Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-caeb-2_16-ap-02219/USCOURTS-caeb-2_16-ap-02219-0/pdf.json

Parties Involved:
Robert Kaye
Plaintiff
LARRY ALAN SCHACK
Defendant

Document Text:

Itasi FILED 

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In re: S ) Case No. 16-24794-B-7 

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LARRY ALAN SCHACK, ) Adversary No. 16-2219 

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6 Debtor(s) 

7 

ROBERT KAYE, AS SUCCESSOR IN 

8 INTEREST TO SHIRLEY COLLINS, 

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Plaintiff(s), 

10 

SAM 

11 

LARRY ALAN SCHACK, 

12 

13 Defendant(s). 

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15 MEMORANDUM DECISION AFTER TRIAL 

16 INTRODUCTION 

17 This is an adversary proceeding by plaintiff Robert Kaye, as 

18 successor in interest to Shirley Collins ("Collins"), against 

19 defendant Larry Alan Schack to have certain debts declared non20 dischargeable in defendant's chapter 7 case. Plaintiff filed the 

21 complaint that initiated this adversary proceeding on October 13, 

22 2016. The complaint alleges three claims for relief: (i) a § 

23 523(a) (2) (A) claim in the first claim for relief; (ii) a § 

24 523(a) (4) claim in the second claim for relief; and a (iii) § 

25 523(a) (6) claim in the third claim for relief. Each claim for 

26 relief is based on multiple loans that Collins made to Sunshine 

27 Systems, LLC ("Sunshine") 

28 Defendant, who is also the debtor in the parent chapter 7 

bankruptcy case, answered the complaint on November 8, 2016. The 

UNITED STATES BANKRUPTCY COURT 

EASTERN DISTRICT OF CALIFORNIA 

MAY -1 2O1 

UNITED STATES BANKRUPTCY 

EASTERN DISTRICT OF CALIF 

Filed 05/01/18 Case 16-02219 Doc 59
1 answer asserts three affirmative defenses: (i) unclean hands; 

2 (ii) failure to state a claim; and (iii) statute of limitations. 

3 Trial was held on April 9, 2018, and continued to May 1, 

4 2018, for purposes of this decision. Appearances were noted on 

5 the record. Plaintiff appeared through counsel. Defendant 

6 appeared pro se. 

7 The court's pretrial rulings stated on the record in open 

8 court on April 9, 2018, are incorporated by this reference and 

9 made a part of this written deáision. The court's findings of 

10 fact and conclusions of law which were also stated on the record 

11 on April 9, 2018, in support of judgment for the defendant and 

12 against the plaintiff on the § 523(a) (2) (A) claim in the first 

13 claim for relief and the § 523(a) (6) claim in the third claim for 

14 relief are also incorporated by reference and made a part of this 

15 written decision. This memorandum decision constitutes the 

16 court's findings of fact and conclusions of law on the remaining 

17 § 523(a) (4) claim in the second claim for relief. Fed. R. Civ. 

18 P. 52(a); Fed. R. Bankr. P. 7052. 

19 For the reasons explained below, judgment on the § 523(a) (4) 

20 claim in the second claim for relief will be entered for the 

21 plaintiff and against the defendant and $95,787.66 of defendant's 

22 debt to plaintiff is determined to be non-dischargeable in 

23 defendant's chapter 7 case. The continued trial on May 1, 2018, 

24 at 9:30 a.m. will also be vacated. 

25 

26 JURISDICTION AND VENUE 

27 Federal subject matter jurisdiction is founded on 28 U.S.C. 

28 § 1334. This adversary proceeding is a core proceeding under 28 

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1 U.S.C. §§ 157(b) (2) (A), (I), and (0) . To the extent this 

2 adversary proceeding may ever be determined to be a matter that a 

3 bankruptcy judge may not hear and determine without consent, the 

4 parties have nevertheless consented to such determination by a 

5 bankruptcy judge. See 28 U.S.C. § 157(c) (2). Venue is proper 

6 under 28 U.S.C. § 1409. 

7 

8 FINDINGS OF FACT 

S 

9 The debt at issue arises from a series of loans that Collins 

10 made to Sunshine. Those loans are evidenced by multiple 

11 promissory notes dated between July 2010 and May 2011. Plaintiff 

12 prepared the promissory notes. Defendant signed the promissory 

13 notes on behalf of Sunshine. Defendant also personally 

14 guaranteed under the promissory notes. 

