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11-05103 Cherry et al v. Neuschafer (Doc. # 64)

Cherry et al v. Neuschafer, 11-05103 (Bankr. D. Kan. Apr. 10, 2013) Doc. # 64

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____________________________________________________________________________ ____________________________________________________________________________
SO ORDERED.
SIGNED this 10th day of April, 2013.

 

Designated for on-line use but not print publication

IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS

In Re:
JOHN CHARLES NEUSCHAFER and
AUDREY LANE NEUSCHAFER,
DEBTORS.

ANDREW CHERRY and
PAMELA CHERRY,

PLAINTIFFS,

v.
JOHN CHARLES NEUSCHAFER,
DEFENDANT.

CASE NO. 11-10282
CHAPTER 7

ADV. NO. 11-05103

MEMORANDUM OPINION AND ORDER GRANTING IN PART
PLAINTIFFS’ COMPLAINT FOR EXCEPTION FROM DISCHARGE

Case 11-05103 Doc# 64 Filed 04/10/13 Page 1 of 22

Plaintiffs Andrew and Pamela Cherry (Plaintiffs or Cherrys) seek a determination
under 11 U.S.C. §§ 523(a)(2)(A) and (a)(6)1 that under the doctrine of issue preclusion
Defendant John C. Neuschafer’s (Debtor) obligation to them under a Georgia state court
judgment for fraud in the inducement, violation of the Georgia RICO statute, punitive
damages, attorneys fees, costs, and interest is nondischargeable.2 Following denial of
Plaintiff’s motion for summary judgment,3 trial was held on February 19, 2013. For the
following reasons, the Court grants the compliant in part and holds that Plaintiffs’
judgment against Debtor for fraud in the inducement is excepted from discharge under §
523(a)(2)(A), but otherwise denies the complaint.
FINDINGS OF FACT.

By complaint filed on May 9, 2006, in the Superior Court of Gwinnett County,
Georgia (the Georgia Litigation),4 the Cherrys brought suit against Integrity Funding
Group, LLC (Integrity), Cornerstone Investment Funds, LLC (Cornerstone), John C.
Neuschafer, and Andrew J. Taulbee. The Georgia Litigation arose from a contract for the

1 Future references to Title 11 in the text shall be to the section only.

2 This Court has jurisdiction over the parties and the subject matter pursuant to 28 U.S.C. §§
157(a) and 1334(a) and (b), and the Standing Order of the United States District Court for the District of
Kansas that exercised authority conferred by § 157(a) to refer to the District's bankruptcy judges all
matters under the Bankruptcy Code and all proceedings arising under the Code or arising in or related to a
case under the Code, effective July 10, 1984. Furthermore, this Court may hear and finally adjudicate
this matter because it is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(I). There is no objection to
venue or jurisdiction over the parties.

3 Dkt. 46.

4 Andrew and Pamela Cherry v. Integrity Funding Group, LLC., et al, Civil Action No. 06A04817-
10, Superior Court of Gwinnett County, Ga.

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sale of the Cherrys’ home to Integrity and the Cherrys’ lease from Integrity, with option
to purchase, of a replacement residence. The claims alleged included breach of contract,
fraud, specific performance, violation of Georgia Fair Business Practice Act, and
violation of the Georgia Racketeer Influenced and Corrupt Organizations Act (Georgia
RICO). Debtor was not a member of Integrity, but was a member and the manger of
defendant Cornerstone, which was a member of Integrity. Jury trial was demanded.

The complaint was personally served on Debtor at his residence, 2737 Tarva Place,
Duluth, Ga., the address stated in the compliant. This is the address of the home formerly
owed by the Cherrys; Debtor moved to this property in early April, 2005. Debtor
appeared in the action by an attorney and filed an answer and a counterclaim. On March
30, 2007, an order was entered granting the motion of Debtor’s attorney to withdraw.
Debtor knew of the withdrawal. In the notice of withdrawal, prepared by Debtor’s
counsel, Debtor’s address is stated to be 951 Fernbank Lane, Dacula, GA. Debtor
testified he had lived at the Dacula address, but had moved by the time he retained his
trial counsel, to whom he gave his correct address on Tarva Place in Duluth, GA.

Debtor testified that after the withdrawal of his attorney he did not hire an
attorney, but did consult with his brother-in-law, who is an attorney. They agreed that no
entry of appearance would be made and that Debtor was to notify his brother-in-law in
the event of a trial. Debtor monitored the litigation every month or two by reviewing the
court’s on-line system, which had the information commonly found on a docket sheet.
The record contains a copy of the docket sheet, but Debtor testified that it was not the

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same information as was available on-line, since there are approximately 60 entries
between March 30, 2007 and March 13, 2008, on the docket sheet which Debtor states
were, at least for the most part, not in the information available on-line at the times he
electronically checked the status of the Georgia Litigation.

The docket sheet entry for March 13, 2008 states “dismissal order.” Debtor saw
this entry and understood it to mean that the case against him was dismissed. He
thereafter stopped checking the litigation status on-line. The entry immediately preceding
the “dismissal order” entry states “2/19/2008 - notice of stay in bankruptcy - re taulbee,
andrew judson & taulbee tiffany jones.” The entry immediately following the “dismissal
order”entry states, “05/15/2008 - order - re bankruptcy/case reopened.” Debtor did not
see this entry.

After the withdrawal of his counsel, Debtor received no mailings and no notices
concerning the litigation. Debtor testified that he lived at 2737 Tarva Place, Duluth, GA
on the date of service of the complaint, moved to 3289 Swampwillow Ct., Jefferson, GA
in April 2007, moved to 135 Bill Rutedge Road, Winder, GA in April 2009, and moved to
Kansas in July, 2009. The Fernbank address is the address listed for Debtor, as well as
Integrity, on the Georgia docket sheet included in this record. There is no evidence
whether the Debtor’s address stated on the docket sheet was changed during the pendency
of the Georgia Litigation.

After the dischargeability complaint was filed, Debtor visited Georgia and
reviewed the court file. He found a large envelope postmarked March 27, 2008,
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addressed to him at 951 Fernbank Lane, Dacula, GA and marked “UNDELIVERABLE
AS ADDRESSED NO FORWARDING ORDER ON FILE.” The contents of the
envelope were not present. There is no entry on the docket sheet for March 27, 2008.
The entries immediately before and after that date are the March 13, 2008 “dismissal
order” and the May 15, 2008 “order - re bankruptcy/case reopened.” Plaintiffs’ Georgia
counsel’s uncontroverted testimony is that the returned envelope did not contain notice of
the trial date, because the envelope was sent several months before the July 22, 2008 trial
date and such notices are generally sent approximately 30 days before trial.

As previously stated, a jury trial was requested. The scheduled events portion of
the docket sheet includes two entries for “Calendar Call - Jury,” one dated February 25,
20085 and one dated April 21, 2008. It next entry is “bench trial” for July 22, 2008.
There is no entry on the docket sheet showing the giving of notice of the trial setting. It is
uncontroverted that Debtor did not receive mail notice and had no actual notice of the
trial setting.

Trial to the court was held on July 22, 2008. Cherrys’ counsel, Kevin Pratt, and
Andrew Cherry appeared. Debtor testified that he would have appeared for trial if he had
received notice. The docket sheet simply states “07/25/2008-judgment.”6 The trial

5 The copy of the docket sheet in the record is cut off, so the last digit of the year of the February
25 entry date is missing, but the Court believes the year is 2008, based upon other entries in the docket.
6 Exh. 1.
5

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resulted in a judgment against Debtor filed on July 25, 2008,7 which was amended to

correct a scrivener's error on December 10, 2008.8 The amended judgment (Georgia

Judgment) provides in part:

The Plaintiff presented evidence that the Defendants made
material mistatements when entering into a lease purchase
agreement to sell the Plaintiffs real property, and when entering
into the agreement the Defendants had a present intention not to
perform. The evidence presented supports a finding that
Defendants Integrity and Neuschafer committed Fraud in the
inducement. The facts relevant to this finding include that the
Defendants made material representations to the Plaintiffs
regarding the purchase of their home and the purchase of a
replacement home. The Defendants stated that they would place
the Plaintiffs in a home under a lease purchase agreement, that the
Plaintiff’s would be provided a credit on the closing of the
purchase of the replacement property in the amount of $30,300.00,
plus $1000.00 for 24 months. In reliance on the statements by the
Defendants, the Plaintiff sold Neuschafer the Plaintiffs’ then
current residence, and moved into the new home presented by the
Defendants under the lease purchase agreement. In further reliance
on the agreement to purchase the home, the Plaintiff’s paid for
improvements to be made on the leased property at the cost of
$13,757.00. When the Plaintiff’s attempted to purchase the new
home pursuant to the agreement, it was discovered that the
Defendant Neuschafer did not own the home and that the home
was owned by Defendant Taulbee as a straw buyer. It is also
shown by the record in this case that the Defendant Taulbee
received payment from Defendant Neuschafer for the purchase of
the home.

Based on these facts, Judgment in the amount of
$67,757.00 in favor of the Plaintiff’s and against Integrity Funding
Group, LLC and Neuschafer, jointly and severally, for Fraud in the

7 Exh. 4.

8 Exh. 5.

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Inducement is hereby entered.9

The court also found in favor of the Cherrys on the Fair Business Practices Act claim. It

awarded $54,300.00 in damages, which was "merged into the Fraud Judgment."10

As to the Georgia RICO claim, the Georgia court found in part:

This Court finds that the act of participating in a scheme to
commit Mortgage Fraud in the procurement of two separate
loans used to facilitate the purchase of the home that was to
be sold to the Plaintiffs is a sufficient predicate act to
constitute a violation of Georgia Racketeer Influenced and
Corrupt Organizations Act (RICO). . . . this Court finds that
the actual damages caused to the Plaintiff by the Defendants
actions is $355,000.00. Based on the specific finding of facts
that the Defendants conduct was intentional and wanton, this
Court further holds that the award of punitive damages in
favor of the Plaintiffs and against Defendants Integrity and
Neuschafer in the amount of $100,000.00 is appropriate.
Moreover, as the Georgia RICO expressly provides that any
person injured by reason of a violation of the Act shall have a
cause of action for three times the actual damages sustained,
and where appropriate, punitive damages. The facts clearly
indicate that it is highly appropriate that the actual damages
and punitive damages in this case be tripled. 11

Attorneys fees and costs were also assessed against the defendants. The total judgment

therefore was stated as follows:

a) The principal amount of $67,757.00 for Fraud in the
Inducement and Violation of the Fair Busienss [sic] Practices Act;
and
b) The principal amount of $1,065,000.00 ($355,000 tripled)

9 Id. at 1-2.

10 Id. at 2.

11 Id. at 2-3.

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Case 11-05103 Doc# 64 Filed 04/10/13 Page 7 of 22

for Violation of Georgia RICO;
c) Punitive damages in the amount of $300,000.00 ($100,000
tripled);
d) $19,500.00 Attorneys fees;
e) $130.00 Court Cost
f) Post judgment interest at 8%.12

Debtor did not learn of the judgment until after he moved to Kansas, when through

service of process, he learned that the Georgia judgment had been registered in this state.

The Cherrys’ Georgia trial counsel, Kevin Pratt, testified by deposition, which had

been taken by telephone. When testifying, he referred only to documents which had been

provided by Plaintiffs’ counsel; he had not reviewed his file, did not have his file present,

and had not reviewed the court file. In a written report, about which he testified, Mr.

Pratt stated:

The dockets for cases in this jurisdiction do not reflect notices
sent for trials. This is because the practice of our state court is
to have the judge directly give notice to the litigants of trial
settings. If a trial notice is returned undeliverable the Judges
office makes a note that the notice was returned.
Consequently, although the court docket does not reflect a
trial notice, it also does not reflect that the notice sent by the
judge was returned undeliverable.13

Mr. Pratt testified that it would be extremely rare to get more than 30 days advance notice

of a trial setting, and he did not know what would have been in the returned envelope

addressed to Debtor postmarked March 27, 2008. Mr. Pratt stated in his statement that he

12 Id. at 3.
13 Exh. 15, 63.
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received notice of the July, 2008 trial in the “normal and customary manner.”14 He
testified that the notice would have been received no more than 30 days in advance of the
trial date, would have been calendared, but the notice itself was not retained.

DISCUSSION.

A. Plaintiffs’ nondischageability complaint.
In this adversary proceeding, the Cherrys seek a determination that their judgment
against Debtor entered in the Georgia Litigation is nondischargeable under §§
523(a)(2)(A) and/or 523(a)(6). They rely upon the doctrine of issue preclusion, also
referred to as collateral estoppel. That doctrine “prevents a party that has lost the battle
over an issue in one lawsuit from relitigating that same issue in another lawsuit.”15 It
applies in discharge litigation under § 523.16

B. What portions of the Georgia Judgment are eligible for preclusive effect as
to the § 523(b)(2)(A) exception to discharge?
The first question to ask when applying the doctrine of issue preclusion in this case
is whether the issues in the dischargeability litigation are the same as those in the Georgia
Litigation. Subsection § 524(a)(2)(A) excepts from discharge debts “for money, property,
services . . . to the extent obtained by false pretenses, a false representation, or actual
fraud.” To establish an exception to discharge for fraud, the creditor must prove: “1) the

14 Id. at 64.

15 Melnor, Inc. v. Corey (In re Corey), 583 F.3d 1249, 1251 (10th Cir. 2009).

16 Grogan v. Garner, 498 U.S. 279, 284-85 (1991).

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debtor knowingly committed actual fraud or false pretenses, or made a false
representation or willful misrepresentation; 2) that the debtor had the intent to deceive the
creditor; and 3) that the creditor relied upon the debtor’s representation."17 In addition,
the creditor’s reliance must have been justifiable,18 and the debtor’s non-financial
misrepresentation must be the proximate cause of the debt in issue.19

The first element of the Georgia Judgment is damages of $67,757.00, plus post
judgment interest at the rate of 8% per year, for fraud in the inducement. Under Georgia
law, the elements for a fraud claim are: “(1) a false representation made by the defendant;

(2) which the defendant knew was false; (3) made with an intent to deceive the plaintiff;
(4) justifiable and detrimental reliance by the plaintiff on such representation and (5)
damages suffered by the plaintiff as a result.”20 The Georgia Judgment states the
evidence supports findings that Debtor made “material mistatements when entering into a
lease purchase agreement,”21 that when entering into the agreement he had “a present
intention not to perform,”22 that Cherrys relied on the misstatements, and that Cherrys
17 State of Missouri v. Audley (In re Audley), 275 B.R. 383, 388 (10th Cir. BAP 2002), citing
Fowler Bros. v. Young (In re Young), 91 F.3d 1367, 1373 (10th Cir. 1996).

