J. Craig Whitley, United States Bankruptcy Judge.
This adversary proceeding involves an unfortunate family dispute replete with finger pointing and hurt feelings. The litigation pits a niece and nephew against their father's sister (their aunt). After the niece's and nephew's father died, the aunt was appointed executrix of his decedent's estate and became president of the deceased's business. At the heart of this fight, the niece and nephew (then teenagers) disagreed with how the aunt was managing their father's final affairs, was treating them poorly, and was trying to steal their father's business. The aunt believes the niece and nephew are ungrateful for all her efforts to "protect" them.
After the niece and nephew had their aunt removed as executrix, the decedent's estate and the decedent's company filed a state court lawsuit alleging the aunt committed fraud and negligence in her roles as executrix of the estate and as president of the company. A two-week jury trial ensued during which the claims in favor of the estate were dismissed. The company obtained a judgment for $262,689 plus costs. However, the state court jury's award of damages does not apportion between the torts.
The aunt filed bankruptcy and was pursued by an assignee of the judgment, the plaintiff in this adversary proceeding, who now seeks to have the judgement debt declared nondischargeable under Code Section 523.
The outcome of this dischargeability action hinges on the distinction between the decedent's estate and the company. Because the judgment was solely in favor of the company, the question before the Court is whether the aunt's actions as president against the company meet the standards required under Section 523 to render the debt nondischargeable. To be abundantly clear, the aunt's actions as executrix against her niece and nephew could not be included in the state court's damages calculation because the estate was dismissed from the state court lawsuit. Meaning, the aunt's misdeeds as executrix against her niece and nephew are not determinative of whether the judgment is a dischargeable debt in bankruptcy.
Having read thousands of pages of state court trial transcript, examining over 175 exhibits, and hearing two days of additional evidence, the Court concludes that plaintiff presented ample evidence of intentional wrongs the aunt committed against her niece and nephew in her role as executrix. Yet, claims for those wrongs would be in favor of the decedent's estate (or perhaps personally in favor of the niece and nephew), were dismissed at the state court trial, and were not included in the state court judgment plaintiff now seeks to declare nondischargeable. The debt at issue in this dischargeability action is owed to the company, not the heirs, and the record lacks any indication that the company suffered damages caused by the aunt's wrongdoing that would fall under one of the narrow exceptions to discharge. The Court must therefore conclude that plaintiff has failed to meet its burden on the claims brought in this adversary proceeding.
During his life, Eddie Wallace operated several businesses, the most significant of which was Ed Wallace Construction, Inc. (EWC). EWC provided services to the gas pipeline industry ranging from construction to emergency repairs. Eddie Wallace was the key employee of EWC, being the most experienced and only welder certified to make certain repairs.
Eddie Wallace died in a motorcycle accident on May 24, 2007. Eddie Wallace was divorced when he died. Per his will, Eddie Wallace left all of his property to Carey Wallace, now Carey Bumgardner (Carey), and Clay Wallace (Clay), his two teenage children (together, the heirs). Eddie Wallace's decedent's estate consisted primarily of his interest in EWC and his home. Eddie Wallace's will additionally provided that Susan Jacobs, Eddie Wallace's sister and the defendant of this adversary proceeding, was to be appointed as the personal representative of his decedent's estate.
Pursuant to state law, on June 6, 2007, Jacobs was sworn as the executrix of Eddie Wallace's estate and letters testamentary were issued. She engaged attorney Wesley Deaton to assist her in administering the estate. Shortly thereafter, Jacobs called a meeting to discuss the future of EWC. Jacobs, the heirs, Daniel Jacobs (Susan Jacobs' son), Jack Wallace (Eddie Wallace's and Susan Jacobs' brother), and Deaton attended the meeting. At the meeting, Jacobs proposed that she be made president of EWC. Although it was later understood to be unnecessary, a vote was taken to that effect. As a result, Jacobs was named president of EWC and undertook management of its affairs. Therein lies the genesis of this dispute.
EWC struggled due in part to Eddie Wallace's absence and to Jacobs' mismanagement. Because Eddie Wallace was the only "gold card" certified welder, the company had a short timeline to fill the void else its contracts and licenses be lost. EWC's revenue declined, and the IRS began sending notices of unpaid taxes. At one point, the IRS froze and levied on EWC's payroll account.
