PAVARINI MCGOVERN, LLC v. Waterscape Resort LLC et al

UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK
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In re: 	:
:
WATERSCAPE RESORT LLC, 	: 	Chapter 11
: 	Case No. 11-11593(SMB)
Debtor. 	:
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PAVARINI MCGOVERN, LLC, 	:
:
Plaintiff, 	: 	Adv. Proc. No. 11-02248
-- against -- 	:
:
WATERSCAPE RESORT LLC, et al. 	:
:
Defendants. 	:
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MEMORANDUM DECISION GRANTING IN PART AND
DENYING IN PART MOTIONS FOR LEAVE TO AMEND
A P P E A R A N C E S:
BARTON BARTON & PLOTKIN LLP
Attorneys for Plaintiff
420 Lexington Avenue
New York, NY 10170
Eric W. Sleeper, Esq.
Of Counsel
MEDINA LAW FIRM LLC
Attorneys Defendant Waterscape Resort LLC
The Chrysler Building
405 Lexington Avenue
Seventh Floor
New York, NY 10174
Eric S. Medina, Esq.
John Carlson, Esq.
Of Counsel
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LAZARUS & LAZARUS, P.C.
Attorney for Defendants Salim Assa a/k/a Solly Assa
and Ezak Assa
240 Madison Avenue, 8th Floor
New York, New York 10016
Harlan M. Lazarus, Esq.
Of Counsel
STUART M. BERNSTEIN
United States Bankruptcy Judge:
The plaintiff Pavarini McGovern, LLC (“Pavarini”) moves to amend its complaint to
assert a claim for punitive damages against the Waterscape Defendants, defined below, and a
separate claim against defendant Salim Assa (“Assa”), the debtor’s principal, for punitive
damages and other relief. The gravamen of the proposed amendments is that Assa diverted to
himself certain funds that the defendant Waterscape Resort LLC (“Waterscape”), the debtor in
this case, held in trust for Pavarini under the New York Lien Law. Waterscape opposes the
motion, and Assa joins in the opposition. The other Waterscape Defendants have remained
silent. In addition, Waterscape cross-moves to amend its answer to assert counterclaims against
Pavarini sounding in fraud and willful exaggeration of its mechanic’s lien. Assa joins in the
cross-motion and Pavarini opposes it. For the reasons that follow, Pavarini is granted leave to
amend Count II in the complaint to allege a claim for punitive damages, Waterscape is granted
leave to assert a counterclaim for fraud, and the motions are otherwise denied.
BACKGROUND
A. 	The Project
The background to this bankruptcy case is discussed at length in Pavarini McGovern,
LLC v. Waterscape Resort LLC (In re Waterscape Resort LLC), 483 B.R. 601 (Bankr. S.D.N.Y.
2012) (“Waterscape I”) and In re Waterscape Resort LLC, Case No. 11-11593, 2014 WL
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1389762 (Bankr. S.D.N.Y. Apr. 9, 2014) (“Waterscape II”). I assume familiarity with those
decisions and discuss the facts relevant to the current dispute.
Waterscape entered into a Construction Management Agreement (“CMA”) with Pavarini
pursuant to which Pavarini agreed to act as general contractor to construct a hotel and
condominium building on Waterscape’s property in Manhattan (the “Project”). Pavarini was
responsible for managing and hiring subcontractors, and was entitled to a fee of 2.75% of the
entire cost of construction exclusive of the fee itself.
The Project was funded with loans from U.S. Bank, National Association and USB
Capital Resources, Inc. f/k/a USB Capital Funding Corp. (collectively “US Bank”). Pursuant to
the loan agreements, US Bank agreed to make advances to Waterscape to fund Project costs
based on monthly Draw Requests containing copies of, among other things, invoices of the
Project contractors and vendors. The Draw Requests had to be accompanied by a Draw Request
Certification containing affirmative representations by Waterscape to US Bank that, among other
things, the funds being drawn would be applied to fund the Project as specified in the requisition.
Once approved, US Bank transferred the funds to Waterscape.
Disputes between Waterscape and Pavarini arose, and Waterscape unilaterally terminated
the CMA in September 2010. Pavarini filed a mechanic’s lien on December 17, 2010 in the
amount of $10,674,440.59. (See Claim no. 38–1, dated June 8, 2011, Ex. C at ¶ 8.) A later proof
of claim revealed that Pavarini’s secured claim consisted of two components: (a) $8,581,289 that
it owed its subcontractors, (Claim no. 38–3, dated July 22, 2011, at 5, and (b) $2,251,783.59 that
Pavarini contended Waterscape owed it under the CMA. (See Claim no. 38–3, dated July 22,
2011, at 5.) The subcontractors hired by Pavarini also filed mechanics’ liens against the Property
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for their unpaid work, and these liens, for the most part, duplicated the portion of the Pavarini
mechanic’s lien that included their unpaid claims.
B. 	The Bankruptcy Case
1. 	The Plan
Waterscape commenced this chapter 11 case on April 5, 2011, and filed its initial plan
and disclosure statement one month later. The plan proposed to sell the hotel portion of the
Project free of liens, claims and interests, and pay all of the proceeds to US Bank. Pavarini
objected complaining, inter alia, that hotel sale proceeds constituted trust funds under the New
York Lien Law, and the plan proposed to divert these trust funds (as well as future condominium
sale proceeds) to US Bank.
