In the

United States Court of Appeals

For the Seventh Circuit

No. 00-1162

In re Michael Frain,

Debtor-Appellee,

Appeal of Patrick F. O’Shea and

Roger L. Schoenfeld

Appeal from the United States District Court 

for the Northern District of Illinois, Eastern

Division.

No. 98 C 5651--David H. Coar, Judge.

Argued September 22, 2000--Decided October 30,

2000

 Before Posner, Manion, and Evans, Circuit

Judges.

 Manion, Circuit Judge. Michael Frain

filed for Chapter 7 bankruptcy.

Appellants Patrick O’Shea and Roger

Schoenfeld filed a complaint under the

Bankruptcy Code, 11 U.S.C. sec.

523(a)(4), seeking nondischargeability of

debts owed to them from a business

relationship they had with Frain. The

bankruptcy court held that the asserted

debts were dischargeable, and the

district court affirmed. O’Shea and

Schoenfeld appeal. We reverse and remand

for further proceedings.

I.

 In May 1989, Michael Frain, Patrick

O’Shea, and Roger Schoenfeld formed a

closely held corporation called the

Preferred Land Title Insurance Company.

Under the shareholder agreement, Frain

was Chief Operating Officer and possessed

50% of the shares of the corporation.

O’Shea and Schoenfeld were both directors
and each held 25% of the shares. Frain

was authorized to make day-to-day

business decisions and all decisions

affecting the normal operations of the

corporation. The shareholder agreement

further provided that major decisions

required consent by 75% of the shares of

the corporation, although certain

decisions required a unanimous vote.

Anything requiring a majority vote was

required to have the approval of Frain

and either O’Shea or Schoenfeld.

 The shareholder agreement set a specific

salary formula for Frain during the first

three years of the corporation. He was to

receive $70,000 the first year with

annual increases based on the Consumer

Price Index (CPI). The salary provision

expired in 1992. Frain continued in his

position as Chief Operating Officer after

the end of the three-year term, and

increased his salary annually well above

the CPI formula set by the initial salary

provision. The shareholder agreement,

however, also provided that "[n]o

salaries, bonuses, or other compensation

shall be paid to a shareholder . . .

unless set forth herein or approved by a

unanimous vote of the Board of

Directors." O’Shea and Schoenfeld were

aware that Frain was still receiving a

salary, but at the time did not know of

the salary increase.

 The shareholder agreement also

prioritized distributions of corporate

cash flow. Because it was a so-called

"subchapter S corporation" (see 26 U.S.C.

sec. 1361), income and taxes were passed

through directly to the shareholders. The

agreement designated the distributions in

the following order: first, payments to

the shareholders for payment of federal

and state income taxes in proportion to

ownership of shares of the corporation;

second, payments of any outstanding

shareholder loans; and third, payments of

the balance to the shareholders also in

proportion to their ownership of shares.

Frain made shareholder distributions--the

third priority--before repaying

shareholder loans. O’Shea and Schoenfeld

protested but accepted and deposited

their shareholder distributions.

 The corporation ceased operation in
December, 1995. Frain subsequently filed

for relief under Chapter 7 of the

Bankruptcy Code. O’Shea and Schoenfeld

filed a Dischargeability Complaint in the

bankruptcy court. See In re Frain, 222

B.R. 835 (Bankr. N.D. Ill. 1998). 

Apparently outstanding loans were owed to

one or both of the plaintiffs. They

argued that these debts were not

dischargeable pursuant to the Bankruptcy

Code, sec. 523(a)(4), which provides that

an individual debtor is not discharged

from any debt "for fraud or defalcation

while acting in a fiduciary capacity."

The bankruptcy court held that there was

no fiduciary relationship for purposes of

sec. 523(a)(4), and accordingly that the

alleged debts were dischargeable. The

district court affirmed on the same

basis. O’Shea and Schoenfeld appeal,

alleging that the district court erred in

its determination that no fiduciary

relationship existed.

II.

 Section 523(a)(4) of the Bankruptcy Code

provides that "[a] discharge under

section 727, 1141, 1228(a), 1228(b), or

1328(b) of this title does not discharge

an individual debtor from any debt . . .

for fraud or defalcation while acting in

a fiduciary capacity."

