Opinion
16-14370 Adversary 19-1008
08-11-2021
In Re KENNETH R. RILEY GLORIA G. RILEY Debtors v. KENNETH R. RILEY, et al. Defendants REINHART FOODSERVICE, LLC Plaintiff
This opinion is not intended for publication
Chapter 7
MEMORANDUM OPINION
Plaintiff Reinhart FoodService, LLC ("Reinhart") commenced this adversary proceeding seeking a determination that a contractual obligation of $125,000 owed to Reinhart by an entity identified in the contract as "Riley Restaurant Group dba - J. Austin's American Eatery & Walt's Barbeque" is a debt for which Defendant-Debtors Kenneth and Gloria Riley (jointly referred to as "Debtors") are personally liable and that should be excepted from their discharge under provisions of 11 U.S.C. § 523(a). Furthermore, Reinhart alleges that the Debtors should be denied a discharge under provisions of 11 U.S.C. § 727(a) because they failed to list Reinhart as a creditor in their schedules or list the funds received from Reinhart as income.
A trial was held on January 27, 2021. Based on the documentary evidence and witness testimony presented, this Court determines that Reinhart failed to establish that the Debtors are personally liable for the $125,000 contractual obligation, a prerequisite to determining the debt nondischargeable in their bankruptcy case. Even if it was demonstrated that one or both of the Debtors were personally liable, this Court further determines that Reinhart failed to meet the elements to except the debt from discharge under 11 U.S.C. § 523(a). Reinhart's request to deny the Debtors' discharge under 11 U.S.C. § 727(a) is likewise unsuccessful. Reinhart failed to establish that the Debtors were required to reflect the $125,000 payment from Reinhart as personal income in their bankruptcy papers such that they made a false oath by omitting the information or that any such omission was made with fraudulent intent. As such, Reinhart has failed to carry its burden of proving that the Debtors' discharge should be denied.
I. JURISDICTION
This Court has jurisdiction over this matter pursuant to 28 U.S.C. §§ 157(a) and 1334, and the standing General Order of Reference in this District. This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(I) and (J).
II. FACTUAL BACKGROUND
The following are this Court's findings of facts from the testimony and evidence presented at trial.
A. The Debtors' Early Relationship with Reinhart and 2013 Credit Application
Prior to their bankruptcy filing, Debtors Kenneth Riley ("Ken Riley") and Gloria Riley were associated with several restaurants owned and operated by various corporations and limited liability companies. The first business entity formed by the Debtors in 2007, was William-Royce, Inc., which owned and operated Riley's Restaurant, a family style restaurant in business since 1981. Riley's Restaurant continued to operate through the spring of 2016 at which time the restaurant was "rebranded" as J. Austin's American Eatery with a gastropub menu. The Debtors formed a second business entity, Riverbar, LLC, in February of 2014 which owned and operated another restaurant, J. Austin's Riverbank Cafe in Hamilton. Gloria Riley was the corporate secretary and Ken Riley was the president of both William Royce, Inc. and Riverbar, LLC.
The Debtors' son, James Riley, was also involved in the restaurant business from a young age. He went to culinary school and, at the age of 18, wanted to purchase a restaurant. In March of 2013, the Debtors helped their son incorporate J.R. Austin, LLC to purchase and operate two restaurants, Walt's Barbeque Colerain and Walt's Barbeque Hamilton (collectively "Walt's Barbeque"), previously owned by Walter Baum. J.R. Austin, LLC was owned entirely by James Riley and neither of the Debtors was an officer of that corporation although Gloria Riley became a manager.
Prior to its purchase by James Riley, Walt's Barbeque had a relationship with Reinhart, the plaintiff in this adversary proceeding and a company that engages in food distribution to national accounts and independent restaurants. Walt's Barbeque bought proprietary items from Reinhart and James Riley agreed to continue purchasing certain products from Reinhart upon his purchase of Walt's Barbeque. As part of that agreement, James Riley filed out a credit application with Reinhart that, according to Ken Riley's testimony, also included a personal guaranty
James Riley's 2013 credit application with Reinhart was not entered into evidence by either party.
At that time in 2013, the Debtors used a different food distributor and competitor of Reinhart, Gordon Food Service. However, in conjunction with James Riley's purchase of Walt's Barbeque and in the hope of adding new business with the Debtors, a Reinhart sales representative asked Gloria Riley to complete a credit application with Reinhart. On June 14, 2013, Gloria Riley signed a credit application with Reinhart on behalf of "William-Royce Inc." doing business under the trade name "Riley's Restaurant." [Docket Number 42, Plaintiff's Exhibit ("Pl. Ex.") 1] Although Gloria Riley signed the application as the Secretary of William-Royce, Inc., she also signed an "Individual Personal Guaranty" on the backside of the credit application which stated:
I, the undersigned Guarantor, for and in consideration of your extending credit at my request to Riley's / Gloria Riley (the "Purchaser"), personally guarantee prompt payment of any obligation of the Purchaser to Reinhart FoodService, LLC or any of its subsidiaries ("Seller"), whether now existing or hereinafter incurred, and I further agree to bind myself to pay on demand any sum which is due by the Purchaser to Seller whenever the Purchaser fails to pay same. It is understood that this guarantee shall be absolute, continuing and irrevocable guaranty for such indebtedness of the Purchaser.[Id.] Gloria Riley testified that, although she signed the credit application, she cannot recall making any purchases from Reinhart under the credit agreement. Gloria Riley also testified that she never asked that her individual guaranty be released.
From 2014 to 2016, the restaurants did minimal business with Reinhart mostly limited to purchasing ancillary items for Walt's Barbeque. However, in 2016, a Reinhart sales representative approached a general manager of Reinhart, William Stacey, about putting together a potential incentive package to obtain additional business with the Debtors.
B. Reinhart's Business Analysis of Potential Customers and Its Incentive Program
William Stacey ("Bill Stacey") is a general manager over sales and operations at Reinhart FoodService Cincinnati. He and Jeffrey Peters ("Jeff Peters"), a corporate asset recovery manager for Reinhart, testified to Reinhart's business analysis of potential customers to determine when it would be in Reinhart's interest to offer credit or an incentive package to customers or prospective customers. These Reinhart representatives testified that Reinhart often begins with "prospecting," or sending salespeople out to build relationships with restaurant operators and learn the identity of their current supplier. Prospective customers who are interested in purchasing from Reinhart must then fill out a credit application that provides Reinhart with the name and location of the potential customer's business and other information that allows the underwriting department to pull a credit report. The standard credit application utilized by Reinhart also includes Reinhart's terms and conditions and a personal guaranty provision like the one signed by Gloria Riley.
Bill Stacey further testified that Reinhart uses an incentive program to attract new customers and grow business with existing customers. To determine whether to offer an incentive, Reinhart creates what it calls a "descending dollar case report" to analyze the potential customer's volume from their current supplier. At that point, Reinhart conducts a customer profitability analysis in which Reinhart plugs in the potential customer's current numbers as well as the terms and incentive that the customer would want from Reinhart. The customer profitability analysis calculates the profitability of the potential account and helps Reinhart determine what type of incentive it can offer. The types of incentives Reinhart provides include volume incentives or, sometimes, upfront money.
C. The 2016 Incentive Agreement and Credit Application
In 2016, a Reinhart sales representative who had been in prior contact with the Debtors brought in Bill Stacey to put together a potential incentive package to offer the Debtors in exchange for expanding their business relationship with Reinhart. At that time, Bill Stacey held the belief that the Debtors controlled four restaurants: two Walt's Barbeque restaurants and two J. Austin's restaurants. Bill Stacey testified that the Debtors came to him with the desire to "rebrand" the two Walt's Barbeque restaurants as J. Austin's restaurants with different themes like a sports bar and barbeque restaurant. He testified that the Debtors were looking for an investment from Reinhart to help them with this rebranding. However, this testimony is disputed by Ken Riley. Mr. Riley testified that he turned down two prior offers from Reinhart and, in fact, had better money investment offers from their existing distributor, Gordon Food Service. Ken Riley stated that the reason he finally accepted Reinhart's third offer to solicit their business was because of the potential of a limited mark-up on purchases.
In order to determine whether it was in Reinhart's interests to offer the Debtors an incentive, Bill Stacey did the same type of business analysis that he had done for other companies. He reviewed the Debtors' businesses' buying history with Gordon Food Service, including invoices and volume, and determined that the restaurants were thriving and their volume was high. He also pulled their creditworthiness to make sure that Reinhart would be making a good investment. He testified that his research on the Debtors' businesses showed no financial trouble or red flags of any kind.
Reinhart proceeded to draw up an incentive agreement for the Debtors' restaurants which, according to Bill Stacey, was similar to ones created for other customers and included a weekly quota of purchases from Reinhart that the customer must meet. He noted that the quota had to be a high enough number for Reinhart to make a return on its investment. Based on the research and analysis conducted by Reinhart, including a review of the restaurants' current volume with Gordon Food Service, Bill Stacey believed that they could purchase $30,000 a week from Reinhart, what he considered to be a good volume. He further testified that the incentive agreement included an incentive payment to the Debtors that was intended to be used by them to rebrand the two Walt's restaurants into J. Austin's restaurants, although Ken Riley disagreed and testified that he did not intend such a rebranding since the Walt's Barbeque restaurants were the most successful ones of the four.
Ken Riley testified that he reviewed the terms included in the incentive agreement drawn up by Reinhart prior to the day it was signed and was concerned that the name of the customer listed in the agreement was "Riley Restaurant Group," a name that he had never provided to Reinhart and had never heard used prior to its inclusion in the agreement. For that reason, Ken Riley sent an email to Bill Stacey on August 4, 2016 with the correct restaurant names and corporate ownership: "Jaustins riverbank cafe-River Bar LLC[;] Walts BBQ Hamilton and Colerain-J.R. Austin LLC[;] Jaustins American Eatery-William Royce Inc." [Docket Number 33, Defendant's Exhibit ("Def. Ex.") D] While Bill Stacey replied to the email acknowledging receipt [Id.], the language of the agreement was not changed. When asked why the agreement listed the customer as Riley Restaurant Group, Bill Stacey testified that it was the name Reinhart used to refer to the four restaurants, the two J. Austins and the two Walt's Barbeque, but he did not know where it originated.
