Parklex Associates v. Deutsch

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UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK
In re:
FRED DEUTSCH,
Debtor.
FOR PUBLICATION
Chapter 7
Case No. 15-13369 (MG)
PARKLEX ASSOCIATES,
Plaintiff,
v.
FRED DEUTSCH,
Defendant.
Adv. Pro. No. 16-01217 (MG)
MEMORANDUM OPINION AND ORDER GRANTING PLAINTIFF’S MOTION FOR
SUMMARY JUDGMENT AND DENYING DISCHARGE TO THE DEBTOR UNDER
SECTION 523 OF THE BANKRUPTCY CODE
A P P E A R A N C E S:
THE SCHER LAW FIRM, LLP
Attorney for Plaintiff Parklex Associates
One Old Country Road, Suite 385
Carle Place, NY 11514
By: 	Austin Reis Graff, Esq.
FRED DEUTSCH
Pro se Defendant
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MARTIN GLENN
UNITED STATES BANKRUPTCY JUDGE
Pending before this Court is the motion for summary judgment (the “Motion,” ECF Doc.
# 22) filed by Parklex Associates (“Parklex,” or the “Plaintiff”), the Plaintiff in the above-
captioned adversary proceeding (the “Adversary Proceeding”), seeking a determination that Fred
Deutsch’s (“Deutsch,” or the “Defendant”) debt to the Plaintiff is excepted from discharge
pursuant to 11 U.S.C. §§ 523(a)(2)(A); (a)(4); and (a)(6). (Complaint (ECF Doc. # 1) ¶¶ 33–49.)
On March 26, 2012, Parklex obtained a default judgment (the “Default Judgment”)
against Deutsch in state court in New York (the “State Court Action”) in the amount of
$44,163,637.53. (Motion at Ex. J.) The Default Judgment was entered after Deutsch answered
the complaint – and defended the State Court Action for a time – before abandoning the defense
after the filing of the fourth amended verified complaint in the State Court Action (the “Fourth
Amended Complaint”), at which time the Default Judgment was entered and a three-day
damages inquest (the “Damages Inquest,” Motion at Ex. C–E) was held.
Deutsch argues that he should not be collaterally estopped from denying the
circumstances and amount of the Default Judgment because (1) state law controls the issue of
collateral estoppel, (2) pursuant to New York law, he did not have a full and fair opportunity to
defend or contest the State Court Action or Default Judgment, and (3) there was no finding of
fraud in the State Court Action or in any case in which Deutsch was a party. (Defendant’s Letter
at 1.)
As discussed below, the Court concludes that the Default Judgment is entitled to
preclusive effect, such that under New York law, collateral estoppel applies. Defendant made a
conscious decision to stop defending the State Court Action upon filing of the Fourth Amended
Complaint. (See Plaintiff’s MOL at 6.) Deutsch, by failing to answer the Fourth Amended
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Complaint, thereby admitted all well-pled allegations in the Fourth Amended Complaint,
including the basic allegations of liability. In reaching this conclusion, the Court relies solely
upon the Default Judgment and Deutsch’s decision to stop defending the State Court Action, and
does not rely upon, nor give any weight or authority to, other state court decisions involving
Deutsch.1 Deutsch is collaterally estopped by the Default Judgment from challenging the factual
allegations set forth in the Fourth Amended Complaint.
This Court further concludes that the factual allegations set forth in the Fourth Amended
Complaint and the circumstances surrounding the State Court Action satisfy all of the elements
of a claim under sections 523(a)(2)(A) and (a)(4) of the Bankruptcy Code. Because the Court
finds two independent bases for the nondischargeability of debt under those sections, the Court
finds it unnecessary to analyze the Plaintiff’s section 523(a)(6) claim for willful and malicious
conduct. Similarly, the Court need not conduct a separate inquiry as to the amount of damages
the Plaintiff is owed. As discussed below, the three-day Damages Inquest held after the Default
Judgment was entered satisfies this Court’s need to conduct an independent inquest on damages.
Consequently, the Plaintiff’s Motion is GRANTED.
I. 	BACKGROUND
A. 	Involuntary Bankruptcy Case and Adversary Proceeding
On December 28, 2015, an involuntary bankruptcy case (the “Involuntary Case”) was
filed against Deutsch by petitioning creditors Steven Minn, Lupe Development Partners, LLC,
and Parklex. (ECF Doc. # 1, Case No. 15-13669.) Deutsch appeared in the Involuntary Case by
1 	Counsel for Plaintiff brought to the Court’s attention the New York Supreme Court’s decision in Parklex
Assoc. v. Royal Capital Mkts. Corp., 959 N.Y.S. 2d 91 (Sup. Ct. 2012) (the “RBCCM Case”) to “illuminate[] and
explain[] the basis for the Court’s issuance of the $44 million judgment against the Defendant.” (Plaintiff’s MOL at
5.) Although replete with colorful language about the malfeasances of Deutsch, Deutsch properly noted that he was
not a party to the RBCCM Case. Deutsch also alleges that he was not made aware of, called to testify, or called for
a deposition in the RBCCM Case. This Court’s decision applying collateral estoppel, and the factual findings
necessary for the nondischargeability of debt, do not arise from the RBCCM Case, but rather from the Default
Judgment and State Court Action.
