Opinion
Case No. 20-30397 Adv. No.20-3022
2022-06-09
IN RE: Jeremy John ASBRA, Debtor. Linda A. Gavola, and The Robert S. and Linda A. Gavola Family Trust, Plaintiffs, v. Jeremy John Asbra, Defendant.
Susan Barilich, Glendale, CA, for Plaintiffs. Robert D. Ross, Dayton, OH, for Defendant.
Susan Barilich, Glendale, CA, for Plaintiffs.
Robert D. Ross, Dayton, OH, for Defendant.
DECISION DENYING PLAINTIFFS’ MOTION FOR SUMMARY JUDGMENT ON COUNTS ONE AND TWO OF THE SECOND AMENDED COMPLAINT (DOC. 22) AND GRANTING THE PLAINTIFFS’ SUPPLEMENTAL SUMMARY JUDGMENT MOTION ON COUNT FIVE (DOC. 61)
Guy R. Humphrey, United States Bankruptcy Judge This decision concerns a judgment creditor's summary judgment motion seeking a determination that the judgment is non-dischargeable under 11 U.S.C. § 523(a)(2), (4), and (19). The court determines, as a matter of law, that the amount of the judgment attributable to securities fraud is non-dischargeable pursuant to § 523(a)(19). The remaining counts in the complaint cannot be determined without a trial.
I. Procedural Background
Jeremy John Asbra ("Asbra") filed a voluntary petition for relief under Chapter 7 of the Bankruptcy Code on February 17, 2020. Estate Doc. 1. On June 15, 2020 Linda A. Gavola and the Robert S. and Linda A. Gavola Family Trust (collectively, "Gavola") commenced an adversary proceeding alleging that a $605,692 California state court judgment, arising out of an arbitration, is non-dischargeable pursuant to 11 U.S.C. § 523(a)(2)(A) and (a)(4). Additionally, the complaint seeks to deny Asbra his discharge pursuant to 11 U.S.C. § 727(a)(2) and (a)(4)(A).
Robert S. Gavola, a party to the state court arbitration, was dismissed as a party in the first amended complaint because he was deceased prior to the commencement of this adversary proceeding. Docs. 14 and 16. Any reference to "Gavola" from the events prior to this adversary proceeding includes Mr. Gavola.
The Gavola proof of claim [2-1] includes an additional $267,513.95 of accumulated interest as of August 13, 2020, for a total claim of $873,205.95 as of that date.
Section 727(a)(2) provides for the denial of a discharge when "the debtor, with intent to hinder, delay, or defraud a creditor or an officer of the estate charged with custody of property under this title, has transferred, removed, destroyed, mutilated, or concealed, or has permitted to be transferred, removed, destroyed, mutilated, or concealed—
(A) property of the debtor, within one year before the date of the filing of the petition; or
(B) property of the estate, after the date of the filing of the petition."
11 U.S.C. § 727(a)(2).
Section 727(a)(4)(A) provides for denial of a discharge when "the debtor knowingly, and fraudulently, in or in connection with the case ... made a false oath or account[.]"
Gavola also moved to have the Chapter 7 case dismissed pursuant to 11 U.S.C. § 707(a) for cause, but this court, following an evidentiary hearing, denied that motion. In re Asbra , No. 20-30397, 2021 Bankr. LEXIS 552 (Bankr. S.D. Ohio Feb. 24, 2021).
Gavola moved for summary judgment on the two dischargeability counts. Doc. 22. After filing a summary judgment motion to address § 523(a)(2) and (a)(4), and following Asbra's response (doc. 27), Gavola moved to amend their complaint to include a count pursuant to 11 U.S.C. § 523(a)(19), which concerns the non-dischargeability of debts based upon state or federal securities fraud. Doc. 32. Without objection, the court granted the motion to amend the complaint. Doc. 34. Following the filing of the second amended complaint (doc. 36) and additional discovery, Gavola filed a supplemental summary judgment motion addressing the § 523(a)(19) count. Doc. 61.
II. Jurisdiction
This court has jurisdiction pursuant to 28 U.S.C. § 1334 and the Standing Order of Reference (Amended General Order 05-02) of the District Court for the Southern District of Ohio. This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(I), and this court has constitutional authority to enter final judgment.
III. Summary Judgment Standard
A court "shall grant summary judgment if the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law." Fed. R. Civ. P. 56(a) (made applicable in this adversary proceeding by Federal Rule of Bankruptcy Procedure 7056 ). A factual disagreement is genuine if "a rational trier of fact could find in favor of either party on the issue." SPC Plastics Corp. v. Griffith (In re Structurlite Plastics Corp. ), 224 B.R. 27, 30 (B.A.P. 6th Cir. 1998) (citing Schaffer v. A.O. Smith Harvestore Prods., Inc. , 74 F.3d 722, 727 (6th Cir. 1996) ). A fact is material if it might affect the outcome of the suit under substantive law. Niecko v. Emro Mktg. Co. , 973 F.2d 1296, 1304 (6th Cir. 1992) (quoting Anderson v. Liberty Lobby, Inc. , 477 U.S. 242, 248, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986) ). When reviewing a motion for summary judgment, a court views all evidence and draws all inferences in the light most favorable to the nonmoving party. Matsushita Elec. Indus. Co. v. Zenith Radio Corp. , 475 U.S. 574, 587, 106 S.Ct. 1348, 89 L.Ed.2d 538 (1986).
IV. Factual Background
A. Pre-Arbitration Litigation
As this decision will detail, Gavola received financial advice from Asbra. Gavola trusted Asbra, accepted his advice on investment opportunities, and ultimately lost significant funds in failed real estate investments.
In response to their losses, Gavola sued Asbra and other co-defendants in the District Court for the Southern District of California (the "California District Court") on multiple counts related to their participation in the failed real estate investments, including one count under California securities law. No. 5:11-cv-01417. The litigation was transferred to the District Court for the Northern District of Texas (the "Texas District Court") at the request of the other defendants. No 3:11-cv-03528-O ("N.D. Tex."); Doc. 1 (N.D. Tex.); Doc. 31 (N.D. Tex.) at 1-2. Prior to the transfer, on November 7, 2011, several defendants moved to dismiss the adversary proceeding for failure to state a claim for which relief could be granted (the "Motion to Dismiss"), but Asbra was not included as a party to that motion. Doc. 17 (N.D. Tex.). One week later, Asbra filed a notice to join the Motion to Dismiss. Doc. 26 (N.D. Tex.). Gavola objected. Doc. 31 (N.D. Tex.). On December 20, 2011, in a minute order, the California District Court struck Asbra's notice because he did not correct deficiencies in its electronic filing, explain how any of the arguments in the Motion to Dismiss applied to him, or address the allegations specific to Asbra. Doc. 31 at 2-3 n.3 (N.D. Tex.). The court transferred the litigation to the Texas District Court on December 22, 2011 without deciding the pending Motion to Dismiss. Id. at 1-2.
The court is entitled to take judicial notice of the existence of court records in other jurisdictions. F.R.E. 201. However, the court is not taking judicial notice or otherwise inquiring into the truth of the contents of any of these documents. See Manix Energy, Ltd. v. James (In re James ), 300 B.R. 890, 895 (Bankr. W.D. Tex. 2003) (quoting In re Earl , 140 B.R. 728, 731 n.2 (Bankr. N.D. Ind. 1992) ) (noting judicial notice is limited to the existence and filing of a document, and not the "truth or falsity [of the] contents of any such document").
The docket in the Texas District Court separately lists all filings that were originally filed in the California District Court. This decision cites only to the Texas docket.
The other defendants were Carl Hampton, Fred Gardenour, TBG Investments, Inc., Windsor Property and Surety, LLC, and WCM Direct LLC. Doc. 17 (N.D. Tex.).
The joinder and other filings in that case also included Advanced Financial Concepts, Inc. ("AFC"). This court previously determined AFC was owned by Asbra and a partner, but eventually Asbra became the sole owner. Estate doc. 103 at 9. For simplicity, the court is referring to these filings as by Asbra.
