In re: Dean Bradley v. ( 2014 )

ELECTRONIC CITATION: 14 FED App. 0001P (6th Cir.)
File Name: 14b0001p.06
BANKRUPTCY APPELLATE PANEL OF THE SIXTH CIRCUIT
In re: DEAN R. BRADLEY; CYNTHIA E. )
BRADLEY, )
)
Debtors. )
______________________________________ )
)
KRAUS ANDERSON CAPITAL, INC., )
) No. 13-8010
Plaintiff-Appellant, )
)
)
v. )
)
DEAN R. BRADLEY, )
)
Defendant-Appellee. )
)
______________________________________
Appeal from the United States Bankruptcy Court
for the Northern District of Ohio at Akron.
No. 10-55621; Adv. No. 11-5082.
Submitted: November 5, 2013
Decided and Filed: March 26, 2014
Before: GEORGE W. EMERSON, Jr., GUY R. HUMPHREY and C. KATHRYN PRESTON,
Bankruptcy Appellate Panel Judges.
____________________
COUNSEL
ON BRIEF: Joseph A. Wentzell, WENTZELL LAW OFFICE, PLLC, St. Anthony, Minnesota, for
Appellant. Michael J. Moran, GIBSON & LOWRY, Cuyahoga Falls, Ohio, for Appellee.
____________________
OPINION
____________________
GEORGE W. EMERSON, Jr., Bankruptcy Appellate Panel Judge.
Kraus Anderson Capital, Inc. (“Lender”) appeals the decision of the Bankruptcy Court
determining that the debt owed by Dean R. Bradley (“Debtor”) is dischargeable. The adversary
complaint asserted causes of action under 11 U.S.C. § 523(a)(2)(A), (a)(4) and (a)(6) based on
Lender’s claim that Debtor’s failure to remit the proceeds of the sale of collateral in breach of the
terms of certain agreements and his false representations regarding the status of the collateral render
the debt non-dischargeable. Lender also appeals the Bankruptcy Court’s decision denying its motion
to amend and make additional findings of fact pursuant to Federal Rule of Bankruptcy Procedure
7052. For the reasons set forth below, the Panel REVERSES the decision of the Bankruptcy Court
holding the debt owed to Lender dischargeable and REMANDS for a determination regarding the
amount of damages.
I. ISSUES ON APPEAL
Appellant presents two issues in this appeal. The primary issue is whether the Bankruptcy
Court erred in determining that the debt owed to Lender should be held dischargeable in bankruptcy.
The second issue is whether the Bankruptcy Court erred in denying Lender’s motion to amend or
make additional findings of fact pursuant to Federal Rule of Bankruptcy Procedure 7052.
II. JURISDICTION AND STANDARD OF REVIEW
The Bankruptcy Appellate Panel of the Sixth Circuit (“BAP”) has jurisdiction to decide this
appeal. The United States District Court for the Northern District of Ohio has authorized appeals to
the BAP, and no party has timely elected to have this appeal heard by the district court. 28 U.S.C.
§ 158(b)(6), (c)(1). A “final” order of a bankruptcy court may be appealed by right under 28 U.S.C.
§ 158(a)(1). For purposes of appeal, an order is final if it “ends the litigation on the merits and leaves
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nothing for the court to do but execute the judgment.” Midland Asphalt Corp. v. United States,
489 U.S. 794, 797, 109 S. Ct. 1494, 1497 (1989) (internal quotations and citations omitted).
Determinations of dischargeability are final orders for purposes of appeal. Cash Am. Fin. Servs., Inc.
v. Fox (In re Fox), 370 B.R. 104, 109 (B.A.P. 6th Cir. 2007) (quoting Hertzel v. Educ. Credit Mgmt.
Corp. (In re Hertzel), 329 B.R. 221, 224-25 (B.A.P. 6th Cir. 2005)).
Dischargeability determinations present mixed questions of law and fact. Hogan v. George
(In re George), 485 B.R. 478, 2013 WL 135274, at *1 (B.A.P. 6th Cir. 2013) (table). When a mixed
question of law and fact arises in the bankruptcy context, the reviewing court “must break it down
into its constituent parts and apply the appropriate standard of review for each part.” Bank of
Montreal v. Official Comm. of Unsecured Creditors (In re Am. Homepatient, Inc.), 420 F.3d 559,
563 (6th Cir. 2005) (citations omitted). The appellate court reviews conclusions of law de novo and
factual determinations are reviewed under a clearly erroneous standard. Van Aken v. Van Aken (In
re Van Aken), 320 B.R. 620, 622 (B.A.P. 6th Cir. 2005). “Under a de novo standard of review,
the appellate court must ‘review questions of law independent of the bankruptcy court’s
determination.’ ” Phillips v. Weissert (In re Phillips), 434 B.R. 475, 482 (B.A.P. 6th Cir. 2010)
(citing Bailey v. Bailey (In re Bailey), 254 B.R. 901, 903 (B.A.P. 6th Cir. 2000)). “A finding of fact
is clearly erroneous when although there is evidence to support it, the reviewing court on the entire
evidence is left with the definite and firm conviction that a mistake has been committed.” Riverview
Trenton R.R. Co. v. DSC, Ltd. (In re DSC, Ltd.), 486 F.3d 940, 944 (6th Cir. 2007) (internal
quotation marks and citation omitted).
Contract interpretation is a matter of law which is reviewed de novo. Bender v. Newell
Window Furnishings, Inc., 681 F.3d 253, 259 (6th Cir. 2012); Rhone-Poulenc Basic Chems. Co. v.
Am. Motorists Ins. Co., 616 A.2d 1192, 1195 (Del. 1992). The determination of whether a contract,
or a term therein, is clear or ambiguous is also a question of law reviewed de novo. Official Comm.
of Unsecured Creditors v. Dow Corning Corp. (In re Dow Corning Corp.), 456 F.3d 668, 676 (6th
Cir. 2006).
The Panel reviews the denial of a motion to amend or make additional findings of fact
pursuant to Federal Rule of Bankruptcy Procedure 7052 under the abuse of discretion standard.
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Besser v. Sepanak, 478 Fed. Appx. 1001 (6th Cir. 2012).