After numerous proceedings and significant plan amendments, Waterscape confirmed its
Second Amended Plan of Reorganization (“Plan”) on July 21, 2011. (See Order Approving
Disclosure Statement and Confirming Plan of Reorganization, dated July 21, 2011
(“Confirmation Order”) (ECF/Main Case Doc. # 128).) 1 The Plan represented the product of
substantial negotiation and comment from Pavarini, US Bank and the Court. It still
contemplated the sale of the hotel portion of the Project free and clear of all liens, claims and
interests. (See Confirmation Order at ¶ 18.) However, the Plan carved out $11 million from the
hotel sale proceeds and used the carve out to fund a Trust Fund Account for the benefit of the
overlapping Class 3 Lien Law/trust fund claimants. (Plan at §§ 4.1(b), 5.3.) 2 The $11 million
number was not random; it was selected because it rounded up Pavarini's approximate $10.8
1 	“ECF/Main Case” refers to the docket in the bankruptcy case, and “ECF” refers to the docket in this
adversary proceeding.
2 	A copy of the Plan is annexed to the Confirmation Order.
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million claim. All Class 3 claims were deemed disputed, (Plan at § 4.3(b)), and the Class 3
claimants would continue to litigate their rights primarily in non-bankruptcy fora. (Id. at §
5.6(c).) Once a Class 3 Claim was finally resolved, the claim would be allowed and paid from
the Trust Fund Account, the Secured Claim Reserve Account, new financing, or general funds of
the Debtor. (Id. at § 4.3(c).)3
The Plan also contained various releases and injunctions. To the extent relevant and with
certain exceptions that no party has invoked, the Plan enjoined the commencement or
continuation of any action against Waterscape to recover any claim that arose before the
confirmation date regardless of whether a proof of claim was filed. (Plan at § 7.1.) The releases
and injunctions were subject to several exceptions, including the following:
7.9 	Release Clarification. No provision in this Plan, including sections 7.1,
7.2 and 7.6 hereof, shall release, waive, enjoin, or limit the liability of the Debtor
or the Released Parties with respect to any Claim, cause of action or other
proceeding of any kind and in whatever forum, brought or asserted by or on
behalf of any of the Claimants classified in Class 3 of the Plan, including Pavarini
and Civetta, and all said Claimants’ Claims, rights, interests, and defenses are
hereby, and within the Plan and its provisions, preserved.
The Confirmation Order, at ¶ 15, repeated the exception contained in § 7.9 of the Plan.
The Plan became effective on January 20, 2012, when the parties closed on the sale of
hotel. (See Debtor’s Second Post-Confirmation Report and Notice of Effective Date of the
Debtor’s Confirmed Second Amended Plan of Reorganization, dated Jan. 20, 2012, at ¶ 3
(ECF/Main Case Doc. #306).)
3 	An additional $3 million was carved out of the hotel sale proceeds to fund the Class 5 Reserve Account for
the benefit of the unsecured creditors. (Plan at § 4.1(b).)
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2. 	The Adversary Proceeding
On June 10, 2011, Pavarini commenced this adversary proceeding. (See Complaint,
dated June 10, 2011 (ECF Doc. #1).) The Complaint included seven counts, but the last four
were directed at US Bank and have been dismissed by stipulation. The three remaining counts
asserted against Waterscape and the “Waterscape Defendants”4 centered on the allegations that
they had violated Article 3-A of the New York Lien Law by diverting funds that Waterscape was
required to hold in trust for the benefit of Pavarini and the subcontractors. 	(See Complaint at ¶¶
2, 11, 20(d), 34, 36, 37, 38, 60, 68, 69, 74, 76, 78, 80, 82, 84.) Although the Complaint focused
on diversions to US Bank and the John Doe defendants, it also alleged that the “Debtor and/or
the Waterscape Defendants divided among themselves or otherwise diverted” the trust funds.
(Id. at ¶ 76 (emphasis added).) Count I sought a declaration that the estate held only bare legal
title to any and all trust funds, including the Trust Assets,5 and had no equitable interest in those
funds until the claims of Pavarini and the subcontractors were fully satisfied. (Id. at ¶ 63.)
Count II alleged that Waterscape “should be compelled to identify all trust funds that were
diverted and/or distributed by them, and all such trust funds should be recovered and returned to
the benefit of Pavarini and the Trade Contractors, as the trust beneficiaries.” (Id. at ¶ 80.) Count
III demanded an accounting of all trust funds. (Id. at ¶ 84.)
Pavarini eventually moved for partial summary judgment on Counts I and II. It
contended that Waterscape had diverted approximately $14.5 million received from the proceeds
4 	The Complaint defined the “Waterscape Defendants” to include the Debtor, 45 Inmex Corp., Catmex 45,
Corporation, Gemstone 45 LLC, Salim Assa a/k/a Solly Assa, Ezak Assa, Elias Hanono, Jacobo Hanono, Simon
Masri, Salomon Masri and Ezra Tawil. (Complaint at ¶ 8.)
5 	“Trust Assets” meant “the proceeds generated from the Debtor’s proposed sale of condominium units of the
Project pursuant to this Court’s Order entered on May 31, 2011, and the Debtor’s proposed sale of the hotel portion
of the Project, i.e., the Hotel Assets, pursuant to the Debtor’s pending Plan of Reorganization filed on May 6, 2011.”
