Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-canb-3_04-ap-03177/USCOURTS-canb-3_04-ap-03177-0/pdf.json

Parties Involved:
Kathleen A. Smith
Plaintiff
Nicholas James Fetherolf
Defendant

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MEMORANDUM OF DECISION -1-

DO NOT PUBLISH

UNITED STATES BANKRUPTCY COURT

FOR THE NORTHERN DISTRICT OF CALIFORNIA

In re

NICHOLAS JAMES FETHEROLF, 

Debtor.

 

KATHLEEN A. SMITH,

Plaintiff, 

vs.

NICHOLAS JAMES FETHEROLF, 

Defendant.

 

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Case No: 04-31106 TEC7

Chapter 7

Adv. Proc. No. 04-3177 TEC7

MEMORANDUM OF DECISION

This action came to trial on October 5, 2005. Mark K. Oto

appeared for Plaintiff. Defendant appeared in pro per. Plaintiff

seeks the denial of Defendant’s discharge and a determination that

Defendant’s obligation to her is nondischargeable. For the reasons

stated below, I determine that Defendant should not be denied a 

Signed and Filed: November 02, 2005

________________________________________

THOMAS E. CARLSON

U.S. Bankruptcy Judge

________________________________________

Entered on Docket 

November 02, 2005

GLORIA L. FRANKLIN, CLERK 

U.S BANKRUPTCY COURT 

NORTHERN DISTRICT OF CALIFORNIA

Case: 04-03177 Doc# 31 Filed: 11/02/05 Entered: 11/02/05 11:52:22 Page 1 of

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MEMORANDUM OF DECISION -2-

discharge, but that Defendant’s obligation is nondischargeable to

the extent of $11,000, the value of collateral that Defendant 

converted to his own use.

FACTS

Plaintiff Kathleen A. Smith loaned Defendant Fetherolf $61,000

in February 2001. Plaintiff’s daughter, Penelope, was Defendant’s

girlfriend at the time. Defendant used the money to start a

computer supply business. Penelope worked in the business keeping

books, preparing checks for payment, and doing other office work.

The loan was memorialized in a promissory note (“the Note”). 

The Note recites “[s]ecurity given on the loan is (1) 2000 Chevy

Astro, (2) 1993 Acura Legend and (3) 1996 Honda.” Debtor actually

owned two Chevy Astros at the time, but all witnesses agree that

the parties intended that security interest attach to the van he

then owned free and clear (VIN ...47). It is undisputed Defendant

also owned the Acura and the Honda free and clear at the time he

signed the Note and received the loan proceeds. Defendant did not

give Plaintiff the pink slips for the three vehicles at the time he

signed the Note.

Defendant incorporated the computer supply business as Remedy

Computers Inc. (the Corporation). The Corporation earned only

small profits between the time of its inception in early 2001 and

the time both the Corporation and Defendant filed chapter 7

petitions on April 22, 2004. Penelope testified that Defendant

spent all the profits that the Corporation did earn on his personal

living expenses.

Defendant made numerous payments on the Note. Under the terms

of the Note, no payments were called for until March 2002. 

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MEMORANDUM OF DECISION -3-

Defendant made payments from March through October 2002, and in

April, May, and June 2003. 

In February 2003, Penelope gave birth to a child fathered by

Defendant. In June 2003, Penelope left Defendant. Penelope and

Defendant have been engaged in a bitter child custody dispute ever

since. Defendant made no payments on the Note after June 2003.

Shortly after she made the loan, Plaintiff began to ask

Defendant for the pink slips to the three vehicles that secured the

loan. Defendant never provided the pink slips to her, although

they were readily available.

In June 2002, Defendant sold the Acura Legend for $4,000. 

Although this vehicle was identified as collateral for the Note,

Defendant neither paid the proceeds to Plaintiff, obtained

Plaintiff’s permission to keep the proceeds, nor provided Plaintiff

replacement collateral.

In June 2003, Defendant sold the 2000 Astro Van (VIN ...47)

for $7,000. Although this vehicle was also collateral identified

in the Note, once again Defendant neither paid the proceeds to

Plaintiff, obtained her permission to keep the proceeds, nor

provided Plaintiff replacement collateral.

By early 2004, Defendant found himself in substantial

financial difficulty. The Corporation had never earned significant

profits. He lost important office help when Penelope left him. 

The custody dispute also created a significant burden. Defendant

first contacted bankruptcy attorney Adam C. Kent in February or

March 2004. Both Defendant and the Corporation filed chapter 7

petitions on April 22, 2004.

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MEMORANDUM OF DECISION -4-

One or two days before he filed the chapter 7 petition,

Defendant sold the second Astro Van (VIN ...95) for $7,000. This

van was not collateral for repayment of the Note. Defendant later

used the proceeds to pay delinquent payroll taxes owed to the IRS. 