18 Id.

19 In re Giovanni, 324 B.R. 586, 594 (E.D. Va. 2005).

20 Hebbard v. Camacho (In re Camacho), 411 B.R. 496, 505 (Bankr. S.D. Ga. 2009), citing
Crawford v. Williams, 258 Ga. 806, 806, 375 S.E.2d 223, 224 (1989) and other Georgia cases.

21 Exh. 5, 1.

22 Id.

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were injured. These findings are the same as required for the exception to discharge
under § 523(a)(2)(A).

Since the judgment for Violation of the Fair Business Practices Act is “merged
into the Fraud Judgment,”23 the Court will not separately consider this portion of the
judgment.

The Georgia Judgment also includes finding that Debtor violated the Georgia Civil
RICO statute causing damages of $355,000.00, that the conduct causing the damages was
intentional and wanton such that an award of punitive damages of $100,000.00 was
appropriate, and under RICO statute these damages should be tripled, resulting in a
judgment for $1,065,000.00 and punitive damages of $300,000.00. Plaintiffs contend that
this entire judgment is nondischargeable under Cohen, 24 a Supreme Court decision
holding that the discharge exception for actual fraud prevents the discharge of all liability
arising from the debtor’s fraud, including triple damages assessed on account of fraud
under state law as well as attorney fees and costs.

Under the Georgia civil RICO statute,25 a person injured by reason of any violation
of the activities prohibited by O.C.G.A. 16-14-4 has a cause of action for three times the
actual damages sustained and, where appropriate, punitive damages. Georgia Code 1614-
4 declares “[i]t is unlawful for any person, through a pattern of racketeering activity . .

23 Exh. 5, 2.

24 Cohen v. De La Cruz, 523 U.S. 213 (1998).

25 O.C.G.A. 16-14-6.

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. to acquire or maintain, . . . any interest in or control of any enterprise, real property, or
personal property of any nature, including money.” Pattern of racketeering activity
includes “[e]ngaging in at least two acts of racketeering activity in furtherance of one or
more incidents, schemes, or transactions that have the same or similar intents, results,
accomplices, victims, or methods of commission . . ..”26 “‘Racketeering activity’ means
to commit . . . any crime which is chargeable by indictment” under a very long list of
Georgia statutes, commonly called predicate acts.27 The predicate acts for Debtor’s RICO
liability are violations of the Georgia residential mortgage fraud statute, which provides
in part:

A person commits the offense of residential mortgage
fraud when, with the intent to defraud, such person:

(1) Knowingly makes any deliberate misstatement,
misrepresentation, or omission during the mortgage lending
process with the intention that it be relied on by a mortgage
lender, borrower, or any other party to the mortgage lending
process. 28
As stated above, to except the RICO judgment from discharge under §523(a)(2)(A)

under the doctrine of issue preclusion, the Plaintiffs must show that the RICO judgment

was supported by findings which included the elements of misrepresentation, knowledge

of falsity, intent to defraud, justifiable reliance, and resulting damage. The Georgia

26 O.C.G.A. 16-14-3(8)(a)).

27 O.C.G.A.16-14-3(9)(A)).

28 O.C.G.A. 16-8-102.

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Judgment includes the following as findings of fact to support the judgment for violation

of the mortgage fraud statute:

The facts support that the Defendants [Debtor and Integrity
Funding Group, LLC] combined to arrange for the
procurement of two separate loans to purchase real property,
and that the Defendants participated in outside of closing
transactions that were not disclosed to the lenders. This Court
finds that the act of participating in a scheme to commit
Mortgage Fraud in the procurement of two separate loans
used to facilitate the purchase of the home that was to be sold
to the Plaintiffs is a sufficient predicate act to constitute a
violation of ... RICO. As such the Defendants Integrity and
Neuschafer are liable for all of the damages proximately
caused by the acts. Based on the entire transaction involving
the sale of a principal residence at a discounted price on the
promise and misstatements of Neuschafer, and the fact that
Neuschafer had a present intention not to perform his
obligations under the agreement, this Court finds that the
actual damages caused to the Plaintiff by the Defendants
actions is $355,000.00.29

Thus, the Debtor’s liability under civil RICO is predicated upon

misrepresentations made in the procurement of two separate loans and failure to make

disclosures to lenders. It is crucial that these misrepresentations were made to lenders, not

to the Plaintiffs. The unspecified lenders presumably provided credit to Debtor or a co

defendant based upon the fraud and failure to disclose. If the lenders had pursued Debtor

for fraud and obtained a judgment, that judgment probably would have included the

elements for the exception from discharge under § 523(a)(2)(A) as findings of fact. But

the RICO judgment does not impose liability on Debtor based upon these elements. The

29 Exh. 5, 2.

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misrepresentations which are the basis for the RICO judgment were not made to
Plaintiffs. There is no finding that Plaintiffs relied upon the misrepresentations made to
lenders. There is no finding that the misrepresentations made to lenders were the
proximate cause of the damages awarded to Plaintiffs on the RICO claim. Rather than
being awarded damages for property obtained by Debtor as a result of misrepresentations
made to lenders, Plaintiffs were awarded RICO damages based upon the “entire
transaction” and the fact that Debtor “had a present intention not to perform his
obligations under the agreement,” meaning the agreement to purchase a home which was
to be sold to the Plaintiffs.30 The judgment for fraud in the inducement awards damages
resulting from breach of the agreement. The Court therefore concludes that issue
preclusion is not available to bar the Debtor’s discharge under § 523(a)(2)(A) for his
liability for the RICO portion of the Georgia Judgment.

C. What portions of the Georgia Judgment are eligible for preclusive effect as
to the § 523(a)(6) exception to discharge?
Section 523(a)(6) excepts from discharge any debt “for willful and malicious
injury by the debtor to another entity or to the property of another entity.” It “generally
relates to torts and not to contracts,”31 but a breach of contract which is both willful and

30 Exh. 5, 2.
31 4 Colliers on Bankruptcy ¶ 523.12[1] (Alan N. Resnick & Henry J. Sommer eds.-in-chief, 16th
ed. rev. 2012).
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malicious can be excepted from discharge under the section.32 To fall within the
exception, the injury must have been both willful and malicious. An injury is malicious
when it is without just cause or excuse.33 “[T]he focus of the ‘malicious’ inquiry is on the
debtor’s actual knowledge or the reasonable foreseeability that his conduct will result in
injury to the creditor.”34 “‘Willful’ conduct is conduct that is volitional and deliberate
and over which the debtor exercises meaningful control, as opposed to unintentional or
accidental conduct.”35

None of the elements of the Georgia Judgment include findings that Plaintiffs’
injury resulted from conduct which was both willful and malicious. The fraud in the
inducement judgment relies upon evidence that Debtor made material misstatements and
had no intention of preforming when entering into the agreement with Plaintiffs. There is
no mention of either willfulness or maliciousness. Issue preclusion is not applicable to
Plaintiffs’ claim of exception of the fraud in the inducement judgment from discharge
under § 523(a)(6).

With respect to the punitive damage portion of the RICO claim, the Georgia court
found Debtor’s conduct was “intentional and wanton.” Although one could argue that
intentional and wanton conduct satisfies the willful requirement, there is absolutely no

32 Texas v. Walker, 142 F.3d 813, 823-24 (5th Cir. 1998), cited with approval in Sanders v.
Vaughn (In re Sanders), 210 F.3d 390, 2000 WL 328136 (10th Cir. 2000) (unpublished disposition).

33 4 Colliers on Bankruptcy at ¶ 523.12[2].

34 C.I.T. Financial Serv., Inc. v. Posta (In re Posta), 866 F.2d 364, 367 (10th Cir. 1989).

35 Id.

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finding relating to maliciousness. The judgment is silent as to the whether the Debtor had
actual knowledge or reasonable foreseeability that his conduct would result in injury to
the Cherrys. Since maliciousness is required to except the RICO judgment from
discharge under § 523(a)(6), Plaintiffs’ reliance on issue preclusion to except the RICO
judgment from discharge is rejected.

D. Should the Georgia Judgment be denied preclusive effect because Debtor
did not receive notice of the trial?
When denying Plaintiffs’ motion for summary judgment the Court examined

applicability of the doctrine of issue preclusion to the fraud in the inducement portion of

the Georgia Judgment. It stated:36

“When the issue previously litigated was litigated under state
law, a bankruptcy court will apply the law of collateral
estoppel of the relevant state.”37 Under Georgia law, a party
may only assert the doctrine of collateral estoppel against a
party to a prior proceeding if the issue was (1) raised in a
prior proceeding, (2) actually litigated and decided, and (3)
necessary to final judgment.38 A default judgment satisfies
the requirement that the judgment be on the merits.39

The Georgia Litigation with respect to the fraud judgment
satisfies the forgoing elements for issue preclusion. But the
Court is concerned that there are no uncontroverted facts
showing that Debtor knowingly allowed what appears to be
equivalent to a default judgment to be entered against him.

36 Dkt. 46, 6-7.
37 4 Collier on Bankruptcy at § 523.06; see 28 U.S.C §1738.
38 In re Camacho, 411 B.R. at 501, citing Boozer v. Higdon, 252 Ga. 276, 313 S.E.2d 100, 102

(1984).
39 Spooner v. Deere Credit, Inc., 244 Ga. App. 681, 682, 536 S.E.2d 581, 582 (2000).
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Further, there is nothing in the portion of the record of the
Georgia Litigation before this Court showing that Debtor,
who was pro se, had notice of the hearing which resulted in
the judgment. Some bankruptcy decisions applying Georgia
issue preclusion law have added the requirement that “the
party against whom preclusion is asserted must have had a
‘full and fair opportunity’ to litigate.”40 But this element does
not appear to have been expressly adopted by the Georgia
courts. However, the Georgia courts do follow the
Restatement (Second) of Judgments.41 In § 28, the
restatement addresses exceptions to the general rule of issue
preclusion.42 One of these exceptions is that the party “did
not have an adequate opportunity or incentive to obtain a full
and fair adjudication in the initial action.” The comments to
this provision of the restatement caution that such a “refusal
to give the first judgment preclusive effect should not occur
without a compelling showing of unfairness,” but confirm that
a court has discretion to deny preclusive effect to assure “fair
administration of preclusion doctrine.”43 The Court finds that
a more complete record of the Georgia Litigation is required
before it can be certain that this case is not one of those rare
circumstances where preclusive effect should be denied
because of lack of opportunity to obtain a full and fair
adjudication in the Georgia Litigation. Summary judgment
for nondischageability of the fraud judgment is therefore
denied.

The trial has provided the Court with a more complete record of the Georgia

Litigation. Debtor was served with the complaint, retained counsel, filed an answer and

counterclaim, and participated in the litigation from August 9, 2006 through March 30,

40 In re Camacho, 411 B.R. at 503.

41 Kent v. Kent, 265 Ga. 211, 212, 452 S.E.2d 764, 765 (1995) (citing Restatement (Second) of
Judgments § 27(1982)).

42 Restatement (Second) of Judgments § 28 (1982).

43 Id., comment j.

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2007, when his counsel withdrew. Thereafter, Debtor monitored the case through the online
information provided by the court; he stopped monitoring the case after reading the
docket entry for March 13, 2008, which stated “dismissal order.” He either did not read
or did not find significant the entry immediately preceding the March 13, 2008 entry,
dated February 19, 2008 stating “notice of stay in bankruptcy - re taulbee, andrew judson
& taulbee, tiffany jones.” Debtor interpreted March 13, 2008 “dismissal order” entry to
mean that the entire case was dismissed, but took no action to verify his interpretation.

The Court’s primary concern is that Debtor did not receive notice of the July, 2008
trial setting.44 Plaintiffs’ Georgia counsel testified that he received notice of the setting
by mail approximately 30 days before trial and similar notice would have been sent to
Debtor at his address as shown in the Court records. There is no evidence or other reason
for this Court to conclude that notice was not attempted.45 It is required by O.C.G.A. 911-
40(c). As to service, O.C.G.A. 9-11-5 provides that service upon a party shall be made
by mailing to the person to be served at the person’s last known address and that service
is complete upon mailing. Debtor’s last known address as stated on the docket sheet in
evidence was 951 Fernbank Lane, Dacula, GA. Debtor’s non-receipt of notice is fully

44 The parties did not offer evidence to explain how a case for jury trial was requested and for
which jury calendar call was last stated on the docket sheet on April 21, 2008, came to be heard by a
judge on July 22, 2008.

45 The record includes a copy of a large envelope (without the contents) mailed by the Georgia
court to Debtor at the address stated on the docket sheet mailed first class on March 27, 2008 and returned
as undeliverable as addressed and no forwarding address provided. Plaintiffs’ Georgia counsel’s
uncontroverted testimony is that this envelope did contain notice of the trial, because it was sent several
months before the July 22, 2008 trial date and such notices are generally sent approximately 30 days
before trial.

