Fulton, N.A. v. Robbins (In re Robbins), Bankruptcy No. 14–18860–AMC

562 B.R. 83

IN RE Jon A. ROBBINS, Debtor

Fulton, N.A., Plaintiff

v.Jon A. Robbins, Defendant

Bankruptcy No. 14–18860–AMC

Adv. Proc. No. 14–688–AMC

United States Bankruptcy Court, E.D. Pennsylvania.

December 21, 2016

Sigmund J. Fleck, Scott M. Klein, Jami B. Nimeroff, Brown McGarry Nimeroff LLC, West Chester, PA, for Plaintiff.

Evan Beck Coren, Steven M. Coren, David M Devito, Kaufman, Coren & Ress, P.C., Aris J. Karalis, Robert W. Seitzer, Maschmeyer Karalis P.C., Philadelphia, PA, for Defendant.

OPINION

Honorable Ashely M. Chan, United States Bankruptcy Judge

TABLE OF CONTENTS

I. Introduction...88

II. Facts and Procedural History...90

A. Background of High Fidelity House, Inc....90

1. Officers and Outside Accountant...90

2. HiFi's Accounting Practices...91

a. Refreshed Invoices...92

b. Inventory Valuation...93

c. Advanced Billing...93

B. HiFi Commercial Loans with Fulton...93

1. First Meeting...94

2. Second Meeting...94

3. Third Meeting...95

4. Refreshing Invoices...95

5. The Loan Agreements...96

6. Drexel Contract...97

7. Borrowing Base Certificates...97

C. 2012 Covenant Violation...98

D. 2013 Covenant Violation...99

E. Fulton Field Examination of HiFi...99

F. Liquidation...102

G. The Debtor's Residential Loans with HiFi...103

H. The Debtor's Bankruptcy Proceeding...104

III. Discussion...105

A. Fulton's Nondischargeability Claim Under § 523(a)(2)(B)...106

1. Material Falsity Under § 523(a)(2)(B)(i)...106

2. Insider's Financial Condition Under § 523(a)(2)(B)(ii)...106

3. Reasonable Reliance Under § 523(a)(2)(B)(iii)...109

4. Intent to Deceive Under § 523(a)(2)(B)(iv)...109

5. HiFi's Borrowing Base Certificates and Financial Statements...110

a. HiFi's Borrowing Base Certificates...110

b. HiFi's Financial Statements...111

B. Fulton's Nondischargeability Claim Under § 523(a)(6)...115

IV. Conclusion...118

I. INTRODUCTION

In this case, an unfortunate confluence of events caused the demise of a well-established, family owned business and the loss of collateral worth millions of dollars which significantly damaged both parties in this litigation.

Prior to filing for bankruptcy, Jon A. Robbins ("Debtor") was the President and Chief Executive Officer ("CEO") of High Fidelity House, Inc. ("HiFi"), a high end audio visual company founded by his father in 1955. For many years, the Debtor's brother-in-law acted as Chief Financial Officer ("CFO") of HiFi and, in that role, likely began "refreshing" invoices, a practice which had the effect of making invoices that were more than ninety days past due appear current. Although HiFi's sales people generally only refreshed invoices on long term jobs which were still deemed collectible, the practice technically allowed HiFi to borrow higher monthly amounts from its lenders than it was otherwise permitted under its loan documents.

The CFO was ultimately terminated, in part, because he withdrew $700,000 from an entity related to HiFi as an unauthorized loan. At that point, the Debtor offered the CFO position to a long time employee at HiFi who did not have the requisite financial experience to act as CFO, but who the Debtor considered trustworthy and reliable.

In June of 2012, Fulton Bank ("Fulton") agreed to lend HiFi up to $6 million. Fulton required that HiFi submit monthly borrowing base certificates which set forth the inventory and eligible accounts receivable against which HiFi was permitted to borrow. At the beginning of 2013, Fulton loaned another $1.2 million to HiFi in connection with a large contract that HiFi obtained.

Later in 2013, HiFi disclosed to Fulton, and obtained a waiver of, a financial covenant violation from the prior year. However, in 2014, after HiFi suffered substantial losses in connection with the large contract noted above and disclosed another financial covenant violation, Fulton became concerned about HiFi's operations.

Although HiFi immediately disclosed its practice of "refreshing" invoices (and advanced billing which was instituted in 2013) to Fulton's field examiners when Fulton began an investigation of HiFi's collateral, Fulton ultimately concluded that HiFi had engaged in fraud during its lending relationship with Fulton as a result of: (1) HiFi's improper inclusion of accounts receivable, which were more than ninety days past due, in HiFi's eligible accounts receivable as reported in the monthly borrowing base certificates submitted to Fulton; (2) Fulton's (mistaken) belief that obsolete and display inventory should not have been included in the monthly borrowing base certificates; and (3) HiFi's failure to maintain organized and accurate records in connection with its customers' invoices.

