FILED MAY 28 2014 1 NOT FOR PUBLICATION 2 SUSAN M. SPRAUL, CLERK U.S. BKCY. APP. PANEL OF THE NINTH CIRCUIT 3 UNITED STATES BANKRUPTCY APPELLATE PANEL 4 OF THE NINTH CIRCUIT 5 In re: ) BAP No. CC-13-1077-PaKiLa ) CC-13-1078-PaKiLa 6 ) (Related Appeals) JOHN A. OBARA and MYRNA ) 7 CASTRO, ) Bankr. No. 09-13962-VK ) 8 Debtors. ) Adv. Proc. 09-01239-VK ______________________________) 9 ) JOHN A. OBARA; MYRNA CASTRO, ) 10 ) Appellants, ) 11 ) v. ) M E M O R A N D U M1 12 ) AFC CAL, LLC, ) 13 ) Appellee. ) 14 ______________________________) 15 Argued and Submitted on May 15, 2014 at Pasadena, California 16 Filed - May 28, 2014 17 Appeal from the United States Bankruptcy Court 18 for the Central District of California 19 Honorable Charles E. Rendlen, III, Bankruptcy Judge, Presiding2 20 Appearances: Raymond H. Aver argued for appellant Myrna Castro; 21 Charles Shamash of Caceres & Shamash, LLP argued for appellant John A. Obara; Tom Roddy Normandin 22 of Prenovost, Normandin, Bergh & Dawe, APC argued for appellee AFC CAL, LLC. 23 24 1 This disposition is not appropriate for publication. 25 Although it may be cited for whatever persuasive value it may have (see Fed. R. App. P. 32.1), it has no precedential value. 26 See 9th Cir. BAP Rule 8013-1. 27 2 Judge Rendlen, United States Bankruptcy Judge for the 28 Eastern District of Missouri, as a visiting judge, presided over the trial and entered the judgment on appeal. 1 Before: PAPPAS, KIRSCHER and LATHAM,3 Bankruptcy Judges. 2 3 Appellants, chapter 74 debtors John A. Obara (“Obara”) and 4 Myrna Castro (“Castro” and, together, “Debtors”) appeal the order 5 of the bankruptcy court determining that their debt to AFC CAL, 6 LLC (“AFC”) was excepted from discharge under both § 523(a)(2)(A) 7 and § 523(a)(6). We AFFIRM in part and REVERSE in part regarding 8 the determination under § 523(a)(2)(A), and AFFIRM the 9 determination under § 523(a)(6). 10 FACTS 11 Background 12 Beginning in 2003, Debtors owned and operated Superior 1 13 Auto Sales (“Superior”). AFC Cal, LLC, a car dealership 14 financing group, extended a modest flooring line of credit to 15 Superior. 16 In 2005, Debtors formed JM Automotive Group, Inc. (“JMAG”), 17 to serve as the corporate entity for a new car dealership. While 18 Superior ceased to exist as a separate company in 2007 when Kia 19 granted Debtors a new car franchise, Debtors continued to use 20 Superior as a d/b/a for JMAG. 21 Castro was president of JMAG; Obara, her spouse, was its 22 23 3 Hon. Christopher B. Latham, United States Bankruptcy 24 Judge for the Southern District of California, sitting by designation. 25 4 Unless otherwise indicated, all chapter and section 26 references are to the Bankruptcy Code, 11 U.S.C. §§ 101 – 1532, 27 all Rule references are to the Federal Rules of Bankruptcy Procedure, Rules 1001–9037, and all Civil Rule references are to 28 the Federal Rules of Civil Procedure 1–86.
-2- 1 director of operations.5 AFC gave JMAG a $2.5 million flooring 2 line of credit in 2007 to acquire new cars, and a $1.5 million 3 flooring line for used cars. These credit lines were evidenced 4 by promissory notes and were secured by security agreements 5 (collectively the “JM Automotive Notes”) covering each new and 6 used car financed by AFC, together with the proceeds of those 7 sales. 8 Under this arrangement, when JMAG placed orders for new 9 cars, Kia would directly draw on the $2.5 million line. When 10 JMAG purchased used cars at an auction, the invoices were sent to 11 AFC, and AFC would pay for them from the $1.5 million line. When 12 AFC financed a vehicle, Kia would deliver the Manufacturer’s 13 Statement of Origin (“MSO”) to AFC, or the auction would send the 14 used car title to AFC. AFC retained the title or MSO until the 15 vehicle was paid off. When JMAG received the title or MSO from 16 AFC, it would submit it for registration to the California 17 Department of Motor Vehicles (“DMV”). Obara and Castro were 18 19 5 At oral argument before the Panel, Obara’s counsel 20 contended that Obara was not involved in managing daily operations at JMAG, and that another person was director of 21 operations. However, this conflicts with Obara’s trial 22 declaration, where he stated: “I was the Director of Operations at JM Automotive.” Obara Dec. at 2, ¶ 6, November 14, 2011. 23 Obara also confirmed that he was JMAG director of operations in trial testimony: “As a director of operations, I never saw the 24 bank statements.” Trial Tr. 208:18–209:2, March 6, 2012. 25 Counsel also insisted that “John Obara, rather than being a sophisticated evil mastermind, was nothing more than a kid, a guy 26 in his mid-20s, a go-getter, who was thrust in way over his 27 head.” However, Obara testified at trial that he had approximately twenty years of experience in the auto sales 28 industry. Trial Tr. 230:23-25, 174:13–178:16, March 6, 2012.