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explained by the fact that this was not Debtor’s correct address in July, 2008. Debtor had
not resided at the Dacula address since at least April, 2005, so there is not reason to
believe that mail sent to that address would have been forwarded to Debtor. There is no
evidence when the address error occurred. Debtor’s residence was correctly stated in the
complaint, and he was served at that address. The address on the docket sheet is the same
as that stated in the withdrawal pleadings filed by Debtor’s attorney. Despite the
continuation of the litigation during the year intervening between withdrawal of his
counsel and the dismissal entry, Debtor testified that he received no notices and was not
served with any court documents. Nevertheless, Debtor made no inquiries concerning the
litigation and made no attempt to assure that the record included his correct address.
Under Georgia law, a litigant’s failure to receive notice of trial is not a basis to set aside a
judgment when the lack of notice is the result of the defendant’s own failure to advise the
court of his correct address.46

The Court finds that there is not a compelling showing of unfairness which would
preclude Plaintiffs’ reliance on the doctrine of issue preclusion. Debtor knowingly did
not participate in the Georgia Litigation after the withdrawal of his counsel and took no

46 Sterling Motor Freight Co., Inc. v. Wendt, 156 Ga. App. 516, 517, 275 S.E.2d 101, 103 (1980)
(where defendant was aware that case was pending and ready for trial, defendant himself discharged his
attorneys, and defendant made it impossible to be reached by moving out or state and leaving no
forwarding address, defendant could not complain that trial proceeded in his absence); Stewart v.
Williams, 164 Ga. App. 117, 296 S.E.2d 416 (1982) (default judgment not set aside where defendant did
not have actual notice of trial but clerk of the court testified that notice by mail was provided); cf. Shelton

v. Rodgers, 160 Ga. App. 910, 288 S.E.2d 619 (1982) (default set aside where defendant did not receive
notice of trial because jury trial notice was sent by clerk to defendant’s former address after his counsel
had withdrawn and supplied clerk with defendant’s current address).
19

Case 11-05103 Doc# 64 Filed 04/10/13 Page 19 of 22

action to verify his understanding that he was no longer at risk of judgment after the
March 13, 2008 dismissal order. Even if, as Debtor testified, he was not aware that the
Georgia Court misstated his address on the docket sheet, a person acting diligently to
protect his interests would have made inquiry when he had not received any notices after
the withdrawal of his counsel. The lack of notice of trial, although not solely Debtor’s
fault, could have been avoided if Debtor had been more attentive to his affairs. The result
was a significant judgment which Debtor has not sought to have set aside.

Plaintiffs have provided the Court with citations to Bankruptcy court decisions
applying Georgia law of issue preclusion in dischargeability litigation which fully support
the Court’s holding that issue preclusion applies in this case. Debtor, on the other hand,
has provided no case law supporting his position on the issue preclusion question.
Camcho47 is a case cited by Plaintiffs. In Camcho, as in this case, debtor participated in
the early stages of fraud litigation through counsel, requested his counsel to withdraw, did
not appear for trial, and had fraud judgment entered against him. The court held that
issue preclusion applied under Georgia law. The court found that the full and fair
opportunity element of issue preclusion was in effect a due process requirement, which is
an unspoken element of collateral estoppel, and that due process was accorded debtor.
“Debtor knew about the case, had the opportunity to litigate, and did so for a time. He
then decided not to participate for practical reasons, but not a reason which suggest that

47 In re Camacho, 411 B.R. at 496. Additional Georgia Bankruptcy Court decisions cited by
Plaintiffs are: In re Whelan, 236 B.R. 495 (Bankr. N.D. Ga. 1999) modified 245 B.R. 698 (N.D. Ga.
2000); and In re Hooks, 238 B.R. 880 (Bankr. S.D. Ga. 1999).

20

Case 11-05103 Doc# 64 Filed 04/10/13 Page 20 of 22

due process was not accorded him.”48 An opportunity to participate is not negated by the
“decision to disregard or avoid that opportunity.”49

CONCLUSION.

The Court therefore holds that issue preclusion applies to Plaintiffs’ contention
that discharge of the Georgia Judgment of $67,757.00 for fraud in the inducement is
barred under § 523(a)(2)(A), but not under § 523(a)(6). The amount excepted from
discharge includes all liability arising from the fraud in the inducement.50 The Court
therefore holds that amount excepted from discharge includes post-judgment interest on
$67,757.00 at 8% per year from the date of the judgment to February 14, 2011, the date of
Debtor’s filing for bankruptcy relief. The Georgia Judgment includes $19,500.00 for
attorneys fees and $130.00 court costs, but because there are no findings that these
amounts are recoverable as part of the liability for fraud in the inducement, they are not
included in the amount excepted from discharge. The Georgia Judgment for RICO
damages is not excepted from discharge based upon issue preclusion because that portion
of the Georgia Judgment does not reflect the elements required for exceptions to
discharge under §§ 523(a)(2)(A) or (a)(6).

The foregoing constitute Findings of Fact and Conclusions of Law under Rule
7052 of the Federal Rules of Bankruptcy Procedure which makes Rule 52(a) of the

48 Id. at 503.

49 Id., citing In re Hooks, 238 B.R. 880, 86-87 (Bankr. S. D. Ga. 1999).

50 Cohen v. De La Cruz, 523 U.S. at 213.

21

Case 11-05103 Doc# 64 Filed 04/10/13 Page 21 of 22

Federal Rules of Civil Procedure applicable to this proceeding. A judgment based upon
this ruling will be entered on a separate document as required by Federal Rule of
Bankruptcy Procedure 7058 which makes Federal Rule of Civil Procedure 58 applicable
to this proceeding.

IT IS SO ORDERED.
###

22

Case 11-05103 Doc# 64 Filed 04/10/13 Page 22 of 22

 

12-06043 Redmond, Trustee v. NCMIC Finance Corp (Doc. # 37)

Redmond, Trustee v. NCMIC Finance Corp, 12-06043 (Bankr. D. Kan. Mar. 13, 2013) Doc. # 37

Click here for the pdf document.

---

SO ORDERED.
SIGNED this 13th day of March, 2013.

 

 

Designated for print publication
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS

In Re:

BROOKE CORPORATION, et al.,
DEBTORS.

CHRISTOPHER J. REDMOND,
Chapter 7 Trustee of Brooke
Corporation, Brooke Capital
Corporation (f/k/a Brooke Franchise
Corporation), and Brooke Investments,
Inc.,

PLAINTIFF,

v.
NCMIC FINANCE CORPORATION,

DEFENDANT.

CASE NO. 08-22786
CHAPTER 7

ADV. NO. 12-6043

MEMORANDUM OPINION AND ORDER
GRANTING NCMIC FINANCE CORPORATION’S
MOTION FOR SUMMARY JUDGMENT ON COUNT V

Case 12-06043 Doc# 37 Filed 03/13/13 Page 1 of 23

In Counts IV and V of the Complaint, Plaintiff Christopher J. Redmond, Chapter 7
Trustee (Trustee) of Debtors Brooke Corporation, Brooke Capital Corporation, and
Brooke Investments, Inc., seeks to avoid allegedly fraudulent transfers made by the
Debtors and to recover the value thereof from NCMIC Finance Corporation (NCMIC).
NCMIC moves for summary judgment under Federal Rule of Civil Procedure 56, made
applicable to this proceeding by Federal Rule of Bankruptcy Procedure 7056, on Count V
of the Complaint. The motion presents the question whether, under the facts alleged in
the Complaint, NCMIC is “an entity for whose benefit” the allegedly fraudulent transfers
were made, within the meaning of 11 U.S.C. § 550(a)(1).1 After carefully considering the
pleadings and the oral arguments of counsel,2 the Court finds that summary judgment on
Count V should be granted.
THE COURT WILL REGARD THE MOTION AS ONE FOR SUMMARY
JUDGMENT.

Before reaching the merits, the Court must decide whether the motion should be
regarded as one for summary judgment under Rule 56 or as one for judgment on the
pleadings under Rule 12. NCMIC filed the motion under Rule 56 before any discovery
was completed and relied almost exclusively upon the allegations of the Complaint. In
response, the Trustee contended that the motion should be considered as one for judgment
on the pleadings under Rule 12(c) and presented additional allegations from the

1 Future references to Title 11 in the text shall be to the section number only.
2 The Trustee appears by Michael D. Fielding of Husch Blackwell LLP. NCMIC appears by Paul

D. Sinclair of Polsinelli Shughart PC.
2
Case 12-06043 Doc# 37 Filed 03/13/13 Page 2 of 23

Complaint. But, recognizing that the Court could consider the motion as one for
summary judgment as presented by NCMIC, the Trustee also included additional
statements of allegedly uncontroverted facts supported by copies of the contracts which
determined the relevant relationships between Brooke, its franchisees, Aleritas (who
loaned money to the franchisees), and NCMIC, who purchased interests in the Aleritas
loans.

As urged by the Trustee, because NCMIC relies upon the allegations of the
Complaint (with the exception of paragraph 23 of the statement of uncontroverted facts,
which the Court finds to be irrelevant), the motion could be regarded as one for judgment
on the pleadings under Rule 12(c). However, NCMIC characterizes the motion as one for
summary judgment, and when responding to the motion, the Trustee provided facts not
included in the Complaint, to be considered if the Court treats the motion under Rule 56.
Rule 12(d) provides that if, on a motion under Rule 12(b)(6) or 12(c), matters outside the
pleadings are presented to and are not excluded by the court, the motion must be treated
as one under Rule 56. The Court wishes to consider the contracts submitted by the
Trustee in his response to NCMIC’s motion and therefore will treat the motion under
Rule 56.

The Court will therefore apply the well-known standards for ruling on motions for
summary judgment. Contrary to the Trustee’s argument, the decision to treat the motion
under Rule 56 rather than Rule 12 does not impact the applicable standard as “the

3

Case 12-06043 Doc# 37 Filed 03/13/13 Page 3 of 23

standard applied by the court appears to be identical under” either Rule 12(c) or Rule 56.3
Since the issue presented is the construction of § 550 in light of the uncontroverted facts
regarding the conduct of Brooke’s franchise business, summary judgment is appropriate if
NCMIC is entitled to judgment as a matter of law.4

This ruling that the motion shall be governed by Rule 56 makes it necessary for the
Court to consider NCMIC’s objections to the Trustee’s additional statements of fact.
NCMIC objects to the additional statements from the Complaint on the grounds they are
irrelevant and were not submitted in compliance with Rule 56. The Court overrules these
objections. It finds the statements from the Complaint are relevant to understanding
Brooke’s franchise operations, and they are not controverted by NCMIC. The additional
portions of the Complaint would clearly be properly before the Court if the Court were
proceeding under Rule 12. Also, under Rule 56(c)(3), the Court could consider the
additional allegations from the Complaint even if they had not been cited by either of the
parties. The Court will therefore consider the additional allegations as providing a fuller
background for understanding the allegations of the Complaint on which NCMIC relies,
and the transactions in issue.

NCMIC also objects to the Trustee’s statements of fact discussing the contracts,
copies of which are attached to the Trustee’s response. Those contracts, alleged to be

3 5C Charles Alan Wright & Arthur R. Miller, Federal Practice and Procedure: Civil, § 1369 at
261-62 (3rd ed. 2004).

4 Rule 56(a); Celotex Corp. v. Catrett, 477 U.S. 317, 322 (1986); note: in 2010, the “entitled to
judgment” language was moved from subdivision (c) to (a).

4

Case 12-06043 Doc# 37 Filed 03/13/13 Page 4 of 23

representative of many others, are a franchise agreement, a promissory note between
Aleritas and a franchisee, a security agreement executed in conjunction with the note, a
collateral preservation agreement, and a participation agreement. NCMIC contends the
statements are not submitted in accord with the requirements of Rule 56. This objection
is well founded. The Trustee did not support his discussion by affidavit, deposition
testimony, or other materials of evidentiary value. Those purported statements of fact
will be stricken. However, because, as NCMIC has acknowledged, the contract
documents speak for themselves, the documents will be considered.

THE UNCONTROVERTED FACTS.

Although there are many unknown or disputed issues of fact about the very large
numbers of transfers which the Trustee seeks to avoid, the motion presents only a
question of law about the construction of § 550(a)(1). This determination can be made
based upon the facts as alleged in the Complaint and as shown in the contract documents.
They are as follows.

The Brooke group of companies was involved in many aspects of insurance and
insurance-related businesses, including a network of insurance franchisees and agents.
The parent company was Debtor Brooke Corporation (Brooke Corp.). Debtor Brooke
Capital Corporation (Brooke Capital), a majority-owned subsidiary of Brooke Corp.,
owned 100% of Debtor Brooke Investments, Inc. The three Brooke Debtors will be
referred to collectively as Debtors. Another relevant majority-owned subsidiary of
Brooke Corp. was non-debtor Brooke Credit Corporation, d/b/a Aleritas Capital

5

Case 12-06043 Doc# 37 Filed 03/13/13 Page 5 of 23

Corporation (Aleritas). Aleritas was engaged in lending money to Brooke franchisees
and other insurance agents.

Defendant NCMIC, which began its relationship with Brooke in 1998, initially
fulfilled a “warehouse” financing role for Brooke agency franchise loans, holding the
loans until they were securitized or sold to community banks. Later, NCMIC provided
other services and purchased various participation interests in loans which Aleritas made
to Brooke agents.

Brooke conducted its insurance business through a network of franchise and
company-owned locations. The franchise agreement provided by the Trustee is
representative of the arrangements. Brooke Capital acted as franchisor. Pursuant to the
franchise agreements, the franchisees agreed to pay franchise fees and to provide Brooke
a percentage (usually 15%) of their sales commissions going forward. In return, Brooke
agreed to provide ongoing franchise services throughout the life of the franchise
relationship, including, but not limited to, “cash managements services” such as billing
and collecting insurance premiums, remitting premiums to the respective carriers,
receiving and allocating commission revenues, and receiving and processing agency-
related bills (including bills relating to rent, utilities, advertising, service providers, etc.).
Brooke controlled most of the cash flows for its franchise agencies. Its business practice
was to pay most of the rent and other operating expenses for its agents, including loan
payments, and to charge those payments (along with the percentage of ongoing

6

Case 12-06043 Doc# 37 Filed 03/13/13 Page 6 of 23

commission revenues and recurring franchise fees) to the agents’ monthly statements as
offsets to the commission revenues earned.

When franchise agencies were acquired, the acquisition costs, the franchise fees,
and, often, additional working capital would typically be financed through Brookes’
lending subsidiary, Aleritas. Each loan was evidenced by a promissory note, such as the
one provided by the Trustee, and under the terms of a commercial security agreement,
was secured by all of the assets of the franchisee. In conjunction with each loan, Brooke
Capital and Aleritas entered into a Collateral Preservation Agreement, under which
Brooke Capital would provide services to franchisees to assure that they continued in
business, thereby preserving the value of Aleritas’ collateral. After Aleritas made loans
to franchisees, it would sell the loans in one of two ways: (1) by selling participation
interests in the individual loans to local banks or investors; or (2) by bundling loans and
selling them as part of securitizations.