Based upon Fulton's belief that HiFi had defrauded it, Fulton was unwilling to release the Debtor and his father from their guarantees of HiFi's commercial loans unless the Debtor's father contributed exempt funds from his IRA account as part of the settlement agreement. When the Debtor's father refused to do so, Fulton shut down HiFi and liquidated its inventory and accounts receivable. Although Fulton received over $1 million from HiFi's inventory, it only received a de minimis amount from its accounts receivable because HiFi's customers were unwilling to pay HiFi's invoices after it had gone out of business. Fulton ultimately confessed judgment against both the Debtor and his father in connection with their guarantees of HiFi's commercial loans.

In this adversary proceeding, Fulton asserts that its claims against the Debtor are nondischargeable pursuant to § 523(a)(2)(B), based primarily on the inaccurate borrowing base certificates provided by HiFi to Fulton during their lending relationship. However, Fulton's reliance upon the borrowing base certificates, which did not present a comprehensive picture of HiFi's assets and liabilities, were insufficient to support its claims because they were not broad enough to constitute statements of HiFi's "financial condition" as required by § 523(a)(2)(B)(ii).

Upon realizing this, Fulton ultimately shifted its focus during trial to the accuracy of financial statements provided by HiFi to Fulton near the end of their relationship. However, Fulton failed to provide any evidence that the financial statements submitted by HiFi to Fulton in June of 2012 or January of 2013 (prior to Fulton's two extensions of credit) were materially false or that they were not in compliance with generally accepted accounting principles ("GAAP"). Specifically, Fulton presented no evidence that HiFi overvalued its inventory during the requisite time period and, in contrast, the Debtor credibly testified that HiFi's premium inventory generally maintained its value over time. Nor did Fulton present evidence in support of its assertion that HiFi's list of "current" accounts receivable in its financial statements included accounts receivable that were not collectible within one year of invoice. The Court therefore concludes that the financial statements relied upon by Fulton to extend credit to HiFi were not materially false.

The Court also concludes that Fulton failed to demonstrate that the Debtor intended to deceive Fulton when HiFi submitted financial statements to Fulton prior to the extensions of credit to HiFi because the Debtor, who was not sophisticated in financial matters, reasonably relied upon HiFi's independent accountant to prepare and submit financial statements to Fulton. Fulton accordingly has failed to demonstrate that its claim against the Debtor in connection with his guaranty of HiFi's commercial loans is nondischargeable under § 523(a)(2)(B).

Fulton has also failed to demonstrate that it has standing to pursue a nondischargeability claim against the Debtor under § 523(a)(6) in connection with the Debtor's drawdown of $250,000 under a line of credit with Citizens Bank which should have been closed, but was not, after Fulton refinanced the Debtor's mortgages on his personal residence. As discussed below, Fulton has not yet sustained, and may never sustain, an injury in connection with that drawdown and, therefore, does not have standing to pursue such claim at this time. Moreover, even if Fulton sustains an injury related to the drawdown in the future, any claim for such injury would be subject to discharge under § 523(a)(6) as arising from a simple breach of contract.

II. FACTS AND PROCEDURAL HISTORY

A. Background of High Fidelity House, Inc.

1. Officers and Outside Accountant

HiFi was founded by the Debtor's father, Saul Robbins ("Saul"), in 1955. Tr. Apr. 22, 7:8–11, ECF No. 58. HiFi supplied and installed premium audio visual systems and components in both commercial and residential properties. Tr. Apr. 11, 11:19–20, ECF No. 54. Its headquarters were in Broomall, Pennsylvania. Tr. Apr. 22, 28:4–7.

The Debtor began working full-time for HiFi in 1976 after he graduated from high school, and started out in HiFi's warehouse. Id. at 5:6–6:4. He continued working at HiFi full-time while he attended college and eventually became a sales manager, which involved managing sales at many HiFi stores and supervising sales people at those locations. Id. at 5:12–6:15.

In the 1980s, Saul's health began to deteriorate and, by the mid-1980s, he withdrew from the full-time, day-to-day management of HiFi. Id. at 8:17–25. During that time, the Debtor became heavily involved in the role of purchasing and management at HiFi. Id. at 6:16–18, 7:5–7. In the 1990s, the Debtor became HiFi's Chief Operating Officer ("COO"), and later became CEO and President. Id. at 6:22–7:4. The Debtor eventually became a 75% shareholder of HiFi. Id. at 9:1–10.

During the Debtor's entire tenure at HiFi, he never participated in the management of HiFi's finances. Tr. Apr. 21, 196:11–16, ECF No. 57. The Debtor graduated from college with a political science degree, never studied finance, never received training in, and had no knowledge of, how to read financial statements and was "not particularly sophisticated in accounting matters." Id. at 195:23–25; Tr. Apr. 22, 75:15–17, 141:20–23.

Ken Adelberg ("Adelberg"), who was...