Court Opinion

ID: 215230
Source: CourtListenerOpinion
Date Created: 2011-04-21 23:27:07+00
Date Added: 2024-06-11T09:44:56.431065
License: Public Domain

REVISED April 21, 2011

          IN THE UNITED STATES COURT OF APPEALS
                   FOR THE FIFTH CIRCUIT
                                                                        United States Court of Appeals
                                                                                 Fifth Circuit

                                                                             FILED
                                             No. 10-40406                    April 5, 2011

                                                                           Lyle W. Cayce
In the Matter of: DAVID S. HARWOOD,                                             Clerk

                                                          Debtor
---------------------------------------------------------------------

FNFS, LTD; B & W FINANCE CO., INC.,

                                                          Appellees

v.

DAVID S. HARWOOD,

                                                          Appellant

                      Appeal from the United States District Court
                           for the Eastern District of Texas

Before KING, DAVIS, and SOUTHWICK, Circuit Judges.
KING, Circuit Judge:
        David S. Harwood, a Chapter 7 debtor, appeals the district court’s order
affirming the bankruptcy court’s ruling that certain of his debts are
nondischargeable under 11 U.S.C. § 523(a)(4). He challenges the bankruptcy
court’s determination that his debts—loans obtained from a limited partnership
that Harwood managed in his capacity as officer and director of the
                                 No. 10-40406

partnership’s corporate general partner—were incurred through defalcation
while acting as a fiduciary to the partnership. Because we agree that Harwood
wilfully neglected a duty owed to the partnership in connection with the loans,
we affirm the judgment of the district court affirming the judgment of the
bankruptcy court.
                             I. BACKGROUND
      The parties do not challenge the bankruptcy court’s findings of fact, which
are based on evidence presented during a bench trial before that court and set
forth in the bankruptcy court’s thorough amended memorandum of decision. See
FNFS, Ltd. v. Harwood (In re Harwood), 404 B.R. 366 (Bankr. E.D. Tex. 2009).
We summarize the relevant facts here, providing greater detail as relevant to
our analysis of the issues presented in this appeal.
      In 1991, Harwood, along with Wayne McKinney, purchased B & W
Finance, a consumer lending business. In 1996, B & W Finance reorganized into
a Texas limited partnership, FNFS, Ltd. (“FNFS”).        All consumer lending
operations were transferred into FNFS.          A newly-created subchapter S
corporation, B & W Finance Co., Inc. (“B & W”), served as the sole general
partner of FNFS. McKinney and Harwood each owned 50% of the issued and
outstanding stock of B & W, which in turn owned a 51% partnership interest in
FNFS. Twenty-five limited partners owned the remaining 49% percent of
partnership interests in FNFS.
      Harwood served as president, chief operating officer, and a director of
B & W, and McKinney served as its chief executive officer and chairman of the
board.   While McKinney brought substantial financial resources to the
enterprise, but no particular banking expertise, Harwood brought his extensive
experience in the banking and lending industry.         Harwood managed the
day-to-day business affairs of B & W, which provided executive and managerial
support to FNFS and which, pursuant to FNFS’s partnership agreement,

                                       2
                                       No. 10-40406

exercised “full, sole, exclusive, and complete discretion in the management and
control of the business, operations, and affairs of [FNFS].” Based on evidence
adduced at trial, the bankruptcy court found that Harwood “exercised virtually
all executive power over FNFS operations on a daily basis” in what the court
described as “an almost autocratic fashion.” Harwood, 404 B.R. at 378, 397.
       Early on in his tenure as president of B & W, Harwood began withdrawing
funds from FNFS for his personal use, including a $200,000 loan in 1997 to
finance construction of a large steel-frame gymnasium on his property in Arp,
Texas (the “Arp property”). In 1998, Harwood memorialized these loans in two
promissory notes to FNFS—a $700,000 “Master Note” accompanied by a deed of
trust in favor of FNFS on the Arp property, and a $125,000 note (the “Frazier
Note”) secured by a second-lien deed of trust in favor of FNFS on a residential
rental property on East Frazier Street in Tyler, Texas (the “Frazier property”).
Harwood prepared and signed the Notes and security documents, which he kept
in a personal “loan file” in a desk drawer in his office. He never filed the deeds
of trust with the county clerk.
       Between 1998 and 2005, Harwood received a total of seventy-three
advances on the Notes, using the funds for various personal expenditures,
including a down payment on a family home and a new car.1 Harwood made
only intermittent interest payments to FNFS, which were due quarterly under
the terms of the Notes. On several occasions he borrowed funds from FNFS for
the purpose of making interest payments on the Notes. The bankruptcy court
found that, although the FNFS employee handbook outlined policies and