Ken Riley testified that he had other concerns about the Incentive Agreement's terms, including the restaurants' ability to meet the $30,000 weekly purchasing quota from Reinhart. Ken Riley explained his concerns to Bill Stacey and others at Reinhart and received an email on August 3, 2016 from Reinhart Foodservice-Cincinnati Division President Neil D. Hoover acknowledging a prior discussion and assuring Ken that the "$30,000 weekly purchases is an average number. We understand that some weeks will be less and others more. The agreement is about Reinhart being your primary distributor." [Def. Ex. C]
On August 5, 2016, Ken Riley met with Reinhart representatives to sign the agreement. At the meeting, Ken Riley brought with him a list of what he characterizes as demands that he wanted Reinhart to meet as part of the parties' agreement. One of the items on the list was Ken Riley's desired limited markup on cases of food stating "Our markup on a case is $2.50." [Def. Ex. G, p. 2] Another item on the list related to the $30,000 weekly purchase requirement. Specifically, the list stated: "We have purchased upwards of $30,000 per week, but there is no guarantee we can do this. We may be higher or lower, as long as we continue to buy from RFS." [Id.] Both Bill Stacey and Ken Riley signed the list although they had differing views on whether the list became part of the parties' agreement or was just a checklist of talking points discussed.
Ken Riley testified to his belief that his list of demands became part of the parties' contractual agreement. Bill Stacey, on the other hand, testified that the list was only a checklist or talking points and that he signed the list only after conferring with his division president to confirm that it was not contractual in nature and only to acknowledge that the items had been discussed. Bill Stacey further testified that the list could not be contractually binding or part of the Incentive Agreement because he did not possess the authority to sign contracts on behalf of Reinhart. However, he admitted that he never told the Debtors that he lacked such authority. Bill Stacey further admitted that the demands in Ken Riley's list, including the limited mark up, were met by Reinhart.
The "Customer Incentive Agreement" drafted by Reinhart and signed by Ken Riley at the August 5, 2016 meeting was entered into evidence [Pl. Ex. 3; Def. Ex. G] (the "Incentive Agreement"). The language of the Incentive Agreement identified the "Customer" as "Riley Restaurant Group dba - J. Austin's American Eatery & Walt's Barbeque" and included a three-year term from August 5, 2016 through August 5, 2019.
The Incentive Agreement provided for a one-time incentive payment from Reinhart of $125,000 ("Incentive Payment") to the Customer to be earned by the Customer over the three-year term. In return for receipt of the Incentive Payment, the Incentive Agreement provided that the Customer was to purchase at least $30,000 a week of product from Reinhart over the course of the three-year term. If the purchasing requirement was not met, the Customer agreed to refund the unearned portion of the Incentive Payment to Reinhart upon notification from Reinhart of the Customer's failure to meet the terms of the Incentive Agreement. The Incentive Agreement included no terms for how the Incentive Payment was to be used nor was Ken Riley ever told to put the funds in a separate trust account.
The Incentive Agreement included a provision stating that it was to be governed in accordance with the laws of Wisconsin and further provided that the agreement:
constitutes the sole and entire agreement of the parties to this Agreement with respect to the subject matter contained herein, and supersedes all prior and contemporaneous understandings, agreements, representations and warranties, both written and oral, with respect to the same subject matter. This agreement may only be amended, modified or supplemented by an agreement in writing signed by each party hereto."[Id.] Ken Riley signed the Incentive Agreement on behalf of Riley Restaurant Group as
"President." The Incentive Agreement was not signed by a representative of Reinhart at the meeting but was, instead, signed by Reinhart's Chief Financial Officer on September 14, 2016.
The Incentive Agreement signed by Ken Riley did not include a personal guaranty. Ken Riley testified that he had made it known to Reinhart that he would not sign a personal guaranty and such a requirement was a "deal-killer." On the other hand, Bill Stacey testified that Reinhart would not have entered the Incentive Agreement without one, but was aware of Gloria Riley's 2013 credit application and personal guaranty, which Reinhart felt was sufficient. Gloria Riley did not sign the Incentive Agreement and testified that she is not sure she was present at the meeting when it was signed by Ken Riley.
On the same date that the Incentive Agreement was signed, Ken Riley also signed a new credit application with Reinhart [Def. Ex. F] ("2016 Credit Application"). The 2016 Credit Application includes a line for the Business Name on which is hand-written "William-Royce, Inc." The Trade Name is written in as "J. Austin's American Eatery" and the business's previous name is listed as "Riley's Restaurant." Ken Riley signed the 2016 Credit Application as "President" on August 5, 2016. Like the 2013 Credit Application, the 2016 Credit Application includes a personal guaranty provision on the backside of the application. However, Ken Riley did not sign the personal guaranty on the 2016 Credit Application.
Likewise, James Riley signed a credit application with Reinhart on August 5, 2016 on behalf of "J.R. Austin LLC" under the trade name "Walt's Barbeque." [Def. Ex. E] Like Ken Riley, James Riley did not sign the personal guaranty provision on the credit application. The parties alluded to litigation and a state court judgment concluding that James Riley's second credit application replaced and voided his earlier 2013 credit application that included the personal guaranty. However, the judgment from that litigation was not offered into evidence at the trial.
Debtors' counsel attempted to offer the judgment entry into evidence in a post-trial brief [Docket Number 53] that became the subject of a motion to strike filed by Reinhart's counsel [Docket Number 54]. Because the judgment entry was not included by Debtors' counsel as an exhibit at trial, this Court concludes it is inappropriate to consider in a post-trial brief. Accordingly, Reinhart's motion to strike is granted by separate order.
D. The Incentive Payment
Bill Stacey testified that it took some time for Reinhart to push the Incentive Payment through and that Ken Riley called anxiously about the missing check. Approximately six weeks after Ken Riley signed the Incentive Agreement, Reinhart presented Ken Riley with a check for the Incentive Payment. The $125,000 check, dated September 21, 2016, was made payable to "Riley Restaurant Group." [Pl. Ex. 4] Ken Riley testified that he was upset that the check was made out in this fashion. He did not have an account with this name on it and was not sure it could be deposited. He called Bill Stacey who informed him that, if Ken wanted the check reprinted, it would take another six weeks so he advised Ken to try depositing it. Ken Riley testified that he was not told that he should put the money in a trust account.
Ken Riley testified that each of the corporate entities had separate every day checking and payroll bank accounts and that he made the decision to try and deposit the check in what he termed the "everyday checking account" for Walt's Barbeque. He testified that the Walt's Barbeque account was chosen because Ken did not want his son James Riley to think that he and Gloria were taking all of the money. The bank did accept the deposit although Ken Riley testified that it put a hold on the check for some time. The First Financial Bank statement for the J.R. Austin LLC checking account shows that that the check was deposited on September 22, 2016. [Def. Ex. I]
Both Bill Stacey and Ken Riley testified to their understanding that Reinhart intended the Debtors to use the $125,000 Incentive Payment for investment in the restaurants. And, according to Ken Riley's testimony, the money was used for the businesses, specifically for new signage and remodeling at the Walt's Colerain restaurant.
E. The Debtors' Bankruptcy Filing and Subsequent Business Closures
On November 23, 2016, the Debtors filed a chapter 7 bankruptcy petition, approximately two months after Ken Riley deposited the Incentive Payment from Reinhart into the Walt's Barbeque business checking account. Gloria Riley testified that the Debtors did not list Reinhart in their bankruptcy schedules, nor did they otherwise provide Reinhart with notification of the bankruptcy filing at that time. The Debtors testified to their belief that Reinhart did not need to be scheduled as a creditor because the Debtors filed a personal bankruptcy while the debt to Reinhart was a business debt. In addition, Gloria Riley testified that they did not list the $125,000 Incentive Payment in their schedules as income because they did not believe it to be personal income nor did they believe it needed to be repaid since even after their personal bankruptcy filing, the restaurants continued to purchase from Reinhart and did not try to get out of the Incentive Agreement.
Following their personal bankruptcy filing, the restaurants continued to use Reinhart as their supplier. However, the restaurants never reached the $30,000 a week purchasing quota agreed to in the Incentive Agreement. The restaurants' invoices of Reinhart purchases from September of 2016 through September 2017 [Pl. Exs. 6 - 9; Def. Exs. J - R] along with Gloria Riley's testimony support that total monthly purchases from Reinhart went up to just over $63,000 in monthly purchases in mid-2017 and then began to drop rapidly.
Bill Stacey testified that, although the Debtors were not meeting the $30,000 weekly purchasing quota in the Incentive Agreement from the very beginning, the restaurants were purchasing in the range of $20,000 a week so he did not consider that a red flag nor did he contact the Debtors about missing the quota. Instead, he testified that the first red flag was the closure of one of the Debtors' restaurants, J. Austin's American Eatery, in December of 2016 which he learned of from one of his sales representatives. Bill Stacey called Ken Riley who told him that one of the J. Austin's restaurants was not doing well so they were going to put their resources into the other three restaurants. He said that Ken Riley assured him that he could do the volume in the other three restaurants and everything would be fine.
Following the closure of the first restaurant, Ken Riley testified that the restaurants continued to use Reinhart as their sole distributor after they finished their obligations with Gordon Food Service. Bill Stacey testified that, at that time, the Walt's Colerain restaurant was doing well but the remaining two restaurants were a little slow.
Then another restaurant, Walt's Hamilton, closed in August of 2017. Bill Stacey testified that he went out to visit with the Debtors and talk about his concerns that Reinhart had a major investment with them. Again, Ken Riley assured him that the main restaurant, Walt's Colerain, was doing well and that they would continue to focus their efforts on the two remaining restaurants.
However, a third restaurant, J. Austin's Riverbank, closed in September of 2017 and, finally, the last restaurant, Walt's Colerain, closed near the end of that month. Gloria Riley testified that the last restaurant purchases from Reinhart were made in September of 2017 a month in which purchases totaled approximately $18,000.
