Source: http://www.ecases.us/case/ca6/c409676/7-collier-bankrcas2d-685-bankr-l-rep-p-68874-in-re-gerald-johnson
Timestamp: 2020-08-12 21:10:59
Document Index: 137573662

Matched Legal Cases: ['§ 35', '§ 35', '§ 523', '§ 570', '§ 26', '§ 570']

7 Collier bankr.cas.2d 685, Bankr. L. Rep. P 68,874 in Re Gerald Johnson, Bankrupt, Carlisle Cashway, Inc. v. Gerald Johnson, Sixth Circuit, US Court of Appeals Cases, Federal Courts, COURT CASE
7 Collier bankr.cas.2d 685, Bankr. L. Rep. P 68,874 in Re Gerald Johnson, Bankrupt, Carlisle Cashway, Inc. v. Gerald Johnson , 691 F.2d 249 ( 1982 )
Section 17(a)(4) of the Bankruptcy Act provides that debts created by1 the bankrupt's "fraud, embezzlement, misappropriation, or defalcation while acting as an officer or in any fiduciary capacity," are not dischargeable in bankruptcy proceedings. A debt created while acting in a fiduciary capacity is a special debt, created by a breach of trust obligations defined by law, and is separate and distinct from any underlying contractual debt which arises from a bankrupt's agreement with respect to goods or services. 11 U.S.C. § 35(a)(4) (1976); Carey Lumber Co. v. Bell, 615 F.2d 370 (5th Cir. 1980); Clarke & Rapuano, Inc. v. Morris Ketchum, Jr. and Associates (In re Morris Ketchum, Jr.), 409 F. Supp. 743, 745 (S.D.N.Y.1975). The question of who is a fiduciary for purposes of section 17(a)(4) is one of federal law, although state law is important in determining when a trust relationship exists.2 Pedrazzini v. Runnion, (In re Pedrazzini), 644 F.2d 756, 758 (9th Cir. 1981); Angelle v. Reed (Matter of Angelle), 610 F.2d 1335, 1341 (5th Cir. 1980). The term "fiduciary" applies only to express or technical trusts and does not extend to implied trusts, which are imposed on transactions by operation of law as a matter of equity. Davis v. Aetna Acceptance Co., 293 U.S. 328, 333, 55 S. Ct. 151, 153, 79 L. Ed. 393 (1934); Chapman v. Forsyth, 43 U.S. (2 How. 202, 207, 11 L. Ed. 236 (1844)). Moreover, the requisite trust relationship must exist prior to the act creating the debt and without reference to it Davis, supra, at 333-34, 55 S.Ct., at 153-54. State statutes which impose a trust ex-maleficio are not within the scope of section 17(a)(4) since such trusts only arise upon an act of misappropriation. Id.; Pedrazzini, supra, at 759. Angelle, supra, at 1340; Schlecht v. Thornton (In re Thornton), 544 F.2d 1005, 1007 (9th Cir. 1976). See also Devaney v. Dloogoff (In re Dloogoff), 600 F.2d 166 (8th Cir. 1979). Contra, Allen v. Romero (In re Romero), 535 F.2d 618 (10th Cir. 1976).
Our conclusion that the Michigan Building Contract Fund Act satisfies the requirements of section 17(a)(4) of the Bankruptcy Act and is applicable in this case is consistent with case law from other circuits. Several recent cases have discussed whether section 17(a)(4) prevents the discharge of a general contractor's debts when the general contractor has diverted payments intended to go to subcontractors and materialmen. State statutes that define the res, spell out fiduciary duties and impose a trust on the funds prior to the act creating the debt have been held to create section 17(a)(4) fiduciary relationships. Carey, supra; Besroi Construction Co. v. Kawczynski, (In re Kawczynski), 442 F. Supp. 413 (W.D.N.Y.1977); Truax & Hovey, Ltd. v. Grosso (In re Grosso), 9 B.R. 815 (N.D.N.Y.1981); Neely v. Edmond (In re Edmond) 5 B.R. 172 (W.D.Okl.1980). Those circuits that have dealt with statutes which impose only criminal or other penalties on a general contractor have refused to find a fiduciary relationship within the scope of section 17(a)(4). There the statutory trust arises only upon the act of misappropriation and cannot be said to exist prior to the wrong and without reference to it even though a technical or express trust may exist at that time. Pedrazzini, supra; Angelle, supra; Thornton, supra. See also Dloogoff, supra. Contra, Romero, supra.
