Phelps v. Hunt (In re Hunt)

608 B.R. 477

IN RE: Jeffery Micheal HUNT, Debtor.

Robert D. Phelps, Plaintiff,

v.Jeffery Micheal Hunt, Defendant.

Case No.: 18-20072-RLJ-7

Adversary No. 18-02011

United States Bankruptcy Court, N.D. Texas, Amarillo Division.

Signed September 20, 2019

Ernest P. Nycz, Law Office of Ernest P. Nycz, Plano, TX, for Plaintiff

Bill Kinkead, Kinkead Law Offices, Wesley Will Masters, III, Amarillo, TX, for Defendant

MEMORANDUM OPINION

Robert L. Jones, United States Bankruptcy Judge

On April 2nd and 3rd, the Court conducted the trial on the complaint of Robert D. Phelps (Phelps) against chapter 7 debtor, Jeffery Micheal Hunt (Hunt). Phelps asserts the following seven claims: (1) objection to discharge of Phelps's claim under § 523(a)(2)(A); (2) objection to discharge of Phelps's claim under § 523(a)(2)(B); (3) objection to discharge of Phelps's claim under § 523(a)(4); (4) objection to discharge of Phelps's claim under § 523(a)(6); (5) objection to Hunt's discharge under § 727(a)(3); (6) objection to Hunt's discharge under § 727(a)(4)(A); and (7) a claim for attorney's fees and costs.¹

In addition to denying the factual basis for each of Phelps's causes of action, Hunt raises the following affirmative defenses: (1) failure to state a claim upon which relief may be granted (Federal Rule of Civil Procedure (FRCP) 12(b)(6) ); (2) general denial that Phelps sustained damages and that Hunt caused any damages; (3) exercise of his best judgment under the Business Judgment Rule; and (4) that Phelps's claims under § 523 are barred as untimely.² On the last point, the Court has issued its Memorandum Opinion and Order that grants the motion of Phelps (and his attorney, Ernest Nycz) to amend the Court's order of August 6, 2018 to provide that the deadline to file discharge and dischargeability complaints was extended to September 18, 2018. Case No. 18-20072, Doc. No. 47.

Hunt also submitted the following contested issues of law in the pre-trial order: (1) whether his actions were sufficiently justified to overcome a challenge to his discharge under § 727(a)(3); (2) whether Phelps is precluded from raising his § 523 claims under Bankruptcy Rule 4007(c); and (3) whether Phelps met his burden under FRCP 12(b)(6).³

As set forth, the Court finds and concludes that Phelps shall be granted a nondischargeable claim of $55,000 against Hunt under § 523(a)(4) and (a)(6) of the Bankruptcy Code. All other requested relief is denied.

I.Background

Phelps and Hunt first met in early Summer, 2014. Phelps, a podiatrist in Tyler, Texas, was interested in franchising opportunities with Tea 2 Go, a company that operated tea stores, mostly in Texas, that catered to walk-in customers. Hunt was the principal owner and manager of the Tea 2 Go stores. He had started the business under the company he formed, Tea 2 Go, LLC. Through the LLC, he was promoting and offering Tea 2 Go franchises. Phelps had no experience with operating a small retail outlet but was looking for an investment for his retirement years. Hunt was based out of Lubbock where Phelps's daughter was attending Texas Tech.

In their initial discussions, Hunt, according to Phelps, told Phelps that his existing tea stores were doing extremely well, that they were grossing $750,000 to $1.5 million per year. Phelps also said that Hunt told him that he had sold a tanning business for over $2 million.

Each of the franchises was tied to a specific territory where the prospective owner would have the exclusive right to open a Tea 2 Go store. The stated cost to Phelps of each territory, the franchise fee, was $30,000. In addition, Phelps, as franchisee, would have to pay for the "build-out" of each store so that it would conform to the Tea 2 Go concept. The cost for the build-out, Hunt told Phelps, was $125,000 to $175,000. Phelps testified that Hunt elaborated on the riches to be made from the franchises.

Hunt provided Phelps with two sets of written materials. On October 19, 2014, Hunt sent store "projections" to Phelps for twelve Tea 2 Go stores—two each in Amarillo and Lubbock and one in each of Abilene, Colleyville, Farmers Branch, Midland, Plainview, Sugarland, Waco, and Tempe, Arizona. Pl.'s Ex. 44. The projection for each store reflected an annual profit. The basic costs and operations for each store are reflected with hoped-for income from anticipated sales multiplied by an average price per sale. The projected net of operating costs and income ranged from a low of approximately $114,000 to a high of over $880,000. Id. The projections, realistically considered, were speculative.

