Bankruptcy Fraud

Full disclosure: I don’t know much about bankruptcy fraud. I know that bankruptcy courts have the authority to find that some debts are non-dischargeable. And in that event, filing the bankruptcy may not be the answer the debtor is seeking.

Regardless of my lack of knowledge, it’s a topic that is worth exploring. A recent case will illustrate the point.

In 2004 Humberto Saenz Jr. entered into a Franchise Agreement with Pizza Patron in south Texas. The Franchise Agreement prohibited Saenz from transferring franchises without the consent of the franchisor.

Saenz formed Estrella Ventures, LLC, for the purpose of operating four Pizza Patron restaurants. He financed his accounts receivable, inventory, equipment, furniture and fixtures with the International Bank of Commerce and a $480,000 loan. Sales must have been good, as the debt was reduced to $336,000 in five years

In 2009 Jose Maria Gomez approached Saenz to purchase one store. Gomez and Saenz reached a deal for Gomez to acquire the Rio Grande City Pizza Patron franchise for $350,000, just enough to pay off the IBC debt. Neither Gomez nor Saenz obtained written consent to the transfer from Pizza Patron.

Saenz furnished sales reports, tax returns and income statements to Gomez. Gomez used them to substantiate the purchase price, and predict future revenues and expenses.

Due to health concerns, Gomez closed the store in 2011. Saenz reopened it under the Pizza Patron name.

Gomez, unhappy with a $70,000 loss and believing that Saenz made material wrongful misrepresentations to Gomez which induced Gomez to purchase the store, sued Saenz for fraud. Saenz countered by filing a Chapter 7 bankruptcy petition. The lawsuit was dispatched to bankruptcy court, where the court found for Gomez, entered judgment for $412,000 against Saenz, and determined that since the claim was based in fraud a discharge in bankruptcy would not serve to avoid the judgment.

In other words, the underlying purpose of the Chapter 7 bankruptcy filing – to duck the claim of Gomez – would not succeed and Gomez would still be able to collect monies owed to him even after the bankruptcy was concluded.

Saenz appealed.

The United States Court of Appeals looked at the evidence presented and determined that Saenz “lied frequently whenever it suited him.” Income Statements furnished by Saenz were false; discrepancies in accounting procedures and royalty payments were “problematic and unacceptable.”

The bankruptcy court had the right to weigh the credibility of both Gomez and Saenz, and determine that Saenz’s fraudulent conduct induced Gomez to make business decisions. And that substantial losses were incurred.

Fraud claims are not dischargeable in bankruptcy. Gomez wins. Saenz loses. Gomez may now continue to extract the amount owing to him from Saenz regardless of Saenz’s Chapter 7 bankruptcy proceeding.

See Humberto Saenz v. Jose Maria Gomez; No 17-41004; United States Court of Appeals of Texas, 5^th Circuit, August 7, 2018: https://www.law.com/texaslawyer/almID/1534478158TX1741004/.    

Lessons Learned / Questions Asked:

1.      Fraud claims are not dischargeable in bankruptcy.

2.      Independent due diligence and analysis is critical not only in real estate deals, but also in general business transactions. Complete trust in one party’s statements without verification can yield money losses and litigation.

3.      There’s an unreported piece to this case. Although Gomez ultimately prevailed in our legal system – did he really? He likely spent an exorbitant amount in legal fees to obtain a Judgment. And now what? Our Texas homestead and other debtor-exemption laws are still available to Saenz. What happens if Saenz uses those laws to his benefit and doesn’t pay Gomez – then who won?

                                                                                    Stuart A. Lautin, Esq.*

* Board Certified, Commercial (1989) and Residential (1988) Real Estate Law,

Texas Board of Legal Specialization

Licensed in the States of Texas and New York

Higier Allen & Lautin, PC

Commercial Lease Security Deposits

Our Texas Courts rarely give us insight into the interpretation of commercial lease security deposits laws. Until recently. New guidance awaits.

In August 2010 ProLogis Texas II leased real property in Sugar Land, Texas, to Daryl Flood Logistics. Daryl Flood assigned the lease to FP Stores in 2013, who, in turn, subleased part of it to Tramontina US in 2014.

I intuitively like Tramontina; they have an interesting spiced, citrus-glazed short rib recipe on their website: https://www.tramontina-usa.com/recipes/spiced-citrus-glazed-short-ribs. Ok so that was a minor digression and possibly reflects my ADD. I’ll take another pill now . . .

Tramontina paid FP a $50,000 sublease security deposit. The sublease required FP to refund the deposit, less proper deductions, within 60 days after Tramontina vacated.

The Master Lease between ProLogis and FP Stores terminated March 8, 2015, so by operation of law – the sublease also terminated. FP vacated but Tramontina stayed, as the direct tenant of ProLogis.

A week after termination Tramontina sent a letter to FP with Tramontina’s new forwarding address and demand to return the deposit within the time allowed by Texas law. Regardless, more than two months elapsed without either a return of the deposit or tender of an accounting that would provide for deposit offsets.

Tramontina sued FP for the refund of its security deposit, which by law is required to be returned within 60 days if a shorter time is not otherwise provided in the sublease. See Texas Property Code 93.011: https://statutes.capitol.texas.gov/Docs/PR/htm/PR.93.htm. That same law states that a landlord can be liable for triple damages if the monies are not timely returned, or otherwise a written description of damages and itemization of charges is not timely furnished.

The trial court agreed with Tramontina’s position and awarded Tramontina $150,100 ($50,000 times three, plus $100 statutory damages – exactly as stipulated in the Texas Property Code) and $25,000 in attorney’s fees.

FP appealed.

