In re: Joseph P. Keith and Carolyn G. Keith

Opinion

FILED OCT 3 2013

SUSAN M. SPRAUL, CLERK

U.S. BKCY. APP. PANEL

1 OF THE NINTH CIRCUIT

2 3 UNITED STATES BANKRUPTCY APPELLATE PANEL 4 OF THE NINTH CIRCUIT 5 In re: ) BAP No. NC-12-1635-DPaJu )

6 JOSEPH P. KEITH and CAROLYN G. ) Bk. No. 11-12535-AJ KEITH, )

7 ) Adv. Proc. No. 11-01248-AJ Debtors. )

8 ________________________________ )

)

9 JOSEPH P. KEITH; )

CAROLYN G. KEITH, )

10 )

Appellants, )

11 )

v. ) M E M O R A N D U M1 12 )

EXCHANGE BANK, )

13 )

Appellee. )

14 ________________________________ ) 15 Argued and Submitted on September 20, 2013 at San Francisco, California 16 Filed - October 3, 2013

17 Appeal from the United States Bankruptcy Court 18 for the Northern District of California 19 Honorable Alan Jaroslovsky, Bankruptcy Judge, Presiding 20 Appearances: Douglas Provencher of Provencher & Flatt LLP argued for appellants Joseph P. Keith and Carolyn G. Keith;

21 Lewis R. Warren of Abbey, Weitzenberger, Warren & Emery argued for appellee Exchange Bank.

22 23 Before: DUNN, PAPPAS and JURY, Bankruptcy Judges. 24

1

This disposition is not appropriate for publication.

25 Although it may be cited for whatever persuasive value it may have 26 (see Fed. R. App. P. 32.1), it has no precedential value. See 9th Cir. BAP Rule 8013-1.

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1 The complaint in the subject adversary proceeding asserted that 2 Exchange Bank’s claims against Joseph P. and Carolyn G. Keith were 3 based on Exchange Bank’s forbearance in pursuing a writ of 4 attachment against the Keiths because Exchange Bank had relied on a 5 materially false financial statement submitted by the Keiths. 6 Further, Exchange Bank had clarified in pretrial proceedings that it 7 was asserting a claim only pursuant to § 523(a)(2)(B).2 8 In its Pretrial Brief, Exchange Bank added a claim for relief 9 for actual fraud pursuant to § 523(a)(2)(A). The Keiths objected to 10 the introduction of evidence at trial which might support the 11 late-added claim for relief. 12 Following the trial, the bankruptcy court determined that 13 Exchange Bank had not met its burden of proving damages under either 14 of its alternative theories. Nevertheless, the bankruptcy court 15 granted judgment to Exchange Bank, pursuant to § 523(a)(6), finding 16 that the debt the Keiths owed to Exchange Bank was one for willful 17 and malicious injury by the Keiths to Exchange Bank. 18 We REVERSE. 19 I. FACTS 20 A. Default and Failed Workout. 21 Mr. Keith is a real property developer in the Santa Rosa, 22 California area. As relevant to this appeal, Mr. Keith did business 23 24 2 Unless otherwise indicated, all chapter and section references are to the Bankruptcy Code, 11 U.S.C. §§ 101-1532, and 25 all rule references are to the Federal Rules of Bankruptcy 26 Procedure, Rules 1001-9037. The Federal Rules of Civil Procedure are referred to as Civil Rules.

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1 through Cobblestone Homes, Inc. (“Cobblestone”), of which he was the 2 principal. Mr. Keith also conducted business for more than twenty 3 years with a long-time friend, Russell Flynn. Cobblestone as 4 borrower, and Mr. Keith as guarantor, had a long-standing financing 5 arrangement with Exchange Bank.3 6 When the real estate market collapsed, Mr. Keith and 7 Cobblestone were unable to meet their obligations to Exchange Bank. 8 On March 28, 2007, Exchange Bank commenced a formal workout of its 9 relationship with Mr. Keith. From the perspective of Exchange Bank, 10 Mr. Keith was “slow to initiate the necessary steps to implement a 11 workout plan,” but he soon became “fully engaged.” 12 As a part of the workout process, a series of forbearance 13 agreements were executed extending all loan maturities first to 14 December 31, 2007, then to June 30, 2008, and finally, to 15 December 31, 2008. As required by the forbearance agreements, the 16 Keiths provided periodic personal financial statements to Exchange 17 Bank. 18 From Exchange Bank’s view, by July 2008, considerable progress 19 had been made in the workout arrangement. At that time, in an 20 internal memorandum, an Exchange Bank officer made the following 21 comments regarding Mr. Keith’s actions implementing the workout: 22 The specific accomplishments to date are accompanied by a generally high level of cooperation, a willingness to work 23 collaboratively to find solutions to problems with the various projects, and a very strong commitment to the 24 25 3 The Cobblestone/Exchange Bank financing relationship had 26 been ongoing since the late 1980s. Mr. Keith guaranteed all Cobblestone debt to Exchange Bank.