-3- 1 guarantors on the AFC debts. Both would admit at trial that they 2 did not retain the proceeds of the cars sold subject to AFC's 3 flooring lien in trust and, instead, used those proceeds to pay 4 operating expenses. 5 There were several minor defaults on the AFC loans in 2007 6 and 2008. However, the bankruptcy court would later determine 7 that none of the defaults raised the sort of “red flags” that 8 would have alerted AFC to potential financial difficulties at 9 JMAG. 10 Since 2005, a third party, AutoVin, performed on-site 11 monthly audits for AFC concerning JMAG’s operation. Among other 12 things, an audit included a physical count and inspection of the 13 cars on the lots, a review of sales receipts, and reconciliation 14 of Debtors’ records. Any discrepancies were noted in an audit 15 report (e.g., vehicles that were “off lot” for repairs or test 16 drives, sales information, sales proceeds not received from third 17 party finance companies, etc.). Debtors were then allowed five 18 days after receipt of the audit report to explain and provide 19 information to the auditor or AFC concerning any audit 20 discrepancies, to thereby “close” the audit. Before September 21 2008, debtors successfully passed audit forty times, and only 22 failed once, and that audit failure was ultimately resolved in 23 their favor. 24 The September Audit and the Repossession 25 As part of a review of the accounts, AFC required that 26 Debtors submit to AFC a written “Statement of Net Worth” as well 27 as tax returns. The statement Debtors gave to AFC represented 28 that their net worth was $3,684,842 on August 30, 2008. At
-4- 1 trial, they both admitted that this statement was false, in that 2 their net worth was at the time probably $2 million less than 3 what was represented. 4 In addition, on September 18 and 19, 2008, AutoVin conducted 5 a monthly audit of Debtors’ dealership. Based upon information 6 given to him, the auditor noted in his report that there were a 7 significant number of “unverified” vehicles, which he was lead by 8 JMAG representatives to believe were either "sold unpaid," on 9 “test drive,” or considered "demos." 10 AFC’s representative supervising Debtors’ account, Zach 11 Sterling (“Sterling”), testified at trial that he received the 12 auditor’s report on September 20, 2008, and noted the 13 discrepancies between the audit report and AFC’s records 14 concerning the numbers of vehicles which should be accounted for 15 at the dealership. When Sterling was unable to confirm the car 16 sales with third party financing companies listed in the 17 auditor’s report, he went to the dealership on Wednesday, 18 September 24. He met with Castro to discuss the discrepancies, 19 and to inquire when the audit would be closed. She told him that 20 she was compiling the records needed to close the audit, but that 21 the dealership’s computers were down. Sterling made a detailed, 22 visual inspection of the lot, and confirmed that the car numbers 23 were consistent with the audit report. Sterling also spoke to 24 Obara at least once on September 24, 25, and 26, but it is 25 disputed what was said. 26 Between September 23 and 25, 2008, twenty-five automatic 27 clearing house (“ACH”) transfers issued by JMAG from its bank 28 account to AFC were dishonored by the bank, totaling $78,000.
-5- 1 During this same time, Castro made withdrawals from JMAG’s 2 business bank accounts totaling $142,000. Sterling returned to 3 the dealership on Thursday, September 25, 2008 to again question 4 why the audit had not been closed, and to find out the reason for 5 the dishonored payments. 6 At that time, Castro assured Sterling that she was working 7 diligently on the audit, and that the dishonored payments must 8 have been the result of a bank error. Sterling again made a 9 visual examination of the lot and found the results consistent 10 with the auditor’s report. 11 On Friday, September 26, 2008, Sterling again returned to 12 the dealership. He and Castro then went together to the bank 13 branch that handled the JMAG accounts, where a bank officer 14 advised Sterling that the dishonored payments to AFC were 15 “possibly a bank error.”6 Sterling would later testify that, 16 upon returning to the dealership, Castro appeared to have made 17 several payments by computer to AFC. All payments made on 18 September 26 were later dishonored by the bank. As was later 19 revealed, twenty-four computer payments made by JMAG to AFC on 20 September 30, 2008, were also dishonored, totaling $212,549.47. 21 Sterling returned to the dealership on Monday, September 29, 22 2008. Upon his arrival, he received a cell phone call from a 23 person who identified himself as Don Lake, an attorney for JMAG, 24 who informed him that JMAG was “out of business,” and that all 25 26 6 Sterling would testify that he was later contacted by the 27 bank, and was informed that the dishonored ACH orders were not the result of bank error, but occurred because JMAG had stopped 28 payment on the transfers.
-6- 1 further inquiries should be directed to the attorney. Sterling 2 conducted a visual inspection of the lot and determined that 3 forty-nine vehicles that had been on the lot from September 18 4 through 26 were now gone. 5 When Sterling confronted Obara at the dealership about the 6 missing vehicles, Obara refused to give him any explanation, and 7 told Sterling to speak with Obara’s attorney. According to 8 Sterling’s trial testimony, 9 Q: What did Mr. Obara say to you [on September 29] and what did you say to him? 10 Sterling: My very first question to him is, John, 11 what’s going on? We just showed up and we noticed that there’s a lot of cars missing, 12 and we need to talk to you and figure out what’s going on here. 13 Q: What did Mr. Obara say? 14 Sterling: He said did you receive a call from my 15 attorney, and I responded with yes, that we had. 16 Q: And what did he say to that? 17 Sterling: He said, well, then that’s what you’re going 18 to have to do. You’re going to have to refer any questions to him. I’m not talking to 19 you. 20 Trial Tr. 49:8–20, January 11, 2012. 21 Sterling immediately ordered that all remaining vehicles on 22 the lot be repossessed. The evidence at trial would show that 23 the forty-nine “missing” cars had all been sold over the weekend 24 of September 27-28, 2008, by JMAG through Prime Auto Auction, for 25 prices that were less than the outstanding debt owed on the cars 26 to AFC. Obara and Castro have never fully accounted for the 27 proceeds of those sales. AFC filed a complaint against Debtors 28 in the California Department of Motor Vehicles. In an
-7- 1 administrative decision entered on July 7, 2011, the DMV 2 determined that the purchasers of at least twenty of the 3 forty-nine vehicles in dispute had not been able to obtain good 4 title because Debtors had not paid the liens on the vehicles to 5 AFC.7 6 The Bankruptcy and Adversary Proceeding 7 Obara and Castro filed a joint petition for relief under 8 chapter 7 on April 7, 2009. 9 AFC filed an adversary complaint against Debtors on July 9, 10 2009; a First Amended Complaint (“FAC”) was filed on November 9, 11 2009. In it, AFC sought an exception to discharge for the debts 12 owed by Debtors to AFC under §§ 523(a)(2)(A) and (B), and 13 § 523(a)(6), and asked that Debtors’ discharge be denied under 14 §§ 727(a)(2), (a)(4), (a)(5) and (a)(7). Debtors filed an answer 15 to the FAC on February 22, 2010, generally denying its 16 allegations.8 17 AFC submitted a pretrial brief on July 18, 2011. To support 18 its claim for an exception to discharge under § 523(a)(2)(A), AFC 19 alleged that Debtors provided false and misleading information to 20 AFC regarding the status of vehicles missing from the dealership 21 lot on September 18 and 19, 2008, that numerous checks from JMAG 22 to AFC were dishonored, and that forty-nine vehicles on the lot 23 7 24 The bankruptcy court would determine that the DMV decision was not entitled to preclusive effect concerning the 25 issues raised in the adversary proceeding, a conclusion the parties have not challenged in this appeal. 26 8 27 AFC’s motion for summary judgment in the adversary proceeding was denied by the bankruptcy court after a hearing on 28 October 28, 2010. That order has not been appealed.
