Opinion
CASE NO. SV 02-15899 GM.
September 13, 2005
FINDINGS OF FACT AND CONCLUSIONS OF LAW ON COMPLAINT FOR DENIAL OF DISCHARGE AND FOR NON-DISCHARGEABILITY OF DEBT
On December 30, 2002, Plaintiff Knapp, Petersen Clarke filed its Complaint to Deny Discharge and to Determine Debt to be Non-dischargeable. On February 28, 2003, Plaintiff James Andrew Hinds, Jr. filed its Complaint to Deny Debtor Discharge and to Determine Non-dischargeability of Debts Owed to Plaintiff. These Complaints were administrative consolidated. Trial was held on September 13, 2005.
FINDINGS OF FACT
1. Setsu Hechtman is a resident of the State of California, County of Los Angeles and is the Debtor in this pending chapter 7 case. At all times relevant hereto Defendant was married to Rick Hechtman, although they lived separately during some of the time between the years 2000 and 2005.
2. Setsu Hechtman along with Rick Hechtman retained Plaintiff James Andrew Hinds, Jr. and the Law Offices of James Andrew Hinds, Jr. and Plaintiff Knapp, Petersen Clarke to represent Rick Hechtman in various matters related to Rick Hechtman's then pending chapter 7 case filed before this Court.
3. In or about January of 1998, Rick Hechtman was introduced to Plaintiff James Andrew Hinds, Jr. by Dale Motley, Rick Hechtman's attorney in criminal matters related to his pending chapter 7 case. Rick Hechtman requested that Plaintiff James Andrew Hinds, Jr. represent him in various adversary proceedings filed against him in his chapter 7 case.
4. In conjunction with the proposed engagement, Plaintiff James Andrew Hinds, Jr. met with Rick and Setsu Hechtman at least twice before the engagement was agreed to. During these meeting Setsu and Rick Hechtman orally and in writing represented to Plaintiff James Andrew Hinds, Jr. that (i) Setsu Hechtman was the heir of a substantial sum of money which was held solely in her name, (ii) that Setsu Hechtman was willing to guarantee the payment of the fees incurred by Plaintiff James Andrew Hinds, Jr. in defending Rick Hechtman in his chapter 7 case and in the adversary proceedings, and (iii) that the sums controlled by Setsu Hechtman were large enough to satisfy any future fees incurred by Plaintiff James Andrew Hinds, Jr.
5. In conjunction with the proposed engagement, Rick and Setsu Hechtman showed Plaintiff James Andrew Hinds, Jr. written documentation verifying the existence of a brokerage account in the name of Setsu Hechtman which was to be the primary source of payment of the fees and costs incurred in the defense of Rick Hechtman. Mr. Hinds thought that the brokerage statement shown to him was held at Charles Schwab, but was not completely sure.
6. Rick Hechtman represented to the court in his chapter 7 case, his creditors, and his chapter 7 trustee that he had no personal assets. In reliance on these statements and verification of the Schedules filed by Rick Hechtman in his chapter 7 case, Plaintiff James Andrew Hinds, Jr. only agreed to take on the representation of Rick Hechtman if Setsu Hechtman guaranteed the fees and costs and represented that she had the funds available to her to make these payments based on her own funds and assets.
7. In conjunction with the 1998 pre-engagement discussions, Rick and Setsu Hechtman orally and in writing represented to Plaintiff James Andrew Hinds, Jr. that they controlled under the name of Setsu Hechtman substantial assets in a stock brokerage account sufficient to pay all of the fees and costs incurred by Plaintiff James Andrew Hinds, Jr. in the proposed representation of Rick Hechtman in adversary proceedings filed in Rick Hechtman's chapter 7 case.
8. On or about April 6, 1998, Setsu Hechtman executed an Engagement Letter with Plaintiff James Andrew Hinds, Jr. pursuant to which Hinds agreed to represent Rick Hechtman and Setsu Hechtman agreed to be responsible for all of the debts incurred by Plaintiff James Andrew Hinds, Jr. in this engagement.
9. On the second page of the Engagement Letter there is the following representation: "You understand that as a result of your recent chapter 7 filing and your representations to the Court, your creditors, and the chapter 7 trustee that you have no personal assets, we are asking that you and your wife sign this Engagement Letter binding both of you to make the payments required hereunder. Each party signing below is jointly and severally responsible for all obligations due us and have full authority to execute this agreement so that it is binding."
