Opinion
Bankruptcy Case No. 13-05182-CL7 Adversary Proceeding No. 13-90210-CL
03-06-2015
In re: SUNDUS YOUSIF SAKO, Debtor, HIKMAT MAMMO, Plaintiff, v. SUNDUS YOUSIF SAKO, Defendant.
WRITTEN DECISION - NOT FOR PUBLICATION
Chapter 7 MEMORANDUM DECISION AND ORDER FINDING NONDISCHARGEABILITY AND AWARDING DAMAGES Judge: Christopher B. Latham MEMORANDUM DECISION AND ORDER FINDING NONDISCHARGEABILITY AND AWARDING DAMAGES
In 2007, debtor-defendant Sundus Yousif Sako formed El Nopal Market, LLC to run a grocery business in Chula Vista, California. In 2008, plaintiff Hikmat Mammo joined the LLC as a member; he agreed to make a passive investment of $95,000 in the business. But the business did not do well. Among other things, it repeatedly failed to pay bills on time. Its trade creditors required cash-on-delivery payments for goods. And - without informing Mr. Mammo - Ms. Sako was apparently giving company funds to a Mr. Samir Toma. The three later went into business to form a second store in San Diego, California. But both stores eventually failed.
On May 17, 2013, Ms. Sako filed a voluntary Chapter 7 petition in Case No. 13-05182-CL7. Approximately three months later, on August 12, Mr. Mammo initiated the above-captioned adversary proceeding. He seeks damages, costs, and findings of nondischargeability against Ms. Sako under 11 U.S.C. §§ 523(a)(2)(A), (a)(4), and (a)(6). On October 2, Ms. Sako answered the complaint. And the court tried the matter over three days. The court then took the matter under submission. Now, for the following reasons, the court: (1) awards Mr. Mammo $311,500 in damages; and (2) finds this award nondischargeable under 11 U.S.C. § 523(a)(2)(A).
I. JURISDICTION AND VENUE
The court has jurisdiction over this adversary proceeding under 28 U.S.C. §§ 1334(b) and 157(b)(2)(I). Venue is proper under 28 U.S.C. § 1409(a).
II. FACTUAL BACKGROUND AND FINDINGS
Creditor-plaintiff Hikmat Mammo ("Mammo"), Debtor-defendant Sundus Yousif Sako ("Sako"), Father Sabri Kejbo ("Kejbo"), and Mr. Samir Toma ("Toma") are all members of the Chaldean community - the latter three living in San Diego. Kejbo and Mammo are childhood friends; Mammo became Kejbo's brother-in-law. Kejbo and Toma are also very good friends; they visit each other multiple times per week. Mammo operates a grocery business in Michigan. And Sako has worked in San Diego grocery businesses for many years.
In 2005, Sako became the sole owner of "San Pedro Market" - a grocery store in San Diego's Chula Vista neighborhood. She later renamed this store to "El Nopal Market." And in March 2007, she executed a written operating agreement to form El Nopal Market, LLC ("El Nopal 1") - a California limited liability company that would run the grocery business. Later that June, Sako met Toma. At that time, Sako was some $30,000 behind in rent for El Nopal 1, and she was trying to sell the business. She informed Toma about this, and he expressed interest. He inspected El Nopal 1. But, rather than purchase it whole, he offered to become Sako's partner: Toma would provide $95,000 to the business and Sako would continue to operate it.
Sako accepted Toma's offer and they entered escrow. But before escrow closed, Toma cancelled it due to issues related to his pending divorce. Toma then contacted Kejbo, Kejbo contacted Mammo, and Mammo went into business with Sako. Mammo and Sako amended El Nopal 1's operating agreement effective August 2008; Mammo joined El Nopal 1 as a member, and Sako took the position of "Chief Executive Member." Neither Sako. Mammo, Toma, nor Kejbo dispute that these events occurred. They disagree, however, on the nature of this transaction and the legal relationships it created.
A. El Nopal 1
1. The Relationship Between Sako, Mammo, Toma, and Kejbo
In evaluating the trial testmimony, the court generally finds Mammo highly credible, Sako somewhat credible, and Toma hardly credible at all. Sako testified that - although they used only her and Mammo for business papers - she, Mammo, Toma, and Kejbo were all partners in the husiness. She alleges that Toma did not want his name on any documents because he sought to hide his assets from his soon-to-be ex-wife. To support her position, Sako asserts that Mammo never asked for any of the grocery's financial documents before forming the LLC. She points to Toma and Kejbo's involvement in the business. And, at trial, she maintained that she never met Mammo in person until 2009. Sako later contradicted this testimony by post-trial declaration.
At trial, Mammo testified that he usually came to San Diego once a year. Tr. Transcript vol. 2, 178:11-17. Sako testified that she first met Mammo in person in 2009. Tr. Transcript vol. 1, 64:5-7. And Mammo did not otherwise dispute Sako's testimony. Thus, to complete its analysis, the court reopened evidence to ascertain precisely when this 2009 meeting took place. Unfortunately, the parties' submissions were unhelpful: Sako directly contradicted her trial testimony and declared that she first met Mammo in 2008; and both parties declared that they did not recall when they met in 2009.
Toma was heavily involved in the business's affairs. He acted as an intermediary between Sako, Mammo, and Kejbo. Sako admits that Toma never directly gave money to her or El Nopal 1. But she testified, without objection, that Toma told her he gave money to Mammo and Kejbo; that Toma claimed he held an interest in El Nopal 1 "so [he could] collect [his] money through the company;" and that Toma eventually told Sako, "I'm not putting any more money in the company." According to Sako, Toma also knew everything about the business's activites. He often told Sako what to do. He came to the store almost every day and asked for money, which Sako gave him. And he regularly took store food and lottery tickets without paying.
Likewise, Sako alleged that Kejbo came to the store periodically to take pizza and lottery tickets. She asserted that Kejbo provided funds for the business. Further, Sako, Toma, or store employees would go to Kejbo's church to get coins for the store's cash registers. And Sako claimed that both Toma and Kejbo paid for El Nopal 1's liquor license. Sako also testified that Toma, Kejbo, and Mammo met at the store in April 2010 to clarify each person's contribution to the business. To corroborate Sako's testimony, Ms. Michelle Melton ("Melton") - Sako's roommate and El Nopal 1's bookkeeper - asserted that she was also present at this meeting. Melton created the document that was the product of that meeting. And Melton claims that Toma asked her to modify figures on the document to make it appear that El Nopal 1 did not have as many losses as it actually did.
