The opinion of the court was delivered by: Hon. Norman A. Mordue, Chief U.S. District Judge.
[Bankr. Ct. Adv. Pro. No. 09-50113]
MEMORANDUM-DECISION AND ORDER
On February 26, 2009, debtor Anthony J. Sgroi ("Sgroi") filed a voluntary petition with Bankruptcy Court under title 11 of the United States Code ("Bankruptcy Code"), chapter 7, 11 U.S.C. §§ 701, et seq. In re Anthony J. Sgroi, Bankr. Case No. 09-30416. On August 5, 2009, Michael A. Santaro ("Santaro") commenced this adversary proceeding against Sgroi; on January 4, 2010, he filed an amended complaint. Santaro v. Sgroi, Bankr. Ct. Adv. Pro. No. 09-50113.
Essentially, the amended complaint claims that Sgroi engaged in fraud and misconduct in his role as managing member of an automobile dealership, and that as a result, Santaro, a minority member, was compelled to pay over $1.4 million on his personal guarantee of the dealership's debt to Key Bank.
On January 19, 2010, Sgroi moved to dismiss the amended complaint, arguing that it failed adequately to plead a debt that was non-dischargeable under the Bankruptcy Code, 11 U.S.C. §§ 523(a)(2)(A),(B);(4); 727(a). On February 16, 2010, United States Bankruptcy Judge Margaret Cangilos-Ruiz granted Sgroi a discharge under section 727 of the Bankruptcy Code. 11 U.S.C. § 727. On February 17, 2010, Judge Cangilos-Ruiz granted Sgroi's motion to dismiss the instant adversary complaint in its entirety with prejudice. Santaro appeals from the dismissal order. As set forth below, the Court reverses the dismissal order in part and reinstates Counts I and IV of the amended complaint.
The amended complaint alleges that Sgroi and Santaro were members of Legacy Automotive, LLC ("Company"), which did business as "Legacy Kia" and which sold and serviced automobiles. Sgroi was President and Managing Member of the Company and had full and complete control over its funds, books and records. Santaro, who held a minority interest, was not an active participant in the Company's day-to-day operations. Sgroi obtained inventory financing for the Company from Key Bank in July 2004, and Santaro, as a member of the Company, signed a personal guarantee of the debt.
The amended complaint further claims that prior to January 2007, the Company, under Sgroi's direction and control and without Santaro's knowledge or consent, sold vehicles "out of trust," that is, without remitting to Key Bank the amount of proceeds required by the inventory financing agreement. In January 2007 Key Bank notified the Company that it was in default on its inventory financing "as evidenced by the current Sold out of Trust amount of $721,247.00." Sgroi sold some real estate and used the proceeds to bring the account current by March 2007.
Santaro further alleges that from March, 2007 through January, 2008, the Company, under the direction and control of Sgroi and without Santaro's knowledge or consent, again sold vehicles out of trust and did not remit to Key Bank the proceeds from vehicle sales, in violation of the Key Bank financing agreement. During this time period, Sgroi caused the Company to issue and deliver to Santaro monthly "Dealer Financial Statements" which misrepresented the Company's financial condition by continually understating the amount owed to Key Bank. These Dealer Financial Statements, which were required by the Company's franchise agreement with KIA of America, were prepared under Sgroi's direction and supervision and were regularly delivered to Santaro at Sgroi's direction. Santaro relied on these statements in determining the Company's financial status and in forbearing from taking action to protect his interest as guarantor of the Company's debt to Key Bank.
Also from March 2007 to January 2008, according to the amended complaint, instead of remitting the proceeds of vehicle sales to Key Bank, Sgroi diverted the proceeds to himself and at least three other automobile dealerships of which he was the majority owner and which he controlled. Sgroi engaged in this practice without Santaro's knowledge or consent. The practice caused the Company to be out of trust and increased the debt it owed to Key Bank. It also violated 6.8(b) and (c) of the Company's Operating Agreement which provides: "No loans or guarantees of loans shall be made by the Company to any Manager, Member or any Affiliate thereof"; and "The funds of the Company shall not be commingled with the funds of any other Person." Exhibit A, attached to and incorporated by reference into the amended complaint, lists by date, check number, and amount, three payments from the Company to Sgroi totaling $117,500. Exhibit B lists by date, check number, and amount, 17 payments from the Company to Legacy Ford, Inc. totaling $465,000. Exhibit C lists by date, check number, and amount, seven payments from the Company to Legacy Ventures, LLC totaling $137,000. And Exhibit D lists by date, check number, and amount, 16 payments from the Company to Backus Management, LLC totaling $550,200. These 43 listed payments total $1,269,700. Santaro states he is not aware of, and investigation has not disclosed, any consideration received by the Company for the payments. Thus, Santaro claims, Sgroi acted with fraudulent intent while in a fiduciary capacity by wrongfully diverting funds and assets for no consideration and for other than legitimate Company purposes. Santaro claims that as a result of Sgroi's diversion of funds, the Company lacked sufficient funds to repay its debt to Key Bank, thus compelling Santaro to pay the debt from his own funds.