15 The promissory notes and guarantees were signed, and the 

16 corresponding loans were made, in Illinois. Parties to the loans 

17 and guarantees are residents of, or entities registered in, 

18 Illinois. Sunshine, which is now defunct, was an Illinois 

19 limited liability company based in Wheeling, Illinois. Plaintiff 

20 was Sunshine's CFO and accountant between 2008 and 2012. 

21 Plaintiff is also Collins' nephew and a beneficiary of his aunt's 

22 estate. Collins listed an address in Chicago, Illinois. 

23 Defendant was Sunshine's manager. Defendant also listed an 

24 address in Wheeling, Illinois. 

25 Plaintiff had Collins' power of attorney which he used to 

26 authorize Collins' loans to Sunshine and to obtain funds from 

27 Collins' accounts for those loans. The loans were at an interest 

28 rate lower than commercially available to Sunshine. Plaintiff's 

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1 use of Collins' power of attorney to obtain and fund loans for a 

2 company of which he was the CFO and accountant drew the attention 

3 of the Illinois State Guardian's O'ff ice after which plaintiff 

4 voluntarily terminated the power of attorney. 

5 Proceeds from Collins' loans to Sunshine were deposited into 

6 Sunshine's account with Bank of America. Defendant was an 

7 authorized signatory on the Bank of America account and was 

8 authorized to use funds from that account for Sunshine's business 

9 purposes. Funds from the Bank of America account, and thence 

10 proceeds from Collins' loan to Sunshine, were to pay Sunshine's 

11 business and operating expenses. They were also used to pay the 

12 defendant's personal expenses discussed below. Plaintiff's CFO 

13 compensation was paid from the same account. 

14 In January of 2014 the Circuit Court of Cook County, 

15 Illinois, entered a judgment against defendant in the amount of 

16 $268,410.00. That judgment is based on the defendant's breach of 

17 his guarantees of Collins' loans to Sunshine. Defendant lists 

18 that judgment as an unsecured claim in Schedule F filed in his 

19 chapter 7 bankruptcy case. The judgment was subsequently 

20 assigned to plaintiff. Plaintiff is also the lawful successor in 

21 interest to the promissory notes and obligations owned by 

22 Collins, now deceased, by virtue of a court order from Cook 

23 County, Illinois Probate Division, case #12 P 0284. 

24 Plaintiff and defendant both testified at trial. 

25 Plaintiff's testimony was credible. For the most part, 

26 defendant's testimony was not credible. Accordingly, greater 

27 weight is given to plaintiff's testimony. 

28 Defendant initially testified that funds from Sunshine's 

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1 Bank of America account were used only to pay business expenses. 

2 However, on cross-examination defendant admitted that he used 

3 funds from the Bank of America account to pay personal expenses. 

4 For example, defendant admitted that he made $39,351.44 in 

S mortgage payments on his personal residence with funds from the 

6 Bank of America account. Defendant also admitted there was no 

7 business purpose for his payments from the Bank of America 

8 account to his ex-wife totaling $7,500.00. Thus, defendant 

9 admitted he used funds from the Bank of America account, which 

10 I necessarily included proceeds from Collins' loans to Sunshine, to 

11 pay his personal expenses totaling $46,851.44. 

12 Defendant also testified on cross-examination that funds 

13 from the Bank of America account were used to pay a number of 

14 other expenses that are of questionable business nature and are 

15 more aptly characterized as expenses personal to the defendant. 

16 These include $285.00 for massages, $20.00 for haircuts, $204.00 

17 for nails, a $3,080.14 "Laser Center" charge, a $920.23 "Juicy 

18 Couture" charge, and $44,426.85 in credit card payments. These 

19 additional payments total $48,936.22. 

20 When defendant was asked about the additional expenses on 

21 cross-examination he became agitated and visibly uncomfortable. 

