Opinion
Case No. 99-70292. Adversary No. 99-7067.
December 22, 2000.
OPINION
The issue before the Court is whether the Defendant fraudulently induced the Plaintiff to invest in his company so as to render the debt nondischargeable pursuant to 11 U.S.C. § 523 (a)(2)(A).
The Defendant, Thomas Folder, was the sole proprietor of Cen-Com Internet, a business founded in 1993 which marketed and provided to consumers direct access to the internet. The Plaintiff, Deborah Oughton, was a researcher for the Illinois General Assembly. The Plaintiff met the Defendant in August, 1994, at the Illinois State Fair where the Defendant had a booth. The Defendant was using his booth to demonstrate the services provided by his company. The Plaintiff and the Defendant discussed the possibility of the Plaintiff working for Cen-Com. In addition, they also discussed the Plaintiff investing in Cen-Com.
Between August, 1994, and September, 1994, the Plaintiff testified that the Defendant made a series of representations to her which induced her to invest a substantial sum of money with him. According to the Plaintiff, the Defendant stated that his computer equipment was worth $750,000, and that an investment of $75,000 would equal 10% of the value of the business equipment; an investment of $175,000 would represent 23% of the value of Cen-Com's assets. He told her that the business was breaking even in August, 1994. He told her that he spent $70,000 to obtain a "net" designation (as compared to a dot "com", dot "edu" or dot "org" designation), that there was a limited pool of "net" designations, and that he was fortunate to get one because it allowed him to provide services to everyone. He also told her that he had an agreement worked out with Consolidated Communications wherein Cen-Com would be the preferred or exclusive provider of internet services for Consolidated. He told her that he was expanding the business to the Chicago market. He told her that the business was a corporation, but it was not in fact incorporated until September 30, 1994. He told her that there was no other outstanding stock subscriptions. The Plaintiff testified that she relied on these statements in making her decision to invest in Cen-Com.
On August 26, 1994, the Plaintiff invested $75,000 with the Defendant. She noted on her check that it was for stock in Cen-Com. The Plaintiff subsequently expressed a desire to have the Defendant sign an agreement memorializing their understanding and, on September 30, 1994, the Defendant signed such an agreement. The agreement provides that the Defendant is in the process of incorporating Cen-Com, that all assets of the Cen-Com sole proprietorship will be transferred to the new corporation, that there are no outstanding subscriptions for or offers to buy or acquire stock in the corporation, and that in exchange for her total investment of $125,000, the Plaintiff would receive stock representing 16% of the total of all issued and outstanding preferred stock of Cen-Com. The agreement acknowledged the Plaintiff's prior investment of $75,000. The Plaintiff invested another $25,000 at the time of the signing of the agreement, and on October 4, 1994, she transferred another $50,000 to the Defendant. The Plaintiff never forwarded the final $25,000 called for in the agreement. The Defendant never issued stock to the Plaintiff.
The Plaintiff admitted that she had a limited background in technology. However, prior to her investment in Cen-Com, she contacted personal acquaintances who were knowledgeable in the computer field. They had positive things to say about the internet in general and the Defendant in particular. She even checked with the Defendant's banker in Pawnee and was given a glowing recommendation concerning his payment history. She also noted that the Defendant had a going concern, employees, working equipment, and was lecturing around town about Cen-Com and the internet.
In January, 1995, the Plaintiff hired a computer consultant, Chris McDaniel, to determine the value of the equipment owned by Cen-Com. Mr. McDaniel found that the equipment had a replacement value of $167,500 as of January 20, 1995. The Plaintiff was not pleased with this valuation. She testified that the Defendant had represented that he had spent $750,000 on the equipment, and her investment of $150,000 was used to purchase computer equipment. In addition, she testified that the Defendant had represented that he had liquidated over $1,000,000 of his real estate holdings and used the money to purchase computer equipment.
