Sunday, July 31, 2011

Recent Decisions from the First Circuit regarding Bankruptcy and Foreclosure

BAP reverses Bankruptcy Court’s determination of nondischargeability of debt for breach of construction contract and fraudulent misrepresentations by the debtor, where the debtor’s fraudulent statements were not the direct link to the creditor’s damages:

SHARFARZ v. GOGUEN (IN RE GOGUEN), 2011 Bankr. LEXIS 2722 (1st Cir. BAP  7/21/11).
PRIOR HISTORY: Appeal from the United States Bankruptcy Court for the District of Massachusetts.
Appellant Chapter 7 debtor appealed a determination by the United States Bankruptcy Court that excepted the claim of appellee creditor from discharge under 11 U.S.C.S. § 523(a)(2)(A. The claim was based on the breach of a construction contract and fraudulent misrepresentations by the debtor.
OVERVIEW: The creditor argued that the debtor's misrepresentations about a building permit caused the creditor's damages because the creditor would have terminated the contract before incurring damages. The court held that causation in fact was absent because there was nothing in the record to support a conclusion that the debtor's misrepresentations about the permit were either the direct link to the creditor's damages or the essence of the agreement between the parties. Legal causation was also absent because the creditor did not establish that his damages could reasonably have been expected to result from his reliance on the debtor's misrepresentations. It was not reasonable to suggest that the debtor could have foreseen that the creditor would spend $88,000 beyond the contract price because he misrepresented the status of the permit application for a ten-week period after they signed the contract. The creditor's counsel conceded that the creditor would have spent the additional money to complete the renovation in any event.
OUTCOME:  Reversed.

JUDGES:  Before Judges Votolato, Kornreich and Tester, Per Curiam.
Discussion:   Exceptions to discharge are narrowly construed in favor of the debtor in an effort to further the "fresh start" policy underlying the Bankruptcy Code. The creditor asserting an exception to discharge must show that its claim comes squarely within an exception enumerated in § 523(a). In order to establish that a debt is nondischargeable under § 523(a)(2)(A), a creditor must show that: (1) the debtor made a knowingly false representation or one made in reckless disregard of the truth; (2) the debtor intended to deceive; (3) the debtor intended to induce the creditor to rely upon the false statement; (4) the creditor actually relied upon the misrepresentation; (5) the creditor's reliance was justifiable; and (6) the reliance upon the false statement caused damage. If the creditor fails to establish any one of the six elements by a preponderance of the evidence, then the court must reject its claim.

Section 523(a)(2)(A)"requires a 'direct link' between the alleged fraud and the creation of the debt to be excepted from discharge. In analyzing the causation requirements of § 523(a)(2)(A), the Panel may look to the Restatement (Second) of Torts (1976) for guidance. The Restatement explains that proximate causation encompasses two elements, causation in fact and legal causation. There is causation in fact when a creditor establishes that a debtor fraudulently induced the creditor to enter into a transaction by a misrepresentation that goes to the essence of the transaction. Courts typically find that a debtor's misrepresentation regarding his/her expertise to complete the work contemplated by the transaction satisfies this standard, "if the misrepresentation was a substantial factor in entering into the transaction, the debtor's work later proves to be defective, and the creditor suffers a loss."

The Restatement definition of "causation in fact" required Sharfarz to demonstrate that Goguen's misrepresentation induced him to enter into the construction contract. There is nothing in the record to support a conclusion that Goguen's misrepresentation about the permit is either the "direct link" to Sharfarz's damages or "the essence of the agreement" between the parties. Goguen's misrepresentation regarding the permit application post-dated the signing of the construction contract, so it could not possibly have induced Sharfarz to enter into the contract in the first instance.

