1 FOR PUBLICATION 2 UNITED STATES BANKRUPTCY COURT EASTERN DISTRICT OF CALIFORNIA 3 In re: ) 4 ) RAUL MIRAZO SOTO, JR., ) Case No. 24-21939-C-7 5 ) Debtor. ) 6 ________________________________) ) 7 SAI SUPERMARKETS, INC. dba DEL ) Adversary No. 24-02174 VALLE SUPERMARKET, ) 8 ) Plaintiff, ) 9 v. ) ) 10 RAUL MIRAZO SOTO dba SOTO ) REFRIGERATION & BEVERAGE CO., ) 11 ) Defendant. ) 12 ________________________________) 13 OPINION 14 CHRISTOPHER M. KLEIN, Bankruptcy Judge 15 16 Is the essential element of “circumstances indicating fraud” 17 for nondischargeable embezzlement under 11 U.S.C. § 523(a)(4) 18 satisfied when a licensed contractor fails to account for, and 19 does not refund, advances for labor and special-order equipment 20 that were not ordered before the contract was terminated? 21 A California licensed contractor’s failure to refund and 22 substantially to account for advances and deposits is a ground 23 for discipline, including restitution orders, by the California 24 Contractors State License Board and, if willful, is an offense 25 under the California Penal Code. 26 To the narrow question whether the “circumstances indicating 27 fraud” essential element for nondischargeable embezzlement is 28 satisfied in such circumstances, the answer is, “yes.” 1 Jurisdiction 2 Jurisdiction is founded on 28 U.S.C. § 1334(b). This civil 3 proceeding arising under Title 11 is a core proceeding. Id., 4 § 157(b)(2)(I). The parties agree that, to the extent it may ever 5 be determined not to be a core proceeding, it may be heard and 6 determined by a Bankruptcy Judge. 7 8 Proceedings 9 Findings of Fact and Conclusions of Law were rendered orally 10 on the record after trial pursuant to Civil Rule 7052(a)(1). Fed. 11 R. Civ. P. 52(a)(1), incorporated by Fed. R. Bankr. P. 7052. This 12 Opinion supplements those findings and conclusions. 13 14 Facts 15 Defendant Debtor Raul Mirazo Soto is licensed by the 16 California Contractors State License Board to contract for 17 installation of warm air heating, ventilation, air-conditioning 18 systems, and refrigeration (categories C-20 and C-38). At all 19 relevant times he did business as a sole proprietorship under the 20 name Soto Refrigeration & Beverage Company. 21 Soto contracted in February 2021 with Plaintiff SAI 22 Supermarkets, Inc. dba Del Valle Supermarket to acquire and 23 install refrigeration and ventilation equipment meeting food 24 handling and storage requirements in a building that was being 25 renovated for supermarket purposes from a different use. 26 As it was an ongoing renovation project, the installation 27 schedule was uncertain and design incomplete. The precise 28 specifications for refrigeration and ventilation were subject to 1 modification before construction reached the installation stage. 2 It was understood that changes in specifications might require 3 price increases. 4 There were two components to Soto’s duties under the 5 contract: (1) order and deliver the equipment; and (2) provide 6 the labor to install the equipment. 7 Soto’s purchase orders specified “There are NO refunds on 8 deposits” and “All materials are special order items and there is 9 no return on special order items.” E.g., Ex. 4-1. 10 Between February 12, 2021, and September 21, 2021, SAI made 11 six advances at Soto’s demands totaling $149,741.68. Some of the 12 demands were based on unilateral price increases by Soto. 13 In seeking advances of $149,741.68, Soto represented that 14 all funds were needed for and would be used in SAI’s project. 15 Soto’s bank records reflect that during the period February- 16 August, 2021, Soto withdrew $142,112.74 from his business 17 checking account ($54,732.74 cash and $87,380.00 transfers to his 18 personal checking account). As of July 31, 2021, his business 19 checking account had a negative balance (-$422.59). 20 After an advance in September with no apparent work having 21 been accomplished, SAI lost confidence in Soto, terminated the 22 contract, and demanded refund of all advances. 23 Soto responded to SAI by invoking the “no-refund” language 24 in his purchase orders. Soto later admitted that, except for 25 $7,562.00 spent for 2000 feet of copper pipe, he neither 26 purchased nor installed the required equipment. 