ROGER L. EFREMSKY, Bankruptcy Judge.
On August 18, 2014, John Stirton ("Stirton") and Bonita Investments, LLC ("Bonita" and, together with Stirton, "Plaintiffs") timely filed a Complaint against defendant Matthew Castro ("Castro"), seeking a non-dischargeable judgment pursuant to Bankruptcy Code §§ 523(a)(2)(A), (a)(4) and/or (a)(6). This court held a trial on the Complaint over a four-day period between October 13, 2015, and October 16, 2015. At the conclusion of trial, the court requested post-trial briefs from the parties. The post-trial briefs were filed on February 1, 2016. Plaintiffs followed up their post-trial brief with an Errata on February 3, 2016. Thereafter, the matter was taken under submission. This Memorandum Decision constitutes this court's findings of fact and conclusions of law under Fed. R. Bankr.P. 7052.
As an initial matter, this section is intentionally brief and general. The brevity is made necessary by Stirton's failure (on behalf of Plaintiffs): (1) to establish a coherent timeline of events; (2) to recall the events that underlie the complaint in this case; and (3) to testify consistently regarding various events.
Stirton is highly educated, with an undergraduate degree in psychology, and a minor in mathematics from the University of California Davis. After approximately twelve years working in the electronics and telecommunications industry, he went back to school and earned a degree in mathematics from San Jose State University. Tr. Day 1 at 6:13-7:9. His work experience was primarily in telecommunications and consisted largely of test engineering, designing fixtures, product testing and helping in product development and programming. Tr. Day 1 at 7:10-8:16. While Stirton himself has no background in real estate, finance, or law, his wife is a legal secretary who, at the time of trial, had been working as such for over 25 years. Tr. Day 1 at 8:17-9:21.
Prior to meeting Castro, Stirton had invested over $100,000 with an investment counselor named Gregory Hannah ("Hannah").
Castro holds an undergraduate degree in Business Management from St. Mary's College of California. Tr. Day 3 at 49:3-7. Along with working as an account manager and sales person for Alameda Electrical Distributors, Castro is an employee and owner of his sole proprietorship, Bay Valley Realty ("Bay Valley") and a 51% partner in Bay Valley Property Management. Tr. Day 3 at 49:10-50:9.
Bay Valley was first established in 2005 and, at the time of trial, Castro was the broker and had one broker associate and three licensed realtors working for him. Tr. Day 3 at 50:10-51:12. Between 2010 and 2015, Castro estimates that Bay Valley had done an estimated 300 flipping projects with Castro acting as the broker.
Between 2010 and 2012, Stirton, through his LLC, Bonita,
In the preliminary discussions with Castro regarding these flipping projects, Stirton said that Castro told him the return on investment would be in the 20-30% range. Tr. Day 1 at 16:25-17:5. While Stirton only realized a return of somewhere between 2% and 22% on each of the three flipping projects, he testified that the actual returns gave credibility to the flipping projects undertaken by Bay Valley and its realtors and that, as a result, Stirton had a lot of confidence in Castro.
At some point in late-2009 or early-2010, Castro's home was going into foreclosure and he was introduced to a woman named Lori Arzamendi ("Arzamendi")
Castro testified that in the latter part of 2012, Arzamendi told Castro that she wanted him to meet a gentleman named James Wolfe ("Wolfe"), who was also allegedly involved with HSG. Tr. Day 3 at 68:6-9; 69:22-70:2. Castro testified that Arzamendi spoke very highly of Wolfe, allegedly representing to Castro that Wolfe seemed to be a good businessman, had "contacts", went to Michigan State, was part of the Magic Johnson Foundation, served in the Gulf War, and considered Colin Powell to be a mentor. Tr. Day 3 at 68:16-69:1.
Castro testified that he met with Wolfe multiple times in early to mid-2013. During these meetings, Castro learned about Wolfe's company, Revenue Generation Technologies ("RGT") and about various aspects of RGT's business from Wolfe and from others Castro met at the meetings. Castro recalled being very impressed with Wolfe and his operation and being left with the impression that RGT had experienced success in its various endeavors.
Stirton testified that in early 2013, he was holding funds in Bonita's bank account from the three flipping projects with Bay Valley and from the sale of his residence. Tr. Day 1 at 21:23-22:3. Stirton wanted to invest the funds so he and a colleague started looking for properties to flip on their own. They were unsuccessful, however, as the market had started to recover and prices on real properties were trending upward. Tr. Day 1 at 20:17-21:22.