       1
          Harwood also extracted other financial benefits from FNFS and B & W. The
bankruptcy court found that Harwood placed his now ex-wife, Sherry Harwood, on the B & W
payroll, although she performed no work for the company; that Harwood used the company’s
airplane for personal trips at the company’s expense; that he used a corporate credit card for
personal expenses, expending little effort to identify and reimburse B & W for those expenses;
and that he demanded, and received, reimbursement for purported business expenses without
providing any documentation to support his demands.

                                              3
                                 No. 10-40406

procedures governing employee loans, Harwood followed no formal procedure for
borrowing funds from FNFS. According to the bankruptcy court, Harwood
exceeded any purported debt ceiling “with impunity,” issuing additional notes
to FNFS when the aggregate amount of his indebtedness exceeded the amount
of the Master Note. Id. at 380. The Master Note was then “extended and
renewed” to incorporate the additional advances. Id.
      Although the B & W board of directors routinely approved employee loans,
including Harwood’s, the testimony at trial established that the board was only
generally aware of Harwood’s growing indebtedness to FNFS and the fact that
Harwood did not make any significant effort to pay down the principal amount
of the Notes.   The board apparently believed the Notes to be sufficiently
collateralized, and McKinney orally assured the board that he would personally
cover any losses to the limited partners in the event that Harwood failed to
repay his debts to the partnership.
      A confluence of events—including growing annual losses to the consumer
lending business, McKinney’s death in September 2004, and the company’s
struggle to maintain net capital reserves for each of its lending branches in
compliance with state regulations—caused the board to pay closer attention to
the financial health of the enterprise. The board formed an audit committee in
2004, which discovered, among other things, that Harwood had failed to record
the deeds of trust that he had executed in favor of FNFS as security for the
Master Note and the Frazier Note, leaving the partnership with an unperfected
interest in the pledged collateral. Worse still, Harwood had subsequently
pledged the Arp property as collateral for two other promissory notes from
Hibernia National Bank.
      The Board ultimately terminated Harwood’s employment as president and
chief operating officer of B & W in April 2005, following a dispute with Harwood
regarding Harwood’s unauthorized and ultimately unprofitable efforts to expand

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                                 No. 10-40406

the business and his failure to produce a repayment plan on his loans. By the
end of 2004, the combined unpaid principal balance of the Notes was at least
$843,969.73, with at least $71,802.79 in accrued but unpaid interest.
      B & W and FNFS brought suit against Harwood on June 7, 2005. On June
15, 2005, Harwood filed a voluntary Chapter 7 bankruptcy petition. B & W and
FNFS initiated the instant adversary proceeding to challenge Harwood’s
entitlement to a discharge of any of his debts under Section 727(a) of the
Bankruptcy Code or, alternatively, to determine whether certain debts owed to
them were nondischargeable under Sections 523(a)(2)(A) and (B), 523(a)(4), and
523(a)(6). B & W sought a nondischargeability determination as to certain
travel expense reimbursements, charges to a corporate credit card, and payroll
payments to Harwood’s ex-wife Sherry Harwood. FNFS sought a determination
of the nondischargeability of the outstanding principal amount of the Master
Note and Frazier Note, plus accrued interest, as well as personal expenses on a
corporate credit card and rental sums FNFS paid to Harwood to use the Arp
property, at Harwood’s urging, for employee retreats.
      The bankruptcy court held that Section 523(a)(4)’s exception to discharge
for debts arising from “defalcation while acting in a fiduciary capacity” applied
to B & W’s claim for payroll payments to Sherry Harwood, and to Harwood’s
remaining indebtedness to FNFS on the Master Note and the Frazier Note. The
bankruptcy court held that B & W and FNFS did not carry their burden of
proving that any of the other urged exceptions to discharge applied. Harwood
appealed only the determination that the Notes were nondischargeable under