The heirs viewed Jacobs as the cause of EWC's financial downturn to say nothing of their own financial problems.
While all these events were unfolding, the heirs were calling for Jacobs to sell the company. Their demands fell on deaf ears.
Eventually the heirs initiated legal action against Jacobs. On July 7, 2007, the heirs filed a motion requesting that the Lincoln County Clerk of Court remove Jacobs as the executrix of their father's estate for the alleged actions listed above. Deaton continued to represent Jacobs at the removal hearing before the Clerk.
The Clerk entered an order on October 8, 2008, finding in pertinent part:
The Clerk concluded that Jacobs was in violation of several provisions of Chapter 28A of the North Carolina General Statutes and therefore removed her as executrix of the estate. Jacobs was directed to file a final estate accounting and to turn over the estate to the attorneys for the heirs.
After the Clerk removed Jacobs, the relationship between Jacobs and her attorney, Deaton, deteriorated. In a letter to Jacobs dated October 10, 2008, Deaton recounted the timeline of events leading to Jacobs' removal including numerous occasions where Jacobs had ignored Deaton's counsel. In his letter, Deaton told Jacobs that she could file an appeal of the Clerk's order; however, Deaton stated that he was unwilling to represent her in such an endeavor. Additionally, Deaton advised Jacobs that "[a]n appeal would stay the Clerk's order revoking your letters until the ultimate resolution of the appeal in Superior Court."
In hindsight, Deaton was incorrect regarding the effect of an appeal and a stay of the Clerk's order. Pursuant North Carolina General Statute § 28A-9-4, the Clerk may issue a stay of an order revoking
Based on Deaton's (incorrect) advice, Jacobs filed a pro se notice of appeal on October 14, 2008, believing the Clerk's order would be stayed as a result. A hearing on Jacobs' appeal was set for November 10, 2008. Deaton made a limited appearance on Jacobs' behalf to request the hearing be continued. According to Deaton's motion, the parties were engaged in settlement negotiations and agreed to the continuance to afford them more time to review new tax information.
From there, the removal action stalled for an extended period of time. Jacobs continued to operate EWC and manage the estate in violation of the Clerk's order. All the while, Jacobs was representing to the heirs that she was preparing the required estate documentation. The heirs allowed Jacobs to continue in her role and took no legal action against her even though the conditions that they alleged warranted her removal persisted. This state of affairs lasted for over two years. While it is not clear how the matter came back before the Lincoln County Superior Court, an order was entered on November 1, 2010, affirming the Clerk's order removing Jacobs.
Immediately after the Superior Court entered its order, Jacobs caused the decedent's estate to pay a $61,142.65 obligation of another of Eddie Wallace's businesses, Ed Wallace Rentals, LLC (EWR). At the time, Jacobs apparently believed she was a personal guarantor on the EWR debt. In fact, the debt was guaranteed by Eddie Wallace (personally) and by EWC.
Before turning over control, Jacobs removed EWC's company records from EWC and proceeded to copy them. Jacobs returned the records a few days later. The evidence presented was not clear on the condition of the records before Jacobs took possession of them or if she failed to return any documents.
Carey succeeded Jacobs as executrix of Eddie Wallace's decedents estate, and Clay took over as president of EWC. When Clay became president, EWC had only about $6000 in its operating account.
Following further disputes over Jacobs' commission for her services as executrix, Carey (personally and as executrix) and EWC filed an action in state court alleging that Jacobs damaged the estate and EWC through breach of fiduciary duty, negligence, unjust enrichment, misrepresentation, and fraud. The complaint alleged:
Both sides presented evidence over the course of a two-week jury trial.
Significantly, at the close of Carey's evidence, Jacobs obtained a directed verdict that dismissed the claims brought by Carey both personally and as executrix of the estate. At the close of Jacobs' evidence, Carey and EWC obtained a directed verdict dismissing Jacobs' counterclaims.
Meaning, the only questions the jury considered were:
The jury answered each question in favor of EWC and awarded EWC $222,689 in compensatory damages and $40,000 in punitive damages. Unfortunately, the award lumped all the compensatory damages together. From the verdict, there is no way to discern the amount the jury awarded for negligence (questions three and four) as opposed to the amounts the jury awarded for torts that may be nondischargeable in bankruptcy.
Both sides appealed to the North Carolina Court of Appeals. However, both withdrew their appeals prior to a ruling.
