The creditor and debtor entered into a purchase agreement under which the creditor paid the debtor $4,350,000 for all the issued and outstanding membership units in the company. The debtor also “became a post-transfer employee of [the company] pursuant to a written employment agreement.” A non-solicitation clause and a non-competition clause were contained in this employment agreement were After the creditor purchased the company, the creditor discovered that the debtor owned two businesses that directly competed with the creditor and the company. The debtor had also been actively concealing this ownership from the creditor. Ownership of these two companies was in direct violation of the employment agreement. The creditor also alleged the debtor gained “insight as to the trade secrets and other protected information” of the creditor. The creditor filed an action in state court, and judgment was entered against the debtor in the amount of $58,980,460.20 plus interest. The debtor then filed for bankruptcy; the creditor filed its claim; and also filed an adversary proceeding claiming that the debtor was nondischargeable. The debtor moved to dismiss the claims. The creditor argued that the debt arising from the judgment should not be discharged because the debtor had fraudulently induced the creditor to enter into the purchase and employment agreement. The debtor moved to dismiss the claims, and the creditor opposed the motion.
In Fusion Indus., LLC v. Friday (In re Friday) Case No. 24-12364-JDL, 2025 WL 892618, 2025 Bankr. LEXIS 688 (Bankr. W.D. Okla. Mar. 21, 2025) (opinion not yet released for publication), the bankruptcy court granted the motion in part and denied the motion in part. The debtor argued that the creditor had failed to meet the requirements of alleging fraud under Fed. R. Civ. Pro. 9(b) and had failed to state a claim under Fed. R. Civ. Pro. 12(b)(6). The court explained that the purpose of Rule 9(b) is to provide “a defendant fair notice of the plaintiffs' claim and of the factual ground upon which it is based.” It was not necessary for the creditor to “plead each fraudulent detail,” rather, the creditor was just required to follow Rule 8(a)’s “short and plain statement pleading requirements.” The court therefore found that the creditor’s pleadings had given the debtor fair notice, and the debtor’s motion to dismiss based on Rule 9(b) was denied. The creditor’s complaint alleged the “debtor fraudulently induced” the creditor “to enter into the purchase agreement and employment agreement by false pretenses, a false representation, or actual fraud, with malice, citing [Bankruptcy Code] § 523(a)(2).” A false pretense claim asks “whether, by silence, insinuation, or inference the debtor knowingly acted in such a fashion as to create a false representation in the mind of the creditor about the transaction at issue.” In re Woods, 616 B.R. 803, 813 (Bankr. N.D. Okla. 2020). The elements of a non-dischargeability proceeding based on false pretenses are: “(1) The debtor made a false representation; (2) The debtor made the representation [or omission] with the intent to deceive the creditor; (3) The creditor relied on the representation [or omission]; (4) The creditor's reliance was justifiable; and (5) The debtor's representation [or omission] caused the creditor to sustain a loss.” A false representation claim also contained the same elements. The court also ruled that a claim for actual fraud was stated in the complaint by stating the debtor “materially concealing the fact” that he owned other competitor companies. Material omissions could also be considered false representations because the debtor had failed to explain that at the time of entering into the agreements that the debtor was already in violation of the non-competition provision. Therefore, the court denied the debtor’s motion to dismiss the creditor’s complaint under Bankruptcy Code § 523(a)(2)(A). However, the court ruled that, under § 523(a)(4), the creditor had not stated a claim. The creditor had to prove one of three things to establish that a claim is non-dischargeable under Bankruptcy Code § 523(a)(4): “(1) fraud or defalcation while acting in a fiduciary capacity; (2) embezzlement; or (3) larceny.” Under the fiduciary capacity claim, according to the Tenth Circuit, “an express or technical trust is required for a fiduciary relationship.” However, the creditor had not alleged any trust; therefore, the complaint had not alleged a fiduciary relationship. Accordingly, the creditor’s complaint failed to state a claim for a breach of fiduciary duty under Bankruptcy Code § 523(a)(4). On the embezzlement claim, the creditor did not allege that the “debtor came into any property belonging to the creditor, that he appropriated for his own benefit, or that he had fraudulent intent.” Therefore, the creditor failed to state a claim for embezzlement under Bankruptcy Code § 523(a)(4). Next, on the larceny claim, the creditor failed to “allege that the debtor took and carried away the property of the creditors.” Therefore, the debtor’s motion to dismiss the creditor’s complaint was granted as to the creditor’s claims asserted under Bankruptcy Code § 523(a)(4). Finally, the debtor’s motion to dismiss under Bankruptcy Code § 523(a)(2)(B) was granted because the complaint had not alleged that the debtor gave the creditor a false written financial statement.
By Olivia Lewis, [email protected]
Edited By Hayden Mariott, [email protected]