Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-caeb-2_16-ap-02055/USCOURTS-caeb-2_16-ap-02055-0/pdf.json

Parties Involved:
Armando Garcia Hernandez
Plaintiff
Paul Langford Farrow
Defendant
Tina Bernice Farrow
Defendant

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UNITED STATES BANKRUPTCY COURT

EASTERN DISTRICT OF CALIFORNIA

SACRAMENTO DIVISION

In re

PAUL & TINA FARROW,

Debtors.

 

ARMANDO GARCIA HERNANDEZ,

Plaintiff,

vs.

PAUL LANGFORD FARROW, ET AL,

Defendants.

 

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Case No. 15-29917-A-7

Adv. No. 16-2055

FINDINGS OF FACT AND CONCLUSIONS OF LAW

Plaintiff Armando Garcia Hernandez maintains that a debt

arising from defalcations by chapter 7 debtors and defendants

Paul Langford Farrow and Tina Bernice Farrow of partnership

assets is nondischargeable pursuant to 11 U.S.C. § 523(a)(2)(A),

(a)(4), and (a)(6). The court largely agrees.

This court has jurisdiction over this adversary proceeding

pursuant to 28 U.S.C. §§ 151, 157, and 1334. This is a core

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proceeding within the meaning of 28 U.S.C. § 157(B)(2)(I), in

which the court has the constitutional power to enter a final

judgment.

Findings of Fact

1. The plaintiff and the defendants formed a partnership

around November 2014 to distribute ice under the business name

Polar Bear Ice.

2. The partners had no written partnership agreement.

3. The defendants also operated a separate business,

Farrow Distributing, in which the plaintiff had no interest. 

Farrow Distributing was a Crystal Cream and Butter distributor in

Sutter County. This distribution business had been operating for

approximately 20 years when the parties entered into their

partnership.

4. The partners orally agreed as follows:

a. Polar Bear Ice would sell ice and no other products.

b. Profits and losses would be divided evenly between the

plaintiff, on the one hand, and the defendants, on the other

hand.

c. The plaintiff and the defendants intended to piggyback

the new partnership’s business on Farrow Distributing’s

business assets. That is, Polar Bear Ice would use Farrow

Distributing’s business premises (located at 401 Colusa

Avenue in Yuba City), employees, trucks, and equipment when

possible. The partners would contribute cash, services, and

materials whenever necessary. Only if and when the

partnership was profitable would contributions, whether in

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kind or capital, be repaid and distributions made to the

partners.

d. Farrow Distributing also distributed ice. When the

partnership was formed, the defendants agreed this would

stop and all ice would be distributed through Polar Bear Ice

for the benefit of the partnership.

e. Mrs. Farrow was to serve as the bookkeeper for Polar

Bear Ice although Mr. Farrow and the plaintiff also

regularly made entries in the partnership’s books. Mr.

Farrow and the plaintiff were to deliver ice to customers.

5. As the partners began Polar Bear Ice, Farrow

Distributing was in decline. It later ceased operating in

September 2015. When it failed, it owed outstanding state and

federal taxes of approximately $45,000, insurance premiums of

more than $1,500, a bank loan exceeding $109,000, and more than

$22,000 to a supplier.

6. However, Farrow Distributing managed to stay in

business a bit longer than Polar Bear Ice. On August 14, 2015,

Paul Farrow notified the plaintiff that their partnership was

dissolved. It was not until September 2015 that Farrow

Distributing closed its doors.

7. The partnership ended when the plaintiff questioned

whether Polar Bear Ice’s income and assets were being diverted by

the defendants for the benefit of Farrow Distributing and/or the

defendants. See Exhibit 12. When the plaintiff asked for an

accounting and an explanation, he was advised in writing by Paul

Farrow that their partnership was at an end. See Exhibit 10.

8. At first, the defendants offered to allow the plaintiff

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to take over the partnership business. See Exhibits 10 and 15. 

By August 20 the defendants refused to follow through with this

offer and the plaintiff was locked out of the business premises. 

See Exhibit 16.