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                                      No. 10-40406

Section 523(a)(4).2 The district court affirmed, and Harwood timely appealed to
this court.
                           II. STANDARD OF REVIEW
       We review the bankruptcy court’s conclusions of law de novo and its
findings of facts for clear error. LSP Investment P’ship v. Bennett (In re Bennett),
989 F.2d 779, 781 (5th Cir. 1993). Whether Harwood’s actions amounted to a
defalcation is a mixed question of law and fact that we review de novo. Id. at 781
n.3; Century Indem. Co. v. Nat’l Gypsum Co. Settlement Trust (In re Nat’l
Gypsum Co.), 208 F.3d 498, 504 (5th Cir. 2000).
                                  III. DISCUSSION
       Section 523(a)(4) states in pertinent part:
       (a) A discharge under section 727 . . . does not discharge an
       individual debtor from any debt—
              (4) for fraud or defalcation while acting in a fiduciary capacity
       ....
11 U.S.C. § 523(a)(4). This bar to discharge reaches “debts incurred through
abuses of fiduciary positions . . . [and] involv[ing] debts arising from the debtor’s
acquisition or use of property that is not the debtor’s.” Texas Lottery Comm’n v.
Tran (In re Tran), 151 F.3d 339, 342 (5th Cir. 1998) (citation and internal
quotation marks omitted). The party promoting the exception to discharge must
prove by a preponderance of the evidence that the debt is nondischargeable.
Grogan v. Garner, 498 U.S. 279, 286 (1991). Exceptions to discharge are strictly
construed against the creditor and liberally construed in favor of the debtor.

       2
          FNFS cross-appealed the bankruptcy court’s ruling that it failed to prove that the
remaining indebtedness on the Notes are nondischargeable under Sections 523(a)(2) and
523(a)(6). The district court did not reach the cross-appeal issues, affirming the bankruptcy
court’s judgment that Harwood’s remaining indebtedness on the Notes is nondischargeable
under Section 523(a)(4).

                                             6
                                       No. 10-40406

Hudson v. Raggio & Raggio, Inc. (In re Hudson), 107 F.3d 355, 356 (5th Cir.
1997).
       Harwood challenges the bankruptcy and district courts’ conclusions that
he “acted in a fiduciary capacity” toward FNFS within the meaning of Section
523(a)(4), and that his failure to record the deeds of trust amounted to
defalcation. We address these challenges in turn.

A.     “Acting in a Fiduciary Capacity” under Section 523(a)(4)
       Harwood first challenges the bankruptcy court’s holding that he was
“acting in a fiduciary capacity” within the meaning of Section 523(a)(4). The
term “fiduciary” in this context is construed narrowly, limited to “technical
trusts” and to traditional fiduciary relationships involving “trust-type”
obligations imposed by statute or common law. Bennett, 989 F.2d at 784–85.
“The scope of the concept of fiduciary under [Section 523(a)(4)] is a question of
federal law; however, state law is important in determining whether or not a
trust obligation exists.” Id. at 784 (citation omitted).
       Harwood readily concedes that, as an officer and director of B & W, he
owed a fiduciary duty to B & W. Under Texas law, corporate officers and
directors owe fiduciary duties to the corporations they serve and must not allow
their personal interests to prevail over the interests of the corporation. See, e.g.,
Pinnacle Data Servs., Inc. v. Gillen, 104 S.W.3d 188, 198 (Tex. App.–Texarkana,
2003, no pet.) (citations omitted); see also Moreno v. Ashworth, 892 F.2d 417, 421
(5th Cir. 1990) (officer owed a fiduciary duty to the corporation he served that
satisfied Section 523(a)(4)). Nor is it disputed that, under Texas law, B & W, as
general partner of FNFS, owes a fiduciary duty to FNFS and to the limited
partners.3 See, e.g., Grierson v. Parker Energy Partners, 737 S.W.2d 375, 377