For their part, Toma and Kejbo denied any interest in El Nopal 1. Together with Mammo, they contend El Nopal 1 had only two members: Mammo and Sako. Toma further denied ever taking money from the business. And Mammo insists he was simply a passive investor. He provided money for the business, but left its operation to Sako. Indeed, he could have no hand in its operation because - at the time - he lived in Michigan. He trusted Kejbo when Kejbo proposed this business opportunity. Further, he trusted Sako to manage the business properly.
Mammo, however, did visit San Diego occasionally. Sako admitted to meeting with him and discussing the business. And Sako told him the business was doing fine - she just needed more time and money to build it up. Mammo also kept in regular contact with Sako by phone. He would often inquire about the state of the business. And when he did, Sako would again affirmatively represent that it was doing well, but reiterate her need for more time and money. Mammo testifed that Sako was always asking "for more money." Moreover, Mammo asserted that he had no knowledge of Toma's acts or his involvement in the business. And Mammo claimed that any funds Kejbo provided were paid on Mammo's behalf.
2. The Operation of El Nopal 1
El Nopal 1's operating agreement specifically names Sako as the managing member. Sako herself admits that she was responsible for operating the business; she was in charge of hiring and firing employees; and she managed its day-to-day duties. Apparently, however, Sako did not conduct these operations with diligence or prudence. Sako regularly wrote business checks payable to cash or various people - employees, friends, and family. She alleges that the payees would cash the check at a store or bank, then bring the cash back for the store to use. And she asserts she needed to do this to pay trade creditors: business vendors had issues with bad checks from El Nopal 1 in the past. As a result, the vendors would only accept cash on delivery ("COD") for their goods. Accordingly, she couldn't issue checks to the vendors; she had to pay cash for her inventory.
But Sako never produced any invoices that showed COD vendor payments. And, without explanation, these check-to-cash amounts increased dramatically in late 2009; they went from approximately $5,000 per month to approximately $15,000 per month. Further, it appears El Nopal 1 had virtually no accounting practice; Sako produced no books or ledgers accounting for El Nopal 1's inventory, transactions, or cash. Sako also failed to timely pay the business's income and payroll taxes. She failed to consistently pay the business's rent. She used the business's bank account for personal expenses, such as her own rent and gambling. Again, she gave store money to Toma on a regular basis. And, importantly, she failed to disclose many of these practices to Mammo. Instead, Sako informed Toma about her activities and she asserts - for what it's worth - that Toma gave her permission to run the business this way.
B. El Nopal 2
Despite El Nopal 1's shortcomings, in early 2010, Toma expressed interest in opening another store with Mammo and Sako. Sako herself wanted to open a small store that primarily served participants of the federal government's Women, Infants, and Children program ("WIC"). But Toma desired a larger store in a location where he had owned or operated a previous business. Sako, Toma, and Mammo eventually agreed on the larger store, and became partners in it. They named it "El Nopal Market Too" ("El Nopal 2"); Toma contributed equipment, fixtures, and inventory; Mammo contributed funds; and Sako again provided her labor.
El Nopal 2, however, appeared to perform worse than El Nopal 1. It had complications with its premises lease and its landlord - Mr. Saiam Razuki ("Razuki"). Sako asserted that Mammo and Kejbo offered her $70,000 for her interest in El Nopal 1. She refused, thinking her interest worth more. She alleged that Toma, Mammo, Kejbo and Razuki conspired to take Sako out of El Nopal 2, as well. El Nopal 2 fell behind on rent, and Razuki sued it for unlawful detainer. Razuki then offered to waive El Nopal 2's rent arrears if it vacated the premises. But Sako refused. Issues arose between Toma, Mammo, and Razuki. Toma abandoned his interest in El Nopal 2. And there was some discussion about selling the stores, and various allegations about why that didn't happen.
Eventually, Mammo and Sako reached an agreement: Mammo would take ownership of El Nopal 1, including all its assets and outstanding liabilities; Sako would do the same with El Nopal 2. In October 2011, Mammo and Sako opened escrow to facilitate this ownership change. Mammo hired a man named Nathan to manage El Nopal 1 in his stead. And Sako began the process with California's Department of Alcoholic Beverage Control ("ABC") to transfer El Nopal 1's liquor license to Mammo. But this transfer required a $2,414 fee. Although Sako and El Nopal 1 lacked the funds to pay this fee, Sako nonetheless issued a check from El Nopal 1's account to pay it. She informed Mammo about this who, in turn, wrote a $2,414 check to Sako. But Sako's check to ABC bounced. And Mammo claimed that Sako never returned his check. Sako, on the other hand, asserted that she deposited Mammo's check in the bank account that El Nopal 1 used for WIC payments. Only she had access to those funds because she held the WIC license. And, to ensure El Nopal 1 received the benefit of its WIC sales, she had been withdrawing all funds from that account to give to Nathan. In this way, she argued, she returned Mammo's $2,414.
Mammo further alleged that, before he received the WIC license for El Nopal 1, Sako demanded more money from him. Specifically, Sako demanded some $5,000. And she threatened to stall transfer of the WIC license if he did not pay. Mammo informed Sako that he didn't have $5,000. But, to ensure her cooperation with the transfer, he paid her what he could - $3,000. Sako admitted to receiving the money, but she denied that she threatened Mammo.
C. The End of Los Nopales
In December 2011, Mammo decided to abandon El Nopal 1; he informed Sako that he would not follow through on their agreement. Accordingly, Sako resumed control of El Nopal 1's operations. To that end, and because Mammo stopped funding the company, she took out a $22,000 loan at 46% interest from a Mr. Chanan Fradkin on El Nopal 1's behalf. Later, an auctioneer sold El Nopal 2's assets for $11,770. El Nopal 2 then vacated its premises in February 2014. According to Sako, in order to cash the auction proceeds more quickly, the auctioneer made the check out to Sako personally. Sako then alleges that she used these funds to pay past due rent and utilities on El Nopal 1. And when El Nopal 1 finally closed its doors, Mr. Fradkin took all its assets in repayment of his loan.