27 Soto testified at trial that SAI funds were used on non-SAI 28 projects or for personal purposes. On June 14, 2021, Soto spent 1 $4,443.38 from his business checking account for a Louis Vuitton 2 purse for his wife. 3 SAI sued Soto in state court in January 2022, which action 4 was pending when Soto filed his chapter 7 case on May 6, 2024. 5 This adversary proceeding ensued. 6 7 Analysis 8 The Complaint alleges two counts: § 523(a)(4) embezzlement 9 and § 523(a)(2) fraudulent misrepresentation. SAI contends that 10 § 523(a)(4) embezzlement squarely fits the facts. Analysis here 11 focuses on the law regarding embezzlement. 12 Decisions on § 523(a)(4) embezzlement are relatively scarce. 13 14 I 15 § 523(a)(4) Embezzlement 16 The § 523(4) discharge exception applies to any debt “for 17 fraud or defalcation while acting in a fiduciary capacity, 18 embezzlement, or larceny.” 11 U.S.C. § 523(a)(4). 19 A 20 Embezzlement Basics 21 No fiduciary relationship is required to except embezzlement 22 debt from discharge. As the Supreme Court explains, the syntax of 23 § 523(a)(4) separates “embezzlement” and “larceny” from “fraud or 24 defalcation while acting in a fiduciary capacity.” Bullock v. 25 BankChampaign, NA, 569 U.S. 267, 275 (2013) (construing fiduciary 26 defalcation); 4 COLLIER ON BANKRUPTCY ¶ 523.10[1] n.14 (Richard 27 Levin & Henry J. Sommer, eds) (“COLLIER”). 28 The term “embezzlement” in the Bankruptcy Code is a federal law concept. Hence, federal law, not state law, controls the meaning of “embezzlement” in § 523(a) (4). First Del. Life Ins. v. Wada (In re Wada), 210 B.R. 572, 576 (9th Cir. BAP 1997). 4 The Supreme Court’s classic statement of the meaning of 5 || “embezzlement” in a federal statute is that “embezzlement” is the 6] fraudulent appropriation of property by a person to whom the property has been entrusted or into whose hands it has lawfully come. Moore v. United States, 160 U.S. 268, 269 (1895). Moore remains good law. See 4 COLLIER AT J 523.10[2]. 10 The three essential elements of “embezzlement” are: (1) 11 || property rightfully in the possession of a nonowner; (2) 12 |} nonowner’s appropriation of the property to a use other than 13 || which it was entrusted; and (3) circumstances indicating fraud. Transam. Comm. Fin. Corp. v. Littleton (In re Littleton), 942 F.2d 551 (9th Cir. 1991); Wada, 210 B.R. at 576-77; accord, 16 CoLLIER Q 523.10[2]. 17 All three essential elements - possession by nonowner, 18 |} misappropriation, and circumstances indicating fraud - are 19 |} questions of fact for the trial court to determine by 20 |} preponderance of evidence. See Grogan v. Garner, 498 U.S. 279, 21291 (1991) (§ 523(a) (2)). 22 The first two essential elements are straightforward and 23 || ordinarily easily established. 24 The third essential element, circumstances indicating fraud, 25 a question of fact focused on knowledge and intent of the 26 || actor. Littleton, 942 F.2d at 556. 27 The analyses by the Ninth Circuit and its Bankruptcy 28 || Appellate Panel in Littleton and Wada regarding the fraud-related
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1 FOR PUBLICATION 2 UNITED STATES BANKRUPTCY COURT EASTERN DISTRICT OF CALIFORNIA 3 In re: ) 4 ) RAUL MIRAZO SOTO, JR., ) Case No. 24-21939-C-7 5 ) Debtor. ) 6 ________________________________) ) 7 SAI SUPERMARKETS, INC. dba DEL ) Adversary No. 24-02174 VALLE SUPERMARKET, ) 8 ) Plaintiff, ) 9 v. ) ) 10 RAUL MIRAZO SOTO dba SOTO ) REFRIGERATION & BEVERAGE CO., ) 11 ) Defendant. ) 12 ________________________________) 13 OPINION 14 CHRISTOPHER M. KLEIN, Bankruptcy Judge 15 16 Is the essential element of “circumstances indicating fraud” 17 for nondischargeable embezzlement under 11 U.S.C. § 523(a)(4) 18 satisfied when a licensed contractor fails to account for, and 19 does not refund, advances for labor and special-order equipment 20 that were not ordered before the contract was terminated? 