RALPH B. KIRSCHER, Bankruptcy Judge.
In this Adversary Proceeding, after due notice, the Court conducted a trial on June 20, 2011, in Missoula on the Plaintiffs Beau and Morgan Blixseth's (collectively "the Blixseths") complaint to deny Debtor/Defendant Edra D. Blixseth's ("Edra") discharge under 11 U.S.C. § 523(a)(4).
The parties agree in the Final Pretrial Order that the following facts are undisputed:
a. Debtor, Edra Blixseth's bankruptcy case was filed on March 26, 2009, under Chapter 11 of the Bankruptcy Code.
b. Edra's case was converted from a Chapter 11 to a Chapter 7 by Order of this Court entered May 29, 2009.
c. At all relevant times, Blixseth Family Investments, LLC ("BFI") was a Montana limited liability company formed on August 22, 2000 and governed by an Operating Agreement of the same date.
d. At all relevant times, Plaintiffs, Beau and Morgan Blixseth, each owned a 10% interest in BFI. Edra owned a 60% interest in BFI and served as its Managing Member.
e. As a Managing Member of BFI, Edra had fiduciary duties to all members, including Plaintiffs.
f. At all relevant times, BFI's primary asset was a promissory note in the face amount of $35,650,000 ("the BFI Promissory Note").
g. In November 2007, Edra obtained an unsecured loan from First Bank in the amount of $5,000,0000.
h. In March 2008, Edra, as Managing Member of BFI, executed loan documents for an $8,000,000 loan from First Bank.
i. Following the $8,000,000 loan from First Bank to BFI, BFI approved an $8,000,000 unsecured loan to Edra. Edra used $5,000,000 of the proceeds of this loan to pay off her unsecured $5,000,000 loan to First Bank.
j. Edra did not provide notice to or seek approval of Plaintiffs for the above-referenced transactions.
k. In January 2009, Edra, as Managing Member of BFI, executed loan documents for an extension of the $8,000,000 loan and an additional $2,000,000 advance from First Bank. None of the loan proceeds went to BFI.
l. Neither BFI nor Plaintiffs received any benefit from the loan transactions described herein. The only member of BFI that received any benefit from the $8,000,000 loan and/or $2,000,000 additional advance was Edra.
m. On August 6, 2009, BFI filed a claim in Edra's bankruptcy in the amount of $10,749,095.89.
n. On February 24, 2011, First Bank filed a Complaint against BFI for Breach of Contract and Money Had and Received in the Superior Court of California. The Complaint relates to the loan transactions described herein and alleges damages in the amount of $11,515,762.64.
In addition to the foregoing, the evidence shows that in August of 2000, Edra, Timothy L. Blixseth ("Tim"), Julie Barve, Matthew Crocker, the Beau Blixseth Trust and the Morgan Blixseth Trust entered into a Restated and Revised Operating Agreement with the "purpose of forming a limited liability company" known as Blixseth Family Investments, LLC which was "to be managed by one manager[.]"
Edra testified that prior to January 1, 2005, BFI and an entity owned by James J. Dolan ("Dolan") owned what was referred to as Spanish Peaks. Dolan also owned both A and B shares in the Yellowstone Club, an exclusive private ski and golf community located in Big Sky, Montana.
Edra and Tim separated in late 2006 and Edra filed for divorce in December of 2006. In April of 2007, after her separation from Tim, Edra secured a $2.5 million loan from Palm Desert National Bank. The Negative Covenants of an Addendum to Business Loan Agreement between Edra and Palm Desert National Bank dated April 9, 2007, recite that Edra "holds an interest in Blixseth Family Investments, LLC, a Montana Limited Liability Company (`BFI'). Borrower represents that she is currently prohibited by the BFI Operating Agreement from pledging such interest in BFI to secure the Loan." Edra's representation to Palm Desert National Bank on or about April 9, 2007, is consistent with paragraph 11.1 of BFI's operating agreement, which reads: "No Member may transfer all or any part of such Member's interest as a member of the Company except as permitted in this agreement. Any purported transfer of an interest or a portion of an interest in violation of the terms of this agreement will be null and void and of no effect. For purposes of this section a `transfer' includes a sale, exchange, pledge, or other disposition, voluntarily or by operation of law." The $2.5 million loan from Palm Desert National Bank matured April 9, 2008.