The second element of proximate cause, legal causation, required Sharfarz to establish that his damages could reasonably have been expected to result from his reliance on Goguen's misrepresentation. It is not reasonable to suggest that Goguen could have foreseen that Sharfarz would spend $88,000.00 beyond the contract price because he misrepresented the status of the permit application for a ten-week period after they signed the contract. In fact, at oral argument, Sharfarz's counsel conceded that Sharfarz would have spent the additional $88,000.00 to complete the renovation in any event. Alternatively, it was foreseeable that Goguen could have completed the renovation in a timely and workman-like manner, even after lying about the permit, thereby preventing Sharfarz's pecuniary harm. Thus, legal causation is also absent. Goguen argues persuasively that his negligence in under-estimating the cost of the project and ensuing breach of contract caused Sharfarz's damages. While Goguen's breach of contract might have caused Sharfarz  harm,  breach of contract is not a ground for nondischargeability under § 523.

Chapter 11 case dismissed for post-petition failure to timely pay taxes or timely file returns:

IN RE: FUGITIVE RECOVERY INVESTIGATIONS, INC., 2011 Bankr. LEXIS 2762 (Bankr. D.P.R. 7/13/11).
PROCEDURAL POSTURE:  Movant, the Internal Revenue Service (IRS), the holder of an unsecured priority tax claim under 11 U.S.C.S. § 507(a)(8), filed a motion to dismiss the case for respondent chapter 11 debtor's failure to file both pre-petition and postpetition tax returns and to file postpetition federal employment tax returns pursuant to 11 U.S.C.S. §1112(b)(4)(I), and for retroactive annulment of the automatic stay pursuant to 11 U.S.C. § 362(d).
OVERVIEW: Debtor did not allege unusual circumstances. IRS sought retroactive annulment of the automatic stay regarding a setoff of $131,070.12 in funds owed to debtor by the United States Department of Defense against debtor's outstanding federal tax liabilities pursuant to the Federal Payment Levy Program, 26 U.S.C.S. § 6331(h). IRS conceded that its levy of the funds violated the automatic stay, but alleged federal law permits bankruptcy courts to lift the automatic stay retroactively and thereby validate actions that would otherwise be void. Debtor opposed both motions challenging the IRS' allegation of its bad faith. However, the debtor failed to address the fact that its 2009 unemployment tax return was due approximately a year before the debtor filed for bankruptcy and was filed only after the United States filed its motion to dismiss. Debtor failed to pay its postpetition portion of the federal employment and unemployment taxes, and also failed in its duty to remit the employees' portion of the social security and medicare taxes to the IRS. Dismissal under 11 U.S.C.S. §1112(b)(4)(I) was warranted.
OUTCOME: The IRS' motion to dismiss the case was granted. The IRS' request for retroactive annulment of the automatic stay was denied as moot.
JUDGE: Enrique S. Lamoutte, Bankruptcy Judge.

Discussion:  Section 1112(b) of the Code mandates the bankruptcy court after notice and a hearing to convert or dismiss a chapter 11 case, whichever is in the best interests of creditors and the estate, if the movant establishes cause and the case is devoid of unusual circumstances pursuant to 11 U.S.C. §1112(b)(1) and (b)(2). 11 U.S.C. §1112(b), thus, limiting the bankruptcy court's discretion to dismiss or convert a chapter 11 case for "cause." "Thus, until the movant carries this burden, the statutory direction that the court 'shall convert the case to a case under chapter 7 or dismiss the case' is not operative." Id. Once the movant establishes "cause", the burden shifts to the debtor to demonstrate by evidence the "unusual circumstances" that establish that dismissal or conversion to Chapter 7 is not in the best interests of the creditors and the estate. The bankruptcy court retains discretion in determining whether unusual circumstances exist and whether conversion or dismissal is in the best interest of creditors and the estate. A determination of unusual circumstances is fact intensive and contemplates facts that are not common to chapter 11 cases.  If the Chapter 11 case is devoid of "unusual circumstances" then, the bankruptcy court must apply the Section 1112(b)(2) analysis to determine whether the Chapter 11 case is dismissed or converted. The objecting party must establish all of the factual elements stated in subparagraphs (A) and (B) of section 1112(b)(2).

