Filed: May 28, 2014
Latest Update: Mar. 02, 2020
Summary: , 18 While Debtors each urgently argue to the contrary, the, 19 bankruptcy court found, based upon the disputed evidence, that, 20 Obara and Castro both effectively made false representations as, 21 part of the audit process about the status of the JMAG vehicles. Plaintiffs, 28 Trial Exh.
FILED
MAY 28 2014
1 NO FO PUBL A IO
T R IC T N
2 SUSAN M. SPRAUL, CLERK
U.S. BKCY. APP. PANEL
OF THE NINTH CIRCUIT
3 UNITED STATES BANKRUPTCY APPELLATE PANEL
4 OF THE NINTH CIRCUIT
5 In re: ) BAP No. CC-13-1077-PaKiLa
) CC-13-1078-PaKiLa
6 ) (Related Appeals)
JOHN A. OBARA and MYRNA )
7 CASTRO, ) Bankr. No. 09-13962-VK
)
8 Debtors. ) Adv. Proc. 09-01239-VK
______________________________)
9 )
JOHN A. OBARA; MYRNA CASTRO, )
10 )
Appellants, )
11 )
v. ) M E M O R A N D U M1
12 )
AFC CAL, LLC, )
13 )
Appellee. )
14 ______________________________)
15 Argued and Submitted on May 15, 2014
at Pasadena, California
16
Filed - May 28, 2014
17
Appeal from the United States Bankruptcy Court
18 for the Central District of California
19 Honorable Charles E. Rendlen, III, Bankruptcy Judge, Presiding2
20
Appearances: Raymond H. Aver argued for appellant Myrna Castro;
21 Charles Shamash of Caceres & Shamash, LLP argued
for appellant John A. Obara; Tom Roddy Normandin
22 of Prenovost, Normandin, Bergh & Dawe, APC argued
for appellee AFC CAL, LLC.
23
24 1
This disposition is not appropriate for publication.
25 Although it may be cited for whatever persuasive value it may
have (see Fed. R. App. P. 32.1), it has no precedential value.
26 See 9th Cir. BAP Rule 8013-1.
27 2
Judge Rendlen, United States Bankruptcy Judge for the
28 Eastern District of Missouri, as a visiting judge, presided over
the trial and entered the judgment on appeal.
1 Before: PAPPAS, KIRSCHER and LATHAM,3 Bankruptcy Judges.
2
3 Appellants, chapter 74 debtors John A. Obara (“Obara”) and
4 Myrna Castro (“Castro” and, together, “Debtors”) appeal the order
5 of the bankruptcy court determining that their debt to AFC CAL,
6 LLC (“AFC”) was excepted from discharge under both § 523(a)(2)(A)
7 and § 523(a)(6). We AFFIRM in part and REVERSE in part regarding
8 the determination under § 523(a)(2)(A), and AFFIRM the
9 determination under § 523(a)(6).
10 FACTS
11 Background
12 Beginning in 2003, Debtors owned and operated Superior 1
13 Auto Sales (“Superior”). AFC Cal, LLC, a car dealership
14 financing group, extended a modest flooring line of credit to
15 Superior.
16 In 2005, Debtors formed JM Automotive Group, Inc. (“JMAG”),
17 to serve as the corporate entity for a new car dealership. While
18 Superior ceased to exist as a separate company in 2007 when Kia
19 granted Debtors a new car franchise, Debtors continued to use
20 Superior as a d/b/a for JMAG.
21 Castro was president of JMAG; Obara, her spouse, was its
22
23 3
Hon. Christopher B. Latham, United States Bankruptcy
24 Judge for the Southern District of California, sitting by
designation.
25
4
Unless otherwise indicated, all chapter and section
26 references are to the Bankruptcy Code, 11 U.S.C. §§ 101 – 1532,
27 all Rule references are to the Federal Rules of Bankruptcy
Procedure, Rules 1001–9037, and all Civil Rule references are to
28 the Federal Rules of Civil Procedure 1–86.
-2-
1 director of operations.5 AFC gave JMAG a $2.5 million flooring
2 line of credit in 2007 to acquire new cars, and a $1.5 million
3 flooring line for used cars. These credit lines were evidenced
4 by promissory notes and were secured by security agreements
5 (collectively the “JM Automotive Notes”) covering each new and
6 used car financed by AFC, together with the proceeds of those
7 sales.
8 Under this arrangement, when JMAG placed orders for new
9 cars, Kia would directly draw on the $2.5 million line. When
10 JMAG purchased used cars at an auction, the invoices were sent to
11 AFC, and AFC would pay for them from the $1.5 million line. When
12 AFC financed a vehicle, Kia would deliver the Manufacturer’s
13 Statement of Origin (“MSO”) to AFC, or the auction would send the
14 used car title to AFC. AFC retained the title or MSO until the
15 vehicle was paid off. When JMAG received the title or MSO from
16 AFC, it would submit it for registration to the California
17 Department of Motor Vehicles (“DMV”). Obara and Castro were
18
19 5
At oral argument before the Panel, Obara’s counsel
20 contended that Obara was not involved in managing daily
operations at JMAG, and that another person was director of
21 operations. However, this conflicts with Obara’s trial
22 declaration, where he stated: “I was the Director of Operations
at JM Automotive.” Obara Dec. at 2, ¶ 6, November 14, 2011.
23 Obara also confirmed that he was JMAG director of operations in
trial testimony: “As a director of operations, I never saw the
24
bank statements.” Trial Tr. 208:18–209:2, March 6, 2012.
25 Counsel also insisted that “John Obara, rather than being a
sophisticated evil mastermind, was nothing more than a kid, a guy
26 in his mid-20s, a go-getter, who was thrust in way over his
27 head.” However, Obara testified at trial that he had
approximately twenty years of experience in the auto sales
28 industry. Trial Tr. 230:23-25, 174:13–178:16, March 6, 2012.
-3-
1 guarantors on the AFC debts. Both would admit at trial that they
2 did not retain the proceeds of the cars sold subject to AFC's
3 flooring lien in trust and, instead, used those proceeds to pay
4 operating expenses.