(Complaint at ¶ 46.)
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of the sale of condominium units, and paid the proceeds to US Bank. Pavarini also maintained
that Waterscape had diverted $4,458,616.97 from requisitions funded by US Bank. Waterscape I
referred to the latter sum as the “Shortfall.” Waterscape I, 483 B.R. at 606.
The Court granted partial summary judgment to the extent of concluding that the
condominium proceeds were trust funds, and Waterscape had diverted the trust funds by paying
them to US Bank. Id. at 613. The Court declined, however, to award any monetary relief
because Waterscape and US Bank had restored $11 million by funding the Trust Fund Account
under the Plan. Id. at 616. The Court denied the motion for partial summary judgment with
respect to the Shortfall because Waterscape had failed to demonstrate as a matter of law that a
diversion had occurred. Id. at 612-13.
C. 	The Final Accounting
The CMA included an alternate dispute resolution procedure to resolve contract-related
claims before a Dispute Resolution Board (“DRB”). After years of litigation between
Waterscape and Pavarini, the DRB rendered its Final Accounting on March 11, 2014, in which it
concluded that Waterscape owed Pavarini $8,093,655.92 under the CMA. Pavarini moved to
compel Waterscape to pay this sum, plus interest, in accordance with the provisions of the Plan
and prior to judicial review. The Court granted the motion, Waterscape II, 2014 WL 1389762, at
*6, and Waterscape subsequently paid Pavarini. As matters stand, and subject to the possibility
of further proceedings following judicial review of the DRB determinations, Waterscape has
fully satisfied its contract debt to Pavarini.
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D. 	The Motion and Cross-Motion
One day after the DRB rendered its Final Accounting, Pavarini moved to amend its
complaint to assert two additional claims relating to the diversion of trust funds. The proposed
amended complaint (the “PAC”) alleges that Waterscape and/or Assa “intentionally and
maliciously” diverted trust funds drawn from US Bank to Assa’s other businesses, including 511
9th LLC, Assa Realty LLC, 940 8th Ave LLC, Denver West LLC, Donna Loren LLC, Sheermax
LLC, Assa Hospitality Management LLC, Cassa 28, Cassa NYC, and Ayalon SA. (PAC at ¶¶
41, 78-80.)6 It identifies four instances between December 29, 2008 and July 1, 2010 involving
diversions totaling $8.3 million to Assa, and alleges upon information and belief, that
Waterscape and/or Assa intended to deprive Pavarini as beneficiary of the diverted funds. (PAC
at ¶¶ 42-43.) Based on these allegations, Pavarini proposes to add a claim for punitive damages
against the Waterscape Defendants to Count II and a new Count VIII7 through which it seeks to
compel Assa (1) to identify all trust funds that he diverted, (2) repay the diverted funds to
Pavarini and the Trade Contractors, and (3) pay punitive damages.
In its moving memorandum, (see Memorandum of Law in Support of Motion for Leave to
Amend Complaint to Add a Demand for Punitive Damages, dated Mar. 12, 2014 (ECF Doc.
#150)), Pavarini contended that the information regarding the specific diversions came to light
either during discovery or as a result of the DRB’s Final Accounting, (id. at 3-6), the Waterscape
Defendants would not suffer prejudice and Pavarini did not unduly delay in proposing the
6 	The parenthetical “PAC at ¶ _” refers to the paragraphs in the proposed amended complaint, dated Mar. 12,
2014, a copy of which is annexed as Exhibit 1 to the Declaration of Eric Sleeper, Esq. in Support of Pavarini
McGovern, LLC’s Motion for Leave to Amend Complaint to Add a Demand for Punitive Damages, dated Mar. 12,
2014 (ECF Doc. # 151).
7 	The PAC reasserted Counts IV through VII in the original complaint. Those Counts had been directed
against US Bank but were subsequently dismissed. Pavarini confirmed that it was a mistake to reassert these Counts
in the PAC.
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amendment. (Id. at 7-10.) In addition, Count VIII arose out of the conduct and transactions
alleged in the Complaint, and consequently, related back. (Id. at 11.)
Waterscape opposed Pavarini’s motion to amend and cross moved to add two
counterclaims. 8 (See Waterscape Resort LLC’s: (I) Opposition to the Motion of Pavarini
McGovern, LLC to Amend its Complaint to Assert Punitive Damages; and (II) Cross-Motion in
Support of Motion to Amend Answer to Assert Counterclaim Against Pavarini McGovern, LLC
for Willful Overstatement of Lien Pursuant to N.Y. Lien Law § 39, dated Mar. 27, 2014
(“Waterscape Opposition”) (ECF Doc. #161-1).) Waterscape argued that Pavarini had unduly
delayed in seeking to amend its complaint to assert a punitive damage claim, (id. at ¶ 17),
Waterscape would suffer prejudice because the Court had already decided the scope of Pavarini's
damages resulting from the diversion of funds in Waterscape I, (id. at ¶ 18), punitive damages
are reserved for “exceptional cases,” and the mere diversion of funds did not approach the
"outrageous" level of conduct required to impose punitive damages. (Id. at ¶ ¶ 21, 24.)
