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In re Fustolo

United States Court of Appeals, First Circuit

July 16, 2018

IN RE: STEVEN FUSTOLO, Debtor.
v.
THE PATRIOT GROUP LLC, Appellee. STEVEN FUSTOLO, Appellant,

          APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF MASSACHUSETTS [Hon. Leo T. Sorokin, U.S. District Judge]

          Martin P. Desmery, with whom Travis J. McDermott and Partridge Snow & Hahn, LLP were on brief, for appellant.

          Jack I. Siegal, with whom Gordon & Rees Scully Mansukhani was on brief, for appellee.

          Before Torruella, Thompson, and Kayatta, Circuit Judges.

          TORRUELLA, Circuit Judge.

         Following trial on The Patriot Group, LLC's ("Patriot") adversary complaint requesting denial of the discharge in bankruptcy of Steven Fustolo's ("Fustolo") debt, the bankruptcy court allowed Patriot's motion to amend its pleadings and denied Fustolo's discharge pursuant to the newly added claim. Fustolo seeks reprieve from his encumbrance, imploring us to reverse the bankruptcy court's judgment and remand the case for reconsideration in light of the issues pleaded in Patriot's complaint. Because we find that the allowance of this belated amendment fails to satisfy the prescripts of due process underlying Rule 15(b)(2) and was therefore an abuse of discretion, we grant Fustolo's request.

         I. FACTUAL AND PROCEDURAL BACKGROUND

         We begin by charting the course of this case, as supportably summarized by the district court and undisputed by the parties. See Fustolo v. The Patriot Group, LLC (In re Fustolo), No. 17-cv-10128-LTS, 2017 WL 3896667, at *1-5 (D. Mass. Sept. 6, 2017). After obtaining a $20.5 million dollar judgment against Fustolo from the Massachusetts Superior Court two years earlier, Patriot and two other petitioning creditors filed a contested involuntary petition for relief under Chapter 7 of the Bankruptcy Code in May 2013 against Fustolo. On December 16, 2013, the bankruptcy court allowed the petition for relief. In re Fustolo, 503 B.R. 206 (Bankr. D. Mass. 2013), aff'd, Fustolo v. 50 Thomas Patton Drive, LLC, 816 F.3d 1 (1st Cir. 2016).

         On September 30, 2014, Patriot and another petitioning creditor filed an adversary complaint requesting denial of Fustolo's discharge in bankruptcy pursuant to 11 U.S.C. § 727(a)(2)(A), (a)(2)(B), (a)(3), (a)(4), (a)(5), and, in the alternative, that the court declare Fustolo's debt non-dischargeable pursuant to 11 U.S.C. § 523(a)(2), (a)(4). Among other things, the complaint alleged that Fustolo engaged in fraudulent transactions as to both creditors; deliberately created a corporate web to conceal fraudulent activities; made substantial pre-petition transfers to his wife; made unexplained cash transactions within one year of the involuntary petition; made substantial transfers to insiders and affiliates; concealed, destroyed, or failed to keep business records from which the creditors could ascertain the financial condition of Fustolo's business transactions; and made false statements during bankruptcy.

         In November 2015, Patriot filed a motion to compel Fustolo to provide emails and financial records that Patriot alleged were being wrongfully withheld. In a contested hearing on Patriot's motion, Fustolo argued that his emails had been deleted by his email account provider and were therefore irretrievable, and that, in any event, many of them were protected from production by the Fifth Amendment's right against self-incrimination.[1]

         On December 31, 2015, the bankruptcy court issued an order (the "December 31 Order") for Fustolo to produce non-privileged emails and financial account statements to Patriot, and in consideration of Fustolo's Fifth Amendment rights, to "provide the Court for its in camera inspection only . . . copies of all emails and documents he asserts are protected under the Fifth Amendment, along with two separate item by item indexes" (the "Protocol"). The bankruptcy court stated that it would determine whether the privilege had been properly invoked, and added that submission of the emails and financial statements "shall not constitute a waiver of [Fustolo's] Constitutional right against self-incrimination." In the court's accompanying memorandum, it noted that Fustolo's contention about the email provider's deletion of emails was "devoid of merit," and that if Fustolo was "unable to produce emails, it can only mean that he deleted them." 50 Patton Drive, LLC v. Fustolo (In re Fustolo), No. 13-12692-JNF, 2015 WL 9595421, at *4 (Bankr. D. Mass. Dec. 31, 2015).

