Rimrock Design, Inc. v. Morris (In re Morris), Case No. 3:16-bk-2229-PMG

In re: Jonathan M. Morris, Debtor.

Rimrock Design, Inc., Plaintiff, v. Jonathan M. Morris, Defendant.

Case No. 3:16-bk-2229-PMG

Adv. No. 3:16-ap-235-PMG

UNITED STATES BANKRUPTCY COURT MIDDLE DISTRICT OF FLORIDA JACKSONVILLE DIVISION

May 8, 2018

Chapter 7

FINDINGS OF FACT, CONCLUSIONS OF LAW, AND MEMORANDUM OPINION

THIS CASE came before the Court for trial on the Complaint to Except Debt from Defendant's Discharge Pursuant to 11 U.S.C. §523(a).

Generally, a debt may be excepted from a debtor's discharge under §523(a)(2)(A) of the Bankruptcy Code for "actual fraud," if the debt was incurred by intentional deception or trickery. Also, a debt may be excepted from the debtor's discharge under §523(a)(4) of the Bankruptcy Code for "embezzlement," if the debtor fraudulently appropriated property that had been entrusted to him.

In this case, the Debtor was employed by Rimrock Design, Inc. (Rimrock), a flooring company, from 2009 to 2015. At the same time, the Debtor was the sole owner of a separate entity known as Ridgepoint Design & Associates, LLC (Ridgepoint).

While he was employed by Rimrock, the Debtor used Ridgepoint to sell flooring materials to one of Rimrock's existing customers for a profit, without disclosing the transactions to Rimrock.

Under these circumstances, the Court finds that the Debtor incurred a debt to Rimrock by deception or trickery, and by misappropriating a business opportunity that had been entrusted to him by Rimrock. Consequently, the debt is nondischargeable in the Debtor's Chapter 7 case pursuant to §523(a)(2)(A) and §523(a)(4) of the Bankruptcy Code.

Background

Rimrock has engaged in business as a full-service national flooring company since approximately 1998.

The Debtor was employed by Rimrock in 2009, and worked for Rimrock as its Estimating Manager. On April 4, 2013, the Debtor signed a Covenant Not to Compete with Rimrock. (Rimrock's Exhibit 3; Debtor's Exhibit 2).

Beginning in May or June of 2013, the Debtor also was the sole owner of a separate entity known as Ridgepoint Design & Associates, LLC (Ridgepoint). Ridgepoint provided design services that were different from the type of work performed by Rimrock.

Kona Grill was a significant customer of Rimrock since at least September or October of 2013. (Rimrock's Exhibit 8).

In December of 2014, the Debtor and Terrence Ryan Smith (Smith) discussed Rimrock's account with Kona Grill. Smith was Rimrock's Director of Project Development.

According to the Debtor, Smith told him that Kona Grill wanted a certain type of Italian tile that Rimrock was unable to provide. Accordingly, the Debtor and Smith reached an agreement (1) for Smith's company (R&L Companies, LLC) to purchase the tile from a vendor known as Vitromex USA, Inc., and (2) for the Vitromex tile to be sold to Kona Grill using purchase orders issued by Kona Grill to Ridgepoint. Ridgepoint was used to sell the tile to Kona Grill because it had an established bank account to receive the sales proceeds and pay the related expenses.

The agreement further provided for Smith to receive 60% of the profits from the sales, and for the Debtor to receive 40% of the profits from the sales.

In furtherance of the agreement, Kona Grill paid Ridgepoint the following amounts on account of specific invoices sent by Ridgepoint to Kona Grill for the Vitromex flooring:

December 11, 2014 - $66,263.09

February 10, 2015 - $38,088.50

February 20, 2015 - $24,146.06

March 23, 2015 - $188,359.04

(Rimrock's Exhibit 9; Debtor's Exhibit 5).

The Debtor never informed Rimrock about Ridgepoint's transactions with Kona Grill.

Rimrock discovered the transactions in April of 2015, and terminated the Debtor's employment. (Rimrock's Exhibit 7; Debtor's Exhibit 7).

The Debtor filed a petition under Chapter 7 of the Bankruptcy Code on June 14, 2016.

Discussion

On October 28, 2016, Rimrock filed a Complaint to Except Debt from Defendant's Discharge Pursuant to 11 U.S.C. §523(a). (Doc. 1). In the Complaint, Rimrock alleges that the Debtor secretlysolicited business from Rimrock's existing customer, and diverted the business to the Debtor's solely-owned company. The Complaint contains three Counts: Count 1 is an action under §523(a)(2)(A) for false pretenses, false representations, or actual fraud; Count 2 is an action under §523(a)(4) for embezzlement; and Count 3 is an action under §523(a)(4) for larceny.

A. Section 523(a)(2)(A)

Section 523(a)(2)(A) of the Bankruptcy Code provides that a Chapter 7 discharge does not discharge an individual debtor from any debt obtained by "false pretenses, a false representation, or actual fraud." 11 U.S.C. §523(a)(2)(A).

