Court Opinion

ID: 3187040
Source: CourtListenerOpinion
Date Created: 2016-03-18 22:02:55.293863+00
Date Added: 2024-06-11T07:39:02.887212
License: Public Domain

In the

    United States Court of Appeals
                 For the Seventh Circuit
                     ____________________
No. 15-2252
IN RE: JOHN C. JAHRLING,
                                                                Debtor.
ESTATE OF STANLEY CORA,
                                                   Plaintiff-Appellee,

                                 v.

JOHN C. JAHRLING ,
                                               Defendant-Appellant.
                     ____________________

         Appeal from the United States District Court for the
           Northern District of Illinois, Eastern Division.
              No. 14 C 8056 — James B. Zagel, Judge.
                     ____________________

   ARGUED DECEMBER 11, 2015 — DECIDED MARCH 18, 2016
                ____________________

   Before KANNE, ROVNER, and HAMILTON, Circuit Judges.
   HAMILTON, Circuit Judge. A bankruptcy court held that a
legal malpractice judgment against debtor-appellant John
Jahrling was not dischargeable because the judgment was for
a “defalcation while acting in a fiduciary capacity.” See 11
U.S.C. § 523(a)(4). The district court affirmed, and so do we.
2                                                  No. 15-2252

    Appellant Jahrling acted as an attorney for a client who
was selling his home. Because of language barriers, Jahrling
could not communicate with his client except through the
attorney for the buyers, the adverse parties in the sale. The
result was that Jahrling’s client, an elderly man who could
not speak English, sold his home for a pittance and then
faced eviction from what he thought would be his home for
the rest of his life. We agree with the bankruptcy court and
the district court that Jahrling’s egregious breaches of his fi-
duciary duty to his client were reckless and that the result-
ing legal malpractice judgment is not dischargeable in bank-
ruptcy.
I. Factual and Procedural Background
    John Jahrling is an attorney in Illinois. Walter Rywak, an-
other attorney, contacted Jahrling and asked him to prepare
closing documents for a real estate transaction. Rywak paid
Jahrling $400 for doing the closing work. The transaction
was the sale of Stanley Cora’s home. Cora was 90 years old.
He was approached by Rywak’s clients and offered $35,000
for the property. That price was far below the fair market
value of a fee simple title; the property was worth at least
$106,000 and was later resold by the purchasers for $145,000.
Cora later alleged he understood that one term of the deal
was that he would keep a life estate that would have allowed
him to live in the upstairs apartment of the home rent-free
for the rest of his life. The problem was that the sale docu-
ments prepared by Jahrling did not include a life estate for
Cora.
   The closing documents identified Jahrling as Cora’s at-
torney. Jahrling and Cora could not communicate directly
and privately because Cora spoke only Polish and Jahrling
No. 15-2252                                                   3

spoke no Polish. So instead of direct attorney-client commu-
nication about what the client wanted from the sale, the at-
torney relied on counsel for the adverse parties for all com-
munication with his client. After the buyers tried to evict
Cora because he did not have the life estate he expected,
Cora sued Jahrling in state court for legal malpractice. Cora
passed away in 2006 before the trial, but his estate pursued
the case.
    After a bench trial, the state court judge (Hon. Mary
Anne Mason, now a Justice of the Illinois Appellate Court)
ruled that Jahrling had been Cora’s attorney and thus owed
Cora a duty to know what he wanted from the sale. See In re
Jahrling, 514 B.R. 565, 569 (Bankr. N.D. Ill. 2014) (summariz-
ing state court’s findings). The state court found that Jahr-
ling’s inability to communicate with his client, coupled with
relying on opposing counsel for all his information about the
transaction, was “unreasonable, per se.” Id. The court also
found that Jahrling never talked with his client before the
closing. Finally, the court pointed out the huge discrepancy
between the value of the home and the sale price. After a
partial settlement with a third party and offsets, the state
court ultimately awarded Cora’s estate $26,000, plus costs. Id.
at 569–70.
    Jahrling filed for bankruptcy protection under Chapter 7.
Cora’s estate filed an adversary proceeding alleging that the
state court judgment was not dischargeable in bankruptcy
on several grounds, including under 11 U.S.C. § 523(a)(4) be-
cause the debt was the result of defalcation by the debtor act-
ing as a fiduciary. The bankruptcy court found in favor of
the estate on the § 523(a)(4) claim. In re Jahrling, 514 B.R. at
578. The court found that Jahrling had been Cora’s attorney
4                                                     No. 15-2252