21 A California licensed contractor’s failure to refund and 22 substantially to account for advances and deposits is a ground 23 for discipline, including restitution orders, by the California 24 Contractors State License Board and, if willful, is an offense 25 under the California Penal Code. 26 To the narrow question whether the “circumstances indicating 27 fraud” essential element for nondischargeable embezzlement is 28 satisfied in such circumstances, the answer is, “yes.” 1 Jurisdiction 2 Jurisdiction is founded on 28 U.S.C. § 1334(b). This civil 3 proceeding arising under Title 11 is a core proceeding. Id., 4 § 157(b)(2)(I). The parties agree that, to the extent it may ever 5 be determined not to be a core proceeding, it may be heard and 6 determined by a Bankruptcy Judge. 7 8 Proceedings 9 Findings of Fact and Conclusions of Law were rendered orally 10 on the record after trial pursuant to Civil Rule 7052(a)(1). Fed. 11 R. Civ. P. 52(a)(1), incorporated by Fed. R. Bankr. P. 7052. This 12 Opinion supplements those findings and conclusions. 13 14 Facts 15 Defendant Debtor Raul Mirazo Soto is licensed by the 16 California Contractors State License Board to contract for 17 installation of warm air heating, ventilation, air-conditioning 18 systems, and refrigeration (categories C-20 and C-38). At all 19 relevant times he did business as a sole proprietorship under the 20 name Soto Refrigeration & Beverage Company. 21 Soto contracted in February 2021 with Plaintiff SAI 22 Supermarkets, Inc. dba Del Valle Supermarket to acquire and 23 install refrigeration and ventilation equipment meeting food 24 handling and storage requirements in a building that was being 25 renovated for supermarket purposes from a different use. 26 As it was an ongoing renovation project, the installation 27 schedule was uncertain and design incomplete. The precise 28 specifications for refrigeration and ventilation were subject to 1 modification before construction reached the installation stage. 2 It was understood that changes in specifications might require 3 price increases. 4 There were two components to Soto’s duties under the 5 contract: (1) order and deliver the equipment; and (2) provide 6 the labor to install the equipment. 7 Soto’s purchase orders specified “There are NO refunds on 8 deposits” and “All materials are special order items and there is 9 no return on special order items.” E.g., Ex. 4-1. 10 Between February 12, 2021, and September 21, 2021, SAI made 11 six advances at Soto’s demands totaling $149,741.68. Some of the 12 demands were based on unilateral price increases by Soto. 13 In seeking advances of $149,741.68, Soto represented that 14 all funds were needed for and would be used in SAI’s project. 15 Soto’s bank records reflect that during the period February- 16 August, 2021, Soto withdrew $142,112.74 from his business 17 checking account ($54,732.74 cash and $87,380.00 transfers to his 18 personal checking account). As of July 31, 2021, his business 19 checking account had a negative balance (-$422.59). 20 After an advance in September with no apparent work having 21 been accomplished, SAI lost confidence in Soto, terminated the 22 contract, and demanded refund of all advances. 23 Soto responded to SAI by invoking the “no-refund” language 24 in his purchase orders. Soto later admitted that, except for 25 $7,562.00 spent for 2000 feet of copper pipe, he neither 26 purchased nor installed the required equipment. 27 Soto testified at trial that SAI funds were used on non-SAI 28 projects or for personal purposes. On June 14, 2021, Soto spent 1 $4,443.38 from his business checking account for a Louis Vuitton 2 purse for his wife. 3 SAI sued Soto in state court in January 2022, which action 4 was pending when Soto filed his chapter 7 case on May 6, 2024. 5 This adversary proceeding ensued. 6 7 Analysis 8 The Complaint alleges two counts: § 523(a)(4) embezzlement 9 and § 523(a)(2) fraudulent misrepresentation. SAI contends that 10 § 523(a)(4) embezzlement squarely fits the facts. Analysis here 11 focuses on the law regarding embezzlement. 12 Decisions on § 523(a)(4) embezzlement are relatively scarce. 13 14 I 15 § 523(a)(4) Embezzlement 16 The § 523(4) discharge exception applies to any debt “for 17 fraud or defalcation while acting in a fiduciary capacity, 18 embezzlement, or larceny.” 11 U.S.C. § 523(a)(4). 19 A 20 Embezzlement Basics 21 No fiduciary relationship is required to except embezzlement 22 debt from discharge. As the Supreme Court explains, the syntax of 23 § 523(a)(4) separates “embezzlement” and “larceny” from “fraud or 24 defalcation while acting in a fiduciary capacity.” Bullock v. 25 BankChampaign, NA, 569 U.S. 267, 275 (2013) (construing fiduciary 26 defalcation); 4 COLLIER ON BANKRUPTCY ¶ 523.10[1] n.14 (Richard 27 Levin & Henry J. Sommer, eds) (“COLLIER”). 