Opinion
Case No. 09-22557 (RDD), Adv.Proc. 09-08269 (RDD).
November 25, 2009
Mr. James B. Glucksman, Esq., For Defendant, Jennifer Howard, Rattet, Pasternak and Gordon Oliver, Harrison, New York.
Mr. Keith M. Brandofino, Esq., For Plaintiff, Phillips Lytle, LLP, New York, New York.
Robert Cameron Howard, PRO SE, Defendant, Drake Smith Associates PRO SE, Defendant.
Angela Miller Angela Z. Miller, For Plaintiff.
MODIFIED BENCH RULING ON MOTION TO DISMISS ADVERSARY PROCEEDING BEFORE THE HONORABLE ROBERT D. DRAIN UNITED STATES BANKRUPTCY COURT
THE COURT: All right. Plaintiff S T Bank has filed a complaint against Robert Cameron Howard, Drake Smith Associates, LLC, and, as is relevant to the matter before me, Jennifer Williams Howard, who's a Chapter 7 debtor in this Court. Mrs. Howard has moved to dismiss the complaint under Bankruptcy Rule 7012, which incorporates Federal Rule of Civil Procedure 12(b)(6). When considering a motion under Rule 12(b)(6), the Court must assess the legal feasibility of the complaint, not weigh the evidence that might be offered in its support. Koppel v. 4987 Corporation, 167 F.3d 125, 133 (2d Cir. 1999). The Court's consideration "is limited to facts stated on the face of the complaint, or the documents appended to the complaint, or incorporated in the complaint by reference, as well as to matters of which judicial notice may be taken." Hertz Corp. v. City of New York, 1 F.3d 121, 125 (2d Cir. 1993) cert. denied, 510 U.S. 1111 (1993). The Court accepts the complaint's factual allegations as true, and must draw reasonable inferences in favor of the plaintiff. Tellabs Inc. v. Makor Issues Rights Ltd., 551 U.S. 308, 323 (2007). Rule 8(a) does not, moreover, require a claimant to set forth any legal theory justifying the relief sought on the facts alleged, requiring only sufficient factual reference to show that the claimant may be entitled to some form of relief. Newman v. Silver, 713 F.2d 14, 15 (2d Cir. 1983). Tolle v. Carroll Touch, Inc., 977 F. 2d 1129, 1134 (7th Cir. 1992).
However, if a complaint's allegations are clearly contradicted by documents incorporated into the pleadings by reference, the Court need not accept them. Labajo v. Best Buy Stores, L.P., 478 F. Supp. 2d 523, 528 (S.D.N.Y. 2007). Moreover, the Court is "not bound to accept as true a legal conclusion couched as a factual allegation." Papasan v. Allain, 478 U.S. 265, 286 (1986). Instead, the complaint must state more than "labels and conclusions, and a formulaic recitation of the elements of a cause of action will not do." Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555 (2007).
Relatedly, while the Supreme Court has confirmed in light of the notice pleading standard under Federal Rule of Civil Procedure 8(a) that a complaint does not need detailed factual allegations to survive a motion under Rule 12(b)(6) — see Erickson v. Pardus, 127 S. Ct. 2197, 2200 (2007), its "factual allegations must be enough to raise a right to relief above the speculative level." Bell Atlantic v. Twombly, 550 U.S. at 555. The complaint must contain sufficient facts accepted as true to state a claim that is "plausible on its face." Id. at 570. In other words, if the claim would not otherwise be plausible on its face, the plaintiff must allege sufficient facts to "nudge the claim across the line from conceivable to plausible." Id. Otherwise the defendant should not be subject to the burdens of discovery and the worry of overhanging litigation. Id.
Evaluating plausibility is "a context-specific task that requires the Court to draw on its judicial experience and common sense. But where the well pleaded facts do not permit the Court to infer more than mere possibility of misconduct, the claim has alleged — but it has not shown — that the pleader is entitled to relief." Ashcroft v. Iqbal, 129 S. Ct. 1937, 1949 (2009). "When there are well pleaded factual allegations, a Court should assume their veracity and then determine whether they plausibly give rise to an entitlement to relief." Id. at 1950. "The plausibility standard is not akin to a 'probability requirement,' but it asks for more than sheer possibility that a defendant has acted unlawfully." Id.