The law firm that represented Carey and EWC in state court, Gray Layton Kersh Solomon Furr & Smith, P.A. (plaintiff) took an assignment of EWC's judgment in April 2015.
Jacobs filed a Chapter 7 bankruptcy petition on September 25, 2015. Plaintiff filed this adversary proceeding seeking to deny Jacobs her discharge under 11 U.S.C. § 727 and to have its judgment declared nondischargeable under 11 U.S.C. §§ 523(a)(2)(A) and (B), (4), (6), and (7).
At the outset of this case, Jacobs sought vindication and wished to re-litigate much of the state court trial. She fervently disagreed that she had committed any wrongs — intentional or otherwise — or owed EWC any debt at all. For months, the undersigned entered orders and instructed Jacobs that the Rooker-Feldman Doctrine prevented her from using this forum as an appellate court to review and reverse the state jury's decision. Rather, the question presented was how much of the state judgment debt would survive bankruptcy. By the time these issues came on for trial, Jacobs appeared to have grasped this concept and instead asserted that she had not taken any intentional acts against the company's interests. Rather, anything she did wrong was at most negligent, on the advice of counsel, and/or with
Meanwhile, plaintiff has always taken the position that res judicata and collateral estoppel require the jury's entire verdict be declared nondischargeable. According to plaintiff, Jacobs' negligence was akin to a "lesser included offense" of the intentional wrongs the jury found to have occurred. Put differently, plaintiff believes that any of Jacobs' actions that were negligent were part-in-parcel of her intentional acts and should be treated together. On this theory, plaintiff asserts that the evidence introduced in state court established that EWC's injuries were the natural and proximate consequence of Jacobs' nondischargeable acts. According to plaintiff, the fact that the evidence could also form the basis of a claim for damages that are dischargeable is of no consequence because the damages for the intentional torts subsume anything that could be recovered for negligence.
Plaintiff is correct that state court judgments can, in some circumstances, collaterally estop the litigation of issues in adversary proceedings in bankruptcy court. In re Duncan, 448 F.3d 725, 728 (4th Cir. 2006). However, this general principle does not permit us to simply assume that all debts are nondischargeable in cases involving torts that require intent as well as those with a lesser degree of scienter. Dischargeability is a matter of federal law, informed by, but in the main independent from the underlying state law claims. Grogan v. Garner, 498 U.S. 279, 289, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991). Apart from the fact that the concept of "lesser included offense" is a creature of criminal law, not civil tort law, this Court's review of the bankruptcy case law revealed no support for the proposition that the entire debt should be declared nondischargeable because the damages for the intentional torts subsume damages for negligence. In fact, such an assumption would assure that the state inquiry fully determines the federal inquiry, which is at odds with the Bankruptcy Code and likely the United State Constitution.
The correct analysis requires independently comparing the state law claims with the federal law claims of 11 U.S.C. § 523 and then determining which findings from state court preclude re-litigation of identical issues in bankruptcy court.
4 COLLIER ON BANKRUPTCY ¶ 523.06 (Alan N. Resnick & Henry J. Sommer eds., 16th ed.) [hereinafter COLLIER].
This bifurcated process is admittedly awkward. Where the state verdict is not specific, parties who have fought for and obtained a judgment in state court can find themselves in a difficult spot. Generally, nondischargeability is associated with intentional, fraud-like torts. A plaintiff with a state court judgment on fraud and negligence would have likely presented evidence in state court bearing on the following Section 523 dischargeability claim. However, state court verdict sheets are usually not written with a mind toward a subsequent bankruptcy. They are rarely sufficiently detailed to include all of the elements required to later find a debt is nondischargeable.
When faced with this trying predicament, the United States District Court in this judicial district has prescribed the following procedure. First, the bankruptcy court is to consider the state court verdict sheet. Keever v. Gallagher (In re Gallagher), No. 3:10-CV-00237-W, 2011 WL 1130878, at *5 (W.D.N.C. Mar. 25, 2011), aff'd, 464 Fed.Appx. 163 (4th Cir. 2012).
If reviewing the verdict sheet does not resolve the dispute, the bankruptcy court is then to consider the state court transcript of the evidence presented to the jury. Id. ("Obviously, the preferential method for the bankruptcy court to have determined how to apportion damages would have been to review and rely on a special verdict form, or, since that did not exist, the transcript of the evidence presented to the jury in the State Court Action."). If the court remains unable to make the requisite findings on nondischargeability, a supplemental trial may be conducted. Id.