The Court of Appeals found – surprise to no one – virtually no cases on point in Texas regarding commercial leases although we have had this law for 29 years. So the Court reviewed parallel Texas statutes that are relevant to residential security deposits.

In doing so, the Court decided that the landlord must prove its good faith to avoid liability for treble damages. Good faith, the Court determined, is “honesty in fact in the conduct or transaction concerned” and that the landlord did not intend to deprive the tenant of its rights or of a lawfully due refund.

From there, it was a short stretch to determine that FP had presented at least some evidence that it had intended to act in good faith.

Judgment for Tramontina is reversed; the case is returned to trial court for a do-over. See FP Stores, Inc. v. Tramontina US, Inc.; No 01-16-00031-CV; Court of Appeals of Texas, Houston (1^st District), December 29, 2016: https://caselaw.findlaw.com/tx-court-of-appeals/1763335.html.    

Lessons Learned / Questions Asked:

1.                  This landlord was not found responsible for triple damages. But in doing so, it had to defend a lawsuit in trial court, appeal to the Texas Court of Appeals, and if the litigation was not settled, endure yet another trial back in the district court of Fort Bend County. What do you think this landlord spent in attorney’s fees - $100k? To save $50k?

2.                  While there is honor in defending your position, there is also a substantial cost in doing so. My assumption is that FP would have been *far ahead if it would have timely complied with Texas laws and the Sublease terms.

3.                  In my experience, the landlords that are most at risk are the ones that do not routinely engage in commercial real estate leasing. They don’t know the laws; they don’t have appropriate accounting procedures for deposit return. Brokers can help rookie landlords and tenants by tracking the termination dates of leases and subleases, and then making all parties aware that the security deposits must be timely processed.

                                                                                    Stuart A. Lautin, Esq.*

* Board Certified, Commercial (1989) and Residential (1988) Real Estate Law,

Texas Board of Legal Specialization

Licensed in the States of Texas and New York

Higier Allen & Lautin, PC

2711 N. Haskell Avenue, Suite 2400

Dallas Texas 75204

P: 972.716.1888

E: slautin@higierallen.com

W: www.higierallen.com

Lease Guaranty v 2.0

Faith and True Christian Center, Inc. entered a commercial Lease with USA Real Estate-2, LLC, in which Faith leased space from USA for church activities. The Lease was for five years beginning September 1, 2007. When the Lease was executed the church’s pastor and president, Anthony Harrison and his wife, executed a personal Guaranty along with other persons in leadership positions at the church.

The Guaranties were accepted by USA Real Estate, after it had reviewed and approved federal and state tax returns of the Guarantors.

None of the Guarantors had any ownership interest in Faith; none of them were “commercially sophisticated” as observed by the circuit court.

In any event, evidently Faith was suffering from financial problems so Pastor Harrison sought a Lease extension in exchange for lowering the monthly rental and extending the term for three more years. Harrison did not seek the consent of the other Guarantors who may have objected had they known of Harrison’s plan.

Unfortunately, three years after the Lease was extended Faith was unable to pay the reduced rent. Consequently, Faith and USA Real Estate agreed that Faith would vacate the property eight months before expiration of the Lease term.

After Faith vacated, USA Real Estate asserted a lawsuit against Faith, Pastor Harrison and the other Guarantors. The claims against Pastor Harrison and his wife were dismissed due to a bankruptcy discharge. The litigation continued against Steve Carter and the remaining Guarantors.

At the conclusion of the trial, the circuit court found that Carter and the remaining Guarantors did not consent to the Lease extension amendment. And consequently, Carter and the Guarantors were not liable for rental due under the Lease extension amendment.

USA Real Estate appealed.

The Appellate Court accepted the evidence that the Guarantors did not know of the Lease extension amendment until they were sued. And that date was almost four years after the amendment was executed.

The issue presented to the Court related solely to the language of the Lease and Guaranty.

The Lease stated that no notice to the Guarantors is required with respect to an indulgence, modification, alteration, or accommodation. USA Real Estate focused on the word modification and claimed that a modification is similar to a Lease amendment.

The Appellate Court looked high and low for language in the Lease or Guaranty providing for extensions without the Guarantors’ specific consent. Failing to locate that exact provision, the Court determined that the terms “Lease modification” and “Lease extension” were sufficiently different.

The Court then concluded that absent the formal written consent of the Guarantors to the Lease extension, the Guarantors could not be liable for rental during the Lease extension period.

Judgment for the Guarantors is affirmed; the Guarantors are not liable for rental during the extension period. See USA Real Estate-2, LLC v. Carter; No 2648; Maryland Court of Special Appeals, January 12, 2018: https://scholar.google.com/scholar_case?case=11118511451226795847&hl=en&as_sdt=6&as_vis=1&oi=scholarr.    

Lessons Learned / Questions Asked:

1.      Most commercial Leases are also guaranteed by one or more Guarantors, right? And experienced Guarantors often negotiate and change the text of the Guaranty Agreements, yes?

2.      Both before and after edits, does your Lease Guaranty Agreement provide for the ongoing / continuing duty of the Guarantors without requiring their written consent?

3.      This lawsuit could possibly have been avoided if the Landlord or its agents had obtained execution of the Lease amendment by the Guarantors. And – the Guarantors could not have complained that they were surprised and only learned of the *not* modification when the lawsuit was asserted. Best practice suggests that Landlords and property managers always obtain the written consent of the Guarantors to all extensions, amendments, modifications, renewals, novations, and adjustments, regardless of the text of your Guaranty Agreements.

                                                                                    Stuart A. Lautin, Esq.*

* Board Certified, Commercial (1989) and Residential (1988) Real Estate Law,

Texas Board of Legal Specialization

Licensed in the States of Texas and New York