In sum, therefore, applying Twombly, the Supreme Court has observed that "the pleading standard Rule 8 announces did not require 'detailed factual allegations' but it demands more than an unadorned 'the defendant unlawfully harmed me' accusation." Iqbal, 129 S. Ct. at 1949 (citations omitted. "Therefore in determining whether a claim should survive a motion to dismiss, a court must first identify each element of the cause of action."Id. at 1947. Next, the court "must identify the allegations that are not entitled to 'the assumption of truth' because they are legal conclusions, not factual allegations." Id. at 1951. And, finally, the court must assess the factual allegations in the context of the elements of the claim to determine whether they "plausibly suggest an entitlement to relief." Id.
Here, S T Bank brings claims under 11 U.S.C. section 523(a)(2)(A) and 11 U.S.C. section 523(a)(6).
Section 523(a)(2)(A) of the Bankruptcy Code provides in pertinent part that "A discharge under this title does not discharge an individual debtor from any debt or money, property, services, or an extension, renewal or refinancing of credit to the extent obtained by false pretenses, or false representation, or actual fraud, other than a statement respecting the debtor's or an insider's financial condition." A claim under this "fraud" exception requires that the claim satisfy the heightened pleading requirements for fraud pursuant to Fed.R.Civ.P. 9(b). See In re Jacobs, 403 B.R. 565, 574 (Bankr. N.D. Ill. 2009) (citations omitted), as well as In re Kanaley, 241 B.R. 795, 803 (Bankr. S.D.N.Y. 1991).
Rule 9(b) states "In alleging fraud, a party must state with particularity the circumstances constituting fraud or mistake. Malice, intent, knowledge, and other conditions of a person's mind may be alleged generally." While intent or knowledge may be averred generally, however, the plaintiff must still plead the events claimed to give rise to an inference of intent or knowledge, Devaney v. Chester 813 F.2d 566, 568 (2d Cir. 1987), which may be accomplished by pleading facts consistent with certain well established "badges of fraud." In re Sharp Int'l Corp., 403 F.3d 43, 56 (2d Cir. 2004). In addition to providing a defendant with fair notice of the claim, Rule 9(b) serves the purpose of protecting a defendant from harm to his or her reputation or good will by unfounded allegations of fraud, and by reducing the number of strike suits. In re Actrade Financial Technologies Ltd., 337 B.R. 791, 801 (Bankr. S.D.N.Y. 2005).
Before focusing on section 523(a)(2)(A) in more detail, it also should be noted that it is a primary purpose of the Bankruptcy Code to relieve the honest debtor from the weight of oppressive indebtedness and permit him or her to start afresh, by providing the debtor a new opportunity in life and a clear field for future effort unhampered by the pressure and discouragement of pre-existing debt. Therefore, exceptions to discharge, including under section 523(a)(2)(a), are to be narrowly construed, as has been repeatedly stated by the Second Circuit and courts within the Second Circuit. See In re Renshaw 222 F.3d 82, 86 (2d Cir. 2000); In re Sanchez, 365 B.R. 414, 417 (Bankr. S.D.N.Y. 2007).