-8- 1 during the audit were missing on September 29, 2008. Concerning 2 its allegations under § 523(a)(6), AFC argued that JMAG had 3 converted a total of 170 vehicles that Debtors knew were subject 4 to AFC liens, and did so willfully and maliciously to injure AFC 5 and its property.9 6 Debtors submitted a pretrial brief on September 19, 2011. 7 As to § 523(a)(2)(A), Debtors denied making any false 8 representations to the auditor during the audit of September 18 9 and 19, 2008. As to § 523(a)(6), Debtors denied that there had 10 been any conversion of AFC’s property. 11 Trial in the adversary proceeding took place on January 11, 12 March 6, March 7, and November 13, 2012. The witnesses who 13 testified included Sterling, Obara, Castro, John Durazo (the 14 AutoVin auditor who conducted the inspections/audits on 15 September 18 and 19, 2008), Gabriela Otworth (bank branch 16 manager), and Efren Martinez (an auto registration service 17 agent). At the close of trial, the bankruptcy court requested 18 additional briefing from the parties to address, among other 19 things, why AFC continued to hold 165 titles and MSOs, the course 20 of dealing between AFC and Debtors concerning payments and 21 defaults on the flooring line, and Debtors’ record-keeping 22 practices. 23 AFC argued in its post-trial brief that it was AFC’s 24 practice to withhold titles and MSOs from car purchasers until 25 26 9 We do not discuss here the parties’ arguments concerning 27 AFC’s claims under § 523(a)(2)(B) and § 727(a), because those claims were dismissed by the bankruptcy court and those 28 dismissals have not been appealed.
-9- 1 its lien was satisfied. As to course of dealing, AFC contended 2 that it was not aware of any serious financial difficulties of 3 JMAG before the events of late September 2008. And, AFC 4 insisted, Debtors poorly maintained records, could not provide 5 the bankruptcy court with records because they had intentionally 6 sold the computers where the records were kept, and had not kept 7 copies or backup. 8 Rather than address the bankruptcy court’s specific 9 questions, Debtors’ post-trial brief repeated their general 10 arguments why AFC had not satisfied its burden of persuasion on 11 the elements of §§ 523(a)(2)(A) and (a)(6). 12 The bankruptcy court entered a Memorandum and Opinion on 13 February 8, 2013 (“Memorandum”). After a discussion of the 14 facts, the court made the following findings and conclusions: 15 - “Defendants are personally liable for JM Automotive’s 16 Obligations.” 17 - “Defendants made misrepresentations to plaintiff with 18 knowledge of falsity and intent to deceive.” 19 - “Plaintiff justifiably relied on Defendant’s 20 representations.” 21 - “Plaintiff was damaged in the amount of $2,000,688.00, 22 proximately caused by plaintiff’s reliance on Defendant’s 23 misrepresentations.” 24 - “The court finds that Plaintiff has established all five 25 elements required under § 523(a)(2)(A) by a preponderance of the 26 evidence.” 27 - “The elements of conversion [under California and 28 bankruptcy law] are met.”
-10- 1 - “JM Automotive’s conversion of the one hundred and seventy 2 vehicles was willful and malicious.” 3 - “Plaintiff has established the requirements for a finding 4 under § 523(a)(6) by a preponderance of the evidence.” 5 In the judgment, also entered on February 8, 2013, the 6 bankruptcy court determined that $2,000,688.00, the balance due 7 on JMAG’s debts to AFC, was excepted from discharge under 8 §§ 523(a)(2)(A) and (a)(6). The bankruptcy court granted 9 judgment in favor of Debtors on the § 727(a) claims, and ruled 10 that “all other requests for relief be denied.” 11 Debtors each filed a timely notice of appeal. 12 JURISDICTION 13 The bankruptcy court had jurisdiction under 28 U.S.C. 14 §§ 1334 and 157(b)(2)(I). We have jurisdiction under 28 U.S.C. 15 § 158. 16 ISSUE 17 Whether the bankruptcy court erred in determining that the 18 debt owed by Debtors to AFC was excepted from discharge under 19 § 523(a)(2)(A) and § 523(a)(6). 20 STANDARD OF REVIEW 21 In reviewing a bankruptcy court's determination of an 22 exception to discharge, we review its findings of fact for clear 23 error and its conclusions of law de novo. Oney v. Weinberg 24 (In re Weinberg), 410 B.R. 19, 28 (9th Cir. BAP 2009). 25 /// 26 /// 27 /// 28 ///
-11- 1 DISCUSSION 2 I. 3 The bankruptcy court did not err in determining that the debt owed by Debtors to AFC is excepted from 4 discharge under § 523(a)(2)(A), but the court’s determination of the amount of damages proximately 5 caused by Debtors’ fraud was clearly erroneous. 6 Section 523(a)(2)(A) provides: 7 (a) A discharge under section 727 . . . does not discharge an individual debtor from any debt– . . . 8 (2) for money, property, services, or an extension, 9 renewal, or refinancing of credit, to the extent obtained, by– (A) false pretenses, a false representation, or actual 10 fraud, other than a statement respecting the debtor's or an insider's financial condition[.] 11 12 To establish a claim for an exception to discharge under 13 this provision requires a creditor to demonstrate the existence 14 of five distinct elements by a preponderance of the evidence: 15 (1) the debtor made representations; (2) that at the time the 16 debtor knew they were false; (3) that the debtor made them with 17 the intention and purpose of deceiving the creditor; (4) that the 18 creditor justifiably relied on such representations; and (5) that 19 the creditor sustained the alleged loss and damage as the 20 proximate result of the misrepresentations having been made. 21 Ghomesh v. Sabban (In re Sabban), 600 F.3d 1219, 1221 (9th Cir. 22 2010); Siriani v. Nw. Nat’l Ins. Co. of Milwaukee, WI 23 (In re Siriani), 967 F.2d 302, 304 (9th Cir. 1992). However, 24 even assuming these elements are satisfied, a creditor will not 25 be entitled to an exception to discharge under § 523(a)(2)(A) if 26 the debtor’s fraudulent representations consist of “statement[s] 27 respecting the debtor’s or an insider’s financial condition 28 . . . .” Heritage Pac. Fin., LLC v. Edgar (In re Montano),