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his attorney, Gerard DiConza, on February 12, 2016. (ECF Doc. # 8, Case No. 15-13669.)
Deutsch also filed a Motion for an Order Abstaining from and Dismissing the Involuntary Case
Pursuant to Section 305(a) of the Bankruptcy Code, or in the Alternative, Dismissing the
Involuntary Case Pursuant to Section 707(a) of the Bankruptcy Code and Rule 1017(a) of the
Federal Rules of Bankruptcy Procedure (the “Motion for Abstention and Dismissal”) (ECF Doc.
# 11, Case No. 15-13669). On April 26, 2016, this Court entered an order denying the Motion
for Abstention and Dismissal of the Involuntary Case. (ECF Doc. # 29, Case No. 15-13669.)
A Clerk’s Certificate of Default was entered in this Adversary Proceeding on December
5, 2016, because Deutsch failed to timely respond to the adversary complaint. (ECF Doc. # 12.)
Deutsch, who is not represented by counsel in this Adversary Proceeding, filed a letter dated
March 13, 2017, requesting that he be given two additional weeks to answer the adversary
complaint. (ECF Doc. # 15.) The letter set forth Deutsch’s contentions why he believed he had
meritorious defenses to the Adversary Proceeding. (Id.) Because this Court preferred that the
proceedings be decided on the merits rather than by (another) default, the Court denied the
motion for entry of default judgment in this Adversary Proceeding, and required Deutsch to file
his answer by March 27, 2017. (ECF Doc. # 16.) Deutsch filed his answer on March 27, 2017.
(ECF Doc. # 18.)
As noted, pending before this Court is the Plaintiff’s Motion for summary judgment.
(ECF Doc. # 22.) In support of the Motion, the Plaintiff filed a Memorandum of Law in Support
of the Motion for Summary Judgment (the “Plaintiff’s MOL,” ECF Doc. # 23), and a Statement
of Undisputed Facts in Support of Motion for Summary Judgment (the “Plaintiff’s Facts,” ECF
Doc. # 24). On June 6, 2017, Deutsch filed a Letter in Lieu of a Formal Memorandum of Law
(the “Defendant’s Letter,” ECF Doc. # 28). Deutsch’s letter incorporated a response to the
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Plaintiff’s Facts. (See Defendant’s Letter at 5–7.) In response, the Plaintiff filed an Affirmation
in Reply (the “Plaintiff’s Reply,” ECF Doc. # 29). The Fourth Amended Complaint was attached
as Exhibit O to the Plaintiff’s Reply. (Plaintiff’s Reply at Ex. O.)
B. 	The State Court Action
The Court deems as admitted by Deutsch the following facts detailed in the Fourth
Amended Complaint. On or about May 11, 2006, Plaintiff and its limited partners (the “Limited
Partners”) commenced the State Court Action in the New York State Supreme Court, Kings
County under index number 14514/2006 seeking an accounting for Plaintiff’s assets and causes
of action for breach of fiduciary duty. (Fourth Amended Complaint ¶ 14.)
The State Court Action stemmed from a dispute over property purchased by Parklex.
Parklex was intended to be a financial investment opportunity with attendant tax benefits, and
was formed to acquire, own and operate a seventeen story office building at 114 East 32nd
Street, New York, NY (the “Parklex Property”). (Plaintiff’s Facts ¶ 7; Fourth Amended
Complaint ¶¶ 38–39.) Parklex issued a confidential private placement memorandum to potential
investors, offering them an opportunity to become a limited partner in Parklex, and set forth the
representations to potential investors that a principal benefit would be to receive tax deductions
to a potential limited partner’s income. (Fourth Amended Complaint ¶¶ 37, 40.)
In September 1983, a partnership agreement was entered into by Parklex Associates, Inc.
(“Parklex Corporation”), as general partner of the partnership, and the Limited Partners deciding
to invest in the partnership (the “Partnership Agreement”). (Id. ¶ 50.) At the time, Parklex
Corporation was Parklex’s general partner. (Id. ¶ 41.) At the closing of the purchase of the
Parklex Property, Parklex executed a Wrap Around Mortgage Note (the “Wrap Note”) and Wrap
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Around Mortgage (the “Wrap Mortgage,” and together with the Wrap Note, the “Wrap”) in the
amount of $7.37 million. (Id. ¶ 60.)
On August 6, 1991, Parklex sent a letter of intent to Deutsch offering to sell him all of the
outstanding common stock of Parklex Corporation, all rights, title and interest of R & K Realty
Associates (the holder of the Wrap), and all rights, title and interest to the management
agreement of Redevco Management Company – the management company for the Parklex
Property. (Id. ¶ 68.)
On August 26, 1991, Parklex informed all of the Limited Partners that Deutsch – through
one or more corporations – would be acquiring the outstanding shares of Parklex Corporation as
well as the Wrap and management agreement. (Id. ¶ 69.) This transaction was intended as a
mechanism to avoid adverse tax consequences to the Limited Partners. (Id. ¶ 70.) Deutsch
subsequently became president and treasurer of Parklex Corporation upon Parklex’s first limited
partner and shareholder selling his shares in Parklex Corporation. (Id. ¶¶ 78–79.)
