Azzouz v. Annab, Inc. (In re Azzouz)

In re: Khader Kamal Azzouz and Nannette Azzouz, Debtors

Khader Kamal Azzouz and Nannette Azzouz, Plaintiffs, v. Annab, Inc., Defendant

Case No. 15-12559-KHK

Adv. Proc. No. 16-01117-KHK

UNITED STATES BANKRUPTCY COURT FOR THE EASTERN DISTRICT OF VIRGINIA Alexandria Division

August 17, 2018

(Chapter 11)

MEMORANDUM OPINION

I. INTRODUCTION

This matter is before the Court pursuant to Khader Azzouz'¹s Complaint against Annab, Inc. for breach of contract, actual fraud and fraud in the inducement. Azzouz seeks a judgment of $90,000 reflecting the purchase price under the Asset Purchase Agreement, a judgment in the amount of $40,000 for additional damages that are alleged to be the direct result of the Defendant's breach of warranty andfraud, and punitive damages in the amount of $350,000 dollars as a result of the Defendant's alleged fraud. See Complaint, Doc No. 1, pgs. 5-6. The Plaintiff, in essence, seeks rescission of the Asset Purchase Agreement, the underlying promissory note and the guaranty. Annab, the Defendant, asserts the Azzouz's claims are barred by the doctrine of unclean hands, setoff, Azzouz's failure to mitigate, and ultimately that Azzouz suffered no damages. A trial on the merits took place on December 20, 2017. Having heard the evidence and arguments of counsel, the Court makes the following findings of fact and conclusions of law.

II. FINDINGS OF FACT

The Parties and the Bagel Bakery

Khader "George" Azzouz ("Plaintiff"), a real estate and business broker, is the younger brother of Samar Annab. Samar and her husband, Mansour Annab, are the the owners of Annab, Inc. ("Defendant") which operates a wholesale bagel bakery called Bagel Bagel Inc., in Fairfax, Virginia. Trial Transcript ("Tr") 81-82. The bagel bakery was responsible for manufacturing and delivering bagels, donuts, and muffins to between 300 and 700 customers in Virginia and the District of Columbia.² Those customers largely consisted of cafés and delis. Tr. 167:7-9. From 2010 to 2014, the Defendant operated the bagel bakery with between 7 and 14 employees, including the Annabs. See Tr. 228-232. Some workers were paid by check. Others were paid "under the table," or without withholding proper taxes and without properly reporting to the Internal Revenue Service ("IRS"). Tr. 129:5-6; 159-160.

Central to the instant dispute is the Plaintiff's assertion that the bagel bakery reported lower sales to the IRS than were recorded in the bakery's QuickBooks sales records. Tr. 85:5-16. The parties disagree about the reason for the difference between the records and what was reported to the IRS. The Plaintiff asserts that the difference between the two amounts was pocketed as part of a scheme to underreport sales and pocket the difference. Id. The Defendant asserts that the difference was due to the tax return's failure to include uncollected accounts receivables. Tr. 216:16-23.

In the fall of 2012, the Plaintiff and the Defendant agreed to list the bagel bakery for sale, with the Plaintiff acting as broker. Tr. 82:2-4. In connection with listing the business for sale, the Defendant provided the Plaintiff with the 2010 and 2011 federal tax returns. Tr. 83:20-21. Ultimately, the Plaintiff decided to purchase the business for himself. Tr. 87-88. After the Plaintiff expressed interest in buying the bagel bakery, the Defendant provided the Plaintiff with the 2012 and 2013 tax returns, and eventually, the QuickBooks sales information for the bakery. Tr. 84-86. Specifically, the Plaintiff testified at trial that on March 6, 2014 he received QuickBooks sales information for the bagel bakery via email. Tr. 84:18. The Plaintiff testified as follows:

5 Q Describe again for us the additional information you

6 received about sales.

7 A Sales was in QuickBooks, what they actually do. On the

8 tax record is what they report to the IRS, and the difference

9 is the money that they collect and pocket.

10 Q What's your source of that information?

11 A This was from Mansour and Samar.

12 Q They told you that they were reporting sales

13 differently in QuickBooks than to the IRS?

14 A Yes.

15 Q Did they tell you why they were doing that?

16 A She just said they pocket the difference.

Tr. 85:5-16.

In April of 2014, the Plaintiff purchased the bagel bakery, making a $90,000 down payment and signing a promissory note and guaranty for $485,000. Tr. 126-127; 93:14-15; The Asset Purchase Agreement, Pl. Ex. 1. The Plaintiff's brokerage company simultaneously earned a $20,000 commission for the sale. Tr. 140:15-24.