Federal, not state, law controls our determination because it is the intent of Congress in using the word "defalcation" that we seek to discover. Neither the statute nor the legislative history reveal congressional intent as to the interpretation to be given the term "defalcation." There is no restriction upon the word "defalcation" or any other term in section 17(a)(4). No particular mental state is required on the part of the person creating the debt in contrast to those designated in sections 17(a)(2) and (8), where a special mental element, intent, willfulness or maliciousness, is required above and beyond other elements prerequisite to the nondischargeability of a debt. See Turner v. Ward, 154 U.S. 618, 14 S. Ct. 1179, 23 L. Ed. 391 (1876). Had Congress intended to reach only intentional or bad faith defalcations, it could have easily narrowed the sweep of the definition by requiring a special mental element. See United States v. Turkette, 452 U.S. 576, 581, 101 S. Ct. 2524, 2527, 69 L. Ed. 2d 246 (1981).
In Central Hanover Bank & Trust Co. v. Herbst, 93 F.2d 510 (2d Cir. 1937), the Second Circuit analyzed the term "defalcation" against the backdrop of the Bankruptcy Act of 1800, the Act of 1841 in which the term first appeared, subsequent versions of the bankruptcy laws and case law in concluding that defalcations under the Act of 1898 were not limited to deliberate malversions. Id. at 511-12. Defalcation was found to be a more encompassing term than embezzlement or misappropriation. In an earlier Second Circuit case, In re Bernard, 87 F.2d 705 (2d Cir. 1937),6 misappropriation had been defined as being due to an actually or constructively known breach of duty, and not due to mere negligence or mistake of fact so that not every possible deficiency in a fiduciary's accounts renders a debt nondischargeable. Id. See In re Hammond, 98 F.2d 703, 705 (2d Cir.), cert. denied, 305 U.S. 646, 59 S. Ct. 149, 83 L. Ed. 418 (1938). The Central Hanover court stated that misappropriation, as construed in Bernard, probably carried a larger implication of misconduct than defalcation. Central Hanover assumed arguendo that some measure of misconduct was required to constitute a defalcation and did not decide the issue of whether innocent defaults were also included within its scope. In finding a defalcation, however, the Central Hanover court concluded that the mere taking of money entrusted to a fiduciary constituted a defalcation. In Central Hanover, Herbst, a dentist by profession, was appointed the receiver of a parcel of real estate in a foreclosure suit. Herbst was awarded an added amount in the order passing his intermediate account which he spent without waiting for the time to appeal to expire and without consulting the plaintiff in foreclosure regarding whether or not it intended to appeal. When the added amount was overturned on appeal, the surety, Central Hanover, was ordered to make payment. When Central Hanover sought recompense from Herbst, he filed and was adjudicated a voluntary bankrupt. Central Hanover alleged his debt was nondischargeable, having been created by his fraud, embezzlement, misappropriation or defalcation while acting in a fiduciary capacity. The Second Circuit agreed. It found "some measure of misconduct" by charging the bankrupt with knowledge of the legal principle that an order awarding him a fee would not protect him if reversed on appeal. The bankrupt's actual knowledge of his fiduciary duties was not probative.
