Reperex, Inc. v. May (In re May)

579 B.R. 568

IN RE: Steven Lyle MAY and Bobbie Jean May, Debtors.

Reperex, Inc., a Utah Corporation, Brad Ball, and David Ball, Plaintiffs,

v.Steven Lyle May and Bobbie Jean May, Defendants.

Bankruptcy Number: 13–24002

Adversary Proceeding No. 13–2360

United States Bankruptcy Court, D. Utah.

Signed December 20, 2017

J. Spencer Ball, Salt Lake City, UT, for Plaintiffs.

R. Steven Chambers, R. Steven Chambers PLLC, Jack W. Reed, Richards Brandt Miller Nelson, Salt Lake City, UT, for Defendants.

MEMORANDUM DECISION

R. KIMBALL MOSIER, U.S. Bankruptcy Judge

Brad Ball was looking for a business to buy. With the assistance of his father, David Ball, they bought May's Custom Tile from Steven May in August 2008. Business did not go well for the Balls and they ended up blaming May and filed a lawsuit claiming that the company was underperforming because May had misrepresented its financial condition. May had another business, May's Granite, and business didn't go well for him either. He and his wife Bobbie (collectively, the Mays or Defendants) filed bankruptcy in April 2013, and the Balls commenced the above-captioned adversary proceeding alleging causes of action under 11 U.S.C. §§ 523(a)(2), (a)(6), 727(a)(2), (a)(3), (a)(4), and (a)(5).¹ After four days of trial and after the Balls had been fully heard on all issues, the Defendants moved for judgment on partial findings. The Court permitted briefing on that motion and conducted a hearing on it on July 20, 2017. After considering the parties' briefs and oral arguments, reviewing and weighing the evidence presented at trial, and conducting an independent review of applicable law, the Court issues the following Memorandum Decision granting the Defendants' motion.²

I. JURISDICTION

The Court's jurisdiction over this adversary proceeding is properly invoked pursuant to 28 U.S.C. § 1334 and § 157(b)(1). Actions to except particular debts from discharge and to deny a debtor's discharge are core proceedings within the definition of 28 U.S.C. § 157(b)(2)(I) and (J), and the Court may enter a final order. Venue is appropriate under 28 U.S.C. § 1409.

II. FINDINGS OF FACT

Steven May founded May's Custom Tile, Inc. (Tile) in 1987 and was its owner and president. Tile performed commercial and high-end residential tile work in northern Utah. May founded a second company, May's Granite, LC (Granite), in 2002 and was its manager, registered agent, and organizer. Granite was organized under the Utah Revised Limited Liability Company Act as a manager-managed limited liability company. Tile and Granite shared office space that was located above a showroom within a warehouse. In 2007, May suffered a heart attack and undertook efforts to sell Tile and Granite by listing them with Coldwell Banker Commercial through one of its agents, Duane Bush. Tile was marketed as a non-recurrent revenue business, meaning that an operator of the business would have to find new clients on a regular basis to generate revenue.

Brad Ball enrolled in an MBA program with a scheduled graduation date in 2008. In mid–2007, halfway through the program, he began to search for a business to purchase by looking through financial statements given to him by the businesses and their brokers. In late June or early July 2008, he found Tile and Granite. Ball informed his father, David Ball (collectively with Brad Ball, the Balls or Plaintiffs), about Tile and enlisted him to help vet the company and finance its purchase. The Balls did not hire an accountant or business valuation expert to assist them in examining Tile's financial information, and they did not hire an attorney to help with the purchase of the business.

During July and August 2008, the Balls met with Duane Bush approximately six times and began reviewing some of Tile's records, including a business opportunity brochure prepared by Bush (Ex. 71) and Tile's 2006 and 2007 tax returns (Exs. 1 and 2). The Balls also claim to have reviewed accounts receivable aging reports dated March 3, 2008 and April 24, 2008 (Exs. 20 and 22), Tile's sales by customer summary for January through December 2007, dated March 4, 2008 (Ex. 81) Tile's sales by customer summary for January through February 2008, dated February 29, 2008 (Ex. 80), and Tile's profit and loss statement for January 1 through April 29, 2008, dated April 29, 2008 (Ex. 27). After reviewing this information, the Balls agreed that Tile "looked excellent" based on its sales numbers, appeared healthy and profitable, had a good net adjusted income to price ratio, and "fit the bill perfectly from a financial perspective." After exchanging rounds of offers and counteroffers, the Balls and May eventually came to an agreement for the purchase of Tile (Asset Sale Agreement).