-12- 1 501 B.R. 96, 102 (9th Cir. BAP 2013). 2 A. False Representations 3 In its Memorandum, the bankruptcy court cites examples of 4 misrepresentations by Obara and Castro on which AFC justifiably 5 relied. First, the court found that, 6 Defendants signed the JM Automotive Notes dated August 7, 2007. When Defendants signed the documents, 7 they made representations and warranties that JM Automotive would provide a complete accounting of 8 the financed vehicles and remit the requisite sales 9 proceeds due to Plaintiff in accordance with the terms of the JM Automotive Notes. The representations were 10 material and induced Plaintiff to extend the flooring line of credit. 11 12 Memorandum at 20. 13 Given the context of this action, it is not clear why the 14 bankruptcy court included this representation in discussing 15 Debtors’ conduct. The representation it cites as problematic was 16 made in the contract documents executed in 2007, before JMAG was 17 apparently experiencing any financial problems. Indeed, 18 according to the evidence, JMAG had successfully navigated forty 19 audits before August 2008. There is nothing in the record to 20 suggest that Debtors’ representations to faithfully account for 21 financed vehicles, and any proceeds of sale, nearly a year before 22 Debtors’ questionable behavior occurred in September 2008, were 23 falsely made to deceive AFC at the time they were made. 24 The other two representations targeted by the bankruptcy 25 court took place in connection with Debtors’ delivery of their 26 Statement of Net Worth, dated August 29, 2008, to AFC, and 27 Debtors’ false statements made to the auditor in connection with 28 the September 18 and 19, 2008 audit.
-13- 1 JM Automotive provided false information to the lot auditor during the September 2008 audit. While 2 Defendants maintain that they did not personally provide the lot auditor with any information, the lot 3 auditor specifically identified certain vehicles as “sold unpaid” or “test drive” or on “demo.” The only 4 reasonable conclusion is that a representative of JM Automotive provided the auditor with this false 5 information . . . . Defendants’ arguments as to the August 29, 2008 Statement of Net Worth and the 6 September lot audit are disingenuous. Having intentionally provided the false Statement of Net Worth 7 to Plaintiff and false statements to the lot auditor, it is not a defense to assert that the misconduct 8 should have been discovered or should not have been relied upon . . . . JM Automotive’s fraudulent conduct 9 is attributable to Defendants[.] 10 Memorandum at 22-23. 11 Of course, to the extent that the bankruptcy court deemed 12 the Statement of Net Worth to be a false representation which 13 could support an exception to discharge under § 523(a)(2)(A), the 14 court erred.10 Even if its contents were false, and Debtors 15 intended to defraud AFC through its contents, AFC’s use of this 16 statement is not actionable since "[b]y its terms, § 523(a)(2)(A) 17 excludes ‘a statement respecting the debtor's or an insider's 18 financial condition.'" In re Montano, 501 B.R. at 102; Tallant 19 v. Kaufman (In re Tallant), 218 B.R. 58, 69 (9th Cir. BAP 1998). 20 The bankruptcy court dismissed AFC’s § 523(a)(2)(B) claim for 21 Debtors’ use of false financial information, and AFC has not 22 appealed that aspect of the judgment. 23 On the other hand, we agree with the bankruptcy court that 24 25 10 At argument before the Panel, counsel for AFC conceded 26 that the Statement of Net Worth could not serve as the basis for 27 an exception to discharge under § 523(a)(2)(A), but suggested that it was probative of willful and malicious conduct under 28 § 523(a)(6).
-14- 1 false information given by Debtors to the lot auditor, or to 2 Sterling, either directly or through JMAG employees, could 3 constitute representations adequate to support a discharge 4 exception under § 523(a)(2)(A). In this regard, the Memorandum 5 recites: 6 The Court finds that there is sufficient evidence that Defendants directly participated in or consented to the 7 alleged fraud[ulent representations]. At all time, Defendants were the sole owners, directors and officers 8 of JM Automotive. As signatories to the JM Automotive Notes, Defendants were aware of JM Automotive’s 9 obligations to Plaintiff. Defendants testified extensively as to their course of dealing with 10 Plaintiff evidencing knowledge of JM Automotive’s operations and activities. Obara was involved in the 11 process of acquiring the vehicle at auction and selling them at JM Automotive. Therefore, Obara knew the sales 12 status of vehicles financed by Plaintiff. If a vehicle, financed by Plaintiff, was sold or remained on 13 the lot, Obara knew about it. Obara and Castro are specifically identified as having met with the AutoVin 14 auditor in lot audit reports. Obara knew that an incorrect accounting of the vehicles had been provided 15 during the September 2008 lot audit. Obara failed to take appropriate action to correct the wrong. 16 17 Memorandum at 19-20. 18 While Debtors each urgently argue to the contrary, the 19 bankruptcy court found, based upon the disputed evidence, that 20 Obara and Castro both effectively made false representations as 21 part of the audit process about the status of the JMAG vehicles. 22 To the extent they personally made false statements to the 23 auditor or to Sterling, they are accountable under § 523(a)(2)(A) 24 for direct, actual fraud. Tobin v. San Souci Ltd. P’ship 25 (In re Tobin), 258 B.R. 199, 205-06 (9th Cir. BAP 2001.) But the 26 same is also true if, instead of personally misleading the 27 auditor or banker, they knowingly allowed their agents to provide 28 false information to the auditor or AFC because, under the