Abuse of discretion exists when the court “ ‘relies upon clearly
erroneous findings of fact or when it improperly applies the law or
uses an erroneous legal standard.’ ” Corzin v. Fordu (In re Fordu),
209 B.R. 854, 858 (6th Cir. BAP 1997) (citation omitted). If a trial
court’s decision determining dischargeability is based on the correct
law and facts, the court has not abused its discretion in denying a
party’s motion to amend or make additional findings of fact.
Lowry v. Nicodemus (In re Nicodemus), 497 B.R. 852, 855 (B.A.P. 6th Cir. 2013).
III. FACTS
On November 30, 2010, Debtor and his wife Cynthia E. Bradley, filed a joint petition for
relief under chapter 7 of the Bankruptcy Code. Debtor owns Bradley Machinery, LLC (“Bradley
Machinery”), which was in the business of selling and renting construction equipment. Bradley
Machinery did not file a bankruptcy petition.
On March 21, 2011, Lender filed an adversary proceeding against Debtor pursuant to
§ 523(a)(4) and (a)(6). Lender asserts Debtor caused Bradley Machinery to sell equipment “out of
trust,” that is, without remitting the proceeds of the sale of collateral to Lender. Lender argues this
constituted embezzlement under § 523(a)(4) and was a willful and malicious injury under
§ 523(a)(6). Lender subsequently amended its complaint to add a cause of action under
§ 523(a)(2)(A). The § 523(a)(2)(A) cause of action is based on a settlement agreement reached by
the parties after the sale of some equipment “out of trust.” Lender asserts that Debtor obtained an
extension of credit through false representations to Lender regarding the status of certain pieces of
its collateral. Kraus-Anderson Capital, Inc. v. Bradley (In re Bradley), Adv. Case No. 11-05082,
ECF. Nos. 36, 43.1
1
All references to docket entries are references to the Bankruptcy Court’s electronic case
docket for adversary proceeding no. 11-5082. All transcript references are to the trial conducted on
August 10, 2012. References to exhibits are the exhibits admitted at trial.
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Prior to trial, Lender and Debtor filed three separate stipulations of fact. The facts stipulated
by the parties are as follows:
Defendant owns Bradley Machinery, LLC (“Bradley Machinery”).
Plaintiff and Bradley Machinery entered into various loan and
security agreements . . . whereby Plaintiff provided financing for
Bradley Machinery’s purchase of equipment used in Bradley
Machinery’s business. The equipment purchased with the financing
from Plaintiff was subject to security interests in favor of Plaintiff.
Defendant personally guaranteed the performance of Bradley
Machinery’s obligations under the Loan Documents pursuant to a
written guaranty dated January 27, 2005.
In the spring of 2008, Bradley Machinery’s bank required a
modification to the terms [of a loan] and an increase in the monthly
payment amount of Bradley Machinery’s loan, which caused cash
flow problems for Bradley Machinery.
By the summer of 2008, Bradley Machinery was unable to pay its
bills in the ordinary course of business and did not reveal this
information to Plaintiff.
Second Joint Stipulations, ¶ 4-8, ECF No. 35.
In December 2008, Defendant met with Plaintiff’s representatives,
Carl Carlson and James Stephen Jarussi, in Defendant’s offices, and
at that meeting Defendant informed Plaintiff that he had caused
Bradley Machinery to sell certain equipment subject to Plaintiff’s
security interest but did not pay the proceeds to Plaintiff. Defendant
did not at that time disclose that three other pieces of equipment
subject to Plaintiff’s security interests had been sold.
Second Joint Stipulations, ¶ 10, ECF No. 35.
Within weeks after meeting with Plaintiff’s representatives and
signing the Amendment to the Loan Documents, Defendant caused
Bradley Machinery to sell equipment subject to Plaintiff’s security
interests without paying the proceeds to Plaintiff.
Second Joint Stipulations, ¶ 13, ECF No. 35.
Bradley Machinery sold or caused to be sold the following equipment
subject to Plaintiff’s security interest:
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2007 Gehl Skid Loader, Model 6640E, S/N 606828
2007 Gehl Skid Loader, Model CTL70, S/N 405302
Bobcat T190 Loader, S/N 527717582
Yanmar Vio45, S/N 50616
Yanmar Vio45, S/N 50712
Yanmar Vio35, S/N 51695
Yanmar Vio35-5, Komac Hammer KB300SL
Upon the sale of such equipment, the obligations to Kraus Anderson
secured by the equipment were not paid in full.
Second Joint Stipulations, ¶ 18, ECF No. 35; See also Ex. 29-4, Equip. List.
Defendant knows the equipment was sold because he helped sell it.
Second Joint Stipulations, ¶ 19, ECF No. 35.
Defendant knew that Bradley Machinery and Defendant himself were
experiencing financial problems when he sold the equipment.
Second Joint Stipulations, ¶ 22, ECF No. 35.
A Settlement Agreement (“Settlement Agreement”) was agreed to in
December 2008 and entered into between Plaintiff, Bradley
Machinery, and Defendant on March 27, 2009.
Second Joint Stipulations, ¶ 15, ECF No. 35; Ex. 29.
As part of the Settlement Agreement, Bradley Machinery and
Defendant executed a Confession of Judgment, which authorized
Plaintiff to enter judgment against Bradley Machinery and Defendant
in the amount of $308,828.12 or the portion of that amount that
remains unpaid if Bradley Machinery and Defendant default in any
payment [of the monthly installments] due under the Settlement
Agreement.
Second Joint Stipulations, ¶ 16, ECF No. 35; Ex. 29-11, Confession of Judgment.
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The Settlement Agreement covered all outstanding amounts owed for
all equipment for which Plaintiff provided financing for Bradley
Machinery to purchase.
Third Joint Stipulations, ¶ 3, ECF No. 50.
The total outstanding amounts owing for all equipment for which
Plaintiff provided financing for Bradley Machinery to purchase as of
January 23, 2009 was $232,512.99.
Third Joint Stipulations, ¶ 4, ECF No. 50.
In 2010, Defendant met with Plaintiff’s auditors, Quiktrak, for the
purpose of verifying the location of equipment subject to Plaintiff’s
security interests. Defendant lied to the auditors about the location of
three pieces of equipment, and failed to tell them that the equipment
had already been sold and was no longer in his possession or under
his control. Defendant instead told the auditors that the equipment
was leased and at certain job sites. Defendant knew that Plaintiff
would rely on the information he provided to Plaintiff’s auditors.
