Opinion
Civil Action No. 1:19-cv-1497
07-30-2020
ANNAB, INC., Appellant, v. Khader Kamal AZZOUZ and Nanette Azzouz, Appellees.
Craig Michael Palik, McNamee Hose Jernigan Kim Greenan & Walker PA, Greenbelt, MD, for Appellant. James P. Campbell, Campbell Flannery PC, Leesburg, VA, for Appellees.
Craig Michael Palik, McNamee Hose Jernigan Kim Greenan & Walker PA, Greenbelt, MD, for Appellant.
James P. Campbell, Campbell Flannery PC, Leesburg, VA, for Appellees.
ORDER
T. S. Ellis, III, United States District Judge In this bankruptcy appeal, Annab, Inc. challenges two determinations made by the Bankruptcy Court in an adversary proceeding between Khader Kamal Azzouz and Nanette Azzouz (collectively, "Azzouz"), the former owners of Bagels and Beyond, LLC, and Annab, Inc. d/b/a Bagel Specifically, Annab, Inc. seeks reversal of (i) the Bankruptcy Court's determination that Annab, Inc. materially breached the Asset Purchase Agreement between Annab, Inc. and Azzouz and (ii) the Bankruptcy Court's determination that Annab, Inc.'s proof of claim must be denied in its entirety because of Annab, Inc.'s material breach of the Asset Purchase Agreement. For the reasons that follow, the judgment of the Bankruptcy Court must be affirmed in all respects.
I.
This case's factual and procedural history provides necessary context for the issues presented in this appeal. The appellant, Annab, Inc., is a business owned by Mansour and Samar Annab that owned, operated, and later sold a bagel business. The appellees, Khader and Nanette Azzouz (collectively, "Azzouz"), were the buyers of the bagel business sold by Annab, Inc. Khader Kamal Azzouz and Samar Annab are brother and sister.
In 2012, Annab, Inc. hired Azzouz to serve as a broker for the sale of Annab, Inc.'s bagel business. Eventually, Azzouz decided to purchase the bagel business. Prior to April 4, 2014, Azzouz received federal and state income tax returns for Annab, Inc. from 2010 to 2012 and sales figures recorded using QuickBooks, an accounting software program. As reflected in the previous appellate decision, the QuickBooks sales figures provided to Azzouz prior to April 4, 2014 indicated that Annab, Inc. underreported the bagel business's sales figures to the IRS. Azzouz v. Annab, Inc. , 1:18-cv-1340, slip op. at 4 n. 5 (E.D. Va. April 26, 2019) (noting that "there was ample evidence that the buyers knew that the seller was underreporting revenue to the IRS"); see also Azzouz v. Annab, Inc. (In re Azzouz ), Case No. 15-12559-KHK, Adv. Proc. No. 16-01117-KHK, slip op. at 4, 2018 WL 4006306 (Bankr. E.D. Va. Aug. 17, 2018) (Memorandum Opinion). On April 4, 2014, Azzouz entered into an Asset Purchase Agreement to buy the bagel business from Annab, Inc. for $575,000. That same day, the parties endorsed a Deed of Lease providing that Azzouz would pay Annab, Inc. $5,750 per month for the business's property lease and $780 per month for a condominium fee. Azzouz paid Annab, Inc. $70,000 in cash as a down payment and signed a promissory note made payable to Annab, Inc. for the remaining balance of $485,000. Because Azzouz also served as a broker for the sale, Azzouz received a $20,000 sales commission upon purchasing the business.
Previous opinions in this matter have stated that the down payment was $90,000, but the Bankruptcy Court noted on remand that Azzouz's receipt of a $20,000 commission for the sale effectively reduced the down payment from $90,000 to $70,000. Azzouz v. Annab, Inc. (In re Azzouz ), Case No. 15-12559-KHK, Adv. Proc. No. 16-01117-KHK, slip op. at 8, 2019 WL 5586584 (Bankr. E.D. Va. Oct. 29, 2019) (Memorandum Opinion).
Pertinent to the instant dispute is the following express warranty in the Asset Purchase Agreement:
[Annab, Inc.] warrants and guarantees that the financial statements/records provided to [Azzouz] are 100% true and accurate. Purchaser shall have an evaluation period for 90 days starting in May until end of July. [Annab, Inc.] furthermore
warrants that in the events a discrepancy is found after possession that [Annab, Inc.] will be held liable for such discrepancy.
