Fuciarelli v. Brown

Opinion

1 WO 2 3 4 5 6 IN THE UNITED STATES DISTRICT COURT 7 FOR THE DISTRICT OF ARIZONA

9 KA Fuciarelli, et al., No. CV-20-00279-PHX-DWL

10 Plaintiffs, ORDER

11 v.

12 Richard Paul Brown, et al.,

13 Defendants. 14 15 Pending before the Court is Defendants Richard and Gloria Brown’s motion to 16 withdraw the reference to the bankruptcy court. (Doc. 2.) Defendants seek to withdraw 17 the reference so this Court can potentially determine whether the state secrets privilege 18 applies to certain evidence Defendants wish to introduce during a trial in bankruptcy court. 19 (Id.) For the following reasons, the motion will be denied. 20 BACKGROUND 21 I. Factual Background And State-Court Proceedings 22 Defendants’ motion marks the second time this Court has become involved in their 23 ongoing battle in bankruptcy court with Plaintiff Kevin Fuciarelli and his company, The 24 Fuciarelli Group LLC (collectively, “Fuciarelli”).1 The parties’ dispute stems from 25 Fuciarelli’s $1 million investment in Defendants’ company, Hot Salsa Interactive, LLC 26 (“Hot Salsa”). (Doc. 8 at 2.) Fuciarelli claims this investment was fraudulently induced 27

28 1 The first instance was Defendants’ motion for leave to appeal, which the Court denied. CV-18-03894-PHX-DWL, Doc. 10. 1 because (1) “[Mr.] Brown represented that Plaintiff’s $1 million would be used as business 2 working capital,” but instead it was “largely diverted to pay the Browns’ delinquent federal 3 taxes and other personal expenses including their home mortgages in Arizona and 4 Australia,” and (2) “[Mr.] Brown misrepresented the nature of Hot Salsa’s business by 5 falsely claiming that Hot Salsa was doing business with the government under federal 6 contracts.” (Adversary No. 2:18-ap-00057-DPC, Doc. 68 ¶¶ 8, 36, 40 [hereinafter, 7 citations to the adversary proceeding docket will be abbreviated as “AP Doc.”].) 8 In 2016, Fuciarelli sued Defendants for fraud in Arizona state court. (Doc. 8 at 3.) 9 Defendants asserted a counterclaim, alleging that Fuciarelli had engaged in conduct that 10 “cause[d] Hot Salsa to lose the ability to continue to be a contractor of the U.S. 11 Government.” (Doc. 8-5 at 8.) Defendants further alleged that this loss amounted to 12 “several million dollars at present value.” (Id. at 58.) Whether these “federal contracts” 13 existed led to a protracted discovery battle—Fuciarelli repeatedly sought the contracts, but 14 Defendants refused to produce them, claiming they were classified “and therefore cannot 15 be discussed or shared.” (Doc. 8 at 4; Doc. 8-5 at 69.) 16 On January 25, 2018, before this discovery battle was resolved, Defendants filed for 17 bankruptcy. (Doc. 8 at 4.) This brought an end to the state-court proceedings. (Id.) 18 II. Bankruptcy Proceedings 19 A. Initial Stages 20 On February 16, 2018, Fuciarelli initiated an adversary proceeding against 21 Defendants. (Id. at 3; AP. Doc. 1.) The adversary proceeding complaint alleged that 22 Defendants had procured Fuciarelli’s $1 million investment through “false pretenses, a 23 false representation, or actual fraud” and sought a declaration that any damages arising 24 from that investment were nondischargeable under the Bankruptcy Code. (AP Doc. 1 ¶¶ 25 23-33.) In their answer to the complaint, Defendants again alleged that Fuciarelli had, in 26 fact, caused Hot Salsa to lose its federal contracts. (Doc. 8-6 at 5-6 [“Upon admission of 27 [Fuciarelli] as a Member of Hot Salsa, government contractors terminated any further 28 government contracts with Hot Salsa for software, by reason of investigations conducted 1 into activities of Plaintiffs which were designated as unsuitable and presenting risk to such 2 contractors to high security projects.”].) 