Metheny v. JL Beverage Company LLC

Filing 13

ORDER AFFIRMING ORDER & JUDGMENT OF BANKRUPTCY COURT. ***Civil Case Terminated.*** Signed by Judge Haywood S. Gilliam, Jr. on 2/17/2017. (ndrS, COURT STAFF) (Filed on 2/17/2017)

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UNITED STATES DISTRICT COURT

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NORTHERN DISTRICT OF CALIFORNIA

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METHENY,
Plaintiff,

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v.

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JL BEVERAGE COMPANY LLC,

ORDER AFFIRMING ORDER &
JUDGMENT OF BANKRUPTCY
COURT

Defendant.

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United States District Court
Northern District of California

Case No.16-cv-00077-HSG

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This matter is before this Court on appeal from the United States Bankruptcy Court for the

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Northern District of California (the “bankruptcy court”), pursuant to 28 U.S.C. § 158(a). Debtor-

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Appellant Steven S. Metheny appeals the bankruptcy court’s order granting summary judgment in

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favor of JL Beverage Co. and the related judgment, both entered on December 28, 2015. The

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bankruptcy court concluded that Metheny’s debt to JL Beverage — resulting from a 2012 Nevada

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state court judgment — was non-dischargeable under the Bankruptcy Code. For the following

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reasons, the Court affirms the bankruptcy court’s grant of summary judgment in favor of JL

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Beverage.

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I.

BACKGROUND

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A.

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On November 15, 2012, a Nevada state court granted default judgment in favor of JL

State Court Judgment and Bankruptcy Petition

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Beverage on its several claims for relief against Metheny: breach of contract, breach of covenant

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of good faith and fair dealing, misappropriation of trade secrets/unfair competition, breach of

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fiduciary duty, fraudulent concealment, intentional interference with prospective economic

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advantage, negligence, declaratory relief, and injunctive relief. Dkt. No. 3-20 at 82. The state

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court awarded JL Beverage a total of $5,270,174.98 in damages. Id.

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On March 26, 2014, Metheny filed a Chapter 7 petition for bankruptcy. Dkt. No. 5 at 8.

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On June 20, 2014, JL Beverage filed an adversary suit to determine that Metheny’s debt to JL

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Beverage was non-dischargeable under 11 U.S.C. § 523(a) of the Bankruptcy Code. Dkt. No. 3-5;

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see also Dkt. No. 3-18. JL Beverage then moved for summary judgment on that basis. Dkt. No.

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3-20.

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Shortly thereafter, Metheny moved (1) to convert the bankruptcy case to Chapter 13 and

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(2) to dismiss the adversary complaint under Federal Rule of Civil Procedure Rule 12(b)(6)

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because § 523(a) is inapplicable in Chapter 13 cases. Dkt. No. 5 at 8. Metheny served the motion

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to convert upon all creditors, including JL Beverage. When no creditor objected, the Court

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entered relief via default, converting the case to Chapter 13. Id.

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After the conversion, a dispute arose in the adversary case over whether Metheny was

United States District Court
Northern District of California

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permitted to be a Chapter 13 debtor. The bankruptcy court concluded that although the issue of

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Chapter 13 eligibility can be waived if not timely raised, it could raise eligibility sua sponte under

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11 U.S.C. § 105(a) up until the confirmation hearing. Using its authority under § 105(a), the

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bankruptcy court ordered Metheny to reconvert the case to Chapter 7, holding that Metheny was

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not an eligible Chapter 13 debtor. Id. at 9; Dkt. No. 3-16.
JL Beverage’s Motion for Summary Judgment

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B.

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The bankruptcy court then considered JL Beverage’s summary judgment motion in the

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adversary case. JL Beverage argued that Metheny’s liability in the state court action for fraudulent

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concealment, breach of fiduciary duty, and intentional interference with prospective economic

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advantage conclusively established that the debt was non-dischargeable under 11 U.S.C.