5 There were several minor defaults on the AFC loans in 2007
6 and 2008. However, the bankruptcy court would later determine
7 that none of the defaults raised the sort of “red flags” that
8 would have alerted AFC to potential financial difficulties at
9 JMAG.
10 Since 2005, a third party, AutoVin, performed on-site
11 monthly audits for AFC concerning JMAG’s operation. Among other
12 things, an audit included a physical count and inspection of the
13 cars on the lots, a review of sales receipts, and reconciliation
14 of Debtors’ records. Any discrepancies were noted in an audit
15 report (e.g., vehicles that were “off lot” for repairs or test
16 drives, sales information, sales proceeds not received from third
17 party finance companies, etc.). Debtors were then allowed five
18 days after receipt of the audit report to explain and provide
19 information to the auditor or AFC concerning any audit
20 discrepancies, to thereby “close” the audit. Before September
21 2008, debtors successfully passed audit forty times, and only
22 failed once, and that audit failure was ultimately resolved in
23 their favor.
24 The September Audit and the Repossession
25 As part of a review of the accounts, AFC required that
26 Debtors submit to AFC a written “Statement of Net Worth” as well
27 as tax returns. The statement Debtors gave to AFC represented
28 that their net worth was $3,684,842 on August 30, 2008. At
-4-
1 trial, they both admitted that this statement was false, in that
2 their net worth was at the time probably $2 million less than
3 what was represented.
4 In addition, on September 18 and 19, 2008, AutoVin conducted
5 a monthly audit of Debtors’ dealership. Based upon information
6 given to him, the auditor noted in his report that there were a
7 significant number of “unverified” vehicles, which he was lead by
8 JMAG representatives to believe were either "sold unpaid," on
9 “test drive,” or considered "demos."
10 AFC’s representative supervising Debtors’ account, Zach
11 Sterling (“Sterling”), testified at trial that he received the
12 auditor’s report on September 20, 2008, and noted the
13 discrepancies between the audit report and AFC’s records
14 concerning the numbers of vehicles which should be accounted for
15 at the dealership. When Sterling was unable to confirm the car
16 sales with third party financing companies listed in the
17 auditor’s report, he went to the dealership on Wednesday,
18 September 24. He met with Castro to discuss the discrepancies,
19 and to inquire when the audit would be closed. She told him that
20 she was compiling the records needed to close the audit, but that
21 the dealership’s computers were down. Sterling made a detailed,
22 visual inspection of the lot, and confirmed that the car numbers
23 were consistent with the audit report. Sterling also spoke to
24 Obara at least once on September 24, 25, and 26, but it is
25 disputed what was said.
26 Between September 23 and 25, 2008, twenty-five automatic
27 clearing house (“ACH”) transfers issued by JMAG from its bank
28 account to AFC were dishonored by the bank, totaling $78,000.
-5-
1 During this same time, Castro made withdrawals from JMAG’s
2 business bank accounts totaling $142,000. Sterling returned to
3 the dealership on Thursday, September 25, 2008 to again question
4 why the audit had not been closed, and to find out the reason for
5 the dishonored payments.
6 At that time, Castro assured Sterling that she was working
7 diligently on the audit, and that the dishonored payments must
8 have been the result of a bank error. Sterling again made a
9 visual examination of the lot and found the results consistent
10 with the auditor’s report.
11 On Friday, September 26, 2008, Sterling again returned to
12 the dealership. He and Castro then went together to the bank
13 branch that handled the JMAG accounts, where a bank officer
14 advised Sterling that the dishonored payments to AFC were
15 “possibly a bank error.”6 Sterling would later testify that,
16 upon returning to the dealership, Castro appeared to have made
17 several payments by computer to AFC. All payments made on
18 September 26 were later dishonored by the bank. As was later
19 revealed, twenty-four computer payments made by JMAG to AFC on
20 September 30, 2008, were also dishonored, totaling $212,549.47.
21 Sterling returned to the dealership on Monday, September 29,
22 2008. Upon his arrival, he received a cell phone call from a
23 person who identified himself as Don Lake, an attorney for JMAG,
24 who informed him that JMAG was “out of business,” and that all
25
26 6
Sterling would testify that he was later contacted by the
27 bank, and was informed that the dishonored ACH orders were not
the result of bank error, but occurred because JMAG had stopped
28 payment on the transfers.
-6-
1 further inquiries should be directed to the attorney. Sterling
2 conducted a visual inspection of the lot and determined that
3 forty-nine vehicles that had been on the lot from September 18
4 through 26 were now gone.
5 When Sterling confronted Obara at the dealership about the
6 missing vehicles, Obara refused to give him any explanation, and
7 told Sterling to speak with Obara’s attorney. According to
8 Sterling’s trial testimony,
9 Q: What did Mr. Obara say to you [on September
29] and what did you say to him?
10
Sterling: My very first question to him is, John,
11 what’s going on? We just showed up and we
noticed that there’s a lot of cars missing,
12 and we need to talk to you and figure out
what’s going on here.
13
Q: What did Mr. Obara say?
14
Sterling: He said did you receive a call from my
15 attorney, and I responded with yes, that we
had.
16
Q: And what did he say to that?
17
Sterling: He said, well, then that’s what you’re going
18 to have to do. You’re going to have to refer
any questions to him. I’m not talking to
19 you.
20 Trial Tr. 49:8–20, January 11, 2012.
21 Sterling immediately ordered that all remaining vehicles on
22 the lot be repossessed. The evidence at trial would show that
23 the forty-nine “missing” cars had all been sold over the weekend
24 of September 27-28, 2008, by JMAG through Prime Auto Auction, for
25 prices that were less than the outstanding debt owed on the cars
26 to AFC. Obara and Castro have never fully accounted for the
27 proceeds of those sales. AFC filed a complaint against Debtors
28 in the California Department of Motor Vehicles. In an
-7-
1 administrative decision entered on July 7, 2011, the DMV
2 determined that the purchasers of at least twenty of the
3 forty-nine vehicles in dispute had not been able to obtain good
4 title because Debtors had not paid the liens on the vehicles to
5 AFC.7
6 The Bankruptcy and Adversary Proceeding
7 Obara and Castro filed a joint petition for relief under
8 chapter 7 on April 7, 2009.