In late May of 2013, Stirton met with Castro multiple times and expressed his interest in additional flipping projects or real estate investments. Tr. Day 1 at 24:11-29:12. Stirton testified that during the course of these meetings, Castro told Stirton that the market had changed and that there were no longer flipping opportunities, but that Castro had recently been introduced to Wolfe and RGT, and that RGT was a new company and "investment model" that Castro had been looking into. Tr. Day 1 at 176:1-7; Tr. Day 2 at 5:10-6:2. Stirton further testified that Castro told Stirton about Wolfe's alleged connections, shared his impressions of Wolfe, provided a copy of Wolfe's LinkedIn bio and told Stirton that Wolfe was claiming that RGT was getting returns of over 18% on its investments.
Stirton testified that he attempted to research Wolfe and RGT via Google and LinkedIn, but was unable to find much information. Tr. Day 1 at 99:18-100:16; 174:2-4. Stirton admitted that he never met Wolfe and never asked to meet Wolfe, but acknowledged that "it might have been a good idea." Tr. Day 1 at 86:20-87:2. Castro testified that Stirton never asked him to get any additional information from RGT or Wolfe regarding potential investments, never asked whether Castro had looked at profit and loss statements, and never asked if Castro had received any literature or written documents from RGT. Tr. Day 3 at 125:14-22.
Despite having virtually no facts about Wolfe and RGT and only the vaguest grasp of the investments Castro had described
Stirton testified that instead of Bonita investing directly with RGT, however, Castro proposed, and Stirton agreed, to invest indirectly through Castro's Nevada limited liability company, Source Solutions Group, LLC ("SSG")
On June 11, 2013, Stirton caused Bonita to wire $100,000 to SSG's bank account. Pl. Exh. 7. Two days later, on June 13, 2013, Stirton caused Bonita to wire an additional $25,000 to SSG's bank account, for a total investment of $125,000 (the "First Investment"). Pl. Exh. 7; Tr. Day 1 at 93:9-24. The funds were subsequently transferred from SSG's bank account to RGT.
In July of 2013, Stirton caused Bonita to wire an additional $50,000 to SSG's bank account (the "Second Investment"). Tr. Day 1 at 82:4-17; 93:2-8; Pl. Exh. 10(1). Castro testified that the funds were intended to go to an entity called Labyrinth Technologies for the development of securities market-predicting software that RGT was interested in leasing.
At Stirton's request, the First Investment and Second Investment were memorialized by two separate promissory notes, both dated July 17, 2013, and executed by Castro on behalf of SSG on one hand, and Stirton, on behalf of Bonita, on the other (the "Promissory Notes").
Castro testified that in November 2013, he began calling and exchanging emails with Wolfe regarding the status of the First Investment. He further testified that Wolfe's lack of responsiveness led Castro to suspect that there were going to be issues with repayment. Tr. Day 3 at 170:17-171:6. Wolfe allegedly assured Castro that everything was fine. Tr. Day 3 at 171:7-172:2. Unfortunately, things were not fine and despite informal attempts by Castro to collect, RGT and Wolfe never paid the RGT/SSG Promissory Note. Tr. Day 3 at pp. 173-185; Def. Exh. V. As a result, SSG was unable to repay the First Investment.
Castro also testified that at some point, he contacted Alma Perez about the status of the Second Investment and was told by Perez that it had lost money.
As of the date of trial, Bonita had not been repaid any of the $125,000 First Investment and had only been repaid $32,000 of the $50,000 Second Investment.
The central purpose of the Bankruptcy Code is to permit a deserving debtor to make peace with creditors and obtain a fresh start, free of pre-existing debt.
In an action to determine the dischargability of a debt under Bankruptcy Code § 523(a), plaintiff has the burden of proving all elements of the claim for relief asserted by a preponderance of the evidence.
Bankruptcy Code § 523(a) provides that "A discharge under section 727 . . . of this title does not discharge an individual from any debt. . . ." 11 U.S.C. § 523(a). A "debt" is defined as a "liability on a claim." 11 U.S.C. § 101(12). A "claim" is a "right to payment. . . ." 11 U.S.C. § 101(5). A "right to payment" is "nothing more nor less than an enforceable obligation."
As an initial matter, the court acknowledges that the Promissory Notes themselves are not entirely clear regarding whether the obligor was SSG, Castro, or both. However, it becomes evident that SSG was intended to be the sole obligor on the Promissory Notes when viewed in light of the parties' actions, the history of the parties' previous transactions and Stirton's testimony at trial.
First, Bonita wired the funds for the First Investment and Second Investment to SSG's bank account; not to Castro's individual account.
Second, the Promissory Notes were modeled after the RGT/SSG Promissory Note, with the critical distinction that the Promissory Notes did not contain a personal guarantee by Castro. Stirton admits to having seen the RGT/SSG Promissory Note that contained Wolfe's personal guarantee before making the First Investment. He also admits to having read the Promissory Notes. Yet, he never requested that the Promissory Notes be amended to include a personal guarantee by Castro. If he really believed that Castro was personally liable or intended to be personally liable on the First and Second Investments, it seems apparent that he would have requested such an amendment.
