Hunter v. Martin DBA Veronica Rose Productions, Inc

FILED & ENTERED

JUL 10 2019

CLERK U.S. BANKRUPTCY COURT

Central District of California

BY g o n z a l e z DEPUTY CLERK

UNITED STATES BANKRUPTCY COURT

CENTRAL DISTRICT OF CALIFORNIA

LOS ANGELES DIVISION

In re: Paul William Martin, Debtor Case No.: 2:17-bk-16996-ER

Adv. No.: 2:17-ap-01587-ER

Kevin Hunter, MEMORANDUM OF DECISION FINDING

THAT MARTIN’S INDEBTEDNESS TO

Plaintiffs

HUNTER, IN THE AMOUNT OF $10,000,

v. IS EXCEPTED FROM DISCHARGE

Paul William Martin DBA Veronica Rose

Productions, Inc.,

TRIAL:

Defendant

Date: January 28 and February 4, 2019

Time: 9:00 a.m.

Location: Ctrm. 1568

Roybal Federal Building

255 East Temple Street

Los Angeles, CA 90012

I. Introduction

In this dischargeability action, Plaintiff Kevin Hunter (“Hunter”) alleges that Defendant Paul

William Martin (“Martin”) is liable in the amount of $141,582.88 under §§ 523(a)(2)(A),

(a)(2)(B), (a)(4) (for committing fraud or defalcation in a fiduciary capacity), and (a)(6). The

alleged liability arises from a $50,000 loan that Hunter extended to Martin in 2010. In addition to

recovery of the loan’s principal, Hunter seeks recovery of interest in the amount of $25,232.88

and attorneys’ fees and costs in the amount of $66,350.

Trial was conducted on January 28 and February 4, 2019.1 The parties filed closing briefs on

May 10, 2019.2 This Memorandum of Decision constitutes the Court’s findings of fact and

conclusions of law pursuant to Civil Rule 52, made applicable to these proceedings by

Bankruptcy Rule 7052.3

For the reasons set forth below, the Court finds that Martin is indebted to Hunter in the

amount of $10,000, and that such indebtedness is excepted from Martin’s discharge pursuant to

§ 523(a)(2)(A), on the ground of actual fraud. Hunter is not entitled to judgment on any of his

other claims for relief; judgment will be entered in favor of Martin as to those claims.

II. Facts

Martin was the founder, president, and Chief Executive Officer of Veronica Rose

Productions, Inc. (“VRP”).4 VRP was a start-up company attempting to develop a software

platform that would help music owners maximize royalty collections.5

George Shohet (“Shohet”) is a licensed attorney who maintains an office in Venice,

California.6 Shohet and Martin were acquainted because they both lived in the same

neighborhood.7 Martin would occasionally talk to Shohet about his latest business project when

he encountered Shohet on the street.8

In the summer of 2010, Martin approached Shohet and asked Shohet if he could help VRP

raise capital.9 Shohet agreed to help, and commenced negotiations regarding a potential

investment with his friend, Kevin Hunter (“Hunter”). Shohet and Hunter had been friends for

close to thirty years, having met at law school.10 At the time of the negotiations, Hunter worked

as a managing director and portfolio manager at NWQ Investment Management.11

1 A transcript of the proceedings occurring on January 28, 2019 is available as docket entry 50

and is cited as “Tr. Jan. 28.” A transcript of the proceedings occurring on February 4, 2019 is

available as docket entry 51 and is cited as “Tr. Feb. 4.”

2 Doc. Nos. 53–54.

3 Unless otherwise indicated, all “Civil Rule” references are to the Federal Rules of Civil

Procedure, Rules 1–86; all “Bankruptcy Rule” references are to the Federal Rules of Bankruptcy

Procedure, Rules 1001–9037; all “Evidence Rule” references are to the Federal Rules of

Evidence, Rules 101–1103; all “LBR” references are to the Local Bankruptcy Rules of the

United States Bankruptcy Court for the Central District of California, Rules 1001-1–9075-1; and

all statutory references are to the Bankruptcy Code, 11 U.S.C. §§ 101–1532.

4 Joint Proposed Pre-Trial Stipulation and Order as Modified by the Court [Doc. No. 38] (the

“Pretrial Order”) at ¶ 14.

5 Plaintiff’s Ex. 2 (investor presentation describing VRP’s business).

6 Pretrial Order at ¶ 15.

7 Tr. Jan. 28 at 96:1–5 (testimony of Shohet).

8 Id.

9 Tr. Feb. 4 at 100:12–18 (“I had approached George Shohet seeking financing, not personal

loans, and so the plan was, you know, that we get away from these friends and family and get

into a more sophisticated investor type who would then be able to introduce us to angels, and—

George [Shohet] was, at least at the time, acting as if he was going to be helping us with large

capital raises”) (testimony of Martin).

10 Tr. Jan. 28 at 95:23–96:1 (testimony of Shohet).

11 Tr. Jan. 28 at 44:8–9 (testimony of Hunter).

Shohet was not formally retained as counsel by either Martin or VRP in connection with the

negotiations,12 and received no payments for his work. Shohet became involved because he

believed VRP’s technology showed promise and he anticipated receiving some form of

compensation in the future:

The technology looked very promising and the fact that there were already two

significant contractual relationships with major music industry participants was

intriguing…. [A]ssuming commercialization … I might be in a position to, you know,

receive compensation or get involved in [an] actual role in, you know, corporate

governance of the enterprise.

Tr. Jan. 28 at 134:22–135:17 (testimony of Shohet).

