* The Honorable Gerard E. L ynch, United States District Court for the Souther n District of New York, sitting by

designation. 05-7026- bk In Re: Andrew A. Hyman

UNITED STATES COURT OF APPEA LS 1 F OR THE S ECOND C IRCU IT 2

_____________________ 3 August Term, 2006 4 5 (Argued: September 18, 2006 Decided: September 6, 2007) 6 7 Docket No. 05-7026-bk 8 9

______________________ 10 11 I N RE : ANDREW A. H YMAN , 12 Debtor , 13

____________________ 14 15 G. H ALL ETT D ENTON , 16 As Executor of the Estate of George W. Denton, 17 Appellant , 18 19 — v .— 20 21 22 ANDREW A. H YMAN , 23 Debtor-Appellee. 24

_________________ 25 Before: 26 27 C ALA BRE SI and B. D. P ARKER , Circuit Judges, and L YNCH * , District Judge

. 28 29 30

__________________ 31 32 33 Appeal from a judgment of the United States District Court for the Southern District of 34 New York (Conner, J. ) affirming the Bankruptcy Court’s (Hardin, J. ) ruling that collateral 35 estoppel based on findings in prior Surrogate’s Court proc eedings did not preclude relitigation of 36 a non-dischargeability claim. See 11 U.S.C. § 523(a). 372 1 AFFIRMED. 2

__________________ 3 4 K ENNETH L. S TE IN (Norman A. Senior & Jeffery H. Sheetz, of 5 counsel ), Greenfield Stein & Senior, L LP, New York, NY, 6 for Appellant G. Hallett Denton

. 7 8 ANTHONY L. T ERSI GNI , Mey ers Ter signi Fe ldman & G ray , LL P, 9 New York, NY (Richard N. Gray , Meyers Te

rsigni 10 Feldm an & Gray, Ne w York , NY; M . Stu art Go ldber g, 11 White Plains, NY, on the brief ), for Appellee Andrew A. 12 Hyman

. 13 14

__________________ 15 16 B ARRI

NGTON D. P ARKER , Circuit Judge : 17 Appellant G. Hallett Denton (“Denton”), the executor of the e state of George W. Denton, 18 appeals from a judgment of the United States District Court for the Southern District of N ew 19 York (Conner, J. ). The district court affirmed an order of the Bankruptcy

Court (Hardin, J. ) that 20 collateral estoppel did not relieve Denton from proving tha t a debt owed the estate by Appellee 21 Andrew Hy

man (“Hyma

n”) was not dischargeable unde r § 523(a)(4) of the Bankruptcy Code. 22 That section of the Code precludes discharg e of a debt resulting from a debtor’s “ defalcation 23 while acting in a fiduciary capacity .” 11 U.S.C. § 523(a)(4). During prior litigation, the 24 Westchester County, New Y ork Surrogate’s Court ruled that Hy man, in dealings with the Denton 25 estate, breached his fiduciary duties and misappropriated assets. Both the Bankruptcy Court and 26 the District Court ruled that collateral estoppel did not attach to this finding because the issue of 27 whether Hy

man committed a “defalcation” within the meaning of the Bankruptcy

Code had not 28 actually bee

n decided by the

Surrogate. We agree a

nd we affirm, although on somewhat 293

different grounds. 1 I. BACKGROUND 2 In 1984 Hy man and George W. Denton (“G.W. Denton”) be gan working for an insuranc e 3
agency

in Westchester County, New Yor k owned by He

nry Deppe . The agency

represented the 4 Guardian Life I

nsurance Company

of America and, among other ac tivities, marketed Guardian 5 life insurance products through pension plans. These pla ns were designed and administered 6 through a separate company , National Pension Services, Inc., also owne d by Deppe, w hich 7 channeled business to his insurance agenc y. 8 In 19 87, G.W. De nton and H

yma n took ove

r the busi ness fro m Deppe a

nd forme d their 9 own insurance agency , the Denton-Hyma

n Agency (“Denton-Hy

man”), as well as their own 10 pension administration company, also ca lled National Pension Service, Inc. (“ NPS”), and a third 11 company, Na

tional Pension Actuaries (“NPA”), which gene rated business for the agency but was 12 not profitable. Each owned fifty percent, and served as director a nd executive officer, of the 13 three companies. Guardian designa ted G.W. Denton and Hyman to succ eed Deppe as Guardian’s 14 agent f

