The Business Backer, LLC et al v. Hughes

THE UNITED STATES BANKRUPTCY COURT
FOR THE NORTHERN DISTRICT OF WEST VIRGINIA
IN RE:
BELINDA LEE HUGHES
Debtor.
ERIC J. WEBER
Debtor.
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THE BUSINESS BACKER, LLC
Plaintiff,
v.
ERIC J. WEBER,
Defendant.
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Case No. 08-1125
Case No. 08-1228
Adv. Proc. No. 08-78, administratively
consolidated with
Adv. Proc. No. 08-77
MEMORANDUM OPINION
In May 2008, The Business Backer (“TBB”) purchased $31,550 in future credit card
receivables from Belinda & Eric’s LLC (“B&E”) for $25,240. Belinda Hughes and Eric Weber
(collectively the “Debtors”) are the owners/managers of B&E, and they guaranteed B&E’s
performance under the purchase of receivables agreement. Within a month, B&E ceased to conduct
business. TBB now seeks summary judgment on its complaint to except $21,716.82 – representing
the amount of uncollected future receivables – from the Debtors’ discharge under 11 U.S.C. §§
523(a)(2) and 523(a)(4). 	The Debtors also seek summary judgment on the grounds that the
uncontested facts do not support TBB’s causes of action.
For the reasons stated herein, the court will deny TBB’s motion for summary judgment and
Dated: Friday, April 17, 2009 4:04:05 PM
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will grant the Debtors’ motion for summary judgment in both of these consolidated adversary
proceedings.
I. STANDARD OF REVIEW
Summary judgment is appropriate when the matters presented to the court “show that there
is no genuine issue as to any material fact and that the moving party is entitled to judgment as a
matter of law.” Fed. R. Civ. P. 56(c); Fed. R. Bankr. P. 7056; Celotex v. Catrett, 477 U.S. 317, 322
(1986). The party moving for summary judgment has the initial burden of proving that there is no
genuine issue as to any material fact. Adickes v. S. H. Kress & Co., 398 U.S. 144, 161 (1970). Once
the moving party has met this initial burden of proof, the non-moving party must set forth specific
facts sufficient to raise a genuine issue for trial and may not rest on its pleadings or mere assertions
of disputed facts to defeat the motion. Matsushita Electric Industrial Co., Ltd., v. Zenith Radio
Corp., 475 U.S. 574, 586-87 (1986) (stating that the party opposing the motion “must do more than
simply show that there is some metaphysical doubt as to the material facts”). The mere existence
of a scintilla of evidence in support of the opposing party’s position will not be sufficient to forestall
summary judgment, but “the judge’s function is not himself to weigh the evidence and determine
the truth of the matter but to determine whether there is a genuine issue for trial.” Anderson v.
Liberty Lobby, Inc., 477 U.S. 242, 252 (1986). In ruling on a motion for summary judgment, “the
evidence of the nonmovant is to be believed, and all justifiable inferences are to be drawn in his
favor.” Id. at 255. A fact is not “genuinely disputed” unless the factual conflict between the parties
requires a trial of the case for resolution. Finley v. Giacobbe, 79 F.3d 1285, 1291 (2d Cir. 1996) (“If
there is any evidence in the record from which a jury could draw a reasonable inference in favor of
the non-moving party on a material fact, this Court will find summary judgment is improper.”).
II. BACKGROUND
Belinda Hughes is the sole owner of B&E. Eric Weber is a manager. In October 2003, B&E
executed a 5-year lease with an entity owned by Gino Marchese. B&E used the premises to operate
a business, The Corner Grocery. Although the Debtors did not have a good relationship with Mr.
Marchese, in the late winter and early spring of 2008, they expected that they would be able to sell
The Corner Grocery as a going concern, or at least be able to operate out of the real property until
September 31st of that year. The Corner Grocery did most of its business in the summertime, with
the winter being the slower season. In the winter of 2007-08, The Corner Grocery was low on cash.
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In addition to The Corner Grocery, B&E also operated another business, Good Times Diner
& Market. In 2007, the Diner had a brisk summertime lunch business that served local construction
crews. Like The Corner Grocery, however, in the winter of 2007-08 Good Times Diner & Market
was running out of cash.
To meet B&E’s cash needs at its business locations, the Debtors contacted TBB for the
purpose of selling B&E’s future credit card receivables in exchange for an immediate cash payment.