Hunter declined Shohet’s initial proposal that Hunter make an equity investment in VRP.13

Hunter did not have time to perform due diligence on VRP and so was not comfortable making

an equity investment.14 Shohet then proposed that Hunter make a short-term loan secured by

VRP stock owned by Martin.15 Hunter declined this proposal, again because he did not have time

to perform due diligence on VRP.16 Shohet’s next pitch was that Hunter extend a short-term loan

to Martin personally, to be secured by collateral owned by Martin, with the understanding that

the proceeds would be used by VRP. In furtherance of this proposal, Shohet e-mailed Hunter a

term sheet on Friday, August 20, 2010 (the “Final Term Sheet”).17 The Final Term Sheet

provided for a $50,000 loan from Hunter to Martin, secured by “two Chris Reilly original

paintings and a 1996 Porsche 993.”18 Regarding the collateral, the Final Term Sheet stated: “The

art work and Porsche are owned free and clear by Mr. Martin. VRP and Mr. Martin represent that

the value of the collateral exceeds $50,000.”19

Shohet prepared the Final Term Sheet using two proposed term sheets that Martin had e-

mailed to Shohet the previous day (the “Proposed Term Sheets”).20 Specifically, on August 20,

2010, at 9:19 a.m., Martin sent Shohet an e-mail with the subject line “Stab at term sheets for

50k” (the “August 20th E-mail”).21 The body of the August 20th E-mail provided in its entirety:

“George I have taken a stab at this…let me know what you think…” The Proposed Term Sheets

were attached to the August 20th E-mail as Microsoft Word documents. One of the Proposed

Term Sheets prepared by Martin stated that the value of the collateral exceeded $50,000.22

12 Tr. Feb. 4 at 196:21–197:3 (testimony of Martin).

13 Tr. Jan. 28 at 20:23–21:9 (testimony of Hunter).

14 Id.

15 Tr. Jan. 28 at 21:10–16 (testimony of Hunter).

16 Id.

17 Plaintiff’s Ex. 7.

18 Id.

19 Id.

20 Plaintiff’s Ex. 5–6.

21 Plaintiff’s Ex. 5.

22 The Proposed Term Sheet provided in relevant part: “Collateral is to be issued in the form of

Art work held by Paul Martin. They are Chris Reilly originals and have a retail market value of

50k. Mr. Martin will discount the Art work to 25k for both pieces. In addition, Mr. Martin will

Martin denied preparing the Proposed Term Sheets, but his testimony in this respect was not

credible. On August 19, 2010, Shohet sent Hunter an e-mail containing three attached documents

(the “August 19th E-mail”). 23 The attached documents provided an overview of VRP’s business

plan.24 Martin was blind carbon copied on the August 19th E-mail. At trial, Martin attempted to

exploit a formatting ambiguity to argue that the Proposed Term Sheets were originally sent as

attachments to the August 19th E-mail sent by Shohet, and were not attachments to the August

20th E-mail sent by Martin.25 A careful review of both e-mails shows that Martin’s contention is

meritless.

The filenames of the three attachments to the August 19th E-mail are “VRP Investor

Letter2.5.doc,” “VRP competitive analysis v4.doc,” and “VRP Overview 7-2010.pdf.” Martin

sent the August 20th E-mail to Shohet by replying to the August 19th E-mail. As a result, the

August 20th E-mail contains the text of the August 19th E-mail. The August 20th E-mail does

not contain the attachments to the August 19th E-mail—the filenames “VRP Investor

Letter2.5.doc,” “VRP competitive analysis v4.doc,” and “VRP Overview 7-2010.pdf” do not

appear in the August 20th E-mail. Instead, the August 20th E-mail contains two new

attachments, with the filenames “TS.doc” and “Tsprop.doc.” The difference in the filenames

shows that the “TS.doc” and “Tsprop.doc” files were attachments to the August 20th E-mail, not

attachments to the August 19th E-mail.

Martin admitted at trial that he wrote the August 20th E-mail.26 Based upon this admission,

the text of the August 20th E-mail which clearly indicates that the e-mail is Martin’s “stab” at

creating term sheets, and the fact that the Proposed Term Sheets were attached to the August

20th E-mail, the Court finds that Martin prepared the Proposed Term Sheets.

On August 26, 2010, at 7:33 a.m., Shohet sent Martin a draft promissory note, created by

Shohet, that was based upon the terms set forth in the Final Term Sheet.27 At 8:12 a.m. that

morning, Shohet sent Martin a revised version of the draft promissory note.28 Approximately an

hour later, at 9:34 a.m., Shohet sent Hunter the final version of the promissory note signed by

Martin.29 At 1:32 p.m. that afternoon, Hunter e-mailed Shohet a fully executed copy of the

promissory note (the “Note”).30

The Note memorialized a $50,000 loan from Hunter to Martin, bearing interest at the rate of

6%. A balloon payment of the principal and unpaid interest was due on September 1, 2011. The

Note was secured by the following collateral:

1) 1996 Porsche 993; License No. 5DMX 199; VIN: WPOAA2999TS322286; located in

New York, NY (the “Porsche”); and

put up a 1996 Porsche 993 with a retail value of 34k discounted to 25k to the investor.”

Plaintiff’s Ex. 5 at GS082.

