R. KIMBALL MOSIER, Bankruptcy Judge.
Brad Ball was looking for a business to buy. With the assistance of his father, David Ball, they bought May's Custom Tile from Steven May in August 2008. Business did not go well for the Balls and they ended up blaming May and filed a lawsuit claiming that the company was underperforming because May had misrepresented its financial condition. May had another business, May's Granite, and business didn't go well for him either. He and his wife Bobbie (collectively, the Mays or Defendants) filed bankruptcy in April 2013, and the Balls commenced the above-captioned adversary proceeding alleging causes of action under 11 U.S.C. §§ 523(a)(2), (a)(6), 727(a)(2), (a)(3), (a)(4), and (a)(5).
The Court's jurisdiction over this adversary proceeding is properly invoked pursuant to 28 U.S.C. § 1334 and § 157(b)(1). Actions to except particular debts from discharge and to deny a debtor's discharge are core proceedings within the definition of 28 U.S.C. § 157(b)(2)(I) and (J), and the Court may enter a final order. Venue is appropriate under 28 U.S.C. § 1409.
Steven May founded May's Custom Tile, Inc. (Tile) in 1987 and was its owner and president. Tile performed commercial and high-end residential tile work in northern Utah. May founded a second company, May's Granite, LC (Granite), in 2002 and was its manager, registered agent, and organizer. Granite was organized under the Utah Revised Limited Liability Company Act as a manager-managed limited liability company. Tile and Granite shared office space that was located above a showroom within a warehouse. In 2007, May suffered a heart attack and undertook efforts to sell Tile and Granite by listing them with Coldwell Banker Commercial through one of its agents, Duane Bush. Tile was marketed as a non-recurrent revenue business, meaning that an operator of the business would have to find new clients on a regular basis to generate revenue.
Brad Ball enrolled in an MBA program with a scheduled graduation date in 2008. In mid-2007, halfway through the program, he began to search for a business to purchase by looking through financial statements given to him by the businesses and their brokers. In late June or early July 2008, he found Tile and Granite. Ball informed his father, David Ball (collectively with Brad Ball, the Balls or Plaintiffs), about Tile and enlisted him to help vet the company and finance its purchase. The Balls did not hire an accountant or business valuation expert to assist them in examining Tile's financial information, and they did not hire an attorney to help with the purchase of the business.
During July and August 2008, the Balls met with Duane Bush approximately six times and began reviewing some of Tile's records, including a business opportunity brochure prepared by Bush (Ex. 71) and Tile's 2006 and 2007 tax returns (Exs. 1 and 2). The Balls also claim to have reviewed accounts receivable aging reports dated March 3, 2008 and April 24, 2008 (Exs. 20 and 22), Tile's sales by customer summary for January through December 2007, dated March 4, 2008 (Ex. 81) Tile's sales by customer summary for January through February 2008, dated February 29, 2008 (Ex. 80), and Tile's profit and loss statement for January 1 through April 29, 2008, dated April 29, 2008 (Ex. 27). After reviewing this information, the Balls agreed that Tile "looked excellent" based on its sales numbers, appeared healthy and profitable, had a good net adjusted income to price ratio, and "fit the bill perfectly from a financial perspective." After exchanging rounds of offers and counteroffers, the Balls and May eventually came to an agreement for the purchase of Tile (Asset Sale Agreement).
Before reaching that agreement, however, Ball sent Bush an email on July 17, 2008 wherein he asked questions about Tile's accounts receivable, including whether Tile had "any collections issues."
On August 11, 2008, the Balls met with Steve May and Russ Bradshaw, the accountant for Tile and Granite, for a final due diligence meeting where they could review documents and ask questions of May and Bradshaw. The Balls asked to review all the invoices from January through July 2008 and saw a number of reports.
The Inklyne Construction credit constituted a "red flag"
On August 18, 2008, the Balls, through Reperex, Inc., a company they had created, bought Tile. The Asset Sale Agreement provided that Reperex could use Steve May's contractor's license for 60 days but thereafter the Balls had to qualify for and obtain their own contractor's license.