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1 survival of [Cobblestone]. Further, having worked through an initial period of shock, [Mr. Keith] is doing what is 2 needed to honor the obligation of his guaranty to [Exchange Bank].

3 4 Mr. Keith had facilitated the sale of numerous Cobblestone and 5 affiliate-owned land parcels, which contributed $26.811 million to 6 pay down Exchange Bank debt. Mr. Keith also had sold real property 7 he held individually and in partnership with Mr. Flynn, as well as 8 other assets, collecting $6.239 million to fund Cobblestone 9 operations. Additionally, beginning in April 2007, Mr. Keith 10 significantly reduced Cobblestone’s costs, mostly by reducing staff 11 from thirty-four, first to twenty, and ultimately to thirteen. 12 Until December 2008, Mr. Keith kept all loans with Exchange 13 Bank current by selling partnership interests in income-producing 14 properties. During this period, Mr. Keith contributed more than 15 $8 million to Cobblestone to maintain current interest payments on 16 Exchange Bank loans and to pay Cobblestone’s overhead. In December 17 2008, Mr. Keith informed Exchange Bank he could not continue the 18 interest payments due pursuant to the forbearance agreements. 19 Thereafter, Exchange Bank determined that its primary course of 20 action for collection of the Cobblestone debt would be to liquidate 21 the real property which collateralized its loans. As of March 4, 22 2009, Exchange Bank was owed $44,626,313.09, and the “as is” 23 appraised value of the collateral totaled $45,132,750. Exchange 24 Bank projected that liquidation of the collateral would likely 25 realize between 78 and 90 percent of this value. 26 Exchange Bank offered to release the Keiths fully from their

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1 guaranties upon their payment of $7.5 million (“Release Payment”), 2 conditioned upon Mr. Keith’s cooperation in the liquidation of the 3 real property. In setting the amount of the Release Payment, 4 Exchange Bank used the Keiths’ January 20, 2009 financial statement, 5 which reflected liquid assets of approximately $500,000 and 6 additional assets in the approximate amount of $18.3 million. The 7 financial statement also reflected liabilities in the approximate 8 amount of $10.2 million, such that the stated net worth of the 9 Keiths was $8,698,752. Exchange Bank imposed a very short deadline 10 for the Release Payment, with one-half due by March 16, 2009 and the 11 balance by June 30, 2009. The Release Payment was not made. 12 After Exchange Bank had liquidated its real property 13 collateral, it initiated, on November 10, 2009, litigation against 14 the Keiths in the Sonoma County (California) Superior Court (“State 15 Court”) to enforce the guaranties. On April 22, 2011, the State 16 Court granted Exchange Bank’s motion for summary judgment. On 17 July 1, 2011, before judgment was entered against them in the State 18 Court, the Keiths filed a chapter 11 bankruptcy petition, at which 19 time their unsecured debt to Exchange Bank was approximately 20 $21 million. 21 B. The Adversary Proceeding. 22 It is in the context of the failed workout that the primary 23 dispute in this appeal arose. On June 9, 2008, the Keiths received 24 a $2.6 million federal tax refund. Notwithstanding the ongoing 25 workout with Exchange Bank, the receipt of this payment never was 26 disclosed, including in the personal financial statement the Keiths

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1 provided Exchange Bank almost immediately thereafter on June 18, 2 2008. On August 19, 2008, Mr. Keith transferred $500,000 3 (“Transfer”) from the tax refund to Mr. Flynn with a request that 4 Mr. Flynn “hold” the funds for Mr. Keith.4 At some point not 5 apparent in the record, Exchange Bank became aware of the Transfer. 6 Within the deadline set forth in Rule 4007, Exchange Bank filed 7 an adversary proceeding seeking a determination that its debt was 8 nondischargeable to the extent of the Transfer.5 The complaint 9 (“Complaint”) did not refer to a code section under which Exchange 10 Bank was making its claim; the adversary proceeding cover sheet 11 indicated the claim was based on “§ 523(a)(2), false pretenses, 12 false representation, actual fraud.” 13 Exchange Bank’s theory, as set forth in the complaint, is as 14 follows: The Keiths failed to include the tax refund in the June 18, 15 2008 financial statement they provided to Exchange Bank; they 16 thereafter failed to include the Transfer in the January 20, 2009 17 and June 15, 2009 financial statements they provided to Exchange 18 Bank; they failed to include in the November 18, 2009 financial 19 statement they provided to Exchange Bank after the State Court 20 21 4 Subsequently, on August 28, 2008, the Keiths executed a 22 promissory note in favor of Mr. Flynn, and Mr. Flynn and the Keiths entered into a line of credit loan agreement pursuant to which 23 Mr. Flynn agreed to loan to the Keiths up to a maximum of $5 million, pledging various items of collateral to secure the line 24 of credit. 25 5 Prior to the Trial, the Keiths obtained confirmation of a 26 plan of reorganization which preserved the rights of Exchange Bank to bring the adversary proceeding.