and that his argument to the contrary was barred by collat-
eral estoppel (issue preclusion). Id. at 570–71. The court then
found that Jahrling violated at least three rules of profes-
sional responsibility—competence, diligence, and communi-
cation. Id. at 571–72. The court said that Jahrling’s handling
of the sale without speaking with Cora was a “gross devia-
tion from the standard of conduct that a law-abiding person
as well as any Illinois attorney would observe in Jahrling’s
situation.” Id. at 573. The court concluded that Jahrling “con-
sciously disregarded a substantial and unjustifiable risk that
his conduct would violate a fiduciary duty.” Id. The bank-
ruptcy court concluded that his substandard representation
of Cora amounted to the level of recklessness required by
Bullock v. BankChampaign, N.A., 569 U.S. —, 133 S. Ct. 1754
(2013). In re Jahrling, 514 B.R. at 573. Cora’s estate satisfied its
burden of proving by a preponderance of the evidence un-
der § 523(a)(4) that Jahrling committed defalcation as a fidu-
ciary. Id. at 574.
    The district court affirmed in a concise and persuasive
memorandum, noting: “When an interpreter is an attorney
for the other party, interests are not aligned.” Jahrling v. Es-
tate of Cora, 530 B.R. 679, 681 (N.D. Ill. 2015). Jahrling has ap-
pealed. We have jurisdiction under 28 U.S.C. § 158(d) be-
cause this is an appeal from a final judgment in an adversary
action on the dischargeability of a debt. In re Crosswhite, 148
F.3d 879, 881 (7th Cir. 1998). We review the bankruptcy
court’s findings of fact for clear error and its legal conclu-
sions de novo. Id.
No. 15-2252                                                   5

II. Defalcation in a Fiduciary Capacity
   A. Governing Standard under Bullock
   Federal bankruptcy law is aimed at providing fair and
orderly relief for the “honest but unfortunate debtor,” who
can obtain a “fresh start” by distributing available assets to
creditors and discharging debts left unpaid. See Grogan v.
Garner, 498 U.S. 279, 286–87 (1991). Excluded from discharge,
however, are a number of categories of debts for which Con-
gress has found that the interests of creditors outweigh the
debtor’s interest in a fresh start. See 11 U.S.C. § 523.
   This case addresses the exception from discharge in 11
U.S.C. § 523(a)(4) if the debt is “for fraud or defalcation
while acting in a fiduciary capacity, embezzlement, or lar-
ceny.” To satisfy § 523(a)(4), a creditor must prove that (1)
“the debtor acted as a fiduciary to the creditor at the time the
debt was created,” and (2) “the debt was caused by fraud or
defalcation.” In re Berman, 629 F.3d at 765–66, citing In re
Frain, 230 F.3d 1014, 1019 (7th Cir. 2000); Klingman v. Levin-
son, 831 F.2d 1292, 1295 (7th Cir. 1987).
    The claim here is not for actual fraud but for “defalca-
tion,” a word that only lawyers and judges could love. As
Justice Breyer explained for the Supreme Court, Congress
first used the term in a federal bankruptcy statute in 1867,
and “legal authorities have disagreed about its meaning al-
most ever since.” Bullock, 133 S. Ct. at 1758. Before the Su-
preme Court provided its authoritative guidance in Bullock,
we had explained that defalcation “can be distinguished
from fraud and embezzlement on the basis that subjective,
deliberate wrongdoing is not required to establish defalca-
tion,” though some degree of fault greater than negligence
6                                                   No. 15-2252

or mistake, but less than fraud, was required. In re Berman,
629 F.3d at 765 n.3, citing Central Hanover Bank & Trust Co. v.
Herbst, 93 F.2d 510, 512 (2d Cir. 1937) (L. Hand, J.), and Meyer
v. Rigdon, 36 F.3d 1375, 1385 (7th Cir. 1994).
    The Supreme Court clarified the law in Bullock, holding
that defalcation requires proof of “a culpable state of
mind … involving knowledge of, or gross recklessness in re-
spect to, the improper nature of the relevant fiduciary be-
havior.” 133 S. Ct. at 1757. The objecting creditor bears the
burden of proving by a preponderance of the evidence that
an exception to discharge applies. See Grogan, 498 U.S. at
286–87; see also In re Sheridan, 57 F.3d 627, 633 (7th Cir. 1995)
(requiring creditor to meet preponderance of the evidence
standard under § 523(a)(2)(B)).
   In Bullock the Court explained that the state-of-mind re-
quirement requires at least a subjective, criminal level of
recklessness:
       Thus, where the conduct at issue does not in-
       volve bad faith, moral turpitude, or other im-
       moral conduct, the term requires an intentional
       wrong. We include as intentional not only con-
       duct that the fiduciary knows is improper but
       also reckless conduct of the kind that the crim-
       inal law often treats as the equivalent. Thus we
       include reckless conduct of the kind set forth in
       the Model Penal Code. Where actual
       knowledge of wrongdoing is lacking, we con-
       sider conduct as equivalent if the fiduciary
       ‘consciously disregards’ (or is willfully blind
       to) ‘a substantial and unjustifiable risk’ that his
No. 15-2252                                                                7