Waterscape also contended that the allegations in the PAC regarding intent and malice were
conclusory, (id. at ¶ 23), and the doctrine of law of the case barred Pavarini’s claim for punitive
damages because the Court ruled in Waterscape I that Waterscape had established the defense of
restoration. Waterscape argued that this ruling negated the contention that Waterscape had
intended to permanently deprive Pavarini of the funds. (Id.)
As noted, Waterscape sought leave to interpose two counterclaims. Count I charged that
Pavarini filed an exaggerated notice of lien. (Counterclaim at ¶¶ 4-8, 37-39.) Count II asserted a
8 	A black-lined copy of Waterscape’s proposed Answer to Complaint with Counterclaims (“Counterclaims”)
is annexed as Exhibit A to the Affirmation of Eric S. Medina, dated Mar. 27, 2014 (ECF Doc. # 161-2).) The portion
of the answer responding to the allegations in the Complaint ends at paragraph 122 on page 14 of Exhibit A, and the
counterclaims follow thereafter. All citations to the Counterclaim refer to paragraphs in the counterclaim portion of
the answer. For example, “Counterclaim at¶ 4” refers to paragraph 4 on page 15 of Exhibit A.
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fraud claim primarily alleging that Pavarini charged Waterscape $200,000 for subguard
insurance that it never procured. (Id. at ¶¶ 9-35, 40-41.) Pavarini opposed the cross-motion,
contending that the proposed counterclaims were futile. The willful exaggeration claim fell
because the adversary proceeding did not involve an effort by Pavarini to foreclose a mechanic’s
lien, (Reply Memorandum of Law in Further Support of Pavarini McGovern, LLC’s Motion for
Leave to Amend Its Complaint and in Opposition to Waterscape Resort LLC’s Cross Motion for
Leave to Amend Its Answer, dated Apr. 2, 2014 (“Pavarini Reply”), at 6-7 (ECF Doc. # 164)),
and the fraud claim relating to subguard insurance was barred by prior decisions of the DRB and
the state court. (Id. at 7-8.)
During oral argument of the motion and cross-motion, the Court raised the possibility that
the confirmation of the Plan discharged the claim for punitive damages, and offered the parties
an additional opportunity to brief the issue. Waterscape belatedly submitted a supplemental
memorandum, (see Waterscape Resort LLC’s Supplement in Further Opposition to Pavarini
McGovern LLC’s Motion to Amend the Complaint to Assert Claims for Punitive Damages, dated
Aug. 14, 2014 (ECF Doc. # 185-1)), in which it argued that the claim for punitive damages arose
prior to the petition date, the heavily negotiated plan dealt with Pavarini’s prepetition claims, and
the punitive damage claim was barred by the discharge and injunction provisions in the Plan.
(Id. at ¶¶ 15-17) (citing Olin Corp. v. Riverwood Int’l Corp. (In re Manville Forest Prods.
Corp.), 209 F.3d 129 (2d. Cir. 2000)). Waterscape also contended that the payment of Pavarini’s
claim coupled with the release contained in the Plan, which did not exclude the punitive damage
claim, rendered the claim moot. (Id. at ¶¶ 18-19.) Pavarini responded that the Manville case
cited by Waterscape was distinguishable, it could amend the Complaint to assert a punitive
damage claim because the claim related back to the diversion claim asserted in the original
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complaint (citing In re Ben Franklin Hotel Associates, 186 F.3d 301 (3d Cir. 1999)), and the Plan
did not restrict the distribution to the Class 3 creditors to the $11 million Trust Fund Account.
(Pavarini McGovern, LLC's Response to Waterscape Resort LLC's Supplement in Further
Opposition to Pavarini McGovern, LLC's Motion to Amend the Complaint to Assert Demand for
Punitive Damages, dated Aug. 20, 2014, at ¶¶ 5-7, 9 (ECF Doc. 186-1).)
Concluding that the first round of supplemental briefing did not adequately answer the
question, the Court ordered a second round of briefing centered on two issues. (See Order
Directing Further Supplemental Briefing, dated Sept. 12, 2014 (ECF Doc. # 190).) First, did the
Plan discharge Pavarini’s punitive damage claim as against Waterscape and bar Pavarini from
now asserting it under Farber v. Wards Co., Inc., 825 F.2d 684 (2d Cir. 1987)? Second, if the
claim was not discharged, “what is the appropriate test for determining whether to grant leave to
amend a claim after confirmation?” (Emphasis in original.)
Waterscape responded, (see Waterscape Resort LLC’s Supplemental Briefing Pursuant to
September 12, 2014 Order, dated Sept. 29, 2014 (ECF Doc. # 191)), that the punitive damage
claim was discharged and therefore barred under Farber. It further argued that even if it was not
discharged, the Court should not permit the post-confirmation amendment because Pavarini
failed to show a “compelling reason.” See In re Winn-Dixie Stores, Inc., 639 F.3d 1053, 1056
(11th Cir. 2011); Holstein v. Brill, 987 F.2d 1268, 1270 (7th Cir. 1993); Allstate Insurance Co. v.
Credit Suisse Securities (USA) LLC, Case No. 11-cv-2232, 2011 WL 4965150, at *6 n.7
(S.D.N.Y. Oct. 19, 2011).
In reply, (see Pavarini McGovern, LLC’s Response to Waterscape Resort LLC’s
Supplemental Briefing Pursuant to September 12, 2014 Order, dated Oct. 17, 2014 (ECF Doc.