3 The alleged existence of these federal contracts again gave rise to a protracted 4 discovery dispute. (Doc. 8 at 5.) On October 24, 2018, the bankruptcy court held a 5 hearing to resolve this dispute. (Doc. 8-3.) During the hearing, Defendants’ counsel 6 argued that Fuciarelli’s request for discovery pertaining to the contracts fell “well outside” 7 the scope of the complaint. (Id. at 12.) Defendants’ counsel also represented that 8 Defendants’ federal contracts were so sensitive even he didn’t know what was in them. 9 (Id. at 13.) In the end, the bankruptcy court ordered Fuciarelli to file an amended 10 complaint2 and further ordered that “as to this discovery dispute, I am going to order that 11 all of the Defendant’s responses be submitted to the Court on an in-camera inspection that 12 is under seal. . . . Is there a confidentiality agreement? I want to see it. Is there a federal 13 contract? I want to see it. . . . Only after I’ve looked at it will I then decide where to go 14 with this.” (Id. at 17-19.) The next day, the bankruptcy court entered a written order 15 stating: 16 Defendants shall submit to Plaintiffs full and complete written responses, as well as responsive documents . . . . To the extent that Defendants contend 17 that they are legally prohibited from providing any portion of the Amended 18 Discovery Responses directly to Plaintiffs, the legal basis for the contended legal prohibitions must be set forth in the Amended Discovery Responses 19 and such portions shall be supplied solely to the Court for an in camera 20 review so that the Court may make a determination as to the validity of Defendants’ contentions. 21 (Doc. 13-6 at 3.) 22 B. Motion For Leave To Appeal 23 Rather than comply with the bankruptcy court’s discovery order, Defendants sought 24 leave to pursue an interlocutory appeal. (CV-18-03894-PHX-DWL, Doc. 2.) Defendants 25 26 2 The amended complaint included a second claim for “the use of materially false 27 written statements regarding a debtor or insider’s financial condition on which a creditor reasonably relied if the statement were made with intent to deceive.” (AP Doc. 68 ¶¶ 43- 28 50.) This claim was later dismissed. (AP Doc. 107.) Thus, the only remaining claim is the claim discussed above. (Doc. 13 at 4 n.2.) 1 raised three arguments: (1) “Plaintiffs waived any allegation regarding federal contracts”; 2 (2) “[t]he bankruptcy court erred in permitting an amended complaint after trial was set 3 and without a formal request for leave to amend the complaint”; and (3) “[t]he bankruptcy 4 court erred because compliance with the order is a federal crime.” (Id. at 4-5.) 5 In an order issued on January 23, 2019, the Court denied Defendants’ motion 6 without reaching the merits of any of their challenges to the bankruptcy court’s rulings. 7 (CV-18-03894-PHX-DWL, Doc. 10.) Emphasizing the exacting standard applicable to 8 motions for leave to appeal in the bankruptcy context, the Court concluded that Defendants 9 were not entitled to relief because (1) the bankruptcy court’s decision to allow Fuciarelli 10 to file an amended complaint “appears to this Court, based on the limited material before 11 it, to be entirely correct given the Browns’ prior gamesmanship” and was, in any event, 12 “the antithesis of the sort of decision that justifies interlocutory review,” and (2) the 13 bankruptcy court’s issuance of the order compelling production of the federal-contracts 14 evidence for in camera review was not subject to interlocutory review because “the Browns 15 haven’t identified any controlling authority establishing that this fact-bound ruling was 16 incorrect” and because “the Browns failed to acknowledge that a different judge previously 17 ordered them to produce [the federal contracts].” (Id. at 4-5.) 18 C. Subsequent Proceedings In Bankruptcy Court 19 While Defendants’ motion for leave to appeal was pending, the U.S. Department of 20 Justice (“DOJ”) was advised of the bankruptcy court’s ruling on the discovery dispute. 21 (Doc. 13 at 6.) The DOJ began working “extensively with the parties and Bankruptcy 22 Court to resolve this discovery dispute.” (Id.) This began with a 30-day stay so the DOJ 23 could “determine how best to deal with the evidence.” (Doc. 8 at 7; Doc. 13 at 6-7.) 24 At a March 21, 2019 status hearing, the bankruptcy court reiterated its earlier order 25 that Defendants submit a complete discovery response for in camera review. (Doc. 13 at 26 7.) Defendants complied and also provided a copy of their response to the DOJ, which 27 began reviewing the response “solely to determine if it contained classified information.” 