Opinion
MEMORANDUM DECISION ON ADVERSARY COMPLAINT TO DETERMINE DISCHARGEABILITY OF DEBT
ROBERT KWAN, Bankruptcy Judge.
This adversary proceeding came on for trial before the undersigned United States Bankruptcy Judge on July 29, September 29 and October 14, 2011 on the complaint of plaintiff Richard Lara ("Lara") to determine dischargeability of debt of debtor David A. Wilson ("Wilson") pursuant to 11 U.S.C. §§ 523(a)(2), (4), and (6) (the "Complaint"). Appearances were as noted on the record. After the close of evidence, the parties submitted post-trial briefs and proposed findings of fact and conclusions of law. The court took the matter under submission on November 25, 2011 after the last post-trial brief was filed.
Having considered the testimony of witnesses, the exhibits received into evidence, and the oral and written arguments of the parties, the court hereby makes the following findings of fact and conclusions of law pursuant to Federal Rule of Civil Procedure 52(a), Federal Rules of Bankruptcy Procedure 7052 and 9014, and Local Bankruptcy Rule 7052-1.
BACKGROUND
By his adversary complaint, Lara seeks a determination that debts based on his two separate claims for damages against Wilson are nondischargeable. The first claim for damages is based on Lara's allegations that Wilson assigned Lara a 4½% membership interest in PK Holdings, Inc. ("PK Holdings"), subsequently assigned and encumbered Lara's interest without Lara's knowledge or consent, and later misappropriated Lara's share of a distribution from PK Holdings in the amount of $1,260,193.79. The second claim for damages is based on Lara's allegations that Wilson assigned Lara an 8-% membership interest in MT Investors, LLC ("MT Investors") and Lara received less than he was entitled in two distributions made by MT Investors due to wrongful actions of Wilson. For clarity, the following factual summary separately addresses the chronology of each claim for damages.
PK DISTRIBUTION
In 1995, Lara first met Wilson and began working for Wilson's construction company, A&W Builders, Inc. ("A&W"). Amended Joint Pretrial Order ("Amended JPTO") at 2, ¶ 5; Direct Trial Testimony Declaration of Richard Lara ("Lara Declaration") at 1, ¶ 2. Lara was a 10-year employee for Wilson and A&W. Id. During Lara's employment with A&W, Lara and Wilson developed a very close personal relationship. Id. Lara considered Wilson a strong friend, upon whom he could thoroughly trust and rely. Lara Declaration at 2, ¶ 4.
Lara rose to the position of Executive Vice President of Operations of A&W. Amended JPTO at 2, ¶ 6; Lara Declaration at 2, ¶ 3. As the Executive Vice President of Operations, Lara oversaw and managed all of A&W's field operations and construction projects, and was in charge of accounting, estimating and awarding contracts. Id.
During the beginning of Lara's employment with A&W, Lara was compensated by way of salary with a car allowance, gas card, and cell phone. Amended JPTO at 2, ¶ 7. Lara was also allowed and reimbursed for health insurance costs. Amended Direct Trial Testimony Declaration of David A. Wilson ("Wilson Declaration") at 1, ¶ 2.
In 1999, Lara left the employ of A&W to work for another company. Amended JPTO at 2, ¶ 8. In or around 2001, Lara was induced to return to A&W by a promise by Wilson that Lara would receive increased compensation. Amended JPTO at 2, ¶ 9; Lara Declaration at 2, ¶ 5. Wilson promised Lara a compensation structure that entitled Lara to a bonus equal to ten percent (10%) of the cost savings on each construction project Lara managed for A&W (the "Cost Savings Compensation Scheme"). Amended JPTO at 2, ¶ 10. After Wilson promised to pay Lara such bonus compensation, Lara began tracking the cost savings on the projects he managed. Id. at 2, ¶ 11; Trial Testimony of Richard Lara, September 29, 2011 at 11:31-11:32 a.m. Based on the Cost Savings Compensation Scheme, Lara was entitled to receive a bonus of $137,000 on a project renovating a condo development located in Santa Monica, CA (the "Santa Monica Project"). Lara Declaration at 2, ¶ 11. Of the $137,000 bonus earned on the Santa Monica Project, Lara ultimately received a check in the sum of $75,000 as partial payment for the amount that as owed (the "Partial Payment"), leaving the sum of $62,000 unpaid. Id. at 3, ¶ 12.
In tracking the cost savings on the projects he managed for A&W, Lara discovered that Wilson was using A&W funds to pay personal expenses, including payments to his girlfriend for living expenses and luxury cars. Lara Declaration at 2, ¶¶ 9-11; Trial Testimony of Richard Lara, September 29, 2011 at 11:27-11:32 a.m.. After completion of the Santa Monica Project, Lara presented Wilson with his calculation of the cost savings on that project. Lara Declaration at 3, ¶¶ 10-11. Lara did not include Wilson's personal expenses because they caused the cost savings to be understated. Id. However, Wilson insisted those expenses be included. Id.
Lara grew frustrated with tracking the cost savings of A&W projects. Lara Declaration at 3, ¶ 11; Trial Testimony of Richard Lara, September 29, 2011 at 11:31-11:32 a.m. Thereafter, Lara and Wilson agreed that Lara's bonuses would no longer be calculated as a percentage amount under the Cost Savings Compensation Scheme. Amended JPTO at 3, ¶ 14. Wilson promised to pay Lara a flat $100,000 bonus per project that Lara managed. Id. Lara earned $100,000 fees for projects in West Covina, CA (the "West Covina Project") and San Pedro, CA (the "San Pedro Project"). Id. Wilson did not pay Lara the $100,000 bonuses owed for the West Covina Project and the San Pedro Project. Amended JPTO at 3, ¶ 15.
Thus, by the first quarter of 2004, Wilson promised but failed to pay Lara a total of $262,000 for the Santa Monica, West Covina, and San Pedro Projects (the "Unpaid Bonus Compensation"). Amended JPTO at 3, ¶ 16; Lara Declaration at 3, ¶ 14.
In the fall of 2003, Wilson purchased a membership interest in Presidio Kauai, LLC ("Presidio Kauai"), along with Edward "Ned" DeLorme ("DeLorme"), Sushil Patel ("Patel"), and Bridge Capital, LLC ("Bridge Capital"). Amended JPTO at 3, ¶ 18; Wilson Declaration at 2, ¶ 4. (The court acknowledges that the Amended JPTO, as well as the Wilson's Trial Declaration, state that Wilson purchased a security interest in Presidio Kauai, and the testimony of the witnesses and the exhibits relating to Presidio Kauai indicate that Wilson purchased a membership interest in Presidio Kauai rather than taking a security interest as a lender.) At the time, Presidio Kauai owned the real property located as the "Kauai Coconut Beach Hotel" in Hawaii (the "Kauai Hotel"). Lara Declaration at 3, ¶ 15. Presidio Kauai's sole purpose was to purchase and renovate the Kauai Hotel (the "Kauai Project"). Amended JPTO at 3, ¶ 18; Lara Declaration at 3, ¶ 15. Thereafter, PK Holdings, LLC, a Hawaii limited liability company ("PK Holdings"), was formed as a holding company for Presidio Kauai. Wilson Declaration at 2, ¶ 4; Lara Declaration at 4, ¶ 18. Wilson, DeLorme, and Patel were "Initial Managers" of PK Holdings as such term is defined in the First Amended and Restated Operating Agreement of PK Holdings, LLC (the "First Amended Operating Agreement"). See Plaintiff's Trial Exhibit 107, at 10, Article II, ¶ 31.
A&W was the construction company working on the Kauai Project, and Lara worked on the Kauai Project in his capacity as A&W's Executive Vice President of Operations. Amended JPTO at 3, ¶ 20.
In 2003 (and prior to the formation of PK Holdings), Wilson orally assigned to Lara a 5% membership interest in Presidio Kauai (the "Oral PK Assignment"). Amended JPTO at 4, ¶ 23; Lara Declaration at 3, ¶ 15; Trial Testimony of Richard Lara, September 29, 2011 at 11:59 a.m. The Oral PK Assignment was understood by Lara as consideration for Lara's future work on the Kauai Project. See Lara Declaration at 4, ¶ 17; Trial Testimony of Richard Lara, September 29, 2011 at 12:00-12:02 p.m.
Soon thereafter, Lara insisted that the Oral PK Assignment be put in writing. Lara Declaration at 4, ¶ 20. Wilson approached A&W's then counsel, Irina Drill ("Drill"), and asked that she draft an agreement memorializing the terms of the Oral PK Assignment. Lara Declaration at 4, ¶ 21; Trial Testimony of Richard Lara, September 29, 2011 at 11:33-11:34 a.m. Thereafter, on or about June 7, 2004, Drill prepared a draft assignment (the "Drill Assignment") by Wilson to Lara of a 5% membership interest in Presidio Kauai. Id.; see also Plaintiff's Trial Exhibit 5 (copy of the Drill Assignment). The Drill Assignment reflected Lara's understanding of the Oral PK Assignment in that it absolutely assigned to Lara a 5% membership interest in Presidio Kauai. Lara Declaration at 4, ¶ 22; Trial Testimony of Richard Lara, September 29, 2011 at 11:34-11:36 a.m. Wilson refused to sign the Drill Assignment because he believed it had too much "legalese" and needed to be simplified. Lara Declaration at 4, ¶ 23.
In or about 2004, Lara demanded that Wilson execute a written assignment for the Oral PK Assignment. Lara Declaration at 5, ¶¶ 25-30. Wilson agreed, but insisted on modifying the terms of the Oral PK Assignment to make it economically worse for Lara. Lara Declaration at 5, ¶ 31. Specifically, Wilson insisted that Lara's Unpaid Bonus Compensation, totaling $262,000, act as a capital contribution for a new written assignment of a portion of Wilson's membership interest in PK Holdings (which had now been formed as a holding company for Presidio Kauai). Id. Wilson also insisted that Lara provide a further capital contribution for the written assignment in the form of a $150,000 payment from Lara's home equity line of credit to A&W to pay for Kauai Project expenses. Id. Finally, Wilson informed Lara that he would only receive a 4½% membership interest in PK Holdings under the written assignment, as opposed to the 5.0% membership interest Lara was promised in the Oral PK Assignment. Lara Declaration at 6, ¶ 32.
To induce Lara to accept the new terms, Wilson promised to Lara that Lara would receive a return of his capital contributions, plus interest, and a share of the profits of PK Holdings. Lara Declaration at 6, ¶ 34. Thus, Lara would receive far more than the amount of the capital contributions that Lara would use to procure such written assignments. Id. I n reliance upon Wilson's promises, Lara agreed to the new terms. Lara Declaration at 6, ¶ 35.