During this time frame when the restaurants were closing, both Ken Riley and Bill Stacey testified to their conversations about the restaurants failing to meet the $30,000 weekly purchasing quota. Bill Stacey testified that during these conversations, he made it clear that the $125,000 Incentive Payment would need to be repaid and, perhaps, the payments could be prorated over time. He met with Ken and James Riley at a Frisch's restaurant after the final closure to see if there was a repayment plan that could be worked out, but to no avail. According to Bill Stacey, Ken Riley did not inform him of the Debtors' personal bankruptcy filing. Instead, Bill Stacey learned of the personal bankruptcy from Jeff Peters who sent Ken Riley a letter of default related to the Incentive Agreement in November of 2017.
Ken Riley testified that while Bill Stacey talked about his concerns that the Debtors' restaurants were not meeting their weekly purchasing quota, Bill did not call that a default. Instead, Ken Riley testified that the first time he heard that Reinhart considered the restaurants to be in default was in Jeff Peter's letter of default sent in November of 2017 after which Ken Riley informed Jeff Peters of the Debtors' personal bankruptcy filing. Jeff Peters testified that the letter of default requested that they pay back to Reinhart the unearned portion of the Incentive Payment which, according to his testimony, was $125,000. However, Ken Riley testified that the letter of default stated that only $80,929 was owed. The evidence presented at trial supports that no amount of the Incentive Payment was repaid to Reinhart either before or after the Debtors' bankruptcy filing.
III. LEGAL ANALYSIS
A. Reinhart Failed to Demonstrate a Debt Exists, a Necessary Prerequisite to Excepting a Debt from Discharge Under 11 U.S.C. § 523(a)
Reinhart seeks a determination that the Debtors' alleged obligation to repay the $125,000 Incentive Payment should be excepted from the Debtors' discharge pursuant to provisions of Bankruptcy Code Section 523(a). However, before determining whether a debt may be excepted from discharge, this Court must first determine the threshold issue of whether a debt exists. In other words, Reinhart must first demonstrate that it holds an enforceable claim against the Debtors. Kapish v. Cruz-Brewer (In re Cruz-Brewer), 609 B.R. 1, 7 (Bankr. M.D. Pa. 2019) (holding that a nondischargeability proceeding is a multi-step process in which it must first be shown that the creditor has pled an enforceable obligation under state law and, then determine whether the debt may be excepted from discharge under a provision of § 523(a)); Vande Ryt v. Peace (In re Peace), 546 B.R. 65, 69 (Bankr. S.D. Ohio 2015); Weidle Corp. v. Leist (In re Leist), 398 B.R. 595, 601 (Bankr. S.D. Ohio 2008).
Unless otherwise indicated, use of the terms "Bankruptcy Code Section," "Section," or "§" are references to provisions of Title 11 of the United States Code.
In many nondischargeability cases, a bankruptcy court is never tasked with making a determination as to whether a debt exists. Jennings v. Bodrick (In re Bodrick), 2017 Bankr. LEXIS 3752, at *11-12, 2017 WL 4877266, at *5 (Bankr. S.D. Ohio Sept. 18, 2017). "For example, if the debt is liquidated via a judgment prior to the debtor filing bankruptcy, or if the debtor does not otherwise dispute the validity of the particular debt, then the bankruptcy court may only have to determine whether that debt falls within a category of the nondischargeable debts set forth in 11 U.S.C. § 523(a)." Id.
In this case, however, Reinhart holds no judgment against the Debtors and the Debtors dispute Reinhart's contention that they are personally obligated to repay the Incentive Payment. Accordingly, Reinhart must first prove a legal basis to hold the Debtors personally liable for repayment of the $125,000 Incentive Payment before determining "'whether that set of facts qualifies as a non-dischargeable claim under the bankruptcy law.'" Id. (further citation omitted). This threshold issue is determined by applicable non-bankruptcy law. Peace, 546 B.R. at 69 (citing Grogan v. Garner, 498 U.S. 279, 283-84 (1991)).
Reinhart's Complaint is of limited help in this regard. It includes five causes of action to either deny the Debtors' discharge pursuant to § 727(a) or to except a specific debt from discharge under provisions of § 523(a). [Docket Number 1] The Complaint includes no non-bankruptcy law causes of action to hold the Debtors personally liable for repayment of the $125,000 Incentive Payment. [Id.]
Reinhart may have confused the requirements to except a debt from discharge under § 523(a) with the requirement to prove that an enforceable obligation exists in the first place. This confusion is highlighted by counsel's response to the Court's inquiry near the end of the trial when questioning whether Reinhart had a legal theory for holding Ken Riley personally liable for repayment of the Incentive Payment. In response, counsel stated:
Absolutely, we are seeking personal liability against . . . Mr. Ken Riley, based on all of the counts of the complaint. Mrs. Riley testified that he was the person in
charge of each of these businesses, that he was the person that received the incentive payment check, and that he was the person who deposited the incentive payment check, and so he had fiduciary duty under his agreements with Reinhart in regards to liability to Reinhart, and so he would be personally liable, just the same as co-debtor, Gloria Riley.[Docket Number 48, Transcript from January 27, 2021 Trial ("Tr."), p. 166] Because Reinhart's Complaint includes no non-bankruptcy counts to establish Ken Riley's personal liability, the confusion is apparent. The lack of a non-bankruptcy count to establish that a debt exists may also be fatal to Reinhart's § 523 claims. A plaintiff's failure to plead a basis for holding a debtor personally obligated for a debt owed to the plaintiff may, alone, preclude judgement in favor of the plaintiff in a § 523 action. See, e.g., Lund-Ross Constructors, Inc. v. Buchanan (In re Buchanan), 626 B.R. 520, 527-28 (B.A.P. 8th Cir. 2021) (noting that, on appeal, the Bankruptcy Appellate Panel "cannot see where in the record [the plaintiff-creditor] identified for the bankruptcy court the nonbankruptcy law that would make Debtors personally liable to [the plaintiff-creditor]" and because the plaintiff-creditor failed to establish a debt owed by the Debtors under nonbankruptcy law, there was no reason to reach of the issue of whether such debt would be excepted from discharge under § 523(a)).
Nonetheless, while non-bankruptcy law causes of action are not delineated in Reinhart's Complaint, factual allegations in the Complaint and Reinhart's evidence and arguments at trial raise such claims in a less explicit manner. In Paragraph 11 of the section of the Complaint labeled "Facts Common to All Counts," Reinhart contends that Ken Riley signed the Incentive Agreement "personally" suggesting an argument that Ken Riley may be contractually obligated to repay the Incentive Payment [Docket Number 1, ¶ 11]. While Gloria Riley's guaranty in the 2013 Credit Application is not mentioned in the Complaint, it was cited by Reinhart as the basis for her liability at trial and in Reinhart's post-trial brief [Docket Number 52, pp. 4-6]. In addition, both in the Complaint and at trial, theories of fraud, conversion and breach of fiduciary duty were argued in conjunction with Reinhart's § 523(a) counts. Debtors' counsel neither raised the Complaint's lack of non-bankruptcy law causes of action to establish the existence of a debt as a basis for dismissal or as a basis for judgment in the Debtors' favor. Thus, even though not formally delineated as causes of action within the Complaint, this Court concludes that out of an abundance of caution, it should proceed with a determination of whether Reinhart demonstrates an enforceable claim against either of the Debtors, either contractually or otherwise, under the theories of liability mentioned above.
1. Ken Riley Is Not Personally Obligated under the Terms of the Incentive Agreement
Although there is some indication in the Complaint that Reinhart intended to argue that Ken Riley was contractually obligated to repay the Incentive Payment under the terms of the Incentive Agreement, this argument was not further developed by Reinhart at trial or in its post-trial brief. This Court concludes that had such an argument been made, it would be without merit.
In lieu of closing statements at trial, the parties were asked to file post-trial briefs. This Court requested that the briefs summarize the parties' case for the Court in writing including any case law in support of each parties' assertions and defenses as well as references to the testimony and/or exhibits at trial. Reinhart's brief does not mention any contractual obligation on the part of Ken Riley for repayment of the Incentive Agreement [Docket Number 52] nor does Reinhart cite any case law in support of such an argument.
By its own terms, the Incentive Agreement drafted by Reinhart creates contractual obligations for the "Customer" named in the agreement as "Riley Restaurant Group dba - J. Austin's American Eatery and Walt's Barbeque." [Pl. Ex. 3; Def. Ex. G] Under the terms of the Incentive Agreement, it is this Customer, not Ken Riley, who is obligated to repay any unearned portion of the $125,000 Incentive Payment over the three-year term. While Ken Riley does sign the Incentive Agreement, he does so on behalf of Riley Restaurant Group as "President."
Under Wisconsin law, a corporation or limited liability company is a separate legal entity and a member, shareholder, or officer, such as Ken Riley, generally is not liable for the contractual obligations of that corporation or limited liability company. Marx v. Morris, 925 N.W.2d 112, 120 (Wis. 2019); Benjamin Plumbing, Inc. v. Barnes, 470 N.W.2d 888, 893 (Wis. 1991). However, to be shielded from liability, the agent conducting business on the part of the corporation or limited liability company must disclose the limited liability attributes of the principal. Benjamin Plumbing, 470 N.W.2d at 893-94. "[W]here an agent contracts on behalf of a disclosed principal, the agent does not become personally liable to the other contracting party." Id. at 893; FMN Mgmt. Servs., Inc. v. Kolb, Lauwasser & Co., S.C., 616 N.W.2d 922 (Table), 2000 Wisc. App. LEXIS 401, at *14-15, 2000 WL 523756, at *5 (Wis. Ct. App. 2000). However, an agent may be considered a party to the contract and held liable for its breach when the principal's nature as a corporate or limited liability entity is not fully disclosed and the other contracting party is not aware of the limited liability status of the principal. Benjamin Plumbing, 470 N.W.2d at 893-94; Reinhart Foodservice LLC v. Bouraxis, 918 N.W.2d 127 (Table), 2018 Wisc. App. LEXIS 572, at *10-11, 2018 WL 3054747, at *4 (Wis. Ct. App. June 19, 2018). The agent seeking to escape liability has the duty to prove that the principal's corporate or limited liability status was disclosed and that status must be given at or prior to the execution of the contract documents. Benjamin Plumbing, 470 N.W.2d at 894.