Under the terms of the participation agreements, Defendant NCMIC purchased
various participation interests in Brooke franchisee/agent loans originated by Aleritas.
Aleritas continued to service the loans after selling them to NCMIC. Aleritas repurchased
some participation interests from NCMIC; some loans remain outstanding and are owed
by the franchisees/agents.

Brooke was under “tremendous pressure” for all the loans to perform because its
business model depended on a continuous stream of willing buyers for its loans. But a
large number of Brooke franchisees either underperformed or completely failed to

7

Case 12-06043 Doc# 37 Filed 03/13/13 Page 7 of 23

perform in the months preceding the Debtors’ bankruptcy filings. The Trustee alleged
that when a franchisee underperformed or had insufficient commission income to cover
its loan payments, Brooke Capital transferred its own funds to Aleritas, which, acting as a
mere conduit, made monthly loan payments that the underperforming or non-performing
agents owed on the various participated loans. The Trustee estimates that the total
amount of money transferred by Brooke Capital (via Aleritas) to NCMIC for payments on
loans which NCMIC owned in whole or in part was $5,682,083.97 (NCMIC Loan
Payments). With respect to the Brooke franchisees whose loans were held at least in part
by NCMIC, the Trustee alleges that Brooke Capital paid expenses (Operating Expense
Transfers) totaling $22,306,633.62. The Trustee alleges that Brooke Capital also paid
loan obligations of these Brooke franchisees to lenders other than NCMIC (Other Lender
Transfers) totaling $17,005,570.89.

Details concerning these transfers are shown in Exhibit 1 to the Complaint. In 211
pages, it sets forth with respect to each loan in which NCMIC held a participation
interest, the related agency number and the relevant transfers. The first 41 pages cover 41
agencies, so the total number of agencies is estimated to be 211. Each page contains
about 25 transfers, so the total number of transfers in issue is approximately 5,275.5 The
information is detailed. For example, for agency number 801, the exhibit reflects that it
operated from two locations, and was obligated on Aleritas loan number 3694 for

5 The exhibit lists the transfers by month but does not reveal whether each monthly amount is
itself comprised of more than one transfer.

8

Case 12-06043 Doc# 37 Filed 03/13/13 Page 8 of 23

$476,044, in which NCMIC purchased an interest on December 28, 2004. For each of the
25 months between January 15, 2005, and January 15, 2007, the exhibit shows the agency
revenue, franchise fee, adjusted revenue, net revenue, loan payments, net cash flow,
Operating Expense Transfers, Other Loan Transfers, and NCMIC Loan Payments. In just
one month, January 2005, the transfers on behalf of agency 801 for the three categories of
transfers which the Trustee seeks to recover are alleged to total $116,072.73, comprised
of $76,607.00 for Operating Expense Transfers, $35,144.75 for Other Lender Transfers,
and $4,320.98 for NCMIC Loan Payments.

Count IV of the Complaint alleges that the NCMIC Loan Payments totaling
$5,682,083.97 were transferred by Brooke Capital to NCMIC (via Aleritas) and were
constructively fraudulent transfers under §§ 544 and 548(a)(1)(B) of the Bankruptcy
Code and under K.S.A. 33-204(a)(2)6 and 33-205(a). Recovery from NCMIC is sought
under Bankruptcy § 550 and K.S.A. 33-207, as the initial transferee or a subsequent
transferee. In Count V, the Trustee alleges that the Operating Expense Transfers totaling
$22,306,633.62 and the Other Lender Transfers totaling $17,005,570.89 were likewise
constructively fraudulent transfers under §§ 544 and 548(a)(1)(B) of the Bankruptcy
Code and under K.S.A. 33-204(a)(2)7 and 33-205(a). It is alleged that even though the
payments were made to third parties, these transfers may be recovered from NCMIC

6 The Complaint actually gives 33-204(2) — which does not exist — as the statute number, but
clearly intends to cite 33-204(a)(2).
7 Again the statute number is given as 33-204(2) instead of 33-204(a)(2).
9

Case 12-06043 Doc# 37 Filed 03/13/13 Page 9 of 23

under Bankruptcy § 550 and K.S.A. 33-2078 because NCMIC benefitted from the
transfers. NCMIC seeks summary judgment on Count V, but not on Count IV. The
Trustee acknowledged at oral argument that Count V is an alternative to Count IV, since
the total recovery from NCMIC under Counts IV and V is capped at $5,682,083.97.

DISCUSSION.

A. The Positions of the Parties.
In Count V, the Trustee contends, assuming the Operating Expense Transfers and
the Other Lender Transfers are set aside as fraudulent, that they may be recovered from
NCMIC as a “transfer beneficiary” under § 550(a)(1) since it was “the entity for whose
benefit such transfer was made.” The Complaint alleges the payment of the franchisees’
expenses benefitted NCMIC “because it enabled the agents to continue operating and
thereby preserved the underlying collateral value which secured” NCMIC’s loans and
“because, in certain instances, it enabled underperforming agencies to become profitable
and thereby continue making monthly loan payments to NCMIC without additional
‘subsidization’ by Brooke Capital.”9 At oral argument, counsel for the Trustee
unequivocally stated that the theory of recovery under Count V is that the transfers
benefitted NCMIC in three respects: (1) the collateral for the participated loans held by

8 Despite the allegation that the transfers may be recovered under K.S.A. 33-207, the Trustee did
not raise this state law remedy in response to NCMIC’s motion for summary judgment. The Court finds
that reliance on K.S.A. 33-207 to support a right to relief against NCMIC under Count V has been
waived.

9 Dkt. 1, Complaint ¶103.

10

Case 12-06043 Doc# 37 Filed 03/13/13 Page 10 of 23

NCMIC remained viable and intact; (2) NCMIC continued to get loan payments because
the franchisees continued in business; and (3) NCMIC was paid face value by Aleritas
when it repurchased some participation interests while the loans were performing and not
in default. NCMIC responds that as a matter of law the Trustee cannot recover from it as
a transfer beneficiary because: (1) the Trustee has not avoided, and cannot now avoid
(because of the statute of limitations), the transfers made to the initial transferees; and

(2) NCMIC is not “the entity for whose benefit such transfer was made” under
§ 550(a)(1).
B. NCMIC Is Not Entitled to Summary Judgment on the Theory that the
Trustee Has Not Avoided the Transfers.
The Court finds that NCMIC’s first argument is without merit. NCMIC argues,
based upon the decision of the Tenth Circuit Court of Appeals in Slack-Horner, 10 that the
Trustee may not recover the transfers from NCMIC because he has not avoided the
transfers from Brooke to the third parties. NCMIC also argues that any such avoidance
action would now be time barred.

In Slack-Horner, as a result of the debtor’s failure to pay property taxes, the taxes
became a lien on the debtor’s real property. The lien was sold at a public sale to Simons.
When the debtor failed to timely redeem, Simons received a treasurer’s deed. The debtor
filed for relief within one year, and the trustee brought an action alleging that the transfer
of the property to Simons was voidable as a fraudulent conveyance. Both the bankruptcy

10 Weinman v. Simons (In re Slack-Horner Foundries Co.), 971 F.2d 577, 580 (10th Cir. 1992).
11

Case 12-06043 Doc# 37 Filed 03/13/13 Page 11 of 23

court and the district court found the trustee could not avoid the transfer. On appeal, the
Tenth Circuit affirmed. Contrary to the trustee’s characterization of the transfer to be
avoided as being between the debtor and Simons, the Tenth Circuit held that the debtor’s
interest was transferred from the debtor to the state at the public sale and the state then
transferred the state’s interest to Simons. Therefore the state was the initial transferee
under the § 550, and Simons was considered an immediate transferee of the initial
transferee. The Tenth Circuit then held that although § 550 authorized the trustee in
certain circumstances to recover the value of the property transferred from either the
initial transferee or a subsequent transferee, “in order to recover from a subsequent
transferee the trustee must first have the transfer of the debtor’s interest to the initial
transferee avoided under §548.”11 Since the trustee had made no attempt to have the
transfer from the debtor to the state avoided, the trustee could not demonstrate any basis
for recovering the property from Simons. Slack-Horner therefore stands for the rule that
avoidance of the initial transfer is necessary before the transfer can be recovered from a
subsequent transferee.

But Slack-Horner does not apply to this case. There are three categories of
persons from whom recovery can be made under § 550(a): (1) the initial transferee;

(2) the party for whose benefit the transfer was made; and (3) any immediate or mediate
transferee of the initial transferee (subsequent transferees). Slack-Horner applies to
11 Id. at 580.
12

Case 12-06043 Doc# 37 Filed 03/13/13 Page 12 of 23

subsequent transferees. In this case, the Trustee seeks to recover the transfers from
NCMIC as a transfer beneficiary, not as a subsequent transferee. The Court declines to
extend Slack-Horner to transfer beneficiaries. As this Court has previously observed,
Slack-Horner is a minority position, and the argument that it was wrongly decided is
attractive.12 Further, the Trustee is not seeking to recover from NCMIC without an
adjudication that the transfers are avoidable; in Count V, the Trustee seeks both to avoid
the transfers as fraudulent transfers and to recover from NCMIC.

C. NCMIC Is Entitled to Summary Judgment Because as a Matter of Law
NCMIC Is Not a Transfer Beneficiary.
NCMIC’s next argument, that as a matter of law, it is not a transfer beneficiary of
the third-party payments, has merit.

The phrase “the entity for whose benefit the transfer was made” is ambiguous.
Must the transferor intend to confer a benefit on the transferee? What type of benefit
must be received? How directly must it be related to the avoided transfer? The Code
does not define the conditions for transfer-beneficiary liability, there is no relevant
legislative history, and the liability of a person for whose benefit the transfer was made
had not been codified in prior bankruptcy law. Nevertheless, prior to enactment of the
Code, “[c]ourts . . . permitted trustees to recover from nontransferees who had received

12 Reiderer v. Logan Wildlife Corp. (In re Brooke Corp.), 443 B.R. 847, 853-55 (Bankr. D. Kan.

2010).

13

Case 12-06043 Doc# 37 Filed 03/13/13 Page 13 of 23

the actual benefit of the transfers.”13 Preference recovery was permitted “from
guarantors, sureties, or indorsers of notes even though such parties were not transferees
and had not taken any action to procure payment to the holder of the debt.”14 As to
fraudulent transfers, courts allowed recovery from benefitted parties, but courts “applying
pre-Code law steadfastly rejected attempts by bankruptcy trustees to impose liability on
parties merely because they had conspired with, or aided and abetted, the debtor.”15

Mack v. Newton, 16 a 1984 Fifth Circuit Court of Appeals decision, is an example.
The case concerned the financing of a dairy cattle operation, Dairyland Inc. The trustee
alleged that two principals of Dairyland and Equico, a lender to Dairyland and Dairy
Cows, another business controlled by the Dairyland principals, were liable for the
fraudulent transfer of Dairyland cows mortgaged to Equico where the proceeds were not
applied to the Dairyland secured debt. A jury found in favor of the trustee. On appeal,
the Fifth Circuit considered the right of the trustee to recover the value of the fraudulent
transfers from the principals and Equico. The court started its analysis by stating the
general rule under the Act that “one who did not actually receive any part of the property
fraudulently transferred . . . will not be liable for its value, even though he may have

13 Larry Chek and Vernon O. Teofan, The Identity and Liability of the Entity for Whose Benefit a
Transfer Is Made Under Section 550(a): An Alternative to the Rorschach Test, 4 J. Bankr. L. & Prac. 145,
150 (1995).

14 Id.

15 Id. at 151.

16 Mack v. Newton, 737 F.2d 1343 (5th Cir. 1984).

14

Case 12-06043 Doc# 37 Filed 03/13/13 Page 14 of 23

participated or conspired in the making of the fraudulent transfer.”17 It approvingly

quoted the following rationale for this rule from the Ninth Circuit’s decision in Elliott:

The purpose of those sections of the Bankruptcy Act

which are here relevant is clearly to preserve the assets of the

bankrupt; they are not intended to render civilly liable all

persons who may have contributed in some way to the

dissipation of those assets. The Act carefully speaks of

conveyances of property as being ‘null and void,’ and

authorizes suit by the trustee to ‘reclaim and recover such

property or collect its value.’ The actions legislated against

are not ‘prohibited’; those persons whose actions are rendered

‘null and void’ are not made ‘liable’; and terms such as

‘damages’ are not used. The legislative theory is cancellation,

not the creation of liability for the consequences of a wrongful

act.18

It then noted that there is “an exception to the general Elliott rule for those cases in which

a person does not actually directly receive the transferred property, but nevertheless

indirectly receives it or receives its proceeds or value.”19 Applying these considerations

to the Dairyland transfers, the court affirmed a judgment against the principals and

Equico with respect to 188 cows mortgaged to Equico which were transferred from

Dairyland to Dairy Cows and thereafter sold by Dairy Cows to third parties, with the

proceeds going to Equico and being applied to Dairy Cows’, rather than Dairyland’s,

debt. However, it reversed the judgment as to 275 Dairyland cows mortgaged to Equico

17 Id. at 1357.

18 Elliott v. Glushon, 390 F.3d 514, 516 (9th Cir. 1967); quoted in Mack v. Newton, 737 F.2d at
1358.

19 737 F.2d at 1358.

15

Case 12-06043 Doc# 37 Filed 03/13/13 Page 15 of 23

which were sold at auction to third parties by Dairyland for cash which was deposited in
the Dairyland bank account and used in its operations, rather than to pay its debt to
Equico. The Fifth Circuit rejected the trustee’s argument that although the defendants did
not receive the proceeds, they “received a benefit from the fact that these funds helped
Dairyland continue to operate.”20 It stated:

[S]uch a benefit does not suffice to take the situation out of
the Elliott rule. . . . The exceptions are essentially consistent
with this “disgorging” approach: one must return what one
has wrongfully received. The Trustees’s theory is
inconsistent with this: it is based on an incidental,
unquantifiable, and remote benefit bearing no necessary
correspondence to the value of the property transferred or
received. Hence it essentially is no more than “the creation of
liability for the consequences of a wrongful act.”21

The enactment of § 550(a)(1) of the Bankruptcy Code codified the concept that
one who benefitted from an avoided transfer may be liable to the estate, even though the
person or entity was not the recipient of the transferred property. The archetypical
example of an “entity for whose benefit such transfer was made” occurs where the debtor
pays its creditor and thereby reduces the personal liability of a guarantor of the debt.22
Even though the guarantor does not receive the payment, the guarantor gets the benefit of
the transfer because the guarantor’s liability has been extinguished by the payment.