Following the transfer, Gavola requested an entry of default against Asbra. Doc. 52 (N.D. Tex.). The clerk entered a default against Asbra on March 9, 2012. Doc. 53 (N.D. Tex.). Asbra moved to vacate the default entry on March 15, 2012, but the court did not vacate the order until September 7, 2012. Doc. 60 (N.D. Tex.); Asbra Exhibit A; Doc. 89 (N.D. Tex.).
When the Texas District Court ruled on the Motion to Dismiss on June 12, 2012, Asbra was not a party to that motion. Doc. 80 (N.D. Tex.). In that ruling, the court found that the financial transaction involving the Gavolas did not constitute a "security" and therefore dismissed the federal securities violation count with prejudice. Doc. 80 at 35 (N.D. Tex.). However, the court dismissed the count alleging violations of the California securities statute, California Corporations Code § 25401, without prejudice. Id. at 46.
The Arbitration Decision noted that the dismissal of the § 25401 count by the Texas District Court was without prejudice. On page 22 of the dismissal decision, the Texas District Court states that it is dismissing this count "with prejudice." Gavola Exhibit A at 22; Doc. 80 (N.D. Tex.). But it is clear this was a scrivener error, and the court was referring to the federal securities count under § 10(b)(5) of the Securities Exchange Act. This is readily apparent because the Texas District Court, at the end of the decision, separated the counts into those dismissed with and without prejudice and stated that the dismissal of the California Corporation Code § 25401 count, unlike the federal securities count, was "without prejudice." Id. at 7. The Plaintiffs were given until June 25, 2012 to amend the complaint. Id. On June 25, 2012, the Plaintiffs filed their Second Amended Complaint. Doc. 81 (N.D. Tex.). That complaint included a count under § 25401. Id. at 22-28. Asbra was a party to the Second Amended Complaint. Id. at 1. Shortly after that pleading was filed, the entry of default against him was vacated. Doc. 89 (N.D. Tex.). Asbra was also a party to the Third Amended Complaint that included the § 25401 count. Doc. 95 at 1, 27-34 (N.D. Tex.).
On November 5, 2012 Gavola moved to voluntarily dismiss Asbra as a party to the litigation without prejudice. Doc. 101 (N.D. Tex.). The Texas District Court granted the dismissal motion on November 14, 2012, finding Asbra was not prejudiced. Doc. 106 (N.D. Tex.). Subsequently, on November 29, 2012, Gavola commenced litigation against Asbra in the California Superior Court, Riverside District. No. RIC 1217466; Gavola Exhibit 2. By agreement, Gavola and Asbra submitted the state court litigation to binding arbitration. Gavola Exhibit 2 at 25-46. Both Asbra and Gavola were represented by counsel during the proceedings. The arbitration hearing began on November 5, 2014 and concluded in mid-December 2014. Declaration of Linda A. Gavola at ¶ 4, Gavola Exhibit 1. The arbitrator entered the Findings and Award After Arbitration (the "Arbitration Decision") on May 21, 2015. Gavola Exhibit 2 at 20. Shortly thereafter, the trial court reduced the Arbitration Decision to judgment. Asbra appealed. The California State Court of Appeals affirmed the judgment on September 7, 2018, and the Supreme Court of California declined to accept a petition for review. Gavola Exhibits 4, 5.
Meanwhile, on June 4, 2013, after reaching a settlement, the remaining parties in the Texas litigation jointly moved to dismiss the litigation. Doc. 194 (N.D. Tex.). The Texas District Court granted the motion to dismiss, with prejudice on June 25, 2013. Doc. 196 (N.D. Tex.). On April 26, 2016, after the adverse ruling in the Arbitration Decision was reduced to judgment, Asbra moved to enforce the Texas litigation settlement reached by the remaining parties, despite his status as a dismissed party at the time of the settlement. Doc. 197 (N.D. Tex.). On June 8, 2016 the court struck the motion for procedural deficiencies. Doc. 202 (N.D. Tex.). The motion was not re-filed.
B. The Arbitrator's Factual Findings
In "mid-year 2008" Robert and Linda Gavola (the "Gavolas") were referred to Asbra by a friend. Arbitration Decision at 1, 2. Linda Gavola was the beneficiary of a $32,000 matured bond. Id. at 2. The Gavolas knew Asbra as an insurance agent, and he also "held himself out as a ‘qualified financial counselor.’ " Id. Asbra met with the Gavolas on several occasions and advised the Gavolas "to invest the $32,000 in a financial device know[n] as a ‘Short Term Business Loan Agreement.’ " Id. The Gavolas were unfamiliar with this investment, but Asbra told the Gavolas that the income would be superior to holding the bond. Id. Although the Gavolas questioned purchasing the Short Term Business Loan Agreement instead of paying off the mortgage loan on their home, they ultimately went ahead with the investment, impressed by Asbra's "self-described credentials and stated experience." Id. The Gavolas’ attraction to Asbra derived in part from their positive view of his " religious background," education from a "religion-centered university," "church-centered activities with young people," and "personal dedication to family." Id. at 2 n.1.
In March 2009 the Gavolas, on Asbra's invitation, attended a presentation in Riverside, California given by an individual named Carl Hampton. Id. Forty to fifty people attended. Id. Asbra introduced Hampton "as a published author, a syndicated columnist, and as one who had investment opportunities in properties in St. Louis, Missouri, regarding which he and his crews were doing rehabilitation." Id. Hampton stated that these were "secure" and "safe" investments, and his investors never lost money on these projects. Id. at 2-3.
In June 2009 the Gavolas met with Asbra to discuss their finances and obtain advice. Id. at 3. Upon Asbra's request, the Gavolas provided details of their finances, trusts, insurance, and hopes for retirement. Id. Asbra stated that he was going to school to become a financial planner and developed a retirement plan for the Gavolas. Id. "The Gavolas were pleased with the recommendations provided by Asbra." Id.
The arbitrator concluded that "the terminology and descriptions of transactions," as well as the documents provided to the Gavolas "were confusing to them as to their purpose and intent." Id. at 4. Additionally, the arbitrator determined that, despite the lack of any evidence of authorization by the Gavolas, Asbra signed documents on their behalf. Id. For example, the "Special Sale Contract" and "Management Agreement" were signed "AFC Holdings LLC, FBO Robert S. and Linda A. Gavola Family." Id. In January 2010 Asbra told the Gavolas about an investment similar to what Hampton had outlined at the Riverside presentation. Id. at 5. Asbra convinced the Gavolas to invest $360,000 in a building at 3303-3304 California Avenue, St. Louis, Missouri. Id. The investment was described by Asbra in a January 7, 2010 email to the Gavolas:
FBO meant "for and on behalf of." Arbitration Decision at 4 n. 4.
AFC Holdings LLC was a Nevada limited liability company. Estate Doc. 103 at 9. The two members were (1) Advanced Financial Concepts, Inc. [See fn. 6 infra ] and (2) Asbra's family trust, J and C 2003 Family Trust. Id. at 4, 9. AFC Holdings filed a Chapter 7 bankruptcy case in the Bankruptcy Court for the District of Nevada in 2011. Id. at 9, 11.
Hi Bob & Lynn,
Regarding the four-plex purchased for $360,000. The units will be leased immediately creating income of 5.25% and then sold by year's end. You will then carry-back notes on the sale secured by the property (deed in lieu). Most (omission in original) the notes will be refinanced within 3 years, which will pay you back your original price of $360,000 plus a profit of close to $80,000. You should be netting income around 7% annually or better from the notes. Depending on the year of the final payoff, your internal rate of return would be the following.... (Pay off was to average close to 3 years).
Id. (emphasis added in the Arbitration Decision). Based upon Asbra's representations, the Gavolas committed to this investment on or about January 7, 2010. Id. At this time, Asbra had not inspected or investigated this property. Id. The January 7th email was incorrect in that the property was not ready to "be leased immediately." Id. at 7.
On November 22, 2010, at a dinner with the Gavolas, Asbra informed them that the California Avenue property was not rehabilitated. Id. As opposed to the nature of the investment described in the January 7th email, Asbra offered the Gavolas two $180,000 promissory notes with 30-year amortizations, but the Gavolas rejected this offer. Id.
The Gavolas became increasingly concerned about "the security of their investment." Id. Mr. Gavola learned that the delays in rehabilitation of the California Avenue building were not, as Asbra and Hampton had stated, due to multiple city inspectors requiring changes to the framing. Id. When Mr. Gavola personally travelled to St. Louis, he learned that no rehabilitation had occurred, and no building permits had been obtained. Id. at 8.