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1 litigation was filed, the $450,000 balance of the Transfer remaining 2 after $50,000 was “returned” to them by Mr. Flynn on October 16, 3 2009; and they thereafter failed to disclose to Exchange Bank that 4 Mr. Flynn had “returned” to them $50,000 on March 11, 2010, $50,000 5 on May 19, 2010, $50,000 on December 9, 2010, $50,000 on 6 December 27, 2010, $50,000 on January 19, 2011, $80,000 on 7 January 28, 2011, and $100,000 on March 7, 2011. In submitting each 8 of the financial statements identified in the Complaint, the Keiths 9 intended to deceive Exchange Bank regarding the true nature and 10 scope of their assets. Because the Keiths withheld information 11 about the Transfer from Exchange Bank, Exchange Bank was deprived of 12 its ability to obtain a writ of attachment in the State Court 13 litigation which would have allowed Exchange Bank to recover the 14 Transfer and apply the funds it represented in satisfaction of the 15 Keiths’ debt to Exchange Bank. 16 The Keiths moved to dismiss the Complaint primarily because 17 they did not know on which code section Exchange Bank was relying in 18 asserting its complaint. Because the allegations related to 19 financial statements the Keiths provided during the workout and 20 after the State Court action was filed, they “guessed” that Exchange 21 Bank might be relying on § 523(a)(2)(B). In opposing the motion to 22 dismiss, Exchange Bank stated it was in fact relying on 23 § 523(a)(2)(B). The Keiths thereafter withdrew the motion to 24 dismiss and filed an answer to the Complaint. 25 The bankruptcy court held a scheduling hearing on February 27, 26 2012, at which time it set trial (“Trial”) of the dispute for

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1 November 15, 2012.6 2 The witnesses at the trial included Mr. and Mrs. Keith, two 3 Exchange Bank employees, and Mr. Flynn. 4 The essence of the testimony of the Exchange Bank employees was 5 that had they known of the Transfer, they would have, as a matter of 6 policy, taken steps to initiate a writ of attachment to preserve the 7 funds for the benefit of Exchange Bank. However, the record 8 reflects that Exchange Bank was aware from the Keiths’ June 15, 2009 9 financial statement that the Keiths had $1,000,000 in a certificate 10 of deposit. Yet, Exchange Bank took no action to obtain a writ of 11 attachment at that time. 12 The essence of the testimony of Mrs. Keith is that she allowed 13 others to sign documents without requiring that she be informed of 14 the nature and contents of the documents or any representations they 15 might have included. 16 The essence of Mr. Keith’s testimony is that he made the 17 Transfer because he owed Mr. Flynn money. He denied he had an 18 actual intent to put the funds represented by the Transfer beyond 19 the reach of Exchange Bank while still maintaining his right to 20 them. Exchange Bank effectively impeached Mr. Keith’s trial 21 testimony by his prior deposition testimony. 22 QUESTION: What was the purpose of paying Russell Flynn that $500,000 that is reflected in this check?

23 24

6

No transcript is in the record for the February 27 25 hearing. The bankruptcy court’s scheduling order following the 26 February 27 hearing only set forth basic deadlines for discovery and submission of pretrial materials.

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1 ANSWER: Those were moneys that I sent to Russ for him to hold for me.

2 3 Trial Tr. at 22:11-14. 4 QUESTION: Please tell me what you mean by the words for him to hold for you?

5 ANSWER: What I meant by that is for him to hold, as 6 informal trust wherein he would release funds to me as I requested.

7 8 Trial Tr. at 23:20-24. 9 QUESTION: Do you specifically recall having a conversation with Mr. Flynn about the transmission of this particular 10 check to him? 11 ANSWER: I do recall having a conversation with him. 12 QUESTION: What did you say and what did he say in the course of that conversation, which you specifically 13 recall? 14 ANSWER: I said that I am sending a check to you for you to hold for me and release it as I request.

