Smith v. Fetherolf

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-1-	MEMORANDUM OF DECISION
DO 	NOT 	PUBLISH
UNITED STATES BANKRUPTCY COURT
FOR THE NORTHERN DISTRICT OF CALIFORNIA
In re
NICHOLAS JAMES FETHEROLF,
Debtor.
KATHLEEN A. SMITH,
Plaintiff,
vs.
NICHOLAS JAMES FETHEROLF,
Defendant.
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Case No: 04-31106 TEC7
Chapter 7
Adv. Proc. No. 	04-3177 TEC7
MEMORANDUM OF DECISION
This action came to trial on October 5, 2005. 	Mark K. Oto
appeared for Plaintiff. 	Defendant appeared in pro per. 	Plaintiff
seeks the denial of Defendant’s discharge and a determination that
Defendant’s obligation to her is nondischargeable. 	For the reasons
stated below, I determine that Defendant should not be denied a
Signed and Filed: November 02, 2005
________________________________________
THOMAS E. CARLSON
U.S. Bankruptcy Judge
________________________________________
Entered on Docket
November 02, 2005
GLORIA L. FRANKLIN, CLERK
U.S BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
Case: 04-03177 Doc# 31 Filed: 11/02/05 Entered: 11/02/05 11:52:22 Page 1 of
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-2-	MEMORANDUM OF DECISION
discharge, but that Defendant’s obligation is nondischargeable to
the extent of $11,000, the value of collateral that Defendant
converted to his own use.
FACTS
Plaintiff Kathleen A. Smith loaned Defendant Fetherolf $61,000
in February 2001. 	Plaintiff’s daughter, Penelope, was Defendant’s
girlfriend at the time. 	Defendant used the money to start a
computer supply business. 	Penelope worked in the business keeping
books, preparing checks for payment, and doing other office work.
The loan was memorialized in a promissory note (“the Note”).
The Note recites “[s]ecurity given on the loan is (1) 2000 Chevy
Astro, (2) 1993 Acura Legend and (3) 1996 Honda.” 	Debtor actually
owned two Chevy Astros at the time, but all witnesses agree that
the parties intended that security interest attach to the van he
then owned free and clear (VIN ...47). 	It is undisputed Defendant
also owned the Acura and the Honda free and clear at the time he
signed the Note and received the loan proceeds. 	Defendant did not
give Plaintiff the pink slips for the three vehicles at the time he
signed the Note.
Defendant incorporated the computer supply business as Remedy
Computers Inc. (the Corporation). 	The Corporation earned only
small profits between the time of its inception in early 2001 and
the time both the Corporation and Defendant filed chapter 7
petitions on April 22, 2004. 	Penelope testified that Defendant
spent all the profits that the Corporation did earn on his personal
living expenses.
Defendant made numerous payments on the Note. 	Under the terms
of the Note, no payments were called for until March 2002.
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-3-	MEMORANDUM OF DECISION
Defendant made payments from March through October 2002, and in
April, May, and June 2003.
In February 2003, Penelope gave birth to a child fathered by
Defendant. 	In June 2003, Penelope left Defendant. 	Penelope and
Defendant have been engaged in a bitter child custody dispute ever
since. 	Defendant made no payments on the Note after June 2003.
Shortly after she made the loan, Plaintiff began to ask
Defendant for the pink slips to the three vehicles that secured the
loan. 	Defendant never provided the pink slips to her, although
they were readily available.
In June 2002, Defendant sold the Acura Legend for $4,000.
Although this vehicle was identified as collateral for the Note,
Defendant neither paid the proceeds to Plaintiff, obtained
Plaintiff’s permission to keep the proceeds, nor provided Plaintiff
replacement collateral.
In June 2003, Defendant sold the 2000 Astro Van (VIN ...47)
for $7,000. 	Although this vehicle was also collateral identified
in the Note, once again Defendant neither paid the proceeds to
Plaintiff, obtained her permission to keep the proceeds, nor
provided Plaintiff replacement collateral.
By early 2004, Defendant found himself in substantial
financial difficulty. 	The Corporation had never earned significant
profits. 	He lost important office help when Penelope left him.
The custody dispute also created a significant burden. 	Defendant
first contacted bankruptcy attorney Adam C. Kent in February or
March 2004. 	Both Defendant and the Corporation filed chapter 7
petitions on April 22, 2004.
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-4-	MEMORANDUM OF DECISION
One or two days before he filed the chapter 7 petition,
Defendant sold the second Astro Van (VIN ...95) for $7,000. 	This
van was not collateral for repayment of the Note. 	Defendant later
used the proceeds to pay delinquent payroll taxes owed to the IRS.
Defendant’s schedules and statement of financial affairs were
inaccurate. 	In response to a question that asked him to disclose
transfers out of the ordinary course of business within the year
prior to the April 22, 2004 petition date, Debtor failed to list
the June 2003 transfer of the first Astro Van or the April 2004
transfer of the second Astro Van. 	In Schedule B, which asked him
to list all personal property, Defendant failed to list the 1996
Honda motorcycle, which was the third item of collateral to secure
repayment of the Note, and which he still held on the petition
date. 	Defendant also failed to list among his assets the proceeds
of the sale of the second van, or to disclose any transfer of those
proceeds (which were paid to the IRS on or shortly after the
petition date).