or Westch ester Cou

nty under an agree ment which provide d that, if e ither lef t the business, 15 their

age ncy rela tions hip wi

th Gua rdia n wou ld ter minat e. I n star ting these businesse s, G.W

. 16 Denton and Hyma n incurred substantial debts – exceeding $1.6 million – which they guaranteed 17 jointly and severally . As was the case with Deppe’s ag ency, NPS g enerated business for Denton18 Hyman, but opera ted at a loss. 19 In 19 89, thirte en months a fter sta rting th ese businesses, G .W. Denton died unexpe ctedly 20 and Hy

man succ eeded h

im as pres ident and

sole dire ctor of the three corpora tions. At that point, 214

the age ncy relation ship betwe en Guar dian and D enton-H

yma n automat ically terminat ed and, in 1 accordance with Guardian’s re gulations, both the Denton estate and Denton-Hy man were 2 ineligib le to bec ome shar eholders in the ne

w gene ral ag ency . Denton- Hy

man, howe

ver, still 3 owed $1.6 million in start-up debt for which Denton’s estate and Hy man were personally

liable. 4 To service this obligation Hy man looked, among other sources, to commission income earned by 5 the Denton-Hyma n agency during the thirteen-month period prior to G.W. Denton’s death but 6 receiv ed afte

rwards. After G .W. Denton ’s death , Guardi an acce pted Hy man as its a

gent an d, to 7 service the Guardian business, he formed the Andr ew A. Hyma

n Agency (“Hyman A

gency ”). 8 Hy

man conti nued to op erate N

PS, and to f

und its def

icits so tha

t it would c ontinue to

gener ate 9 business for the Hyman A gency . By 1994, whe

n Hyman’s re lationship with Guardian 10 terminat

ed, Hy man had li quidated

the $1.6 mi llion debt w

ith the est ate’s c onsent, us ing joint

ly 11 owned assets – the residual commissions earned by Denton-Hyman – a

nd the earnings of the 12 Hym an Ag en cy. 13
In a

ddition to r

unning the age

ncy and pay ing down the debt, Hy

man also e

ngag ed in 14 lengthy ne gotiations with G. Hallett Denton, the executor of G.W. Denton’s estate, for the 15 purchas e of the e state’s f ifty percen t interes t in Denton -Hy

man, NPS an

d NPA. The se 16 negotiations were protracted and diff icult, and seem to have foundered over the issue of how 17 much of th e income Hy man gen erated belong ed to him a

nd how much neede d to be sha red with 18 the estate. At the end of the day , no agreement was reac hed. 19 At this point, Denton sued Hyman in Surrog ate’s Court. Denton asserted a derivative 20 claim on behalf of Denton-Hy man, seeking to recover “prof its earned by H

yman and the Hy

man 215

Agenc y in exploiting

assets of [the jointly

-owned] c orporat

ions” and “damag es suffe

red as a 1 result of the diversion of corporate assets.” Hy man asserted a number of affirmative de fenses 2 including ratification and estoppel. After a nine- day trial, the Surrog ate’s Court entered 3 judgment in favor of the estate and ag ainst Hyman and the Hy man Agency

for $2,734,832, 4 “r ep re se nt in g t he ne t p ro fi ts ob ta in ed by [ th em ] a s a re su lt of Hym an ’s br ea ch of

fi du ci ar y du ty, 5 as an off

icer, di rector and 50% sharehold

er of De nton-Hy man, NPS, a

nd NPA and

their 6 misappropriation of the assets and goodwill of said Corporations.” I n so ruling, the Surrogate’s 7 Court foun

d that Hy man had br

eached his fiduc iary

duty by “ co-optin

g the De nton-Hy man, NPS 8 and NPA enterprise for the benefit of the Hy man Agency

and for his own personal enrichment,” 9 using furniture and fixtures of the corporations without compensation, and using “Denton10 Hyman overr

ides to subsidize NPS and NPA and to satisfy the Hy man Agency

debt to the 11 Guardian.” 12 Although the Surrogate’s conclusions were undoubtedly damaging to Hyman, the y were 13 not accompanied by in-depth analysis of a

number of issues relevant to this appeal. The 14 Surrog ate, for

example, ma

de no find

ings con cerning Hy man’s sta te of mind: In us ing joint

ly 15 owned as sets and i ncome g enerat

ed by his own ef

forts both to liquidat

e debt of the esta te and to 16 operate the business that was genera ting the income, was Hy

man breaching a fiduciary obligation 17 by b eing slo

ppy or venal or was he

stealing ? In addi

tion, the Su

rroga te’s dec ision ga

ve little 18 prominence to the substantia

l monetar y be nefits Hy man conf erred on the esta

te. Nor d id it 19 specifically a

ddress Hyman’ s argument that the estate’s represe ntatives acquiesced in, and 20 consented to, Hyman’ s conduct over a lengthy period. 216