15 16 Trial Tr. at 24:21-25:3. 17 QUESTION: Why could you not hold that check in your own account?

18 ANSWER: There was at the time the feeling on my part that 19 banks would attach property of mine. 20 Trial Tr. at 25:11-14. 21 QUESTION: Isn’t it true that you asked him . . . to hold it as opposed to holding it on you own, because at that 22 time you had a fear that banks would attach your bank accounts?

23 ANSWER: Well, I did have fears that Exchange Bank would 24 attach assets of mine, because they told me they would. 25 QUESTION: So your answer to the question is yes? 26 ANSWER: Well, the answer to the question is I had a fear

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1 that the banks - I took Tony Ghisla [an Exchange Bank employee] at his word that he will attach my accounts.

2 And he will, and he will attach property. He’ll do whatever he can. So I did have that concern.

3 4 Trial Tr. at 26:22-27:8. 5 Additionally, Exchange Bank introduced in evidence a document 6 Mr. Keith admitted preparing. That document contained a list of 7 checks Mr. Keith paid to Mr. Flynn and of checks Mr. Keith received 8 from Mr. Flynn. Included under the category “Keith Checks to Russ 9 Flynn” is the check representing the Transfer; the document states 10 that the purpose of the check was “Hold.” Included under the 11 category “Checks Received from Russ Flynn” are eight checks totaling 12 $480,000, received between October 16, 2009 and March 7, 2011. The 13 stated purposes of each of these checks was “Return of funds held.” 14 The essence of Mr. Flynn’s testimony was that he deposited the 15 Transfer into his regular account, commingling it with other funds. 16 He testified that Mr. Keith’s request that he “hold” the funds for 17 Mr. Keith only meant that Mr. Keith, who had borrowed funds in the 18 past, might need to borrow funds in the future. Exchange Bank 19 attempted to impeach the Trial testimony of Mr. Flynn with his 20 testimony at a prior deposition. In the deposition, Mr. Flynn had 21 explained the interrelationship between debts owed to him by 22 Cobblestone and by Mr. Keith, which apparently at one time were 23 combined. Out of concern as to what might happen should Cobblestone 24 seek bankruptcy protection, Mr. Flynn segregated the Cobblestone 25 debt from that owed by Mr. Keith. The $750,000 balance previously 26 owed by Mr. Keith had been paid. Once the accounts were segregated

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1 it was clear to Mr. Flynn that the $500,000 represented by the 2 Transfer actually belonged to Mr. Keith. When asked why he did not 3 just send the $500,000 to Mr. Keith upon realizing he had, in 4 effect, overpaid, Mr. Flynn responded “He didn’t ask for it.” Trial 5 Tr. at 95:1-96:8. 6 The trial brief filed by Exchange Bank addressed claims for 7 relief pursuant to both § 523(a)(2)(A) and (B).7 In its opening 8 statement, Exchange Bank’s counsel emphasized that it was proceeding 9 on two legal theories: 10 Your Honor, Exchange Bank is proceeding under two separate and independent theories for a finding that $500,000 11 should be nondischargeable under Sections [sic] 523, the first one being (2)(A) that is for money obtained by 12 actual fraud and 523(a)(2)(B) that relates to the bank’s forbearance on collection of a debt to the extent caused 13 by a materially false financial statement. 14 Tr. of Trial at 3:19-25. 15 During the questioning of Mr. Keith by Exchange Bank, the 16 Keiths’ counsel objected to questions to the extent they exceeded 17 the scope of the Complaint and the § 523(a)(2)(B) claim. In 18 defending against an objection to relevance of questions relating to 19 what Mr. Keith did with various funds he received from Mr. Flynn, 20 counsel for Exchange Bank articulated Exchange Bank’s § 523(a)(2)(A) 21 theory as follows: 22 The second part of the legal analysis and a totally separate and independent theory is to the extent [the 23 Transfer] constituted a fraudulent transfer it is a debt.

And to the extent it is a debt which was willfully 24 transferred fraudulently while Mr. Keith owes $40 million to Exchange Bank that constitutes fraud on a creditor as 25 26 7 The Keiths filed no trial brief.

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1 provided in the statute [§ 523(a)(2)(A)]. 2 Tr. of Trial at 46:9-15. 3 The following colloquy thereafter took place between counsel 4 for the Keiths and the bankruptcy court regarding whether Exchange 5 Bank’s questions to Mr. Keith were beyond the scope of the issues 6 framed by the Complaint. 7 MR. PROVENCHER: Well, Your Honor, I’m also -- Your Honor, I want to object. Of course, this innovative fraudulent 8 transfer theory – 9 . . . 10 MR. PROVENCHER: Well, I’m objecting to this whole line.

