IN RE BEHNAM

DOROTHY EISENBERG, Bankruptcy Judge

MEMORANDUM DECISION

This matter is before the Court pursuant to an adversary proceeding filed by Shlomo Grad ("Plaintiff") against Yacov Benham ("Debtor" or "Defendant") seeking denial of Debtor's discharge and seeking to have a debt declared non-dischargeable pursuant to 11 U.S.C. § 523(a)(2)(A) and (a)(6). Based on the facts of this case and the relevant case law, the Court finds in favor of Plaintiff under 11 U.S.C. § 523(a)(2)(A) in the amount of $327,345.45 and dismisses the cause of action seeking to bar Debtor's discharge. The following constitutes the Court's findings of fact and conclusions of law pursuant to Fed.R.Bankr.P. 7052.

BACKGROUND

Benham Gem Company ("BGC") was a New York based limited liability company. BGC was engaged in the purchasing and sale of diamonds. The Defendant founded BGC with his son, Masoud Benham, in 1980. At all relevant times during 1997, Defendant participated in making the business decisions for BGC. Defendant also had check writing authority for BGC. (March 10, 2004 Trial Transcript ("March TR"), p. 26). During the time period between October 1997 and January 1998, BGC was involved in the purchasing of diamonds from 37 members of the Israeli Diamond Exchange, including Plaintiff. These purchases were all made on credit. In the aggregate, the orders placed with BGC during the period between October 1997 and January 1998 totaled approximately $6.5 million.

Although Defendant was evasive at trial regarding his role at BGC, he did refer to himself as the "owner" and the "boss" of BGC. (March TR), p. 17.

Towards the end of this same time period, BGC was experiencing financial difficulties. According to the testimony of Moshe Benham, Debtor's son, BGC normally borrowed money from various individuals who would, on a yearly basis, ask for repayment on the loans, and then immediately loan the money back to BGC. Moshe Behnham testified that the individuals who had loaned money to BGC in the past suddenly refused to continue loaning money to BGC for various reasons. (July 26, 2004 Trial Transcript ("July TR"), p. 76-77). In addition, Moshe Benham testified that "something happened" in Israel during this time period which caused parties who sold diamonds to BGC to demand the return of their diamonds. (July TR, p. 78). Debtor provided no documentary evidence to support or clarify these assertions, and the Court finds that these explanations are insufficient. In early 1998 the diamond vendors that BGC had made purchases from began to attempt to cash checks for the goods delivered in late 1997. Many, if not all of these checks, which were signed by Defendant on behalf of BGC, could not be negotiated as there were insufficient funds in BGC's bank account to cover the checks. It was BGC's practice to store all of the diamonds from all of the vendors together, and not to segregate them according to each vendor. (July TR, p. 89-90). The diamonds were commingled. As a result, vendors usually could not get back the specific diamonds they sold to BGC even if BGC still had them.

In the Spring of 1998, BGC entered into a number of settlements with the various diamond dealers from whom BGC had purchased diamonds. These settlements entailed partial payments and partial returns of like merchandise in consideration for executing general releases. Of the approximately $6.5 million of merchandise purchased by BGC between October 1997 and January 1998, approximately $787,353.87 had been returned to the suppliers.

On March 6, 1998, an involuntary petition for relief under Chapter 7 was filed against BGC in the Bankruptcy Court in the Southern District of New York. An order of relief was entered against BGC on December 30, 1998, and Albert Togut was appointed as Chapter 7 Trustee of BGC.

In the meantime, on February 19, 1998, Plaintiff commenced an action against BGC, Debtor, Masoud Benham and Moshe Benham in the Supreme Court of the State of New York, New York County (the "State Court Action"). Pursuant to the third cause of action, Plaintiff sought recovery of $183,161.28 from all of the defendants in the State Court Action, including Debtor. Pursuant to the first cause of action, Plaintiff sought recovery of $519,345.45 from all of the defendants in the State Court Action as well. None of the defendants in the State Court action filed an answer to the complaint. On or about April 27, 1998, judgment was obtained by Plaintiff against Debtor in the amount of $188,445.35 as to the third cause of action, and against BGC, Masoud Benham and Moshe Benham in the amount of $534,328.21 as to the first cause of action (the "State Court Judgment"). No appeals were taken from the State Court Judgment. Since entry of the State Court Judgment, Plaintiff has received partial distribution from the estate of BGC in the amount of approximately $192,000.