9 AFC filed an adversary complaint against Debtors on July 9,
10 2009; a First Amended Complaint (“FAC”) was filed on November 9,
11 2009. In it, AFC sought an exception to discharge for the debts
12 owed by Debtors to AFC under §§ 523(a)(2)(A) and (B), and
13 § 523(a)(6), and asked that Debtors’ discharge be denied under
14 §§ 727(a)(2), (a)(4), (a)(5) and (a)(7). Debtors filed an answer
15 to the FAC on February 22, 2010, generally denying its
16 allegations.8
17 AFC submitted a pretrial brief on July 18, 2011. To support
18 its claim for an exception to discharge under § 523(a)(2)(A), AFC
19 alleged that Debtors provided false and misleading information to
20 AFC regarding the status of vehicles missing from the dealership
21 lot on September 18 and 19, 2008, that numerous checks from JMAG
22 to AFC were dishonored, and that forty-nine vehicles on the lot
23
7
24 The bankruptcy court would determine that the DMV
decision was not entitled to preclusive effect concerning the
25 issues raised in the adversary proceeding, a conclusion the
parties have not challenged in this appeal.
26
8
27 AFC’s motion for summary judgment in the adversary
proceeding was denied by the bankruptcy court after a hearing on
28 October 28, 2010. That order has not been appealed.
-8-
1 during the audit were missing on September 29, 2008. Concerning
2 its allegations under § 523(a)(6), AFC argued that JMAG had
3 converted a total of 170 vehicles that Debtors knew were subject
4 to AFC liens, and did so willfully and maliciously to injure AFC
5 and its property.9
6 Debtors submitted a pretrial brief on September 19, 2011.
7 As to § 523(a)(2)(A), Debtors denied making any false
8 representations to the auditor during the audit of September 18
9 and 19, 2008. As to § 523(a)(6), Debtors denied that there had
10 been any conversion of AFC’s property.
11 Trial in the adversary proceeding took place on January 11,
12 March 6, March 7, and November 13, 2012. The witnesses who
13 testified included Sterling, Obara, Castro, John Durazo (the
14 AutoVin auditor who conducted the inspections/audits on
15 September 18 and 19, 2008), Gabriela Otworth (bank branch
16 manager), and Efren Martinez (an auto registration service
17 agent). At the close of trial, the bankruptcy court requested
18 additional briefing from the parties to address, among other
19 things, why AFC continued to hold 165 titles and MSOs, the course
20 of dealing between AFC and Debtors concerning payments and
21 defaults on the flooring line, and Debtors’ record-keeping
22 practices.
23 AFC argued in its post-trial brief that it was AFC’s
24 practice to withhold titles and MSOs from car purchasers until
25
26 9
We do not discuss here the parties’ arguments concerning
27 AFC’s claims under § 523(a)(2)(B) and § 727(a), because those
claims were dismissed by the bankruptcy court and those
28 dismissals have not been appealed.
-9-
1 its lien was satisfied. As to course of dealing, AFC contended
2 that it was not aware of any serious financial difficulties of
3 JMAG before the events of late September 2008. And, AFC
4 insisted, Debtors poorly maintained records, could not provide
5 the bankruptcy court with records because they had intentionally
6 sold the computers where the records were kept, and had not kept
7 copies or backup.
8 Rather than address the bankruptcy court’s specific
9 questions, Debtors’ post-trial brief repeated their general
10 arguments why AFC had not satisfied its burden of persuasion on
11 the elements of §§ 523(a)(2)(A) and (a)(6).
12 The bankruptcy court entered a Memorandum and Opinion on
13 February 8, 2013 (“Memorandum”). After a discussion of the
14 facts, the court made the following findings and conclusions:
15 - “Defendants are personally liable for JM Automotive’s
16 Obligations.”
17 - “Defendants made misrepresentations to plaintiff with
18 knowledge of falsity and intent to deceive.”
19 - “Plaintiff justifiably relied on Defendant’s
20 representations.”
21 - “Plaintiff was damaged in the amount of $2,000,688.00,
22 proximately caused by plaintiff’s reliance on Defendant’s
23 misrepresentations.”
24 - “The court finds that Plaintiff has established all five
25 elements required under § 523(a)(2)(A) by a preponderance of the
26 evidence.”
27 - “The elements of conversion [under California and
28 bankruptcy law] are met.”
-10-
1 - “JM Automotive’s conversion of the one hundred and seventy
2 vehicles was willful and malicious.”
3 - “Plaintiff has established the requirements for a finding
4 under § 523(a)(6) by a preponderance of the evidence.”
5 In the judgment, also entered on February 8, 2013, the
6 bankruptcy court determined that $2,000,688.00, the balance due
7 on JMAG’s debts to AFC, was excepted from discharge under
8 §§ 523(a)(2)(A) and (a)(6). The bankruptcy court granted
9 judgment in favor of Debtors on the § 727(a) claims, and ruled
10 that “all other requests for relief be denied.”
11 Debtors each filed a timely notice of appeal.
12 JURISDICTION
13 The bankruptcy court had jurisdiction under 28 U.S.C.
14 §§ 1334 and 157(b)(2)(I). We have jurisdiction under 28 U.S.C.
15 § 158.
16 ISSUE
17 Whether the bankruptcy court erred in determining that the
18 debt owed by Debtors to AFC was excepted from discharge under
19 § 523(a)(2)(A) and § 523(a)(6).
20 STANDARD OF REVIEW
21 In reviewing a bankruptcy court's determination of an
22 exception to discharge, we review its findings of fact for clear
23 error and its conclusions of law de novo. Oney v. Weinberg
24 (In re Weinberg), 410 B.R. 19, 28 (9th Cir. BAP 2009).
25 ///
26 ///
27 ///
28 ///
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1 DISCUSSION
2 I.
3 The bankruptcy court did not err in determining that
the debt owed by Debtors to AFC is excepted from
4 discharge under § 523(a)(2)(A), but the court’s
determination of the amount of damages proximately
5 caused by Debtors’ fraud was clearly erroneous.
6 Section 523(a)(2)(A) provides:
7 (a) A discharge under section 727 . . . does not
discharge an individual debtor from any debt– . . .
8
(2) for money, property, services, or an extension,
9 renewal, or refinancing of credit, to the extent obtained,
by– (A) false pretenses, a false representation, or actual
10 fraud, other than a statement respecting the debtor's or an
insider's financial condition[.]