The amended complaint alleges that Sgroi's fraudulent diversion of vehicle sale proceeds to himself and his other dealerships caused the Company to be out of trust with Key Bank for more than $600,000 by October 2007. Santaro received a notice from Key Bank on November 30, 2007, stating that "the SOT [sold out of trust] appears to have increased by approximately $220,000.00." When Santaro asked Sgroi for an explanation, Sgroi falsely stated to Santaro: "We are not SOT.... You will not be out any more than what we currently have." Santaro relied on this representation in forbearing from taking action to protect his interest as guarantor.
According to the amended complaint, the Dealer Financial Statements under-reported the amount owed to Key Bank in October 2007 by $613,185; in November 2007 by $148,715; in December 2007 by $681,968; and in January 2008 by $1,337,617.*fn1 Santaro avers that the failure of the Dealer Financial Statements to reflect accurately the sums owed to Key Bank enabled Sgroi to conceal the diversion of monies to himself and his other entities.*fn2
The amended complaint also refers to an Agreement entered in August 2008 ("August 2008 Agreement") by Santaro, Sgroi, and Daniel J. Knoblock (the third member of the Company), which, inter alia, permitted Sgroi to withdraw from the Company. It provided in part:
5. Representation bv Sgroi. Sgroi hereby represents to Santaro that, during the time Sgroi and Knoblock had authority or control over, or access to, the books, records, accounts or funds of the Company, Sgroi did not appropriate, withdraw, use or expend Company funds or assets for other than legitimate Company purposes. Repayment of loans made by Sgroi or other Sgroi family members to the Company is deemed to be a "legitimate Company purpose." Sgroi further represents and warrants that he has not accumulated for his own, or others', use or benefit, nor does he presently hold or have control over, any Company funds or assets. Sgroi acknowledges that Santaro is relying specifically on these representations in entering into this Agreement.
The amended complaint also cites to paragraph 7: "In the event any material representation(s) made by Sgroi in paragraph '5' above is/are false ... Santaro retains the right to seek all remedies available to him, in law or in equity, including, in the event Sgroi files for protection under the Bankruptcy Code, Santaro's rights under Sections 523(a) and 727(a) of the Bankruptcy Code." According to the amended complaint, in reliance on Sgroi's representations, Santaro "waived certain contractual claims he had against Defendant, and also waived and released any non-dischargeability claims against Defendant under section 523(a) of the Bankruptcy Code."
Ultimately, Santaro paid the bank $1,477,094.20 (i.e., $1,337,617 plus interest) on his personal guarantee. Santaro claims that this loss resulted from Sgroi's fraud and misconduct. The amended complaint claims in Count I that Sgroi owes Santaro a debt of $1,477,094.20 which is non-dischargeable under 11 U.S.C. § 523(a)(4). Counts II and III claim that the debt is non-dischargeable under 11 U.S.C. § 523(a)(2)(A). Count IV claims the debt is non-dischargeable under 11 U.S.C. § 523(a)(2)(B).
Bankruptcy Court's determination that Santaro's amended complaint fails to state a cause of action is a legal conclusion subject to de novo review. See Fed. R. Bankr. P. 7012(b); Fed. R. Civ. P. 12(b)(6); In re Ionosphere Clubs, Inc., 922 F.2d 984, 988 (2d Cir.1990); In re Musicland Holding Corp., 386 B.R. 428, 435-36 (S.D.N.Y. 2008). In addressing a dismissal motion, a court must "constru[e] the complaint liberally, accepting all factual allegations in the complaint as true, and drawing all reasonable inferences in the plaintiff's favor." Chambers v. Time Warner, Inc., 282 F.3d 147, 152 (2d Cir. 2002). A complaint must plead "enough facts to state a claim to relief that is plausible on its face." Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 570 (2007). Although all allegations contained in the complaint are assumed to be true, this tenet is "inapplicable to legal conclusions." Ashcroft v. ...