In March 2005, Wilson then approached Eric Dean ("Dean"), PK Holdings' and MT Investors' attorney, to prepare a written assignment that would replace the terms of the Oral PK Assignment. See Lara Declaration at 6, ¶ 36. Wilson and Lara met with Dean and described the written assignment that they wanted him to draft. Lara Declaration at 6, ¶ 37.
On March 15, 2005, Wilson and Lara executed a written assignment of a share of Wilson's interest in PK Holdings to Lara (the "Written PK Assignment"). Amended JPTO at 4, ¶ 27; see also Plaintiff's Trial Exhibit 1 (copy of the Written PK Assignment). Dean drafted the Written PK Assignment. Amended JPTO at 4, ¶ 26.
In the Written PK Assignment, Wilson assigned Lara a 4½% of his "capital account and percentage interest" in PK Holdings. Amended JPTO at 4, ¶ 27; see also Plaintiff's Trial Exhibit 1. In exchange, Lara forgave the Unpaid Bonus Compensation ($262,000) and contributed an additional $150,000 to A&W, for a total consideration of $412,000. Amended JPTO at 4, ¶ 29.
The Written PK Assignment was a valid assignment and effective to transfer a 4½% interest in and to Wilson's membership interest in PK Holdings, and thereby reduce Wilson's membership interest in PK Holdings to 25½%, and was made for valid consideration as recited in the total sum of $412,000. Amended JPTO at 5, ¶ 36. Wilson had actual knowledge that the Written PK Assignment was a valid assignment and was not a term sheet. Amended JPTO at 5-6, ¶¶ 37-40.
After executing the Written PK Assignment, Wilson made three (3) separate attempts to assign and/or encumber his original 30% interest in PK Holdings even though Wilson only owned a 25½% interest in PK Holdings after the Written PK Assignment. These attempts necessarily impaired the 4½% interest in PK Holdings that he previously assigned to Lara. See Lara Declaration at 10, ¶ 54.
In October 2005, approximately seven (7) months after executing the Written PK Assignment, Wilson first attempted to re-assign and encumber the portion of the membership interest in PK Holdings he already transferred to Lara. Id. At that time, Wilson owned a controlling interest in another company, Parkside Ventures, LLC ("Parkside"). Id. On or about October 24, 2005, Wilson caused Parkside to obtain a loan from Bridge Capital in the amount of $4.85 million (the "October 2005 Loan"). Id. As security for the October 2005 Loan, Wilson executed, or caused to be executed, several instruments:
a. A security agreement granted by A&W in favor of Bridge Capital, whereby Bridge Capital received a security interest on all of A&W's accounts receivable from PK Holdings;
b. A pledge agreement executed by Wilson in favor of Bridge Capital, whereby Wilson pledged a first priority lien on a 30% membership interest in PK Holdings, and any future distributions therefrom (the "October 2005 Pledge Agreement");
c. An assignment by Wilson, as assignor, to Bridge Capital, as assignee, of a 30% membership interest in PK Holdings (the "October 2005 Assignment").
Id. ; see also Plaintiff's Trial Exhibits 6-8. The October 2005 Pledge Agreement and the October 2005 Assignment represent Wilson's first attempt to encumber or assign the 4½% interest in PK Holdings that Wilson already transferred to Lara. Id.
Meanwhile, in or about late 2005, the Kauai Hotel was sold. Lara Declaration at 10, ¶ 57. A dispute arose between Wilson, on the one hand, and the other members of PK Holdings, including DeLorme and Patel (collectively, the "Members"), on the other hand, regarding inter alia the distribution of the sale proceeds from the Kauai Hotel. Lara Declaration at 11, ¶ 58. This dispute resulted in litigation, which was subsequently sent to arbitration in Hawaii (the "Hawaii Arbitration"). Id. Lara was not a party to the Hawaii Arbitration. Lara Declaration at 11, ¶ 63. Pending the resolution of the Hawaii Arbitration, the sale proceeds from the Kauai Hotel (the "Kauai Sale Proceeds") were deposited in an escrow account with Title Guaranty Escrow Services, Inc. ("TG Escrow"). Lara Declaration at 11, ¶ 58.
On November 29, 2005, Wilson was removed as a managing member of PK Holdings. Wilson Declaration at 6, ¶ 33. Lara did not participate in the vote to remove Wilson. See Trial Testimony of Sushil Patel, September 29, 2011 at 9:57 a.m.
In December 2005, Wilson's counsel, Benjamin Meeker ("Meeker"), approached Lara and asked that he sign a declaration in support of Wilson in the Hawaii Arbitration. Wilson Declaration at 7, ¶ 40; Lara Declaration at 11, ¶ 59. Lara refused to sign the proposed declaration as drafted because he believed it contained numerous inaccuracies. Lara Declaration at 11, ¶ 59. Instead, Lara signed a declaration in support of DeLorme and Patel. Id.; see also Wilson Declaration at 7, ¶ 41-42.
Shortly thereafter, by a letter dated January 18, 2006 from Meeker to Marshall Mintz, counsel for Lara, Wilson denied the validity of the Written PK Assignment. Lara Declaration at 11, ¶ 60; see also Plaintiff's Trial Exhibit 100.
On May 1, 2006, Lara filed a complaint for declaratory relief regarding the validity of the Written PK Assignment against Wilson ("Lara State Court Complaint") in the Superior Court of California, County of Orange, commencing the lawsuit of Richard Lara v. David Wilson, Case No. 06CC05599. Amended JPTO at 7, ¶ 56. Those proceedings are further described below.
On May 9, 2006, Wilson procured another loan from Bridge Capital (the "May 2006 Loan"). Amended JPTO at 8, ¶ 60. The May 2006 Loan was a personal loan to Wilson in an amount of $1.5 million. Amended JPTO at 8, ¶ 61. As security for the May 2006 Loan, Wilson once again assigned to Bridge Capital a 30% membership interest in PK Holdings (the "May 2006 Assignment"), despite only owning a 25½% membership interest after the Written PK Assignment. Amended JPTO at 8, ¶ 62; see Plaintiff's Trial Exhibit 10 (copy of May 2006 Assignment). The May 2006 Assignment represents Wilson's second attempt to encumber or assign Lara's 4½% interest in PK Holdings.
On or around November 2, 2006, the Hawaii Arbitration panel entered the Arbitrators' Partial Final Award (the "Partial Hawaii Award"), providing that Wilson and the Members should each receive a distribution of a return of their capital, plus interest, and a percentage share of the Kauai Sale Proceeds (the "PK Distribution"). Amended JPTO at 8, ¶ 63; see also Plaintiff's Trial Exhibit 11 (copy of the Partial Hawaii Award).
Because Lara was not a party to the Hawaii Arbitration, the Partial Hawaii Award did not provide Lara a share of the PK Distribution. Lara Declaration at 11, ¶ 63; see also Plaintiff's Trial Exhibit 11. Instead, the Partial Hawaii Award awarded Wilson a distribution on account of a 30% membership interest, rather than the 25½% interest he actually owned. Id.
The Members, through counsel, informed the Hawaii Arbitration panel of the Written PK Assignment and Lara's right to a portion of the PK Distribution attributable to Wilson's former or original 30% membership interest in PK Holdings. Direct Trial Testimony Declaration of Sushil Patel ("Patel Declaration") at 5, ¶ 26; Direct Trial Testimony Declaration of Edward DeLorme ("DeLorme Declaration") at 5, ¶ 27. Wilson did not inform the Hawaii Arbitration panel of the Written PK Assignment or otherwise disclose during the Hawaii Arbitration that he assigned 4½% of his membership interest in PK Holdings to Lara. Patel Declaration at 5, ¶ 27; DeLorme Declaration at 5, ¶ 28. In fact, during the course of the Hawaii Arbitration, Wilson denied that he assigned a 4½% membership interest in PK Holdings to Lara. Id.
On December 19 and 20, 2006, the Hawaii Arbitration panel entered a final order directing TG Escrow to make the PK Distribution ("Final Hawaii Award"). Amended JPTO at 8, ¶ 64.
Lara tried to enjoin TG Escrow from distributing his share of the PK Distribution to Wilson. Lara Declaration at 12, ¶ 67; Patel Declaration at 6, ¶ 28; DeLorme Declaration at 6, ¶ 29; see also Plaintiff's Trial Exhibit 118. In particular, on or about December 21, 2006, Lara filed a motion with the Circuit Court of the State of Hawaii to enjoin TG Escrow from making distributions that were inconsistent with the Written PK Assignment. Id.
On November 2, 2006, Bridge Capital initiated an action against Wilson to foreclose on its lien under the October 2005 Pledge Agreement, the October 2005 Assignment and/or the May 2006 Assignment. Amended JPTO at 9, ¶ 70.
In or about November 2006, to prevent foreclosure by Bridge Capital, Wilson secured another loan from United Commercial Bank (the "United Commercial Loan"). Amended JPTO at 9, ¶ 71. United Commercial agreed to pay off the October 2005 Loan and/or the May 2006 Loan, in return for which Wilson promised to immediately transfer to United Commercial the entire share of the PK Distribution attributable to his former 30% membership interest in PK Holdings (the "United Commercial Assignment"). Wilson Deposition (July 13, 2007) at 178:16-183:22. The United Commercial Assignment represents Wilson's third attempt to encumber or assign Lara's 4½% interest in PK Holdings.
Thereafter, Wilson actually received the gross sum of approximately $4.5 million from the PK Distribution. Amended JPTO at 9, ¶ 74. On account of Lara's 4½% interest in PK Holdings, Lara was entitled to a portion of the PK Distribution in the amount of $1,260,193.79. See Amended JPTO at 8, ¶ 65.
After his paying attorneys' fees, Wilson immediately paid the balance of the PK Distribution, including Lara's share, to United Commercial pursuant to the United Commercial Assignment. Lara Declaration at 13, ¶ 73; see also Amended JPTO at 8, ¶¶ 67, 74.
Therefore, Wilson breached the Written PK Assignment by failing to pay Lara his share of the PK Distribution. Amended JPTO at 8, ¶ 68. Wilson's failure to pay to Lara his share of the PK Distribution was not justified or excused. Id. As a result of this breach, Lara was damaged and entitled to recover $1,260,193.79. Amended JPTO at 8, ¶ 69.
MT DISTRIBUTION
In addition to his membership in PK Holdings, Wilson was also a member of MT Investors, LLC ("MT Investors"), a company that owned and was renovating several properties in Alabama and Oklahoma. Amended JPTO at 4, ¶ 22. Sushil Patel was a managing member of MT Investors. Patel Declaration at 2, ¶ 4. Edward DeLorme was a "member of the manager" of MT Investors. DeLorme Declaration at 2, ¶ 4.