Although neither party discussed Wisconsin law with respect to the contracts at issue in this case, the Incentive Agreement includes a provision stating that it is to be governed by Wisconsin law. [Pl. Ex. 3; Def. Ex. G]
In this instance, the Incentive Agreement was drafted by Reinhart including the listing of the "Customer" as "Riley's Restaurant "Riley Restaurant Group dba - J. Austin's American Eatery and Walt's Barbeque," a label that does not reveal the corporate or limited liability status of the business entities that operate under the trade names J. Austin's American Eatery or Walt's Barbeque. "Because the contracting party needs notice of the principal's corporate status, the use of a trade name is normally not sufficient disclosure." Id.
While "Riley's Restaurant Group" would have been insufficient if that was the trade name of the principal disclosed by Ken Riley, the testimony at trial revealed that such was not the case. Indeed, Ken Riley denied ever using the name "Riley's Restaurant Group" in his dealings with Reinhart and Reinhart's own witnesses could not recall where the name originated. Furthermore, when Ken Riley's review of the Incentive Agreement revealed that the corporate names were not properly identified, he sent an email to Bill Stacey on August 4, 2016 disclosing all four restaurant names and their corporate ownership: "Jaustins riverbank cafe-River Bar LLC[;] Walts BBQ Hamilton and Colerain - J.R. Austin LLC[;] Jaustins American Eatery-William Royce Inc." [Def. Ex. D] Bill Stacey replied to the email acknowledging receipt, even though Reinhart did not change the language of the Incentive Agreement before it was signed by Ken Riley the following day on August 5, 2016.
This Court concludes that Ken Riley's email provided Reinhart with notice of the corporate or limited liability status of the business entities owning and operating the restaurants identified in the Incentive Agreement prior to the date that the Incentive Agreement was executed. Thus, Ken Riley is not the principal or "Customer" contractually obligated under the terms of Incentive Agreement nor did Ken Riley sign the contract in his personal capacity, but as an agent. As such, Reinhart failed to prove that Ken Riley is personally liable for obligations under the Incentive Agreement's terms.
2. Gloria Riley Did Not Guarantee Obligations Under the Incentive Agreement
In its post-trial brief, Reinhart argues that the obligations due under the Incentive Agreement, including the obligation to repay the unearned portion of the Incentive Payment, were guaranteed by Gloria Riley via the personal guaranty she signed as part of the 2013 Credit Application with Reinhart. [Pl. Ex. 1] All parties acknowledge that the personal guaranty was signed by Gloria Riley three years prior to the Incentive Agreement and that Gloria Riley did not sign the Incentive Agreement itself. Reinhart cites Ohio law to support the continuing nature of Gloria Riley's guaranty and argues that the guaranty extends to all of debts of the "Debtor Businesses" to Reinhart "whether now existing or hereafter incurred." [Docket Number 52, p. 3-4] Reinhart offers no further explanation or analysis of the interplay between these two documents. Indeed, the connection between the two is tenuous.
This Court notes that, unlike the Incentive Agreement, the 2013 Credit Application includes no provision regarding what state law governs its terms. Reinhart applied Ohio law in its post-trial brief and this Court agrees with Reinhart that the 2013 Credit Application is appropriately construed in accordance with Ohio law because this is the state in which the Debtors and Reinhart engaged in their business transactions.
Ohio courts construe guaranty agreements in the same manner as they interpret other contracts. New Mkt. Acquisitions, Ltd. v. Powerhouse Gym, 154 F.Supp.2d 1213, 1219 (S.D. Ohio 2001); R.L.R. Invs., LLC v. Wilmington Horsemens Group, LLC, 22 N.E.3d 233, 240 (Ohio Ct. App. 2014). "In interpreting a contract, courts are to give effect to the intent of the parties and to examine the contract as a whole and presume that the intent of the parties is reflected in the language of the contract." R.L.R. Invs., LLC, 22 N.E.3d at 240 (noting further that "[t]he court's construction of a contract should attempt to harmonize all the provisions of the document rather than produce conflict in them"); see also New Mkt. Acquisitions, Ltd., 154 F.Supp.2d at 1220 (noting that "writings that are part of the same transaction shall be read as a whole, and the intent of each section shall be ascertained from a consideration of the whole").
Based on these principles of contract interpretation, Gloria Riley's guaranty and its language must be examined in light of the circumstances as they existed when she signed it and in light of the whole transaction. At the time she signed the guaranty in June of 2013, the Debtors operated one restaurant, Riley's Restaurant, which was owned by William-Royce, Inc. She testified that she signed the 2013 Credit Application around the time that her son, James Riley, signed a credit application with Reinhart in conjunction with his purchase of Walt's Barbeque. The 2013 Credit Application signed by Gloria Riley is on behalf of the business entity, "William-Royce Inc." doing business under the trade name "Riley's Restaurant." [Pl. Ex. 1] The "Individual Personal Guaranty" signed by Gloria Riley on the backside of the application states:
I, the undersigned Guarantor, for and in consideration of your extending credit at my request to Riley's / Gloria Riley (the "Purchaser"), personally guarantee prompt payment of any obligation of the Purchaser to Reinhart FoodService, LLC or any of its subsidiaries ("Seller"), whether now existing or hereinafter incurred, and I further agree to bind myself to pay on demand any sum which is due by the Purchaser to Seller whenever the Purchaser fails to pay same. It is understood that this guarantee shall be absolute, continuing and irrevocable guaranty for such indebtedness of the Purchaser.[Id.]
By its explicit language, Gloria Riley guaranteed the obligations of the "Purchaser" specifically identified in the guaranty as "Riley's / Gloria Riley." [Id.] Interpreting the credit application and guaranty as a whole, the term "Riley's," as used in the guaranty on the backside of the application, is a reference to "Riley's Restaurant," the only restaurant then operated by the Debtors and the trade name listed on the front page of the credit application of the entity applying for credit.
In its post-trial brief Reinhart maintains that this guaranty extends to the "Debtor Businesses," which Reinhart identifies as the "business entities that entered into the Incentive Agreement and received the Incentive Payment." [Docket Number 52, p. 3-4] The named entity that is contractually obligated to Reinhart under the Incentive Agreement is "Riley Restaurant Group dba - J. Austin's American Eatery & Walt's Barbeque," [Pl. Ex. 3; Def. Ex. G], and the entity named on the Incentive Payment check is "Riley Restaurant Group." [Pl. Ex. 4] Neither "Riley Restaurant Group dba - J. Austin's American Eatery & Walt's Barbeque," as named in the Incentive Agreement, nor "Riley Restaurant Group," as named on the check issued by Reinhart for the Incentive Payment, however, is an entity named in the guaranty.
Reinhart, who bears the burden to establish the existence of the asserted debt to Reinhart arising from the guaranty, fails to explain in its Complaint (which does not even mention the guaranty) or its post-trial brief how the principal debtor named in the guaranty is also the principal debtor named in the Incentive Agreement or recipient of the Incentive Payment. The evidence at trial, including Bill Stacey's testimony, established that "Riley Restaurant Group" is not an official title for any legal business entity. Debtor Ken Riley testified that he never used that name in his business dealings with Reinhart [Tr., pp. 131-32]. In fact, the evidence showed that Ken Riley questioned Reinhart's inaccurate reference to "Riley Restaurant Group dba - J. Austin's American Eatery & Walt's Barbeque," and "Riley Restaurant Group" on at least two occasions-prior to the signing of the Incentive Agreement and upon receipt of the check for the Incentive Payment [Tr., pp. 131-32, 140].
The ambiguous references to "Riley Restaurant Group dba - J. Austin's American Eatery & Walt's Barbeque" in the Incentive Agreement and "Riley Restaurant Group" on the check issued by Reinhart for the Incentive Payment is insufficient to create a personal obligation to Reinhart by Gloria Riley under the terms of the guaranty. Neither "Riley Restaurant Group dba - J. Austin's American Eatery & Walt's Barbeque" or "Riley Restaurant Group" are mentioned in the guaranty. "A guarantor, like a surety, is bound only by the precise words of his contract." G.F. Bus. Equip., Inc. v. Liston, 454 N.E.2d 1358, 1359-60 (Ohio Ct. App. 1982). "If a contract is ambiguous so that it may either extend or limit a guarantor's obligation, such contract should be construed to limit the obligation." R.L.R. Invs., LLC, 22 N.E.3d at 240; Yearling Props., Inc. v. Tedder, 557 N.E.2d 1231, 1233 (Ohio Ct. App. 1988) (same); see also Norris v. D. D. Fashions, Inc., 1991 Ohio App. LEXIS 1527, at *4; 1991 WL 47600, at *2 (Ohio Ct. App. April 3, 1991) ("The general rule in Ohio is that, in case of ambiguity or uncertainty, a contract of guaranty will be construed in favor of the guarantor." (citing Morgan v. Boyer, 39 Ohio St. 324 (1883); Liquidating Midland Bank v. Stecker, 40 Ohio App. 510 (Ohio Ct. App. 1930)); Rosy Blue, NV v. Lane, 767 F.Supp.2d 860, 865 (S.D. Ohio 2011) (noting that, under Ohio law, a guaranty should be construed in favor of the guarantor).
Any potential argument that "Riley Restaurant Group dba - J. Austin's American Eatery & Walt's Barbeque" or "Riley Restaurant Group" may be subsequent iterations of the Riley's Restaurant that existed in 2013 when the guaranty was executed also fails to provide a sufficient nexus between the guaranty and the Incentive Agreement. "[A] Guaranty cannot guarantee a future debt by an entity that does not exist." Midas Int'l Corp. v. Fischer, 2005 Ohio App. LEXIS 540, at **9, 2005 WL 315388, at *3 (Ohio Ct. App. Feb. 10, 2005).
Finally, any subjective intent by Reinhart regarding the applicability of the 2013 guaranty to the Incentive Agreement is similarly unavailing. While Bill Stacey testified that he was aware that Gloria Riley's 2013 guaranty was in place at the time the Incentive Agreement was entered into in 2016 and that Reinhart would not have approved the Incentive Agreement without a personal guaranty, this Court did not find Mr. Stacey's testimony credible. Even if true, Reinhart produced no evidence to support that Reinhart's intention was conveyed to either Gloria or Ken Riley. Ohio case law supports that "uncommunicated subjective intentions of one party have no significance in determining the meaning of disputed terms in a guaranty contract." Yearling Props., 557 N.E.2d at 1233 (citing G.F. Bus. Equip., Inc., 454 N.E.2d at 1361). Instead, any such intention to bind a guarantor "must be clearly manifested." Yearling Props., 557 N.E.2d at 1233-34.
