Joan N. Feeney, United States Bankruptcy Judge.
The matter before the Court is the Plaintiff's Complaint for an exception to discharge of debts he alleges are owed by the debtor arising out of their business venture in Honey Dew Donuts franchises. The Complaint originally contained seven counts and was filed against the Chapter 7 debtor, Jamie L. Melo (the "Debtor"), by George Zacharakis ("Zacharakis"), in his individual capacity and as a member of two Massachusetts limited liability companies, namely, Memoza Enterprises LLC ("Memoza") and M & Z Enterprises, LLC ("M & Z")(jointly, the "LLCs" or the "Companies"), which were co-owned by Zacharakis, the Debtor and others. Prior to trial, the Court dismissed the following counts in the Complaint pursuant to Fed. R. Civ. P. 12(b)(6), made applicable hereto by Fed. R. Bankr. P. 7012(b): Count IV (Conversion), Count V (Breach of Fiduciary Duty), Count VI (Deceit), and Count VII (Mass. Gen. Laws ch. 93A) as such counts were claims based on state law, were duplicative of Counts I through III of the Complaint, did not state a claim for any exception to discharge under 11 U.S.C. § 523 and were not properly before this Court.
The parties filed a Joint Pretrial Memorandum on June 19, 2015, in which they admitted to numerous facts. The Court conducted a trial over four days, at which five witnesses testified and 26 agreed exhibits were introduced into evidence. On the first day of trial, the parties submitted an Amended Stipulation of Facts in which they stipulated to additional facts.
This Court has jurisdiction over this matter pursuant to 28 U.S.C. § 1334(a) and (b) and the order of reference from the United States District Court for the District of Massachusetts. This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(I). The Court now makes the following findings of fact and conclusions of law pursuant to Fed. R. Bankr. P. 7052. For the reasons set forth below, the Court rules that Zacharakis has not sustained his burden of proving an exception to discharge for any debt owed to him by the Debtor pursuant to 11 U.S.C. § 523(a)(2)(A), (4) or (6) and shall enter a judgment in favor of the Debtor with respect to all remaining counts in the Complaint, namely Counts I, II and III.
On June 5, 2014, the Debtor filed a voluntary petition under Chapter 7 of the Bankruptcy Code, and he filed required Schedules of Assets and Liabilities and Statements on the same date. On Schedule A — Real Property, the Debtor listed a home, which he held through a trust, located in North Dartmouth, Massachusetts, with a value of $260,000, subject to secured claims in the total amount of $220,129. On Schedule B — Personal Property, the Debtor listed personal property valued at $19,338.00. On Schedule F — Creditors Holding Unsecured Nonpriority Claims, the Debtor listed George and Maria Zacharakis with "Unknown Trade Debt" in the amount of $1.00, and total unsecured nonpriority claims of over $258,000, many of which were characterized as "trade debt."
On September 9, 2014, Zacharakis filed a Motion to conduct an examination of the Debtor pursuant to Fed. R. Bankr. P. 2004 (the "2004 Exam") for the purpose of probing the Debtor's conduct and business activities in the operation and management of the franchise business. The Motion was
This proceeding involves failed Honey Dew Donuts franchise businesses operated through Memoza and M & Z which were owned, to varying degrees, by six original partners, namely, Zacharakis, the Debtor, Lina Mota ("Lina") and her then husband, Carlos Mota ("Carlos"), Maria Zacharakis ("Maria"), who is Zacharakis's wife, and Samia Melo, who is the Debtor's wife. Zacharakis testified that the venture began when he, as the manager of several gas stations, was approached by Samia, who worked with Lina at a Honey Dew franchise located in one of Zacharakis's gas stations, to ascertain whether Zacharakis would be interested in financing a new Honey Dew Donuts franchise.
All of the original partners, except for Maria, testified at the trial. Zacharakis received his college degree in 1988 and has worked in gas station management since that time. He devoted a minimum of 50 hours per week to his work. Lina testified that she had worked at various Honey Dew Donuts locations, including the one located in the station managed by Zacharakis, for about two years, and that she worked at that location with Samia who was her friend. According to Lina, the two discussed the possibility of owning their own Honey Dew Donuts franchise. Carlos, an owner of his own Honey Dew franchises, was an original partner in the venture, but eventually left the business following a dispute with the other partners which is discussed in greater detail below.
Zacharakis, Lina and Carlos testified and were credible in their accounts of the genesis of the business venture and their respective roles in the day-to-day operations. Despite their general credibility, each had difficulty recalling specific dates and frequently spoke in generalities, often referring to "the store" or "the bank account" when the business operated three retail locations and had multiple bank accounts. During their testimony, they also tended to conflate the ownership, assets, liabilities and operations of the LLCs.
The Debtor is a Deputy Sheriff at the Bristol County Sheriff's Office in Massachusetts. He had some restaurant and cooking experience at his parents' restaurant. At numerous times during the trial, his testimony was unclear and evasive. He also was unresponsive to many questions.
Prior to formation of the LLCs, Zacharakis testified that he attended a meeting with Maria, Lina, Carlos, the Debtor, and Samia, at which the group discussed a plan to have Zacharakis finance a Honey Dew Donuts franchise which would be operated by Lina and Samia.
Samia testified that Zacharakis was going to be the "financial guy," that he had the most business experience and that "he was going to be basically the head of the partnership." She also testified that Maria
Following their initial meeting, Zacharakis, Maria, the Debtor, Samia, Carlos and Lina met with representatives of the Honey Dew franchisor. On March 7, 2011, Memoza was formed as a Massachusetts limited liability company. The following day, on March 8, 2011, an Operating Agreement was entered into by and among Samia, Lina and Zacharakis, as managers of Memoza, and the Debtor, Carlos and Zacharakis as members of Memoza (the "Memoza Operating Agreement"). According to Schedule A of the Memoza Operating Agreement, the capital contributions and membership interests of Memoza were as follows:
Name Capital % Capital Contribution/
Contribution Percentage Interest
George Zacharakis $10,000 40%
Carlos Mota, Jr. $ 7,500 30%
Jamie Melo $ 7,500 30%
Total $25,000 100%
As stated above, Zacharakis was both a member and a manager of Memoza, Samia and Lina were nonmember managers and Carlos and the Debtor were members of Memoza, but not managers. Section 6.01 of the Memoza Operating Agreement, entitled "Management of the LLC" provided that, except for certain transactions which required unanimous member approval, "the overall management and control of the business and affairs of the LLC shall be vested in the Managers ..., [and] all... actions ... taken ... by the Manager shall require the approval of a majority in number of the persons serving as Managers unless otherwise specifically provided herein." The Debtor, in contrast to Zacharakis, had no duties or powers as a manager of Memoza under the terms of the Operating Agreement. The Memoza Operating Agreement also provided the following:
(emphasis added).
(emphasis added).
Zacharakis testified that it was his expectation that Samia and Lina would run the day-to-day operations of Memoza. He maintained that his role was limited because he had another full-time job: "I knew that I was just financing. I didn't have time to run a donut shop. Samia and Lina were supposed to run the donut shop."
Memoza opened its Honey Dew franchise in Raynham, Massachusetts (the "Memoza Location") in June of 2011, under a lease with Linear Properties ("Linear"). Zacharakis testified that he, the Debtor, and Carlos agreed to and became personally obligated under the lease. Zacharakis testified that the Memoza Location opened after Memoza secured a $150,000 loan from Rockland Trust Company ("Rockland Trust") and the three members of Memoza agreed to and guaranteed the obligation to Rockland Trust. To secure the loan, Zacharakis testified that he pledged $50,000 in cash and that Carlos pledged his house. According to Zacharakis, the Memoza Location served as both a Honey Dew retail location and a baking facility which supplied goods and products to other Honey Dew locations.