In In re Chase, 372 B.R. 133 (Bankr. S.D.N.Y.), the court discussed the elements of false pretenses, false representations and actual fraud, as they exist in section 523(a)(2)(A). As an initial matter, those three terms, as used in that section, "embody different concepts in Congress' use of the disjunctive, or evidence an intent to deny a discharge under any such term." Id. at 136. The term "false pretenses" is defined as "conscious, deceptive or misleading conduct, calculated to obtain or deprive another of property." Id. (quoting Gentry v. Kolver, 249 B.R. 238, 261 (Bankr. S.D.N.Y. 2000)). It includes an implied misrepresentation or conduct intended to create a false impression. Id. The term "false representation" requires that the plaintiff present proof that the defendant (1) made a false or misleading statement, (2) with the intent to deceive, and (3) to cause the plaintiff to turn over money or property to the defendant. Id. (citing In re Dobrayel 287 B.R. 3, 12 (Bankr. S.D.N.Y. 2002)). The term "actual fraud" requires proof of the five fingers of fraud, or five elements of fraud, which are (1) a misrepresentation, (2) fraudulent intent or scienter, (3) intent to induce reliance, (4) justifiable reliance, and (5) damage. See In re Dobrayel, 287 B.R. at 12. A reckless representation or silence regarding a material fact may in some cases constitute the requisite falsity, and in certain cases a causal link, as opposed to actual reliance, may establish the creditor's injury. See In re Gonzalez, 241 B.R. 67, 74 (S.D.N.Y. 1999), and In re Lupino, 221 B.R. 693, 701 (Bankr. S.D.N.Y. 1998). Although the statute could conceivably be read as providing that one's debt may not be subject to the discharge if one merely benefits from someone else's fraud, in keeping with the Congressional purpose behind section 523 that is not the approach taken by the courts. The foregoing case law requires fraudulent conduct, false pretenses, or false representations on the part of the particular debtor in question, either directly or by imputation.
I have reviewed the complaint here, and I see nothing in the complaint that would satisfy Rule 8, let alone Rule 9(b), as to whether a claim has been alleged under Bankruptcy Code section 523(a)(2)(A) for fraud, false pretenses or misrepresentation. The complaint deals with two loans, in connection with which it is alleged the debtor's husband, Robert Howard, committed fraud. In each case it is alleged that the loan proceeds, which were intended to be applied to specific construction projects, were instead retained by "the Debtors" — that is, both Mr. Howard and Mrs. Howard, without any differentiation as to how they were retained, whether they were retained jointly, or by one or the other of them.
With respect to the first loan, which involves a property on Locust Avenue, in Rye, New York, it is asserted that "the Debtors," that is Mr. Howard and Mrs. Howard, executed a loan agreement and mortgage, and that under the loan agreement funds would be advanced periodically upon "the Debtors' request" which merely summarizes a provision of the loan agreement. The complaint, in the next paragraph, paragraph 23, states that between January 31, 2007 and September 8, 2008, Mrs. Howard's husband, Robert Howard, made nine written advance requests, signed by him, as set forth in paragraph 24, and that, as set forth in paragraph 28, the bank subsequently learned that Robert Howard's representations, in the Locust Avenue advance requests and in the Locust Avenue supporting documents regarding construction work that had been completed at the Locust Avenue property, were materially false, and that, as set forth in paragraph 33, S T Bank relied upon such material misrepresentations made by Robert Howard and disbursed the funds as requested.
The first factual allegation clearly pertaining solely to Mrs. Howard, other than that she was the co-borrower under the Locust Avenue agreement and co-owner of the Locust Avenue property, is found at paragraph 60 in the first claim for relief under section 523(a)(2), where the complaint states, "As co-borrower under the Locust Avenue agreement and co-owner of the Locust Avenue property, Jennifer Howard had actual knowledge of, or should have known of, or was recklessly indifferent to, the fraud perpetrated by Robert Howard." No facts are alleged to support this statement other than those previously noted.
