No creditor-debtor relationship?

[Corkie]

Can any one initiate a Chapter 7 adversary if there is no creditor-debtor relationship? No personal or fiduciary obligations. No paper, no loans. Claiming fraud on sale of a piece equipment by related business entity.

[HHM]

How about some more context here. Are you the debtor, are you the aggrieved party? What exactly is this "fraud on sale of equipment."

Generally, for a federal court to hear and adjudicate a claim, the complaining party must have a stake in the outcome. There must be some harm to the complaining party to redress.

For someone who is aware of some sort of fraud that affects a debtor's BK, but is not a party in interest, the proper channel would be to report the activity to both the bankruptcy trustee and U.S. trustee.

[Corkie]

Yes, I am the debtor. The piece of equipment was sold by a business entity (a partnership) which i managed (as a LLC general partner). However there was bank lien on the equipment. The business entity continued to make payments on the bank note even though the equipment had been sold. The proceeds of the sale were used for the business operations. it was anticipated that the sale of some land would cover the balance due on the note. However about 4 months, and before the land could be sold, the business entity filed for Chapter 11. The bank went into state civil court and received a judgement in their favor against the business entity. The court also ruled that the equipment had to be turned over to the bank by what is now the AP plaintiff.

They are seeking to recover the amount paid for the equipment plus legal fees from me as an individual in the Chapter 7 AP. i am also representing myself pro se.

[justbroke]

A pro-se LLC with issues regarding equipment could be problematic! If you read the terms of the Security Instrument that you executed with the bank, there is probably at least one clause about sale of the collateral and stating that you can't do that or some other acceleration. I would say it is fraud if you sold collateral which you knew secured a promissory note (loan) and you didn't do a contemporaneous payoff of that underlying note.

For the creditor (bank) to open an Adversary Proceeding (AP/complaint) in the bankruptcy case, tells me that they believe that they have a case. I suppose this equipment is valued over $4,000 as well (or at least the balance on the note was more than $4,000).

As for the LLC, is this just some shadow LLC which is just an alternate ego (persona) of yourself? In other words, either a single-member LLC or you, the debtor, own most of the shares? Did you personally guarantee the note? Are you thinking of settling (since I assume you're pro se because you can't afford representation)? Have you thought about what you'll do if you lose?

[Corkie]

For clarification it is not the bank that is bringing the AP but the company that bought the equipment and the only piece of paper is the bill of sale between the business entity and buyer of the equipment is a bill of sale. i would admit that it was fraudulent, but not willful. The bank is not involved in my personal Chapter 7. Their motion for summary judgement and another MSJ were the only reason i filed for Chapter 7. i had no consumer credit problems. And i am the only member of the LLC.

I raised this question when I began researching Section 523(a)(2)(A) and the context seemed to always be about the creditor-debtor relationship. And I brought up the LLC as a whether it would limit any fiduciary responsibility if this became an issue. Although I had a lawyer in the state civil actions, we agreed to do a minimal response since there was no more funds for legal fees and no assets to support a judgement.

If I lost the AP? I have no assets, only my social security and pension. Haven't been able to find out what an AP judgement would mean if one has no assets. I asked them once why they were pursuing this, given that my chapter 7 is a no asset case. Their response was that if I committed "fraud" once how do they know I am still not committing fraud.

[despritfreya]

What is the dollar amount involved? Is the purchaser represented by an attny?

Can the purchaser pierce the "corporate veil"? Probably, as you are the only member of the LLC, you knew the equipment was subject to a security agreement and you knew it was wrong to sell it without paying off (or disclosing) the lien. On the other hand, depending upon the purchaser’s sophistication and assuming there was a valid and recorded UCC1, an argument could be made that the purchaser had notice of the lien.

And, yes, 523(a)(2) and (a)(6) would be the provisions that apply if the purchaser is to pierce the veil in an effort to have the claim determined to be non-dischargeable.

Des.

[Corkie]

The amount is over $500k and the purchaser is represented by counsel. They also participated in my 341.

Yes, you are right. I assume they could very easily pierce the "corporate veil" since, if nothing else, I signed the purchase agreement in my name as general partner, a common practice, with no mention of the LLC. Hence i am abandoning this as an avenue of pursuit. ironically the bank never filed a UCC.