Zacharakis testified that the Honey Dew franchisor insisted that a second Honey Dew franchise location be opened soon after the opening of the Memoza Location. On August 12, 2011, M & Z was formed as a Massachusetts limited liability company for, as Zacharakis testified, the purpose of operating a second franchise location. In February of 2012, an Operating Agreement was entered into by and among the Debtor, Zacharakis, Samia and Maria, as members of M & Z (the "M & Z Operating Agreement"). M & Z had no managers, and its affairs were managed by its members based on the Membership Percentage Interest as set forth on Schedule A to the Operating Agreement which provided:
Member Capital Percentage Contribution Interest Jamie Melo $1,350 45% George Zacharakis $1,350 45% Samia Melo $ 150 5% Maria Zacharakis $ 150 5%Total $3,000 100%
On March 16, 2012, Honey Dew Associates, Inc., as franchisor (hereinafter the "Franchisor") entered into a Franchise Agreement with M & Z, as franchisee (the "M & Z Franchise Agreement"). Zacharakis testified that M & Z opened a Honey Dew location at a Mobil gas station managed by Zacharakis located at 1095 County Street in Taunton, Massachusetts (the "M & Z Mobil Location") in the fall of 2011,
According to Zacharakis, neither Carlos nor Lina were offered ownership interests in M & Z because a dispute among the parties arose in the spring of 2011 involving the construction and permitting of the Memoza Location which had been directed by Carlos. As a result of this dispute, Zacharakis testified that he and the Debtor "had to pay off Carlos" as Carlos had sold his house in May of 2012, apparently to satisfy his guaranty of Memoza's obligation to Rockland Trust. Zacharakis testified that, by agreement, he and the Debtor became obligated under a promissory note in favor of Carlos in the principal amount of $135,000 (the "Carlos Note").
Memoza and M & Z experienced financial problems early in their operations. During 2011 and 2012, the Debtor made loans to the business and asked Zacharakis for loans to help sustain business operations.
In order to explain the circumstances surrounding the advancement of loans by Zacharakis, his eventual departure from the business, and his claims against the Debtor, the operations and banking practices of Memoza and M & Z from inception through 2013, as described by Zacharakis, the Debtor, Lina, and Samia are pertinent.
Zacharakis described the roles of each principal in the day-to-day operations of Memoza and M & Z:
Although Zacharakis's operational role was limited, he testified that he hired a number of friends and family members as accountants, bookkeepers and attorneys for the Companies. With respect to the Debtor's involvement, Zacharakis testified that the Debtor took a more active role after Carlos left the venture:
Zacharakis testified that the Debtor would call and text him on a daily basis with sales information during the period of 2011 through early 2013. Zacharakis had limited knowledge of operational issues, such as whether M & Z ever paid Memoza for any of the baked goods or products it received from Memoza. According to Zacharakis, although the store locations were managed by Lina, Vanessa and Samia, the Debtor was overseeing the operations of all three locations, paying the bills for each and controlling the checkbooks for checking accounts maintained by Memoza and M & Z at Citizens Bank.
Lina testified that she was a store manager at the Memoza Location from 2011 to the beginning of 2014, and that she and Samia generally managed that location at different times of the day because of the long hours required. According to Lina, it was initially agreed among the parties that she and Samia would run the day-to-day operations of the stores. She shared responsibilities with Samia for placing orders, scheduling shifts, managing employees, and compiling "cash and balance" weekly reports to submit to the Franchisor. She described the process of compiling those reports: "[E]very day we count the cash, enter in what our credit cards are, gift cards, and then that's whatever the amount is that gets deposited[,]" and the reports would then be emailed to the Franchisor on a weekly basis.
According to Lina, the Debtor was generally not present at the stores during the work week. She testified that he did not work at the counters or cash registers, supervise employees or handle either hiring or firing employees. She said the Debtor was not in charge of the day-to-day operations at the stores and did not handle the cash deposits as those were handled by her and Samia on a daily basis. She also maintained that the business suffered from cash problems starting in 2013.
According to Lina, the Debtor was "mainly" responsible for paying the Memoza bills, that she did not pay them, and that she never observed Samia paying them. She testified that the Debtor would sign checks payable to "Perkins," a large food and dry goods supplier, which she would give to Perkins when it delivered food and supplies to the stores. With respect to regular monthly bills, such as utilities and rent, Lina testified that those bills also were paid by the Debtor.
Lina testified that Zacharakis would stop by the store in the mornings to see if anything was needed. Otherwise, she observed, he did not pay any bills. She testified that she never checked bank balances as she had no access to, or signatory authority with respect to the LLCs' bank
The Debtor recounted his own management role in the venture as more limited than the role Zacharakis and Lina described. His testimony was often evasive and sometimes cryptic with respect to day-to-day management issues. He repeatedly claimed ignorance about critical operational issues such as the amount of bank balances at various times, whether M & Z paid Memoza for supplies and products, and whether M & Z or Memoza paid employees who worked at both locations. He reiterated at several points during the trial that the business had cash problems since "day one" and that the business was in constant need of cash: "Things just kept falling behind and in order to go forward we'd have to put money in." Samia agreed; Lina, however, maintained that the cash problems started in 2013. The Debtor testified that he personally loaned funds to pay mortgage, rent, and utility expenses for the business, and such loans have never been repaid to him. The parties stipulated that the Debtor made loans totaling $124,734 to Memoza and M & Z between 2011 and 2014.
The Debtor repeatedly suggested that Samia and Lina truly operated the business, with input from Zacharakis, and that he was merely there to "help out" and do "whatever I was asked to help with" because he had a full-time job at the Sheriff's Department, often working more than 40 hours per week. He maintained that he did not visit the stores on a day-to-day basis and would typically visited on weekends or during the week if he had a day off. He testified that Samia managed the three store locations at different times, and that "she did everything," although he was generally vague in his description: "She did daily duties, whatever the daily duties were." He said he did not supervise Samia with respect to deposits or in any regard and that "it was her business," not his. Nonetheless, the parties stipulated that the Debtor instructed and directed the work of employees when he was on site at a franchise location. He also signed numerous checks on the business accounts as discussed in greater detail below. With respect to paying bills, the Debtor testified that he did not always check bank account balances prior to writing checks. He further testified that Samia and Lina were both authorized signatories on the business checking accounts and that he often relied on them for determining what bills to pay:
The Debtor also maintained that he received input from Zacharakis when determining what bills to pay. The Debtor testified that Samia and Lina had control of the business checkbooks, adding that he sometimes had custody of them.
With respect to monitoring sales information of Memoza and M & Z, the Debtor testified that he would call and text employees at the franchise locations at the end of their shifts to obtain sales volume information and would then pass the information along to Zacharakis. He stated that he otherwise did nothing with the information, and he did not check to see whether deposits were being made on a daily basis
Samia testified that it was she, and not the Debtor, who ran the day-to-day operations of the business, with Lina's help, and that she was the person most knowledgeable about the bills, financial condition and cash position of the business. She said the Debtor would come to the stores on the weekends when she worked and only came during the week when he had a day off from work. She conceded that she sometimes paid vendors, such as Perkins, by check even when she knew there were insufficient funds in the bank accounts to cover the checks, hoping that there would be sufficient funds to honor the check when it was later cashed. She said that the Debtor paid a number of the business bills by check, including Perkins and the utilities, that she did not direct him to do so, because "he was ... trying to help us." When examined by the Court regarding why the Debtor signed checks when she had the checkbook and the ability to sign checks, she replied "[H]e will [sic] do that just to help out ... doing something to help." She testified that she and the Debtor both balanced the checkbooks, although they did it separately and that the Debtor did it "towards the end." According to her, Zacharakis was generally "not around" to sign checks but she would give him "updates of everything that was going on" every morning when he would stop by the stores until 2013, when their communication stopped. She maintained that the business was "not doing well" from the beginning, that it required personal loans from the partners.