11
12 To establish a claim for an exception to discharge under
13 this provision requires a creditor to demonstrate the existence
14 of five distinct elements by a preponderance of the evidence:
15 (1) the debtor made representations; (2) that at the time the
16 debtor knew they were false; (3) that the debtor made them with
17 the intention and purpose of deceiving the creditor; (4) that the
18 creditor justifiably relied on such representations; and (5) that
19 the creditor sustained the alleged loss and damage as the
20 proximate result of the misrepresentations having been made.
21 Ghomesh v. Sabban (In re Sabban), 600 F.3d 1219, 1221 (9th Cir.
22 2010); Siriani v. Nw. Nat’l Ins. Co. of Milwaukee, WI
23 (In re Siriani),
967 F.2d 302, 304 (9th Cir. 1992). However,
24 even assuming these elements are satisfied, a creditor will not
25 be entitled to an exception to discharge under § 523(a)(2)(A) if
26 the debtor’s fraudulent representations consist of “statement[s]
27 respecting the debtor’s or an insider’s financial condition
28 . . . .” Heritage Pac. Fin., LLC v. Edgar (In re Montano),
-12-
1 501 B.R. 96, 102 (9th Cir. BAP 2013).
2 A. False Representations
3 In its Memorandum, the bankruptcy court cites examples of
4 misrepresentations by Obara and Castro on which AFC justifiably
5 relied. First, the court found that,
6 Defendants signed the JM Automotive Notes dated
August 7, 2007. When Defendants signed the documents,
7 they made representations and warranties that
JM Automotive would provide a complete accounting of
8 the financed vehicles and remit the requisite sales
9 proceeds due to Plaintiff in accordance with the terms
of the JM Automotive Notes. The representations were
10 material and induced Plaintiff to extend the flooring
line of credit.
11
12 Memorandum at 20.
13 Given the context of this action, it is not clear why the
14 bankruptcy court included this representation in discussing
15 Debtors’ conduct. The representation it cites as problematic was
16 made in the contract documents executed in 2007, before JMAG was
17 apparently experiencing any financial problems. Indeed,
18 according to the evidence, JMAG had successfully navigated forty
19 audits before August 2008. There is nothing in the record to
20 suggest that Debtors’ representations to faithfully account for
21 financed vehicles, and any proceeds of sale, nearly a year before
22 Debtors’ questionable behavior occurred in September 2008, were
23 falsely made to deceive AFC at the time they were made.
24 The other two representations targeted by the bankruptcy
25 court took place in connection with Debtors’ delivery of their
26 Statement of Net Worth, dated August 29, 2008, to AFC, and
27 Debtors’ false statements made to the auditor in connection with
28 the September 18 and 19, 2008 audit.
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1 JM Automotive provided false information to the lot
auditor during the September 2008 audit. While
2 Defendants maintain that they did not personally
provide the lot auditor with any information, the lot
3 auditor specifically identified certain vehicles as
“sold unpaid” or “test drive” or on “demo.” The only
4 reasonable conclusion is that a representative of
JM Automotive provided the auditor with this false
5 information . . . . Defendants’ arguments as to the
August 29, 2008 Statement of Net Worth and the
6 September lot audit are disingenuous. Having
intentionally provided the false Statement of Net Worth
7 to Plaintiff and false statements to the lot auditor,
it is not a defense to assert that the misconduct
8 should have been discovered or should not have been
relied upon . . . . JM Automotive’s fraudulent conduct
9 is attributable to Defendants[.]
10 Memorandum at 22-23.
11 Of course, to the extent that the bankruptcy court deemed
12 the Statement of Net Worth to be a false representation which
13 could support an exception to discharge under § 523(a)(2)(A), the
14 court erred.10 Even if its contents were false, and Debtors
15 intended to defraud AFC through its contents, AFC’s use of this
16 statement is not actionable since "[b]y its terms, § 523(a)(2)(A)
17 excludes ‘a statement respecting the debtor's or an insider's
18 financial condition.'" In re Montano, 501 B.R. at 102; Tallant
19 v. Kaufman (In re Tallant),
218 B.R. 58, 69 (9th Cir. BAP 1998).
20 The bankruptcy court dismissed AFC’s § 523(a)(2)(B) claim for
21 Debtors’ use of false financial information, and AFC has not
22 appealed that aspect of the judgment.
23 On the other hand, we agree with the bankruptcy court that
24
25
10
At argument before the Panel, counsel for AFC conceded
26 that the Statement of Net Worth could not serve as the basis for
27 an exception to discharge under § 523(a)(2)(A), but suggested
that it was probative of willful and malicious conduct under
28 § 523(a)(6).
-14-
1 false information given by Debtors to the lot auditor, or to
2 Sterling, either directly or through JMAG employees, could
3 constitute representations adequate to support a discharge
4 exception under § 523(a)(2)(A). In this regard, the Memorandum
5 recites:
6 The Court finds that there is sufficient evidence that
Defendants directly participated in or consented to the
7 alleged fraud[ulent representations]. At all time,
Defendants were the sole owners, directors and officers
8 of JM Automotive. As signatories to the JM Automotive
Notes, Defendants were aware of JM Automotive’s
9 obligations to Plaintiff. Defendants testified
extensively as to their course of dealing with
10 Plaintiff evidencing knowledge of JM Automotive’s
operations and activities. Obara was involved in the
11 process of acquiring the vehicle at auction and selling
them at JM Automotive. Therefore, Obara knew the sales
12 status of vehicles financed by Plaintiff. If a
vehicle, financed by Plaintiff, was sold or remained on
13 the lot, Obara knew about it. Obara and Castro are
specifically identified as having met with the AutoVin
14 auditor in lot audit reports. Obara knew that an
incorrect accounting of the vehicles had been provided
15 during the September 2008 lot audit. Obara failed to
take appropriate action to correct the wrong.
16
17 Memorandum at 19-20.
18 While Debtors each urgently argue to the contrary, the
19 bankruptcy court found, based upon the disputed evidence, that
20 Obara and Castro both effectively made false representations as
21 part of the audit process about the status of the JMAG vehicles.
22 To the extent they personally made false statements to the
23 auditor or to Sterling, they are accountable under § 523(a)(2)(A)
24 for direct, actual fraud. Tobin v. San Souci Ltd. P’ship
25 (In re Tobin), 258 B.R. 199, 205-06 (9th Cir. BAP 2001.) But the
26 same is also true if, instead of personally misleading the
27 auditor or banker, they knowingly allowed their agents to provide
28 false information to the auditor or AFC because, under the
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1 circumstances here, the fraud committed by their agents can be
2 imputed to the Debtors for purposes of § 523(a)(2)(A).