In Februar

y 2003, Hy

man filed for protection under the bankruptcy laws. Denton, as 1
executor

of G.W. De

nton’s es tate, the

n filed a claim bas ed on the S urroga te’s Cour t’s judg ment, 2 to declare that judgment non-discharg eable under § 523(a)(4) of the B ankruptcy Code a s a debt 3 arising from “defalcation while ac ting in a fiduciary

capacity .” Denton contended that the 4 Surrogate’s findings were c onclusive and that Hyman was collaterally estopped from contesting 5 them. 6 The Bankruptcy Court found the Surrogate’s Court’s judgment valid and enf orceable and 7 allowed Denton’s claim based on the judgment. Howeve r, the court rejected Denton’s contention 8 that collateral estoppel precluded further litiga tion over the dischargeability of the debt. The 9 Bankruptcy

Court ruled that under § 523(a)(4) “defalc ation” was narrower than the conce pt of 10 “misappropriation” under state law, with defalcation re quiring “some portion of misconduct.” 11 The court then concluded that the Surrogate ’s Court’s findings failed to satisfy the more 12 restrictive definition. In re aching this conc lusion, the

court em phasized D enton’s f

ailure to 13 identify any

specific conduct of Hy

man’s that amounted to a defalcation or that could be 14 characterized as wrongful, illeg al or morally re prehensible, “other than the fact that the parties 15 did not reach agreement on a buy out.” 16
Becau se Dento n had volu ntarily dismissed a

lternati ve claims for reli ef, and had agr

eed to 17 abide by the B ankruptcy Court’s r esolution of the collateral estoppel issue rather than retry the 18 claim, the

Bankru ptcy Court issue d a final

judgmen t in favor of Hy man, and D enton app ealed to 19 the distri ct court . The distr ict cour t affirmed. Judge

Conner r uled that defalc ation re quires so me 20 element o f wrong ful intent , so as to be more tha n a “mer e negli gent” o

r innoce nt act, a nd held 217

that bec ause the

Surrog ate’s Cou

rt made no finding

as to Hy man’s inte

nt, it nec essarily

failed to 1 decide the issue of defalcation. The district court found that Hy man’s immediate offer to buy out 2 the estate’s interest, the three-y ear-long negotiation over the pur chase price, and the pay

down of 3 the $1.6 million in debt did not demonstrate the level of misconduct necessary to trigger the 4 application of § 523(a)(4). Specifically, Judge Conner concluded that “Debtor’s conduct 5 throughout was fully consistent with a good faith effort to preserve the business for the mutual 6 benefit of AHA and the Estate.” This appeal followe d. 7 II. DISCUSSI ON 8 A. Standard of Review 9 Our review of a d istrict c ourt’s or

der in its c apacity

as an app ellate ba

nkruptcy court is 10 plenary. In re DeTrano , 326 F.3d 319, 321 (2d Cir. 2003). The factual determinations and leg al 11 conclusions of the Bankruptcy Court are, therefore, reviewe d independently by this Court. Id. 12 The Bankruptcy

Court’s legal conclusions are reviewe d de novo and its factual conclusions are 13 reviewed for clear err or. Id. 14 B. New York’s Law of Collateral Estoppel 15 To determine whether collateral estoppel applies to the Surrogate’s Court’s judgment, we 16 look to New York law. See Marrese v. Am. Acad. of Orthopaedic Surgeons , 470 U.S. 373, 380 17 (1985) ; Colon v. Coughlin, 58 F.3d 865, 869 n.2 (2d Cir. 1995). Under New York law, collate ral 18 estoppel bars relitigation of an issue when (1) the identica l issue necessarily was decided in the 19 prior action and is decisive of the present action, and (2) the party to be pr

ecluded from 20 relitigating the issue had a full and fair oppor tunity to litigate the issue in the prior ac tion. 218

