McMahon v. Hickman (In re Hickman)

IN RE: ROBERT HICKMAN, Debtor.JOHN C. McMAHON, JR., JAMES LANGSDORF, JAMES McCORMICK,and ELON PROPERTIES, L.L.C., Plaintiffs. v. ROBERT HICKMAN, Debtor/Defendant.

CASE NO. 11-39943(GMB)

ADVERSARY NO. 12-01043(GMB)

UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF NEW JERSEY

Dated: January 31, 2014

NOT FOR PUBLICATION

CHAPTER 7

MEMORANDUM OPINION

APPEARANCES: Jeffrey A. DiLazzero, Esq.

Attorney for Plaintiffs

Adam D. Greenberg, Esq.

Honig & Greenberg, LLC

Attorney for Debtor/Defendant

I. INTRODUCTION

This matter comes before the Court upon the filing of an adversary complaint by Plaintiffs, individually, and as members on behalf of Elon Properties, LLC ("Elon"), to determine the dischargeability of a debt owed by the Debtor, Robert Hickman ("Debtor"), pursuant to 11 U.S.C. § 523(a)(4) for fraud or defalcation while acting in a fiduciary capacity, orin the alternative, embezzlement or larceny. In addition, Plaintiffs request the Court deny Debtor a discharge under §§ 727(a)(4) and 727(a)(5) for failure to disclose assets to the Court or explain the loss of assets sufficiently.

The Debtor and his wife, Kimberly E. Hickman, commenced their joint Chapter 7 case on October 14, 2011. On January 13, 2012, the Plaintiffs initiated this adversary proceeding against Debtor. The trial commenced on June 13, 2013. During the course of trial, the Plaintiffs' argument centered on a series of checks that the Debtor wrote to himself during his time as President and manager of Elon, a New Jersey limited liability company, formed by the Debtor and the Plaintiffs in 2004.

After a comprehensive trial in which four witnesses testified and over one hundred and thirty exhibits were introduced into evidence, the Court concludes that the Plaintiffs failed to meet their burden to prove that the Debtor did not disclose assets under § 727(a)(4) or explain the loss of assets sufficiently under §727(a)(5). However, the Court does find that $51,250 of Plaintiffs claim is nondischargeable as having been embezzled from Elon's business accounts. For these reasons the Court grants in part and denies in part Plaintiffs' request to determine that their debts are non-dischargeable.

II. JURISDICTION

The Court has jurisdiction over this matter pursuant to 28 U.S.C. §§ 1334(b) and 157(b), and the Standing Order of the United States District Court for the District of New Jersey dated July 23, 1984 as amended Sept 18, 2012 referring all bankruptcy cases to the bankruptcy court. Venue of the case is proper in the District of New Jersey pursuant to 28 U.S.C. §§ 1408 and 1409. This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(I), (J) and (O). The following shall constitute the Court's findings of fact and conclusions of law as required by Federal Rule of Bankruptcy Procedure 7052.

III. FINDINGS OF FACT

Forming of the business

In September 2004, the Debtor entered into a business arrangement with longtime friends, John C. McMahon, Jr. ("McMahon"), James Langsdorf ("Langsdorf"), and JamesMcCormick ("McCormick") (collectively, "the Plaintiffs"). Elon Properties, LLC, a New Jersey limited liability company, was formed for the purposes of acquiring, developing, selling and/or leasing real estate. All three plaintiffs invested in Elon under the collective belief in Debtor's business acumen and his expertise in entrepreneurship due to the prior success of his medical supply company.

Financing of Elon

In order to capitalize Elon, both Plaintiffs and Debtor contributed initial funding equal to their ownership interest. The money invested and the ownership interest of each is outlined as follows:

Investment

% Ownership

Robert C. Hickman

$450,000

66.667%

James W. Langsdorf

$75,000

11.111%

James P. McCormick

$50,000

7.407%

John C. McMahon, Jr.

$100,000

14.815%

In addition to the initial start-up capital, Elon took out a loan from Millville Savings Bank. Plaintiffs and Defendant personally guaranteed the loan. Pledged as collateral for the loan were the Debtor's personal residence, McCormick's personal residence, and the home of McCormick's mother. Each plaintiff testified at trial that he believed the loan proceeds were only going to be used for real estate investment.