Neither Brad nor David had any experience in the construction industry in general or the custom tile business in particular. David had purchased a residential bathroom remodeling and antique bathtub refinishing business in 1998. He owned the business for about three years and worked there for approximately six months. In his own estimation, his experience with that company did not qualify him to run a tile company.
At the time the Balls bought Tile, Brad knew the economy was in a mild recession, but he viewed this as an opportunity because it might cause a business seller to accept less. David knew that the economy was slowing down, but he believed it had reached the bottom. Due to the Balls' concern with the economy, they negotiated a provision in the promissory note for the purchase of Tile that would automatically renew the note for twelve months if they were not able to refinance it within a year. Brad testified that the economy fell off a cliff in September and October 2008.
On August 20, 2008, Brad made an unremarkable entry in his journal noting that Promontory, a luxury subdivision near Park City that was one of Tile's larger clients in 2007 and early 2008, had declared bankruptcy a few months earlier.
Business began to slow down after the Balls bought Tile, and cash flow diminished.
In his journal entry for January 13, 2009, Brad expressed frustration that Tile was not as profitable as he thought it would be. Two days later, he made the same observation, concluding that the economy must be partially responsible, but also suggesting for the first time that he and his father might have been misled in the purchase of the business.
In the months after the Balls bought Tile, tensions gradually rose between them and Steve May.
On March 30, the Balls offered to sell Tile back to May, and they resumed negotiations on April 6. May rejected the Balls' offer on April 15. On April 18, the Balls met with Alex Mismash to gauge his interest in becoming a partner in Tile. The Balls hired Mismash in late April to run Tile in place of Brad, who had initially handled the day-to-day management of Tile since the Balls bought the business, but had been spending less and less time there beginning in late March. Mismash began working at Tile on May 1. He was at the business two or three days a week and always had a key to the office. He worked at Tile for about a month until David Ball told him there was no need to come to work anymore. After Brad's involvement in Tile decreased in March and April 2009, David gradually took on a larger role in the business, especially after Mismash started, when David assisted him with the company's books and accounting.
On April 23, May changed the locks on the building where Tile was located. Brad arrived at the business between 5:30-6:00 p.m. to find that he could not gain access to the building. The Balls did continue to have access to the premises during regular business hours. On April 29, the Balls received written notice of default under the Asset Sale Agreement and were given 30 days to cure.
Bradshaw prepared Tile's 2007 and 2008 tax returns. In preparing the 2007 tax return, Bradshaw went through Tile's accounting records to ensure that the numbers on the return were accurate, including the apportionment of a rent expense between Tile and Granite. With respect to the 2008 tax return, Bradshaw advised Steve May that Tile could claim a deduction for bad debt that arose in 2006 and 2007.
The Great Recession hit Granite hard, reducing its business by 50% in 2008.
After the Plaintiffs rested their case, the Defendants orally moved to dismiss the amended complaint. The Court confirmed that the Defendants were seeking judgment on partial findings pursuant to Fed. R. Civ. P. 52(c).
Although Rule 52(c) parallels judgment as a matter of law under Rule 50(a) in their timing during a trial — motions under both rules are made after a party has been fully heard on an issue — the standards applicable to these rules differ significantly. The difference stems from who the trier of fact is in the case. Rule 50(a) applies to jury trials, where the jury serves as the trier of fact. "Because the district judge lacks the authority to resolve disputed issues of fact under those circumstances, judgment as a matter of law is appropriate only if no reasonable jury could find for a party on that claim."
The non-moving party gets no such benefit under Rule 52(c), however.
The Plaintiffs' amended complaint asserts six claims: §§ 523(a)(2)(A), 523(a)(6), 727(a)(2), 727(a)(3), 727(a)(4), and 727(a)(5). To prevail on any one of these claims, the Plaintiffs must prove each element of that claim by a preponderance of the evidence.
Section 523(a)(2)(A) excepts from discharge any debt "for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained, by — false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor's or an insider's financial condition."
The problem for the Balls is that these documents and oral representations are not actionable under § 523(a)(2)(A). That subparagraph expressly does not apply to statements respecting a debtor's or an insider's financial condition. Statements respecting financial condition "are those that purport to present a picture of the debtor's overall financial health."