23 Plaintiff’s Ex. 1.

24 The attached documents are Plaintiff’s Exhibits 2–4.

25 Tr. Jan. 28 at 100:17–102:11 (Martin’s objection to admission of the August 20th E-mail).

26 Tr. Feb. 4 at 145:24–146:1.

27 Tr. Jan. 28 at 111:22–112:24 (testimony of Shohet) and Plaintiff’s Ex. 13.

28 Tr. Jan. 28 at 113:6–22 (testimony of Shohet) and Plaintiff’s Ex. 14.

29 Tr. Jan. 28 at 114:4–115:4 (testimony of Shohet) and Plaintiff’s Ex. 15.

30 Plaintiff’s Ex. 16.

2) Two untitled, signed original Chris Reilly art works: (i) painting on white wooden door

with red border and two thornless red roses in a gold leaf window; (ii) painting on

canvas, “Color of Money” effect with carvings, Japanese maple leaf and a border of

silver leaf; located at 34 Ozone Ave. #3, Venice, CA 90291 (both paintings collectively,

the “Artwork,” and the Artwork and Porsche collectively, the “Collateral”).

See Note at Ex. A (Plaintiff’s Ex. 16).

The Note contained the following provisions regarding the Collateral:

On and as of the date of this Note, Borrower [Martin] represents and warrants to Lender

[Hunter] that Borrower is the true and lawful owner of the Collateral, having good and

marketable title thereto, free and clear of any and all Liens other than the Lien and

security interest granted to Lender hereunder and Permitted Liens. Borrower shall not

create or assume or permit to exist any such Lien on or against any of the Collateral

except as created or permitted by this Note and Permitted Liens, and Borrower shall

promptly notify Lender of any such other Lien against the Collateral and shall defend the

Collateral against, and take all such action as may be necessary to remove or discharge,

any such Lien.

Note at ¶ G.

The Note further provided that upon and during the continuance of any event of default,

Hunter would have the right to sell all or any part of the Collateral.31 The Note provided that

Hunter had the right, but not the obligation, to convert the Note into shares of VRP common

stock.32 Hunter never made any representation that he would exercise his option to convert the

Note into equity in VRP.33

Martin used the proceeds of the Note to fund VRP’s operations.34 Martin has not repaid any

portion of the Note’s principal and has not repaid any portion of the accumulated interest.35

In determining whether to loan Martin the funds, Hunter considered various documents

describing VRP’s business sent to him by Shohet (all such documents collectively, the “VRP

Investment Materials”).36 In particular, Hunter relied upon statements in a document titled

31 Pretrial Order at ¶ 26; Note at ¶ J.

32 Pretrial Order at ¶¶ 26 and 28; Note at ¶ E.

33 Pretrial Order at ¶ 28.

34 Tr. Feb. 4 at 198:18–22 (testimony of Martin).

35 Pretrial Order at ¶ 30.

36 The VRP Investment Materials consisted of the following documents:

1) A document titled Veronica Rose Productions Partner Overview (the “VRP

Overview”) (Plaintiff’s Ex. 2);

2) A revised version of the Veronica Rose Productions Partner Overview (Plaintiff’s Ex.

10);

3) An investor letter, dated August 13, 2010, addressed to “Tom” (Plaintiff’s Ex. 3);

4) An investor letter, dated August 16, 2010, addressed to “Amy” (Plaintiff’s Ex. 9);

5) A set of financial assumptions and projections (Plaintiff’s Ex. 4);

6) A revised set of financial assumptions and projections (Plaintiff’s Ex. 11).

Veronica Rose Productions Partner Overview (the “VRP Overview”).37 Hunter testified that he

focused on the following statements in making the lending decision:

So I looked to these documents to give me an indication of the time to market and the

potential magnitude of revenues to determine having made a loan that was

collateralized—would this be a company that I might be interested in converting my loan

into stock as stated in the loan document over the next few months as I did my due

diligence…. [I looked at] Paragraph 4 on page 3 which indicated that the product was

fully prototyped from both the technical and business aspect and that they planned to

have the product in market in the fall of 2010. I also focused on the statements that there

was the potential of 50 million dollars in gross revenues by 2015.

On page 5, [the] statement that stuck out was “Generate the first $100,000 of gross

revenue in the second quarter of 2011.” And those were the two—I guess two areas that

had statements that I would, you know, reflect [that] … this company has significant

revenue potential and their product should be coming to market or almost immediately.

Tr. Jan. 28 at 30:10–31:8 (testimony of Hunter).

At trial, the Court admitted the VRP Overview only for the limited purpose of establishing

that Hunter received the VRP Overview and that Hunter understood that the VRP Overview had

been created by Martin.38 This ruling was based upon the absence of evidence showing either

that Martin had created the VRP Overview or that Martin knew that Shohet had sent the VRP

Overview to Hunter to solicit funds for VRP. Later in the trial, Martin admitted that he prepared

the VRP Overview with the assistance of others.39 Martin further testified that Shohet was

heavily involved in the process of soliciting funds for VRP:

George [Shohet] had already started taking me out and introducing me to other venture

capital. We had, you know, a specific meeting with a VC in Santa Monica that had

experience investing in the music—disruptive music space and so, you know, I was very

optimistic and that’s when he said he was going to get Mr. Hunter to invest.

Tr. Feb. 4 at 192:25–193:5 (testimony of Martin).

Martin’s testimony shows that at the time of the communications between Shohet and

Hunter, Shohet was actively soliciting funding for VRP on Martin’s behalf. Based upon this

relationship between Martin and Shohet, the Court finds that the VRP Investment Materials that

Shohet sent to Hunter had been provided by Martin, and that Martin intended for Shohet to use

the VRP Investment Materials to pitch VRP to potential investors and lenders. Martin’s

contention that he did not intend for Shohet to use the VRP Investment Materials in this manner

is simply not plausible.40 In view of this finding, the Court will not limit the scope of the

admissibility of the VRP Overview or the VRP Investment Materials.