That leaves the question, can the purchaser, in effect, create a debt under 523(a)(2) where an individual now becomes the debtor?

Another question or two: if the purchaser prevails, what impact does a non-dischargeable claim have on my life, given no assets and likely too old to be employed? Given that their facts are largely correct, would it be better to "throw in the towel" now and not waste everyone's time? My only argument at trial would be that it was not willful or malicious since i thought i had it covered, just not contemporaneously - if that is the word. And no one asked if there were any liens.

[HHM]

Okay, this is pretty cut and dry.

The purchasing entity has a cause of action. (probably under something like, breach of marketability, I forget the technical term, but the idea being that whenever you sell anything, one of the implied warranties is that the seller has marketable title to transfer, which you didn't because of the security interest). If the judge ordered the property returned, that means the purchaser couldn't qualify as a "bona fide" purchaser for some reason (maybe because there was a UCC-1 recorded and the buyer was held to have notice). In any event, the buyer would have some recourse to the seller (you, or the company) for damages. Whether it will constitute outright fraud and therefore become a non-dischargeable debt, that remains to be seen, but that is what the buyer is alleging.

So, the issue is not whether they have standing to bring the AP (which was your original question). The issues seem to be (1) what is the nature of the claim, (2) what entity is liable, (just the LLC, or both you and the LLC), (3) what is the measure of damages, (4) did the transaction rise to the level of fraud such that it would be a non-dischargeable debt.

This will be messy, if it really goes to a hearing, I am thinking a good attorney will spend cost about $10K-20K+ all said in done to defend this action.

As for the outcome, if you let the creditor win, you now have a non-dischargeable debt with NO statute of limitations on collection. They can go after whatever they can and make your life pretty difficult for a very long time if they were really aggressive.

[despritfreya]

That leaves the question, can the purchaser, in effect, create a debt under 523(a)(2) where an individual now becomes the debtor? If the purchaser prevails, what impact does a non-dischargeable claim have on my life, given no assets and likely too old to be employed?

In answer to your questions:

1."Yes". One cannot hide behind a corporate entity if one knowingly misrepresented a material fact.

The elements under 523(a)(2) in the 9th Circuit are:

The Debtor made a false representation;
The Debtor knew the representation was false;
The Debtor intended to deceive by making the false representation;
The aggrieved party relied upon the false representation and;
The aggrieved party’s reliance was justified.

See Grogen v Garner, 498 U.S. 279 (1991) and In re Harmon, 250 F.3d 1240 (9th Cir. 2001).

Now you could argue that you did not make a false representation. In fact you made no representation at all. However, a failure to disclose a material fact can rise to the level of making a false representation and can show intent to deceive. Such failure can result in reliance by the aggrieved party. See In re Apte, 180 B.R. 223 (9th Cir. B.A.P. 1995), affd. 96 F.3d 1319 (9th Cir. 1996).

There is tons of case law in the 9th Circuit on these issues and, if I have the time I may try to find one that is exactly on point.

The cost of litigating this through trial (not including any appeals) will exceed $30,000.00 - been there done that. I can tell you my Firm, if we were going to handle something like this, would want $10,000 down.

2. You mentioned your sole source of income is disability and SS. As a result, you may be judgment proof. SS (please make sure it is deposited into a separate account and you NEVER, EVER, commingle it with any other $$ including disability) cannot be attached as long as it is not commingled. Disability, that is not from the Federal Government, is protected at the source. It cannot be garnished. But, once it hits the bank account it may be subject to bank account garnishment. You would need to check on this to be sure.

Lastly. . .

I must correct a statement made by HHM relating to the effect of a non-dischargeable judgment. His comment was “if you let the creditor win, you now have a non-dischargeable debt with NO statute of limitations on collection.”

In actuality the debt is merged into a judgment that is subject to Arizona’s renewal statutes. In Arizona, a judgment must be renewed every 5 years. If it is not renewed, it becomes stale. If it is timely renewed, and the renewal statute is tricky, then the judgment can live forever. So long as the judgment is “alive”, it cannot be discharged in any subsequent bk, ever.

Des.