At the outset of trial, the Court addressed the Plaintiffs' apparent failure to plead the correct cause of action.
The Court concludes that the parties impliedly consented to trial of the § 523(a)(2)(B) claim. During trial the Plaintiffs presented written statements, such as Tile's 2006 and 2007 tax returns, that are plainly not relevant to a § 523(a)(2)(A) claim, but are particularly relevant to a § 523(a)(2)(B) claim. But the Defendants failed to object to the admission of such evidence. By failing to object, the Defendants gave their implied consent to trial of the unpleaded § 523(a)(2)(B) claim.
Section 523(a)(2)(B) excepts from discharge any debt "for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by —
With respect to each alleged false statement, the Balls failed to establish several of the elements of their § 523(a)(2)(B) claim, namely, that the statements were materially false, that the Balls' reliance was reasonable, and that the Mays made these statements with the intent to deceive.
In order for a statement to be materially false, it must "paint[ ] `a substantially untruthful picture of an entity's financial condition that objectively would, and subjectively did, affect a creditor's decision to pay money to a debtor."
Reliance under § 523(a)(2)(B)(iii) must be actual reliance,
A debtor's intent to deceive will rarely exist in the form of direct evidence. Instead, "[i]ntent to deceive may be inferred from the totality of the circumstances, including a reckless disregard for the truth."
The Court elects to address Tile's 2006 tax return and the 2008 aging reports collectively because they are at the core of the Plaintiffs' allegation that the Mays hid $230,000 in bad debt. The Plaintiffs' narrative of events begins with Tile's 2006 tax return and their claim that "[t]here was in excess of $200,000.00 in bad debt on which the Mays paid taxes in 2006."
The evidence does not support the Balls' fraud claim. In the first instance, the Balls did not show that Tile's 2006 tax return or the 2008 aging reports were materially false. With respect to the tax return, the Plaintiffs presented no evidence to demonstrate that the return had been prepared improperly or that it was not the one that had been filed with the IRS. In addition, they did not show that the sales were overstated, how the unpaid accounts receivable should have been reflected on the tax return, or that they must have been reflected on the tax return. As regards the 2008 aging reports, the Plaintiffs failed to provide any evidence that proper accounting procedures required the unpaid accounts receivable to be included in the aging reports even though they were nearly two years old.
The Plaintiffs also failed to establish that their reliance was justifiable, much less reasonable. Brad Ball testified that Tile's profits were critical to the Balls' evaluation of whether to purchase the business, they relied on Tile's 2006 tax return and other documents to assess its financial health, and if they had known about these unpaid accounts receivable they would not have chosen to buy Tile. The Court doesn't find this testimony credible. Other than their self-serving statements, the Balls did not even attempt to articulate any reasons why these unpaid accounts receivable would be so important to their decision to purchase Tile. Tile was marketed as a non-recurrent revenue business. That is clear notice to potential buyers that future business is not based on returning customers, so a poor-paying customer should not be relevant to the company's ability to collect on its accounts going forward. These unpaid accounts were nearly two years old at the time the Balls were conducting their due diligence, and the reason for non-payment on the Inklyne account was a contract dispute.
But more importantly, there was no reasonable reliance on the alleged failure to disclose the unpaid accounts because the Plaintiffs knew about the credit memos, which revealed the unpaid accounts, prior to purchasing the company. The Balls testified that they learned of the Inklyne "credit" or "anomaly" when they "saw" it at the due diligence review of Tile's financial documents.
But whether the Balls saw all the credit memos or just the Inklyne credit memo, the analysis is the same. The Balls testified that the only issue that concerned them was the Inklyne credit. They considered that credit a "red flag" and felt that they "needed to get to the bottom" of the issue.
At the closing of the sale, the Balls agreed to waive any remaining conditions to closing, thereby essentially acknowledging that they had completed their due diligence to their satisfaction.
