ROBERT J. KRESSEL, UNITED STATES BANKRUPTCY JUDGE.
This adversary proceeding came on for trial on July 23, 2018 on the plaintiff's complaint to determine the dischargeability of a debt under 11 U.S.C. § 523(a)(2)(A) and 11 U.S.C. § 523(a)(4). Richard G. Jensen appeared for the plaintiff. John H. Bray appeared for the defendant. This court has jurisdiction over this adversary proceeding pursuant to 28 U.S. §§ 157(b)(1) and 1334, and Local Rule 1070-1. This is a core proceeding within the meaning of 28 U.S.C. § 157(b)(2)(I).
1. Plaintiff Mark Kassebaum is a Minnesota resident. He is one of the four shareholders of PDMM, Inc. He has been a shareholder and member of the board since 1994.
2. PDMM is a Minnesota corporation, founded in July 1994. It is a franchisee of Green Mill Restaurants, LLC, and operates a Green Mill restaurant located at 340 South Lake Avenue, Duluth, MN 55802.
3. Douglas E. Smith lives in Duluth and is a Minnesota resident. He is the debtor in this case.
4. The debtor is one of the four shareholders of PDMM and the general manager of PDMM's restaurant. He was also president of PDMM until September 14, 2016.
5. The shareholders of PDMM and their percentage of ownership are:
a. Kassebaum — 34%
b. Smith — 19%
c. Smith's father, Russell Smith II — 38%
d. Smith's brother, Russell Smith III — 9%
The plaintiff asserts that his claims should be excepted from discharge under 11 U.S.C. § 523(a)(2)(A) and 11 U.S.C. § 523(a)(4). He argues that the debt is excepted from discharge under 11 U.S.C. § 523(a)(2)(A) because the debtor made false representations of material facts to the plaintiff and falsified the books and records of PDMM to conceal his conduct, on which the plaintiff reasonably relied and failed to take appropriate action to investigate and stop his actions. The plaintiff also argues that the debt is excepted from discharge under 11 U.S.C. § 523(a)(4) because the debtor obtained and benefited from money and other assets of PDMM through embezzlement and larceny.
Section 523(a)(2)(A) of the Bankruptcy Code provides that:
11 U.S.C. § 523(a)(2)(A).
Exceptions to discharge under section 523 are narrowly construed against the creditor and liberally in favor of the debtor to facilitate the debtor's fresh start. E.g., Reshetar Systems, Inc., v. Thompson (In re Thompson), 686 F.3d 940, 944 (8th Cir. 2012). For a debt to be excepted from discharge under section 523(a)(2)(A), the creditor must prove the elements of fraud by a preponderance of the evidence. Grogan v. Garner, 498 U.S. 279, 288, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991).
The plaintiff does not allege that the debt should be excepted from discharge under this section based on false pretense or actual fraud. He argues that the debt is excepted from discharge because of false representations.
To establish fraud under section 523(a)(2)(A), the plaintiff must show:
The Merchants Nat'l Bank of Winona v. Moen (In re Moen), 238 B.R. 785, 790 (8th Cir. BAP 1999).
To qualify as a false representation under section 523(a)(2)(A), the statement must relate to a present or past fact. Shea v. Shea (In re Shea), 221 B.R. 491, 496 (Bankr. D. Minn. 1998). A debtor's promise relating to a future action, which does not purport to depict current or past
The plaintiff claims that the debtor committed fraud by representing to PDMM that he did not receive bonuses. The plaintiff also alleges that the debtor committed fraud by intentionally failing to disclose (1) the payments paid to him by PDMM, (2) the personal loan he caused PDMM to incur to purchase a vehicle, (3) causing PDMM to pay expenses of Avenue C, and (5) the payroll and dividend advances that he was not entitled to.
The plaintiff argues that the bonuses were employee benefits and required the approval of the board of directors in accordance to the bylaws. The plaintiff does not cite to a specific provision of the bylaws.
The debtor admitted that he paid himself and other managers bonuses. However, he disputes that bonus required the board's approval. He stated that he exercised his managerial duties in implementing a bonus system similar to one at a previous restaurant he managed and payed bonuses to himself and other employees. The debtor cited to section 4 of Article V, titled "Officers" of the bylaws to argued that bonuses are not employee benefits. The provision provides in pertinent part that "the salaries of all officers and agents shall be as fixed by the Board of Directors." However, the bylaws say nothing about restaurant employees' compensation.
