Opinion
NOT FOR PUBLICATION
Argued and Submitted at Sacramento, California: May 20, 2005
Appeal from the United States Bankruptcy Court for the Eastern District of California. Honorable David E. Russell, Bankruptcy Judge, Presiding. Bk. No. 03-24832-C-7. Adv. Nos. 03-02402. 03-02403.
Before: SMITH, PERRIS and MARLAR, Bankruptcy Judges.
MEMORANDUM
The debtors, Aaron D. Loos (" Loos" or " Debtor") and Alice M. Loos (" Mrs. Loos")(collectively, " Debtors"), appeal final judgments of the bankruptcy court, entered on May 5, 2004, which rendered the debts owed to Stanley Ayers (" Ayers") and Brian Baniqued (" Baniqued")(collectively " Plaintiffs") nondischargeable. We VACATE and REMAND.
The bankruptcy court made a finding as to Loos and not Mrs. Loos and held that Plaintiffs " take nothing against" Mrs. Loos. Nevertheless, both Debtors appealed.
FACTS
Debtors filed a voluntary chapter 7 petition on April 29, 2003. On July 25, 2003, Ayers and Baniqued initiated separate adversary proceedings against Debtors objecting to discharge under § § 727(a)(3) and (a)(5). The complaints each alleged that Loos was hired to manage Plaintiffs' respective apartment buildings and that under the terms of the management agreements, Loos was to " advertise and lease units, collect rents, pay bills for services and supplies, and perform necessary repairs." According to Plaintiffs, Loos failed to perform the duties as required. Specifically, Loos failed to " provide [Plaintiffs] with invoices and other documentation sufficient to justify the amounts of rent retained."
Unless otherwise indicated, all chapter, section and rule references are to the Bankruptcy Code, 11 U.S.C. § § 101-1330, and to the Federal Rules of Bankruptcy Procedure, Rules 1001-9036.
Prior to the bankruptcy filing, both Ayers and Baniqued had commenced litigation against Loos. Ayers had filed a complaint in state court for breach of contract, breach of implied covenant of good faith and fair dealing, conversion, and breach of fiduciary duty. However, the bankruptcy case was filed before the complaint could be served. Baniqued had commenced an arbitration proceeding asserting the same claims, as well as intentional misrepresentation and fraud, and obtained an arbitration award in the amount of $20, 530.32 prior to the bankruptcy. The arbitration award, however, makes no findings regarding any of the specific charges.
The trial in both adversary proceedings was set for February 5, 2004. On January 30, 2004, just six days prior to the trial and without leave of the court, Plaintiffs filed a pleading which apparently sought to amend the complaint to add exceptions to discharge under § 523. At trial, Plaintiffs' attorneys orally moved to amend the complaint and explained the basis for the proposed amendment:
The adversaries were consolidated for purposes of trial. Though Debtor has raised an objection to the " conjoining" of the proceedings on appeal, no objection was made prior to or during the trial. In any event, the consolidation of the two actions seeking the denial of discharge under identical subsections of § 727 is not clearly erroneous.
The docket reflects the filing of a document entitled " Supplemental Filing/Support By Plaintiff Brian Baniqued To . . . Complaint 727 Objection" on January 30, 2004. At trial, Plaintiffs' counsel identified the supplemental pleading as one purporting to add § 523 exceptions. However, as the document was not submitted as part of the record on appeal, its content is unknown.
Bildhauer: [Plaintiffs] had spoken with the clerk who suggested that we file 523 to give - anyway, we wanted to give you another option in the event that you felt specific exception was equitable, as to oppose - as opposed to a total conclusion of discharge.
Mathias Bildhauer (" Bildhauer") appeared at trial on behalf of the Plaintiffs and Eric Farber (" Farber") served as co-counsel. Transcript of Proceedings, February 5, 2004, p. 4.
Transcript of Proceedings, February 5, 2004, p. 11.