The evidence also clearly shows that the Mays did not intend to deceive the Balls by concealing the unpaid accounts. In the first place, the unpaid accounts were not concealed because they were clearly contained in Tile's general sales ledger at the time of the due diligence meeting. Because the Balls raised a question about the Inklyne credit at the due diligence meeting, immediately afterward Bradshaw investigated the credits on the general sales ledger and discovered that Marie Christiansen, Tile's bookkeeper, had mistakenly posted them on the general sales ledger on March 3, 2008.
The Balls' argument that the Mays had the intent to deceive rests on the tacit premise that the Mays had developed a plan to defraud a potential buyer of the business long before Brad Ball even discovered Tile in late June or early July 2008. The Mays' intended scheme would have had to begin with the preparation of Tile's 2006 tax return and the deliberate overstatement of taxable income, then proceed to posting unpaid accounts receivable on the general sales ledger and generating aging reports on March 3 and April 24, 2008 to conceal those unpaid accounts. To believe the Balls' version of events is to conclude that these actions were part of the Mays' plan in setting a trap for an unwary buyer.
But the evidence simply does not support such a conclusion. There was no evidence that the Mays believed that Tile's 2006 tax return was improper when filed or when shown to the Balls. The Balls failed to establish that any of the accounts at issue could have been, let alone should have been, deducted when Tile's 2006 tax return was prepared. There was no evidence that Marie Christiansen posted the unpaid accounts receivable to the general sales ledger to conceal them from a potential buyer; to the contrary, the evidence showed that she did not know the proper accounting procedure to handle them and posted them to the ledger by mistake. In addition, the Balls' assertion of the Mays' intent to deceive is contradicted by evidence that in August 2008 Steve May requested that Bradshaw's firm verify that Tile's records were accurate.
The Balls also emphasized the Mays' actions after the sale as demonstrating their intent to deceive. According to the Balls, after the Mays hid the 2006 unpaid accounts receivable from the Balls during the sale process, they proceeded to take a tax deduction for those unpaid accounts receivable on their 2008 return. The Balls further argue that the Mays should have amended their 2006 return, but took the deduction in 2008 to draw as little attention to the 2006 return as possible. Again, none of these allegations are supported by the evidence. The Plaintiffs produced no evidence that the Mays discovered the unpaid accounts receivable in time to deduct them on Tile's 2006 return. In fact, Bradshaw testified that when he was preparing Tile's 2007 return, he had no cause to believe that Tile's 2006 return was not accurate.
In sum, based on the facts and circumstances of the case, the Court concludes that the Balls have failed to show that Tile's 2006 tax return or the 2008 aging reports were false, that the Balls reasonably relied on those documents, or that the Mays intended to deceive the Balls with respect to those documents.
The Balls contend that Tile's 2007 tax return was materially false because it misrepresented profits. But this assertion does not involve bad debts. Instead, it concerns the alleged improper allocation of business expenses between Tile and Granite in order to make Tile appear more profitable. In particular, the Balls focus on the division of rent expenses between the companies.
The evidence does not show that Tile's 2007 tax return was false. The Plaintiffs established that Tile and Granite shared expenses,
Bradshaw's testimony also established that the Mays had no intent to deceive when they presented Tile's 2007 tax return to the Balls in connection with the sale. Tile's 2007 tax return was prepared by an accountant who attested that it was accurate and complete. The Balls produced no evidence to show that it did not accurately reflect Tile's financial condition. Presenting such a tax return to the Balls does not show evidence of fraudulent intent, but rather the opposite.
Additionally, the Balls' reliance on the alleged misrepresentation of Tile's rent expenses was not reasonable. The Balls reviewed Tile's 2006 and 2007 returns. A simple comparison of these two returns clearly reveals the change in rent expenses, as well as wage expenses, from 2006 to 2007. This is exactly the type of information that a competent review of the returns would reveal. The Balls cannot claim they were misled about Tile's rent expenses when they had the information necessary to question those expenses before their eyes at the time they bought Tile.
There are two allegations that fall into this category of "other representations." The first is that the Mays, through Duane Bush, told the Balls that Tile had no serious collection issues. This representation is founded upon an email exchange between Brad Ball and Duane Bush. On July 17, 2008, Ball sent Bush an email wherein he asked questions about Tile's accounts receivable, including whether Tile had "any collections issues."