3 In Sachan v. Huh (In re Huh), 506 B.R. 257 (9th Cir. BAP
4 2014), the Panel adopted the standard for imputation of fraud
5 liability articulated by the Eighth Circuit in Walker v. Citizens
6 State Bank (In re Walker),
726 F.2d 452 (8th Cir. 1984), and
7 concluded that, to be true to the policies of the Bankruptcy Code
8 and case law, the emphasis should be the actions of the debtor.
9
Id. at 266. As the Panel explained, to show that an agent's
10 fraud should be imputed to the debtor, the creditor seeking an
11 exception to discharge must show that the debtor acted with
12 "culpable state of mind," and that the debtor "knew or should
13 have known" of the perpetrator's fraudulent activities.
Id. at
14 267.
15 In this case, the bankruptcy court made the sort of findings
16 necessary under In re Huh to show that Debtors knew, or should
17 have known, that false representations were made to the auditors
18 by their staff. In particular, the court found that Obara “knew
19 the sales status of vehicles financed by Plaintiff. If a
20 vehicle, financed by Plaintiff, was sold or remained on the lot,
21 Obara knew about it. Obara knew that an incorrect accounting of
22 the vehicles had been provided during the September 2008 audit.
23 Obara failed to take appropriate action to correct the wrong.”
24 Memorandum at 20.
25 In addition, even if Obara and Castro did not personally, or
26 through others, misinform the auditor or AFC about the true state
27 of affairs concerning the cars securing the debts, if they
28 withheld critical information from AFC with the intent to defraud
-16-
1 the creditor, an exception to discharge is appropriate. Citibank
2 (South Dakota), N.A. v. Eashai (In re Eashai), 87 F.3d 1082,
3 1089-90 (9th Cir. 1996) (holding that “a debtor's failure to
4 disclose material facts constitutes a fraudulent omission under
5 § 523(a)(2)(A) if the debtor was under a duty to disclose and the
6 debtor's omission was motivated by an intent to deceive.”); see
7 also Harmon v. Kobrin (In re Harmon),
250 F.3d 1240, 1246 (9th
8 Cir. 2001); RESTATEMENT (SECOND) OF TORTS § 551 (1976).
9 In this case, it is undisputed that, in the JM Automotive
10 Notes, Obara and Castro signed an Unconditional and Continuing
11 Guaranty of the debt of JMAG which imposed the following
12 obligations upon them to AFC:
13 4.0 Upon the sale of any item of purchase money
inventory, Dealer shall hold the amount received
14 from the disposition of inventory in trust for the
benefit of Lender.
15
* * *
16
5.1 Unless Purchase Money Inventory is the subject of a
17 retail Installment Contract . . . or is sold pursuant
to Section 4.0, Dealer shall not attempt to or actually
18 sell, lease, transfer, mortgage, encumber, or otherwise
dispose of the Purchase Money Inventory[.]
19
* * *
20
5.3 Dealer shall keep and maintain the collateral in
21 good repair and safe condition.
22 5.4 Dealer has kept and shall continue to keep true
and accurate books and records concerning the
23 business affairs and the collateral.
24 The bankruptcy court found that by these guaranties, and other
25 warranties they made to AFC, Debtors had an affirmative
26 obligation to provide a complete accounting, and to remit the
27 sales proceeds of sold cars, to AFC, and generally to “keep safe”
28 the vehicles. Memorandum at 20.
-17-
1 The bankruptcy court found that both Obara and Castro were
2 present at the dealership during the auditor’s visits in
3 September 2008, and had spoken with the auditor. Both were aware
4 that there were irregularities with the audit that they must
5 address before it would be “closed.” At least as to Obara, the
6 court also found that “Obara knew that an incorrect accounting of
7 the vehicles had been provided during the September 2008 lot
8 audit . . . [and that] Obara failed to take appropriate action to
9 correct the wrong.”11
10 Though they had a contractual duty to fully disclose correct
11 information to AFC about the vehicles and sales transactions, the
12 bankruptcy court determined that, instead, the auditor, and later
13 Sterling, were given false statements about the status of the
14 cars to mask the truth that numerous “missing vehicles” that the
15 auditor had been informed were sold unpaid, on test drive, or
16 were demos had in fact been sold, and the liens of AFC not paid.
17 Finally, the bankruptcy court determined that Castro engaged
18 in fraudulent representations to Sterling regarding the string of
19 dishonored automated payments made by JMAG to AFC between
20 September 23 and 25, 2008. Indeed, the court found that Castro
21 “inexcusably withdrew” $142,100.37 from the JM Automotive
22 accounts, during the time the ACH transfers to AFC (some of which
23 were performed by Castro in Sterling’s presence) for $78,764 were
24 dishonored. While a single bad check is not a false
25 representation for exception to discharge purposes, Williams v.
26
11
27 The court had evidence from the testimony of Durazo, the
auditor, that he had given a copy of his audit results to Obara.
28 Trial Tr. 99:8–100:1, March 6, 2012.
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1 United States, 458 U.S. 279, 284 (1982), the bankruptcy court
2 found that “Castro was aware of the amount of funds available [or
3 not] in the account.” Memorandum at 21. The court therefore
4 could reasonably infer that the numerous dishonored ACH transfers
5 from JMAG to AFC were tantamount to fraudulent representations,
6 by which Debtors were stalling for time so that they could
7 liquidate the vehicle inventory before AFC could exercise its
8 contractual rights to repossess and accelerate any debt.
9 At bottom, whether the debtor made a misrepresentation is a
10 finding of fact reviewed for clear error. Candland v. Ins. Co.
11 of N. Am. (In re Candland),
90 F.3d 1466 (9th Cir. 1996) (citing
12 Lansford v. LaTrattoria (In re Lansford),
822 F.2d 902, 904 (9th
13 Cir. 1987)); Miller v. IRS (In re Miller),
174 B.R. 791, 794 (9th
14 Cir. BAP 1994). Here, based upon the disputed evidence, the
15 bankruptcy court did not clearly err in determining that Obara
16 and Castro made false representations to AFC in connection with
17 the audit, or otherwise engaged in fraudulent conduct in their
18 dealings with AFC.