Azzouz v. Annab, Inc. (In re Azzouz ), Case No. 15-12559-KHK, Adv. Proc. No. 16-01117-KHK, slip op. at 5, 2018 WL 4006306 (Bankr. E.D. Va. Aug. 17, 2018) (Memorandum Opinion) (quoting Asset Purchase Agreement at 4(A)(xi)). The Asset Purchase Agreement also provided that Annab, Inc. would be entitled to accounts receivables for sales accrued prior to the bagel business's sale. Id. at 4.
On April 6, 2014, Azzouz assumed control of the business and, within days, noticed discrepancies between the business's actual labor costs and the labor costs reported to the Internal Revenue Service (IRS) in the bagel business's previous tax returns. On July 15, 2014, Azzouz attempted to rescind or terminate the Asset Purchase Agreement, but Annab, Inc. refused to honor the rescission. Azzouz operated the bakery until October 15, 2014.
In state court litigation, each party contended that the other breached the Asset Purchase Agreement. Before that litigation concluded, Azzouz filed for Chapter 11 bankruptcy and brought an adversary proceeding for breach of contract, fraud, and fraud in the inducement against Annab, Inc. to recover compensatory and punitive damages and rescind the Asset Purchase Agreement. Annab, Inc. filed a proof of claim in Azzouz's bankruptcy case seeking $511,656.56 for Azzouz's failure to make payments required under the Asset Purchase Agreement.
On December 18, 2017, a bench trial was held in the adversary proceeding. On August 17, 2018, the Bankruptcy Court entered judgment in favor of Annab, Inc. on all counts of the adversary proceeding, holding (i) that Azzouz's breach of contract claim failed because Azzouz failed to prove damages flowing from Annab, Inc.'s alleged breaches of warranty, (ii) that Azzouz's fraud and fraud in the inducement claims failed because Azzouz's knowledge of Annab, Inc.'s underreporting of sales figures to the IRS made Azzouz's reliance on any contrary representations unreasonable, and (iii) that Azzouz was not entitled to rescind the Asset Purchase Agreement. Azzouz v. Annab, Inc. (In re Azzouz ), Case No. 15-12559-KHK, Adv. Proc. No. 16-01117-KHK, slip op. at 9–14, 2018 WL 4006306 (Bankr. E.D. Va. Aug. 17, 2018) (Memorandum Opinion). On Azzouz's motion, the Bankruptcy Court amended the judgment in the adversary proceeding to make clear that Azzouz's objection to Annab, Inc.'s proof of claim would be sustained because Annab, Inc.'s first material breach of the Asset Purchase Agreement precluded Annab, Inc. from asserting a subsequent breach by Azzouz of the same contract. Azzouz v. Annab, Inc. ( In re Azzouz ), Case No. 15-12559-KHK, Adv. Proc. No. 16-01117-KHK (Bankr. E.D. Va. Oct. 19, 2018) (Order); see also October 11, 2018 Hr'g Tr at 6:20–7:8 (citing Hurley v. Bennett , 163 Va. 241, 253, 176 S.E. 171 (1934) ). Both parties appealed to the United States District Court for the Eastern District of Virginia.
On April 26, 2019, the Bankruptcy Court's decision was affirmed in part, vacated in part, and remanded to the Bankruptcy Court for further proceedings. Khader Azzouz v. Annab, Inc. , 1:18-cv-1340 (E.D. Va. April 26, 2019) (Order). The April 26, 2019 Order agreed with the Bankruptcy Court's factual finding that Azzouz knew that Annab, Inc. was underreporting sales figures to the IRS. Id. at 4 n. 5 (noting that "there was ample evidence that the buyers knew that the seller was underreporting revenue to the IRS"). But the April 26, 2019 Order remanded the case to the Bankruptcy Court with instructions to make an additional factual finding as to whether Azzouz knew about the bagel business's labor cost underreporting before purchasing the bagel business. Id. at 3–4. In the event the Bankruptcy Court found no evidence that the buyers knew about the bagel business's labor cost underreporting prior to purchasing the business, Annab, Inc. would have committed a material breach of the Asset Purchase Agreement. Id. at 4 (noting that if Azzouz "bought a business with higher operating expenses than reported, [Azzouz] did not get the benefit of the[ ] bargain"). Conversely, if Azzouz knew of the bagel business's true labor costs before the purchase, Annab, Inc. would not have materially breached the contract, and the seller's proof of claim would be permitted to proceed. Id. at 4–5. The April 26, 2019 Order also made clear that a finding on remand that Annab, Inc.'s failure to provide accurate labor cost information constituted a breach would not preclude the Bankruptcy Court from "determin[ing] that the buyers are entitled to no damages because they received more value from the business than their $90,000 deposit was worth." Id. at 4 n. 6. Of course, all of the Bankruptcy Court's factual findings and conclusions of law not appealed by the parties were affirmed by the district court. Id. at 5.