Debtors opposed the motion for leave on the ground that they did not receive adequate notice pursuant to Fed.R.Civ.P. 15 (as incorporated by Fed.R.Bankr.P. 7015):
Loos: Under Rule 7015 it is okay to convert it from a 727 to a 523, but thirty days needs to be given advance notice, a motion needs to be filed, summons to the court, an order needs to be signed, and that was never accomplished. The [P]laintiffs' attorney has said that he filed [the amended complaint] two or three weeks ago, but, again, the facts in the docket show that it was filed on the mere eve of trial attempting to convert it from everyone being discharged on the 727 to only their clients being discharged on the 727, so I object to the conversion.
Loos represented himself pro se at trial.
Id. at p. 10.
The court agreed with Loos and denied the oral motion for leave to amend, as well as the admission of all evidence in support of the § 523 claims:
The Court: Well, I'm definitely very troubled by [the amended complaint]. I have not had such a situation occur before. I am aware that there is provision about changing or amending a pleading, which would be the complaint, I suppose, at the end of the trial if the evidence that comes in is admitted and the evidence shows that another cause of action or another approach could be satisfied by the evidence that was permitted. Here, however, we have someone who is objecting from the beginning of the proceeding about the change in the complaint. Again, without having - had this matter come before previously, I still think I have to make a decision on this morning in regard to it [sic] because the matter has been set for trial, we have proceeded this far to get to trial. And I must - I think I agree with the debtor, I'm going to deny the amendment of the complaint.
Id. at p. 17 (emphasis added).
The Court: . . . I have omitted or not taken in or not permitted Plaintiff Baniqued's objection to discharge supplemental filing because that does refer almost entirely to 523, and I don't think it's applicable to 727, that is going to be excluded . . . .
Id. at 20.
Thereupon, the trial proceeded as scheduled. The court heard testimony and reviewed evidence in support of the objection to discharge under § 727. At various points in the proceeding, Loos objected to evidence directed to § 523 allegations and the court seemed to take great pains to limit the evidence admitted to that which supported denial of discharge under § 727.
At the close of trial, and after both parties had rested, Plaintiffs once again moved to amend the complaint to assert exceptions to discharge under § 523. At this point, the court and Plaintiffs engaged in a curious round of negotiation:
Farber: At this time I would like to make a motion to amend the pleadings to amend the complaint to add 523. I believe that the evidence has clearly shown in this that 523 is applicable code and complaint to be added.
The Court: Are you going to waive the denial of discharge?
Farber: Are you going to allow me to amend 523?
The Court: I may very well allow you to amend your pleadings to show 523 if you will remove your request for denial of discharge.
Farber: I do so.
The Court: All right. Very well. We will remove the - your request is granted.
Id. at 175-176.
The bankruptcy court explained its rationale for reversing its earlier decision:
The Court: . . . And I have a very specific reason why I permitted the change at the last minute, when previously I had ruled that it would not be permitted, that is because I think you were going to lose the other one, and that is far more devastating to you than 523(a)(2), which I think has been proven here.
We know that - it's weird the way the facts came into this case, I guess, because we initially had started with a 727, there was a request to change it to a 523, which I denied, and then we moved in the evidence under 523 - I mean, under 727(a)(3) and (5). What I think the evidence clearly shows is that there was an effort by you, Loos, to deceive these parties. I think that the financial statements that you gave them were wrong. I think that you made up those statements deliberately for the purpose of taking their money and not giving them an honest accounting of what happened to the money. I have no doubt that you spent some monies on repairs, I have no doubt that you did a lot of the repair work yourself, but you had a duty to your clients to present them with or provide to them an appropriate accounting, which you didn't do. And from that I can only conclude that you had taken money that didn't belong to you under this management - under these management agreements.
I think that was - that you had the intent at the time you took the money to misrepresent what you were doing to Dr. Ayers and Baniqued - pardon me, Baniqued. That because you had the intent to take the money, that you made material misrepresentations to them about what happened during the time that you were operating the management agreements with them.
Id. at 176-77.