9. The plaintiff asserts that the defendants diverted,

both before and after August 14, the following assets for nonpartnership purposes:

a. $1,000 was taken from the partnership account and paid

to Crystal Milk on account of an obligation owed by Farrow

Distributing. See Exhibit 1.

b. $890 was taken from the partnership bank account and

paid to Farrow Distributing. See Exhibit 2.

c. The partnership bank account was used to pay $5,774.03

to Penske for rental trucks used by Farrow Distributing, not

the partnership. See Exhibit 7.

d. The partnership paid $5,500 for an event box which the

defendants have retained since the partnership dissolved. 

Also, the defendants inflated the cost of this item by

adding an additional $2,750 to the purchase price on its

books. See Exhibit 4.

e. The defendants diverted $10,793.73 from the partnership

account to pay down an obligation Farrow Distributing owed

to Wonder Ice Cream. See Exhibit 3.

f. The partnership purchased $114,486.05 in ice from,

primarily Diamond Ice and Wonder Ice, but the defendants

recorded the purchases as $131,797. Even when three other

purchases from Food Maxx and San Francisco Ice totaling

$1,226.59 are taken into account, the defendants overstated

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this expense by $9,644.98. See Exhibits 5, 11, 15, 22.

g. $2,497.91 belonging to the partnership was

misappropriated by the defendants.

h. The plaintiff paid to the defendants $3,900 as a

partnership contribution but the defendants never deposited

this into the partnership bank account.

i. Mr. Farrow did not deposit cash totaling $674.48

collected from Polar Ice customers on August 13, 2015 into

the partnership bank account. See Exhibit 9.

j. Defendants took $391.98 from the partnership account to

purchase a television for their own use. See Exhibit 6.

k. The defendants retained for their benefit five display

doors belonging to the partnership. These have a value of

$500 each, a total of $2,500.

l. The defendants retained for their benefit the

partnership’s ending ice inventory, worth $13,706.20 at

cost. See Exhibit 15.

The plaintiff demands that these amounts, totaling

$60,317.56, be repaid so that the plaintiff can retire the debts

of the partnership and complete its dissolution. He also asks

that this debt be declared nondischargeable.

10. The defendants deny that $60,317.56 of partnership

money and assets were misappropriated.

a. The partnership used a freezer at Farrow Distributing

and the defendants reimbursed themselves the $1,000 for the

electricity consumed by the freezer. See Exhibit B.

However, as noted above, use of Farrow Distributing’s

business premises, including utilities, was one of the

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defendants’ contributions to the partnership. See Exhibit

I. And, the parties agreed that contributions would not be

repaid until the partnership was profitable. It was never

profitable, or at least the plaintiff was informed by the

defendants that it was not profitable. Hence, the $1,000

should not have been withdrawn from the partnership account

by the defendants.

b. The $890 allegedly was paid to Farrow Distributing as

reimbursement for a Penske rental truck used by the

partnership in May and June 2015 but incorrectly billed to,

and paid by, Farrow Distributing. See Exhibit C.

The defendants, however, produced no invoice from

Penske in the amount of $890. See Exhibit C. And, as noted

by counsel for the plaintiff, a truck rental expense from

Penske was not even entered on the partnership’s expense

journal until August 17, after the partnership had

dissolved. That entry lumped together all rental charges

for two trucks, one leased from November 5, 2014 to July 6,

2015, and a second from May 18, 2015 through August 15,

2015. See Exhibit F, p. 30 of 36. There is no indication

in the expense journal that the rental expense had been paid

by the defendants (unlike other expenses entered in the

partnership’s expense journal but paid by the defendants).

Based on this record, the court finds that the payment

of the $890 cannot be linked to an expense paid on behalf of

the partnership. It was misappropriated by the defendants.

c. The partnership bank account was used to pay $5,774.03

to Penske for a milk truck rented by Farrow Distributing,

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not the partnership. See Exhibit 7.

When the plaintiff challenged the payment of this

expense, the defendants attempted to set off $4,479 they

paid on behalf of the partnership for ice delivery trucks

against the $5,774.03. See Exhibit H. The $1,295.03

difference was accounted for as a capital contribution by

the defendants to the partnership. See Exhibit I.