Third, Stirton testified that he formed Bonita at Castro's suggestion, and ran his investments through Bonita as a way of shielding himself from personal liability. It is not credible that Stirton believed that Castro was not using his own limited liability company to shield himself from liability while advising Stirton to do the same thing.
Fourth, none of the previous flipping projects Stirton had participated in were structured between individuals; instead they were all structured between Bonita and the respective LLCs of Bay Valley's realtors. Thus the historical pattern contradicts the theory that the First Investment and Second Investment were with Castro individually.
Fifth, Stirton testified at trial that he understood that the First Investment and the Second Investment and the Promissory Notes were between Bonita and SSG.
Finally, the court notes that SSG is a Nevada limited liability company. As a general proposition, under Nevada law, unless otherwise provided in the articles of incorporation or a signed agreement, "no member or manager of any limited-liability company formed under the laws of [Nevada] is individually liable for the debts or liabilities of the company." Nev. Rev. Stat. Ann. § 86.371 (West 2016). Members or managers may incur liability for the debts or liabilities of a Nevada LLC, however, if "alter ego" liability is established.
To establish alter ego liability in Nevada, the following elements must be proved: (1) the LLC must be influenced and governed by the person asserted to be its alter ego; (2) there must be such a unity of interest and ownership that one is inseparable from the other, and (3) the facts must be such that adherence to the fiction of separate entity would, under the circumstances, sanction a fraud or promote injustice.
For all the foregoing reasons, the court finds that Plaintiffs failed to carry their burden of proving by a preponderance of the evidence that Castro was personally liable for the debts created by the First Investment and Second Investment. As a result, the court finds that § 523(a) does not apply and the debts owed to Plaintiffs as a result of the First Investment and Second Investment are dischargable.
Assuming solely for the sake of argument and completeness of the record that the debts owed to Plaintiffs are debts owed by Castro personally, the court turns next to Plaintiffs' argument that the debts are nondischargable as debts obtained by "false pretenses, a false representation, or actual fraud[.]" 11 U.S.C. § 523(a)(2)(A). In the Ninth Circuit, the terms "false pretenses" and "false representation" have the same meaning in § 523(a)(2)(A) as the term "actual fraud" and do not provide an independent basis for finding a debt nondischargeable.
To demonstrate that a debt is nondischargable under § 523(a)(2)(A), Plaintiffs must establish by a preponderance of the evidence: (1) misrepresentation, fraudulent omission or deceptive conduct by Castro; (2) Castro's knowledge of the falsity or deceptiveness of his statement or conduct; (3) Castro's intent to deceive; (4) justifiable reliance by Plaintiffs on Castro's statement or conduct; and (5) damage to Plaintiffs proximately caused by their reliance on Castro's statement or conduct.
Here, Plaintiffs did not come close to proving any of the elements of the § 523(a)(2)(A) cause of action by a preponderance of the evidence. Of critical importance, Plaintiffs were unable to articulate any misrepresentations (knowing or otherwise), fraudulent omissions, or deceptive conduct by Castro when the First Investment and Second Investment were made. When questioned on the topic, it became clear that Stirton relied solely on his own assumptions about what background information Castro had, what the investments were, how they would work, and their chances for success.
Again, assuming solely for the sake of argument and completeness of the record that the debts owed to Plaintiffs are debts owed by Castro personally, the court turns next to Plaintiffs' argument that the debts owed by Castro are nondischargable as debts that arose from "fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny." 11 U.S.C. § 523(a)(4).
To prevail on a nondischargability claim under this section, Plaintiffs must prove not only Castro's fraud or defalcation, but also that Castro was a fiduciary to Plaintiffs when he committed the fraud or defalcation.
Under non-bankruptcy law, the definition of "fiduciary" is a broad one, involving trust, confidence and good faith.
While the scope of the term "fiduciary capacity" is a question of federal law, the Ninth Circuit considers state law to ascertain whether the requisite trust relationship exists.
Here, Plaintiffs first argue that a fiduciary relationship existed between Plaintiffs and Castro because Castro testified that it did. This argument is nonsense. Castro was clearly not qualified to testify as to whether his relationship with Plaintiffs satisfied the legal definition of "fiduciary." Further, even if he were qualified to testify in this manner, Castro's testimony that Stirton trusted him and had confidence in him falls well short of the legal definition.
Plaintiffs next argue that a fiduciary relationship existed between Plaintiffs and Castro by virtue of Castro's real estate license. This allegations misstates the law and the facts.
In California, a real estate licensee does not meet the fiduciary capacity requirement of § 523(a)(4) solely based on his status as a real estate licensee.
Federal law controls the definition of embezzlement for purposes of § 523(a)(4).
Here, there was clearly no embezzlement of the $125,000 First Investment as the evidence at trial showed that: (1) Plaintiffs gave Castro the funds for the purpose of investing in RGT; and (2) Castro actually did transfer the funds to RGT. Thus, as to the First Investment, there was no proof of misappropriation of funds and the cause of action for embezzlement fails.