-15- 1 circumstances here, the fraud committed by their agents can be 2 imputed to the Debtors for purposes of § 523(a)(2)(A). 3 In Sachan v. Huh (In re Huh), 506 B.R. 257 (9th Cir. BAP 4 2014), the Panel adopted the standard for imputation of fraud 5 liability articulated by the Eighth Circuit in Walker v. Citizens 6 State Bank (In re Walker), 726 F.2d 452 (8th Cir. 1984), and 7 concluded that, to be true to the policies of the Bankruptcy Code 8 and case law, the emphasis should be the actions of the debtor. 9 Id. at 266. As the Panel explained, to show that an agent's 10 fraud should be imputed to the debtor, the creditor seeking an 11 exception to discharge must show that the debtor acted with 12 "culpable state of mind," and that the debtor "knew or should 13 have known" of the perpetrator's fraudulent activities. Id. at 14 267. 15 In this case, the bankruptcy court made the sort of findings 16 necessary under In re Huh to show that Debtors knew, or should 17 have known, that false representations were made to the auditors 18 by their staff. In particular, the court found that Obara “knew 19 the sales status of vehicles financed by Plaintiff. If a 20 vehicle, financed by Plaintiff, was sold or remained on the lot, 21 Obara knew about it. Obara knew that an incorrect accounting of 22 the vehicles had been provided during the September 2008 audit. 23 Obara failed to take appropriate action to correct the wrong.” 24 Memorandum at 20. 25 In addition, even if Obara and Castro did not personally, or 26 through others, misinform the auditor or AFC about the true state 27 of affairs concerning the cars securing the debts, if they 28 withheld critical information from AFC with the intent to defraud
-16- 1 the creditor, an exception to discharge is appropriate. Citibank 2 (South Dakota), N.A. v. Eashai (In re Eashai), 87 F.3d 1082, 3 1089-90 (9th Cir. 1996) (holding that “a debtor's failure to 4 disclose material facts constitutes a fraudulent omission under 5 § 523(a)(2)(A) if the debtor was under a duty to disclose and the 6 debtor's omission was motivated by an intent to deceive.”); see 7 also Harmon v. Kobrin (In re Harmon), 250 F.3d 1240, 1246 (9th 8 Cir. 2001); RESTATEMENT (SECOND) OF TORTS § 551 (1976). 9 In this case, it is undisputed that, in the JM Automotive 10 Notes, Obara and Castro signed an Unconditional and Continuing 11 Guaranty of the debt of JMAG which imposed the following 12 obligations upon them to AFC: 13 4.0 Upon the sale of any item of purchase money inventory, Dealer shall hold the amount received 14 from the disposition of inventory in trust for the benefit of Lender. 15 * * * 16 5.1 Unless Purchase Money Inventory is the subject of a 17 retail Installment Contract . . . or is sold pursuant to Section 4.0, Dealer shall not attempt to or actually 18 sell, lease, transfer, mortgage, encumber, or otherwise dispose of the Purchase Money Inventory[.] 19 * * * 20 5.3 Dealer shall keep and maintain the collateral in 21 good repair and safe condition. 22 5.4 Dealer has kept and shall continue to keep true and accurate books and records concerning the 23 business affairs and the collateral. 24 The bankruptcy court found that by these guaranties, and other 25 warranties they made to AFC, Debtors had an affirmative 26 obligation to provide a complete accounting, and to remit the 27 sales proceeds of sold cars, to AFC, and generally to “keep safe” 28 the vehicles. Memorandum at 20.
-17- 1 The bankruptcy court found that both Obara and Castro were 2 present at the dealership during the auditor’s visits in 3 September 2008, and had spoken with the auditor. Both were aware 4 that there were irregularities with the audit that they must 5 address before it would be “closed.” At least as to Obara, the 6 court also found that “Obara knew that an incorrect accounting of 7 the vehicles had been provided during the September 2008 lot 8 audit . . . [and that] Obara failed to take appropriate action to 9 correct the wrong.”11 10 Though they had a contractual duty to fully disclose correct 11 information to AFC about the vehicles and sales transactions, the 12 bankruptcy court determined that, instead, the auditor, and later 13 Sterling, were given false statements about the status of the 14 cars to mask the truth that numerous “missing vehicles” that the 15 auditor had been informed were sold unpaid, on test drive, or 16 were demos had in fact been sold, and the liens of AFC not paid. 17 Finally, the bankruptcy court determined that Castro engaged 18 in fraudulent representations to Sterling regarding the string of 19 dishonored automated payments made by JMAG to AFC between 20 September 23 and 25, 2008. Indeed, the court found that Castro 21 “inexcusably withdrew” $142,100.37 from the JM Automotive 22 accounts, during the time the ACH transfers to AFC (some of which 23 were performed by Castro in Sterling’s presence) for $78,764 were 24 dishonored. While a single bad check is not a false 25 representation for exception to discharge purposes, Williams v. 26 11 27 The court had evidence from the testimony of Durazo, the auditor, that he had given a copy of his audit results to Obara. 28 Trial Tr. 99:8–100:1, March 6, 2012.