Functioning of the Company

Plaintiffs and Defendant signed the Operating Agreement of Elon Properties, LLC ("Elon Operating Agreement") on September 1, 2004. (Ex. P-37.) Each of the Plaintiffs and the Debtor were named Managers of Elon pursuant to this agreement. Each Manager was vested with the responsibility for "the management of the business and affairs of the Company" according to Elon Operating Agreement, Article VI 6.1. Additionally, under Article VI 6.1, each manager was vested with specifically enumerated powers, but retained "all rights and powers and [would] make all decisions affecting the Company in furtherance of the Company's purposes." (Ex. P-37.)

Despite language in the Elon Operating Agreement, testimony at trial evidenced that Debtor was the primary, and in most cases, the only person responsible for all business functions of Elon. He was, pursuant to Article VII Section 7.5 of the Operating Agreement, the Chairman, President, Secretary, and Treasurer of Elon. In return for his role as President, Debtor was given a weekly salary of $1,000 and was provided a car and cell phone allowance. None of the Plaintiffs initially objected. Debtor kept all of Elon's books and records. These records were memorialized in QuickBooks software that the Debtor testified he meticulously updated. Occasionally during the course of a year, Debtor would call the company's accountant to inquire about certain accounting practices. After these conversations, he adjusted his QuickBooks records accordingly. He was the only one with access to the bank debit card and checkbook of Elon properties. Despite his seemingly diligent record keeping, both Plaintiffs and Defendant demonstrated at trial that the Defendant lacked a true understanding of universally accepted accounting practices for a small business.

The roles of the other managers were limited. McCormick and Langsdorf were self-titled "silent partners." Although they had the title of "Manager" in the operating agreement, they testified to having no day-to-day responsibilities in the management of Elon. Besides calling the Debtor, they failed to inquire independently about the records of Elon, the investments of Elon, or the business practices of Elon. In fact, they testified to often neglecting to read documents which Debtor provided to them. As a result, Plaintiffs were only provided balance sheets on a semiannual basis and K-1 documents for tax reporting purposes.

By contrast, McMahon held a somewhat larger role in the company. He was, according to his testimony, in communication with Debtor, and assisted in some limited decision making in his position as Vice President.

Collectively, the Plaintiffs were compensated with reimbursement for acquiring required life insurance policies. In addition, all four managers received dividend checks from Elon as return on their investment. Both dividend checks and life insurance reimbursement checks were signed only by Debtor and were often in amounts in excess of $500.00.

At trial, it was established that none of the parties adhered to the Elon Operating Agreement they signed in 2004. For example, Debtor frequently used his own money forbusiness expenses. He then was reimbursed for these purchases by Elon, often in excess of $500.00. Debtor, as President and Manager of Elon, wrote himself a check to facilitate reimbursement. Debtor's practices with regard to reimbursement were generally understood by the other managers but conflicted with the Elon Operating Agreement Article VI Section 6.4, which required that "expenses in excess of $500.00 per month" receive approval of the Board of Managers. It was also in direct contravention to Article VI Section 6.1(c), which required that checks over $500.00 be signed by two managers. Although Section 6.1(c) signature requirement was possibly observed in the beginning of the company's formation, McMahon and Debtor orally agreed to waive this obligation without consulting the other managers, whose permission was required by the Operating Agreement under Article XI Section 11.1. Furthermore, despite asserting that Debtor's failure to adhere to this provision in the Operating Agreement was inappropriate, all three plaintiffs accepted numerous checks in excess of $500.00 signed only by Debtor, never questioning this practice.

Loans from Elon to the managers were also permitted. No terms or interest rates were ever discussed. For example, in July of 2005, due to family illness, Langsdorf received a sizeable loan from Elon. Debtor wrote a check for $15,000 from Elon's account with only his signature, and neither man sought approval of the other managers of Elon. Plaintiffs all subsequently ratified the transaction and Langsdorf repaid the loan in 2012, without interest. Later in 2008, Debtor received a similar loan, absent terms, with approval of the Plaintiffs.

Checks Written by Debtor for Elon's Business Ventures

At trial, as a basis for their many allegations, Plaintiffs presented numerous checks written by Debtor to himself from Elon's bank account. Each check was in excess of $5,000, totaling approximately $112,000 over the course of his time as president. The largest amounts were written via checks #1166, #1149, and #1297. (Ex. P-22.) At trial, the Debtor demonstrated that all three of these checks were written to reimburse the Debtor for Elon related expenses. These expenses including deposits on land, home improvement supplies for the properties that Elon was rehabilitating, or allowed administrative allowances, such as a cell phone payment or gas for Debtor's car.

In 2006, McMahon and Debtor decided to buy rental property in Myrtle Beach¹ on behalf of Elon. Debtor purchased the condominium in his own name, due to alleged restrictions by the seller on...