However, under the agreement between the parties,

amounts each contributed were to be repaid only when the

partnership was profitable. The $4,479 could not be taken

as a set off. It was a capital contribution, not an

expense. 

d. The defendants acknowledge that they now possess the

event box and that it is an asset of the partnership. But,

the defendants deny that have inflated the cost of the event

box. They admit that Exhibit 4 misstates the cost of the

event box by an additional $2,750. Exhibit 4, however, was

a preliminary version of the partnership expense journal. 

Exhibit F is the final version and it correctly lists the

expense at $5,500.

The court finds that the defendants have not somehow

misappropriated the $2,750. However, they have appropriated

the event box for the their own use.

e. The defendants acknowledge that on June 27, 2015,

$10,793.73 was paid by the partnership to pay an obligation

Farrow Distributing owed to Wonder Ice Cream. Allegedly,

this done because the partnership wished to purchase ice

from Wonder Ice Cream over the July 4 holiday. Because the

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partnership did not have an account with Wonder Ice Cream

and because Farrow Distributing’s account was at its credit

limit, the defendants used partnership funds, with the

plaintiff’s consent, to reduce Farrow Distributing’s debt to

Wonder Ice Cream and then purchased ice on credit for the

partnership.

The court finds that the plaintiff did not agree to, or

even discuss, such an arrangement.

If the partnership paid an obligation of Farrow

Distributing to Wonder Ice Cream, why didn’t Farrow

Distributing pay for the ice purchased by the partnership? 

In fact, the partnership paid for that ice. See Exhibits 5

and F.

The defendants instead maintain that they gradually

reimbursed the partnership for the $10,793.73 and that their

payments to the partnership are documented in Exhibit D. 

Exhibit D, however, was not prepared contemporaneously with

these alleged payments. This is made obvious by the fact

that one of the alleged payments to the partnership ($1,000

on May 28, 2015) predates the $10,793.73 paid by the

partnership to Wonder Ice Cream.

Exhibit D was prepared after the plaintiff had accused

the defendants of misappropriating partnership funds to make

it appear he had agreed to a loan and that it had been

repaid.

A review of the alleged payments made by the defendants

to the partnership, as summarized on Exhibit D, reveals that

there is no documentation or corroboration that these

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amounts were to retire a loan to the defendants from the

partnership. It is equally plausible from the record that

most of these “payments” were funds that belonged to the

partnership or that were due it by its customers.

Only two of the payments, $800 and $2,000, post-date

the “loan” and were from the defendants to the partnership. 

The court will credit these amounts against the obligation

of the defendants to the plaintiff.

Exhibit D is an after-the-fact attempt to cast the

$10,793.73 misappropriation of partnership funds as a loan,

and to falsely document, other than the payment of $2,800,

its repayment.

f. While the defendants concede that the partnership

purchased $114,486.05 of ice from Diamond Ice and Wonder

Ice, and that ice purchases are recorded at $131,797.30 on

the partnership books, they deny that they have inflated ice

purchases. They maintain that the plaintiff has not

accounted for the fact that ice also was purchased from

other suppliers. See Exhibit F.

However, a review of Exhibits 5 and F reveal that the

documentary evidence produced by both sides includes proof

of only three purchases of ice from two other sources: two

purchases on July 16, 2015 from Food Maxx totaling $923.14

and one purchase of $302.95 on July 15, 2015 from San

Francisco Ice. These three purchases total $1,226.59, not

$9,644.98. Further, the plaintiff has taken these three

purchases into account. See Exhibit 11. The court finds

that this expense was overstated by the defendants on the

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partnership books by $9,644.98.

g. The defendants maintain that the $2,497.91 was used to

make cash purchases of fuel for the partnership’s delivery

trucks. As a general practice, however, the partnership

used its credit cards, not cash, to purchase fuel. The

plaintiff therefore asserts these purchases must have been

for the Farrow Distributing delivery truck.

Mrs. Farrow testified that Polar Bear Ice operated two

delivery trucks, sometimes three, as opposed to Farrow

Distributing’s one truck. Further, Polar Bear Ice delivered

throughout a larger geographic area and Farrow

Distributing’s business was slower, particularly on weekends

and holidays.