The court thereafter ruled in favor of Plaintiffs pursuant to § § 523(a)(2)(A) and (a)(4) as follows:
1. Debtor Aaron Loos, in his dealings with [Plaintiffs], through false accountings, false representations and actual fraud, violated 11 U.S.C. Section 523(a)(2)(A).
2. Debtor Aaron Loos, as [Plaintiffs' Real Property Manager], engaged in fraud, or defalcation while acting in a fiduciary capacity and embezzled rents and other funds and therefore violated 11 U.S.C. Section 523(a)(4).
The bankruptcy court awarded Baniqued $20, 530.32, which was the amount of the arbitration award, as being excepted from discharge. As to Ayers, the proceeding was continued to February 8, 2005 for further findings on damages. On that date, the bankruptcy court awarded a judgment in the amount of $22, 494.51. Transcript of Proceedings, February 8, 2005, p. 41.
ISSUE
Whether bankruptcy court abused its discretion in granting the motion for leave to amend the § 727 complaint to add § 523 exceptions to discharge at the conclusion of trial.
Debtors also assert on appeal: (1) the bankruptcy court failed to hold the Plaintiffs responsible for late filings, including the amended complaint, which handicapped their defense; (2) impartiality and clarity were impaired by the consolidation of the two adversary proceedings; (3) " [Baniqued] in his capacity as an agent in contract with the plaintiff was authorized to do repairs without holding a contractor's license; " and (4) the " absence of testimony, expert witness, etc. to expound a perfect affirmative defense gave sure and right precedent to the bench to generally and specifically award a carte blanc [sic] judgment to plaintiff."
JURISDICTION
The bankruptcy court had jurisdiction under 28 U.S.C. § 1334 and § 157(b)(1)(and (b)(2). This Panel has jurisdiction under 28 U.S.C. § 158(b)(1).
STANDARD OF REVIEW
Leave to amend a complaint is generally within the discretion of the bankruptcy court and is reviewed under the abuse of discretion standard. Mende v. Dun & Bradstreet, Inc., 670 F.2d 129 (9th Cir. 1982); Waters v. Weyerhaeuser Mortg. Co., 582 F.2d 503, 507 (9th Cir. 1978); Komie v. Buehler Corp., 449 F.2d 644, 648 (9th Cir. 1971). Even under the abuse of discretion standard, the bankruptcy court's decision is reversible if it is based upon an incorrect legal conclusion. In re Dominguez, 51 F.3d 1502, 1508 n.5 (9th Cir. 1995); Magno v. Rigsby (In re Magno), 216 B.R. 34, 38 (9th Cir. BAP 1997) (citation omitted). Whether an amendment relates back to the date of the original pleading under Fed.R.Civ.P. 15(c)(2) is a legal question which we review de novo. Id.; Martell v. Trilogy, Ltd., 872 F.2d 322, 325 (9th Cir. 1989).
DISCUSSION
Leave to amend pleadings " shall be freely given when justice so requires." Fed.R.Civ.P. 15. The Ninth Circuit applies this rule with " extreme liberality." Forsyth v. Humana, Inc., 114 F.3d 1467, 1482 (9th Cir. 1997)(citing Morongo Band of Mission Indians v. Rose, 893 F.2d 1074, 1079 (9th Cir. 1990)).
Fed.R.Civ.P. 15, made applicable in an adversary proceedings by Rule 7015, provides in part:
In exercising its discretion, a bankruptcy court " must be guided by the underlying purpose of Rule 15 to facilitate decision on the merits, rather than on the pleadings or technicalities." In re Magno, 216 B.R. at 38; United States v. Webb, 655 F.2d 977, 979 (9th Cir. 1981). A bankruptcy court considers the following factors in determining whether a motion to amend should be granted: " (1) undue delay; (2) bad faith; (3) futility of amendment; and (4) prejudice to the opposing party." Hurn v. Ret. Fund Trust of the Plumbing, Heating & Piping Indus., 648 F.2d 1252, 1254 (9th Cir. 1981); In re Magno, 216 B.R. at 38.