22 Defendant's testimony about the additional expenses was also 

23 evasive and argumentative, and defendant refused to answer direct 

24 questions about the nature of the expenses or explain their 

25 business purpose(s) . This was particularly notable with regard 

26 to the credit card payments. Defendant did not deny that funds 

27 from Sunshine's Bank of America account were used to pay his 

28 personal credit cards in the amount referenced above. And 

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although defendant suggested those payments were for business 

2 charges, again, when he was asked to identify business-related 

3 charges on his personal credit cards he became agitated, 

4 argumentative, evasive, and refused to do so. Defendant's 

5 overall demeanor and his cross-examination testimony lead the 

6 court to conclude that there was no business purpose or 

7 justification for any of the additional expenses, credit card 

8 payments in particular, and that the additional expenses were 

9 personal expenses paid with Sunshine's funds from the Bank of 

10 America account for defendant's personal benefit. 

11 

12 DISCUSSION 

13 Plaintiff narrowed the § 523(a) (4) claim to embezzlement in 

14 both his trial brief and closing argument. Therefore, the court 

15 considers only non-dischargeability under that limited aspect of 

16 § 523(a) (4) which states as follows: 

17 (a) A discharge under section 727 . . . of this title 

does not discharge an individual debtor from any debt - 

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(4) for fraud or defalcation while acting in a 

19 fiduciary capacity, embezzlement, or larceny[.] 

20 11 U.S.C. § 523(a) (4). 

21 Embezzlement in the context of non-dischargeability requires 

22 three elements: (1) property rightfully in the possession of a 

23 nonowner; (2) nonowner's appropriation of the property to a use 

24 other than that to which. it was entrusted; and (3) circumstances 

25 indicating fraud. Transam. Comm'l Fin. Corp. v. Littleton (In re 

26 Littleton) , 942 F.2d 551, 555 (9th Cir. 1991) . Embezzlement 

27 under § 523(a) (4) does not require the presence of a fiduciary 

28 I relationship or an express trust relationship. 

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1 The first element is satisfied. The funds in the Bank of 

2 America account, including proceeds from Collins' loan to 

3 Sunshine, all belonged to Sunshine and not the defendant. 

4 However, as Sunshine's manager, defendant was an authorized 

5 signatory on the Bank of America account and he was authorized to 

6 allow funds from that account to be used for the payment of 

7 Sunshine's business and operating expenses. In short, defendant 

8 was rightfully in possession of all funds in the Bank of America 

9 account as a nonowner of those funds. 

10 The second element is also satisfied. Defendant admitted 

/ 11 that he used $46,851.44 from Sunshine's Bank of America account 

12 to pay his personal expenses consisting of the mortgage on his 

13 residence and payments to his ex-wife. And based on the 

14 defendant's contradictory, evasive, and argumentative cross15 examination testimony the court is persuaded that an additional 

16 $48,936.22 from the Bank of America account was used to pay other 

17 expenses that have no business justification and, instead, were 

18 expenses personal to the defendant. All totaled, the court is 

19 persuaded that $95,787.66 from Sunshine's Bank of America account 

20 was used to pay defendant's personal expenses unrelated to 

21 Sunshine or any business purpose. Put another way, the defendant 

22 I as the nonowner of the funds in the Bank of America account 

23 appropriated funds from that account for a purpose other than for 

24 which they were, intended. 

25 And the third element is satisfied. During the time that 

26 funds from the Bank of America account were used to pay the 

27 defendant's personal expenses the defendant was a fiduciary to 

28 Sunshine. In re SKG Ventures, LLC, 521 B.R. 842, 864 (Bankr. 

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N.D. Ill. 2014) (applying Illinois law). "In a corporate 

setting, a fiduciary has the duty to act with utmost loyalty and 

good faith in managing the business and affairs of a 

corporation." Rubin v. Bedford, 2015 WL 9463995 1 *13 (Il1.App. 

2015) (citation omitted)).' That means the defendant was 

I.prohibited from enhancing his own personal interests at 

Sunshine's expense. Kovac v. Barron, 6 N.E.3d 819, 833 (Ill.App. 

2014) (citation omitted). That also means the defendant breached 

his fiduciary duty when he used funds from Sunshine's Bank of 

America account to pay personal expenses and allowed funds from 

that account to be used for his personal benefit. Tully, 948 

N.E.2d at 739 (Ill.App. 2011) (citation omitted). Those breaches 

are circumstances that amount to fraud for purposes of 

embezzlement under § 523(a) (4). In re Bullock, 2010 WL 2202826, 

*7 (Bankr. N.D. Ala. 2010) ("Accordingly, 'the Court finds that 

the finding of breach of fiduciary duty by self-dealing which is 

a form of fraud in Illinois supports a finding of fraud for 

purposes of § 523(a) (4). 11 ). 