       3
         Although this point is not disputed in this case, we note that, since Bennett, we have
called into question whether partners owe fiduciary duties to their co-partners under Texas law

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                                       No. 10-40406

(Tex. App.–Houston [14th Dist.] 1987) (citation omitted); see also Bennett, 989
F.2d at 787 (“Texas law clearly and expressly imposes trust obligations on
managing partners of limited partnerships and these obligations are sufficient
to meet the narrow requirements of section 523(a)(4).”). Harwood contends,
however, that although he owed a fiduciary duty to B & W, which in turn owed
a duty to FNFS, he owed no fiduciary duty to FNFS because he was not a
partner of the limited partnership and did not exercise a level of control over the
affairs of the partnership to justify the recognition of fiduciary obligations owing
to FNFS. Thus, we consider whether Texas law imposes a “trust-type obligation”
on Harwood to the limited partnership, where Harwood was an officer and
director, as well as 50% shareholder, of the corporate general partner of the
limited partnership.
       In LSP Investment Partnership v. Bennett (In re Bennett), we considered
an analogous issue: whether a debtor—the managing partner of a general
partner of a Texas limited partnership—owed a fiduciary duty to the limited
partners within the meaning of Bankruptcy Code Section 523(a)(4).                           To
determine whether Texas law recognizes a fiduciary duty owed by a second-tier
managing partner in a two-tiered partnership structure, we relied largely on
Crenshaw v. Swenson, 611 S.W.2d 886 (Tex. Civ. App.–Austin 1980, writ ref’d
n.r.e.). In Crenshaw, the Texas court held that a managing partner of a
partnership’s general partner owed to the underlying partners “the highest
fiduciary duty recognized in the law.” 611 S.W.2d at 890 (citing Huffington v.

that satisfy the narrow construction of Section 523(a)(4), based on a provision of the Texas
Revised Partnership Act stating that partners are not to be held to a trustee standard. See
Gupta v. Eastern Idaho Tumor Inst., Inc. (In re Gupta), 394 F.3d 347, 351 (5th Cir. 2004)
(citing Tex. Rev. Civ. Stat. Ann. art. 6132b-4.04(f) (expired Jan. 1, 2010) (“A partner, in that
capacity, is not a trustee and is not held to the same standards as a trustee.”)); see also Tex.
Bus. Orgs. Code, § 152.204(d). We have nonetheless continued to state as a general rule that
general partners owe fiduciary duties to the partnerships and the limited partners they serve,
and that these duties are “trust-like.” See McBeth v. Carpenter, 565 F.3d 171, 177 (5th Cir.
2009) (discussed below).

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                                  No. 10-40406

Upchurch, 532 S.W.2d 576 (Tex. 1976)). We found significant that the Crenshaw
court “focused on the nature of the business relationship as a whole, in which
one person . . . in her various roles . . . exercised almost complete control over”
the business of the partnership in concluding that the second-tier managing
partner owed a duty to the underlying partners. Bennett, 989 F.2d at 789. We
noted that, under Texas law, “the issue of control has always been the critical
fact looked to by the courts” in determining whether to impose fiduciary
responsibilities on individuals whose actions directly determine the conduct of
a general partner of a limited partnership. Id.
      In Bennett, the debtor was the sole general partner of a general partner
charged with the exclusive authority to manage and make all decisions relating
to the underlying partnership. See id. at 781. As a result, Bennett, individually,
and through a corporation that he owned which he hired to manage the
partnership, had the exclusive power and authority to manage the affairs of both
the general partner and the limited partnership. Id. We concluded that by
virtue of this control, Bennett was a fiduciary of the underlying partnership
under Texas law, overturning the bankruptcy court’s ruling that the
partnership’s multi-tiered partnership structure shielded Bennett from personal
liability to the partnership for misapplication of partnership funds. Id. at 790.
We further held that Bennett’s fiduciary obligations to the partnership sufficed
to make Bennett a “fiduciary” within the meaning of Section 523(a)(4), finding
that Texas law imposes on managing partners in a position of control over the
partnership a duty analogous to that owed by a trustee to the beneficiaries of the
trust. Id. (citations omitted).
      The bankruptcy court in the instant case noted that it found no controlling
authority precisely on point concerning the duty of an operational officer of a
corporate general partner toward a limited partnership. However, it found the
Bennett court’s analysis—that the actual degree of authority exercised over the