On remand, an evidentiary hearing was held on June 27, 2019, and the matter was taken under advisement on August 9, 2019. On October 29, 2019, the Bankruptcy Court issued a Memorandum Opinion that made the following factual findings:
• Before April 4, 2014, Annab, Inc. provided Azzouz with federal and state income tax returns for Annab, Inc. for tax years 2010, 2011, and 2012 and QuickBooks sales reports for the bagel business.
• Annab, Inc.'s tax returns for 2010, 2011, 2012, and 2013 listed labor costs that averaged between $160,00 and $180,000 per year, including wages for Samar Annab, Mansour Annab, and their two sons, George and David Annab.
• The tax returns reported total wage expenses but did not include a Form W-2 for each employee on the payroll.
• Prior to the purchase, Azzouz did not receive a written employee list, copies of employees' W-2s, or any other information regarding the number of individuals on Annab, Inc.'s payroll or those individuals' compensation prior to April 4, 2014.
• After Azzouz purchased the business, Azzouz acquired copies of employees' W-2s by subpoenaing the records of Kyung Kim, the accountant hired by Annab, Inc. to prepare those W-2s.
• In 2012, Annab, Inc. reported withholdings to the IRS in W-2s for nine employees, only five of whom were not members of the Annab family.
• In 2013, Annab, Inc. reported withholdings for seven employees, only three of whom were not members of the Annab family.
• After Azzouz assumed control of the business on April 6, 2014, Azzouz determined that labor costs for the staff of eleven employees and the four members of the Annab family were $6,160 per week, or $320,320 annually.
• Azzouz's calculation of $6,160 for weekly labor costs was consistent with Samar Annab's testimony on
Azzouz did not obtain the 2013 tax return until the summer of 2014, well after the April 4, 2014 purchase of the bagel business. See Dec. 18, 2017 Trial Tr. at 86:13–17.
three occasions regarding the number of employees necessary to run the business and those employees' weekly compensation.
• According to Mansour Annab, David and George Annab operated the QuickBooks program for the bagel business's financial transactions. From 2006 to 2008, George Annab managed the bagel business's office and performed data entry into QuickBooks. George Annab knew that QuickBooks records for Annab, Inc. did not track labor costs or other business expenses.
• In 2010, David Annab assumed the duties of office manager and was responsible for QuickBooks data entry until the business's sale in 2014. At the December 2017 trial, David Annab testified that the QuickBooks software was not used to track Annab, Inc.'s business expenses.
• The QuickBooks records disclosed to Azzouz prior to April 4, 2014 contained no information about the business's labor costs. On April 6, 2014, Azzouz gained full access to Annab, Inc.'s QuickBooks records and discovered that none of the QuickBooks records contained information regarding labor costs.
• On July 15, 2014, Azzouz sent a Notice of Demand for Rescission or, in the Alternative, for Termination of the Agreement to Annab, Inc. because Azzouz determined he could not resolve the discrepancies between the tax returns' listed labor costs and the bagel business's actual labor costs.
• Annab, Inc. refused to honor Azzouz's demand, and Azzouz continued to operate the business.
• Between April and October 2014, Azzouz paid Annab, Inc. $19,590 for lease and condominium fees due for the property pursuant to the Deed of Lease.
• Azzouz collected $51,000 in accounts receivable to which Annab, Inc. was entitled pursuant to the Asset Purchase Agreement, but Azzouz did not turn over the funds to Annab, Inc.
• Bagels and Beyond, LLC's Bank of America Statements indicate that Azzouz deposited $540,723.49 into business accounts. Azzouz wrote checks to Khader Azzouz in the amount of $35,700 while Azzouz ran the business, and those checks were cashed.