Memoza and M & Z each maintained separate payroll and operating accounts at Citizens Bank. The parties introduced into evidence bank statements with respect to the Memoza Payroll Account (#4374), the Memoza Operating Account (#4382), the M & Z Payroll Account (#9327), and the M & Z Operating Account (#9319), as well as copies of numerous checks issued from these accounts. The Debtor testified that he was a signatory on all of the Citizens Bank accounts and that he had on-line access to those accounts as well. The Debtor also maintained seven (7) personal bank accounts at Citizens Bank. In general, the Debtor's testimony about the Companies' banking practices, including the facts surrounding electronic funds transfers and the issuance of checks, was vague and evasive. He frequently responded "possibly" when asked if he made certain electronic transfers and "I don't know" regarding the details of certain transfers. He also consistently maintained that anyone else with electronic access to the accounts could have also made the transfers. With respect to the issuance of certain checks signed by him which were introduced into evidence, the Debtor frequently testified that he signed checks at the direction of Samia and Lina.
The Debtor initially testified that he did not recall transferring funds between his personal accounts and the Companies' accounts, but then acknowledged doing so when presented with evidence of several electronic transfers of funds between one of his personal accounts and the LLCs' bank accounts during the summer of 2013.
With respect to the Memoza Operating Account bank statement for August of 2012, there were seven electronic transfers made on August 29, 2012, four of which went from the Memoza Operating Account into the Memoza Payroll Account. When asked who made those transfers, totaling $950, the Debtor initially said he did not know, but then conceded that it could have been him. He could not explain the reasons for the transfers or the circumstances surrounding the transactions. He said Lina or Samia could have made the transfers, but he could not recall whether anyone other than himself made transfers. He testified that anyone with access to the account passwords could have made the transfers and that the Debtor, Zacharakis, Lina and Samia all had passwords for the business accounts. He explained that he knew this because he got calls from each of them at different times to tell him there was no money in one or more of the accounts. He denied that they called him because he was "running the finances of the company" and that it was more likely they called him because he was putting so much money into the business. Notwithstanding the Debtor's contention about her access to the Citizens Bank accounts, Lina testified that she had no access to, or signatory authorization for, those accounts.
Similarly, when shown bank statements reflecting numerous inter-company electronic transfers among the Memoza Payroll and the Memoza and M & Z Operating accounts in April and July of 2013, the Debtor testified that he could have made the transfers but could not explain the details surrounding them. Many of these transfers involved small amounts of money and occurred on the same date. The Debtor could not recall or explain why multiple electronic transfers were made to and from business bank accounts on the same day. When Samia was asked whether she made any electronic transfers between the business and personal accounts, she initially testified that she did not remember, but later said she may have effected such transfers to reimburse herself or the Debtor for business expenses paid personally by them. She said that she had receipts for expenditures which were given to the bookkeeper and that she and Lina maintained a book to record cash expenditures at the office although she did not know the present location of the book. She added: "[I]f I knew ... that I was going to be here one of these days ... I would have kept everything."
The Debtor testified several times during the trial that he only signed checks for certain creditors, usually at the direction of Samia or Lina, and that he did not sign payroll checks. The parties introduced Memoza Operating Account checks signed by the Debtor in the spring of 2012, which were made payable to suppliers Perkins and Garelick. When asked why he wrote those checks, he said he was directed to by Samia and Lina and that otherwise "I wouldn't know who to write the check to."
Several M & Z Operating Account checks were also introduced into evidence, made payable to some vendors, the Debtor's personal attorney, and the owner of the M & Z Prestige Location. As with the Memoza bank accounts, the Debtor testified that he did not check the account balance prior to signing these checks.
The Debtor testified that "The Jamie Melo Memorial Fund" (the "Fund") was established for his son in 2006 after his mother died. The Debtor testified that the Fund maintained its own bank account, on which the Debtor was the sole signatory, and which was separate from and had nothing to do with Memoza or M & Z. A series of checks issued in the name of the "Jamie Melo Memorial Fund" but bearing the account number for the Memoza Payroll Account were introduced into evidence. The checks were issued in August and October of 2013, totaled approximately $370, and were made payable to vendors of the LLCs. When asked why the checks had the Memoza Payroll Account numbers, the Debtor initially said he was confused and replied "That I would not be able to explain. I have no idea, sir[.]" The Debtor later explained that the Fund checks were issued by Citizens Bank with the Memoza Payroll Account number due to his on-line banking "profile," that his social security number may have been linked between his personal accounts and the LLCs' accounts at Citizens Bank. When asked whether he did anything to address this matter after receiving his monthly bank statements for the Fund, he replied "No, I didn't. Shame on me." The parties stipulated on the record that the amounts reflected on the Fund checks were actually paid from the Memoza Payroll Account.
In the summer of 2013, cash deposits into the Memoza Operating Account ceased and never resumed, even though Memoza was conducting business during that time.
When asked what happened to the cash deposits that should have been made during the months of the MDOR "freeze" on the Memoza account, the Debtor testified that the cash generated by Memoza was deposited into the M & Z bank accounts. Although he said he understood that Memoza and M & Z were separate entities with separate expenses, employees and tax obligations, the Debtor said the M & Z bank accounts were used to deposit cash generated by both entities. He said that Memoza and M & Z bills were both paid from the M & Z accounts, and he denied that funds were deposited into the M & Z account to evade creditors, specifically Carlos.
Samia testified that either she or Lina made cash deposits on a daily basis, including on Sundays, and that Memoza cash was deposited into M & Z accounts after the MDOR "froze" the Memoza account. She said that she would open the Memoza Location at 5:00 AM and that Lina would then come to the Memoza Location after collecting all cash from the M & Z Locations in the mornings. Samia said that the cash was "pulled" early in the morning. The money would then be counted and a deposit slip would be prepared by one of them. According to Samia, either she or Lina would later deliver the cash deposit to the bank with the completed deposit slip. She maintained that from the time the deposit slip was prepared until the time of deposit, no one could have taken cash. She said that she and Lina were the only ones with access to cash on a daily basis, and that neither she nor Lina stole any money. She testified that the Debtor "never" had access to cash but then said he would occasionally handle a deposit on a Saturday, but only after she had counted the cash and prepared the deposit slip.
Lina testified about the "cashing out" process which occurred at the end of every shift:
When asked about how cash was handled, she explained:
According to the Amended Stipulation of Facts, the Debtor admitted that he "would remove money from the cash registers on certain occasions when he was at a franchise location[,]" but he maintained at trial that he did so to repay himself after he had personally paid a business expense and that he or Samia would send receipts for these expenditures to the bookkeeper. The Debtor testified that he would purchase print shop items and goods from local supermarkets for which he would submit a receipt and be repaid from the cash register by Lina or Samia. He maintained that he otherwise "never" took any cash from Memoza or M & Z. The Debtor reported that some expenses and employees, including bakers, were also paid in cash. He was able to identify some, but not all of, the bakers by name but could not say how much or how frequently they were paid in cash as there were no records or accountings of the cash payments as far as he knew. When asked whether those employees were paid partly or completely in cash, the Debtor said that some received checks in addition to cash but that Lina and Samia actually made the determination about the method of payment. "I did sign some checks, but I didn't make that determination."
