Nat'l Credit Union Admin. Bd. v. Zovkic (In re Zovkic), Case No. 15–16860

564 B.R. 291

IN RE: Vlado ZOVKIC, Debtor.

National Credit Union Administration Board, Acting in its Capacity as Liquidating Agent for St. Paul Croatian Federal Credit Union, Plaintiff,

v.Vlado Zovkic, Defendant.

Case No. 15–16860

Adversary Proceeding No. 16–1031

United States Bankruptcy Court, N.D. Ohio, Eastern Division.

Signed November 21, 2016

Robert E. Goff, Jr., Samuel J. Lauricia, III, Matthew C. Miller, Weston Hurd LLP, Cleveland, OH, for Plaintiff.

Jim Petropouleas, James E. Boulas Co., L.P.A., Broadview Hts., OH, for Defendant.

MEMORANDUM OF OPINION

Pat E. Morgenstern–Clarren, United States Bankruptcy Judge

The plaintiff National Credit Union Administration Board is the liquidating agent for the failed St. Paul Croatian Federal Credit Union. The Board filed this complaint seeking a determination under Bankruptcy Code §§ 523(a)(2)(A) and (a)(2)(B) that a debt owed to St. Paul by the defendant-debtor Vlado Zovkic is not dischargeable in his chapter 7 case. For the reasons that follow, the Court finds that the Board did not meet its burden of proof and the debt is, therefore, discharged.

JURISDICTION

Jurisdiction exists under 28 U.S.C. § 1334 and General Order No. 2012–7 entered by the United States District Court for the Northern District of Ohio on April 4, 2012. This is a core proceeding under 28 U.S.C. § 157(b)(2)(I), and it is within the Court's constitutional authority as analyzed by the United States Supreme Court in Stern v. Marshall , 564 U.S. 462, 131 S.Ct. 2594, 180 L.Ed.2d 475 (2011) and its progeny.

TRIAL

The National Credit Union Administration Board (Board) presented its case through the direct testimony of Kempe Hayes (a Board asset recovery analyst), Anthony Raguz (St. Paul's former chief operating officer),¹ Anna Soskic (the debtor's ex-wife), and cross-examination of the debtor, together with exhibits.² The debtor presented his case through his own testimony, that of Michael Dosen (the debtor's accountant), and cross-examination of other witnesses. The parties also stipulated to certain facts.³

The findings of fact are based on that evidence and reflect the Court's weighing of the evidence presented, including determining the credibility of the witnesses. "In doing so, the Court considered the witness's demeanor, the substance of the testimony, and the context in which the statements were made, recognizing that a transcript does not convey tone, attitude, body language or nuance of expression." In re The V Companies , 274 B.R. 721, 726 (Bankr. N.D. Ohio 2002). See FED. R. BANKR. P. 7052 (incorporating FED. R. CIV. P. 52 ).

BANKRUPTCY CODE § 523(a)(2)(A) and § 523(a)(2)(B)

While an individual chapter 7 debtor is generally entitled to a discharge of most debts, there are exceptions to that rule. The Board relies on two of them:

§ 523. Exceptions to discharge

(a) A discharge under section 727 ... of this title does not discharge an individual debtor from any debt—* * *

(2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by—

(A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor's or an insider's financial condition; [or]

(B) use of a statement in writing—

(I) that is materially false;

(ii) respecting the debtor's or an insider's financial condition;

(iii) on which the creditor to whom the debtor is liable for such money, property, services or credit reasonably relied; and

(iv) that the debtor caused to be made or published with intent to deceive ....

11 U.S.C. § 523(a)(2).

The exceptions are to be construed strictly against the creditor because a central purpose of the Bankruptcy Code is to provide a fresh start to the honest but unfortunate debtor. Pazdzierz v. First Am. Title Ins. Co. (In re Pazdzierz) , 718 F.3d 582, 586 (6th Cir. 2013). The creditor must prove its case by a preponderance of the evidence. Grogan v. Garner , 498 U.S. 279, 291, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991).

The two exceptions at issue here are mutually exclusive. "One [§ 523(a)(2)(A) ] applies expressly when the debt follows a transfer of value or extension of credit induced by falsity or fraud (not going to financial condition), the other [§ 523(a)(2)(B) ]when the debt follows a transfer or extension induced by a materially false and intentionally deceptive written statement of financial condition upon which the creditor reasonably relied." Field v. Mans , 516 U.S. 59, 66, 116 S.Ct. 437, 133 L.Ed.2d 351 (1995).

