Court: United States Bankruptcy Court, S.D. Texas; July 27, 2015; Us Bankruptcy; United States Bankruptcy Court
Marvin Isgur, the United States Bankruptcy Judge, ruled that Humberto Saenz, Jr. and Estrella Ventures, LLC committed common law fraud against Plaintiffs Jose Maria Gomez and JMG JMG Ventures, LLC, resulting in actual damages of $330,000. The Court awarded exemplary damages totaling $82,500, bringing the total award to $412,500, which is non-dischargeable under 11 U.S.C. 523(a)(2)(A).
The procedural history began when Gomez and JMG filed suit on September 11, 2011, in the 381st District Court of Starr County, Texas, alleging fraudulent misrepresentation, breach of contract, common law fraud, and conversion against Saenz and Estrella Ventures. After amending their petition on December 4, 2012, to include IBC and Pizza Patrón, Saenz filed for Chapter 7 bankruptcy on August 27, 2013. The case was transferred to bankruptcy court on November 19, 2013, where Plaintiffs initiated an adversary proceeding on November 26, 2013, seeking exceptions to discharge under 11 U.S.C. 523. Subsequent legal actions included separate motions for summary judgment by Lone Star and IBC, with the Court denying IBC's motion on February 6, 2015.
A consolidated trial took place on February 17, 2015, where motions for judgment on partial findings from IBC and Saenz/Estrella Ventures were granted concerning certain claims. The case's background involved Gomez's inquiry about purchasing a Pizza Patrón franchise in 2009, facilitated by Jesús Ortiz, Saenz's brother-in-law, who introduced Gomez to Saenz, the purported corporate representative for the franchise in South Texas. Gomez's decision to pursue Pizza Patrón came after six months of considering other franchises.
On September 7, 2004, Saenz entered into a Franchise Development Agreement with Pizza Patrón, signing as President of Estrella Ventures, Inc., which he founded to operate franchises. The agreement granted him exclusive rights to develop Pizza Patrón restaurants within a specified but undefined Development Area, which Saenz described as extending from Starr County to Alamo and bordering Mexico, with the northern limit at Monte Cristo Street in Edinburg. Although the Franchise Agreement for the Rio Grande City location is not part of the court's documents, it includes a clause prohibiting voluntary franchise transfers without prior written consent from the franchisor, with unauthorized transfers constituting a default.
By 2009, Saenz owned at least four Pizza Patrón locations and secured financing for these through three cross-collateralized loans from the International Bank of Commerce, totaling an original principal of $480,500, with a remaining balance of $335,880 as of November 25, 2009. In August 2009, Saenz and Gomez reached a preliminary agreement for Gomez to purchase the Rio Grande City location for $350,000, with Gomez seeking a Small Business Administration loan for $287,200.
Gomez requested a profit and loss statement from Saenz, who claimed to have sought help from Elizabeth Gauna, his banker at IBC, for its preparation. Gauna, however, denied this request, maintaining that Saenz only approached her for formatting assistance and did not mention the potential sale until later. Gauna documented her interactions with Saenz in an Activity Summary, which recorded eight contacts from June 10 to October 27, 2009, none of which referenced the sale until a report dated November 25, 2009.
By August 18, 2009, Lone Star had received an interim profit and loss statement for the Rio Grande City location, referred to as the June income statement, which reported net sales of $243,414.00, cost of goods sold at $74,496.00, operating expenses of $85,911.55, and a net income of $83,006.45 from January 1 to June 30, 2009. Mr. Gomez could not specifically recall seeing this statement. Saenz later provided Gomez with a September income statement, which Gomez reviewed in mid-October 2009. This statement indicated total sales of $338,924.00 and net income of $107,505.16, with identical cost of goods sold as the October income statement prepared by Saenz, raising questions about their accuracy.
Additionally, a Net Sales Report from Pizza Patrón showed net sales of $254,635.32 for the same period, which was significantly lower than the figures provided in the September income statement, indicating discrepancies in reported sales. Saenz's tax returns for Estrella Ventures revealed that in 2006, the Rio Grande City location had net sales of $431,127.00, with deductions leading to only $27,457.00 in ordinary business income. This was inconsistent with the September income statement's projection of over $134,000.00 for 2009, which was more than double the income reported for 2007.
Lone Star requested a Certification of No Change for an SBA loan, which Saenz was uncertain about but acknowledged was necessary. A Certification of No Change dated November 10, 2009, was received by Lone Star, signed by Charlotte Hargrove for Pizza Patrón, though both Gomez and Saenz denied sending it.