-18- 1 United States, 458 U.S. 279, 284 (1982), the bankruptcy court 2 found that “Castro was aware of the amount of funds available [or 3 not] in the account.” Memorandum at 21. The court therefore 4 could reasonably infer that the numerous dishonored ACH transfers 5 from JMAG to AFC were tantamount to fraudulent representations, 6 by which Debtors were stalling for time so that they could 7 liquidate the vehicle inventory before AFC could exercise its 8 contractual rights to repossess and accelerate any debt. 9 At bottom, whether the debtor made a misrepresentation is a 10 finding of fact reviewed for clear error. Candland v. Ins. Co. 11 of N. Am. (In re Candland), 90 F.3d 1466 (9th Cir. 1996) (citing 12 Lansford v. LaTrattoria (In re Lansford), 822 F.2d 902, 904 (9th 13 Cir. 1987)); Miller v. IRS (In re Miller), 174 B.R. 791, 794 (9th 14 Cir. BAP 1994). Here, based upon the disputed evidence, the 15 bankruptcy court did not clearly err in determining that Obara 16 and Castro made false representations to AFC in connection with 17 the audit, or otherwise engaged in fraudulent conduct in their 18 dealings with AFC. 19 B. Knowledge of Falsity and Intent to Deceive the Creditor 20 The bankruptcy court examined the evidence of the 21 representations and behavior of Obara and Castro at the time of 22 the September audit process and thereafter. The court determined 23 that Debtors’ knowledge of the falsity of the information given 24 to AFC, and their intent to deceive the creditor “can be inferred 25 from Defendants’ failure to remit sale proceeds.” Moreover, as 26 the court noted, JMAG dishonored hundreds of thousands of dollars 27 in ACH transfers to AFC during this time. And, of course, 28 forty-nine of the cars that were on the lot on Friday, had
-19- 1 disappeared by the following Monday, and were subsequently found 2 to have been sold for less than the debt owed AFC over the 3 weekend, only for Sterling to be informed that the business was 4 closed. 5 Simply put, the record includes ample evidence from which 6 the bankruptcy court could reasonably infer that Obara and Castro 7 acted with a fraudulent state of mind at the time of, and 8 subsequent to, the September audit. Runnion v. Pedrazzini 9 (In re Pedrazzini), 644 F.2d 756, 758 (9th Cir. 1981) (The 10 existence of scienter is a question of fact, not to be reversed 11 on appeal unless clearly erroneous.); Williamson v. Busconi, 12 87 F.3d 602, 603 (1st Cir. 1996) (explaining that "subsequent 13 conduct may reflect back to the promisor's state of mind and thus 14 may be considered in ascertaining whether there was fraudulent 15 intent at the time the promise was made"); Stein v. Tripp 16 (In re Tripp), 357 B.R. 544, 548 (Bankr. D. Ariz. 2006) (noting 17 that a court "may consider subsequent conduct to the extent that 18 it provides an insight into the debtor's state of mind at the 19 time of the representations."). 20 C. Justifiable Reliance 21 To sustain an exception to discharge, § 523(a)(2)(A) also 22 requires that the bankruptcy court find that the creditor 23 justifiably relied on a debtor’s false statements or 24 misrepresentations. Field v. Mans, 516 U.S. 59, 74-75 (1995). 25 Justifiable reliance is measured under a subjective standard, 26 which turns on a person’s knowledge under the particular 27 circumstances. In re Eashai, 87 F.3d at 1090. “Justification is 28 a matter of the qualities and characteristics of the particular
-20- 1 plaintiff, and the circumstances of the particular case, rather 2 than of the application of a community standard of conduct to all 3 cases.” Id. (quoting Field, 516 U.S. at 70). Therefore, the 4 inquiry regarding the justifiable standard focuses on “whether 5 the falsity of the representation was or should have been readily 6 apparent to the individual to whom it was made.” Beneficial 7 Cal., Inc. v. Brown (In re Brown), 217 B.R. 857, 863 (Bankr. S.D. 8 Cal. 1998). 9 The justifiable reliance standard generally does not entail 10 a duty to investigate; a person may be justified in relying on a 11 representation even if he might have ascertained the falsity of 12 the representation had he made an investigation. See Field, 13 516 U.S. at 70. However, a creditor’s duty to investigate arises 14 by virtue of suspicious circumstances. Id. at 71. Thus, 15 “justifiable reliance does not exist where a creditor ignores red 16 flags.” In re Anastas, 94 F.3d at 1286; Romesh Japra, M.D., 17 F.A.C.C., Inc. v. Apte (In re Apte), 180 B.R. 223, 229 (9th Cir. 18 BAP 1995)(same). 19 The bankruptcy court addressed Debtors’ arguments that, in 20 this case, AFC ignored several significant “red flags” about 21 Debtors’ business operations. The court noted that the evidence 22 showed that, before September 2008, AFC had received the required 23 payments for financed vehicles within the ninety-day curtailment 24 period required by the JM Automotive Notes. The court also had 25 evidence that JMAG had passed forty of forty-one audits before 26 September 2008. Based on this and other evidence, the court 27 summarized, “the evidence fails to show that, prior to August 28 2008, Plaintiff disregarded red flags based on its knowledge of
-21- 1 JMAG’s financial difficulties.” Memorandum at 24. We see no 2 error in the court’s reasoning. 3 The bankruptcy court also heard the testimony of Sterling 4 about his concerns with the inconsistency between the 5 representations made to the auditor, his company’s records, and 6 his discussions with third party lenders identified by the 7 auditor’s report calling the true status of several vehicles into 8 question. He testified that in light of the findings in the 9 audit he immediately went to the dealership to inquire about the 10 delay in closing the audit, and again later to inquire about the 11 many dishonored ACH transfers. Sterling noted that, based on 12 JMAG’s long history of good payments, and what he perceived as 13 the efforts of its management, including Castro, to close the 14 audit, he did not, at least initially, feel compelled to exercise 15 the power to terminate the parties’ credit relationship, to 16 accelerate the debt, or to repossess the cars. However, Sterling 17 testified that, had he known of the false representations made to 18 the auditor, he would have immediately exercised the repossession 19 option: “Obara and Castro mislead the AutoVin auditors on 20 September 18 and 19, 2008, as to the status of AFC’s collateral. 21 Had we known the true facts, AFC would have repossessed its 22 Collateral on September 19, 2008.” Sterling Dec. at 6-7, 23 July 18, 2011. 24 Perhaps in retrospect AFC should have been more keenly alert 25 to the possibility that the information Debtors were giving the 26 creditor about the status of the vehicles, and their ACH 27 payments, was unreliable. However, based on the conflicting 28 evidence, the bankruptcy court did not clearly err in finding