The three occasions to which the Bankruptcy Court refers are Samar Annab's December 9, 2016 deposition, the December 18, 2017 trial, and the June 27, 2019 evidentiary hearing. Dec. 18, 2017 Trial Tr. 45:15–53:1 (reading portion of Samar Annab's deposition testimony into the trial record); Id. at 223:12–224:7; Id. at 231:23–234:10; June 27, 2019 Evid. Hr'g Tr. 27:15–35:13.
Azzouz v. Annab, Inc. ( In re Azzouz ), Case No. 15-12559-KHK, Adv. Proc. No. 16-01117-KHK, slip op. at 3–5 (Bankr. E.D. Va. Oct. 29, 2019) (Memorandum Opinion).
In light of these factual findings, the Bankruptcy Court determined that Azzouz did not know the bagel business's actual labor costs prior to purchasing the business on April 4, 2014 because Annab, Inc. "caused the true labor costs to be underreported on its tax returns." Id. at 6. The Bankruptcy Court further concluded that the inaccuracy of the tax forms resulted from Samar Annab deliberately or inadvertently providing withholding data for fewer individuals than the bagel business employed to the bagel business's accountant. Id. ("Mrs. Annab's responses and her demeanor when being questioned in Court showed she either did not understand how to meet her obligation for reporting withholdings or that she deliberately underreported them.").
The Bankruptcy Court also concluded that Azzouz never learned about the bagel business's true labor costs through any other means prior to the April 4, 2014 purchase. In this respect, the Bankruptcy Court found that the QuickBooks records provided to Azzouz contained no information about the bagel business's labor costs. In making this determination, the Bankruptcy Court gave no weight to David Annab's June 2019 testimony that the bagel business's QuickBooks records contained labor cost information because David Annab's June 2019 testimony directly contradicted his December 2017 testimony about the QuickBooks records' contents. Id. at 7–8. The Bankruptcy Court also observed that David Annab's testimony reflected that "he had very little knowledge about the payroll expense data he claimed he entered into QuickBooks." Id. at 8. And Samar Annab's testimony that Azzouz received labor cost information through QuickBooks was also given no weight because Samar Annab relied completely on her sons to use QuickBooks and thus had no direct knowledge of the QuickBooks records' contents. Id. at 7.
The Bankruptcy Court concluded that Annab, Inc. materially breached the Asset Purchase Agreement because Annab, Inc. provided inaccurate information regarding labor costs in the tax returns and Azzouz never learned of the bagel business's true labor costs. Id. The Bankruptcy Court sustained Azzouz's objection to Annab, Inc.'s proof of claim for $511,656,56 because Annab, Inc. committed the first material breach of the contract, precluding Annab, Inc. from enforcing the contract against Azzouz. Although Annab, Inc. breached the Asset Purchase Agreement, the Bankruptcy Court held that Azzouz was not entitled to recover any damages because the benefits Azzouz received because of the breach exceeded any actual loss sustained by Azzouz because of the breach. Azzouz v. Annab, Inc. ( In re Azzouz ), Case No. 15-12559-KHK, Adv. Proc. No. 16-01117-KHK, slip op. at 8–9 (Bankr. E.D. Va. Oct. 29, 2019) (Memorandum Opinion) (noting that Azzouz retained accounts receivables owed to Annab, Inc. and operated the business rent-free for several months). On October 29, 2019, the Bankruptcy Court entered an Order disallowing Annab, Inc.'s proof of claim in the main bankruptcy case in its entirety, awarding Azzouz no damages in the adversary proceeding, and dismissing the adversary proceeding with prejudice. Azzouz v. Annab, Inc. ( In re Azzouz ), Case No. 15-12559-KHK, Adv. Proc. No. 16-01117-KHK (Bankr. E.D. Va. Oct. 29, 2019) (Order). Annab, Inc.'s appeal followed.
See Countryside Orthopaedics, P.C. v. Peyton , 261 Va. 142, 156, 541 S.E.2d 279 (2001) ("[T]his Court has stated that the first party to commit a material breach can neither enforce the contract nor maintain an action on it.") (citing Hurley v. Bennett , 163 Va. 241, 253, 176 S.E. 171 (1934) ); Horton v. Horton , 254 Va. 111, 115–16, 487 S.E.2d 200 (1997) (same); see also Bayer Cropscience LP v. Albemarle Corp. , 696 F. App'x 617, 623 (4th Cir. 2017) (explaining that under Virginia's first material breach doctrine, "a first material breach excuses a nonbreaching party's nonperformance").
