Two of the more common adversary complaints against debtors in bankruptcy are objections to dischargeability under §§523(a)(2)(A) and 523(a)(6). The District Court for the Southern District of New York recently affirmed a ruling in favor of the debtor with a detailed analysis of the law in Reddy v Melnick, 2019 U.S.Dist.LEXIS 110330, Case# 3:18-CV-1197 (S.D. N.Y. 2 July 2019). The adversary proceeding was founded on a sale and financing of the purchase price of a dental practice from Reddy to Melnik. Melnik subsequently defaulted on the payments to Reddy, and filed for relief under chapter 7. Reddy then sought to have the debt determined nondischargeable under §523(a)(2)(A) for material misrepresentation, and under §523(a)(6) for transferring patient records to another practice.
The complaint under §523(a)(2)(A) asserted that Melnik misrepresented his marital status in the application. The bankruptcy court had determined that a) such misrepresentation was not material to the decision to sell the practice to Melnick give the use of a professional broker to mediate the transactions, b) there was no reliance on such representation before or at the time of the representation, and c) there was no evidence of fraudulent intent given the Debtor's credible testimony that he wanted to run a successful practice at the time he entered the transaction, and only later discovered the practice was not the 'turn-key' operation he had been led to expect; and that he had made payments on the lease and note and attempted to resell the practice when he determined he could not afford it.
In reviewing the bankruptcy court's decision, the appellate court first examined the statute.
Pursuant to 11 U.S.C. § 523(a)(2)(A), "[a] discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) 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— (A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor's or an insider's financial condition." 11 U.S.C. 523(a)(2)(A).
This section requires a creditor to show by a preponderance of the evidence five elements 1) the debtor made a misrepresentation; 2) the debtor knew the representation was false at the time it was made; 3) the representation was made with the intent to deceive the creditor; 4) the creditor relied on the representation; and 5) the creditor was injured by the representation and suffered damages as a result.1 In the case of a false representation a creditor must show 1) the debtor made a false or misleading statement 2) with intent to deceive, 3) in order for the creditor to turn over money or property to the debtor. In the case an action for false pretense rather than a false statement, conduct that makes an implication that is misleading is required. In either case, the creditor must prove misrepresentation, scienter, reliance, and harm.2
Reddy alleged misrepresentations as to marital status, that the financing was short term, and that Melnik failed to disclose child support and alimony obligations. The District Court found that Reddy failed to show that it was Melnik that made the representations as to the term of the financing, instead having been made by the broker. Reddy admitted that it did not ask Melnik for information about alimony or child support, not for any financial information at all; rather Reddy alleges it got such information from the broker, and offered no evidence that Melnik withheld information about such obligations from such brokers. As to the marital status, Reddy has not shown that Melnik made such statements that he was married to Ms. Melnik-Stuart with the intent to deceive Reddy to both selling him the practice and extending financing. Fraudulent intent cannot be presumed and any permissible inference will be negated when the debtor comes forward with some evidence that he did not intend to deceive the plaintiff.3
The trial court's finding as the the credibility of Melnik was supported in the record. There is no evidence that at the time Melnik entered into the transactions without a good faith intent to fulfill his contractual obligations. Rather the actions by Melnik and his ex-wife reflect an intent to work in the practice as expected. Two payments were mad eon the agreement, he applied for insurance company affiliations at the practice location even before the sale was final, both Melnik and the ex-wife spent time working at the practice, Melnik spent money for advertising, and the ex-wife left her job in New York City to move to an apartment they rented in Syracuse. The record showed that the ex-wife's decision to leave the practice and Melnik's inability to repay the loan were both based on events occurring after the sale and financing, and are therefore not indicative of a lack of good faith at the time of the transaction. Though Melnik and the ex-wife were not married at the time of the transaction, Melnik testified they continued to have a relationship, were attempting to reconcile, and intended to to run the business together.
Nor was the court convinced that Reddy satisfied his burden to show that the misrepresentations as to marital status were material or that Reddy relied on them. There were inconsistencies in Reddy's testimony in depositions and at trial as to such reliance. The evidence shows that rather than relying on the marital status, the reliance was more to the effect that the ex-spouse would be working at the practice in certain capacities to make things run smoothly and reduce overhead.
As to the court under 11 U.S.C. 523(a)(6) the court also found a lack of evidence meeting the creditor's burden of proof. This section provides
"[a] discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt — . . . for willful and malicious injury by the debtor to another entity or to the property of another entity." 11 U.S.C. 523(a)(6).
Willful requires deliberate or intentional conduct, while malicious means wrongful or without just cause or excuse, even in the absence of personal hatred, spite, or ill-will.4 Reddy alleges that Melnik's actions in transferring patient files to a nearby Aspen Dental location destroyed the remaining goodwill in the practice, and made it impossible for Reddy to resell the practice to someone else. The Bankruptcy Court determined that the transfer occurred after Reddy commenced eviction proceedings and after rejecting an offer related to the sale of the practice to a third party; and that the transfer did not suggestion tortious conduct by Melnik.
While noting numerous personal attacks against Melnik's character in creditor's briefs, the District Court found no citation to actual evidence supporting the claim. At the time Melnik sent the patients letters announcing the closing of the practice the 'new buyer' had not yet entered a contract for such purchase. Melnik testified that he was willing to sell the practice, but Reddy imposed conditions on Melnik, including that Melnik would be liable for the entire debt if the new buyer defaulted, and that Melnik would be required to make a large up-front payment of all past due amounts plus rent and fees until the sale was finalized, and that Melnik would not file bankruptcy, that Melnik could not agree to. Also, as the time of the negotiations as to such sale Melnik had already been evicted from the premises, such that the decision to close the practice was more a matter of practical necessity than a malicious action.
Thus the Bankruptcy Court's finding that the debt was discharged was sustained on appeal.
1 In re Williams, 579 B.R. 314, 323 (S.D.N.Y. Bankr. 2016)↩
2 In re Cahill, 2017 Bankr. LEXIS 501, 2017 WL 713565, at *7 (citing Husky Int'l Elecs., Inc. v. Ritz, 136 S.Ct. 1581, 1586, 194 L. Ed. 2d 655 [2016]; Evans v. Ottimo, 469 F.3d 278, 283 [2d Cir. 2006])↩
3 In re Williams, 579 B.R. at 323↩
4 In re Stelluti, 94 F.3d 84, 87-88 (2d Cir. 1996).↩
Michael Barnett
Michael Barnett, PA
506 N Armenia Ave.
Tampa, FL 33609-1703
813 870-3100
https://hillsboroughbankruptcy.com