Thus, the bankruptcy court must not convert or dismiss a case if: "(1) there is a reasonable likelihood that a plan will be confirmed within a reasonable time; (2) the 'cause' for dismissal or conversion is something other than a continuing loss or diminution of the estate coupled with a lack of reasonable likelihood of rehabilitation; and (3) there is a reasonable justification or excuse for a debtor's act or omission and the act or omission will be cured within a reasonable time."

Section 1112(b)(4)(I) specifically establishes that cause to dismiss or convert a chapter 11 case includes, "failure timely to pay taxes owed after the date of the order for relief or to file tax returns due after the date of the order for relief."

Summary judgment granted for nondischargeability of debt where debtor caused injury while driving a vehicle under the influence of alcohol, and it was not then discharged by the debtor’s Chapter 13 plan:

(IN RE: ROSADO, REYES) ROSADO, REYES v. COLON, 2011 Bankr. LEXIS 2776 (Bankr. D.P. R. 7/15/11)
JUDGE: Enrique S. Lamoutte, Bankruptcy Judge.
PROCEDURAL POSTURE:  This adversary proceeding is before the court upon defendants' motion for summary judgment and the opposition thereto by the debtors/plaintiffs. Defendants allege and contend that the determination regarding the nondischargeability of their claim under 11 U.S.C. §523(a)(9) was adjudicated by the Superior Court of Puerto Rico. Plaintiffs allege that defendants violated the discharge injunction and should be sanctioned because the state court made no specific finding or determination regarding the dischargeability of defendants' claim.

Summary judgment is warranted where, after adequate time for discovery and upon motion, a party fails to make a showing sufficient to establish the existence of an element essential to its case and upon which it carries the burden of proof at trial.  The moving party must "show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law."

For there to be a "genuine" issue, facts which are supported by substantial evidence must be in dispute thereby requiring deference to the finder of fact. Furthermore, the disputed facts must be "material" or determinative of the outcome of the litigation. When considering a petition for summary judgment, the court must view the evidence in the light most favorable to the nonmoving party. The moving party invariably bears both the initial as well as the ultimate burden in demonstrating its legal entitlement to summary judgment.  It is essential that the moving party explain its reasons for concluding that the record does not contain any genuine issue of material fact in addition to making a showing of support for those claims for which it bears the burden of trial. The moving party cannot prevail if any essential element of its claim or defense requires trial.  In addition, the moving party is required to demonstrate that there is an absence of evidence supporting the nonmoving party's case. In its opposition, the nonmoving party must show genuine issues of material facts precluding summary judgment; the existence of some factual dispute does not defeat summary judgment. A party may not rely upon bare allegations to create a factual dispute but is required to point to specific facts contained in affidavits, depositions and other supporting documents which, if established at trial, could lead to a finding for the nonmoving party.

The moving party has the burden to establish that it is entitled to summary judgment; no defense is required where an insufficient showing is made. The nonmoving party need only oppose a summary judgment motion once the moving party has met its burden.

Here, the Vega Baja District court adjudicated that plaintiff was guilty of driving a motor vehicle under the influence of alcohol.  Defendants filed a civil action for damages against plaintiffs based on the accident caused by Rafael Maldonado Rosado and subject of the above described criminal conviction.
Judgment by stipulation was entered on June 7, 2001, settling the claim for $15,000.

Plaintiffs filed a voluntary Chapter 13 petition on June 19, 2001. Plaintiffs included the defendants in the schedules as unsecured creditors in the amount of $15,000.  After completion of all plan payments, plaintiffs were granted a discharge under Section 1328(a) on October 24, 2005.

On October 17, 2008 Plaintiffs filed a complaint based on alleged violations of the discharge injunction pursuant to SECtion 524(a) of the Bankruptcy Code committed by the Defendants and that they should be held in civil contempt for their reckless disregard of this court's discharge order.  In a proceeding to determine nondischargeability under SEction 523(a)(9), the claimant must prove the following three (3) elements: (1) an existing debt based on death or personal injury; (2) caused by operation of a motor vehicle, vessel or aircraft; and (3) which was being operated unlawfully under state law due to debtor's intoxication.  A claimant must prove the above-referenced elements by a preponderance of the evidence. A claimant need not establish a causal link between debtor's intoxication and the death or personal injury.