As to the second loan, the facts are even more barebones and conclusory. In the second loan, it is stated in paragraph 34, upon information and belief, that "The Debtors owned 50 percent of the membership interest in Drake Smith" — not specifying which of the two debtors or how, if they both owned an interest, they owned it. (Drake Smith is an LLC that's also named as a defendant.) And then the complaint, in paragraph 35, states that, upon information and belief, Robert Howard is, or at all relevant times was, the managing member of Drake Smith, that Drake Smith incurred indebtedness from S T Bank, and, as stated in paragraph 38, Drake Smith executed a promissory note and granted, as set forth in paragraph 39, a mortgage encumbering the relevant property. And then it is stated that, as set forth in the Drake Smith loan agreement, Drake Smith was permitted to apply for advances under the loan with respect to work actually done by the general contractor and for material and equipment actually incorporated into the Drake Smith property, and, as set forth in paragraph 44, Robert Howard, acting on behalf of Drake Smith, made non-written advance requests in respect of the property. Paragraph 45 states that each such request was signed by Robert Howard. Paragraph 49 then states that the bank subsequently learned that representations made by Robert Howard, and/or Drake Smith, in the Drake Smith advance requests and Drake Smith supporting documents regarding construction work that had been completed at the Drake Smith property, were materially false. And paragraph 54 states that S T Bank, unaware of the material misrepresentations made by Robert Howard and/or Drake Smith, relied thereon in furnishing the funds.
The only basis for the complaint to state that Mrs. Howard is liable under section 523(a)(2) in respect of all the foregoing is set forth in paragraph 75, in which it is stated that, as a co-owner of Drake Smith, Jennifer Howard had actual knowledge of, or should have known, or was recklessly indifferent to, the fraud perpetrated by Robert Howard and Drake Smith — i.e., it's asserted that, simply as a shareholder of the borrower, Mrs. Howard had actual knowledge of, or should have known of, or was recklessly indifferent to, the corporate borrower's fraud perpetrated through its officer, her husband. No other facts are alleged to support that allegation.
Clearly no misrepresentation by Mrs. Howard has been alleged here, or any intent on her part to induce reliance thereon. Moreover, I find that the conclusory allegation that she had knowledge or was recklessly indifferent is just that, a conclusory allegation, simply reciting one of the elements of the cause of action; and, under both Rule 9(b), as well as Rule 8, the complaint is, therefore, deficient in setting forth a cause of action under section 523(a)(2) against Mrs. Howard in respect of either of the two loans. It not only does not plead sufficient "badges of fraud" as to her intent, it also does not plead facts, as opposed to conclusions, describing her fraud, as opposed to her husband's or Drake Smith Associates LLC's. To be contrasted with the present complaint, are the facts pled in In re Demarest 176 B.R. 917 (Bankr. W.D. Wash. 1995), where the plaintiff clearly asserted that the defendant wife, Mrs. Demerest, actively participated in the concealment of the fraud, even though the fraud was committed by her husband, and that such concealment resulted in a direct benefit to her. The present complaint does not set forth anything like comparable facts to that scenario.
It's also clear that if a so-called "imputation" theory may be used to impute Mr. Howard's alleged frauds to Mrs. Howard (a concept that is subject to conflicting case law) — but to the extent that the imputation theory would apply in this Circuit — the complaint does not state a cause of action based on imputing Mr. Howard's alleged fraud to Mrs. Howard. As far as the validity of the "imputation" theory in the first place is concerned, see the conflicting authorities cited in paragraph 523.08[3] of 4 Collier on Bankruptcy (15th ed. 2009) at 523-52-3. The courts that have recognized the imputation of one spouse's fraud or wrongdoing to the other have generally concluded that it must be shown that the debtor-spouse was a partner, a business partner or the business partner, of the spouse who committed the fraud, "or was otherwise in a principal/agent relationship." Id; see generally In re Tsurukawa 258 B.R. 192, 198 (9th Cir. BAP 2001), as well as In re Luce, 960 F.2d 1277, 1282-83 (5th Cir. 1992), and In re Allison, 960 F.2d 481, 485-86 (5th Cir. 1992). In that latter case, while recognizing the validity of the imputation therein, the Fifth Circuit refused to impute a husband's fraudulent conduct to a wife where there was "no evidence in the record linking the wife to false or fraudulent acts or plans, and where no agency relationship was established."
