Bank of Commerce v. Schupbach (In re Schupbach), CASE NO. 11–13633

• Decision Date: 10 September 2013
• Docket Number: CASE NO. 11–13633,ADV. NO. 12–5047
• Citation: 500 B.R. 22
• Court: U.S. Bankruptcy Court — District of Kansas
• Parties: In re: Jonathan Isaac Schupbach and Amy Marie Schupbach, Debtors. Bank of Commerce & Trust Co., Plaintiff, v. Jonathan Isaac Schupbach and Amy Marie Schupbach, Defendants.

500 B.R. 22

In re: Jonathan Isaac Schupbach and Amy Marie Schupbach, Debtors.

Bank of Commerce & Trust Co., Plaintiff,

v.Jonathan Isaac Schupbach and Amy Marie Schupbach, Defendants.

CASE NO. 11–13633

ADV. NO. 12–5047

United States Bankruptcy Court, D. Kansas.

September 10, 2013

David P. Eron, Emily K. Wilson, Eron Law, P.A., Wichita, KS, for Defendants.

James J. Long, Wichita, KS, for Plaintiff.

CHAPTER 11

MEMORANDUM OPINION AND ORDER DENYING COMPLAINT FOR EXCEPTION OF DEBT FROM DISCHARGE

Dale L. Somers, United States Bankruptcy Judge

The Complaint in this adversary proceeding was filed by Bank of Commerce & Trust Company, Wellington, Kansas (Bank), to except from discharge under 11 U.S.C. §§ 523(a)(2) and (a)(6) its claim against Debtors Jonathan I. Schupbach and Amy M. Schupbach (collectively Debtors) and for a determination of the amount excepted from discharge. The Court has jurisdiction.¹ By Memorandum Opinion and Order issued on June 7, 2012, the Court granted Debtors' motion to dismiss the § 523(a)(2) count because it was not timely filed.² A two-day trial to the Court on the § 523(a)(6) count was held on July 9 and 10, 2013, after which the Court took the matter under advisement. Having carefully considered the pleadings, the evidence, the exhibits, and the statements of counsel, the Court is now ready to rule. For the reasons stated below, the Court denies the Complaint and finds that Bank's claim against Debtors is dischargeable.

THE ALLEGATIONS OF THE COMPLAINT.

Bank alleges that Debtors should not be discharged from damages caused by conversion. The conversion claim arises from six prepetition loans made by Bank to Debtors and their company, Schupbach Investments. Each of these loans was made for the purchase or refinance of an individual residential property. ³ It is alleged that the loan proceeds were advanced for the specific purpose of renovating the six homes and that Debtors converted the loan proceeds when the proceeds were used for other purposes, resulting in a willful and malicious injury of approximately $170,000 to Bank, within the meaning of § 523(a)(6).

FINDINGS OF FACT.

Beginning in 2001, Debtors engaged in the business of buying, owning, and selling homes in low income areas of Wichita, Kansas. Initially the business was conductedas a proprietorship, which by 2004 owned up to 50 homes. Starting in about 2004, the business was conducted through Schupbach Investments, L.L.C. (Schupbach Investments). Jonathan Schupbach was the manager and 50% owner. Amy Schupbach was a member and 50% owner. Both Jonathan and Amy worked full time for Schupbach Investments, with Jonathan making the decisions about properties to purchase, renovate, rent, and sell, and Amy maintaining the financial records.

Schupbach Investments generally purchased distressed homes for less than fair market value, and then either rented or sold the properties. The purchase and renovation costs were financed through various lending institutions, including Bank. Bank started making loans to Schupbach Investments in 2004, when Clint Lawrence, currently a vice president of Bank and through whom the Schupbachs had obtained business loans while he was employed by another financial institution, solicited the Schupbachs' business. Although there is disagreement as to the exact number of loans,⁴ the evidence clearly showed that Jonathan Schupbach had a well-established and harmonious business relationship with Clint Lawrence and Bank. There was mutual trust, and a pattern of business practices developed. Schupbach Investments also obtained financing from other financial institutions, but Jonathan Schupbach generally contacted Bank to ascertain its interest before contacting other lenders.