28 (Id.) 1 On May 28, 2019, the bankruptcy court held another hearing. (Id. at 8.) During this 2 hearing, which took place both on and off the record, the DOJ indicated that it was 3 continuing to review Defendants’ discovery response. (Id.; Doc. 8 at 6.) To facilitate the 4 DOJ’s review process, the bankruptcy court vacated a previously set trial date and 5 scheduled another status conference. (Doc. 13 at 8.) 6 On June 27, 2019, the bankruptcy court held that status conference. (Id.) During 7 this hearing, the DOJ provided Fuciarelli and the bankruptcy court with a redacted version 8 of the discovery response that Defendants had previously provided. (Doc. 8 at 7.) Notably, 9 the redacted version does not eliminate all of the details concerning Mr. Brown’s federal 10 contracts. (Doc. 8-6 at 94-99.) Among other things, it confirms that Mr. Brown has “held 11 a top-secret security clearance with the United States government since 2008” (id. at 94), 12 clarifies that “Hot Salsa was never a party to federal or government contracts. The 13 contractual relationship was between myself [i.e., Mr. Brown] and the government” (id. at 14 96), and states that when Mr. Brown received payment from the federal government, he 15 would deposit the proceeds into Hot Salsa’s bank account: “My level/amount of 16 compensation varied . . . [and] I generally directed payments to Hot Salsa[’s] account which 17 also was in the business of mobile app development” (id. at 95). After reviewing the 18 redacted document, the bankruptcy court ordered: 19 The responses to Plaintiff’s first request for admissions, first set of interrogatories, and first request for production of documents as redacted by 20 the government will be admitted at trial. There will be no further discovery 21 related to the questions posed in the written discovery, and at trial the questions that can be asked by either party of any party or witness will be 22 capped by the redactions. 23 (AP Doc. 122 at 2. See also Doc. 8-6 at 91-92 [written order issued by bankruptcy court 24 on July 2, 2019 confirming this ruling].) The parties were further urged “to work with the 25 [DOJ] in coming to agreement with an acceptable protective order.” (Doc. 13 at 8.) 26 After discussions concerning the proposed protective order proved unsuccessful, the 27 bankruptcy court ordered the parties to submit declarations summarizing their anticipated 28 direct testimony concerning the federal-contracts issue. (Doc. 8 at 7-8.) On August 31, 1 2019, Fuciarelli signed a declaration claiming that “Mr. Brown represented himself to me 2 as a successful businessman who owned Hot Salsa, which Brown claimed was a growing 3 business that had the ability to obtain federal contracts and that did in fact have federal 4 contracts that produced 100s of thousands of dollars in revenue.” (Doc. 8-6 at 102.) 5 Fuciarelli’s declaration also states that Mr. Brown had shown him “bank statements 6 showing wire transfers into Hot Salsa’s bank account of over $830,000. . . . Brown claimed 7 that the deposits from these wire transfers were payments for work that Hot Salsa did under 8 its federal contracts.” (Id.) 9 On September 17, 2019, Mr. Brown signed a responsive declaration, which the DOJ 10 then reviewed and redacted. (Doc. 8-6 at 110-12.) The redacted declaration contains 11 information similar to the information contained in Defendants’ redacted discovery 12 response. In a nutshell, it states that (1) Mr. Brown periodically “received [funds] from the 13 U.S. government” (id. ¶ 9), (2) Hot Salsa itself “had no relationship with the government 14 outside of myself” (id. ¶ 5), (3) Mr. Brown would “always” deposit the funds he received 15 from the government into Hot Salsa’s bank account, because he believed he “had a 16 fiduciary duty to direct all corporate opportunities to my entity performing services within 17 the same areas” and “felt that directing these funds to me personally would be improper” 18 (id. ¶¶ 9-10), and (4) “[t]he only statement I made to Plaintiff regarding government 19 contracts was referenced in [an] email . . . [that] specifically stated ‘Keep in mind that if 20 you decide to invest, I/Hot Salsa Interactive have federal contracts that I will not be able to 21 discuss with you” (id. ¶3). 