Azzouz has not appealed any aspect of the Bankruptcy Court's decision.
II.
On appeal, the Bankruptcy Court's findings of fact are reviewed for clear error, and conclusions of law are reviewed de novo. In re Litton , 330 F.3d 636, 642 (4th Cir. 2003). A mixed question of law and fact is also reviewed de novo. Id. Here, because the Bankruptcy Court's factual findings and legal conclusions are firmly supported by the record and relevant case law, the Bankruptcy Court's judgment must be affirmed.
Annab, Inc. argues on appeal that the Bankruptcy Court committed clear error when it found that Annab, Inc. provided Azzouz with inaccurate labor cost information in its tax returns. At oral argument, counsel for Annab, Inc. contended that Azzouz presented no evidence that the stale information in the 2010, 2011, and 2012 tax returns was inaccurate at the time Annab, Inc. filed those returns. This argument is unpersuasive; ample record evidence supports the Bankruptcy Court's finding that the tax returns provided to Azzouz prior to the sale contained inaccurate labor cost information. First, the record reflects a significant discrepancy between the number of bagel business employees Azzouz identified at the time Azzouz assumed control (15), the number of employees Samar Annab identified prior to the sale (approximately 14), and the number of employees who received W-2 in previous tax years (9 employees in 2012 and 7 employees in 2013). Second, the record reflects a significant discrepancy between the annual labor costs Azzouz calculated when he assumed control of the business (over $320,000) and the annual labor costs listed on the 2010 to 2013 tax returns (between $160,000 and $180,000). Third, the record reflects that Samar Annab, the sole person responsible for submitting employee wage data to Annab, Inc.'s accountant, admitted to paying employees without withholding taxes. In light of this evidence, the Bankruptcy Court drew the legitimate and well-supported inference that the tax returns provided to Azzouz prior to April 4, 2014 underreported Annab, Inc.'s labor costs. Importantly, in making these factual findings, the Bankruptcy Court evaluated the credibility and demeanor of the testifying witnesses. See In re Biondo , 180 F.3d 126, 134 (4th Cir. 1999) (noting that bankruptcy court had "unique ability to judge the credibility of the witnesses" and holding that its finding regarding debtor's lack of credibility was not clearly erroneous). The Bankruptcy Court considered Khader Azzouz's "oral testimony [to be] credible" and noted that Azzouz "presented documentary evidence at both trials to support his assertions that [Annab, Inc.] caused the true labor costs to be underreported on its tax returns." Azzouz v. Annab, Inc. ( In re Azzouz ), Case No. 15-12559-KHK, Adv. Proc. No. 16-01117-KHK, slip op. at 6 (Bankr. E.D. Va. Oct. 29, 2019) (Memorandum Opinion). By contrast, the Bankruptcy Court considered Samar Annab's credibility and demeanor during her testimony and concluded that Samar Annab "either did not understand how to meet her obligation for reporting withholdings or that she deliberately underreported them." Id. The Bankruptcy Court therefore rejected an assertion on which Annab, Inc. now relies, namely that Samar Annab failed to report employee wage data to the IRS on only a handful of occasions where employees who left the business were paid $200 or $300 for short periods of employment. Annab, Inc. has not provided any persuasive reason to second-guess the Bankruptcy Court's evaluation of Samar Annab's credibility. In sum, the Bankruptcy Court appropriately relied on record evidence and assessed the witnesses' credibility in making the factual finding that the tax returns provided to Azzouz inaccurately reported the bagel business's labor costs, and that factual finding is not clearly erroneous.
June 27, 2019 Evid. Hr'g Tr. at 65:20–22.
Specifically, Samar Annab testified:
Q. Okay. Now, in your deposition last year, you shared with us that there were 12 employees, or 10 to 12 employees other than family. Do you recall that?
A. Yeah, I recall that but I explained to you too, why I have these. I don't have them all the time. I told you.
Dec. 18, 2017 Trial Tr. at 231:23–232:2. Assuming that only 10 non-Annab employees worked at the bagel business and including the 4 Annab family members as employees, the total number of employees Samar Annab identified in her testimony is 14.