This theory is nowhere in the complaint. So in the trial 11 brief they came up and said, well, we’re suing for false financial statement and we’re suing for actual fraud. The 12 complaint just talks about forbearance on a false financial statement. There’s nothing in there about 13 fraud. So I don’t even think it meets the requirements of alleging the fact.

14 THE COURT: I think you are probably correct. But I will 15 allow counsel, just that in the off chance that when I get back into chambers and review the case law, I suddenly 16 see, oh, my goodness. There’s a case that I wasn’t thinking about. I don’t think that’s going to happen, but 17 it might. So I’ll allow just a very few questions, because I am pretty sure that the line of questioning is 18 irrelevant. And that is without even considering whether or not the complaint fairly encompasses the theory.

19 20 Trial Tr. at 51:17-52:12. 21 In its closing argument, Exchange Bank continued to emphasize 22 its assertion that it was the submission of the false financial 23 statements that created the basis for nondischargeability of debt in 24 the amount of the funds represented by the Transfer, either in its 25 full amount or in the amount remaining at the time the State Court 26 litigation was filed, $450,000. Specifically, the conduct of the

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1 Keiths prevented Exchange Bank from exercising its right to seek a 2 writ of attachment in the State Court litigation because neither the 3 funds represented by the Transfer, nor the “return” of funds to 4 Mr. Keith, ever appeared on any financial statements the Keiths 5 provided to Exchange Bank. 6 C. The Decision. 7 Following the trial, the bankruptcy court took the matter under 8 submission. The bankruptcy court’s decision is contained in its 9 Memorandum After Trial (“Decision”). In the Decision, the 10 bankruptcy court characterized Mr. Keith’s arrangement with 11 Mr. Flynn as “very foolish,” pointing out that under other 12 circumstances, i.e., had the timing been different, the Transfer 13 might have been avoidable and the Keiths might have lost their 14 discharge. 15 However, the bankruptcy court ruled against Exchange Bank both 16 on the § 523(a)(2)(A) and § 523(a)(2)(B) claims for relief. 17 With respect to the § 523(a)(2)(B) claim, the bankruptcy court 18 determined that Exchange Bank had not met its burden of proof with 19 respect to the element of reliance. 20 The evidence before the court is that [Exchange Bank] was waiting to file suit [against the Keiths] until its 21 secured remedies were exhausted. No bank officer testified that it would have filed sooner if it had known 22 about the transfer to Flynn, nor does the court draw that inference from general testimony that the Bank is always 23 aggressive in seeking attachment. 24 Decision, at p. 3 n.1. Neither did Exchange Bank meet its burden of 25 proof on the element of damages: “In fact, under California law, an 26 attachment cannot be issued on behalf of a creditor holding real

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1 estate as security. 16A Cal.Jur.3d, Creditors’ Rights and Remedies 2 § 79. The Bank did not show that it was unsecured in January of 3 2009.” Decision, at p. 3 n.1. 4 With respect to the § 523(a)(2)(A) claim, the bankruptcy court 5 similarly determined that Exchange Bank had not met its burden of 6 proof on the issue of damages. Because Mr. Flynn had commingled the 7 funds represented by the Transfer with other funds, at most the 8 Keiths had an expressed willingness from Mr. Flynn to make future 9 loans to them. The bankruptcy court ruled that a “willingness” is a 10 contingent or uncertain obligation and as such was not attachable 11 under California law, citing Javorek v. Super. Ct., 17 Cal.3d 629, 12 643 (1976). Id. at 4:5-10. 13 After chiding Exchange Bank for making its work more difficult, 14 the bankruptcy court stated, “I have found another way,” and 15 thereafter determined that what Exchange Bank should have asserted 16 was a claim for relief under § 523(a)(6), and under the facts, it 17 was entitled to judgment against not just Mr. Keith, but Mrs. Keith 18 as well, on that theory. 19 When a debtor makes a fraudulent transfer with the intent to harm a specific creditor, that creditor has a 20 nondischargeable claim under § 523(a)(6) for its damages.

In re Bammer, 131 F.3d 788 (9th Cir. 1997). See also 21 In re Jennings, 670 F.3d 1329, 1334 (11th Cir. 2012). It is the transfer itself, not the subsequent failure to list 22 the transferred funds as an asset in the financial statement, that created the nondischargeable debt.