37 Plaintiff’s Ex. 2.

38 Tr. Jan. 28 at 29:22–25.

39 Tr. Feb. 4 at 100:12–18.

40 See Tr. Feb. 4 at 200:8–11 (“I wasn’t under the impression that these numbers went out to Mr.

Hunter in regards to making an investment”) (testimony of Martin).

The most significant factor motivating Hunter’s decision to extend the loan to Martin was

that Shohet had vouched for Martin and that Shohet was working with VRP. Hunter testified:

George [Shohet] came to me for short-term financing. I knew he was working with

this company, that he would be involved. He had sent me these documents which I

reviewed, showed the company through the projections obviously thought they had

potential. I knew that that was—it was one indicator that, okay, it’s here. It’s something

that the company is of interest, something that I can do due diligence on given the

financials I’ve seen and the terms of the loan that I had some time to do that due

diligence.

I matched that with the term sheet, the stated value of the collateral, the fact that it

was a short-term loan, the fact that George can vouch for Paul’s integrity said, “Okay, I’ll

make the loan. It’s collateralized.”

Tr. Jan. 4 at 67:12–25.

Hunter did not perfect his security interest in the Porsche or the Artwork based upon

Shohet’s representations as to Martin’s integrity. Hunter testified:

No, I didn’t [perfect my security interest]. And George [Shohet] and I discussed it. I

said “Look, it’s a short-term loan. You’re working with the company. You’ve ask [sic]

for Paul Martin’s integrity. I don’t want to hold his car as collateral for him. Is he

trustworthy?” “Yes, he is,” according to George. “Friendly deal. Let’s move forward.”

Tr. Jan. 4 at 78:25–79:5.

Hunter’s actions subsequent to Martin’s failure to repay the loan further establish that Hunter

made the lending decision primarily because Shohet had vouched for Martin. The Note came due

in November 2011.41 Martin had made no payments. Hunter did not contact Martin to discuss the

Note until 2014.42 Instead, Hunter periodically asked Shohet about VRP and the status of the

Note. Hunter was “a little uncomfortable,”43 but was satisfied with Shohet’s statements that

Martin just needed more time to repay:

Remember, this was a friendly deal. George [Shohet] is working with the company. He

had vouched for the honesty and integrity of Paul [Martin], so I went with it. You know, I

wanted to be supportive, I would say. But obviously at some point I would want my

money back with a six percent nominal interest rate.

Tr. Jan. 4 at 87:8–14 (testimony of Hunter).

That Hunter placed only minimal reliance upon the VRP Investment Materials is also shown

by Hunter’s testimony that VRP was “a technology company that’s in an area which I’m not

familiar with at all” and that Hunter lacked time “to do any due diligence, real due diligence on

this company.”44 That is, Hunter admitted that he lacked the expertise to assess VRP’s business

41 The Note initially came due in September 2011. Hunter agreed to Martin’s request to extend

the deadline by two months to November 2011.

42 Tr. Jan. 28 at 86:23–87:3 (testimony of Hunter).

43 Tr. Jan. 28 at 87:8 (testimony of Hunter).

44 Tr. Jan. 28 at 21:4–7 (testimony of Hunter).

and did not have the time to do the work that would be necessary to gain such expertise. These

admissions show that Hunter did not place substantial weight upon the VRP Investment

Materials in making the lending decision.

VRP did not achieve the financial projections set forth in the VRP Investment Materials.

However, the projections were not unreasonable as of August 2010, when they were presented to

Hunter. This finding is based upon the testimony of Edward Hunter Williams (“Williams”),

which the Court found to be especially credible, given that Williams has no financial stake in the

outcome of this litigation. As of 2010, Williams was the Senior Vice President of Strategic

Development and Royalty Distribution at SESAC.45 SESAC is a performing rights organization

that licenses the public performances of songs on behalf of composers and music publishers.46

Williams’ responsibilities at SESAC included assessing the impact of new technologies on the

music licensing business.47 Williams was familiar with VRP’s technology because SESAC had

entered into an agreement to invest $150,000 in VRP.48

Williams testified that the financial projections set forth in the VRP Investment Materials

were “not unrealistic numbers for the type of industry that we [are] in,”49 considering that VRP’s

business had the potential to “scale very quickly, very easily.”50 He testified that VRP’s

“technology was there”51 and that the “business plan was very real to us.”52 In Williams’ view,

VRP failed to achieve the financial projections because its technology “was ahead of its time”:

It—not to digress or get sidetracked, but I think it’s relevant to the relationship with

Mr. Martin is that, you know, when I first met him he was talking about things that the

industry is just now—and I’m not trying to set him up as some savant or, you know,

whatever, but he was truly talking about things that the world is just now starting to

realize, starting to really seriously consider….

[The] [t]echnology was there. It’s just—it’s like a lot of products that are launched.

The ideas, the technology. It works, but there’s more to it. You know, there has to be

other things to—for it to really fly. And it was close.

Tr. Jan. 28 at 196:19–197:11.

In 2015, Martin sold the Porsche to a mechanic for $10,000.53 Martin did not inform Hunter

of the sale or remit any of the sale proceeds to Hunter.54 Martin sold the Porsche because the

engine required major repairs that Martin could not afford to have completed.55

45 SESAC was originally known as the “Society of European Stage Authors and Composers.”

The organization no longer uses its full name and is now known only as SESAC.