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§§ 523(a)(2)(A), (a)(4), and (a)(6). Dkt. No. 3-20 at 10. The state court had expressly found the

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following in the underlying default judgment: Metheny was a part-owner and officer of JL

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Beverage who owed fiduciary duties to JL Beverage pursuant to the company’s operating

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agreement. Dkt. No. 3-20 Ex. A at 3–5. In contravention of those duties, Metheny intentionally

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and secretly organized his own company. Id. at 5–6. He then used JL Beverage’s confidential

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information and intellectual property to interfere with and usurp JL Beverage’s corporate

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opportunities, including JL Beverage’s opportunity to sell its assets to another company for over

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$5 million. Id. at 6–7. According to JL Beverage, the doctrine of issue preclusion, or collateral
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estoppel, barred the bankruptcy court from re-litigating the state court’s legal and factual findings.
The bankruptcy court agreed that issue preclusion applied and that the debt was non-

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dischargeable based on the state court’s findings. The bankruptcy court consequently granted in

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part and denied in part JL Beverage’s summary judgment motion on December 28, 2015. Dkt.

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No. 3-24. Although the bankruptcy court rejected JL Beverage’s argument that the debt was non-

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dischargeable under 11 U.S.C. § 523(a)(2)(A) as money or property obtained by actual fraud, it

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agreed that the debt was non-dischargeable under both 11 U.S.C. § 523(a)(4) and § 523(a)(6) as a

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debt for defalcation in a fiduciary capacity and for willful and malicious injury respectively. Id.;

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see also Dkt. No. 3-23.

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II.

A district court reviews a bankruptcy court’s decision by applying the same standard of

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United States District Court
Northern District of California

STANDARD OF REVIEW

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review used by circuit courts when reviewing district court decisions. In re Greene, 583 F.3d 614,

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618 (9th Cir. 2009). The district court reviews the bankruptcy court’s findings of fact for clear

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error and its conclusions of law de novo. In re Harmon, 250 F.3d 1240, 1245 (9th Cir. 2001).

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“Because this dispute was decided on summary judgment, [the district court] must determine

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whether viewing all evidence in the light most favorable to the nonmoving party, there are any

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genuine issues of material fact and whether the [bankruptcy court] correctly applied the relevant

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substantive law.” In re Mortg. Store, Inc., 773 F.3d 990, 994 (9th Cir. 2014) (quotation omitted).

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III.

DISCUSSION

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Metheny raises three issues on appeal. He argues that the bankruptcy court erred by

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(1) requiring him to re-convert his case to Chapter 7; (2) determining that the debt to JL Beverage

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was non-dischargeable under § 523(a)(4) and under § 523(a)(6) based on the state court’s findings;

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and (3) applying Nevada’s issue preclusion doctrine to a default judgment. Metheny argues that,

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as a result, any exceptions from discharge should be reversed.

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A.

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As a threshold issue, Metheny contends that the bankruptcy court erred in reconverting his

The Bankruptcy Court Had Authority to Convert the Case to Chapter 7

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case to Chapter 7. The Court disagrees. The bankruptcy court did not err when it sua sponte

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raised and decided the issue of eligibility to convert from a Chapter 13 to a Chapter 7 case.
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Although JL Beverage waived any objection to the conversion, the court has the power to

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determine eligibility up until the confirmation.
“A proceeding that is commenced under Chapter 7 may be converted to a Chapter 13

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proceeding and vice versa.” Marrama v. Citizens Bank of Massachusetts, 549 U.S. 365, 367

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(2007) (citing 11 U.S.C. §§ 706(a), 1307(a), and (c)). A bankruptcy court is empowered to

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convert or dismiss a case sua sponte. See 11 U.S.C. § 105(a) (“No provision of this title providing

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for the raising of an issue by a party in interest shall be construed to preclude the court from, sua

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sponte, taking any action or making any determination necessary or appropriate to enforce or

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implement court orders or rules, or to prevent an abuse of process.”); see also In re Rosson, 545

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F.3d 764, 771 n.8 (9th Cir. 2008) (“Although the statute provides for conversion ‘on request of a

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United States District Court
Northern District of California

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party . . . or the . . . trustee, . . . ’ there is no doubt that the bankruptcy court may also convert on

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its own motion.”) (citing 11 U.S.C. § 105(a)); In re Labankoff, No. 09–1300–PAJUK, 2010 WL

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6259969, at *5 (9th Cir. BAP June 14, 2010) (collecting cases).1

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B.