        conduct will turn out to violate a fiduciary du-
        ty.
133 S. Ct. at 1759 (citation omitted). The Court said further
that the risk “must be of such a nature and degree that, con-
sidering the nature and purpose of the actor’s conduct and
the circumstances known to him, its disregard involves a
gross deviation from the standard of conduct that a law-
abiding person would observe in the actor’s situation.” Id. at
1760. (emphasis in original), quoting ALI, Model Penal Code
§ 2.02(2)(c), at 226 (1985). The Court added that defalcation,
unlike fraud, “may be used to refer to nonfraudulent breaches
of fiduciary duty.” Id. (emphasis in original).
    B. Applying the Subjective Standard
    Jahrling argues that the bankruptcy court committed a
legal error by applying an objective test to decide defalca-
tion. He also argues that the bankruptcy court erred by rely-
ing on the Illinois Rules of Professional Conduct for attor-
neys to determine the standard of care against which his
conduct was judged. We reject both arguments. The bank-
ruptcy court properly applied Bullock and made findings
about Jahrling’s state of mind to find that he committed a de-
falcation while acting in a fiduciary capacity. The court did
not err by taking into account his serious violations of fun-
damental rules of professional conduct in finding that his
conduct was subjectively reckless.1

1 Jahrling also argues that the willfulness standard that a bankruptcy
court articulated in In re Howard (Pearson v. Howard), 339 B.R. 913 (Bankr.
N.D. Ill. 2006), could apply to this case. Howard is not precedential. It was
also decided before the Supreme Court provided a definitive standard in
Bullock. In any event, the Howard court correctly read our precedents,
8                                                            No. 15-2252

   Judges and juries rarely have access to direct evidence
about a person’s state of mind at a prior time. Even the rare
direct evidence, such as a contemporaneous expression by
that person, is not necessarily reliable. Like almost any find-
ings about a person’s state of mind, then, the bankruptcy
court had to base its findings on circumstantial evidence.
The court drew inferences about Jahrling’s state of mind
based on the objective circumstances, but the court applied
the correct subjective standard.
    The facts almost speak for themselves. Jahrling was
Cora’s attorney, yet he could not and did not communicate
with him except through counsel for the adverse party in the
transaction. The result, according to the detailed findings of
both the state court and the bankruptcy court, was that Jahr-
ling did not include in the closing documents for the bar-
gain-basement sale of the home the one term most important
to Cora: retaining a life estate in one residence so that he
could live there rent-free. And so, a few months later, the 90-
year-old Cora faced eviction by the buyers, whose own law-
yer had been the sole channel for communication between
attorney Jahrling and client Cora.
    Jahrling’s conduct amounted to at least negligence, but as
Bullock shows, negligence is not sufficient to show defalca-
tion within the meaning of § 523(a)(4). The bankruptcy
court’s finding of subjective recklessness was a reasonable
finding from the circumstantial evidence. In essence, the
court found, Jahrling’s breaches of an attorney’s fiduciary

and anticipated Bullock, in saying that defalcation required more than
negligence but that either willfulness or recklessness could suffice. Id. at
920.
No. 15-2252                                                   9

duty to his client were so basic and the risk of harm to the
client so obvious that Jahrling must have recognized them
and proceeded despite the risk. We find no error in this
analysis.
    A useful illustration of this reasoning comes from a quite
different area of federal law that also applies a subjective
recklessness standard. The Supreme Court has interpreted
the Eighth Amendment to the Constitution to forbid prison
officials from being deliberately indifferent to serious threats
to the health and safety of inmates. The deliberate indiffer-
ence standard requires proof that the prison official was sub-
jectively aware of the risk: “the official must both be aware of
facts from which the inference could be drawn that a sub-
stantial risk of serious harm exists, and he must also draw
the inference.” Farmer v. Brennan, 511 U.S. 825, 837 (1994).
That is a similar standard from criminal law, of recklessness
involving actual, subjective knowledge of the risk, that the
Supreme Court found to govern defalcation cases under 11
U.S.C. § 523(a)(4) in Bullock, 133 S. Ct. at 1759–60.
   But the Supreme Court in Farmer added a helpful expla-
nation for how such subjective recklessness may be shown:
       We doubt that a subjective approach will pre-
       sent prison officials with any serious motiva-
       tion “to take refuge in the zone between ‘igno-
       rance of obvious risks' and ‘actual knowledge
       of risks.’” Brief for Petitioner 27. Whether a
       prison official had the requisite knowledge of a
       substantial risk is a question of fact subject to
       demonstration in the usual ways, including in-
       ference from circumstantial evidence, cf. Hall[,
       General Principles of Criminal Law] 118 [2d
10                                                     No. 15-2252