Edra contends S.P. Realty made a payment of $6.8 million to BFI in April of 2007, but that Tim took all the proceeds for himself. In late July 2007, Edra and her children, Julie Barve and Matthew Crocker, prepared a document that sought to expel Tim from BFI. As reflected in Exhibit 104, Edra alleged that Tim claimed sole control over BFI's books, records and operations, that Edra was entitled to an equal allocation of the first $8,799,576.49 of BFI's net profits,
In lieu of having to provide an accounting of S.P. Realty's 2007 payment to BFI, Tim agreed on November 1, 2007, to assign his 30% ownership interest in BFI to Edra, giving Edra a 60% ownership interest in BFI. On December 13, 2007, Tim and Edra, as trustees of the Beau Blixseth and Morgan Blixseth Trusts, conveyed each of the Trusts' 10% ownership interests in BFI to Beau and Morgan individually.
In 2007, Alan Rye ("Rye"), an executive vice president of First Bank who was also in charge of First Bank's Southern California real estate group, learned that Edra and Tim were divorcing and that Edra may have a need for short-term funding.
S.P. Realty made a payment of $4,875,696 to BFI on January 14, 2008. Edra caused BFI to distribute $443,716 each to Beau, Morgan, Julie Barve and Matthew Crocker. Edra also caused BFI to pay Beau and Morgan an additional $25,742.15 each on an undisclosed date. It is not clear what Edra did with her share of S.P. Realty's 2008 payment to BFI, but Edra agreed that it was fair to say that none of S.P. Realty's 2008 payment was used to pay down Edra's $5 million obligation to First Bank. As noted above, the November 15, 2007, loan matured March 1, 2008. Edra was not able to payoff the obligation at maturity.
As the March 1, 2008, maturity date approached, First Bank expressed its willingness to extend Edra's loan. However, First Bank wanted to secure its position as a condition to extending the loan. Many assets, such as Porcupine Creek, which
Notwithstanding her desire to obtain funds in a different manner, Edra, with assurances from First Bank's counsel and her personal counsel that she had authority to do so, caused BFI to secure a line of credit from First Bank. From the $8 million loan, First Bank retained sufficient proceeds to pay off Edra's previous $5 million loan, and after payment of various costs, interest, etc., the balance of the proceeds were disbursed to Edra. The primary source of repayment at that time was expected to be a $30 million line of credit secured by Porcupine Creek, which was owned by BLX Group, Inc., and the sale of the Yellowstone Club. The S.P. Realty Note was not listed on the loan documents as either a primary or secondary source of repayment for the $8 million loan, but as reflected in an Allonge dated March 18, 2008, Edra, as the manager of BFI, transferred and assigned all BFI's "right, title and interest in" S.P. Realty's Promissory Note to First Bank.
Rye testified that he, Edra and either Matthew Crocker or Julie Barve were present when Edra signed the loan documents for the $8 million loan. Exhibits 116 and 177 are "Action by Written Consent of Members of Blixseth Family Investments, LLC" signed by Edra, Julie Barve and Matthew Crocker dated March 9, 2008. In the Action documents, Edra, Julie Barve and Matthew Crocker ratified BFI's $8 million loan with First Bank, ratified BFI's assignment of S.P. Realty's note to First Bank and ratified BFI's loan of $8 million to Edra. With respect to BFI's $8 million loan to Edra, the Action document at Exhibit 117 recites that "it was advisable and in the best interests of [BFI] to make the Company Loan to EDRA because [BFI] obtained a reasonable rate of return on the Company Loan investment because the interest rate under the Company Loan is one percent (1%) in excess of the interest rate that [BFI] will be charged by First bank under the First Bank Loan."
Notwithstanding the date of the Action documents, Exhibit 165 suggests that "the BFI authorizing documents with respect to the $8 million dollar First Bank Loan to BFI, and the subsequent loan from BFI to Edra[,]" consisting of perhaps the consents of Matthew Crocker and Julie Barve and a Revolving Line of Credit, were not signed until sometime after April 9, 2008. Whether the documents were signed on March 9, 2008, or sometime after April 9, 2008, Edra's actions on behalf of BFI were ratified by members holding a collective 80% ownership interest in BFI.