10. Plaintiffs have proven that, in March of 1998, neither Rick nor Setsu Hechtman controlled any such brokerage account nor were there sufficient funds available to Rick and Setsu Hechtman to satisfy the fees and costs which were then reasonably contemplated to be incurred in the engagement. The representations made to Plaintiff James Andrew Hinds, Jr. were made to induce his reasonable and justified reliance thereon and to provide needed legal services to Rick Hechtman at a time when, without the misrepresentations, no such representations would have been provided by Plaintiff James Andrew Hinds, Jr.
11. In February of 1998, Rick Hechtman was referred to Plaintiff Knapp, Petersen Clarke by Plaintiff James Andrew Hinds, Jr. to represent Rick Hechtman in nondischargeability litigation related to his then pending chapter 7 case brought by various third parties. In conjunction with the request to have Plaintiff Knapp, Petersen Clarke undertake this representation, Setsu Hechtman represented to Mitchell Ludwig of Plaintiff Knapp, Petersen Clarke that (I) Setsu Hechtman was the heir of a substantial sum of money which was held solely in her name, (ii) that Setsu Hechtman was willing to guarantee the payment of the fees incurred by Plaintiff Knapp, Petersen Clarke in defending Rick Hechtman in his chapter 7 case and in the adversary proceedings, (iii) that the sums controlled by Setsu Hechtman were large enough to satisfy any future fees incurred by Plaintiff Knapp, Petersen Clarke, and (iv) that Setsu Hechtman had kept these interests and sources of income solely in her name in order to protect them from Rick Hechtman's creditors. Based on the foregoing representations, and in light of the fact that Rick Hechtman was then in a no-asset chapter 7 liquidation case, Plaintiff Knapp, Petersen Clarke only agreed to take on the representation of Rick Hechtman if Setsu Hechtman guaranteed the fees and costs and represented that she had the funds available to her to make these payments based on her own funds and assets.
12. In conjunction with the 1998 pre-engagement discussions, Rick and Setsu Hechtman orally represented to Plaintiff Knapp, Petersen Clarke that they controlled under the name of Setsu Hechtman substantial assets in a stock brokerage account sufficient to pay all of the fees and costs incurred by Plaintiff Knapp, Petersen Clarke in the proposed representation of Rick Hechtman in adversary proceedings filed in Rick Hechtman's chapter 7 case.
13. On or about February 17, 1998, both Rick and Setsu Hechtman executed an Acknowledgment of Conflict/Legal Services Agreement with Plaintiff Knapp, Petersen Clarke, pursuant to which Knapp, Petersen Clarke agreed to represent Rick Hechtman, and both Rick and Setsu Hechtman agreed to be responsible for all of the debts incurred by Plaintiff Knapp, Petersen Clarke in this engagement.
14. On the third page of the Acknowledgment of Conflict/Legal Services Agreement there is the following representation: "Each client is jointly and severally liable to Attorney for payment of the fees and costs under this Agreement."
15. Plaintiffs have proven that, in March of 1998, neither Rick nor Setsu Hechtman controlled any such brokerage account nor were there sufficient funds available to Rick and Setsu Hechtman to satisfy the fees and costs which were then reasonably contemplated to be incurred in the engagement. The representations made to Plaintiff Knapp, Petersen Clarke were made to induce reasonable and justified reliance thereon and the provision of needed legal services to Rick Hechtman at a time when, without the misrepresentations, no such representations would have been provided by Plaintiff Knapp, Petersen Clarke.
16. Not having timely paid their bill, on or about March 16, 2000, after extensive negotiations between Plaintiff Knapp, Petersen Clarke and Rick and Setsu Hechtman's attorney, Dale Motely, Rick and Setsu Hechtman executed a Promissory Note setting forth their agreement to pay off their debt in the sum of $41,168.45 to Plaintiff Knapp, Petersen Clarke.
17. On October 16, 2000, Rick and Setsu Hechtman executed a Modification to Note, the essential terms of which were that the original terms of the Promissory Note would be modified and Plaintiff Knapp, Petersen Clarke would accept an immediate payment of $8,000.00 from Rick and Setsu Hechtman, to be followed by payment of $21,168.45 in installments.
18. In connection with the modification of the Note, Setsu Hechtman represented to Plaintiff Knapp, Petersen Clarke that she had an interest in real estate that was about to be sold. Setsu Hechtman represented that her Aunt had bequeathed said real property to Setsu Hechtman and that she was the sole heir and that upon the sale of the property, Plaintiff Knapp, Petersen Clarke would be paid in full. Setsu Hechtman later claimed that there were glitches in the sale of the property, but that when it was sold, payment to Plaintiff Knapp, Petersen Clarke would be made.