22 On November 4, 2019, after the declarations had been submitted, the bankruptcy 23 court held another status hearing. (Doc. 13 at 10.) In light of the DOJ’s preference “to 24 have the trial proceed by Declarations, with no cross-examination,” the bankruptcy court 25 ordered that the declarations would be used as the direct testimony at trial. (AP Doc. 138 26 at 2.) Additionally, Fuciarelli and Defendants were both authorized to submit final, 27 supplemental declarations. (Id. at 2-3.) Fuciarelli took that opportunity but Defendants 28 only resubmitted Mr. Brown’s earlier declaration. (Doc. 8 at 8; Doc. 13 at 10.) Trial was 1 set for February 13, 2020. (Doc. 13 at 10.) 2 On January 31, 2020, less than two weeks before trial was set to begin, Defendants 3 filed the motion to withdraw the reference. (Doc. 1.) 4 ANALYSIS 5 A. The Parties’ (And DOJ’s) Arguments 6 Defendants argue that the reference must be withdrawn because the DOJ has 7 ordered the redaction of significant portions of Mr. Brown’s declaration, the unredacted 8 “information is necessary for a full and fair defense” during the trial in bankruptcy court, 9 and it would promote judicial economy to withdraw the reference to the bankruptcy court 10 now so this Court can determine whether the state secrets privilege applies to the redacted 11 information. (Doc. 2 at 3-5.) Fuciarelli opposes this request, arguing that: (1) Defendants’ 12 motion is untimely, because they have long known of the bankruptcy court’s plan to 13 proceed with redacted declarations, and indeed participated for months in the process to 14 formulate the declarations, only to file their motion on the eve of trial; (2) “[t]here is simply 15 no practical reason or legal justification for the alleged need to ‘perfect’ the privilege” 16 because there is no guarantee the DOJ will even invoke the state secrets privilege if the 17 reference is withdrawn, the DOJ has already authorized Defendants to disclose some 18 information related to Mr. Brown’s federal contracts, and Defendants have failed to 19 provide any non-conclusory reasons why this information is insufficient to provide a full 20 and fair defense in the bankruptcy trial; and (3) in a related vein, any error by the 21 bankruptcy court can be remedied on appeal. (Doc. 8.) 22 On March 17, 2020, the DOJ filed a statement of interest. (Doc. 13.) The DOJ 23 indicates that it “was prepared to follow the process identified by the Bankruptcy Court for 24 trial to protect its interests” and was under the impression that all parties, including 25 Defendants, were on board with that approach. (Id. at 2-3.) The DOJ takes no position on 26 the merits but notes that Defendants “cannot seek to compel” the DOJ to decide whether to 27 assert the state secrets privilege. (Id.) As such, the DOJ requests that, if the Court chooses 28 to withdraw the reference, it be allowed extra time to confer with various agency heads to 1 determine whether the privilege should be invoked in this case. (Id. at 3-4.) 2 B. Discussion 3 Generally, a bankruptcy court “may hear and determine all cases under title 11 and 4 all core proceedings arising under title 11, or arising in a case under title 11.” 28 U.S.C. 5 157(b)(1). Similarly, a bankruptcy court “may hear a proceeding that is not a core 6 proceeding but that is otherwise related to a case under title 11.” Id. § 157(c)(1). That 7 said, “the district court may withdraw, in whole or in part, any case or proceeding referred 8 [to the bankruptcy court], on its own motion or on timely motion of any party, for cause 9 shown.” Id. § 157(d). 10 “In determining whether cause exists, a district court should consider the efficient 11 use of judicial resources, the delay and costs to the parties, uniformity of bankruptcy 12 administration, the prevention of forum shopping, and other related factors.” Sec. Farms 13 v. Int’l Bhd. of Teamsters, 124 F.3d 999, 1008 (9th Cir. 1997). “The party seeking 14 withdrawal bears the burden of establishing that withdrawal is appropriate.” In re 15 N’Genuity Enters. Co., 2012 WL 3095002, *2 (D. Ariz. 2012). 