Thursday, August 30, 2018

Bankruptcy Fraud



Full disclosure: I don’t know much about bankruptcy fraud. I know that bankruptcy courts have the authority to find that some debts are non-dischargeable. And in that event, filing the bankruptcy may not be the answer the debtor is seeking.

Regardless of my lack of knowledge, it’s a topic that is worth exploring. A recent case will illustrate the point.

In 2004 Humberto Saenz Jr. entered into a Franchise Agreement with Pizza Patron in south Texas. The Franchise Agreement prohibited Saenz from transferring franchises without the consent of the franchisor.

Saenz formed Estrella Ventures, LLC, for the purpose of operating four Pizza Patron restaurants. He financed his accounts receivable, inventory, equipment, furniture and fixtures with the International Bank of Commerce and a $480,000 loan. Sales must have been good, as the debt was reduced to $336,000 in five years

In 2009 Jose Maria Gomez approached Saenz to purchase one store. Gomez and Saenz reached a deal for Gomez to acquire the Rio Grande City Pizza Patron franchise for $350,000, just enough to pay off the IBC debt. Neither Gomez nor Saenz obtained written consent to the transfer from Pizza Patron.

Saenz furnished sales reports, tax returns and income statements to Gomez. Gomez used them to substantiate the purchase price, and predict future revenues and expenses.

Due to health concerns, Gomez closed the store in 2011. Saenz reopened it under the Pizza Patron name.

Gomez, unhappy with a $70,000 loss and believing that Saenz made material wrongful misrepresentations to Gomez which induced Gomez to purchase the store, sued Saenz for fraud. Saenz countered by filing a Chapter 7 bankruptcy petition. The lawsuit was dispatched to bankruptcy court, where the court found for Gomez, entered judgment for $412,000 against Saenz, and determined that since the claim was based in fraud a discharge in bankruptcy would not serve to avoid the judgment.

In other words, the underlying purpose of the Chapter 7 bankruptcy filing – to duck the claim of Gomez – would not succeed and Gomez would still be able to collect monies owed to him even after the bankruptcy was concluded.

Saenz appealed.

The United States Court of Appeals looked at the evidence presented and determined that Saenz “lied frequently whenever it suited him.” Income Statements furnished by Saenz were false; discrepancies in accounting procedures and royalty payments were “problematic and unacceptable.”

The bankruptcy court had the right to weigh the credibility of both Gomez and Saenz, and determine that Saenz’s fraudulent conduct induced Gomez to make business decisions. And that substantial losses were incurred.

Fraud claims are not dischargeable in bankruptcy. Gomez wins. Saenz loses. Gomez may now continue to extract the amount owing to him from Saenz regardless of Saenz’s Chapter 7 bankruptcy proceeding.

See Humberto Saenz v. Jose Maria Gomez; No 17-41004; United States Court of Appeals of Texas, 5th Circuit, August 7, 2018: https://www.law.com/texaslawyer/almID/1534478158TX1741004/.    

Lessons Learned / Questions Asked:

1.      Fraud claims are not dischargeable in bankruptcy.

2.      Independent due diligence and analysis is critical not only in real estate deals, but also in general business transactions. Complete trust in one party’s statements without verification can yield money losses and litigation.

3.      There’s an unreported piece to this case. Although Gomez ultimately prevailed in our legal system – did he really? He likely spent an exorbitant amount in legal fees to obtain a Judgment. And now what? Our Texas homestead and other debtor-exemption laws are still available to Saenz. What happens if Saenz uses those laws to his benefit and doesn’t pay Gomez – then who won?

                                                                                    Stuart A. Lautin, Esq.*

* Board Certified, Commercial (1989) and Residential (1988) Real Estate Law,
Texas Board of Legal Specialization

Licensed in the States of Texas and New York

Higier Allen & Lautin, PC

No comments:

Post a Comment