This Court concludes that the personal guaranty signed by Gloria Riley as part of the 2013 Credit Application did not extend to cover obligations under the 2016 Incentive Agreement and no new guaranty was signed in conjunction with the Incentive Agreement. Accordingly, Gloria Riley is not contractually liable for obligations under the Incentive Agreement.
3. Reinhart Failed to Prove Debtor Liability Under a Tort or Fiduciary Theory
In its Complaint and post-trial brief, Reinhart asserts that the Debtors committed fraud in conjunction with entering into the Incentive Agreement, breached their fiduciary duties with regard to the Incentive Payment and/or converted the Incentive Payment. Reinhart asserts these facts in connection with its legal theories to except a debt from discharge under § 523(a)(4) rather than to establish that a debt exists under state law. Nonetheless, this Court determines that the factual assertions raised in the Complaint and evidence presented at trial are sufficient for it to proceed with an examination of whether Reinhart demonstrated facts to support holding the Debtors liable to Reinhart under a state law tort or breach of fiduciary duty theory of liability.
While individuals generally are not liable for the debts of corporate or limited liability entities, an individual may be held liable for a tort if the individual personally commits the tort while acting within the scope of his or her employment. Cash Am. Fin. Servs. v. Fox (In re Fox), 370 B.R. 104, 113 (B.A.P. 6th Cir. 2007); Yo-Can, Inc. v. Yogurt Exch., Inc., 778 N.E.2d 80, 90 (Ohio Ct. App. 2002). Alternatively, a member of an LLC or shareholder of a corporation may be held liable for an LLC or corporation's misdeeds under the doctrine of piercing the corporate veil, a doctrine reserved for the "rare exception" when members or shareholders exercise control over an LLC or corporation in such a manner as to commit "fraud, an illegal act, or similarly unlawful act." Dombroski v. WellPoint, Inc., 895 N.E.2d 538, 544-45 (Ohio 2008); Denny v. Breawick, LLC, 137 N.E.3d 578, 584 (Ohio Ct. App. 2019). In this case, Reinhart did not proceed under a theory of piercing the corporate veil: it did not raise the issue in its Complaint, at trial, or in its post-trial brief. Accordingly, this Court finds any such argument abandoned and limits its analysis to a determination of whether the Debtors personally committed a tort while acting within the scope of their employment.
a. Reinhart Failed to Demonstrate Fraud
In the Complaint and its post-trial brief, Reinhart asserts that the Debtors committed fraud by misrepresenting their ability to meet the $30,000 weekly purchasing quota in the Incentive Agreement when they were "likely" considering personal bankruptcy [Docket Number 1, ¶¶ 37-41 and Docket Number 52, pp. 6-7].
Under Ohio law, the elements of fraud are:
(1)a representation or, where there is a duty to disclose, a concealment of a fact,
(2)which is material to the transaction at hand,
(3)made falsely, with knowledge of its falsity, or with such utter disregard and recklessness as to whether it is true or false that such knowledge can be inferred,
(4)with the intent of misleading another into relying upon it,
(5)justifiable reliance upon the representation or concealment, and
(6)a resulting injury proximately caused by the reliance.Captiva, Inc. v. Viz Commc'ns, Inc., 85 Fed.Appx. 501, 505 (6th Cir. 2004) (citing Williams v. Aetna Fin. Co., 700 N.E.2d 859, 868 (Ohio 1998)). Although not clearly set forth in the Complaint, it appears that Reinhart may be alleging two strains of fraud: fraud in the inducement and promissory fraud. Id. This Court will examine the facts under both theories.
"'A claim of fraud in the inducement arises when a party is induced to enter into an agreement through fraud or misrepresentation.'" Id. (further citation omitted). The fraud must relate not to the "nature or purport" of the contract "but to the facts inducing its execution." ABM Farms, Inc. v. Woods, 692 N.E.2d 574, 578 (Ohio 1998). In order to prove fraud in the inducement, a plaintiff must prove that the defendants made a knowing material misrepresentation with the intent of inducing the plaintiff's reliance and that the plaintiff relied upon the misrepresentation to its detriment. Id.
In this case, Reinhart points to no specific misrepresentation by either Gloria or Ken Riley in either written form or in conversations with Reinhart representatives that fraudulently induced Reinhart into entering the Incentive Agreement. Although Reinhart implies that the Debtors concealed their intention to file a bankruptcy petition in the near future, Reinhart provided no evidence that its representatives requested or relied upon personal financial information about the Debtors in connection with the Incentive Agreement. Rather, Bill Stacey testified that Reinhart relied on its own background investigation of the businesses and, particularly, its review of the restaurants' purchasing history with Gordon Food Service to determine creditworthiness and whether the Incentive Agreement would be a good investment for Reinhart. With no demonstration by Reinhart of a misrepresentation by the Debtors relied upon by Reinhart to its detriment when entering the Incentive Agreement, this Court finds no fraud in the inducement.
Next, this Court analyzes whether Reinhart proves promissory fraud in connection with promises made in the Incentive Agreement. Generally, a fraud claim under Ohio law must be based on a misrepresentation of fact rather than predicated upon promises or representations of future action in a contract. Captiva, Inc., 85 Fed.Appx. at 505; Patel v. Univ. of Toledo, 95 N.E.3d 979, 990 (Ohio Ct. App. 2017). Promissory fraud is an exception to this rule limited to instances when an actor who makes a promise of future action or conduct has no intention of keeping the promise at the time the promise is made. Captiva, Inc., 85 Fed.Appx. at 505. "Importantly, 'the mere proof of nonperformance does not prove a lack of intent to perform." Id. at 506 (further citation omitted) (noting that "'[i]t would be as wrong morally as legally, as offensive to logic as to law, to hold that mere denial and nonperformance are evidence that, if a promise was made, it was made fraudulently'").
In this case, the $30,000 weekly purchasing quota in the Incentive Agreement is the type of promise of future performance that does not form the basis for a fraud claim unless the contract is signed without the present intent to perform. The evidence presented at trial does not support such fraudulent intent. While it is true that Ken Riley had concerns about the restaurants' ability to meet the $30,000 weekly purchasing quota, he did not conceal or misrepresent those concerns. Instead, they were communicated to Reinhart prior to the Incentive Agreement being executed. In response, Ken Riley received assurances, in the form of an email from Reinhart FoodService - Cincinnati Division President Neil D. Hoover, that the weekly purchasing quota was only "an average number" and that "[t]he agreement is about Reinhart being your primary distributor." [Def. Ex. C] That understanding was confirmed by Ken Riley and Reinhart representative Bill Stacey when they both signed Ken Riley's checklist stating "We have purchased upwards of $30,000 per week, but there is no guarantee we can do this. We may be higher or lower, as long as we continue to buy from RFS." [Def. Ex. G, p.2] Whether or not this checklist became a part of the Incentive Agreement, it certainly reveals the parties' mutual understanding and intent: that the restaurants' failure to meet the $30,000 weekly purchasing quota was not a deal-breaker so long as the restaurants continued to use Reinhart as their primary distributor.
This Court notes that Gloria Riley did not sign the Incentive Agreement and Reinhart made no allegations against her with respect to promissory fraud.
Following the execution of the Incentive Agreement, the restaurants operated by the Debtors did perform their purchasing obligation to the best of their ability. The Debtors' testimony and the restaurants' invoices demonstrate that the restaurants used Reinhart as their primary distributor even after their personal bankruptcy filing in November of 2016 with Gloria Riley testifying that purchases from Reinhart reached a monthly high of just over $63,000 in mid-2017. Although the restaurants did not meet the weekly purchasing quota, this breached contractual obligation, alone, does not support fraud. See Captiva, Inc., 85 Fed.Appx. at 506-07 (noting that fraud cannot be predicated on the mere fact that a promise has been broken; otherwise, a plaintiff would be able to transform any breach of contract claim into a fraud claim). To the contrary, the fact that the restaurants operated by the Debtors continued purchasing from Reinhart up until the dates they closed supports their intent to perform. Reinhart has failed to demonstrate that the Debtors are liable under a theory of fraud in the inducement or promissory fraud in connecting with the execution of the Incentive Agreement.
b. Reinhart Failed to Demonstrate the Existence of a Trust
Next, Reinhart argues that the Debtors breached a fiduciary duty to Reinhart by failing to place the $125,000 Incentive Payment in trust until earned and by using the funds for purposes other than meeting their $30,000 weekly purchasing quota [See Docket Number 1, ¶¶ 43-48; Docket Number 52, pp. 8-9].
Under Ohio law, "[t]o succeed on a claim for breach of fiduciary duty, a plaintiff must first establish the existence of a fiduciary duty, a breach of that duty and an injury proximately resulting therefrom." Asia-Pacific Futures Research Symposium Planning Comm. v. Kent State Univ., 63 N.E.3d 780, 787 (Ohio Ct. App. 2016). In this case, Reinhart points to no special relationship between itself and the Debtors except allegations that, under the terms of the Incentive Agreement, the Debtors were required to hold the $125,000 Incentive Payment in trust until earned. However, the evidence presented at trial does not support the existence of an express or technical trust nor, for that matter, does it support the imposition of a constructive trust.
First, to establish either an express or technical trust under Ohio law, a creditor must demonstrate: (1) an intent to create a trust; (2) a trustee; (3) a trust res; and, (4) a definite beneficiary. Commonwealth Land Title Co. v. Blaszak (In re Blaszak), 397 F.3d 386, 391 (6th Cir. 2005). To prove an intent to create a trust, there must be an explicit declaration of trust or circumstances which show beyond reasonable doubt that a trust was intended to be created. Booth v. Vaughan (In re Booth), 260 B.R. 281, 290-91 (B.A.P. 6th Cir. 2001); Johnson v. Kuehn, 2020 Ohio App. LEXIS 2684, at *8, 2020 WL 4036875, at *3 (Ohio Ct. App. July 10, 2020). Reinhart points to no language in the Incentive Agreement explicitly declaring a trust nor does Reinhart produce evidence to support that the parties discussed the creation of a trust in connection with the Incentive Agreement and $125,000 Incentive Payment. Accordingly, this Court concludes that no express or technical trust was created.
