Wachovia Securities, LLC v. Jahelka (In Re Jahelka)Wachovia Securities, LLC v. Jahelka (In Re Jahelka)
MEMORANDUM OPINION
This matter is before the court for ruling on the motion of debtor-defendant Andrew A. Jahelka (“Jahelka”) to dismiss the amended complaint of plaintiff Wachovia Securities, LLC (“Wachovia”) under Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure (made applicable by Fed. R. Bankr.P. 7009, 7012(b)). In an earlier order, the court granted Jahelka’s motion to dismiss Wachovia’s initial single-count complaint but also granted leave to amend. Wachovia filed an amended complaint expanding its original claim to seven counts.
For the reasons that follow, Jahelka’s motion to dismiss will be granted as to the first five counts of the amended complaint with leave to amend. The remaining two counts will be dismissed on the court’s own motion for lack of jurisdiction.
On a motion to dismiss under Rule 12(b)(6), the court takes as true all well-pleaded allegations in the complaint and draws all reasonable inferences in favor of the non-movant.
Rujawitz v. Martin,
Wachovia’s amended complaint alleges the following facts. Jahelka was president and a shareholder of a small closely-held company called Loop Corp. (“Loop”) that he co-owned with Leon Greenblatt (“Greenblatt”), and Richard Nichols (“Nichols”). On January 3, 2000, Loop obtained from Banco Panamericano (“Ban-co”) a $9.9 million line of credit (the “Ban-co Loan”). The purpose of obtaining the Banco Loan was to make Loop judgment-proof, and the loan had that effect. The Banco Loan also shielded Loop from its creditors by fully encumbering Loop’s assets and effectively placing Banco and Banco’s majority shareholder in control of them.
On September 28, 2000, Loop opened a margin account at Wachovia. Before, during, and after the account was opened, Jahelka acted to give Wachovia the false impression that Loop was a viable company capable of covering its losses. In reality, Loop was at all times inadequately capitalized and was insolvent when it opened the Wachovia account. Loop used the Wachovia account to acquire stock in a company called “HMRI” on margin. In connection with the stock acquisition, Loop incurred substantial margin debt to Wa-chovia. Wachovia later obtained an NYSE arbitration award against Loop which was reduced to a judgment of $2,478,418.80. The judgment has not been paid. After Loop incurred the margin debt and after entry of the judgment, Loop transferred over $1 million in assets to its shareholders, including Jahelka.
In 2004, Wachovia filed an action in the district court against Loop and its shareholders, including Jahelka. On October 22, 2008, the district court entered a judgment piercing Loop’s corporate veil and holding Jahelka liable to Wachovia.
In its opinion, the district court found, among other things, that:
• The representations of the shareholders to Wachovia created the false impression that Loop was a vital company capable of covering its losses when in fact a company insider had fully encumbered Loop’s assets.
• Jahelka knew Loop was using the Wa-chovia account to acquire HRMI stock on margin, that Loop was inadequately capitalized and unable to function without Ban-co’s loan, and that Loop’s assets were fully encumbered as a result of the Banco loan.
• Because of Jahelka’s purposeful actions, Loop was inadequately capitalized, it failed to issue stock, it failed to observe corporate formalities, it failed to pay its taxes, and it was insolvent when the Wa-chovia account was opened and the margin debt incurred.
• The Banco Loan was designed to shield Loop from its creditors by placing Greenblatt (who according to Wachovia was not only Banco’s majority shareholder but also the majority shareholder of Loop) in control of Loop’s fully encumbered assets.
• Jahelka knowingly assisted Greenblatt in his efforts to shield Loop from its creditors.
• After the margin debt came due, Ja-helka and his fellow shareholders transferred to insiders and related entities more than $1 million in Loop’s corporate assets, of which Jahelka received nearly $100,000.
The amended complaint has seven counts. Counts I through V allege claims
Counts VI and VII are objections to Jahelka’s discharge under section 727(a) of the Code. Count VI alleges that Jahelka is not entitled to a discharge under section 727(a)(3) because he has failed to keep records from which his business transactions might be ascertained. Count VII is a claim under section 727(a)(5) alleging that Jahelka cannot explain satisfactorily the loss of $10,000 in assets while the bankruptcy case was pending. 1
Jahelka now moves to dismiss the amended complaint on the ground that all seven counts are premised on fraud, and the complaint fails to allege fraud with sufficient specificity to satisfy Rule 9(b)— or, for that matter, Rule 8(a). 2
2. Discussion
The gist of Wachovia’s amended complaint is the same as its initial complaint: that Jahelka and others fraudulently induced Wachovia to open the margin account for Loop by leading Wachovia to believe that Loop had the ability to cover its losses when in fact Jahelka and others had deliberately rendered Loop unable to do so through the Banco Loan. The amended complaint is essentially the same as the initial complaint, except that it (1) recites specific findings from the district court’s opinion, (2) in some respects contains even less information than its predecessor, (3) teases a single claim into five separate legal theories, and (4) adds two section 727 claims.