As the maturity date of BFI's $8 million loan approached, Edra and First Bank began discussing an extension of the $8 million loan. On July 30, 2008, Edra, on behalf of BFI, signed an Extension and Modification Agreement extending the July 1, 2008, maturity date of the $8 million loan to October 1, 2008.
In mid-2008, Edra began negotiating with other lenders to secure longer term financing, not only for her existing obligations, but also to finalize her divorce with Tim. Edra originally believed she had reached a deal with Wachovia but that deal fell apart due to Wachovia's "catastrophic issues." Edra then scrambled to find "hard money" to get her divorce finalized so she could start putting her affairs back in order. Edra eventually secured a 30 or 45-day $35 million loan from CrossHarbor Capital Partners. Edra expected to repay the CrossHarbor Capital Partners' loan with funds she hoped to obtain from "hard moneylender," Archer Capital. The CrossHarbor Capital Partners' loan proceeds were used to finalize Edra's divorce from Tim, including substantial payments to or on behalf of Tim, and to pay a financing fee to Archer Capital.
The extended maturity date of BFI's $8 million loan expired, and Edra had not secured funds to repay the loan. As a result, on January 6, 2009, First Bank agreed to extend the $8 million loan agreement for an additional twelve months and advance an additional $2 million to BFI, thereby increasing the total loan amount to $10 million. As an incentive to First Bank to extend the loan, Edra, through BLX Group, Inc., granted First Bank a fourth position Trust Deed against Porcupine Creek. The purpose of the extension and additional advance was to provide Edra "additional funds and necessary time to consummate various cash flow raising activities, which would repay the loan." As partial compensation to BLX Group, Inc. for granting First Bank a Trust Deed against Porcupine Creek, First Bank agreed to allow BLX Group, Inc. to place a second lien, behind First Bank's $10 million lien, against S.P. Realty's note. See Exhibit 138, Commercial Credit Approval Form dated January 6, 2009, accompanied by a Corporation Resolution of BFI signed by Edra on January 15, 2009.
S.P. Realty did not make its scheduled payment to BFI in 2009 and in fact, has not made a payment since its payment of $4,875,696 made January 14, 2008. Beau telephoned Dolan in August of 2009 and asked if Dolan could make the required payment. Dolan responded that he could not make the payment because he did not have the ability to do so. Dolan advised Beau at that time that "if you foreclose on this, that [S.P. Realty] doesn't hold anything and it will file for bankruptcy." Similarly, in an email to Edra dated April 2, 2009, Dolan advised Edra that "these assets
Beau conceded that had Dolan made the payments scheduled for 2009, 2010 and 2011, Edra would have received sufficient funds to repay BFI's obligation to First Bank in full, plus make the required distributions to Beau and Morgan. Edra expressed her belief that Dolan did not pay the S.P. Realty note in 2009 and thereafter at the "direction of Tim[.]" Edra explained that "when that note wasn't paid, that was the domino effect or I wouldn't be sitting here today, expecting that $5 million to be paid. And shortly thereafter is when I had to file the bankruptcy."
Edra filed a voluntary Chapter 11 bankruptcy petition on March 26, 2009. Edra's bankruptcy was converted to Chapter 7 on May 29, 2009, and Samson was appointed the Chapter 7 Trustee of Edra's bankruptcy estate. In July 2009, the members of BFI voted to remove Edra as manager of BFI and replace Edra with Beau. Beau served as a manager of BFI for a period of two months. During his tenure as manager, Beau caused BFI to file a proof of claim in Edra's case on August 6, 2009, wherein BFI asserts an unsecured claim against Edra in the amount of $10,749,095.89. Neither Beau nor Morgan filed individual claims against Edra.
Edra's son, Matthew Crocker, filed a voluntary Chapter 7 bankruptcy petition on February 13, 2009. The Chapter 7 Trustee in Matthew's bankruptcy, Joseph V. Womack, took over as manager of BFI after Beau's two-month stint was concluded. An involuntary Chapter 11 bankruptcy petition was filed on behalf of BLX Group, Inc. on September 21, 2009. First Bank did not receive any payment from the sale of the Porcupine Creek property in BLX Group, Inc.'s bankruptcy proceeding.