The following portion of Samar Annab's deposition testimony was read into the record at the December 2017 trial:
Q. And how many of these employees were paid without withholding taxes?
A. Just three or four of them, that's it.
Q. Tell me which ones were paid without withholding taxes?
A. It's Christian—
Q. Christian
A. And the one, he helped Christian, like you said, Ayesha, but I forget his name, Kiko, Francisco, and Augustine.
Q. What about Elsa? How was she paid?
A. It depends, sometimes cash, sometimes check.
Dec. 18, 2017 Trial Tr. 52:23–53:12.
Annab, Inc. insists that Azzouz's testimony at the December 2017 trial is dispositive. Azzouz testified as follows:
Q. You don't have any evidence here today indicating that the employment reporting and wages on the 2012, 2011, and 2010 [tax returns] is inaccurate, correct?
...
A. I mean, I wasn't there. I mean, that's really important.
Q. You don't have any evidence here today indicating that any of that data was inaccurate correct?
A. No.
Dec. 18, 2017 Trial Tr. 161:17–25. Annab, Inc. essentially contends that Azzouz's lack of direct evidence of underreporting forecloses any claim that Annab, Inc. underreported its labor costs. This argument is unpersuasive because it ignores the strong circumstantial evidence supporting the Bankruptcy Court's factual finding, namely that Annab, Inc. paid some employees without withholding taxes and that more employees were necessary to run the bagel business than were listed on its tax returns.
See June 27, 2019 Evid. Hr'g Tr. 21:6–25.
The record also provides substantial support for the Bankruptcy Court's finding that Azzouz never learned of the business's true labor costs by any other means prior to April 4, 2014. Specifically, there is no credible record evidence that the QuickBooks records provided to Azzouz contained information about the bagel business's labor costs. Samar Annab's testimony to the contrary was unworthy of credence because she relied completely on her sons to use QuickBooks and thus possessed no direct knowledge about the QuickBooks' records contents. At the June 2019 evidentiary hearing, Samar Annab testified as follows:
Q. You yourself are not familiar with QuickBooks, is that correct?
A. No, I'm not familiar with it but I look with my son, David, and I see what he have in there and if I need anything.
Q. You didn't put any information into QuickBooks?
A. Me? I didn't.
Q. You didn't know how to?
A. The only—no, I didn't know how to.
June 27, 2019 Evid. Hr'g. Tr. at 25:22–26:4. The Bankruptcy Court also appropriately found that David Annab's testimony that the QuickBooks records reflected labor costs was not credible. At the December 2017 trial, David Annab testified as follows:
Q. The Quickbooks information you were tracking was sales information?
A. Yeah the sales.
...
Q. You weren't tracking expenses.
A. Expense?
Q. Expenses.
A. No.
Dec. 18, 2017 Trial Tr. 201:5–16. By contrast, at the June 2019 evidentiary hearing, David Annab testified as follows:
Q. And did the QuickBooks' information include information about expenses?
A. Yes, on everything we bought, like flour, and product.
Q. Would that also include employee wage expenses?
A. I believe so.
Q. Do you believe so or you're not sure?
A. Yeah. Yeah, I believe so, yes.
June 27, 2019 Evid. Hr'g Tr. 46:8–16. David Annab's testimony in December 2017 cannot be squared with his testimony in June 2019, and the Bankruptcy Court properly gave no weight to his claims about the QuickBooks records' contents. Accordingly, the Bankruptcy Court properly concluded that the QuickBooks records did not inform Azzouz about the bagel business's labor costs prior to the purchase.
Seeking to avoid this result, Annab, Inc. argues that Azzouz's reliance on the tax returns alone to evaluate the bagel business was unreasonable. This argument is unpersuasive. Azzouz had no reason to question the accuracy of the tax returns' labor cost information prior to assuming control of the business because the QuickBooks records were devoid of information about the business's labor expenses. This conclusion is not altered by Azzouz's testimony that he relied only on the tax returns in deciding whether to purchase the bagel business. June 27, 2019 Evid. Hr'g Tr. at 69:22–25. Whether Azzouz relied solely on the tax returns or relied on the tax returns in conjunction with the QuickBooks records to evaluate the bagel business is of no consequence because, as the Bankruptcy Court properly found, neither source of information accurately reflected the bagel business's labor expenses. Accordingly, plaintiff reasonably relied on the tax returns provided prior to plaintiff's purchase of the bagel business.