The September 30, 1994 agreement provided that the Plaintiff could elect to have her investment returned if the Defendant did not comply with certain terms. When the Defendant failed to fully comply with the agreement, the Plaintiff requested the return of her investment in early 1995. The Defendant failed to return her investment, and the Plaintiff filed a three-count complaint in the Circuit Court of Sangamon County on October 30, 1995. On February 9, 1996, summary judgment was granted in favor of the Plaintiff and against the Defendant. Damages in the amount of $190,637.49 were awarded to the Plaintiff. The Plaintiff has collected $6,280.19 from the Defendant since the judgment, leaving a balance of $184,291.30.
The Defendant's testimony painted a different picture. However, his testimony strained the Court's credulity on several points. The Defendant initially denied that there were any discussions about the Plaintiff working for Cen-Com, but he later admitted that the Plaintiff had asked about working for Cen-Com. He also denied asking the Plaintiff for money. His testimony suggested that the Plaintiff just gave him $75,000 on the spur of the moment. He stated that he was not looking for investors, but the Plaintiff really wanted to invest in the company, and he accepted the money because he wanted to make the company grow. The Court believes that the Defendant solicited the investment from the Plaintiff, and that the parties discussed the possibility of the Plaintiff working for Cen-Com.
The Defendant testified that the business was breaking even in August, 1994, but it started losing money in November, 1994. The Defendant testified that the internet start-up cost for his equipment was $50,000, and that as much as half of the Plaintiff's investment went to purchase additional equipment. He denied telling the Plaintiff that Cen-Com's equipment was worth $750,000. He further testified that it did not cost him anything to get the "net" designation. He stated that the deal with Consolidated fell through when Consolidated decided to go with MCI rather than Cen-Com. He admitted that another investor, Gregory McCully, invested $30,000 with Cen-Com on July 11, 1994, and received a promissory note and stock option in return, but he explained that Mr. McCully told him that he was not interested in exercising his stock option. The Defendant testified that he thought the company would make it, that he put everything he had into the company, and that he ended up with a divorce and a bankruptcy.
On August 2, 1996, Cen-Com Internet filed its petition pursuant to Chapter 7 of the Bankruptcy Code. The Defendant filed his personal bankruptcy petition in 1999.
The Plaintiff seeks a determination of the dischargeability of her debt pursuant to 11 U.S.C. § 523(a)(2)(a), which provides as follows:
(a) A discharge under section 727. . . of this title does not discharge an individual debtor from any debt —
(2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by —
(A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor's or an insider's financial condition(.)
The party seeking to establish an exception to the discharge bears the burden of proof. In re Harasymiw, 895 F.2d 1170, 1172 (7th Cir. 1990). The burden of proof required to establish an exception to discharge is a preponderance of the evidence. Grogan v. Garner, 498 U.S. 279, 291 (1991). To further the policy of providing a debtor with a fresh start in bankruptcy, "exceptions to discharge are to be construed strictly against a creditor and liberally in favor of a debtor." In re Scarlata, 979 F.2d 521, 524 (7th Cir. 1992).
In order to successfully bring an action under § 523(a)(2)(A), a creditor must prove that the debtor committed "actual fraud". Field v. Mans, 516 U.S. 59, 69 (1995). To prove "actual fraud", a creditor must establish the following common law elements of fraud:
(1) the debtor made a false representation; (2) the debtor knew that the representation was false at the time that he made it; (3) the debtor made the representation with the intention and purpose of deceiving the creditor; (4) the creditor justifiably relied on the representation; and (5) the creditor sustained a loss as the proximate result of the representation. In re Chinchilla, 202 B.R. 1010, 1013-14 (Bankr.S.D.Fla. 1996).
The Plaintiff has carried her burden of proving that the Defendant made false representations to her. The Defendant represented that his business equipment was worth $750,000. Even allowing for some puffing on the part of the Defendant and the rapid depreciation of computer equipment, this statement was false. The Defendant's own preliminary business plan valued all of the business assets, prior to depreciation, at $376,360 as of November 30, 1994. The Plaintiff's computer consultant found that the equipment had a replacement value of $167,500 in January, 1995. Both of these valuations were made after the Plaintiff invested her $150,000, an investment that was used in large part to purchase equipment. It is clear that the Defendant substantially overvalued his equipment in his representations to the Plaintiff.