Before reaching that agreement, however, Ball sent Bush an email on July 17, 2008 wherein he asked questions about Tile's accounts receivable, including whether Tile had "any collections issues."³ Bush responded the next day and said that while Tile has "no major issues on collections," he elaborated that Tile has "had bad debt from time to time, mostly when no one is paying attention to collections/who they give credit to. This is an area that can definitely be tightened up and Steve has said that."⁴

On August 11, 2008, the Balls met with Steve May and Russ Bradshaw, the accountant for Tile and Granite, for a final due diligence meeting where they could review documents and ask questions of May and Bradshaw. The Balls asked to review all the invoices from January through July 2008 and saw a number of reports.⁵ During that meeting, David Ball "saw a large credit for $129,000 that was unusually large," and he looked at Steve May and asked what was going on with the credit.⁶ May responded that he didn't know but would check with his bookkeeper. Although the Balls claim to have seen a $129,000 credit, they did not identify the document they were looking at when they "saw" it. The Balls deny that they saw Tile's general sales ledger,⁷ which is the only document identified by the parties that mentions a $129,000 credit.⁸ Immediately after this meeting, Tile's general sales ledger was faxed to Bradshaw's office. The following day, Bradshaw reviewed that ledger and discovered that Marie Christiansen, Tile's bookkeeper, had mistakenly posted approximately $230,000 in unpaid accounts receivable from 2006 and 2007—which included a $129,000 invoice to Inklyne Construction—to Tile's general sales ledger on March 3, 2008. On August 14, 2008, Bradshaw sent an associate from his accounting firm to Tile who made a journal entry that removed the unpaid accounts receivable from the general sales ledger and posted them as a bad debt expense.

The Inklyne Construction credit constituted a "red flag"⁹ for the Balls, and they felt they "needed to get to the bottom of that."¹⁰ The Balls had no further discussions with May about the credit, but a day or two after the due diligence meeting, David Ball received a phone call from Duane Bush about the credit. According to Ball, the explanation Bush gave him regarding the Inklyne credit was that "it was some improperly done invoice they had to credit off and redo again."¹¹ Although this explanation is extremely vague, the Balls did not inquire further about the Inklyne credit.

On August 18, 2008, the Balls, through Reperex, Inc., a company they had created, bought Tile. The Asset Sale Agreement provided that Reperex could use Steve May's contractor's license for 60 days but thereafter the Balls had to qualify for and obtain their own contractor's license.¹² There was no evidence that the Balls ever attempted to obtain their own contractor's license. The Balls took possession of Tile the next day and began to operate the business. Granite and Reperex also entered into an Agreement for Lease of Employees (Employee Lease) whereby Granite agreed to provide Reperex with the services of two of its salespeople, Jason Johns and Kristy Larsen, to assist in obtaining sales for Tile. The Employee Lease provides that the leased employees "will devote 35% of their time and attention" to working for Tile. The Employee Lease could be terminated by either party after 45 days' written notice to the other party.

Neither Brad nor David had any experience in the construction industry in general or the custom tile business in particular. David had purchased a residential bathroom remodeling and antique bathtub refinishing business in 1998. He owned the business for about three years and worked there for approximately six months. In his own estimation, his experience with that company did not qualify him to run a tile company.

At the time the Balls bought Tile, Brad knew the economy was in a mild recession, but he viewed this as an opportunity because it might cause a business seller to accept less. David knew that the economy was slowing down, but he believed it had reached the bottom. Due to the Balls' concern with the economy, they negotiated a provision in the promissory note for the purchase of Tile that would automatically renew the note for twelve months if they were not able to refinance it within a year. Brad testified that the economy fell off a cliff in September and October 2008.

On August 20, 2008, Brad made an unremarkable entry in his journal noting that Promontory, a luxury subdivision near Park City that was one of Tile's larger clients in 2007 and early 2008, had declared bankruptcy a few months earlier.¹³ Brad mentions Promontory only once more in his journal—on September 19, 2008—when he notes that he and Steve May went up to the Promontory development.

Business began to slow down after the Balls bought Tile, and cash flow diminished.¹⁴ Although new jobs appeared on the horizon,¹⁵ the business continued to struggle and one of the jobs was losing Tile money.¹⁶ A new job provided a brief respite, but it faltered when the tile for the job was delayed by two months.¹⁷ Tile's financial condition grew more precarious as 2009 advanced and banks became...