Kaufman v. Eli Lilly & Co. , 65 N.Y.2 d 449, 455- 56 (1985) ; see Jef freys v. Griffin , 1 N.Y.3d 34, 1 39 (2003) ; Bueche l v. Bain , 97 N.Y.2 d 295, 303- 04 (2001) ; see also Kh andahar v . Elfenbe in , 943 2 F.2d 244, 247 (2d Cir. 1991). Under New York law, collate ral estoppel is a flexible doctrine and 3 whether to apply it a pa rticular case depends on “ge neral notions of fairness involving a practical 4 inquiry into the realities of the litiga tion.” Jeffreys , 1 N.Y.3d at 41. 5 On this appeal, these principles must be analy zed jointly with others that have special 6 signific ance in t

he bankr uptcy context. The basic p olicy animating

the Ban kruptcy Code is to 7 afford the “honest but unfortunate” debtor a f resh start. Marrama v

. Citizens B ank of Mas

s. , 127 8 S. Ct. 1105, 1 107 (2007 ); Grogan v. Garner , 498 U.S. 279, 286-87 (1991); DeTrano, 326 F.3d at 9 322. The cons equenc es to a de btor whos e obliga

tions are not discha

rged a re consi derable ; in 10 many instances, fa ilure to achieve discharge ca n amount to a financial death sentence. I n view of 11 these harsh consequences, exceptions to discharg e are to be narrowly construed and genuine 12 doubts should be resolved in favor of the debtor. In re Renshaw , 222 F.3d 82, 86 (2d Cir. 2000); 13 In re Hayes, 183 F.3d 162, 167 (2d Cir. 1999). 14 Th e f

ir st cr it ic al qu es ti on is wh et he r a “d ef al ca ti on wh il e a ct in g i n a fi du ci ar y ca pa ci ty” 15 under § 523(a)(4) of the Bankr uptcy Code is identical to the fac tual and legal determinations 16 necessarily

decided in the prior Surrogate’s Court action. De nton argues that the issue of 17 whether a defalcation occurr ed was necessarily

decided by the

Surrogate’s Court’s findings that 18 Hyman brea

ched his fiduciary

duty and misappropriated a ssets. Hyman contends that in view of 19 the pervasive confusion in the federal courts ove r what constitutes “defalcation” under § 20 523(a)(

4), and a lso in view

of the ha rsh conse quence s that atta ch and the

require ment that d

oubts 211 Defalcation is defined in Black’s Law Dictionary (8th ed. 2004), as “loosely , the failure to meet an obligation” and “a non-fraudule nt debt.” Id. at 427; see Oxford English Dictionary 389 (2d ed. 1989) (“a monetary deficiency

through breach of trust by one who has the management or charg e of funds”). 9 in a close case such as this should be resolved in his favor, he should not be denie d the 1 opportunity to prove at a trial in B ankruptcy Court that he did not violate § 523( a)(4). 2 C. Whether “Defalcation” Was Necessarily Decided 3 While the Code generally allows for the discharge of debts, sig nificant exceptions exist. 4 DeTrano, 326 F.3d at 322. Among them is § 523(a)(4) excepting f rom discharge any

debt “for 5 fraud or defalcation while acting in a fiduciary

capacity , embezzlement, or larceny .” 11 U.S.C. § 6 523(a)(4). As previously noted, this exception, like most, must be narrowly construed. 7 Kawaauhau v. Geiger , 523 U.S. 5 7, 62 (199 8) (obse rving that except

ions to disc

harge “‘should 8 be confined to those plainly e xpressed’”) (quoting

Gleason v. Thaw, 236 U.S. 558, 562 (1915)); 9 Renshaw , 222 F.3d at 86. 10 There has been much debate among the Circuits over whether a “defalca tion” under § 11 523(a)(

4) includ es all misa

ppropria tions or fa

ilures to a ccount or only those tha t evince some 12 wrongf

ul conduct. 1 See Zohlman v. Zoldan, 226 B.R. 767, 775 (S.D.N.Y. 1998) (discussing the 13 circuit split). This Circuit, although previously ha ving suggested that “some portion of 14 misconduct” may be requi red to es tablish a “ defalc ation” un der § 523 (a)(4) , has y

et to squa rely 15 address this issue. Cent. Hanover Bank & Trust Co. v. Herbst, 93 F.2d 510, 512 (2d Cir. 1937); 16 see Hayes, 183 F.3d a t 172 (ass uming tha

t defalc ation demands “some portion of misconduct,” in 17 finding that the debtor committed a defalcation). 182 The Act found non-dischargeable debts resulting from “defalcation as a public of ficer, or while acting in any

fiduciary c

haracter,” fraud or embe zzlement. Herbst , 93 F.2d at 511.