An objective standard for finding a defalcation, that does charge a bankrupt with knowledge of the law and that does not weigh intent or motive, is consistent with the policy behind the bankruptcy laws of giving an honest debtor the opportunity for economic rehabilitation. See Local Loan Co. v. Hunt, 292 U.S. 234, 54 S. Ct. 695, 78 L. Ed. 1230 (1934). Exceptions to the general rule of discharge exist for certain types of "bad acts." See 11 U.S.C. §§ 35(a)(2), (4), (8). Although the "badness" of fraud, embezzlement or misappropriation is readily apparent, creating a debt by breaching a fiduciary duty is a sufficiently bad act to invoke the section 17(a)(4) exception even without a subjective mental state evidencing intent to breach a known fiduciary duty or bad faith in doing so. This is because the requisite "badness," to conform with the spirit of the bankruptcy laws, is supplied by an individual's special legal status with respect to another, with its attendant duties and high standards of dealing, and the act of breaching these duties.
Neither is the case of Neal v. Clark, 95 U.S. 704, 24 L. Ed. 586 (1878), a bar. In Neal the Supreme Court stated that "the 'fraud' referred to in that section (the former equivalent of section 17(a)(4) ) means positive fraud, or fraud in fact, involving moral turpitude or intentional wrong, as does embezzlement; and not implied fraud, or fraud in law, which may exist without the imputation of bad faith or immorality." Id. 95 U.S. at 709. This language cannot be said to qualify "defalcation" to require intentional or bad faith breaches of known fiduciary duties for several reasons. First, the only issue before the Supreme Court was the scope of the term "fraud." Second, the above-quoted language must be read in the context of the facts of that case. In Neal the bankrupt was not charged with actual fraud. The courts found that he had committed constructive fraud when he participated in the devastavit, or wasting, of a testator's estate by purchasing bonds at a discount from the executor of that estate without inquiring whether the condition of the testator's estate required the sale of that property. The Supreme Court went on to add that the evidence did not show that Neal entertained any purpose himself to commit a fraud, or aid the executor in committing one. Id. 95 U.S. at 709, 24 L.Ed. at 587. Whether Neal was guilty of constructive fraud under the law of Virginia was not before the Court. The lower federal court, however, had determined that both constructive fraud and actual fraud were within the scope of the term "fraud" under the bankruptcy laws. The Supreme Court disagreed. In its use of the language "moral turpitude" and "intentional wrong," the Court was indicating that all of the underlying elements necessary for the nondischargeability of a debt created by fraud must be effected by the personal action of the bankrupt and may not be imputed to him by the acts of another. The Supreme Court did not address the issue of whether the debtor had to have the intent to do an act which he knew would create liability, only that he had to intend to do the underlying acts. Finally, while intent is a necessary element of actual fraud, a defalcation may exist when there is a diminution, abatement or deficit in an account as a result of a mistake or negligence in addition to misconduct. See generally, 3 Collier on Bankruptcy, § 523.14(b), n. 3-4 (15th ed. 1981).
In considering this appeal, the Court cannot disturb or set aside Judge Nims's findings of fact unless they are clearly erroneous. In re Albert-Harris, Inc., 313 F.2d 447 (6th Cir. 1963); Cle-Ware Industries, Inc. v. Sokolsky, 493 F.2d 863 (6th Cir. 1974), cert. denied 419 U.S. 829, 95 S. Ct. 50, 42 L. Ed. 2d 53 and sub nom. Whalen v. Cle-Ware Industries, Inc., 419 U.S. 829, 95 S. Ct. 50, 42 L. Ed. 2d 53; In re Wyse, 296 F.2d 214 (6th Cir. 1961). See also In re Pennyrich International, Inc. of Dallas, 473 F.2d 417 (5th Cir. 1973).
