RESCUECOM Corporation v. Khafaga

UNITED STATES BANKRUPTCY COURT
EASTERN DISTRICT OF NEW YORK
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In re:
Case No. 06-43018-608
MOHAMED E. KHAFAGA, Chapter 7
Debtor.
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RESCUECOM CORPORATION,
Plaintiff,
- against - Adv. Pro. No. 09-01259-608
MOHAMED E. KHAFAGA,
Defendant.
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DECISION
APPEARANCES:
Edward Gegan, Esq.
2560 Burnet Avenue
Syracuse, New York 13206
Attorney for Plaintiff
Wayne Greenwald, Esq.
175 Park Avenue South, 26 Floorth
New York, New York 10016
Attorney for Defendant
CARLA E. CRAIG
Chief United States Bankruptcy Judge
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This matter arises in an adversary proceeding seeking to have the debt owed to
Rescuecom Corporation (“Plaintiff” or “Rescuecom”) by the Defendant, Mohamed E. Khafaga,
(“Defendant” or “Khafaga”) declared nondischargeable pursuant to 11 U.S.C §§ 523(a)(2)(A),
523(a)(2)(B), and 523(a)(6). Defendant has moved to dismiss the first claim for relief set forth
in the amended complaint of Rescuecom as time barred under Fed. R. Bankr. P. 4007(c). For the
reasons set forth below, the motion is granted.
Facts
Rescuecom is a nationwide computer services franchisor. Rescuecom franchisees offer
services including computer consulting, repair and Internet services to business and residential
customers. (Complaint ¶ 8.) On July 30, 2004, the Defendant and his wholly owned1
corporation, 01 Networks, Inc., executed a franchise agreement with the Plaintiff to operate a
Rescuecom franchise. (Complaint ¶ 10.) On December 30, 2004, the Defendant purchased a
second Rescuecom franchise, signing a second franchise agreement substantially similar to the
first (collectively, the “Franchise Agreements” or the “Agreements”). (Complaint ¶ 11.)
The Franchise Agreements prohibited the Defendant from competing with Rescuecom
and from diverting business away from Rescuecom, during the term of the Agreements and for a
period of time after any termination of the Agreements. Under the Franchise Agreements, the
Defendant was required to report all sales and services rendered and all income earned through
providing computer services, and to pay royalties on all such revenue, whether or not it was
provided through his Rescuecom franchise. (Complaint ¶ 12.) The Defendant was also required
by the Franchise Agreements to make annual financial disclosures to Rescuecom, which
"Complaint" refers to the complaint filed on May 19, 2009.1
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included disclosure of all business and personal bank accounts, all business and personal tax
returns and all sales and income. (Complaint ¶ 16.)
On May 19, 2009, Rescuecom commenced this adversary proceeding seeking a
declaration that the debt owed to it by the Defendant is nondischargeable pursuant to §§
523(a)(2)(A) , 523(a)(2)(B), and 523(a)(6) (“Original Complaint”). The Defendant moved to2
dismiss the Original Complaint under Federal Rule of Civil Procedure 12(b)(6), alleging, among
other things, that Rescuecom failed to allege that the Defendant wrongfully induced the Plaintiff
to extend money, property, or services under §§ 523(a)(2)(A) and 523(a)(2)(B). By decision
dated November 30, 2009, the Court denied the Defendant’s motion to dismiss with respect to
the claim made under § 523(a)(6); granted the motion with respect to the claims under §§
523(a)(2)(A) and 523(a)(2)(B); and granted Rescuecom’s request for leave to amend the
Original Complaint. Rescuecom Corp. v. Khafaga (In re Khafaga) 419 B.R. 539, 553 (Bankr.
E.D.N.Y. 2009).
On December 22, 2009, the Plaintiff filed an amended complaint alleging facts and
conduct not set forth in the Original Complaint to support its claim under § 523(a)(2)(B)
(“Amended Complaint”). No new claims or legal theories were raised. The Defendant seeks to
dismiss the repleaded § 523(a)(2)(B) claim, contending that any claim based on these new
allegations is time barred under Federal Rule of Bankruptcy Procedure 4007(c).