On July 21, 1992, Parklex wrote to its Limited Partners informing them of Deutsch’s
completion of his takeover as general partner of Parklex. (Id. ¶ 85.) The Parklex letter described
a dire financial situation regarding the Parklex Property and the building and assets of Parklex
(Id. ¶ 86.) Parklex Corporation also wrote to the Limited Partners that, as a result of this dire
financial situation, it appeared that the Parklex Property’s value was less than its mortgage and,
to the extent the Limited Partners believed they had equity in the building, such equity was
extinguished. (Id. ¶ 87.) Notwithstanding these representations, the Parklex Property continued
to generate millions of dollars that were paid to the companies owned and dominated by Deutsch
from Parklex accounts. (Id. ¶ 88.)
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From 1983 through 1995, Parklex’s Limited Partners received yearly K-1 tax statements
for Parklex that permitted them to report the tax consequences of their interest in Parklex. (Id. ¶
89.) From 1995 through 2005, Parklex’s Limited Partners did not receive any K-1 tax
statements, even after attempts to obtain copies of the statements from, among others, Parklex,
Deutsch, and Parklex Corporation. (Id. ¶¶ 90, 92.) Copies of the statements from the years 2002
through 2004 were sent to one of Parklex’s Limited Partners, but these K-1 forms were
fraudulent and never filed with the Internal Revenue Service. (Id. ¶¶ 94-95.)
In or about May 2006, certain Limited Partners discovered that Parklex sold the Parklex
Property (the “Sale”). (Id. ¶¶ 107-108.) The Limited Partners did not receive any notices,
consent forms, or disclosure from Parklex, Parklex Corporation, or Deutsch in regards to the
Sale. (Id. ¶¶ 109, 110.) The first communication the Limited Partners received was on or about
May 30, 2006, when some of Parklex’s Limited Partners received what Deutsch stated was a
partial payment from the proceeds of the Sale. (Id. ¶ 111.)
On May 8, 2006, Deutsch signed a letter, on behalf of Parklex Corporation as Parklex’s
general partner, authorizing Fidelity National Title Insurance Company (“Fidelity”), the title
company insuring title for the purchaser, to distribute the proceeds of the Sale of the Parklex
Property. (Id. ¶ 118.) Deutsch, as president of Parklex Corporation, instructed Fidelity to wire
transfer $4,500,000.00 to Chicago Deferred Exchange Corporation (“Chicago”). (Id. ¶ 119.)
Deutsch, as president of Parklex Corporation, also instructed Fidelity to wire transfer
$6,097,104.63 to Chicago (the “Target Property #2 Monies”). (Id. ¶ 121.)
The Target Property #2 Monies were to be used by Parklex, through Deutsch, to purchase
a second property in an IRC § 1031 Exchange. (Id. ¶ 122.) Neither Parklex nor Deutsch
completed the proposed purchase of the second property. (Id. ¶ 123.) On June 27, 2006,
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Deutsch authorized RBC Dain Rauscher (“RBC Dain”) to transfer over $4,000,000.00 to
Collateral LLC. (Id. ¶ 125.)
On June 29, 2006, the New York State court issued a temporary restraining order,
restraining and enjoining the monies held in the name of Parklex and Parklex Corporation. (Id. ¶
126.) Nevertheless, on June 30, 2006, Deutsch authorized RBC Dain to transfer $1,000,000.00
from RBC Dain to an account in the name of Parklex. (Id. ¶ 127.) Deutsch, as president of
Parklex Corporation, also instructed Fidelity to wire transfer $23,080,351.63 to FAL Associates,
LLC (“FAL Monies”) in an account at JP Morgan Chase (“JP Morgan”). (Id. ¶ 129.)
From May 2006 through June 2006, Deutsch used the FAL Monies for his own benefit.
(Id. ¶ 130.) In July 2006, Deutsch directed JP Morgan to transfer $20,000,000.00, or the
remaining balance of the FAL Monies, to RBC Dain into an account of DB Partners I, LLC. (Id.
¶ 131.) Deutsch, as president of the Parklex Corporation did not instruct Fidelity to distribute
any monies to Parklex’s Limited Partners, nor did he instruct Fidelity to distribute any monies to
Parklex or Parklex Corporation. (Id. ¶¶ 133–34.)
On or about May 26, 2006, Deutsch distributed $1,683,000.00 to Parklex’s Limited
Partners. (Id. ¶ 136.) Parklex Corporation and Deutsch also authorized Parklex Corporation to
be paid $17,000.00 from the proceeds of the Sale. (Id. ¶ 137.) Deutsch or his agent, or Parklex
Corporation or its agent, allegedly mailed checks totaling $1,683,000.00 to Parklex’s Limited
Partners at Parklex’s Limited Partners last known addresses. (Id. ¶ 138.) However, several of
Parklex’s Limited Partners did not receive the checks allegedly mailed to them because the last
known address was incorrect as they had not been updated in ten years, which was the last time
Deutsch and Parklex Corporation attempted to communicate with Parklex’s Limited Partners.
(Id. ¶ 139.)