The Balls appear to take issue with the portion of Bush's statement that represented Tile had "no major issues on collections." The Court is uncertain whether the Balls allege that this statement is materially false because it is an affirmative misrepresentation or because Bush or the Mays did not disclose approximately $230,000 in unpaid accounts receivable from 2006.
In order for Bush's statement to be an affirmative misrepresentation, the assertion that Tile has "no major issues on collections" — a qualitative statement — must be inconsistent with the fact that Tile had $230,000 in unpaid accounts receivable from 2006 — a quantitative measurement. While there may appear to be a facial inconsistency, the Balls did not establish what "major issues on collections" would be in the context of this case or that the accounts in question were in fact "collection issues." They simply assumed that $230,000 in unpaid accounts receivable would constitute a major collection issue. As it turned out, the Inklyne credit involved a contract dispute, and there was no evidence that the other unpaid accounts and credits were "collection issues."
Even assuming, for the sake of argument, that $230,000 in unpaid accounts receivable would be a "collection issue" in the context of this case, the Balls have not shown that Bush's statement was materially false. Tile was marketed as a non-recurrent revenue business, which means that Tile did not rely on a base of repeat customers, but instead had to find new clients on a regular basis to generate revenue.
In addition, the Balls have failed to establish that their reliance on Bush's statement was reasonable for the same reasons articulated in Section III.A.1, supra. In short, the Balls knew or should have known about Tile's unpaid accounts receivable because they knew about the Inklyne credit and reasonable investigation would have revealed the unpaid accounts receivable.
Last, neither the Mays nor Bush had an intent to deceive. Although the unpaid accounts receivable were incorrectly entered in Tile's general sales ledger, they were clearly included in that ledger and were not deleted. There is no evidence that the Mays attempted to delete that information, and the Court finds no inference of an intent to deceive.
The second alleged representation is that the Mays, either directly or through Bush, told the Balls that Tile's business was coming in at the same rate when they knew that Promontory, one of Tile's major accounts, had declared bankruptcy. The Balls allege that this representation was made in two ways: first, in oral statements made at meetings between the Balls and Mays, and second, in a document entitled Sales by Customer Summary,
The Balls appear to argue that the customer summary is an implied representation that Tile's business is remaining steady, which they allege is inconsistent with the fact that Promontory had filed bankruptcy.
But the Balls mischaracterize what the customer summary says. It does not make the express representation that Tile's business was continuing at the same rate. The customer summary only says that Tile had sales of $194,658.36 through the end of February 2008 and a note that anticipated about $1 million more by the end of the year. It certainly does not state that Tile's business was continuing at the same rate. To make that statement, there must necessarily be a comparison, but the Balls never even attempted to establish a comparison benchmark. The Balls did not contest the accuracy of the $194,658.36 sales figure through February 2008, and they neither argued nor produced any evidence to show that the handwritten note was false. Promontory had not filed bankruptcy when the customer summary was generated on February 29, 2008 and forwarded to Duane Bush. Critically, the Balls did not show whether and to what extent Promontory's bankruptcy caused Tile to take in less than the anticipated $1 million in additional jobs booked through the end of 2008. The Court concludes that the customer summary does not make any representation comparing Tile's 2008 sales to its sales in prior years. At bottom, the Balls have not proved that the Mays made a false statement on the customer summary for two reasons. First, the customer summary does not state what the Balls believe it does. Second, they have not shown that what it actually states is false.
The Balls failed to establish that they reasonably relied on the customer summary when they decided to purchase Tile. First of all, the Balls' testimony that they relied on the customer summary is not credible. Although they deny seeing Tile's general sales ledger through July 2008 at the due diligence meeting, the Balls testified that they reviewed all of the invoices from January through July 2008 and saw a number of reports.
