Opinion
Case No. 94-12842-AB, ADVERSARY PROCEEDING NO. 94-1440
December 20, 1994
MEMORANDUM OPINION
This case is before the Court on the debtor's motion under F.R.Bankr.P. 7012 and Fed.R.Civ.P. 12(b(6)) to dismiss the plaintiffs nondischargeability complaint for failure to state a claim upon which relief can be granted. The Court has considered the pleadings, the briefs of the parties, and the arguments of counsel at the hearing held on December 13, 1994, and concludes, for the reasons set forth herein, that the motion to dismiss should be granted.
The debtor, Michael P. Turner, filed a voluntary chapter 7 petition in this court on July 21, 1994. The plaintiffs, Jeffrey Knapp and his wholly-owned company, Sports and Entertainment Marketing, Inc. (SEM), filed a timely complaint to have a prepetition default judgment obtained against the debtor in a New York state court declared to be nondischargeable under Section 523(a)(2) of the Bankruptcy Code, 11 U.S.C. § 523(a)(2).
Although the nondischargeability complaint characterizes the default judgment as one for fraud, the judgment itself is somewhat equivocal on that point. The state court action was against both Turner and the entity Broadcast Entertainment Network, Inc. The first cause of action, which sounded in breach of contract, was solely against Broadcast Entertainment. The second, which sounded in fraud, was against both defendants. The Judgment entered December 31, 1992, however, grants Knapp a judgment against both the debtor and Broadcast Entertainment, jointly and severally, in the amount of $444,568.92 "on the first and second causes of action" (emphasis added); additionally, both SEN and Knapp were granted judgment against the debtor and Broadcast Entertainment in the amount of $1,1662.67 solely on the second cause of action.
Under familiar principles, the well-pleaded facts in the plaintiff's complaint must, on a motion to dismiss, be taken as true and must be construed in the light most favorable to the plaintiff. Conley v. Gibson, 355 U.S. 41 (1957). The complaint, in substance, sets forth that Knapp, a marketing expert then employed by another company, was introduced in January 1991 to the debtor and Gary Byrd, described as the principals of a company known as Broadcast Entertainment Network, Inc. Initially, Knapp, the debtor, and Byrd discussed a possible pay-per-view cable television joint venture with a company called Dick Scott Entertainment. The focus of the discussion soon shifted, however, to a similar joint venture directly between Broadcast Entertainment and a company to be formed by Knapp, with Knapp's company to be the marketing arm for Broadcast Entertainment.
During the course of these discussions, the debtor assured Knapp that Broadcast Entertainment had funding "in place" in the form of $24 million from investors in Europe that was available to fund Knapp's marketing activities. In reliance on these assurances, Knapp caused SEM to be formed and began marketing efforts on behalf of Broadcast Entertainment. In the mean time, Knapp, the debtor and Broadcast Entertainment continued to negotiate an interim consulting agreement between Broadcast Entertainment on the one hand, and Knapp and his company on the other, which would govern until a formal joint venture could be formed.
In June 1991, the debtor told Knapp for the first time that while financing was "committed," the funds were not yet "available," and he could not sign the agreement until the funds were "locked up." Knapp did not want to sign the agreement until the funding was in place, since he would be leaving his current employment on the effective date of the agreement and did not wish to jeopardize his income stream. On June 21, 1991, the consulting agreement, which included provision for a consulting fee of $144,000.00 per year and reimbursement of expenses, including health and life insurance, as well as provision for SEM to receive an equity interest in Broadcast Entertainment, was signed by Knapp and Turner. Knapp then left his employment on July 3, 1991, to work full time under the consulting agreement. The yearly compensation under the consulting agreement was less than Knapp was earning in his current employment but the arrangement was nevertheless attractive to Knapp because his company would receive an equity interest in Broadcast Entertainment and Broadcast Entertainment had undertaken to provide start up financing for Knapp's company.
The agreement required Broadcast Entertainment either to escrow, or to provide a letter of credit to secure, an amount equal to two years compensation.
While these negotiations were on-going, the debtor, Knapp and Byrd also were meeting with the principals of another company called Between The Lines (BTL) to discuss an investment by Broadcast Entertainment of $2.7 million in BTL in exchange for a 50% equity stake. The debtor represented at one of these meetings that the money needed to consummate the transaction would be available "in a heartbeat." In early July 1991, the debtor told Knapp that he was having difficulty acquiring funds "due to the BCCI bank scandal" but that funding would be in place by mid-July. In any event, Knapp's company was never paid anything under the consulting agreement, nor was the promised escrow account set up or letter of credit furnished, notwithstanding several assurances by the debtor that funds would be available "momentarily."
Knapp and SEM then sued the debtor and Broadcast Entertainment in the Supreme Court of the State of New York and obtained default judgments for breach of contract and fraud. In the course of the hearing on damages and in a deposition in aid of execution, testimony "indicated" that Turner had falsely represented that he was a principal of, and had authority to bind, Broadcast Entertainment.
Under Section 523(a)(2) of the Bankruptcy Code, a discharge in a bankruptcy case does not discharge a debtor from a debt
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;
(B) use of a statement in riting —
(i) that is materially false;
(ii) respecting the debtor's or an insider's financial condition;
(iii) on which the creditor to whom the debtor is liable for such money, property, services, or credit reasonably relied; and
(iv) that the debtor caused to be made or published with intent to deceive;
(emphasis added).
At the outset, the debtor's contention that the alleged fraud is not pleaded with sufficient particularity, as required by F.R.Bankr.P. 7009 and Fed.R.Civ.P. 9(b) may be quickly disposed of. The detailed 18-page complaint sets forth with more than sufficient detail the course of dealings between the parties and the misrepresentations constituting the fraud.