Legal records from a prior state court proceeding in which there is a finding with respect to debtor's liability may provide a sufficient basis for the bankruptcy court to ascertain that such claim is nondischargeable pursuant to
Section 523(a)(9) of the Bankruptcy Code. However, if the legal records from a prior state proceeding are insufficient to prove nondischargeability of a debt, the claimant may submit to the bankruptcy court additional evidence to substantiate the necessary elements in a nondischargeability action under Section 523(a)(9) of the Bankruptcy Code.
The uncontested facts show that the defendants' claim meets the requirements of Section 523(a)(9). The debt is the result of a personal injury caused by the plaintiffs while operating a motor vehicle, unlawfully as per the laws of the Commonwealth of Puerto Rico due to debtor's intoxication.  Since there was no action to determine the dischargeability of a debt meeting the requirements of Section 523(a)(9), the same survived the discharge.  Based on the above findings and conclusions, the court hereby grants defendants' motion for summary judgment and orders that judgment be entered dismissing the

Debtor’s failure to timely honor a turnover order was contempt, and debtor was denied any possible exemption in the funds to be turned over, but costs and fees of the Chapter 7 Trustee’s motion was denied as debtor had already been denied a discharge due to nondisclosures , which was enough punishment:

In re SARAFOGLOU, 2011 Bankr. LEXIS 2744 (Bankr. D. Mass. 7/15/11).
PROCEDURAL POSTURE:  Chapter 7 trustee moved to hold the debtor in contempt for failing to timely turn over funds in a bank account.  The debtor eventually turned over the account funds, but the trustee then sought to recover attorney costs and fees and to preclude the debtor from claiming an exemption in the funds.
OUTCOME:  Bankruptcy Court held that although the debtor was in contempt of the turnover order,  requiring her to pay the costs and fees was not warranted.  The debtor had already been denied a discharge based on nondisclosures.  However, preclusion of any claim of exemption in the funds was warranted, even though the debtor had made no such claim or gave any indication of doing so.
JUDGE: Frank J. Bailey, Chief Bankruptcy Judge.
Discussion:  By virtue of 11 U.S.C. 105(a) a bankruptcy court has subject matter jurisdiction to employ civil contempt to enforce its orders. The contempt power conferred by  Section 105(a) includes the power to compensate the injured party for losses sustained, bankruptcy courts have appropriately used their contempt power to award actual damages and attorney's fees.  Contempt must be proven by clear and convincing evidence. In order to establish contempt of an order, such as would justify a sanction in the form of compensatory damages and attorney's fees, the Trustee must prove that the alleged contemnor committed an act that violated the order with general intent to commit the act and with knowledge of the order at issue. Due process further requires that the order in question be clear and unambiguous as to what it requires. However, neither specific intent to violate the order nor bad faith is required.

Challenge to discharge denied, defalcation, embezzlement, and willful and malicious conduct not found by a preponderance of the evidence:

KINSELLA v. TODISCO (In re TODISCO),  2011 Bankr. LEXIS 2763 (Bankr. D. Mass. 7/14/11).
PROCEDURAL POSTURE:  Plaintiff, creditor, who invested his life savings with debtor, filed an adversary complaint seeking to except debts owed to the creditor from discharge under 11 U.S.C.S. § 523(a)(4) and (a)(6), by converting funds that creditor had entrusted to debtor, breach of fiduciary duty, and willful and malicious injury, in the amount of $620,000, representing the funds entrusted and reasonable interest thereon.  Debtor, a long time friend and advisor to the creditor, denied the factual allegations of the complaint arguing that at least some of the funds were his own gifted to him by the creditor, and that the creditor's losses were a result of his own flagrant spending. The court found that, notwithstanding his clear gift of the funds to debtor, the creditor remained quite dependent upon him and did not relieve debtor of an agreed obligation to continue providing a 12 percent annuity. Debtor also appeared to have appropriated at least $20,000 from creditor's retirement account and invested it poorly. However, the creditor had not proven by a preponderance of the evidence that debtor had agreed to hold the funds in creditor's name, nor that he made such a representation without intent to honor it. No defalcation, embezzlement, or willful and malicious conduct was shown warranting denial of discharge of the debts.
OUTCOME: The liabilities of the debtor to the creditor were discharged.