Schupbach Investments filed for relief under Chapter 11 of the Bankruptcy Code on May 16, 2011. Jonathan and Amy Schupbach filed for relief on July 16, 2011, under Chapter 13, but the case was later converted to Chapter 11. Schupbach Investments' schedule A listed 165 parcels of real property, 39 of which were mortgaged to Bank. Bank filed a proof of claim for $748,748.72 against the Schupbachs.⁵

The six loans which are the basis for the conversion claim were made over a two-and-half-year period and involve single residential properties requiring improvements before being rented. The dates and the amounts of the loans, and the addresses and the purchase prices of the Wichita properties mortgaged to secure the loans are: September 18, 2007 loan for $41,600, secured by 2611 E. 13th Street,⁶ purchased for $5,000; ⁷ February 12, 2009 loan for $39,000, secured by 1539 N. Hillside,⁸ purchased for $6,000; ⁹ June 29, 2009 loan for $36,000, secured by 1524 N. Lorraine, ¹⁰ purchased for $2,000; ¹¹ July 14, 2009 loan for $45,750, secured by 1753 N. Chautauqua,¹² purchased for $13,500; ¹³ March 25, 2010 loan for $37,500, secured by 434 S. Illinois,¹⁴ purchased for $18,500; ¹⁵ and April 9, 2010 loan for $33,750, secured by 1504 N. Erie,¹⁶ purchased for $3,700.¹⁷

Each of the six loans was originated in accord with the customary procedures used by Bank and Schupbach Investments when Schupbach Investments desired financing to be secured by a home needing renovation. Jonathan Schupbach would contact Clint Lawrence. If Bank was interested in making the loan, Clint Lawrence would contact the appraiser whom he used for Wichita properties and who valued approximately 10 homes per year for loans to Schupbach Investments, resulting in the appraiser's being very familiar with Jonathan Schupbach and his business. Bank would instruct the appraiser to value the subject property as if the needed renovations and repairs had been completed. Then Jonathan Schupbach would show the property to the appraiser and inform him that he intended to make the “usual” renovations, meaning such things as roof repair, painting, new siding, new HVAC, and floor covering. Jonathan Schupbach did not provide the appraiser with a list of anticipated improvements for each property, but the appraisal report for each property included a list prepared by the appraiser of anticipated repairs. For example, the appraisal for the East 13th Street property states, “Owner is totally redoing the home inside and out. New electrical, new plumbing, new bath fixtures, dry wall, insulation, new porch, paint and siding. Storage shed,” ¹⁸ and the appraisal for the North Hillside property states, “New paint inside and out, carpet being replaced, new appliances, heat and air as needed, plumbing as needed and electrical as needed.” ¹⁹ The appraiser became comfortable with Jonathan Schupbach and his intent to make the needed repairs.

Bank would then loan Schupbach Investments an amount equal to 70% to 80% of the appraised value of the selected property for various terms, some for twenty years and some for one year. Each loan was evidenced by a promissory note executed by Debtors personally and on behalf of Schupbach Investments. ²⁰ The improvements enumerated in the appraisal report were not stated in the note. Each note would be secured by a mortgage of the subject residential property executed by Debtors on behalf of Schupbach Investments. No additional collateral was pledged, and the loans were not cross-collateralized. Debtors did not sign the appraisal report but were provided an opportunity to receive a copy of the report before closing. There is no evidence with respect to any of the six loans that Debtors requested a copy or that a copy was provided to them before the closing. As to the six loans in issue, both Jonathan Schupbach and Amy Schupbach testified that they did not receive a copy of the appraisal report before executing the note for any of the properties.

When each of the six loans was made, the loan amount, usually less some loan costs, was disbursed to Schupbach Investments by a cashier's check in a lump sum. The proceeds were deposited into Schupbach Investments' general business account at another bank. There was no requirement or expectation by Clint Lawrence that the proceeds would be segregated from other funds. Bank no made attempt to retain a security interest in the loan proceeds.

The loan proceeds were used for the general business expenses of Schupbach Investments. Some of the withdrawals from the account were for Debtors' personal expenses, such as home mortgage payments and utility costs. But Debtors, who worked full time for Schupbach Investments, were not paid salaries and regarded use of company funds for their personal expenses as their compensation. Salaries paid Debtors would have been regarded as business expenses; payment of personal expenses in lieu of salaries should also be so regarded. Further, examination of the bank statements shows that there were sufficient deposits from sources other than Bank's loans to cover the personal expenses. The Court therefore rejects Bank's position that the proceeds were used in part for purposes other than the business of Schupbach Investments.

Amy Schupbach, who maintained the financial records, could not identify any specific expenditures for improvements to the six mortgaged properties, but she did testify that some of the ongoing expenses, such as for contractors whom Schupbach hired to repair and maintain the company's properties, could have spent time on some of the six homes. Jonathan Schupbach testified that although he disagreed with some of the specific renovations listed on the appraisal reports, he intended to renovate the properties mortgaged to secure the six loans. As a business practice, Schupbach Investments made repairs on an as-needed basis. Easy turnaround homes were repaired first, and repair of those needing significant work was deferred. In 2010, Jonathan Schupbach estimated that there were 18 homes in line for repairs, and that although he intended to repair the six homes financed by Bank, all the company's resources were being devoted to other properties. As to the six homes, the electrical service ...