In 2005, Saenz obtained a Certification of No Change for the Rio Grande City franchise, signed by Charlotte Hargrove of Pizza Patrón, Inc. A 2009 Certification of No Change appeared to be a forgery of the 2005 document, with only the date altered. On October 15, 2009, Saenz, as President of Estrella Ventures, entered a Purchase-Sale Agreement to sell equipment and inventory for $350,000, also agreeing to transfer the lease and franchise for a $9,000 fee. Gomez, the buyer, did not pay this fee, believing it was included in the purchase price, and Saenz did not request it. Both testified they did not consider the contract binding at that time, as it lacked approval from Pizza Patrón.
After the ownership change, Saenz faced issues regarding royalty payments to Pizza Patrón, as he had not disclosed the transfer. To manage this, he requested Gomez's account number to remit payments, falsely claiming to Pizza Patrón that he needed to change his account due to returned items. Saenz admitted this was a lie to conceal the sale. He received all but $20,000 of the sale price from the transaction.
On February 26, 2010, Saenz informed Elizabeth Gauna that he had sold the location, reporting the proceeds as $150,000. Gauna allowed Saenz to retain $66,777 after paying down a loan, based on her understanding of the lower sale price. She later discovered the actual sale price was $350,000, which Saenz had not disclosed. Gauna acknowledged she should have verified the sale amount, stating that had she known, she would have settled Saenz's remaining loans. Ultimately, Saenz defaulted on these loans, resulting in a loss of approximately $200,000 for IBC.
Gomez secured an SBA loan from Lone Star, closing on February 8, 2010, and took possession of the restaurant on March 10 or 11, 2010. Prior evaluations of the Rio Grande City location showed a decline in performance: a score of 95 in April 2007 dropped to 33 by June 2009, but improved during Gomez's management, reaching grades of 84.4% on June 19, 2010, and 94.4% on August 12, 2010. Disputes arose regarding Gomez's attendance at corporate inspections; Saenz claimed he warned Gomez to be in uniform, while Gomez contended that Saenz told him franchise owners could not attend. Additionally, Gomez alleged that Saenz discouraged him from attending required training sessions, despite Gomez's desire to participate. Saenz asserted there was a "gentleman’s agreement" that Gomez would complete the training before the franchise transfer, contradicting the Purchase-Sale Agreement's terms. Gomez operated the restaurant until March 8, 2011, while juggling a full-time job. In late 2010, he discovered a health issue affecting his eye, which the doctor advised him to manage by reducing time spent in the kitchen. Although health concerns influenced his decision to close the restaurant, Gomez primarily cited financial losses as the main reason.
Gomez ceased operations at the Rio Grande City restaurant due to declining net sales, which fell from $842,548.19 in the year ending December 1, 2009, to $302,901.02 the following year. He decided not to renew the lease and closed the restaurant on March 11, 2011, having incurred losses of approximately $70,000 that year. Following the closure, Gomez handed the keys to Saenz, who claimed to have found a new tenant and removed all restaurant equipment for auction without Gomez's consent. Saenz informed Pizza Patrón corporate that the restaurant closed due to roof damage but later claimed the closure was to facilitate repairs and renovations, which included installing new equipment. However, Saenz could not substantiate his claims about the roof issues and did not notify Pizza Patrón of the true reasons for the restaurant's closure.
Despite efforts to maintain operations, sales continued to decline, totaling only $236,359.16 from December 1, 2010, to December 1, 2011, a decrease of $66,541.86 from the prior year. By October 8, 2012, Saenz abandoned or sold the restaurant, leading to a change in operations. The court noted discrepancies between Saenz's testimony and that of Gomez and Gauna but found Gomez's account more credible, supported by his business experience and consistent responses. Gauna's testimony was also deemed credible, as it was consistent with documentary evidence and lacked discrepancies, even when it was against her own interest.
Gauna expressed regret over not verifying the purchase price of the Rio Grande City Restaurant, acknowledging her mistake may have resulted in significant financial loss for IBC. In contrast, Saenz was characterized as frequently dishonest, admitting to misleading Pizza Patrón about the reasons for withdrawing funds from Gomez's bank account and lying about the restaurant's closure dates. He also misled Gauna regarding the sale price, claiming it was $150,000 when it was actually $350,000. The court viewed Saenz's claims as implausible, particularly his assertion that Gauna misrecorded the purchase price despite the agreement clearly stating the correct amount.
The court emphasized Saenz's lack of credibility and noted the importance of witness credibility and documentary evidence in resolving two key factual disputes. The first dispute concerned the truthfulness of a September income statement. Although it was unclear if Gomez reviewed this document before signing the purchase agreement, both Saenz and Gomez testified that they believed the agreement was non-binding. Gomez acknowledged that he relied on the September income statement to justify purchasing the restaurant, knowing he would incur significant debt payments.