Asbra was unfamiliar with the details of the California Avenue property. Id. He did not know whether the property was comprised of two buildings with two units each or one building with four units. Id. It also appeared that both Asbra and Hampton were ignorant of the legal status of the California Avenue property, specifically whether the units were condominiums as defined under Missouri law, which requires a declaration of that status. Id. at 9, 10. The evidence did not show the requirements of Missouri condominium law as a regulatory impediment to leasing the units in the St. Louis property. Id. at 10. The Arbitration Decision noted that "[t]he Gavolas would not have had any way of knowing, at the time of their investment, what the legal status of their property was in Missouri." Id. at 10. The Arbitration Decision noted that condominiums normally have higher costs and would be more difficult to lease in the low-income section of St. Louis in which the California Avenue property was located, which would in turn affect the ability of the Gavolas’ investment to produce income. Id.
See Missouri Statutes §§ 448.020 (Property submitted to condominium law by declaration); 448.030 (Declaration, contests – amendments).
The arbitrator found that the Gavolas’ investment was lost not due to their conduct, "but primarily by Asbra and those from whom he took his information and instructions, namely Carl Hampton, operating the entity known as ‘Windsor Property and Surety.’ " Id. at 15. The arbitrator concluded that "the conduct of Respondent Asbra alone, was in breach of his fiduciary duties to the claimants, as alleged in the complaint, resulting in actual damages to the Gavolas in the amount of $360,000." Id.
C. The Arbitrator's Legal Findings
The Arbitration Decision determined that a fiduciary relationship had been established between Asbra and the Gavolas under California law. Id. The arbitrator cited the standard for a fiduciary relationship under California law:
[A]ny relation existing between parties to a transaction wherein one of the parties is in duty bound to act with the utmost good faith for the benefit of the other party. Such a relation ordinarily arises where a confidence is reposed by one person in the integrity of another, and in such a relation the party in whom the confidence is reposed, if he voluntarily accepts or assumes to accept the confidence, can take no advantage from his acts relating to the interest of the other party without the latter's knowledge or consent[.]
Cleveland v. Johnson, 209 Cal.App.4th 1315, 147 Cal. Rptr. 3d 772, 791 (2012) (quoting Herbert v. Lankershim , 9 Cal.2d 409, 71 P. 2d 220, 257 (1937) ) (cited in Arbitration Decision at 3). The arbitrator noted that, in addition to principles of "intentional or actual fraud," a fiduciary may be liable for "constructive fraud," "even though his conduct is not actually fraudulent." Arbitration Decision at 6. The arbitrator explained that constructive fraud applied in the context of a fiduciary can be based on an "omission or concealment ... which results in damage to another even though the conduct is not otherwise fraudulent. " Id. (emphasis in original); see William Morris Enter., LLC v. Writers Guild of Am. , 478 F. Supp. 3d 932, 940 (C.D. Cal. 2020) (similar).
The citation in the Arbitration Decision indicates that it is quoting from the second edition of Miller and Starr California Real Estate . The legal principle is re-stated in the current edition. See Miller and Starr California Real Estate § 3.46 (4th ed.) (Agent's liability to principal for fraud or misrepresentation (constructive fraud)).
The arbitrator determined that by January 2010 a fiduciary relationship was established under California law between Asbra and the Gavolas. Arbitration Decision at 6. The arbitrator further determined that Asbra, as a fiduciary to the Gavolas, was liable because he encouraged the investment in the California Avenue property without inspection, and the property was misrepresented to the Gavolas. Id. at 6. The arbitrator also concluded that Asbra's representations, within this fiduciary relationship, were the primary reason for the Gavolas’ $360,000 investment loss:
The evidence has established that the investment which the Gavolas made, based upon the representations made to them by Carl Hampton and Asbra, were lost, which loss was not caused by the Gavolas’ conduct, in any respect, but primarily by Asbra and those from whom he took his information and instructions, namely Carl Hampton, operating the entity known as "Windsor Property and Surety." As indicated above, the conduct of Respondent Asbra alone, was in breach of his fiduciary duties to the claimants, as alleged in the complaint, resulting in actual damages to the Gavolas in the amount of $360,000.
Id. at 15. The arbitrator concluded that, absent estoppel or evidence of ratification by the principal, a contract entered into by an agent cannot be enforced against the principal without written authority to act for the principal. Id. at 4-5. Such evidence was lacking. Id. at 4.
In addressing damages for Asbra's conduct, the arbitrator awarded $360,000, the amount of the Gavolas’ initial investment in the St. Louis property, as damages for breach of fiduciary duty. In addition, the arbitrator found damages for violations of the California Corporations Code §§ 25401 and 25501, part of the California Corporate Securities Law of 1968. Section 25401 provides that:
It is unlawful for any person to offer or sell a security in this state, or to buy a security in this state, by means of any written or oral communications that includes an untrue statement of a material fact or omits to state a material fact necessary to make the statements made, in the light of the circumstances under which the statements were made, not misleading.
Cal. Corp. Code § 25401. Section 25501 states that:
Any person who violates Section 25401 shall be liable to the person who purchases a security from him or sells a security to him, who may sue either for rescission or for damages (if the plaintiff or the defendant, as the case may be, no longer owns the security), unless the defendant proves that the plaintiff knew the facts concerning the untruth or omission or that the defendant exercised reasonable care and did not know (or if he had exercised reasonable care would not have known) of the untruth or omission. Upon rescission, a purchaser may recover the consideration paid for the security, plus interest at the legal rate, less the amount of any income received on the security, upon tender of the security. Upon rescission, a seller may recover the security, upon tender of the consideration paid for the security plus interest at the legal rate, less the amount of any income received by the defendant on the security. Damages recoverable under this section by a purchaser shall be an amount equal to the difference between (a) the price at which the security was bought plus interest at the legal rate from the date of purchase and (b) the value of the security at the time it was disposed of by the plaintiff plus the amount of any income received on the security by the plaintiff. Damages recoverable under this section by a seller shall be an amount equal to the difference between (1) the value of the security at the time of the filing of the complaint plus the amount of any income received by the defendant on the security and (2) the price at which the security was sold plus interest at the legal rate from the date of sale. Any tender specified in this section may be made at any time before entry of judgment.
Cal. Corp. Code § 25501 (emphasis added). In calculating the damages under § 25501, the arbitrator stated that damages are calculated based on the consideration paid ($360,000), plus 7 percent compounded interest ($126,000), minus the amount the Gavolas actually received. Arbitration Decision at 15. As the Arbitration Decision found the Gavolas had received $1,575 for 12 months (the "Financial Payment Guarantee") or $18,900, the arbitrator's final calculation of damages on the California securities violations was $107,100 ($126,000 - $18,900). Arbitration Decision at 15. The arbitrator noted that the underlying $360,000 in principal, which would otherwise be awarded as part of the securities violation damages, had already been awarded for breach of fiduciary duty.
Finally, the arbitrator found that "Asbra's failing to personally investigate and observe the condition of the property to which he directed the Gavolas’ investment, and to report his personal findings to the Gavolas, renders him responsible for the damages caused to the Gavolas for his commission of constructive fraud ...." Id. at 16. The damages for constructive fraud under California law were an additional $70,000. Id.
The Arbitration Decision does not make clear how the $70,000 was calculated. It appears that figure may be related to the "profit" that the Gavolas were told they would receive upon the refinancing of the notes, as Asbra described in his January 7, 2010 email. See Arbitration Decision at 5.
V. Analysis
A. The Common Law Preclusive Effect of the Arbitration Decision
The Arbitration Decision forms the basis for the final non-appealable judgment against Asbra. Therefore, the first question is whether the factual findings and legal conclusions have preclusive effect in this adversary proceeding.