28 The term “embezzlement” in the Bankruptcy Code is a federal law concept. Hence, federal law, not state law, controls the meaning of “embezzlement” in § 523(a) (4). First Del. Life Ins. v. Wada (In re Wada), 210 B.R. 572, 576 (9th Cir. BAP 1997). 4 The Supreme Court’s classic statement of the meaning of 5 || “embezzlement” in a federal statute is that “embezzlement” is the 6] fraudulent appropriation of property by a person to whom the property has been entrusted or into whose hands it has lawfully come. Moore v. United States, 160 U.S. 268, 269 (1895). Moore remains good law. See 4 COLLIER AT J 523.10[2]. 10 The three essential elements of “embezzlement” are: (1) 11 || property rightfully in the possession of a nonowner; (2) 12 |} nonowner’s appropriation of the property to a use other than 13 || which it was entrusted; and (3) circumstances indicating fraud. Transam. Comm. Fin. Corp. v. Littleton (In re Littleton), 942 F.2d 551 (9th Cir. 1991); Wada, 210 B.R. at 576-77; accord, 16 CoLLIER Q 523.10[2]. 17 All three essential elements - possession by nonowner, 18 |} misappropriation, and circumstances indicating fraud - are 19 |} questions of fact for the trial court to determine by 20 |} preponderance of evidence. See Grogan v. Garner, 498 U.S. 279, 21291 (1991) (§ 523(a) (2)). 22 The first two essential elements are straightforward and 23 || ordinarily easily established. 24 The third essential element, circumstances indicating fraud, 25 a question of fact focused on knowledge and intent of the 26 || actor. Littleton, 942 F.2d at 556. 27 The analyses by the Ninth Circuit and its Bankruptcy 28 || Appellate Panel in Littleton and Wada regarding the fraud-related
element were essentially validated by the subsequent Supreme 2 |} Court decision in BankChampaign that fraud in this connection 3 ||/means positive fraud, or fraud in fact, involving moral turpitude or intentional wrong, leading to the imputation of bad faith or 5 immorality. BankChampaign, 569 U.S. at 274-76.; Neal v. Clark, 95 704, 709 (1877). 7 Putting a finer point on the pencil, and comparing 8 || defalcation to embezzlement, the Supreme Court explained in BankChampaign that defalcation includes conscious disregard of or 10 || willful blindness to a substantial and unjustifiable risk of a 11 || violation. The risk “must be of such a nature and degree that, 12 || considering the nature and purpose of the actor’s conduct and the 13 | circumstances known to him, its disregard involves a gross 14 || deviation from the standard that a law-abiding person would observe in the actor’s situation.” BankChampaign, 569 U.S. at 16] 274, quoting ALI Model Penal Code § 2.02(2)(c), p. 226 (1985). 17 In other words, there must be a showing of “wrongful intent.” BankChampaign, 569 U.S. at 27. Accord, Kim v. Kim (In re 19} Kim), 2025 WL 3654696, at *5 (9th Cir. BAP 2025); Newman v. Lee 20 || (In re Newman), 2022 WL 2100905, at *7 (9th Cir. BAP 2022). 21 The Supreme Court’s willful blindness analysis of 22 | defalcation in BankChampaign likewise informs the analysis of 23 || “circumstances indicating fraud” in § 523(a) (4) embezzlement. 24 As with other forms of fraud-related intent, the trier of 25 || fact may draw inferences from circumstantial evidence. Particular 26 || circumstances surrounding nonpayment/nonremittance of entrusted 27 || property may suffice to persuade the court to infer the requisite 28 || fraudulent intent.
1 For example, in Wada a false statement regarding the reason 2 for improper appropriation and failure to refund warranted 3 inferring circumstances indicating fraud. Wada, 210 B.R. at 577. 4 Finally, it should be emphasized that the “circumstances 5 indicating fraud” essential element lies in the penumbra of 6 fraud, is not congruent with actual fraud, and does not require 7 proof of actual fraud. Rather, it suffices to establish a gross 8 deviation from the standard that a law-abiding person would 9 observe in the actor’s situation. 