46 Tr. Jan. 28 at 173:12–19 (testimony of Williams).

47 Tr. Jan. 28 at 182:13–19 (testimony of Williams).

48 Tr. Jan. 28 at 188:2–7 and Plaintiff’s Ex. 18.

49 Tr. Jan. 28 at 182:23–24 (testimony of Williams).

50 Tr. Jan. 28 at 182:19–20 (testimony of Williams).

51 Tr. Jan. 28 at 187:4–5 (testimony of Williams).

52 Tr. Jan. 28 at 187:4 (testimony of Williams).

53 Tr. Feb. 4 at 205:2–5 (testimony of Martin).

54 Tr. Feb. 4 at 205:12–15 (testimony of Martin).

55 Tr. Feb. 4 at 205:2–11 (testimony of Martin).

III. Discussion

A. Section 523(a)(2)(A)—False Pretenses or False Representations

Section 523(a)(2)(A) provides: “A discharge under section 727 … of this title does not

discharge an individual debtor from any debt for money, property, services, or an extension,

renewal, or refinancing of credit, to the extent obtained by false pretenses, a false representation,

or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition.”

To except debts from discharge, a creditor has the burden of proof under the preponderance of

the evidence standard. Grogan v. Garner, 498 U.S. 279, 287, 111 S.Ct. 654 (1991).

Statements respecting the debtor’s or an insider’s financial condition are governed by the

heightened standard set forth in § 523(a)(2)(B). See Lamar, Archer & Cofrin, LLP v. Appling,

138 S. Ct. 1752, 1763–64, 201 L. Ed. 2d 102 (2018) (explaining the structure and legislative

history of § 523(a)(2)). A “statement is ‘respecting’ a debtor’s financial condition if it has a

direct relation to or impact on the debtor’s overall financial status.” Lamar, 138 S.Ct. at 1761.

Such statements can include statements pertaining to a single asset. A “single asset has a direct

relation to and impact on aggregate financial condition, so a statement about a single asset bears

on a debtor’s overall financial condition and can help indicate whether a debtor is solvent or

insolvent, able to repay a given debt or not.” Id.

Martin’s representations can be grouped into two categories: representations regarding

VRP’s business potential and representations regarding the value of the Collateral.

Representations regarding VRP’s business potential do not qualify as statements respecting

Martin’s financial condition. Although Martin held an interest in VRP, other investors did as

well. VRP’s performance undoubtedly had the potential to have some effect on Martin’s

financial condition, but since Martin was not the sole owner of VRP, that effect was too

attenuated for Martin’s statements regarding VRP to qualify as statements respecting Martin’s

financial condition.56 In contrast, Martin’s statements regarding the value of the Collateral—

which Martin owned free and clear—do qualify as statements respecting Martin’s financial

condition.

To prevail on a § 523(a)(2)(A) claim on the grounds of false pretenses or false representation,

a creditor must prove that:

(1) the debtor made the representations;

(2) that at the time he knew they were false;

(3) that he made them with the intention and purpose of deceiving the

creditor;

(4) that the creditor relied on such representations; and

(5) that the creditor sustained the alleged loss and damage as the

proximate result of the misrepresentations having been made.

Ghomeshi v. Sabban (In re Sabban), 600 F.3d 1219, 1222 (9th Cir. 2010).

56 Even if Martin’s representations regarding VRP were statements respecting Martin’s financial

condition, the Court’s ultimate conclusion (explained below) that such representations do not

give rise to non-dischargeable indebtedness would remain unchanged. The standard imposed by

§ 523(a)(2)(B) is more difficult to satisfy than the standard imposed by § 523(a)(2)(A).

Therefore, Hunter’s failure to demonstrate non-dischargeability under § 523(a)(2)(A) means that

Hunter could not demonstrate non-dischargeability under § 523(a)(2)(B).

Martin’s representations regarding VRP’s business potential were not false at the time they

were made. Williams’ testimony established that the financial projections set forth in the VRP

Investment Materials were not unreasonable when presented to Hunter in August 2010. The fact

that VRP, like many start-up companies, did not achieve its ambitions does not show that the

projections were false or misleading. As Williams testified, VRP failed because its technology

was “ahead of its time.”57

The determination that the VRP Investment Materials were not false or misleading must also

take into account that the materials were projections describing a fast-moving start-up enterprise.

As a sophisticated investor, Hunter understood that it was necessary to approach the projections

with a degree of caution. Hunter’s own testimony acknowledged this reality: “I did note that they

[VRP] missed the milestone of actually bringing the product to market in the fall, you know, but

these things are somewhat in flux.”58 Like nearly all investor presentations, the projections

reflected an aggressively optimistic view of VRP’s future. But Hunter, whose job is to assess

investment opportunities, knew that. In hindsight, the gap between VRP’s failure and the $50

million gross revenue projected by 2015 appears striking. However, when considering the

context in which they were made, even such aggressively optimistic projections do not qualify as

false or misleading.

Hunter did not rely primarily upon the representations contained in the VRP Investment

Materials when making the lending decision, which is also fatal to Hunter’s § 523(a)(2)(A)

claim. Under § 523(a)(2)(A), a debt is not excepted from discharge unless the creditor justifiably

relies upon the debtor’s representation. Field v. Mans, 516 U.S. 59, 77, 116 S. Ct. 437, 447, 133

L. Ed. 2d 351 (1995). As discussed above, the most significant factor motivating Hunter’s

decision to extend the loan to Martin was that Shohet had vouched for Martin and that Shohet

was working with VRP. Hunter reviewed the VRP Investment Materials, but did not place

substantial weight upon them when making the lending decision. Therefore, Hunter did not

justifiably rely upon the VRP Investment Materials.