A few months after Wilson and Lara entered into the Oral PK Assignment (described above) in late 2003, Lara was personally involved in negotiating a settlement of a dispute between A&W and a third party regarding the San Pedro Project (the "Settlement"), pursuant to which A&W received a payment of $1,950,000 (the "Settlement Proceeds"). Amended JPTO at 4, ¶ 23. Wilson promised or gave Lara $250,000 of the Settlement Proceeds as compensation for his services (the "Settlement Compensation"). Amended JPTO at 4, ¶ 24 (stating that Wilson "gave" Lara $250,000). The Settlement Compensation was then used by Lara as a capital contribution in exchange for Wilson's oral assignment to Lara of 50% of Wilson's Class "A" shares (or 8-% of outstanding shares) and 50% of Wilson's Class "B" shares in MT Investors (the "Oral MT Assignment"). Amended JPTO at 4, ¶ 24.
In or about August 2004, MT Investors sold a hotel property in Mobile, Alabama, commonly known as the "Crowne Plaza Hotel, " and made a distribution of the proceeds from such sale to its members, including Wilson (the "First MT Distribution"). Lara Declaration at 5, ¶ 25; Trial Testimony of Richard Lara, September 29, 2011 at 11:37-11:38 a.m.; see also Amended JPTO at 4, ¶ 25. Due to the Oral MT Assignment, Lara was entitled to a share of the First MT Distribution, pursuant to which each member of MT Investors received their respective original capital contributions. Lara Declaration at 5, ¶ 26. Wilson did not inform Lara of the First MT Distribution. See Lara Declaration at 5, ¶¶ 25-27. Patel and DeLorme were aware of the Oral MT Assignment through conversations with Wilson and Lara, and informed Lara of the sale of the Crowne Plaza Hotel and the First MT Distribution. Patel Declaration at 2, ¶¶ 6-7; DeLorme Declaration at 2, ¶¶ 6-7; see also, Lara Declaration at 5, ¶ 25. After being informed of the First MT Distribution by Patel, Lara confronted Wilson and demanded that Wilson turn over Lara's share of the First MT Distribution. Lara Declaration at 5, ¶ 27; Trial Testimony of Richard Lara, September 29, 2011 at 11:39 a.m. In response, Wilson informed Lara that he needed additional funds for other projects, and, therefore, despite the Oral MT Assignment, Lara would not receive his share of the First MT Distribution. Lara Declaration at 5, ¶ 28. Lara did not receive his share of the First MT Distribution. See id. Wilson promised Lara that he (Wilson) would ensure that Lara received Lara's share of any future distributions from MT Investors. Lara Declaration at 5, ¶ 29.
As a result of the First MT Distribution, Lara demanded that Wilson execute written assignments for the Oral PK Assignment (discussed above) and the Oral MT Assignment. Lara Declaration at 5, ¶ 30. Wilson agreed, but insisted on modifying the terms of the Oral MT Assignment to make it economically worse for Lara. See Lara Declaration at 5, ¶ 31.
Specifically, Wilson informed Lara that a written assignment of his interests in MT Investors would only grant Lara 50% of Wilson's Class "A" shares in MT Investors (8-% of outstanding shares), and would not grant Lara any of Wilson's Class "B" shares, as provided in the Oral MT Assignment. Lara Declaration at 6, ¶ 33.
To induce Lara to accept the new terms of the written assignment, Wilson promised to Lara that Lara would receive a return of his capital contributions, plus interest, and a share of the profits of MT Investors. Lara Declaration at 6, ¶ 34. Thus, Wilson promised Lara that he would receive far more than the amount of the capital contributions that Lara would use to procure such written assignments. Id.
On March 15, 2005, Wilson executed a written assignment to replace the terms of the Oral MT Assignment. See Amended JPTO at 5, ¶ 32. In the written assignment, Wilson assigned to Lara one-half of his 17½% Class "A" interest, or 8-% of the outstanding Class "A" equity, in MT Investors (the "Written MT Assignment"). Amended JPTO at 5, ¶ 32; Lara Declaration at 7, ¶ 39; see also Plaintiff's Trial Exhibit 3.
In the Written MT Assignment, Wilson acknowledged that Lara had "provided funds to [Wilson] in the amount of Two Hundred Sixty Two Thousand Five Hundred Dollars ($262,500)...." Amended JPTO at 5, ¶ 33; see also Lara Declaration at 6, ¶ 37. The $262,500 represented the $250,000 Wilson owed Lara from the Settlement Proceeds, plus interest. Amended JPTO at 5, ¶ 34; Lara Declaration at 6, ¶ 37.
Lara was not required to pay any additional or other consideration for the Written MT Assignment. Amended JPTO at 5, ¶ 35. Wilson understood this. Amended JPTO at 6, ¶ 46. Lara did not breach the Written MT Assignment by failing to actually pay the Settlement Compensation to Wilson. See Amended JPTO at 6, ¶ 47. The Written MT Assignment was a valid assignment, which Wilson knowingly agreed to. Amended JPTO at 6, ¶ 41. The Written MT Assignment was not a term sheet, nor did Wilson believe it to be a term sheet. Amended JPTO at 6, ¶¶ 44-45.
In early July 2005, approximately four (4) months after the execution of the Written MT Assignment, MT Investors was preparing to make a distribution to its members from the proceeds of the sale of a commercial office building in Mobile, Alabama, commonly known as "Riverview Plaza" (the "Second MT Distribution"). Patel Declaration at 2, ¶ 9; Lara Declaration at 7, ¶ 42; Trial Testimony of Richard Lara, September 29, 2011 at 11:41 a.m.
Despite Wilson knowing that he previously assigned to Lara an 8-% Class "A" interest in MT Investors pursuant to the Written MT Assignment, Wilson did not inform Lara of the Second MT Distribution. Lara Declaration at 7, ¶ 43.
Wilson represented to Patel, DeLorme, and the escrow company holding the proceeds from the sale of the Riverview Plaza property (the "Riverview Escrow Company") that he was entitled to a portion of the Second MT Distribution based on his original 17½% Class "A" interest in MT Investors, instead of based on the 8-% Class "A" interest that he actually owned at the time. Patel Declaration at 2, ¶ 9; DeLorme Declaration at 2, ¶ 9.
Because DeLorme was aware of the Written MT Assignment, he contacted Lara to inform him of Wilson's statements and that Wilson was attempting to obtain Lara's share of the Second MT Distribution. See Lara Declaration at 7, ¶ 43; DeLorme Declaration at 2, ¶ 9. DeLorme also urged Lara to obtain counsel to protect his interest in the Second MT Distribution. Id.
Subsequently, Lara confronted Wilson about the Second MT Distribution, and Wilson told Lara that Lara would not be receiving Lara's share of the Second MT Distribution. Lara Declaration at 8, ¶ 44.
Immediately thereafter, Lara resigned from A&W and hired counsel to enforce his rights under the Assignments. Amended JPTO at 7, ¶ 53.
By a letter dated July 14, 2005 (the "Demand Letter"), Lara's counsel made a formal claim to Patel, DeLorme, and Wilson, for Lara's share of any future distributions, including the Second MT Distribution. Amended JPTO at 7, ¶ 54; Lara Declaration at 8, ¶ 45; see also Plaintiff's Trial Exhibit 4 (copy of the Demand Letter).
Due to the conflicting claims of Wilson and Lara, Dean, on behalf of MT Investors, urged and required Wilson to obtain joint escrow instructions regarding how the portion of the Second MT Distribution attributable to Wilson's original 17½% Class "A" interest should be allocated and disbursed among the competing claimants. Lara Declaration at 8, ¶ 47; Trial Testimony of Richard Lara, September 29, 2011 at 11:46 a.m. Trial Testimony of Sushil Patel, September 29, 2011 at 10:10 a.m.; see also Plaintiff's Trial Exhibit 50.
After Lara's counsel sent the Demand Letter and before the Joint Escrow Instructions (defined below) were submitted, Wilson continued to attempt to obtain all or a portion of Lara's share of the Second MT Distribution for himself. See Patel Declaration at 3, ¶ 13; DeLorme Declaration at 3, ¶ 14. Specifically, Wilson represented to DeLorme, Patel, and the Riverview Escrow Company that Lara had agreed: (1) to limit his share of the Second MT Distribution to $100,000; and (2) that Wilson should receive Lara's share of the Second MT Distribution, which Wilson would then forward to Lara. Id.
On July 17, 2005, Lara and Wilson executed joint escrow instructions regarding the allocation and distribution of the portion of the Second MT Distribution attributable to Wilson's original 17½% Class "A" interest in MT Investors (the "Joint Escrow Instructions"). Amended JPTO at 7, ¶ 55; see also Plaintiff's Trial Exhibit 73 (copy of the Joint Escrow Instructions); Defendant's Trial Exhibit I (copy of the Joint Escrow Instructions).
Prior to the Second MT Distribution, Wilson had assigned shares of his membership interest in MT Investors to lender Bridge Capital, as security for loans from Bridge Capital. Lara Declaration at 9, ¶ 52. As a result, and pursuant to the Joint Escrow Instructions, Bridge Capital received $510,138.96 from the Second MT Distribution. See id.; Plaintiff's Trial Exhibit 73. Because Wilson did not inform Lara of the First MT Distribution and refused to pay Lara his share of the First MT Distribution, in which each member of MT Investors received a return of their respective original capital contributions, and because Bridge Capital received $510,138.96 of the Second MT Distribution, Lara received $28,169.59 less than he was entitled to under the Written MT Assignment. Lara Declaration at 9, ¶ 52; see also Plaintiff's Trial Exhibit 70 (copy of email correspondence from Marshall Mintz to David Wilson).
As compensation, Wilson promised Lara to make up this shortfall out of future distributions from MT Investors' other property, namely a property located in Tulsa, Oklahoma, or from a "future distribution from the Kauai deal." Lara Declaration at 9, ¶ 53; Plaintiff's Trial Exhibit 70.
Lara received disbursements totaling approximately $200,000 pursuant to the terms and provisions of the Written MT Assignment and was owed the further and remaining sum of $28,169.59 prior to Wilson filing for bankruptcy protection. Amended JPTO at 6, ¶ 49; Trial Testimony of Richard Lara, September 29, 2011 at 2:47 p.m.
Wilson breached the terms of the Written MT Assignment by failing to pay Lara the remaining sums due pursuant to the Written MT Assignment, and, as a result, Lara was damaged in the sum of $28,169.59. Amended JPTO at 6, ¶ 50.