In March 2008, B&E executed two agreements. The Corner Grocery sold $7,910 in future credit
card receivables for $6,000. 	Good Times Diner & Market sold $24,320 in future credit card
receivables for $16,000. TBB was to receive the value of its purchases by retaining between 33%
and 40% of each future credit card transaction. As part of the purchase agreement, TBB filed a
financing statement in an effort to obtain a security interest in substantially all the property of B&E.
In the purchase agreements, the Debtors, on behalf of B&E, made certain representations, including:
(a) B&E was duly organized, validly existing and in good standing under the laws of West Virginia
and its local jurisdiction; 1 (b) B&E had full power and authority to enter into the purchase
agreement; (c) all information provided to TBB in connection with the purchase agreements was
true, accurate and complete in all respects; (d) B&E would conduct business in the ordinary course,
consistent with past practice, and would not cease operations; and (e) B&E would not sell, dispose
of, convey or otherwise transfer its business or assets without the prior written consent of TBB.
When B&E requested that TBB purchase its future receivables in March 2008, the Debtors
knew that the initial 5-year term of B&E’s lease with Mr. Marchese would be ending on September
31, 2008. 	TBB also knew this, inasmuch as its representative called Mr. Marchese and was
informed that he would not extend B&E’s lease. Also, at the time B&E executed the March 2008
purchase agreement, it had been actively seeking a purchaser for The Corner Grocery. Although
B&E received several inquiries, the potential sales eroded after the prospective purchasers spoke
with Mr. Marchese about extending the lease, or obtaining a new one. 	One of the prospective
purchasers, Ron Funkhouser, decided not to purchase The Corner Grocery after speaking with Mr.
1 At the time B&E obtained financing from TBB, B&E had failed to file an annual report
with the West Virginia Secretary of State and its status as a business entity was revoked. In
January 2009, B&E paid its missing annual fee, and was reinstated as a West Virginia business
entity.
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Marchese because Mr. Marchese informed him that he would be better off waiting until B&E’s lease
terminated, at which time Mr. Marchese would lease the premises to him. In the event that the
Debtors could effect a sale, then they anticipated that B&E would pay TBB in full.
Meanwhile, due to conditions that the Debtors attribute to the worsening regional economy,
neither The Corner Grocery nor Good Times Diner & Market was experiencing the expected
increase in seasonal business. The downturn in business, combined with the continuing loss of a
prospective sale of The Corner Grocery, convinced the Debtors to have B&E close The Corner
Grocery on April 22, 2008:
Once we learned that Mr. Funkhouser had made a deal or that Gino Marchese had
made a deal with Mr. Funkhouser which basically removed him from being a buyer
of The Corner Grocery, and we confronted Gino Marchese about it and he admitted
it, we knew at that point–well, at that point, we had just had it with Mr. Marchese
and knew that business was–it just didn’t warrant continuing business there.
(Eric Weber Depo. p. 61).
On April 30, 2008, B&E sold much of the personal property in The Corner Grocery to Mr.
Funkhouser for $5,000 – without informing TBB. The Debtors did, however, contact TBB with
regard to the closing of The Corner Grocery and they requested that the receivables remaining to be
collected from The Corner Grocery be combined with the receivables to be collected from Good
Times Diner & Market.
TBB agreed to consolidate the purchase of receivables, and in May 2008, the parties
executed another purchase of receivables agreement whereby TBB purchased $31,550 in future
receivables from Good Times Diner & Market for $25,240. In actuality, B&E only received about
$2,500 in new money, and the remainder of the purchase reflected the consolidation of the two
earlier agreements. 	The Debtors’ hope was that Good Times Diner & Market would generate
sufficient business to repay TBB:
Our intention and our hope was that we were going to push really since we didn’t
have to worry about The Corner Grocery anymore and didn’t have that overhead
hanging over us and the running of that business hanging over us, that we can
concentrate on Good Times and hopefully really push Good Times and make Good
Times work and be able to pay off The Business Backers. That was our intention.
(Eric Weber Depo. p. 71).
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By June 2008, however, it became clear to the Debtors that Good Times Diner & Market was
having decreasing sales, it lacked adequate funds to operate, and it was behind on its rent.