Alternatively, Reinhart argues that "[a] constructive trust was created where the Debtors were only to use the $125,000 Incentive Payment to make the weekly purchase requirements from Reinhart, or to repay such amount to Reinhart, in the event they did not meet the weekly payment requirements under the Incentive Agreement." [Docket Number 52, pp. 8-9] Contrary to Reinhart's argument, a constructive trust is not created by the terms of the parties' agreement, but, instead, is a remedy imposed by operation of law. Under Ohio law, a constructive trust is defined as:
"A trust by operation of law which arises contrary to intention and in invitum, against one who, by fraud, actual or constructive, by duress or abuse of confidence, by commission of wrong, or by any form of unconscionable conduct, artifice, concealment, or questionable means, or who in any way against equity and good conscience, either has obtained or holds the legal right to property which he ought not, in equity and good conscience, hold and enjoy. It is raised by equity to satisfy the demands of justice."Poss v. Morris (In re Morris), 260 F.3d 654, 667 (6th Cir. 2001) (quoting Ferguson v. Owens, 459 N.E.2d 1293, 1295 (Ohio 1984)). To be recognized in a bankruptcy proceeding, constructive trusts generally must be imposed by a court prior to the bankruptcy filing. Id. at 666-67; Clark v. Mason, 2014 U.S. Dist. LEXIS 45793, at *13-14, 2014 WL 12546666 at *5 (N.D. Ohio Apr. 2, 2014). Under this case law, whether this Court could impose a constructive trust is, at best, questionable. Even if this Court were in a position to impose such a remedy, Reinhart's argument does not support the imposition of a constructive trust with respect to the Incentive Payment. Contrary to Reinhart's argument, the Incentive Agreement includes no terms mandating that the Incentive Payment be used to meet the $30,000 weekly purchasing quota. Nor, for that matter, did Reinhart introduce any evidence to support that the parties discussed using the Incentive Payment solely for purposes of meeting the weekly purchasing quota. Instead, Reinhart witness Bill Stacey testified that his understanding of what Ken Riley was to do with the Incentive Payment check, ". . . was supposed to conduct business ..... to rebrand the two Walt's, and . . . to . . . get new signage [and] revamp all that he did[.]" [Tr. p. 39] And, according to Ken Riley's testimony, the Incentive Payment funds were used for business purposes: "[n]ew signage and things for Walt's Colerain. We did completely remodel Walt's Colerain, so yes, there was a lot of it." [Tr., p. 139] Reinhart produced no evidence to contradict Ken Riley's testimony or demonstrate that the funds were used for other purposes.
Furthermore, and, critically important in this case, a constructive trust does not form the basis to except a debt from discharge under Bankruptcy Code Section 523(a)(4). See infra Section III.B.2.
For these reasons, this Court concludes that Reinhart failed to establish the existence of an express or technical trust or a basis for imposition of a constructive trust.
c. Reinhart Failed to Demonstrate Conversion
Finally, Reinhart argues that the Debtors may still be held personally liable under Ohio law for actively engaging in their restaurants' conversion of the Incentive Payment. [Docket Number 52, pp. 9-10]
Under Ohio law, the elements of conversion include: (1) a plaintiff's ownership or right to possess the property at the time of the conversion; (2) a defendant's conversion by a wrongful act or disposition of the plaintiff's property; and (3) damages. Kuvedina, LLC v. Cognizant Tech. Solutions, 946 F.Supp.2d 749, 761 (S.D. Ohio 2013). "Money may be the subject of a conversion claim only if 'identification is possible and there is an obligation to deliver the specific money in question.'" Id. (further citation omitted). "'An action will not lie for the conversion of a mere debt, and where there is only a relationship of debtor and creditor, not an obligation to return identical money, an action for conversion of the funds representing the indebtedness will not lie against the debtor.'" Id. (further citation omitted) (noting that a claim for conversion requires a defendant to have an obligation to deliver specific money and not merely a certain sum of money).
In this case, Reinhart fails to prove the elements of conversion. First, Reinhart provides no factual or legal basis to support that it retained an ownership interest or right to possess the Incentive Payment once the check was paid to the "Customer." Nor did Reinhart demonstrate that the Debtors wrongfully disposed of the funds. Instead, as noted in the prior section, the Incentive Agreement, itself, imposed no limit on the use of the funds and the evidence at trial supported that the funds were used to purchase signage and to remodel one of the restaurants in the manner contemplated by both Ken Riley and Reinhart representative Bill Stacey. Finally, Reinhart failed to demonstrate that it was otherwise owed identifiable funds. The Incentive Agreement included no requirement that the Incentive Payment funds be segregated or kept in a separate account nor, as noted in the prior section, did Reinhart prove that the Incentive Payment was the subject of an express or technical trust. Because the Debtors used the funds in the manner intended by both them and Reinhart, Reinhart's claim for conversion fails.
In summary, this Court concludes that Reinhart has failed to prove that either Debtor is personally liable for a debt owed to Reinhart. Without proof of an enforceable obligation owed to Reinhart, there is no debt to except from discharge under the provisions of § 523(a). Peace, 546 B.R. at 69; Leist, 398 B.R. at 601 ("As elementary as it may seem, a creditor must establish that he is owed a debt before it can be determined that the debt is nondischargeable under any § 523(a) exception to discharge.").
B. Reinhart Did Not Establish the Elements Necessary to Except a Debt from Discharge as an Unscheduled Creditor
Even if it was demonstrated that one or both of the Debtors were personally liable to Reinhart for the obligations owed under the Incentive Agreement, Reinhart still failed to meet the elements required to except any such debt from discharge under Bankruptcy Code Section 523(a).
In seeking to except a debt from discharge pursuant to one of the provisions of § 523(a), a creditor bears the burden of proof by a preponderance of the evidence. Rembert v. AT&T Universal Card Servs., Inc. (In re Rembert), 141 F.3d 277, 281 (6th Cir. 1998) (citing Grogan v. Garner, 498 U.S. 279, 291 (1991)). Furthermore, "[b]ecause the overarching purpose of the Bankruptcy Code is to provide a fresh start to those in need of relief from collection efforts of creditors, exceptions to discharge are to be strictly construed against the complaining party." Coughlin Chevrolet, Inc. v. Thompson (In re Thompson), 458 B.R. 409, 417 (Bankr. S.D. Ohio 2011); see also Rembert, 141 F.3d at 281 (noting that "exceptions to discharge are to be strictly construed against the creditor").
Reinhart bases its claim to except a debt from discharge as an "unscheduled creditor" under § 523(a)(3)(B). This provision provides an exception to discharge for a debt that is:
(3) neither listed nor scheduled under section 521(a) of this title, with the name, if known to the debtor, of the creditor to whom such debt is owed, in time to permit-
(B) if such debt is of a kind specified in paragraphs (2), (4), or (6) of this subsection, timely filing of a proof of claim and timely request for a determination of dischargeability of such debt under one of such paragraphs, unless such creditor had notice or actual knowledge of the case in time for such timely filling and request.11 U.S.C. § 523(a)(3)(B). Importantly, this provision does not create an automatic exception to discharge when a debtor fails to schedule or list a creditor. Instead, the unscheduled creditor must be without timely notice or knowledge of the bankruptcy case and hold a claim "of a kind" specified in § 523(a)(2), (a)(4), or (a)(6). Jones v. Warren Constr. (In re Jones), 296 B.R. 447, 448 (Bankr. M.D. Tenn. 2003).
Reinhart was not listed as a creditor in the Debtors' schedules. Furthermore, the Debtors do not dispute that Reinhart failed to receive notice of the Debtors' bankruptcy case in time to permit a timely filing of a request to determine the dischargeability of a debt. Nonetheless, Reinhart must still prove the merits of its causes of action under § 523(a)(2), (a)(4), or (a)(6), to except a debt from discharge as an unscheduled creditor under Bankruptcy Code Section 523(a)(3)(B). Jones, 296 B.R. at 450-51.
As noted in the Jones case, courts have not been in agreement as to the standard of proof required for a creditor to except a debt from discharge under § 523(a)(3)(B). Jones, 296 B.R. at 449-51 (discussing the differing approaches adopted by courts). This Court agrees with Jones that the requirement in § 523(a)(3)(B) that the claim be "of a kind" specified in § 523(a)(2), (a)(4), or (a)(6) requires the creditor to prove the merits of its causes of action under one of these provisions. Id.; see also Yoppolo v. Asbury (In re Asbury), 2014 Bankr. LEXIS 1328, at *18-19, 2014 WL 1323216, at *7 (Bankr.N.D.Ohio March 31, 2014) (agreeing with Jones that a creditor must not only prove that the debt owed to the creditor was unscheduled and that the creditor lacked notice of the bankruptcy in time to file a dischargeability complaint, but also must prove the merits of its claim under § 523(a)(2), (a)(4), or (a)(6)).
1. Bankruptcy Code Section 523(a)(2)(A)
Reinhart argues that the debt should be excepted from discharge under § 523(a)(2)(A), which excepts from discharge a 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 condition." 11 U.S.C. § 523(a)(2)(A). Reinhart asserts that the Debtors were able to enter the Incentive Agreement by wrongly representing to Reinhart an ability to meet the weekly purchase quota for the three-year term of the agreement. [Docket Number 1, ¶¶ 39-41]
A separate provision of § 523(a) addresses fraud claims based on a debtor's use of a fraudulent statement about the debtor's financial condition. See 11 U.S.C. § 523(a)(2)(B). Reinhart's complaint does not set forth a claim under § 523(a)(2)(B).
In order to except a debt from discharge under § 523(a)(2)(A) based on a false representation, a creditor must prove, by a preponderance of the evidence:
. . . (1) the debtor obtained money through a material misrepresentation that, at the time, the debtor knew was false or made with gross recklessness as to its truth; (2) the debtor intended to deceive the creditor; (3) the creditor justifiably relied on the false representation; and (4) its reliance was the proximate cause of loss.Rembert, 141 F.3d at 280-81. Courts evaluating these elements have noted that they are substantially equivalent to those required to establish common law fraud in Ohio. Ed Schory & Sons, Inc. v. Francis (In re Francis), 226 B.R. 385, 389 (B.A.P. 6th Cir. 1998); Schafer v. Rapp (In re Rapp), 375 B.R. 421, 430 (Bankr. S.D. Ohio 2007).