Issue preclusion is a "fundamental precept of common-law adjudication." Corzin v. Fordu (In re Fordu ), 201 F.3d 693, 702 (6th Cir. 1999). If a question has been determined by a court of competent jurisdiction, it " ‘cannot be disputed in a subsequent suit between the same parties or their privies ....’ " Id . (quoting Montana v. United States , 440 U.S. 147, 153, 99 S.Ct. 970, 59 L.Ed.2d 210 (1979) ). Issue preclusion applies in non-dischargeability proceedings when facts or legal issues determined in the prior litigation are relevant to the elements of a creditor's § 523 claim. Grogan v. Garner , 498 U.S. 279, 284 n.11, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991) ; Clark v. Springhart (In re Springhart ), 450 B.R. 725, 730 (Bankr. S.D. Ohio 2011). Further, the Sixth Circuit has generally applied issue preclusion to arbitration awards when the subsequent proceeding is between the same parties. Central Transport v. Four Phase Systems, Inc. , 936 F.2d 256, 260 (6th Cir. 1991) (noting that federal courts ordinarily give preclusive effect to arbitrations); Ivery v. United States , 686 F.2d 410, 413–14 (6th Cir. 1982) ; In re Robinson , 256 B.R. 482, 488 (Bankr. S.D. Ohio 2000). The full faith and credit statute requires federal courts to give the same preclusive effect to a state court judgment as it would receive from other state courts. Fordu , 201 F.3d at 703 (citing 28 U.S.C. § 1738). In making this determination, "the federal court must apply the law of the state in which the prior judgment was rendered in determining whether and to what extent the prior judgment should be given preclusive effect in a federal action." Id .
In this instance, the judgment is from the state of California. California issue preclusion requires the following elements: "(1) identical issue; (2) actually litigated in the former proceeding; (3) necessarily decided in the former proceeding; (4) former decision final and on the merits; and (5) party against whom preclusion sought either the same, or in privity with, party in former proceeding." Khaligh v. Hadaegh (In re Khaligh ), 338 B.R. 817, 824 (B.A.P. 9th Cir. 2006). In addition, there is a final test of whether "issue preclusion in the particular setting would be fair and consistent with sound public policy." Id. ; Lucido v. Superior Court , 51 Cal.3d 335, 272 Cal.Rptr. 767, 795 P.2d 1223, 1225 (1990).
Here, the arbitration involved the same facts relevant to this litigation and was litigated by the same parties who were all represented by counsel; the determinations of the arbitrator were necessary to the ruling; the decision was, by consent of the parties, final; and the parties to this litigation were parties to the arbitration. The decision to resolve the dispute by binding arbitration was by mutual agreement. The court finds that applying preclusion principles to this proceeding is "fair and consistent with sound public policy." Id. See also Nguyen v. Nguyen (In re Nguyen ), No. 12-05081, 2013 WL 5429942, at *4, 2013 Bankr. LEXIS 4099, at *11 (Bankr. C.D. Cal. Sept. 30, 2013) (noting under California Code of Civil Procedure § 1287.4, "a judgment confirming an arbitration award has the same force and effect as a judgment in a civil action.").
B. The Texas Litigation Does Not Impact the Preclusive Effect of the Arbitrator's Findings
First, Asbra requests this court to consider the findings of the Texas District Court dismissing the California securities fraud count as to other defendants as having some preclusive effect. In effect, Asbra argues that the Texas District Court decision is binding on Gavola, and the arbitrator should have applied it, rather than reaching an independent determination as to § 25401.
Under federal common law, courts apply the law applicable to the state in which the judgment court sits to determine whether a prior federal judgment is preclusive. Under Texas law, a court's decision to dismiss a count without prejudice has no preclusive effect because the decision is not final or on the merits. See Pirani v. Baharia (In re Pirani ), 824 F.3d 483, 491 (5th Cir. 2016) (quoting Weaver v. Tex. Capital Bank N.A. , 660 F.3d 900, 906 (5th Cir. 2011) ) (claim preclusion requires "a prior final judgment on the merits."). The Supreme Court has explained this principle in the context of Rule 41 dismissals:
We think, then, that the effect of the "adjudication upon the merits" default provision of Rule 41(b)—and, presumably, of the explicit order in the present case that used the language of that default provision—is simply that, unlike a dismissal "without prejudice," the dismissal in the present case barred refiling of the same claim in the United States District Court for the Central District of California. That is undoubtedly a necessary condition, but it is not a sufficient one, for claimpreclusive effect in other courts.
Semtek Int'l Inc. v. Lockheed Martin Corp. , 531 U.S. 497, 506, 121 S.Ct. 1021, 149 L.Ed.2d 32 (2001) (emphasis added); see also Federated Dept. Stores, Inc. v. Moitie , 452 U.S. 394, 398, 101 S.Ct. 2424, 69 L.Ed.2d 103 (1981), abrogated on other grounds by Rivet v. Regions Bank of La. , 522 U.S. 470, 118 S.Ct. 921, 139 L.Ed.2d 912 (1998) ("A final judgment on the merits of an action precludes the parties or privies from relitigating issues that were or could have been raised in that action.") (emphasis added); Wilson v. Grumman Ohio Corp. , 815 F.2d 26, 27 (6th Cir. 1987) ("It is generally accepted that a dismissal without prejudice leaves the situation the same as if the suit had never been brought[.]"). Asbra made this same preclusion argument to the arbitrator, who, as this court does now, determined the Texas District Court decision concerning California Corporate Code § 25401 has no preclusive effect because the dismissal was without prejudice. Arbitration Decision at 11.
Second, Asbra argues that the settlement reached by the remaining defendants in the Texas litigation, following his dismissal without prejudice from that litigation, applies to him. Again, Asbra made that exact argument to the Texas District Court, but his motion was stricken from the record. Doc. 7 (N.D. Tex). Asbra cites Schomburg v. TRW Vehicle Safety Sys., Inc. , 242 S.W.3d 911 (Ct. App. Tex. 2008). In Schomburg , the parties entered into a settlement agreement with "General Motors Corporation, its related and affiliated companies or corporations, agents, servants, authorized dealers, component suppliers ..." Id. at 913. When Schomburg later sued a seatbelt manufacturer, the court that approved the settlement held that the term "component suppliers" included the seatbelt manufacturer, and that decision was affirmed on appeal. Id. at 915. As Schomburg demonstrates, the Texas District Court is the correct court before which to re-argue the interpretation of an order entered by that court. See Liberte Capital Group, LLC v. Capwill , 99 Fed. Appx. 627, 633 (6th Cir. 2004) (citing Brown v. Neeb , 644 F.2d 551, 559 n.12 (6th Cir. 1981) ) (stating that the judge who approved a consent decree is the person best positioned to interpret its meaning). Second, and relatedly, Asbra could have re-filed that motion in the court that entered the judgment but did not.
On November 11, 2012 Gavola moved to dismiss Asbra without prejudice pursuant to Federal Rule of Civil Procedure 41(a)(2). Doc. 101 (N.D. Tex.). Asbra opposed the dismissal and alternatively sought certain conditions upon dismissal. Doc. 103 (N.D. Tex.). The court granted the dismissal without prejudice, did not impose any conditions, and found Asbra's pending motion to dismiss the plaintiff's complaint moot. Doc. 106 (N.D. Tex.). At that point, the case proceeded without Asbra. Doc. 196 (N.D. Tex.). Ultimately, Gavola and the remaining defendants reached a settlement, and the complaint was dismissed with prejudice. Doc. 196 (N.D. Tex.).
Third, Asbra argues that the Texas litigation settlement bars further recovery under California Code of Civil Procedure § 877. That section provides, in part:
Where a release, dismissal with or without prejudice, or a covenant not to sue or not to enforce judgment is given in good faith before verdict or judgment to one or more of a number of tortfeasors claimed to be liable for the same tort, or to one or more other co-obligors mutually subject to contribution rights, it shall have the following effect:
(a) It shall not discharge any other such party from liability unless its terms so provide, but it shall reduce the claims against the others in the amount stipulated by the release, the dismissal or the covenant, or in the amount of the consideration paid for it, whichever is the greater.