19 B. Knowledge of Falsity and Intent to Deceive the Creditor
20 The bankruptcy court examined the evidence of the
21 representations and behavior of Obara and Castro at the time of
22 the September audit process and thereafter. The court determined
23 that Debtors’ knowledge of the falsity of the information given
24 to AFC, and their intent to deceive the creditor “can be inferred
25 from Defendants’ failure to remit sale proceeds.” Moreover, as
26 the court noted, JMAG dishonored hundreds of thousands of dollars
27 in ACH transfers to AFC during this time. And, of course,
28 forty-nine of the cars that were on the lot on Friday, had
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1 disappeared by the following Monday, and were subsequently found
2 to have been sold for less than the debt owed AFC over the
3 weekend, only for Sterling to be informed that the business was
4 closed.
5 Simply put, the record includes ample evidence from which
6 the bankruptcy court could reasonably infer that Obara and Castro
7 acted with a fraudulent state of mind at the time of, and
8 subsequent to, the September audit. Runnion v. Pedrazzini
9 (In re Pedrazzini), 644 F.2d 756, 758 (9th Cir. 1981) (The
10 existence of scienter is a question of fact, not to be reversed
11 on appeal unless clearly erroneous.); Williamson v. Busconi,
12
87 F.3d 602, 603 (1st Cir. 1996) (explaining that "subsequent
13 conduct may reflect back to the promisor's state of mind and thus
14 may be considered in ascertaining whether there was fraudulent
15 intent at the time the promise was made"); Stein v. Tripp
16 (In re Tripp),
357 B.R. 544, 548 (Bankr. D. Ariz. 2006) (noting
17 that a court "may consider subsequent conduct to the extent that
18 it provides an insight into the debtor's state of mind at the
19 time of the representations.").
20 C. Justifiable Reliance
21 To sustain an exception to discharge, § 523(a)(2)(A) also
22 requires that the bankruptcy court find that the creditor
23 justifiably relied on a debtor’s false statements or
24 misrepresentations. Field v. Mans,
516 U.S. 59, 74-75 (1995).
25 Justifiable reliance is measured under a subjective standard,
26 which turns on a person’s knowledge under the particular
27 circumstances. In re
Eashai, 87 F.3d at 1090. “Justification is
28 a matter of the qualities and characteristics of the particular
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1 plaintiff, and the circumstances of the particular case, rather
2 than of the application of a community standard of conduct to all
3 cases.” Id. (quoting Field, 516 U.S. at 70). Therefore, the
4 inquiry regarding the justifiable standard focuses on “whether
5 the falsity of the representation was or should have been readily
6 apparent to the individual to whom it was made.” Beneficial
7 Cal., Inc. v. Brown (In re Brown),
217 B.R. 857, 863 (Bankr. S.D.
8 Cal. 1998).
9 The justifiable reliance standard generally does not entail
10 a duty to investigate; a person may be justified in relying on a
11 representation even if he might have ascertained the falsity of
12 the representation had he made an investigation. See Field,
13 516 U.S. at 70. However, a creditor’s duty to investigate arises
14 by virtue of suspicious circumstances.
Id. at 71. Thus,
15 “justifiable reliance does not exist where a creditor ignores red
16 flags.” In re
Anastas, 94 F.3d at 1286; Romesh Japra, M.D.,
17 F.A.C.C., Inc. v. Apte (In re Apte),
180 B.R. 223, 229 (9th Cir.
18 BAP 1995)(same).
19 The bankruptcy court addressed Debtors’ arguments that, in
20 this case, AFC ignored several significant “red flags” about
21 Debtors’ business operations. The court noted that the evidence
22 showed that, before September 2008, AFC had received the required
23 payments for financed vehicles within the ninety-day curtailment
24 period required by the JM Automotive Notes. The court also had
25 evidence that JMAG had passed forty of forty-one audits before
26 September 2008. Based on this and other evidence, the court
27 summarized, “the evidence fails to show that, prior to August
28 2008, Plaintiff disregarded red flags based on its knowledge of
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1 JMAG’s financial difficulties.” Memorandum at 24. We see no
2 error in the court’s reasoning.
3 The bankruptcy court also heard the testimony of Sterling
4 about his concerns with the inconsistency between the
5 representations made to the auditor, his company’s records, and
6 his discussions with third party lenders identified by the
7 auditor’s report calling the true status of several vehicles into
8 question. He testified that in light of the findings in the
9 audit he immediately went to the dealership to inquire about the
10 delay in closing the audit, and again later to inquire about the
11 many dishonored ACH transfers. Sterling noted that, based on
12 JMAG’s long history of good payments, and what he perceived as
13 the efforts of its management, including Castro, to close the
14 audit, he did not, at least initially, feel compelled to exercise
15 the power to terminate the parties’ credit relationship, to
16 accelerate the debt, or to repossess the cars. However, Sterling
17 testified that, had he known of the false representations made to
18 the auditor, he would have immediately exercised the repossession
19 option: “Obara and Castro mislead the AutoVin auditors on
20 September 18 and 19, 2008, as to the status of AFC’s collateral.
21 Had we known the true facts, AFC would have repossessed its
22 Collateral on September 19, 2008.” Sterling Dec. at 6-7,
23 July 18, 2011.
24 Perhaps in retrospect AFC should have been more keenly alert
25 to the possibility that the information Debtors were giving the
26 creditor about the status of the vehicles, and their ACH
27 payments, was unreliable. However, based on the conflicting
28 evidence, the bankruptcy court did not clearly err in finding
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1 that there were no red flags that would have caused AFC to
2 investigate further, and would have prevented its reliance on the
3 false representations made to the auditor to be justified.
4 D. Proximate Cause and Damages
5 Another element for an exception to discharge under
6 § 523(a)(2)(A) is that AFC must have sustained loss or damages as
7 the proximate result of the misrepresentations having been made.
8 In re Sabban, 600 F.3d at 1221. Proximate cause under
9 § 523(a)(2)(A) requires a finding by the bankruptcy court that
10 there was (1) causation in fact, or in other words, that the
11 debtor’s misrepresentations or fraud was a substantial factor in
12 determining the course of conduct that results in loss and
13 (2) legal causation, which requires the creditor's loss to
14 reasonably be expected to result from the reliance. Sharfarz v.