Western Capital Partners is a creditor of Edra and Matthew Crocker. Western Capital Partners contends it is now the owner of Edra and Matthew's combined 70 percent interest in BFI. The parties state Western Capital Partners and Samson are threatening to litigate or are litigating who is the appropriate party to pursue collection of the S.P. Realty note.
Beau testified he first heard rumors about First Bank's $8 million loan to BFI from Tim.
First Bank initiated a state court lawsuit against BFI in the Superior Court for the County of Orange, State of California on or about February 24, 2011, seeking to collect on its note. Western Capital Partners, on behalf of BFI, asserts three counterclaims in that action, including a claim the $8 million note and any purported pledge or assignment of the S.P. Realty note by BFI to First Bank are void.
For reasons unexplained, not a single party, including First Bank, has pursued collection of the S.P. Realty note. Samson, however, testified that Joseph V. Womack, the Chapter 7 Trustee of Matthew Crocker's bankruptcy estate and the Manager of BFI in late 2009, had talked with the Goetz law firm in Bozeman and they had agreed to pursue the S.P. Realty note on a contingency fee basis. Beau asked Samson and Womack to hold off retaining the Goetz law firm to pursue the S.P. Realty note because Beau wanted to find a different law firm to pursue collection of the S.P. Realty note. Beau located another attorney in Bozeman, but Samson was not comfortable moving forward because he had never heard of the attorney. Beau also told Samson at or about this same time that he wanted additional time to talk personally to Dolan. Western Capital Partners then entered the scene, and Samson elected not to pursue the S.P. Realty matter further.
Beau and Morgan each seek to except from Edra's discharge the sum of $1 million, plus costs, interest, and attorneys fees. The Blixseths do not claim Edra committed larceny or embezzlement, but rather, contend only that Edra committed fraud or defalcation while acting in a fiduciary capacity pursuant to 11 U.S.C. § 523(a)(4). The Blixseths assert they are entitled to judgment in their favor because (1) Edra, as Managing Member of BFI, had a fiduciary duty to manage the funds of BFI for the benefit of its members, (2) Edra committed fraud or defalcation while acting in that capacity when she obtained loans, purportedly on behalf of BFI, for her own personal benefit, using BFI assets as collateral and obligating BFI for repayment of the loan, and (3) that Blixseths have been damaged as a result. In response, Edra asserts several elements of defense, many of which are not applicable in this proceeding. Applicable here are Edra's claims that any fiduciary relationship Edra may have had was not a fiduciary relationship within § 523(a)(4), that Edra was authorized to secure the loans in question, that Edra had the authority to enter into a loan agreement with First Bank and then loan the proceeds to herself, and that Blixseths have suffered no damages. Edra also challenges the Blixseths' standing to bring the pending claim.
The Blixseths each seek to except $1 million from Edra's discharge under 11 U.S.C. § 523(a)(4). It is well-settled that the Bankruptcy Code's central purpose is to provide a fresh start to the honest but unfortunate debtor. See Grogan v. Garner, 498 U.S. 279, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991). However, under
Before any federal court exercises jurisdiction over a matter, the court must determine whether the plaintiff has standing. "Standing is a `threshold question in every federal case, determining the power of the court to entertain the suit.'" In re Veal, 450 B.R. 897, 906 (9th Cir. BAP 2011) (quoting Warth v. Seldin, 422 U.S. 490, 498, 95 S.Ct. 2197, 45 L.Ed.2d 343 (1975)). Constitutional standing requires injury in fact, causation, and redressability. In addition to constitutional standing, as one aspect of the judicially self-imposed prudential limitations on the exercise of federal court jurisdiction, plaintiffs must also demonstrate they have prudential standing. Id.