FACTS

Plaintiff was in the business of selling diamonds. Sometime in October 1997, Plaintiff was approached by Moshe and Masoud Benham (Debtor's children) about selling diamonds to BGC. Moshe and Masoud Benham represented to Plaintiff that Debtor was the head of BGC and that BGC was a capable diamond dealer. (October 21, 2003 Trial Transcript ("October TR"), p. 171). Moshe and Masoud Benham also provided Plaintiff with business references on behalf of BGC, which Plaintiff called and verified. (October TR, p. 65). The references provided positive financial and business references for the Benham family, including Debtor. Plaintiff asked for a reference from a bank regarding BGC, which was promised by Moshe and Masoud Benham. Between October 30, 1997 and December 9, 1997, Plaintiff sold and delivered to BGC a quantity of diamonds. There were two separate transactions. The first transaction occurred on October 30, 1997 at Plaintiff's office in Israel (the "First Transaction"). BGC purchased diamonds from Plaintiff for the agreed price of $183,161.25. Debtor's sons, Masoud and Moshe Benham, negotiated the first transaction with Plaintiff in Israel, and Debtor participated by telephone in New York. Debtor spoke to Plaintiff directly on the telephone, and Debtor agreed to provide a personal guarantee for the payment on the First Transaction. As a term of payment BGC was given 60 days to pay, payment due on December 30, 1997. Plaintiff was provided with an invoice signed and guaranteed by Masoud and Moshe Benham. (Plaintiff's Ex. 1). Plaintiff was also provided with a check made payable to Plaintiff, dated December 30, 1997, and signed by Debtor ("Check No. 1"). (Plaintiff's Ex. 3). Debtor orally represented to Plaintiff that Check No. 1 was good, and BGC would have sufficient funds at Chase to cover the check. (October TR, p. 94). Both parties agree that the 60 — day term is common in the diamond business, as a majority of business is done on credit. Debtor did not provide a written personal guarantee promising payment for the First Transaction on or before delivery of the diamonds to BGC, but such guarantee was promised to Plaintiff.

Although Plaintiff testified that Debtor promised to provide a personal guarantee and the Court found Plaintiff to be truthful, no such guarantee was provided prior to delivery of the diamonds. Therefore, it is clear that Plaintiff did not rely on a guarantee of BGC's obligations prior to delivering the diamonds for the First Transaction.

On December 9, 1997, Plaintiff came to New York and met with Debtor, Masoud and Moshe Benham in order to sell additional diamonds to BGC (the "Second Transaction"). Debtor left the meeting at around 7 p.m., before it was concluded. Plaintiff agreed to sell additional diamonds to BGC, provided that he was paid in full for the First Transaction by December 30, 1997. In connection with this condition, Plaintiff was given a written personal guarantee from Debtor for payment on the First Transaction, which was executed on a copy of Check No. 1 and on the invoice for the First Transaction. (Plaintiff's Exs. 1, 3). As to the Second Transaction, Plaintiff was provided an invoice for the diamonds in the amount of $336,184.20, which reflected a 1% discount. (Plaintiff's Ex. 2). The terms of payment for the Second Transaction were 1/3 in February, 1998, 1/3 in March, 1998 and 1/3 in April, 1998. Plaintiff received post-dated checks signed by Debtor on behalf of BGC reflecting these payments. (Plaintiff's Ex. 5). Debtor verbally represented to Plaintiff that the post-dated checks would be honored by Chase for the full amounts on their presentment dates. (October TR, p. 95). Debtor also verbally promised to provide Plaintiff with a written personal guarantee for payment on the Second Transaction after the meeting on December 9, 1997 had been concluded. However, Debtor never provided his personal written guarantee as promised, even after repeated telephone inquiries by Plaintiff.