Jahelka’s motion will be granted on the section 523(a) claims in Counts I-V of the amended complaint. Those counts will be dismissed, and Wachovia will be given one final chance to amend. The section 727(a) claims in Counts VI and VII will also be dismissed, though not for failure to state a claim. Counts VI and VII will be dismissed for lack of jurisdiction on the court’s own motion because those claims are not ripe.
a. Rule 12(b)(6) and Rule 9(b) Standards
Under Rule 12(b)(6), a complaint will be dismissed unless it clears “two easy-to-clear hurdles.”
E.E.O.C. v. Concentra Health Servs., Inc.,
Second, the complaint’s allegations must plausibly suggest that the plaintiff has a right to relief, raising that right above a “ ‘speculative level.’ ”
Concentra,
Where fraud is concerned, Rule 9(b) requires more. Rule 9(b) declares that “in alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake.” Fed. R.Civ.P. 9(b). “Particularity” means “the who, what, when, where, and how: the first paragraph of any newspaper story.”
Katz v. Household Int’l, Inc.,
b. Counts I — III: Section 523(a)(2)(A)
Counts I through III, the claims under section 523(a)(2)(A), will be dismissed— Counts II and III for failure to plead fraud with specificity under Rule 9(b), and Count I for failure to state a claim.
Section 523(a)(2)(A) excepts from discharge any debt “for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by ... false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition[.]” 11 U.S.C. § 523(a)(2)(A). Although some courts have applied a single test for determining nondischargeability under section 523(a)(2)(A), that section actually describes three separate grounds for holding a debt to be nondischargeable: false pretenses, false representation, and actual fraud.
Bletnitsky v. Jairath (In re Jairath),
To state a claim under the false representation or false pretenses prong, a creditor must allege that the debtor owes a debt resulting from a false representation or omission of fact, a representation the debtor either knew was false or made with reckless disregard for its truth.
Ojeda v. Goldberg,
To state a claim under the actual fraud prong, the creditor must allege that a fraud occurred, the debtor intended to defraud, and the fraud created the debt.
Consumers Coop. Credit Union v. Munson (In re Munson),
Nos. 10 B 1559, 10 A 218,
Counts II and III, the false pretenses and false representation claims, fail to comply with Rule 9(b). The amended complaint alleges that Jahelka and Loop “acted in concert to falsely create the appearance to Wachovia that Loop was a viable company capable of covering its losses” (Am. Compl. ¶ 9), and that Loop’s shareholders, including Jahelka, created this appearance through “representations on the margin accounts” (id. ¶ 19). But that is all Wachovia alleges. Nowhere does Wachovia specify (1) who made the representations, (2) what representations were made, (3) how the representations were made, (4) when the representations were made, and (5) to whom the representations were made. The amended complaint contains no greater detail than its predecessor. Counts II and III will be dismissed.
Count I, the actual fraud claim, will also be dismissed but for a different reason. The problem with Count I is not a failure to comply with Rule 9(b) — although Rule 9(b) does apply to actual fraud claims,
see Lazzaro v. Weichman (In re Weichman),
It may be that Wachovia considers the Banco Loan and the later transfers of corporate assets “actual fraud,” and certainly those actions do smack of fraud, as the district court found. But section 523(a)(2) does not except from discharge every debt somehow connected with a fraud.
On
e—on—One
Fitness Personal Training Serv., Inc. v. Reyes (In re Reyes),
Nos. 09 B 35198, 09 A 1277,
Jahelka’s motion to dismiss will be granted as to Counts I, II, and III of the amended complaint. Those counts will be dismissed with leave to amend.
c. Count IV: Section 523(a)(4)
Count IV, the section 523(a)(4) claim, will also be dismissed for failure to state a claim. Section 523(a)(4) excepts from discharge, among other things, any debt “for fraud or defalcation while acting in a fiduciary capacity.” 11 U.S.C. § 523(a)(4). Count IV fails to allege facts suggesting that Jahelka owed Wachovia a fiduciary duty.