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                                  No. 10-40406

limited partnership is relevant to determining whether a second-tier manager
owes a duty to the limited partnership—equally applicable to a corporate officer
who controls a limited partnership by virtue of his control over the corporate
general partner. “The relevant issue should not be the choice of organizational
form . . . but rather an analysis of whether the degree of control actually
exercised by a corporate officer over the actions of a corporate general partner
warrants a corresponding recognition” that the officer has assumed
responsibilities to the limited partnership. Harwood, 404 B.R. at 397; see also
Park v. Moorad, 132 B.R. 58, 63 (Bankr. N.D. Okl. 1991) (officer and sole
shareholder of a general partner was a fiduciary of the underlying partnership
for purposes of Section 523(a)(4), stating that the court would “not allow the
Debtor to hide beneath a corporate shell when he so completely controlled the
corporate actions, representations and decisions that in effect it had no life
without him”).
      We have since decided McBeth v. Carpenter, 565 F.3d 171 (5th Cir. 2009),
in which we addressed, in a non-bankruptcy context, the duties owed by an
officer to a subsidiary entity that the officer controlled. In McBeth, we noted as
a general principle that “managing partners owe trust obligations to the
partnership, having a duty of loyalty and due care as well as being under an
obligation to discharge their duties in good faith and in the reasonable belief that
they are acting in the best interest of the partnership.” Id. at 177 (citing Tex.
Rev. Civ. Stat. Ann. art. 6132b–4.04(b)-(d)). We held that Texas law imposes the
same fiduciary obligations on the president of a corporate general partner to the
limited partners, where the president, Carpenter, was in a position of control
over the partnership by virtue of his control over the partnership’s corporate
general partner. Id. at 178. The partnership agreement entrusted in the
president the “exclusive rights to manage all contracts and agreements” relating
to the purchase and development of land, the purpose for which the partnership

                                        10
                                   No. 10-40406

was created. Id. Carpenter was described as “the man in control” and the one
“heading the efforts” of the partnership, and acted as—and indeed held himself
out to others as being—the general partner of the partnership. Id. Carpenter
also controlled two of the partnership’s limited partners. Id. at 175. Citing to
Bennett and Crenshaw, we held that his control over the direction of the
partnership sufficed to find him a fiduciary of the partnership under Texas law.
Id. at 178.
      We conclude that an officer of a corporate general partner who is entrusted
with the management of the limited partnership and who exercises control over
the limited partnership in a fashion analogous to Bennett and McBeth owes a
fiduciary duty to the partnership that satisfies Section 523(a)(4). We emphasize
that it is not only the control that the officer actually exerts over the
partnership, but also the confidence and trust placed in the hands of the
controlling officer, that leads us to find that a fiduciary relationship exists
sufficient for the purposes of Section 523(a)(4).
      With this background, we focus our analysis on whether Harwood
exercised a similar degree of control over FNFS as was sufficient to find a
fiduciary duty in McBeth and Bennett. In determining whether Harwood owed
a fiduciary duty to both tiers of the organization, we “focus[ ] on the nature of the
business relationship as a whole.” Bennett, 989 F.2d at 789.
      We first reject Harwood’s contention that the bankruptcy court improperly
relied on Harwood’s drafting of, and ability to draw upon, the Master Note at
will as evidence of his control, and that insufficient evidence was presented at
trial to establish his level of control over FNFS prior to and apart from obtaining
the loans. He correctly argues that, to establish that a debtor acted “in a
fiduciary capacity” under 523(a)(4), the trust-type relationship must exist “prior
to the act creating the debt and without reference to that act” to satisfy Section
523(a)(4). See Bennett, 989 F.2d at 784. Therefore, under Section 523(a)(4), “[i]t