To establish a claim under §523(a)(2)(A), a creditor generally must show the traditional elements of common law fraud: (1) the debtor made a false representation with the intent to deceive the creditor; (2) the creditor relied on the misrepresentation; (3) the reliance was justified; and (4) the creditor sustained a loss as a result of the misrepresentation. In re Sutton, 550 B.R. 917, 921-22 (Bankr. N.D. Ga. 2016).

An overt misrepresentation is not always required. Under certain circumstances, a debtor's silence or failure to disclose a material fact or pertinent information can constitute a false representation under §523(a)(2)(A). In re Zaidel, 553 B.R. 655, 663 (Bankr. E.D. WI 2016). Or as stated in In re Strauss, 523 B.R. 614, 625 (Bankr N.D. Ill. 2014), a debtor's fraudulent or deliberately misleading omission amounts to the same thing as an intentional misrepresentation.

Additionally, a "claim for actual fraud is broader than a claim for false representation," and the Supreme Court of the United States "has confirmed that actual fraud does not require a misrepresentation." In re Sutton, 550 B.R. at 922. Indeed, the Supreme Court held in Husky International Electronics, Inc. v. Ritz, 136 S.Ct. 1581, 1590 (2016):

Because we must give the phrase "actual fraud" in §523(a)(2)(A) the meaning it has long held, we interpret "actual fraud" to encompass fraudulent conveyance schemes, even when those schemes do not involve a false representation.

In other words, "actual fraud is deception or trickery committed with wrongful intent." In re Utter, 2017 WL 1091875, at 3 (Bankr. M.D. Fla.)(citing Husky International Electronics, Inc. v. Ritz, 136 S.Ct. at 1590).

1. False pretenses, false representations, or actual fraud

In this case, the debt owed by the Debtor to Rimrock is nondischargeable under §523(a)(2)(A) based on the Debtor's false pretenses, false representations, or actual fraud.

The Debtor was Rimrock's employee, and Kona Grill was Rimrock's existing and on-going customer.

Rimrock had furnished flooring materials and installation services to Kona Grill since 2013. Beginning in 2014, while serving as Rimrock's employee, the Debtor caused his solely-owned company (Ridgepoint) to sell materials to Kona Grill. The product sold by Ridgepoint to Kona Grill was flooring tile, which was generally the same type of product or service that his employer was selling to Kona Grill.

At trial, the Debtor acknowledged (1) that the motive for the sales to Kona Grill through Ridgepoint was to make some "extra money" for himself, (2) that he never asked Rimrock whether Rimrock had an interest in providing the materials to Kona Grill, and (3) that he never disclosed the sales to Rimrock's president.

The Debtor's conduct is comparable to the conduct of the employee in In re Janssens, 449 B.R. 42 (Bankr. D. Md. 2010). In Janssens, the debtor had solicited his employer's customers for the purpose of selling or renting equipment to them, without his employer's knowledge. In re Janssens, 449 B.R.at 58. The employer later filed a dischargeability action in the debtor's Chapter 7 case, and the Court found:

In the instant case, Janssen's silence led Freedom to believe that he was dutifully serving Freedom, instead of working against its interests by diverting corporate opportunities to its competitors.

Janssen's intention to deceive Freedom regarding his diversion of corporate business may be inferred from his desire to receive larger commissions from Freedom's competitors.

Id. at 76. The debt owed by the debtor to his employer in Janssen was nondischargeable under §523(a)(2)(A) of the Bankruptcy Code. See also In re Sullivan, 305 B.R. 809, 824 (Bankr. W.D. Mich. 2004)(The debtor's "theft of a corporate opportunity by nondisclosure" constituted "actual fraud" under §523(a)(2)(A), where the debtor had secretly taken his employer's business opportunity for his own personal benefit.).

2. Secret agreement with Smith

In this case, the Debtor contends that Terrence Ryan Smith (Smith) originated the idea of purchasing floor tile from a supplier known as Vitromex USA, Inc. (Vitromex), and selling the tile to Kona Grill without Rimrock's involvement. Smith was also employed by Rimrock as Rimrock's Director of Project Development.

According to the Debtor, Smith approached him with the proposal in December of 2014, and told him that Kona Grill wanted a particular type of Italian tile provided by Vitromex, but that Rimrock was unable to acquire the tile for Kona Grill because Vitromex only wanted to sell to buyers who had a Certificate of Authorization to Pay Use Tax. Rimrock did not have such a Certificate, but Smith's company (R&L Companies, LLC) acquired one in December of 2014. (Debtor's Exhibit 4).

The Debtor testified that he followed Smith's direction and advice regarding the proposal. Consequently, he did not believe that selling Vitromex tile to Kona Grill was a business opportunity that belonged to Rimrock, because Rimrock was unable to provide the material and service that Kona Grill wanted.

The Debtor's defense to the fraud claim fails, however, because the circumstances show that he intended to engage in a scheme to deceive Rimrock when he participated in the sales to Kona Grill.

Specifically, after Smith approached him with the proposal, the Debtor never asked Rimrock (his employer) whether...