23 24 Id. at 5:5-9. The bankruptcy court found that the Transfer was 25 “wrongful, intentional, and necessarily harmed the Bank by reducing 26 the assets it could reach,” pointing out that if Mr. Keith had not

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1 made the Transfer he would have had $450,000 which the Bank could 2 have attached when it filed the State Court litigation. Finally, 3 the bankruptcy court found there was no just cause for Mr. Keith’s 4 actions because he could have legitimately made a loan payment to 5 Mr. Flynn rather than “creating a slush fund.” 6 The Keiths timely appealed the judgment. 7 II. JURISDICTION 8 The bankruptcy court had jurisdiction under 28 U.S.C. §§ 1334 9 and 157(b)(2)(I). We have jurisdiction under 28 U.S.C. § 158 10 III. ISSUE8 11 Whether the bankruptcy court erred in entering a 12 nondischargeable judgment in favor of Exchange Bank pursuant to 13 § 523(a)(6), a claim for relief not asserted by Exchange Bank in its 14 pleadings. 15 IV. STANDARDS OF REVIEW 16 In the context of an appeal from a judgment determining a debt 17 to be nondischargeable, the issues often present mixed questions of 18 law and fact. Murray v. Bammer (In re Bammer), 131 F.3d 788, 792 19 (9th Cir. 1997). Such issues are reviewed “de novo because they 20 require consideration of legal concepts and the exercise of judgment 21 about the values that animate legal principles.” Id. Similarly, 22 whether adequate due process notice was given in any particular 23 24 8 Exchange Bank has not appealed the bankruptcy court’s denial of relief pursuant to §§ 523(a)(2)(A) and (B); our review of 25 this dispute therefore is limited to the propriety of the bankruptcy 26 court entering judgment in favor of Exchange Bank pursuant to § 523(a)(6).

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1 instance is a mixed question of law and fact that we review de novo. 2 Educ. Credit Mgmt. Corp. v. Repp (In re Repp), 307 B.R. 144, 148 3 (9th Cir. BAP 2004) (citations omitted). De novo review requires 4 that we consider a matter afresh, as if no decision had been 5 rendered previously. United States v. Silverman, 861 F.2d 571, 576 6 (9th Cir. 1988); B-Real, LLC v. Chaussee (In re Chaussee), 399 B.R. 7 225, 229 (9th Cir. BAP 2008). 8 V. DISCUSSION 9 Civil Rule 8(a) sets out the requirements for pleading a 10 claim for relief: 11 Claim for Relief. A pleading that states a claim for relief must contain:

12 (1) a short and plain statement of the grounds for the court’s jurisdiction, unless the court already has 13 jurisdiction and the claim needs no new jurisdictional support;

14 (2) a short and plain statement of the claim showing that the pleader is entitled to relief; and 15 (3) a demand for the relief sought, which may include relief in the alternative or different types of relief.

16 17 Of relevance in this appeal is the provision which required 18 Exchange Bank to include in the Complaint a short and plain 19 statement of its claim showing that it was entitled to relief. 20 Under the liberal system of notice pleading set up by the Federal Rules, [Civil] Rule 8(a)(2) does not require a 21 claimant to set out in detail the facts upon which he bases his claim. To the contrary, all the Rules require is 22 a short and plain statement of the claim that will give the defendant fair notice of what the plaintiff's claim is 23 and the grounds upon which it rests. 24 Lee v. City of Los Angeles, 250 F.3d 668, 679 (9th Cir. 2001) 25 (alterations and quotations omitted). 26 It is undisputed by the parties, and acknowledged by the

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1 bankruptcy court in its expression of frustration with Exchange 2 Bank, that Exchange Bank did not plead a claim for relief pursuant 3 to § 523(a)(6). 4 Exchange Bank relies on Civil Rule 15(b)(2) as the authority 5 upon which the bankruptcy court nevertheless could enter judgment on 6 its behalf, notwithstanding its failure to plead a claim for relief 7 pursuant to § 523(a)(6). Civil Rule 15(b)(2), applicable in the 8 adversary proceeding pursuant to Rule 7015, provides: 9 When an issue not raised by the pleadings is tried by the parties’ express or implied consent, it must be treated in 10 all respects as if raised in the pleadings. A party may move–at any time, even after judgment–to amend the 11 pleadings to conform them to the evidence and to raise an unpleaded issue. But failure to amend does not affect the 12 result of the trial of that issue. 13 The problem for Exchange Bank is that the record does not 14 establish that an issue not raised in the pleadings was tried with 15 the express or implied consent of the Keiths. To the contrary, at 16 Trial, counsel for the Keiths opposed Exchange Bank’s efforts to 17 introduce evidence on § 523(a)(2)(A) issues, including Exchange 18 Bank’s theory that the alleged fraud derived from a fraudulent 19 transfer, on the basis that the claim was not included in the 20 Complaint, reflecting the Keiths’ vigilance in ensuring that the 21 scope of the proceeding was limited to the claim pled. Accordingly, 22 Civil Rule 15(b)(2) does not provide a basis for us to affirm the 23 judgment of the bankruptcy court on a legal theory not included in 24 the pleadings.9 More important, as cited to us by Exchange Bank, 25