-22- 1 that there were no red flags that would have caused AFC to 2 investigate further, and would have prevented its reliance on the 3 false representations made to the auditor to be justified. 4 D. Proximate Cause and Damages 5 Another element for an exception to discharge under 6 § 523(a)(2)(A) is that AFC must have sustained loss or damages as 7 the proximate result of the misrepresentations having been made. 8 In re Sabban, 600 F.3d at 1221. Proximate cause under 9 § 523(a)(2)(A) requires a finding by the bankruptcy court that 10 there was (1) causation in fact, or in other words, that the 11 debtor’s misrepresentations or fraud was a substantial factor in 12 determining the course of conduct that results in loss and 13 (2) legal causation, which requires the creditor's loss to 14 reasonably be expected to result from the reliance. Sharfarz v. 15 Goguen (In re Goguen), 691 F.3d 62, 70 (1st Cir. 2012) (citing 16 Restatement (Second) of Torts, §§ 546, 548A) ("A fraudulent 17 misrepresentation is a legal cause of a pecuniary loss resulting 18 from action or inaction in reliance upon it if, but only if, the 19 loss might reasonably be expected to result from the reliance."); 20 Burks v. Bailey (In re Bailey), 499 B.R. 873, 891 (Bankr. D. 21 Idaho 2013) (same). 22 Concerning AFC’s loss as a result of Debtors’ fraud, the 23 bankruptcy court found that: 24 Defendants made representations on behalf of JM Automotive with the knowledge and intent to deceive 25 Plaintiff. Had Plaintiff known JM Automotive withheld funds from the sale of vehicles financed by Plaintiff, 26 Plaintiff could have discontinued financing vehicles for JM Automotive and enforced its rights under the 27 terms of the JM Automotive Notes. Instead, Plaintiff was kept in the dark and as a result suffered damages 28 of $2,000,688.00 — the outstanding balance on the lines
-23- 1 of credit extended to JM Automotive. The damages were proximately caused by Defendants’ and JM Automotive 2 fraudulent conduct. . . . In sum, the court finds Plaintiff has established all five elements required 3 under § 523(a)(2)(A) by a preponderance of the evidence. 4 5 Memorandum at 25. We agree with the bankruptcy court that 6 Debtors’ misconduct caused AFC to suffer a loss. We disagree, 7 however, with the court’s determination of the extent of that 8 loss. 9 In particular, we do not understand how the facts in this 10 case support a fraud exception to discharge for the full balance 11 due on the AFC debt. Of course, apparently to this day, AFC has 12 not recovered any of the sums due on the 170 cars that were not 13 properly accounted for in the September audit. And we understand 14 that Sterling testified that, had he known of the falsity of the 15 representations made to the auditor, he would have immediately 16 repossessed the cars on the lot. 17 However, only forty-nine cars “went missing” during the 18 September audit. It was only as to these vehicles that AFC could 19 have exercised its repossession rights but for Debtors’ fraud. 20 Put another way, while AFC no doubt suffered a loss from the 21 other missing, and presumably sold, vehicles, that loss cannot be 22 tied to Debtors’ misconduct during the September audit. Thus, 23 AFC’s damages stemming from Debtors’ fraudulent representations 24 in September 2008 must be limited to the balance due on the 25 forty-nine cars, not the full balance due on the JM Automotive 26 Notes. 27 In sum, we AFFIRM the judgment of the bankruptcy court 28 determining that, as a result of Debtors’ false representation
-24- 1 and fraud, AFC is entitled to an exception from discharge under 2 § 523(a)(2)(A). However, we REVERSE that portion of the judgment 3 incorporating the bankruptcy court’s incorrect calculation of the 4 amount of AFC’s damages as equaling the full amount due from 5 Debtors to AFC on the 170 cars, rather than the amount due for 6 the missing forty-nine cars.12 However, based upon our 7 conclusions about AFC’s § 523(a)(6) claim below, we do not think 8 a remand to the bankruptcy court to calculate the correct amount 9 of damages is necessary at this time. 10 II. 11 The bankruptcy court did not err in determining that the debt owed by Debtors to AFC was excepted from 12 discharge under § 523(a)(6). 13 Section 523(a)(6) provides: "(a) A discharge under 727 . . . 14 of this title does not discharge an individual debtor from any 15 debt — . . . (6) for willful and malicious injury by the debtor 16 to another entity or to the property of another entity." 17 Ordinarily, tortious conduct is a required element for a finding 18 of exception to discharge under § 523(a)(6), and we look to state 19 12 20 At argument before the Panel, counsel for AFC conceded that an exception to discharge under § 523(a)(2)(A) would only 21 apply to the value of the forty-nine cars. However, counsel 22 argued that the bankruptcy court’s award of $2,000,688 was less than the Kelly Bluebook value of the cars of approximately 23 $2.6 million. The Panel asked counsel if the $2.6 million referred to the forty-nine cars, and counsel replied yes. It 24 appears that counsel was confusing the value of the 170 cars with 25 the value of the forty-nine cars. According to AFC’s own evidence, the Kelly Bluebook value of the forty-nine cars was 26 $638,297.54, and the outstanding debt owed by JMAG to AFC on 27 those forty-nine cars was $627,938.98; the Kelly Bluebook value of the 170 cars was approximately $2.6 million. Plaintiff’s 28 Trial Exh. 6 at 2-4.
-25- 1 law to determine the elements of a tort. Lockerby v. Sierra, 2 535 F.3d 1038, 1040 (9th Cir. 2010). Whether a particular debt 3 is for willful and malicious injury by the debtor to another or 4 the property of another under § 523(a)(6) requires application of 5 a two-pronged test: the creditor must prove that the debtor's 6 conduct in causing the creditor’s injuries was both willful and 7 malicious. Barboza v. New Form, Inc. (In re Barboza), 545 F.3d 8 702,711 (9th Cir. 2008) (citing Carrillo v. Su (In re Su), 9 290 F.3d 1140, 1146-47 (9th Cir. 2002) and requiring the 10 application of a separate analysis of each prong of "willful" and 11 "malicious"). 12 To show that a debtor's conduct is willful requires proof 13 that the debtor deliberately or intentionally injured the 14 creditor or the creditor's property, and that in doing so, the 15 debtor intended the consequences of his act, not just the act 16 itself. Kawaauhau v. Geiger, 523 U.S. 57, 60-61 (1998). The 17 debtor must act with a subjective motive to inflict injury, or 18 with a belief that injury is substantially certain to result from 19 the conduct. In re Su, 290 F.3d at 1143; Petralia v. Jercich, 20 238 F.3d 1202, 1208 (9th Cir. 2001). 21 An injury is malicious within the meaning of § 523(a)(6) if 22 the debtor (a) commits a wrongful act, (b) done intentionally, 23 (c) which necessarily causes injury and (d) the act is done 24 without just cause or excuse. In re Su, 290 F.3d at 1147. 