.
  • Field v. Mans; Mercer; Grogan: Establish “justifiable” (not “reasonable”) reliance under § 523(a)(2)(A) and confirm the creditor’s burden of proof for nondischargeability.
  • Miller; Williams (IBEW); Walker: Articulate the § 523(a)(6) willful-and-malicious standard—subjective motive to cause harm or objective substantial certainty of harm is required.
  • Modicue; Green; Theroux; Kite; Zolnier: Confirm § 523(a)(6) encompasses conversion of collateral (including proceeds), that damages equal the value of lost collateral, and that course-of-dealing or consent may matter. Green and Theroux, in particular, demonstrate that “ordinary business” spending after default does not immunize a debtor’s diversion of encumbered proceeds from § 523(a)(6) scrutiny absent creditor consent.
  • Vollbracht: Discussed in a narrow context (physical assault and self-defense) for considering whether the “actions of the injured party” can render conduct not willful and malicious; the majority does not extend this “justification” concept to business-use-of-collateral cases.

Legal Reasoning

1) § 727(a)(2)(A) and (a)(7): Denial of Discharge Requires “Actual Intent to Defraud” and Is Narrowly Applied

TGL argued that § 727(a)(2)(A)’s phrase “intent to hinder, delay, or defraud” should be read disjunctively—so an intent to hinder or delay without intent to defraud would suffice. The Fifth Circuit declined to reach that argument because TGL did not preserve it below; its briefing had expressly framed the standard as requiring “actual intent to defraud,” mirroring the bankruptcy court.

On the merits, the Fifth Circuit reaffirmed core § 727 principles:

  • Denial of discharge is an extreme remedy and strictly construed in the debtor’s favor.
  • Intent is a factual finding, reviewed for clear error, and often proved circumstantially through badges of fraud.
  • “Mere conversion” or business triage to preserve a going concern is not itself “fraudulent”; courts distinguish legitimate business efforts from schemes to shield assets.

The bankruptcy court credited Matloff’s testimony that he moved funds to avoid an imminent sweep, pay “emergency bills,” keep shipments moving, and preserve value for all creditors—including TGL—with the goal of eventually repaying TGL. Given the deference owed to credibility determinations and the strict construction of § 727, the panel found no clear error in concluding there was no “actual intent to defraud.” The court also clarified it did not impose any extra “injury” element; its comments about failure to show that particular funds were pledged collateral appeared in the badges-of-fraud analysis.

2) § 727(a)(3): Adequate Personal Recordkeeping and Justification

Under § 727(a)(3), an objecting creditor must show the debtor failed to keep adequate records and that the failure made it impossible to discern the debtor’s financial condition; the burden then shifts to the debtor to justify any inadequacy. This is assessed case-by-case, calibrated to the debtor’s sophistication and circumstances, with broad discretion and clear-error review.

The bankruptcy court found TGL did not carry its initial burden and that, in any event, any shortcomings were justified. The Fifth Circuit affirmed, noting TGL’s deep involvement in the borrower’s affairs and the debtor’s pattern of using professional bookkeepers—all consistent with no clear error in finding adequate or justified records.

3) § 523(a)(2)(A): “Justifiable Reliance” Applied; No Proven False Representation About a $1 Million Bonus

TGL claimed that side-letter statements promising that a “bonus paid to DSM in 2017 for 2016 shall be reclassified and treated as a loan” were false representations inducing credit extensions. The court:

  • Confirmed the bankruptcy court applied the correct “justifiable reliance” standard, not “reasonable reliance.” References to a lack of investigation simply highlighted a lack of evidence that the bonus was actually paid.
  • Found the side letters did not specify any dollar amount and that records did not credibly show a $1 million bonus was in fact paid. The debtor’s testimony—properly quoted—was that he did not expect to repay funds he never received, which is not a contemporaneous admission of fraudulent intent.

Result: TGL failed to prove a knowingly false representation or justifiable reliance.