First of all, nothing in the record indicates that the debtor was aware of this provision. Second, this provision of the bylaws is not applicable to payment of bonuses to employees. The beginning of Article V, Section 1, states that officers include chairman of the board, a president, a secretary and a treasurer. This provision of the bylaws relates specifically to officers of the board of directors of PDMM and salaries of these officers. The debtor was paying a bonus to himself and other employees of the restaurant in his capacity as a manager of the restaurant and not as an officer of the PDMM's board of directors. Therefore, this section of bylaws is inapplicable to the bonus payments.
Additionally, any lack of authorization for payment of the bonuses would not constitute misrepresentation. The debtor did not conceal the payment of the bonuses. The bonus payments are documented in the financial records as early as 2008. The debtor told PDMM about the charges by informing the bookkeeper. Without any evidence of the debtor influencing the bookkeeper, what she did with the record is not his fault.
Next, the plaintiff argues fraud by omissions for not disclosing payments made to the debtor, personal loans to purchase a vehicle, expenses paid for Avenue C and payroll and dividend advances paid to him. The plaintiff does not allege that the debtor directly stated that he did not receive the payments to himself and to Avenue C or caused PDMM to pay for a vehicle. The plaintiff only argues that the debtor's failure to inform him of these facts and also concealing of these payments in complex financial statements making it difficult to find, constituted misrepresentation by silence.
However, the evidence does not show that the debtor failed to inform or concealed evidence of these transactions. In fact, all of the payments were in written records, including written checks and credit card statements. McCloskey testified
As to the derivative claim, the debtor did not make misrepresentations to PDMM because he told the company about all the payments through the bookkeeper. He disclosed payments to the bookkeeper. The plaintiff did not present sufficient evidence to prove that the debtor made misrepresentation by his silence or took part in concealing records of the payments.
In order to assess the debtor's knowledge of the falsity of the representation, the court must consider the knowledge and experience of the debtor. In re Moen, 238 B.R. at 791. A representation that is made "under circumstances where a debtor should have known of the falsity is one made with reckless disregard for the truth" satisfies the knowledge requirement. Id.
Fraudulent misrepresentation requires that the representation is accompanied by an element of scienter. Hernandez v. Sulier (In re Sulier), 541 B.R. 867, 879 (Bankr. D. Minn. 2015). The maker of the representation must (a) knows or believes that the matter is not as he represents it to be; (b) lacks confidence in the accuracy of his representation; or (c) knows that he does not have the basis for the representation. Id. There is rarely evidence that shows a person knew that his statement is false, thus the court must look to circumstances in the case. Id.
The debtor is member of the board of directors, shareholder and employee of PDMM since its creation in 1994. At least according to the plaintiff's evidence, the debtor has been borrowing money from the company since 2008. The evidence does not show that the debtor knew that he was not entitled to bonuses as an employee of the restaurant without the approval of the board. He believed he paid the bonuses as part of his managerial duty and not as his role as the officer of the board.
The debtor did not know he was making false representation about the money he borrowed because he admitted he borrowed the money and he intended to pay it back. In fact, he had paid some of that money back. The debtor did not omit disclosure of information with fraudulent intent. He gave information of the payments to the bookkeeper and she made record of it. The debtor testified that he bought the car to be used by him and the other employees for delivery because the other company car was too big to be used for delivery. The evidence and testimony do not show by the preponderance of the evidence that the debtor knew he was making false representation nor did he knew his failure to disclose the payments to the plaintiff was misrepresentation. The plaintiff did not meet his burden of proof on this element.
The plaintiff argues that the debtor intended for the plaintiff to rely on his misrepresentation to prevent the disclosure of the payments with the specific purpose of inducing the plaintiff to not act to investigate and prevent the debtor from his conduct.
The plaintiff asserts that the debtor falsified the books and records of the company to conceal his conducts. There is no evidence to show that the debtor falsified the books and records of the company. The bookkeeper documented almost all of the transactions with notations and labeling made solely by her. While McCloskey had difficulties discerning the labeling of the transaction used by the bookkeeper, there is no evidence that the debtor mislabeled or influenced the bookkeeper to mislabel the transaction to make it difficult for plaintiff to investigate or take actions. The plaintiff has failed to prove this element.