10 11 II 12 This Defendant’s Context 13 The context of the applicable nonbankruptcy law regime in 14 which California licensed contractors operate is crucial to 15 understanding the embezzlement theory in this case and what a 16 law-abiding licensed contractor would do. 17 The California Business and Professions Code proscribes 18 diversions by licensed contractors of funds received from 19 contracting parties and failures to account for application or 20 use of funds. Discipline for violations is authorized.1 21 The permitted forms of discipline under § 7108 include 22 23 1 The Business and Professions Code § 7108 (Diversions of funds or Property) provides: 24 Diversion of funds or property received for prosecution 25 or completion of a specific construction project or operation, or for a specified purpose in the prosecution or 26 completion of any construction project or operation [...] for which such funds or property were received constitutes a 27 cause for disciplinary action. 28 Cal. Bus. & Prof. Code § 7108. 1 license suspension, restitution, just terms and conditions 2 regarding continued operations, and payment of costs of 3 investigation.2 4 Worse, a contractor’s willful failure to complete the 5 improvement for which funds were provided, willful failure to pay 6 for services, labor, materials or equipment provided incident to 7 such construction, or willful diversion of funds to a use other 8 than that for which the funds were received constitutes criminal 9 construction fraud under California Penal Code § 484b.3 10 11 2Business & Professions Code § 7095 (Mode of Discipline) provides in part: 12 (a) The decision may: 13 (1) Provide for the immediate complete suspension by the licensee of all operations as a contractor during the 14 period fixed by the decision. ... 15 (3) Impose upon the licensee compliance with such specific terms and conditions as may be just in connection 16 with the licensee’s operations as a contractor disclosed at 17 the hearing and may further provide that until those terms and conditions are complied with no application for 18 restoration of the suspended or revoked license shall be accepted by the registrar. 19 ... (b) The specific terms and conditions imposed pursuant to 20 paragraph (3) or (4) of subdivision (a) may include, but are not limited to, any of the following: 21 (1) Payment of restitution to persons injured as a 22 result of the violation (2) Payment of the costs of investigation and enforcement 23 pursuant to Section 125.3. 24 Cal. Bus. & Prof. Code § 7095 (emphasis supplied). 25 3California Penal Code 484b provides: 26 § 484b. Any person who receives money for the purpose of obtaining or paying for services, labor, materials or 27 equipment and willfully fails to apply such money for such purpose by either willfully failing to complete the 28 improvements for which funds were provided or willfully 1 As part of the licensing process, California contractors are 2 trained in these provisions and agree to be held responsible for 3 obeying state law regarding permitted uses of funds. They know 4 they cannot divert project funds for other uses. They know they 5 must be prepared to account for uses of project funds. 6 7 III 8 Essential Elements of § 523(4) Embezzlement 9 A 10 Possession by Nonowner 11 The element of possession by nonowner is admitted and beyond 12 dispute in this case. SAI is the owner of the subject funds, 13 which it delivered into the possession of Soto. 14 B 15 Misappropriation 16 The element of misappropriation is likewise beyond cavil. 17 Soto testified that project funds were used on other projects. 18 Nor did he contest that project funds were transferred to his 19 personal account and used for personal purposes, including 20 failing to pay for services, labor, materials or equipment 21 provided incident to such construction, and wrongfully diverts the funds to a use other than that for which the 22 funds were received, shall be guilty of a public offense and 23 shall be punishable by a fine not exceeding ten thousand dollars ($10,000), or by imprisonment in a county jail not 24 exceeding one year, or by imprisonment pursuant to subdivision (h) of Section 1170, or by both that fine and 25 that imprisonment if the amount diverted is in excess of two thousand three hundred fifty dollars ($2,350). If the amount 26 diverted is less than or equal to two thousand three hundred fifty dollars ($2,350), the person shall be guilty of a 27 misdemeanor. 