9

26 Nor does it provide a basis for us to vacate the judgment (continued...)

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1 the Ninth Circuit long ago clarified that Civil Rule 15(b) relates 2 to factual issues, not legal theories or claims. Dering v. 3 Williams, 378 F.2d 417, 419 (9th Cir. 1967). 4 Rather, the authority for the bankruptcy court to enter 5 judgment on a legal theory not pled by Exchange Bank is found in 6 Civil Rule 54(c), applicable in adversary proceedings pursuant to 7 Rule 7054, which provides: 8 Demand for Judgment. A judgment by default shall not be different in kind from or exceed in amount that prayed for 9 in the demand for judgment. Except as to a party against whom a judgment is entered by default, every final 10 judgment shall grant the relief to which the party in whose favor it is rendered is entitled, even if the party 11 has not demanded such relief in the party’s pleadings. 12 “[Civil Rule 54(c)] has been used to support the conclusion 13 that the legal theories set out in the complaint are not binding on 14 plaintiff.” 10 Wright, Miller & Kane, Fed. Practice & Proc. § 2664 15 (3d ed. 2013). 16 If defendant has appeared and begun defending the action, adherence to the particular legal theories of counsel that 17 may have been suggested by the pleadings is subordinated to the court’s duty to grant the relief to which the 18 prevailing party is entitled, whether it has been demanded or not.

19 20 Id. 21 The bankruptcy court’s authority to award Exchange Bank 22 judgment on a theory it did not assert is not without limits, 23 however. 24

9

(...continued)

25 and remand the matter to the bankruptcy court to allow Exchange Bank 26 an opportunity to file a Civil Rule 15(b)(2) motion, as counsel for Exchange Bank requested at oral argument.

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1 A court may not, without the consent of all persons affected, enter a judgment which goes beyond the claim 2 asserted in the pleadings. “Unless all parties in interest are in court and have voluntarily litigated some 3 issue not within the pleadings, the court can consider only the issues made by the pleadings, and the judgment 4 may not extend beyond such issues nor beyond the scope of the relief demanded.” Sylvan Beach, Inc. v. Koch, 5 140 F.2d 852, 861 (8th Cir. 1944). The relief must be based on what is alleged in the pleadings and justified by 6 plaintiff’s proof, which the opposing party has had an opportunity to challenge. “Rule 54(c) creates no right to 7 relief premised on issues not presented to, and litigated before, the trier.” Dopp v. HTP Corp., 947 F.2d 506, 518 8 (1st Cir. 1991). 9 Delaney-Morin v. Day (In re Delaney-Morin), 304 B.R. 365, 370-71 10 (9th Cir. BAP 2003). 11 Further, “[o]ur adversary system is designed around the premise 12 that the parties know what is best for them, and are responsible for 13 advancing the facts and argument entitling them to relief.” 14 Greenlaw v. United States, 554 U.S. 237, 244 (2008)(quoting Castro 15 v. United States, 540 U.S. 375, 386 (2003)(internal quotation marks 16 omitted). 17 This is particularly true in the context of dischargeability 18 issues in bankruptcy cases, where the policy of a fresh start for 19 debtors is emphasized. To this end, it is well recognized that 20 exceptions to discharge are to be construed narrowly. See Snoke v. 21 Riso (In re Riso), 978 F.2d 1151, 1154 (9th Cir. 1992). 22 In determining whether to award relief to Exchange Bank on a 23 theory it did not raise, the bankruptcy court must first have found 24 that doing so would not prejudice the Keiths. The Decision is 25 explicit that the Keiths in fact were prejudiced. Specifically, the 26 bankruptcy court found that the failure of Exchange Bank to

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1 recognize its true claim for relief foreclosed any opportunity for 2 the Keiths to settle with Exchange Bank. On that basis, the 3 bankruptcy court denied Exchange Bank its attorney fees. We submit 4 that the prejudice to the Keiths runs deeper than exposure to 5 liability for the attorney fees incurred by Exchange Bank in 6 pursuing a nondischargeable judgment against the Keiths. 7 The factors required to establish a claim for relief pursuant 8 to § 523(a)(6) differ significantly from those necessary to prove 9 claims for relief pursuant to § 523(a)(2)(A) or (B).10 10 11 10 Section 523(a)(2) provides:

12 A discharge under section 727...of this title does not 13 discharge an individual debtor from any debt– ...

14 (2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained, 15 by –

16 (A) false pretenses, a false representation, or actual 17 fraud, other than a statement respecting the debtor’s or an insider’s financial condition;

18 19 (B) use of a statement in writing – (i) that is materially false;

20 (ii) respecting the debtor’s or an insider’s financial condition;

21 (iii) on which the creditor to whom the debtor is liable for such money, property, services, or credit reasonably 22 relied; and

23 (iv) that the debtor caused to be made or published with the intent to deceive; ....