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#192)), Pavarini asserted that the confirmation did not discharge the punitive damage claim,
directing the Court’s attention for the first time to the exception to the discharge of Class 3
claims contained in the Confirmation Order. As to the second question, Pavarini ignored the
case law cited by Waterscape, and argued for the more liberal test under In re Ben Franklin
Hotel Associates, 186 F.3d 301 (3d Cir. 1999).9
DISCUSSION
A. 	Discharge
With exceptions that are not relevant, Bankruptcy Code § 1141(d)(1)(A)10 discharges the
debtor from any debts that arose prior to confirmation unless the plan or confirmation order
provide otherwise. Although it required two rounds of briefing, it is now clear that the Plan and
Confirmation Order excepted the claims of the Class 3 claimants, including Pavarini, from the
discharge, release and injunction provisions of the Plan. (Plan at § 7.9; Confirmation Order at ¶
15.) Pavarini’s claims were not discharged, and I turn to the question of whether the proposed
amendment should be permitted.
9 	Pavarini subsequently filed an unauthorized supplemental declaration attaching an unsworn memorandum
from a state court proceeding involving allegations that Assa had diverted trust funds from another project. (See
ECF Doc. #193.) The submission was unauthorized and irrelevant, and the facts presented in it were hearsay. The
Court has not considered the submission.
10 	Bankruptcy Code § 1141(d)(1)(A) provides:
(1) Except as otherwise provided in this subsection, in the plan, or in the order confirming the
plan, the confirmation of a plan-
(A) discharges the debtor from any debt that arose before the date of such confirmation,
and any debt of a kind specified in section 502(g), 502(h), or 502(i) of this title, whether or not-
(i) a proof of the claim based on such debt is filed or deemed filed under section
501 of this title;
(ii) such claim is allowed under section 502 of this title; or
(iii) the holder of such claim has accepted the plan . . . .
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B. 	The Proposed Amendment
1. 	Introduction
The Complaint, inter alia, asserted that Waterscape had diverted trust funds aggregating
$4,457,983.07 by failing to pay over to Pavarini the work requisitions funded by US Bank and
owed to Pavarini based upon the work provided under the CMA. (See ¶¶ 36-41.) The Complaint
also alleged that Waterscape had diverted trust funds by paying the proceeds of condominium
sales to US Bank. (See ¶¶ 42-49.) In Count II, the Complaint demanded that the diverted trust
funds “should be recovered and returned to the benefit of Pavarini and the Trade Contractors, as the
trust beneficiaries.” (¶ 80.)
The filing of a timely proof of claim is the proper procedure to assert a right to a
distribution from a chapter 11 estate. See FED. R. BANKR. P. 3003(c)(2) (stating that a creditor
who fails to file a timely proof of claim “shall not be treated as a creditor with respect to such
claim for the purposes of voting or distribution”). Pavarini’s proof of secured claim sought the
unpaid amounts due under the CMA, but did not attach the Complaint or assert the specific
claims alleged in the Complaint. Nevertheless, the proof of claim arguably subsumed the claim
for recovery of the diverted trust funds to the extent the unpaid amounts formed part of its claim,
but even if it did not, Waterscape has never objected to the assertion of the diversion claim in the
Complaint rather than in a proof of claim. Moreover, the Complaint may be treated as an
informal proof of claim to the extent that the diversion claim asserts a “right to payment” under
11 U.S.C. § 101(5)(A).11
11 	A Court may treat a request for monetary relief asserted in a complaint as an informal proof of claim where
the complaint (1) is timely filed and becomes part of the judicial record, (2) states the nature, existence and amount
of the debt, and (3) evidences the creditor’s intent to hold the estate liable. See Wilson v. Residential Capital, LLC
(In re Residential Capital, LLC), Adv. P. No. 12-01936, 2014 WL 3057111, at *7 (Bankr. S.D.N.Y. July 7, 2014).
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The Complaint did not, however, assert a claim for punitive damages, and the deadline
for filing claims expired on June 10, 2011. (Order Establishing Deadline for Filing Proofs of
Claim and Approving the Form and Manner of Notice Thereof, dated May 4, 2011 (ECF/Main
Case Doc. #41).) Pavarini’s current motion seeks leave to amend the Complaint, inter alia, to
now assert the punitive damages claim, but for the reasons stated, it should be viewed as a
motion for leave to amend a proof of claim after the bar date. The decision to permit a post-bar
date amendment to a proof of claim is within the discretion of the bankruptcy court. In re
Integrated Resources, Inc., 157 B.R. 66, 69-70 (S.D.N.Y. 1993). Amendments should be freely
allowed, but post-bar date amendments are subject to “careful scrutiny to assure that there was
no attempt to file a new claim under the guise of an amendment.” Midland Cogeneration
Venture L.P. v. Enron Corp. (In re Enron Corp.), 419 F.3d 115, 133 (2d Cir. 2005) (quoting
Integrated Resources, 157 B.R. at 70). Courts generally engage in a two-step inquiry when
considering the allowance of late amendments. First, the amended claim must “relate back” to a
timely filed proof of claim. An amendment relates back to an original claim if it cures a defect
of form in the original claim, describes the original claim with greater particularity, or pleads a
new theory of recovery on the facts set forth in the original claim. Enron, 419 F.3d at 133.