STATE COURT LITIGATION
As mentioned above, on May 1, 2006, Lara filed a complaint for declaratory relief regarding the validity of the Written PK Assignment against Wilson in the Superior Court of California, County of Orange, commencing the lawsuit Richard Lara v. David Wilson, Case No. 06CC05599 (the "Lara State Court Complaint"). Amended JPTO at 7, ¶ 56.
On January 3, 2007, Wilson filed a separate complaint against Lara for breach of contract and declaratory relief related to the Written MT Assignment (Case No. 07CC00159). Amended JPTO at 7, ¶ 57.
On February 21, 2007, Lara filed a cross-complaint for damages resulting from Wilson's breach of the Written PK Assignment and the Written MT Assignment and for declaratory relief (altogether with the Lara State Court Complaint, the "State Court Litigation"). Amended JPTO at 7, ¶ 58.
On October 9, 2007, Lara and Wilson agreed to resolve the State Court Litigation in binding arbitration (the "Arbitration"). Amended JPTO at 9, ¶ 75.
On May 28, 2008, the arbitrator, Judge Judith M. Ryan (ret.) (the "Arbitrator"), rendered a final award (the "Final California Award"), finding for Lara on all issues, and awarding Lara all amounts requested in the total sum of $1,288,363.38, plus prejudgment interest thereon. Plaintiff's Trial Exhibit 14 (copy of Final California Award). The Arbitrator made many factual findings and determinations and ultimately concluded the following:
a. The Written PK Assignment was valid and effective to transfer a 4½% interest in and to Wilson's membership interest in PK Holdings;
b. The Written MT Assignment was valid and effective to transfer an 8-% interest in and to Wilson's membership interest in MT Investors;
c. Wilson breach the Written PK Assignment by failing to pay Lara his share of the PK Distribution in the amount of $1,260,193.79; and
d. Wilson breached the Written MT Assignment by failing to pay Lara the remaining $28,169.59 owed under the First and Second MT Distributions.
Amended JPTO at 9, ¶ 76.
Arbitrator further denied Wilson's claims that Lara had breached the Written MT Assignment and that the Written PK Assignment was not valid, and concluded that Wilson was not entitled to the relief he sought on his breach of contract and declaratory relief claims as to the Written MT Assignment. Id.
On August 12, 2008, the Superior Court of California for the County of Orange entered a judgment confirming the Final California Award (the "Judgment"). Amended JPTO at 10, ¶ 77; see also Plaintiff's Trial Exhibit 15. Under the Judgment, Lara is owed $1,288,363.38, with interest thereon at an annual statutory rate on judgments of ten percent (10%) from May 1, 2006, until paid. See Plaintiff's Trial Exhibit 15.
On August 13, 2008, the day after entry of the Judgment, Wilson commenced this bankruptcy case by filing his voluntary petition for relief under Chapter 7 of the Bankruptcy Code. Amended JPTO at 10, ¶ 78.
On January 23, 2009, Lara initiated this adversary proceeding by timely filing the Complaint, alleging inter alia that Wilson's debt to Lara under the Judgment is nondischargeable pursuant to 11 U.S.C. § 523(a)(2)(A), (4), and (6). Amended JPTO at 10, ¶ 79; see also, Complaint.
On April 15, 2011, this court entered an "Order Granting Plaintiff's Motion to Confirm Arbitrator's Findings" (Docket No. 89), wherein the court ordered that certain findings of the Arbitrator in the Final California Award are entitled to preclusive effect and may not be relitigated in this adversary proceeding, including the amount of damages (i.e., damages from Wilson's breach of the PK Assignment total $1,260,193.79, and damages from Wilson's breach of the MT Assignment total $28,169.59).
DISCUSSION
The court has jurisdiction over this adversary proceeding to determine dischargeability of debts pursuant to 28 U.S.C. §§ 157(a) and (b)(1) and (2)(I) and 1334. Venue is proper in this judicial district pursuant to 28 U.S.C. § 1409(a). This adversary proceeding is a core matter pursuant to 28 U.S.C. § 157(b)(2)(I).
Lara contends that Wilson's liabilities to him under the Judgment are excepted from discharge pursuant to 11 U.S.C. §§ 523(a)(2)(A), (4), and (6). In debt dischargeability cases, the burden of proof is on creditors, "strictly construing exceptions to discharge in favor of debtors in order to effectuate the Congressional policy' of affording debtor's a fresh start.'" Beneficial California, Inc. v. Brown ( In re Brown ), 217 B.R. 857, 860 (Bankr. S.D. Cal. 1998), citing, Gregg v. Rahm ( In re Rahm ), 641 F.2d 755, 756-757 (9th Cir. 1981). Furthermore, "the standard of proof for the dischargeability exceptions in 11 U.S.C. § 523(a) is the ordinary preponderance-of-the-evidence standard." Grogan v. Garner, 498 U.S. 279, 291 (1991). Because the Judgment awards damages for two separate injuries-Lara's failures to receive the PK Distributions and MT Distributions-each injury will be separately analyzed under each claim for relief.
I. Section 523(a)(2)(A) Claim
11 U.S.C. § 523(a)(2)(A) provides that, "[a] discharge under section 727... of this title does not discharge an individual debtor from any debt - (2) for, money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained, by - (A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor's or an insider's financial situation." To render a debt nondischargeable under § 523(a)(2)(A), the following five elements must be met: (1) the debtor made the representations; (2) that at the time he knew they were false; (3) that he made them with the intention and purpose of deceiving the creditor; (4) that the creditor relied on such representations; and (5) that the creditor sustained the alleged loss and damage as the proximate result of the representations having been made. Citibank ( South Dakota ), N.A. v. Eashai ( In re Eashai ), 87 F.3d 1082, 1086 (9th Cir. 1996); Britton v. Price ( In re Britton ), 950 F.2d 602, 604 (9th Cir. 1991); see also, In re Sabban, 600 F.3d 1219, 1222 (9th Cir. 2010). The § 523(a)(2)(A) elements "mirror the elements of common law fraud' and match those for actual fraud under California law." Tobin v. Sans Souci Limited Partnership ( In re Tobin ), 258 B.R. 199, 203 (9th Cir. BAP 2001), quoting, Younie v. Gonya ( In re Younie ), 211 B.R. 367, 373-374 (9th Cir. BAP 1997).
A. Representations Made by Wilson
Under 11 U.S.C. § 523(a)(2)(A), Lara must prove that Wilson made the representations at issue. Eashai, 87 F.3d at 1086.
Regarding Lara's damages arising from the PK Distribution, in 2003, Wilson orally assigned Lara a 5.0% membership interest in PK Holdings as consideration for Lara's future work on the Kauai Project (the Oral PK Assignment). Amended JPTO at 4, ¶ 23. Thereafter Lara demanded a written assignment be executed. Wilson agreed, but insisted on modifying the terms of the Oral PK Assignment to the detriment of Lara. On March 15, 2005, Wilson and Lara executed a written assignment (the Written PK Assignment) wherein Wilson assigned Lara a 4½% membership interest in PK Holdings in consideration for Lara contributing $412,000 of capital, including $262,000 in Unpaid Bonus Compensation and $150,000 in new capital, to pay A&W's expenses on the Kauai Project. Amended JPTO at 4, ¶ 27; see also Plaintiff's Trial Exhibit 1 (copy of Written PK Assignment). And, pursuant to the implied covenant of good faith within the Written PK Assignment, Wilson implicitly represented to Lara that he would not interfere with Lara's right to distributions vis-à-vis the assigned 4½% interest in PK Holdings. Id. To induce Lara to accept the new terms, Wilson promised to Lara that Lara would receive a return of his capital contributions, plus interest, and a share of the profits of PK Holdings. Lara Declaration at 6, ¶ 35.
Regarding Lara's damages arising from the MT Distribution, in late 2003, Wilson promised to pay Lara $250,000 for Lara's services in resolving a dispute between A&W and a third party (the Settlement Compensation), which sum was to be used as a capital contribution to obtain 50% of Wilson's Class "A" interest (or 8-% of outstanding Class "A" shares) and 50% of Wilson's Class "B" interest in MT Investors (the Oral MT Assignment). Amended JPTO at 4, ¶ 24. Thereafter, and despite the Oral MT Assignment, Wilson failed to distribute to Lara his share of the First MT Distribution because Wilson needed the funds for other projects. Lara Declaration at 5, ¶ 28. However, Wilson promised Lara that he (Wilson) would ensure that Lara receive his share of any future distributions from MT Investors. Id. at ¶ 29. As a result of the First MT Distribution, Lara demanded a written assignment be executed. Wilson agreed, but insisted on modifying the terms of the Oral MT Assignment to the detriment of Lara. On March 15, 2005, Wilson and Lara executed a written assignment (the Written MT Assignment) wherein Wilson assigned Lara 50% of his Class "A" interest in MT Investors but did not assign Lara any of his Class "B" interest. Id. at ¶¶ 30-33. Like the Oral MT Assignment, Wilson contributed the Settlement Compensation as a capital contribution in exchange. Id. And, pursuant to the implied covenant of good faith within the Written MT Assignment, Wilson implicitly represented to Lara that he would not interfere with Lara's right to distributions vis-à-vis the assigned 8-% Class "A" interest in MT Investors. See Plaintiff's Trial Exhibit 3 (copy of Written MT Assignment). To induce Lara to accept the new terms of the Written MT Assignment, Wilson promised to Lara that Lara would receive a return of his capital contributions, plus interest, and a share of the profits of MT Investors. Lara Declaration at 6, ¶ 34.
Wilson argues that Lara cannot establish this element of a representation: "Perhaps even more problematic for LARA is that he has never, and cannot now, identify a single express statement by WILSON that was made on or around March 15, 2005 that demonstrates a false representation." Defendant's Trial Brief at 6. In this case, Lara has offered credible evidence of promises made by Wilson to him that he would assign him membership interests in PK Holdings and MT Investors. While "[t]he failure to perform a mere promise is not sufficient to make a debt nondischargeable, even if there is no excuse for the subsequent breach, " 4 Resnick and Sommer, Collier on Bankruptcy, ¶ 523.08[1][d] at 523-45-523-46 (16th ed. 2012), "section 523(a)(2)(A) may make a creditor's claim nondischargeable if the debtor had no intention of performing any of the obligations under the contract." Id., ¶ 523.08[1][d] at 523-46. "This intent may be inferred from the fact that the debtor failed to take any steps to perform under the contract." Id., citing inter alia, Merchants Nat'l Bank & Trust Co. v. Pappas (In re Pappas), 661 F.2d 82 (7th Cir. 1981). Thus, "a promise made with a positive intent not to perform or without a present intent to perform satisfies § 523(a)(2)(A)" and may constitute a material misrepresentation under this section. Rubin v. West (In re Rubin ), 875 F.2d 755, 759 (9th Cir. 1989).