         After being granted two extensions of time to comply with the December 31 Order, on February 5, 2016, Fustolo filed a motion to impound submission regarding his assertion of the Fifth Amendment, in which he stated that he was not complying with the December 31 Order by refusing to submit emails. Patriot subsequently filed a motion for sanctions against Fustolo pursuant to Fed.R.Civ.P. 37 for failing to comply with the December 31 Order and for alleged email spoliation. The bankruptcy court held a hearing on Patriot's motion on March 17, 2016, [2] at which Patriot requested as sanctions: that the bankruptcy court set an expeditious trial date; that Fustolo be required to submit to a deposition; and an order that Patriot was "not going to get dumped on with emails on the eve of trial." In response, Fustolo again responded that production of emails and documents for in camera inspection would violate his Fifth Amendment rights in light of the "overriding concern that [the bankruptcy court] is the finder of fact in this case." The court made clear at the hearing that it had "gone to great lengths to protect Mr. Fustolo's right to invoke the Fifth Amendment," but that Fustolo had "refused to comply . . . without legitimate reason." In addition, the court found that Fustolo failed to comply with the December 31 Order by deleting emails that he had not claimed to be privileged or refusing to provide them to Patriot, and by failing to comply with the Protocol. See id. Accordingly, the court granted Patriot's motion for sanctions, prohibited Fustolo from presenting any emails not previously produced, and scheduled the trial to commence on May 23, 2016.

         During his deposition, Fustolo provided to Patriot paper print outs of what he claimed were his "books and records," but refused to produce the electronic spreadsheets from which the information was derived, repeatedly invoking the Fifth Amendment right against self-incrimination. Fustolo further invoked his Fifth Amendment right when asked if he intentionally deleted his electronic spreadsheets. On May 10, 2016, Patriot again moved for sanctions pursuant to Fed.R.Civ.P. 37, seeking a pretrial ruling that Fustolo had spoliated the electronic financial records, and a court order barring Fustolo from introducing into evidence any documents or financial records not produced in their original electronic format. On May 18, 2016, the bankruptcy court granted Patriot's motion in part and denied it in part, prohibiting Fustolo from introducing any evidence not provided prior to his deposition, but refraining from making a finding as to whether Fustolo intentionally spoliated his books and records.

         In a Joint Pretrial Memorandum ("JPM"), Patriot included "Fustolo's discovery misconduct in this proceeding, including but not limited to Fustolo's spoliation of evidence" among its "fact issues for trial." Fustolo did not file an objection to the inclusion of this issue. Three days before trial, Patriot filed a request for the bankruptcy court to take judicial notice of several documents, including: 1) the December 31 Order; 2) the December 31 accompanying memorandum; 3) the transcript of the March 17, 2016 hearing; 4) the court's May 18, 2016 order on Patriot's motion for a spoliation inference. The court allowed the request with no objection from Fustolo.

         Trial started on May 23, 2016. The court began by reciting the allegations in the complaint: that Patriot had an objection to discharge of Fustolo's debt under 11 U.S.C. § 727(a)(2)(A) as Count I, § 727 (a)(2)(B) as Count II, § 727 (a)(3) as Count III, § 727 (a)(4) as Count IV, and § 727 (a)(5) as Count V; and that Patriot further alleged that Fustolo's debt was non-dischargeable under § 523(a)(2)(A) as Count VIII.[3] The parties confirmed that there were no amendments. In Patriot's opening statement, Patriot's counsel offered that the evidence would "show that Mr. Fustolo ha[d] repeatedly abused the bankruptcy process, violated this Court's orders, [and] failed to preserve evidence." The bankruptcy court immediately asked whether Patriot had a claim under § 727(a)(6), and counsel stated that Patriot did not.

         On June 14, 2016, the fourth of six days of trial, during Fustolo's testimony, Patriot's counsel questioned him about his compliance with the December 31 Order. The following exchange took place:

COUNSEL: In December of 2015 the Court entered an order in which you were to provide the Court in camera documents that you contend you were withholding based on the Fifth Amendment privilege. Do you recall that?
FUSTOLO: I do, yes.
COUNSEL: You never produced those documents to the Court, did you?
FUSTOLO: My attorney supplied them to the Court, yes.
COUNSEL: I don't believe that you followed - there was a protocol that you were supposed to follow in terms of providing documents withheld on Fifth Amendment grounds, as well as a log of documents. Sir, ...

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