The Defendant told the Plaintiff that he had spent $70,000 to obtain a special "net" designation. The Defendant admitted at the trial that he did not spend anything for the "net" designation.
The Defendant also misrepresented the nature of his deal with Consolidated Communications, Inc. He led the Plaintiff to believe that Cen-Com had a lucrative contract with Consolidated and that it was a done deal when in fact he was merely negotiating with Consolidated.
Finally, the Defendant misrepresented the nature of the stock of Cen-Com. Prior to her initial investment, the Defendant represented that the Plaintiff would receive ten percent of the corporate stock for her $75,000 investment. This promise never materialized. In addition, the Defendant represented in his September 30, 1994, letter to the Plaintiff that there were "no outstanding subscriptions for or offers to buy or acquire stock" in Cen-Com. In fact, Mr. McCully had an option for 10% of the corporation.
The Defendant was the President and sole proprietor of Cen-Com when he made the false representations to the Plaintiff. He knew the value of the computer equipment, how much he spent for the "net" designation, the status of the deal with Consolidated, and the details of the Cen-Com stock. Thus, he knew that his representations to the Plaintiff were false at the time he made them.
The Defendant made the representation to the Plaintiff with the intention and purpose of deceiving the Plaintiff. Cen-Com needed cash to purchase equipment, market its product, and expand its services. The Defendant made the false representations to the Plaintiff in order to induce her to invest in his company.
The Defendant suggests that his lack of intent to deceive may be seen in the fact that he did not realize any monetary advantage personally from the operation. However, it is not necessary for the debtor to receive the money personally; it is sufficient if he benefits in some way from the debtor's deception. In re Horwitz, 100 B.R. 395 (Bankr.N.D.Ill. 1989). Here, the Defendant was the sole proprietor or president of the entity that received the money. Thus, he benefitted from the fraud. In re Vermont, 98 B.R. 581 (Bankr.M.D.Fla. 1989).
The Plaintiff justifiably relied on the Defendant's misrepresentations. She was an unsophisticated investor with little knowledge of the internet. The Defendant held himself out as an expert on the internet; he gave presentations about the internet around town and was the subject of articles in the local newspaper. The Plaintiff contacted acquaintances with knowledge of the computer industry and was informed that the internet was going to be explosive and the Defendant was on the verge of something big. She contacted the Defendant's banker and was given a positive report. She personally checked out Cen-Com's operations and found that it was a going concern with equipment and employees. Finally, she had the Defendant sign a written agreement to memorialize and protect her investment. Under these circumstances, the Plaintiff's reliance on the Defendant's misrepresentations was justified.
Finally, the Plaintiff sustained a loss as the proximate result of the Defendant's false representations. She invested $150,000 in 1994. In 1996, she was awarded damages of $190,637.49. Since the time of the judgment, the Plaintiff has collected a total of $6,280.19 from the Defendant. Thus, there is a balance due on the judgment of $184,291.30.
The Defendant argues that the state court judgment order contains an error. Part One of the judgment is for $150,000 plus 5% interest; Part Two is for $25,000 plus 5% interest. The Defendant asserts that Part Two of the judgment was erroneously entered, and the Plaintiff did not dispute this assertion in her testimony. Therefore, the Court will limit its determination of nondischargeability to Part One of the Judgment. See In re Owen, 181 B.R. 288 (Bankr.W.D.Va. 1995) (for purposes of § 523(a)(2), nondischargeability does not extend beyond actual money or property received by debtor, based upon the phrase "to the extent obtained by" in statute).
For the foregoing reasons, the Court finds that the debt of the Defendant to the Plaintiff is nondischargeable in the amount of $150,000 and interest from September 30, 1994, to February 8, 1996, at the rate of 5% per annum in the amount of $10,192, for a total of $160,192, less payment previously collected in the amount of $6,280.19.
This Opinion is to serve as Findings of Fact and Conclusions of Law pursuant to Rule 7052 of the Rules of Bankruptcy Procedure.
See written Order.
ORDER
For the reasons set forth in an Opinion entered this day, IT IS HEREBY ORDERED that the debt of Thomas Folder to Deborah Oughton be and is hereby determined to be nondischargeable in the amount of $153,912.