15 Goguen (In re Goguen),
691 F.3d 62, 70 (1st Cir. 2012) (citing
16 Restatement (Second) of Torts, §§ 546, 548A) ("A fraudulent
17 misrepresentation is a legal cause of a pecuniary loss resulting
18 from action or inaction in reliance upon it if, but only if, the
19 loss might reasonably be expected to result from the reliance.");
20 Burks v. Bailey (In re Bailey), 499 B.R. 873, 891 (Bankr. D.
21 Idaho 2013) (same).
22 Concerning AFC’s loss as a result of Debtors’ fraud, the
23 bankruptcy court found that:
24 Defendants made representations on behalf of
JM Automotive with the knowledge and intent to deceive
25 Plaintiff. Had Plaintiff known JM Automotive withheld
funds from the sale of vehicles financed by Plaintiff,
26 Plaintiff could have discontinued financing vehicles
for JM Automotive and enforced its rights under the
27 terms of the JM Automotive Notes. Instead, Plaintiff
was kept in the dark and as a result suffered damages
28 of $2,000,688.00 — the outstanding balance on the lines
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1 of credit extended to JM Automotive. The damages were
proximately caused by Defendants’ and JM Automotive
2 fraudulent conduct. . . . In sum, the court finds
Plaintiff has established all five elements required
3 under § 523(a)(2)(A) by a preponderance of the
evidence.
4
5 Memorandum at 25. We agree with the bankruptcy court that
6 Debtors’ misconduct caused AFC to suffer a loss. We disagree,
7 however, with the court’s determination of the extent of that
8 loss.
9 In particular, we do not understand how the facts in this
10 case support a fraud exception to discharge for the full balance
11 due on the AFC debt. Of course, apparently to this day, AFC has
12 not recovered any of the sums due on the 170 cars that were not
13 properly accounted for in the September audit. And we understand
14 that Sterling testified that, had he known of the falsity of the
15 representations made to the auditor, he would have immediately
16 repossessed the cars on the lot.
17 However, only forty-nine cars “went missing” during the
18 September audit. It was only as to these vehicles that AFC could
19 have exercised its repossession rights but for Debtors’ fraud.
20 Put another way, while AFC no doubt suffered a loss from the
21 other missing, and presumably sold, vehicles, that loss cannot be
22 tied to Debtors’ misconduct during the September audit. Thus,
23 AFC’s damages stemming from Debtors’ fraudulent representations
24 in September 2008 must be limited to the balance due on the
25 forty-nine cars, not the full balance due on the JM Automotive
26 Notes.
27 In sum, we AFFIRM the judgment of the bankruptcy court
28 determining that, as a result of Debtors’ false representation
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1 and fraud, AFC is entitled to an exception from discharge under
2 § 523(a)(2)(A). However, we REVERSE that portion of the judgment
3 incorporating the bankruptcy court’s incorrect calculation of the
4 amount of AFC’s damages as equaling the full amount due from
5 Debtors to AFC on the 170 cars, rather than the amount due for
6 the missing forty-nine cars.12 However, based upon our
7 conclusions about AFC’s § 523(a)(6) claim below, we do not think
8 a remand to the bankruptcy court to calculate the correct amount
9 of damages is necessary at this time.
10 II.
11 The bankruptcy court did not err in determining that
the debt owed by Debtors to AFC was excepted from
12 discharge under § 523(a)(6).
13 Section 523(a)(6) provides: "(a) A discharge under 727 . . .
14 of this title does not discharge an individual debtor from any
15 debt — . . . (6) for willful and malicious injury by the debtor
16 to another entity or to the property of another entity."
17 Ordinarily, tortious conduct is a required element for a finding
18 of exception to discharge under § 523(a)(6), and we look to state
19
12
20 At argument before the Panel, counsel for AFC conceded
that an exception to discharge under § 523(a)(2)(A) would only
21 apply to the value of the forty-nine cars. However, counsel
22 argued that the bankruptcy court’s award of $2,000,688 was less
than the Kelly Bluebook value of the cars of approximately
23 $2.6 million. The Panel asked counsel if the $2.6 million
referred to the forty-nine cars, and counsel replied yes. It
24
appears that counsel was confusing the value of the 170 cars with
25 the value of the forty-nine cars. According to AFC’s own
evidence, the Kelly Bluebook value of the forty-nine cars was
26 $638,297.54, and the outstanding debt owed by JMAG to AFC on
27 those forty-nine cars was $627,938.98; the Kelly Bluebook value
of the 170 cars was approximately $2.6 million. Plaintiff’s
28 Trial Exh. 6 at 2-4.
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1 law to determine the elements of a tort. Lockerby v. Sierra,
2 535 F.3d 1038, 1040 (9th Cir. 2010). Whether a particular debt
3 is for willful and malicious injury by the debtor to another or
4 the property of another under § 523(a)(6) requires application of
5 a two-pronged test: the creditor must prove that the debtor's
6 conduct in causing the creditor’s injuries was both willful and
7 malicious. Barboza v. New Form, Inc. (In re Barboza),
545 F.3d
8 702,711 (9th Cir. 2008) (citing Carrillo v. Su (In re Su),
9
290 F.3d 1140, 1146-47 (9th Cir. 2002) and requiring the
10 application of a separate analysis of each prong of "willful" and
11 "malicious").
12 To show that a debtor's conduct is willful requires proof
13 that the debtor deliberately or intentionally injured the
14 creditor or the creditor's property, and that in doing so, the
15 debtor intended the consequences of his act, not just the act
16 itself. Kawaauhau v. Geiger,
523 U.S. 57, 60-61 (1998). The
17 debtor must act with a subjective motive to inflict injury, or
18 with a belief that injury is substantially certain to result from
19 the conduct. In re
Su, 290 F.3d at 1143; Petralia v. Jercich,
20
238 F.3d 1202, 1208 (9th Cir. 2001).
21 An injury is malicious within the meaning of § 523(a)(6) if
22 the debtor (a) commits a wrongful act, (b) done intentionally,
23 (c) which necessarily causes injury and (d) the act is done
24 without just cause or excuse. In re
Su, 290 F.3d at 1147.