                                         11
                                  No. 10-40406

is not enough that, by the very act of wrongdoing out of which the contested debt
arose, the bankrupt has become chargeable as a trustee ex maleficio.” Gupta v.
Eastern Idaho Tumor Inst., Inc. (In re Gupta), 394 F.3d 347, 350 (5th Cir. 2004)
(quoting Davis v. Aetna Acceptance Co., 293 U.S. 328, 333 (1934)).
      However, we do not think that we are precluded from considering the
circumstances surrounding the Notes as evidence of the level of control that
Harwood exercised prior to and apart from his obtaining the loans. The relevant
case law does not purport to state an evidentiary rule; it merely limits the
applicability of the Section 523(a)(4) exception to discharge to those “debts
incurred through abuses of fiduciary positions.” Tran, 151 F.3d at 342. Thus,
we are required to find a fiduciary duty owed by Harwood to FNFS that is
separate and apart from the loans—that is, FNFS cannot rely on a constructive
trust, which is remedial in nature and which arises only after the wrongdoing,
to satisfy the fiduciary capacity element of Section 523(a)(4).
      In this case, the bankruptcy court found that Harwood’s control over FNFS
enabled him to execute the Notes at issue and draw upon them at will—it did
not hold that a trust relationship would be imposed because of the Notes. In any
event, as discussed below, the bankruptcy court did not rely on Harwood’s ability
to raid FNFS’s coffers to find a pre-existing fiduciary relationship; it found that
Harwood exercised managerial control over FNFS from the inception of the
partnership, a fact finding that is not clearly erroneous.
      Harwood also contends that the evidence does not establish that he
exercised the level and kind of control over FNFS sufficient to be considered a
fiduciary of FNFS under the relevant case law, pointing out that he was but one
director among many, and a non-controlling shareholder. He maintains that the
board could and did limit his authority to manage B & W and obtain loans from
FNFS towards the end of his tenure at B & W. He also points out that, in fact,

                                        12
                                       No. 10-40406

the board ultimately terminated his employment—further evidence of his lack
of control over B & W and, consequently, FNFS.
       To the contrary, the facts found by the bankruptcy court amply establish
that Harwood exercised near-complete control over both tiers of the entity until
a few months prior to his termination. Although B & W as an entity was tasked
with the management of FNFS pursuant to FNFS’s partnership agreement, the
bankruptcy court found that the B & W board entrusted Harwood with the sole
and plenary authority over the day-to-day management of the partnership
enterprise. The board paid little attention to the day-to-day operations of FNFS,
and McKinney, the other managing shareholder and chief executive officer of
B & W, was not able to exercise meaningful oversight because he had no
particular banking expertise. Although Harwood’s authority was subject to the
board’s oversight, the bankruptcy court found that the board placed no actual
limits on Harwood’s management of FNFS until 2004.4 The board of directors
apparently rubber-stamped Harwood’s advances on the FNFS Master Note
based on the incomplete disclosures that Harwood made to the board, and the
bankruptcy court found “little evidence to suggest that any person with actual

       4
         For this reason, we reject Harwood’s efforts to distinguish Bennett on the basis that
the managing partner in Bennett, by virtue of being a partner rather than an officer of a
corporation, was not subject to any oversight or limits on authority analogous to that exerted
by a board of directors. Similarly, we do not think that Park and McBeth are distinguishable
on the basis that they involve officers who were also the sole shareholder or director of the
corporate general partner, where Harwood was not. The fact that Harwood was not a majority
shareholder, and one of several directors of B & W, did not appear to limit his control over the
management of the partnership in any meaningful way; in fact, based on testimony at trial,
the bankruptcy court found that because Harwood was one of two shareholders of the
privately-held subchapter S corporation, the board gave little attention to the day-to-day
operations of the business or what perks were provided to corporate officers. See Harwood, 404
B.R. at 380. We also reject Harwood’s contention that the fact that the board eventually
exercised its authority and terminated his employment conclusively establishes his lack of
actual managerial control over the partnership during the overwhelming portion of his tenure
at B & W.

