Arfa v. Roni LLC

Rachel Lisa Arfa Debtor,Rachel Lisa Arfa, Appellant, v. Roni LLC, et al. Respondents.

14-CV-7895 (AJN)

UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK

September 23, 2015

MEMORANDUM & ORDER

ALISON J. NATHAN, District Judge:

This case concerns a bankruptcy court determination on the nondischargability of debt under 11 U.S.C. § 523(a)(2)(A). That section provides: "A discharge [in bankruptcy] . . . does not discharge an individual debtor from any debt . . . for money, property, [or] services . . . to the extent obtained by - false pretenses, a false representation, or actual fraud." 11 U.S.C. § 523(a)(2)(A). Here, a group of investors from Roni LLC, Eshel Properties, LLC, Gili Holdings LLC, and KRR Investments, LLC (collectively "Respondents") has sought to prevent Ms. Rachel Lisa Arfa ("Appellant") from discharging in bankruptcy a New York Supreme Court judgment in their favor. Appellant appeals from the order entered by Bankruptcy Judge Glenn on August 28, 2014 finding the debt nondischargeable. See 14-CV-7895 Dkt. No. 1. For the following reasons, the judgment of the bankruptcy court is affirmed.

I. BACKGROUND

A. Underlying Real Estate Investment

In the early 2000s, Appellant, a licensed real estate broker and former attorney for the Securities and Exchange Commission ("SEC"), was a promoter for limited liability companies ("LLCs") purchasing and managing residential real estate in New York City. Resp. Br. at 3. From mid-2002 to early 2005, Appellant and her business associates solicited Israeli investors to acquire multi-family residential properties in New York City. Id. at 4. During this time, Appellant failed to disclose to the investors certain commissions she would receive in connection with the transactions which substantially increased the cost of acquiring the properties. Id. at 4.

B. The State Court Action

In 2007, the investors (twenty-five LLCs and thirty-three individuals) consolidated their claims by assigning them to a smaller group within the investors, the named Respondent LLCs in the instant case. See 13-BR-01526 Dkt. No. 10 Ex. 1 at 5. Thereafter, Respondents commenced an action against Appellant and her business associates in New York State Supreme Court, asserting claims for breach of fiduciary duty, actual fraud, and constructive fraud. See App. Item No. 1 Ex. B at 2. On June 27, 2013, Justice Ramos granted summary judgment, finding in favor of Respondents on the claims for breach of fiduciary duty and constructive fraud without ruling on the claim for actual fraud. Id. at 20. Importantly, Justice Ramos made no finding regarding Appellant's intent to deceive the investors, which was not an element of the charges in that proceeding. Id. at 6-18.

C. The Bankruptcy Proceeding

On July 25, 2013, Appellant filed a voluntary petition for relief under Chapter 7 of the Bankruptcy Code. See 13-BR-12433 Dkt. No. 1. On October 1, 2013, Respondents filed acomplaint in Appellant's bankruptcy proceeding to render her state court judgment to them nondischargeable under 11 U.S.C. § 523(a)(2)(A). See App. Item No. 1. Respondents then moved for summary judgment on their nondischargability claim, arguing Appellant was collaterally estopped from denying Justice Ramos's findings, which established all the necessary elements of nondischargability. See 13-BR-01526 Dkt. No. 7 at 2. In an order dated March 4, 2014, Judge Chapman, who was originally assigned the matter, denied the motion because Justice Ramos had made no finding regarding intent to deceive, a required element under § 523(a)(2)(A). See App. Item No. 11. Judge Chapman did, however, find Appellant collaterally estopped from denying (1) that Promoters made false representations and omission to the Respondents; (2) that the Respondents relied on the false representations and omissions; (3) that Respondents sustained a loss of $5,848,648.30 as the proximate consequence of the false representation or omission; and (4) that the assignments of claims to Respondents were valid. Id. at 1-2. Judge Chapman then ordered a trial limited in scope to the following issues: (1) the Appellant's "reckless disregard and intent to deceive"; and (2) whether Appellant "herself made the misrepresentations and/or omissions at issue." Id. at 2.

The debtor's chapter 7 case and the related adversary proceeding were transferred to Judge Glenn on June 9, 2014. See 13-BR-01526 Dkt. No. 18. Judge Glenn held a trial on June 26, 2014 limited to the issues reserved for trial by Judge Chapman's summary judgment order: whether the Appellant herself made the false representations and omissions at issue with the required intent to deceive. See App. Item No. 22. On August 28, 2014, Judge Glenn entered a ruling following a bench trial, finding the state court judgment nondischargable under § 523(a)(2)(A). Id. at 2.

On September 30, 2014, Appellant filed a Notice of Appeal with the district court of the Southern District of New York, challenging Judge Glenn's August 28, 2014 ruling. See 14-CV-7895 Dkt. No. 1.