The following new factual allegations appear in the Amended Complaint:
9. Defendant first applied for consideration to become a franchisee
of Rescuecom by submitting a written Request for Consideration,
which included various false financial representations.
Unless otherwise indicated, statutory citations are to provisions of Title 11, U.S.C.2
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10. Defendant represented in his Request for Consideration that he
had $25,000 in cash and $100,000 in real estate, which he held free
and clear of any mortgage. Altogether, he represented himself as
having $132,000 in assets and $20,000 in liabilities with a net
worth of $112,000.
11. Upon information and belief, at the time Defendant submitted
his Request for Consideration, he did not have $25,000 in cash, did
not have any cash at all, and his bank account was overdrawn.
12. Upon information and belief, at the time Defendant submitted
his Request for Consideration, he did not own any real estate.
13. Upon information and belief, although Defendant’s wife did
own real estate, such real estate was encumbered by a mortgage
and the Defendant’s representations regarding value or equity in
that property were not correct.
14. Upon information and belief, at the time Defendant submitted
his Request for Consideration, he did not have a net worth of
$112,000, but in fact had a negative net worth of negative $12,000.
15. Upon information and belief, Defendant intended to submit
this Request for Consideration for the purpose of inducing Plaintiff
to sell him a franchise.
16. Plaintiff relied upon these false representations in offering the
franchise to Defendant.
(Amended Complaint, Paragraphs 9-16.)
Jurisdiction
This Court has jurisdiction of this core proceeding pursuant to 28 U.S.C. §§ 157(b)(2)(I)
and 1334, and the Eastern District of New York standing order of reference dated August 28,
1986. This decision constitutes the Court's findings of fact and conclusions of law to the extent
required by Federal Rule of Bankruptcy Procedure 7052.
Discussion
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Original Complaint
In the Original Complaint, Rescuecom alleged that the debt owed by the Defendant is
nondischargeable pursuant to § 523(a)(2)(A) based on the Defendant’s misrepresentations
regarding his involvement in a competing business, Computer Medics. Rescuecom sought
$33,487.68 under a stipulated damages provision in the Franchise Agreements, as well as
royalties and fees based on revenues generated by Computer Medics. Rescuecom alleged that
the Defendant started and operated Computer Medics with his wife, under his wife’s name, in
violation of the Franchise Agreements; and that the Defendant diverted business from his
Rescuecom franchise to Computer Medics, and concealed revenues earned through Computer
Medics, in order to generate additional income from computer repair sales and servicing without
paying royalties and fees to Plaintiff, as required under the Franchise Agreements.
Plaintiff’s claim under § 523(a)(2)(A) was dismissed because of the failure to allege that
the purported damages were caused by the Defendant’s misrepresentations and omissions that
were detailed in the original complaint for purposes of § 523(a)(2)(A). “The damages claimed
by Rescuecom arose at the point of breach, prior to any alleged false pretense or omission made
by the Defendant, and would be ‘precisely the same’ without a claim of fraudulent conduct.”
Khafaga, 419 B.R. at 547-48 (E.D.N.Y. 2009) (quoting Sandek v. Dobrayel (In re Dobrayel),
287 B.R. 3, 24 (Bankr. S.D.N.Y. 2002)).
Rescuecom confronted the same obstacle with its original claim under § 523(a)(2)(B). In
that count, Rescuecom alleged that in the course of operating the franchise, the Defendant
knowingly submitted false “financial reports regarding sales and services rendered and revenues
earned . . . with the specific intent of deceiving Plaintiff as to Defendant-Debtor’s true sales and
services rendered and true revenues earned through the Computer Medics business.” (Complaint
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¶ 41.) This claim was also dismissed “because the requisite causal connection [was] lacking
between the allegedly false written statements and the damages claimed by Rescuecom.”