Defendant’s schedules and statement of financial affairs were

inaccurate. In response to a question that asked him to disclose

transfers out of the ordinary course of business within the year

prior to the April 22, 2004 petition date, Debtor failed to list

the June 2003 transfer of the first Astro Van or the April 2004

transfer of the second Astro Van. In Schedule B, which asked him

to list all personal property, Defendant failed to list the 1996

Honda motorcycle, which was the third item of collateral to secure

repayment of the Note, and which he still held on the petition

date. Defendant also failed to list among his assets the proceeds

of the sale of the second van, or to disclose any transfer of those

proceeds (which were paid to the IRS on or shortly after the

petition date).

Defendant’s business records are also haphazard. He was

unable to produce a general ledger or periodic statements of

business operations. His business records consist primarily of

bank statements for his business and personal accounts.

In the present action, Plaintiff asserts that Defendant’s

obligations under the Note should be determined to be

nondischargeable under section 523(a)(2), because Defendant induced

Plaintiff to make the loan through intentional misrepresentations. 

More specifically, Plaintiff alleges that Defendant never intended

to repay the Note and never intended to give Plaintiff a security

interest in the vehicles listed in the Note. Plaintiff also seeks

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MEMORANDUM OF DECISION -5-

to have Defendant denied a discharge on the bases: (1) that

Defendant failed to maintain records from which his financial

condition can be ascertained; and (2) that Defendant concealed or

transferred the three vehicles that constituted Plaintiff’s

collateral with the intent to delay or defraud creditors.

ANALYSIS AND DECISION

1. Fraud in the inducement. I find that Defendant did not

fraudulently induce Plaintiff to make the loan. At the time he

obtained the loan and signed the Note, Defendant intended to repay

the loan and to provide Plaintiff a security interest in the

vehicles listed in the Note.

In this regard, I first note that Defendant made a substantial

number of payments on the Note, and completely stopped making

payments only after Plaintiff’s daughter broke off her relationship

with Defendant. This break-up did not, of course, excuse the

breach of contract, but the payment history clearly suggests that

any deliberate decision not to repay occurred after Defendant

obtained the loan.

I also note that Defendant did provide Plaintiff a security

interest in the three vehicles. I find that the language in the

Note was sufficient by itself to grant a security interest. 

See Nolden v. Plant Reclamation (In re Amex-Protein Devel. Corp.),

504 F.2d 1056, 1058-60 (9th Cir. 1974). It is undisputed that the

other requisites for the attachment of a security interest also

existed at the time the loan was made: Plaintiff had advanced funds

to Defendant, and Defendant owned the vehicles. See Cal. Comm.

Code § 9203(a),(b). Defendant’s failure to provide Plaintiff the

pink slips did render Plaintiff’s security interest unperfected and

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1

 The complaint did not allege conversion of the collateral as

a basis for nondischargeability, but instead alleged more generally

that Defendant never intended to perform the security agreement. 

The complaint did allege transfer or concealment of the collateral

with the intent to defraud creditors in general as a basis for

denial of discharge. For the reasons set forth below, I determine

MEMORANDUM OF DECISION -6-

therefore vulnerable to the claim of a good faith purchaser. This

unperfected security interest was, however, still enforceable

between Plaintiff and Defendant. See Cal. Comm. Code § 9201(a).

The evidence also shows, however, that Defendant willfully and

maliciously failed to pay the Plaintiff the proceeds from the 2002

sale of the Acura Legend, and from the 2003 sale of the Astro Van.

I find that Plaintiff had a property interest in these proceeds. 

See Cal. Comm. Code §§ 9203, 9306. I find that Defendant knew

Plaintiff had such an interest. I find that Defendant acted with

the subjective intent of depriving Plaintiff of her interest in

these proceeds. In so finding, I note that starting sometime after

he received the loan, Defendant refused Plaintiff’s repeated

requests for the pink slips. Possession of the pink slips would

have enabled Plaintiff to obtain the proceeds of any sale. I also

note that the second failure to turn over the sale proceeds

occurred just after Plaintiff’s daughter left Defendant. Defendant

also stopped making payments on the Note at this time. These

circumstances suggest that the failure to pay over the proceeds of

sale represented a deliberate decision never to pay Plaintiff the

value of the collateral, rather than an inability to pay or an

intent to pay at a later date. 

Thus, I find that Defendant is liable for conversion of the

$11,000 proceeds of the two sales noted above, and that this

obligation is nondischargeable under section 523(a)(6) of the

Bankruptcy Code.1

 Because of Defendant’s insolvency and the fact

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28 that the transfer of the collateral is not a basis for denial of

discharge. I determine that the complaint should be amended to

conform to the evidence at trial. See Fed. R. Civ. P. 15(b) and 

Fed. R. Bankr. P. 7015.

MEMORANDUM OF DECISION -7-

that the conversion consisted of a failure to pay cash proceeds of

a sale in satisfaction of a debt, I determine that punitive damages

are not appropriate.

Plaintiff is also entitled to enforce her security interest in

the motorcycle still held by Defendant. The chapter 7 trustee

never attempted to avoid Plaintiff’s unperfected security interest. 