Hunter contends that the Note’s option for Hunter to convert his loan into an equity interest

in VRP amounts to a false representation under § 523(a)(2)(A). Hunter’s theory is that it would

have been impossible for him to exercise the conversion option, because VRP had not issued a

sufficient number of shares to accommodate Hunter in the event he elected conversion. Hunter’s

argument lacks merit. As a result of a typographical error, VRP issued only 100,000 shares of

stock, when it had intended to issue 100 million shares.59 The error was not intentional and could

have easily been corrected had Hunter actually been interested in exercising his conversion

option.

B. Section 523(a)(2)(A)—Actual Fraud

A creditor may also prevail on a § 523(a)(2)(A) claim on the ground of “actual fraud.”

“Actual fraud” includes “a fraudulent conveyance of property made to evade payment to

creditors.” Husky Int'l Elecs., Inc. v. Ritz, 136 S. Ct. 1581, 1585, 194 L. Ed. 2d 655 (2016). Such

fraudulent conveyance schemes fall within the ambit of § 523(a)(2)(A) even when they do not

involve a false representation or are carried out subsequent to the credit transaction that created

the debt. See Husky, 136 S.Ct. at 1589–90 (holding that § 523(a)(2)(A) does not require that the

57 Tr. Jan. 28 at 196:19–20.

58 Tr. Jan. 28 at 80:7–9 (testimony of Hunter).

59 Tr. Jan. 28 at 161:22–162:1 (testimony of Shohet).

relevant debt “result from fraud at the inception of a credit transaction”) (emphasis in original);

id. at 1590 (“[W]e interpret ‘actual fraud’ to encompass fraudulent conveyance schemes, even

when those schemes do not involve a false representation”).

As stated by the Supreme Court in Husky:

“Actual fraud” has two parts: actual and fraud. The word “actual” has a simple meaning

in the context of common-law fraud: It denotes any fraud that “involv[es] moral turpitude

or intentional wrong.” “Actual” fraud stands in contrast to “implied” fraud or fraud “in

law,” which describe acts of deception that “may exist without the imputation of bad faith

or immorality.” Thus, anything that counts as “fraud” and is done with wrongful intent is

“actual fraud.”

Husky Int'l Elecs., Inc. v. Ritz, 136 S. Ct. 1581, 1586, 194 L. Ed. 2d 655 (2016) (internal citations

omitted).

A fraudulent conveyance constitutes “actual fraud” for purposes of § 523(a)(2)(A) if the

purpose of the conveyance is to conceal assets from a creditor or hinder the creditor’s ability to

collect a debt. Husky, 136 S. Ct. 1581, 1587, 194 L. Ed. 2d 655 (2016).

In 2015, Martin sold the Porsche to a mechanic for $10,000, even though Martin knew that

the Porsche was collateral for the Note. Martin did not inform Hunter of the sale or remit any of

the sale proceeds to Hunter. This conduct qualifies as “actual fraud.” It was wrong for Martin to

sell the Porsche without remitting the sales proceeds to Hunter. Martin was aware that the

Porsche was Hunter’s collateral, and thus knew that the unauthorized sale was wrong. By

disposing of Hunter’s collateral without authorization, the sale hindered Hunter’s ability to

collect upon the Note.

C. Section 523(a)(2)(B)

Section 523(a)(2)(B) excepts from discharge indebtedness obtained through use of a

statement in writing:

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....

§ 523(a)(2)(B).

To prevail upon a claim under § 523(a)(2)(B), a creditor must satisfy, by a preponderance of

the evidence, the following requirements:

(1) a representation of fact by the debtor,

(2) that was material,

(3) that the debtor knew at the time to be false,

(4) that the debtor made with the intention of deceiving the creditor,

(5) upon which the creditor relied,

(6) that the creditor’s reliance was reasonable,

(7) that damage proximately resulted from the representation.

In re Candland, 90 F.3d 1466, 1469 (9th Cir. 1996), as amended (Oct. 2, 1996).

The requirements are similar to those imposed by § 523(a)(2)(A), except that the creditor

must make a heightened showing in two respects: (1) the representation at issue must be

materially false (as opposed to simply false), and (2) the creditor’s reliance must be reasonable

(as opposed to justifiable).

A statement is “materially false if it includes information which is ‘substantially inaccurate’

and is of the type that would affect the creditor’s decision making process. To except a debt from

discharge, the creditor must show not only that the statements are inaccurate, but also that they

contain important and substantial untruths.” Candland, 90 F.3d at 1470.

Hunter’s § 523(a)(2)(B) claim fails because he failed to show, by a preponderance of the

evidence, that (1) Martin’s claims regarding the value of the Collateral were materially false

when made, or that (2) Martin intended to deceive Hunter with respect to the Collateral’s value.

First, Hunter presented no evidence establishing the value of the Collateral as of August

2010, when Martin represented that the Collateral’s value exceeded $50,000. Martin testified that

he sold the Porsche to a mechanic for $10,000 in 2015 after the engine stopped working. This

testimony sheds no light on the Porsche’s value as of August 2010. Martin was using the Porsche

as his daily driver in New York City subsequent to August 2010, which would have caused its

value to depreciate.

Martin testified that as of the present time, one of the two paintings would be worth $3,500,

but only after receiving rehabilitation costing between $2,000 to $3,000.60 Martin testified that

the other painting likely had no value because it had decayed as a result of exposure to the salt

and air in his seaside apartment.61 Martin’s testimony did not indicate precisely when either

painting began to deteriorate or what the paintings were worth as of August 2010. Martin’s

testimony does little to establish the value of the paintings at the time of execution of the Note.

Without presenting evidence as to what the Collateral was worth as of August 2010, Hunter

cannot carry his burden of showing that Martin’s claimed valuation as of that date was materially

false.