Appellant contends that Judge Nims erred in concluding that appellee's debt is not dischargeable because Michigan law created in appellee a fiduciary obligation toward appellant, the breach of which through misappropriation or defalcation would give rise to nondischargeability of the debt under Section 17(a)(4). Such a position necessarily involves a mixed question of law and fact. The legal issues hinge on the application of Michigan's Building Contract Fund Act, M.C.L.A. §§ 570.151-570.153, M.S.A. §§ 26.331-26.333, including the defining of all elements for a civil cause of action to be maintained successfully thereunder. The factual issues focus on Judge Nims's findings as to the degree to which appellant satisfied the elements of proving the existence of a fiduciary relationship under the Building Contract Fund Act and a breach of that fiduciary duty within the meaning of that Act. The Court will limit its plenary review of Judge Nims's opinion and order to a reconsideration of his conclusions of law regarding the applicability of the Building Contract Fund Act in a Section 17(a)(4) setting. As indicated above, however, Judge Nims's treatment of the facts will not be disturbed unless they are clearly erroneous, and any of his findings of fact are considered by this Court cloaked with a presumption of correctness. General Order 47; In re Souder, 449 F.2d 284 (5th Cir. 1971); In re National Furniture Co., 230 F. Supp. 130 (W.D.Ark.1964), rev'd on other grounds sub nom. United States v. National Furniture Company, Inc., 348 F.2d 390 (8th Cir. 1965).
A literal reading of the "created by" language in section 17(a)(4) has been rejected by the Fifth Circuit in Carey Lumber Co. v. Bell, 615 F.2d 370, 375 (5th Cir. 1980), and John P. Maguire & Co. v. Herzog, 421 F.2d 419 (5th Cir. 1970), and by a district court in New York, Clarke & Rapuano, Inc. v. Morris Ketchum, Jr. and Associates (In re Morris Ketchum, Jr.), 409 F. Supp. 743, 745 (S.D.N.Y.1975). Otherwise section 17(a)(4) would have little meaning since most debts arise from some sort of contractual agreement
The lower courts' reliance on Perez v. Campbell, 402 U.S. 637, 91 S. Ct. 1704, 29 L. Ed. 2d 233 (1971), for the proposition that the Supremacy Clause prevents recognition of Mich.Comp.Laws Ann. §§ 570.151-153, is misplaced. State law is merely a factor in the equation used to determine whether the fiduciary capacity requirement is satisfied as a matter of federal law, using federal standards
In Bernard the bankrupt, the president of an insolvent corporation, appropriated a part of the corporation's assets to discharge indebtedness of himself and his son, who was also an officer. In doing so he violated then section 15 of the New York Stock Corporation Law, Consol. Laws, c. 59, and committed a breach of duty as a fiduciary. A judgment recovered against him by the assignee of the corporation was held to be nondischargeable in bankruptcy. The Second Circuit stated that the bankrupt had knowingly committed a breach of duty as a fiduciary which was an appropriation within section 17. The bankrupt was charged with knowledge that the corporation was insolvent and knowledge of the law that prohibited preferential payments, although nothing was said as to such knowledge. In re Hammond, 98 F.2d 703, 705-06 (2d Cir.), cert. denied, 305 U.S. 646, 59 S. Ct. 149, 83 L. Ed. 418 (1938)
Citation Numbers： 691 F.2d 249
in-the-matter-of-orval-wyse-dba-wyse-brothers-turkey-farm-bankrupt-two , 296 F.2d 214 ( 1961 )
in-the-matter-of-frank-william-souder-jr-bankrupt-two-cases-francis , 449 F.2d 284 ( 1971 )
General Insurance Company of America, a Washington ... , 482 F.2d 856 ( 1973 )
bankr-l-rep-p-67084-robert-e-parker-trustee-for-olympia-construction , 590 F.2d 649 ( 1979 )
in-re-calvin-roy-kelley-and-delores-bayersdorfer-kelley-debtors-carol-h , 948 F.2d 1281 ( 1991 )
Commonwealth of Kentucky, Ex Rel. Chris Gorman, Attorney ... , 1 F.3d 1240 ( 1993 )
In Re Saad , 319 B.R. 147 ( 2004 )