10 In Herbst , 93 F.2d at 511-12, Judge Lea rned Hand wrestled with this problem without 1 resolving it. He wrote: 2 Colloquially perhaps the word, “ defalcation,” ordinarily implies some moral 3 dereliction, but in this context [the first reference to defalcation in the Bankr uptcy 4 Code] it may have included innocent de faults, so as to include all fiduciaries who 5 for any r

eason were short in their accounts. I t must be remembered that the 6 “fiduci ary

capaci ty” was limite d to “spec ial” or “ technic al” fidu

ciaries

. 7

.... 8 Whatever was the original meaning of “defalcation,” it must here [in the 9 Bankru

ptcy Act of 18 67] have c overed other def aults than deliber ate 10 malversations, else it added nothing to the words, “fraud or e mbezzlement.” 2 11

.... 12 We must give the words different meanings so fa r as we can, especially

when a 13 contr ary interp retat ion wo uld wr est “d efalca tion ,” if n ot fro m its origin al mea ning, 14 at least from that which it must have had in the Act of 1867. 15

.... 16 We do not hol d that no po ssible de ficienc y in a fiduci ary ’s acco

unts is 17 dischargeable; in [ In ] Re Bernard, 87 F.2d 705, 707 [(2d Cir. 1937)], we said that 18 “the misappropriation must be due to a known breach of the duty , and not to mere 19 negligence or mistake.” A lthough that word probably carries a larger implication 20 of misconduct than “defalcation,” “defa lcation” may de

mand some portion of 21 misconduct; we will a ssume ar guendo that it doe s. 22 23 Denton relies on In re Hammond, 98 F.2d 703, 704 (2d Cir. 1938), for the proposition 24 that no actual intent is necessary to establish a defalcation. Hammond involved our 25 determination of whether the unlawful appropriation of a c orporate contract constituted a 26 “misappropriation” under the previous version of § 523(a)( 4), absent any

finding by the lowe

r 27 court of a “conscious wrongdoing ” or “purpose to defraud.” Id. at 704, 705. Hammond does not 28 stand for

the propo sition that

a “misap propria tion” unde

r this prov

ision can be found absent a 29 wrongful intent. In Hammond , we held that a wrongful or evil intent, if require d by the 303 The Ninth Circuit do es, howe

ver, mor e strictl y lim it the app lication o f defal cation to fiducia ry of trusts a

nd relat ionships th at exhibit c

haract eristics of the tra ditional tr ust relationship. Hemmeter, 242 F.3d at 1189-90. 11 provision, could

be inferred based on the debtor’s intentional unlawful a ct and by finding

the 1 debtor chargeable with the knowledg e that his actions violated the law. Id. at 705. 2 The Fourth, Eighth, and Ninth Circuits hold that an innocent mistake can constitute a 3 defalcation. In re Uwimana, 274 F.3d 806, 811 (4th Cir. 2001) (“[N]egligence or e ven an 4 innocent

mistake w

hich res ults in misa

ppropria tion or fa ilure to a ccount is sufficie nt.”); In re 5 Hemmeter, 242 F.3d 1186, 1190 (9th Cir. 2001) (“Even innocent acts of failure to fully account 6 for money re ceived in trust will be held as non-dischargeable defalcations.”); In re Cochrane, 7 124 F.3d 978, 984 (8th Cir. 1997) (“Defalcation includes the innocent de fault of a fiduciary who 8 fails to account fully f or money re ceived.”). 3 9 The majority of the Circuits addr essing this issue, however, require some level of 10 wrongf

ul conduct in order

to find a d

efalca tion under

§ 523(a) (4). The

Fifth, Sixth , and Seve

nth 11 Circuits require a level of fault grea ter than mere negligenc e. In re Schwager , 121 F.3d 177, 185 12 (5th Cir. 1997) (“While defalcation may not require actual intent, it does require some level of 13 mental cu

lpability . It is

clear in the Fift h Circuit that a ‘wil lful neg lect’ of fiducia ry duty 14 constitute s a defa lcation – essentia lly a reckle ssness sta

ndard.” ); Meyer v. Rigdon, 36 F.3d 1375, 15 1384-85 ( 7th Cir. 199 4) (“[A] me re neg ligent breach o f a fiduc iary duty is not a ‘defalcation’ 16 under section 523(a)(11).”); In re Johnson, 691 F.2d 2 49, 257 (6 th Cir. 1982 ) (ruling that while 17 “subjective intent to violate a known fiduciary duty or bad fa

ith is irrelevant,” the misuse of 18 monies as the result of negligence or a mistake of fact does not constitute defalcation). The 194 The Eleventh Circuit also has yet to adopt a clear standard. See In re Fernandez-Rocha,