D. Mammo's Forgery Allegations
Finally, Mammo alleged that Sako - or Melton, at Sako's direction - forged his signature on four documents: (1) a credit agreement and guaranty in favor of Southern Wine and Spirits; (2) an equipment finance agreement and guaranty in favor of Northern Leasing; (3) a new customer application with Bakemark USA; and (4) an indemnity bond with Platte River to cover El Nopal 1's payments to San Diego Gas & Electric. Mammo provided an Expert Witness Report explaining that the signatures on the documents are not his. He argued that circumstancial evidence proved that Sako caused the signatures to be forged. And he asserted that Sako damaged him, as a result.
E. Mammo's Contributions
Over the course of these events, Mammo contributed $341,500 to the husinesses through the following payments:
• August 10, 2008: $30,000 from Mammo for El Nopal 1's Rent (Ex. 24);
• August 21, 2008: $20,000 from Mammo to El Nopal 1 (Ex. 25);
• December 23, 2008: $6,000 from Kejbo to El Nopal 1 (Ex. 28);
• January 3, 2009: $25,000 from Mammo to El Nopal 1 (Ex. 26);
• April 10, 2009: $20,000 from Kejbo for El Nopal 1's Rent (Ex. 28);
• April 25, 2009: $50,000 from Kejbo to El Nopal 1 (Ex. 27);Notably, these contributions do not include: (1) Mammo's $2,414 payment for the ABC liquor license transfer; or (2) his $3,000 payment for the WIC license transfer. The court addresses these two payments separately in its analysis, below,
• August 28, 2009: $10,000 from Kejbo to El Nopal 1 (Ex. 28);
• October 14, 2009: $38,500 from Kejbo for El Nopal 1's Liquor License (Ex. 28);
• November 3, 2009: $12,500 from Kejbo for El Nopal 1's Rent (Ex. 28);
• January 26, 2010: $5,750 from Kejbo for El Nopal 2 (Ex. 49);
• January 29, 2010: $28,000 from Kejbo to El Nopal 1 (Ex. 61);
• March 5, 2010: $11,250 from Kejbo to El Nopal 1 (Ex. 28);
• June 13, 2010: $4,000 from Kejbo to El Nopal 1 (Ex. 28);
• December 31, 2010: $35,000 from Mammo to El Nopal 1 (Ex. 29);
• December 31, 2010: $15,000 from Kejbo for El Nopal 2's Rent (Ex. 29);
• February 14, 2011: $25,000 from Mammo to El Nopal 1 (Ex. 30); and
• February 21, 2011: $5,500 from Kejbo for El Nopal 2's Rent (Ex. 50).
See also Tr. Transcript vol. 2, 41:11-42:16.
III. LEGAL ANALYSIS AND CONCLUSIONS
The court finds Mammo's debts nondischargeable under § 523(a)(2)(A). It does not, however, find nondischargeability under §§ 523(a)(4) or (a)(6).
Unless otherwise noted, all sections referred to in this memorandum decision relate to the Bankruptcy Code, Title 11 of the United States Code.
A. Section 523(a)(2)(A) Nondischargeability
Section 523(a)(2)(A) provides that debts are nondischargeable if they are obtained by: "false pretenses, a false representation, or actual fraud . . . ." To except her debt from discharge under § 523(a)(2)(A), Mammo must show by a preponderance of the evidence that:
(1) Sako made representations;
(2) Sako knew at the time that the representations were false;
(3) Sako made those representations with the intention and purpose of deceiving Mammo;
(4) Mammo justifiably relied on the representations; andIn re Sabban, 600 F.3d 1219, 1222 (9th Cir. 2010); In re Galindo, 467 B.R. 201, 208 (Bankr. S.D. Cal. 2012).
(5) Mammo sustained losses as a proximate result of Sako's representations.
1. Mammo's Forgery Allegations
As a preliminary matter, Mammo's arguments with respect to § 523(a)(2)(A) relate primarily to his allegation that Sako forged his signatures on certain documents. Mammo, however, has no actual knowledge of who forged his signature. Rather, he relies on: (1) an expert report that indicates he himself did not sign the documents; and (2) circumstantial evidence that Sako might benefit from the forgeries. But the court found Sako credible when she testified that she knew nothing about the forged documents. And the circumstantial evidence does not show that Sako is the only person that could have benefitted from them. Indeed, Toma and Melton were both involved in the business, and they are just as likely to have forged Mammo's signatures. Thus, even if Mammo shows that he himself did not sign the documents, he has not shown - by a preponderance of the evidence - that Sako was the one who forged his signature. The court therefore finds that Sako is not liable for the forgeries. She is, however, liable for other fraudulent acts as the court describes below.
2. False Representations and Omissions
"A debtor's failure to disclose material facts constitutes a fraudulent omission under § 523(a)(2)(A) if the debtor was under a duty to disclose and the debtor's omission was motivated by an intent to deceive." In re Harmon, 250 F.3d 1240, 1246 n.4 (9th Cir. 2001) (citing In re Eashai, 87 F.3d at 1089-90). A party to a business transaction has a duty to disclose:
(a) matters known to him that the other is entitled to know because of a fiduciary or other similar relation of trust and confidence between them; and (b) matters known to him that he knows to be necessary to prevent his partial or ambiguous statement of the facts from being misleading . . . .RESTATEMENT (SECOND) OF TORTS § 551.
The Restatement also provides, "[a] representation stating the truth so far as it goes but which the maker knows or believes to be materially misleading because of his failure to state additional or qualifying matter is a fraudulent misrepresentation." RESTATEMENT (SECOND) OF TORTS § 529.
