July 25, 2025|Publications
July 25, 2025 | United States Bankruptcy Court for the Eastern District of Texas, Sherman Division | Unpublished Opinion
Executive Summary
In an unpublished decision, Judge Joshua P. Searcy of the Bankruptcy Court for the Eastern District of Texas rejected a creditor’s attempt to except a debt from discharge under 11 U.S.C. §§ 523(a)(2)(A) and 523(a)(6). The creditor, Mustaali Carbaidwala, alleged that his state court judgment against debtor Patrick Gerleman arose from fraud and willful injury after Gerleman defaulted on the sale of two Farrell’s Extreme Bodyshaping gyms and moved gym operations to a new location. The debtor denied that the judgment should be nondischargeable. The court found that Carbaidwala failed to prove by a preponderance of the evidence that the judgment debt was obtained by false pretenses, misrepresentation, actual fraud, or willful and malicious injury, and therefore the debt was discharged.
Relevant Background
According to the filings, Carbaidwala owned two Farrell’s Extreme Bodyshaping franchise gyms in Frisco and Little Elm, Texas. In November 2019, FXB Dallas, LLC, managed by Carbaidwala, entered into an Asset Purchase Agreement with Gerleman Group, Inc. (“GG”), managed by Patrick Gerleman. The purchase price was $550,000, with $350,000 paid upfront and the remaining $200,000 covered by a promissory note, which Gerleman personally guaranteed.
Plaintiff alleged that by mid-2020, GG stopped paying rent under the leases and failed to make any payments on the promissory note. By December 2020, both gyms had ceased operations. In January 2021, Gerleman opened a new Farrell’s location that was managed by a new entity he formed, using some of the equipment from the closed locations. Plaintiff filed suit in the 471st Judicial District Court of Collin County, Texas, asserting breach of contract and violations of the Texas Uniform Fraudulent Transfer Act (“TUFTA”). After a bench trial, the state court entered judgment in September 2021 against Gerleman for $239,520.61, based on breach of contract and TUFTA.
Gerleman filed for Chapter 7 bankruptcy on December 30, 2022. Carbaidwala commenced this adversary proceeding on March 28, 2023, seeking to have the state court judgment declared nondischargeable under §§ 523(a)(2)(A) and (a)(6). Gerleman answered in April 2023. Plaintiff moved for summary judgment in January 2024, but the court denied the motion in October 2024. Trial was held on March 31, 2025, at which both parties appeared and testimony was heard. Judge Searcy issued findings of fact and conclusions of law on July 25, 2025.
Decision
Judge Searcy began by underscoring the balance in bankruptcy law: “All exceptions to discharge under 11 U.S.C. § 523 must be strictly construed against a creditor and liberally construed in favor of a debtor so that the debtor may be afforded a fresh start.” FNFS, Ltd. v. Harwood (In re Harwood), 637 F.3d 615, 619 (5th Cir. 2011) (quoting Hudson v. Raggio & Raggio, Inc. (In re Hudson), 107 F.3d 355, 356 (5th Cir. 1997)). At the same time, “the Bankruptcy Code limits the opportunity for a completely unencumbered new beginning to the honest but unfortunate debtor.” Grogan v. Garner, 498 U.S. 279, 286–87 (1991).
On the fraud claims under § 523(a)(2)(A), the court explained that “false pretenses” and “false representations” involve either misleading conduct or outright false statements about past or current facts. A promise about future actions qualifies only if the debtor never intended to perform it. Bank of La. v. Bercier (In re Bercier), 934 F.2d 689, 692 (5th Cir. 1991), overruled on other grounds by Husky Int’l Elecs., Inc. v. Ritz, 578 U.S. 356 (2016). The court found that Carbaidwala “failed to demonstrate by a preponderance of the evidence that Defendant, Patrick Charles Gerleman, made a misrepresentation … which was a knowing and fraudulent falsehood … [or] had the requisite intent to deceive.”
The court also addressed the “actual fraud” claim. In Husky Int’l Elecs., Inc. v. Ritz, 578 U.S. 356, 359 (2016), the Supreme Court clarified that “the term ‘actual fraud’ … encompasses forms of fraud, like fraudulent conveyance schemes, that can be effected without a false representation.” Still, such fraud requires “wrongful intent.” Id. at 360 (quoting Neal v. Clark, 95 U.S. 704, 709 (1878)). Judge Searcy concluded that Carbaidwala “failed to demonstrate by a preponderance of the evidence that Defendant … made representations … with the requisite intent to deceive” or that the losses were the “proximate result” of such conduct.