Second, Hunter has failed to establish that Martin intended to deceive Hunter with respect to

the Collateral’s value. As discussed above, in August 2010, Martin represented that the Porsche

and both paintings were collectively worth more than $50,000. Testimony at trial did not clearly

elucidate exactly how Martin derived this valuation. It appears that the portion of the valuation

attributable to the paintings was Martin’s estimate, informed by Martin’s understanding that the

artist had sold a different painting for $30,000.62 Martin plausibly testified that he did not have

the qualifications to value art.63 The Court finds that the $50,000 valuation of the Collateral was

Martin’s unsophisticated estimate, but that Martin did not present this valuation with the intent to

deceive Hunter.

D. Section 523(a)(4)

Section 523(a)(4) excepts from discharge “any debt for fraud or defalcation while acting in a

fiduciary capacity.” “To prevail on a nondischargeability claim under § 523(a)(4) the plaintiff

60 Tr. Feb. 4 at 207:10–19 (testimony of Martin).

61 Tr. Jan. 28 at 206:18–207:5 (testimony of Martin).

62 Tr. Feb. 4 at 207:16–19 (testimony of Martin).

63 Tr. Feb. 4 at 206:23 (testimony of Martin).

must prove not only the debtor’s fraud or defalcation, but also that the debtor was acting in a

fiduciary capacity when the debtor committed the fraud or defalcation.” In re Honkanen, 446

B.R. 373, 378 (B.A.P. 9th Cir. 2011).

Federal bankruptcy law determines whether a fiduciary relationship exists within the

meaning of §523(a)(4). Cal-Micro, Inc. v. Cantrell (In re Cantrell), 329 F.3d 1119, 1125 (9th

Cir. 2003). For purposes of §523(a)(4), the fiduciary relationship “must be one arising from an

express or technical trust that was imposed before and without reference to the wrongdoing that

caused the debt.” Lewis v. Scott (In re Lewis), 97 F.3d 1182, 1185 (9th Cir. 1996). State law

determines whether the requisite trust relationship exists. In re Mele, 501 B.R. 357, 363 (B.A.P.

9th Cir. 2013).

Hunter’s § 523(a)(4) claim fails because no fiduciary relationship existed between Hunter

and Martin. Martin and Hunter conducted no business prior to execution of the Note. The

parties’ business relationship was limited to Hunter’s extension of credit to Martin through the

Note. Hunter’s act of extending credit did not create an express or technical trust under

California law.

E. Section 523(a)(6)

“Section 523(a)(6) excepts from discharge debts arising from a debtor’s ‘willful and

malicious’ injury to another person or to the property of another. The ‘willful’ and “malicious’

requirements are conjunctive and subject to separate analysis.” Plyam v. Precision Development,

LLC (In re Plyam), 530 B.R. 456, 463 (9th Cir. B.A.P. 2015) (internal citations omitted).

An injury is “willful” when “a debtor harbors ‘either subjective intent to harm, or a

subjective belief that harm is substantially certain.’ The injury must be deliberate or intentional,

‘not merely a deliberate or intentional act that leads to injury.’” Id. at 463 (internal citations

omitted). An injury is “malicious” if it “involves ‘(1) a wrongful act, (2) done intentionally, (3)

which necessarily causes injury, and (4) is done without just cause or excuse.’” Carrillo v. Su (In

re Su), 290 F.3d 1140, 1146–47 (9th Cir. 2002) (internal citations omitted).

In addition, the injury-producing conduct must be tortious in order to be excepted from

discharge under §523(a)(6). Lockerby v. Sierra, 535 F.3d 1038, 1040 (9th Cir. 2008). “[C]onduct

is not tortious under § 523(a)(6) simply because injury is intended or ‘substantially likely to

occur,’ but rather is only tortious if it constitutes a tort under state law.” Id. at 1041.

None of Martin’s conduct qualifies as “willful” and “malicious” within the meaning of

§ 523(a)(6). Martin did not solicit the loan with the intent of injuring Hunter. Martin genuinely

believed that VRP would be a success and that he would be able to repay the proceeds. Martin’s

decision to sell the Porsche and retain the proceeds, all without telling Hunter, was wrongful, but

does not qualify as a deliberate and intentional injury. Martin did not sell the Porsche for the

purpose of injuring Hunter; he sold the Porsche because he could no longer afford the expensive

engine repairs the car required.

F. Damages

As a result of the “actual fraud” that Martin committed by selling the Porsche and failing to

remit the sales proceeds to Hunter, Hunter was damaged in the amount of $10,000. Martin’s

unauthorized sale prevented Hunter from foreclosing upon the Porsche and applying its value

toward repayment of the Note. The only evidence of the Porsche’s value at the time of the sale

was Martin’s testimony that the sale price was $10,000.

Hunter seeks an award of attorney’s fees. The Note contains the following provision with

respect to attorney’s fees:

Borrower shall pay all costs and expenses, including, without limitation, reasonable

attorneys’ fees and expenses Lender expends or incurs in connection with the

enforcement of this Note, the collection of any sums due hereunder, any actions for

declaratory relief in any way related to this Note, or the protection or preservation of any

rights of the holder hereunder.

Note at ¶ S (Plaintiff’s Ex. 16).

“No general right to attorney fees exists under the Bankruptcy Code. However, a prevailing

party in a bankruptcy proceeding may be entitled to an award of attorney fees in accordance with

applicable state law if state law governs the substantive issues raised in the proceedings.” Ford v.