As Goodman v. Lozano explained, " Section 877 establishes that a good faith settlement bars other defendants from seeking contribution from the settling defendant, but at the same time provides that the plaintiff's claims against the other defendants are to be reduced by the amount of consideration paid for a settlement." 47 Cal.4th 1327, 104 Cal.Rptr.3d 219, 223 P.3d 77, 81 (2010) (cleaned up). But § 877 applies to "tortfeasors claimed to be liable for the same tort," and Asbra apparently seeks to apply this provision as an agent of certain settling defendants. The arbitrator did not determine that Asbra was a joint tortfeasor to the settling defendants. Instead, the Arbitration Decision found liability based on the unique actions and statements of Asbra. See Lozano , 47 Cal. 4th at 1333, 104 Cal.Rptr.3d 219, 223 P.3d 77 ( § 877 applies to a "non-settling joint tortfeasor or co-obligor"). The arbitrator found that Asbra's individual liability stemmed in part from his fiduciary relationship with the Gavolas. The Arbitration Decision also included specific findings, including a violation of California securities law, and determined damages without any setoff under § 877. Asbra appealed the Arbitration Decision through the California state court two-tier appellate system and lost. The Texas District Court also never determined the settlement had any application to Asbra. In short, even if § 877 could apply, any potential credit or setoff from the Texas settlement was an issue for the Texas District Court or the California state court. Having failed to convince those courts, and absent any evidence of extrinsic fraud or lack of subject matter jurisdiction, there is no cognizable basis to collaterally attack the California judgment, including the damage award. See Lake v. Capps (In re Lake ), 202 B.R. 751, 756-58 (B.A.P. 9th Cir. 1996) (explaining the narrow basis for collateral attacks on state court judgments).
As noted, these arguments are not new. In the stricken motion filed in the Texas litigation, it is clear that Asbra is asking this court to review legal issues that either were or could have been raised not only with the Texas District Court, but in the California litigation prior to the arbitration:
17. The Asbra Parties, at the time of the above-referenced settlement agreement, were unaware of the terms of the settlement agreement. Id. at ¶ 4. Prior to the Arbitration in the California State Court Litigation and Arbitration that the Asbra Parties became aware of the settlement made on their behalf. Id. at ¶ 4-5. The delay in production of the settlement agreement was by design of the Plaintiffs herein because despite repeated requests for production of the Settlement Agreement from this cause of action through the California State Court Litigation and Arbitration, said Settlement Agreement was not produced by Plaintiffs until well into that litigation. Id. at ¶ 4. Upon review of the settlement agreement, the Asbra Parties, filed a motion to dismiss the California State Court Litigation and Arbitration based on the release of agents in the Settlement Agreement from this cause of action. Id. at ¶ 5. The California Arbitration panel, despite the filing of the motion to dismiss prior to the arbitration, did not hear arguments on the matter, nor consider or rule upon the motion and proceeded to the arbitration. Id. The Arbitration panel referenced an intention to hear the matter in the future during the penalty phase of the arbitrartion [sic]. However, no penalty phase of the arbitration ever took place. Id. 18. An arbitration award based on the claims of Misrepresentation, California Corp. Code § 25401 and Fiduciary Duty was made against only Jeremy Asbra. In the Arbitration Award, no allowance was made for funds received, despite the claims having been joint and several. Id. at ¶ 7-8. The California Court has entered a judgment based on the arbitration award against Jeremy Asbra. Id. at ¶ 8. The Asbra Parties respectfully request that this Court enforce the Settlement Agreement entered into in this cause of action, enter an order enjoining the Plaintiffs from enforcing the judgment against Jeremy Asbra and award costs of Court to the Asbra Parties for the damages they have incurred as a result of the Plaintiffs’ continued prosecution of claims against the Asbra Parties since the time of the settlement agreement. In the event this Court believes it is required of them, the Asbra Parties also respectfully request permission to intervene in this suit.
Doc. 197 at 10-11 (N.D. Tex.) (emphasis added). As noted earlier, the appellate process in the California state courts did not change the arbitration judgment either.
Accordingly, the court will give all the factual findings and legal determinations from the Arbitration Decision preclusive effect in this litigation.
C. Gavola is not Entitled to Summary Judgment Under § 523(a)(2)(A)
Section 523(a)(2)(A) of the Bankruptcy Code "implements the long-standing bankruptcy policy that only those debts which are honestly incurred are entitled to the benefits of a bankruptcy discharge." Schafer v. Rapp (In re Rapp ), 375 B.R. 421, 429 (Bankr. S.D. Ohio 2007) (quoting Mack v. Mills (In re Mills ), 345 B.R. 598, 603 (Bankr. N.D. Ohio 2006) ). Additionally, because a policy of the Code is to provide debtors with a fresh start, "exceptions to discharge are to be strictly construed against the creditor." Rembert v. AT&T Universal Card Servs., Inc. (In re Rembert ), 141 F.3d 277, 281 (6th Cir. 1998). Section 523(a)(2)(A) provides an exception to the dischargeability of a debt "for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by ... false pretenses, a false misrepresentation, or actual fraud[.]" 11 U.S.C. § 523(a)(2)(A). To prove that a debt is nondischargeable under § 523(a)(2)(A), a creditor must show that the debt occurred as a result of one of these three categories: false pretenses, a false misrepresentation, or actual fraud.
1. False Representation or Pretenses
"A debt arising from a false representation or from false pretenses is nondischargeable if the creditor establishes, among other things, that ‘the debtor intended to deceive the creditor.’ " Cabrera v. Wilson (In re Wilson ), 613 B.R. 907, 921 (Bankr. S.D. Ohio 2020) (quoting Rembert , 141 F.3d at 280 ). The creditor must establish that "the debtor obtained money through a material misrepresentation that, at the time, the debtor knew was false or made with gross recklessness as to its truth[.]" Rembert , 141 F.3d at 280.
The findings in the Arbitration Decision are insufficient to establish a § 523(a)(2)(A) claim for false pretenses or representation as a matter of law. In order to establish such a claim, it must be proven that Asbra intended to deceive the creditor by material misstatements or actions that were known to be false or made with gross recklessness to the truth. While such deception may be proven at trial, the arbitrator's findings established only that Asbra violated his fiduciary duty under California law by committing constructive fraud. Courts addressing constructive fraud in this context have emphasized that it is a particular subset of fraud applicable only to a fiduciary or a confidential relationship. Salahutdin v. Valley of Cal., Inc. , 24 Cal. App. 4th 555, 562, 29 Cal.Rptr.2d 463 (1994). Constructive fraud by a fiduciary "comprises any act, omission or concealment involving a breach of legal or equitable duty, trust or confidence which results in damage to another even though the conduct is not otherwise fraudulent. " Id. (emphasis in original) (citation omitted); see also William Morris Endeavor Ent., LLC v. Writers Guild of Am. , West, Inc. , 478 F. Supp. 3d 932, 940 (C.D. Cal. 2020) (similar); Pro Water Solutions, Inc. v. Angie's List, Inc. , No. 2:19-cv-08704-ODW (SSx), 2021 WL 4288520, at *9, 2021 U.S. Dist. LEXIS 180130, at *27–28 (C.D. Cal. Sept. 21, 2021) (similar). Constructive fraud is insufficient to show false representation or pretenses because it can include "a careless misstatement." Salahutdin , 24 Cal. App 4th at 562, 29 Cal.Rptr.2d 463 ; Assilzadeh v. Cal. Fed. Bank , 82 Cal. App. 4th 399, 415, 98 Cal.Rptr.2d 176 (Cal. Ct. App. 2000).
According to the Arbitration Decision, Asbra appeared ignorant of the details of the investment properties. Arbitration Decision at 8. He did not inspect the California Avenue property or understand all the details of the investments. Id. The Arbitration Decision established that Asbra failed to complete the minimum due diligence a fiduciary would be required to do under California law before recommending any investment. Id.
However, giving Asbra the benefit of reasonable inferences, the Arbitration Decision does not establish that Asbra himself made material misstatements he knew were false when he encouraged the investments, nor does it prove that he made statements with gross recklessness as to the truth. The closest is the finding that that "[t]he evidence is devoid of any showing that either of the Gavolas authorized Asbra to sign anything ‘... for and on behalf of ...’ them." Id. at 4. But the arbitrator's findings only reach the question that Asbra violated California law as a fiduciary by not obtaining authority to act for the Gavolas in writing. Id. at 4-5. Of course, this failure, along with Mrs. Gavola's position that she had never seen various contracts, is highly probative. But Asbra's intent must be resolved at trial.