20 Id. at 1359.
21 Id. at 1359-1360.
22 E.g., Bonded Fin. Servs., Inc. v. European Am. Bank, 838 F.2d 890, 895 (7th Cir. 1988); Terry

v. Meredith (In re Meredith), 527 F.3d 372, 375 (4th Cir. 2008); Reily v. Kapila (In re International
Mgmt. Assocs.), 399 F.3d 1288, 1292 (11th Cir. 2005).
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“[N]othing in the text of § 550(a)(1) limits ‘the entity for whose benefit’ the transfer was
made only to a debtor or guarantor.”23

The issue here is to determine and apply the criteria for liability of a transfer
beneficiary under § 550(a)(1). There are no Tenth Circuit Court of Appeals or
Bankruptcy Appellate Panel decisions construing “the entity for whose benefit such
transfer was made” as used in § 550(a)(1). Both the Trustee and NCMIC direct the Court
to the McCook decision, which rejects intent to benefit as sufficient for transfer
beneficiary liability, and holds that “transfer beneficiary status depends on three aspects
of the ‘benefit’: (1) it must actually have been received by the beneficiary; (2) it must be
quantifiable; and (3) it must be accessible to the beneficiary.”24 The disgorgement-based
understanding of recovery, as discussed in Mack, is the basis for each of these three
elements. When requiring an actual benefit and not merely intent to benefit, the McCook
decision cited Mack and agreed with the observation of commentators that “fraudulent
transfer recovery is a form of disgorgement, so that no recovery can be had from parties
who participated in a fraudulent transfer but did not benefit from it.”25 The requirement

23 Meredith at 375; see also Citicorp N. Am., Inc. v. Official Comm. of Unsecured Creditors (In re
TOUSA, Inc.), 680 F.3d 1298, 1313 (11th Cir. 2012) (reduced liability of guarantor when debt is paid is
“not the only circumstance that can give rise to ‘for whose benefit’ liability”).

24 Baldi v. Lynch (In re McCook Metals, L.L.C.), 319 B.R. 570, 590 (Bankr. N.D. Ill. 2005).
When presenting its written arguments, NCMIC contended that debtor intent to benefit the transfer
beneficiary was also a necessary element. Dkt. 17 at 16-27. But at oral argument, NCMIC’s counsel did
not pursue that position and stated that upon further examination of the case law, he no longer understood
intent to benefit to be a necessary element. The Court therefore does not address the relevance of intent.

25 Id. at 591 (citing Chek and Teofan, The Identity and Liability of the Entity for Whose Benefit a
Transfer Is Made, 4 J. Bankr. L. & Prac. at 169).

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Case 12-06043 Doc# 37 Filed 03/13/13 Page 17 of 23

that the benefit be quantifiable was described as a “corollary to the disgorgement-based
requirement . . . . A merely theoretical benefit is not sufficient since it would not be
subject to disgorgement.”26 Likewise the accessible benefit requirement follows from the
disgorgement-based requirement, since “[e]ven if a quantifiable benefit is actually
received, it could not fairly be disgorged if the beneficiary never had access to it.”27
Turning to the facts before it, the bankruptcy court held that debtor McCook’s transfer to
another entity of the debtor’s contractual right to acquire a smelter, in an attempt to
protect this asset from the reach of McCook’s creditors, was a fraudulent transfer. As to
recovery, it applied the foregoing three criteria and held that Lynch, a man who controlled
both McCook and the transferee, was liable as the entity for whose benefit the transfer
was made. The court reasoned that Lynch received an actual benefit (his share of the
value of the assets on the date of transfer); that the benefit was quantifiable (since
testimony established a value of $11.1 million for the smelter); and that the value was
accessible (through Lynch’s control of the transferee).

As stated above, the Trustee’s theory of recovery is that NCMIC benefitted from
Brooke Capital’s transfers in three respects: (1) the collateral for the participated loans
held by NCMIC remained viable and intact; (2) NCMIC continued to get loan payments
because the franchisees continued in business; and (3) NCMIC was paid face value when
Aleritas repurchased some participation interests while the loans were performing and not

26 Id. at 591.

27 Id. at 592.

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Case 12-06043 Doc# 37 Filed 03/13/13 Page 18 of 23

in default. In support of its summary judgment motion, NCMIC argues that the benefit
allegations do not satisfy the McCook criteria. It contends that the Trustee’s “‘continuing
operations’ theory is based upon an alleged benefit to [NCMIC] that was, at best,
theoretical and amorphous” and that to the extent NCMIC benefitted at all, the benefit is
“neither quantifiable nor accessible” by NCMIC.28 The Trustee responds that the
transfers benefitted NCMIC because they “enabled NCMIC to continue receiving its
monthly loan payments because the other creditors did not take actions that would cause
the agency to cease operating.”29 According to the Trustee, the actual benefit is therefore
the monthly loan payments, which are both quantifiable and directly accessible because
they were received by NCMIC.

The Court will therefore examine each of the McCook aspects of benefit. The first
question is whether NCMIC actually received a benefit. This must be answered in light
of the disgorgement-based understanding of recovery of fraudulent transfers from those
benefitting from the transfer. The words “such transfer” in the phrase “the entity for
whose benefit such transfer was made” refers to the transfer avoided as a fraudulent
conveyance. Therefore, the benefit actually received must flow from the initial transfer
which is avoided.30 Here the transfers which the Trustee seeks to avoid are thousands of

28 Dkt. 17 at 24.

29 Dkt. 18 at 33-34. When making this argument in his written submission, the Trustee focuses
exclusively upon examination of a situation where an agency has sufficient funds to pay NCMIC’s loan
payments, but has insufficient revenues to make its other monthly payments. This is considered later in
this memorandum.

30 Bonded Fin. Servs., 838 F.2d at 896.

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Case 12-06043 Doc# 37 Filed 03/13/13 Page 19 of 23

transfers to creditors of hundreds of franchisees, whose loans from Aleritas were held by
NCMIC. The Trustee does not argue that NCMIC received a benefit from any single
transfer; he argues that the benefit derives from the cumulative effect of many transfers to
creditors of a franchisee. Under § 550(a)(1), it is the franchisees who benefitted from
“such transfers,” since as to each transfer, their liability to their creditors was diminished.
But under the Trustee’s continuation of business theory, NCMIC did not receive an actual
benefit from “such transfers” — the alleged benefit is a secondary result of the benefit to
the franchisees/agents. Also, under the Trustee’s continuation of business theory, the
second McCook requirement, that the benefit be quantifiable, is not satisfied.
Continuation of the franchisees/agents’ businesses is a theoretical and amorphous benefit
to which a monetary value related to the avoided transfers cannot be assigned. Likewise,
the benefit of continued operation of the franchises was not accessible to NCMIC. It
would not be fair to disgorge the transfers from NCMIC which benefitted, if at all, only
indirectly from the cumulative effect of the transfers.

In the Trustee’s brief opposing summary judgment, rather than relying upon the
general allegation that the benefit to NCMIC was the continuation of the
franchisees/agents’ businesses, as alleged in the Complaint and repeated at oral argument,
the Trustee focuses upon a more specific situation which he contends would satisfy each
of the McCook requirements. He states:

To illustrate the “indirect benefit” that NCMIC
received it is necessary to consider a situation where an agent
generates sufficient revenues to make its monthly loan

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Case 12-06043 Doc# 37 Filed 03/13/13 Page 20 of 23

payments to NCMIC but has insufficient monies to pays its
remaining monthly obligations (including operating expenses
and monies owed to other lenders). In that scenario, Brooke’s
payments to the third-parties created a direct benefit to
NCMIC because [they] enabled NCMIC to continue receiving
its monthly loan payments because the other creditors did not
take actions that would cause the agency to cease operating.
Thus, the first element of the McCook decision is met —
NCMIC received an actual benefit (i.e., its monthly loan
payments) from the revenues generated by the
agent/franchisee. Moreover, the monthly loan payment was
quantifiable and it was directly accessible because it was
received by NCMIC (thereby satisfying the second and third
elements of the McCook decision).31

In a footnote to this explanation, the Trustee makes the argument that summary judgment

should not be granted because discovery is required. He states:

Quantifying the exact dollar amount of that benefit
necessarily requires a fact intensive, in-depth loan-by-loan
review which will depend upon the monthly loan payments to
NCMIC as well other monies that Brooke paid to third-parties
on behalf of each agent/franchisee. Additionally, this will
require a review of all monies received by NCMIC with
respect to each loan (including monthly loan payments as well
as monies from the sale of any participated interests). This in-
depth, loan-by-loan review cannot be completed without
discovery which the Trustee has already commenced.32

The Court finds that this scenario does not change the foregoing analysis that the

Trustee’s claim alleged in Count V does not satisfy the McCook requirements or provide

a basis to deny summary judgment because there are material facts in dispute. Recovery

from NCMIC under the scenario presented relies upon the aggregate effect of the

31Dkt. 18 at 33-34.

32 Id. at 34, n. 10.

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allegedly fraudulent transfers to third-party creditors of the franchisees/agents. The
Trustee does not suggest that he would conduct discovery on a transfer-by-transfer basis.
And even if such an analysis were made, the making of a loan payment to NCMIC by an
agent/franchisee whose other creditors were paid would be the result of that
agent/franchisee’s independent decision to pay NCMIC; the third-party payments would
have made such payment possible but there would be no direct relationship between the
transfers and the payment to NCMIC. The alleged benefit to NCMIC would not “derive
directly from the transfer”33 and would bear “no necessary correspondence to the value of
the property transferred or received.”34 As stated by the Trustee, the transfers would have
simply “enabled” the payments to NCMIC. To adopt the Trustee’s theory would
dramatically expand the scope of § 550(a)(1) liable parties beyond those against whom
the disgorgement-based theory of recovery is applicable.

CONCLUSION.

For the foregoing reasons, the Court finds that, assuming the Operating Expense
Transfers and the Other Lender Transfers from Brooke Capital to third-party creditors of
the franchisees/agents who were liable on the notes in which NCMIC held participation
interests are avoidable as fraudulent transfers, NCMIC is not liable to the Trustee under
§ 550(a)(1) as an entity for whose benefit such transfers were made. There are no

33 Turner v. Phoenix Fin., LLC (In re Imageset, Inc.), 299 B.R. 709, 718 (Bankr. D. Me. 2003)
(citing Bonded Fin. Servs., 838 F.2d at 896).
34 Mack v. Newton, 737 F.2d at 1360.
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Case 12-06043 Doc# 37 Filed 03/13/13 Page 22 of 23

material facts in controversy, and NCMIC is entitled to judgment as a matter of law on
Count V of the Complaint.

The foregoing constitutes Findings of Fact and Conclusions of Law under Rule
7052 of the Federal Rules of Bankruptcy Procedure which makes Rule 52(a) of the
Federal Rules of Civil Procedure applicable to this proceeding.

IT IS SO ORDERED.
# # #

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Case 12-06043 Doc# 37 Filed 03/13/13 Page 23 of 23

 

09-22647 Creason (Doc. # 125)

In Re Creason, 09-22647 (Bankr. D. Kan. Apr. 3, 2013) Doc. # 125

Click here for the pdf document.

---

SO ORDERED.
SIGNED this 2nd day of April, 2013.

 

 

Designated for on-line use but not print publication
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS

In re:
ROGER ALLEN CREASON and CASE NO. 09-22647
PATRICIA GALE CREASON, CHAPTER 13
DEBTORS.

MEMORANDUM OPINION AND JUDGMENT
REGARDING TURNOVER OF ESTATE’S INTEREST IN
DEBTORS’ INTEREST IN GMC, LLC, AND
THE TRUSTEE’S OBJECTION TO GMC, LLC’S PROOF OF CLAIM

On September 20, 2012, the Court held an evidentiary hearing on two related
substantive matters: (1) The Chapter 13 Trustee’s objection to claim number 9 filed by
GMC, LLC (GMC);1 and (2) the Chapter 13 Trustee’s motion for turnover of the interest
of Debtors Roger Allen Creason and Patricia Gale Creason (Debtors) in GMC, comprised

1 Dkt. 28.

Case 09-22647 Doc# 125 Filed 04/02/13 Page 1 of 15

of proceeds of the liquidation of GMC.2 The Court has jurisdiction.3 Resolution of both
matters turns upon two matters: (1) the amount of GMC’s claim against Debtors as
guarantors of the obligations of Johnson County Drywall Supply, Inc. (Drywall), to
GMC; and (2) Debtors’ claim, as holders of one-third of the GMC membership interests,
in the proceeds of the liquidation of GMC’s assets. Having carefully considered the
evidence, the exhibits, the arguments and briefs of counsel, the Court holds that Debtors’
interest in GMC is $189,681.00, that GMC has a claim for $151,679.61 secured by
Debtors’ membership interest, and that the Trustee is entitled to turnover of $38,001.39,
the difference between the value of Debtors’ interest and Debtors’ liability.

FINDINGS OF FACT.

Debtors Roger and Patricia Creason are the sole owners of the stock of Drywall.
Drywall conducted its business on real property owned by GMC. Debtors also are the
owners of an undivided 1/3 interest in GMC.4 Two other individuals, Frank A. Glorioso
and William L. Morris, are also holders of undivided 1/3 interests in GMC. Until

2 Dkt. 57.

3 This Court has jurisdiction pursuant to 28 U.S.C. §§ 157(a) and 1334(a) and (b), and the
Standing Order of the United States District Court for the District of Kansas that exercised authority
conferred by § 157(a) to refer to the District’s bankruptcy judges all matters under the Bankruptcy Code
and all proceedings arising under the Code or arising in or related to a case under the Code, effective July
10, 1984. An objection to a proof of claim and a motion for turnover are core proceedings which this
Court may hear and determine as provided in 28 U.S.C. § 157(b)(2). There is no objection to venue or
jurisdiction over the parties.