Plaintiff was provided with a reference letter from Chase Manhattan Bank ("Chase Bank") dated December 22, 1997, which stated that BGC "maintained an excellent account standing" with Chase Bank and that BGC's average bank balance for the last 12 months was approximately $68,000. (Plaintiff's Ex. 4). This amount is less than half of what was owed by BGC to Plaintiff for the First Transaction.

As December 30, 1997 approached, Plaintiff was requested by Moshe and Masoud Benham to hold off on depositing Check No. 1 for the First Transaction for two weeks after the date of the check. Plaintiff refused, and the check issued by BGC to pay for the First Transaction was returned for insufficient funds. (October TR, p. 97). The first check issued for payment on the Second Transaction was not honored due to insufficient funds. (October TR, p. 97). The second check issued for payment on the Second Transaction was marked "stopped payment." Plaintiff was not able to negotiate any of the checks issued by BGC for payment on the First and Second Transaction.

The Debtor filed a petition for relief under Chapter 7 of the Bankruptcy Code on August 14, 1998. On July 12, 1999, Plaintiff filed this Complaint against Debtor. The Complaint, which is inartfully drawn, includes the following seven causes of action, all referred to as claims under 11 U.S.C. § 523:

Brian J. Oberman, Esq., filed the complaint on behalf of Plaintiff, but he withdrew as counsel and was replaced by Plaintiff's current counsel prior to the start of the trial.

1. Recovery of $519,345.45 for diamonds sold and delivered to Defendant.

2. Recovery of $183,161.25 based on Defendant's guaranty of payment by BGC in the form of check number 8055, which was refused payment by reason of insufficient funds.

3. Defendant made false representations regarding the financial condition of BGC and BGC's willingness to pay for diamonds in order to induce Plaintiff to sell diamonds on credit to BGC, in the aggregate amount of $519,345.45.

4. Within one year of the petition date, Defendant transferred and/or concealed or permitted to be transferred and/or concealed certain of his personal assets and assets of BGC, including diamonds valued at $519,345.45.

5. Between October 30, 1997 and April 1, 1999, Defendant concealed and failed to keep and/or falsified recorded information from which Defendant's financial condition or business transactions might be ascertained.

6. Defendant knowingly and fraudulently in connection with his bankruptcy case presented to this Court a false claim for Plaintiff's diamonds obtained by false pretenses, false representations and actual fraud.

7. Defendant failed to explain satisfactorily a deficiency or loss of diamonds having a value of $519,345.45 to meet his liabilities.

On August 10, 1999, Defendant filed an Answer to the Complaint, and on September 27, 1999, Defendant filed an Amended Answer, denying all allegations and asserting various affirmative defenses, including failure to state a claim against the Debtor and extinguishment of Plaintiff's claims as a result of obtaining judgment by default against the Debtor.

Prior to trial, Plaintiff withdrew claims numbered six and seven. The Court heard testimony on October 21, 2003, March 10, 2004 and July 26, 2004. Counsel to Plaintiff and Defendant filed post-trial findings of fact and conclusions of law, and the matter was marked submitted.

DISCUSSION

Plaintiff's Complaint does not refer to the specific subsections of the Bankruptcy Code upon which Plaintiff is relying. At trial, counsel to Plaintiff clarified that he was relying on 11 U.S.C. § 523(a)(2) and (a)(6), and 11 U.S.C. § 727 (a)(3) and (a)(3). In his post-trial findings of fact and conclusions of law, Plaintiff also asserted reliance on 11 U.S.C. § 727(a)(7), which permits denial of a debtor's discharge where a debtor, as an insider of another debtor entity, violates 11 U.S.C. § 727(a)(2), (3), (4), (5) or (6) within one year of the filing of the debtor's individual bankruptcy. The Court shall take the allegations set forth under 11 U.S.C. § 727 first.

a. 11 U.S.C. § 727.