In addition, even if the omission of Promontory's bankruptcy was a false representation, the Court concludes that Promontory's bankruptcy was not material to the Balls' purchase of Tile. The Court does not find the Balls' repeated, self-serving statements that they would not have bought Tile had they known of Promontory's bankruptcy credible. Their testimony is belied by the entries in Brad Ball's journal. On August 20, 2008, two days after closing on the sale of Tile, Ball went to Park City with Steve May to visit a couple of job sites. He writes: "Apparently May's worked on a big luxury subdivision called Promontory just East [sic] of Park City but the whole thing went belly up a few months ago."
Last, the Court concludes that the customer summary does not evince an intent to deceive. At the time it was prepared, the customer summary was accurate and Promontory had not filed bankruptcy. The actual sales through July 2008 exceeded $590,000, which is not inconsistent with the estimate of sales evidenced by Bush's handwritten note on the customer summary. Without evidence that Promontory's bankruptcy rendered any of the statements in the customer summary false at the time it was prepared, the Court cannot infer on these facts that the Mays intended to deceive the Balls by forwarding the customer summary to Bush. Since the Plaintiffs have not carried their burden under § 523(a)(2), the Court will enter judgment for the Defendants on this claim.
Section 523(a)(6) excepts from discharge any debt "for willful and malicious injury by the debtor to another entity or to the property of another entity."
The Plaintiffs complain of six acts under this statutory provision. They allege that the Mays (1) locked the Balls out of the warehouse where Tile was located; (2) breached the Employee Lease by terminating it without 45 days' written notice; (3) converted Tile's sales orders; (4) caused Alex Mismash to leave Tile; (5) refused to allow the Balls to continue to use May's contractor's license; and (6) arranged a scheme to harm the Balls and their property. The common thread running through these alleged acts is their timing — they occurred in or around April and May 2009. The Balls' theory of their § 523(a)(6) claim is that the Mays engaged in these post-sale acts in an attempt to hamstring the Balls' operation of Tile and ultimately wrest control of the business from them.
With respect to the first act, the evidence showed that Steve May changed the locks to the warehouse where Tile and Granite were located on or around April 23, 2009. He did that because he came to distrust the Balls and did not want them to have access to his office — which shared space with Tile's office — after hours.
The second and third acts are related. The Balls allege that the Mays stopped the sales employees — Jason Johns and Kristy Larsen — from continuing to fill orders for Tile without the requisite 45 days' notice, thereby breaching the Employee Lease. As a result, the Balls contend that the Mays took orders that should have gone to Tile and instead gave them to Granite. There is no dispute that Jack Reed, Tile's and Steve May's attorney, sent a letter dated May 22, 2009 to Spencer Ball, the Balls' attorney, that served as written notice of termination of the Employee Lease.
The evidence on this point is contradictory, but ultimately does not support the Plaintiffs' version of events. David Ball testified that Marie Christiansen would invoice Brad Ball weekly pursuant to the Employee Lease, but the invoices stopped for a period of about three weeks in late April through mid-May 2009.
After weighing the evidence and assessing the credibility of the witnesses, the Court finds that May did not tell Johns and Larsen to stop providing orders to Tile. But even if he had, that would only establish a breach of the Employee Lease. That lease expressly provides that it can be terminated on 45 days' written notice, so the Balls knew termination was a possibility. But most importantly, the Plaintiffs failed to introduce any evidence showing that the Mays intended to injure them through an intentional termination of the Employee Lease. Accordingly, the second and third acts do not support a § 523(a)(6) claim.
As regards the fourth act, there was no evidence that the Mays caused Mismash to leave Tile. In fact, Mismash's own testimony was that David Ball called him and told him "there was no need to do anything anymore."
The fifth act the Balls complain of does not provide any support for their claim. The Asset Sale Agreement clearly provided that the Balls could continue to operate Tile under May's license for 60 days after the date of closing, but thereafter the Balls had to qualify for and obtain their own contractor's license. The term is self-effectuating. May was not required to give notice to the Balls that they could not use his contractor's license after the expiration of the 60-day period. The Balls are the ones who failed to obtain a contractor's license, and any notice May did give that the Balls had breached the Asset Sale Agreement cannot form a basis for this claim.