The Asset Purchase Agreement, the Promissory Note and the Personal Guaranty

The Asset Purchase Agreement (the "APA") provided for the sale of substantially all of Bagel Bagel's assets, including machinery, vehicles, mixers, baking and kitchen equipment, and the bagel bakery's customer list. The APA also provided for the execution of a new lease of the real property where the bagel bakery was located, including the option to purchase the real estate. See Pl. Ex. 1, at pg. 1.

Although the agreement provided for the sale of substantially all of Bagel Bagel's assets, the Defendant would still be entitled to accounts receivables for sales accrued prior to the sale of the business. See Pl. Ex. 1, at ¶ 4(A)(xii). The APA contained a "study period" provision which provides under paragraph "4(A)",

xi. Seller warrants and guarantees that the financial statements/records provided to purchasers are 100% true and accurate. Purchaser shall have an evaluation period for 90 days starting in May until end of July. Seller furthermore warrants that in the events a discrepancy is found after possession that Seller will be held liable for such discrepancy.

Pl. Ex. 1, at pg. 3, ¶ xi. Also relevant to the instant dispute is the APA's Default Provision, which provides:

Default. If Purchaser's contingencies shall have been satisfied but Purchaser fails to proceed to settlement, Purchaser shall be in default of its obligations under this Agreement. If Seller fails to proceed to settlement, Seller shall be in default of its obligations under this Agreement. The parties acknowledge that the damages, if any, that either party might incur in the event of a breach of this Agreement by either party would be difficult, if not impossible to determine. Therefore, the other party may elect to accept partial performance or, in lieu of any other remedy, elect to terminate this Agreement. All deposit and down payment paid into escrow account shall be returned to Purchaser without any delay or demand.

The APA included various warranties. Of those warranties, the Plaintiff alleges that the following warranties were breached:

Section 4(A)(i):

All commissions, salaries, bonuses and additional compensation due any of the employees of Seller for services rendered prior to settlement are to be paid in full by Seller, at time of settlement. Any employee wages held by Seller must be paid to Purchaser at time of settlement to be held by Purchaser in Purchasers account.

Section 4(A)(iii):

Seller warrants that it has paid all taxes [including but not limited to sales taxes, employment taxes, FICA withholdings imposed by any federal, state, or municipal authority], impositions, interest, and or penalties upon any such taxes or impositions relating to the Assets, the Business, or the Business premises.

Section 4(A)(x):

For a period of ten (10) years after the effective date of this agreement, Mansour & Samar Annab will not directly or indirectly solicit business from or attempt to sell, license or provide the same or similar products or services as are not provided to any customer or client of Annab Inc. T/A Bagel Bagel Wholesale Bakery. See customer list - Exhibit C. - * However, Mansour & Samar Annab shall be permitted to operate a Danish/doughnut/muffin business.

See Complaint at pgs. 4-5; See Pl. Ex. 1, at ¶ 4.

Take-over of the business:

On or about April 6, 2014, the Plaintiff took over the bagel bakery. Within a few days of taking over, the Plaintiff began noticing discrepancies between the actual payroll figures and the payroll figures reported to the IRS. See Tr. 125:10-12. On July 24, 2014, the IRS issued a Notice of Federal Tax Lien to the Defendant for outstanding 2012 and 2013 obligations. Pl. Ex. 20. The Notice was sent via U.S. Postal Service to the bagel bakery. The Defendant did not receive the Notice but was notified of its existence via a telephone call. Tr. 120:4-20. The Defendant asserts that she implemented a payment plan and that as of the trial date, she has fully resolved the matters that gave rise to the Notice. Tr. 66:1-5. The Plaintiff was not required to make any, and did not make any payments in connection with the Notice, nor was the Plaintiff prevented from operating the business by the Notice. Tr. 138-139. On July 15, 2014, the Plaintiff, through counsel, sent a Notice of Rescission to the Defendant. The Defendant refused to honor the rescission. See Tr. 125.

Following the Notice of Rescission, and the Defendant's refusal to honor the rescission, the Plaintiff continued to operate the bagel bakery and collect on the accounts receivables up through and even after returning possession of the bagel bakery to the Defendant in October of 2014. Tr. 148-149. Indeed, between April and October of 2014, the Plaintiff operated the business and collected roughly $51,000 in receivables to which the Defendant was entitled. Tr. 135:18-20. Although the Plaintiff admits to collecting accounts receivables that belonged to the Defendant, the Plaintiff has not turned any of those funds over to the Defendant. Tr. 136:9-13.

III. CONCLUSIONS OF LAW:

Jurisdiction

The Complaint seeks an award of damages and rescission of the APA. The recovery of damages or the down-payment from the APA would affect the amount of property available for distribution to creditors, making the claims "related to" the Debtor's bankruptcy estate. Therefore, pursuant to 28 U.S.C. §§ 157 and 1334(b) and the general order of reference for the U.S. District Court...