Khafaga, 419 B.R. at 548. “[T]he claimed damages arose when the Franchise Agreements were
breached, prior to the receipt of the false statements. Therefore, Rescuecom cannot plausibly
allege that it suffered damages because it relied, let alone ‘reasonably relied’ on the Defendant’s
false written statements, as it is required to do under § 523(a)(2)(B).” Id. (quoting 11 U.S.C. §
523(a)(2)(B).”
Amended Complaint’s First Claim for Relief under § 523(a)(2)(B)
In an attempt to correct the deficiencies in the Original Complaint, Rescuecom
admittedly “[does] not raise any new claims or assert new legal theories, but instead include[s]
new factual allegations to address the Court’s finding that the original factual allegations
occurred after the signing of the franchise agreement.” (Plaintiff’s Memorandum of Law in
Response and Opposition to Defendant’s Second Motion to Dismiss, P. 5, Section A.) To
support its claim under § 523(a)(2)(B), Rescuecom now contends that it approved the Defendant
as a franchisee in reliance on the Defendant’s written request for consideration (“Request for
Consideration”), which Rescuecom alleges was “materially false” with respect to the
Defendant’s finances and assets (“Amended Claim”). 11 U.S.C. § 523(a)(2)(B).
The Defendant argues that the Amended Claim is time barred under Federal Rule of
Bankruptcy Procedure 4007(c), which provides that “a complaint to determine the
dischargeability of a debt under § 523(c) [includes § 523(a)(2) debts] shall be filed no later than
60 days after the first date set for the meeting of creditors under § 341(a).” Fed. R. Bankr. P.
4007(c). While the original complaint seeking the determination of nondischargeability was
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timely filed, the Amended Claim under § 523(a)(2)(B) was not. In response, Rescuecom argues
that the Court should equitably toll the statute of limitations. Rescuecom also argues that the
Amended Claim relates back to the date of the original complaint under Federal Rule of Civil
Procedure 15(c)(1), made applicable to these proceedings by Federal Rule of Bankruptcy
Procedure 7015, and is therefore not barred by the statute of limitations. Fed. R. Civ. P.
15(c)(1).
Equitable Tolling
Rescuecom argues that the Court has the authority to toll the statute of limitations
provided in Federal Rule of Bankruptcy procedure 4007(c). See European Am. Bank v.
Benedict (In re Bendict), 90 F.3d 50 (2d Cir. 1996) (holding that “Rule 4007(c) is not
jurisdictional and thus is subject to waiver, estoppel, and equitable tolling”). “Under the doctrine
of equitable tolling, a court may, under compelling circumstances, make narrow exceptions to
the statute of limitations in order to prevent inequity.” Rochester v. Sixth Precinct Police
Station, 2010 U.S. App. LEXIS 6127, No. 09-0630-pr, at *2 (2d Cir. 2010). “In New York, a
plaintiff seeking to invoke the doctrine[] of . . . equitable tolling is required to demonstrate that
the failure to timely commence the lawsuit is not attributable to a lack of diligence on his or her
part.” Rochester, 2010 U.S. App. LEXIS 6127 at *3. “Typically, the statute of limitations is
equitably tolled when a defendant fraudulently conceals from a plaintiff the fact that the plaintiff
has a cause of action, or when the plaintiff is induced by the defendant to forgo a lawsuit until
the statute of limitations has expired.” Id. (citing Pearl v. City of Long Beach, 296 F.3d 76, 82-
83 (2d Cir. 2002)).
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Rescuecom makes no claim of fraudulent concealment on the Defendant’s part that
would justify equitable tolling. To the contrary, Rescuecom asserts that it questioned the
Defendant “exhaustively” on the facts that gave rise to Rescuecom’s Amended Claim at the
Defendant’s Rule 2004 examination (Plaintiff’s Memorandum of Law in Response and
Opposition to Defendant’s Second Motion to Dismiss, P. 8-9, Section B), and asserts in
opposition to this motion that the examination was so extensive as to have provided notice to the
Defendant of Rescuecom’s claims. (Id. at 7-8.) Clearly, nothing in the record supports
Rescuecom’s claim that the doctrine of equitable tolling should be applied in this case.