In short, the court is persuaded that plaintiff has 

established embezzlement under § 523(a) (4). Defendant's 

I affirmative defenses do not alter that conclusion. 

DEFENDANT'S AFFIRMATIVE DEFENSES 

Unclean Hands 

Defendant's "unclean hands" affirmative defense is 

1The same applies with regard to a limited liability 

1company. See Tully v. McClean, 948 N.E.2d 714 (Il1.App. 2011). 

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1 overruled. Although unclean hands may be an affirmative defense 

2 to a non-dischargeability action, it requires a court to •weigh 

3 the plaintiff's conduct against the defendant's conduct. 

4 Northbay Wellness Grp., Inc. v. Beyries (In re Beyries), 789 F.3d 

5 956, 959-60 (9th Cir. 2015); In re Rose, 565 B.R. 178, 183 

6 (Bankr. D. Nev. 2017). Doing so here, the balance tips in 

7 plaintiff's favor. 

8 Plaintiff and defendant were both fiduciaries to Sunshine 

9 during the time that Collins loaned Sunshine money and Sunshine's 

10 money was used to pay defendant's personal expenses. Plaintiff 

11 arguably breached a fiduciary duty to his aunt and her estate 

12 when, as a beneficiary of his aunt's estate, he used his aunt's 

13 power of attorney to obtain money from her accounts which he 

14 loaned to a entity of which he was the CFO and by which he was 

15 paid from the account into which the loan proceeds were 

16 deposited. Defendant breached a fiduciary duty by using business 

17 funds from the Bank of America account to pay his personal 

18 expenses and by benefitting from the payment his personal 

19 expenses with those funds. So to some degree, both parties have 

20 engaged in inequitable conduct. 

21 That said, whereas plaintiff may have harmed his aunt and 

22 other beneficiaries of her estate, plaintiff's conduct benefitted 

23 Sunshine inasmuch as it provided Sunshine access to capital for 

24 business and operating expenses at an interest rate lower than 

25 otherwise available commercially. On the other hand, the use of 

26 business funds to pay defendant's personal expenses harmed 

27 Sunshine, its creditors, the Collins estate, and beneficiaries of 

28 the Collins estate. And in that regard, the harm resulting from 

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1 defendant's conduct is broader and more far-reaching than any 

2 harm caused by the plaintiff. 

3 Failure to State a Claim 

4 Defendant's "failure to state a claim" defense is moot as it 

5 pertains to the first and third claims for relief. It is 

6 overruled for the reasons stated above as to the second claim for 

7 relief. 

8 Statute of Limitations 

9 The statute of limitations affirmative defense is overruled. 

10 The debt was timely established and this adversary proceeding was 

11 timely filed. Banks v. Gill Distribution Ctrs., Inc. (In re 

12 Banks), 263 F.3d 862, 868 (9th Cir. 2001); In re Moore, 2014 WL 

13 3570600, *5 (Bankr. E.D. Cal. 2014) (citing Banks, 263 F.3d at 

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16 CONCLUSION 

17 Based on all the foregoing, and also for the reasons stated 

18 on the record on April 9, 2018; 

19 (1) judgment on the § 523(a) (2) (A) claim in the first claim 

20 for relief and judgment on the § 523(a) (6) claim in the third 

21 claim for relief will be entered for the defendant and against 

22 the plaintiff with plaintiff taking nothing on those claims; and 

23 (2) judgment on the § 523(a) (4) claim in the second claim 

24 for relief will be entered for the plaintiff and against the 

25 defendant and defendant's debt to plaintiff in the amount of 

26 $95,787.66 is non-dischargeable in defendant's chapter 7 

27 bankruptcy case. 

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1 A separate judgment and a separate order vacating the 

2 continued trial date of May 1, 2018, at 9:30 a.m. will enter. 

3 Dated: May 1, 2018. 

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UNITED STATES BANKRUPTCY ~UDGE 

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INSTRUCTIONS TO CLERK OF COURT 

SERVICE LIST 

The Clerk of Court is instructed to send the attached 

document, via the BNC, to the following parties: 

Douglas B. Jacobs 

20 Independence Cir 

Chico CA 95973 

LARRY ALAN SCHACK 

15013 EMMA MINE WAY 

MAGALIA CA 95954 

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