Under California law, "[t]he fiduciary duties a manager owes to [a] limited liability company and to its members are those of a partner to a partnership and to the partners of the partnership." Cal. Corp. C. § 17153. And in California,
In 2012, the California legislature enacted the California Revised Uniform Limited Liability Company Act (the "Revised Act"), California Corporations Code § 17701.01, et seq. The Revised Act became operative January 1, 2014, and it repealed the Beverly-Killea Limited Liability Company Act (the "Repealed Act"), California Corporations Code § 17000, et seq. But, under its savings clause, the Revised Act "does not affect an action commenced, proceeding brought, or right accrued or accruing before [January 1, 2014]." Cal. Corp. C. § 17713.03. Mammo brought this nondischargeability action on August 12, 2013. Accordingly, the Revised Act does not affect this action; the Repealed Act still applies.
"Partners are trustees for each other, and in all proceedings connected with the conduct of the partnership every partner is bound to act in the highest good faith to his copartner and may not obtain any advantage over him in the partnership affairs by the slightest misrepresentation [or] concealment . . . ." [Llewelyn v. Levi, 157 Cal. 31, 37 (1909)]. A managing partner has a legal duty to disclose to copartners "matters affecting their business relationship." [Berg v. King-Cola, Inc., 227 Cal. App. 2d 338, 341 (1964)]. Partners have a duty to make a full and fair disclosure of all matters substantially affecting the value of the partnership. [Estate of Witlin, 83 Cal. App. 3d 167, 175 (1978)].McCain v. Phoenix Resources, Inc. 185 Cal. App. 3d 575, 579 (1986); see also Callison and Sullivan, Partnership Law and Practice 12:5 (2006) ("The duty of loyalty includes a duty to disclose all material facts concerning the partnership business, together with all facts connected with transactions involving partnership interests and property.").
In In re Haddad, debtor Thomas Haddad was partners with his brother, Abe Haddad, in a California partnership named Golden H. Packing Company ("GHP"). Haddad v. Haddad (In re Haddad), 21 B.R. 421, 422 (B.A.P. 9th Cir. 1982). GHP and Tom were the beneficiaries to Abe's two life insurance policies. Id. In the course of its business, GHP borrowed $500,000 from Bank of America. Id. Abe then passed away and, as a result, GHP and Tom received some $1,75 million in life insurance proceeds; Tom withdrew GHP's proceeds for his own use. Id. Abe's widow - Caroline Haddad - became the beneficiary of Abe's partnership interest under GHP's standing buy-and-sell agreement. Id. And Bank of America later demanded payment of its loan. Id.
When Caroline met with Tom and others to discuss the loan, she was asked to pay Abe's half. Id. at 423. Tom, however, did not disclose his receipt of the insurance proceeds. Id. And Caroline ultimately paid Bank of America some $250,000. Id. Caroline later discovered the proceeds, Tom filed bankruptcy, and - in a nondischargeability action - the bankruptcy court found that Tom had not committed § 523(a)(2)(A) fraud against Caroline. Id. at 422. On appeal, the Ninth Circuit Bankruptcy Appellate Panel ruled that: (1) under California law, Tom had a duty to disclose the insurance proceeds to Caroline; and (2) Tom knowingly concealed this information to induce Caroline to pay Bank of America. Id. at 423-24. The panel thus held Tom's liability for this fraudulent omission nondischargeable under § 523(a)(2)(A), and reversed the bankruptcy court. Id. at 424.
In In re Lopez, debtor Lopez borrowed $60,000 from creditor Pagliero to pay for living expenses so she could quit her job a pursue a career in art. In re Lopez, No. 09-1277-A, 2011 WL 10642952, at *2 (Bankr. E.D. Cal. May 18, 2011). She represented to Pagliero that, if she could not sell enough artwork to repay the loan, she would either go back to work or sell her house. Id. But she failed to disclose to Pagliero that: (1) her employer was ready to lay her off because it was discontinuing her department; (2) she possessed a retirement account that she could cash out; (3) she had recently borrowed $50,000 against the equity in her house; (4) she held a large amount of credit card debt; (5) she had previously filed bankruptcy; and (5) she had no intent to make enough money to pay back her loan to Pagliero. Id. at *3. The bankruptcy court found that these omissions satisfied § 523(a)(2)(A)'s false representation requirement.
Sako admitted that she was giving business funds to Toma almost every day. Giving away these business funds substantially affected El Nopal 1's value. Thus, like Tom's duty to disclose the insurance proceeds to Caroline, Sako held a duty to disclose her use of business funds to Mammo. But, like Tom, Sako failed to meet her duty. Further, like Lopez's partial representations about her employment and her home equity, Sako only partially represented the state of the business. She represented to Mammo that the business was doing well - it just needed more time and money. But it was not doing well. The entire truth about the business and why it needed more money was that: (1) it relied on costly check cashing services because its vendors only accepted COD payments; (2) it was regularly late on taxes and rent; (3) Sako was using the business account for her personal expenses; and (4) again, Sako was regularly giving business funds to Toma. Like Lopez, Sako did not disclose this whole truth.
When Sako became managing member of El Nopal 1, she acquired with it a duty to fully and fairiy disclose to Mammo all matters substantially affecting El Nopal 1's value. When Sako partially represented to Mammo that the business was doing well, she was misleading. She therefore had a duty to disclose the whole truth about the business to Mammo. Because Sako failed to meet her duties, and because the court finds below that Sako intended to deceive Mammo by her omissions, the court concludes that Sako's omissions and half-truths constitute false representations under § 523(a)(2)(A).
3. Intent to Deceive
To find nondischargeability under § 523(a)(2)(A), the debtors must have had the subjective intent to deceive at the time of the transaction. The court may infer this intent from the surrounding circumstances. In re Kennedy, 108 F.3d 1015, 1018 (9th Cir. 1997). After carefully considering the evidence and the various witnesses' credibility, the court is not persuaded that Sako had intent ab initio to defraud Mammo. She originally pursued her business deal with Toma. She did not seek Mammo out. Nor does the court find it likely that Sako conspired with Toma to bring Mammo in just to defraud him. Rather, it appears that Toma and Kejbo brought Mammo into the deal without any solicitation from Sako.
The court does, however, find that Sako formed her fraudulent intent very shortly after Mammo joined El Nopal 1. The parties' business deal contemplated Mammo's role as a passive investor. Sako ran the grocery business; Mammo provided the capital. And, after she received this capital, she began right away diverting some of it to Toma at Toma's request. Although Sako did not initially intend to defraud Mammo, she must have known that had she presented the whole truth about El Nopal 1's operations - particularly her regular gifts to Toma - Mammo would have likely stopped funding the business.