Defendant’s business records are also haphazard. 	He was
unable to produce a general ledger or periodic statements of
business operations. 	His business records consist primarily of
bank statements for his business and personal accounts.
In the present action, Plaintiff asserts that Defendant’s
obligations under the Note should be determined to be
nondischargeable under section 523(a)(2), because Defendant induced
Plaintiff to make the loan through intentional misrepresentations.
More specifically, Plaintiff alleges that Defendant never intended
to repay the Note and never intended to give Plaintiff a security
interest in the vehicles listed in the Note. 	Plaintiff also seeks
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-5-	MEMORANDUM OF DECISION
to have Defendant denied a discharge on the bases: (1) that
Defendant failed to maintain records from which his financial
condition can be ascertained; and (2) that Defendant concealed or
transferred the three vehicles that constituted Plaintiff’s
collateral with the intent to delay or defraud creditors.
ANALYSIS AND DECISION
1. 	Fraud in the inducement. 	I find that Defendant did not
fraudulently induce Plaintiff to make the loan. 	At the time he
obtained the loan and signed the Note, Defendant intended to repay
the loan and to provide Plaintiff a security interest in the
vehicles listed in the Note.
In this regard, I first note that Defendant made a substantial
number of payments on the Note, and completely stopped making
payments only after Plaintiff’s daughter broke off her relationship
with Defendant. 	This break-up did not, of course, excuse the
breach of contract, but the payment history clearly suggests that
any deliberate decision not to repay occurred after Defendant
obtained the loan.
I also note that Defendant did provide Plaintiff a security
interest in the three vehicles. 	I find that the language in the
Note was sufficient by itself to grant a security interest.
See Nolden v. Plant Reclamation (In re Amex-Protein Devel. Corp.),
504 F.2d 1056, 1058-60 (9 th Cir. 1974). 	It is undisputed that the
other requisites for the attachment of a security interest also
existed at the time the loan was made: Plaintiff had advanced funds
to Defendant, and Defendant owned the vehicles. 	See Cal. Comm.
Code § 9203(a),(b). 	Defendant’s failure to provide Plaintiff the
pink slips did render Plaintiff’s security interest unperfected and
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1 The complaint did not allege conversion of the collateral as
a basis for nondischargeability, but instead alleged more generally
that Defendant never intended to perform the security agreement.
The complaint did allege transfer or concealment of the collateral
with the intent to defraud creditors in general as a basis for
denial of discharge. 	For the reasons set forth below, I determine
-6-	MEMORANDUM OF DECISION
therefore vulnerable to the claim of a good faith purchaser. 	This
unperfected security interest was, however, still enforceable
between Plaintiff and Defendant. 	See Cal. Comm. Code § 9201(a).
The evidence also shows, however, that Defendant willfully and
maliciously failed to pay the Plaintiff the proceeds from the 2002
sale of the Acura Legend, and from the 2003 sale of the Astro Van.
I find that Plaintiff had a property interest in these proceeds.
See Cal. Comm. Code §§ 9203, 9306. 	I find that Defendant knew
Plaintiff had such an interest. 	I find that Defendant acted with
the subjective intent of depriving Plaintiff of her interest in
these proceeds. 	In so finding, I note that starting sometime after
he received the loan, Defendant refused Plaintiff’s repeated
requests for the pink slips. 	Possession of the pink slips would
have enabled Plaintiff to obtain the proceeds of any sale. 	I also
note that the second failure to turn over the sale proceeds
occurred just after Plaintiff’s daughter left Defendant. 	Defendant
also stopped making payments on the Note at this time. 	These
circumstances suggest that the failure to pay over the proceeds of
sale represented a deliberate decision never to pay Plaintiff the
value of the collateral, rather than an inability to pay or an
intent to pay at a later date.
Thus, I find that Defendant is liable for conversion of the
$11,000 proceeds of the two sales noted above, and that this
obligation is nondischargeable under section 523(a)(6) of the
Bankruptcy Code. 1 	Because of Defendant’s insolvency and the fact
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28 that the transfer of the collateral is not a basis for denial of
discharge. I determine that the complaint should be amended to
conform to the evidence at trial. 	See Fed. R. Civ. P. 15(b) and
Fed. R. Bankr. P. 7015.
-7-	MEMORANDUM OF DECISION
that the conversion consisted of a failure to pay cash proceeds of
a sale in satisfaction of a debt, I determine that punitive damages
are not appropriate.
Plaintiff is also entitled to enforce her security interest in
the motorcycle still held by Defendant. 	The chapter 7 trustee
never attempted to avoid Plaintiff’s unperfected security interest.
As noted earlier, the unperfected security interest is fully
enforceable between Plaintiff and Defendant. 	Cal. Comm. Code
§ 9201(a).