Second Joint Stipulations, ¶ 17, Docket No. 35.
A trial was held in the adversary proceeding on August 10, 2012. In addition to the three
Joint Stipulations of Fact filed by Lender and Debtor, the parties presented the testimony of Debtor
and James Stephen Jarussi, the vice president and representative of Lender. During the trial, Lender
and Debtor also stipulated to the admission of thirty-three exhibits, including but not limited to the
following: Guaranty dated January 27, 2005 (Ex. 1); Dealer Credit Agreement (Ex. 2) and
Promissory Note dated June 16, 2006 (Ex. 3); Promissory Notes and Security Agreements for Gehl
loaders (Ex. 4) and a Bobcat loader (Ex. 10); Settlement Agreement dated March 27, 2009 (Ex.
29); List detailing status of equipment as of January 31, 2009 (Ex. 29A); Confession of Judgment
dated March 27, 2009 (Ex. 29C); QuikTrak audit invoice dated November 12, 2010 (Ex. 31);
History of contacts by Lender with Bradley Machinery from December 13, 2005 through January 18,
2011 (Ex. 32); Email correspondence between Debtor and Lender dated April 2010 (Ex. 33). At
the conclusion of trial, the parties were ordered to file written closing arguments by August 24, 2012.
Debtor filed a post-trial brief and Lender filed its closing argument and findings of fact.
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On February 5, 2013, the Bankruptcy Court issued a memorandum opinion and order holding
that Lender had failed to show that the debt was nondischargeable. On February 19, 2013, Lender
filed a motion to amend and make additional findings of fact and conclusions of law and to alter,
amend, or vacate judgment entered on February 6, 2013. Debtor filed an objection. After
consideration of Lender’s motion and Debtor’s objection, the Bankruptcy Court denied the motion
in an order dated March 6, 2013. Lender timely filed this appeal.
IV. DISCUSSION
Two of the counts of the complaint are based on Debtor’s actions2 prior to the Settlement
Agreement. Lender asserts that under the terms of the Dealer Credit Agreement and Promissory
Note, Debtor was required to remit proceeds from the sales of equipment. Lender asserts that
Debtor’s action of selling equipment “out of trust” constitutes embezzlement and is non-
dischargeable under § 523(a)(4) and is also a non-dischargeable willful and malicious injury under
§ 523(a)(6). Debtor admitted that he sold the equipment “out of trust” but asserts that the debt is
dischargeable. Amended Ans. to Complaint, ¶ 6, ECF No. 10; August 10, 2012 Trial Tr. 225:7-11,
ECF No. 74.
2
There is no dispute that Debtor was the person who acted on behalf of Bradley Machinery
and committed the torts creating the nondischargeable debt. A debtor acting on behalf of a
corporation, who actively converts property or commits any other tort giving rise to a
nondischargeable debt under § 523 is personally responsible to the injured party and the debt is
nondischargeable under § 523. See Ford Motor Credit Co v. Owens, 807 F.2d 1556, 1559 (11th Cir.
1987); Eaton v. Ford Motor Credit Co., LLC, 2012 WL 3579644, at *3 (M.D. Tenn. Aug. 16, 2012);
First American Title Ins. Co. v. Gaskill (In re Gaskill), 480 B.R. 291, 300 (Bankr. W.D. Mich.
2012); and Bombardier Corp. v. Penning (In re Penning), 22 B.R. 616, 619 (Bankr. E.D. Mich.
1982). Thus, because Debtor was the person who made the representations to Lender and carried
out the acts giving rise to the non-dischargeable debt, for purposes of the nondischargeability
determinations, it makes no difference as to whether those acts are viewed as having been taken in
his individual capacity or as an officer of the corporation. For this reason, the decision will refer to
Debtor and Bradley Machinery interchangeably without differentiating between them.
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A. 11 U.S.C. § 523(a)(4)
Under 11 U.S.C. § 523(a)(4), a debt is not dischargeable if it was incurred by embezzlement.
Lender argues that “Debtor’s sale of the equipment subject to [Lender’s] security interest and
retention and use of the sale proceeds constitutes embezzlement.” Plaintiff’s Closing Arg. ¶ 36, ECF
No. 60. “A creditor proves embezzlement by establishing that (1) he entrusted his property to the
debtor or debtor lawfully obtained the property, (2) the debtor appropriated the property for a use
other than that for which it was intended, and (3) the circumstances indicate fraud.” Robinson v.
Robinson (In re Robinson), 2012 WL 4715093, at *4 (Bankr. N.D. Ohio Oct 1, 2012) (citing Brady
v. McAllister, 101 F.3d 1165, 1173 (6th Cir. 1996)). See also Fox, 370 B.R. at 115-16; Peavey Elec.
Corp. v. Sinchak (In re Sinchak), 109 B.R. 273, 276 (Bankr. N.D. Ohio 1990).
The first prong of an “embezzlement claim requires a showing that the property, allegedly
embezzled by the defendant, was the property of the plaintiff.” Fla. Outdoor Equip., Inc. v.
Tomlinson (In re Tomlinson), 220 B.R. 134, 136 (Bankr. M.D. Fla. 1998). In this case, the property
which Lender accuses Debtor of embezzling is the proceeds arising from the sale of equipment
subject to Lender’s security interest.
Many courts have held “a mere lien or security interest does not rise to the level of ownership
sufficient to support a claim under § 523(a)(4)'s embezzlement provision.” Hulsing Hotels Tenn.,
Inc. v. Steffner (In re Steffner), 479 B.R. 746, 766 (Bankr. E.D. Tenn. 2012). See also First Nat'l
Bank of Fayetteville v. Phillips (In re Phillips), 882 F.2d 302, 304–05 (8th Cir. 1989); Mutual Mgmt.
Servs., Inc. v. Fairgrieves (In re Fairgrieves), 426 B.R. 748, 756 (Bankr. N.D. Ill. 2010);
Morganroth & Morganroth, PLLC v. Stollman (In re Stollman), 404 B.R. 244, 272-73 (Bankr. E.D.