Lina testified there were "cash problems" with the business beginning in 2013. She testified that she and Samia were supposed to receive $500 per week in salary for their work at the stores but that frequently, after 2012, there was not enough cash to support those payments, and they would take a lesser amount. Sometimes, she testified, she was paid in cash "when supposedly there was no money and we kind of would hold off on getting paid so that it wouldn't go through payroll ... so we would hold off and get paid in cash instead." She was vague about the number of times this occurred, testifying that it could have happened between five and ten times involving "probably" less than $2,000, but she seemed unsure about her answer. She also maintained there were a few times when others were paid in cash "but for the most part everybody got paid by check unless there was an issue with the payroll." She estimated that fewer than four employees were paid in cash. She said the Debtor sometimes advised her to tell employees not to cash their Friday paychecks because there was no money in the bank. She testified that no records were maintained about which employees were paid in cash, how much or when they were paid, but that Samia usually made the cash payments to employees. When asked whether employees could have received more than $10,000 in cash, she equivocally replied that she did not think so, but said "I could be wrong." Lina maintained that vendors were not paid in cash: "You can't pay cash to vendors ..." and that they were paid "by check on delivery."
The parties introduced an email sent by the mother of three Memoza and M & Z employees to the customer support department of the Franchisor in February of 2013, in which she complained that "The Manager, Jamie [Melo], has held checks several times without explanation, their checks have been returned by the bank for insufficient funds on more than one occasion
The Debtor testified that he handled the electronic submission of meals tax returns to the MDOR for both LLCs during the entire period they were in business at the request of Zacharakis, Lina, Carlos and Samia at a meeting held among them on an unknown date. He said that this practice began in 2011 and that he performed this function until the business closed in 2014, using sales figures supplied to him by Samia and Lina. He said that Memoza and M & Z did not always have sufficient funds in their bank accounts to pay the meals taxes when they became due. In such cases, the Debtor testified, he would discuss whether to pay the taxes, or some other outstanding bill, with Zacharakis before he resigned from the Companies and later with Samia and Lina. "It would be, do we pay the rent? Do we pay the meals tax? What do we pay?" The parties stipulated that the Debtor signed all tax returns for both LLCs for the years 2013 and 2014. The Debtor testified that he did not always check bank account balances prior to issuing a check to the taxing authorities.
Zacharakis testified that the Debtor called him in November 2011 to report that the business had slowed down and to request a loan from Zacharakis to pay rent for the Memoza Location. He said he wrote a check directly to Linear, Memoza's landlord, at the request of the Debtor, who represented to Zacharakis that he was also loaning money to the business. Zacharakis testified that he made ten to fifteen loans in the approximate total amount of $83,000. Some of the loan proceeds were used to pay Linear or were sent directly to Memoza and/or M & Z at the request of the Debtor through June 2012.
The Debtor maintained that he would ask Zacharakis for loans after being told by Samia or Lina that cash was needed to pay a particular creditor. The Debtor testified that he also made loans to Memoza and M & Z, and the parties stipulated that the loans totaled $124,734.12. He also said that Samia, Lina and Zacharakis frequently asked him "to put money into the business" whenever supplies were needed or creditors needed to be paid. Despite the problems with the business, the Debtor testified that he could not seek assistance from Carlos, who had left the business, or Lina, who had no money, and that Zacharakis was the only other available source for loans among the partners. The Debtor testified that he spoke to, or met with, Zacharakis every morning during this time period to provide sales information and discuss the business, although they did not discuss bank deposits.
According to Zacharakis, he called a meeting among the partners in November 2012 "to help us see why [the business] needed all the money," to make suggestions to improve business operations and to ask for control of the business checkbooks. This was the first time, Zacharakis said, that he became involved in the financial operations of the business. Zacharakis testified that he, Maria, Samia, and Lina attended the meeting, but the Debtor did not attend. At the meeting, he testified, he requested control of the checkbooks and made suggestions about improving business operations. He further testified that his requests and ideas were rejected by the Debtor who called him later in the day to tell him "to get out of the business" if he did not like the way it was being operated. Zacharakis was concerned: "[W]e looked at the numbers from the bank and the money should have been there and it was not there." Samia said that she did not give Zacharakis control of the checkbooks because all members, including the Debtor who was not at the meeting, had to discuss the matter. According to Samia, no full member meeting was ever called or held.
Zacharakis testified that he decided to seek a buyout of his interests in the business after the November 2012 meeting, and that he and Maria approached the Debtor for a buyout in January of 2013 after meeting with an attorney, but no agreement was reached. At some point in late 2012 or early 2013, Zacharakis and the Debtor stopped speaking directly, although their respective attorneys exchanged correspondence. On February 2, 2013, Attorney Paul Prew, who represented Zacharakis and Maria, sent a letter to the Debtor as the "de facto Operator" of Memoza and M & Z, requesting a buyout and indemnification of liabilities for Zacharakis and Maria. Zacharakis and the Debtor both testified that the Debtor did not respond to the overture, and the Debtor maintained that he did not want to buy their interests and had no money to do so.
On March 6, 2013, Zacharakis executed letters of resignation with respect to Memoza and M & Z (the "Resignations"). Each letter provided "Although I do not have record of official appointment of such, but to the extent recognized by law, I hereby resign as Director and Officer of [the LLCs] ... effective immediately." At that point, Zacharakis testified, he concluded that the business needed to be sold.
In the fall of 2013, a potential buyer, Sunil Patel, was identified to purchase the franchise locations but no sale was consummated because, according to Zacharakis, "the numbers were not adding up to the amount that we were trying to sell to him for." Attempts to sell to other potential buyers also were unsuccessful, according to Zacharakis, because they asked for financial information and "we couldn't get to them — the information to them fast and they dropped off." Zacharakis maintained that he allowed the business to continue after it showed signs of distress rather than close operations because he did not want to lose his investment.
After Zacharakis resigned, the Debtor testified, he would determine whether to pay the MDOR after consultation with Lina and Samia. "I'd ask them if I can pay it and they would say yes or they would say no, hold off." He testified that he worked with a CPA but did not review the tax returns or talk to the professional who prepared them prior to signing them. With respect to banking operations for Memoza and M & Z, the Debtor testified that Samia and Lina, until she left the venture in early 2014, handled the majority of the banking duties, including deposits and payroll and that he and Vanessa also performed some duties as well. When asked whether anybody else handled banking duties in 2013 and 2014, the Debtor replied: "Maybe the people that worked there. I wasn't there all the time, so I don't know. I couldn't answer that truthfully." He maintained that he did not know "how deposits were made [or] how they were compiled and calculated[.]" He also maintained that, to the best of his memory, every decision regarding which bill to pay from January 1, 2013 through the closure of the stores, which occurred in 2014, was made in consultation with Lina and Samia. On October 22, 2013, the Debtor's attorney, Attorney Michael Medeiros, sent a letter to Zacharakis's counsel concerning a potential sale of the LLCs in which he stated that the Debtor "is willing to allow [Zacharakis] until ... November 20, 2013 to conduct ... due diligence ... Thereafter [the Debtor] states that he does not believe he can continue with the day to day operations." When asked whether he considered himself the day-to-day operator at that time, the Debtor replied "I wasn't a day-to-day operat[or]. I did — I did help," and insisted that Lina and Samia were the day-to-day operators.
The M & Z Prestige Location opened in the spring of 2012 and operated as a kiosk at a gas station and car wash owned by a third party. The Debtor testified that the store performed poorly from the start, and that in the spring of 2013 a decision was made to close the store. Zacharakis testified that the Debtor handled the logistics of closing that location because he had a good relationship with the landlord and that "[the Debtor] told me that he had to leave [the equipment at the Prestige Location] to cover the lease." The Debtor testified at trial that he stored the M & Z Prestige Location equipment in his garage after closing the store, and he continues to possess it. At the Deposition, the Debtor testified to the contrary and maintained that he did not have possession of the Prestige Location equipment and that it "`had to stay'" at the site following the closure because "`That's what the lease said[.]" When asked at trial why he made conflicting statements, the Debtor replied that he was very angry and frustrated during the Deposition and conceded that he had lied. Zacharakis valued the equipment at $7,500, which the Debtor did not refute.