As recognized in Veal, the requirements for constitutional standing are minimal. Id. Like the appellees in Veal, the larger hurdle for the Blixseths is the "doctrine that a plaintiff must assert its own legal rights and may not assert the legal rights of others." Id. at 907 (citing Sprint Commc'ns Co., LP v. APCC Servs., Inc., 554 U.S. 269, 289, 128 S.Ct. 2531, 171 L.Ed.2d 424 (2008)). As explained in Veal,
Id. 907-08.
The Blixseths' claim is brought pursuant to § 523(a)(4) of the Bankruptcy Code. The Blixseths argue Edra used BFI assets as security for what was essentially a personal loan. To challenge the dischargeability of a debt under § 523(a)(4), "the creditor to whom such debt is owed" must request the bankruptcy court to except the debt from discharge. 11 U.S.C. § 523(c)(1). Standing to bring a dischargeability action calls for a "creditor" holding a "debt" or "claim" that "is owed" to that "creditor." The Bankruptcy Code defines "creditor" as an "entity that has a claim against the debtor." Central to the standing requirement of § 523(c) is a "debt" and its counterpart, a "claim." The definition of "creditor" found in 11 U.S.C. § 101(10)—"entity that has a claim against the debtor"—requires that the entity possess some bankruptcy claim, not that it be owed money.
In re Cross, 218 B.R. 76, 78 (9th Cir. BAP 1998). On the other hand, "creditor to whom such debt is owed" means literally that the creditor is owed money by the debtor, and that the creditor holds a claim in its own behalf or in its own right. The Blixseths hold no claims against Edra in their own right, which is evidenced by the fact that only BFI, and not the Blixseths, filed a proof of claim in Edra's bankruptcy case.
Furthermore, as mentioned above, the Blixseths contend Edra used assets belonging to BFI to secure her personal loan. The alleged injury suffered was to BFI as an entity, and not to the Blixseths directly. The Blixseths suffered a loss, if any, only indirectly as members of BFI.
While the Blixseths' claim is brought under § 523(a)(4), the substantive law implicated is Montana's law governing limited liability companies. As the Court will discuss later, Montana law imposes an unqualified duty on members of limited liability companies ("LLC"), who hold company property, to act as a trustee. See MONT. CODE ANN. ("MCA") § 35-8-310(2)(a). Montana law further provides:
MCA § 35-8-1104.
A bankruptcy court in Florida recently held that members of an LLC lack standing to claim an exception to discharge of the company manager under § 523 for losses suffered as members of the company. In re Whittle, 449 B.R. 427, 429-430 (Bankr.M.D.Fla.2011). The court in Whittle held that LLC members were not "creditors to whom a debt is owed," id. at 429, and that "[t]he Florida statutory scheme is clear that a limited liability company holds property separate and apart from the property of its members[.]" Id. at 430. In an unpublished decision construing Texas law, the Ninth Circuit also determined that members of an LLC must bring a derivative rather individual claim: "Thus, in order for Appellants to bring a claim based on injuries allegedly suffered by [the LLC], the suit must be brought derivatively." Albers v. Guthy-Renker Corp., 92 Fed.Appx. 497, (9th Cir.2004).
As in other states, an LLC in Montana is a separate entity: "A limited liability company is not merely an informal business association. It is a legal entity, distinct from its members, formed by signing and filing articles of organization with the secretary of state. Its obligations are separate from its members." Ioerger v. Reiner, 2005 MT 155, ¶ 20, 327 Mont. 424, 114 P.3d 1028, 1032. Furthermore, the Montana Supreme Court has held that limited partners cannot bring an individual claim when a derivative claim is the appropriate remedy. Larson v. First Interstate Bank of Kalispell (1990), 241 Mont. 350, 786 P.2d 1176, 1179.
Like in Larson, the Blixseths' claim is based solely on their membership in BFI. Taken together, the cases discussed above indicate that Montana prohibits individual actions to be brought in place of a derivative action. Under such circumstances, a derivative claim is not only appropriate, but required.
With respect to derivative standing, Edra's counsel argues in his Post-Trial Memorandum that the Blixseths lack standing to sue Edra under MCA § 35-1-543 because the Blixseths failed to show they made written demand upon BFI to bring suit against Edra. MCA § 35-1-543 pertains to corporations, partnerships and associations. BFI was and is a limited liability company. Derivative standing of LLCs is governed specifically by MCA. § 35-8-1104. Montana's Limited Liability Company Act clearly authorizes derivative claims brought by members on behalf of LLCs.