There is a split in the case authority as to the proper interpretation of the phrase "other than a statement respecting the debtor's or an insider's financial condition" as required for § 523(a)(2)(A) to apply. This Court adopts the Sixth Circuit Bankruptcy Appellate Panel's strict interpretation of the phrase to mean "statements that are made regarding a debtor's overall net worth, assets and liabilities[.]" Prim Capital Corp. v. May (In re May) , 368 B.R. 85, 2007 WL 2052185 at *7 (6th Cir. B.A.P. 2007) (unpublished opinion). As the Panel stated in that decision:

A broad interpretation simply brings too many statements under the rubric "concerning the debtor's financial condition," rendering the limitation meaningless. See [ In re ] Joelson , 427 F.3d [700], 710–11 [10th Cir. 2005].

The operative terms in § 523(a)(2)(A), ..., 'false pretenses, a false representation, or actual fraud,' carry the acquired meaning of terms of art. They are common-law terms, and, ..., they imply elements that the common law has defined them to include.

Field v. Mans , 516 U.S. 59, 69, 116 S.Ct. 437, 133 L.Ed.2d 351 (1995) (citations omitted). In fact, "if the phrase 'respecting the debtor's ... financial condition' were given a broad reading, the resulting exclusion might eliminate coverage for many misrepresentations typical of the common-law torts that Field represents as lying at the heart of §[§] 523(a)(2)(A)." Joelson , 427 F.3d at 710 (citing Field, 516 U.S. at 68–69, 116 S.Ct. 437 (explaining that § 523(a)(2)(A) refers mainly to common-law torts set forth in § 523(a)(2)(A) ). A broad interpretation of the phrase "concerning the debtor's ... financial condition" would allow debts incurred as a result of these common-law torts to be dischargeable. Joelson , 427 F.3d at 710. That result is not in line with the Court's analysis in Field. See id. at 710–11.

Id.

THE POSITIONS OF THE PARTIES

There is no question but that St. Paul's chief operating officer Anthony Raguz and certain other St. Paul members committed financial crimes against St. Paul. The issue here is different: did the debtor commit civil fraud and/or other acts in his dealings with St. Paul such that the debt he owes is non-dischargeable in this bankruptcy case?

The Board argues yes, saying that over the course of years when the debtor borrowed money from St. Paul, he:

1. obtained a mortgage construction loan in 1997 under false pretenses by telling St. Paul that it would have a first lien on property being used to build a house in Bratenahl when in fact another lender obtained a first lien [§ 523(a)(2)(A) ];⁴

2. engaged in a scheme with Raguz starting in 2003 to open St. Paul accounts in false names and use these accounts together with a corporate account and his then-wife's account to move loan balances around to evade review by St. Paul's examiners, while committing federal crimes [§ 523(a)(2)(A) ];⁵ and

3. failed to disclose material information relating to his financial condition in loan applications starting in 2007 [§ 523(a)(2)(B) ].⁶

The debtor denies that he committed any fraud or obtained money under false pretenses, and also denies that St. Paul, through Raguz, relied upon anything either stated in or omitted from the documents placed into evidence by the Board.

FACTS

I. Background

A. St. Paul's Operations

St. Paul Croatian Federal Credit Union (St. Paul), established in 1943 to serve members of Cleveland's St. Paul Croatian Parish, was a federally regulated and insured credit union that operated until April 30, 2010 when the Board stepped in to liquidate it due to a massive fraud perpetrated by Anthony Raguz.

As a federal credit union, St. Paul offered share accounts to customers who were referred to as members. A share account is the equivalent of a checking or savings account at a bank.⁷ St. Paul had authority to make these kinds of loans: car, house, unsecured, and "share secured;" it did not have authority to make commercial loans.

The unsecured loans were limited to $5,000.00 per member. St. Paul could make share secured loans in higher amounts if they were secured dollar for dollar by funds pledged from a St. Paul account. Annually after year end, St. Paul's examiners set a limit for the amount that St. Paul could loan to any individual member, usually in the range of about $250,000.00 to $300,000.00. A loan balance exceeding that amount was termed a high concentration loan.

The only testimony about loan procedures came from Raguz, who had sole authority to make loans throughout his tenure as chief operating officer. He described the process he used in approving loans, as discussed below. There was no testimony about any loan committee, other officers, or about the procedures followed by St. Paul's examiners or auditors (other than with respect to the high concentration limit).

B. Raguz's Criminal Fraud

Raguz began his employment with St. Paul in 1989 as a teller, moving to operations manager in the mid-1990s and to chief operating officer in the early 2000s. Starting in early 2001, Raguz conceived of and carried out a fraudulent scheme that had two parts. First, he took bribes from members (not including the debtor) in exchange for "covering bad loans," which he defined as making a commercial loan that appeared on paper to be share secured by a member's account, when it was not. And second, Raguz opened new accounts to conceal the loans when they were 90 days delinquent or the loan violated the high concentration limit because either event would draw attention from the...