The Bankruptcy Court correctly held that Annab, Inc.'s breach was a first material breach that precluded Annab, Inc. from proceeding against Azzouz to recover payments due under the Asset Purchase Agreement. This legal conclusion appropriately follows from the Bankruptcy Court's factual finding that the bagel business's true annual labor costs were over $320,000—an amount far above the $160,000 to $180,000 in annual labor costs reported in the 2010, 2011, and 2012 tax returns. See Parr v. Alderwoods Grp., Inc. , 268 Va. 461, 467, 604 S.E.2d 431 (2004) ("A breach is material if it is a failure to do something that is so fundamental to the contract that the failure to perform that obligation defeats an essential purpose of the contract.") (internal citation and quotation marks omitted). Put another way, Annab, Inc.'s breach was material because Azzouz bought a bagel business with significantly higher operating expenses than Annab, Inc. disclosed. Azzouz v. Annab, Inc. , 1:18-cv-1340, slip op. at 4 (E.D. Va. April 26, 2019) (Order). Accordingly, Annab, Inc.'s first material breach precludes Annab, Inc. from maintaining an action against Azzouz on the Asset Purchase Agreement, and Azzouz's objection to Annab, Inc.'s proof of claim must be sustained. Seeking to avoid this result, Annab, Inc. argues that Azzouz waived the right to assert the breach against Annab, Inc. by continuing to perform and accepting Annab, Inc.'s performance under the Asset Purchase Agreement. This argument is unavailing. Under Virginia law, a party claiming waiver must show a "knowledge of the facts basic to the exercise of the right [waived] and the intent to relinquish that right." Horton v. Horton , 254 Va. 111, 117, 487 S.E.2d 200 (1997) (quoting Stuarts Draft Shopping Ctr. v. S-D Associates , 251 Va. 483, 489–490, 468 S.E.2d 885 (1996) ). Here, far from displaying any intent to relinquish rights under the Asset Purchase Agreement, Azzouz sought to rescind or terminate the agreement in July 2014 based on Annab, Inc.'s failure to provide accurate labor expense information prior to the purchase. Moreover, courts applying Virginia law's first material breach doctrine have held that where, as here, a nonbreaching party accepts the breaching party's performance, waiver does not occur because "[a]cceptance of defective performance, without more, does not prove intent to relinquish the right to full performance." Horton , 254 Va. 111, 117, 487 S.E.2d 200 (1997) (citing Stanley's Cafeteria v. Abramson , 226 Va. 68, 74, 306 S.E.2d 870 (1983) ). Accordingly, Annab, Inc.'s waiver argument fails.
See Countryside , 261 Va. at 156, 541 S.E.2d 279 ("[T]his Court has stated that the first party to commit a material breach can neither enforce the contract nor maintain an action on it.") (citing Hurley , 163 Va. at 253, 176 S.E. 171 ).
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In sum, the judgment of the Bankruptcy Court must be affirmed. The factual record supports the Bankruptcy Court's finding that Annab, Inc. provided Azzouz with inaccurate financial information and that Azzouz did not learn of Annab, Inc.'s underreporting of labor costs to the IRS prior to purchasing the bagel business. Annab, Inc.'s failure to do so constituted a first material breach of the Asset Purchase Agreement, and Annab, Inc. is thus precluded from asserting that Azzouz subsequently breached the Asset Purchase Agreement. Because Azzouz has not appealed the Bankruptcy Court's determination that Azzouz is not entitled to recover any damages for Annab, Inc.'s breach, the Bankruptcy Court's conclusion in that regard is affirmed.
Accordingly.
It is hereby ORDERED that the judgment of the Bankruptcy Court is AFFIRMED. Specifically, (i) Azzouz's objection to Annab, Inc.'s proof of claim in the main bankruptcy case, Claim 5-1, is SUSTAINED , and Annab, Inc.'s proof of claim is disallowed in its entirety; (ii) Azzouz is entitled to no damages in the adversary proceeding; and (iii) this adversary proceeding is DISMISSED WITH PREJUDICE.