Gavola points to the other statements in the arbitration decision that, although probative for trial, do not establish a § 523(a)(2) claim on summary judgment as to Asbra's intent and are insufficient. Drawing inferences in favor of Asbra, the fact that the Gavolas were unfamiliar with the "Short Term Business Loan Agreement" as an investment and did not understand the explanation of that investment does not prove, by itself, a false representation or pretenses. Arbitration Decision at 2. In addition, the Hampton presentation does not settle whether Asbra acted in full knowledge of a fraudulent scheme when he encouraged the Gavolas to invest the $360,000, or if he was acting, in part or in whole, in ignorance. The arbitrator was not required to make these determinations as to Asbra's intent to find a breach of fiduciary duty or constructive fraud under California law. It was sufficient to find he breached his fiduciary duty, and was, at a minimum, giving careless statements to the Gavolas. Salahutdin , 24 Cal. App 4th at 562, 29 Cal.Rptr.2d 463 ; Assilzadeh , 82 Cal. App. 4th at 415, 98 Cal.Rptr.2d 176. Similarly, the arbitrator made highly probative findings as to the timing of the execution of the contract in January 2010. As the arbitrator found, this timing may raise "question marks about the legitimacy of the transaction." Arbitration Decision at 5 n.5. But as with other findings, Asbra's intent remains a material question of fact left unresolved. Finally, while the record raises factual questions about whether the Gavolas were being deceived by Asbra, Hampton, or both concerning the condition and marketability of the St. Louis properties, it does not resolve them.
2. Actual Fraud
Similarly, the summary judgment record also does not prove actual fraud under § 523(a)(2)(A) as a matter of law. Actual fraud is different than false representation or pretenses in that it "more broadly consists of ‘any deceit, artifice, trick, or design involving direct and active operation of the mind, used to circumvent or cheat another.’ " Cabrera , 613 B.R. at 921 (quoting Mellon Bank, N.A. v. Vitanovich (In re Vitanovich ), 259 B.R. 873, 877 (B.A.P. 6th Cir. 2001) ). In addition, the Supreme Court has held that "[t]he term ‘actual fraud’ in § 523(a)(A)(2) encompasses forms of fraud, like fraudulent conveyance schemes, that can be effected without a false representation." Husky Int'l. Elecs., Inc. v. Ritz , 578 U.S. 356, 359, 136 S.Ct. 1581, 194 L.Ed.2d 655 (2016). In Ritz , the Supreme Court made clear that it had "historically construed the terms in § 523(a)(2)(A) to contain the ‘elements that the common law has defined them to include.’ " Id. (quoting Field v. Mans , 516 U.S. 59, 69, 116 S.Ct. 437, 133 L.Ed.2d 351 (1995) ). "The word ‘actual’ has a simple meaning in the context of common-law fraud: It denotes any fraud that ‘involv[es] moral turpitude or intentional wrong.’ " Id. (quoting Neal v. Clark , 95 U.S. 704, 709, 24 L.Ed. 586 (1878) ). "[A]nything that counts as ‘fraud’ and is done with wrongful intent is ‘actual fraud.’ " Id. Further, the Court stated that "a false representation has never been a required element of ‘actual fraud[.]’ " Id. at 362, 136 S.Ct. 1581. "[A] creditor may establish circumstances indicating a debtor's fraudulent intent, even if the debtor did not make a misrepresentation or misleading omission on which the creditor relied." Cash Am. Fin. Servs., Inc. v. Fox (In re Fox ), 370 B.R. 104, 116 (B.A.P. 6th Cir. 2007).
For the same reasons discussed as to false representation or pretenses, the Arbitration Decision is also insufficient to show actual fraud. Although certain facts may be highly probative to show actual fraud, the Arbitration decision does not make sufficient findings to establish that Asbra acted with the intent to cheat the Gavolas.
At trial, Gavola can seek to establish what Asbra knew at the time these investments were made and delve into why he believed that the Gavolas, residents of California, should invest retirement funds in a financial vehicle based upon real property halfway across the country. Other possible issues include why Asbra signed documents for the Gavolas without any written power of attorney; how he determined (by himself, or in concert with Hampton or others) to take that action; the nature and development of Asbra's relationship with the individual known as "Carl Hampton"; and his role in encouraging an investment of retirement funds that included claims of guaranteed income. At present, it is unclear to the court what, if anything, occurred in this relationship during the crucial time period when Asbra encouraged the Gavolas to commit funds to investments in these St. Louis properties.
Gavola's motion for summary judgment as to Count 1 is denied.
D. Gavola is Not Entitled to Summary Judgment Under § 523(a)(4)
Gavola seeks summary judgment based upon the first prong of § 523(a)(4), "fraud or defalcation while acting in a fiduciary capacity," and argues that the arbitrator's findings are sufficient to establish nondischargeability of this debt. Doc. 22 at 13-18. Section 523(a)(4) provides an exception to discharge "for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny[.]"
The Sixth Circuit has determined that "fiduciary capacity" in § 523(a)(4) is "limited only to those situations involving an express or technical trust relationship arising from placement of a specific res in the hands of the debtor." Commonwealth Land Title Co. v. Blaszak (In re Blaszak ), 397 F.3d 386 (6th Cir. 2005) (quoting R.E. Am., Inc. v. Garver (In re Garver ), 116 F.3d 176, 180 (6th Cir. 1997) ). To establish a § 523(a)(4) claim, the creditor must show "(1) a pre-existing fiduciary relationship, (2) breach of that relationship, and a (3) resulting loss." Commonwealth Land Title Co. v. Blaszak (In re Blaszak ), 397 F.3d 386, 390 (6th Cir. 2005). See also Poynter v. Great Am. Ins. Co. (In re Poynter ), 535 Fed. Appx. 479, 481-82 (6th Cir. 2013) (quoting Cumberland Surety Ins. Co. v. Smith (In re Smith ), 238 B.R. 664, 670 (Bankr. W.D. Ky. 1999) ) ( § 523(a)(4) requires "(1) the existence of a trust, either express or statutorily created; (2) the debtor owed a fiduciary capacity obligation with relation to that trust; and (3) the debtor breached his or her fiduciary duty by either misappropriating the trust res or by simply failing, intentionally or unintentionally, to properly account for the trust res."). Whether a relationship meets the standard for a "fiduciary" of § 523(a)(4) is a question of "federal, not state, law[.]" Blaszak , 397 F.3d at 390. It is insufficient that Asbra was a fiduciary under California state law. See Cal-Micro, Inc. v. Cantrell (In re Cantrell ), 329 F.3d 1119, 1125 (9th Cir. 2003) (noting the "broad, general definition of fiduciary—a relationship involving confidence, trust and good faith—is inapplicable in the dischargeability context.") (citation omitted). 1. Requirement of An Express Trust
It is fundamental that the trust relationship must pre-exist "the act creating the debt and without reference to it." Id. (citing Davis v. Aetna Acceptance Co. , 293 U.S. 328, 333-34, 55 S.Ct. 151, 79 L.Ed. 393 (1934) ). Therefore, a debtor's role as an ERISA fiduciary was not sufficient for a § 523(a)(4) claim because "[the debtor's] breach of his contractual obligation to pay the employer contributions—is also the exercise of control that the Funds allege made [the debtor] an ERISA fiduciary." Bd. of Trs. of the Ohio Carpenters’ Pension Fund v. Bucci (In re Bucci) , 493 F.3d 635, 643 (6th Cir. 2007). In order to establish an express trust, a creditor must show "(1) an intent to create a trust; (2) a trustee; (3) a trust res; and (4) a definite beneficiary." Patel v. Shamrock Floorcovering Svcs., Inc. (In re Patel ), 565 F.3d 963, 968 (6th Cir. 2009) (quoting Blaszak , 397 F.3d at 391-92 ).
Alternatively, a technical or statutorily created trust will meet this requirement. For example, in evaluating the Bankruptcy Act's predecessor to § 523(a)(4), the Sixth Circuit determined that the "Michigan Building Contract Fund Act imposes a ‘trust’ upon the building contract fund paid by any person to a contractor or subcontractor for the benefit of the person making the payment, contractors, laborers, subcontractors and materialman." Carlisle Cashway, Inc. v. Johnson (In re Johnson ), 691 F.2d 249, 252 (6th Cir. 1982). However, there is no evidence of a technical or statutory trust in this record.