The Debtor and Samia both testified that they closed the Memoza store during the afternoon of March 16, 2014 because Samia was sick. Samia testified that she and the Debtor were working at the Memoza Location on that date when she "dropped on the floor in the middle of the store" and had to go to the emergency room. The Debtor and Samia both testified that Samia informed Jim Beland, the Franchisor district manager, of her illness. According to the Debtor he did not inform Zacharakis or any of the Companies' members, employees or staff of the closure. He
Zacharakis testified that he received a phone call from Jim Beland on March 17, 2014 informing him of the closure. Following that phone call, Zacharakis testified, he called Carlos, who owned and operated other Honey Dew franchises, and asked him to temporarily operate the locations "until we found someone to buy them." Carlos agreed. Zacharakis testified that he and Carlos met at the Memoza Location on March 17th whereupon they found that the store was closed and that Zacharakis's keys no longer worked. A locksmith was called, who changed the locks, Zacharakis testified. He and Carlos then gained entry to the store. "We walked inside to look around. The registers were there. The video equipment was there." According to Zacharakis, he did not give a key to the newly changed locks to the Debtor who was "nowhere to be found" and had "walked away" from the business at that point. Zacharakis said it was necessary to gain access to the store to determine if it was ready to open for business, otherwise "I was in default [under the Franchise Agreement]." Zacharakis testified that upon gaining entry, everything appeared in order in the store and that "it was ready to open as soon as we could get people to run the store."
The Debtor testified that at some point on March 17th, he was informed by Samia that "somebody went into our stores." He admitted going to the Memoza Location and gaining entry by pushing in the back door which was locked. Once inside, he testified, "I took the two registers, the DVR [surveillance recording system] and the [donut] filler machine, things they couldn't operate [without] the following day." When asked why he did this, the Debtor replied: "Because I didn't know what was going on, why they changed the locks...." When asked why he wanted the store closed, as opposed to getting someone in to operate it, he said "that's probably how I felt that day," and added, "It was a big mess after that." He said that he was very emotional about his wife's health and was upset. "Somebody came into the store and changed [the] locks and did all these things and I didn't know what was going on ... if there was something that we would have known what was going maybe the outcome would have been different, sir."
The Debtor testified that he transported the items he took from the Memoza Location to his house and returned the equipment a few days later after speaking with counsel. Memoza had also owned a laptop computer which Samia would take back and forth from the Memoza Location to perform work (the "Laptop"). At his Deposition, the Debtor denied having possession of the Laptop and testified that he did not know what had happened to it. At trial, the Debtor testified that Samia had possession of the Laptop. When asked about the conflict between his trial and Deposition testimony, the Debtor said he was "frazzled" at the Deposition.
Carlos also testified about the events of March 17, 2014. He testified that when he first viewed the store, there was no "cash and balance sheets," no computer and "any paperwork was totally gone." He recounted that when he returned to the location later, he realized the cash registers, jelly filling machine and camera system were
The Debtor initially testified that, in addition to equipment, he also removed cash register receipts from the Memoza Location on March 17th because he did not want them "to get lost" and because he did not want someone else opening the Memoza Location. He later clarified that he had approximately 100 boxes contained in garbage bags containing the "register receipts for every week ... or month," and that he did not remove the register receipts or any other paperwork from the Memoza Location on March 17th. Rather, he testified, he and Samia had been taking the receipts home "every so often" for storage over a period of time and eventually turned them over to the Debtor's attorney. With respect to other business records of the LLCs, the Debtor testified that he did not take them, does not have them and does not know what happened to them. When Samia was asked about the whereabouts of the cash register receipts she testified that because of the ongoing attempts to sell the business to Sunil Patel, "I did not keep any receipts at the store," and she took them home every night.
Carlos continued to run the Memoza Location and the M & Z Mobil Location after March 17, 2014, and, on May 23, 2014, he formally executed a Settlement Agreement with and among Memoza, M & Z, Zacharakis, the Debtor, Samia, Lina and Maria. All members signed the Settlement Agreement on behalf of the LLCs, in their capacities as managers and/or members of the LLCs and individually. The Settlement Agreement contained an acknowledgement that the LLCs had been formerly operated by the Debtor.
The Settlement Agreement
There was additional evidence introduced at trial regarding the potential valuation the LLCs could have achieved had all cash been deposited in the bank accounts. Such evidence, however, was speculative, unreliable and inconclusive.
Less than two weeks after the execution of the Settlement Agreement, on June 5, 2014, the Debtor filed his Chapter 7 bankruptcy petition. Zacharakis testified that following the Debtor's bankruptcy filing, he went to Debtor's counsel's office to review the Memoza and M & Z sales receipts which had been in the possession of the Debtor: "They were in plastic bags, but each box was separated by month and store and year." In addition, Zacharakis testified that he obtained copies of bank statements showing bank deposits "and we compared them to the store sales number [sic]." According to Zacharakis, there were some monthly periods where "no cash [was] being deposited into the bank accounts." He maintained that he also checked the Debtor's financial records with information sheets prepared by the Franchisor which reflected that the total cash which had not been deposited equaled approximately $168,000 from 2012 through 2014.
The parties submitted into evidence an agreed upon chart summary (the "Summary") as an exhibit, pursuant to Fed. R. Evid. 1006, prepared by Zacharakis after review of bank deposit records, Franchisor data sheets and daily sales receipts from cash register tapes for both Memoza and M & Z. The Summary compares the amount of cash sales for each LLC, as reflected in the cash register tapes (after subtracting for payments made by bank cards), to the amount of actual bank deposits for the same month, on a monthly basis, from April 2012 through March 14, 2014 (the "Reporting Period"). The Summary reflects the "difference" between the register tapes and the bank deposits. According to the Summary, and as discussed above, cash deposits into the Memoza account ceased in September of 2013 and did not resume. Also, there were significant negative differences between receipts and deposits for most other months during the Reporting Period for Memoza, ranging from -$1,580.43 (April 2012) to -$24,361.46 (June 2013). For example, the Summary reflects the following with respect to Memoza during November of 2012:
Nov. 2012 Register Tapes: $21,090.31 Bank Deposits: $12,706.13 Difference:-$8,384.18
The Summary also reflects that there were significant positive differences between the receipts and deposits for M & Z for most months during the Reporting Period. For example, the Summary reflects the following with respect to M & Z for the month of July in 2012 and 2013:
July 2012 Register Tapes: $16,558.88 Bank Deposits: $22,019 Difference: +$ 5,460.88 July 2013 Register Tapes: $16,152.14 Bank Deposits: $34,356 Difference:+$18,203.86
Zacharakis testified that the surplus deposits into the M & Z accounts did not offset the negative Memoza deposits. The Summary reflects that a total of $168,311.78 in cash was taken in by Memoza or M & Z during the Reporting Period which was not deposited into their bank accounts. The Summary was supported by Zacharakis's analysis of cash register receipts compared to cash deposits on a daily basis. That analysis reflects that there were only a few days during the entire Reporting Period on which the cash receipts for M & Z or Memoza nearly equaled the cash deposits into the bank accounts.
Zacharakis initially testified that his examination and analysis of the bank records led him to conclude that the Debtor stole cash from the business causing it to fail.