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II. 	LEGAL STANDARD
A. 	Summary Judgment
Rule 56(a) of the Federal Rules of Civil Procedure, made applicable by Bankruptcy Rule
7056, states that “[t]he court shall grant summary judgment if the movant shows that there is no
genuine dispute as to any material fact and the movant is entitled to judgment as a matter of
law.” Issues of non-material fact, however, will not prevent a court from awarding a party
summary judgment. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247–48 (1986) (stating that
“the mere existence of some alleged factual dispute between parties will not defeat an otherwise
properly supported motion for summary judgment; the requirement is that there be no genuine
issue of material fact”) (emphasis in original). Facts are material if they “might affect the
outcome of the suit under the governing law.” Overton v. New York State Div. of Military and
Naval Affairs, 373 F.3d 83, 89 (2d Cir. 2004) (quoting Liberty Lobby, 477 U.S. at 248) (internal
quotation marks omitted).
On a motion for summary judgment, the movant bears the initial burden to offer evidence
that satisfies “each material element of his claim or defense, demonstrating that he is entitled to
relief.” Isaac v. City of New York, 701 F. Supp. 2d 477, 485 (S.D.N.Y. 2010). Once the movant
has made this initial showing, the nonmoving party must provide evidence of a genuine issue of
fact in order to successfully oppose the motion. Matsushita Elec. Indus. Co., LTD. v. Zenith
Radio Corp., 475 U.S. 574, 586 (1986). A factual issue is genuine “if the evidence is such that a
reasonable jury could return a verdict for the nonmoving party,” Liberty Lobby, 477 U.S. at 248,
and all inferences to be drawn from the underlying facts must be viewed in the light most
favorable to the party opposing the motion. Id. at 249; Adickes v. S. H. Kress & Co., 398 U.S.
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144, 157 (1970). If the nonmoving party is unable to provide evidence of a genuine issue of
material fact, “the movant is entitled to judgment as a matter of law.” FED. R. CIV. P. 56(a).
B. 	Preclusive Effect Of State Court Judgments in Federal Court
“The law is well settled that a state court judgment must be given preclusive effect, at
least for collateral estoppel purposes, in a subsequent federal court proceeding if the state in
which the judgment was rendered would do so.” Wharton v. Shiver (In re Shiver), 396 B.R. 110,
117 (Bankr. S.D.N.Y. 2008). In Marrese v. Am. Acad. of Orthopaedic Surgeons, 470 U.S. 373,
380 (1985), the Supreme Court stated:
[28 U.S.C. § 1738] directs a federal court to refer to the preclusion law of
the State in which judgment was rendered. 	It has long been established that §
1738 does not allow federal courts to employ their own rules of res judicata in
determining the effect of state judgments. 	Rather, it goes beyond the common
law and commands a federal court to accept the rules chosen by the State from
which the judgment is taken. 	Section 1738 embodies concerns of comity and
federalism that allow the States to determine, subject to the requirements of the
statute and the Due Process Clause, the preclusive effect of judgments in their
own courts.
This Court in Shiver held that collateral estoppel can apply in a denial of discharge
adversary proceeding specifically where the state court judgment entered was a default
judgment. 396 B.R. at 119 (“[T]here is no logical reason why different rules apply to default
judgments. Controlling case law from the Second Circuit . . . makes this point abundantly clear.
Three Second Circuit cases hold that state law controls issue preclusion in bankruptcy cases
whether the state court judgment arose from a fully litigated case or from a default judgment.”)
(citing Kelleran v. Andrijevic, 825 F.2d 692, 694 (2d Cir. 1987); Giaimo v. DeTrano (In re
DeTrano), 326 F.3d 319, 322 (2d Cir. 2003); Evans v. Ottimo, 469 F.3d 278, 281 (2d Cir. 2006)).
Therefore, it is necessary to look to New York State law and its collateral estoppel rules to
determine whether a default judgment would be given preclusive effect.
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In New York, collateral estoppel prevents a party from re-litigating an issue where (1) the
identical issue was decided in the prior action and is decisive of the present action, and (2) the
party had a full and fair opportunity to contest the prior determination. See Kaufman v. Eli Lilly
& Co., 65 N.Y.2d 449, 455 (1985).
In Rokina Opt. Co. v. Camera King, 63 N.Y.2d 728, 729 (1984), after the defendant
answered the complaint, but subsequently failed to answer a set of interrogatories, the plaintiff
sought an order striking the defendant’s answer, and a default judgment was granted in favor of
the plaintiff. A trial was then held solely on the issue of amount of damages, whereby the
defendant was limited in the evidence to be taken at the trial establishing the reasonable value of
damages. Id at 729–30. On appeal, the issue was whether preclusive effect could be given to the
state court default judgment that, in effect, limited the rights of the defendant to establish, or
defend against, the amount of damages. Id. The New York Court of Appeals held preclusive
effect applied, but that “unless the damages sought in an action are for a sum certain or for a sum
which can by computation be made certain, judgment against a defaulting party may be entered
only upon application to the court along with notice to the defaulting party and a full opportunity
to cross-examine witnesses, give testimony and offer proof in mitigation of damages.” Id.
(citations omitted).