Mich. 2009); Bank of Castile v. Kjoller (In re Kjoller), 395 B.R. 845, 851 (Bankr. W.D.N.Y. 2008);
Banco Popular, N. Am., v. Rodriguez (In re Rodriguez), 2007 WL 543750, at *5–6 (Bankr. S.D. Tex.
Feb. 15, 2007); Calumet v. Whiters (In re Whiters), 337 B.R. 326, 333 (Bankr. N.D. Ind. 2006);
Bombardier Capital, Inc. v. Tinkler (In re Tinkler), 311 B.R. 869, 877 (Bankr. D. Colo. 2004);
Everwed Co. v. Ayers (In re Ayers), 25 B.R. 762, 774-75 (Bankr. M.D. Tenn. 1982).
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This Panel agrees with this line of cases. “As owner of the collateral, the debtor remained the
owner of its proceeds, even though both the collateral and its proceeds were subject to a security
interest. No person can embezzle from himself.” Deere & Co. v. Contella (In re Contella), 166 B.R.
26, 30 (Bankr. W.D.N.Y. 1994).3
Neither the Bankruptcy Court nor either party addressed the issue of whether the proceeds
of the sale of collateral were “property” of Lender for purposes of § 523(a)(4). However, “the
bankruptcy court's decision . . . may be affirmed on any grounds supported by the record.”
Montedonico v. Beckham (In re Beckham), 421 B.R. 602, 2009 WL 1726526, at *7 (B.A.P. 6th Cir.
2009) (table). See also Besing v. Hawthorne (In re Besing), 981 F.2d 1488, 1494 (5th Cir. 1993);
Phillips, 434 B.R. at 488 (Rhodes, J., concurring). Accordingly, the Panel AFFIRMS the Bankruptcy
Court’s conclusion that the elements of § 523(a)(4) are not met.
B. 11 U.S.C. § 523(a)(6)
Under 11 U.S.C. § 523(a)(6), a debt is not dischargeable if it is due to a willful and malicious
injury. Lender argues that “[Debtor’s] sale of the equipment subject to [Lender’s] security interest
and retention and use of the sales proceeds were willful and malicious.” Plaintiff’s Closing Arg. ¶41,
ECF No. 60. The Supreme Court has explained that for a debt to be non-dischargeable under
§ 523(a)(6), the “ ‘actor [must] intend ‘the consequences of an act,’ not simply ‘the act itself.’ ”
Kawaauhau v. Geiger, 523 U.S. 57, 61-62, 118 S. Ct. 974, 977 (1998) (quoting Restatement
(Second) of Torts § 8A, Comment a, p. 15 (1964)). The Sixth Circuit Court of Appeals has further
qualified that a willful and malicious injury occurs only if the debtor (1) desires “to cause the
consequences of his act, or” (2) “believes those consequences are substantially certain to result from
it.” Markowitz v. Campbell (In re Markowitz), 190 F.3d 455, 464 (6th Cir. 1999).
3
The Panel acknowledges a line of cases holding “that a debtor commits an embezzlement
under section 523(a)(4) when the debtor sells mortgaged property and fails to remit the proceeds to
a properly perfected, secured creditor or consignor." Jones v. Hall (In re Hall), 295 B.R. 877, 882
(Bankr. W.D. Ark. 2003). However, those cases typically involve a duty to segregate proceeds of the
sale of collateral subject to a security interest. See Tomlinson, 220 B.R. at 136. There is no evidence
of a duty to segregate proceeds in the present case.
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In reviewing the Bankruptcy Court's determination whether Lender suffered an injury and
whether the injury to Lender was willful and malicious for purposes of § 523(a)(6), the Panel applies
the clearly erroneous standard.
“The clearly erroneous standard does not permit this Panel to
substitute its assessments of credibility in place of the explicit
findings made by the bankruptcy court.” In re Forbes, 372 B.R. at
334. As long as the bankruptcy court's findings are “reasonable and
supported by the evidence,” the Panel may not overturn them. Id.
(quoting DuVoisin v. Foster (In re S. Indus. Banking Corp.), 809 F.2d
329, 331 (6th Cir.1987)).
Phillips, 434 B.R. at 484.
1. Willful
In the context where a debtor has converted a creditor's collateral, it
has been held . . . that the ‘willful’ requirement of 523(a)(6) may be
indirectly established by the creditor demonstrating the existence of
two facts: (1) the debtor knew of the creditor's lien rights; and (2) the
debtor knew that his conduct would cause injury to those rights.
Takacs v. Ruderson (In re Ruderson), 2007 WL 4570581, at *6 (Bankr. N.D. Ohio Dec. 20, 2007)
(quoting J & A Brelage, Inc. v. Jones (In re Jones), 276 B.R. 797, 802 (Bankr. N.D. Ohio 2001),
citing Mitsubishi Motors Credit of Am., Inc. v. Longley (In re Longley ), 235 B.R. 651, 657 (B.A.P.
10th Cir.1999)).
The Bankruptcy Court did not address Debtor’s knowledge of Lender’s lien rights because
it found that Debtor was not required to turn over the proceeds of the sale of the collateral. This
legal conclusion requires an analysis of the contract. It is a question of law reviewed de novo.
In footnotes, the Bankruptcy Court dismissed the role of the Dealer Credit Agreement and
the Promissory Note dated June 16, 2006, each of which contain clauses requiring Debtor to remit
the proceeds of sales of collateral to Lender. The Bankruptcy Court stated that “the court is not
convinced that the Dealer Creditor Agreement has any significant relation to the individual security
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agreements and notes. Kraus Anderson representative Mr. Jarussi’s testimony suggested that he
himself was unsure about the relationship.” Feb. 5, 2013, Op. at 9, n.1, ECF No. 61.
A review of the trial transcript reveals that Mr. Jarussi was not at all unsure about the
relationship. “There is no conflict in my mind. The overriding document is the dealer credit
agreement.” August 10, 2012, Trial Tr. 119:1-2, ECF No. 74. Mr. Jarussi explained that the
Promissory Note attached to the Dealer Credit Agreement includes everything Debtor financed. It
represented a revolving line of credit on which the borrower, Bradley Machinery, could (and did)
draw to purchase pieces of equipment. Each individual purchase of a piece of equipment was also
represented by individual schedules, security agreements, and notes under the line of credit. Tr.