Procedurally, Montana law requires the Blixseths to show that the members or managers having authority to bring the action have refused to commence the action or that an effort to cause those members or managers to commence the action is not likely to succeed. Beau was the manager of BFI for a period of two months and did not file a complaint against Edra on behalf of BFI. The Court can appreciate that Beau's short tenure did not allow him adequate time or experience to take action on behalf of BFI against Edra. However, the Blixseths failed to show that the subsequent managers, such as Joseph Womack, either refused to commence a dischargeability action against Edra or that such an effort would be futile.
Moreover, MCA 35-8-1104(3) provides: "In a derivative action for a limited liability company, the complaint must set forth with particularity the effort of the plaintiff to secure initiation of the action by a member or manager or the reasons for not making the effort." In some instances, the Court may infer the basis for the belief a
This Court concludes that the Blixseths lack standing to pursue their § 523(a)(4) claim. However, even if the Blixseths had standing, which they do not, their claim under § 523(a)(4) would nevertheless fail.
Section 523(a)(4) provides that a "discharge under section 727 . . . does not discharge an individual from any debt—. . . (4) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny." To prevail on their § 523(a)(4) claim, the Blixseths are required to establish (1) that Edra was acting in a fiduciary capacity, and (2) that Edra committed a "defalcation" in that capacity.
As to the first element, the broad, general definition of "fiduciary" under nonbankruptcy law is inapplicable in the bankruptcy context. Cal-Micro, Inc. v. Cantrell (In re Cantrell), 329 F.3d 1119, 1125 (9th Cir.2003); In re Honkanen, 446 B.R. 373, 378 (9th Cir. BAP 2011). To fall within the narrow definition of "fiduciary" under § 523(a)(4), "the fiduciary relationship must be one arising from an express or technical trust that was imposed before, and without reference to, the wrongdoing that caused the debt as opposed to a trust ex maleficio, constructively imposed because of the act of wrongdoing from which the debt arose." Id. (citations omitted).
The scope of the term "fiduciary capacity" under § 523(a)(4) is a question of federal law. See Mills v. Gergely (In re Gergely), 110 F.3d 1448, 1450 (9th Cir. 1997). The Ninth Circuit has adopted a narrow definition of "fiduciary" for purposes of § 523(a)(4), requiring that the fiduciary relationship arise from an express or technical trust that was imposed prior to the wrongdoing that caused the debt. Lewis v. Scott (In re Lewis), 97 F.3d 1182, 1185 (9th Cir.1996). Similarly, in Davis v. Aetna Acceptance Co., 293 U.S. 328, 333, 55 S.Ct. 151, 79 L.Ed. 393 (1934), the Supreme Court instructed that the term "fiduciary capacity" is narrower here than it is in some other contexts: section 523(a)(4) covers only "express" or "technical trusts" and not trusts arising out of "the very act of wrongdoing." See also, In re Cantrell, 329 F.3d at 1125 ("The broad, general definition of fiduciary—a relationship involving confidence, trust and good faith—is inapplicable in the dischargeability context. . . . The fiduciary relationship must be one arising from an express or technical trust that was imposed before and without reference to the wrongdoing that caused the debt.")
Although the definition of fiduciary is governed by federal law, the Ninth Circuit has relied in part on state law to ascertain whether the requisite trust relationship exists. Cantrell, 329 F.3d at 1125; In re Lewis, 97 F.3d at 1185. To establish the trust relationship required by § 523(a)(4), "the applicable state law must clearly define fiduciary duties and identify trust property." Honkanen, 446 B.R. at 379 (citing Runnion v. Pedrazzini (In re Pedrazzini), 644 F.2d 756, 759 (9th Cir. 1981)). "The mere fact that state law puts two parties in a fiduciary-like relationship does not necessarily mean it is a fiduciary relationship within 11 U.S.C. § 523(a)(4)." Id. However, establishing an express trust in Montana is straightforward and requires four elements: (1) intent to create a
The Blixseths assert that Edra was a fiduciary of BFI and its members based on MCA § 35-8-310 which provides:
Under MCA § 35-8-310(2)(a), Montana law imposes an unqualified duty on members of an LLC who hold company property to act as a trustee. The statute (1) defines the trust res: "any property, profit, or benefit derived by the member in the conduct or winding up of the company's business or derived from a use by the member of the company's property;" (2) spells out the trustee's fiduciary duties: "account to the company and to hold as trustee for it;" and (3) imposes a trust on the funds prior to the act which created the debt: the obligation arises with membership in the LLC and does not depend on any subsequent conduct. Therefore, Montana law creates an express trust, recognized by federal law for purposes of § 523(a)(4).