25 Here, the bankruptcy court determined that, in their
26 dealings with AFC, Debtors committed an intentional conversion of
27
28
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1 AFC’s collateral under California law.13 “[T]he elements of
2 conversion are the creditor’s ownership or right to possession of
3 the property at the time of conversion; the debtor’s conversion
4 by a wrongful act or disposition of property rights; and
5 damages.” Thiara v. Spycher Bros. (In re Thiara), 285 B.R. 420,
6 427 (9th Cir. BAP 2002) (citing Farmer’s Ins. Exch. v. Zerin,
7
51 Cal. App. 4th 445, 451 (1997)); Meserali v. Fulwider,
53 Cal.
8 App. 4th 445, 447 (1988) (holding that, in California, a debtor
9 may be liable for conversion where the debtor wrongfully
10 withholds personal property from a creditor entitled to the
11 property under a security agreement).
12 In particular, the bankruptcy court found that Debtors had:
13 sold and transferred a total of one hundred and seventy
vehicles financed by Plaintiff. Plaintiff held a
14 security interest in those vehicles at the time of the
sale and transfer. By selling and transferring the one
15 hundred and seventy vehicles without repaying Plaintiff
and obtaining the original titles or MSOs to pass on to
16 buyers, JM Automotive wrongfully deprives Plaintiff of
its security interest. As a result of JM Automotive’s
17 actions, Plaintiff was damaged in the amount of
$2,000,688.00 — the outstanding balance on the lines of
18 credit extended to JM Automotive for the one hundred
seventy vehicles.
19
20 13
A judgment for conversion under California law "does
21 not, without more, establish that a debt arising out of that
judgment is nondischargeable under § 523(a)(6)." Peklar v. Iklar
22 (In re Peklar), 260 F.3d 1035, 1038 (9th Cir. 2001). Instead,
23 such a judgment decides only that the defendant has engaged in
the "wrongful exercise of dominion" over the personal property of
24 the plaintiff; it does not necessarily decide that the defendant
25 has caused a "willful and malicious injury" within the meaning of
§ 523(a)(6). Id. Of course, there was no state court judgment
26 entered against Debtors. However, the bankruptcy court examined
both the willful and malicious prongs of the § 523(a)(6) test,
27 and decided that all requirements for an exception to discharge
28 were satisfied.
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1 Memorandum at 27.
2 The bankruptcy court correctly found that the conversion of
3 the 170 vehicles was willful and malicious. As to the
4 willfulness prong, the court found on the evidence that, among
5 other actions, Debtors sold or transferred forty-nine vehicles
6 the weekend of September 26, 2008, knowing that it would deprive
7 AFC of its security interest in the vehicles, and by these
8 actions, they exhibited a subjective motive to inflict injury on
9 AFC. We agree with the bankruptcy court that, given these facts,
10 the court could reasonably infer that Debtors acted willfully,
11 “because the evidence indicates that JM Automotive knew its
12 conduct [] was substantially certain to cause injury to Plaintiff
13 and JM Automotive had the subjective motive to inflict injury to
14 Plaintiff on or about the weekend of September 26, 2008.”
15 Memorandum at 27.
16 As to the malicious prong, the bankruptcy court found, based
17 on the evidence, that Debtors intentionally deprived AFC of its
18 security interest without just cause or excuse. Memorandum at
19 27. Again, we agree with the bankruptcy court that this is a
20 reasonable inference under these facts.
21 The one significant objection by Debtors to the bankruptcy
22 court’s ruling that there was an exception to discharge under
23 § 523(a)(6) is based on the Ninth Circuit’s opinion in Transam.
24 Commercial Fin. Corp. v. Littleton (In re Littleton), 942 F.2d
25 551, 554-55 (9th Cir. 1991). Debtors argue that, because AFC did
26 not show that Debtors used the diverted car sale proceeds for
27 their own purposes and, instead, used the money to pay other
28 debts, AFC has not shown Debtors acted maliciously.
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1 Of course, Littleton was decided before Geiger, Jercich and
2 Su revised the Circuit’s case law concerning the proof required
3 for an exception to discharge under § 523(a)(6). In addition,
4 Littleton held that, for a flooring agreement like the one at
5 issue in this appeal, malice could not necessarily be shown
6 solely by the fact that the debtor diverted the proceeds from the
7 sale of the collateral of a secured creditor to pay other
8 creditors. Id. However, the Littleton court observed that the
9 debtor in that case was operating with hopes of saving the
10 business. As noted by the bankruptcy court in this case, the
11 Littleton court had concluded that:
12 the methods by which [the debtor] made payments and
handled inventory did not constitute acts that
13 necessarily produced harm. Furthermore, the bankruptcy
court found that at all times the debtors were acting
14 with the hope and expectation of saving the business
and that they cooperated with Transamerica by seeking
15 additional financing that would allow Jacob's to stay
in business. Additionally, the debtors offered a third
16 trust deed on their residence as additional security
for the loan. Moreover, there was no evidence that the
17 debtors used any of the proceeds for their personal
benefit, or that any other creditor was paid other than
18 in the ordinary course of business in the month before
insolvency proceedings were filed.
19
Considering these facts, it was not clearly erroneous
20 for the bankruptcy court or the BAP to conclude that
the debtors' acts would not have necessarily produced
21 harm. Consequently, the debtors' conduct was not
malicious, as that term is used in § 523(a)(6).
22
23 Id. at 555.
24 In this case, in contrast to Littleton, the bankruptcy court
25 found that Debtors were not motivated by a desire to preserve
26 their business. Rather, “Defendants’ behavior suggests a desire
27 to extract as much money as possible from a failing business.”
28 Memorandum at 28. This finding adequately supports the
-29-
1 bankruptcy court’s conclusion that Debtors’ conversion of
2 170 vehicles, and the sale proceeds, was a malicious enterprise,
3 justifying an exception to discharge under § 523(a)(6).
4 CONCLUSION
5 We AFFIRM the bankruptcy court’s judgment concluding that a
6 portion of the debt owed by Debtors to AFC is excepted from
7 discharge under § 523(a)(2)(A), but we REVERSE its determination
8 under § 523(a)(2)(A) of the amount of damages suffered by AFC as
9 a result of Debtors’ fraudulent conduct. We AFFIRM the
10 bankruptcy court's judgment that the debt of $2,000,688.00 owed
11 by Debtors to AFC is excepted from discharge under § 523(a)(6).
12 Under the circumstances, we decline to remand the damages issue
13 under § 523(a)(2)(A) to the bankruptcy court since no purpose
14 would be served at this time by doing so.
15
16
17
18
19
20
21
22
23
24
25
26
27
28
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