Saenz claimed the income statement discrepancies stemmed from rental income not reported by Pizza Patrón and the sale of specialty items that did not incur royalties. While the court accepted that some discrepancy could be attributed to rental income, a significant gap of $56,688.68 remained unexplained. Saenz's assertion regarding specialty items was challenged by Gomez, who denied that such items were sold at the restaurant apart from a limited sale of t-shirts during the 2010 World Cup.
Saenz's explanation regarding merchandise sales raises issues since Pizza Patrón would not typically allow franchises to sell branded items without receiving royalty payments, as stipulated in the 2012 Franchise Agreement, which mandates a 5% royalty on gross sales. Saenz failed to provide any documentation of revenue from the alleged merchandise sales, leading the Court to reject his explanation for discrepancies in the September income statement. Saenz admitted to regularly withdrawing $800 to $1,000 in cash from the register for personal expenses, claiming this was necessary due to cash payment practices with vendors to avoid overdraft fees. However, he kept no records of these withdrawals, casting doubt on the accuracy of the income statement figures. The September income statement was found to be false, as it did not align with Pizza Patrón’s net sales report and suggested implausible profit increases despite declining sales in subsequent years. Additionally, the identical figures for the cost of goods sold in consecutive months indicated a significant error.
The second factual dispute involves whether Saenz misrepresented himself as a corporate employee to Gomez, who claims Saenz asserted he was the corporate representative for the South Texas region, a claim Saenz denies. This contradiction complicates the actions of both individuals. Gomez, having researched franchise acquisition beforehand, understood the necessity of obtaining franchisor consent but could not recall specifics of his conversation with Pizza Patrón regarding a franchise opportunity.
Gomez sought to acquire a Pizza Patrón franchise and, after consulting his friend Jesús Ortiz, was advised to contact regional director Saenz instead of the Dallas office for a smoother process. Saenz confirmed his ownership of the southern region and indicated he had exclusive rights to develop franchises. Gomez later testified that Saenz claimed to be part of Pizza Patrón corporate and was proud of it, a claim supported by documentary evidence indicating Saenz was working on leasehold improvements for future franchises. However, Saenz disputed this, asserting he never claimed to be a corporate employee.
Witnesses corroborated Gomez's understanding that Saenz represented Pizza Patrón, which explains Gomez's failure to directly confirm the franchise transfer with the Dallas office. Despite Gomez's substantial investment and active involvement in the restaurant, Saenz delayed Gomez's training necessary for the franchise transfer, contradicting the purchase agreement. It is suggested that Saenz intended to make it appear as though the franchise was transferred while preventing Gomez from contacting corporate employees, raising concerns about the legitimacy of the transfer. Saenz also misled Pizza Patrón regarding royalty payment deductions from Gomez's account, obscuring the sale and misleading Gomez into believing the transfer was approved. Consequently, Gomez was led to believe that the franchise transfer was legitimate when he observed regular withdrawals labeled 'Pizza Patr.'
Saenz forged a Certification of No Change to mislead Gomez into believing the sale of the Rio Grande City restaurant had Pizza Patrón's approval, while concealing the sale from the corporation. Gomez required this certification for his SBA loan from Lone Star. Saenz possessed an original certification from when he purchased the restaurant but claimed ignorance about how a forged copy reached Lone Star. Unlike Saenz, who had a motive to forge the document and had lied to Pizza Patrón twice to keep the sale secret, Gomez had no reason to create a forgery and could have simply asked Pizza Patrón for the certification.
Saenz prevented Gomez from meeting Pizza Patrón representatives, asserting that Gomez should not attend franchise inspections, despite Gomez's testimony of working long hours at the restaurant. This pattern of deception allowed Saenz to continue operating the franchise shortly after Gomez ceased operations. Saenz had previously sold another restaurant and later informed Pizza Patrón, who approved the transfer, indicating he could have done the same for Gomez. The court concluded that Saenz misrepresented himself as an employee of Pizza Patrón to keep Gomez from seeking the franchisor’s approval.
The plaintiffs allege multiple causes of action against Saenz and Estrella Ventures, including fraudulent misrepresentation, breach of contract, common law fraud, and an exception from discharge under 523(a)(2)(A). Although fraudulent misrepresentation and fraud were pleaded as separate claims, the court noted that fraudulent misrepresentation is an element of fraud. To establish fraud, the plaintiffs must demonstrate that a material representation was made.