Indeed, it would have been an easy thing for Sako to inform Mammo about Toma. Mammo regularly inquired ahout the business. And if Sako truly believed Toma to be a legitimate business partner, disclosure should have been even easier - Sako could have simply explained to Mammo that the business needed more money because their partner Toma was constantly taking its funds. But Sako didn't explain this; she remained conspicuously silent about Toma. Instead, she told Mammo that the business was doing well. Then she asked him for more money. Given these circumstances, the court finds that Sako made the partial representations and omissions described above with the intent to deceive Mammo and induce him into providing El Nopal 1 with more funds.
4. Justifiable Reliance
Reliance on the representation need not reach the level of "reasonableness;" it need only be justifiable. Field v. Mans, 516 U.S. 59, 73-76 (1995); In re Eashai, 87 F.3d 1082, 1090 (9th Cir. 1996). This is a subjective standard that considers the relationship between the parties. In re Tallant, 218 B.R. 58, 67 (B.A.P. 9th Cir. 1998).
[A] person is justified in relying on a representation of fact "although he might have ascertained the falsity of the representation had he made an investigation. . . . Justification is a matter of the qualities and characteristics of the particular plaintiff, and the circumstances of the particular case, rather than of the application of a community standard of conduct to all cases."Field v. Mans, 516 U.S. at 70-71 (quoting RESTATEMENT (SECOND) OF TORTS §§ 540, 545A, Comment b). "Although one cannot close his eyes and blindly rely, mere negligence in failing to discover an intentional misrepresentation is no defense to fraud." In re Apte, 96 F.3d 1319, 1322 (9th Cir. 1996). Further, in cases involving fraudulent omissions,
[P]ositive proof of reliance is not a prerequisite to recovery. All that is necessary is that the facts withheld be material in the sense that a reasonable [person] might have considered them important in the making of this decision. This obligation to disclose and this withholding of a material fact establish the requisite element of causation in fact.Id. at 1323 (quoting Affiliated Ute Citizens v. United States, 406 U.S. 128, 153-54 (1972)).
Mammo learned about the El Nopal 1 business deal through his brother-in-law, Kejbo, and through Kejbo's friend, Toma. Mammo, Sako, Kejbo, and Toma all belong to the same ethnic community; they share similar backgrounds. Toma regularly visited the store. Kejbo occasionally visited it. And Mammo testified that he trusted Sako to run the business. Thus, when Sako affirmately represented that the business was doing well, there was little reason for Mammo to suspect otherwise. And there was no reason for Mammo to suspect that Sako was giving money over to Toma nearly every day. Moreover, even if Mammo had suspected it, it's not clear that a reasonable investigation would have uncovered Sako's fraudulent intent. The business operated largely on cash. And it does not appear that Sako or Melton were at all diligent with accounting for this cash - Sako produced no documents specifically describing where the funds went.
The court notes, however, that Mammo might have been more discerning about the transaction as a whole. Mammo has experience in the grocery business; he himself operates a store in Michigan. Had he scrutinized the way Sako ran El Nopal 1, he would have discovered the many checks made out to employees or cash. Had he reviewed the business's bank records, he would likely have discovered that Sako was using El Nopal 1's account as her own personal account. But, nonetheless, Mammo and Sako's business deal contemplated Mammo heing a passive investor. And living in Michigan made assiduous scrutiny of the business difficult. The court therefore finds that Mammo's failure to investigate did not rise above the level of negligence. Moreover, the court finds that a reasonable person would have considered Sako's undisclosed facts important in deciding whether to continue funding the business. These facts are therefore material, and accordingly, Mammo justifiably relied on both Sako's affirmative misrepresentations and fraudulent omissions for purposes of § 523(a)(2)(A).
5. Proximate Cause
The Restatement (Second) of Torts (1976) explains that proximate cause entails (1) causation in fact, which requires a defendant's misrepresentations to be a substantial factor in determining the course of conduct that results in loss, § 546; and (2) legal causation, which requires a creditor's loss to "reasonably be expected to result from the reliance." § 548A.In re Brown, 217 B.R. 857, 862 (Bankr. S.D. Cal. 1998). And, again: a debtor's failure to satisfy his or her obligation to disclose a material fact establishes causation in fact. In re Apte, 96 F.3d at 1323.
The court found above that Sako's affirmative misrepresentations and material omissions induced Mammo to continue funding El Nopal 1. And, in the end, Mammo lost much of the capital he contributed. But Sako's duty to disclose her gifts to Toma did not arise until she started giving such gifts. Her duty to disclose the truth behind her partial representations did not arise until she made such representations. Moreover, the court has found that Sako did not intend ab initio to defraud Mammo. Thus, Sako could not have not proximately caused the loss of Mammo's initial investment in El Nopal 1. But she did proximately cause the loss of Mammo's investments after she began: (1) diverting funds to Toma without informing Mammo; and (2) misleading Mammo with partial representations that the business was doing well.
The record does not make explicitly clear when Sako started paying Toma. Nor does it clearly show when, precisely, Sako began making partial representations to Mammo about the business. But the court infers from the parties' testimony that these things started almost immediately after Toma and Kejbo brought Mammo into the deal. Sako testified, without qualification, that Toma was always involved in El Nopal 1's business affairs, that he came to the store regularly, and that he asked for money nearly every day. She further testified to meeting with Mammo to discuss the business. And Mammo claimed he stayed generally informed about the business through regular telephone calls with Sako, where Sako would represent to him that the business was doing okay.
Thus, Sako's duties to disclose arose almost immediately after Mammo's initial investment on August 10, 2008. Sako's failure to meet her duties was a substantial factor in determining Mammo's continued investment and loss. Further, it was reasonable to expect that Mammo's reliance on Sako's partial representations and omissions would result in this loss. The court therefore finds that the false representations and omissions proximately caused Mammo's losses between August 21, 2008 and late 2011, when Mammo decided to end his business relationship with Sako. Mammo has accordingly shown all the elements necessary to find nondischargeability under § 523(a)(2)(A).