This testimony, however, is not inconsistent with the

fuel having been purchased for Farrow Distributing. 

Comparing the dates of the cash receipts to the 2015

calendar reveals that all cash purchases were on weekdays,

not weekends or holidays, and with the exception discussed

immediately below, were at least seven days apart. Further,

all but one purchase were in the immediate vicinity of

Farrow Distributing.

The court finds that the $20 purchase in Elk Grove was

not by Farrow Distributing inasmuch as it had no customers

near that locale. Second, there were two fuel purchases on

May 5 approximately 8 minutes apart. Because Farrow

Distributing operated only one delivery truck, the court

finds that one purchase of $160 is attributable to Polar

Bear Ice.

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h. The defendants’ evidence, primarily Exhibit I, proves

only that the plaintiff’s $3,900 capital account was

credited with the contribution. They produced no evidence

that the $3,900 was deposited into the partnership bank

account.

i. The failure to deposit cash totaling $674.48 collected

from Polar Bear Ice customers on August 13, 2015 is

confirmed in a handwritten note by Mrs. Farrow, Exhibit 9. 

While both defendants testified the note is incorrect

because the money was deposited, there is no convincing

corroboration of a deposit.

j. Defendants took $391.98 from the partnership account to

purchase a television for their own use. See Exhibit 6.

The defendants concede that this was for the purchase

of a television that should not have been charged to the

partnership account. They claim the mistake was an innocent

one. The receipt for the television was mistaken for a

receipt for a printer purchased by the partnership.

k. The defendants admit that they have the five display

doors belonging to the partnership.

l. The defendants deny that they sold the partnership’s

ending ice inventory. They maintain that the ice was made

available to the plaintiff but he declined to pick it up. 

As a result, it melted.

However, the ice was not made available to the

plaintiff because the defendants rescinded their offer to

allow him to continue the partnership business. See

Exhibits 10, 15, and 16. The court finds that the

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defendants sold the inventory on hand. This is corroborated

by the fact that Exhibit E, the August 20 letter from Mr.

Farrow to the plaintiff indicates that Mr. Farrow intended

to sell the ice if the plaintiff did not agree to do so. 

Further, Exhibit F records the September 4 payment of two

invoices from Riverview for truck rentals during the period

of August 18 to August 31, 2015, after the plaintiff had

been excluded from the business.

11. The defendants have misappropriated $54,293.31 in

partnership assets. This differs from the plaintiff’s $60,023.31

demand in three respects: (1) the court finds that $2,800 of the

$10,793.73 paid to Wonder Ice Cream was returned; (2) there is no

phantom expense of $2,750 associated with the display box

purchased by the partnership; and (3) $180 of the cash fuel

purchases were by the partnership.

12. The defendants asserted at trial that the partnership

had income of $192,870.40 in 2015. See Exhibit I. However, this

total is not accurate.

a. According to the partnership’s sales journal, it had

$283,844.53 in gross ice sales and actually collected

$261,524.48 of these sales. See Exhibit 17.

b. According to the 2015 partnership tax return the

defendants provided to the plaintiff, the plaintiff’s

proportional share of sales was $131,432. Since the parties

were 50/50 partners, this means sales for 2015 were

$262,864. See Exhibit 21.

c. The court takes judicial notice of Form 122A, the

Statement of Current Monthly Income, etc., filed by the

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defendants in their chapter 7 bankruptcy case. For the

period June, July, and August 2015 alone, the defendants

reported that Polar Bear Ice’s income totaled $205,975.91. 

Even if it is assumed the partnership had no income from

January through May 2015, Form 122A indicates that Polar

Bear Ice had more income than $192,870.40 in 2015.

d. The court finds that the partnership’s income in 2015

was $262,864.

13. The $69,993.60 discrepancy between the partnership’s

actual income, $262,864, and the defendants’ testimony that it

was only $192,870.40, corroborates for the court that the

defendants misappropriated at least $54,293.31 from the

partnership.