The term “fiduciary” in section 523(a)(4) is a matter of federal rather than state law,
In re McGee,
In Count IV of its amended complaint, Wachovia relies on the “unequal relationship” theory to claim a fiduciary relationship with Jahelka. Wachovia alleges that Loop was insolvent at all relevant times. (Am. Compl. ¶ 39). Because Jahelka was president of Loop and Loop was insolvent, Wachovia continues, Jahelka owed a fiduciary duty to Loop’s creditors, including Wachovia. (Id. ¶ 40).
These allegations invoke concepts usually associated with state corporate law. Under Illinois law, corporate officers and directors typically owe fiduciary duties only to the corporation itself and its shareholders.
Paul H. Schwendener, Inc. v. Jupiter Elec. Co.,
Of course, “a fiduciary relationship under state law in a corporate context does not a ‘fiduciary’ under 11 U.S.C. § 523(a)(4) make.”
Martello v. Fowers (In re Fowers),
The problem with these decisions, as a recent contrary decision points out, is that the “trust fund” doctrine from state corporate law creates a fiduciary relationship between officers and directors and
all
creditors of the corporation, not a single creditor like Wachovia, and creates a remedy for the benefit of
all
creditors, not a single creditor like Wachovia.
Associated Bank, N.A. v. Sever (In re Sever),
In Count IV, Wachovia alleges facts giving rise only to a fiduciary duty running from Jahelka to all creditors and thus a potential remedy for all creditors. No facts are alleged showing a fiduciary duty owed to Wachovia itself. In the absence of a fiduciary relationship “specifically between” Jahelka and
Wachovia,
there can be no nondischargeable debt under section 523(a)(4).
Sever,
Jahelka’s motion to dismiss Count IV of the amended complaint will be granted. Count IV will be dismissed with leave to amend.
d. Count V: Section 523(a)(6)
Count V, the claim under section 523(a)(6), will be dismissed for failure to state a claim, as well. Count V is based on the same fraud allegations as the rest of the amended complaint, and section 523(a)(6) does not apply to debts based on fraud.
Section 523(a)(6) makes nondischargeable a debt “for willful and malicious injury by the debtor to another entity or to the property of another entity.” 11 U.S.C. § 523(a)(6). The general language of section 523(a)(6) would arguably encompass debts for fraud.
See Berkson v. Gulevsky (In re Gulevsky),
But as discussed earlier, the Code has a provision, section 523(a)(2), that addresses the nondischargeability of debts related to fraud. Sections 523(a)(2) and (a)(6) are mutually exclusive. Debts resulting from fraud are therefore nondischargeable un
This result follows naturally from standard rules of statutory construction. Section 523(a)(6) is a general statutory provision addressing a range of tortious conduct, whereas section 523(a)(2) is a specific one concerned only with fraud, and it is well established that when two provisions govern a matter, the specific provision controls.
Morales v. Trans World Airlines, Inc.,
Because the only claim alleged in the amended complaint concerns a nondis-chargeable debt for an extension of credit obtained through fraud, Wachovia has no claim under section 523(a)(6). Count V will be dismissed with leave to amend. 4
e. Counts VI and VII: Sections 727(a)(3) and (a)(5)
Finally, Counts VI and VII will be dismissed, but not on the grounds Jahelka urges. Jahelka insists these counts are premised on fraud and therefore fail to state claims for the same reasons as Counts II and III. But the claims in Counts VI and VII are objections to Jahelka’s discharge under section 727(a), concern Jahelka’s conduct in the bankruptcy case post-petition, and have nothing to do with fraud. Counts VI and VII must instead be dismissed on the court’s own motion for lack of jurisdiction because the claims are unripe.
Section 727(a) has no direct application to this bankruptcy case. This case is a case under chapter 11 of the Bankruptcy Code. Section 727(a), however, appears in subchapter II of chapter 7 and as such applies “only in a case under such chapter.” 11 U.S.C. § 103(b);
see Park View Fed. Sav. & Loan Ass’n v. Rich-Morrow Realty Co. (In re Rich-Morrow Realty Co.),
Section 727(a) applies in chapter 11 cases only under the limited circumstances described in section 1141(d) of the Code, the provision that concerns the discharge of chapter 11 debtors.
Williams,
The confirmation of a plan does not discharge a debtor if—
(A) The plan provides for the liquidation of all or substantially all of the property of the estate;
(B) the debtor does not engage in business after consummation of the plan; and
(C) the debtor would be denied a discharge under section 727(a) of this title if the case were a case under chapter 7 of this title.