6. Damages
Mammo's complaint sought compensatory damages, punitive damages, and costs. His post-trial brief specifically requested damages caused by the forged documents. But the court has not found Sako liable for the forgeries. At trial, Mammo made no arguments with respect to punitive damages. And neither party raised the issue of prejudgment interest. Even so, Rule 54(c) of the Federal Rules of Civil Procedure provides: "[a non-default judgment] should grant the relief to which each party is entitled, even if the party has not demanded that relief in its pleadings."
Rule 7054 of the Federal Rules of Bankruptcy Procedure incorporates by reference Rule 54 of the Federal Rules of Civil Procedure.
The Restatement describes that damages for fraud include "pecuniary loss suffered [] as a consequence of the [] reliance upon the misrepresentation." RESTATEMENT (SECOND) OF TORTS § 549. Indeed, the damages in a nondischargeability action are not limited to the amount of money Debtors obtained by fraud. They extend to the creditor's loss resulting from the fraud, even if this exceeds the value Debtors received. Cohen v. de la Cruz, 523 U.S. 213, 214-18 (1998); Muegler v. Bening, 413 F.3d 980, 983 (9th Cir. 2005). Under Rule 54(d) of the Federal Rules of Civil Procedure, a prevailing party may recover costs other than attorney fees.
Further, "[t]he federal prejudgment interest rate applies to actions brought under federal statute, such as bankruptcy proceedings, unless the equites of the case require a different rate." Banks v. Gill Distribution Centers, Inc. (In re Banks), 263 F.3d 862, 871 (9th Cir. 2001) (citing Nelson v. EG & G Energy Measurements Group, Inc., 37 F.3d 1384, 1392 (9th Cir. 1994)). And, in particular, an action under § 523(a)(2)(A) is a product of federal law engendering federal prejudgment interest. In re Eberts, No. CV 11-08827-MWF, 2013 WL 1248637, at *10-11 (C.D. Cal., March 27, 2013).
Here, Mammo contributed $311,500 between August 21, 2008 and late 2011. As the court found above, Sako's false representations and omissions proximately caused Mammo to contribute and ultimately lose these funds. There's no indication that Mammo ever received any of these funds back from Sako or the El Nopal entities. Accordingly, the court finds Sako liable to Mammo for $311,500. It further finds Sako liable to Mammo for costs - other than attorney fees - that he incurred in bringing this action. And because Sako's liability arises under federal law, the court awards Mammo prejudgment interest at the federal rate starting from August 21, 2008.
B. Section 523(a)(4) Nondischargeability
A debt is nondischargeable under § 523(a)(4) if: "[(1)] an express trust existed, [(2)] the debt was caused by fraud or defalcation, and [(3)] the debtor acted as a fiduciary to the creditor at the time the debt was created." Otto v. Niles (In re Niles), 106 F.3d 1456, 1459 (9th Cir. 1997); Maxwell v. Maxwell (In re Maxwell), 509 B.R. 286, 289 (Bankr. E.D. Cal. 2014). Again, a manager owes the same fiduciary duties to her LLC that a partner owes to her partnership. Cal. Corp. C. § 17153. Under California law, partners are trustees for purposes of § 523(a)(4) liability. Ragsdale v. Bailer, 780 F.2d 794 (9th Cir. 1986). So, too, are managing LLC members. Plikaytis v. Roth (In re Roth), 518 B.R. 63, 72 (S.D. Cal. 2014).
But actions for damages to the LLC belong to the LLC; not the individual members. See Cal. Corp. C. § 17300. Members only have standing to bring such actions derivatively. See In re Blixeth, 459 B.R. 444 (Bankr. D. Mont. 2011); Albers v. Gunthy-Renker Corp., 92 Fed. Appx. 497 (9th Cir. 2004); Cal. Corp. C. § 17501. And in California, a derivative complaint must state with particularity the plaintiff's efforts for demand on the LLC or their reasons for not making that effort. Cal Corp. C. § 17501(a)(2). It must further allege that the plaintiff informed the LLC or the LLC's managers in writing about the underlying facts of the complaint. Id.
Here, the parties spent much of trial focused on Sako's apparent defalcation - she admitted mat she regularly gave funds to Toma; she used the company's bank account for personal expenses; and she largely failed to account for cashed checks. But these defalcations all relate to funds belonging to El Nopal 1, not Mammo personally; Mammo had already given these funds over to the business. Accordingly, these acts damaged the LLC and Mammo only has standing to sue on them derivatively.
Mammo's complaint, however, fails to state with particularity his efforts for demand on El Nopal 1 or his reasons for not making such demand. It likewise fails to allege that he informed El Nopal 1 or Sako in writing about the underlying facts of his complaint. And there is otherwise no indication that Mammo brought this action derivatively. He did not join El Nopal 1 as a party to the action. He makes no specific arugments about El Nopal 1's damages. He hardly mentions his rights as an LLC member. And, indeed, he often and inaccurately referred to El Nopal 1 as a partnership rather than a limited liability company.
The court takes judicial notice that £1 Nopal 1 is an "FTB Suspended" company according to the California Secretary of State. This, in itself, might have been good reason not to make demand under Cal. Corp. C. § 17503(a)(2). But the court notes that a plaintiff in a derivative LLC action has no greater standing than the company itself. Cohen v. Davis Creek Lumber Co., 151 Cal. App. 2d 420, 427 (1957). And suspended companies have no power to sue. Cal. Corp. C. § 17654. Thus, even if Mammo had complied with the requirements of California Corporations Code § 17501, it appears his 11 U.S.C. § 523(a)(4) claim would nonetheless fail for a derivative lack of standing. Davis Creek Lumber Co., 151 Cal. App. 2d at 427.
The court notes specifically that - even if Mammo had brought this action derivatively - both he and Sako hold interests in El Nopal 1. And Mammo failed to address what portion of the damages he would be entitled to for his membership interest.
Because: (1) Sako's apparent defalcation damaged El Nopal 1 and not Mammo personally; (2) Mammo's complaint fails to comply with California Corporations Code § 17501's requirements; and (3) Mammo does not otherwise appear to bring this action derivatively, Mammo lacks standing to assert a § 523(a)(4) defalcation action. Accordingly, the court does not find that Sako owes Mammo a nondischargeable debt under § 523(a)(4).