The existence of an express trust is a matter of state law. Rowland v. Walls (In re Walls ), 375 B.R. 399, 405 (Bankr. S.D. Ohio 2007). "[C]reation of an express trust [under California law] requires: (1) a competent trustor; (2) trust intent; (3) trust property; (4) trust purpose; and (5) a beneficiary." Swimmer v. Moeller (In re Moeller ), 466 B.R. 525, 535 (Bankr. S.D. Cal. 2012). In this instance, an express trust res may have existed when Gavola made the initial $32,000 investment through Asbra. However, Asbra must have been responsible for a specific trust res that he held for the benefit of the Gavolas that was separate from "the wrongdoing that caused the debt." Id. See also Honkanen v. Hopper (In re Honkanen ), 446 B.R. 373, 381 (B.A.P. 9th Cir. 2011) (real estate agent not liable under § 523(a)(4) because it did not hold "any property in trust" for the debtor); As required under § 523(a)(4), this express trust pre-dated the $360,000 investment that formed the basis for the arbitrator's judgment. Blaszak , 397 F.3d at 390. See also Est. of Lola Brewer v. Jones (In re Jones) , 369 B.R. 340, 346 (Bankr. N.D. Ohio 2007) ( § 523(a)(4) claim existed when "the Debtor ... represented to the Plaintiffs that he was a financial planner and, based on that representation, the Plaintiffs entered into an investment agreement[.]"). However, the arbitrator did not specifically indicate the funds were entrusted to Asbra but only that Gavola invested those funds on Asbra's advice. Arbitration Decision at 5. The exact role of the other parties, particularly Hampton, is not clear in this summary judgment record. These issues can be addressed at trial.
The only possible exception is the court cannot determine the factual basis for the $70,000 award from the summary judgment record. See fn. 12, infra.
2. Fraud or Defalcation Requirement
The court must also determine whether the summary judgment record supports that Asbra acted with the required intent. Specifically, does the record support a finding a finding of fraud or defalcation. In Bullock v. BankChampaign, N.A. , the Supreme Court settled the meaning of "defalcation" in context of § 523(a)(4). 569 U.S. 267, 133 S.Ct. 1754, 185 L.Ed.2d 922 (2013). The Court first explained that "fraud" under this discharge exception has been defined to mean:
"[D]ebts created by ‘fraud’ are associated directly with debts created by ‘embezzlement.’ Such association justifies, if it does not imperatively require, the conclusion that the ‘fraud’ referred to in that section means positive fraud, or fraud in fact, involving moral turpitude or intentional wrong, as does embezzlement; and not implied fraud, or fraud in law, which may exist without the imputation of bad faith or immorality."
Id at 273, 133 S.Ct. 1754 (quoting Neal v. Clark , 95 U.S. 704, 709, 24 L.Ed. 586 (1878) ). See also Long v. Piercy (In re Piercy ), 21 F. 4th 909, 919 (6th Cir. 2021) (similar). The Court likewise defined "defalcation" in a somewhat similar but distinct fashion:
Thus, where the conduct at issue does not involve bad faith, moral turpitude, or other immoral conduct, the term requires an intentional wrong. We include as intentional not only conduct that the fiduciary knows is improper but also reckless conduct of the kind that the criminal law often treats as the equivalent. Thus, we include reckless conduct of the kind set forth in the Model Penal Code. Where actual knowledge of wrongdoing is lacking, we consider conduct as equivalent if the fiduciary "consciously disregards" (or is willfully blind to) "a substantial and unjustifiable risk" that his conduct will turn out to violate a fiduciary duty. ALI, Model Penal Code § 2.02(2)(c), p. 226 (1985). See id., § 2.02 Comment 9, at 248 (explaining that the Model Penal Code's definition of "knowledge" was designed to include " ‘wilful blindness’ "). That risk "must be of such a nature and degree that, considering the nature and purpose of the actor's conduct and the circumstances known to him, its disregard involves a gross deviation from the standard of conduct that a law-abiding person would observe in the actor's situation." Id., § 2.02(2)(c), at 226 (emphasis added). Cf. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194, n. 12, 96 S. Ct. 1375, 47 L.Ed.2d 668 (1976) (defining scienter for securities law purposes as "a mental state embracing intent to deceive, manipulate, or defraud").
Bullock , 569 U.S. at 273–74, 133 S.Ct. 1754.
The summary judgment record before this court does not establish fraud or defalcation as a matter of law. To support a finding of fraud or defalcation, the record must show that Asbra acted with intent or moral turpitude, or gross recklessness as defined in Bullock . As with Gavola's § 523(a)(2)(A) arguments, the record is not sufficient to find intentional conduct or fraud by Asbra; a trial is required. The standard for defalcation presents a slightly lower bar and is therefore a closer call. But the record does not sufficiently establish whether Asbra consciously disregarded the risk to the Gavolas or was willfully blind to unjustifiable risks. While the differing requirements for fraud and defalcation as to Asbra's state of mind could be relevant or even outcome determinative at trial, the record does not support granting Gavola summary judgment under either standard.
Gavola's summary judgment motion as to Count 2 is denied.
E. 11 U.S.C. § 523(a)(19) (Securities Fraud)
Gavola also seeks summary judgment on count 5 of the complaint based on the Arbitration Decision finding that Asbra committed securities fraud under California law. The legislature added § 523(a)(19) to the Bankruptcy Code in 2002 as part of the Sarbanes-Oxley Act in an effort to "disallow debts incurred in violation of securities fraud laws from being discharged in bankruptcy [.]" Smith v. Gibbons , 289 B.R. 588, 591 (Bankr. S.D.N.Y. 2003) (citation omitted) (emphasis in original). Accordingly, 11 U.S.C. § 523(a)(19) states:
Section 523(a)(19)(B) was amended in 2005 to state that the judgment may be "before, on, or after the date on which the petition was filed." The amendment was effective as of July 30, 2002. Bankruptcy Abuse and Consumer Protection Act of 2005, Pub. L. 109-8, 119 Stat. 24 § 1404 (Apr. 20, 2005).
(a) A discharge under section 727 ... of this title does not discharge an individual debtor from any debt—
(19) that—
(A) is for—
(i) the violation of any of the Federal securities laws (as that term is defined in section 3(a)(47) of the Securities Exchange Act of 1934), any of the State securities laws, or any regulation or order issued under such Federal or State securities laws ; or
(ii) common law fraud, deceit, or manipulation in connection with the purchase or sale of any security; and
(B) results, before, on, or after the date on which the petition was filed, from—
(i) any judgment, order, consent order, or decree entered in any Federal or State judicial or administrative proceeding ;
(ii) any settlement agreement entered into by the debtor; or
(iii) any court or administrative order for any damages, fine, penalty, citation, restitutionary payment, disgorgement payment, attorney fee, cost, or other payment owed by the debtor.
11 U.S.C. § 523(a)(19) (emphasis added). Section 523(a)(19) applies to debts incurred from both federal and state securities fraud violations. See Warren v. Cybulski , 556 B.R. 429, 436 (N.D. Cal. 2016) (stating that a judicially determined securities fraud violation is non-dischargeable pursuant to § 523(a)(19) ). As explained earlier, all of the arbitrator's legal findings are entitled to preclusive effect.
A separate debate exists about whether the bankruptcy court can determine liability under § 523(a)(19) or if that is required to be done by a non-bankruptcy tribunal. In re Chui , 538 B.R. 793, 806-07 (Bankr. N.D. Cal. 2015) (explaining the case law split and collecting cases). The court expresses no opinion on this question as liability has been determined, and the creditor does not seek any relief from this court beyond a determination of nondischargeability.