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The Bankruptcy Court Did Not Err in Granting Summary Judgment Given
the Preclusive Effect of the State Court Judgment

Issue preclusion bars a party from re-litigating an issue necessarily decided in a prior, valid

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and final judgment. Amadeo v. Principal Mut. Life Ins. Co., 290 F.3d 1152, 1159 (9th Cir. 2002)

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(citing Arizona v. California, 530 U.S. 392, 395 (2000)). The Supreme Court has confirmed that

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the doctrine applies to dischargeability proceedings under § 523(a). Id. (citing Grogan v. Garner,

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498 U.S. 279, 284 (1991)). Under the principles of “full faith and credit,” federal courts give prior

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state-court judgments the same preclusive effect that they have under state law. Cal-Micro, Inc. v.

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Cantrell (In re Cantrell), 329 F.3d 1119, 1123 (9th Cir. 2003) (citing 28 U.S.C. § 1738).

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Therefore, Nevada’s issue preclusion principles apply here.
Under Nevada law, issue preclusion only applies if: (1) the issue decided in the prior

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Despite Metheny’s conclusory suggestion otherwise, the Supreme Court in Law v. Siegel, 134 S.
Ct. 1188, 1194 (2014), did not limit the bankruptcy court’s authority to reconvert a case sua
sponte. In Law, the Supreme Court merely reiterated that § 105(a) cannot be used to “override
explicit mandates of other sections of the Bankruptcy Code.” Id. at 1194. Metheny has not
identified any provision of the Bankruptcy Code that limits a court’s ability to re-convert a case to
Chapter 7.
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litigation was identical to the issue presented in the current action; (2) the initial ruling was on the

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merits and has become final; (3) the party against whom the judgment is asserted was a party or in

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privity with a party to the prior litigation; and (4) the issue was actually and necessarily litigated.

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Five Star Capital Corp. v. Ruby, 124 Nev. 1048, 1055 (2008), holding modified by Weddell v.

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Sharp, 131 Nev. Adv. Op. 28 (2015). Metheny claims that issue preclusion should not apply

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because the issues in the state court action were not identical to those raised here regarding

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dischargeability under § 523(a), and because those issues were not actually litigated in the state

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court action.

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Identity of Issues and Dischargeability under Section 523(a)

The bankruptcy court concluded that in light of the state court’s findings, Metheny’s $5

United States District Court
Northern District of California

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million debt to JL Beverage was non-dischargeable under the exceptions established under both 11

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U.S.C. §§ 523(a)(4) and 523(a)(6). To affirm the bankruptcy court’s grant of summary judgment,

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it is enough for the Court to find that one of the two exceptions applies to Metheny’s debt to JL

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Beverage, since the debt would be non-dischargeable under either. The Court addresses

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Metheny’s challenge to the application of § 523(a)(6), which involves a straightforward review of

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the underlying state law claims. Cf. F.T.C. v. Network Servs. Depot, Inc., 617 F.3d 1127, 1137

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(9th Cir. 2010) (“We may affirm the grant of summary judgment on any basis supported by the

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record and need not reach each ground relied upon by the [lower] court.”).

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Section 523(a)(6) excepts from discharge any debt “for willful and malicious injury by the

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debtor to another entity or to the property of another entity.” 11 U.S.C. § 523(a)(6). The

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“willfulness” and “maliciousness” prongs are distinct and analyzed separately. In re Su, 290 F.3d

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1140, 1147 (9th Cir. 2002) (remanding where bankruptcy court failed to independently analyze the

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two prongs). Accordingly, to fall within this exception to discharge, the debtor must have acted

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both willfully and maliciously. Id. Metheny argues that the bankruptcy court failed to analyze

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separately whether his conduct was both willful and malicious under the meaning of the statute.