The complaint here does not plead facts setting forth any such agency or other business relationship with respect to the conduct of the operation of Drake Smith Associates LLC or the operation of, or the making of the representations in respect of, the Locust Avenue property, nor, as noted, any facts, as opposed to conclusory allegations, linking Mrs. Howard to the fraudulent acts of her husband, let alone facts regarding her own alleged misconduct. Merely being a co-borrower on the Locust Avenue property or, in an unspecified way, an interest holder in Drake Smith Associates LLC does not suffice. Without more, therefore, the complaint's claim under section 523(a)(2) of the Bankruptcy Code should be dismissed.
The complaint also, on the same allegations, asserts a claim under section 523(a)(6) of the Bankruptcy Code. That section provides that "A discharge under Section 727 of this title does not discharge an individual from any debt for willful and malicious injury by the debtor to another entity, or to the property of another entity." It has been held that the word "willful" in this context means, "a deliberate or intentional injury, not merely a deliberate or intentional act that leads to injury." Ball v. A.O. Smith Corp., 451 F.3d 66, 69 (2d Cir. 2006). "Malicious" in this context means "wrongful and without just cause or excuse," even in the absence of personal hatred, spite, or ill will. Id. at 70. While it may be argued that all fraud could conceivably constitute willful and malicious injury, that would render section 523(a)(6) superfluous, given section 523(a)(2)(A), although some courts nevertheless have applied taken that approach — see Printy v. Dean Witter Reynolds, Inc., 110 F.3d 853, 859 (1st Cir. 1997). (However, I've already found that the complaint has not set forth a claim for fraud).
This Court has held, however, that there must be a difference between fraud and "willful and malicious injury" as used in section 523(a)(6), and that, therefore, section 523(a)(6) is not subsumed by section 523(a)(2). See In re Lupino, 221 B.R. at 700, in which Judge Hardin stated that
"Actual malice may be inferred or imputed from the fact that the debtor's conduct, giving rise to liability, has no potential for economic gain or other benefit to the debtor, from which one could only conclude that the Debtor's motivation must have been to inflict harm upon the creditor."
To the extent that that interpretation applies, i.e. that section 523(a)(6) is aimed more at conduct that maliciously inflicts harm, as opposed to all fraudulent conduct, the forgoing facts that I've recited from the complaint are also, however, clearly deficient in setting forth a section 523(a)(6) claim. The claim isn't even pleaded as, in the words of Iqbal, an unadorned and conclusory, "the defendant unlawfully harmed me" accusation. It merely repeats the same representations and conclusory statements that the defendant Mrs. Howard must have known about the fraudulent misconduct of her husband and co-borrower (on the Locust Avenue property) and/or the business, Drake Smith Associates LLC, in which she owned some unspecified interest; therefore, the complaint clearly does not set forth a cause of action in respect of either of the loans under Bankruptcy Code section 523(a)(6).
I should note that I've been addressing, as I believe I must, only the complaint and the documents attached to it, or referred to in it, or incorporated in it by reference. The responsive papers to the motion have alleged that there are additional facts — or have alleged additional facts — that might go to show a cause of action under section 523(a)(2). However, it's a basic principle that a complaint may not be amended by the briefs in opposition to a motion to dismiss, and, therefore, I haven't considered those factual allegations as set forth in the responsive papers. See In re Jacques, 2009 WL 2915823 (Bankr. E.D.N.Y. September 4, 2009).
Nor am I persuaded by the plaintiff's argument that the Court should overlook the complaint's deficiencies because the plaintiff is largely in the dark about Mrs. Howard's conduct. Not only is this argument at cross purposes with Rule 9(b) and the basic Rule 8 pleading requirements enunciated by the Supreme Court in Twombly and Iqbal, but also it is belied by the fact that the plaintiff has had ample time to take free ranging discovery under Bankruptcy Rule 2004 before filing its complaint.
So, for all those reasons, the motion is granted, and the complaint's causes of action as against Mrs. Howard are dismissed.
At oral argument counsel for the plaintiff raised the possibility of seeking to amend the complaint, and I'll consider such a motion if it's raised. I can tell you, however, that I have substantial doubts about the efficacy of an amendment, at least with regard to the Drake Smith Associates LLC property. But I'll wait to see such a motion if it's made.