133:10-22. Several times Mr. Jarussi explained that the Promissory Note attached to the Dealer
Credit Agreement was a fluid or floating line of credit, with collateral coming in and going out. Tr.
139:21-24; 141:20-25. He explained that the other notes were all part of the line of credit under the
Dealer Credit Agreement. Tr. 142:6-12; 145:6-11. He consistently testified that the Dealer Credit
Agreement was “umbrella financing” (Tr: 132:4-6) and that the Promissory Note (Ex. 3) was a credit
line limit and it spelled out the rules of the relationship. Tr. 150:15-19. Finally, he explained that
if he needed to enforce the transactions with Bradley Machinery he would use the Dealer Credit
Agreement, Promissory Note, subsequent notes and security agreement(s).
Examination of the documents support Mr. Jarussi’s explanation of the financing
arrangement. Paragraph 3 of the Dealer Credit Agreement provides in part:
As long as Borrower is not in default, Borrower may sell any item of
Collateral in the ordinary course of Borrower’s business for a price
not less than the Advance made for such item of Collateral, unless
otherwise agreed to in writing by Lender, provided Borrower pays
Lender any amounts due under the Note as a result of such sale.
Dealer Credit Agreement, ¶ 3, Ex. 2. Paragraph 3 also clearly conveys that, to secure payment on
all current and future debts, Bradley Machinery granted Lender a security interest on all present and
future equipment purchased with advances made by Lender from the line of credit and all proceeds
of that property. Paragraph 3 further explains that Bradley Machinery was required to execute
additional security documentation as additional equipment was purchased. Moreover, the Dealer
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Credit Agreement allowed Bradley Machinery to sell equipment in the ordinary course of business
so long as Bradley Machinery paid the amounts due under the Promissory Note as a result of the sale.
The Amendment of Loan Documents executed by the parties after the breach further reflects
the parties’ understanding of their prior agreement. The Amendment of Loan Documents refers to
the individual notes and security agreements as “schedules” and makes references to the Dealer
Credit Agreement,“The Promissory Note,” Security Agreement and Individual Guaranty. This
language supports Mr. Jarussi’s testimony that the Dealer Credit Agreement was the umbrella
document that explained the rules of the relationship.
Likewise, the Confession of Judgment executed by the parties also reflects that Debtor owes
Lender $308,828.12 under the Dealer Credit Agreement and the related schedules. Finally, Debtor
himself referred to the arrangement as “a revolving line of credit.” Tr. 205:14-15. The admitted
exhibits included several of the amendments to the June 16, 2006 Promissory Note that reflect
increases in the maximum amount of the line of credit, extension of time for the maturity date, and
changes in terms of interest. Perhaps most telling is Debtor’s admission that he sold equipment “out
of trust.” Amended Ans. to Complaint, ¶ 6, ECF No. 10, Tr. 225:7-11. In the automotive sales
industry, a dealer's sale of automobile inventory without paying the secured lender is known as
selling “out of trust.” Eaton v. Ford Motor Credit Co., LLC, 2012 WL 3579644, at *3-4 (M.D.
Tenn. Aug. 17, 2012) (citing Ford Motor Credit Co. v. Moody (In re Moody), 277 B.R. 865, 868
(Bankr. S.D. Ga. 2001)).
The contract documents, exhibits and testimony show that the Dealer Credit Agreement did
control and play a key role in the financing arrangement. The individual security agreements and
promissory notes laid out payment plans that supplemented the Dealer Credit Agreement and were
used to pay down the debt while equipment remained unsold. The individual security agreements
and promissory notes, as well as the Dealer Credit Agreement and Promissory Note, allowed
collateral to be sold in the ordinary course of business. The Dealer Credit Agreement provided that
collateral could be sold as long as the proceeds were paid to Lender. The Promissory Note contained
a specific provision for this payment to occur five days after the sale.
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Accordingly, the Panel holds that based on the Dealer Credit Agreement, and other
documents, Lender had a security interest in the proceeds of the sale of collateral and Debtor had a
duty to use the proceeds of sales of collateral to pay Lender.
The record firmly establishes that Debtor knew about Lender’s lien rights and knew that
failure to remit the proceeds would be substantially certain to harm Lender. The parties intended the
proceeds of sale of collateral to be used to pay down the debt owed to Lender and Debtor did not
do so. He retained them for a different use. The fact that it was for a business use does not alter this
finding.
Under § 523(a)(6), the business person is held to a higher standard as
a business person who is more knowledgeable of the natural
consequences of his acts. Trust Co. Bank v. Ricketts (In re Ricketts),
16 B.R. 833, 834–35 (Bankr. N.D. Ga. 1982). . . . A willful and
malicious conversion occurs where an individual in bankruptcy
obtains vehicles, as an officer of a dealership, with money advanced
by a secured creditor, and then disposes of those vehicles without
remitting the sale proceeds to the secured creditor. Such acts are
contrary to the parties' floor plan agreement's express provisions. A
debtor's sales out of trust creates a debt that is nondischargeable under
§ 523(a)(6). Ford Motor Credit Co. v. Owens, 807 F.2d 1556, 1559
(11th Cir. 1987).
Eaton, 2012 WL 3579644, at *3-4.
Debtor admitted he knew about Lender’s lien rights in the collateral. Debtor described the
relationship between the Debtor and Lender as “floor plan” financing. Tr. 205:15; 215:10-12. He
signed the financing documents that gave Lender a security interest in the collateral. In the answer
to the complaint and at trial, Debtor admitted that he sold equipment “out of trust.” Tr.225:7-11.
Moreover, Debtor’s action of selling the collateral and lying about it so that he did not have to turn
over the proceeds of the collateral shows that Debtor knew that his conduct would cause injury to
Lender’s right to receive the proceeds.
Accordingly, the Panel finds that the injury to Lender was willful.
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2. Malicious
The Bankruptcy Court made the factual finding that Debtor did not intend to harm Lender
when it kept the proceeds of the sales of Lender’s collateral. The Bankruptcy Court noted that
“[Debtor] testified based on history he believed his business would recover and he would be able to
pay his debts. Feb. 5, 2013, Op. at 6, ECF No. 61. However, the test for maliciousness in the
context of § 523(a)(6) does not focus on Debtor’s subjective intent to repay.4
[M]alicious “means in conscious disregard of one's duties or without just cause or
excuse; it does not require ill-will or specific intent to do harm.” Wheeler v. Laudani,
783 F.2d 610, 615 (6th Cir.1986). Stated differently, “[t]here must also be a
consciousness of wrongdoing. . . . It is this knowledge of wrongdoing, not the
wrongfulness of the debtor's actions, that is the key to malicious under § 523(a)(6).”