Regarding the $50,000 Second Investment, the court acknowledges that the circumstances surrounding this investment are bizarre and that Castro's story regarding where the funds went, why, and what happened to them, is fairly unbelievable. Having said that, it was Plaintiffs' burden to prove embezzlement and they failed.
First, as to the initial transfer of the $50,000 from SSG's account to Forex Capital Markets, it is clear from Stirton's testimony that while he transferred the funds to SSG willingly, he had no understanding at all of what the $50,000 was to be used for. He apparently made little, if any, inquiry prior to transferring the funds to SSG's account and, at trial, could not testify consistently regarding what he thought he was causing Bonita to invest in. Stirton presented no written agreement regarding the ultimate destination for the $50,000 and the promissory note documenting the Second Investment (which was prepared at Stirton's request and reviewed by him before he signed it), was similarly silent regarding the anticipated use for the funds. Plaintiffs can hardly complain that the funds were used for something other than the intended purpose when there was no understanding of or agreement (written or otherwise) about the intended purpose. Thus, Plaintiffs failed to sustain their burden to show misappropriation by a preponderance of the evidence.
Plaintiffs also failed to sustain their burden to show circumstances indicating fraud by a preponderance of the evidence. As articulated at trial, the court was left with the impression that Castro was enamored with Wolfe and the appearance of Wolfe and RGT's legitimacy and the prospect of healthy returns on investment. Put simply, he appears to have been a shill for Wolfe's apparently-fraudulent activity. But there is no evidence that he actually participated in the fraud or even knew about it until well after the fact.
Plaintiffs also argue rather vaguely that Castro's failure to trace the $50,000 supports a finding of embezzlement. Plaintiffs apparently want the court to conclude that because it is unclear where the funds went, Castro must have committed some wrongdoing sufficient to support nondischargability. Unfortunately for Plaintiffs, that is not the way the law works. The burden was on Plaintiffs to prove all of the elements of this cause of action. Plaintiffs cited, and the court can find, no case law that dictates otherwise. Plaintiffs could have subpoenaed bank records and witnesses in an attempt to prove that Castro had misappropriated all or a portion of the $50,000. They failed to do so. Because Plaintiffs failed to prove embezzlement, the cause of action must fail.
Finally, the fact that $36,000 of the $50,000 was returned to SSG's account and $32,000 of that amount was subsequently returned to Bonita requires the court to consider whether Castro "embezzled" the approximately $4,000 that he failed to return to Bonita. The court finds that he did not.
The record shows that when Castro learned that $14,000 of the $50,000 had been lost, he requested that the remaining $36,000 be returned. The $36,000 was returned to SSG's account and Castro instructed Corporate Nevada to forward those funds to Bonita. Ultimately, however, only $32,000 was transferred to Bonita as Castro testified that Corporate Nevada had taken $4,000 to pay outstanding fees owed by SSG and to reimburse Bay Valley Realty for funds it had previously advanced to SSG. Castro testified that it was his understanding that Corporate Nevada had authorization to automatically deduct fees from any available funds in SSG's account. He further testified that he did not realize that Corporate Nevada would be taking funds out of the $36,000. Finally, he testified that he tried to return the outstanding $4,000. All of this testimony went unchallenged. Thus, while the first two elements for embezzlement were arguably satisfied, the requirement to show circumstances indicating fraud, was not. Again, Plaintiffs could have challenged this testimony. They could have called witnesses from Corporate Nevada. They could have produced the agreement between Corporate Nevada and SSG. They did not. As a result, they failed to meet their burden of proving embezzlement by a preponderance of the evidence.
Federal law also controls the definition of larceny for purposes of § 523(a)(4).
Here, there was no unlawful taking of Plaintiffs' property. Plaintiffs gave the First Investment and Second Investment funds to SSG and/or Castro freely. Thus, Plaintiffs have not and cannot establish larceny by a preponderance of the evidence.
In their Post-Trial Brief, Plaintiffs effectively dismissed or withdrew the § 523(a)(6) cause of action, acknowledging that it is "unnecessary and untenable." As a result, the court will not address the cause of action.
For all of the foregoing reasons, the court finds that Plaintiffs failed to carry their burden of proving by a preponderance of the evidence that: (1) Castro was personally liable to Plaintiffs on the First Investment and Second Investment; (2) the debts resulting from the First Investment and Second Investment were debts obtained by false pretenses, a false representation or actual fraud as required by § 523(a)(2)(A); and (3) the debts resulting from the First Investment and Second Investment were debts that arose from fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny as required by § 523(a)(4). As a result, the debts resulting from the First Investment and Second Investment are dischargable. Judgment shall be entered in favor of Defendant.