As noted earlier in this opinion when examining common law fraud in Ohio, Reinhart points to no fraudulent activity or misrepresentation of fact that induced Reinhart to enter the Incentive Agreement. [See Section III. (A.)(3.)(a.) above] Instead, Reinhart relies on the unfulfilled contractual promise to meet a $30,000 weekly purchasing quota to establish fraud.
Like the requirements to establish common law fraud in Ohio, a broken contractual promise, alone, will not establish a fraud claim under § 523(a)(2)(A). Risk v. Hunter (In re Hunter), 535 B.R. 203, 213 (Bankr.N.D.Ohio 2015). "Instead, the existence of fraudulent intent under § 523(a)(2)(A) hinges on whether the debtor, at the time the debt in question is incurred, intended to honor the obligation." Id.; see also Wilhelm v. Finnegan (In re Finnegan), 428 B.R. 449, 453 (Bankr.N.D.Ohio 2010) (noting that "where there is a promise to perform a future act, fraud will only exist when coupled with a present intent not to perform").
In the case at hand, Reinhart has failed to demonstrate that the Debtors did not intend to honor the contractual obligations in the Incentive Agreement at the time it was executed. As noted previously in this opinion, Ken Riley did have concerns about the restaurants' ability to meet the $30,000 weekly purchasing quota. [See Section III. (A.)(3.)(a) above] However, rather than hide these concerns, Ken Riley expressed them to Reinhart prior to the parties entering into the Incentive Agreement. In response, Reinhart reassured him that the weekly purchasing quota was only an average and that the focus of the agreement was the Debtors using Reinhart as their primary distributor. Following the execution of the Incentive Agreement, the Debtors' subsequent actions support their intent to honor their contractual obligations: they fulfilled the $30,000 weekly purchasing obligation to the best of the restaurants' ability and used Reinhart as their primary distributor until the time that each restaurant closed. Accordingly, for the same reasons that Reinhart failed to establish common law fraud under Ohio law, Reinhart has likewise failed to meet the requirements to except the debt from discharge for fraud under § 523(a)(2)(A).
2. Bankruptcy Code Section 523(a)(4)
Next, Reinhart argues that the debt should be excepted from discharge pursuant to § 523(a)(4). This provision excepts from discharge "any debt - (4) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny." 11 U.S.C. § 523(a)(4). Reinhart claims that the Debtors engaged in defalcation while acting in a fiduciary capacity by failing to hold the Incentive Payment in trust or to use the funds solely to meet the weekly purchasing quota. [Docket Number 1, ¶¶ 45-46; Docket Number 52, pp. 8-9].
In order to establish the requirement to hold a debt excepted from discharge for defalcation while acting in a fiduciary capacity, the creditor must establish by a preponderance of the evidence: "'(1) a preexisting fiduciary relationship; (2) breach of that fiduciary relationship; and (3) a resulting loss.'" Bd. of Trs. of the Ohio Carpenters' Pension Fund v. Bucci (In re Bucci), 493 F.3d 635, 639 (6th Cir. 2007) (quoting Commonwealth Land Title Co. v. Blaszak (In re Blaszak), 397 F.3d 386, 390 (6th Cir. 2005)).
The Sixth Circuit has taken the opportunity to consider the nature of the "fiduciary capacity" requirement of § 523(a)(4) and construes the term more narrowly than it is used in other circumstances. See Bucci, 493 F.3d at 639; Blaszak, 397 F.3d at 391. The fiduciary relationship must turn on the existence of a pre-existing express or technical trust whose res encompasses the property at issue. Blaszak, 397 F.3d at 391. The provision does not extend to constructive or implied trusts. Id.; Bucci, 493 F.3d at 639-40.
As discussed in Section III. (A.)(3.)(b) above, Reinhart failed to establish a pre-existing express or technical trust encompassing the $125,000 Incentive Payment. The Incentive Agreement includes no express language imposing a trust on the funds nor did the evidence support that the parties discussed creating a trust or even limiting the use of the funds beyond a mutual understanding that the funds would be used by the Debtors for business purposes.
A trust may also be created by statute for purposes of § 523(a)(4) if that statute defines the trust res, imposes trust obligations, and those duties exist prior to any wrongdoing. Bucci, 493 F.3d at 640 (noting that the Michigan's Building Contract Fund Act created a trust relationship sufficient to satisfy the express or technical trust requirement); Coughlin Chevrolet, Inc. v. Thompson (In re Thompson), 458 B.R. 409, 422-23 (Bankr. S.D. Ohio 2011). However, in this case, Reinhart points to no statutory basis for the creation of a trust.
Alternatively, Reinhart argues that a constructive trust should be imposed on the funds. [Docket Number 52, pp. 8-9] Even if the facts supported the imposition of a constructive trust, which they do not [see Section III. (A.)(3.)(b) above], a constructive trust does not form a basis to except a debt from discharge under § 523(a)(4). Blaszak, 397 F.3d at 391 ("It is well established that the defalcation provision of § 523(a)(4) applies to express or technical trusts, but not to constructive trusts that courts may impose as an equitable remedy."); Perry v. Ichida (In re Ichida), 434 B.R. 852, 860-61 (Bankr. S.D. Ohio 2010).
Accordingly, the elements to except a debt from discharge under § 523(a)(4) are not met.
3. Bankruptcy Code Section 523(a)(6)
Reinhart also relies on § 523(a)(6) which excepts from discharge a debt for a "willful and malicious injury by the debtor to another entity or to the property of another entity[.]" 11 U.S.C. § 523(a)(6). In its post-trial brief, Reinhart asserts that the Debtors acted to intentionally injure Reinhart by converting the Incentive Payment funds, comingling the funds with other funds, and by spending the funds in a manner other than to meet the weekly purchasing quota and then failing to repay the funds [Docket Number 52, pp. 9-10].
The standard under § 523(a)(6) is a stringent one requiring proof that the injury is both "willful" and "malicious". Steier v. Best (In re Best), 109 Fed.Appx. 1, 4 (6th Cir. 2004) (noting that "debts arising from recklessly or negligently inflicted injuries do not fall within the compass of § 523(a)(6)"); CMEA Title Agency v. Little (In re Little), 335 B.R. 376, 383 (Bankr.N.D.Ohio 2005). To rise to the level of a "willful" injury, the Supreme Court has determined that the debtor's acts must not only be intentional, but must be committed with the intent or desire to cause injury. Kawaauhau v. Geiger, 523 U.S. 57, 61 (1998); see also Best, 109 Fed.Appx. at 5. Thus, "'unless the actor desires to cause [the] consequences of his act or . . . believes that the consequences are substantially certain to result from it, he has not committed a willful and malicious injury as defined under § 523(a)(6).'" Best, 109 Fed.Appx. at 5 (citing Kennedy v. Mustaine (In re Kennedy), 249 F.3d 576, 580 (6th Cir. 2001)).
In addition to being willful, the injury must also be "malicious." Greer v. Bruce (In re Bruce), 593 B.R. 765, 774-75 (Bankr. S.D. Ohio 2018). "A person is deemed to act maliciously within the meaning of Section 523(a)(6) when the person acts 'in conscious disregard of his duties or without just cause or excuse.'" Id. at 775 (further citation omitted). The malice necessary to except a debt from discharge "requires a heightened level of culpability transcending mere willfulness." Superior Metal Prods. v. Martin (In re Martin), 321 B.R. 437, 442 (Bankr.N.D.Ohio 2004).
Finally, the Sixth Circuit has held that the injury must involve a deliberate or intentional invasion of the creditor's legal rights. Best, 109 Fed.Appx. at 6. "The conduct 'must be more culpable than that which is in reckless disregard of creditors' economic interests and expectancies, as distinguished from . . . legal rights. Moreover, knowledge that legal rights are being violated is insufficient to establish malice . . . ." Id. (further citation omitted).
As noted above, the standard to prove a willful and malicious injury is a stringent one. While conversion of funds may suffice, a debtor's mere inability or refusal to meet a contractual obligation, without proof of accompanying tortious conduct, will not. Best, 109 Fed.Appx. at 3, 8. In Best, the creditor argued on appeal that a debtor's refusal to meet a contractual requirement to repay the creditor's $300,000 investment in the debtor's business following the closure of the business amounted to a willful and malicious injury that should be excepted from discharge pursuant to § 523(a)(6). Id. at 3. The Sixth Circuit disagreed holding that such a breach of contract, even a knowing one, "cannot constitute the willful and malicious injury required to trigger § 523(a)(6)." Id. at 8 (citing Salem Bend Condo. Assoc. v. Bullock-Williams (In re Bullock-Williams), 220 B.R. 345, 347 (B.A.P. 6th Cir. 1998)).
In Bruce, this Court noted that conversion is among the type of intentional torts that may be subject to nondischargeability pursuant to § 523(a)(6) if it is demonstrated that both the act and the injury were intentional. 593 B.R. at 775.
As discussed in Section III. (A.)(3.)(c) above, Reinhart failed to prove that the Debtors converted the Incentive Payment. And, contrary to Reinhart's argument, the Incentive Agreement includes no provision requiring the funds be segregated, put in trust, or used for the limited purpose of meeting the weekly purchasing quota. Instead, both Reinhart representative Bill Stacey and Ken Riley testified to their mutual understanding that Reinhart expected the Incentive Payment to be used for business purposes to improve or grow the restaurants. According to the only evidence presented on the subject, the testimony of Ken Riley, the funds were used in accordance with Reinhart's expectations.
This leaves Reinhart's remaining argument that the Debtors committed a willful and malicious injury by breaching contractual obligations within the Incentive Agreement, including the required weekly purchasing quota and the requirement to refund the unearned portion of the Incentive Payment if the quota was not met. However, consistent with the Sixth Circuit's determination in Best, this breach of contract and failure to repay money owed does not trigger the exception to discharge for a willful and malicious injury under § 523(a)(6). 109 Fed.Appx. at 6.