ABF, Inc. v. Russell (In re Russell), 262 B.R. 449, 455 (Bankr. N.D. Ind. 2001)
(citations omitted).
Auto. Fin. Corp. v. Leonard (In re Leonard), 2012 WL 1565120, at *11 (Bankr. E.D. Tenn. May 2,
2012).. While a debtor’s “subjective mind set is central to the inquiry,” the focus is not on whether
a debtor intended to repay the debt eventually.5 Rather, the focus is on “whether debtor acted
deliberately in knowing disregard of a creditors’ rights in property.” Ocean Equity Grp., Inc. v.
4
While the Panel does not have cause to review the Bankruptcy Court’s determination
regarding Debtor’s subjective intent to repay, the Panel notes that some of the facts relied upon by
the Bankruptcy Court in reaching this conclusion are clearly erroneous. For example, the
Bankruptcy Court held that Debtor paid $100,000 - “a sizeable amount” toward the Settlement
Agreement. Feb. 5, 2013, Op. at 9,11, ECF No. 61. However, this fact is not supported by the
record. Mr. Jarussi testified that of the $100,000 that Lender recouped, $84,000 was on account of
equipment that was returned to Yanmar. The credit from Yanmar was already pending at the time
Bradley Machinery, Debtor and Lender entered into the Settlement Agreement and was not a result
of any post-settlement efforts by Debtor to repay the debt. August 10, 2012, Trial Tr. 149:6-14;Tr.
157:17-158:9, ECF No. 74. Mr. Jarussi also testified that Bradley Machinery made “some
payments” toward the settlement agreement. Tr. 158:1-5. Debtor admitted that Mr. Jarussi was
correct, and he only made payments totaling approximately $18,000 toward the debt over the course
of almost two years. Tr. 208:11-14.
5
The bankruptcy court placed emphasis on Debtor’s desire to save his business. However,
a debtor’s desire to save his business is not dispositive of whether he intended to harm the creditor,
particularly within the Sixth Circuit. Eaton v. Ford Motor Credit Co., LLC, 2012 WL 3579644
(M.D. Tenn. Aug, 17, 2012) (citing General Motors Acceptance Corp. v. Cline, 431 B.R. 407, 2010
WL 22334 (B.A.P. 6th Cir. 2010) (table)).
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Wooten (In re Wooten), 423 B.R. 108 (Bankr. E.D. Va. 2010) (quoting Johnson v. Davis (In re
Davis), 262 B.R. 663, 670-71 (Bankr. E.D. Va. 2001)). Under § 523(a)(6), malice is inferred when
a car dealer knows the harm for his failure to remit the proceeds obtained from vehicles sold out of
trust. Leonard, 2012 WL 1565120, at *11. See also Longley, 235 B.R. at 656–58; HOC, Inc. v.
McAllister (In re McAllister), 211 B.R. 976, 982–83 (Bankr. N.D. Ala. 1997).
The Panel holds that Debtor acted maliciously as defined by § 523(a)(6). The record
establishes that Debtor acted in “knowing disregard” of Lender’s security interest in the proceeds
of the collateral. Debtor’s extensive efforts to keep information regarding the sales hidden from
Lender, indicates that Debtor knew that his action of keeping the proceeds of the sales was wrongful
under the terms of the contracts. Debtor knew that his use of the proceeds for other business
purposes would injure Lender’s right to receive the proceeds. The fact that Debtor may have had
a subjective intent to eventually repay the debt owed to Lender does not excuse the injury to Lender’s
security interest. The record is devoid of any facts which could support the notion that Debtor acted
with just cause or excuse.
Debtor converted the proceeds of the sales of collateral which were subject to Lender’s
security interest. Lender’s damages are a debt that is the result of a willful and malicious injury.
Accordingly, it is non-dischargeable pursuant to § 523(a)(6). The record before the Panel does not
reflect the amount of proceeds that were retained by Debtor upon the sale of Lender’s collateral.
Accordingly, the matter is REMANDED for a determination regarding the amount of damages.6
6
When Lender attempted to assert proof of damages at trial, the Bankruptcy Court stated that
it normally does not liquidate claims, but just determines non-dischargeability. August 10, 2012,
Trial Tr. 101:19-104:24, ECF No. 74. The Panel notes that the bankruptcy court has concurrent
jurisdiction with the state court to determine the amount of damages. 28 U.S.C. § 1334(b); Longo
v. McLaren (In re McLaren), 3 F.3d 958, 965-66 (6th Cir. 1993). The measure of damages may not
be equivalent to the full amount of the debt owed by Debtor to Lender: only the damages caused by
Debtor’s conduct in converting the proceeds are nondischargeable pursuant to § 523(a)(6). Those
damages are comprised of the amount of the sale proceeds and possibly other damages. In this case,
there was no concurrent state court action, so the Panel finds it is particularly appropriate for the
bankruptcy court to determine damages given its familiarity with the underlying facts.
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C. 11 U.S.C. § 523(a)(2)(A)
Section 523(a)(2)(A) excepts from discharge “any debt . . . for money, property, services, or
. . .an extension, renewal, or refinance of credit, to the extent obtained by . . . false pretenses, a false
representation, or actual fraud.” 11 U.S.C. § 523(a)(2)(A). Under § 523(a)(2)(A), the creditor bears
the burden of proving by a preponderance of the evidence, that:
(1) the debtor obtained money [or an extension, renewal, or
refinancing of existing credit] through a material misrepresentation
that, at the time, the debtor knew was false or made with gross
recklessness as to its truth;
(2) the debtor intended to deceive the creditor;
(3) the creditor justifiably relied on the false representation; and
(4) its reliance was the proximate cause of the loss.
See Old Republic Title Co. of Tenn. v. Looney (In re Looney), 453 B.R. 252, 259 (B.A.P. 6th Cir.