In other words, a defendant subject to a default judgment “admits all traversable
allegations in the complaint, including the basic allegation of liability, but does not admit the
plaintiff’s conclusion as to damages.” Id. (citation omitted); see also In re Amanat, 321 B.R. 30,
37 (Bankr. S.D.N.Y. 2005) (citing Rokina and noting that New York law permits a party to
enforce un-stayed default judgments, subject to an inquest on damages). However, where an
inquest on damages occurred in the state court, pursuant to New York law, such judgment is
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valid and enforceable – including the determination of damages – and is subject to preclusive
effect in this Court. See Amanat, 321 B.R. at 37 (“[T]he State Court entered an order on liability
and a judgment after an inquest on damages (at which [defendant] was represented). Thus,
pursuant to New York law, [plaintiff’s] judgment is valid and enforceable.”).
In Evans, the Second Circuit likewise held that a judgment obtained by a creditor in New
York State court, grounded in fraud and imposing punitive damages, precluded re-litigation in
bankruptcy court and concluded that New York courts give collateral estoppel effect to default
judgments. 469 F.3d at 282–83. This Court has previously questioned that decision in regards to
“pure defaults” where a defendant never responds to the complaint or appears in the action. See
Vyshedsky v. Soliman (In re Soliman), 515 B.R. 179, 185, 187 (Bankr. S.D.N.Y. 2014) (citing
D’Arata v. N.Y. Cent. Mut. Fire Ins. Co., 76 N.Y.2d 659, 667 (1990); Halyalkar v. Bd. of
Regents of N.Y., 72 N.Y.2d 261, 267–68 (1988); Kaufman, 65 N.Y.2d at 456–57). However, in
Soliman, this Court also noted that where a defendant appeared and defended the action for a
period, but later abandoned the defense, “the issues of notice and service of pleadings is less of a
concern.” 515 B.R. at 187.
C. 	Nondischargeability of Debts Under Section 523
“A bankruptcy discharge covers all prepetition debts, other than debts expressly excepted
from discharge by section 523 of the Bankruptcy Code. Consistent with the Bankruptcy Code’s
fresh start policy, courts nevertheless construe the exceptions enumerated in section 523
narrowly against the creditor in favor of the debtor.” Vyshedsky v. Soliman (In re Soliman), 539
B.R. 692, 699 (Bankr. S.D.N.Y. 2015).
1. 	Section 523(a)(2)(A)
Section 523(a)(2)(A) excepts from discharge any debt “for money, property, services or
an extension, renewal, or refinancing of credit, to the extent obtained by (A) false pretenses or
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actual fraud . . . .” Thus, to object to the discharge of a debt under section 523(a)(2)(A), a
creditor must show that:
i. 	The debtor made a false representation;
ii. 	At the time the representation was made, the debtor knew it was false;
iii. 	The debtor made the representation with intent to deceive the creditor;
iv. 	The creditor justifiably relied on the representation; and
v. 	The creditor sustained loss or damage as a proximate consequence of the false
representation.
Chase Bank, USA, N.A. v. Vanarthos (In re Vanarthos), 445 B.R. 257, 262 (Bankr. S.D.N.Y.
2011); see also Owens v. Owens (In re Owens), 2005 WL 387258, at *1–2 (Bankr. S.D.N.Y.
2005); Charell v. Gonzalez (In re Gonzalez), 241 B.R. 67, 71–72 (Bankr. S.D.N.Y. 1999); Smith
v. Meyers (In re Schwartz & Meyers), 130 B.R. 416, 422 (Bankr. S.D.N.Y. 1991). The creditor
bears the burden of proving these elements by preponderance of the evidence. See Grogan v.
Garner, 498 U.S. 279, 286 (2002).
In interpreting the elements of section 523(a)(2)(A), “[t]he Court looks to the common
law of torts, as embodied in the Restatement (Second) of Torts.” Lubit v. Chase (In re Chase),
372 B.R. 125, 130 (Bankr. S.D.N.Y. 2007). For purposes of applying section 523(a)(2)(A), a
“false representation means that “(1) the defendant made a false or misleading statement (2) with
intent to deceive (3) in order for the plaintiff to turn over money or property to the defendant.”
Frishberg v. Janac (In re Janac), 407 B.R. 540, 552 (Bankr. S.D.N.Y. 2009). Omissions of fact
can qualify as false representations: “[a] false representation can be shown through either an
express statement or through an omission where the circumstances are such that disclosure is
necessary to correct what would otherwise be a false impression.” Signature Bank v. Banayan
(In re Banayan), 468 B.R. 542, 574–75 (Bankr. N.D.N.Y. 2012) (citations omitted); see also
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RESTATEMENT (SECOND ) OF TORTS § 529 (1976) (“A representation stating the truth so far as it
goes but which the maker knows or believes to be materially misleading because of his failure to
state additional or qualifying matter is a fraudulent misrepresentation.”). It does not matter
whether the debtor believes that the undisclosed fact is material. See RESTATEMENT (SECOND)
OF TORTS § 529, cmt. b (1976) (“Whether or not a partial disclosure of the facts is a fraudulent
misrepresentation depends upon whether the person making the statement knows or believes that
the undisclosed facts might affect the recipient’s conduct in the transaction in hand. It is
immaterial that the defendant believes that the undisclosed facts would not affect the value of the
bargain he is offering. The recipient is entitled to know the undisclosed facts in so far as they are
material and to form his own opinion of their effect.”).