Accordingly, the court finds that Lara has shown by a preponderance of the evidence that Wilson represented that he would assign Lara a 4½% membership interest in PK Holdings and an 8-% membership interest (Class "A" shares) in MT Investors and implicitly represented that he would not interfere with Lara's right to distributions vis-à-vis the assigned interests. Thus, Lara has proven by a preponderance of the evidence the first element of § 523(a)(2)(A) that Wilson made these representations, and the court rejects Wilson's argument that Lara has not met his burden of proof as to this element.
B. Knowledge of Falsity
Second, under § 523(a)(2)(A), Lara must prove that at the time Wilson made the representations at issue, Wilson knew they were false. Wilson argues that Lara cannot establish this element of falsity of any of his alleged misrepresentations: "Similarly, LARA cannot identify facts showing whatever statement(s) WILSON was alleged to have made were made with knowledge of falsity or with the specific intent (i.e., scienter) to deceive." Defendant's Trial Brief at 6.
In the context of promissory fraud, which is the allegation in this case, a plaintiff can satisfy this element of falsity by showing a promise was made without intent to perform. In re Tobin, 258 B.R. at 203; Palmacci v. Umpierrez, 121 F.3d 791, 786 (1st Cir. 1997) ("A representation of the maker's intention to do... a particular thing is fraudulent if he does not have the intention' at the time he makes the representation."), quoting, Restatement (Second) of Torts § 530(1). Thus, "a promise made with a positive intent not to perform or without a present intent to perform satisfies § 523(a)(2)(A)." McCrary v. Barrack ( In re Barrack ), 217 B.R. 598, 606 (9th Cir. BAP 1998), citing, In re Rubin, 875 F.2d at 759.
California law, which mirrors the elements of § 523(a)(2)(A) ( see In re Tobin, 258 B.R. at 203), recognizes that "[a]n action for promissory fraud may lie where a defendant fraudulently induces the plaintiff to enter into a contract." Lazar v. Superior Court, 12 Cal.4th 631, 638-639 (1996) (citations omitted). Promissory fraud may also exist where one is induced to accept employment by promises of increased compensation and the employer has no intention to perform. Id. Likewise, "where the promisor knew or should have known of his prospective inability to perform, ' the promise can be found to be fraudulent." In re Barrack, 217 B.R. at 606 (citation omitted). "[I]n determining whether the debtor had no intention to perform, a court may look at all the surrounding facts and circumstances." In re Barrack, 217 B.R. at 607 (citation omitted).
Regarding Lara's damages arising from the PK Assignment, Wilson's intent not to perform is evident from the totality of the circumstances. Just months after the Written PK Assignment was executed on March 15, 2005, Wilson attempted to reassign and encumber Lara's 4½% membership interest in PK Holdings in the October 2005 Pledge Agreement, the October 2005 Assignment, the May 2006 Assignment, and the United Commercial Assignment (in November 2006). See Plaintiff's Trial Exhibits 7 (copy of October 2005 Pledge Agreement); 8 (copy of October 2005 Assignment); and 10 (copy of May 2006 Assignment). Then in the Hawaii Arbitration, Wilson did not inform the arbitration panel of Lara's interest in PK Holdings, and denied ever assigning Lara an interest when Patel and DeLorme informed the panel of the assignment. Wilson had no reasonable basis for this position. Patel Declaration at 5, ¶¶ 26-27; DeLorme Declaration at 5, ¶¶ 27-28. Finally, when Wilson received the PK Distribution, Wilson knew that he had received Lara's share of the PK Distribution and knowingly transferred Lara's share of the PK Distribution to United Commercial, instead of to Lara. Lara Declaration at 13, ¶ 73; Amended JPTO at 8, ¶¶ 73-74, 9, ¶ 74.
Regarding Lara's damages arising from the MT Distribution, Wilson's intent not to perform is evident from the totality of the circumstances. First, after making the Oral MT Assignment, Wilson did not inform Lara of the First MT Distribution and later refused to distribute to Lara his share of the First MT Distribution because Wilson needed the funds for other projects. Lara Declaration at 5, ¶¶ 25-27. Thereafter, Wilson resisted Lara's attempts to memorialize the Oral MT Assignment. When Wilson finally agreed to executed a written assignment, Wilson reneged on the terms of the Oral MT Assignment and insisted on new terms to the detriment of Lara. Id. at 5, ¶ 31. After the Written MT Assignment was executed, Wilson again failed to inform Lara of the Second MT Distribution. Lara Declaration at 7, ¶ 43. After DeLorme notified Lara of the Second MT Distribution and Lara confronted Wilson about it, Wilson told Lara that he (Lara) would not receive his share of the Second MT Distribution. Lara Declaration at 7-8, ¶ 43-44. Lara then sent a demand letter to legal counsel for MT Investors (Dean). Lara Declaration at 8, ¶ 45; Plaintiff's Trial Exhibit 4 (copy of the Demand Letter). Even after Lara delivered the demand letter, Wilson continued to falsely represent to Dean that Lara had agreed to (i) accept $100,000 as his share of the Second MT Distribution, and (ii) allow Wilson to collect Lara's share of the Second MT Distribution who would then forward payment to Lara. Patel Declaration at 3, ¶ 13; DeLorme Declaration at 3, ¶ 13. Neither of these representations were true. Lara Declaration at 8, ¶ 46.
During trial, Wilson argued that his knowledge and intent when executing the Written PK and MT Assignments (hereinafter, the "Written Assignments") could be established by subsequent events. See Defendant's Trial Brief at 6. The court disagrees. While most of the events described above occurred after the Written Assignments were executed, they represent consistent patterns of behavior aimed at depriving Lara of any distributions from the assigned interests. Absent any evidence to the contrary, these patterns of behavior constitute circumstantial evidence that Wilson never intended to allow Lara to receive distributions from the assigned interests, and therefore knew at the time he executed the Written Assignments that the representations he was making therein were false.
Wilson also argued that the identical language used in the Written Assignments is indicative that he intended to perform his obligations when he executed the Written Assignments. See Defendant's Trial Brief at 6. Again, the court disagrees. The language used in an assignment bears on what representations were made, but it is not indicative of whether Wilson knew such representations were false when he made them.
Finally, Wilson testified during trial that he had a good-faith belief that Lara had not paid full consideration due under the Written Assignments. See Amended Trial Declaration of David Wilson at 4, ¶ 22, 9, ¶ 51. Wilson gave the same testimony during the State Court Litigation. See Plaintiff's Trial Exhibit 14 at 6-8 (copy of Final California Award). There, the Arbitrator, after reviewing circumstances surrounding the execution of the Written Assignments, found such testimony not credible:
In sum, the preponderance of the evidence, if not the clear weight of the evidence, supports that the [ sic. ] Richard Lara and David Wilson discussed and ultimately entered into assignments for the interests in PK Holdings, LLC and MT Investors, LLC as specifically set forth in the Exhibits in evidence as set forth above.... Mr. Wilson did not offer credible contrary testimony.
Specifically, there was no testimony or evidence presented, that Mr. Wilson at anytime contemporaneous with the signing of the assignments ever objected to or took any other action that was contrary to the assignments or the provisions of the assignment. Further, there was no evidence presented as to any objection as to the amount of the recited consideration and how that amount was determined from the perspective of Mr. Wilson or that there was any disagreement with those sums. Mr. Wilson in his capacity as Claimant has not met his burden by a preponderance of the evidence to support his position as to either of the assignments.
Id. at 8-9.
Similarly, for the following reasons this court finds that Wilson did not at any point have a "good-faith belief" that the Written Assignments were not enforceable against him for Lara's failure to pay consideration. First, the Written Assignments provide that the Wilson had already received value for the assignments. See Plaintiff's Trial Exhibits 1 and 3 ("For value received, David Wilson, ("Assignor") hereby assigns to Richard Lara ("Assignee"), a portion of his capital interest and percentage interest...."). Second, Wilson's testimony is not credible because it is conclusory, vague, and unsupported by other evidence. Wilson did not testify specifically as to what amounts Lara failed to pay for the Written Assignments, or how and when Lara was to pay such amounts. See Wilson Declaration at 4, ¶ 22, 9, ¶ 51. Lara's testimony is far more credible as it is supported by the language of the Written Assignments and the subsequent actions of the parties. For example, when the parties executed the Joint Escrow Instructions, Wilson did not dispute the validity of the Written MT Assignment. See Plaintiff's Trial Exhibit 73.
Accordingly, the court finds by a preponderance of the evidence that at the time Wilson executed the Written Assignments he had actual knowledge that he did not intend to perform his obligations therein. Thus, Lara has proven by a preponderance of the evidence the second element of § 523(a)(2)(A) that Wilson knowingly made false representations by making promises without intending to perform.
C. Intent to Deceive
To satisfy the third element to a § 523(a)(2)(A) claim, the creditor must prove that the debtor had the intent and purpose to deceive the creditor. Just like the second element, "direct proof of intent to deceive is nearly impossible to obtain." In re Brown, 217 B.R. at 861. Thus, "the element of intent may be inferred from proof of the surrounding circumstances if the facts and circumstances of a particular case present a picture of deceptive conduct by the debtor.'" Id., citing, In re Eashai, 87 F.3d at 1087. Furthermore, "a court may infer an intent to deceive from a false representation." In re Rubin, 875 B.R. at 759 (citation omitted).
Wilson's intent to deceive Lara with the Written Assignments can be inferred from Wilson's intention to not perform his obligations therein by purporting to own, transfer and/or encumber the transferred interests after assigning them to Lara. Moreover, the court also finds that Wilson had motives to deceive Lara. Specifically, Wilson's misrepresentations induced Lara to forego terminating his employment with A&W and seeking to collect the Unpaid Bonus Compensation and Settlement Compensation. In addition, Wilson's misrepresentations induced Lara to transfer $150,000 from his home equity line of credit to Wilson's construction company, A&W.
Accordingly, the court finds by a preponderance of the evidence that at the time Wilson executed the Written Assignments he had an intention to deceive Lara. Thus, Lara has proven by a preponderance of the evidence the third element of § 523(a)(2)(A) that Wilson made the representations with the intention of deceiving him.