2011); Rembert v. AT & T Universal Card Servs., Inc. (In re Rembert), 141 F.3d 277, 280-81 (6th
Cir. 1998).
In the present case, there is no dispute that the first and second prongs of § 523(a)(2)(A) are
met. In the stipulated facts and at trial, Debtor testified that he lied to Lender regarding which pieces
of equipment had been sold prior to entering into the Settlement Agreement. August 10, 2012, Trial
Tr. 225:23-25; 240:4-12, ECF No. 74. Moreover, Debtor admitted at trial that he knew he was
deceiving Lender and that he did so to get Lender to agree to an extension of credit. Tr. 226:5-6.
Debtor testified that he made a conscious choice to disclose some, but not all of the sales of Lender’s
collateral because he did not want to “make it look any worse.” Tr. 226:8. He admitted that when
he entered the Settlement Agreement in March, there was an equipment list attached that
affirmatively stated that he had possession of the Bobcat loader and two Gehl loaders that he did not
have possession of because they had already been sold. Tr. 244:10-13; 247:5-6. He admitted that
he continued to lie to Lender for over eighteen months because he was trying to give himself more
time to pay off the debt. Tr. 226:18-24. See also Ex. 33-1 (email from Debtor to Lender’s
representative containing false information regarding hours on a Bobcat loader that had already been
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sold.) Additionally, he lied to Lender’s auditors and supplied them with false documents so that
Lender would not know that its collateral had been sold. He also stipulated that he knew Lender
would rely on these misrepresentations. Second Joint Stipulations, ¶ 17, ECF No. 35.
The Bankruptcy Court, however, found that Lender did not justifiably rely on the
misrepresentations. The Bankruptcy Court found that Lender “did little to keep tabs on its
collateral.” Feb. 5, 2013, Op. at 7, ECF No. 61. The Bankruptcy Court noted that Lender did send
auditors to investigate the status of equipment, however, once told by Defendant that the equipment
was at another job site, the auditors ended the inquiry. The Bankruptcy Court found that since
Lender knew that Debtor had previously sold equipment without turning over the proceeds (having
“lied”) it was not reasonable to enter into a Settlement Agreement without conducting a more
thorough investigation. The Bankruptcy Court held that § 523 actions “are not meant to be
substitutes for appropriate due diligence. [And Lender] could have done more to monitor the status
of the equipment.” Therefore, the Bankruptcy Court found that Lender’s reliance on Debtor’s
omissions and misrepresentations regarding the status of the collateral was not justifiable. Feb. 5,
2013, Op. at 7, ECF No. 61.
The Bankruptcy Court’s finding is clearly erroneous. The Bankruptcy Court imposed a duty
upon the Lender to investigate the truthfulness of Debtor’s representations that is not required by
law.
In Field v. Mans, 516 U.S. 59, 72–75, 116 S. Ct. 437, 444-46 (1995), the Supreme Court
specifically rejected the notion that creditors must conduct an investigation to discover fraud. See
also Foley & Lardner v. Biondo (In re Biondo), 180 F.3d 126, 135 (4th Cir.1999) (citing Field for
the proposition that a creditor has no duty to investigate a debtor's factual representations, even if
the falsity easily could be discovered).
[T]he plaintiff is entitled to rely upon representations of fact of such
a character as to require some kind of investigation or examination on
his part to discover their falsity, and a defendant who has been guilty
of conscious misrepresentation cannot offer as a defense the plaintiff's
failure to make the investigation or examination to verify the same.
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Field, 516 U.S. at 72 (quoting 1 F. Harper & F. James, Law of Torts 7.12, pp., 581–83 (1956)). See
also Lentz v. Spadoni (In re Spadoni), 316 F.3d 56, 59 (1st Cir. 2003) (citing Field for the rule that
“the circumstances of the reliance claim must be taken into account and that the individual is not
obliged to investigate statements made to him (although he cannot shut his eyes to an obvious
falsehood).”); Eugene Parks Law Corp. Defined Benefit Pension Plan v. Kirsh (In re Kirsh), 973
F.2d 1454, 1459 (9th Cir.1992) (noting that under the justifiable reliance standard, “although a
person ordinarily has no duty to investigate the truth of a representation, a person cannot purport to
rely on preposterous representations or close his eyes to avoid discovery of the truth”)(citation
omitted); Holmes v. Nat’l City Bank (In re Holmes), 414 B.R. 115, 122-23 (E.D. Mich. 2009).
If Debtor had confessed the sales, Lender would not have entered the Settlement Agreement.
August 10, 2012, Trial Tr. 184:23-185:4, ECF No. 74 (testimony of Mr. Jarrusi that if Lender had
known the collateral had been sold “there would have been nothing to work out.”). Lender relied
on oral statements and written documentation provided by Debtor (whom the Bankruptcy Court
found “quite credible”) that the equipment had not been sold and was still held as collateral subject
to a security interest for the extension of credit provided by the Settlement Agreement and
Amendment to Loan Documents. Lender relied on Debtor’s continued false representations as to
the status of the collateral in its decision to agree to a forbearance under the Settlement Agreement.
Lender did attempt to determine the location and status of its collateral following the Settlement
Agreement through several audits and requests for information from Debtor. The reasons given for
the equipment to be unavailable to view (because it was on lease to third parties) appeared legitimate
in light of the supporting documentation provided by Debtor indicating that this was an authorized
use of the equipment under the terms of the parties’ agreements. Lender did not “shut [its] eyes to
an obvious falsehood.” Accordingly, Lender’s reliance on Debtor’s misrepresentation of the
equipment’s status was, in fact, justifiable. The Bankruptcy Court’s finding to the opposite is clearly
erroneous.
The last element Lender is required to prove for a finding of non-dischargeability under
§ 523(a)(2)(A) is that reliance on the material misrepresentation is the proximate cause of its loss.
The Bankruptcy Court did not conduct a separate analysis of this prong but simply stated that
Lender’s “actions at the time it entered into the Settlement Agreement and thereafter do not support
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a finding . . . of justifiable reliance or that Debtor’s deceit was the proximate cause of its loss.” Feb.