The Plaintiffs did not address the sixth act — the alleged scheme to harm the Balls and their property — in their brief and they did not present any evidence to support the finding of a scheme. The Court interprets this sixth act to be an aggregation of the prior five, and since those acts are insufficient to support a claim under § 523(a)(6), the Court reaches the same conclusion about the sixth. Accordingly, the Court concludes that the Plaintiffs have failed to carry their burden under § 523(a)(6) and will enter judgment for the Defendants on this claim.
Section 727(a)(2)(B) denies a debtor's discharge where "the debtor, with intent to hinder, delay, or defraud a creditor or an officer of the estate charged with custody of property under this title, has transferred, removed, destroyed, mutilated, or concealed . . . property of the estate, after the date of the filing of the petition."
The Plaintiffs' § 727(a)(2) claim is premised on an alleged transfer of a majority interest in Granite from Steve May to Bobbie May. Initially, the Court notes that Granite's tax returns show that Bobbie May has always held a 50% ownership interest in Granite.
The Plaintiffs attempted to characterize these changes as effecting a transfer of ownership in Granite, but none of this information shows any transfer of an ownership interest in Granite from Steve May to Bobbie May or Stacy May. Granite was organized under the Utah Revised Limited Liability Company Act.
Section 727(a)(3) denies a debtor's discharge where "the debtor has concealed, destroyed, mutilated, falsified, or failed to keep or preserve any recorded information . . . from which the debtor's financial condition or business transactions might be ascertained, unless such act or failure to act was justified under all of the circumstances of the case."
The Plaintiffs' § 727(a)(3) claim is predicated on the alleged falsification of documents, but there appears to be some inconsistency regarding which documents have been falsified. In their brief opposing the Defendants' Rule 52(c) motion, the Plaintiffs suggest that the Mays falsified their bankruptcy schedules, particularly their income, the value of Granite, and the value of two notes payable from Granite. But § 727(a)(3) does not deal with making false statements on one's bankruptcy schedules;
In the amended complaint, however, the Plaintiffs allege that the Mays falsified a different set of documents, namely the books and records of Tile and Granite. But the Plaintiffs did not produce any evidence that showed the Mays falsified the books and records of Tile or Granite. To be sure, there were bookkeeping errors. Russ Bradshaw testified that Tile's QuickBooks records were in average to slightly worse than average condition, although that was not unusual for a business of that size.
Moreover, the Plaintiffs failed to show that Tile's and Granite's records were insufficient to ascertain the Mays' financial condition and material business transactions. To the contrary, the evidence showed that Tile and Granite kept records commensurate with businesses of like complexity. Because the Plaintiffs did not make a prima facie case on their § 727(a)(3) claim, the Court will enter judgment for the Defendants on that claim.
Section 727(a)(4)(A) denies a debtor's discharge where "the debtor knowingly and fraudulently, in or in connection with the case made a false oath or account."
The Plaintiffs' § 727(a)(4)(A) claim focuses on four alleged inaccuracies in the Mays' schedules: (1) the Mays' income, (2) the value of Granite, (3) the value of May's Properties, and (4) the value of two notes payable from Granite. The Mays' Schedule I lists $1,723 in Social Security for Steve May and $3,000 in regular income for Bobbie May for total monthly income of $4,723. On their Schedule B, the Mays listed ownership interests in Granite and May's Properties, which they each valued at $0. They elaborated that Granite "has negative net worth of $522,098 as of April 1, 2013," and May's Properties "owns land that is fully encumbered," so "[t]here is no market for Debtors' interests."
The Plaintiffs did not establish that these statements were false. Regarding the Mays' income, the Plaintiffs' assert that the Mays omitted payments they were receiving on the notes payable from Granite. In particular, the Plaintiffs contend, based on Granite's balance sheets, that the Mays received approximately $30,000 on those notes from December 2012 to May 2013. Granite's balance sheet dated December 31, 2012 lists, under Long Term Liabilities, a "Note Payable — Steve & Bobbie May" with a balance of $98,563.21 and a "Note Payable — Steve May HELOC-39" with a balance of $82,933.44.