Consequently, in early July 2008, Good Times Diner & Market closed its doors and sold off its
remaining inventory and fixtures for $5,100. Only after Good Times Diner & Market had closed,
and after B&E had sold off the remainder of the property in the store, did the Debtors contact TBB
to inform it that neither B&E nor themselves would be able to perform under the purchase
agreement. When Good Times Diner & Market closed, TBB was still owed $21,716.82 in future
receivables.
III. DISCUSSION
TBB argues that the Debtors owe it $21,716.82 based on their guarantee of B&E’s
performance on the receivables purchase agreement, and that this debt is excepted from the Debtors’
bankruptcy discharges pursuant to 11 U.S.C. §§ 523(a)(2) and 523(a)(4). In the alternative, TBB
asserts that $10,100 should be excepted from the Debtors’ discharges, representing the proceeds
from the unauthorized sale of B&E’s property and TBB’s secured collateral. The Debtors do not
dispute owing money to TBB, 2 but they dispute that the debt is one excepted from their Chapter 7
bankruptcy discharges.
A. 	Section 523(a)(2)
In seeking relief under § 523(a)(2), TBB argues that the following uncontested facts entitle
it to relief: (1) the Debtors caused B&E to fail to meet is reporting requirements with the West
Virginia Secretary of State and, at the time TBB purchased B&E’s future receivables, B&E was not
2 The Debtors executed the agreements with TBB as “guarantors” of B&E’s performance.
The terms of the May 2008 Guaranty Agreement state that, should B&E fail to timely make
payments to TBB on a timely basis, then “all amounts then due to TBB and unpaid under this
Agreement shall become due and collectible from each of the undersigned [guarantors]
immediately.” Based on this language, the Debtors were acting as sureties of B&E’s
performance – they were insuring payment and not B&E’s solvency. As such, no requirement
exists that TBB first obtain judgment against B&E before proceeding against the Debtors
individually. E.g., 18 Michie’s Jurisprudence of Virginia and West Virginia, Suretyship § 30
(2008) (“The creditor may proceed at law against the principal and the sureties in the first
instance and obtain a judgment and execution against them jointly, the general rule being that the
creditor is under no obligation to look to the principal debtor or to his property or to exhaust his
remedies against the latter before resorting to the surety.”).
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a recognized corporation in good standing with the Secretary of State; (2) the Debtors did not review
the purchase of receivables agreements so as to be familiar with their terms; and (3) the Debtors
failed to notify TBB that the assets of B&E’s businesses were being liquidated and the Debtors kept
the proceeds for themselves.
Section 523(a)(2)(A) excepts from discharge any debt “for money . . . to the extent obtained,
by-- (A) false pretenses, a false representation, or actual fraud . . . .” 	In a similar manner, §
523(a)(2)(B) excepts from discharge debts for money obtained by the “use of a statement in writing
– (i) that is materially false . . . . and (iv) that the debtor caused to be made or published with intent
to deceive . . . .” These exceptions to discharge are to be narrowly construed in favor of the debtor.
E.g., Bellco First Fed. Credit Union v. Kaspar (In re Kaspar), 125 F.3d 1358, 1361 (10 th Cir. 1997)
(explaining that the rule of narrow construction is based on the “fresh start objectives of
bankruptcy”).
Not all debts incurred as a result of fraud fall within the § 523(a)(2) exception to discharge;
rather, this exception only includes those “debts in which the debtor used fraudulent means to obtain
money . . . .” Nunnery v. Rountree (In re Rountree), 478 F.3d 215, 219 (4th Cir. 2007). The intent
of § 523(a)(2) is “to protect creditors who were tricked by debtors into loaning them money or
giving them property, services, or credit through fraudulent means.” Id. at 219-20. Regarding a
debtor’s misstatement of intention, it is only “fraudulent if he does not have that intention at the time
he makes the representation.” Palmacci v. Umpierrez, 121 F.3d 781, 786 (1st Cir. 1997) (quoting
Restatement (Second) of Torts § 530(1) (1976)); see also Lindau v. Nelson (In re Nelson), 357 B.R.
508, 513 (B.A.P. 8th Cir. 2006) (“Even if a false statement is made, no fraud exists unless the maker
knows the statement is false at the time the statement is made. . . . To amount to fraud, a statement
must be made deliberately and intentionally with the intention and purpose of deceiving.”). 	A
fraudulent misrepresentation may also be made when a debtor makes a statement with reckless
disregard as to whether the statement is true or false. Boyuka v. White (In re White), 128 Fed. Appx.