Strictly speaking, the debtor's argument appears addressed only to the allegation in paragraph 58 of the complaint that the debtor committed fraud by falsely representing his relationship to, and his authority to bind, Broadcast Entertainment. While paragraph 58 is indeed vague as to exactly why the debtor did not have authority to bind Broadcast Entertainment or what his true relationship to the company was, the complaint as a whole is quite explicit as to the nature, place and chronology of the alleged misrepresentations.
The problem is not lack of detail. The problem is that, at bottom, the fraudulent conduct consists of oral misrepresentations concerning the financial ability of Broadcast Entertainment to carry through on the proposed consulting agreement and joint ventures. The plaintiff has pleaded that the debtor's conduct renders the judgment debt nondischargeable under both Section 523(a)(2)(A) and Section 523(a)(2)(B), but since the latter by its terms applies only to a statement "in writing," there can be clearly be no cause of action stated under Section 523(a)(2)(B). The plaintiff suggests that the consulting agreement itself constitutes just such a writing, but there is no allegation in the complaint that the agreement contained any explicit representation as to the financial condition of Broadcast Entertainment. While it is perhaps true that every contract in some sense implies not only the willingness but the ability of the contracting parties to carry through, to adopt the position that oral misrepresentations as to financial condition become grounds for nondischargeability so long as they result in a written contract would be to eviscerate the limitation that Congress plainly sought to impose in Section 523(a)(3)(B).
The real issue here, since the misrepresentations were all clearly oral, is whether they were "statements respecting the debtor's or an insider's financial condition." If so, they clearly fall within the exception to Section 523(a)(2)(A), and, being oral, are not saved by Section 523(a)(2)(B). On the other hand, if they do not constitute a "statement respecting . . . financial condition", then the fact that they were made orally rather than in writing is no bar to nondischargeability. The plaintiff has argued, with some force, that the term "statement respecting . . . financial condition" should be narrowly construed to embrace only financial statements in the traditionally-understood sense of net worth statements, profit-loss statements, balance sheets and the like. See, e.g., In re: Kirsh, 973 F.2d 1454 (9th Cir. 1992).
Were this Court writing on a clean slate, it would be inclined to agree. However, the Fourth Circuit, in Engler v. Van Steinburg (In re: Van Steinburg), 744 F.2d 1060 (4th Cir. 1984), has adopted a broad view of what constitutes a statement respecting financial condition not limited to "a typical balance sheet or a profit and loss statement." Id. In Engler the false representation at issue was an oral assurance that cattle and farm implements being given as security for a loan were not subject to existing liens. As the Fourth Circuit observed,
Concededly, a statement that one's assets are not encumbered is not a formal financial statement in the ordinary usage of that phrase. But Congress did not speak in terms of financial statements. Instead, it referred to a much broader class of statements — those "respecting the debtor's . . . financial condition." A debtor's assertion that he owns certain property free and clear of other liens is a statement respecting his financial condition. Indeed, whether his assets are encumbered may be the most significant information about his financial condition. Consequently, the statement must be in writing to bar the debtor's discharge.
Id. at 1060-1061 (emphasis added; citation omitted). As in Engler, the debtor's false statement that $24 million in funding was "in place" and had been "committed" is a statement concerning financial condition and, as such, cannot provide a basis for nondischargeability unless in writing.
The plaintiffs, however, urge that since they allege at one point in their complaint (¶ 58) that the debtor falsely represented himself to be a principal of Broadcast Entertainment and to have "had the ability to bind [Broadcast Entertainment] to a contract," the debtor should not be considered an "insider" of Broadcast Entertainment, and therefore the exception in Section 523(a)(2)(A) for false statements concerning "the debtor's or an insider's financial condition" simply does not apply.
The alleged misrepresentation on this point, however, is not pleaded as having any nexus to the loss suffered by the plaintiffs. For example, there is no allegation that Broadcast Entertainment successfully disaffirmed liability under the consulting agreement based on the debtor's lack of authority or that the plaintiffs were unable to obtain judgment against Broadcast Entertainment because the debtor falsely represented the extent of his authority.
Although, as the plaintiffs note, the definition of "insider" in Section 101(35) of the Bankruptcy Code includes, with respect to a corporation, an "director, officer, or person in control . . ." the definition is not limited to the enumerated relationships. 11 U.S.C. § 102(3).
The difficulty here is that at other points in the complaint (e.g., ¶¶ 10, 13, 17), the plaintiffs unequivocally describe the debtor as a "principal" of Broadcast Entertainment, and, in any event, the complaint is clear that throughout the relationship, the debtor acted as an insider, and Knapp believed the debtor to be an insider, of Broadcast Entertainment. Thus, viewed from the perspective of Knapp's decision to leave the security of his current employment to enter into the consulting agreement with Broadcast Entertainment, it makes no discernible difference whether the debtor had actual authority, apparent authority, or no authority.
For the foregoing reasons, the Court concludes that, although the allegations of fraud are pleaded with sufficient particularity, the pleaded conduct amounts at bottom to a misrepresentation as to the financial condition of an entity with respect to which the debtor was an actual or apparent insider, and, inasmuch as the statement is not in writing, the complaint does not state a claim for nondischargeability under Section 523(a)(2). Accordingly, an order will be entered granting the debtor's motion to dismiss. Although the debtor has asked that the dismissal be with prejudice, the Court is unwilling to conclude that the plaintiffs would necessarily be unable to plead additional facts entitling them to relief and will therefore allow the plaintiffs, if they are so advised, 20 days from the entry of an order dismissing the complaint to file an amended complaint.