16 A. Core Vs. Non-Core 17 As an initial matter, the usual approach—when evaluating a motion to withdraw the 18 reference to the bankruptcy court—is to begin by determining whether the claim at issue 19 is core or non-core. Gillespie v. 100% Natural Gourmet Inc., 2015 WL 736296, *2 (D. 20 Ariz. 2015). See also Flores v. Gray Servs., LLC, 2014 WL 4179888, *1 (D. Ariz. 2014) 21 (“The Court must evaluate whether the claim is core or non-core, since it is upon this issue 22 that such questions of efficiency and uniformity will turn.”) (quotation omitted). “To 23 determine whether a proceeding is core or non-core, courts look to see if the proceeding is 24 created by title 11 . . . or depends upon resolution of a substantial question of bankruptcy 25 law.” Gillespie, 2015 WL 736296 at *2 (citation omitted). 26 Here, the underlying proceeding is Fuciarelli’s adversary proceeding, which seeks 27 to determine the dischargeability of debt pursuant to 11 U.S.C. § 523(a)(2)(A). (AP Doc. 28 1.) “Actions seeking a determination that a debt is not dischargeable in bankruptcy are 1 core proceedings.” In re Kennedy, 108 F.3d 1015, 1017 (9th Cir. 1997). Defendants 2 haven’t argued otherwise. (Docs. 2, 10.) Thus, there is an argument that the core nature 3 of the underlying claim weighs against withdrawing the reference. 4 On the other hand, Defendants aren’t seeking withdrawal of the reference so this 5 Court can decide the merits of the dischargeability issue. Instead, they seek limited 6 withdrawal so this Court can address one discrete issue—whether the state secrets privilege 7 applies to certain evidence Defendants wish to introduce during the bankruptcy proceeding. 8 Given these somewhat unusual circumstances, the Court concludes that the core nature of 9 Fuciarelli’s underlying claim has little bearing on whether cause exists to withdraw the 10 reference. 11 B. Whether Cause Exists 12 As noted, whether cause exists to withdraw the reference to the bankruptcy court 13 turns on “the efficient use of judicial resources, delay and costs to the parties, uniformity 14 of bankruptcy administration, the prevention of forum shopping, and other related factors.” 15 Security Farms, 124 F.3d at 1008. 16 Here, withdrawing the reference would be highly inefficient from a judicial- 17 economy perspective and would likely delay the ultimate resolution of dischargeability 18 issue. First, it is important to note that Fuciarelli’s fraud claim has two different 19 components: (a) Defendants lied about how Fuciarelli’s investment proceeds would be 20 used (they promised the money would be used as Hot Salsa’s working capital, then used it 21 to pay back taxes and to support their lavish lifestyle), and (b) Defendants lied about the 22 existence of Hot Salsa’s federal contracts. The federal-contracts issue has nothing to do 23 with the first theory. Thus, if Fuciarelli were to prevail in bankruptcy court based on the 24 first theory, this could obviate the need (during any later appeal by Defendants) to assess 25 whether Defendants’ ability to present federal-contracts evidence was improperly 26 restricted. 27 Second, it is also important to note that the DOJ and bankruptcy court aren’t 28 preventing Defendants from presenting any and all evidence concerning Defendants’ 1 federal contracts. To the contrary, Defendants’ discovery response and Mr. Brown’s 2 declaration, even after redaction, reveal that Mr. Brown possessed federal contracts, that 3 he received payments pursuant to those contracts, and that he routed those payments 4 through Hot Salsa’s bank accounts (even though Hot Salsa itself didn’t have any federal 5 contracts). Given this backdrop, it is entirely possible that Defendants will be able to mount 6 a successful defense during the bankruptcy trial as to Fuciarelli’s second fraud theory. 7 This, too, would obviate the need (in a future proceeding) to assess whether Defendants’ 8 ability to present federal-contracts evidence was improperly restricted. 