But even if one accepted the argument that the Arbitration Decision did not meet the well-established standard for preclusion under California law, the unique language of § 523(a)(19) renders the securities fraud portion of the state court judgment non-dischargeable. Specifically, § 523(a)(19) applies to "any judgment ... entered in any Federal or State judicial or administrative proceeding[.]" 11 U.S.C. § 523(a)(19)(B)(ii) (emphasis added). Therefore, any judgment finding securities fraud, even when inconsistent with state law preclusion, is non-dischargeable. Tripodi v. Welch , 810 F.3d 761, 767 (10th Cir. 2016) ; Cooley-Linder v. Behrends (In re Behrends ), 660 Fed. Appx. 696, 700-01 (10th Cir. 2016) ; Simon v. Boccarsi (In re Boccarsi ), 578 B.R. 800, 812 (Bankr. N.D. Ill. 2017) (similar). Such awards are non-dischargeable even if the judgment was entered by default and therefore not "actually litigated." Ahuja v. Fleming (In re Fleming ), 637 B.R. 390, 395 (Bankr. D. Conn. 2021) ; but see Floyd v. Hill (In re Hill ), 495 B.R. 646 (Bankr. D. N.J. 2013) ("summary order" from state regulator could not be given preclusive effect in securities fraud non-dischargeability proceeding under § 523(a)(19) because the order was not the source of the debt to be exempted from discharge).
Here, the Arbitration Decision found that Asbra violated the California Corporate Securities Law when he advised and facilitated the Gavolas’ $360,000 investment in the California Avenue St. Louis property. The arbitrator ruled, without any ambiguity, that the Gavolas’ $360,000 investment in the Short Term Rental Agreement constituted a security within the meaning of California law. Arbitration Decision at 13-14. The arbitrator also determined that Asbra made material misstatements or omitted material facts. Therefore, Asbra was liable for securities fraud under California law. Cal. Corp. Code § 25401 ; Stewart v. Ragland , 934 F.2d 1033, 1047 (9th Cir. 1991) ("[ Section 25401 ] provides that is unlawful to sell a security by means of a communication containing false statements or omissions."); Zalkind v. Ceradyne, Inc. , 194 Cal.App.4th 1010, 124 Cal. Rptr. 3d 105, 120 (2011) (similar).
In Kokas v. Osborne (In re Osborne ), No. 16-4068, 2017 WL 1232407, at *6, 2017 Bankr. LEXIS 931, at *13–14 (Bankr. E.D. Tex. Apr. 3, 2017), the court cited Cohen v. de la Cruz , 523 U.S. 213, 118 S.Ct. 1212, 140 L.Ed.2d 341 (1998), and applied it to § 523(a)(19) when awarding damages for a Texas securities law violation. The decision noted that:
The United States Supreme Court has concluded that a debt that is declared nondischargeable under § 523(a) should include the full amount associated with the conduct at issue, including any "debt arising from" or "debt on account of" that conduct. Cohen v. de la Cruz, 523 U.S. 213, 220– 21 [118 S.Ct. 1212, 140 L.Ed.2d 341] (1998). Though the facts in Cohen specifically addressed a liability rendered nondischargeable under the actual fraud prong of § 523(a)(2)(A), its rationale to prevent a discharge of all liability arising from circumstances that render a debt nondischargeable under § 523(a) is applicable in this case. Thus, the exemplary damages award is rendered nondischargeable because such fraud constitutes a proper basis under Texas law for the recovery of exemplary damages ... and § 523(a)(19) specifically renders nondischargeable a "debt ... that is for ...common law fraud, deceit, or manipulation in connection with the purchase or sale of any security. 11 U.S.C. § 523(a)(19)(A)(ii). It also encompasses the attorneys' fees awarded to the Plaintiff under the statutory authority ... Thus, in light of the jurisprudence that § 523(a) should be properly construed to bar the discharge of all liability arising from the categories of misconduct that render a debt nondischargeable, thereby [e]nsuring "that the creditors' interest in recovering full payment of debts in these categories outweigh[s] the debtors' interest in a complete fresh start," Cohen , 523 U.S. at 222 , the Court concludes that the damages awarded to the Plaintiff in the State Court Judgment for exemplary damages and attorneys' fees based upon the Defendant's misconduct must also be rendered nondischargeable under § 523(a)(19).
Id. (emphasis added). Similarly, in this situation, as the arbitrator recognized, the original consideration provided by the investor is the starting point and an integral part of any damages awarded under Cal. Corporate Code § 25501.
Gavola's summary judgment motion as to Count 5 is granted.
F. The Amount of the Non-Dischargeable Judgment as to Count 5
Having found that Gavola is entitled to summary judgment on Count 5, the court addresses the amount of the non-dischargeable judgment. Under California law, the applicable security fraud damages include the $360,000 in original consideration, plus the additional $107,100 in damages awarded by the arbitrator. Although the Arbitration Decision awarded $360,000 for the separate breach of fiduciary duty tort and referred to $107,000 in damages for securities violations, the arbitrator correctly noted that damages under California Corporate Code § 25501 (constructive fraud) include the original consideration. Compare Cal. Corp. Code § 25501 (Damages recoverable under this section by a purchaser shall be an amount equal to the difference between (a) the price at which the security was bought plus interest at the legal rate from the date of purchase and (b) the value of the security at the time it was disposed of by the plaintiff plus the amount of any income received on the security by the plaintiff.) and Arbitration Decision at 15 (quoting Boam v. Trident Fin. Corp. , 6 Cal. App. 4th 738, 744, 8 Cal.Rptr.2d 177 (1992) ) ("As statutes go, the language of section 25501 is fairly straightforward, laying out a simple arithmetical formula to calculate relief: ‘Consideration’ + ‘interest’ - ‘income’ = recovery."). It is beyond debate that the original investment would be part of any securities fraud award because California securities fraud award calculations are not discretionary – the amounts are prescribed by § 25501 and begin with the original consideration paid by the investor. Cal. Corp. Code § 25501. See also Zalkind , 124 Cal. Rptr. 3d at 121-22 (calculation of the "damages formula" begins with the value of the security); Slates v. Adama Tech. Corp. , No. CV 21-4496 PA (PVCx), 2021 WL 6752217, at *3, 2021 U.S. Dist. LEXIS 252190, at *7–8 (C.D. Cal. Dec. 10, 2021) (similar). Thus, while the arbitrator first addressed breach of fiduciary duty under California law and awarded the $360,000 on that basis, California law also requires the award of this amount as the basis of the securities violation. Having awarded the $360,000 in damages, the arbitrator apparently found it superfluous to include it in the securities fraud award.
As addressed, Asbra is not entitled to any offset for the settlement between Gavola and the other defendants in the Texas litigation.
The arbitrator stated that "[f]or the violation of Corporations Code § 25401/25501, the damages are fixed at $107,100. derived from the [sic] interest on the consideration paid (already found as damages in paragraph #1 above) , less the income received by the Gavolas." Arbitration Decision at 15-16 (emphasis added). Thus, this case is unlike Gray v. Wenzel (In re Gray ), in which the panel found "there is nothing in the record connecting the breach of fiduciary determination and awards to any violation of either federal or state securities laws." No. AZ-10-1304-MkMaD, 2011 WL 4503078, at *10, 2011 Bankr. LEXIS 3067, at *31 (B.A.P. 9th Cir. July 7, 2011).
Finally, the $70,000 award for constructive fraud under California law cannot be found non-dischargeable on this summary judgment record. As explained earlier, constructive fraud is not sufficient basis for a nondischargeability determination under § 523(a)(2)(A) or (a)(4), and the factual basis for that award would require clarification at trial. The court will enter an amended judgment, if appropriate, following the adjudication of the remaining counts.
VI. Conclusion
The Plaintiffs’ motions for summary judgment are granted in part and denied in part. Summary judgment is denied as to Counts One and Two of the Second Amended Complaint seeking non-dischargeability pursuant to 11 U.S.C. § 523(a)(4) and (a)(2). Summary judgment is granted as to Count 5 of the Second Amended Complaint seeking non-dischargeability pursuant to 11 U.S.C. § 523(a)(19). The Debtor owes a non-dischargeable debt in the amount of $467,100, costs from the arbitration in the amount of $39,897.75, and interest on the judgment. The court will enter a separate order consistent with this decision.
Gavola Exhibit 3. See 11 U.S.C. § 523(a)(19)(B)(iii) (providing that any "cost" is included the judgment). As this court did not liquidate the amount of the judgment, the appropriate interest rate is as provided in the state court judgment, and under California law. Hamilton v. Elite of L.A., Inc. (In re Hamilton ), 584 B.R. 310, 322-24 (B.A.P. 9th Cir. 2018), aff'd by In re Hamilton , 785 F. App'x 438 (9th Cir. 2019).