Plaintiff alleges that Debtor's discharge should be denied under 11 U.S.C. § 727(a)(2) for transferring, destroying or concealing property of his estate or the estate of BGC within one year of the filing date. In order to succeed on this claim, and in all claims under sections 727 or 523, Plaintiff must establish each element by a preponderance of the evidence. In re Scarpinito, 196 B.R. 257 (Bankr E.D.N.Y. 1996). However, the testimony at trial, along with the exhibits proffered, do not support Plaintiff's claims under section 727 of the Bankruptcy Code. No evidence was introduced to support a finding that the Debtor personally destroyed or concealed any of his assets, or the assets of BGC. At trial, no mention at all was made of the disappearance of the Debtor's personal assets, and the only matter which was made clear was that diamonds held by BGC were transferred or sold by BGC and the funds received from the sale may have disappeared. However, these findings are not enough to support a finding against Debtor under section 727(a)(2) of the Bankruptcy Code. Debtor is one of the insiders of BGC because he was a person in control of BGC as required under 11 U.S.C. § 101(31), but this insider status does not mean that Debtor is presumed to have caused the loss of BGC's assets. Furthermore, no evidence was adduced that Debtor secreted or destroyed assets of BGC in order to hinder, delay or defraud its creditors. Therefore, cause of action number four shall be dismissed as Plaintiff failed to set forth a prima facie case in support of this claim.

Pursuant to the fifth cause of action, Plaintiff asserts that Debtor's discharge should be denied because he concealed, failed to keep and/or falsified recorded information from which Debtor's or BGC's financial status could be ascertained pursuant to 11 U.S.C. § 727(a)(3). Plaintiff argues in his post-trial submission that there are "virtually" no business records for BGC from October 1997 through the date of the involuntary petition, but counsel provides no evidence to support this argument. Without any evidence to consider, the Court cannot find, by a preponderance of evidence, that Debtor personally concealed or falsified financial information of BGC. The same holds true for Debtor's personal financial books and records, as these matters were not discussed on any of the trial dates. Without any testimony or evidence to support a finding under 11 U.S.C. § 727(a)(3), this cause of action fails.

b. 11 U.S.C. § 523. 1. 11 U.S.C. § 523(a)(2)(A).

Plaintiff alleges that the entire debt owed by BGC to Plaintiff in the amount of $519,345.45 is non-dischargeable pursuant to 11 U.S.C. § 523(a)(2)(A). 11 U.S.C. § 523(a)(2)(A) provides as follows:

(a) a discharge . . . does not discharge an individual debtor from any debt —

(2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained by —

(A) false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor's or an insider's financial condition.

The creditor must prove the following five elements by a preponderance of the evidence in order to preclude discharge of the debt in question: (1) the debtor made the representations; (2) at the time he knew they were false; (3) the representations were made with the intention and purpose of deceiving the creditor; (4) the creditor relied on such representations; and (5) the creditor sustained the alleged loss and damage as the proximate result of the representations having been made. In re Hanna, 197 B.R. 413, 423-24 (Bankr.E.D.N.Y. 1996), Kovitz v. Tesmetges (In re Tesmetges), 74 B.R. 911, 914 (Bankr. E.D.N.Y. 1987), aff'd, 86 B.R. 21 (E.D.N.Y.), aff'd, 862 F.2d 304 (2d Cir. 1988). Exceptions to discharge are to be literally and strictly construed against the plaintiff and liberally in favor of the debtor. Community Mutual Savings Bank v. Landrin (In re Landrin), 173 B.R. 307, 310 (Bankr. S.D.N.Y. 1994).

In this case, Plaintiff is relying on alleged false representations by Defendant that the four checks issued by BGC would be honored, which representations Plaintiff alleges were false at the time they were made. Plaintiff also alleges that he relied on these statements by Defendant prior to delivering the diamonds to BGC pursuant to the First Transaction and the Second Transaction. In addition, Plaintiff claims he relied on Defendant's personal guaranty of BGC's obligations with respect to the First Transaction, and the promise of Defendant's personal guaranty with respect to the Second Transaction. With regard to the personal guaranty provided by the Defendant, Plaintiff cannot assert he relied on it to engage in the First Transaction because he transferred the diamonds to BGC well before he obtained Defendant's personal guarantee. As to the Second Transaction, Defendant never provided a personal guaranty at all. Therefore, any cause of action under 11 U.S.C. § 523(a)(2)(A) based on the Defendant's promises to provide personal guaranties fails Plaintiff's reliance on the guaranties cannot be established by a preponderance of the evidence. Clearly, Plaintiff was willing to enter into the First and Second Transactions without Defendant's personal guarantee in hand.