MCA § 35-8-310(2)(a) stands in contrast to the statutes recently considered by the Bankruptcy Court in Idaho which found no fiduciary duty among members of an LLC. In re Woodman, 451 B.R. 31 (Bankr.D.Idaho, 2011). Idaho law provides:
Idaho Code § 53-622(2) (2009) (emphasis added).
In re Woodman, 451 B.R. at 39-40.
Both Woodman and Ragsdale contemplate a statute in which the trust arises only when the LLC member acts without consent. Such a statute creates a trust ex maleficio. By contrast, MCA § 35-8-310 contains no similar qualification on the imposition of the trustee relationship. This difference is sufficient to distinguish MCA § 35-8-310 from the statutes in Woodman and Ragsdale.
A Washington court recently analyzed a statute similar to MCA § 35-8-310 and concluded Washington law imposed an express trust for purposes of § 523(a)(4):
In re Errez, (slip copy) 2010 WL 5185399, *2 (W.D.Wash.2010).
As to the second element of § 523(a)(4), "[d]efalcation is defined as the `misappropriation of trust funds or money held in any fiduciary capacity; [the] failure to account for such funds.'" In re Bigelow, 271 B.R. 178, 186 (9th Cir. BAP 2001), quoting Lewis v. Scott, 97 F.3d 1182, 1186 (9th Cir.1996).
As discussed above, Montana state law creates an express trust relationship between members of an LLC who hold company property and the members of the LLC. Edra exercised control of company assets in pledging them as collateral to First Bank. In doing so, she made
The Blixseths claim that Edra breached her fiduciary duty because she lacked authority under the Operating Agreement to pledge BFI assets to secure a personal loan. The basis of this claim is their assertion that "Section 6.5 of the Operating Agreement provides that in cases of self-dealing, the transaction must be ratified by the non-self-interested members." See the Blixseths' Post-Trial Memorandum at docket entry no. 116, p. 11. To the contrary, ¶ 6.5 of the Operating Agreement provides:
Exhibit 101 (emphasis added). The Restated and Revised Operating Agreement for BFI specifically allows members to obtain approval for financial deals with BFI and permits interested parties to vote on those matters. The Blixseths do not raise any applicable law that would override the clear language of the Operating Agreement. Edra obtained approval of members representing an 80% ownership interest in BFI.
The Blixseths also contend that the loans did not benefit BFI as an independent ground to find Edra committed defalcation. They rely on FNFS, Ltd. v. Harwood (In re Harwood), 404 B.R. 366, 389 (Bankr.E.D.Tex.2009), for the proposition that the failure to properly secure loans for personal gain is a defalcation. However, Harwood is distinguishable. The debtor in Harwood was a "sophisticated banker" who owned a 50% interest in a subchapter S corporation, B & W Finance Co. The subchapter S corporation was the sole general partner and owned a 51% partnership interest in a limited partnership, FNFS. The debtor in Harwood served as president, chief operating officer, and a director of the subchapter S corporation, which in turn provided executive and managerial support to FNFS and which, pursuant to FNFS's partnership agreement, exercised "full, sole, exclusive, and complete discretion in the management and control of the business, operations, and affairs of [FNFS]." The debtor began taking loans from FNFS, which loans were memorialized in two promissory notes to FNFS—a $700,000 Master Note accompanied by a deed of trust in favor of FNFS, and a $125,000 note secured by a second-lien deed of trust in favor of FNFS on a residential rental property. The debtor 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. The board of directors of the subchapter S corporation later learned that the debtor had failed to record the deeds of trust that he had executed in favor of FNFS as security for the two notes, leaving the partnership with an unperfected interest in the pledged collateral. The board of directors also learned after the fact that the debtor had subsequently pledged the property, which was supposed
The bankruptcy court found that the debtor in Harwood "absolutely knew or had reason to know" of the detrimental effect that failure to secure the loans would have. Id. at 399. Additionally, the debtor in Harwood borrowed cash directly from the company rather than pledging uncertain future payments as collateral, failed to follow established procedure for obtaining his loans and continued to borrow money without any apparent intention or ability to repay the loans. Id. at 379-80. Finally, and most importantly, the debtor in Harwood appears to have conspired to mislead the board of directors into believing that the loans were collateralized when they were not. Id. at 380-381.