JUDGE:  Frank J. Bailey, Chief Judge.

Plaintiff’s stated a claim against bank for failing to consider them for a loan modification, which was not pre-empted by HOLA; promissory estoppel applied:

DIXON v. WELLS FARGO BANK, N.A., 2011 U.S. Dist. LEXIS 80187 (D. Mass. 7/22/11).
JUDGE: William G. Young, District Judge.
PROCEDURAL POSTURE:  Frank and Deana Dixon (collectively "the Dixons") bring this cause of action against Wells Fargo seeking (1) an injunction prohibiting Wells Fargo from foreclosing on their home; (2) specific performance of an oral agreement to enter into a loan modification; and (3) damages.   Wells Fargo, having removed the action from state court, now moves for dismissal of the Dixons' complaint under Fed. R. Civ. P. 12(b)(6), arguing that the allegations are insufficient to invoke the doctrine of promissory estoppel and that, to the extent the Dixons have stated a state-law claim, it is preempted by the Home Owners' Loan Act ("HOLA"), 12 U.S.C. §§ 1461-1470, and its implementing regulations, 12 C.F.R. §§ 500-99.
OUTCOME: Wells Fargo’s motion to dismiss denied.
Discussion:  Although the Court must accept as true all of the factual allegations contained in the complaint, that doctrine is not applicable to legal conclusions.  Threadbare recitals of the legal elements, supported by mere conclusory statements, do not suffice to state a cause of action. Accordingly, a complaint does not state a claim for relief where the well-pleaded facts fail to warrant an inference of anything more than the mere possibility of misconduct.

In this case, Wells Fargo and the Dixons had not yet contemplated the terms of a loan modification, but they had contemplated negotiations. Their failure to elaborate on the boundaries of that duty to negotiate, however, would seem to militate against enforcement of it. Yet, Wells Fargo made a specific promise to consider the Dixons' eligibility for a loan modification if they defaulted on their payments and submitted certain financial information.

Promissory estoppel has developed into "an attempt by the courts to keep remedies abreast of increased moral consciousness of honesty and fair representations in all business dealings."  It now "provides a remedy for many promises or agreements that fail the test of enforceability under many traditional contract doctrines," but whose enforcement is "necessary to avoid injustice," Restatement (Second) of Contracts § 90, comment (b).

Admittedly, the courts of Massachusetts have yet to formally embrace promissory estoppel as more than a consideration substitute. Nonetheless, without equivocation, they have adopted section 90 of the Restatement (Second) of Contracts, which reads, "A promise which the promisor should reasonably expect to induce action or forbearance on the part of the promisee or a third person and which does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise."

One final case, the core allegations of which mirror those presented in the Dixons' complaint, merits mention. In Cohoon v. Citizens Bank, No. 002774, 2000 Mass. Super. LEXIS 604, 2000 WL 33170737 (Mass. Super. Nov. 11, 2000)(Agnes, J.), the parties orally agreed to a discounted payoff in full satisfaction of the plaintiff's original mortgage obligation. 2000 Mass. Super. LEXIS 604, [WL] at *1.  The defendant encouraged the plaintiff to default on a mortgage payment to ensure approval of the discounted payoff. 2000 Mass. Super. LEXIS 604, [WL] at *4. Until that time, the plaintiff had made timely payments. Id. Once in default, however, the defendant sold the note to a buyer who promptly commenced foreclosure. Id. The court upheld the plaintiff's claim for promissory estoppel because, "[t]aking the facts in the light most favorable to the plaintiff, it could be found that [the defendant] encouraged [the plaintiff] to delay mortgage payment and, as a result of that reliance, the eventual buyer . . . took advantage of [the plaintiff's] vulnerable state by initiating foreclosure on [the plaintiff's] property interest." Id. While the court indicated that, to prevail at  trial, the plaintiff would need to establish that he "was misled or induced to believe that by defaulting he would achieve the discounted purchase of the note that he was seeking," 2000 Mass. Super. LEXIS 604, [WL] at *6, he was at least entitled to "th[is] opportunity to prove facts in support of his claim of detrimental reliance," 2000 Mass. Super. LEXIS 604, [WL] at *4.