C. Section 523(a)(6) Nondischargeability
Debts for "willful and malicious injury" are nondischargeable under § 523(a)(6),
The word "willful" in (a)(6) modifies the word "injury," indicating that nondischargeability takes a deliberate or intentional injury, not merely a deliberate or intentional act that leads to injury. . . . [T]he (a)(6) formulation triggers in the lawyer's mind the category "intentional torts," as distinguished from negligent or reckless torts. Intentional torts generally require that the actor intend "the consequences of an act," not simply "the act itself."Kawaauhau v. Geiger, 523 U.S. 57, 61 (1998) (emphasis in original). This standard "focuses on the debtor's state of mind and precludes application of § 523(a)(6)'s nondischargeability provision short of the debtor's actual knowledge that harm to the creditor was substantially certain." Carrillo v. Su (In re Su), 290 F.3d 1140, 1146 (9th Cir. 2002).
"A 'malicious' injury involves '(1) a wrongful act, (2) done intentionally, (3) which necessarily causes injury, and (4) is done without just cause or excuse.'" Petralia v. Jercich (In re Jercich), 238 F.3d 1202, 1209 (9th Cir. 2001). "Malice may be inferred based on the nature of the wrongful act." Ormsby v. First American Titlae Company of Nevada (In re Ormsby), 591 F.3d 1199, 1207 (9th Cir. 2010) (citing Transamerica Commerical Fin. Corp. v. Littleton (In re Littleton), 942 F.2d 551, 554 (9th Cir. 1991)).
Again, Mammo did not show by a preponderance of the evidence that Sako forged any documents. And Mammo did not sue derivatively for damages that El Nopal 1 sustained. Accordingly, the only remaining debts subject to § 523(a)(6) nondischargeability are: (1) Sako's liability for her fraudulent omissions and partial representations; (2) Sako's purported failure to return the $2,414 liquor license transfer fee; and (3) Mammo's $3,000 payment to ensure Sako's cooperation. The court addresses each of these debts in turn.
1. Sako's Fraud Liability
When Sako committed her fraud by omissions and partial representations, she did it to induce Mammo into giving the business more money. And, in the end, this injured Mammo. But it does not necessarily mean that Sako intended such injury. Despite the fact that Sako regularly diverted business funds to Toma, her testimony plainly indicates that she wanted El Nopal 1 to do well. And although she lacked diligence and prudence in running the business, it is nonetheless apparent that she was working hard toward its success. Sako wanted the business to grow and, accordingly, she wanted the value of Mammo's interest to grow with it. Nothing indicates that Sako intended to permanently deprive Mammo of his investment or any return on it. Nor did she know that her acts were substantially certain to cause Mammo harm. Thus, with respect to the $341,500 Mammo provided to the business, the court finds that Sako did not intend to injure Mammo. Accordingly, the court does not find nondischargeability of that debt under § 523(a)(6).
2. The Liquor License Transfer Fee
Sako asked Mammo for $2,414 to pay ABC's liquor license transfer fee. And the court finds credible Sako's testimony that she intended to use those funds to pay the transfer fee. That the funds never successfully reached ABC is not, by itself, proof that Sako intended to hurt Mammo in asking for those funds. Moreover, the court also finds credible Sako's testimony that she: (1) deposited Mammo's $2,414 in El Nopal 1's WIC account; and (2) emptied that account to provide WIC funds to Mammo's employee, Nathan. The court notes that El Nopal 1's WIC account appears to be with Neighborhood National Bank. And the check Sako issued to ABC instead drew upon El Nopal 1's Chase Bank account. It is thus unclear how Sako thought Mammo's funds would reach the ABC. But the court does not find this mistake an indication of malice. Rather, it attributes the error to the general lack of diligence, competence, and attention to detail that Sako demonstrated throughout her operation of the business. Thus, with respect to the $2,414 Mammo provided for ABC's liquor license transfer fee, the court finds that Sako did not intend to injure Mammo. Accordingly, the court does not find nondischargeability of that debt under § 523(a)(6).
It is also worth noting that, for all the bank statements the parties brought into evidence, they did not bring the December 2011 statement for E3 Nopal 1's Neighborhood National Bank account. This statement would presumably show whether or not Sako did deposit Mammo's check, and what then happened to those funds. But, because the court does not have this statement, Sako's testimony is the only evidence the court has regarding the $2,414.
3. The Cooperation Payment
"While bankruptcy law governs whether a claim is nondischargeable under § 523(a)(6), [the] court looks to state law to determine whether an act falls within the [underlying] tort []." Del Bino v. Bailey (In re Bailey), 197 F.3d 997, 1000 (9th Cir. 1999). Thus, an intentional breach of contract will not give rise to a nondischargeable debt unless the breach is accompanied by tortious conduct that results in willful and malicious injury. In re Jercich, 238 F.3d at 1205. And "[i]n California, tort recovery for breach of contract is permitted only when a defendant's conduct violates a fundamental public policy of the state." Jenkins v. Mitelhaus (In re Jenkins), BAP Nos. CC-14-1185-PaTaD, CC-14-1258-PaTaD, 2015 WL 735799, at *7 (B.A.P. 9th Cir., Feb. 20, 2015) (internal quotations omitted) (quoting Rattan v. United Servs. Auto. Assoc., 84 Cal. App. 4th 715, 720 (2000)).
Near the end of 2011, Mammo and Sako agreed to swap interests and create sole ownerships in El Nopal 1 & 2. But before they fully consummated this deal, Sako held El Nopal 1's WIC license hostage: she threatened to prevent its transfer to Mammo unless Mammo paid her $5,000. And, ultimately, Mammo paid Sako $3,000 to ensure her cooperation. At trial, however, Mammo did not describe or otherwise specify what tort Sako committed by doing this. Indeed, it is unclear whether she committed a tort at all - she threatened to breach her contract with Mammo unless he paid her more money. A claim for Sako's actions might thus sound in contract rather than tort.
