While the debtor served a prison sentence for bank fraud, he met the creditor’s son. The debtor told him about his plans to start a business upon release, and the creditor’s son informed him that the creditor, an elderly widow with limited knowledge of English, might be willing to invest. The creditor’s son told the creditor that the debtor would help her start a business, had extensive experience, and was trustworthy. The debtor met with the creditor after he was released, and they agreed that the creditor would go into business with the debtor’s father and would open a “high-end” restaurant. The debtor told the creditor that if she would invest 50% of the costs in the business venture, he would invest the other half, and the profits would be split 50/50. The creditor also wanted her son to have an ownership interest so he would have an occupation after being released. The creditor mortgaged her house and invested $194,644 because she “trusted [the debtor].” The debtor, however, did not invest 50% of the amount himself; instead, he borrowed money from his parents and only invested $80,000. The debtor then formed an LLC in Washington state, and the debtor received only a 25% ownership interest, rather than the 50% promised. Additionally, because of both of their criminal backgrounds, the debtor, despite being a co-owner, was not named on any of the legal documents, and the creditor’s son was not listed as an owner. Instead, the debtor’s father was named as an owner on the legal documents. Despite not being listed as an owner, the debtor was at all times in control of the management of the business venture and all its finances. The debtor later drew up a purchase agreement, which he represented to the creditor that she had to sign (and she did) for liquor license purposes; however, the document actually provided that the creditor was obligated to pay $480,000 to the debtor for a 75% ownership interest in the business. The debtor eventually found a restaurant location and received a $250,000 bid from the contractor. The space was remodeled, but the remodel violated the fire code. The restaurant did open but made very little profit, and the creditor’s son, who had been released from prison, commonly came and “drank the profits,” a fact of which the debtor was aware. At the end of the business relationship, the debtor sent the creditor a default letter stating that the creditor’s interest in the LLC had been forfeited due to her failure to make the required payments. The restaurant closed shortly after. Throughout the entire relationship, the debtor also engaged in a series of wrongful behaviors, without the creditor’s knowledge, including forging the creditor’s signature on a credit card application and opening a credit card in her name. He also stopped making his mortgage payments he was supposed to make, bought a boat with the creditor’s son using money from the LLC and, using a loan that the debtor obtained in the creditor’s name, opened a credit card for “business expenses” in the creditor’s son’s name that was used for “clothing, expensive dinners, and trips.” In addition, he purchased a limousine with the LLC’s money. The creditor sued the debtor in Oregon state court (the “prior state court judgment”) for violations of the state’s Abuse of a Vulnerable Person statute, conversion, wrongful LLC distributions, and sought to remove the debtor as a member of the LLC. The state court found the debtor liable and entered a judgment of $1,001,866. The debtor filed for Chapter 7 bankruptcy and was granted a discharge. The creditor then filed this adversary proceeding, which was remanded from the district court to the bankruptcy court for additional findings and conclusions of law.