451 F.3d 813, 817 (11th Cir. 2006) (discussing the different possible interpreta tions of defalcation); Quaif v. Johnson, 4 F.3d 950, 955 (11th Cir. 1993) (finding a defalcation whe re the improper transfer of funds by a fiduciary

“was far more than an innocent mistake or e ven negligence”). 12 Tenth Circuit’s standard is not entirely c lear but at least requires “some portion of misconduct.” 1 Compare I

n re Storie , 216 B.R. 283, 288 (B.A.P. 10th Cir. 1997) (announcing a standar d 2 requiring that includes “intentional, wilful, reckless or neg ligent” breaches of fiduciar y duty ), 3 with In re Millikan, 188 Fed. App’x 699, 7 02 (10th Cir . 2006) (u npublishe d) (dec lining to 4 identify a spec ific standard but requiring “some portion of misconduct” to prove defalcation). 5 The First Circuit set the highest bar, requiring a showing of extreme recklessness, “akin to the 6 level of recklessness required for scie nter [in securities law].” In re Baylis, 313 F.3d 9 , 20 (1st 7 Cir. 2002) . In s o ruling , the First Circuit i nterpre ted “def alcation ” as req uiring a degre e of fau

lt, 8 “closer to fraud, without the necessity of meeting a strict specific intent requirement.” 4 Id. at 18- 9 19. 10 In light of this persistent confusion, we now a lign ourselves with the First Circuit, see 11 Baylis , 313 F.3d at 20, in holding that defalcation under § 523(a) (4) requires a showing of 12 conscious misbehavior or extreme recklessness – a showing a kin to the showing required for 13 scienter in the securities law context. See Ganino v. Citizens Utils. Co. , 228 F.3d 154, 168 (2d 14 Cir. 2000); Novak v. Kasaks , 216 F.3d 300, 308 ( 2d Cir. 200 0); Press v. C hemical I nv. Serv s. 15 Corp. , 166 F.3d 529, 538 (2d Cir. 1999). We believe that these concepts – well understood and 16 commonly applied in the secur ities law context – strike the proper balance under § 523(a)( 4). 17 This stand

ard ensu res that t he term “ defalc ation” c omplemen ts but does

not dilute t

he other terms 1813

of the provision – “fraud,” “embezzlement,” and “larc eny” – a ll of which require a showing of 1 actual wrongful intent. See In re Stern , 231 B.R. 25, 26 (S.D.N.Y. 1999) (noting that larceny 2 under § 5 23(a)(4) requi res a showing of

fraudul ent inten

t to conve rt anothe r’s prop erty

to 3 debtor’ s own use) ; In re Caulf ield , 192 B .R. 8 08, 81 8 (Bank r. E.D .N.Y. 1996) (requi ring a 4 showing

of frau dulent inte

nt for lar ceny and embe zzlement); see also In re Zois , 269 B.R. 89, 5 101 (Bankr. S.D.N.Y. 1999) (requiring a showing of intentional deceit to establish “fraud” under 6 this section); 4 Collier on Bankruptcy § 523.10(1)(a) (15th ed. rev. 2007) (“‘Fraud’ for purposes 7 of this exception has generally been interpreted as involving intentional deceit, rathe r than 8 implied or constructive fraud.”). 9 By re quiring the courts to make appropriate finding s of conscious misbehavior or 10 recklessness in the course of discharg eability litigation, the standar d we adopt today insure s that 11 the harsh sanction of non-dischargea bility is reserved for

those who exhibit “some portion of 12 misconduct.” Herbst , 93 F.2d at 512. The standard does not reach fiduc iaries who may ha ve 13 failed to account for funds or property for which they

were responsible only

as a consequence of 14 negligence, inadverte nce or similar conduct not shown to be sufficiently culpable. This standard, 15 we believe, also has the virtue of ease of a pplication since the courts and litigants have refer ence 16 to a robust body of sec urities law examining what these terms mean. 17 In finding that Hy man breached his fiduciary duty by “misappropriating and co-opting 18 assets of the jointly-owned c ompanies for his personal benefit,” the Surroga te’s Court made no 19 express findings with regard to Hy man’s state of mind. We assume that the Surrogate concluded 20 that under New York law such findings wer e not necessary , since misappropriation and breach of 215 The New York Jurisprudence