19. Setsu Hechtman commenced this bankruptcy case by filing a voluntary petition under chapter 7 of Title 11 of the United States Code on June 28, 2002.
20. Plaintiff James Andrew Hinds, Jr. and Plaintiff Knapp, Petersen Clarke timely filed their respective adversary proceedings under 11 U.S.C. §§ 523(a) and 727(a).
21. Contrary to the representations made to Plaintiff James Andrew Hinds, Jr. and Plaintiff Knapp, Petersen Clarke, Setsu Hechtman has never owned an interest in substantial stocks and cash in the form of a brokerage account held in her name at Charles Schwab or any other brokerage company in 1998 or thereafter.
22. Contrary to the representations made to Plaintiff James Andrew Hinds, Jr. and Plaintiff Knapp, Petersen Clarke, in 1998, Setsu Hechtman did not have the ability to pay all of the fees and costs associated with the representation of Rick Hechtman in the adversary proceedings pending in his chapter 7 case.
23. Plaintiff James Andrew Hinds, Jr. reasonably and justifiably relied upon the oral and written representations made by Rick and Setsu Hechtman and the written representation made by Setsu Hechtman in the April 6, 1998 Engagement Letter.
24. Plaintiff Knapp, Petersen Clarke reasonably and justifiably relied upon the oral and written representations made by Rick and Setsu Hechtman and the written representation made by Rick and Setsu Hechtman in the February 17, 1998 Acknowledgment of Conflict/Legal Services Agreement.
25. Plaintiff James Andrew Hinds, Jr. has been damaged and harmed by the conduct and actions of Setsu Hechtman in a sum of not less than $19,808.56.
26. Plaintiff Knapp, Petersen Clarke has been damaged and harmed by the conduct and actions of Setsu Hechtman in a sum of not less than $21,168.45.
27. Setsu Hechtman has defrauded Plaintiff James Andrew Hinds, Jr. by misleading Plaintiff James Andrew Hinds, Jr. prior to the execution of the Engagement Letter regarding her assets and resources and her ability to pay the claims of Plaintiff James Andrew Hinds, Jr. under the terms of the Engagement Letter.
28. Setsu Hechtman has defrauded Plaintiff Knapp, Petersen Clarke by misleading Plaintiff Knapp, Petersen Clarke prior to the execution of the Acknowledgment of Conflict/Legal Services Agreement regarding her assets and resources and her ability to pay the claims of Plaintiff Knapp, Petersen Clarke under the terms of the Acknowledgment of Conflict/Legal Services Agreement.
29. Setsu Hechtman testified during her Rule 2004 Exam that she executed the Engagement Letter with Plaintiff James Andrew Hinds, Jr. on April 6, 1998.
30. In conjunction with the execution of the April 6, 1998 Engagement Letter with Plaintiff James Andrew Hinds, Jr., Setsu Hechtman admitted that she understood and agreed to the terms of the guarantee of the debts incurred as part of the representation of Rick Hechtman in his chapter 7 case.
31. In conjunction with the execution of the February 17, 1998 Acknowledgment of Conflict/Legal Services Agreement with Plaintiff Knapp, Petersen Clarke, Setsu Hechtman admitted that she understood and agreed to the terms of the guarantee of the debts incurred as part of the representation of Rick Hechtman in his chapter 7 case.
32. In his trial testimony, Rick Hechtman claimed that Setsu Hechtman had not understood that she had guaranteed his fees and contracted Setsu Hechtman's own deposition testimony.
33. Setsu Hechtman moved frequently and appears to have lost some of her records as a consequence. Nonetheless, she has provided, to use Mr. Hind's words, a "stack of documents" that took real effort to dig up, including escrow commission checks, W-2 forms, federal and state tax returns, cancelled checks, bank statements, a vehicle registration card, an insurance card, an order describing her 1/12 interest in residential real estate, installment notes, and a personal property appraisal.
34. Rick Hechtman's testimony at trial was not credible. He was evasive and frequently contradicted himself. He purposely obfuscated the nature of his earlier fraud conviction and evaded any details of his or his wife's financial dealings. He appears to have dissipated any funds he could get access to, including those of his wife and her family.
35. Setsu Hechtman did not testify at trial and relied solely on her deposition testimony, which was filed in its entirety.
CONCLUSIONS OF LAW
1. This adversary proceeding is brought in connection with Setsu Hechtman's pending chapter 7 case and thus this Court has jurisdiction over this adversary proceeding pursuant to 28 U.S.C. §§ 157 and 1334. This is a core proceeding under 28 U.S.C. § 157(b)(2).