D. Plaintiff's Reliance
Fourth, under § 523(a)(2)(A), Lara must prove that he justifiably relied on Wilson's representations. In re Eashai, 87 F.3d at 1086. In regards to the fourth element of § 523(a)(2)(A), Lara must show that his reliance on Wilson's promise to assign the membership interests in PK Holdings and MT Investors was "justified." Field v. Mans, 516 U.S. 59, 73-76 (1995) (holding that reliance need not reach a level of "reasonableness" to establish nondischargeability under § 523(a)(2)(A), but must still be justifiable). There cannot be justifiable reliance upon a representation if Lara knew it is false or its falsity is obvious. 4 March, Ahart and Shapiro, California Practice Guide: Bankruptcy, ¶ 22:481 at 22-59 (2011), quoting, In re Kirsh, 973 F.2d 1454, 1459 (9th Cir. 1992) ("[A] person cannot purport to rely upon preposterous representations or close his eyes to avoid discovery of the truth.").
Regarding Lara's damages arising from the PK Distribution, Lara justifiably relied upon Wilson's representations that he would assign Lara an interest in PK Holdings. Lara forewent his Unpaid Bonus Compensation and contributed $150,000 of new capital in exchange for the Written PK Assignment. Amended JPTO at 4, ¶ 29. Lara's reliance on Wilson's representations was justified because Lara and Wilson were close personal friends at the time the representations were made and had worked together since at least 1995. See Lara Declaration at 1, ¶ 2. There is also no evidence that Lara had any reason to believe that Wilson would later impede Lara's efforts to receive the distributions entitled to him pursuant to the assigned interest.
Similarly, regarding Lara's damages arising from the MT Distributions, Lara justifiably relied upon Wilson's representations in the MT Assignments (both Oral and Written) for the same reasons. Lara agreed to forego his Settlement Compensation in exchange for the Written MT Assignment. Amended JPTO at 5, ¶ 33-34; Lara Declaration at 6, ¶ 37. At the time of the Oral MT Assignment in 2003 and the Written MT Assignment in March 2005, Lara had no reason to believe that Wilson's representations were fraudulent.
Accordingly, the court finds by a preponderance of the evidence that Lara justifiably relied upon Wilson's representations. Thus, Lara has proven by a preponderance of the evidence the fourth element of § 523(a)(2)(A) that Lara justifiably relied upon Wilson's representations.
E. Damages
Finally, under § 523(a)(2)(A), "a creditor must establish that a claim sought to be discharged arose from an injury proximately resulting from its reliance on a representation that was made with an intent to deceive." In re Brown, 217 B.R. at 862 (citation omitted). Furthermore, "proximate cause is sometimes said to depend on whether the conduct has been so significant and important a cause that the defendant should be legally responsible." Id.
Regarding Lara's damages arising from the PK Distribution, the court finds that Wilson's fraudulent representations in the PK Assignments (both Oral and Written) were the proximate cause of Lara's failure to receive his share of the PK Distribution. Based upon Wilson's fraudulent representations in the PK Assignments, Lara forewent his Unpaid Bonus Compensation and contributed $150,000 of new capital to A&W. But for Wilson's fraudulent representations, Lara would not have suffered damages from the PK Distribution. Furthermore, the court finds there was no intervening cause for Lara's damages from the PK Distribution that limits Wilson's liability for the fraudulent representations. Wilson's fraudulent representations are "so significant and important a cause" for Lara's damages from the PK Distributions that Wilson should be held legally responsible for them.
Regarding Lara's damages arising from the MT Distributions, the court finds that Wilson's fraudulent representations were not the proximate cause of Lara's failure to receive his share of the MT Distributions. On July 27, 2005, Wilson and Lara executed the Joint Escrow Instructions for the Second MT Distribution. Lara agreed to subordinate his claim to the Second MT Distribution to that of Bridge Capital. Lara has not explained why he agreed to the subordination. Lara also has not explained what interests in MT Investors Wilson assigned to Bridge Capital or when that purported assignment occurred. If the assignment to Bridge Capital occurred before the MT Assignments to Lara, Lara has not alleged that Wilson failed to notify him of the Bridge Capital assignment. If the assignment to Bridge Capital occurred after the MT Assignments to Lara, Lara has not alleged how the MT Assignments to Lara were perfected. Thus, Lara has not proven that Wilson's assignment to Bridge Capital was not an intervening cause.
Accordingly, the court finds by a preponderance of the evidence that Wilson's representations in the PK Assignments were the proximate cause of Lara's damages from the PK Distribution. However, the court also finds that Wilson's fraudulent representations in the MT Assignments were not the proximate cause of Lara's damages from the MT Distributions. Thus, Lara has proven by a preponderance of the evidence the fifth element of § 523(a)(2)(A) that Lara's damages from the PK Distribution were proximately caused by Wilson's representations in the PK Assignments. However, Lara has not proven by a preponderance of the evidence the fifth element of § 523(a)(2)(A) that Lara's damages from the MT Distributions were proximately caused by Wilson's representations in the MT Assignments.
Therefore, Lara has proven by a preponderance of the evidence the five elements for a § 523(a)(2)(A) claim with respect to his damages from the PK Distribution. However, Lara has not proven by a preponderance of the evidence the five elements of § 523(a)(2)(A) claim with respect to his damages from the MT Distributions. The court determines that the portion of the Judgment attributable to Lara's damages from the PK Distribution is excepted from discharge pursuant to 11 U.S.C. § 523(a)(2)(A), but that the portion of the Judgment attributable to Lara's damages from the MT Distributions is not excepted from discharge pursuant to 11 U.S.C. § 523(a)(2)(A).
II. Section 523(a)(4) Claim
11 U.S.C. § 523(a)(4) states, "[a] discharge under section 727... of this title does not discharge an individual debtor from any debt - (4) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny." Lara alleges that his damages from the PK Distribution and MT Distributions were caused by Wilson's fraud and defalcation while in a fiduciary capacity. See Complaint, ¶ 32.
Lara did not allege that Wilson committed embezzlement for purposes of § 523(a)(4) until his closing argument. Further, the Amended JPTO does not list whether Lara committed embezzlement as an issue to be litigated. Allowing Lara to first raise an embezzlement claim at closing arguments would be unduly prejudicial to Wilson because the issue was not listed in the Amended JPTO. Therefore, the court finds that Lara has waived his right to claim embezzlement as a basis for a § 523(a)(4) claim for relief.
Finally, while the Complaint and Amended JPTO indicate that Lara is pleading a § 523(a)(4) claim for the entire debt owed by Wilson (i.e., Lara's damages arising from the PK Distribution and MT Distributions), Lara's counsel limited his § 523(a)(4) arguments made in his Trial Brief (Docket No. 107) and during trial to Lara's damages from the PK Distribution. Moreover, Lara has not clearly articulated why Wilson's debt to Lara from the MT Distributions constitutes fraud or defalcation while in a fiduciary capacity. Specifically, Lara has not alleged that Wilson was a managing member of MT Investors, explained why Wilson owed Lara any fiduciary duties with respect to Lara's interest in MT Investors, or introduced the applicable operating agreement for MT Investors into evidence. Therefore, the court finds that Lara has not proven by a preponderance of the evidence that his damages arising from the MT Distributions are nondischargeable pursuant to § 523(a)(4).
Thus, the only issue before the court is whether Lara's damages from the PK Distribution are nondischargeable under § 523(a)(4) on the basis that the debt arose from fraud or defalcation while in a fiduciary capacity. In order for Lara to prevail under § 523(a)(4), he must demonstrate, by a preponderance of the evidence, the following: (1) an express or technical trust existed; (2) the debt at issue was caused by fraud or defalcation; and (3) the debtor was a fiduciary to the creditor at the time the debt was created. Nahman v. Jacks (In re Jacks), 266 B.R. 728, 735 (9th Cir. BAP 2001), citing, Otto v. Niles (In re Niles), 106 F.3d 1456, 1459 (9th Cir. 1997).
A. Nature of Lara's Interest in PK Holdings
Before the court can determine whether an express or technical trust exists, the court must first determine the nature of Lara's interests in PK Holdings. The parties dispute whether the Written PK Assignment made Lara a member of PK Holdings or only granted Lara a distributional interest in PK Holdings as an assignee.
When the Written PK Assignment was executed on March 15, 2005, the "First Amended and Restated Operating Agreement of PK Holdings, LLC" was in effect. See Plaintiff's Trial Exhibit 174 (copy of First Amended Operating Agreement). (The Second Amended Operating Agreement was not executed until September 30, 2005 and only became effective upon the filing of the Articles of Organization with the Department of Commerce and Consumer Affairs, State of Hawaii. See Plaintiff's Trial Exhibit 175 (copy of Second Amended Operating Agreement), at 3, Art. I, ¶ 4.)
The First Amended Operating Agreement of PK Holdings provides two methods for transferring a membership interest in PK Holdings. First, Article XIII, paragraph 2, provides that "an Assignee of a Membership Interest shall be so admitted only with the approval, which may be withheld in their sole and absolute discretion, of all of the Managers and of Members having ninety percent (90%) of the Sharing Ratios of all Members." Plaintiff's Trial Exhibit 174 at 33. Second, Article VII, paragraph 8.1 provides in pertinent part:
Notwithstanding any other provisions or requirements of this Operating Agreement, within two (2) year of the Effective Date [August 26, 2004], the Initial Managers [including Wilson] may sell or otherwise transfer portions of their Membership Interest as reflected in Schedule A to raise additional capital for the Company of its operations.
Plaintiff's Trial Exhibit 174 at 22. Article VII, paragraph 8.3 further provides: "In the event there is an assignment pursuant to this Paragraph 8, the Assignee shall have all rights of a Member executing this Operating Agreement, including voting rights." Plaintiff's Trial Exhibit 174 at 23. Paragraph 8 includes no requirement that the assignment be approved by other Members of PK Holdings.
The court finds that the Written PK Assignment did not comply with Article XIII, paragraph 2, because Members, as defined by Article II, paragraph 41, having 90% of the Sharing Ratios of all Members did not vote to approve the Written PK Assignment.
However, the court finds that the Written PK Assignment, which was executed on March 15, 2005, complied with Article VII, paragraph 8.1, because (i) it was executed within two years of the Effective Date, which was August 26, 2004 (Article II, ¶ 31); (ii) Wilson was an Initial Member of PK Holdings (Article II, ¶ 28); (iii) Wilson owned a 30% interest in PK Holdings (Exhibit A); and (iv) the $412,000 contributed by Lara "were used by [Wilson] in relation to funding of improvements to the assets of [PK Holdings]" ( Plaintiff's Trial Exhibit 1 (Written PK Assignment), Recitals D-E). Thus, the court finds that the Written PK Assignment made Lara a member of PK Holdings because Lara was granted "all rights of a Member executing [the First Amended Operating Agreement], including voting rights." See Plaintiff's Trial Exhibit 174 at 23.