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An injury is “willful” under § 523(a)(6) if the debtor intends the consequences of his

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action. Kawaauhau v. Geiger, 523 U.S. 57, 61 (1998). “Willful” indicates “a deliberate or

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intentional injury, not merely a deliberate or intentional act that leads to injury.” Id. The focus is
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on the debtor’s state of mind at the time the injurious action is taken: either the debtor must have

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the subjective intent to cause harm, or have the subjective belief (i.e., actual knowledge) that harm

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is substantially certain. In re Su, 290 F.3d at 1142, 1145–46. Subjective intent or substantial

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certainty may be inferred from all of the facts and circumstances established. In re Jacks, 266

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B.R. 728, 742 (9th Cir. BAP 2001); see also In re Su, 290 F.3d at 1146 n.6 (“[T]he bankruptcy

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court may consider circumstantial evidence that tends to establish what the debtor must have

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actually known when taking the injury-producing action.”).
The “maliciousness” prong, on the other hand, requires proof of “(1) a wrongful act,

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(2) done intentionally, (3) which necessarily causes injury, and (4) is done without just cause or
excuse.” In re Jercich, 238 F.3d 1202, 1209 (9th Cir. 2001). “[I]t is the wrongful act that must be

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United States District Court
Northern District of California

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committed intentionally rather than the injury itself.” In re Sicroff, 401 F.3d 1101, 1106 (9th Cir.

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2005).

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The bankruptcy court did not engage in a detailed analysis in finding Metheny’s conduct

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was both willful and malicious. Looking at the state court’s factual findings, the bankruptcy court

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concluded that “Mr. Metheny’s conduct was both willful and malicious in the sense that it was

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intended — it was not proper — it was unauthorized conduct and it was not done with just cause.”

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Dkt. No. 3-23 at 19. Despite Metheny’s arguments to the contrary, however, there is sufficient

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evidence in the state court findings to support this conclusion.

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Metheny’s sole argument against the bankruptcy court’s finding of willfulness appears to

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be that the state court default judgment does not clarify whether Metheny intentionally injured JL

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Beverage. The Court disagrees. Metheny acknowledges that the underlying state court judgment

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was for, inter alia, intentional interference with prospective economic advantage. See Dkt. No. 7

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at 3; see also Dkt. No 3-20 at 82. Under Nevada state law, that tort requires:

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(1) a prospective contractual relationship between the plaintiff and a
third party; (2) the defendant’s knowledge of this prospective
relationship; (3) the intent to harm the plaintiff by preventing the
relationship; (4) the absence of privilege or justification by the
defendant; and, (5) actual harm to the plaintiff as a result of the
defendant’s conduct.

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Las Vegas-Tonopah-Reno Stage Line, Inc. v. Gray Line Tours of S. Nevada, 106 Nev. 283, 287

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(1990) (emphasis added). The Nevada Supreme Court explained that the intent element is

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satisfied if “the defendant [is] substantially certain that interference with a commercial relationship

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will occur.” Id. Accordingly, in order to find for JL Beverage on this claim, the Nevada state

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court had to find that Metheny was at least “substantially certain” that his conduct would disrupt

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the relationship between JL Beverage and its prospective buyer. This intent is further supported

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by the state court’s findings of fact that Metheny “secretly creat[ed] a business to compete against

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[JL Beverage],” had been contacting JL Beverage’s “investors, distributors, manufacturers and

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even its chemist . . . in an effort to further [his] interests to [JL Beverage’s] detriment,” and had
contacted JL Beverage’s prospective buyer with a business plan of his own. Dkt. No. 3-20 at 80.

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United States District Court
Northern District of California

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Even Metheny’s authorities find this level of intentionality amounts to “willfulness” under

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§ 523(a)(6). In re Su, 290 F.3d at 1145–46.

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Similarly, Metheny argues that the record does not support a finding of malicious conduct.

