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Bankruptcy Court Excepts from Discharge Debt for Property Obtained by False Pretenses

Wednesday, October 19, 2011

Esposito v. Hartley (In re Hartley), No. 09-37770, Adv. Pro. No. 10-9055, 2011 BL 257709 (Bankr. S.D.N.Y. Oct. 5, 2011) The United States Bankruptcy Court for the Southern District of New York granted a plaintiff’s request to except from discharge a judgment obtained against a corporation owned and operated by debtor-defendants. The bankruptcy court held that because defendants dissolved their corporation without giving plaintiff notice and an opportunity to enforce her judgment, defendants were jointly and severally liable for the judgment. The bankruptcy court also ruled that the judgment was a non-dischargeable debt pursuant to 11 U.S.C. § 523(a)(2)(A) for property obtained by false pretenses and pursuant to 11 U.S.C. § 523(a)(3)based on defendants’ failure to list plaintiff or schedule her debt in their bankruptcy petition.

Plaintiff’s Judgment and Defendants’ Bankruptcy

In February 2008, Jennifer Esposito (“Plaintiff”) obtained a $300,000 judgment (“Judgment”) against a deli and catering business (“Corporation”) owned and operated by Richard and Kara Hartley (“Defendants”). In July 2008, while Defendants’ appeal was pending in state court, Defendants dissolved the Corporation but continued operating the business until September 2009. Defendants provided notice of the dissolution to some creditors but not to Plaintiff. In October 2009, following the dissolution of the Corporation but prior to the completion of the appeal, Defendants filed for chapter 13 bankruptcy relief. At that time, Plaintiff filed an adversary proceeding to except the Judgment obtained against the Corporation from discharge.

Defendants Jointly and Severally Liable

The bankruptcy court began its analysis by explaining that under New York law a corporation that dissolves non-judicially may elect to notify creditors of the dissolution or, alternatively, it may informally dissolve by transferring all of its assets without giving creditors any notice. Parent v. Amity Autoworld, Ltd., 15 Misc.3d 633, 640 (N.Y. Dist. Ct. 2007). However, the bankruptcy court went on to explain that the cost of informal dissolution without notice is that directors, officers and shareholders cannot shield themselves from liability for the corporation’s debts. Additionally, the bankruptcy court stated that while New York law holds shareholders jointly and severally liable to the corporation’s creditors once dissolution is complete, a creditor seeking to enforce a corporate liability generally must obtain and attempt to execute a judgment against the corporation before seeking satisfaction against the shareholders. Rodgers v. Logan, 121 A.D.2d 250, 253 (N.Y. App. Div. 1st Dep’t 1986). Moreover, the bankruptcy court declared that when obtaining such a judgment is futile the creditor may bring an action directly against the corporation’s directors or shareholders. In rendering its decision, the bankruptcy court observed that Defendants had informally dissolved the Corporation in secrecy and had distributed the Corporation’s assets years earlier, thereby denying Plaintiff an opportunity to enforce the Judgment against the Corporation and making any subsequent attempt to do so futile. As a result, the bankruptcy court held that Plaintiff had properly proceeded against Defendants and that Defendants were jointly and severally liable for the debts of the Corporation.

Property Obtained by False Pretenses

Continuing its analysis, the bankruptcy court noted that under § 523(a)(2)(A) a debt for property obtained by false pretenses, a false representation, or actual fraud is non-dischargeable. To prevail under § 523(a)(2)(A), the bankruptcy court explained that a plaintiff must show "that the debtor made a false representation; knowing it was false; with the intent to deceive; that creditor justifiably relied on that representation; and sustained a loss that was proximately caused by the misrepresentation." In re Iulo, 421 B.R. 49, 54 (Bankr. S.D.N.Y. 2009). Notably, the bankruptcy court indicated that silence, or the concealment of a material fact, can be the basis of a misrepresentation under § 523(a)(2)(A). In re Weinstein, 31 B.R. 804, 809 (Bankr. E.D.N.Y. 1983). The bankruptcy court explained that insofar as Defendants obtained and transferred the Corporation’s assets, they had obtained “property” within the meaning of § 523(a)(2)(A). Additionally, the bankruptcy court found that Defendants had actively concealed from Plaintiff the dissolution of the Corporation by litigating an appeal of the Judgment from May 2008 until October 2009 and continuing to operate the business during that period. In so finding, the bankruptcy court declared that Defendants’ failure to notify Plaintiff of the dissolution constituted the concealment of a material fact that qualified as a misrepresentation. In finding that Plaintiff had justifiable relied on Defendants' misrepresentation that the Corporation was a going concern, the bankruptcy court found that during the pendency of their appeal Defendants never informed Plaintiff that the Corporation no longer existed. Turning to the issue of intent, the bankruptcy court reasoned that by secretly dissolving the Corporation without notice to Plaintiff, continuing to operate the business in violation of state law, and pursuing an appeal in the name of the dissolved Corporation, Defendants intended to deceive Plaintiff. Observing that the lack of notice prevented Plaintiff from enforcing her Judgment against the Corporation, the bankruptcy court determined that Plaintiff was damaged by Defendants’ misrepresentation. Accordingly, the bankruptcy court held that the debt was non-dischargeable under § 523(a)(2)(A).

Failure to Provide Notice of Bankruptcy Proceeding under § 523(a)(3)

Next, the bankruptcy court explained that § 523(a)(3) protects a creditor’s right to receive a distribution through the filing of a timely proof of claim or a timely objection to discharge. To that end, the bankruptcy court noted that under § 523(a)(3), a debt is non-dischargeable if a debtor fails to list or schedule a debt of the type specified in 11 U.S.C. §§ 523(a)(2), (4) or (6). Noting that the Judgment was non-dischargeable under § 523(a)(2)(A), the bankruptcy court held that Plaintiff also met her burden under § 523(a)(3).

Bankruptcy Court Awards Plaintiff Summary Judgment

In sum, holding that the Judgment was non-dischargeable under §§ 523(a)(2)(A) and (a)(3), the bankruptcy court granted summary judgment in Plaintiff’s favor.   DisclaimerThis document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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