       ed. 1960] (cautioning against “confusing a
       mental state with the proof of its existence”),
       and a factfinder may conclude that a prison official
       knew of a substantial risk from the very fact that the
       risk was obvious.
511 U.S. at 842 (emphasis added).
    That was in essence the reasoning of the bankruptcy
court in this case: the risks to client Cora were so obvious
that Jahrling must have recognized them yet forged ahead
recklessly, acting in a way that amounted to a “gross devia-
tion” from the standards expected of an attorney in a fiduci-
ary role. That state-of-mind finding satisfies the Bullock
standard under § 523(a)(4). See also In re Sheridan, 57 F.3d at
634 (circumstantial evidence may be used to determine in-
tent to deceive under § 523(a)(2)(B)). The bankruptcy court
did not erroneously apply a purely objective standard.
    The bankruptcy court framed much of its analysis in
terms of Jahrling’s violations of several basic rules of profes-
sional conduct for attorneys: the rules requiring competence
and diligence on behalf of clients, and communication with
clients. In re Jahrling, 514 B.R. at 571–72, quoting Illinois
Rules of Professional Conduct 1.1, 1.3, & 1.4 (2002) (the ver-
sion in effect at the time of Jahrling’s actions). The court
found that Jahrling’s conduct was “a gross deviation from
the standard of conduct that a law-abiding person as well as
any Illinois attorney would observe in Jahrling’s situation.”
Id. at 573.
   Jahrling argues that the bankruptcy court erred by con-
fusing a violation of rules of professional conduct with the
more demanding standard for “defalcation” under
No. 15-2252                                                 11

§ 523(a)(4). As we have explained, the court did not confuse
the objective criteria of the rules of professional conduct re-
quiring competence, diligence, and communication with the
subjective recklessness standard under Bullock. We also find
no error in the bankruptcy court’s use of the rules of profes-
sional conduct to determine the baseline standard of care
that Jahrling owed his client.
    To be clear, a finding that an attorney has violated a rule
of professional conduct is not sufficient, by itself, to show
defalcation by a fiduciary under § 523(a)(4). In applying the
statutory standard, however, the rules of professional con-
duct can be relevant, as they were here. Jahrling points out
that the preamble to the rules states: “Violation of a Rule
should not itself give rise to a cause of action against a law-
yer nor should it create any presumption in such a case that
a legal duty has been breached.” Ill. Rules of Prof’l Conduct,
Preamble at [20] (2002). But the preamble also explains that
“since the Rules do establish standards of conduct by law-
yers, a lawyer’s violation of a Rule may be evidence of
breach of the applicable standard of conduct.” Id. That is
precisely how the bankruptcy court in this case used these
basic and obvious rules aimed at protecting the interests of
clients. We have noted before that Illinois courts treat “the
rules of professional responsibility, insofar as they are de-
signed for the protection of lawyers’ clients (not all of the
rules are),” as furnishing “potentially useful guidance to
courts … .” Maksym v. Loesch, 937 F.2d 1237, 1243–44 (7th Cir.
1991).
   Finally, Jahrling argues that Cora’s estate did not present
sufficient evidence of Jahrling’s failures. Cora’s estate was
not required to relitigate the factual and legal issues under-
12                                                 No. 15-2252

lying the state court judgment for malpractice. Grogan v.
Garner, 498 U.S. 279, 284 n.11 (1991) (collateral estoppel prin-
ciples apply in discharge exception proceedings under
§ 523(a)); In re Bulic, 997 F.2d 299, 304 (7th Cir. 1993) (bank-
ruptcy courts give state court judgments full faith and credit
under 28 U.S.C. § 1738). The estate was required to prove on-
ly the higher standard of subjective recklessness, which it
did through circumstantial evidence as discussed above.
     The judgment of the district court is AFFIRMED.