In addition, under section 523(a)(2)(A)(ii), a debtor’s “intent to deceive” need not be
express, as “intent may be inferred when the totality of the circumstances presents a picture of
deceptive conduct by the debtor, which indicates that [he] did intend to deceive and cheat the
[creditor].” Hong Kong Deposit and Guar. Co. v. Shaheen (In re Shaheen), 111 B.R. 48, 53
(S.D.N.Y. 1990) (citations omitted); see Voyatzoglou v. Hambley (In re Hambley), 329 B.R. 382,
396–97 (Bankr. E.D.N.Y. 2005) (“[I]t is well established that intent to deceive may be
established through circumstantial evidence and inferred from the totality of the evidence
presented.”). This Court has held that intent to deceive under section 523(a)(2) can also be
satisfied if the debtor acted with reckless disregard for the truth, with the recklessness of the
debtor’s behavior determined from the totality of the circumstances. See Medina v. Paredes (In
re Paredes), 2017 WL 2603687, at *4–6 (Bankr. S.D.N.Y. June 15, 2017) (citing Nat'l Union
Fire Ins. Co. v. Bonnanzio (In re Bonnanzio), 91 F.3d 296, 301 (2d Cir. 1996).
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2. 	Section 523(a)(4)
In the Motion, the Plaintiff also invokes section 523(a)(4), which excepts from discharge
a debt for “fraud or defalcation while acting in a fiduciary capacity . . . .” 11 U.S.C. § 523(a)(4).
“To sustain a cause of action for fraud or defalcation under [section] 523(a)(4), the plaintiff must
first establish that the debtor acted while in a fiduciary capacity.” Zohlman v. Zoldan, 226 B.R.
767, 772 (S.D.N.Y. 1998). “The mere existence of a fiduciary relationship is not sufficient to
deny dischargeability under section 523(a)(4).” Zohlman v. Zoldan (In re Zoldan), 221 B.R. 79,
87 (Bankr. S.D.N.Y. 1998). Rather, the court must find that the defendant “was ‘acting in a
fiduciary capacity’ with respect to the particular conduct giving rise to the liability which is
claimed to be non-dischargeable.” Id. (emphasis in original). The meaning of fiduciary is a
matter of federal law and the term “fiduciary capacity” is narrowly construed. See Zohlman, 226
B.R. at 772; see also Sandak v. Dobrayel (In re Dobrayel), 287 B.R. 3, 14 (Bankr. S.D.N.Y.
2002) (“The meaning of ‘fiduciary capacity’ under Federal laws is more restricted than under the
more general common law or state definitions.”).
Under section 523(a)(4), the term fiduciary capacity “may be an express trust, technical
trust, or statutorily imposed trust.” Mirarchi v. Nofer (In re Nofer), 514 B.R. 346, 353 (Bankr.
E.D.N.Y. 2014). “[T]he fiduciary relationship must exist prior to the act creating the debt; a trust
relationship cannot be said to arise merely from the wrongful conduct itself.” Zohlman, 226 B.R.
at 773; see also In re Scheller, 265 B.R. 39, 52 (Bankr. S.D.N.Y. 2001). Bankruptcy courts
“may look to state law to determine whether a trust exists.” Chitester v. Watterson (In re
Watterson), 524 B.R. 445, 451 (Bankr. E.D.N.Y. 2015). Under New York law, a fiduciary
relationship “may arise where power and knowledge within a corporation are concentrated in one
individual. Majority shareholders who dominate the corporation’s affairs are fiduciaries, and
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their powers are held in trust for the benefit of minority shareholders. Corporate officers and
directors are likewise fiduciaries.” In re Nofer, 514 B.R. at 354 (citing cases).
If the defendant was acting in a fiduciary capacity, courts then examine whether the acts
undertaken constitute fraud or defalcation under section 523(a)(4). See Zohlman, 226 B.R. at
775. The Bankruptcy Code “incorporates the common law elements of fraud, ‘includ[ing] a false
representation, scienter, reliance, and harm.’” In re Nofer, 514 B.R. at 355 (quoting Evans, 469
F.3d at 283). Under section 523(a)(4), fraud requires “intentional deceit, and is thus akin to
actual fraud.” Id. (citing Evans, 469 F.3d at 283; G.W. White & Son, Inc. v. Tripp (In re Tripp),
189 B.R. 29, 35 (Bankr. N.D.N.Y. 1995)). Defalcation has been defined as a “misappropriation
or failure to account” and “requires a showing of conscious misbehavior or extreme
recklessness.” Denton v. Hyman (In re Hyman), 502 F.3d 61, 68 (2d Cir. 2007). “Mere
negligence, without some element of intentional wrongdoing, breach of fiduciary duty or other
identifiable misconduct, does not constitute a ‘defalcation’ within the meaning of section
523(a)(4).” In re Scheller, 265 B.R. at 53 (citation omitted). Yet, a defalcation “need not rise to
the level of fraud, embezzlement, or misappropriation.” Id. The Supreme Court has held that
defalcation requires “a culpable state of mind” and “where the conduct at issue does not involve
bad faith, moral turpitude, or other immoral conduct, the term requires an intentional wrong.”
