In re: Joseph P. Keith and Carolyn G. Keith ( 2013 )

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.
1
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.
2
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.
3
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
4
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
5
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 Ҥ 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.
6
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
7
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.
8
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
9
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
10
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.
11
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
12
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
13
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
14
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. §§ 13349 and 157(b)(2)(I). We have jurisdiction under 28 U.S.C. § 15810 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).
15
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
16
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...)
17
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.
18
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
19
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...)
20
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.
21
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.
22
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.
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