14. To the extent any of the conclusions of law below are

findings of fact, they are incorporated by reference as findings

of fact.

Conclusions of Law

15. To the extent any of the foregoing findings of fact are

conclusions of law, they are incorporated by reference as

conclusions of law.

16. The defendants dissociated themselves from Polar Bear

Ice by their express will and by wrongful conduct that adversely

and materially affected the partnership’s business. See Cal.

Corp. Code § 16601(1) & (5)(A). This caused the dissolution of

the partnership.

17. As the dissociating partners, the defendants are

ineligible to wind up the partnership’s business. See Cal. Corp.

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Code § 16803(a), (b). Only the plaintiff is entitled to wind up

its business.

18. As the partner eligible to wind up the partnership’s

business, the plaintiff is entitled to collect and liquidate the

partnership’s assets and claims, discharge the partnership’s

liabilities, and then distribute any remaining assets to the

partners. See Cal. Corp. Code § 16803(c).

19. One of the claims the plaintiff is entitled to collect

and liquidate is the claim against the defendants arising from

their misappropriation of $54,293.31 in partnership money and

assets as outlined above.

20. Under California law, to be liable for conversion, a

defendant must exercise dominion over another’s personal

property. See e.g., Poggi v. Scott, 167 Cal. 372, 375 (1914);

Rest.2d, Torts, § 222A. It is not necessary to prove that the

defendant acted with a wrongful intent or the intent to harm the

owner of the property. A conversion is committed even if the

defendant converted the property in error, in good faith, or with

due care. Poggi v. Scott, 167 Cal. at 375. The plaintiff is

required to show only that the act of conversion was intentional. 

Id.

21. The defendants converted for their own use $54,293.31

of partnership money and assets as outlined above. This

conversion was intentional and done with the intent to deprive

the partnership of its property.

22. Much of what the defendants took from the partnership 

was money. Generally speaking, money cannot be the subject of

conversion. See Haigler v. Donnelly, 18 Cal.2d 674 (1941);

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McKell v. Washington Mut., 142 Cal. App. 4th 1457, 1491 (2006). 

When the money taken, however, is a specific, identifiable sum,

an action for conversion can be sustained. See Haigler, 18 Cal.

2d at 681. That is what has been proven in this case. The

plaintiff has proven more than that money is missing. He has

identified specific sums taken by the defendants at discrete

points in time.

23. In order for a debt arising from a conversion to be

nondischargeable under 11 U.S.C. § 523(a)(6) more than an

intentional act must be proven. The defendant must act willfully

and maliciously. Kawaauhau v. Geiger, 523 U.S. 57, 61 (1998);

Baldwin v. Kilpatrick (In re Baldwin), 249 F.3d 912, 917 (9th

Cir. 2001).

24. The term willful means a deliberate or intentional

injury. Kawaauhau, 523 U.S. at 61. This requires proof not only

that the actor intended to act, but that the injury was also

intended by the actor. Id. 

25. A malicious injury involves (1) a wrongful act, (2)

done intentionally, (3) which necessarily causes injury, and (4)

is done without just cause or excuse. Carrillo v. Su (In re Su),

290 F.3d 1140, 1146-47 (9th Cir. 2002) (citing In re Jercich, 238

F.3d 1202, 1209 (9th Cir. 2001)); see also Jett v. Sicroff (In re

Sicroff), 401 F.3d 1101, 1106 (9th Cir. 2005).

26. The court concludes that the defendants’ conversion of

$54,293.31 in partnership money and assets were both willful and

malicious. The defendants took this property knowing it belonged

to the partnership, using it to prop up the failing Farrow

Distributing despite knowing that the loss of the partnership’s

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property would likely cause it to fail.

27. Whether or not the defendants are liable for

conversion, their conduct also amounts to embezzlement of the

$54,293.31. Embezzlement for purposes of 11 U.S.C. § 523(a)(4)

occurs when a person entrusted with the property of another

fraudulently appropriates it for his or her own benefit. In re

Bucci, 493 F.3d 635 (6th Cir. 2007) cert. denied 128 S.Ct. 2903

(2008). It is not enough to show that property is missing; it

must have been taken with the fraudulent intent to convert it for

the benefit of the debtor to the detriment of the owner.