4 Debtors’ interest in GMC is titled in the name of the Roger A. Creason and Patricia A. Creason
Revocable Trust. The distinction between Debtors and their trust is not material to the issues before the
Court and will be ignored.

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Case 09-22647 Doc# 125 Filed 04/02/13 Page 2 of 15

December 2007, Glorioso and Morris were also owners of Drywall stock, although they
had retired in approximately 2002.

On March 31, 2006, Drywall entered into a written lease with GMC. On
December 27, 2007, in conjunction with Glorioso and Morris’s entering into an
agreement for redemption of their Drywall stock, Drywall and GMC entered into an
amendment extending the lease for an additional thirty-three months. On the same date,
Debtors entered into a guaranty in favor of GMC, Glorioso, and Morris, personally
guarantying Drywall’s obligations to GMC under the lease as amended. Debtors agreed
to secure their personal guaranty by a pledge of their interest in GMC, and executed a
security agreement and a pledge agreement to accomplish this result. Also on that date,
Roger Creason, Gloriso, and Morris executed an amendment to the GMC operating
agreement providing that the rental income paid to GMC by Drywall would be distributed
on an equal basis to Glorioso and Morris for 48 months from January 1, 2008, and that
Roger Creason would not be entitled to receive any portion of such rental income.

On August 17, 2009, Debtors filed for protection under Chapter 13, and Drywall
filed for protection under Chapter 7. Drywall closed its business. Steve Rebein, the
Chapter 7 Trustee of Drywall, sold all of Drywall’s assets and vacated the leased
premises. The lease with GMC was rejected.

W.H. Griffin (Trustee) was appointed Chapter 13 Trustee in this bankruptcy.
Debtors’ Schedule B lists a 1/3 interest in GMC, estimated to have a value of $225,000.
On December 8, 2009, GMC filed a proof of claim for $66,600.75, which was amended
3

Case 09-22647 Doc# 125 Filed 04/02/13 Page 3 of 15

on April 30, 2012, to a secured claim of $221,600 for “breach of lease/guarantee.” On
January 26, 2010, the Trustee objected to GMC's proof of claim, stating it should not be
allowed because it “will be paid upon liquidation of Debtor’s interest in GMC, LLC.”5
On March 31, 2011, GMC sold its last asset, the premises leased to Drywall, for net
proceeds of $569,045.19. On April 5, 2011, the Trustee filed the motion for turnover of
Debtors’ interest in the sale proceeds.

Trial on the motion for turnover was combined with trial on the objection to
GMC’s proof of claim. At trial, GMC contended that Debtors’ debt to GMC based upon
their guaranty of the debts of Drywall and their share of GMC’s expenses exceeded their
interest in the sale proceeds, so that the Trustee’s motion should be denied. The Trustee
and Debtors contend that Debtors are owed $65,935 by GMC. Debtors claim their
interest in GMC’s assets exceeds their liability to GMC based upon: (1) a challenge to
some of the elements of GMC’s claim against them; and (2) a proposed construction of
the rent allocation provision in the amended operating agreement that would make it not
applicable to Debtors’ liability under the guaranty.
DISCUSSION.

GMC is being liquidated, and its only remaining asset is the net proceeds from the
sale of its real property. There is no dispute that Debtors, as the owners of a one-third

5 Dkt. 28.

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Case 09-22647 Doc# 125 Filed 04/02/13 Page 4 of 15

interest in GMC, are entitled to $$189,681.00, which is one-third of $569,045.19,6 the net
proceeds from the sale of GMC’s real property. The controversy is about the amounts
which should be offset from Debtors’ share for two general categories of claims:

(1) Debtors’ liability to GMC as guarantors of Drywall’s lease obligations; and
(2) Debtors’ liability for expenses of GMC.
A. Debtors’ Liability as Guarantors of Drywall’s Obligations under the GMC
Lease.
1. Debtors Personally Guarantied Drywall’s Lease Payments.
The guaranty unconditionally obligates Debtors to pay all amounts owing to GMC
under the lease between GMC and Drywall. When Drywall filed for bankruptcy relief, it
rejected the lease with GMC, the lease was terminated, and GMC as lessor became
entitled to damages. Debtors do not contest their liability for GMC’s damage claim, but
they do challenge the amount of that liability.

2. Drywall’s Liability to GMC Is Determined by State Law, Subject to the
Cap of 11 U.S.C. § 502(b)(6).
As stated above, Drywall, the lessee of GMC’s property, filed for relief under
Chapter 7. The lease was not assumed and was terminated. GMC asserts it was damaged
by Drywall’s termination of the lease. Under 11 U.S.C. § 502(b)(6), a lessor’s damage
claim is subject to a cap — it is disallowed to the extent that —

6 The Court is aware that 569,045.19 divided by 3 is actually 189,681.73, but the parties have not
concerned themselves with the extra 73 cents, and the Court will follow their lead.

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Case 09-22647 Doc# 125 Filed 04/02/13 Page 5 of 15

(6) if such claim is the claim of a lessor for damages resulting
from the termination of a lease of real property, such claim
exceeds —
(A) the rent reserved by such lease, without
acceleration, for the greater of one year, or 15 percent,
not to exceed three years, of the remaining term of
such lease, following the earlier of —
(i) the date of the filing of the petition; and
(ii) the date on which such lessor repossessed,
or the lessee surrendered, the leased property; plus
(B) any unpaid rent due under such lease, without
acceleration, on the earlier of such dates.
“In determining the landlord’s claim for rejection of a lease, the court should first

calculate the amount of the claim under applicable state law without application of any

bankruptcy limitation and then apply the cap under Code § 502(b)(6).”7

The Tenth Circuit has not addressed the meaning of “rent reserved by such lease”

under § 502(b)(6)(A), which defines the amount of the cap that is applicable in this case.

A leading test for determining the rent reserved was formulated by the Bankruptcy

Appellate Panel for the Ninth Circuit in McSheridan. 8 After thoroughly reviewing the

case law, the McSheridan court adopted the following three-part test for finding that a

charge constitutes “rent reserved,” which this Court finds to have been well reasoned.

1) The charge must: (a) be designated as “rent” or
“additional rent” in the lease; or (b) be provided as the
tenant’s/lessee’s obligation in the lease;

7 3 William L. Norton, Jr., and William L. Norton III, Norton Bankruptcy Law & Practice 3d,
§ 48:36 at p. 48-94 (Thomson Reuters/West 2012).

8 Kuske v. McSheridan (In re McSheridan), 184 B.R. 91 (9th Cir. BAP 1995), overruled in part on
other grounds Saddleback Valley Cmty. Church v. El Toro Materials Co. (In re El Toro Materials Co.),
504 F.3d 978, 981-82 (9th Cir. 2007).

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Case 09-22647 Doc# 125 Filed 04/02/13 Page 6 of 15

2) The charge must be related to the value of the
property or the lease thereon; and
3) [T]he charge must be properly classifiable as rent
because it is a fixed, regular or periodic charge.9
One of the cases cited was Rose’s Stores, 10 a decision of the Bankruptcy Court for the
Eastern District of North Carolina which had adopted a two-part test. That test requires
that “the charge must be provided for in the lease as the tenant’s obligation, though it
need not be denominated as rent,” and “the charge must be related to ‘the value of the
property and the value of the lease thereon.’”11 Under this test, charges “generally related
to the tenant’s use of the premises rather than to the value of the property or the leasehold
estate,” such as general maintenance and utilities, “should not be included in the
§ 502(b)(6) calculation.”12
Under § 502(b)(6), all of the damages claimed to have resulted from the
termination of the lease are subject to the cap, and claims for such damages in excess of
the cap are not allowed. However, a claim for rent due prepetition not resulting from the
termination is not subject to the cap.13 When presenting its damage claim in GMC exhibit
402, GMC states that its claim for expenses related to the breach of the lease are “Limited
to One Year Period Following Bankruptcy Filing.” GMC has thereby correctly

9 Id. at 99-100.

10 In re Rose’s Stores, Inc., 179 B.R. 789 (Bankr. E.D.N.C. 1995).

11 Id. at 791 (quoting In re Heck’s Inc., 123 B.R. 544, 546 (Bankr. S.D. W.Va. 1992)).

12 179 B.R. at 791.

13 11 U.S.C. § 502(b)(6)(B).

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Case 09-22647 Doc# 125 Filed 04/02/13 Page 7 of 15

acknowledged the applicability of the cap to Debtors’ liability as the guarantors of
Drywall’s lease obligations.14

At trial, GMC claimed that $196,949.4115 is owed as damages by Debtors for
termination of the lease. GMC’s claim is comprised of the following elements:

Lease payments for one year - Sept. 2009 to August 2010 $100,000.00

Real estate taxes (for 2008 through August 2010) 52,740.16

Utilities 550.00

Insurance 5,995.75

Legal and accounting 8,740.22

Maintenance/mowing/repairs 8,776.78

Building management 20,146.50
Debtors do not challenge the first four elements of these amounts claimed under state law.
Although they do challenge the last three elements, for the reasons explained below, the
Court need not determine if these amounts are owed under state law. The Court will
therefore apply the § 502(b)(6)(A) cap to the total damages GMC claims, $196,949.41.

The Court next determines the amount of “rent reserved” for purposes of the
§ 502(b)(6)(A) cap.16 The lease between Drywall and GMC obligates Drywall to pay a
base “rent” plus “additional rent,” defined to be “all charges required to be paid by Tenant

14 See In re Episode USA, Inc., 202 B.R. 691, 695-96 (Bankr. S.D.N.Y. 1996) (holding
§ 502(b)(6) applies to debtor-guarantors).

15 In its exhibit 402 admitted at trial, GMC claimed termination damages of $201,449.41, which
included total taxes of $57,240.16. In its post-trial brief, dkt. 113 at 4, GMC acknowledged that it made
an error in the amount of taxes by transposing two numbers and the correct amount of taxes is
$52,740.16, which makes the total claim $196,949.41.

16 In this case, all of the elements of the damage claim are amounts owed under the lease, so the
determination of the cap requires examination of the elements of the damage claim. In other
circumstances, the damages for termination could be measured in a different manner, such as profits lost
when, after the termination, the premises were leased to a third party.

8

Case 09-22647 Doc# 125 Filed 04/02/13 Page 8 of 15

under this Lease.”17 The additional charges which were the responsibility of Drywall
under the lease included utilities, taxes, maintenance and repair costs, insurance costs, and
legal costs, including attorney fees. Thus, all of the elements claimed by GMC satisfy the
first part of the McSheridan test. But only some of the elements satisfy the second part of
the test that they be related to the value of the real property or the lease. The elements of
monthly rent, taxes, and insurance satisfy this requirement, but the claims for utilities,
maintenance/mowing/repair, and building management relate to Drywall’s occupancy of
the premises, not to the value of the lease. In addition, the utilities,
maintenance/mowing/repair, and building management elements, as well as the charge for
legal and accounting expenses, do not satisfy the third part of the test because they are not
fixed, regular, or periodic payments due the landlord. GMC claims interest on past-due
payments, but interest, although provided for by the lease, is not the type of expense
included in the McSheridan test. Therefore, the Court concludes that only the claims for
one year of rent, taxes, and insurance are included in the cap on termination damages
imposed by § 502(b)(6)(A).

There is no dispute that the rent included in the cap is $100,000, the rent for one
year following termination of the lease. There is also no dispute that $5,995.75 is the
correct amount for insurance. Although the parties agree that the total taxes for the period
2008 through August 2010 are $52,740.16,18 a portion of this amount must be excluded

17 Exh. 403.

18 Dkt. 113 at 4; dkt. 111 at 4.

9

Case 09-22647 Doc# 125 Filed 04/02/13 Page 9 of 15

from the cap since it is for periods outside of the one-year period between September
2009 and August 2010. Only those taxes owed by Drywall during the year immediately
following termination may be included in the cap. They are the taxes owed by Drywall
on December 20, 2009, for the first half of the 2010 taxes ($12,410.81)19 and a pro rata
share of the second half of the 2010 taxes, stated to be $4,136.94,20 for a total of
$16,547.75. To the extent that the taxes Drywall owed to GMC under the lease include
taxes due before Drywall filed for bankruptcy relief,21 they are a prepetition claim not
subject to the § 502(b)(6)(A) cap.

To summarize, GMC claims $196,949.41 for expenses related to termination of the
lease. Under § 502(b)(6)(A), the amount of these damages is capped at the amounts due
during one year following the termination for base rent ($100,000), taxes ($16,547.75),
and insurance premiums ($5.995.75). The remaining elements of the damage claim are
disallowed because of the cap,22 with the exception of the taxes which were due

19 Exh. 402.
20 Id.

21 The testimony at trial was that the second half of the 2008 taxes was past due when Drywall
filed for relief (Tr. 83, l. 20 to 84, l. 4), yet the damage calculation as shown as exhibit 402 includes taxes
for all of 2008 and both halves of 2009. It is impossible for the Court to determine from the record the
correct allocation of the total taxes claimed to the categories of those due prepetition, those due within
one year of termination of the lease, and those due thereafter.

22 In a post-trial brief, Debtors and the Trustee assert that the following adjustments should be
made to GMC’s claim: a $4,500 reduction in taxes because of a transposition of numbers; a $7,611.42
reduction in attorney fees which were not itemized; $3,273.66 for maintenance/mowing/repairs; and
$20,146.50 for building management. Since the Court finds that none of the elements, except the taxes,
can be recovered because of the cap, the Court does not rule on these objections. In its post-trial brief,
dkt. 113 at 4, GMC acknowledged that it made an error in the amount of taxes claimed by transposing
two numbers, and the correct amount is $52,740.16.