25 Here, the bankruptcy court determined that, in their 26 dealings with AFC, Debtors committed an intentional conversion of 27 28 -26- 1 AFC’s collateral under California law.13 “[T]he elements of 2 conversion are the creditor’s ownership or right to possession of 3 the property at the time of conversion; the debtor’s conversion 4 by a wrongful act or disposition of property rights; and 5 damages.” Thiara v. Spycher Bros. (In re Thiara), 285 B.R. 420, 6 427 (9th Cir. BAP 2002) (citing Farmer’s Ins. Exch. v. Zerin, 7 51 Cal. App. 4th 445, 451 (1997)); Meserali v. Fulwider, 53 Cal. 8 App. 4th 445, 447 (1988) (holding that, in California, a debtor 9 may be liable for conversion where the debtor wrongfully 10 withholds personal property from a creditor entitled to the 11 property under a security agreement). 12 In particular, the bankruptcy court found that Debtors had: 13 sold and transferred a total of one hundred and seventy vehicles financed by Plaintiff. Plaintiff held a 14 security interest in those vehicles at the time of the sale and transfer. By selling and transferring the one 15 hundred and seventy vehicles without repaying Plaintiff and obtaining the original titles or MSOs to pass on to 16 buyers, JM Automotive wrongfully deprives Plaintiff of its security interest. As a result of JM Automotive’s 17 actions, Plaintiff was damaged in the amount of $2,000,688.00 — the outstanding balance on the lines of 18 credit extended to JM Automotive for the one hundred seventy vehicles. 19 20 13 A judgment for conversion under California law "does 21 not, without more, establish that a debt arising out of that judgment is nondischargeable under § 523(a)(6)." Peklar v. Iklar 22 (In re Peklar), 260 F.3d 1035, 1038 (9th Cir. 2001). Instead, 23 such a judgment decides only that the defendant has engaged in the "wrongful exercise of dominion" over the personal property of 24 the plaintiff; it does not necessarily decide that the defendant 25 has caused a "willful and malicious injury" within the meaning of § 523(a)(6). Id. Of course, there was no state court judgment 26 entered against Debtors. However, the bankruptcy court examined both the willful and malicious prongs of the § 523(a)(6) test, 27 and decided that all requirements for an exception to discharge 28 were satisfied.
-27- 1 Memorandum at 27. 2 The bankruptcy court correctly found that the conversion of 3 the 170 vehicles was willful and malicious. As to the 4 willfulness prong, the court found on the evidence that, among 5 other actions, Debtors sold or transferred forty-nine vehicles 6 the weekend of September 26, 2008, knowing that it would deprive 7 AFC of its security interest in the vehicles, and by these 8 actions, they exhibited a subjective motive to inflict injury on 9 AFC. We agree with the bankruptcy court that, given these facts, 10 the court could reasonably infer that Debtors acted willfully, 11 “because the evidence indicates that JM Automotive knew its 12 conduct [] was substantially certain to cause injury to Plaintiff 13 and JM Automotive had the subjective motive to inflict injury to 14 Plaintiff on or about the weekend of September 26, 2008.” 15 Memorandum at 27. 16 As to the malicious prong, the bankruptcy court found, based 17 on the evidence, that Debtors intentionally deprived AFC of its 18 security interest without just cause or excuse. Memorandum at 19 27. Again, we agree with the bankruptcy court that this is a 20 reasonable inference under these facts. 21 The one significant objection by Debtors to the bankruptcy 22 court’s ruling that there was an exception to discharge under 23 § 523(a)(6) is based on the Ninth Circuit’s opinion in Transam. 24 Commercial Fin. Corp. v. Littleton (In re Littleton), 942 F.2d 25 551, 554-55 (9th Cir. 1991). Debtors argue that, because AFC did 26 not show that Debtors used the diverted car sale proceeds for 27 their own purposes and, instead, used the money to pay other 28 debts, AFC has not shown Debtors acted maliciously.
-28- 1 Of course, Littleton was decided before Geiger, Jercich and 2 Su revised the Circuit’s case law concerning the proof required 3 for an exception to discharge under § 523(a)(6). In addition, 4 Littleton held that, for a flooring agreement like the one at 5 issue in this appeal, malice could not necessarily be shown 6 solely by the fact that the debtor diverted the proceeds from the 7 sale of the collateral of a secured creditor to pay other 8 creditors. Id. However, the Littleton court observed that the 9 debtor in that case was operating with hopes of saving the 10 business. As noted by the bankruptcy court in this case, the 11 Littleton court had concluded that: 12 the methods by which [the debtor] made payments and handled inventory did not constitute acts that 13 necessarily produced harm. Furthermore, the bankruptcy court found that at all times the debtors were acting 14 with the hope and expectation of saving the business and that they cooperated with Transamerica by seeking 15 additional financing that would allow Jacob's to stay in business. Additionally, the debtors offered a third 16 trust deed on their residence as additional security for the loan. Moreover, there was no evidence that the 17 debtors used any of the proceeds for their personal benefit, or that any other creditor was paid other than 18 in the ordinary course of business in the month before insolvency proceedings were filed. 19 Considering these facts, it was not clearly erroneous 20 for the bankruptcy court or the BAP to conclude that the debtors' acts would not have necessarily produced 21 harm. Consequently, the debtors' conduct was not malicious, as that term is used in § 523(a)(6). 22 23 Id. at 555. 24 In this case, in contrast to Littleton, the bankruptcy court 25 found that Debtors were not motivated by a desire to preserve 26 their business. Rather, “Defendants’ behavior suggests a desire 27 to extract as much money as possible from a failing business.” 28 Memorandum at 28. This finding adequately supports the
-29- 1 bankruptcy court’s conclusion that Debtors’ conversion of 2 170 vehicles, and the sale proceeds, was a malicious enterprise, 3 justifying an exception to discharge under § 523(a)(6). 4 CONCLUSION 5 We AFFIRM the bankruptcy court’s judgment concluding that a 6 portion of the debt owed by Debtors to AFC is excepted from 7 discharge under § 523(a)(2)(A), but we REVERSE its determination 8 under § 523(a)(2)(A) of the amount of damages suffered by AFC as 9 a result of Debtors’ fraudulent conduct. We AFFIRM the 10 bankruptcy court's judgment that the debt of $2,000,688.00 owed 11 by Debtors to AFC is excepted from discharge under § 523(a)(6). 12 Under the circumstances, we decline to remand the damages issue 13 under § 523(a)(2)(A) to the bankruptcy court since no purpose 14 would be served at this time by doing so. 15 16 17 18 19 20 21 22 23 24 25 26 27 28
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