24 Section 523(a)(6) provides:

25 26 A discharge under section 727...of this title does not (continued...)

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1 The Keiths never were on notice that a § 523(a)(6) claim was 2 being asserted against them; accordingly, they had no opportunity to 3 prepare or present a defense with respect to that claim for relief. 4 The bankruptcy court pointed out as much: “The Keiths, having 5 successfully refuted all the arguments made by [Exchange Bank], 6 cannot be very happy that the court discovered another route 7 [Exchange Bank] did not take.” Decision, at 6:9-11. 8 Moreover, the Ninth Circuit recently reemphasized that a 9 bankruptcy court cannot implicitly extend the time for filing an 10 exception to discharge complaint, the time deadline for which is set 11 forth in Rule 4007(c). See Willms v. Sanderson, 723 F.3d 1094 (9th 12 Cir. 2013). Rule 4007(c) provides: 13 . . . [A] complaint to determine the dischargeability of a debt under § 523(c) shall be filed no later than 60 days 14 after the first date set for the meeting of creditors under § 341(a). . . . On motion of a party in interest, 15 after hearing on notice, the court may for cause extend the time fixed under this subdivision. The motion shall 16 be filed before the time has expired. 17 Section 523(c) applies to exception to discharge claims pursuant to 18 §§ 523(a)(2), (a)(4), and (a)(6). Exchange Bank did not plead a 19 claim for relief pursuant to § 523(a)(6) within the 60-day 20 limitation period. In awarding judgment pursuant to § 523(a)(6), 21 the bankruptcy court implicitly extended the Rule 4007(c) deadline. 22 In light of the Rule 4007(c) time limitation, had Exchange Bank 23 24 10 (...continued) discharge an individual debtor from any debt– 25 ... 26 (6) for willful and malicious injury by the debtor to another entity or to the property of another entity.

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1 filed a Civil Rule 15(b) motion, it would have been required to 2 establish that the § 523(a)(6) claim related back to the original 3 complaint. 4 The basic test [for determining whether a claim in an amended complaint relates back to the original complaint]

5 is whether the evidence with respect to the second set of allegations could have been introduced under the original 6 complaint, liberally construed; or as a corollary, that in terms of notice, one may fairly perceive some 7 identification or relationship between what was pleaded in the original and amended complaints.

8 9 Gelling v. Dean (In re Dean), 11 B.R. 542, 545 (9th Cir. BAP 10 1981)(citation omitted). This it could not have done in light of 11 the bankruptcy court’s findings. “[Exchange Bank] has made things 12 harder for itself and the court by focusing on the financial 13 statements instead of the [T]ransfer itself.” Decision, at 5:4-5. 14 Finally, the Panel recently issued an unpublished disposition 15 expressing skepticism about the propriety of a bankruptcy court 16 “offering an advisory opinion” on a § 523(a)(6) claim for relief 17 when the creditor had raised only a claim for relief pursuant to 18 523(a)(2)(B). Antioch Comm. Fed. Credit Union v. Pagnini 19 (In re Pagnini), 2012 WL 5489032 at *1 n.4 (9th Cir. BAP 20 November 13, 2012). Similar to the case now before us, the 21 bankruptcy court found against the creditor on its § 523(a)(2)(B) 22 claim for relief on the basis it had failed to establish the element 23 of damages. We express more than skepticism when, as here, the 24 bankruptcy court did not merely offer an advisory opinion, but 25 awarded judgment pursuant to § 523(a)(6), when the creditor had not 26 raised § 523(a)(6) as a legal theory.

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1 VI. CONCLUSION 2 Exchange Bank did not meet its burden of proof to establish 3 that a portion of the debt owed to it by the Keiths was 4 nondischargeable. The bankruptcy court nevertheless imposed a 5 nondischargeable judgment against the Keiths under a theory not 6 contemplated by Exchange Bank. Further, it did so without affording 7 the Keiths an opportunity to present a defense. We REVERSE. 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24