II. STANDARD OF REVIEW

11 U.S.C. § 523(a)(2)(A) provides that a "discharge [in bankruptcy] . . . does not discharge an individual debtor from any debt . . . for money, property, [or] services . . . to the extent obtained by - false pretenses, a false representation, or actual fraud." § 523(a)(2)(A). Appellant argues primarily that there is insufficient evidence of her intent to deceive, a required element of nondischargability under § 523(a)(2)(A). In addition, Appellant challenges the bankruptcy court's collateral estoppel ruling and argues that nondischargability in this case is more properly considered under 11 U.S.C. § 523(a)(4).

A district court has "jurisdiction to hear appeals . . . from orders and decrees [] of bankruptcy judges." 28 U.S.C. § 158(a)(3). On appeal, the bankruptcy court's legal conclusions are reviewed de novo, but findings of fact are reversed only when "clearly erroneous." Kuhl v. United States, 467 F.3d 145, 147 (2d. Cir. 2006) (citation omitted) (per curiam). A finding is "clearly erroneous" when "the reviewing court . . . is left with the definite and firm conviction that amistake has been committed." Anderson v. City of Bessemer City, N.C., 470 U.S. 564, 573 (1985).

III. INTENT TO DECEIVE

The elements of 11 U.S.C. § 523(a)(2)(A) incorporate the common law of torts and are interpreted in light of the Restatement (Second) of Torts. See Field v. Mans, 516 U.S. 59, 69-70 (1995); In re Chase, 372 B.R. 125, 130 (Bankr. S.D.N.Y. 2007). To demonstratenondischargability due to false representation under § 523(a)(2)(A), a creditor must establish five elements: (1) that "the debtor made a false representation"; (2) "the debtor knew the representation was false at the time it was made"; (3) the debtor made the representation with the intent to deceive the creditor; (4) the creditor justifiably relied on the representation, and (5) the creditor sustained loss or damage as the proximate consequences of the false, material representation. In re Fenti, No. 94-5025, 1994 WL 16167976 (2d Cir. 1994); In re Hartley, 479 B.R. 635, 641 (S.D.N.Y. 2012). Each element must be proved by a preponderance of the evidence. See Grogan v. Garner, 498 U.S. 279, 286 (1991).

As will be discussed in greater depth below, Judge Chapman held that collateral estoppel applied to Justice Ramos's findings of fact regarding false representation and omission, materiality, reliance, and damages. See App. Item No. 11 at 1-2. Thus, the Appellant's intent to deceive was the sole subject of the bench trial before Judge Glenn, who found she possessed the requisite intent under § 523(a)(2)(A). See id. at 2; App. Item No. 22 at 33-39. Generally, intent to deceive is an issue of fact and the bankruptcy court's finding on intent should only be set aside if clearly erroneous. See In re Hartley, 479 B.R. at 642 (citing In re Bonnanzio, 91 F.3d 296, 302 (2d Cir. 1996)).

Appellant makes two arguments bearing on intent. First, Appellant argues that reckless disregard of an omission cannot, as a matter of law, constitute the requisite intent to deceive. Second, Appellant argues that her belief that an LLC promoter owed no fiduciary duty to potential investors negates any possible intent to deceive. Neither of these arguments has merit.

A. Reckless Disregard of an Omission

The Second Circuit has held that intent to deceive under §523(a)(2) may be satisfied if the debtor acted with reckless disregard for the truth; in such a case, recklessness is to bedetermined based on the totality of the circumstances. See In re Bonnanzio, 91 F.3d 296, 301 (2d Cir. 1996) ("[I]ntent to deceive can be inferred from the totality of circumstances, including reckless disregard."). Appellant argues that reckless disregard involving an omission is fundamentally different than reckless disregard involving an affirmative representation, and thus cannot as a matter of law satisfy § 523(a)(2)(A)'s intent to deceive requirement. Because Appellant's arguments on reckless disregard and omission are questions of law, the Court will review the bankruptcy court's ruling on these issues de novo. See Kuhl, 467 F.3d at 147. Under this standard, Appellant's argument fails.

Appellant argues that the reckless disregard approach to intent is not appropriate for omissions because "[s]ilence has never been the basis of a holding of reckless disregard in a discharge case." App. Br. at 11. To the contrary, "[t]he law is well settled . . . that so-called "half-truths"—literally true statements that create a materially misleading impression—will support claims for . . . fraud" under a reckless disregard theory. S.E.C. v. Gabelli, 653 F.3d 49, 57-58 (2d Cir. 2011) rev'd on other grounds, 133 S. Ct. 1216 (2013) (citing List v. Fashion Park, Inc., 340 F.2d 457, 462 (2d Cir. 1965)). This general principle has also been applied to the bankruptcy discharge context. In In re Capelli, the bankruptcy court found debt nondischargeable because the Debtor-Defendant...