To establish a claim for fraud, the following elements must be proven: (ii) the representation was false; (iii) the speaker knew it was false or acted recklessly; (iv) the representation was made with the intent for the other party to rely on it; (v) the other party did rely on it; and (vi) damages occurred. In the case of Stone v. Lawyers Title Ins. Corp., the court found that Saenz made two false representations to Gomez before the sale of a restaurant: a fraudulent September income statement and a false claim of employment with Pizza Patrón corporate. Saenz was aware that he did not work for Pizza Patrón, and even if he wasn’t aware the income statement was false, his lack of record-keeping raised serious doubts about its accuracy. Gomez relied on these representations, believing the restaurant would be a profitable investment, as indicated by the stated profit of $107,505.16. Had he known the true financial state of the restaurant or that Saenz was not an authorized representative, he would have withdrawn from the purchase.
Gomez's reliance on the income statement was challenged by Saenz on the grounds of reasonableness, citing Gomez's failure to consult an accountant or attorney. However, Gomez had prior business experience and was not unsophisticated in financial matters. Relying on his own judgment for the $350,000 purchase was deemed justified, and the fact that he could have discovered the truth through further inquiry does not negate his right to rely on the misrepresentation. The legal standard holds that a victim of fraudulent misrepresentation is justified in trusting its accuracy, even if they could have uncovered its falsity through investigation.
Gomez justifiably relied on a false income statement provided by Saenz, which was critical to his decision to invest in a franchise after being denied one directly from Pizza Patrón. Saenz’s claim of being a Pizza Patrón employee was essential for Gomez’s belief that he could secure the necessary authorization to proceed with the franchise. Despite questioning the exclusivity of Saenz's rights in the area, there was no evidence that Pizza Patrón informed Gomez of this limitation. Gomez's testimony indicated that both Saenz and another individual, Ortiz, confirmed Saenz’s employment status, reinforcing his belief in Saenz’s representation.
In a fraud case, the plaintiff must establish proximate causation, which requires showing that the defendant's actions were a substantial factor in causing the injury and that the injury was foreseeable. Gomez suffered a loss of $330,000 when the restaurant failed, and this loss was directly linked to the false income statement Saenz provided. Had Gomez received accurate financial information, he would not have proceeded with the investment. Furthermore, it was foreseeable that providing misleading financial information would lead someone to invest and subsequently incur a loss. The misrepresentation regarding Saenz’s employment was also pivotal; had Gomez not been led to believe in Saenz's affiliation with Pizza Patrón, he would likely have not engaged in the deal. The foreseeability of the resultant injury was assessed based on the circumstances surrounding the misrepresentation at the time.
A reasonable person would recognize the importance of disclosing to a potential franchise buyer that one is an employee of the franchisor and can approve the transaction. Saenz misrepresented his employment status to Gomez during a recession, leading to foreseeable injury when Gomez was induced to purchase the restaurant. Saenz’s fraudulent claims resulted in actual damages of $330,000 for the plaintiffs. They seek exemplary damages under Texas law, which requires proof of fraud, malice, or gross negligence by clear and convincing evidence. The factors affecting exemplary damages include the nature of the wrongdoing, the conduct's character, the wrongdoer's culpability, the situation of the parties, public justice sensibilities, and the defendant's net worth. While the first five factors favor awarding exemplary damages due to Saenz's repeated lies, the last factor limits the award because Saenz’s assets were only $196,340, less than the actual damages. The court awarded $82,500 in exemplary damages, representing 25% of the actual damages, aiming to punish and deter future misconduct while considering Saenz's financial capacity. Additionally, plaintiffs requested attorney’s fees, but under Texas law, such fees are not recoverable for fraud claims unless authorized by statute or contract, which does not apply in this case.
Plaintiffs are denied recovery of attorney's fees due to the absence of a contractual provision allowing such recovery. To establish a breach of contract claim, four elements must be demonstrated: 1) the existence of a valid contract, 2) performance or tender of performance by the plaintiff, 3) breach of the contract by the defendant, and 4) damages suffered by the plaintiff as a result of the breach. Defendants allegedly breached the purchase agreement by failing to transfer the franchise as stipulated. The existence of a valid contract and the failure to transfer the franchise are acknowledged, but there is a dispute regarding Gomez's performance. Gomez only paid $330,000 of the purchase price and did not pay the $9,000 transfer fee, which raises questions about his ability to claim breach due to the doctrine that a party in default cannot sue for breach. Materiality of breach is also examined; Gomez's breach is deemed non-material as he paid over 90% of the total price. Furthermore, Gomez has not proven he suffered damages from the breach since he operated as if he were the franchise owner, paid franchise fees, and did not attempt to stop Saenz from reopening the store post-termination. Without evidence of damages, Plaintiffs cannot establish that Defendants are liable for breach of contract. Additionally, Section 523(a)(2)(A) of the Bankruptcy Code excludes from discharge any debts obtained through false pretenses or fraud, excluding statements about financial condition.