Here, the prejudice to Debtor is so overwhelming that it alone is enough to prompt remand. However, for completeness, the Panel will consider all four factors.
1. Undue Delay
Plaintiffs initiated this adversary proceeding on July 25, 2003. The request to amend the complaint was filed seven months after the commencement of the adversary proceeding and just six days before trial; the oral motions for leave were made at trial. No explanation for the extraordinary delay in seeking the amendment has ever been offered by Plaintiffs.
2. Bad Faith
Nothing in the record suggests that Plaintiffs acted in bad faith.
3. Futility of Amendment
There is no question that the amendment to the complaint was allowed after the June 10, 2003 deadline for the filing of a complaint under § 523. Therefore, if the amendment did not relate back to the original complaint it would have been a " futile gesture for the bankruptcy court to grant leave to amend." In re Magno, 216 B.R. at 38.
Rule 4007(c) provides:
Under the Fed.R.Civ.P. 15(c)(2):
An amendment of a pleading relates back to the date of the original pleading when the claim or defense asserted in the amended pleading arose out of the conduct, transaction, or occurrence set forth or attempted to be set forth in the original pleading.
Thus, the new claim should be capable of being proven by the " same kind of evidence offered in support of the original pleading." 216 B.R. at 39 (ciation omitted). Indeed, the " focus of the inquiry is on the factual allegations made in the two complaints so as to give the opposing party fair notice of the claims against him." Id. (citing In re Dean, 11 B.R. 542 (9th Cir. BAP 1981), aff'd, 687 F.2d 307 (9th Cir. 1982)). In Dean, we observed:
The basic test is whether the evidence with respect to the second set of allegations could have been introduced under the original complaint, liberally construed; or, as a corollary, that in terms of notice, one may fairly perceive some identification or relationship between what was pleaded in the original and amended complaints.
Though it is not clear from the record which specific subsections of § 523 Plaintiffs sought to add to the complaint, it is abundantly clear that the evidence required to support denial of discharge under § 727(a)(3) and (a)(5) was not factually similar to the bankruptcy court's ultimate findings under § § 523(a)(2)(A) and (a)(4).
Section 727 provides, in relevant part:
Sections 523(a)(2)(A) and (a)(4) provide:
For example, the bankruptcy court found that Loos violated § 523(a)(2)(A) in his dealings with Ayers through false accountings, false representations, and actual fraud. Significantly, the bankruptcy court made a finding of fraud where no requirement of fraud exists under either § 727(a)(3) or § 727(a)(5). Additionally, the bankruptcy court also found the existence of a " fiduciary relationship" under § 523(a)(4) though no such requirement exists under § § 727(a)(3) or (a)(5). The elements required to prove discharge exceptions under § § 523(a)(2)(A) and (a)(4) simply do not fit into the requirements for establishing denial of discharge under § § 727(a)(3) and (a)(5). In Magno, we declined to affirm a court's decision to allow an amended pleading which added a new claim under § 523 to a § 727 complaint, reasoning that:
To prove a § 523(a)(6) claim, [plaintiff] must show that there was an intentional act by debtor which caused injury to [plaintiff] or their property. On the other hand, under § 727(a)(2)(A), there must be findings that debtor concealed his property with the intent to hinder, delay, or defraud a creditor. Section 727(a)(4)(A) requires a finding that Debtor knowingly and fraudulently made a false oath or account in, or in connection with, the case. ¶ The elements under § 523(a)(6) are not included in those required for § 727 and are clearly distinct from them. Even under a liberal definition of lesser-included claim, the 523(a)(6) claim does not fit the definition.
In re Magno, 216 B.R. at 42 (citations omitted).
Here, it is clear that the evidence required to establish the § 727 claims on the one hand, and the § 523 claims on the other, are not identical, or even related.