5, 2013, Op. at 5, ECF No. 61. In his post-trial brief, Debtor argues that the misrepresentation of the
status of the equipment was not the proximate cause of Lender’s loss because if Lender had not
entered into the Settlement Agreement, and instead had pursued a judgment against Debtor under
the guaranty, it would not have recovered any more money because Debtor did not have any more
assets in 2009 than he had at the time the petition was filed. Def. Post-Tr. Br. at 3, ECF No. 59.
On appeal, Debtor argues that even if this Panel reverses the Bankruptcy Court, only a portion of the
total debt would be non-dischargeable because not all of the loss is a direct result of the lies about
the status of the equipment.
After the Settlement Agreement, Debtor continued in business for approximately eighteen
months. During that time, Debtor continued to provide false reports to Lender regarding the status
of its collateral. Debtor stipulated that he sold at least one piece of equipment that was subject to
Lender’s Security interest after the Settlement Agreement without turning over proceeds.7 Second
Joint Stipulations ¶ 13, ECF No. 35. Lender may be able to establish that it would have been able
to recover more collateral, or collateral with less depreciation, or that it may have been able to pursue
other remedies with more likelihood of success, if it had not entered into the Settlement Agreement
with Bradley Machinery and Debtor and had begun pursuing its remedies almost two years earlier.
Additionally, Debtor testified that he took a “draw” from Bradley Machinery of $15,900 in 2009 and
$23,000 in 2010. August 10, 2012, Trial Tr. 243:8-10, ECF No. 74. Therefore, it does appear that
the business had enough assets to pay Debtor $38,900 while Lender continued to extend credit based
on Debtor’s material misrepresentations regarding Lender’s collateral. Additionally, ceasing
business almost two years earlier might have provided even more assets if all overhead was
eliminated rather than just reduced. (See Debtor’s testimony that he reduced overhead by $2,000
per month by firing all other employees and moving to a new location. August 10, 2012, Trial Tr.
249:19-22, ECF No. 74.) Finally, during 2009 and 2010, Lender expended funds attempting to, as
the Bankruptcy Court put it, “keep tabs on” its collateral due to Debtor’s material misrepresentations.
7
Debtor did contradict this admission at trial, asserting that he had not sold any equipment
after the date of the Settlement Agreement. August 10, 2012, Trial Tr. 225:23-25, ECF No. 74.
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If Lender had known the collateral had been sold, Lender may not have needed to pay for some or
all of an auditor’s services.
Accordingly, the Panel holds that the Bankruptcy Court’s factual finding that reliance on
Debtor’s misrepresentation(s) regarding the status of the collateral was not the proximate cause of
loss is clearly erroneous. Lender suffered a loss due to Debtor’s misrepresentations and lies
regarding the status of the collateral. The Panel must remand for further factual findings to
determine the amount of damages attributable to Lender’s forbearance from collection that resulted
from entering into the Settlement Agreement.8
The Bankruptcy Court relied heavily on its determination that at the time of the Settlement
Agreement, Debtor had a subjective intent to repay the debt. However, Debtor’s subjective intent
to repay is not a factor under the § 523(a)(2)(A) Rembert test when there is a separate specific false
material misrepresentation. Debtor’s representation that Bradley Machinery still possessed three
pieces of valuable equipment that were collateral for the loans in question was a material
misrepresentation. Debtor stipulated that he intended to deceive the creditor. Further, Debtor knew
that Lender would rely on these misrepresentations when determining whether to continue to extend
credit to him. Accordingly, the Bankruptcy Court’s determination that Lender did not prove the
elements of § 523(a)(2)(A) is REVERSED and the case is REMANDED for a determination of
damages.
D. Lender’s Motion to Amend or Make Additional Findings of Fact
Federal Rule of Bankruptcy Procedure 7052 applies Rule 52 of the Federal Rules of Civil
Procedure to bankruptcy adversary proceedings. Fed. R. Bankr. P. 7052. Rule 52(a)(1) states that
“[i]n an action tried on the facts without a jury . . . the court must find the facts specially and state
its conclusions of law separately.” Id. “Findings [of fact] are to be liberally construed in support
8
See footnote 5. Damages for the § 523(a)(2)(A) cause of action would be whatever loss
is attributable to Lender’s forbearance under the Settlement Agreement and thereafter, due to
Debtor’s repeated misrepresentations regarding the status of the collateral.
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of a judgment, even if the findings are not as explicit or detailed as might be desired.” Fordu,
201 F.3d at 710 (citation omitted).
It is not necessary for the [Bankruptcy] Judge to prepare elaborate
findings on every possible issue raised at trial. However, there must
be findings, in such detail and exactness as the nature of the case
permits, of subsidiary facts on which an ultimate conclusion can
rationally be predicated. The findings should be explicit so as to give
the appellate court a clear understanding of the basis of the trial
court’s decision, and to enable it to determine the grounds on which
the trial court reached its decision.
Orlett v. Cincinnati Microwave, Inc., 954 F.2d 414, 418 (6th Cir. 1992) (citing Grover Hill Grain
Co. v. Baughman-Oster, Inc., 728 F.2d 784, 792-93 (6th Cir. 1984)).
In the present case, there were more stipulated facts than the Bankruptcy Court included in
the written opinion. There were also additional facts in the admitted exhibits and provided by the
testimony of both witnesses. Those additional facts dictate a different result on the merits.
Therefore, the Bankruptcy Court erred in not granting the Rule 7052 motion.
V. CONCLUSION
The Bankruptcy Court’s holding that Lender did not prove the elements of § 523(a)(4) is
AFFIRMED on alternative grounds.
However, the debt is non-dischargeable pursuant to § 523(a)(2)(A) and § 523(a)(6). Debtor
obtained an extension of credit, via the Settlement Agreement, due to Lender’s reliance on Debtor’s
false statements. Debtor’s actions show that he knew that he had a duty to remit the proceeds to
Lender and that his failure to remit the proceeds would harm Lender. Additionally, the Bankruptcy
Court abused its discretion in denying Lender’s motion to amend the findings of fact and conclusions
of law. The Bankruptcy Court’s ruling that the debt owed to Lender is dischargeable is REVERSED.
The case is REMANDED for a determination of the amount of damages that Lender suffered due
to Debtor’s conversion pursuant to § 523(a)(6) and fraudulent misrepresentations pursuant to
§ 523(a)(2)(A) and for an entry of judgment in favor of Lender accordingly.
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