The elements of “actual fraud” under 11 U.S.C. § 523(a)(2)(A) include: 1) the debtor made a representation; 2) the debtor knew the representation was false; 3) the representation was made with intent to deceive the creditor; 4) the creditor actually and justifiably relied on the representation; and 5) the creditor sustained a loss as a proximate result. These elements align with common law fraud principles under Texas law.
A financial statement, such as the September income statement, cannot serve as a basis for a § 523(a)(2)(A) exception to discharge, as such claims fall under § 523(a)(2)(B). The Court previously dismissed the plaintiffs' claim under § 523(a)(2)(B). The § 523(a)(2)(A) claim against Saenz must be supported by more than the income statement.
Saenz falsely claimed to work for Pizza Patrón and to be able to secure a franchise for Gomez, which led to Gomez's injury when the restaurant failed. Gomez justifiably relied on Saenz's representation due to trust in Saenz's connections, particularly from Ortiz, a manager at Pizza Patrón. Without this misrepresentation, Gomez would not have engaged in the transaction, leading to foreseeable losses.
The Court found that all elements of § 523(a)(2)(A) were satisfied, preventing the discharge of any liability arising from the fraud. This includes actual damages of $330,000 and exemplary damages of $82,500, totaling $412,500, which is excepted from discharge under § 523(a)(2)(A). The Judgment will be consistent with this Memorandum Opinion. Additionally, the Small Business Act permits the SBA to provide loans to qualified small businesses. The document also notes that depreciation is not a true cash expense and acknowledges that Gomez understood the income statements did not reflect loan servicing expenses.
Saenz provided Gomez with a document as an example of a Certification of No Change, while noting that Pizza Patrón had altered its evaluation scoring system for 2010 to a maximum of 108 points, focusing on percentage scores. Gomez acknowledged his prior training at Saenz’s Pizza Patrón locations before purchasing the Rio Grande City restaurant, despite potential inaccuracies regarding the timeline of the restaurant's closure from March 8 to March 10, 2011. Gomez estimated Saenz’s rent income through September 30, 2009, at $18-19,000, leading to an annualized figure of approximately $22,500-$23,750, a discrepancy that the Court found immaterial. Gomez also clarified that while he did not sell cups, he incorrectly stated that he sold shirts, which was later contradicted by an audio recording. Saenz maintained records of cash payments for vendor transactions, although he did not track total cash withdrawals. During questioning, Gomez indicated he believed Saenz was associated with Pizza Patrón corporate based on information from his brother-in-law, who claimed Saenz was in charge of the Southern region. Saenz argued against the need for expert testimony to declare a document forged, a stance the Court rejected, affirming the trier of fact's role in assessing witness credibility and evidentiary disputes. Under Federal Rules of Evidence, the Court can compare handwriting samples to determine authenticity without expert assistance, as Saenz had authenticated a prior Certification of No Change, enabling the Court to evaluate a subsequent document.
Handwriting expert testimony is not essential for a forgery conviction, with the jury capable of making determinations based on the evidence presented. Saenz references a Texas case where the court found a forgery determination inadequate without expert testimony. However, federal procedural rules, which mirror Texas's rules on this issue, allow for other forms of proof regarding forgery. Although expert testimony is not mandatory, there must be evidence of forgery itself.
Saenz contends that his previous falsehoods to Pizza Patrón are considered prior bad acts, which are inadmissible under Federal Rule of Evidence 404(b) to demonstrate character. Nevertheless, such evidence can be used to show motive, opportunity, intent, and other relevant factors. The instances of lying are viewed as part of a common scheme to defraud rather than merely prior bad acts.
Testimony indicates that Gomez paid only $330,000 of the agreed purchase price, which has not been disputed. Financial evidence shows declining sales at Pizza Patrón, exacerbated by economic downturns and competition. Even if Saenz's claims of an oral agreement regarding Gomez's training are accepted, the underlying purchase agreement is governed by the statute of frauds, necessitating written modifications for any material changes. The alleged oral modification requiring training is deemed unenforceable as it creates new obligations not included in the original written agreement.
Factors relevant to breaches of contract include the extent of deprivation of expected benefits, compensation for the breach, potential forfeiture, likelihood of remedial action, and adherence to good faith standards. Finally, Section 523(a)(2)(A) of the bankruptcy code requires only justified reliance from the plaintiff, a lower threshold than reasonable reliance.