In keeping with the direction of the United States District Court and with the parties' consent, first the undersigned considered the verdict sheet, but was unable to make a determination based on that document alone. The parties then both moved for summary judgment, and the Court undertook an in-depth review of the state court transcript and exhibits presented to the state court jury. This review was also not fruitful. The Court was unable rule as a matter of law and consequently set the case for trial.
The parties agreed that this Court could consider the state court transcript and state court trial exhibits as evidence in the current adversary proceeding. Prior to the trial, the Court read the entire 2322-page
Unfortunately, at the trial, the parties mainly focused on re-hashing the evidence presented in state court. In addition, plaintiff called Casey, Clay, and Jacobs as witnesses.
Prior to presenting its case, plaintiff consented to dismissal of the counts under 11 U.S.C. § 523(a)(7) and 11 U.S.C. § 727. Meaning, the only issues left to be resolved are whether the debts owed by Jacobs to EWC are nondischargeable due to fraud or false pretenses under 11 U.S.C. § 523(a)(2)(A), due to fraud or defalcation while acting in a fiduciary capacity under 11 U.S.C. § 523(a)(4), or due to willful and malicious injury under 11 U.S.C. § 523(a)(6).
One primary purpose of the Bankruptcy Code is to give the honest but unfortunate debtor a fresh start. To that end, a bankrupt debtor enjoys the presumption that all debts are dischargeable pursuant to Section 727, and exceptions to discharge are construed strictly against creditors. In re Rountree, 478 F.3d 215, 219 (4th Cir. 2007). In an action brought under Section 523, the party seeking to establish an exception to the discharge of a debt must prove the requisite elements by a preponderance of the evidence. Garner, 498 U.S. at 291, 111 S.Ct. 654. With these fundamental principles in mind, the Court will set out the controlling law of plaintiff's remaining causes of action and point out instances of how plaintiff has failed to carry its burden as to each:
Under 11 U.S.C. § 523(a)(2)(A), debts are nondischargeable to the extent they were obtained by "false pretenses, a false representation, or actual fraud." Courts generally speak of false pretenses and false representations together and require "four elements: (1) a fraudulent misrepresentation; (2) that induces another to act or refrain from acting; (3) causing harm to the plaintiff; and (4) the plaintiff's justifiable reliance on the misrepresentation." In re Biondo, 180 F.3d 126, 134 (4th Cir. 1999). The fraudulent misrepresentation element "is satisfied if the debtor's representation was known to be false or recklessly made without knowing whether it was true or false." Boyuka v. White (In re White), 128 Fed.Appx. 994, 998 (4th Cir. 2005) (citing In re Woolley, 145 B.R. 830, 834 (Bankr. E.D. Va. 1991)).
A debt may be nondischargeable under 11 U.S.C. § 523(a)(2)(A) even absent a false representation if the debt was obtained through actual fraud. Husky Int'l Elecs., Inc. v. Ritz, ___ U.S. ___, 136 S.Ct. 1581, 1586, 194 L.Ed.2d 655 (2016). "Actual fraud consists of any deceit, artifice, trick or design involving direct and active operation of the mind, used to circumvent and cheat another — something said, done or omitted with the design of perpetrating what is known to be a cheat or deception." 4 COLLIER ¶ 523.08. In short, "anything that counts as `fraud' and is done with wrongful intent is `actual fraud.'" Husky Int'l, 136 S.Ct. at 1586.
Debts owed due to "fraud or defalcation while acting in a fiduciary capacity" are nondischargeable. 11 U.S.C. § 523(a)(4). "`Defalcation'" refers to a failure to produce funds entrusted to a fiduciary." 4 COLLIER ¶ 523.10. An action under 11 U.S.C. § 523(a)(4) to declare a debt owed due to defalcation nondischargeable requires proof of an intentional wrong. Bullock v. BankChampaign, N.A., 569 U.S. 267, 273, 133 S.Ct. 1754, 185 L.Ed.2d 922 (2013).
