McClung v. Castaneda (In re Castaneda)
| Decision Date | 26 January 2022 |
| Docket Number | CASE NO: 20-35854,ADVERSARY NO. 21-3051 |
| Citation | 638 B.R. 737 |
| Parties | IN RE: Luis Alberto CASTANEDA and Esther Alicia Castaneda, Debtors. Matthew McClung, Plaintiff, v. Luis Alberto Castaneda and Esther Alicia Castaneda, Defendants. |
| Court | U.S. Bankruptcy Court — Southern District of Texas |
John Akard, Jr., Coplen & Banks, PC, Cypress, TX, for Plaintiff.
Jack Nicholas Fuerst, Attorney at Law, Houston, TX, for Defendant Esther Alicia Castaneda, Luis Alberto Castaneda.
Luis Alberto Castaneda and Esther Alicia Castaneda ("Debtors," "Defendants" or "Castanedas") are small business owners, and experienced restauranteurs, who filed Chapter 7 in the expectation that they would get a fresh start. However, the Bankruptcy Code will not discharge debt that was incurred through intentional wrongdoing. Here, the plaintiff invested in an existing restaurant owned and operated by the Debtors in July of 2018. He then invested additional funds in 2018 and 2019 for a 25% ownership interest in another restaurant, which was also to be owned and run by the Debtors. The plaintiff argues that his debt is non-dischargeable as his funds were obtained by fraud (excepted from discharge under Section 523(a)(2)(A)), or were embezzled (excepted from discharge under Section 523(a)(4)), or for willful and malicious injury (excepted from discharge under Section 523(a)(6)). The Debtors’ explanation was that the new restaurant was amongst the victims of the COVID-19 pandemic after all restaurants were closed by the Fort Bend County Judge. The Court agrees that the Debtors embezzled funds and the debt of $137,500.00 is excepted from discharge.
Jurisdiction is conferred on this court by 28 U.S.C. § 157(a). The parties have entered into a Joint Pretrial Stipulation (ECF No. 35 ), which the Court adopts. The parties agree that this is a core proceeding and this Court has authority to render a final judgment in this proceeding.1
Trial was held on January 25, 2022, with the plaintiff, Matthew McClung and a defendant, Luis Alberto Castaneda as witnesses.
This adversary proceeding No. 21-03051 was filed on April 6, 2021 (ECF No. 1 ) by plaintiff, Matthew McClung (hereinafter "McClung" or "Plaintiff"). An answer was filed on May 21, 2021 (ECF No. 11 ). Thereafter, Plaintiff filed an Amended Complaint on December 17, 2021 (ECF No. 22) (the "Complaint"), the live pleading, concerning whether the debt owed by the Castanedas in the amount of $175,000 to Plaintiff is a non-dischargeable debt pursuant to 11 U.S.C. § 523(a)(2)(A), (a)(2)(B), 11 U.S.C. § 523(a)(4), and (a)(6) ; and alleging that Plaintiff is entitled to a constructive trust for the funds that he loaned to the Defendants. Although the Complaint lists Section (a)(2)(B) in the initial paragraph of the Complaint, there are no other allegations regarding that section in the remainder of the Complaint, nor at trial on this matter.
The parties agree that McClung was a customer at the midtown Houston restaurant Luna y Sol Mexican Grill (the "Grill"), and through frequenting the restaurant, got to know the Castanedas. The Castanedas were the sole members, managers and officers of the Grill, and ran the day-to-day operations of the Grill.
Their daughter, Anna Castaneda, also a manager at the restaurant, and in conversations with McClung indicated her parents were considering setting up a food truck to supplement their business. McClung mentioned that he had worked with a couple of small businesses, providing loans for operating capital if her parents ever wanted to talk.
The Castanedas contacted McClung and indicated that they had decided not to go into the food truck business, but rather wanted to make improvements to the Grill. In their discussions, the Castanedas said they needed funds to revamp the bar area, add new furniture and related fixtures, and add a "buzzer" system whereby customers would receive a buzzer and be buzzed once food was ready, notifying them to go to the counter and retrieve their food. Using the buzzer would allow the Grill to reduce staff (and enhance profit) because fewer food runners would be necessary to take food to customers. The Castanedas represented that their business was growing, and they were wanting to expand the location and do more catering as well.
McClung agreed to make a short-term loan to the Defendants in the amount of $50,000.00 to be deposited for the use of the Grill, and to improve the restaurant. On July 27, 2018 a Loan Agreement2 was signed providing for 12% interest to be paid quarterly, with the principal of $50,000 due on July 29, 2020.