Second, courts will consider the facts of the case and determine whether it would be equitable to
allow the amendment. Id. Belated amendments to timely claims will be freely allowed in the
absence of prejudice to the other parties. Id. at 133-34.
Leave to amend may be less appropriate after confirmation. Holstein v. Brill, 987 F.2d
1268, 1270 (7th Cir. 1993). With certain exceptions, confirmation discharges all pre-
confirmation debts other than those provided for in the plan. 11 U.S.C. § 1141(d)(1)(A) and
Bankruptcy Code § 524(a)(2) operates as an injunction against the collection of a discharged
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debt. “[E]ach claimant gets a ‘new’ claim, based upon whatever treatment is accorded to it in the
plan itself.” Holstein, 987 F.2d at 1270 (quoting In re Benjamin Coal Co., 978 F.2d 823, 827 (3d
Cir. 1992). In the Second Circuit, the bankruptcy court has no authority to permit an amendment
to assert a discharged claim even if the proposed amendment relates back to a timely claim.
Farber v. Wards Co., 825 F.2d 684, 689 (2d Cir. 1987). Even in those circuits where post-
confirmation amendments are not foreclosed as a matter of law, the creditor must demonstrate a
“compelling reason” to amend the claim given the discharge, the res judicata effect of the plan,
the disruption to the orderly process of adjudication and the interests of finality. IRT Partners,
L.P. v. Winn-Dixie Stores, Inc. (In re Winn-Dixie Stores, Inc.), 639 F.3d 1053, 1056-57 (11th Cir.
2011); Holstein, 987 F.2d at 1270-71; but cf. In re Ben Franklin Hotel Associates, 186 F.3d 301,
309 (3d Cir. 1999) (affirming bankruptcy court’s application of relation back test to post-
confirmation amendment).
Here, the rationale for requiring Pavarini to show “compelling circumstances” is missing.
The Plan did not discharge Pavarini’s claims, and distribution on its allowed claim was not
limited to the Trust Fund Account. In fact, the Court has been advised that the Trust Fund
Account was insufficient to discharge Pavarini’s allowed claim liquidated through the Final
Accounting, and Waterscape had to use additional funds. Nor will the amendment disrupt the
claims resolution process; the only claim left to resolve in this Court is Pavarini’s punitive
damage claim. In short, the confirmation of the Plan lacked the finality that the “compelling
circumstances” test is designed to foster.
Most important, Waterscape has never contended that the assertion of the punitive
damage claim will disrupt the Plan or threaten its ultimate consummation. The only prejudice
that Waterscape has asserted is based on its belief that the Court had already decided the scope of
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Pavarini’s damages on the diversion theory when it ruled “that diversion did occur but
Waterscape had restored the funds, absolving it of further liability.” (Waterscape Opposition at ¶
18.)
Waterscape is mistaken. The Court granted partial summary judgment to Pavarini
concluding that Waterscape had diverted nearly $14.5 million of condominium sales proceeds,
Waterscape I, 483 B.R. at 613, but had restored $11 million of the diverted funds by establishing
the Trust Fund Account, id. at 616, and it was premature to conclude that Waterscape should be
required to restore any more funds especially in light of the other security available to the Class 3
claimants. Id. at 616-17. The Court denied summary judgment with respect to Pavarini’s
distinct claim that the Waterscape Defendants had diverted $4.46 million of trust funds
requisitioned from US Bank primarily because Pavarini conceded for the purpose of its motion
that Waterscape’s trust fund expenditures exceeded its trust fund receipts. Id. at 612-13. The
Court did not rule on the amount of that claim. Accordingly, Pavarini’s motion must be judged
under the two-step analysis discussed in Enron.
2. 	Proposed Count II
Although the Complaint focused on two types of diversion ‒ the payments to US Bank
and the Shortfall ‒ Count II of the Complaint alleged more broadly that the Waterscape
Defendants “ divided among themselves or otherwise diverted” trust funds. (Complaint at ¶ 76.)
Through discovery, Pavarini has identified with greater specificity the diversion claim alleged in the
Complaint. The claim for punitive damages pleads a new theory of recovery arising from the
same facts asserted in the Complaint, and therefore, relates back. Ben Franklin Hotel, 186 F.3d
at 309 (punitive damage claim related back to timely claims).
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Furthermore, equitable considerations weigh in favor of granting leave to amend.
Multiple factors play a role in this analysis, including whether the debtor, or other
creditors, would be unduly prejudiced by the amendment, or whether, instead,
other creditors would “receive a windfall” from the disallowance of the
amendment, and whether the late claimant acted in good faith and the delay was
justified. [Citation omitted.] Of these, however, “[t]he critical consideration is
whether the opposing party will be unduly prejudiced by the amendment.”
Enron, 419 F.3d at 133 (quoting In re Integrated Resources, 157 B.R. at 70).
As just discussed, Waterscape has not identified any prejudice to itself or the Class 3
creditors if Pavarini is permitted to assert a claim for punitive damages. Furthermore, Pavarini
has acted in good faith and not unduly delayed in asserting its proposed amendment. Although
Pavarini raised diversion claims at the outset of the adversary proceeding, it only learned through
discovery that Assa diverted millions of requisitioned funds to himself while Pavarini remained
unpaid. Accordingly, equitable considerations support Pavarini’s request.