But the Plaintiffs did not show by a preponderance of the evidence that the Mays' Schedule I was false. At most, the Plaintiffs established that the Mays had received nearly $30,000 on the notes payable at some point between December 31, 2012 and May 31, 2013. The Mays filed bankruptcy on April 12, 2013. The Plaintiffs simply presume that because the later balance sheet is dated after the Mays filed bankruptcy, they must have received payments on the notes post-petition. But there was no evidence presented that the payments on the notes occurred after the petition date or continued thereafter. In fact, Steve May testified that he did not continue to receive payments on the notes.
With respect to the valuation of Granite, the Mays based the -$522,098 figure on the balance sheet that the Mays' CPA prepared for Granite as of April 1, 2013.
As regards the valuation of May's Properties, the Plaintiffs contend that it could not have been worth $0 because its major asset, a warehouse, sold for $760,000 in September 2013, and the Mays received $277,000 in cash from the sale and used it to pay down a loan taken out by Granite. Again, the Plaintiffs mischaracterize the evidence. Of the $760,000 sales price for the warehouse, $677,374.94 went to Bank of Utah, with the balance going to satisfy closing costs, taxes, and utility assessments.
Concerning the value of the notes payable, the Plaintiffs assert that the notes could not have been worth $0 when the Mays had received nearly $30,000 in payments on those notes. The Plaintiffs focus on the $0 valuation while ignoring the explanation the Mays gave for that figure. The Mays disclosed on Schedule B that the notes had a face value of $165,496.65, but because Granite had a negative net worth, the notes were worthless. Steve May further explained at trial that he valued the notes at $0 because if he no longer had an interest in Granite, the notes would not be worth anything.
In addition, the Plaintiffs failed to establish that the Mays made these four statements with intent to deceive. In the first place, it is difficult to infer fraudulent intent when the Defendants have not made a false oath. Moreover, the record shows that the Mays were forthcoming and transparent on their schedules. They disclosed their interests in Granite, May's Properties, and the notes payable. And they explained the bases for their valuation of those assets, which was supported by the evidence. If the Mays erred on their schedules, the Court concludes that it was at most an honest mistake, which falls short of the intent required under § 727(a)(4). Accordingly, because the Plaintiffs have not carried their burden to show a false oath or the requisite intent, the Court will enter judgment for the Defendants on the § 727(a)(4) claim.
Section 727(a)(5) denies a debtor's discharge where "the debtor has failed to explain satisfactorily, before determination of denial of discharge under this paragraph, any loss of assets or deficiency of assets to meet the debtor's liabilities."
The Plaintiffs' § 727(a)(5) claim alleges that the Mays cannot satisfactorily explain the decline in value of two assets: Granite and the notes payable from Granite. With respect to Granite, the Plaintiffs contend that there is no explanation for the difference between its $3,000,000 valuation on a personal financial statement in 2006 and its -$522,098 valuation on the Mays' schedules in 2013.
But even if the Plaintiffs had made a prima facie case, the Court concludes that the Mays provided a satisfactory explanation for the difference in value. The Great Recession hit Granite hard, reducing its business by 50% in 2008.
The Plaintiffs also failed to make a prima facie case with respect to the two notes payable. The Mays' Schedule B lists the notes' face value as $165,496.65, but explains that because Granite has a negative net worth of $522,098, the notes are worthless and have a current value of $0. The Plaintiffs view this difference between the face value and the current value as an unexplained loss of assets. They are mistaken. The difference is simply due to how the Mays believed the notes would be valued in a bankruptcy case.
On the precipice of the worst financial crisis the United States had seen since the Great Depression, the Balls bought a business in an industry they knew nothing about. About six months later, with cash flow drying up and stress mounting, Brad Ball wanted to get out and move on to something else and developed an "exit strategy." In this lawsuit, the Balls have laid the blame for Tile's failure at the Mays' feet, arguing that the Mays sold them a business whose profits had been fraudulently inflated and then undermined their efforts to conduct that business. The evidence supports neither allegation. The evidence also does not support any of the Plaintiffs' claims under § 727(a). Because the Plaintiffs have not carried their burden on any of their claims, the Court will grant the Defendants' motion under Rule 52(c). A separate Order and Judgment will be entered in accordance with this Memorandum Decision.