Bullock v. BankChampaign, N.A., 569 U.S. 267, 273 (2013).
III. 	DISCUSSION
Applying these legal principles, the Court concludes that the Plaintiff has satisfied the
elements of collateral estoppel, and that the factual allegations set forth in the Fourth Amended
Complaint in the State Court Action establish the elements necessary to find that Deutsch
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misrepresented and defrauded the Plaintiff under section 523(a)(2)(A), and committed fraud or
defalcation while acting in a fiduciary capacity under section 523(a)(4).
A. 	New York Law Would Give Preclusive Effect to the Default Judgment
As a preliminary matter, although this Court has previously raised concerns over whether
bankruptcy courts give preclusive effect to default judgments rendered by a New York State
court (see Soliman, 515 B.R. at 185), this Court is comfortable that New York State courts would
apply collateral estoppel – and give preclusive effective – to the Default Judgment where the
Defendant has appeared in the State Court Action, defended for a time, and subsequently decided
to stop defending the State Court Action and failed to answer the Fourth Amended Complaint.
Taking the elements of collateral estoppel under New York law in turn, first, the issues
decided in the State Court Action by the Default Judgment were identical to the issues here.
Specifically, counts four through seven in the Fourth Amended Complaint were for common law
and contractual breaches of fiduciary duty, and for fraud. (See Fourth Amended Complaint ¶¶
256–293.) As discussed below, those issues are the identical issues for nondischargeability of
debt pursuant to sections 523(a)(2)(A) and (a)(4).
Second, the Defendant undisputedly had a full and fair opportunity to contest the State
Court Action. The Defendant has never disputed that he had notice and service of all pleadings
in the State Court Action – prior to abandoning his defense, the Defendant was actively
participating in the State Court Action. Notably, the Defendant does not dispute that he
defaulted on the State Court Action, nor does he dispute that his counsel was directed not to
challenge the Default Judgment. (See Motion at Ex. J) (whereby Deutsch’s former counsel states
in an email that “I have been instructed by my client to not oppose the motion for a default
judgment”). Deutsch litigated and subsequently decided to stop defending the State Court
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Action upon the filing of the Fourth Amended Complaint. Deutsch had a full and fair
opportunity to contest the State Court Action, and he will not be allowed to abuse the judicial
process and take an “undeserved second bite at the apple.” See Soliman, 515 B.R. at 186
(quotations omitted).
It follows that pursuant to New York law on collateral estoppel, Deutsch “admits all
traversable allegations in the [Fourth Amended Complaint], including the basic allegation of
liability . . . .” See Rokina v. Camera King, 63 N.Y.2d at 729. The Court will therefore deem
true the factual allegations set forth in the Fourth Amended Complaint, and will look to those
facts for purposes of nondischargeability of debt pursuant to section 523 of the Bankruptcy
Code.
B. 	The Elements of Section 523(a)(2)(A) are Satisfied
The Court finds that the factual allegations set forth in the Fourth Amended Complaint
satisfy the five elements of 523(a)(2)(A). First, with respect to the first requirement of section
523(a)(2)(A) pertaining to a “false representation,” in an affidavit by Deutsch to the Plaintiff’s
Limited Partners, Deutsch stated that in order to prevent foreclosure upon the Property (which
would have had negative tax consequences for the Limited Partners), the Wrap was converted
into a 95% limited partnership interest in Plaintiff. (Fourth Amended Complaint ¶ 281.)
Deutsch also stated in the affidavit that in consideration of the discharge of the interest portion of
the mortgage debt, the holder of the mortgage was granted a 95% limited partner interest in the
Plaintiff. (Id. ¶ 282.) However, Deutsch failed to disclose that he was the person or entity that
discharged the obligation to continue paying the interest portion of the Wrap, and that, as the
largest shareholder of the Plaintiff, he was the beneficial interest holder in the refinancing of the
Wrap. (Id. ¶¶ 283–84.)
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Further, in or about May 2006, certain Limited Partners discovered that Parklex sold
(through Deutsch) the Parklex Property. (Id. ¶¶ 107–108.) The Limited Partners did not receive
any notices, consent forms, or disclosure from Parklex, Parklex Corporation, or Deutsch in
regards to the Sale. (Id. ¶¶ 109, 110.) The first communication received was on or about May
30, 2006, when some of Parklex’s Limited Partners received what Deutsch stated was a partial
payment from the proceeds of the Sale. (Id. ¶ 111.) The Limited Partners did not have the
opportunity to participate in the Sale, and therefore did not have the knowledge necessary to
realize the proceeds of the Sale. Moreover, even after not giving notice of the Sale to the
Limited Partners, Deutsch, as president of the Parklex Corporation, did not instruct Fidelity to
distribute any monies to Parklex’s Limited Partners, nor did he instruct Fidelity to distribute any
monies to Parklex or Parklex Corporation. (Id. ¶¶ 133–34.) Failure to mention those facts to the
Limited Partners constituted a blatant omission, which prevented the Plaintiff from participating
in the advantages afforded by IRC § 1031 Tax Exchange program. These allegations allow this
Court to reach one conclusion – Deutsch defrauded the Plaintiff.