                                              13
                                  No. 10-40406

authority at B & W or FNFS ever became concerned about the rising amount of
the Harwood indebtedness prior to September 2004.” Harwood, 404 B.R. at 380.
      With this significant degree of trust placed on Harwood over the
management of the partnership and partnership funds, Harwood exercised
“virtually all executive power over FNFS operations on a daily basis.” Id. at 378.
Harwood, as president and chief operating officer of B & W,

      planned and supervised the growth and expansion of the FNFS
      lending locations. He controlled the hiring, evaluation, promotion,
      and termination of FNFS employees, the number of which soon
      exceeded 100 at 25 B & W Finance locations. No one with daily
      involvement in the company’s affairs could challenge Harwood’s
      authority or decision-making. He managed all FNFS operations
      from the central office in Tyler[, Texas].

Id. The bankruptcy court also found that Harwood held himself out as the
“president” of FNFS, “which, while not technically accurate, was practically true
in every sense.” Id. Moreover, Harwood exercised substantial control over
B & W and partnership funds. Harwood made oral demands for advances on the
Master Note, as well as for reimbursements for undocumented business
expenses, which Harwood’s subordinates processed without question. “The only
governing policy was to do what Harwood directed.” Id. at 380 n.23.
      We agree with the bankruptcy and district courts that the board’s
entrustment in Harwood of the management of the partnership’s affairs and the
partners’ investments, when combined with the practically complete control that
Harwood actually exercised over the partnership’s management, compels a
conclusion that Harwood stood “in the same fiduciary capacity to the limited
partners as a trustee stands to the beneficiaries of the trust.” McBeth, 565 F.3d
at 177 (quoting Crenshaw, 611 S.W.2d at 890). In the circumstances of this case,
we find that Harwood acted “in a fiduciary capacity” to FNFS within the
meaning of Section 523(a)(4).

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                                  No. 10-40406

B.    Defalcation under Section 523(a)(4)
      Harwood also challenges the bankruptcy court’s conclusion that his failure
to record the deeds of trust securing the Master Note and Frazier Note
constituted defalcation. “Defalcation” for the purposes of Section 523(a)(4) “is a
willful neglect of duty, even if not accompanied by fraud or embezzlement.”
Moreno, 892 F.2d at 421. Willful neglect “does not require actual intent, as does
fraud,” and is “essentially a recklessness standard.” Schwager v. Fallas (In re
Schwager), 121 F.3d 177, 185 (5th Cir. 1997). Willfulness in this context “is
measured objectively by reference to what a reasonable person in the debtor’s
position knew or reasonably should have known.” Office of Thrift Supervision
v. Felt (In re Felt), 255 F.3d 220, 226 (5th Cir. 2001).
      The bankruptcy court held that B & W and FNFS failed to establish that
Harwood’s making of the loans to himself constituted a willful neglect of duty,
noting that the loans were not made surreptitiously, and that the board was at
least generally aware of and approved their existence. Harwood, 404 B.R. at
398. The bankruptcy court suggested that Harwood’s failure to maintain a
manageable debt ceiling “could be deemed a credible consideration in
determining whether his actions or omissions rise to the level of a defalcation,”
but held that B & W and FNFS’s evidence on this point “establishes a level of
culpability by Harwood no greater than negligence,” which the court held to be
insufficient to establish a defalcation. Id. at 398–99 (citing Meyer v. Rigdon, 36
F.3d 1375, 1384–85 (7th Cir. 1994) and FDIC v. Gaubert (In re Gaubert), 149
B.R. 819, 827 (Bankr. E.D. Tex. 1992)). The bankruptcy court held, however,
that “[i]n light of his fiduciary duty to protect FNFS from financial harm, and in
light of his knowledge that he would personally benefit from any failure of
recordation, Harwood’s failure to ensure the proper recordation of the deeds of
trust constituted a willful neglect of his duty to FNFS” and therefore his