Turning to § 523(a)(6), the court noted that the statute excludes debts “for willful and malicious injury by the debtor to another entity or to the property of another entity.” 11 U.S.C. § 523(a)(6). The Supreme Court has interpreted this narrowly: “Nondischargeability takes a deliberate or intentional injury, not merely a deliberate or intentional act that leads to injury.” Kawaauhau v. Geiger, 523 U.S. 57, 61 (1998). The Fifth Circuit has elaborated that a “willful injury” may be shown only where there is “either (1) an objective substantial certainty of harm arising from a deliberate action or (2) a subjective motive to cause harm.” Miller v. J.D. Abrams, Inc. (In re Miller), 156 F.3d 598, 604–06 (5th Cir. 1998). Judge Searcy found that Carbaidwala “failed to demonstrate by a preponderance of the evidence the existence of a deliberate or intentional injury inflicted upon him” and likewise failed to show that Gerleman’s actions created either objective or subjective certainty of harm.
Because the plaintiff could not establish nondischargeability under either theory, the court concluded that “judgment must be rendered for the Defendant … under 11 U.S.C. §§ 523(a)(2)(A) and 523(a)(6).”
Looking Forward
This case illustrates how challenging it may be for creditors—including franchisors, franchisees selling their businesses, and other commercial sellers—to prevent a judgment debt from being discharged in bankruptcy. Even a state court judgment that includes findings of fraudulent transfer may not be enough to establish nondischargeability. Bankruptcy courts apply their own standards and often require new proof tailored to § 523’s specific requirements.
For the franchise community, several broader points emerge:
First, the case shows how difficult it may be to translate state court victories into bankruptcy nondischargeability. A TUFTA judgment or similar fraudulent transfer ruling under state law does not automatically equal “actual fraud” under the Bankruptcy Code. Creditors may need to present additional evidence of wrongful intent to satisfy federal bankruptcy standards. This creates uncertainty for franchisors or franchisees who pursue litigation expecting their judgments to hold firm if the debtor later files bankruptcy. Consulting with experienced bankruptcy counsel while state court litigation is pending can help creditors shape judgments and settlement agreements to better align with the requirements for nondischargeability under the Bankruptcy Code.
Second, promissory notes and personal guarantees, while useful, may not offer complete protection if not paired with secured interests. In this case, the $200,000 note and guaranty were unsecured, leaving the creditor to litigate in bankruptcy court with limited leverage. Franchisors selling company-owned outlets, or franchisees selling their locations, may wish to insist on perfected security interests, collateral, or escrow structures that survive bankruptcy.
Third, the timing of this dispute underscores how external events such as the COVID-19 pandemic can complicate fraud claims. Courts may be reluctant to treat closures and business failures during that period as intentional wrongdoing absent strong proof of fraudulent intent. This may signal that creditors will need to present particularly compelling evidence when alleging that business failures tied to extraordinary events amount to fraud.
Fourth, the case highlights the evidentiary burden that creditors face. Judge Searcy noted that Carbaidwala “failed to demonstrate by a preponderance of the evidence” each element of his claims. That phrase—“preponderance of the evidence”—is deceptively simple. It means “more likely than not,” but in practice requires a carefully documented record of intent, reliance, causation, and harm. Creditors who cannot establish a clear evidentiary chain may find their judgments discharged despite earlier litigation success.
Finally, franchisors and multi-unit operators may take from this case the importance of proactive deal structuring. Bankruptcy may be unpredictable, but agreements can be crafted to mitigate risks: using UCC filings and collateral to secure notes; building in step-in rights for franchisors if defaults occur; and ensuring that guaranties are not merely symbolic, but backed by real, reachable assets. When disputes arise, consulting with experienced bankruptcy counsel can help shore up against these risks.
Taken together, this case serves as a reminder that while bankruptcy law allows exceptions for fraud and willful injury, those exceptions are narrow. Creditors in franchise transactions may benefit from structuring deals with bankruptcy risk in mind, rather than relying on litigation after the fact to preserve repayment.
This article is based solely on the opinion of the Court in this matter. The author has not conducted any independent investigation into the facts. For the avoidance of doubt, each statement related to the law and facts in this article is drawn from the Court’s opinion in this case.
Thomas O’Connell is a Shareholder at Buchalter APC and Chair of the firm’s Franchise Practice Group. Valerie Banter Peo is a Shareholder at Buchatler APC and Administrative Co-Chair of Buchalter’s Insolvency & Financial Law Group. For questions about this article or media inquiries, you can contact Tom at toconnell@buchalter.com and Val at vbantnerpeo@buchalter.com.
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