4) § 523(a)(6): Willful and Malicious Injury—Measure Is Collateral Lost; No Categorical “Ordinary Business” Defense

The panel marshals controlling Fifth Circuit law:

  • Willful and malicious injury requires either a subjective motive to cause harm or an objective substantial certainty of harm; it is not satisfied by mere breach of contract.
  • Conversion of encumbered property—including proceeds—can qualify, and the creditor’s nondischargeable “debt” equals the injury (i.e., the value of collateral lost), not the unpaid loan balance.
  • Consent, acquiescence, or a course-of-dealing can negate the wrongful character of the use of proceeds (Theroux versus Grier).
  • Critically, there is no blanket rule that paying ordinary operating expenses insulates a debtor from § 523(a)(6). The focus remains the debtor’s knowledge and intent vis-à-vis the secured creditor’s rights in the collateral.

Applying these rules, the court:

  • Affirmed as to the discrete $846,919.82 transfer: TGL did not show an enforceable collateral interest in those specific funds.
  • Vacated and remanded as to:
    • $176,000 in payroll transfers (lack of consent conceded; purpose was payroll but “ordinary business” use is not dispositive); and
    • Two categories of post-default collections and disbursements—approximately $2,074,083.17 (Rooftop USA) and $405,529.62 (Rooftop Services)—which TGL contends were non-factored receivable proceeds pledged to TGL but kept out of the Charged Accounts.

The record suggested roughly $6 million in “Non-Factored” receivable collections across Asian Express (about $3.3 million) and Rooftop USA (about $2.8 million) that may have been TGL’s collateral. The panel could not discern how (or whether) the bankruptcy court assessed these amounts, consent, tracing, or intent. It thus remanded for specific findings on:

  • What portion of these collections were TGL-collateral (as distinguished from Star Funding’s primed collateral or other sources), with appropriate tracing evidence;
  • Whether TGL consented or acquiesced in the use of those proceeds, expressly or by course of dealing; and
  • Whether Matloff acted with subjective motive to harm TGL’s collateral position or with objective substantial certainty of harm.

Judge Oldham’s Partial Concurrence and Dissent

Judge Oldham would have affirmed across the board, stressing:

  • Clear-error review and the heavy, debtor-favoring construction of discharge exceptions;
  • Supreme Court authority (Davis v. Aetna Acceptance) recognizing “innocent” or “technical” conversion and honest mistakes as not willful or malicious; and
  • That none of the cited Fifth Circuit precedents holds a bankruptcy court clearly erred by finding no willful-and-malicious injury after a trial.

He emphasized that Matloff’s non-self-dealing use of funds to keep the business alive plausibly lacked substantial certainty or motive to harm, making the bankruptcy court’s finding of no willful-and-malicious injury “plausible” and not clearly erroneous.

Impact and Practical Implications

For Secured Lenders

  • “Ordinary business expenses” are not a safe harbor: If a debtor diverts encumbered proceeds outside agreed control mechanisms post-default, a § 523(a)(6) claim may lie even if the money pays payroll or vendors.
  • Tracing is pivotal: Lenders must be prepared to trace proceeds to their collateral and segregate factored/non-factored streams. Failure to do so risks losing § 523(a)(6) claims.
  • Control arrangements matter: True control agreements or “first fixed charge” structures should be operationally enforced. Read-only access to non-charged accounts is insufficient when the borrower can unilaterally redirect collections.
  • Consent and course of dealing: If a lender tacitly or expressly tolerates deviations (e.g., permitting borrower use of proceeds to pay operating costs), later § 523(a)(6) theories may be weakened or defeated.

For Debtors and Guarantors

  • § 727 denial remains rare: The Fifth Circuit continues to strictly confine § 727(a)(2)(A) to cases with proven actual fraudulent intent. Credible testimony that fund movements aimed to preserve value can carry the day.
  • But § 523(a)(6) exposure is real: Even if total discharge denial fails, specific debts traceable to the value of converted collateral may be non-dischargeable. Intent can be inferred where proceeds are rerouted to avoid pledged control mechanisms.
  • Document your rationale and communications: Communications reflecting transparent efforts to preserve the business for all creditors may help rebut § 727 claims, but they will not necessarily defeat § 523(a)(6) where collateral is diverted without consent.