McClung did receive loan interest payments of $1,500.00 each on October 31, 2018, February 19, 2019, and May 3, 2019 pursuant to the terms of the $50,000.00 loan. In the meantime, the parties discussed further expanding the restaurant business. The Castanedas were evaluating the market in Katy and were considering adding two (2) additional restaurants and potentially more. The Castanedas wanted to follow the Hwy 99 corridor opening several restaurants over the next few years. They planned to start a restaurant in a new development called District West (https://www.district-west.com/)
The Castanedas put in a letter of intent to open a flagship Luna y Sol restaurant at District West. District West was to break ground in October of 2018 and the new restaurant would be in business the following May. However, prior to opening this "flagship" restaurant, the Castanedas wanted to open a small bakery/restaurant that would produce additional revenue and help fund the flagship. The "deal" was that McClung would invest in the bakery/restaurant in exchange for a large equity stake and he would be given a preferred position to invest in the flagship.
The plan for the bakery/restaurant was to make fresh tortillas and Mexican baked goods. The Castanedas planned to run the restaurant and generate royalties by selling house made salsa and tortilla recipes by licensing to other vendors. The Castanedas even mentioned having Luna y Sol tortillas and salsa at HEB and similar stores. The Castanedas provided to McClung a business plan that indicated it needed $125,000.00 for the build out of a bakery/restaurant, equipment, furniture, fixtures and working capital.
From November 2018 through May 2019 (with an additional $5,300 to cover rent in August 2019), McClung "invested" $87,500 in the new restaurant in exchange for a 25% ownership interest. The Castanedas did not open a bakery but did open a casual Mexican restaurant, Luna y Sol Mexican Eatery ("the Eatery") in January 2020.
Thus, McClung's total investment was $92,800. The Eatery was located in The Shops on Richmond Lakes. The original lease for the space included a Tenant Allowance of $59,377.50.3 After entering into the lease and having only taken minor steps in finishing out the anticipated Shops on Richmond Lakes location, another space in the strip center opened up which was previously an Asian food restaurant. The landlord agreed to change locations and entered into an amendment to the lease. The Lease Amendment provided for $118,755.00 Tenant Allowance.4 The Castanedas were the managers and officers of the Eatery and held the majority membership interest in the Eatery.
The Castanedas also applied for funding from NextSeed in December 2018, but NextSeed refused to provide funding. In connection with negotiations with Inroveca in 2019 to loan money to the Eatery, the Castanedas prepared a business plan reflecting significant sales over the next several years and a total funding request of $125,000 for "the build out of the restaurant, equipment, furniture, fixtures and working capital."5 The Castanedas provided a copy of the business plan to McClung as well. Ultimately, Inroveca loaned $150,000 in 2019 to the Eatery, which allowed it to purchase the assets of the Asian restaurant.6
The Grill closed in June of 2019, the Eatery opened in January of 2020 and closed in September 2020, with all investors losing their funds. Prior to closing, the Eatery received a PPP loan for approximately $65,000.00.
Although, the Castanedas blame the failure of the Eatery on the pandemic, the Plaintiff alleges that it was the misrepresentations regarding the cash flow issues at the Grill, as well as the embezzlement of the funds that he loaned and invested with them for their own personal use, that caused the closures of the two businesses. In all, the Plaintiff alleges that the Defendants misappropriated between $300,000 and $500,000 from the Grill and the Eatery for their personal benefit, including funding repairs to their personal home. The Court finds four separate causes of action.
McClung asserts that the Castanedas used his entire initial loan of $50,000.00 for personal expenses, instead of for operating expenses and improvements to the Grill as set forth in the Loan Agreement. In support of his assertion, McClung offered the Grill's bank account records, account No. 6142.7 These records show the deposit of the $50,000.00 on July 26, 2018. The beginning balance in the account on July 26, 2018 was $0.19. In reviewing the total deposits and transfers from July 27, 2018 through August 16, 2018, the Court finds that all of McClung's funds were exhausted by August 16, 2018, leaving a balance in the bank account of $0.46.8 During this period of time, six transfers were made to the Castanedas’ personal bank account totaling $31,540.00.9 Mr. Castaneda did not testify as to what operating expenses or improvements were made with any of these funds, and presented no evidence as to how these funds were spent. The Plaintiff testified that no improvements were made to the Grill during this time.
However, contrary to Defendants’ representations, the Grill had significant cash flow issues at this time, and the Castanedas were diverting the company loaned funds to other uses. On July 27, 2018,...
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