Having ruled that Plaintiff cannot assert that he relied on the guaranties, the Court turns to whether Defendant's actions as an officer or insider of BGC renders him personally liable to Plaintiff in this adversary proceeding. The hurdle to overcome in this case relates to the nature of the obligation at issue. The fact is that Plaintiff contracted with BGC, not Debtor, to purchase Plaintiff's diamonds. In order to find that Debtor is liable for this debt, the Court must make a finding that Debtor controlled BGC and used that control to commit the fraudulent act against Plaintiff. See Wm. Passalacqua Builders, Inc. v. Resnick Develpers South, Inc., 933 F.2d 131, 136-40 (2d Cir. 1991) (Under New York law, an officer or shareholder in direct control of a corporation becomes personally liable for the fraudulent acts of the corporation.).

The facts of this case support a finding that Debtor controlled BGC during the relevant time period. Debtor testified at trial that he was the "boss" of BGC. Plaintiff testified that Debtor had the final authority to approve or disapprove of the First Transaction and the Second Transaction. Although Debtor's son tried to downplay this description of the Debtor's involvement with BGC, the Court finds that based on all of the evidence, including the fact that Debtor had check writing authority, Debtor controlled BGC during the relevant time period.

Having made this determination, the Court can now look to the elements of Section 523(a)(2)(A). Moshe and Masoud Benham made representations to Plaintiff that BGC was in sound financial shape at the time of the First Transaction after it took place. Debtor, on behalf of BGC, signed Check No. 1 as payment for the First Transaction. The implied representation made by Debtor was that Check No. 1 would be honored at the appropriate time, which was in the future. Debtor also signed Check Nos. 2, 3 and 4 as payment for the Second Transaction, and provided a personal guaranty for the First Transaction. The only actionable representations made by Debtor were the implied representation that all four checks would be honored and that Debtor had the financial ability to pay Plaintiff for the First Transaction in the event BGC defaulted.

Courts looking at the issue of dischargeability in the context of dishonored checks have found that a misrepresentation has been made either in the form of "false pretenses" based on the totality of the circumstances, or that based on the facts of the case, the debtor either had no intention of permitting the check to clear at the time the check was issued or had no wherewithal to make good on the check. Check Control, Inc. v. Anderson (In re Anderson), 181 B.R. 943 (Bankr D. Minn. 1995) (" Anderson"), Kline's Service Center, Inc. v. Fitzgerald (In re Fitzgerald), 109 B.R. 893 (Bankr. N.D. Ind. 1989).

Some courts hold that "false pretenses" as set forth in Section 523(a)(2)(A) contemplates:

a series of events, activities or communications which, when considered collectively, create a false and misleading set of circumstances, or false and misleading understanding of a transaction, in which a creditor is wrongfully induced by the debtor to transfer property or extend credit to the debtor. `False pretenses' may, but does not necessarily, include a written or express false representation. It can consist of silence when there is a duty to speak.

In re Dunston, 117 B.R 632, 641 (Bankr. D. Colo. 1990), aff'd in part, rev'd in part, 146 B.R 269 (D. Colo. 1992). See also In re Weinstein, 31 B.R. 804 (Bankr. E.D.N.Y. 1983) (Silence, or the concealment of a material fact, can constitute the basis of false pretenses). The pretense involved in this situation is that the bank will honor the check for the full amount when it is presented. Anderson, 181 B.R. at 951. In the case before this Court, Debtor encouraged this pretense when he authorized the issuance of Check No. 1 with his signature on it. Check No. 1 constituted an implied representation that there would be sufficient funds in BGC's account at Chase to cover the check. The pretense was false and constituted a false representation because BGC did not have sufficient funds to honor the check at the time of presentment. BGC's bank account at Chase reflected a balance of $92,846.00 as of December 22, 1997, which was eight days prior to the presentment date of December 30, 1997. In fact, the average balance for 1997 through December 22, 1997 was $67,977.00. This was woefully short of the amount set forth on Check No. 1. This evidence supports a finding that Debtor knew that Check No. 1 would not be honored at the time of presentment. In addition, BGC issued many more checks during this time period, which indicates that the issuance of Check No. 1 and the three other checks in connection with the Second Transaction were not an anomaly. When viewed in the context of BGC's business activities at the time, it becomes clear that Debtor acted fraudulently or with reckless disregard of the truth.