2. Venue for this proceeding is proper in this Court pursuant to 28 U.S.C. § 1409.
3. This proceeding to determine the dischargeability of debt is an Adversary Proceeding within the meaning of Federal Rule of Bankruptcy Procedure 7001(6).
4. Under 11 U.S.C. § 523(a)(2) "[a] finding that a debt is non-dischargeable under [§] 523(a)(2)(A) requires a showing of actual or positive fraud, not merely fraud implied by law." In re Anastas, 94 F.3d 1280, 1286 n. 3 (9th Cir. 1996) (citation omitted).
5. The burden of proof for actions under § 523(a) of the Code is on the Plaintiff to prove each of the elements of his claim under § 523(a)(2) by a preponderance of the evidence. Grogan v. Garner, 498 U.S. 279, 287, 112 L. Ed. 2d 755, 111 S. Ct. 654 (1991). Thus, to establish a claim under § 523(a)(2)(A), Plaintiff is required to establish by a preponderance of the evidence that Setsu Hechtman made a misrepresentation of fact or failed to disclose material information on her financial condition.
6. In order to establish dischargeability under § 523(a)(2)(A), the Plaintiff must prove that Setsu Hechtman had an intent to deceive; that is, that Setsu Hechtman made the alleged misrepresentations with "scienter." In the Matter of Sheridan, 57 F.3d 627 (7th Cir. 1995). The scienter element inherent in § 523(a)(2)(A) refers to intent to deceive, manipulate, or defraud.Ernst Ernst v. Hochfelder, 425 U.S. 185, 193, 47 L. Ed. 2d 668, 96 S. Ct. 1375 (1976). This requirement may be met in one of several ways: if the maker of the misrepresentation "(a) knows or believes that the matter is not as he represents it to be; (b) does not have the confidence in the accuracy of his representation that he states or implies; or (c) knows that he does not have the basis for his representation that he states or implies." Rest. (Second) of Torts § 526; see also W. Page Keeton, et al., Prosser and Keeton on the Law of Torts, § 107, at pp. 740-42.
7. Under § 523(a)(2)(A), Plaintiff is required to show through competent evidence that he justifiably relied on the actions and conduct of Setsu and Rick Hechtman. Field v. Mans, 516 U.S. 59, 61, 116 S. Ct. 437, 439 (1995). The justifiable reliance standard is an individual standard that requires examination of the surrounding circumstances and the qualities of the particular plaintiff. Id. at 71 ("the qualities and characteristics of the particular plaintiff, and the circumstances of the particular case, rather than of the application of a community standard of conduct to all cases"). In general, the standard does not require a duty to investigate; however, once a creditor has reason to suspect that he is being deceived, he then has a duty to investigate. Id.
8. In the Ninth Circuit, the inquiry is whether the creditor justifiably relied in light of the subjective effect of the circumstances. In re Kirsh, 973 F.2d 1454, 1460 (9th Cir. 1992); In re Vann, 67 F.3d 277, 283 (11th Cir. 1995) (stating that to constitute justifiable reliance "the plaintiff's conduct must not be so utterly unreasonable, in the light of the information apparent to him, that the law may properly say that his loss is his own responsibility."). As a comment to § 541 of Restatement of Torts (Second) explains, a person is "required to use his senses, and cannot recover if he blindly relies upon a misrepresentation the falsity of which would be patent to him if he had utilized his opportunity to make a cursory examination or investigation. . . . On the other hand, the rule stated in this section applies only when the recipient of the misrepresentation is capable of appreciating its falsity at the time by the use of his senses. Thus a defect that any experienced horseman would at once recognize at first glance may not be patent to a person who has had no experience with horses." Id., § 541, Comment a.
9. A principal goal behind bankruptcy law is to provide a fresh start. The fresh start should be afforded to the honest but unfortunate debtor. Grogan, 498 U.S. at 286. When debts are based on fraud, a competing policy must be considered — protection of fraud victims. In this case, determining the Plaintiffs' debt to be nondischargeable would not be outweighed by the limited policy of affording a fresh start to the honest debtor. Id.
10. Damages are a requirement of the claim under § 523(a)(2)(A). The measure of damages in a fraud action is "out-of-pocket" loss. This notion is codified in Cal. Civ. Code Section 3343(a), which defines "out-of-pocket" loss as the "difference between the actual value of that with which the defrauded person parted and the actual value of that which he received. . . ." Cal. Civ. Code Section 3343(a); see also Garrett v. Perry, 53 Cal. 2d 178, 184, 346 P.2d 758 (1959).