The plaintiff must prove this element by showing that he justifiably, but not reasonably, relied on the debtor's representation. Field v. Mans, 516 U.S. 59, 74, 116 S.Ct. 437, 133 L.Ed.2d 351 (1995). Justifiable reliance is a subjective determination made in light of the qualities and characteristics of the particular creditor and circumstances of the particular case. Id.
A court analyzing this element can examine any number of factors to determine whether a creditor's reliance was justifiable. In re Sulier, 541 B.R. at 882. These factors include:
The parties are shareholders, members of the board of directors and family members. Their business relationship dates to at least 1994, since the formation of PDMM. Kassebaum, a medical doctor, testified that he was put on notice of the financial issues when he received notices of a tax liability as a shareholder of PDMM. He stated that the debtor did not tell him that he was not making those payments. The plaintiff's evidence also shows bonus payments and checks written to the debtor as early as 2008.
A "victim of fraud is not justified in relying on a representation, and a duty to investigate arises, where the facts should be apparent to one of his knowledge and intelligence from a cursory glance, or he has discovered something which should serve as a warning that he is being deceived." Hernandez v. General Mills Federal Credit Union (In re Hernandez), 860 F.3d 591, 604 (8th Cir. 2017). A simple inspection of the company's books and bank account statements would have shown charges made to the company accounts for the benefit of the debtor. Kassebaum never met the bookkeeper nor did he inspect the book or rely on any entries in the book. The plaintiff failed to show justifiable reliance.
The proximate cause element requires the plaintiff to show that the action of the debtor was the act, without which the plaintiff would not have suffered the loss complained of. Rezac v. Maier (In re
As to him individually, the evidence does not show that any representation was made to the corporation and no specific representation was made to him. The plaintiff alleges that by relying on the debtor's misrepresentation he purchased stocks. The plaintiff has been a shareholder since 1994 and the supposed allegation happed after the 1994 purchase. He did not show any damage separate from the corporation that he suffered. He did not prove his individual claim.
The plaintiff also alleges that the debt should be excepted from discharge under section 523(a)(4) because the debtor's conduct constitute embezzlement and larceny.
Section 523(a)(4) of the Bankruptcy Code provides that:
Embezzlement, for the purpose of 11 U.S.C. § 523(a)(4), is defined as the "fraudulent appropriation of property by a person to whom such property has been entrusted or into whose hands it has lawfully come." Gadtke v. Bren (In re Bren), 284 B.R. 681, 698 (Bankr. D. Minn. 2002). The plaintiff must establish that the debtor was not lawfully entitled to use the funds for the purposes for which it was in fact used. Bank of America N.A. v. Armstrong (In re Armstrong), 498 B.R. 229, 234 (8th Cir. BAP 2013).
To prove embezzlement, the plaintiff must prove that he entrusted his "property to the debtor, the debtor appropriated the property for a use other than that for which it was entrusted, and the circumstances indicate fraud." Id. Courts often examine whether the terms by which a debtor came into possession of the funds create a particular obligation on the debtor. Id. "Obligations sufficient to support a claim of embezzlement are ones which make the debtor's discretionary use of the payments, prior to complying with obligations, improper. Id.
Here, the plaintiff has not presented evidence to show that he entrusted property to the debtor nor that he instructed the debtor to use the money for a certain purpose. There are no terms by which the debtor came into possession of the plaintiff's property that created an obligation upon him. The plaintiff does not present any obligations of the debtor to support a claim of embezzlement.
Additionally, the debtor's role as a manager of the restaurant or an officer of the board of directors alone does not establish sufficient and specific obligations of the debtor to support a claim of embezzlement.
The plaintiff also asserts a claim of larceny under section 523(a)(4). Larceny is the "wrongful taking and carrying away of the property of another with the intent to convert such property to the taker's use without the consent of the owner." Reshetar Systems, Inc. v. Thompson (In re Thompson), 458 B.R. 504, 510 (8th Cir.
The plaintiff has not proven larceny. The debtor testified that he borrowed the money with the intent to pay back and he had in fact paid some of the money. The plaintiff has not shown the debtor had the intent to convert the plaintiff's property.
For the reasons stated above, I conclude that the plaintiff failed to meet his burden to establish claims under 11 U.S.C. § 523(a)(2)(A) and (a)(4).
THEREFORE, IT IS ORDERED:
LET JUDGMENT BE ENTERED ACCORDINGLY.