On Reliance-Based Fraud Claims

  • Justifiable reliance is creditor-friendly but not toothless: A written promise, without corroborating facts (like amount, dates, or proof of payment), may not support a § 523(a)(2)(A) claim. Documentary clarity matters.
  • Avoid mischaracterizing testimony: Courts scrutinize claimed admissions, particularly when excerpts are used out of context.

Complex Concepts Simplified

  • Discharge versus non-dischargeability:
    • § 727 denial of discharge wipes out the debtor’s fresh start entirely—no debts are discharged. It is reserved for egregious misconduct and requires strict proof, typically of “actual intent to defraud.”
    • § 523 exceptions target specific debts—only those particular liabilities survive bankruptcy if an exception applies (e.g., fraud, willful and malicious injury).
  • Justifiable versus reasonable reliance:
    • Justifiable reliance asks if the particular creditor could justifiably rely without needing to investigate, unless red flags are obvious.
    • Reasonable reliance would demand more diligence; § 523(a)(2)(A) does not require that.
  • Willful and malicious injury (§ 523(a)(6)):
    • Willful: The debtor intended the injury, not just the act.
    • Malicious: Either a subjective motive to cause harm or an objective substantial certainty of harm.
    • Damages: Equal the value of collateral lost (e.g., converted receivable proceeds), not the entire loan balance.
  • Charged Accounts and control:
    • A “first fixed charge” is akin to a perfected security interest and control agreement: the lender can restrict withdrawals and, on default, sweep setoff against secured obligations.
    • If proceeds are kept outside the charged account, the lender’s practical control can be nullified—raising potential § 523(a)(6) exposure for the debtor if done knowingly and without consent.
  • Factoring:
    • When receivables are factored, the factor often holds a first-priority interest in those specific receivables and proceeds. Subordination to a factor leaves the original lender with priority only on non-factored receivables.

What the Remand Must Decide Under § 523(a)(6)

  • Quantification: What portion of roughly $6 million in “Non-Factored” receivable collections (about $3.3 million via Asian Express and $2.8 million via Rooftop USA) were TGL’s collateral?
  • Consent/course of dealing: Did TGL consent to, or acquiesce in, the borrower’s post-default handling of proceeds outside the Charged Accounts?
  • Intent: Did Matloff act with a subjective motive to deprive TGL of its collateral, or with objective substantial certainty that TGL would be harmed by the diversion of proceeds?
  • Damages: If § 523(a)(6) applies, the remedy equals the value of collateral lost—not the entire unpaid balance—minus any credit for collateral value otherwise recovered.

Key Takeaways

  • Fifth Circuit confirms no categorical safe harbor for “ordinary business” uses of encumbered proceeds under § 523(a)(6).
  • For § 727(a)(2)(A), “actual intent to defraud” remains the practical standard in the Fifth Circuit, and the court will strictly construe the denial-of-discharge remedy.
  • Under § 523(a)(2)(A), courts will insist on credible proof of a false representation and justifiable reliance; vague contract language without proof of the underlying fact (e.g., the existence and amount of a “bonus”) will not do.
  • On § 523(a)(6), the correct damages measure is the value of the collateral converted, not the note balance; tracing and proof of priority are essential.

Conclusion

Triumphant Gold v. Matloff underscores a consistent Fifth Circuit through-line: total denial of discharge under § 727 remains rare and requires proof of actual fraudulent intent, with appellate courts deferring to bankruptcy judges’ credibility determinations. At the same time, the court clarifies that debtors cannot rely on “ordinary business” purposes to insulate the willful diversion of encumbered proceeds from § 523(a)(6). The correct question is whether the debtor acted with a subjective motive to injure the secured creditor’s lien rights or with objective substantial certainty that injury would occur, and the correct remedy is the value of collateral lost.

On remand, the bankruptcy court must decide whether non-factored receivable proceeds—kept outside TGL’s Charged Accounts post-default—were TGL’s collateral, whether TGL consented, and whether the debtor’s state of mind meets § 523(a)(6)’s standard. For lenders and debtors alike, the opinion is a reminder to draft, perfect, and enforce control mechanisms over proceeds—and to build a full evidentiary record on tracing, consent, and intent when disputes arise.

Case Details

Year: 2025
Court: Court of Appeals for the Fifth Circuit

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