11 U.S.C. § 1141(d)(3). For section 1141(d)(3) to apply, however, all three elements must be met.
In re T-H New Orleans Ltd. P’ship,
In this case, Jahelka’s plan filed on February 17, 2010, proposed nothing of the kind. It said: “The Debtor will retain all of his assets and will be obligated to make the payments required under the Plan.” (Dkt. No. 142, Ex. A at 14). 5 But the February 17 plan is not the last word. After that plan was filed, Jahelka retained new counsel (see Dkt. Nos. 203, 214) who voiced his intention to file an amended plan. That plan is due to be filed on October 29, 2010 (Dkt. No. 216), but Jahelka has moved for an extension until December 10, 2010, to file the amended plan (Dkt. No. 235). Effectively, then, no plan is on file — certainly not one that satisfies section 1141(d)(3)(A).
With no plan before the court, any consideration of section 1141(d)(3) — and therefore section 727(a) — is premature.
See Paolino,
The prematurity of Counts VI and VII deprives the court of jurisdiction. Article III of the Constitution restricts federal jurisdiction to “cases” and “controversies.”
Here, Jahelka has yet to file a plan that satisfies the requirements of section 1141(d)(3). He may never do so. Therefore, the question of whether his discharge should be barred under section 1141(d)(3) has not yet arisen and indeed may never arise. Wachovia’s claims in Counts VI and VII concerning Jahelka’s conduct in the bankruptcy case, and the questions those counts raise about whether he would receive a discharge if he were a chapter 7 debtor, are not yet ripe.
See Paolino,
Subject matter jurisdiction is a threshold question, “the first question in every case,”
State of Ill. v. City of Chi.,
Because the court lacks subject matter jurisdiction over Counts VI and VII of the amended complaint, those counts will be dismissed. 6
f. Leave to Amend
Wachovia has leave to file a second amended complaint and replead the claims dismissed here — even the seemingly dubious claims in Counts I, IV, and V. The next amendment, however, will be Wachovia’s third stab at producing a viable pleading. Wachovia has experienced counsel with all the discovery from the district court action at his disposal. Writing a complaint that withstands a motion to dismiss — if such a complaint is possible— should be simple. The Seventh Circuit has said that pro se plaintiffs do not have “carte blanche for unlimited successive complaint amendments,”
Tarkowski v.
3. Conclusion
The motion of defendant Andrew A. Ja-helka to dismiss the amended complaint of plaintiff Wachovia Securities, LLC, is granted in part and denied in part. The motion is granted as to Counts I-V. Those counts are dismissed with leave to amend. The motion is denied as to Counts VI and VII. Those counts are dismissed on the court’s own motion for lack of jurisdiction. A separate scheduling order will be entered.
Notes
. Wachovia cites section 727(a)(3) in Count VII, but that section concerns the concealment, destruction, or loss of information, not a loss of assets. See 11 U.S.C. § 727(a)(3).
. Jahelka spends most of his supporting memorandum responding to Wachovia’s recitation of the district court's findings ("not worth the paper they are printed upon,” he says) and Wachovia's assertion that he is "collaterally estopped” to relitigate them. He attaches a Loop stock certificate to his memorandum, presumably to refute the findings in some way. As Wachovia notes, however, matters of issue preclusion are premature at the pleading stage. The court declines to consider Jahelka's materials outside the pleadings and declines to convert the motion to one for summary judgment under Rule 12(d) of the Federal Rules of Civil Procedure, Fed.R.Civ.P. 12(d) (made applicable by Fed. R. Bankr.P. 7012(b)).
See Slayton
v.
White (In re Slayton),
. Another problem with the theory underlying Count IV is that the fiduciary relationship under section 523(a)(4) must exist independently; it cannot arise as a result of the putative fiduciary's wrong.
Marchiando,
. The view that sections 523(a)(2) and (a)(6) are mutually exclusive is decidedly the minority. Two courts of appeals (apparently the only two to consider the question) have taken the opposite view.
See Printy v. Dean Witter Reynolds, Inc.,
. The February 17 plan also did not suggest that Jahelka would not engage in business after consummation of the plan, as section 1141(d)(3)(B) requires. See 11 U.S.C. § 1141(d)(3)(B). The same plan provision stated: "The Debtor will obtain funds to pay his obligations under the Plan from income generated from his employment and distributions from one or more companies in which he holds an ownership interest.” (Dkt. No. 142, Ex. A at 14).
. The dismissal of Counts VI and VII is without prejudice, as all jurisdictional dismissals are.
See Goldschmidt v. Patchett,