11. The Debtor may be denied a discharge where it is established that, under 11 U.S.C. § 727(a)(3), Setsu Hechtman has concealed, destroyed, 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. A creditor objecting to discharge under this section "`must show (1) that the debtor failed to maintain and preserve adequate records, and (2) that such failure makes it impossible to ascertain the debtor's financial condition and material business transactions.'"Lansdowne v. Cox, 41 F.3d 1294, 1296 (9th Cir. 1994) (citation omitted). The debtor must then respond with a "credible explanation." Id. "`Justification for [a] bankrupt's failure to keep or preserve books or records will depend on . . . whether others in like circumstances would ordinarily keep them.'" Id. at 1299. The preponderance of the evidence standard applies. Id. at 1297. Because "[f]ew consumer debtors maintain anything more than, at most, a collection of bills, receipts and canceled checks, . . . absent a sudden and large dissipation of assets, a discharge should not be denied in a typical consumer bankruptcy case due to a lack of books and records." 6 Collier on Bankruptcy ¶ 727.03[3][g], p. 727-37 (15th ed. rev. 2005). A failure to maintain records is not grounds for denying a discharge if "such . . . failure was justified under all of the circumstances of the case." 11 U.S.C. § 727(a)(3);see also Lansdowne, 41 F.3d 1294 (9th Cir. 1994) (holding debtor's reliance on her husband to keep or preserve books or records was objectively reasonable under the totality of the circumstances).
12. The Debtor may be denied discharge where it is established that under 11 U.S.C. § 727(a)(4)(A) Setsu Hechtman knowingly and fraudulently has made a false oath or account in connection with this case. The false oath may be an unsworn declaration, a false statement in the Debtor's schedules, or a false statement by the Debtor at an examination during the course of the proceedings. 6 Collier on Bankruptcy ¶ 727.03[4], pp. 727-39 to 727-44 (15th ed. rev. 2005). False oaths include material omissions. Id.
13. The Debtor may be denied discharge where it is established that, under 11 U.S.C. § 727(a)(5), Setsu Hechtman has failed to explain satisfactorily the loss of assets or a deficiency of assets. Plaintiffs have the initial burden of proof in establishing that Debtor has failed to explain a loss of assets.In re Carter, 236 B.R. 173, 180 (Bankr. E.D. Pa. 1999). More than a mere allegation that the debtor has failed to explain losses is required. Plaintiffs must produce some evidence of the asset losses. Id.
14. Once Plaintiffs have met their burden, "debtor must provide some credible explanation that will convince the court that [s]he has not hidden or improperly shielded assets. Explanations of losses that are generalized, vague, indefinite and uncorroborated by documentation are unsatisfactory." Id. "A debtor's repeated failure to answer questions with anything but evasions and half-truths constitutes a willful and bad faith failure." Id. at 181. Factors to be considered include the debtor's business, financial affairs and lifestyle. Id. at 180. The preponderance of the evidence standard applies. Id.
15. I find that Plaintiffs have proven all of the elements of a cause of action under 11 U.S.C. § 523(a)(2) and Defendant's debt to both Plaintiffs is nondischargeable.
16. I find that Plaintiffs have not proven by a preponderance of the evidence that Setsu Hechtman has concealed, destroyed, or failed to keep or preserve books, records and papers under 11 U.S.C. § 727(a)(3). Her access to necessary records has been limited by Rick Hechtman or lost through numerous moves related to marital separations and financial troubles. Based on the records that were turned over, Setsu Hechtman appears to have made a reasonable effort to supply what records she had.
17. I find that Plaintiffs have not proven their claim under 11 U.S.C. § 727(a)(4)(A). It is not clear that Setsu Hechtman has made a material false oath and Plaintiffs have failed to point to and prove a specific false statement made in the bankruptcy proceeding itself. There is no doubt that Setsu Hechtman was difficult and uncooperative, but the proof of a specific falsity was lacking.
18. I find that Plaintiffs have not proven their claim under 11 U.S.C. § 727(a)(5). Setsu Hechtman, to the extent she had any assets, satisfactorily explained what happened to them. The evidence demonstrated that she did not have the extensive assets she claimed to have when securing legal representation for her husband. Any other access to funds was explained, and it appears she used those funds to live on. If Rick Hechtman had any assets, Plaintiffs never showed that Setsu Hechtman had access to them.
19. Judgment will be entered for Plaintiffs under 11 U.S.C. § 523(a)(2). Judgment will be entered for Defendant under 11 U.S.C. § 727(a)(3), (a)(4) and (a)(5).