9 Notwithstanding this, Defendants argue that “[t]he redacted information is critical 10 to a full and fair defense” because “Rick Brown now needs to explain in full the scope of 11 his services with the government to understand why those were company funds.” (Doc. 10 12 at 1, 3.) The problem with this argument is that it is conclusory. The redacted discovery 13 response and redacted declaration already contain information addressing why Mr. Brown 14 believed he had a duty to deposit the federal-contract proceeds into Hot Salsa’s bank 15 accounts. It is possible the fact-finder in the bankruptcy proceeding will deem these 16 materials sufficient. And even if not, the reviewing court will have the benefit of a 17 developed record in any subsequent appeal. 18 Third, Defendants’ motion is premised on the assumption that withdrawing the 19 reference will enable this Court “to finally resolve the treatment of the [DOJ’s] assertion 20 that certain information is classified.” (Doc. 10 at 2.) This argument overlooks that the 21 state secrets privilege may only be invoked through a formal claim of privilege by the 22 government. Mohamed v. Jeppesen Dataplan, Inc., 614 F.3d 1070, 1080 (9th Cir. 2010) 23 (“The privilege belongs to the Government and must be asserted by it; it can neither be 24 claimed nor waived by a private party.”) (citation omitted). The DOJ has yet to assert such 25 a claim here and could decline to do so even if the Court withdrew the reference. (Doc. 13 26 at 3 [noting that “Defendants’ Motion to Withdraw cannot seek to compel the United States 27 to assert privilege—a decision that is the Government’s alone to make” and that if the Court 28 withdrew the reference, the DOJ would then “complete the high-level deliberations” 1 necessary “to decide whether to assert privilege”].) Thus, one scenario (if the Court granted 2 Defendants’ motion and withdrew the reference) would be that the Court would wait to 3 hear from the DOJ for some unspecified period of time, then receive word that the privilege 4 won’t be invoked, and then send the case back to bankruptcy court on the exact same record 5 that existed before the withdrawal request. It is difficult to imagine how such an outcome 6 could be viewed as an “efficient use of judicial resources” that reduced “delay and costs to 7 the parties.” Security Farms, 124 F.3d at 1008. 8 At bottom, Defendants’ current motion is more of a request for interlocutory review 9 of a pretrial evidentiary or discovery ruling than a motion to withdraw—the bankruptcy 10 court has reviewed the redacted information and determined that an acceptable solution is 11 to proceed to trial using the redacted information as Defendants’ evidence. Defendants are 12 now trying to make an end run around that decision.3 Such an attempt does not serve 13 judicial economy or reduce cost and delay. Cf. Mohawk Indus., Inc. v. Carpenter, 558 U.S. 14 100, 103, 106-09 (2009) (declining to allow immediate interlocutory review of “disclosure 15 orders adverse to the attorney-client privilege” because “[p]ermitting piecemeal, 16 prejudgment appeals . . . undermines ‘efficient judicial administration’ and encroaches 17 upon the prerogatives of [trial] judges, who play a ‘special role’ in managing ongoing 18 litigation” and because “postjudgment appeals generally suffice to protect the rights of 19 litigants . . . . Appellate courts can remedy the improper disclosure of privileged material 20 in the same way they remedy a host of other erroneous evidentiary rulings: by vacating an 21 adverse judgment and remanding for a new trial”). 22 … 23 … 24 … 25 … 26

27 3 This is exemplified by Defendants’ reply, which makes unsupported assertions that the bankruptcy court’s solution “violates substantive due process and procedural fairness.” 28 (Doc. 10 at 4.) In addition to citing no cases, Defendants’ reply makes no mention of the standard for withdrawal. 1 Accordingly, IT IS ORDERED that Defendants’ motion to withdraw the reference to the bankruptcy court (Doc. 2) is denied. The Clerk of the Court shall terminate this || action and enter judgment accordingly. 4 Dated this 30th day of April, 2020. 5 6 Lm ee” 7 f t _o—— Dominic W. Lanza 8 United States District Judge 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

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