[Corkie]

Thank you for your very thoughtful and thorough answer. No loop holes. Hence time for me to proceed to preparation for trial. Unfortunately retaining counsel is out of the question, given my annual income is only about $20k. One correction: What i have is a small pension, not a disability, plus the social security, both directly deposited to the same account. There is literally nothing else that is not already encumbered with liens. As an aside, would this give them the opportunity to try to undo the liens, all of which are quite solid? i ask only because, with all due respect to your profession, the legal world is becoming a bit tiresome. I was looking forward to the "fresh start", to do something different in my "retirement".

Again thanks to you and to HHM for your time and thoughtfulness.

[justbroke]

This is still a fascinating case, although it may be run of the mill. Between Des and HHM, I think you now have a clear(er) understanding of what is going on and what could happen. As Des wrote, you may want to unminhgle those funds into separate accounts... just in case.

[despritfreya]

One correction: What i have is a small pension, not a disability, plus the social security, both directly deposited to the same account. There is literally nothing else that is not already encumbered with liens. As an aside, would this give them the opportunity to try to undo the liens, all of which are quite solid?

My bad - but the outcome is the same. The pension is protected at the source but most definitely not protected once it hits your bank account. Tomorrow, go to the bank. Open a new account. This account is to be designated as a Social Security account. Have the SS directly deposited into this new account. NEVER, EVER add to the account. You can withdraw from it but DO NOT add to it. Your pension should not be commingled. In fact, to the extent you can, live off the pension money and save the SS money.

As it relates to liens. . . I am assuming you are talking about valid liens against your vehicle and/or home. If the liens are valid and properly perfected under Arizona law any judgment obtained will not "jump" ahead of the liens. Further, the judgment will not become a lien against your homestead unless the equity in the home exceeds $150,000.00.

Good luck and keep us posted. I will try to do some research for you so make sure you keep an eye on your thread.

Des.

[despritfreya]

I did do a bit of searching and came up with the below, for whatever they may be worth. Hope it helps.

Des. . .

In re Sanner, 218 B.R. 941 (Bankr.Ariz., 1998)

"Defendants argue that Stan Novak, founder and general manager of Madison Granite, cannot be held personally liable for any damages that may result if this Court finds that Defendants engaged in collusive bidding. This Court agrees.

Arizona law is well settled that courts will not disregard the corporate fiction and impose liability on the corporation's officers, directors, and shareholders unless the corporation is simply the alter ego of such officer, director, or shareholder. Bischofshausen, Vasbinder, and Luckie v. D.W. Jaquays Mining and Equipment Contractors Co., 145 Ariz. 204, 208, 700 P.2d 902, 906 (App.1985).

To prove that Madison Granite is simply the alter ego of Stan Novak, or to pierce the corporate veil, Trustee must establish that there is such a unity of interest and ownership between Stan Novak and Madison Granite that the separate personalities of him and the corporation cease to exist. Bischofshausen, 145 Ariz. at 208, 700 P.2d at 906.

For example, courts may pierce the corporate veil where it is shown that corporate formalities were ignored, the corporation was substantially undercapitalized, and there was impermissible intermingling of corporate and personal funds. See Chapman v. Field, 124 Ariz. 100, 102, 602 P.2d 481, 483 (1979). Arizona also requires that fraud be shown in order to pierce the corporate veil. Id. at 103, 602 P.2d at 484; see also In re Nash, 6,0 B.R. 27 (9th Cir. BAP 1986)."

In re Tobin, 258 B.R. 199 (9th Cir. BAP 2001) Citing to other authority. . .

"Where corporate and individual affairs are badly intermingled and it would be unjust to recognize the distinction between individuals and corporations, courts will hold the individuals liable for corporate debts and vice versa.The determination of whether or not to pierce the corporate veil and hold a shareholder personally liable for corporate debts is based on three factors: the amount of respect given to the separate identity of the corporation by its shareholders, the degree of injustice visited on the litigants by recognition of the corporate entity, and the fraudulent intent of the incorporators."

[Corkie]

Letting it all percolate, but i think i could make this work. Again, thank you. (has anyone ever listed as a legal fee carpet replacement from pacing back and forth?) i may have some questions later, but am okay for now.

[Bell30656]

Carpet pacing... Good one. I'd move to a state that doesn't have wage garnishment or allow out of state judgements... Does one of those exist? But I'm a total jerk. I can see why the purchaser is a bit miffed. Especially considering the value of the equipment.