Itria Ventures LLC v. Chadha (In re Chadha)

Citation: 598 B.R. 710Docket: Case No. 17-40590-nhl; Adv. Pro. No. 17-01043-nhl

Court: United States Bankruptcy Court, E.D. New York; March 30, 2019; Us Bankruptcy; United States Bankruptcy Court

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Itria Ventures LLC initiated an adversary proceeding against Rakesh K. Chadha to determine if his debt to Itria is non-dischargeable under 11 U.S.C. § 523(a)(2) or to deny his discharge under § 727(a). After trial, the Court concluded that Itria did not meet the burden of proof to show that Chadha secured funds through false pretenses, fraud, or falsified documents. Consequently, the debt is not exempt from discharge, nor is there grounds to deny Chadha's discharge.

The Court has jurisdiction under 28 U.S.C. §§ 1334(b) and 157(b)(1), confirming this as a core proceeding. The trial included testimony from four witnesses and the submission of post-trial statements. Itria, a small business financing company run by President Ramit Arora, relies on Biz2Credit for financial documentation review. Chadha, a restaurant entrepreneur since 1986, operated three eateries in the Roosevelt Field Mall until early 2017. His restaurants included Ranch One and Café Spice in the food court and La Bottega, a full-service restaurant requiring a lease facelift as a condition for lease renewal. 

In late 2015, Chadha engaged architect Martin A. Passante for La Bottega’s redesign, paid him $5,000, and obtained multiple price quotes for necessary renovations and equipment. These preparations aimed to comply with the landlord's requirements for a ten-year lease extension.

Between May and October 2016, the Debtor communicated with Kristen Harris, the Senior Tenant Coordinator at the Mall, regarding the approval of Passante's designs and renovation coordination. La Bottega's lease was renewed for a ten-year term in June 2016. In late 2015, the Debtor sought working capital from Itria for the Restaurants and was assigned case manager Summit Arora at Biz2Credit. On December 18, 2015, Arora instructed the Debtor to submit a financing application with supporting documentation. The Debtor forwarded this request to his bookkeeper, Manprit Chawla, who had been managing the Debtor's bookkeeping since 1996. Chawla completed and sent the application along with the necessary documents to Biz2Credit, which created an Underwriting File based on this information.

The Underwriting File included financial documentation such as partnership tax returns for Café Spice, Schedule C attachments to the Debtor's individual tax returns for La Bottega, a corporate tax return for Ranch One, merchant processing statements, bank statements, UCC financing statements, and a report from a Biz2Credit site visit. Arora reviewed the Underwriting File and noted stable revenue for La Bottega, growth for Café Spice, and significant revenue for Ranch One. He assessed the Restaurants as doing well based on bank and merchant statements and concluded they were in a favorable location. After evaluating the file and speaking with the Debtor, Itria decided to advance funds to the Restaurants. On April 1, 2016, the Debtor received an email from Summit with a proposed agreement for Itria to provide $350,000 in working capital.

The Debtor rejected a proposal for financial assistance, believing the Restaurants required less funding and expressing concerns over a 13% interest rate. Instead, he sought $150,000 from Itria. Subsequently, an agreement titled "Future Receivables Sale Agreement" (April FRSA) was executed on April 4, 2016, whereby Itria agreed to purchase $208,500 in future receivables from the Restaurants for $150,000. The Restaurants were obligated to make weekly payments to Itria based on a percentage of the purchased receivables or a fixed amount. They warranted that the funds would be used solely for working capital, provided accurate financial information, affirmed their financial solvency, disclosed all material information, and promised to notify Itria of any material breaches. The Debtor personally guaranteed this agreement and reaffirmed its terms, also executing an Affidavit of Confession of Judgment.

From June to August 2016, the Debtor observed a decline in mall activity and an increase in store closures but attributed these issues to ongoing renovations, concluding that the Restaurants were performing sufficiently to meet financial obligations to Itria. Consequently, he did not disclose these concerns to Itria. On August 1, 2016, he requested an additional $150,000 for remodeling La Bottega, asking for required documentation. In response to Itria's request for financial statements, Chawla provided relevant profit and loss statements and bank statements. The 2015 statements indicated modest profits for the Restaurants. On August 10, 2016, a second Future Receivables Sale Agreement (August FRSA) was executed, personally guaranteed by the Debtor.