As noted earlier, the unperfected security interest is fully

enforceable between Plaintiff and Defendant. Cal. Comm. Code 

§ 9201(a). 

2. Denial of discharge. Defendant should not be denied a

discharge under section 727(a)(3) on the basis that he failed to

preserve records from which his financial condition can be

ascertained. Defendant’s business records are not exemplary. But

we must remember that Defendant is not well-educated, and that he

ran a small business. More important, the records are sufficient

for the core purpose of determining whether Defendant had withheld

assets from creditors. The bank records are sufficient to show

that he did not divert cash or other assets from the business and

his creditors. Moreover, Plaintiff’s own evidence explains the

financial condition of Debtor and his wholly owned Corporation at

the time of bankruptcy. Plaintiff’s daughter testified that the

Corporation earned only small profits and that Defendant spent

those profits promptly on living expenses. Finally, the state of

Defendant’s records reflects a general sloppiness, rather than

Defendant’s attempt to cover his tracks.

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2

 The wild-card exemption available to Defendant was $17,425. 

See Cal. C.C.P. § 703.140(a), (b)(1). Defendant had used only

$3,000 of that amount in his schedule C. The van sale proceeds

($7,000) and the value of the motorcycle ($1,000) total less than

the unused wild-card exemption ($14,425).

MEMORANDUM OF DECISION -8-

Although it is a closer question, Defendant also should be not

denied a discharge on the basis of the inaccuracies in his

schedules and statement of financial affairs. Defendant’s failure

to disclose his sale of the second van and his failure to list the

Honda motorcycle or the van sale proceeds in his schedules may have

been willful, but the omissions were not fraudulent. In this

context, a misstatement in fraudulent only if “made with the

intention and purpose of deceiving the creditors.” Roberts v.

Erhard (In re Roberts), B.R. , 2005 WL 2508144 at 6 

(9th Cir. BAP 2005). 

The circumstances suggest that neither Defendant’s failure to

disclose the sale of the second van, nor his failure to list the

motorcycle or van sale proceeds among his personal property were

intended to deceive his creditors. First, Defendant had no motive

to do so. Defendant could easily have exempted both the motorcycle

and van sale proceeds using his wild-card exemption.2

 Nor was he

hiding these assets from secured creditors against whom the

exemption would be ineffective. The van proceeds were not

encumbered. The motorcycle was encumbered by Plaintiff’s lien, but

she already knew Defendant still had that motorcycle. Second,

Defendant is not well-educated (he left school after the ninth

grade) and the overall manner in which he kept records and

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3

 Defendant did not list in his statement of financial affairs

the transfer of the van sale proceeds to the IRS, but the evidence

suggests that he made that transfer postpetition. It appears that

Defendant bought a cashiers check on the same day he filed his

bankruptcy petition. It is more likely than not that the IRS

received this check postpetition. Thus, Defendant would not think

of this as a prepetition transfer to be disclosed.

MEMORANDUM OF DECISION -9-

completed his bankruptcy papers evinces a general carelessness,

rather than any intent to conceal specific facts.3

There is also no reason to believe Defendant’s failure to list

the June 2003 transfer of the first van was fraudulent. The only

creditor who could be affected by that transfer was Plaintiff, and

Defendant knew Plaintiff would never be deceived by his failure to

disclose that transfer. Plaintiff knew she had a security interest

in those vehicles and would inevitably demand surrender of her

collateral or its proceeds.

Finally, Defendant should not be denied a discharge on the

basis of his conversion of Plaintiff’s collateral. Defendant did

not sell the collateral with the intent to hinder, delay, or

defraud creditors in general. The sales were at arms-length and

the proceeds were retained and used by Debtor. The failure to pay

the sale proceeds to Plaintiff was wrongful toward Plaintiff

specifically, not an injury to creditors as a whole, and should be

analyzed under section 523(a)(6), as the court has done above. 

CONCLUSION

Plaintiff made a risky loan to her daughter’s boyfriend to

help him start a business. Defendant demonstrated his original

intent to repay that loan by making payments fairly regularly until

Plaintiff’s daughter left him. Plaintiff’s own evidence shows that

Defendant consumed contemporaneously all the profits that the

Corporation created and, thus, Defendant’s haphazard business

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MEMORANDUM OF DECISION -10-

records and bankruptcy papers do not serve to hide assets from his

creditors. Plaintiff complains legitimately that she should have

received her collateral upon Defendant’s default. The judgment of

this court restores to Plaintiff the value of that collateral.

**END OF MEMORANDUM**

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Court Service List

Mark K. Oto, Esq.

Law Offices of Mark K. Oto

255 N Market Street, #260

San Jose, CA 95110 

Nicholas James Fetherolf

2995 Woodside Rd. #400

Redwood City, CA 94062 

E. Lynn Schoenmann

800 Powell Street

San Francisco, CA 94108

Office of the U.S. Trustee

235 Pine Street, Suite 700

San Francisco, CA 94104 

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