Waterscape also contends that leave to amend should be denied because the amendment
would be futile. A court may deny leave to amend as futile where the proposed amended claim
would not withstand a motion to dismiss under Federal Civil Rule 12(b)(6). Krys v. Pigott, 749
F.3d 117, 134 (2d Cir. 2014); Ricciuti v. New York City Transit Auth., 941 F.2d 119, 123 (2d Cir.
1991). While not every diversion of trust funds will support a punitive damage award, see ARA
Plumbing & Heating Corp. v. Abcon Assocs., Inc., 843 N.Y.S.2d 154, 154-55 (N.Y. App. Div.
2007), the allegations that trust funds were diverted to the owner’s principals while the claims of
contractors, subcontractors and suppliers remained unsatisfied meets the high threshold of moral
culpability to support an award of punitive damages. Sabol & Rice, Inc. v. Poughkeepsie
Galleria Co., 572 N.Y.S.2d 811, 813 (N.Y. App. Div. 1991); see Pinnacle Environmental Sys.,
Inc. v. R.W. Granger & Sons, Inc., 665 N.Y.S.2d 473, 475 (N.Y. App. Div. 1997). The PAC
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alleges that Assa diverted trust funds drawn from US Bank to fund shortfalls in his other
businesses at a time when the claims of Pavarini and the subcontractors remained unpaid. (PAC
at ¶¶ 41-42, 78-80.) These allegations assert a plausible claim for punitive damages.12
The Court notes that the same conclusion would flow from the application of the general
rules that govern the amendment of pleadings under Rule 15(a) of the Federal Rules of Civil
Procedure. Generally, leave should be freely granted, but the court may deny the motion in
instances of undue delay, bad faith, dilatory motive, undue prejudice to the opposing party or
futility. Foman v. Davis, 371 U.S. 178, 182 (1962). Legal prejudice involves consideration,
inter alia, of whether the new claim would require the opposing party to expend significant
additional resources to conduct discovery or prepare for trial and whether the amendment would
significantly delay the resolution of the case. Block v. First Blood Assocs., 988 F.2d 344, 350
(2d Cir. 1993). For the reasons stated, the amendment was not interposed with undue delay or in
bad faith, Waterscape has not identified any legal prejudice and the amendment is not futile.
The motion for leave to assert Count II is, therefore, granted.
3. 	Proposed Count VIII
Proposed Count VIII alleges that Assa exercised dominion and control over the trust
assets, “intentionally and maliciously” used the funds drawn from US Bank to pay himself
millions of dollars without satisfying Pavarini’s trust claims, and upon information and belief,
intended to deprive Pavarini permanently of these assets. (PAC at ¶¶ 117-19.) As a
12 	Waterscape contends that the restoration of funds under the Plan “negates any contention that Waterscape
intended to permanently deprive [Pavarini] of its funds.” (Waterscape Opposition at ¶ 23.) The relevant time to
determine Assa’s intent is when the diversion occurred. The restoration of the trust funds occurred after the alleged
acts of diversion and were not contemplated by Waterscape in its initial plan. Waterscape (and US Bank) agreed to
establish the Trust Fund Account as a compromise to settle Pavarini’s objection to the original plan.
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consequence, Assa should be compelled to identify all such diverted trust assets, all such funds
should be recovered and returned to the benefit of Pavarini and the subcontractors and Assa
should pay Pavarini punitive damages. (PAC at ¶¶ 120-21.)
This claim duplicates proposed Count II, which already alleges the Waterscape
Defendants, including Assa, diverted funds and seeks punitive damages. (PAC at ¶¶ 78-80, 87.)
Moreover, the Complaint already seeks to compel the Waterscape Defendants, including Assa, to
identify all trust funds that were diverted or distributed to them and recover and return the
diverted funds to the benefit of Pavarini and the Trade Contractors. (Complaint at ¶ 80.)
Accordingly, the motion for leave to assert Count VIII is denied.
C. 	The Cross-Motion to Amend to Add Counterclaims
Waterscape is not seeking to amend a proof of claim, and the usual rules governing leave
to amend, discussed supra, apply to the cross-motion. Pavarini’s opposition to the cross-motion
is limited to the argument that the amendment is futile.13
1. 	Count I – Willful Exaggeration of Lien
Waterscape seeks to add a counterclaim for willful exaggeration of a mechanic’s lien
relying on New York Lien Law § 39. Section 39 states:
In any action or proceeding to enforce a mechanic’s lien upon a private or
public improvement or in which the validity of the lien is an issue, if the court
shall find that a lienor has wilfully exaggerated the amount for which he claims a
lien as stated in his notice of lien, his lien shall be declared to be void and no
recovery shall be had thereon. No such lienor shall have a right to file any other
or further lien for the same claim. A second or subsequent lien filed in
13 	Neither side discussed the possibility that the cross-motion would be rendered moot if I granted Pavarini’s
motion for leave to amend. Waterscape would then have the opportunity to file an answer to the amended complaint
that could include the counterclaims identified in its cross-motion. Since neither side discussed the issue, I will
decide the cross-motion independent of the disposition of Pavarini’s motion.
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contravention of this section may be vacated upon application to the court on two
days' notice.
N.Y. LIEN LAW § 39 (McKinney 2014).
I agree that the claim is futile. The Complaint did not assert a claim to foreclose a
mechanic’s lien. In fact, Pavarini’s mechanic’s lien was discharged under the Plan when the
Trust Fund Account was funded. (Plan at § 5.3.) Consequently, the cross-motion for leave to
amend to add this counterclaim is denied.