994, 998; 2005 U.S. App. LEXIS 7374 at *9-10 (4th Cir. April 28, 2005).
Regarding the Debtors’ representation in the purchase agreements that B&E was in
compliance with all applicable laws, and was a validly existing business entity in good standing
under the laws of West Virginia, the record does not reflect that the Debtors knew these statements
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to be false at the time they were made, or that the Debtors made the statements with reckless
disregard for the truth. B&E maintained all of its business licenses, with the exception that it failed
to file an annual report in 2007, which led to revocation of B&E’s status as an LLC in September
2007. As stated in the Debtors’ depositions, however, they believed that B&E was a validly existing
LLC in good standing, and they were unaware that B&E’s status as an LLC had been revoked when
they executed their agreements with TBB. 3 Consequently, the Debtors’ representation that B&E was
a validly existing business in good standing was not reckless, or knowingly false, when the Debtors
executed the purchase of receivables agreements with TBB.
TBB also complains that the Debtors failed to fully read the terms of the receivables
purchase agreements and understand their basic terms. 	For example, Eric Weber stated in his
deposition that he was unaware that TBB had filed a financing statement to perfect a secured interest
in the personal property of B&E. It does not appear, however, that TBB undertook any effort to
educate the Debtors that they were signing a security agreement giving TBB rights to the personal
property of B&E. When TBB called the Debtors to go over the basic terms of the agreements with
3 Eric Weber explained how B&E’s status as a West Virginia LLC was revoked:
Basically, what happened was we never got a renewal from the State Tax
Department and because we were both working managers of the corporation and
worked every single day, we relied upon notices to keep everything current and in
the past anytime we didn’t get a notice, it had some effect on some operation of
our business and we were made aware of that which reminded us that we had to
renew the license or whatever the license was.
In every other case, over the course of years we were in business, we had
renewed every license that we needed to stay in business, in order to keep the
operation going. So, because we were not sent a renewal notice, we were not
aware that the LLC had been revoked. We never got notice that the LLC had
been revoked after it had been revoked.
. . . .
Normally the form that they send in the past was a status of the LLC and
requesting if any information had changed. If the information had changed, you
were supposed to indicate that on the renewal form, if not, just indicate not,
enclose the $30 fee and send it in. That was it.
(Eric Weber Depo. p. 25-26).
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them, TBB never mentioned that the purchase agreements also granted TBB a security interest in
B&E’s personal property. In any event, the Debtors’ failure to understand that TBB was retaining
a security interest in B&E’s property at the time they executed the purchase agreements is not the
type of fraudulent misrepresentation or statement in writing that is intended to deceive TBB into
transferring money to the Debtors. TBB obtained the security agreement. No indication exists in
the record that the Debtors made a false or reckless promise to provide TBB with a security
agreement for B&E’s personal property for the purpose of inducing TBB to extend value. TBB
received exactly what was promised.
Finally, TBB complains that the Debtors failed to notify it that the assets of B&E’s
businesses were being liquidated, and then failed to remit the sale proceeds to it. Under the terms
of the purchase agreement, B&E was neither allowed to cease its operations, nor to sell its business
without the consent of TBB. No indication exists, however, that these covenants were falsely made,
or recklessly made, by the Debtors at the time they executed the purchase agreements. Although
the Debtors were actively seeking to sell The Corner Grocery at the time the agreements were
executed, that sale never materialized, and seeking prospective purchasers was not a prohibited act
under the terms of the agreements. Moreover, the Debtors anticipated that TBB would be fully
repaid in the event that the Debtors’ sale efforts were successful. The fact that the Debtors may have
later caused B&E to sell its collateralized assets without paying the proceeds to TBB does not render
the covenants in the purchase of receivables agreements false when made. Also, while, in hindsight,
the Debtors’ hope and anticipation that Good Times Diner & Market would be able to perform under
the receivables purchase agreement was unfounded, no showing has been made that the Debtors’
business optimism was so unfounded as to amount to a false representation of B&E’s ability to
perform, or a reckless statement as to B&E’s ability.
In sum, TBB has failed to demonstrate that any of the covenants made by the Debtors in the
purchase agreements were reckless, or knowingly false, when made, and, therefore, TBB is not
entitled to summary judgment on its § 523(a)(2) causes of action.