Baroff (In re Baroff), 105 F.3d 439, 441 (9th Cir. 1997). The applicable provisions of California

law governing the award of attorney’s fees are Cal. Civ. Code § 1717(a) and Cal. Code Civ.

Proc. § 1021.

Cal. Civ. Code § 1717(a) provides in relevant part:

In any action on a contract, where the contract specifically provides that attorney’s fees

and costs, which are incurred to enforce that contract, shall be awarded either to one of

the parties or to the prevailing party, then the party who is determined to be the party

prevailing on the contract, whether he or she is the party specified in the contract or not,

shall be entitled to reasonable attorney's fees in addition to other costs.

Cal. Civ. Code § 1717(a) applies only to attorney’s fees incurred in actions involving a contract

claim. Santisas v. Goodin, 17 Cal.4th 599, 71 Cal.Rptr.2d 830, 951 P.2d 399 (1998). A non-

dischargeability claim based on actual fraud is not a contract claim. Redwood Theaters v.

Davison (In re Davison), 289 B.R. 716, 724 (B.A.P. 9th Cir. 2003). Hunter is not entitled to

attorney’s fees pursuant to Cal. Civ. Code § 1717(a).

Cal. Code Civ. Proc. § 1021 provides in relevant part:

Except as attorney’s fees are specifically provided for by statute, the measure and mode

of compensation of attorneys and counselors at law is left to the agreement, express or

implied, of the parties; but parties to actions or proceedings are entitled to their costs, as

hereinafter provided.

Cal. Code Civ. Proc. § 1021 does not limit the recovery of attorney’s fees to certain claims. 3250

Wilshire Boulevard Bldg. v. W.R. Grace & Co., 990 F.2d 487, 489 (9th Cir. 1993). Fees may be

recoverable under Cal. Code Civ. Proc. § 1021 even if not recoverable under Cal. Civ. Code

§ 1717(a). Id. “Section 1021 allows the parties to agree that the prevailing party in litigation may

recover attorney’s fees, whether the litigation sounds in contract or in tort.” Taburaza v. Zarate

(In re Zarate), 567 B.R. 176, 182 (Bankr. N.D. Cal. 2017). “To determine whether a prevailing

party may recover attorney’s fees for non-contractual claims under Section 1021, a court must

look to the language of the agreement.” Terra Nova Industries, Inc. v. Chen (In re Chen), 345

B.R. 197, 201 (N.D. Cal. 2006).

Fee provisions limited to the enforcement of the terms of the contract or to the collection of

monies owed under the contract have been held not to extend to fees incurred in litigating tort

claims, such as the instant non-dischargeability action. See, e.g., Exxess Electronixx v. Heger

Realty Corp., 64 Cal.App.4th 698, 707–708, 75 Cal.Rptr.2d 376 (1998) (an action or proceeding

to “enforce the terms or declare rights” under a lease did not cover tort claims); Sharma v.

Salcido (In re Sharma), 2013 WL 1987351, *18 (9th Cir. B.A.P. 2013) (suit to “enforce or

interpret” a settlement agreement did not cover fees in a § 523(a)(2)(A) case involving fraud in

inducement of settlement agreement). In contrast, provisions with broader language—suits

arising from or with respect to the subject matter or enforcement of a contract—have been held

to extend to fees incurred in litigating tort claims. See, e.g., 3250 Wilshire Blvd. Building v. W.R.

Grace & Co., 990 F.2d 487, 489 (9th Cir. 1993) (contract providing for fees for any suit with

respect to “the subject matter or enforcement” of contract covered tort claims); Santisas v.

Goodin, 17 Cal.4th 599, 608, 71 Cal.Rptr.2d 830, 951 P.2d 399 (1998) (agreement for fees for

any “litigation arising out of the execution” of agreement or sale of property covered tort

claims); Xuereb v. Marcus & Millichap, Inc., 3 Cal.App.4th 1338, 1341, 5 Cal.Rptr.2d 154

(1992) (agreement providing for prevailing party fees in “any lawsuit or other legal proceeding

to which it gives rise” covered tort claims including events that occurred prior to agreement's

formation).

The Note’s fee provision provides for the recovery of fees incurred “in connection with the

enforcement of this Note” or in “the collection of any sums due hereunder.” Consistent with the

authorities cited above, these provisions do not extend to fees incurred in the litigation of the

instant dischargeability action. The Note provides for a recovery of fees incurred in an action

“for declaratory relief in any way related to this Note.” This dischargeability action is not an

action for declaratory relief.

Finally, the Note provides for the recovery of fees incurred in connection with “the

protection or preservation of any rights of the holder hereunder.” This language is sufficiently

broad to encompass the instant dischargeability action. The language is similar to provisions

allowing recovery for fees incurred with respect to suits arising from or with respect to the

subject matter of a contract; such provisions have been held to extend to tort claims.

Hunter is entitled to an award of attorney’s fees incurred in connection with establishing

Martin’s liability for “actual fraud” on account of the unauthorized sale of the Porsche. Hunter is

not entitled to attorney’s fees incurred in presenting other aspects of his case against Martin. By

separate order, the Court will set deadlines for Hunter to submit evidence establishing the fees

incurred in connection with his § 523(a)(2)(A) claim for “actual fraud.”

III. Conclusion

Based upon the foregoing, Martin is indebted to Hunter in the amount of $10,000. Such

indebtedness is excepted from Martin’s discharge pursuant to § 523(a)(2)(A), on the ground of

“actual fraud.” The Court will not enter final judgment until the issue of Hunter’s attorney’s fees

has been determined.

IR a EE

HHH

Date: July 10, 2019 “oat Yer

Ernest M. Robles

United States Bankruptcy Judge