28 Cal. Penal Code § 484b. 1 payment of $4,443.38 for a Louis Vuitton purse. 2 C 3 Circumstances Indicating Fraud 4 As to the “circumstances indicating fraud” essential 5 element, BankChampaign provides the matrix for analysis. 6 One begins with the premises that licensed contractors know 7 their duties under state law governing their licenses and that no 8 law-abiding contractor would violate those duties. 9 The question in any particular case is whether, in the words 10 of the Supreme Court, the contractor consciously disregarded or 11 was willfully blind to a substantial and unjustifiable risk of a 12 violation of contractor duties of such a nature and degree that, 13 considering the nature and purpose of the actor’s conduct and the 14 circumstances known to him, its disregard involves a gross 15 deviation from the standard that a law-abiding person would 16 observe in the actor’s situation. 17 Circumstances “known to the contractor” include the state- 18 law criminal prohibition of diverting funds, the duty to account, 19 and the exposure to a restitution order as disciplinary action. 20 The burden of proof is preponderance of evidence. The 21 unsupported contrary assertion by Soto’s counsel that clear and 22 convincing evidence is required is rejected as lacking merit in 23 light of the Supreme Court decision in Grogan that preponderance 24 of evidence is the standard of proof in § 523 dischargeability 25 litigation. Grogan, 498 U.S. at 291. If preponderance is the 26 standard for proof of actual fraud, then a higher standard cannot 27 apply to the lower showing of “circumstances indicating fraud.” 28 While the precise degree of fraud “indications” required for 1 § 523(a)(4) embezzlement may be uncertain, at a minimum, facts 2 that could support an actual criminal prosecution are sufficient. 3 This Court is persuaded, and finds as fact, that Defendant 4 Soto consciously disregarded or was willfully blind to a 5 substantial and unjustifiable risk of violation of his California 6 contractor duties of such a nature and degree that, considering 7 the nature and purpose of his conduct and the circumstances known 8 to him, its disregard involved a gross deviation from the 9 standard that a law-abiding licensed contractor would have 10 observed in Soto’s situation. 11 The reality is that Soto was using SAI as, in effect, an 12 automatic teller machine in a manner not permitted by the law 13 governing licensed contractors. 14 The debt of Soto to SAI is excepted from discharge as an 15 embezzlement by virtue of 11 U.S.C. § 523(4). 16 17 IV 18 § 523(a)(2) Fraud 19 SAI asserts that 11 U.S.C. § 523(a)(2) arguably provides a 20 ground for excepting at least some of Soto’s debt from discharge 21 but candidly concedes that its case is not so strong as its 22 § 523(a)(4) case. This Court agrees. 23 Evidence probative of fraudulent intent at the time of 24 formation of the SAI-Soto contract, the time of some of the early 25 representations, and knowledge of their falsity is ambiguous. 26 To be sure, each advance made by SAI to Soto during the 27 contractual relationship came with a representation by Soto that 28 the funds needed to be advanced would be used for project 1] purposes. But their untruth and Soto’s knowledge of the untruth evolved over time and would require a stretch of inferences that 3 || could affect the measure of nondischargeable damages. 4 Moreover, time limitations imposed by this trier of fact 5 |} during the management of the trial attenuated SAI’s and Soto’s 6] presentations of § 523(a) (2) evidence to an extent that could 7\|)merit further proceedings that would be wasteful in light of the 8 |} embezzlement determination. Fed. R. Bankr. P. 1001 (a). 9 Accordingly, the prudent course is to dismiss the 10 |} (2) count without prejudice. 11 12 Conclusion 13 This Court is persuaded by preponderance of evidence that 14 |} the debt of Defendant Raul Soto to Plaintiff SAI in the amount of 15 |} $149,741.68 represents embezzlement within the meaning of 16 || S 523(a) (4) and is to be excepted from discharge. 17 An appropriate separate judgment shall be entered. 18 19 | Datea; February 05, 2026 Wi \| 21 ed f 22 United States Bankruptcy Judge 23 24 25 26 27 28