In Martin v. Zamani-Zadeh (In re Zamani-Zadeh), No. 20-11939-t7, Adv. No. 20-1077-t, 2025 WL 1073135, 2025 Bankr. LEXIS 905 (Bankr. D.N.M. Apr. 9, 2025) (unpublished opinion), the bankruptcy court held that a portion of the debtor’s prior state court judgment debt, in the amount of $194,644, was nondischargeable under § 523(a)(2)(A) of the Bankruptcy Code. “Section 523(a)(2)(A) prohibits the discharge of a debt ‘for money … to the extent obtained by … false pretenses, a false representation, or actual fraud.’” In re Young, 91 F.3d 1367, 1373 (10th Cir. 1996). In order to succeed on a § 523(a)(2)(A) claim, a plaintiff must prove the necessary facts by a preponderance of the evidence. First, the court addressed the creditor’s false pretenses and false representation claim. The court stated that a claim for false pretenses “presents the issue of ‘whether, by silence, insinuation, or inference, [the d]ebtor knowingly acted in [a way] as to create a false impression in the mind of [the creditor] about the transaction at issue.” In re Woods, 660 B.R. 905, 918 (10th Cir. B.A.P. 2024). The court then explained that “‘[f]alse representations are representations knowingly and fraudulently made that give rise to the debt.” In re Osborne, 520 B.R. 861, 868 (Bankr. D.N.M. 2014). The court stated that the elements for both are the same. To prove false pretenses and false representation under § 523(a)(2)(A), a plaintiff must show that the debtor: (1) made a false representation or omission; (2) made such false representation or omission to deceive the creditor; (3) the creditor relied on such representation or omission; (4) the reliance was justifiable; and (5) the creditor suffered a loss as a result of its reliance. The court emphasized that false pretenses under § 523(a)(2)(A) include material omissions when the omission or failure to disclose creates a false impression that the debtor is aware of. However, bankruptcy courts generally only find a failure to disclose under § 523(a)(2) when there was a duty to disclose. The Restatement (Second) of Torts § 551, as the bankruptcy courts have applied it, provides that there is a duty to disclose when the debtor knows: (1) matters that the creditor is entitled to know because of a fiduciary duty or similar relationship of trust and confidence between the debtor and creditor; (2) matters the debtor knows are necessary to prevent partial or ambiguous statements from being misleading; (3) information that the debtor subsequently acquired and would make a representation previously made untrue or misleading; (4) the falsity of a previous false representation made by the debtor when the debtor has knowledge that the creditor is about to rely on the false representation in the transaction with him; and (5) facts basic to the transaction when the debtor knows the creditor is about to enter into the transaction due to a mistake of the basic facts and the creditor would reasonably expect disclosure of facts because of the parties’ relationship, the customs of trade, or other objective circumstances. The court found that the debtor had a duty to disclose based on reasons (1), (2), (3), and (5). First, there was a fiduciary duty and a similar relation of trust and confidence between the debtor and creditor. Washington law provides that a managing member of an LLC owes a fiduciary duty to the LLC and its other members. The court explained that the debtor was the manager of the company, and the creditor was a member; therefore, a fiduciary relationship existed. Additionally, the court found that, because the debtor was experienced and sophisticated, and because of the creditor’s age, education, lack of sophistication, and limited knowledge of the English language, a relationship of trust and confidence existed. Next, the court found that the debtor was aware of matters necessary to prevent his partial or ambiguous statements of fact from being misleading. The court noted that the debtor had informed the creditor that the debtor’s father would be involved in the business; however, the father was only listed on the legal documents and was not involved in the actual business. The debtor also represented that he was an equal investor, but in fact, he did not put in 50% of the total investment. Lastly, the debtor represented that the investment amount was sufficient for the venture, which it was not. Next, the court found that the debtor had subsequently acquired information that he knew made previous representations untrue or misleading. The court explained that the debtor represented that the investment funds would be sufficient for the venture, but then the debtor spent a significant amount of the funds on other items not disclosed to the creditor. Later, the debtor received a construction estimate that made him aware that the remaining investment funds were insufficient to continue the business. The debtor also learned that the creditor’s son continued to fund his “drug dealer” lifestyle. Lastly, the court found that the debtor was aware of facts basic to the transaction that the creditor was mistaken about, and the creditor would have expected the debtor to correct the mistaken understanding due to the nature of the relationship. The creditor was under the impression that the debtor was competent to do the remodel, and the debtor should have told the creditor that he was not qualified or competent to do the remodel because his remodel resulted in the venture not complying with the necessary fire code. The debtor also should have informed the creditor that the investment funds were not enough to lead to the venture becoming a high scale restaurant when the creditor had been led to believe they would be sufficient. The creditor was also led to believe the debtor was trustworthy, and the debtor should have informed her that he forged her signature on a credit card and boat loan application. The debtor also misled the creditor as to what documents she signed, for what purpose, and the amount of ownership interest she would actually be given.