Pursuant to the second requirement under section 523(a)(2)(A), the Plaintiff’s well-pled
allegations that Deutsch engaged in fraud establish that Deutsch knew his representation was
false. Third, Deutsch’s intent to deceive can be inferred both from the totality of the
circumstance and from Deutsch’s numerous false representations and failed disclosures that
qualify as a “misstatement of fact which the Debtor [knew or should have known] [would have]
induc[ed]” Plaintiff to act. Ardizzone v. Scialdone (In re Scialdone), 533 B.R. 53, 60 (Bankr.
S.D.N.Y. 2015) (internal citation omitted); see also Paredes, 2016 WL 2603687, at *4-6
(explanation). The totality of the circumstances paints a picture of deceptive conduct by
Deutsch, which indicates that he intended to deceive and cheat Plaintiff and its Limited Partners.
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See In re Shaheen, 111 B.R. at 53. Even if this Court were to hold that the totality of the
circumstances of this case do not indicate his intent to deceive, Deutsch’s reckless disregard for
the truth in failing to disclose the elements of the Sale to the Limited Partners would support an
inference of such intent.
Fourth, this Court also finds that Plaintiff justifiably relied on the false representations
and omissions by Deutsch. The Plaintiff’s Limited Partners relied upon the misrepresentations
by Deutsch that no change in beneficial interests in the Plaintiff occurred, and that no change in
owners of the Property had taken place. (Fourth Amended Complaint ¶ 290). As noted, Plaintiff
and Plaintiff’s Limited Partners failed then to realize proceeds from the Sale and the benefits of
the IRC § 1031 Tax Exchange program. Lastly, as a result, Plaintiff properly alleged (and as the
state court found during the Damages Inquest, discussed below) that Plaintiff suffered proximate
damages because of the false representations and omissions. (Id. ¶ 291). Therefore, Plaintiff has
properly pled sufficient cause for the non-dischargeability of debt pursuant to section
523(a)(2)(A) of the Bankruptcy Code.
C. 	The Elements of Section 523(a)(4) are Satisfied
The Court also independently finds that the factual allegations set forth in the Fourth
Amended Complaint satisfy the elements of section 523(a)(4). First, the Plaintiff adequately
pled that Deutsch was acting in a fiduciary capacity – and breached that fiduciary duty – with
respect to the particular conduct giving rise to the liability which is claimed to be non-
dischargeable. (See id. ¶ 257 (“Defendant . . . had a fiduciary duty to [Plaintiff] regarding
[Plaintiff]’s administration”); id. ¶ 260 (“Defendant . . . breached his fiduciary duty to [Plaintiff]
when he was involved in self-dealing . . . .”).
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Moreover, under New York law, the fiduciary relationship also arose because Deutsch’s
power and knowledge within both Plaintiff and Parklex Corporation were concentrated in only
one individual – Deutsch. The Plaintiff established that Deutsch, as majority shareholder,
dominated the corporation’s affairs. In re Nofer, 514 B.R. at 354.
Further, as noted under the section 523(a)(2)(A) analysis, the acts undertaken while in the
fiduciary capacity constituted fraud and defalcation under section 523(a)(4). To avoid undue
repetition, among the more pungent acts, Deutsch mislead Plaintiff during the Sale process
(Fourth Amended Complaint ¶¶ 107–111), engaged in self-dealing during the Sale process by
not allowing Plaintiff’s Limited Partners to realize proceeds of the Sale (id. ¶¶ 133–34), failed to
seek consent or approval for the sale of Plaintiff’s property (id. ¶¶ 109, 110), failed to disclose to
Plaintiff and its Limited Partners that Deutsch was taking advantage of certain tax benefits (id. ¶
278), and failed to disclose that there was a change in the beneficial interests of Plaintiff. (id. ¶
284.) This Court finds that the totality of these fraudulent acts equate to a clear breach of
Deutsch’s fiduciary duties, such that Plaintiff properly pled sufficient cause for the non-
dischargeability of debt under section 523(a)(4).
D. 	The State Court Action Damages Inquest was Sufficient
Lastly, in terms of damages, as noted above, where an inquest on damages took place in
the state court, the damages judgment resulting from the inquest is viewed as a valid and
enforceable judgment, and no further inquest is necessary in this Court. See Amanat, 321 B.R. at
37. As part of Plaintiff’s Motion, Plaintiff’s counsel provided transcripts from the three-day
Damages Inquest held by the state court from May 7–10, 2012. (See Motion at Ex. C-E.)
Plaintiff has also provided a thorough and detailed breakdown from the State Court Action on
the precise computation of damages (the “Computation”). (See id. at Ex. F.) Deutsch has not
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disputed this evidence in the Defendant’s Letter. The Court finds the detailed Computation and
Damages Inquest sufficient, and need not conduct a separate inquest.
III. CONCLUSION
For the reasons stated above, Deutsch’s debt to the Plaintiff resulting from the Default
Judgment is determined to be NONDISCHARGEABLE.
IT IS SO ORDERED.
Dated: October 18, 2017
New York, New York
_____Martin Glenn______
MARTIN GLENN
United States Bankruptcy Judge
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