Zacharakis maintained that this conclusion was reasonable because the Debtor "had control of the checkbooks and he was there daily and he was the one running the businesses." Later in the trial, Zacharakis's tempered his position and said the Debtor "could have taken it" although he admitted that he did not directly see him do it. When asked whether the other partners or employees could have stolen cash from cash registers, paid expenses or purchased products directly from cash on hand, Zacharakis conceded that it was possible although he did not think so. He also testified that he saw no vendor receipts indicating that expenses were paid in cash, that he never reviewed the payroll records for Memoza or M & Z, and that the Debtor never told him that he was paying people in cash. Zacharakis did not proffer an expert witness to interpret the Summary or underlying records.
The Debtor testified that he did not review the Summary prior to trial and did not know if it was accurate, although his counsel stated that there was no dispute about the calculations reflected in the Summary. He also said he did no investigation upon learning that Zacharakis had claimed there was approximately $168,000 in missing cash deposits. The Debtor was unable to provide any cogent explanation for why the cash receipts did not match or approximate the cash deposits, as reflected in the Summary, although he conceded that he wished he "had done a better job" and added "It [wasn't] just me. This company was owned by all of us." The Debtor testified that Samia and Lina paid themselves and employees and "bought stuff for the business" with cash, but he conceded that such expenditures did not fully account for the approximately $168,000 in missing cash deposits. He later testified that he was not on site at the stores enough to make an informed explanation for the missing cash but that Samia would know. He also said that some vendors, including Perkins, may have been paid in cash. Although Lina testified that vendors, such as Perkins, were paid only by check, the Debtor said that he and Samia sometimes obtained product directly from Perkins at its wholesale location on a cash and carry basis and later sought reimbursement for their expenditures. "I would either
Samia also testified about why the amount of cash sales reflected by the cash registers did not equal the amount of cash deposited in the bank. "[W]e used a lot of cash to pay a lot of people and a lot ... of other things." Samia said she made cash payments from the registers to her and Lina for their work (up to $500 per week for each) and their gas expenses (up to $50 per week for each) and that she also made cash payments to some of the bakers, to Perkins for cash and carry items and to employees whose paychecks had been dishonored. She testified that "everybody knew what was going on" with respect to the expenses paid in cash, including Zacharakis who had access to the bank accounts. She maintained that she and Lina would take between $1,500 to $2,000 on a weekly basis in cash from the cash registers to pay themselves, the bakers, employees and Perkins. She added that the LLCs incurred high bank fees because of returned checks.
The Debtor summed up his position with respect to the Companies' constant need for cash:
He summed up his management style: "I was not a good business owner, sir."
As discussed above and further below, the LLCs are not plaintiffs in this adversary proceeding, and Zacharakis did not assert or plead his claims against the Debtor as derivative claims on behalf of the LLCs. See Mass. Gen. Laws ch. 156C, § 56 (permitting members to bring suits on behalf of an LLC and in its name, subject to certain conditions). Zacharakis's claims against the Debtor are a mix of allegations which he claims caused losses to him both as a member of the LLCs and individually. As a further complicating factor, the members of the LLCs transferred, prepetition, all of their membership interests in the LLCs to Carlos under the Settlement Agreement. The Court issued the May 13, 2016 Order to afford the parties the opportunity to address legal issues related to standing presented by the facts in this case. Specifically, the Order required the parties to address the following issues: 1) whether Zacharakis has direct claims against the Debtor or whether such claims are owned by the LLCs and should have been asserted derivatively on behalf of the LLCs; 2) whether the current status of the LLCs precludes a derivative action against the Debtor; 3) whether Zacharakis established the existence of debt owed to him by the Debtor for purposes of § 523 (a)(2), (4) and/or (6); 4) what are the rights of the other members of the LLCs, who are not parties to this adversary proceeding, to any recovery asserted by Zacharakis; and 5) whether the Debtor, who never
Zacharakis maintains that the Debtor assumed control of the management and financial operations of the business and did so in an improper, deceptive and reckless manner and in violation of the fiduciary duty he owed to all members of the Companies. Zacharakis maintains, that as a result, he has been held personally liable for many obligations of the Companies and demands on him for monies owed continue although he did not quantify that amount. He asserts that the Debtor owes him a debt equal to the amount of (1) cash which was not deposited by Memoza and M & Z into their bank accounts during the Reporting Period ($168,311.78)(the "Missing Cash"); (2) the value of equipment missing from the M & Z Prestige Location ($7,500) (the "Prestige Equipment"); (3) the amounts Zacharakis loaned the LLCs ($84,211.16) (the "Loans"), which he asserts he would not have loaned had he known that the full amount of cash sales was not being deposited into the LLCs' bank accounts; and (4) the amount he paid to Carlos under the Settlement Agreement to assume debts of the LLCs ($8,000) (the "Carlos Payment"),
In Zacharakis's supplemental memorandum filed in response to the Court's Order dated May 13, 2016, he expounded upon his standing to assert claims against the Debtor. With respect to the Loans, he maintains that even though the funds "passed through" the LLCs, the Debtor is not shielded from a direct claim because the Loans were personally solicited by the Debtor and procured through false pretenses, relying on
With respect to the issue of whether the current status of the LLCs precludes a derivative action, Zacharakis advances a confusing argument. He maintains that "corporate existence [of the LLCs] was
With respect to Zacharakis's standing to assert an exception to discharge for a debt owed to him by the Debtor with respect to the Missing Cash and the Prestige Equipment, he maintains that "If the present claims are qualified as a derivative action, those claims may be asserted derivatively by Zacharakis as a Member." He offers no legal support for this theory and simply asserts that "the missing cash and equipment is a non-dischargeable debt to the LLCs...." adding that the other members of the LLCs have no right to participate in any recovery awarded to Zacharakis for his direct claims although they may have a claim for a proportionate award for the "derivative claims of Zacharakis." In such a case, he asserts, he would be entitled to attorneys' fees expended by him to achieve an award against the Debtor, citing numerous cases involving the award of attorneys' fees to a party who successfully brings a derivative action.
With respect to the issue of whether the Debtor waived the defense of Zacharakis's lack of standing, Zacharakis argues at length that he, individually, has standing to assert claims against the Debtor. Although his argument is difficult to follow, he appears to contend that he can now assert derivative claims on behalf of the LLCs with respect to the Missing Cash and the Prestige Equipment because he owned his membership interests in the LLCs at the time of the LLCs' injury, citing Fed. R. Civ. P. 23.1, the procedural rule governing derivative actions by shareholders, and
Lastly, Zacharakis relies on the doctrine of jus tertii standing and maintains that he should not be constrained by prudential limitations on his assertion of the LLCs' rights against the Debtor in a case such as this where practical obstacles prevent the LLCs from asserting rights on their own behalf, citing
The Debtor maintains that he is not responsible for the failure of the business and that he became involved in business operations "only out of desperation" to help Samia and Lina. The Debtor contends that Zacharakis, who had experience in operating retail businesses, breached his fiduciary duty when he failed to assume operations of the business while he "had managerial control, ownership control and [a] relationship with the LLCs' lawyer, accountant and bookkeeper." With respect to Count I of the Complaint, based on § 523(a)(4), the Debtor asserts that Zacharakis did not establish that the Debtor committed fraud or defalcation while acting in a fiduciary capacity or converted any funds, committed larceny or embezzled any funds. He argues that the business was undercapitalized from its inception, that Zacharakis failed to establish that the Debtor stole cash from the business, and that the total cash paid to employees, to Perkins and other suppliers, and to Samia and Lina "more than explains the cash discrepancy" reflected in the Summary.