2. 	Denial of discharge. 	Defendant should not be denied a
discharge under section 727(a)(3) on the basis that he failed to
preserve records from which his financial condition can be
ascertained. 	Defendant’s business records are not exemplary. 	But
we must remember that Defendant is not well-educated, and that he
ran a small business. 	More important, the records are sufficient
for the core purpose of determining whether Defendant had withheld
assets from creditors. 	The bank records are sufficient to show
that he did not divert cash or other assets from the business and
his creditors. 	Moreover, Plaintiff’s own evidence explains the
financial condition of Debtor and his wholly owned Corporation at
the time of bankruptcy. 	Plaintiff’s daughter testified that the
Corporation earned only small profits and that Defendant spent
those profits promptly on living expenses. 	Finally, the state of
Defendant’s records reflects a general sloppiness, rather than
Defendant’s attempt to cover his tracks.
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2 The wild-card exemption available to Defendant was $17,425.
See Cal. C.C.P. § 703.140(a), (b)(1). 	Defendant had used only
$3,000 of that amount in his schedule C. 	The van sale proceeds
($7,000) and the value of the motorcycle ($1,000) total less than
the unused wild-card exemption ($14,425).
-8-	MEMORANDUM OF DECISION
Although it is a closer question, Defendant also should be not
denied a discharge on the basis of the inaccuracies in his
schedules and statement of financial affairs. 	Defendant’s failure
to disclose his sale of the second van and his failure to list the
Honda motorcycle or the van sale proceeds in his schedules may have
been willful, but the omissions were not fraudulent. 	In this
context, a misstatement in fraudulent only if “made with the
intention and purpose of deceiving the creditors.” 	Roberts v.
Erhard (In re Roberts), 	B.R. 	, 2005 WL 2508144 at 6
(9 th Cir. BAP 2005).
The circumstances suggest that neither Defendant’s failure to
disclose the sale of the second van, nor his failure to list the
motorcycle or van sale proceeds among his personal property were
intended to deceive his creditors. 	First, Defendant had no motive
to do so. 	Defendant could easily have exempted both the motorcycle
and van sale proceeds using his wild-card exemption. 2 	Nor was he
hiding these assets from secured creditors against whom the
exemption would be ineffective. 	The van proceeds were not
encumbered. 	The motorcycle was encumbered by Plaintiff’s lien, but
she already knew Defendant still had that motorcycle. 	Second,
Defendant is not well-educated (he left school after the ninth
grade) and the overall manner in which he kept records and
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3 Defendant did not list in his statement of financial affairs
the transfer of the van sale proceeds to the IRS, but the evidence
suggests that he made that transfer postpetition. 	It appears that
Defendant bought a cashiers check on the same day he filed his
bankruptcy petition. 	It is more likely than not that the IRS
received this check postpetition. 	Thus, Defendant would not think
of this as a prepetition transfer to be disclosed.
-9-	MEMORANDUM OF DECISION
completed his bankruptcy papers evinces a general carelessness,
rather than any intent to conceal specific facts. 3
There is also no reason to believe Defendant’s failure to list
the June 2003 transfer of the first van was fraudulent. 	The only
creditor who could be affected by that transfer was Plaintiff, and
Defendant knew Plaintiff would never be deceived by his failure to
disclose that transfer. 	Plaintiff knew she had a security interest
in those vehicles and would inevitably demand surrender of her
collateral or its proceeds.
Finally, Defendant should not be denied a discharge on the
basis of his conversion of Plaintiff’s collateral. 	Defendant did
not sell the collateral with the intent to hinder, delay, or
defraud creditors in general. 	The sales were at arms-length and
the proceeds were retained and used by Debtor. 	The failure to pay
the sale proceeds to Plaintiff was wrongful toward Plaintiff
specifically, not an injury to creditors as a whole, and should be
analyzed under section 523(a)(6), as the court has done above.
CONCLUSION
Plaintiff made a risky loan to her daughter’s boyfriend to
help him start a business. 	Defendant demonstrated his original
intent to repay that loan by making payments fairly regularly until
Plaintiff’s daughter left him. 	Plaintiff’s own evidence shows that
Defendant consumed contemporaneously all the profits that the
Corporation created and, thus, Defendant’s haphazard business
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-10-	MEMORANDUM OF DECISION
records and bankruptcy papers do not serve to hide assets from his
creditors. 	Plaintiff complains legitimately that she should have
received her collateral upon Defendant’s default. 	The judgment of
this court restores to Plaintiff the value of that collateral.
**END OF MEMORANDUM**
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Court Service List
Mark K. Oto, Esq.
Law Offices of Mark K. Oto
255 N Market Street, #260
San Jose, CA 95110
Nicholas James Fetherolf
2995 Woodside Rd. #400
Redwood City, CA 94062
E. Lynn Schoenmann
800 Powell Street
San Francisco, CA 94108
Office of the U.S. Trustee
235 Pine Street, Suite 700
San Francisco, CA 94104
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