B. 	Section 523(a)(4)
TBB asserts that the Debtors owed it a fiduciary obligation on the grounds that they engaged
in acts that were not appropriate to the winding up of B&E’s business activity. This fiduciary duty,
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TBB argues, is imposed by W. Va. Code § 31B-8-804(b), which governs an LLC member’s or
manager’s power and liability to act as an agent for the LLC after its dissolution:
(b) A member or manager who, with knowledge of the dissolution, subjects a limited
liability company to liability by an act that is not appropriate for winding up the
company's business is liable to the company for any damage caused to the company
arising from the liability.
Id.
Section 523(a)(4) excepts debts from discharge that arise out of “fraud or defalcation while
acting in a fiduciary capacity.” 11 U.S.C. § 523(a)(4). An essential element of a § 523(a)(4) cause
of action is that the debtor be acting in fiduciary capacity. The definition of “fiduciary” for purposes
of § 523(a)(4) is controlled by federal common law. Harrell v. Merchant's Express Money Order
Co. (In re Harrell), No. 98-1728, 1999 U.S. App. LEXIS 4743 at *7 (4th Cir. March 19, 1999) (citing
Miller v. J.D. Abrams, Inc. (In re Miller), 156 F.3d 598, 602 (5th Cir. 1998)). Under the federal
common law, the term “fiduciary” is limited to instances involving express or technical trusts. Id.
In an express or technical trust, “[t]he trustee’s obligations must have been imposed prior to, rather
than by virtue of, any claimed misappropriation of funds . . . .” Id. at *8. Like all exceptions to a
debtor’s discharge, § 523(a)(4) is narrowly construed in favor of the debtor. Kaspar, 125 F.3d at
1361.
Here, TBB has failed to demonstrate the existence of an express or technical trust – no words
of trust are contained in the purchase agreements. Cf., Kubota Tractor Corp. v. Strack (In re Strack),
524 F.3d 493 (4th Cir. 2008) (finding that the debtor and creditor established an express trust based
on the specific language in their financing agreement); Airlines Reporting Corp. v. Ellison, 296 F.3d
266, 269-70 (4th Cir. 2002) (finding that the creditor and debtor corporation created an express trust
with regard to bank account funds, and that the debts owed by the corporate guarantors with respect
to that express trust were excepted from discharge under § 523(a)(4)). Moreover, the source of the
Debtors’ alleged fiduciary duty to TBB is W. Va. Code § 31B-8-804(b), which is only made
applicable when some event causes the dissolution or the winding up of an LLC’s business. See
31B-8-801(b) (specifying the events causing dissolution and winding up of an LLC). TBB has not
made any showing that B&E was in the process of dissolving or winding up its business so as to
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make the statute applicable. Indeed, as of January 2009, B&E was still a licensed LLC in the State
of West Virginia, and although it liquidated two of its business operations, the LLC has not been
dissolved. B&E is still poised to continue business operations in the future.
Consequently, the court will deny TBB’s motion for summary judgment on its 11 U.S.C. §
523(a)(4) cause of action both because TBB has not demonstrated the existence of an express or
technical trust, and because TBB has failed to demonstrate that the Debtors were acting in a
fiduciary capacity to it.
IV. CONCLUSION
TBB filed a three-count complaint against the Debtors alleging causes of action under 11
U.S.C. §§ 523(a)(2)(A), 523(a)(2)(B) and 523(a)(4). 	TBB has failed to establish an essential
element of each of its stated causes of action on summary judgment, and, therefore, its summary
judgment motion will be denied. The Debtors also filed a motion for summary judgment arguing
that they never made a fraudulent misrepresentation to TBB when they executed the purchase of
receivables agreements under § 523(a)(2), and that they were not fiduciaries to TBB or in a trust
relationship with it. Construing the evidence in a light most favorable to TBB as the non-movant
on the Debtors’ summary judgment motion, the court can deduce no genuine issue of material fact
showing that the Debtors made a fraudulent misrepresentation under § 523(a)(2), or acted in a
fiduciary capacity with respect to a trust within the meaning of § 523(a)(4), and, therefore, the court
will grant the Debtors motion for summary judgment on all counts of the Complaint.
A separate order will be entered pursuant to Fed. R. Bankr. P. 9021.
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