10

Case 09-22647 Doc# 125 Filed 04/02/13 Page 10 of 15

prepetition. The excluded elements total $38,213.50, so the total recovery under Debtors’
guaranty of Drywall’s prepetition obligations under the lease and for damages for
termination is $158,735.91. During the Drywall bankruptcy, the Chapter 7 Trustee paid
GMC $10,000 rent for the time the leased premises were occupied. GMC proposes that
Debtors be given credit for this payment,23 thereby reducing their obligation to
$148,735.91.

B. The Claim for Expenses of GMC.
In addition to Debtors’ liability as guarantors of Drywall’s lease obligations, GMC
also claims Debtors are liable, as one-third owners of GMC, for certain expenses of
GMC. The expenses total $8,831.11, for such matters as insurance, appraisals, surveying,
and building maintenance not attributable to termination of the lease. Debtors did not
challenge this portion of GMC’s claim.24 Debtors’ obligation for one-third of the
expenses is $2,943.70, an amount which should be offset from the value of their interest.

C. Calculation of the Proper Division of Assets.
The primary dispute in calculating the division of assets is whether the lease
termination damages (comprised primarily of rent for one year) is an asset of GMC to be
allocated equally to each of the three co-owners, or whether that asset should be allocated

23 Exh. 401-A.

24 Debtors and the Trustee in their post-trial brief (dkt. 111) contend most of these expenses
should be disallowed as not covered by the guaranty. The Court agrees that they are not within the
guarantied liabilities of Drywall. But because GMC is not claiming these expenses under the guaranty,
this does not provide a defense.

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Case 09-22647 Doc# 125 Filed 04/02/13 Page 11 of 15

only to Glorioso and Morris under the terms of the amended operating agreement. As
stated above, the amendment to the operating agreement states that for the period of 48
months from January 1, 2008, “rental income paid to the Company [GMC] by Johnson
County Drywall” shall be divided equally between Glorioso and Morris, and Roger
Creason “shall not be entitled to receive a portion of such rental income” during that
period.

Roger Creason admits he signed the amendment to the operating agreement, but he
and the Trustee contend that the amounts owed under Debtors’ guaranty of Drywall’s
obligation to GMC are not rental income for purposes of the amendment. They argue that
the amendment applies only to rents paid by Drywall to GMC and that payments made by
a third party, such as Debtors, for termination damages are not covered. Reliance is
placed upon the principle of Kansas law that contracts are “enforced according to their
plain, general, and common meaning in order to insure the intentions of the parties are
enforced.”25 They contend that because the amendment is complete and unambiguous,
the Court must determine the intent of the parties from “the four corners” of the
amendment, “without regard to extrinsic or parole evidence.”26

25 Dkt. 111 at 3-4 (quoting Bunnell Farms Co. v. Samuel Gary, Jr. & Assocs., 30 Kan. App. 2d
739, 741-42, 47 P.3d 804, 806 (2002), which was quoting Hall v. JFW, Inc., 20 Kan. App. 2d 845, 848,
893 P.2d 837 (1995)).

26 Id. at 4 (quoting Bettis v. Hall, 852 F. Supp. 2d 1325, 1334 (D. Kan. 2012), which was quoting
Kay–Cee Enter., Inc. v. Amoco Oil Co., 45 F. Supp. 2d 840, 843 (D. Kan. 1999)).

12

Case 09-22647 Doc# 125 Filed 04/02/13 Page 12 of 15

GMC responds that Debtors’ argument fails for two reasons. First, there is no
language in the amendment stating that payment only from Drywall is to be divided
between Morris and Glorioso. Second, it argues that adopting Debtors’ interpretation
would reward them for the breach of Drywall’s obligation to pay rent. It points out that
the amendment and the guaranty were executed in conjunction with the agreement for
redemption of Glorioso’s and Morris’s stock in Drywall (resulting in Debtors becoming
the sole owners of Drywall) and the grant to Drywall of an option to purchase the real
property leased by GMC. According to GMC, Debtors’ giving up their claim to one-third
of the rent for 48 months was part of the consideration for these benefits. GMC presented
evidence that the allocation of rent solely to Glorioso and Morris was suggested in a draft
redemption agreement presented by Debtors, which included the proposal that “[m]onthly
rent shall remain the same, but it shall be distributed by GMC, LLC to only Glorioso and
Morris.”27 Reviewers of the proposal suggested that this allocation be removed from the
agreement so it would not be construed as additional consideration for the stock, which
would make it subject to income taxation.28

The Court finds GMC’s arguments more persuasive. Debtors’ obligations under
the guaranty are in satisfaction of Drywall’s liability for termination of the lease. The
amount owed is calculated by reference to the rent owed under the lease. The
circumstances of the amendment to the operating agreement evidence that Glorioso and

27 Exh. 415 at 4.

28 Id at 1.

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Case 09-22647 Doc# 125 Filed 04/02/13 Page 13 of 15

Morris, but not Debtors, were to benefit from the value of the lease. The allocation stated
in the amendment to the operating agreement is applicable to “rental income”; the phrase
“paid to the Company by Johnson County Drywall Supply” defines the applicable lease,
but does not serve to limit the rental income so allocated to that paid directly by Drywall,
as opposed to on Drywall’s behalf.

D. Calculation of the Estate’s Interest in GMC’s Assets.
GMC’s claim against Debtors as guarantors is secured by Debtors’ GMC
membership interest. It is therefore appropriate to offset the amount owed to GMC by
Debtors against Debtors’ share of the liquidation assets, which are the net proceeds from
the sale of GMC’s real property. Likewise, GMC’s claim for expenses is an obligation of
Debtors as holders of an interest in GMC, and is properly offset against the net proceeds
from the sale of GMC’s real property.

The Court therefore holds that the estate’s interest is calculated as follows:

One-third interest in net proceeds from sale $189,681.00
Less obligations under guaranty ($148,735.91)
Less one-third of GMC’s expenses (2,943.70)
Total owed to Debtors from sale proceeds $38,001.39.
CONCLUSION.

For the forgoing reasons, the Court holds that GMC has a claim against Debtors
for $151,679.61, secured by Debtors’ one-third interest in GMC, which has a value of

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Case 09-22647 Doc# 125 Filed 04/02/13 Page 14 of 15

$189,681.00. The Trustee’s turnover motion is granted as to $38,001.39, the value of
Debtors’ interest after the offset of GMC’s claim.

The foregoing constitute Findings of Fact and Conclusions of Law under Rules
7052 and 9014(c) of the Federal Rules of Bankruptcy Procedure, which make Rule 52(a)
of the Federal Rules of Civil Procedure applicable to this matter.
JUDGMENT.

Judgment is hereby entered sustaining the Trustee’s objection to GMC’s proof of
claim. The Court holds that GMC has a secured claim for $151,679.61, payable by offset
against $189,681.00, the value of Debtors’ membership interest in GMC.

Judgment is hereby entered sustaining the Trustee’s motion for turnover. The
Court holds that GMC shall turn over $38,001.39, the difference between the value of
Debtors’ membership interest in GMC and the amount owed by Debtors to GMC.

IT IS SO ORDERED.
# # #

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Case 09-22647 Doc# 125 Filed 04/02/13 Page 15 of 15

 

11-05190 Dugan Truck Line LLC v. Ranz et al (Doc. # 37)

Dugan Truck Line LLC v. Ranz et al, 11-05190 (Bankr. D. Kan. Feb. 6, 2013) Doc. # 37

Click here for the pdf document.

---

________________________________________________________________________________________________________________________________________________________
SO ORDERED.
SIGNED this 6th day of February, 2013.

 

Designated for on-line use but not for print publication

IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS

In Re:
GILBERT C. RANZ and
HELEN D. RANZ,
DEBTORS.

DUGAN TRUCK LINE, LLC,
PLAINTIFF,

v.
GILBERT C. RANZ and
HELEN D. RANZ,
DEFENDANTS.

CASE NO. 11-11691
CHAPTER 7

ADV. NO. 11-05190

MEMORANDUM OPINION AND ORDER FOLLOWING TRIAL ON
PLAINTIFF'S OBJECTION TO
DEBTORS' DISCHARGE UNDER 11 U.S.C. § 523(a)(6)

Case 11-05190 Doc# 37 Filed 02/06/13 Page 1 of 13

Plaintiff Dugan Truck Lines (Dugan), Debtor Gilbert C. Ranz's former employer, seeks to
exempt its claim for breach of fiduciary duty from discharge pursuant to 11 U.S.C. § 523(a)(6).
Plaintiff further seeks judgment for the amount of its claim and attorneys’ fees. The Court has
jurisdiction.1

Trial was held on August 7, 2012. Plaintiff Dugan appeared by Molly M. Gordon of
Depew Gillen Rathbun & McInteer LC. Debtors Gilbert C. Ranz (Gil Ranz) and Helen D. Ranz
appeared by Todd Allison of the Law Off ice of Todd Allison, P.A. Debtor Gil Ranz also
appeared in person. After the close of evidence and hearing the statements of counsel, the Court
requested the parties to file proposed findings of fact and conclusions of law. Plaintiff did so,
but Debtor did not. Having considered the testimony, the exhibits, the statements of counsel,
and the case record, the Court is now ready to rule. For the reasons stated below, the Court finds
that judgment should be entered against Debtor Gil Ranz excepting the claim of Dugan from
discharge under § 523(a)(6) and that judgment should be entered in favor of Debtor Helen D.
Ranz on the § 523(a)(6) complaint for lack of evidence of her involvement in the actions which
gave rise to Dugan's claim. The Court finds the amount of the nondischargeable debt owed by
Debtor Gil Ranz to Plaintiff Dugan is $1,539,381.55.

1 This Court has jurisdiction over the parties and the subject matter pursuant to 28 U.S.C. §§
157(a) and 1334(a) and (b), and the Standing Order of the United States District Court for the District of
Kansas that exercised authority conferred by § 157(a) to refer to the District's bankruptcy judges all
matters under the Bankruptcy Code and all proceedings arising under the Code or arising in or related to a
case under the Code, effective July 10, 1984. This Court may hear and finally adjudicate this matter
because it is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(I). Furthermore, the Court has
jurisdiction to award money damages in a 11 U.S.C. §523(a) proceeding. Lang v. Lang (In re Lang), 293

B.R. 501, 516-17 (10th Cir. BAP. 2003).
2

Case 11-05190 Doc# 37 Filed 02/06/13 Page 2 of 13

FINDINGS OF FACT.

Dugan is a LTL (less than full load) regional carrier operating in Kansas, Missouri,
Oklahoma, Texas, Arkansas, and Illinois. The company was founded in 2006 and is owned by
members of the Dugan family. Glen Dugan, one of the owners, testified on behalf of Dugan.
Debtor Gil Ranz was hired in September 2006 as general manager of Dugan. The role of manger
is the top position at Dugan, which had approximately 80 employees. As general manager, Gil
Ranz had access to Dugan’s confidential information, and Dugan assumed that he would be loyal
to the company as it conducted operations in a highly competitive business.

In the fall of 2009 and the spring of 2010, when the events which gave rise to this action
occurred, Kratos Trucking, LLC (Kratos) was a direct competitor of Dugan owned by Kevin C.
Busch (Busch). Turnpike Transit, Inc. (TTI) was a trucking company owned by Chris and
Debbie Smith. The Smiths were interested in selling their business.

In 2009, at the suggestion of Gil Ranz, Dugan had attempted to purchase TTI. Dugan
had prepared a document, which was reviewed by Gil Ranz, which conservatively estimated that
the annual operational savings to Dugan from purchasing TTI to be $1,352,572.50.2 Although
the sale proposed in 2009 did not go through, Dugan continued to actively seek to purchase TTI.
Dugan sent TTI a new letter of intent (LOI) dated December 1, 2009. It was signed on January
14, 2010.3

Unbeknownst to the owners of Dugan, starting in September 2009 several Dugan
employees, principally Gil Ranz, were involved in a series of disloyal activities relating to the

2 Exh. 23.

3 Exh. 6.

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Case 11-05190 Doc# 37 Filed 02/06/13 Page 3 of 13

ultimately successful acquisition of TTI by Kratos. At all times, the Dugan employees hid their
activities on behalf of Kratos from Dugan. Concurrently, Gil Ranz was negotiating his purchase
of an interest in Kratos.

Gil Ranz was actively involved in the purchase of TTI by Kratos. Kratos issued a LOI to
TTI on October 9, 2009.4 An exchange of e-mails between Gil Ranz and Busch on October 8,
2009 includes details of an anticipated requirement of TTI regarding personal guarantees and
advises Gil Ranz of a scheduled conference call with Debbie and Mark Smith. Gil Ranz wrote
that even though he wished to participate, he should not be on the call because he was known to
the Smiths.5 Glen Dugan testified that Gil Ranz had met the Smiths in conjunction with Dugan’s
attempted acquisition of TTI. Gil Ranz reviewed the TTI due diligence items sent to him by
Busch.6 A copy of the Kratos revised LOI dated November 24, 2009 was sent by Busch to Gil
Ranz and one other Dugan employee, Richard Handsaker.7

Gil Ranz supplied insider information about Dugan to Busch. By e-mail dated December
9, 2009, Gil Ranz forwarded an equipment listing to Bush with the comment that it was “More
Dugan news.”8 On the same day, Gil Ranz and Busch had telephone calls that lasted

thirty-seven minutes, nineteen minutes, and fifteen minutes.9

4 Exh. 5. It was revised on November 24, 2009.
5 Exh. 2.
6 Exh. 4.
7 Exh. 5.
8 Exh. 7.
9 See Exh. 1.

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Case 11-05190 Doc# 37 Filed 02/06/13 Page 4 of 13

 After Dugan proposed a new LOI to TTI dated December 1, 2009, by e-mail dated
December 15, 2009, Gil Ranz informed Busch that “Dugan was waiting for LOI” and that Chris
Smith had called asking a third party assisting with the TTI sale to “dump our [Kratos] LOI and
pursue the Dugan deal.”10 Gil Ranz admitted when testifying that the owners of Dugan would
have been the source of the information sent to Busch. On December 15, 2009, after the
information was sent to Busch, there were seven phone calls exchanged between Busch and Gil
Ranz.11

On January 5, 2010, Busch e-mailed Gil Ranz and stated that he was in the process of
amending the Kratos operating agreement to add Gil Ranz as a one-fifth owner of Kratos.12 On
behalf of Kratos Trucking, LLC, Gil Ranz filled out a financial services application dated
January 5, 2010.13

On January 25, 2010, Gil Ranz and Busch exchanged messages about Dugan pricing,
which was confidential information.14 On that same date, there were eight phone calls placed
between Gil Ranz and Busch.15 Dugan discount tariffs, which are confidential, were given to
Kratos.16

10 Exh. 8.
11 See Exh. 1.
12 Exh. 13.
13 Exh. 14.
14 Exh. 16.
15 See Exh. 1.
16 The tariffs were found in a Kratos office on July 20, 2010, after the resignation of Gil Ranz.