With respect to the allegations contained in Count II of the Complaint based on § 523(a)(2)(A), the Debtor asserts that "the evidence is void of any misrepresentations made by [the Debtor] to Zacharakis." With respect to Count III, the Debtor maintains that Zacharakis's claim under § 523(a)(6) is based on the same allegations as Counts I and II. In sum, the Debtor maintains that Zacharakis failed to sustain his burden of proof, citing
With respect to the standing issues, the Debtor first asserts that Zacharakis's claims against the Debtor with respect to the Missing Cash and the Prestige Equipment are claims that belong to the LLCs because they allege wrongs against, and damages to, the LLCs, citing
Second, the Debtor contends that Zacharakis has no standing to assert any derivative claims on behalf of the LLCs against him because Zacharakis does not have a "continuous" membership interest in the LLCs. He adds that Carlos was the only member of the LLCs on the petition date and that his general release of the Debtor in the Settlement Agreement precludes any claim by Zacharakis on behalf of the LLCs against him. Given these facts, the Debtor asserts, Zacharakis lacks constitutional standing to bring derivative claims against him, a defect which is not waivable by him, citing
With respect to the Loans, the Debtor argues that no debt exists from the Debtor to Zacharakis because the Loans were made to the LLCs and not the Debtor personally. Likewise with respect to the Missing Cash and Prestige Equipment, the Debtor maintains that Zacharakis failed to
Before the Court can determine whether any of the exceptions to discharge have been proven by Zacharakis, it must first determine the threshold and related issues of whether Zacharakis has standing to assert claims against the Debtor and whether there is any debt owed by the Debtor to Zacharakis.
Standing is a "threshold question in every federal case, determining the power of the court to entertain the suit."
For the reasons stated below, the Court finds that Zacharakis has neither constitutional nor prudential standing to
Zacharakis filed the Complaint "individually and as he is Member of Memoza Enterprises, LLC and M & Z Enterprises, LLC." In his Complaint, Zacharakis did not name either LLC as a plaintiff, and he did not expressly assert his exception to discharge claims against the Debtor in the Complaint as a derivative action on behalf of the LLCs. In some portions of the Complaint, he alleges damages to the LLCs, however, the prayer for relief with respect to the surviving Counts I through III provides: "WHEREFORE, Plaintiffs respectfully request this Honorable Court: 1. As to Counts I, II and III, determine the debt owed to the Plaintiffs by the Debtor in the amount of $269,423.38 as not dischargeable pursuant to 11 U.S.C. §§ 523(a)(4), 523(a)(2)(A), and 523(a)(6)...." (emphasis added). The term "Plaintiffs" is not defined in the Complaint and appears only once in the foregoing quoted prayer for relief. Zacharakis is defined as the "Plaintiff" in the Complaint, and the Court concludes that the reference to "Plaintiffs" in the prayer for relief is not substantive and is a typographical error; it is solely a reference to Zacharakis. Accordingly, the Court concludes that Zacharakis is asserting only direct claims against the Debtor in this adversary proceeding and not derivative ones on behalf of the LLCs, nor could he as discussed below.
The next inquiry is whether Zacharakis has standing to assert direct claims against the Debtor with respect to the Missing Cash or the Prestige Equipment or whether those claims, which involve alleged wrongs which injured Zacharakis (and the other members), as well as the LLCs, are truly the property of the LLCs and should have been asserted as a derivative action on their behalf.
In
The Missing Cash and the Prestige Equipment constituted property of the LLCs, not Zacharakis. The alleged embezzlement and misappropriation by the Debtor of those assets did not harm Zacharakis directly. Rather, any losses related to these assets were suffered directly by the LLCs, and Zacharakis's losses were an indirect loss of his investment value in the LLCs. As the LLCs are the owners of the claims relating to the Missing Cash and the Prestige Equipment, the claims should have been asserted as a derivative action on behalf of the LLCs and not as a direct action by Zacharakis against the Debtor.
The allegations here are analogous to those asserted in
To the extent Zacharakis relies on a direct claim against the Debtor with respect to the Missing Cash and the Prestige Equipment because a derivative claim on behalf of the LLCs is unavailable or difficult to establish, as was the case in
To the extent Zacharakis attempts to recast his Complaint to now assert derivative claims on behalf of the LLCs with respect to the Missing Cash and the Prestige Equipment, such an attempt is impermissible and also would be futile. First, Zacharakis did not comply with the applicable statute and rules of procedure governing derivative actions. Section 56 of Mass. Gen. Laws ch. 156C permits any member of an LLC to sue on its behalf provided that such member is authorized to sue by "the vote of members who own more than fifty percent of the unreturned contributions," excluding those members who have an interest in the outcome of the suit that is adverse to the interest of the LLC. Mass. Gen. Laws ch. 156C, § 56(a). Additionally, Fed. R. Civ. P. 23.1, made applicable hereto by Fed. R. Bankr. P. 7023.1, governs the prerequisites and pleading requirements for derivative actions. The rule requires that a derivative action be instituted by a verified complaint which, among other things, must "allege that the plaintiff was a shareholder or member at the time of the transaction
Second, none of the past members of the LLCs, including Zacharakis, can pursue derivative claims on the LLCs' behalf against the Debtor.
Zacharakis appears to argue that because he established ownership of membership interests in the LLCs at the time the LLCs were injured and satisfied the contemporaneous ownership requirement of Rule 23.1, that he can now assert derivative claims on the LLCs' behalf with respect to the Missing Cash and the Prestige Equipment because the presentment and verification requirements of Rule 23.1 can be waived when defendants fail to assert those requirements prior to trial, see
The Court concludes that Zacharakis has no constitutional or prudential standing to assert derivative claims on behalf of
In addition, Zacharakis's assertion of jus tertii standing would be inappropriate in a case where there is no injury of a third party to redress. Even if Zacharakis were able to establish constitutional standing, the unique facts of this case weigh against a waiver of prudential standing. Although the Debtor did not file a dispositive motion in this adversary proceeding, many of the subtleties surrounding the standing issues were not apparent until after the entire record was presented at trial, at which time the Court afforded the parties the opportunity to brief the legal issues. Moreover, the Court cannot permit Zacharakis to assert barred claims. Accordingly, there is no threshold debt for purposes of determining an exception to discharge pursuant to 11 U.S.C. § 523 with respect to any losses sustained relating to the Missing Cash and the Prestige Equipment. See
The Court turns next to Zacharakis's claims based on losses relating to the Loans and the Carlos Payment which are not as clearly demarcated as "corporate claims" because they involved some degree of personal and individual loss by Zacharakis which was not shared equally by the other members. Zacharakis has asserted that all debts owed to him are excepted from discharge pursuant to 11 U.S.C. § 523(a)(4) (Count I), (a)(2)(A) (Count II) and/or (a)(6) (Count III). The Court will consider each count with respect to the Loans. The Court will not consider the above Counts with respect to the Carlos Payment as Zacharakis has advanced no theory for holding the Debtor liable for amounts he paid to Carlos, especially where the Debtor was required to pay Carlos twice the cash amount Zacharakis was responsible for under the Settlement Agreement. Moreover, the Carlos Payment claim appears to be a further complaint by Zacharakis about the value of his investment in the LLCs, which cannot form the basis of a direct claim. The Court will also not consider any evidence introduced at trial regarding the valuation the LLCs could have achieved had all cash been deposited as such evidence was speculative, unreliable and inconclusive.
Section 523(a)(4) provides:
11 U.S.C. § 523(a)(4). The standard of proof of each element of a § 523 claim is by a preponderance of the evidence.
Section 523(a)(4) of the Bankruptcy Code prohibits the discharge of an individual debtor from any debt for "fraud or defalcation while acting in a fiduciary capacity" 11 U.S.C. § 523(a)(4). In order for Zacharakis to prevail under this clause of § 523(a)(4), he must prove (1) that the debt in issue arose while the Debtor acted in a fiduciary capacity and (2) the debt arose from his fraud or defalcation.