With that, this Court concludes that Reinhart failed to demonstrate the elements required to except a debt from discharge under § 523(a)(2), (a)(4) or (a)(6). Because this is a necessary step to excepting a debt from discharge as an "unscheduled creditor," Reinhart's claim under § 523(a)(3)(B) is without merit.
C. The Debtors' Failure to Disclose the Incentive Payment or Schedule Reinhart as a Creditor Does Not Form a Basis to Deny Their Discharge
As an alternative to excepting a debt from discharge, Reinhart pursues denial of the Debtors' discharge pursuant to provisions of Bankruptcy Code Section 727(a)(3) or (a)(4) [Docket Number 1, ¶¶ 23 - 31; Docket Number 52, pp. 2-3]. Generally, debtors filing under chapter 7 are to be granted a discharge unless one of the specific grounds for denying a discharge in § 727(a) applies. 11 U.S.C. § 727(a); Baker v. Reed (In re Reed), 310 B.R. 363, 367 (Bankr.N.D.Ohio 2004). Consequently, the provisions to deny a discharge are construed liberally in favor of debtors. Buckeye Retirement Co., LLC v. Swegan (In re Swegan), 383 B.R. 646, 653 (B.A.P. 6th Cir. 2008); Buckeye Retirement Co., LLC v. Hake (In re Hake), 387 B.R. 490, 502 (Bankr.N.D.Ohio 2008).
Nonetheless, the exceptions to discharge serve the purpose of ensuring compliance with basic bankruptcy policy, including full disclosure and honesty. Reed, 310 B.R. at 367. "From a global perspective, honesty envisions a debtor who 'has tried his best to pay his creditors but failed.'" Id. (further citation omitted). In this case, Reinhart argues that the Debtors' honesty is called into question by their failure to list Reinhart as a creditor or the Incentive Payment as income in their schedules. Reinhart asserts that these omissions warrant a denial of their discharge pursuant to § 727(a)(3) and/or (a)(4)(A).
1. Reinhart Failed to Establish Inadequate Recordkeeping
Pursuant to Section 727(a)(3), a debtor's discharge may be denied when:
the debtor has concealed, destroyed, mutilated, falsified, or failed to keep or preserve any recorded information, including books, documents, records, and papers, from which the debtor's financial condition or business transactions might be ascertained, unless such act or failure to act was justified under all of the circumstances of the case[.]11 U.S.C.A. § 727(a)(3). This Bankruptcy Code provision requires a debtor to provide creditors "'with enough information to ascertain the debtor's financial condition and track his financial dealings with substantial completeness and accuracy for a reasonable period past to present.'" Turoczy Bonding Co. v. Strbac (In re Strbac), 235 B.R. 880, 882 (B.A.P. 6th Cir. 1999) (further citation omitted). "In order to prevail on a section 727(a)(3) action, the creditor must establish: (1) that the debtor failed to keep or preserve books or records; and (2) that such failure makes it impossible to ascertain the debtor's financial condition and material business transactions." Stevenson v. Cutler (In re Cutler), 291 B.R. 718, 724 (Bankr. E.D. Mich. 2003) (internal citations and quotation marks omitted). The adequacy of a debtor's records must be established on a case by case basis. Id. "Considerations to make this determination include debtor's occupation, financial structure, education, experience, sophistication and any other circumstances that should be considered in the interest of justice." Id. It is the party seeking the denial of discharge that carries the burden of proving the inadequacy of the debtor's records. Id.
In this case, Reinhart's legal and factual arguments focus on the Debtors' alleged failure to disclose items in their schedules rather than a failure to keep adequate records. Reinhart points to no missing or incomplete records nor do the facts presented at trial support inadequate record keeping. Accordingly, Reinhart failed to prove the elements to deny the Debtors' discharge under § 727(a)(3).
2. Reinhart Failed to Demonstrate a False Oath Made with Fraudulent Intent
Section 727(a)(4)(A) provides that a debtor be denied a discharge if "the debtor knowingly and fraudulently, in or in connection with the case- (A) made a false oath or account[.]" 11 U.S.C. § 727(a)(4)(A). To prevail, Reinhart must prove the following by a preponderance of the evidence:
(1)the Debtors made a statement under oath;
(2)the statement was false;
(3)the Debtors knew the statement was false;
(4)the Debtors made the statement with fraudulent intent; and
(5)the statement related materially to the bankruptcy case.Keeney v. Smith (In re Keeney), 227 F.3d 679, 685 (6th Cir. 2000). For purposes of § 727(a)(4)(A), statements made by a debtor in bankruptcy schedules and the statement of financial affairs constitute statements made under oath. Noland v. Johnson (In re Johnson), 387 B.R. 728, 743 (Bankr. S.D. Ohio 2008).
With respect to the element of fraudulent intent, the Sixth Circuit has held:
"Complete financial disclosure" is a prerequisite to the privilege of discharge . . . . [I]ntent to defraud "involves a material representation that you know to be false, or, what amounts to the same thing, an omission that you know will create an erroneous impression." A reckless disregard as to whether a representation is true will also satisfy the intent requirement. "'Courts may deduce fraudulent intent from all the facts and circumstances of a case.'" However, a debtor is entitled to discharge if false information is the result of mistake or inadvertence.Keeney, 227 F.3d at 685-86 (further citation omitted); see also McDermott v. French (In re French), 592 B.R. 653, 657 (Bankr. E.D. Mich. 2018).
In this case, it is undisputed that the Debtors did not list Reinhart as a creditor in their schedules. However, it is also true that Reinhart did not demonstrate a valid claim against the Debtors. [See Section III. (A.) above] Accordingly, the Debtors' failure to list Reinhart as a creditor does not constitute a false oath.
A "creditor" is defined in the Bankruptcy Code as an "entity that has a claim against the debtor that arose at the time or before the order for relief concerning the debtor[.]" 11 U.S.C. § 101(10)(A).
Even if Reinhart could be considered a creditor who should have been listed by the Debtors in their schedules, Reinhart failed to demonstrate that the omission was made with fraudulent intent. Both Debtors testified to their belief that the debt owed to Reinhart was business debt and not a personal debt. [Tr. pp. 118-120; 142-43, 146] Their belief is supported by the fact that the Incentive Agreement created contractual obligations on the part of the "Customer" listed in the contract as Riley Restaurant Group and not Ken or Gloria Riley personally. This Court finds the Debtors' testimony credible and concludes that their failure to list Reinhart in the schedules was not made with fraudulent intent.
Next, Reinhart argues that the Incentive Payment should have been listed by the Debtors in their schedules as income received within a year of the bankruptcy petition filing date. Although Reinhart does not pinpoint where that income should have been reported, this Court believes that Reinhart refers to Question Five from the Chapter 7 Statement of Your Current Monthly Income which requires the calculation of the debtor's net income form operating a business, profession or farm. See Official Form 122A-1.
Official Form 122A-1 requires the Debtors to provide information to calculate the Debtors' "current monthly income" defined in the Bankruptcy Code as "the average monthly income from all sources that the debtor receives (or in a joint case the debtor and the debtor's spouse receive) without regard to whether such income is taxable income[.]” 11 U.S.C. § 101(10A)(A). The form requests information on all income and payments the debtors receive during the six months prior to the bankruptcy filing including wages, alimony payments as well as income from operating a business. With respect to how to calculate income, the directions state:
Fill in the average monthly income that you received from all sources, derived during the 6 full months before you file this bankruptcy case. 11 U.S.C. § 101(10A). For example, if you are filing on September 15, the 6-month period would be March 1 through August 31. If the amount of your monthly income varied during the 6 months, add the income for all 6 months and divide the total by 6. Fill in the result. Do not include any income amount more than once. For example, if both spouses own the same rental property, put the income from that property in one column only. If you have nothing to report for any line, write $0 in the space.[Official Form 122A-1].
Although lacking in detail, the definition of current monthly income in the Bankruptcy Code and Official Form 122A-1 focuses on reporting income that the debtor receives. While certain debtors operating a business may be required to report their full business income, because the business income is attributable to the debtor, the same is not necessarily true of businesses that are treated as separate legal entities. Corporations and limited liability companies are generally regarded as separate legal entities distinct from their shareholders, members, and officers and those entities have their own distinct liabilities, obligations and assets. West Valley Med. Partners, LLC v. Shapow (In re Shapow), 599 B.R. 51, 71 (Bankr. C.D. Cal. 2019). When an individual files a bankruptcy petition who is an owner, shareholder or member of a corporate or limited liability entity, the owner brings into the estate only his ownership or membership interest and not the assets of the corporation or limited liability entity. Id. An individual would not generally report the income of the business entity unless the income was attributable to the individual under state or federal law.
In this case, the Incentive Agreement obligated Reinhart to a make a one-time incentive payment of $125,000 to the "Customer" which is listed in the contract, not as the individual Debtors, but as "Riley Restaurant Group dba - J. Austin's American Eatery & Walt's Barbeque". [Pl. Ex. 3; Def. Ex. G] Similarly, Reinhart made the Incentive Payment check payable to "Riley Restaurant Group" [Pl. Ex. 4] and not to the Debtors individually. Reinhart presented no evidence at trial to support that the Incentive Payment was treated as personal income by the Debtors or used for their personal expenses. To the contrary, Ken Riley testified to depositing the check in a restaurant account rather than a personal account, and to using the funds for business purposes including signage and remodeling of one of the restaurants. No other evidence on the use of the funds was submitted. In short, Reinhart failed to provide any evidence that the Incentive Payment is income that should be attributed to the Debtors under applicable state or federal law.
Accordingly, Reinhart failed to prove that the omission of the Incentive Payment from the Debtors' current monthly income was a false oath. Furthermore, Reinhart failed to demonstrate fraudulent intent on the part of the Debtors who credibly testified to their belief that the Incentive Payment was business income of the restaurants that did not need to be disclosed in their personal bankruptcy schedules.
For these reasons, Reinhart's claim to deny the Debtors' discharge under § 727(a)(4)(A) is denied.
IV. CONCLUSION
For the reasons stated above, this Court concludes that Reinhart failed to prove entitlement to judgment on any of the claims set forth in its Complaint. A separate final judgment will be entered in accordance with this opinion. This opinion constitutes this Court's findings of facts and conclusions of law in accordance with Federal Rule of Bankruptcy Procedure 7052.
SO ORDERED.