At trial, Wilson's counsel argued that the Written PK Assignment is unenforceable because it explicitly required the concurrent execution of a subscription agreement and other documents signed by other members of PK Holdings:
Concurrent with the execution of this Assignment, Assignee will sign a subscription agreement and other documents signed by other members of Company and receive a copy of the Operating Agreement of Company and a copy of this Assignment will be provided the [sic] Managers of Company by Assignor with instructions to reflect this Assignment on the books and records of Company effective as of the date of this Assignment.
See Plaintiff's Trial Exhibit 1 (copy of the Written PK Assignment), ¶ 2. The Written PK Assignment was executed on March 15, 2005, and other members of PK Holdings did not execute a subscription agreement until Patel and DeLorme signed a confirmation of the Written PK Assignment (the "Confirmation of Assignment") on December 6, 2005. See Plaintiff's Trial Exhibit 2. The belated execution of the Confirmation of Assignment did not satisfy the "concurrent subscription agreement requirement" of the Written PK Assignment. However, the court interprets the "concurrent subscription agreement requirement" as an obligation owed to Lara to protect Lara's interest from any objections to the Written PK Assignment by other members of PK Holdings. The plain language of the Written PK Assignment does not suggest that the "concurrent subscription agreement requirement" was a condition precedent to the enforceability of the assignment against Wilson. Thus, the court finds that the belated execution of the Confirmation of Assignment does not render the Written PK Assignment unenforceable against Wilson.
Finally, Patel's trial testimony that Lara did not sign any operating agreements of PK Holdings or participate in the vote to remove Wilson as managing member of PK Holdings does not prove that Lara was not granted the membership rights in the PK Holdings pursuant to Article VII, paragraph 8.1 of the First Amended Operating Agreement. See Trial Testimony of Sushil Patel, September 29, 2011 at 9:56-10:00 a.m. This evidence only suggests that Lara was not actively involved in the management of PK Holdings, which is not dispositive as to whether the Written PK Assignment complied with Article VII, paragraph 8 of the First Amended Operating Agreement. Thus, the court finds that the Written PK Assignment made Lara a member of PK Holdings.
B. Express Trust
Section 523(a)(4) requires an express or technical trust in existence before and independently of the defalcation. In re Jacks, 266 B.R. at 736, citing Lewis v. Scott (In re Lewis), 97 F.3d 1182, 1185 (9th Cir.1996). Within the meaning of § 523(a)(4), an express or technical trust must be "imposed before, and without reference to, the wrongdoing that caused the debt as opposed to a trust ex maleficio, constructively imposed because of the act of wrongdoing from which the debt arose." Honkanen v. Hopper ( In re Honkanen ), 446 B.R. 373, 379 (9th Cir. BAP 2011). Further, "[w]hether a fiduciary is a trustee in that strict and narrow sense, ' is determined in part by reference to state law." In re Lewis, 97 F.3d at 1185, quoting, Ragsdale v. Haller, 780 F.2d 794, 795 (9th Cir. 1986).
Hawaii law applies in this case because PK Holdings is a Hawaii limited liability company. In re Lewis, 97 F.3d at 1185, quoting, Ragsdale v. Haller, 780 F.2d at 795. Lara argues that the Hawaii Limited Liability Company Act, Chapter 428 of the Hawaii Revised Statutes ("HRS"), creates an express trust and imposes a duty on manager members to act as trustees. Pursuant to HRS § 428-409(h)(2), "a manager is held to the same standard of conduct prescribed for members in subsections (b) to (f)." Haw. Rev. Stat. § 428-409(h)(2). As such, under HRS § 428-409, the manager of a manager-managed limited liability company is held to the following fiduciary duties:
(b) A member's duty of loyalty to a member-managed limited liability company and its other members is limited to the following:
(1) To account to the company and to hold as trustee for it any property, profit, or benefit derived by the member in the conduct or winding up of the company's business or derived from a use by the member of the company's property, including the appropriation of a company's opportunity;
(2) To refrain from dealing with the company in the conduct or winding up of the company's business as or on behalf of a party having an interest adverse to the company; and
(3) To refrain from competing with the company in the conduct of the company's business before the dissolution of the company.
(c) A member's duty of care to a member-managed limited liability company and its other members in the conduct of and winding up of the company's business is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law.
(d) A member shall discharge the duties to a member-managed limited liability company and its other members under this chapter or under the operating agreement and exercise any rights consistent with the obligation of good faith and fair dealing.
Haw. Rev. Stat. § 428-409(b)-(d) (1996).
A bankruptcy court in Montana recently held that a Montana statute with the exact same language as HRS § 428-409(b) created an express trust relationship recognized by federal law for purposes of § 523(a)(4) because the statute:
(1) defines the trust res: "any property, profit, or benefit derived by the member in the conduct or winding up of the company's business or derived from a use by the member of the company's property;" (2) spells out the trustee's fiduciary duties: "account to the company and to hold as trustee for it;" and (3) imposes a trust on the funds prior to the act which created the debt: the obligation arises with membership in the LLC and does not depend on any subsequent conduct.
See Blixseth v. Blixseth ( In re Blixseth ), 459 B.R. 444 (Bankr. D. Mont. 2011) (analyzing Mont. Code Ann. § 35-8-310(2)-(4)).
The Blixseth court distinguished the Montana statute with a similar California statute analyzed in Ragsdale v. Haller, supra . Id. at 459-460. In Ragsdale, the court was asked to determine whether, under California law, partners in a partnership hold partnership assets as trustees. 780 F.2d at 796. The relevant California statute provided:
Every partner must account to the partnership for any benefit, and hold as trustee for it any profits derived by him without the consent of the other partners from any transaction connected with the formation, conduct, or liquidation of the partnership or from any use by him of its property.
Blixseth, 459 B.R. at 460 (quoting Cal. Corp. Code § 15021(1)). The Ninth Circuit in Ragsdale concluded that the California statute did not create a trust relationship for purposes of § 523(a)(4) because "the trust arises only when the partner derives profits without the consent of the partnership...." 780 F.2d at 796. The Blixseth court distinguished Ragsdale by acknowledging that:
... Ragsdale contemplate[s] a statute in which the trust arises only when the [partner] acts without consent. Such a statute creates a trust ex maleficio. By contract, MCA § 35-8-310 contains no similar qualification on the imposition of the trustee relationship. This difference is sufficient to distinguish MCA § 35-8-310 from the statute[ ]... in Ragsdale.
Id. at 460.
This court agrees with the reasoning in Blixseth. The applicable Hawaii statute, HRS § 428-409(b), contains identical language as to that in the Montana statute, Mont. Code Ann. § 35-8-310(2). Like the Montana statute, HRS § 428-409(b)(1) imposes an unqualified duty of loyalty on members of an LLC who hold company property to act as a trustee. HRS § 428-409(b) also (1) defines the trust res: "any property, profit, or benefit derived by the member in the conduct or winding up of the company's business or derived from a use by the member of the company's;" (2) spells out the trustee's fiduciary duties: "account to the company and to hold as trustee for it;" and (3) imposes a trust on the funds prior to the act which created the debt: the obligation arises with membership in the LLC and does not depend on any subsequent conduct. See Blixseth, 459 B.R. at 459. Thus, based on the language of HRS § 428-409(b) and based on the same reasoning in Blixseth, the court finds an express trust was created and Wilson was a trustee during his time as a manager of PK Holdings.
However, this fiduciary relationship only existed during the time that Wilson served as a managing member for PK Holdings. Indeed, HRS § 428-409(h)(1) provides: "A member who is also not a manager owes no duty to the company or to the other members solely by reason of being a member." Thus, the court finds that Wilson's fiduciary duties to PK Holdings' other members ceased when Wilson was removed as a managing member, which occurred in November 2005.
C. Fraud
For reasons stated above, Lara has proven that Wilson made fraudulent representations in the PK Assignments. However, there is no evidence that Wilson committed fraud while he served in a fiduciary capacity. The fiduciary relationship between Wilson and Lara began on March 15, 2005 with the execution of the Written PK Assignment and ended in November 2005 when Wilson was removed as a managing member of PK Holdings. Thus, all of Wilson's fraudulent representations made prior to the execution of the Written PK Assignment, including the Oral PK Assignment, were made before the fiduciary relationship between Wilson and Lara existed. Likewise, Wilson's fraudulent assignments and encumbrances of Lara's 4½% interest made after Wilson's removal as managing member, including the May 2006 Assignment and the Unite Commercial Assignment, were made after the fiduciary relationship terminated.
Due to the short duration of the fiduciary relationship, the only fraudulent action that Wilson could have committed while acting in his fiduciary capacity was when he executed the October 2005 Pledge Agreement and the October 2005 Assignment (collectively, the "October 2005 Transactions"). The October 2005 Transactions pledged and assigned Wilson's original 30% membership interest in PK Holdings as security for a loan to Wilson's company, Parkside Ventures. Thus, the October 2005 Transactions necessarily encumbered the 4.5% interest in PK Holdings that Wilson had previously assigned to Lara.
The court finds that the October 2005 Transactions did not breach Wilson's duty of loyalty to PK Holdings and its members, as provided in HRS § 428-409(b), because Wilson did not (1) fail to account for PK Holdings' property; (2) deal with PK Holdings on behalf of a party having an adverse interest to PK Holdings; or (3) compete with PK Holdings. The court further finds that the October 2005 Transactions did not breach Wilson's duty of care to PK Holdings and its other members, as provided in HRS § 428-409(c), or Wilson's obligation of good faith and fair dealing, as provided in HRS § 428-409(d), because the October 2005 Transactions did not affect Wilson's management of PK Holdings in any way. Rather, the October 2005 Transactions only affected the private agreement between Wilson and Lara. The court finds that the scope of HRS § 428-409 was not intended to include transactions that have no bearing whatsoever on the management of limited liability company. Lara has not provided any authority to the contrary. Thus, the court finds that Lara failed to show Wilson committed a fraud that also breached a fiduciary duty Wilson owed to Lara.
D. Defalcation
"A defalcation' is the misappropriation of trust funds or money held in any fiduciary capacity, or the failure to properly account for such funds." Lewis v. Scott ( In re Lewis), 97 F.3d 1182, 1186 (9th Cir. 1996), citing, Black's Law Dictionary 417 (6th ed. 1990); see also, Bullock v. BankChampaign. N.A., 133 S.Ct. 1754, 1758-1759 (2013)(setting out various dictionary definitions of defalcation). Black's Law Dictionary defines misappropriation as "[t]he application of another's property or money dishonestly to one's own use." Garner, Black's Law Dictionary at 1088 (9th ed. 2009). Further, as clarified by the Supreme Court in Bullock v. BankChampaign, N.A ., defalcation is an intentional act that includes: not only conduct that the fiduciary knows is improper but also reckless conduct." 133 S.Ct. at 1759-1760.