Nonetheless, after examining California law, Sako's actions appear to fall closest to economic duress or civil extortion. But neither of these actions afford Mammo § 523(a)(6) relief. First, a claim for economic duress appears to sound in contract: it forms a basis for contract rescission. Chan v. Lund, 188 Cal. App. 4th 1159, 1173-74 (2010). Further,
["Economic duress requires] a wrongful act which is sufficiently coercive to cause a reasonably prudent person faced with no reasonable alternative to succumb to the perpetrator's pressure. . . . [A] reasonably prudent person subject to such an act may have no reasonable alternative but to succumh when the only other alternative is bankruptcy or financial ruin."Id. at 1174 (quoting Rich v. Whillock, Inc. v. Ashton Development, Inc., 157 Cal. App. 3d 1154, 1158-59 (1984)). Here, Mammo has not shown that a reasonably prudent person would be faced with no reasonable alternative but to succumb to Sako's demand for $5,000. There is no indication that Mammo's only other alternative was bankruptcy or financial ruin. Indeed, Mammo and Sako had already formed their contract - Mammo could have easily sued Sako for performance of it. Thus, even if a claim for economic duress qualifies as a tort for purposes of § 523(a)(6) liability, Mammo has not met its standard under California law.
On the other hand, "[e]xtortion is the obtaining of property from another, with his consent, . . . induced by a wrongful use of force or fear . . . ." Cal. Pen. C. § 518. "Fear, such as will constitute extortion, may be induced by a threat . . . [t]o do an unlawful injury to the person or property of the individual threatened . . . ." Cal. Pen. C. § 519. The court, however, has found no authority that suggests a breach of contract constitutes an "unlawful injury" for the purposes of extortion. Accordingly, Mammo has not shown that Sako committed civil extortion when she threatened to breach her contract with him.
Black's Law Dictionary defines "unlawful" as, "1. Not authorized by law; illegal . . . . 2. Criminally punishable . . . . [or ] 3. Involving moral turpitude . . . ." BLACK's LAW DICTIONARY 1678 (9th ed. 2009).
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Finally, Mammo has described no fundamental public policy in California that would transform Sako's breach into a tortious act. In In re Lawson, debtor Lawson refused to release goods that a creditor had already paid for in full. Coastal Industrial Partners, LLC v. Lawson (In re Lawson), A.P. No. 13-1105, 2014 WL 1017908, at *1 (Bankr. N.D. Cal. Mar. 14, 2014). Lawson insisted that the creditor owed him some $76,000 in additional fees. Id. But an arbitrator found Lawson's claim false and wrongful - Lawson's refusal was part of a "'fraudulent scheme' to 'extort' money from" the creditor. Id. And the arbitrator found Lawson liable for conversion and breach of contract. Id. at *2. Lawson later filed bankruptcy and the creditor sought § 523(a)(6) nondischargeability of the arbitration award. Id. at *1. The Northern District of California Bankruptcy Court stated, "[t]here is no fundamental public policy in this case which would rum Lawson's breach of contract, however unjustified, into a tort." Id. at *2. And it thus denied the creditor § 523(a)(6) nondischargeability for the breach of contract portion of the award. Id.
As Lawson breached his contract by refusing to release goods unless his creditor paid additional fees, so Sako breached her contract by refusing to cooperate with the WTC license transfer unless Mammo paid additional funds. Just as Lawson's demand was wrongful and unjustified, so too was Sako's. But like the In re Lawson court, this court has found no fundamental public policy that would transform Sako's breach of contract into a tort. And Mammo has not otherwise met his burden to show an intentional tort in Sako's breach. The court therefore denies Mammo nondischargeability of that $3,000 debt under § 523(a)(6).
IV. CONCLUSION
For the foregoing reasons, the court finds that: (1) Sako failed to disclose information that she had a duty to disclose; (2) she made partial representations that at the time she knew to be misleading; (3) she made these partial representations and omissions with the intent to deceive Mammo; (4) Mammo justifiably relied on these partial representations and omissions; and (5) these representations and omissions proximately caused Mammo $311,500 in damages plus costs.
But since Mammo lacks standing to sue for damages that El Nopal 1 sustained, the court does not find that Sako owes Mammo a nondischargeable liability under § 523(a)(4). Because the court finds that either: (1) Sako did not intend to injure Mammo; or (2) Mammo did not meet his burden to show an intentional tort, the court does not find that Sako owes Mammo a nondischargeable debt under § 523(a)(6). Nor does the court find punitive damages appropriate under the facts at bar.
The court therefore awards Mammo a total of $311,500 plus costs against Sako. It awards prejudgment interest at the federal rate from August 21, 2008. This award is nondischargeable under 11 U.S.C. § 523(a)(2)(A) and likewise accrues postjudgment interest at the federal rate. A separate judgment in favor of Mammo and against Sako shall issue.
IT IS SO ORDERED.
Dated: March 6, 2015
/s/_________
CHRISTOPHER B. LATHAM, JUDGE
United States Bankruptcy Court
CERTIFICATE OF MAILING
The undersigned, a regularly appointed and qualified clerk in the office of the United States Bankruptcy Court for the Southern District of California, at San Diego, hereby certifies that a true copy of the attached document, to wit:
MEMORANDUM DECISION AND ORDER
FINDING NONDISCHARGEABILITY AND AWARDING DAMAGES
was enclosed in a sealed envelope bearing the lawful frank of the bankruptcy judges and mailed via first class mail to the parties at their respective addresses listed below: Hikmat Mammo
625 Broadway #620
San Diego CA 92101
Hikmat Mammo
c/o Ronald W. Noya
701 B Street, Suite 228
San Diego CA 92101
Sundus Yousif Sako
1295 Green Bay Street
San Diego CA 92154
Ronald W. Noya
701 B Street, Suite 228
San Diego CA 92101
Alan L. Williams
Law Offices of Alan L. Williams
2550 Fifth Avenue, Suite 520
San Diego CA 92103
Gerald H. Davis
PO Box 124640
San Diego CA 92112-4640
Said envelope(s) containing such document was deposited by me in the City of San Diego, in said District on March 6, 2015.
/s/_________
Jillmarie R. McGrew, Deputy Clerk