The August FRSA mirrored the April FRSA in key aspects, reaffirming warranties via personal guaranty by the Debtor. After executing the August FRSA and disbursing funds, Summit requested the Restaurants' rent checks, 2015 business tax returns, and trade references. Chawla provided all but the 2015 tax returns, which were delayed due to an extension filed by the accountant. The tax returns were not finalized until mid-September 2016. By October 2016, the Debtor had landlord approval for renovations at La Bottega but awaited final design approval, prompting a delay until January 2017 due to the holiday revenue expectations. However, the actual revenue fell short, leading the Debtor to determine that La Bottega's operations were unsustainable. The Debtor informed Itria of payment difficulties and proposed alternative arrangements, believing he could sustain Café Spice and Ranch One while repaying Itria. An agreement was not reached, and the Debtor paid $99,000 to Itria from remaining operational funds before closing La Bottega on February 5, 2017. The Debtor filed for chapter 7 bankruptcy on February 10, 2017, including his debt to Itria from the guaranty. The discharge of this guaranty obligation under the August FRSA is contested. The bankruptcy law aims to provide deserving debtors with a fresh start while preventing dishonest behavior, allowing discharge unless successfully challenged by a trustee or creditor based on specific grounds.

Section 523(a) of the Bankruptcy Code allows creditors to exclude specific debts from a debtor's general discharge by proving certain elements. It contrasts with Section 727(a), which addresses broader dischargeability issues. Courts interpret exceptions under 523(a) strictly against creditors and liberally for debtors, requiring separate analyses for objections under both sections. Creditors may seek relief under both provisions in an adversary proceeding. To succeed under either section, they must meet their burden of proof by a preponderance of the evidence.

Section 523(a)(2) specifically addresses non-dischargeability based on fraudulent actions. It states that debts incurred through false pretenses, false representations, or actual fraud are not dischargeable. To prove a claim under 523(a)(2)(A), a creditor must demonstrate five elements: the debtor made a false representation, knew it was false, intended to deceive, the creditor justifiably relied on it, and the creditor suffered a loss due to this representation. Misrepresentations are considered fraudulent if the debtor lacks confidence in their truthfulness or knowingly misrepresents facts. Additionally, concealment of material information may be treated as false pretenses if intent to deceive is established.

Section 523(a)(2)(A) allows debts obtained through non-written misrepresentations to be excepted from discharge, whereas Section 523(a)(2)(B) requires a written statement. A debtor can be held accountable for a written false statement if they wrote, signed, or adopted it. A written statement is materially false if it misrepresents the debtor's financial condition in a way that would influence a creditor's decision to extend credit. Courts have determined that financial statements are not limited to formal documents. Reasonable reliance on a false written statement is assessed objectively, determining if a reasonably prudent person would rely on it. A debtor's intent to deceive can be inferred from the overall circumstances.

Regarding the denial of discharge under Section 727(a), Itria's claims under 727(a)(1) and 727(a)(3) were found inapplicable. Section 727(a)(1) is irrelevant as it pertains only to non-individual debtors. Section 727(a)(3) requires that a debtor failed to maintain records necessary for understanding their financial condition, but Itria's allegations focused on pre-bankruptcy misrepresentations rather than record preservation. Section 727(a)(2) addresses concealment or destruction of property with intent to defraud, but Itria did not effectively pursue this claim during trial or in post-trial statements, leading to its abandonment.

Itria presents five allegations to support its claim against the Debtor's dischargeability under 11 U.S.C. § 523(a)(2). First, Itria claims the Debtor failed to inform them about a downturn in restaurant business starting June 2016, which they label the "Economic Downturn Allegation." Second, the Debtor allegedly did not disclose an ongoing dispute with the landlord (the "Landlord Dispute Allegation"). Third, Itria argues that profit and loss statements provided by the Debtor in 2016 were misleading and inaccurate (the "Inaccurate Profit and Loss Statements Allegation"). Fourth, Itria asserts that tax returns for 2013 and 2014 were provided but never filed (the "Unfiled Tax Returns Allegation"). Lastly, Itria contends that the Debtor misrepresented the use of funds advanced for remodeling La Bottega, which constitutes fraud (the "Misuse of Funds Allegation"). Itria claims these misrepresentations induced an additional $150,000 advance.

Itria cites Article 8 of the April and August Financial Restructuring and Settlement Agreements (FRSA), which required the Debtor to inform them if any representation became untrue, arguing this supports the claim for non-dischargeability of debt. Regarding the Economic Downturn Allegation, the Debtor acknowledged a perceived business decline but explained it was not significant and attributed it to general mall conditions rather than a specific issue with the Restaurants. Itria argues that the Debtor's failure to disclose this information was fraudulent; however, the Debtor maintains that his observations were anecdotal, and he believed the Restaurants could continue meeting their obligations, making his silence reasonable and not fraudulent.