                                        15
                                       No. 10-40406

remaining indebtedness to FNFS on the Master Note and Frazier Note is
nondischargeable. Id. at 399.
       Supporting its holding, the bankruptcy court found that Harwood was
aware that McKinney—who Harwood contends was charged with the
responsibility of recording the liens—had no banking expertise and “no
particular knowledge regarding sound lending practices.” Id. In contrast, the
bankruptcy court found that Harwood was a sophisticated banker who
“absolutely knew the ramifications of any failure to properly record a deed of
trust on real property under Texas law,” and also knew what actions had to be
taken “in order to ensure that FNFS held a rightful first-lien position as to the
collateralized properties, thereby preserving, at the very least, a degree of
protection for FNFS in the face of increasing economic difficulties and increasing
note balances.” Id.
       Furthermore, the bankruptcy court found that Harwood was aware that
FNFS’s failure to properly record the deeds of trust worked to his benefit, as it
allowed him to pledge the unencumbered collateral to procure additional funds.
After Harwood executed the deed of trust granting a lien on the Arp property in
FNFS’s favor to secure the Master Note, Harwood signed deeds of trust granting
liens on the Arp property for the benefit of Hibernia National Bank, securing two
promissory notes with a combined total of $499,402. Unlike the FNFS’s liens on
the Arp property, the Hibernia National Bank liens were properly recorded. As
a result, Hibernia National Bank held a senior secured position on the Arp
property.5

       5
          In 2001, Harwood pledged his B & W stock as replacement collateral for the Master
Note. However, the bankruptcy court found that the stock certificates were not placed in the
loan file with the loan documents, and, indeed, were never found. Harwood, 404 B.R. at
381–82. B & W reissued the certificates in 2004 after the audit committee discovered the loan
file and the absence of the certificates. The stock was ultimately sold and its proceeds applied
to the accrued interest and principal amount owing on the Notes.

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                                   No. 10-40406

      The bankruptcy court also found that Harwood “absolutely knew or had
reason to know the devastating effect which [a failure to ensure recordation of
the deed of trust liens] would have on any subsequent collection effort by FNFS,
and that such a risk to FNFS grew in proportion to the escalating balance of the
sums that he personally borrowed from that entity.” Id. And indeed, Harwood’s
failure to record the deeds of trust complicated FNFS’s recovery on the Notes.
For instance, FNFS recorded the deed of trust on the Frazier property in
January 2005, but because the recordation occurred within one year of the filing
of Harwood’s bankruptcy petition, the Chapter 7 trustee commenced a
proceeding to avoid the recordation as a preferential transfer under 11 U.S.C.
§ 547.   FNFS ultimately settled with the trustee for less than what the
partnership would have received had Harwood recorded the deed of trust soon
after executing the Note.
      Harwood does not challenge the bankruptcy court’s factual findings, and
we do not find them to be clearly erroneous. Harwood argues, however, if the
taking of the loans themselves does not constitute defalcation, then he cannot
be denied a discharge for taking additional, yet incomplete steps to secure the
loans for the benefit of FNFS. The district court rejected this argument, finding
that Harwood’s duty to protect FNFS from financial harm “included properly
securing the more than $800,000 in personal loans he withdrew in FNFS funds,”
and that “Harwood is not redeemed by making it halfway to the goal.” Harwood
v. FNFS, Ltd. (In re Harwood), 427 B.R. 392, 398 (E.D. Tex. 2010).
      We likewise find that Harwood’s half-measures with regard to securing the
loans constitutes willful neglect of his duties to FNFS. A fiduciary “is not
permitted to place himself in a position where it would be for his own benefit to
violate” his duty to administer the partnership affairs solely for the benefit of the
partnership.    Crenshaw, 611 S.W.2d at 890; cf. Moreno, 892 F.2d at 421
(citations omitted) (an officer’s duty “encompasse[s], at least, a responsibility not

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                                  No. 10-40406

to lend [the corporation’s] money to himself or corporations controlled by him on
less than an arms-length basis”). Even if the existence of the loans themselves
was not a defalcation, the bankruptcy court did not err in further concluding
that Harwood recklessly breached his duty to FNFS by failing to protect against
the increasing financial risk created by those loans by ensuring that FNFS
perfected its liens on the pledged collateral, particularly where his failure
accrued to his benefit. Accordingly, the district court did not err in holding that
the bankruptcy court properly found Harwood’s remaining indebtedness on the
Notes to be nondischargeable under Section 523(a)(4).

                              IV. CONCLUSION
      For the foregoing reasons, we AFFIRM the judgment of the district court
affirming the bankruptcy court’s judgment.

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