5

Case 11-05190 Doc# 37 Filed 02/06/13 Page 5 of 13

Glen Dugan, an owner of Dugan, testified that Gil Ranz and the other disloyal employees
undertook actions to harm the ongoing business of Dugan. If Dugan failed, that would have
meant more business for Kratos. Gil Ranz was officed primarily in Springfield, Missouri.
Business was moved out of the Springfield terminal; drivers refused to pick up loads. In March
2010 Busch wrote, “waiting and waiting . . . for DTL [Dugan Truck Line] to die!!!”17

By March 2010, Richard Handsaker (Dugan’s director of sales) and Paul Scherer
(Dugan’s top salesman in the Kansas City market) had resigned from Dugan to go to work with
Kratos. In June 2010, after the purchase of TTI by Kratos, Gil Ranz resigned form Dugan.
Upon learning of and investigating details of Gil Ranz’s and other’s disloyal behavior, Dugan
filed suit in Sedgwick County, Kansas District Court on September 15, 2010 against Kevin
Busch, Kratos Trucking, LLC, Gilbert C. Ranz, Richard Handsaker, and Paul Sherer. Dugan
alleged that defendants Gil Ranz, Handsaker and Scherer engaged in a series of disloyal
activities while employed at Dugan for the benefit of Busch and Kratos.

On June 8, 2011 , Gil Ranz, together with his wife, Helen D. Ranz, filed a voluntary
petition under Chapter 7. On September 6, 2011, Dugan filed this adversary complaint objecting
to the Ranzs’ discharge of Dugan’s claim under § 523(a)(6). Meanwhile, the Sedgwick County
court case proceeded against defendants other than Gil Ranz. On March 9, 2012, the jury
returned a verdict against Busch and Kratos in favor of Dugan for $1.45 million.

Busch testified by deposition since his attendance could not be compelled. He fully
corroborated that Gil Ranz sought to hide his activities from Dugan and that both Gil Ranz and
Busch regarded the conduct as wrongful. Busch testified that on December 9, 2009, Gil Ranz

17 Exh. 18.
6

Case 11-05190 Doc# 37 Filed 02/06/13 Page 6 of 13

had told Busch that he (Ranz) had convinced Dugan to offer a much lower price for TTI that Gil
Ranz believed that TTI would accept.18 Busch also testified that in December and later Gil Ranz
told him about “his shenanigans with trying to derail and interfere with the deal.”19 Busch
testified that Gil Ranz represented to him that Dugan “was going to bite the dust,” but denied
knowing of specific actions of Gil Ranz to assure that Dugan did not survive until after Gil Ranz
left Dugan. Busch also testified that Gil Ranz told him that even afer he left Dugan he had back
door access to Dugan’s computer system and was manipulating Dugan’s pricing.20

Gil Ranz testified briefly at trial. He admitted to most of his conduct as stated above. He
admitted that his actions were intentional. He characterized his conduct as ill-advised and
reckless, but not malicious. Although he acknowledged that Kratos’ acquisition of TTI would
benefit him financially, Gil Ranz denied that when facilitating the sale of TTI to Kratos he
intended to harm Dugan. In light of the evidence of Gil Ranz’s actions, the Court finds the
denial not to be credible. For example, Gil Ranz testified that until the state court litigation was
filed, he did not know that the efforts of Dugan and Kratos to buy TTI overlapped, even though
the record contains correspondence from him about promoting the Kratos offer over that of
Dugan. He denied many aspects of Busch’s testimony. He denied that he had access to Dugan’s
computer system after he left Dugan, but there is convincing evidence to the contrary. He denied
his own attempts to keep his relationship with Busch from Dugan, saying that the concern was
that of Busch only, but the record contradicts this position. He suggested that the 800 phone

18 Exh. 27 at 55:23 - 60:10.

19 Id. at 62:10-17.

20 Id. at 102:10 - 103:12.

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Case 11-05190 Doc# 37 Filed 02/06/13 Page 7 of 13

contacts between himself and Busch for the period September 15, 2009 through May 2010 as

shown on the Dugan phone logs21 could have been for the conduct of Dugan’s business regarding

warehousing and Kratos matters other than the acquisition on TTI. Debtor provided no evidence

to corroborate this suggestion.

Glen Dugan testified as to the damages to Dugan caused by the disloyal acts of Gil Ranz.
They are comprised of four elements. First, Dugan claims that Gil Ranz was the cause of
Dugan’s failure to purchase TTI and this resulted in damages of at least $1,352,572.50, the
estimated savings to Dugan’s operations which would have been realized during the first year if
the purchase occurred.22 Second, Dugan claims Gil Ranz damaged Dugan by instigating the
resignation of two Dugan employees who became Kratos employees in March 2010. The
damages claimed are for $117,666.01 in lost revenues for the period March 9, 2010, to June 20,
2010. The damages were calculated by comparing the productivity in 2009 with that in 2010.23
Glen Dugan testified that other trucking companies were experiencing an increase in revenues in
this period of 2010 as compared with 2009, but Dugan experienced a loss in the market where
these employees worked. Third, Dugan seeks to recover $10,710.00 as revenues lost based upon
Gil Ranz’s use of stolen Dugan Tariffs after he left Dugan. Fourth, Dugan seeks to recover
$58,433.04, the wages it paid Gil Ranz for the period September 2009, when Gil Ranz began
promoting Krato’s purchase of TTI, to June 2010, when he left Dugan’s employment and went to

21 Exh. 1.

22 Exh. 23. The calculation of the projected losses is fully supported by the testimony of Glen
Dugan. As noted above, the estimates were made when Dugan was attmepting to purchase ITT and were
reviewed by Gil Ranz at that time.

23 Exh. 29. The calculation of this element of damages is supported by the testimony of Glen
Dugan.

8

Case 11-05190 Doc# 37 Filed 02/06/13 Page 8 of 13

work for Kratos. The calculation is based upon Dugan’s employment records and does not
include the cost of any benefits or expense reimbursements.24 Gil Ranz did not challenge either
Dugan’s entitlement to these elements of damages or the specific amounts claimed.

There was no evidence that Debtor Helen D. Ranz was involved in the conduct which
gave rise to Dugan's claim.

DISCUSSION.

Subsection 523(a)(6), the basis for Dugan’s dischargeability claim, provides as follows:

(a) A discharge under section 727 . . . of this title does not discharge
an individual debtor from any debt -.
. .
(6) for willful and malicious injury by the debtor to
another entity or to the property of another entity[.]
The Supreme Court has held that this subsection encompasses “only acts done with the actual
intent to cause injury.”25 The fact that the word “willful”modifies the word “injury” indicates that
“nondischargeability takes a deliberate or intentional injury not merely a deliberate or intentional
act that leads to injury.”26 Without proof of both a willful act and malicious injury the objection
to discharge fails.27 Malicious “requires proof ‘that the debtor either intend the resulting injury or
intentionally take action that is substantially certain to cause the injury.’”28 “Most courts have
held that an injury inflicted intentionally and deliberately, and either with the intent to cause the
harm complained of, or in circumstances in which the harm was certain or almost certain to result

24 Exh. 28.
25 Kawaauhau v. Geiger, 523 U.S. 57, 61 (1998).
26 Id.

27 Panalis v. Moore (In re Moore), 357 F.3d 1125, 1129 (10th Cir. 2004).
28 Id., quoting Hope v. Walker (In re Walker), 48 F.3d 1161, 1164 (11th Cir. 1995).
9

Case 11-05190 Doc# 37 Filed 02/06/13 Page 9 of 13

from the debtor’s act, constitutes willful and malicious conduct under section 523(a)(6).”29
Claims arising from intentional business torts have been excepted from discharge.30 A creditor
seeking to except a claim from discharge has a burden to prove by a preponderance of the
evidence that the debt is nondischargeable.31

Dugan’s claim against Debtor Gil Ranz is based upon the tort of breach of fiduciary duty.
Gil Ranz was the general manager of Dugan, and in that capacity, he owed fiduciary duties to
Dugan.32 Those duties included acting with utmost good faith and loyalty for the furtherance and
advancement of Dugan’s business.33 There is no doubt that Gil Ranz’s intentional actions
constituted breaches of his fiduciary duties. While general manager of Dugan, he secretly
assisted Kratos in the acquisition of TTI, while knowing that Dugan was also seeking to acquire
the company. He provided confidential Dugan information to Busch for the benefit of Kratos.
He interfered with Dugan’s employment of two salesmen, who left Dugan to work for Kratos. He
placed his own interests above those of Dugan.

29 4 Collier on Bankruptcy ¶ 523.12[2] (Alan N. Resnick & Henry J.Sommer eds.-in-chief, 16th
ed. rev. 2012).

30 E.g., Piccicuto v. Dwyer, 39 F.3d 37 (1st Cir. 1994) (intentional interference with advantageous
business relation and unfair trade practices); Tusco Budget Outlet, Inc. v. Stutsman (In re Stutsman), 163

B.R. 374 (Bankr. N.D. Okla. 1993) (usurpation of corporate opportunities); The Spring Works, Inc. v.
Sarff (In re Sarff), 242 B.R. 620 (6th Cir. BAP 2000) (debtor’s obligation for compensatory and punitive
damages for breach of duty of loyalty in providing assistance to competitor while he was still employed
by plaintiff and for misappropriation of plaintiff’s trade secrets excepted from discharge).
31 Grogan v. Garner, 498 U.S. 279 (1991).

32 Monarch Transport, LLC v. FKMT, LLC, 283 P.3d 249 (Table), 2012 WL 3629861, *10 (Kan.
App. 2012), citing Emprise Bank v. Rumisek, 42 Kan. App.2d 498, Syl. ¶ 12, 215 P.3d 621 (2009).

33 Henderson v. Hassur, 225 Kan. 678, 687, 594 P.2d 650, 658-59 (1979).

10

Case 11-05190 Doc# 37 Filed 02/06/13 Page 10 of 13

Dugan has a claim against Debtor Gil Ranz for compensation for the injuries caused by
Gil Ranz’s breach of fiduciary duty.34 Dugan presented evidence that the losses sustained were:
$1,352,572.50, the estimated savings to Dugan’s operations which would have been realized
during the year following the acquisition of TTI; $117,666.01, the estimated lost revenues for the
period March 9, 2010, to June 20, 2010, based upon the resignation of two Dugan salesmen who
were hired by Kratos; and $10,710.00, the estimated revenues lost based upon Gil Ranz’s use for
the benefit of Kratos of Dugan tariffs stolen afer he left Dugan. Further, “[a]n unfaithful servant
forfeits that compensation he would otherwise have earned but for his unfaithfulness.”35 Dugan
may therefore also recover $58,433.04, the wages it paid Gil Ranz for the period September 2009,
when Gil Ranz began promoting Kratos’ purchase of TTI, to June 2010, when he left Dugan’s
employment and went to work for Kratos. The total claim is therefore $1,539,381.55. Gil Ranz
did not challenge his liability to Dugan for breach of fiduciary duty, the elements of damages, or
the specific amounts claimed.

The Court finds that Debtor Gil Ranz acted willfully and maliciously when injuring
Dugan and Dugan’s claim is therefore excepted from discharge under § 523(a)(6). Gil Ranz
admits that his conduct was intentional. Although he denies that he acted with intent to harm
Dugan, the Court nevertheless finds his denial not to be credible and that his conduct was
malicious. Harm to Dugan was certain or substantially certain to follow if Gil Ranz was
successful in his efforts to have Kratos rather than Dugan acquire TTI. Gil Ranz was aware of the
significant amount of the harm which would result, since he had reviewed Dugan’s projections of

34 Ford v. Guarantee Abstract & Title Co., Inc., 220 Kan. 244, 261, 553 P.2d 254, 268 (1976).

35 Henderson v. Hassur, 225 Kan. at 688, 594 P.2d at 659.

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the savings it would realize from the acquisition. The benefit which Gil Ranz sought for himself
as part owner of Kratos after its acquisition of TTI could occur only if Dugan were harmed. Gil
Ranz’s concealment from Dugan of his actions on behalf of Kratos and his acquisition of an
interest in Kratos are circumstantial evidence that he was aware of the wrongfulness of his secret
actions and the damage he was causing Dugan. While employed by Dugan as general manager,
Gil Ranz provided Kratos with insider information and worked from inside of Dugan to weaken
its operations. Gil Ranz facilitated the employment of two Dugan sales persons by Kratos. Even
after leaving Dugan, Gil Ranz accessed Dugan’s computer system and manipulated prices to the
detriment of Dugan. The Court finds that harm to Dugan was substantially certain to result from
Gil Ranz’s breaches of his duty of loyalty and confidence arising from his position as general
manger of Dugan.
CONCLUSION.

For the foregoing reasons, the Court determines that Dugan is entitled to judgment against
Debtor Gil Ranz in the amount of $1,539,381.55 compensatory damages and that such judgment
should be excepted from discharge under § 523(a)(6). Although Dugan also prayed for an award
of attorneys fees, because it presented no evidence or arguments in support, the prayer should be
denied. The complaint for judgment and nondischargeability against defendant Helen D. Ranz
should be dismissed for lack of evidence.

The foregoing constitute Findings of Fact and Conclusions of Law under Rule 7052 of the
Federal Rules of Bankruptcy Procedure which makes Rule 52(a) of the Federal Rules of Civil
Procedure applicable to this proceeding. A judgment based upon this ruling will be entered on a

12

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separate document as required by Federal Rule of Bankruptcy Procedure 7058 which makes
Federal Rule of Civil Procedure 58 applicable to this proceeding.

IT IS SO ORDERED.
###

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