Plaintiff's evidence reflects that this adversary proceeding is the type of "intrafamily" dispute that the Supreme Court has described as insufficient of a defalcation claim brought under 11 U.S.C. § 523(a)(4). Indeed, Jacobs was a "nonprofessional trustee" who was running a "small family" company and "immersed in intrafamily arguments." Bullock, 569 U.S. at 276, 133 S.Ct. 1754. There was no evidence presented that Jacobs was engaged in conduct she either knew was improper or that was reckless in the sense it would amount to a crime.
At most, Jacobs is guilty of continuing in her role as executrix and president of EWC for two years after the Clerk's removal order. But even then, Jacobs was acting on advice of counsel that the order was stayed, and the heirs allowed her to continue in this role, seemingly without contest.
Pursuant 11 U.S.C. § 523(a)(6), debts are nondischargeable when caused by "willful and malicious injury by the debtor to another entity or to the property of another entity." Typically, debts found to be nondischargeable under this subsection are related to intentional torts. 4 COLLIER ¶ 523.12. To prevail under 11 U.S.C. § 523(a)(6), the plaintiff must show that the defendant's acts leading to the debt were "`done with the actual intent to cause injury.'" Duncan, 448 F.3d at 729 (citation omitted); see also Kawaauhau v. Geiger, 523 U.S. 57, 61, 118 S.Ct. 974, 140 L.Ed.2d 90 (1998) ("The word `willful' in (a)(6) modifies the word `injury,' indicating that nondischargeability takes a deliberate or intentional injury, not merely a deliberate or intentional act that leads to injury.").
Even as plaintiff posits that Jacobs intentionally harmed EWC, plaintiff's ultimate theory is that Jacobs intended to steal EWC for herself. These accusations are incompatible. If Jacobs was trying to steal EWC, why would she intentionally try to harm the company? Any such acts would ultimately fall back to injure her own alleged interest. The Court believes plaintiff's latter theory is more likely, that Jacobs was trying to steal EWC from the heirs, or at least that she tried to delay turning over control long enough to boost her executrix commission. Both are damages to the estate, not to EWC.
To be fair, plaintiff presented a wealth of evidence that Jacobs intentionally harmed the heirs and was "in over her head" in terms of being president of EWC. The Court agrees with many of the heirs' assessments regarding Jacobs' management decisions. For instance, it was probably not the best business decision to replace EWC's longtime accountant. Though that decision cost EWC thousands of dollars, the Court cannot conclude that Jacobs proceeded with an intent to harm the company within the meaning of Geiger.
Rather, the evidence weighs more in favor of Jacobs believing she was acting in the best interests of EWC. As with all the other instances to which plaintiff directed the Court, Jacobs was generally negligent in her actions as president of EWC, and negligence cannot form the basis of a claim under Section 523(a)(6). Duncan, 448 F.3d at 729.
Finally, even had plaintiff shown some intentional injury, plaintiff failed to put forth sufficient evidence from which a finder of fact could calculate damages caused by such acts that would be nondischargeable under Section 523(a)(6). Consequently, the Court concludes that plaintiff has failed to carry its burden on this cause of action.
While not a stand-alone action, the Court feels compelled to address punitive damages separately. Plaintiff seems to believe that any award of punitive damages falls under the auspices of Section 523 and should thus be declared nondischargeable. Plaintiff argues further that the award of punitive damages also makes the entire underlying damages award nondischargeable. However, in North Carolina, juries are instructed that punitive damages may be awarded for conduct that does not always lead to a nondischargeable debt in a following bankruptcy.
The United States District Court in this district has specifically rejected plaintiff's
Perhaps the jury thought Jacobs' negligence amounted to 99% of the damages, maybe only 1%, or possibly somewhere in between. The jurors may even have crafted a remedy they felt fitting of the wrongs committed against the heirs rather than EWC.
No one will ever know exactly how the jurors arrived at their verdict or how they apportioned damages between negligence and intentional torts. The resolution of the adversary proceeding does not require this Court to read the tea leaves to glean the jury's actual thoughts. Dischargeability is a federal action independent from the underlying state court claims, and in this setting, plaintiff has the burden to make its case for nondischargeability. Having considered all the evidence and testimony presented in both state court and in this forum and construing exceptions to discharge strictly against creditors as we must, the Court concludes that plaintiff has failed to meet its burden of demonstrating that any part of the state court judgment awarding damages to EWC is nondischargeable under 11 U.S.C. § 523. This adversary proceeding is therefore dismissed with prejudice.