Itria failed to prove that the Debtor intended to deceive by delaying the disclosure of economic conditions concerning the Mall and Restaurants, rendering the Economic Downturn Allegation insufficient for a 523(a)(2)(A) exception. Regarding the Landlord Dispute Allegation, Arora testified about learning of a landlord dispute only in January 2017, which the Debtor claimed had existed for over six months. However, the Debtor’s testimony and supporting emails demonstrated ongoing efforts to fulfill lease renewal conditions and a successful ten-year lease extension achieved in June 2016. While the Debtor did request a rent reduction in January 2017 due to poor business performance, he denied any historical disputes with the landlord. The evidence indicates that rather than a dispute, the Debtor was actively cooperating with the landlord and other parties. The Court found that there was no basis for the Landlord Dispute Allegation as it lacked detail and did not support claims of a false representation regarding the Restaurants' viability. Thus, this allegation also cannot support a 523(a)(2)(A) exception to discharge.

Itria alleges that the 2015 Profit and Loss (P.L.) Statements provided by the Debtor and Chawla misrepresented the financial performance of the Restaurants, claiming they were fabricated to induce Itria into advancing an additional $150,000 under the August Financial Restructuring and Settlement Agreement (FRSA). Although Itria asserts that these statements were materially false and intended to deceive, it failed to demonstrate by a preponderance of evidence that the Debtor intended to mislead.

The P.L. Statements reported positive net incomes for Café Spice ($1,453.48), Ranch One ($30,575.22), and La Bottega ($24,739.24). Chawla prepared these statements using QuickBooks, based on data from invoices, operating reports, and bank statements provided by the Restaurants' managers, adhering to a cash basis accounting method. Kini explained that this method records income and expenses based on actual cash flow, which can lead to discrepancies when expenses for the prior year are not accounted for in the correct month.

Kini routinely adjusted the cash-basis statements for accruals when preparing tax returns, which was a standard practice, and he testified that he had no prior knowledge of the statements being submitted to Itria. The Debtor did not participate in the creation of these statements and did not review them before they were sent, emphasizing that Chawla was responsible for compiling all necessary documentation for the reports.

The Debtor testified that Chawla performed work on a personal computer to which the Debtor had no access. Chawla confirmed that he sent the 2015 Profit and Loss (P&L) Statements directly to Biz2Credit. A discrepancy was noted between Ranch One's 2015 P&L statement, showing a profit of $30,575.22, and its 2015 tax return, which reported a loss of $31,798. Kini clarified that this discrepancy arose from adjusting Chawla's cash-basis P&L Statements to an accrual basis for tax filing purposes. This credible explanation, combined with the Debtor’s lack of knowledge and involvement in the P&L calculations, led the Court to conclude that the Debtor did not intend to deceive Itria regarding the statements. Consequently, the allegation of inaccurate P&L statements was insufficient to support a 523(a)(2)(B) exception.

Itria also alleged that the 2013 and 2014 tax returns for La Bottega and Café Spice were unfiled, despite the Debtor's representations that they were filed. Itria presented Tax Guard reports indicating unfiled returns, but Kini testified that the returns had been filed as attachments to another entity's tax returns. He explained that the IRS considers these LLCs as disregarded entities, allowing their tax information to be reported on the Debtor's personal tax return. The tax information for La Bottega and Café Spice was not concealed and was included in the Underwriting File as part of the Debtor's individual tax returns. Therefore, the Court found no misrepresentation regarding the tax returns, leading to the failure of Itria’s 523(a)(2)(A) claim concerning the Unfiled Tax Returns Allegation.

Lastly, Itria claimed that the Debtor's representation in an email regarding the use of advanced funds for remodeling La Bottega constituted fraud. An email dated August 1, 2016, requested $150,000 for remodeling, forming the basis of this allegation.

The document details a legal finding regarding the use of funds advanced under the August FRSA (Funding and Restructuring Services Agreement). It clarifies that although an email indicated the intention to use an additional $150,000 for remodeling La Bottega, this intention was not reflected in the August FRSA itself. Instead, Article 9 of the August FRSA mandated that the funds be used solely for general working capital purposes. An integration clause in Article 19 further reinforced that the August FRSA represented the complete agreement between the parties, rendering any prior intentions irrelevant.

As a result, the court concluded that Itria could not claim that the Debtor committed fraud or misrepresented the intended use of the funds based on its own documentation, which specified different requirements. The Misuse of Funds Allegation was deemed insufficient to prevent the discharge of the debt under 11 U.S.C. § 523(a)(2)(B). The court determined that Itria failed to prove any claims of false pretenses, false representations, actual fraud, or fraudulent documentation related to the August FRSA. Consequently, the court granted the Debtor’s discharge, including the obligation under the August FRSA guaranty. The reference to 11 U.S.C. 101 et seq. indicates the legal framework applicable to the case, while Itria's omission of discussion regarding 727 in its post-trial statement was noted.