In Bullock v. BankChampaign, N.A ., the Supreme Court addressed the issue of the scienter requirement for defalcation under Section 523(a)(4) as opposed to the scope of the conduct within the meaning of the term "defalcation": "In resolving these differences, we note that this longstanding disagreement concerns state of mind, not whether defalcation' can cover a trustee's failure (as here) to make a trust more than whole. We consequently shall assume without deciding that the statutory term is broad enough to cover the latter type of conduct and answer only the state of mind' question." 133 S.Ct. at 1759.
Wilson received Lara's share of the PK Distribution and, instead of remitting the funds to Lara as he should have, he used them for his own personal benefit. However, at the time of the misappropriation, Wilson was not acting in a fiduciary capacity. Wilson was removed as a manager of PK Holdings in November 2005. It was not until December 2006, that Wilson received the proceeds from the distribution as a member of PK Holdings, though more than he was entitled, having assigned part of his membership interest to Lara to whom part of the distribution should have went. Nevertheless, because Wilson was not acting in a fiduciary capacity when he misappropriated Lara's share of the PK distribution, there was no defalcation. Therefore, the court finds that Lara has not established by a preponderance of the evidence the necessary elements for a § 523(a)(4) claim. Lara is not entitled to judgment on his claim under § 523(a)(4).
III. Section 523(a)(6) Claim
Section 523(a)(6) of the Bankruptcy Code excepts from discharge any debt "for willful and malicious injury by the debtor to another entity or to the property of another entity." 11 U.S.C. § 523(a)(6). "The willful injury requirement of § 523(a)(6) is met when it is shown either that defendant had a substantive motive to inflict the injury or that defendant believed that injury was substantially certain to occur as a result of his conduct." Petralia v. Jercich (In re Jercich), 238 F.3d 1202, 1208 (9th Cir. 2001). In other words, "§ 523(a)(6) renders debt nondischargeable when there is either a subjective intent to harm, or a subjective belief that harm is substantially certain." Carillo v. Su (In re Su), 290, F.3d 1140, 1145 (9th Cir. 2002) (emphasis added). In Jercich, the Ninth Circuit rejected the objective substantial certainty approach. See id. at 1145-1146. However, when determining "willfulness, " the debtor is charged with the knowledge of the natural consequences of his actions. Ormsby v. First American Title Co. of Nevada (In re Ormsby), 591 F.3d 1199, 1206 (9th Cir. 2010)(citations omitted). The "malicious injury" requirement of § 523(a)(6) is met when the injury is caused by a wrongful act, done intentionally, which necessarily causes injury, and which is done without just cause or excuse. In re Jercich, 238 F.3d at 1208.
"[A]lthough § 523(a)(6) generally applies to torts rather than to contracts and an intentional breach of contract generally will not give rise to a nondischargeable debt, where an intentional breach of contract is accompanied by tortious conduct which results in willful and malicious injury, the resulting debt is excepted from discharge under § 523(a)(6)." In re Jercich, 238 F.3d at 1205 (emphasis in original). To determine whether Wilson's actions were tortious, the court must look to state law. Id. at 1206. The parties agree that California law applies based on the underlying California Judgment. However, "[w]hether the actions constitute the tort of conversion under California state law are not dispositive of whether the underlying claims are nondischargeable under § 523(a) of the Bankruptcy Code." Andrews v. Manser (In re Manser), 99 B.R. 434, 435-436 (9th Cir. BAP 1989). "Generally, outside the insurance context, a tortious breach of contract... may be found when... the breach is accompanied by a traditional common law tort, such as fraud or conversion....'" Stop Loss Insurance Brokers, Inc. v. Brown & Toland Medical Group, 143 Cal.App.4th 1036, 1057-1058 (2006), quoting Erlich v. Menezes, 21 Cal.4th 543, 553-554 (1999).
1. Fraud
Under California law, the tort of fraud consists of the following elements: (1) misrepresentation (false representation, concealment, or nondisclosure); (2) knowledge of falsity (or scienter'); (3) intent to defraud, i.e., to induce reliance; (4) justifiable reliance; and (5) resulting damage. Lazar v. Superior Court, 12 Cal.4th 631, 638 (1996). These elements are identical to elements required to prove a claim for fraud under 11 U.S.C. § 523(a)(2)(A). See Britton v. Price ( In re Britton ), 950 F.2d 602, 604 (9th Cir. 1991). Because this court already found that Wilson's representations in the PK Assignments were fraudulent for purposes of § 523(a)(2)(A), this court necessarily finds that Wilson's representations in the PK Assignments were also fraudulent under California law.
As a matter of law, Wilson's fraudulent representations in the PK Assignments constitute willful and malicious injuries to Lara within the meaning of § 523(a)(6). See In re Diamond, 285 F.3d 822, 828-829 (9th Cir. 2002) (holding that a state court judgment for fraud under Washington law, which necessarily required a finding that the defendant "intentionally caused injury", had preclusive effect with regard to a § 523(a)(6) claim).
The court further finds that Wilson's fraudulent representations in the PK Assignments were "willful" because Wilson, who is charged with the natural consequences of his actions, had a subjective belief that his fraudulent representations in the PK Assignments were substantially certain to harm Lara. The court also finds that Wilson's fraudulent representations in the PK Assignments were "malicious" because they were wrongful acts, done intentionally, which necessarily caused injury, and which were done without just cause or excuse. Thus, Lara has proven by a preponderance of the evidence that Wilson's fraudulent representations in the PK Assignments were "willful" and "malicious" for purposes of § 523(a)(6).
2. Conversion
During trial, Lara also argued that Wilson converted his share of the PK Distribution, but conceded that Wilson did not convert Lara's share of the MT Distributions. See Closing Argument of Lara, October 14, 2011 at 2:16 p.m.
Under California law, the tort of conversion consists of the following elements: (1) the creditor's ownership or right of possession of the property at the time of conversion; (2) the debtor's conversion by a wrongful act or disposition of property rights; and (3) damages. Thiara v. Spycher Brothers ( In re Thiara ), 285 B.R. 420, 427 (9th Cir. BAP 2002), citing, Farmers Insurance Exchange v. Zerin, 53 Cal.App.4th 445, 451 (1997). Further, "It is not necessary that there be a manual taking of the property; it is only necessary to show an assumption of control or ownership over the property, or that the alleged converter has applied the property to his own use." Farmers Insurance Exchange v. Zerin, 53 Cal.App.4th at 451-452. "Neither legal title or absolute ownership of the property is necessary.... A party need only allege it is entitled to immediate possession at the time of conversion.'" Id. (citations omitted).
"Money can be the subject of an action of conversion if a specific sum capable of identification is involved." Id. at 452. But, "it is not necessary that each coin or bill be earmarked." Weiss v. Marcus, 51 Cal.App.3d 590, 599 (1975), citing, Haigler v. Donnelly, 18 Cal. 2d 674, 681 (1941). Rather, the plaintiff need only identify a specific sum of money that was received by the defendant, of which a portion belonged to the plaintiff. See id. (holding that the plaintiff stated a claim for conversion where the plaintiff alleged that the defendant received settlement proceeds in the sum of $35,000, of which $6,750 belonged to the plaintiff pursuant to a lien on such proceeds).
Regarding Lara's damages arising from the PK Distribution, the court finds that each of the three elements for conversion has been satisfied. First, it is a determined fact Lara was entitled to and had a right to possess 4½% of the PK Distribution, which totaled $1,260,193.79, vis-à-vis Lara's ownership of a 4½% membership interest in PK Holdings. The court finds that Wilson knew this despite his repudiation of the Written PK Assignment in January 2006. Second, Wilson admitted to receiving the net sum of approximately $3.4 million from the PK Distribution, after the payment of approximately $1.2 million to his attorneys. Wilson further admitted to knowingly using all of the net proceeds from the PK Distribution, including Lara's share, to repay the United Commercial Loan. Wilson's use of Lara's share of the PK Distribution was not authorized by Lara, or otherwise excused or justified. Third, it is a determined fact that Lara suffered $1,260,193.79 in damages from Wilson's conversion of Lara's share of the PK Distribution and that these sums are identifiable to Lara's 4½% interest in PK Holdings.
Therefore, the court finds that Wilson intentionally converted Lara's share of the PK Distribution without justification or excuse. As a matter of law, Wilson's conversion of Lara's share of the PK Distribution constitutes a "willful" and "malicious" injury to Lara within the meaning of § 523(a)(6). See Del Pino v. Bailey (In re Bailey), 197 F.3d 997, 1000 (9th Cir. 1999) ("The conversion of another's property without his knowledge or consent, done intentionally and without justification and excuse, to the other's injury, constitutes a willful and malicious injury within the meaning of § 523(a)(6).") ( quoting, Transamerica Commercial Finance Corp. v. Littleton, 942 F.2d 551, 554 (9th Cir.1991)).
The court further finds that Wilson's conversion of the PK Distribution was "willful" because Wilson, who is charged with the natural consequences of his actions, had a subjective belief that his conversion of the PK Distribution was substantially certain to harm Lara. The court also finds that Wilson's conversion of the PK and MT Distributions were also "malicious" because they were wrongful acts, done intentionally, which necessarily causes injury, and which were done without just cause or excuse. Thus, Lara has proven by a preponderance of the evidence that Wilson's conversion of Lara's share of the PK Distribution was "willful" and "malicious" for purposes of § 523(a)(6).
Therefore, Lara has proven by a preponderance of the evidence the elements for a § 523(a)(6) claim with respect to his damages from the PK Distribution. But Lara has not proven by a preponderance of the evidence the elements of § 523(a)(6) claim with respect to his damages from the MT Distributions for the same reasons discussed above relating to § 523(a)(2)(A). The debt based on the portion of the Judgment attributable to Lara's damages from the PK Distribution should be excepted from discharge pursuant to § 523(a)(6), while the debt based on the portion of the Judgment attributable to Lara's damages from the MT Distributions should not be excepted from discharge pursuant to § 523(a)(6).
CONCLUSION
For the foregoing reasons, the court determines that the debt owed by Wilson to Lara based on portion of the Judgment attributable to Lara's damages from the PK Distribution is excepted from discharge pursuant to 11 U.S.C. § 523(a)(2)(A) and (6), but not excepted from discharge pursuant to 11 U.S.C. § 523(a)(4). The court further determines that the debt owed by Wilson to Lara based on the portion of the Judgment attributable to Lara's damages from the MT Distributions is not excepted from discharge pursuant to 11 U.S.C. § 523(a)(2)(A), (4) or (6).
Lara is ordered to submit a proposed judgment within 30 days of the entry of this memorandum decision consistent with this decision.
IT IS SO ORDERED.