The court found that the creditor proved all elements for the § 523(a)(2)(A) nondischargeability claim for false pretenses and false representations. The court found that the debtor made numerous misrepresentations, such as the ownership interest amount the creditor would receive, the investment amount the debtor was putting in and where that money actually came from; failed to tell the creditor that he forged her signature and obtained a creditor card in her name; failed to tell the creditor he had been to prison for bank fraud; failed to give information about the creditor’s son (i.e. that he was a drug dealer and was drinking away profits) that jeopardized the venture; failed to inform the creditor of where large portions of the investment funds were going; failed to inform the creditor of certain terms of the purchase agreement that would result in her forfeiting her interest in the company; and failed to inform the creditor of the payments due but had not been paid. Several of these representations were made before the creditor invested any money. The court then found that the debtor made the false representations with the intent to deceive the creditor, and that the debtor hid the truth because he knew if the creditor had known of the misrepresentations, the creditor would have changed her mind about investing.
The court next found that the creditor actually relied on the debtor’s misrepresentations and omissions. The court explained that actual reliance is equivalent of causation-in-fact. The creditor believed she was acquiring a 50% ownership interest and thought the debtor had been incarcerated for tax reasons, not bank fraud. The court then found that the creditor’s reliance on the misrepresentations was justifiable. Courts, in deciding whether reliance was justifiable, “appl[y] a subjective standard that takes into account the qualities and characteristics of the particular creditor.” Woods, 660 B.R. at 921-22. “To justifiably rely, a party is ‘required to use its sense and cannot recover if it blindly reli[ed] upon a misrepresentation, the falsity of which would be patent to it if it had utilized its opportunity to make a cursory examination or investigation.” Id. The court explained that the creditor was an elderly widow, who knew limited English, and was not knowledgeable or sophisticated in business or legal matters; therefore, because of her naivety, there were no red flags. Further, the creditor had no knowledge of the creditor’s conviction, fraud, or forgery. The court emphasized that if she did have such knowledge, then red flags should have been raised for her, but she did not, and she had confidence in the debtor. Addressing the last element, the court found that the creditor suffered a loss as a result of her justifiable reliance. The court found that the misrepresentations induced the creditor to invest her life savings, all $194,644 of which was lost. Therefore, the court found that the creditor successfully proved that the debtor’s false pretenses and false representations caused her to sustain an actual loss of $194,644.
Finally, the court addressed claims for actual fraud for nondischargeability actions. Actual fraud for § 523(a)(2) purposes, includes any fraud involving “moral turpitude or intentional wrong” such as fraudulent schemes. The elements of actual fraud are: (1) fraud; (2) wrongful intent; (3) the debtor obtained “money, property, services, or …credit”; and (4) the debt arose as a result of the actual fraud. Proof of reliance is not required for fraud claims. The court found the creditor met her burden to prove actual fraud under § 523(a)(2)(A) because the entire scheme constituted an actual fraud. The court explained that the debtor first fraudulently induced the creditor to invest her savings for a 25% ownership interest, and then continued to defraud her by using a very significant amount of the investment funds for a boat and limousine, forging her signature, using company money for purposes the creditor was not aware of, and induced the creditor to sign the purchase agreement, which provided a way for her to lose her interest in the company. The court then found that the debtor wrongfully intended to defraud the creditor out of her life savings. The repeated acts of fraud were all actual, and the debtor used the creditor’s blind love for her child to con her into investing. The court then found that the debtor obtained money by actual fraud in the amount of at least $194,644. Lastly, the court found that a portion of the debt arose from the actual fraud. The court explained that all debts arising from fraudulently obtained money must be declared nondischargeable by the court. The court found the creditor was entitled to a nondischargeability judgment for the entire amount invested ($194,644) because that entire amount had been lost as a result of the debtor’s fraud. The court also explained that as a part of the prior state court judgment, the creditor was entitled to non-economic damages, treble damages, and post-judgment interest as a result of the fraud. Ultimately, the court held that together with the $194,644, the creditor’s damages for fraud equaled $883,992 plus interest accrued, the entirety of which was nondischargeable under § 523(a)(2)(A).
By Kristin Meurer, [email protected]
Edited By Hayden Mariott, [email protected]