By contrast, Edra had authority from members holding an 80% ownership interest in BFI to borrow the funds, did not misrepresent the lack of securitization, and planned to repay the loans out of the same funds that were pledged as collateral (meaning that her ability to repay was tied to the value of the Company's original asset.) Edra offered a promissory note and interest on the loans she took, and BFI's members accepted this as a legitimate investment. In retrospect, Edra's promissory note to BFI was no less valuable to BFI than the S.P. Realty note. Although Edra owed a fiduciary duty to the Blixseths with regard to BFI property, they have failed to establish that she breached that duty.
Furthermore and more importantly, the Court is not persuaded the Blixseths suffered any damage as a result of Edra's actions. In order to maintain a cause of action, the Blixseths bear the burden of establishing they suffered damages as a result of Edra's alleged defalcation. In determining whether damages are speculative, this circuit has "`distinguished uncertain damage, which prevent[s] recovery, from an uncertain extent of damage, which [does] not prevent recovery[.]'" Allen v. United Food & Commercial Workers Int'l. Union, 43 F.3d 424, 427-28 (9th Cir.1994) (quoting In re Multidistrict Vehicle Air Pollution, 591 F.2d 68, 73 (9th Cir.1979), cert. denied, 444 U.S. 900, 100 S.Ct. 210, 62 L.Ed.2d 136 (1979)). See also, PM Factors, Inc. v. Kreisel (In re Kreisel), 399 B.R. 679, 690 (Bankr. C.D.Cal.2008).
The Blixseths have failed to establish the existence of any damages. Not a single shred of evidence was presented to establish the Blixseths and BFI would be better off had BFI not pledged the S.P. Realty note as collateral. At a minimum, the Blixseths were required to show that the S.P. Realty note had value because absent some value, the Blixseths cannot sustain their burden of proving damages. S.P. Realty has not made a payment on the Promissory Note since January 14, 2008, and has advised the parties in this proceeding that the membership agreements, if they in fact exist, are worth nothing and if BFI or its members attempt to foreclose, S.P. Realty will simply file bankruptcy. The evidence presented in this case strongly suggests that the S.P. Realty note is, in all likelihood, worthless.
The Blixseths theory of damages does not merely lack precision, it is entirely speculative. The Blixseths indirectly admit as much by arguing in their post-trial memorandum that "each of Plaintiffs' interests are now worth, at most, $1.4 million—a reduction of $1.1 million each." The foregoing statement does not prove damages. In other words, the Blixseths have failed to establish that their claimed damage figure of $1 million is remotely
The Blixseths attempt to seek an exception to discharge fails on multiple grounds. First, the Blixseths have not met the procedural requirements to bring a derivative action claim, nor can they bring the pending claim on their own behalf. Thus, they lack standing before this Court. Second, Edra complied with the Operating Agreement and did not commit a defalcation by causing BFI to obtain a loan from First Bank secured by the S.P. Realty note. Finally, the Blixseths have failed to show they suffered any damages as a result of Edra causing BFI to pledge the S.P. Realty note as security to First Bank. Any one of these issues is sufficient to deny the Blixseths claim.
In accordance with the foregoing,
IT IS ORDERED that the Court will enter a separate judgment in favor of the Debtor/Defendant Edra Blixseth and against the Plaintiffs Beau and Morgan Blixseth; and the Plaintiffs' complaint against the Defendant is dismissed with prejudice.