In the present case, Wells Fargo convinced the Dixons that to be eligible for a loan modification they had to default on their payments, and it was only because they relied on this representation and stopped making their payments that Wells Fargo was able to initiate foreclosure proceedings. While there is no allegation that its promise was dishonest, it was only because they relied on this representation and stopped making their payments that Wells Fargo was able to initiate foreclosure proceedings. While there is no allegation that its promise was dishonest, Wells Fargo distinctly gained the upper hand by inducing the Dixons to open themselves up to a foreclosure action. In specifically telling the Dixons that stopping their payments and submitting financial information were the "steps necessary to enter into a mortgage modification," Wells Fargo not only should have known that the Dixons would take these steps believing their fulfillment would lead to a loan modification, but also must have intended that the Dixons do so. The bank's promise to consider them for a loan modification if they took those steps necessarily "involved as matter of fair dealing an undertaking on [its] part not to [foreclose] based upon facts coming into existence solely from" the making of its promise.

Wells Fargo’s decision to foreclose without warning was unseemly conduct at best. In the opinion of this Court, such conduct presents "an identifiable occasion for applying the principle of promissory Bebchuk & Ben-Shahar, supra at 457.

This Court, therefore, holds that the complaint states a claim for promissory estoppel: Wells Fargo promised to engage in negotiating a loan modification if the Dixons defaulted on their payments and provided certain financial information, and they did so in reasonable reliance on that promise, only to learn that the bank had taken advantage of their default status by initiating foreclosure proceedings. Assuming they can prove these allegations by a preponderance of the evidence, their damages appropriately will be confined to the value of their expenditures in reliance on Wells Fargo’s promise.

candidly explained."). It is the view of this Court that "[f]oreclosure is a powerful act with significant consequences," Ibanez, 458 Mass. at 655 (Cordy, J., concurring), and where a bank has obtained the opportunity to foreclose by representing an intention to do the exact opposite -i.e., to negotiate a loan modification that would give the homeowner the right to stay in his or her home - the doctrine of promissory estoppel is properly invoked under Massachusetts law to provide at least reliance-based recovery.

Having concluded that the Dixons' complaint states a claim for promissory estoppel, the Court now turns to Wells Fargo’s contention that this state-law cause of action is preempted by the federal statutory and regulatory scheme of HOLA. HOLA initially established the Federal Home Loan Bank Board to regulate the conduct of federal savings associations. Congress replaced the Board with the OTS when it amended HOLA in 1989.

Paragraph (c) lists state laws that HOLA is not presumed to preempt, including contract and commercial law, real property law, homestead laws, tort law, and criminal law. 12 C.F.R. § 560.2(c). Any other law that, in the estimation of the OTS, promotes a vital state interest and either has only an incidental effect on lending or is not otherwise contrary to the regulatory intent to "occupy the field" is also not preempted. Id. Courts, however, are to interpret paragraph (c) narrowly, with any doubt resolved in favor of preemption.

Without guidance from another court within the First Circuit and without clear direction from other federal and state courts across the nation, this Court agrees with Judge Posner's conclusion that, especially because HOLA does not give a private right of action, Congress could not have intended to deny all traditional state-law avenues of recourse to consumers who are harmed by the unseemly conduct of lenders.

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