 The bankruptcy court and the district

court held that there was no fiduciary

relationship between Frain and appellants

because the terms of the shareholder’s

agreement did not create a fiduciary

relationship under this circuit’s case

law. We review the bankruptcy and

district court’s legal findings and

contract interpretations de novo. See In

re Scott, 172 F.3d 959, 966 (7th Cir.

1999); GNB Battery Technologies, Inc. v.

Gould, Inc., 65 F.3d 615, 621 (7th Cir.

1995). Findings of fact, however, are

reviewed for clear error. See Scott, 172

F.3d at 966. In this appeal, the

relevant facts are not disputed. The

dispute is over the lower courts’

interpretation of the shareholder

agreement and whether those courts

correctly applied the law to the facts.

Accordingly, we apply de novo review.

 This court has defined a fiduciary
relationship under sec. 523(a)(4) as "a

difference in knowledge or power between

fiduciary and principal which . . . gives

the former a position of ascendancy over

the latter." In re Marchiando, 13 F.3d

1111, 1116 (7th Cir. 1994). See also

Woldman v. Johnson, 92 F.3d 546, 547

("section 523(a)(4) reaches only those

fiduciary obligations in which there is

substantial inequality in power or

knowledge in favor of the debtor seeking

the discharge and against the creditor

resisting discharge.").

 A "fiduciary duty" under this test

covers circumstances which, although not

comprising a literal "trust," do "call

for the imposition of the same high

standard." See Marchiando, 13 F.3d at

1115 (citing Restatement (Second) of

Trusts sec. 2, comment b (1959)). For

example, a lawyer-client relation, a

director-shareholder relation, or a

managing partner-limited partner relation

all call for the principal to "repose a

special confidence in the fiduciary." See

id., 13 F.3d at 1116.

 The existence of a "fiduciary

relationship" is a matter of federal law.

It bears emphasis that not all fiduciary

relationships qualify under the

Bankruptcy Code. See Woldman, 92 F.3d at

547 (7th Cir. 1996) ("[O]nly a subset of

fiduciary obligations is encompassed by

the word ’fiduciary’ in section

523(a)(4)."). A fiduciary relation only

qualifies under sec. 523(a)(4) if it

"imposes real duties in advance of the

breach." See Marchiando, 13 F.3d at 1116.

In Marchiando, we recognized the wellestablished principle that, for purposes

of sec. 523(a)(4), the fiduciary’s

obligation must exist prior to the

alleged wrong. A constructive trust, for

example, will not qualify for purposes of

sec. 523(a)(4), since the obligations do

not exist until the wrong is committed.

See Marchiando, 13 F.3d at 1115 (citing

Davis v. Aetna Acceptance Co., 293 U.S.

328, 333 (1934); In re Bennett, 989 F.2d

779, 784 (5th Cir. 1993); In re Tiechman,

774 F.2d 1395 (9th Cir. 1985)).

 As this court has noted, there is a

"broad spectrum of fiduciary obligations

from the case in which a trustee defrauds
a child beneficiary or a lawyer defrauds

a client or a general partner defrauds a

limited partner." Woldman, 92 F.3d at 547

(7th Cir. 1996). For example, a joint

venture between equals will not qualify

as a fiduciary relationship. See id. The

relationship in this case, however, falls

on the fiduciary end of the spectrum.

 A difference in knowledge or power can

create a fiduciary relationship, see

Marchiando, 13 F.3d at 1116. Frain was

responsible for the day-to-day business

decisions of the corporation, giving him

a natural advantage over the other two

shareholders in terms of knowledge of the

corporation’s finances. But it does not

necessarily follow that this knowledge

was unavailable to appellants. Indeed, it

was no secret that Frain was drawing a

salary after the initial three-year

period, and the appellants themselves

received and accepted shareholder

distributions from Frain even though they

were disgruntled because their loans were

not repaid first. Frain’s superior

knowledge of day-to-day operations was

not sufficient in itself to establish a

position of ascendancy. 