2. 	Count II – Fraud
Count II mainly concerns Pavarini’s failure to procure subguard insurance. Subguard
insurance pays for the costs of subcontractor defaults by enabling the prime contractor to
terminate a defaulting subcontractor and recover the costs of the default through insurance.
(Counterclaim at ¶ 10.) The Counterclaim alleges upon information and belief that “Pavarini
falsely or fraudulently took $200,000 in trust funds” to pay insurance premiums to cover 160
Broadway Concrete Corp. (“Broadway Concrete”), a major subcontractor, but did not obtain the
required subguard insurance. (Counterclaim at ¶¶ 9, 11-13.) Toward that end, Pavarini
submitted inaccurate and untruthful Applications for Payment to Waterscape between September
2007 and June 2009 in which it sought reimbursement for subguard premiums it never paid.14
(Counterclaim at ¶¶ 18, 22-24.) Waterscape alleges upon information and belief that Pavarini
refused to place Broadway Concrete in default although it was responsible for 140 days of delay
because its default was not insured. (Counterclaim at ¶¶ 14, 15, 29.)
14 	Waterscape alleges that Pavarini’s project executive represented in a March 27, 2014 e-mail that it had
subguard insurance that covered Broadway Concrete. (Counterclaim at ¶ 24.) The email could not have induced
Waterscape to pay premiums between 2007 and 2009.
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The Counterclaim includes additional allegations that purport to sound in fraud.
Waterscape asserts that Pavarini failed to disclose the terms of the Broadway Concrete Trade
Contract (and obtain Waterscape’s approval), (Counterclaim at ¶¶ 16, 20), and that Broadway
Concrete lacked adequate financial resources and bondability, was not included in Pavarini’s
subguard program, and had not provided payment and performance bonds. (Counterclaim at ¶¶
17, 21.) Waterscape claims that Pavarini failed to bill Waterscape for and collect from
Waterscape only actual costs of work and the agreed fee. (Counterclaim at ¶ 19.) Finally,
Waterscape avers that Pavarini misrepresented the levels of completion by the subcontractors in
its Application for Payments and that Waterscape paid for incomplete and defective work in
reliance on those misrepresentations. (Counterclaim at ¶¶ 30-34.) Nevertheless, its fraud claim
appears to be limited to the subguard insurance that Pavarini billed but never procured or
intended to procure, the resulting cover up and the adverse effects that these actions had on the
Project. (Counterclaim at ¶ 41.)
As noted, Pavarini argues that the fraud claim is barred by prior decisions of the state
court and the DRB. In determining the legal sufficiency of a claim, “courts must consider the
complaint in its entirety, as well as other sources courts ordinarily examine when ruling on Rule
12(b)(6) motions to dismiss, in particular, documents incorporated into the complaint by
reference, and matters of which a court may take judicial notice.” Tellabs, Inc. v. Makor Issues
& Rights, Ltd., 551 U.S. 308, 322 (2007). The court may also consider documents that the party
relied on in bringing suit and that are either in the party’s possession or that the party knew of
when bringing suit. Chambers v. Time Warner, Inc., 282 F.3d 147, 153 (2d Cir. 2002); Brass v.
Am. Film Techs., Inc., 987 F.2d 142, 150 (2d Cir. 1993); Cortec Indus., Inc. v. Sum Holding L.P.,
949 F.2d 42, 47-48 (2d Cir. 1991), cert. denied, 503 U.S. 960 (1992); McKevitt v. Mueller, 689
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F. Supp. 2d 661, 665 (S.D.N.Y. 2010). Where the complaint cites or quotes from excerpts of a
document, the court may consider other parts of the same document submitted by the parties on a
motion to dismiss. 131 Main St. Assocs. v. Manko, 897 F. Supp. 1507, 1532 n.23 (S.D.N.Y.
2010).
Pavarini’s opposition goes well beyond the four corners of the record, and cites evidence
that Waterscape did not rely on in drafting its fraud claim. Furthermore, Pavarini implies that
Waterscape’s fraud claim is really a breach of contract claim, but the distinction is not always an
easy one to make. See Sommer v. Federal Signal Corp., 593 N.E.2d 1365, 1369 (N.Y. 1992)
(discussing the “guideposts for separating tort from contract claims”). The Court declines to
speculate on the viability of the fraud claim without the benefit of briefing on the issue.
Moreover, if Pavarini contends that prior determinations in another forum estop Waterscape
from asserting a fraud claim relating to subguard insurance, it should place that information
before the Court on a motion for summary judgment. Accordingly, the cross-motion for leave to
amend to assert the fraud claim in Count II of the Counterclaim is granted. To avoid any
misreading of the scope of this determination, the Court is not deciding that the fraud claim is
legally sufficient, but only that Pavarini’s specific futility arguments are procedurally improper
for the reasons stated.
The Court has considered the remaining arguments asserted by the parties and concludes
that they lack merit. The parties are directed to submit a consensual order or settle non-
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consensual orders that reflect the disposition of the motions and provide for the service and filing
of the amended complaint and the amended answer.
Dated: New York, New York
November 24, 2014
/s/ Stuart M. Bernstein
STUART M. BERNSTEIN
United States Bankruptcy Judge
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