Debtor attempted to rebut this allegation by providing testimony from his son that BGC's sources of funding suddenly disappeared. Debtor offered no documentary evidence to support his argument, and the Court finds that Moshe Benham's testimony on this point lacks credibility. Based on the evidence before the Court, it is apparent that from October through December, 1997, BGC purchased far more diamonds than normal. BGC's own bank records indicate that BGC did not have the financial strength to pay for these diamond sales which were in the millions of dollars. Many checks issued by BGC during this time period were not honored, and customers were only partially reimbursed after BGC made partial payments thereafter. Debtor's arguments do nothing to refute the evidence before the Court.

The question of reliance is easily settled. Plaintiff took Check No. 1 along with the personal guarantees of Moshe and Masoud Benham at the time he delivered the diamonds to BGC. Clearly, Plaintiff relied on the tacit representation that the check would be honored when presented to Chase for payment. The fact that Plaintiff relied also on the personal guarantees of Moshe and Masoud does not mean that Plaintiff did so to the exclusion of receipt of Check No. 1. Reliance can be proven where the false representation was one of a number of factors a plaintiff relies on in providing goods or services. Anderson, 181 B.R. at 952. Based on testimony provided by Debtor and Plaintiff, accepting a check for payment in sixty days constituted the normal mode of business for these entities. Therefore, it was reasonable for Plaintiff to believe that Check No. 1 would be honored upon presentment on December 30, 1997.

The same analysis set forth for Check No. 1 applies to the three other checks issued by BGC for the Second Transaction in the aggregate amount of $336,184.20.

With regard to damages, Plaintiff has already been paid $192,000 from the BGC bankruptcy. Therefore, Plaintiff is entitled to damages in the amount of $327,345.45. This amount shall be excepted from Debtor's discharge based on 11 U.S.C. § 523(a)(2)(A).

2. 11 U.S.C. § 523(a)(6).

Given that the debt owed by BGC to Plaintiff is excepted from discharge under Section 523(a)(2)(A) of the Code, the Court need not consider the applicability of this section of the Bankruptcy Code to the case at hand.

CONCLUSION

1. The Court has jurisdiction over this matter pursuant to 28 U.S.C. § 1334. This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(I) and (J).

2. The Court dismisses the fourth cause of action pursuant to 11 U.S.C. § 727(a)(2)(A). Plaintiff failed to prove a prima facie case that Debtor concealed his own assets within one year of Debtor's petition date, and Plaintiff also failed to provide sufficient evidence that Debtor as an insider concealed the assets of BGC within one year of Debtor's petition date. Although assets of BGC appear to have been missing, Plaintiff introduced no evidence that Debtor caused the loss or concealment of diamonds held by BGC.

3. The Court dismisses the fifth cause of action pursuant to 11 U.S.C. § 727(a)(3). Plaintiff introduced no evidence that Debtor failed to keep or maintain his own books and records. Plaintiff also failed to introduce any evidence to support his allegation that Plaintiff failed to keep or maintain the books and records of BGC. Without establishing a prima facie case on this count, it must be dismissed.

4. The Court finds in favor of Plaintiff on the third cause of action pursuant to 11 U.S.C. § 523(a)(2)(A). Plaintiff proved a prima facie case that Debtor fraudulently induced Plaintiff into selling diamonds to BGC based in part on the issuance of checks by BGC. Debtor signed the checks and made oral representations that the checks would be honored by Chase for their full amounts. At the time these events took place, he was in control of BGC. As the party in control of BGC, he is personally liable for the fraudulent acts of BGC. As the party responsible for writing the checks, Debtor had to have known that BGC could not make good on these representations to Plaintiff. Plaintiff relied on these representations, and Debtor failed to provide sufficient evidence to overcome Plaintiff's evidence. Plaintiff suffered damages in the aggregate amount of $327,345.45, which amount is non-dischargeable under 11 U.S.C. § 523(a)(2)(A). Settle an Order in accordance with this decision.