Relation Back Under Rule 15(c)
Under Rule 15(c)(1), “[a]n amendment to a pleading relates back to the date of an
original pleading when . . . the amendment asserts a claim or defense that arose out of the
conduct, transaction, or occurrence set out - - or attempted to be set out - - in the original
pleading.” Fed. R. Civ. P. 15(c)(1). “An amended complaint is deemed to arise out of the same
conduct, transaction or occurrence as the original complaint when both are linked by a common
core of operative facts.” Ainbinder v. Kelleher, 1997 U.S. Dist. LEXIS 10832, No. 92 Civ. 7315
(SS), at *21-22 (S.D.N.Y. July 25, 1997) (quoting Oliner v. McBride’s Indus., Inc., 106 F.R.D.
9, 12 (S.D.N.Y. 1985). Even where an amended claim seeks relief under an entirely new cause
of action, it will relate back so long as additional facts are not alleged. See CIT Group/Factoring
Manufacturers Hanover, Inc. V. Srour (In re Srour), 138 B.R. 413, 418 (Bankr. S.D.N.Y. 1992)
(noting that the focus of the Federal Rules is on “‘the specified conduct of the defendant upon
which the plaintiff’” bases his new claim) (quoting James Moore et al., Moore’s Manual Federal
Practice and Procedure, § 909.09[9], 9-153 (2d ed. 1991)). On the other hand, an amended
complaint that “sets forth a separate set of operative facts” does not relate back under Rule 15(c).
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Ainbinder, 1997 U.S. Dist. LEXIS 10832 at *22. “The essential inquiry . . . ‘is whether the
defendant was given adequate notice that such claims might be made upon examining the facts
alleged in the original pleading.’” Ainbinder, 1997 U.S. Dist. LEXIS 10832 at *22 (quoting
Marine Midland Bank v. Keplinger & Assocs., Inc., 94 F.R.D. 101, 104 (S.D.N.Y. 1982).
The Defendant in this case received no such notice from the allegations in the original
pleading. The Original Complaint set forth in detail conduct allegedly committed by the
Defendant in violation of the executed Franchise Agreements after the Defendant began
operating his Rescuecom franchise. The Amended Claim, by contrast, is based on an allegedly
fraudulent Request for Consideration submitted to Rescuecom prior to the execution of the
Franchise Agreements. The factual discrepancies between the original and amended claims - -
different time frames, different alleged conduct, and different operative facts - - preclude a
finding that the amended claim relates back. See Flexi-Van Leasing, Inc. v. Perez (In re Perez),
173 B.R. 284, 292 (Bankr. E.D.N.Y. 1994) (noting that original and amended claims arising out
of the same factual occurrence is condition precedent to finding of relation back under 15(c));
See also Bank Brussels Lambert v. Chase Manhattan Bank, N.A., 1999 U.S. Dist. LEXIS 13235,
No. 93 Civ. 5298 (LMM), at *8 (S.D.N.Y. Aug. 27, 1999) (new allegations relate back only if
they “amplify the facts alleged in the original pleading or set forth those facts with greater
specificity”).
Rescuecom admits that the Amended Complaint is based on new factual allegations and
does not claim that the Original Complaint provided the requisite notice to the Defendant for
purposes of relation back under Rule 15(c). (Plaintiff’s Memorandum of Law in Response and
Opposition to Defendant’s Second Motion to Dismiss, P. 5, Section A) (noting that the Amended
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Complaint “include[s] new factual allegations to address the Court’s finding” in the Decision
dated November 30, 2009.) Rather, Rescuecom argues that the Defendant had adequate notice
of the allegations raised in the Amended Claim by virtue of the questions asked during the
examination taken pursuant to Federal Rule of Bankruptcy Procedure 2004, which was
conducted on April 5, 2007, two years prior to its commencement of this adversary proceeding.