states: Corporate directors and officers will be held a ccountable for the wrongful use, diversion, or misappropriation of corporate funds or proper ty in an action appropriate for the enforceme nt of such liability. Good intentions do not justify the misapplication or misuse of corporate assets where the dire ctors know that the use they ar

e making of the assets is not for the benefit of the compa ny, but for the use and benefit of other enterprises in which they are interested. N.Y. Jur. 2d, 14A Business Relationships § 695 (2006).

14 fiducia ry duties ap parentl y do not, unde r New York law, c onsistentl y r equire proof of a

culpable 1 mental state. See Strough v. Bd. of Supervisors, 3 N.Y.S. 110, 112 (N.Y. Gen. Term 1888), 2 modified on other grounds and aff’d, 119 N.Y. 2 12 (1890)(holding defenda nt liable f or “illegal, 3 though innocent in intent, misappropriation”); Matter of Happy Time Fashions, 7 B.R. 665, 670 4 (Bankr . S.D.N.Y . 1980) (n oting tha t good fa ith or inno cent motiv es are n o defens e to a cor

porate 5 officer’s breach of fiducia ry duties). 5 6 Having clarified the standard under § 523(a)(4) and given the unique circ umstances of 7 this case, we decline to mechanically apply collatera

l estoppel. See Jeffreys , 1 N.Y. 3d at 41; 8 People v

. Roselle , 84 N.Y.2 d 350, 357 ( 1994) (“ [C]ollatera l estoppe l, a flexibl e doctri ne, should 9 not be mechanically applied just because some of its formal prerequisites, like identity of the 10 parties, identity

of issues , a final

and valid prior jud gment a nd a full a

nd fair o pportunit y to 11 litigate

the prior determination, ma

y be present .”); Halyalka r v. Bd. of Regents , 72 N.Y.2d 261, 12 269 (1988) (declining to give an administrative conse nt order preclusive effect and noting that 13 the doctrine of collateral estoppel “should never be rigidly or me chanically a pplied”). The 14 Surrogate had neither the ability nor the incentive to apply the standard we announce. Moreover, 156 Denton a rgues t hat the Sur

rogate ’s Court e ffectiv ely did find a

n absenc e of go od faith in rejecti ng Hy man’s af firmativ e defen ses of ra

tification and con sent. Eve n if the Sur

rogate did clearly r eject Hyma

n’s argument that Denton consented to these ac ts – which is entirely unclea r – a lack of good faith was not necessa rily decided by

the Surrogate’s rejection of Hy man’s affirma tive def enses. E ven abse nt Denton ’s conse

nt or rati fication

of Hy man’s acts, good

faith could still be found based on evidence in the record. As indicate d by the Ba nkruptcy Court and the district court, there is other evidence, namely the extensive buy-out neg otiations and the payment of De

nton-Hyman debt that stands as e vidence of good faith on Hy man’s part; therefore a lack of ratification and consent would not necessa rily decide the e

xistence of good faith.

15 the rec ord conta

ins evide nce of H yma n’s goo d faith in u sing the procee ds of the new Age ncy to 1 pay off the

debts for which both he and the Denton estate were liable, and in attempting for y ears 2 to nego tiate a bu

y- out with the

Denton e state 6 – all of which could militate against the required 3 showing of recklessness or conscious misbehavior. As noted a bove, the Surrogate’s Court was 4 not required to take such considerations into account when re aching its conclusions concerning 5 misappro

priation a nd breac h of fiduc iary

duty . In view of the se comple xities, we a

re loath to 6 conclude

that an id

entical i ssue was

necessa rily decided or that Hy

man had a

full and f air 7 opportuni

ty to contest h is state of mind. I n addition

to the murk

iness of the law, the

harsh 8 consequences that follow a finding of nondischar geability a

nd the requirement that exceptions be 9 narrowly c onstrued both counsel against precluding a ple nary trial in B ankruptcy Court, had the 10 estate not voluntarily ag reed to forego one here . Accordingly , we conclude that collateral 11 estoppel does not attach. 12 III. CONCL USION 13 The district court’s judgment is AFFI RMED. 14 15