 While the parties’ access to knowledge

and information may have been reasonably

similar, the concentration of power was

substantially one-sided. The

shareholder’s agreement was structured to

give Frain ultimate power over both his

own employment and the direction of the

corporation. Frain’s control over the

day-to-day business of the corporation

and ownership of 50% of the shares gave

him significant freedom to run the

corporation as he saw fit, including

oversight of such items as salary and

distributions of corporate cash flow. The

only real limit to his power was the

chance of deadlock; that is, if he voted

his 50% one way and O’Shea and Schoenfeld

voted their combined 50% the other,

nothing would happen. A further reading

of the thirty-plus-page contract

discloses that "major decisions shall

require the consent of the holders of

seventy-five percent (75%) of the voting

common shares" (with some decisions

requiring 100%). The contract defined

"major decisions" to include "all

decisions affecting the Corporation which

are not in the ordinary course of

business of the Corporation." So no major
decisions can be made unless Frain

agrees. The district court, while noting

that O’Shea and Schoenfeld had 50% of the

shares and had a balance of power in many

areas, emphasized the provision that they

could "purchase Frain’s interest for

$1.00 in the event [he] . . . committed

any material breach . . . ." O’Shea v.

Frain, 1999 WL 1269352, *3 (N.D. Ill.

Dec. 22, 1999).

 But the contract requires a majority

vote to determine whether to continue

Frain’s employment. Unless Frain

voluntarily terminates his employment,

the $1.00 purchase option kicks in only

if he is terminated for cause. Obviously

that is a major decision requiring 75% of

the voting shares; he can’t be fired

unless he votes in favor of it. Thus the

$1.00 purchase option cannot be exercised

without Frain’s approval.

 Both lower courts relied on the $1.00

purchase provision in reaching their

decision, on the theory that the power to

buy Frain out limited his position of

power in the corporation. Theoretically,

they were correct. The termination

provision did limit Frain’s position of

ascendancy under the shareholder’s

agreement, but in practice this power was

hollow. Not only is for-cause termination

a "major decision" requiring consent of

holders of 75% of voting shares, but also

the contract specifically provides that

in order to terminate Frain for cause, a

majority vote was required. And as noted,

a majority vote was defined as a vote by

75% of the shares. Since Frain held 50%

of the shares, he could be removed by

appellants only if he wanted to be

removed. Thus, the power for O’Shea and

Schoenfeld to independently remove Frain

and purchase the corporation for $1.00

did not exist.

III.

 A Chief Operating Officer with 50% of

the shares who cannot be removed for

cause without his consent possesses a

position of considerable ascendancy over

the other shareholders. All of the

decisions made in the ordinary course of

business were Frain’s to make. All of

the major decisions required Frain’s

agreement. If Frain abused this power,
termination for cause was a tantalizing,

but unavailable fiction. This

shareholder’s agreement was not a system

of checks and balances. Frain had more

knowledge, and substantially more power,

than appellants.

 In this case, a fiduciary relationship

was created by the structure of the

corporation under the shareholder

agreement, which had given Frain a

position of ascendancy under our case

law. Frain argues that violations of a

contract entered into by equals are not

covered by sec. 523(a)(4). However, Frain

had a pre-existing fiduciary obligation

to O’Shea and Schoenfeld independent of

any breach of contract. This is not a

case where a fiduciary relationship was

implied from a contract. See Bennett, 989

F.2d at 784 (sec. 523 (a)(4) does not

cover fiduciary duty implied from

contract). A contract was necessary to

the existence of a fiduciary

relationship, but the obligations of the

contract were not the source of the

fiduciary relationship. The source of the

fiduciary relationship was Frain’s

substantial ascendancy over O’Shea and

Schoenfeld. Whether any alleged breach of

contract was a defalcation is an issue

for the bankruptcy court.

 We conclude, therefore, that based on

the contract Frain possessed an ascendant

position in relation to appellants. There

was accordingly a fiduciary relationship

for purposes of sec. 523(a)(4). The

bankruptcy court must now decide whether

Frain actually committed any defalcation

under sec. 523(a)(4).

REVERSED and REMANDED.