The issue of whether a party is "acting in a fiduciary capacity" within the meaning of § 523(a)(4) is one of federal law.
The United States Bankruptcy Appellate Panel for the First Circuit in
This Court also has addressed the issue of corporate fiduciaries in the context of § 523(a)(4) in
In
Zacharakis faces a number of obstacles in his assertion of claims against the Debtor for fraud or defalcation while acting in a fiduciary capacity pursuant to § 523(a)(4). Although the Debtor may have owed Zacharakis and the other members of the Companies a fiduciary duty, Zacharakis did not establish that the Debtor acted as a trustee with respect to the funds advanced through the Loans. Unlike the case in
In addition to excepting debts from discharge which arise by fraud or defalcation while acting in a fiduciary capacity, § 523(a)(4) also prohibits the discharge of debts incurred by embezzlement or larceny.
The exception to discharge under § 523(a)(4) for embezzlement is inapplicable to the Loans which consisted of funds advanced by Zacharakis either directly to
Section 523(a)(2)(A) provides:
11 U.S.C. § 523(a)(2)(A).
To establish that a debt is excepted from discharge because it was obtained by "false pretenses, a false representation, or actual fraud," a creditor must show that 1) the debtor made a knowingly false representation or one made in reckless disregard of the truth, 2) the debtor intended to deceive, 3) the debtor intended to induce the creditor to rely upon the false statement, 4) the creditor actually relied upon the misrepresentation, 5) the creditor's reliance was justifiable, and 6) the reliance upon the false statement caused damage.
At trial, Zacharakis testified that he was receiving daily sales numbers from the Debtor at the time he was making the Loans and assumed at that time that all cash sales revenues were being deposited into the Memoza and M & Z bank accounts. He added that, had the full deposits been made, he would not have had to make the Loans in the first place. Based upon Zacharakis's testimony, his claim for nondischargeability with respect to the Loans under § 523(a)(2)(A) appears to be that the Debtor's failure to advise Zacharakis that all cash was not being deposited into the LLCs' bank accounts while he was reporting the daily gross sales figures to him constituted a misrepresentation of the Companies' true financial condition. Representations can be either express or implied. "A false representation is an express misrepresentation, while a false pretense refers to an implied misrepresentation of `conduct intended to create and foster a false impression.'"
Zacharakis is constrained in his claims for the Loans under § 523(a)(2)(A) for a number of reasons. First, Zacharakis has asserted no grounds, other than § 523(a)(2)(A) itself, to impose personal liability on the Debtor for the debts of the LLCs. He presented no evidence that the Debtor executed a guaranty or otherwise promised to personally repay the Loans which were advanced directly to the LLCs or Memoza's creditor, Linear. See
Second, the Court finds that Zacharakis failed to sustain his burden that he justifiably relied on the Debtor's recitation of daily sales figures when he funded the Loans. To constitute justifiable reliance, a plaintiff's conduct does not have to "`conform to the standard of the reasonable man[, as] [j]ustification is a matter of the qualities and characteristics of the particular plaintiff, and the circumstances of the particular case, rather than of the application of a community standard of conduct to all cases.'"
Although the Debtor's silence concerning the failure to make all cash deposits could have, in some circumstances, created or fostered a false impression, Zacharakis's reliance cannot be said to have been justified under the facts of this case. The LLCs were formed and the Franchise Agreements were signed shortly after Zacharakis met the Debtor, and the two did not have a long-standing relationship prior to undertaking the business venture. Additionally, Zacharakis knew that the Debtor had a full-time job at the Sheriff's Department and had little, if any, real experience running a business, let alone a fast food restaurant and coffee/donut shop which generated significant cash revenue. Zacharakis, on the other hand, was an experienced gas station manager and seasoned business person. While the Debtor lacked sophistication and business acumen, it is hard to understand how Zacharakis inquired only about gross sales figures and made no apparent, even cursory, inquiry about net income, expenses or cash management
Zacharakis cannot salvage his claim to the Loans under § 523(a)(2)(A) by reliance on the Supreme Court's recent ruling in
Zacharakis's reliance on
Lastly, the Court finds that Zacharakis failed to establish by a preponderance of the evidence that the Debtor committed "actual fraud" with respect to the failure to deposit all cash revenue. The Summary reflects that there were only a few days during the entire Reporting Period on which the cash receipts for M & Z or Memoza nearly equaled the cash deposited into their bank accounts. Based upon the testimonial evidence concerning the methods used for the daily cash collection and deposits, it is reasonable to infer that cash was taken or used on a daily basis, leaving it unavailable for deposit. The evidence is insufficient, however, to conclude that the Debtor, who was largely absent from the stores during the work week, diverted cash for personal or non-business purposes.
The Court concludes that the missing cash deposits are largely, if not completely, attributable to the Debtor's careless management of the business and the significant cash flow problems experienced by the business. Despite his assertions to the contrary at trial, the Court finds that the Debtor controlled the LLCs. Samia and Lina may have handled the bulk of the
Additionally, there was credible testimony that numerous legitimate business expenses, such as those for goods, products, wages, salaries, and gasoline were paid by cash and that the Debtor reimbursed himself in cash after paying business expenses, a claim which could have been refuted by the bookkeeper had she been called as a witness by Zacharakis. While the Debtor and Samia did not fully explain the disposition of all of the Missing Cash, the Court cannot ignore that the business continued to operate under the Debtor's management for more than a year after Zacharakis stopped funding the Loans. Thus, it is reasonable to conclude that most, if not all, of the Missing Cash was used to pay business expenses absent contrary evidence. Moreover, the Debtor himself loaned more than $124,000 to the business. It is unlikely that he was intentionally diverting cash in a fraudulent manner while simultaneously keeping the business afloat with his own money. Despite Lina's different recollection, the Court is inclined to believe the Debtor's contention that the business had cash problems from the outset and that it was in constant need of cash: "Things just kept falling behind and in order to go forward we'd have to put money in." Vendors, landlords, and the MDOR went unpaid or were paid late, the Companies bounced checks with resulting bank fees, and employees were told to wait to cash their paychecks. The Debtor personally funded some of the shortfalls through his own loans, but did not have the skills or financial sophistication to manage this business. Despite the negative consequences for Zacharakis, the Court finds that the Debtor was engaged in mismanagement rather than actual fraud. For the above stated reasons, the Court finds that Zacharakis has not sustained his burden under § 523(a)(2)(A) and shall enter judgment for the Debtor on Count II.
Section 523(a)(6) provides:
11 U.S.C. § 523(a)(6).
In
Zacharakis did not establish at trial that the losses connected to the Loans were due to a deliberate or intentional injury inflicted on him by the Debtor. To the contrary, the Debtor loaned more funds to the business ($124,734.12) than Zacharakis did ($84,211.16), and the Debtor remained liable on many business debts. There was insufficient evidence from which the Court could find that the Debtor intended to injure Zacharakis.
The Debtor was evasive and untruthful at several points during the trial, admitted to lying at his Deposition and took possession of LLC property on more than one occasion. To be sure, there are several unanswered questions about his conduct and why he continued to manage the business when he was clearly in over his head. The bases asserted by Zacharakis for claims against the Debtor, however, do not give rise to the finding of an exception to discharge against the Debtor for willful and malicious injury. The Court shall enter a judgment on Count III in favor of the Debtor.
For all of the above stated reasons, the Court finds that Zacharakis has not sustained his burden of proving an exception to discharge for any debt owed to him by the Debtor pursuant to 11 U.S.C. § 523(a)(2)(A), (4) or (6). The Court shall enter a separate judgment in favor of the Debtor with respect to all remaining counts in the Complaint, namely Counts I, II and III.