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The state court’s findings, he suggests, amount to merely reckless conduct. Yet this ignores the

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actual content of the findings. The state court explicitly found that Metheny created a competing

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business, falsely represented that it was affiliated with JL Beverage, and contacted JL Beverage’s

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business contacts to pitch his own business plan. Dkt. No. 3-20 at 80. Metheny neither disputes

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this evidence nor points to any other evidence in the record that these acts were anything but

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intentionally committed. Moreover, such acts not only would “necessarily cause injury” to JL

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Beverage, In re Jercich, 238 F.3d at 1209, but as explained above, the state court found that

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Metheny actually intended to cause such injury. The bankruptcy court correctly concluded that

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Metheny acted both willfully and maliciously. His debt to JL Beverage is consequently non-

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dischargeable under § 523(a)(6).

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2.

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Actually Litigated

Metheny argues that the bankruptcy court erred in applying issue preclusion to a default

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judgment because such issues were not “actually litigated.” The state court entered the default

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judgment following a prove-up hearing because Metheny had flouted his discovery obligations.

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That is not the type of default judgment immune from issue preclusion under Nevada law.
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Metheny’s only citation is to In re Sandoval, 232 P.3d 422, 423 (Nev. 2010), in which the

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Nevada Supreme Court held that the failure to answer a complaint served by publication does not

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carry issue-preclusive effect. The court reasoned that fundamental fairness counseled against

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finding preclusive effect where a party may not even have received notice of the action. Id. at

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424–25. The court emphasized that Sandoval had no knowledge of the action before the default

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judgment and had not participated in the action in any way prior to the judgment. Id. at 425. The

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Nevada Supreme Court explicitly declined to decide whether issue preclusion is available when a

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default judgment is based on abusive or dilatory litigation tactics. Id. at 424 n.1.
In the absence of controlling Nevada law, this Court must predict how the Nevada

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Supreme Court would rule. Gravquick A/S v. Trimble Navigation Int’l Ltd., 323 F.3d 1219, 1222

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United States District Court
Northern District of California

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(9th Cir. 2003). The fundamental fairness concerns at issue in In re Sandoval are not present here.

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Metheny does not dispute that he was represented by counsel and participated in the action, the

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state court granted default judgment because Metheny had failed to meet his discovery obligations,

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and the court held a prove-up hearing in which Metheny also participated. See Dkt. No. 5 at 3–5.

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The Ninth Circuit has concluded under similar circumstances that such default judgments warrant

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issue preclusion. In In re Daily, 47 F.3d 365 (9th Cir. 1995), for example, the Ninth Circuit found

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that a default judgment should have preclusive effect where the debtor had deliberately evaded its

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discovery obligations. To deny preclusive effect in such circumstances “would permit [the debtor]

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to delay substantially and perhaps ultimately avoid payment of the debt by deliberate abuse of the

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judicial process.” Id. at 368; see also In re Ohler, No. ADV 11-01376-BAM, 2012 WL 5408771,

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at *4 (Bankr. D. Nev. Nov. 6, 2012) (predicting Nevada Supreme Court would award preclusive

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effect to default judgment); In re Gessin, No. ADV NV-11-05078, 2013 WL 829095, at *6 (9th

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Cir. BAP Mar. 4, 2013) (same); accord Matter of Besing, 981 F.2d 1488, 1493 (5th Cir. 1993).

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Because of the undisputed nature of the state court default judgment, the bankruptcy court did not

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err in applying issue preclusion based on that judgment.

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To the extent that Metheny also seeks to challenge the merits of the underlying 2012 state

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court judgment, this is not the appropriate forum. This Court lacks jurisdiction to hear an appeal

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from a state court judgment.
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IV.

CONCLUSION
Because there are no genuine issues of material fact as to whether the debt was non-

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dischargeable under 11 U.S.C. § 523(a)(6), the Court AFFIRMS the bankruptcy court’s decision

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to grant summary judgment in favor of JL Beverage. The Clerk of the Court is instructed to close

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the file.

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IT IS SO ORDERED.
Dated: 2/17/2017

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HAYWOOD S. GILLIAM, JR.
United States District Judge

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United States District Court
Northern District of California

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