Phelps was also given a Tea 2 Go Franchise Disclosure Statement dated February 9, 2015. Pl.'s Ex. 2. This included the disclosures presumably required by law. It reflected that the franchise fee was $20,000, with an additional $10,500 for advertising the store's opening and for licensing and software. An estimated additional maximum amount of $50,000 was allocated for the store's equipment. The costs for each of "property," construction, and utilities were listed as "varies." Id. Royalty payments were 4% of gross revenues each quarter. The brochure reflected that the franchisor, Tea 2 Go, LLC, had assets of $569,910 and liabilities of $213,574. The most valuable single asset is stated as "Assets"—without elaboration—of $386,000. Id.

Between August 2014 and mid-to-late 2015, Phelps acquired nine territories, each with an exclusive right to open and operate a Tea 2 Go store. The first franchise he acquired was for College Station, Texas. He paid the $30,000 franchise fee in August 2014. College Station was a complete failure. In addition to the initial fee, Phelps acquired a store on a 10-year lease. He testified that he paid $365,000 for the build-out of the store. Based on his conversations with Hunt, he expected that such cost would run no more than $175,000. Tea 2 Go's involvement as franchisor was minimal. Phelps found the facility and negotiated the lease; he hired a consultant to advise him on the build-out. Construction was delayed; the store opened on September 11, 2015, several months past the anticipated opening date. Tea 2 Go provided staff training for a few days before the store opened but very little assistance after it opened. The College Station store never made a profit and closed a year and a half after opening. Phelps sold the store but, in doing so, financed part of the purchase price for the buyer. The sales price was $110,000, with $20,000 paid down and the balance of $90,000 financed by Phelps for three years. The buyer defaulted, and Phelps lost at least $50,000 on the sale. Phelps asserts a total claim against Hunt of $462,000 on the College Station investment: $30,000 for the franchise fee, $365,000 for the build-out, $45,000 for lease payments, $72,000 in operating losses, and a credit of $50,000 that he received on the sale of the store.

In addition to College Station, Phelps purchased rights to the following Tea 2 Go franchises: Katy, Spring, Tyler, Lufkin, Longview, Rockwall, Brenham, and Nacogdoches. He paid the full franchise fee of $30,000 for each of Katy, Spring, and Tyler. He made a down payment of $5,000 against the franchise fee for each of the other five territories; he invested nothing further on the five, however. Phelps made no further investment, apart from the $30,000 fee, for the Katy territory—no store was started. He did, however, obtain a lease and do a build-out for each of Spring and Tyler. They, like College Station, were also failures. Phelps spent an additional $392,000 for build-out and lease expenses on the Spring store. It never opened. He spent an additional $200,000 on the Tyler store. It opened in August 2017 and closed within a year. The store lost over $70,000. (By its opening, Phelps had abandoned the Tea 2 Go concept; he named the store Coffee, Tea, & Me.)

In the Spring of 2016, Phelps made an investment at Hunt's prompting that was different from the prior franchising deals. For $50,000 (or $55,000),⁴ he obtained, from Hunt personally , a 49% interest in a company-owned tea store in Austin. The purchased-interest was not for an interest in Tea 2 Go; instead, it was for an interest in EJ T Kickers, LLC, a Texas limited liability company. Phelps never received a signed purchase agreement from Hunt. Within a few weeks after Phelps's purchase, and unbeknownst to Phelps, Hunt sold the store for $50,000. And after Hunt had sold the store, Phelps inquired of the store's status; Hunt did not tell him then that he had sold the store—he instead said he needed an additional $8,000 to cover expenses related to the store. Hunt never accounted back to Phelps for his share of any proceeds from the sale.

The evidence confirms that Phelps's $50,000 wire transfer was deposited in an account of Tea 2 Go, LLC's and then immediately paid out on Tea 2 Go loans. In addition, Phelps testified that all claims of Mr. JP Ventures, LLC, which had paid an additional $5,000 for the Austin store, were assigned to him, personally.⁵

Hunt admitted that, in April of 2016, he and his businesses, Tea 4 U and Tea 2 Go, incurred a default judgment of over $598,000 taken by Midway Associates, LLC. See also Pl.'s Ex. 18.

Hunt was the sole member of Tea 2 Go, LLC. He also owned "100% of the issued and outstanding membership interests in EJ T Kickers, LLC." Pl.'s Ex. 3 ¶ A.⁶

Phelps incorrectly asserts that he was in a partnership with Hunt. Rather, Phelps acquired a minority interest in EJ T Kickers, LLC. And no partnership relationship was established for any of the nine franchises purchased by Phelps. The stores (and the rights to open other stores) were acquired by Phelps (or, perhaps, an entity Phelps started, Mr. JP Ventures, LLC) as a franchisee of Tea 2 Go, LLC.

At trial, neither party offered a written franchise agreement into evidence, nor was there any evidence of a company agreement for EJ T Kickers, LLC.

A.

As with most dischargeability issues, the Court is asked to liquidate the claims that are said...