4. Prejudice to Debtor
Notwithstanding the court's unequivocal denial of the motions to add the discharge exceptions under § 523 at the outset of trial and its limitation of the evidence to the § 727 allegations during trial, the court nevertheless allowed the amendments at the close of the trial.
At oral argument, Plaintiffs' counsel conceded that the fraud evidence was introduced on rebuttal.
The bankruptcy court abused its discretion by allowing the post-trial amendments. The prejudice to Debtors, who proceeded throughout trial under the belief that the allegations and evidence against them were solely rooted in § 727, was substantial. Simply put, the bankruptcy court effectively deprived Debtors of a defense. As the Fehrle court so eloquently articulated:
The recitation of a specific cause of action, and the selection of a particularized section of the Bankruptcy Code under which to proceed, both profoundly affect the nature of the resulting defense. To construct a complaint invoking a general denial of discharge inspires an altogether different form of defense from that which would be forthcoming in the case of a complaint seeking to have a particular debt excepted from discharge. The whole theory of the defense and the elements of its rebuttal proof are radically distinguishable in the two types of cases.
In re Fehrle, 34 B.R. 974, 975 (Bankr. W.D. Ky. 1983).
As stated above, and as implicitly recognized by the court itself, the proof requirements under § § 727(a)(3) and (a)(5) do not include fraud or the existence of a fiduciary relationship. Thus, Debtors defended the § 727 claims without regard for, among other things, presenting evidence relating to Loos' intent (or lack thereof) to deceive Plaintiffs, Plaintiffs' reliance on alleged misrepresentations, or the existence (or lack thereof) of a fiduciary relationship between Loos and Plaintiffs. Allowing Plaintiffs to completely abandon the original focus of the complaint at the end of the trial, after the bankruptcy court clearly denied the amendment at the outset, substantially prejudiced Debtor.
CONCLUSION
We VACATE and REMAND to the bankruptcy court with instructions to: (1) set aside the withdrawal of the § 727 complaints; and (2) enter findings and judgment as appropriate under § § 727 (a)(3) and (a)(5).
The Panel does not address these issues primarily because, in our view, the dispositive issue on appeal is whether the court abused its discretion when it granted the motion for leave to amend the complaint at the conclusion of the trial.
(a) A party may amend the party's pleading once as a matter of course at any time before a responsive pleading is served or, if the pleading is one to which no responsive pleading is permitted and the action has not been placed upon the trial calendar, the party may so amend it at any time within 20 days after it is served. Otherwise a party may amend the party's pleading only by leave of court or by written consent of the adverse party; and leave shall be freely given when justice so requires. A party shall plead in response to an amended pleading within the time remaining for response to the original pleading or within 10 days after service of the amended pleading, whichever period may be the longer, unless the court otherwise orders.
A complaint to determine the dischargeability of a debt under § 523(c) shall be filed no later than 60 days after the first date set for the meeting of creditors under § 341(a). The court shall give all creditors no less than 30 days' notice of the time so fixed in the manner provided in Rule 2002. On motion of a party in interest, after hearing on notice, the court may for cause extend the time fixed under this subdivision. The motion shall be filed before the time has expired. Pursuant to the court's Notice of Filing Report of No Distribution Combined with Order Fixing Deadline to Object Thereto, the deadline for filing a nondischargeability complaint was June 10, 2003.
(a) The court shall grant the debtor a discharge, unless --. . . . (3) the debtor has concealed, destroyed, mutilated, falsified, or failed to keep or preserve any recorded information, including books, documents, records, and papers, from which the debtor's financial condition or business transactions might be ascertained, unless such act or failure to act was justified under all of the circumstances of the case; [or]. . . . (5) the debtor has failed to explain satisfactorily, before determination of denial of discharge under this paragraph, any loss of assets or deficiency of assets to meet the debtor's liabilities[.]
(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 (2)(A) for money, property, services, or an extension, renewal or refinancing of credit, to the extent obtained by false pretenses, or actual fraud, other than a statement respecting the debtor's or an insider's financial condition; [or] (4) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny[.]