28. Here, the defendants as partners had rightful

possession of the partnership’s money and assets. They converted

that property for their own benefit to the detriment of the

partnership.

29. In California, “[p]artners are trustees for each

other, and in all proceedings connected with the conduct of the

partnership every partner is bound to act in the highest good

faith to his co-partner and may not obtain any advantage over him

in the partnership affairs by the slightest misrepresentation,

concealment, threat or adverse pressure of any kind.” Leff v.

Gunter, 33 Cal.3d 508, 514 (1983) (quoting Page v. Page, 55

Cal.2d 192, 197 (1961)).

30. Therefore, in the Ninth Circuit, California partners

are fiduciaries within the meaning of section 523(a)(4). See

Ragsdale v. Haller, 780 F.2d 794, 796-97 (9th Cir. 1986).

31. By misappropriating partnership money and assets as

outlined above, the defendants have committed a defalcation of

partnership assets in breach of their fiduciary obligation to the

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plaintiff. This defalcation was done with knowledge that the

property taken belonged to the partnership and it was taken in

order to advance the defendants’ personal interests to the

detriment of the plaintiff and the partnership.

32. Whether the defendants committed conversion,

embezzlement, or a defalcation while acting as fiduciaries, their

misappropriations were with the requisite fraudulent intent under

sections 523(a)(4) and (a)(6). They were not the result of

confusion as to the terms of the partnership (see Paragraph 10(a)

above), or an innocent mix-up as to what was or was not a

partnership expense (see Paragraphs 10(b), (c), (g), and (j)

above). Rather, they were concerted efforts to divert

partnership money and assets to benefit the defendants and their

other business, to the exclusion of the plaintiff and the

partnership. This conduct must be viewed in the most pejorative

of lights given that the defendants took considerable pains to

cover up their misappropriations by under-reporting partnership

income by more than $60,000, creating a ledger falsely indicating

they had repaid the $10,793.73 “loan,” and finally by withdrawing

from the partnership as soon as the plaintiff began to question

the defendants’ use of partnership money and assets.

33. A debt for obtaining money, property, or services by

fraudulent means is made nondischargeable by 11 U.S.C. §

523(a)(2)(A). In a typical case, a debtor’s fraud or trickery

induces a creditor to part with value for the benefit of the

debtor. The fraud induces the creditor’s loss.

34. It has not been alleged, or proven, that fraud induced

the plaintiff to enter into the partnership or otherwise part

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with property. Rather, over nine months and in connection with

the operation of the partnership’s business, the defendants

misappropriated partnership money and assets. This loss is best

addressed under sections 523(a)(4) and (a)(6), not section

523(a)(2)(A).

Conclusion

The court will enter a judgment for the plaintiff on the

second and third claims for relief in the complaint. The

defendants shall pay to the plaintiff $54,293.31. This

obligation is made nondischargeable under 11 U.S.C. §§ 523(a)(4)

and (a)(6).

The plaintiff shall receive this sum as the partner of Polar

Bear Ice entitled to wind up its affairs. From the amounts

awarded and collected pursuant to this judgment, the plaintiff

shall pay the debts of the partnership, then reimburse all

capital contributions of the partners, and then distribute any

remaining amounts to the partners in such proportion as they

agreed to divide profits and losses. To the extent there is a

dispute as to the partnership’s debts or the partners’ capital

contributions, such dispute must be resolved in the appropriate

nonbankruptcy forum.

Dated: By the Court

 

Michael S. McManus

United States Bankruptcy Judge

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Instructions to Clerk of Court

Service List – Not Part of Order/Judgment

The Clerk of Court is instructed to send the Order/Judgment or other court

generated document transmitted herewith to the parties below. The Clerk of

Court will send the Order via the BNC.

Brant J. Bordsen

1129 D St

PO Box A

Marysville CA 95901

Gabriel E. Liberman

1395 Garden Highway #150

Sacramento CA 95833

Filed 01/15/18 Case 16-02055 Doc 41