A similar argument in support of allowing an amended pleading to relate back was
rejected in Bank Brussels Lambert. There, plaintiffs, seeking leave to amend their original
complaint, argued that the defendant was put on notice of the claims alleged in the amended
complaint “through discovery or other pretrial proceedings.” Bank Brussels Lambert, 1999 U.S.
Dist. LEXIS 13235 at *7. In rejecting the plaintiff’s argument, the court held that the requisite
notice must be given by the allegations set forth in the original complaint, and held that
Ainbinder stated the correct rule: an amended complaint relates back to the date of the filing of
the original complaint where adequate notice of an amended claim was given by “‘the facts
alleged in the original pleading.’” Ainbinder, 1997 U.S. Dist. LEXIS 10832 at *22 (quoting
Marine Midland Bank, 94 F.R.D. at 104) (emphasis added). See also In re Asbestos Prods. Liab.
Litig., 2009 U.S. Dist. LEXIS 68254, No. 07-cv-63839, at *26-27 (E.D. Pa. Aug. 5, 2009)
(notice inquiry focuses on whether the original complaint provided adequate notice, “not
whether discovery . . . gave the defendants constructive notice of the claim asserted in the
proposed amended pleading”).
Citing Grattan v. Burnett, 710 F.2d 160 (4th Cir. 1983), Rescuecom maintains that notice
of the factual basis for an amended claim need not be given in the original pleading. There, the
plaintiffs filed amended claims in 1981 raising race and sex discrimination claims not pled in
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their original complaint filed in 1977. Finding that the 1981 claims related back under Rule
15(c), the Grattan court noted that the Defendants, as top officials of the college in question were
“bound to have known” of the discrimination claims raised in complaints filed with the Equal
Employment Opportunity Commission (“EEOC”) in 1976, and therefore, had notice of the
claims and would not be prejudiced by the amendment. Grattan, 710 F.2d 160, 163 (4th Cir.
1983).
Rescuecom misstates the basis on which the Grattan court found that the claims related
back, and overstates the court’s reliance, in its holding, on the earlier complaint filed with the
EEOC. Although the court looked outside the four corners of the original complaint to
determine whether the Defendant would be prejudiced by inadequate notice, it did so only after
making the requisite preliminary determination that a factual nexus existed between the
plaintiffs' original claim for arbitrary dismissal from public employment and later claims for sex
and race discrimination. The court explained its analysis as follows:
First, to relate back there must be a factual nexus between
the amendment and the original complaint. Second, if there is
some factual nexus an amended claim is liberally construed to
relate back to the original complaint if the defendant had notice of
the claim and will not be prejudiced by the amendment.
Grattan, 710 F.2d at 163 (citations omitted). Before considering whether the defendant would be
prejudiced by inadequate notice, the Grattan court first concluded that “both [the original
complaint and amended complaint] concern the events leading up to their termination . . . , and
[that] in both [the original complaint and amended complaint] the termination was the ultimate
wrong of which they complained." Grattan, 710 F.2d at 163. The holding in Grattan is
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consistent with Ainbinder and with the unambiguous language of Rule 15(c), which requires a
court to determine whether the amendment asserts a claim “that arose out of the conduct,
transaction, or occurrence set out . . . in the original pleading.” Fed. R. Civ. P. 15(c)(1).
As the Amended Claim wholly relies on facts not alleged in the Original Complaint, the
Amended Claim does not relate back under Rule 15(c)(1). Slayton v. Am. Express Co., 460 F.3d
215, 228 (2d Cir. 2006) (“[E]ven where an amended complaint tracks the legal theory of the first
complaint, claims that are based on an ‘entirely distinct set’ of factual allegations will not relate
back”) (quoting Nettis v. Levitt, 241 F.3d 186, 193 (2d Cir. 2001)).
Conclusion
The Defendant’s motion to dismiss is granted. A separate order shall issue herewith.
____________________________
Carla E. Craig
United States Bankruptcy Judge
Dated: Brooklyn, New York
July 9, 2010
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