Shelley D. Rucker, UNITED STATES BANKRUPTCY JUDGE.
Plaintiffs Dwight Jenkins and J & S Construction ("J & S") (collectively "Plaintiffs") have filed this action against the defendant debtor Michael Wolfgang Schmank ("Defendant" or "Debtor") alleging that the Defendant misused their funds and that such debt should be non-dischargeable pursuant to 11 U.S.C. §§ 523(a)(2)(A), 523(a)(4), 523(a)(6). Although the Plaintiffs cited 11 U.S.C. § 727 in their complaint (Doc. No. 1, "Complaint"), they withdrew their claims under section 727 prior to trial.
The Plaintiffs identify three claims which they contend are nondischargeable. The first is a claim for an advance of $13,500 paid to the Defendant based on future partnership distributions. The Plaintiffs have alleged this advance was made based on false pretenses or fraud. The second claim is for $11,500 which was either the amount taken by the Defendant pursuant to an undisclosed subcontract entered into in violation of his fiduciary obligations as a partner, or in the alternative, was a conversion of funds due to a subcontractor. The third is a claim for the lost profits from a contract which the Plaintiffs contend the Defendant caused to terminate resulting in a loss of profits to the partnership.
The court finds that the Plaintiffs have carried their burden of proof as to only the second claim, and the court will grant the plaintiffs a nondischargeable judgment in the amount of $11,500. The court further finds that the plaintiffs are entitled to attorney fees for their claims of fraud and misrepresentation. The court will set a
These are the court's findings of fact and conclusions of law pursuant to Fed. R.Bankr.P. 7052.
In the spring of 2008, the Defendant was experiencing financial difficulties. He was out of work and behind on his mortgage payments and his car payments. He had previously earned his living building log homes. When he was contacted by a log supplier with whom he had previously worked about an opportunity to build homes in a development in Roane County, Tennessee, he realized he would not be able to take advantage of the opportunity because of his financial condition. He approached Mr. Jenkins in the spring of 2008 with the opportunity to work with the developer. He proposed a partnership to construct residential log homes in a subdivision known as the Eagle Ridge Development located in Roane County, Tennessee being developed by Duff Development, LLC. If the first home went well, he was hopeful that there might be an opportunity to build many more in the development.
He had met Mr. Jenkins through a high school football booster program in which both men participated. Both had sons who played football for the school. Mr. Jenkins had been in the construction business for about 30 years and was a licensed contractor. The Defendant had had roughly the same amount of experience in the log home construction business although he was not a licensed contractor. Mr. Jenkins visited the proposed project and decided that he would enter into the deal with the Defendant. The two agreed the Defendant would manage the project for a share in the partnership's profits. Mr. Jenkins would supply the money and contractor's license. They negotiated a contract to build a log home with Duff Development LLC, opened a bank account, and entered into a general partnership agreement as J & S General Contractors ("J & S") on April 28, 2008. Their partnership agreement was memorialized in a document entitled "Partnership Contract Agreement" ("Agreement"). [Trial Ex. 1.]
[Agreement.]
A couple of days before signing the Agreement, J & S had executed a contract with a James David Duff d/b/a Duff Development, LLC ("Duff") on April 25, 2008. In the contract, J & S agreed to construct residential improvements to Lot 16, Unit 1 in the Eagle Ridge subdivision in Rockwood in Roane County, Tennessee. The project was a fixed price contract for $415,525. [Trial Ex. 14, p. 2.] J & S expected to receive $50,000 in profits upon its completion. [Trial Ex. 15, p. 1.] The profits were to be split 50/50 according to the Agreement. The contract called for a $15,000 advance and monthly progress payments going forward. [Trial Ex. 14, par. 4.]
In the beginning of the partnership and as the Eagle Ridge project was commencing, the Defendant asked the Plaintiff for an "advance payment" from the $15,000 advance to help him pay his bills. The Defendant agreed that the advance would be offset against his share of the profits to
That same day, the Defendant opened two accounts at First Tennessee Bank—one in the name of Mike Schmank d/b/a Integrity Log Homes (the "Integrity Account") and a second account in the names of Mike and Lori Schmank (the "Personal Account"). [Trial Ex. 11 and 12.] When questioned about the operations of Integrity Log Homes at his deposition in 2008, the Defendant had stated that Integrity had ceased its operations in 2007 and did not operate after he entered into the Agreement with Mr. Jenkins. [Trial Ex. 19, Deposition of Michael Schmank, pp. 13-15, lines 9-23.] At trial, Defendant contended that Integrity was a subcontractor on the Duff project to do the dry-in for the house. When questioned about his inconsistent positions on the date Integrity stopped operations, the Defendant repeatedly said he did not understand the questions. The court views the questions as clear, but the Defendant's responses as evasive. The Debtor's testimony at trial clearly indicated that he intended to do business as Integrity Log Homes and use that business to act as a subcontractor on the project. These statements lead the court to conclude that the Defendant's testimony at his 2008 deposition was untrue and inconsistent with his intention to use Integrity Log Homes as the subcontractor for the dry-in of the project without disclosing to his partner that he intended to obtain additional profits for himself.
With respect to the advance of $13,500, $11,500 was deposited by Defendant into the Personal Account. The advance was used to pay ongoing and personal living expenses, debts, etc. unrelated to the part-nership or the project. [Trial Ex. 12.] The Defendant testified that he used the remaining $2,000 to pay Vance Stephens who was going to work on the Defendant's crew to do the "dry-in." [Testimony of M. Schmank, June 9, 2015 at 9:55:10.] The Defendant testified that Mr. Stephens came to his house to get the $2,000 in cash. [Id. at 9:55:50.] He stated that this payment was made because the job start date was late and Mr. Stephens had complained that he was tired of waiting to receive some money. [Id. at 9:55:40.]
Mr. Stephens, a resident of Kentucky, whose deposition was offered as evidence, testified that he was hired to handle the dry-in for about $45,000. He contradicted the Defendant's recollection about an initial cash payment of $2,000. [Trial Ex. 20, Deposition of Vance Stephens, p. 21, lines 14-15.] Mr. Schmank produced a receipt at trial for $2,000 signed by Vince Stephens. Mr. Stephens testified that he did not recognize the receipt, and he denied that it was his signature on the receipt. [Id. at lines 2-13.] Although there were other deposits made to the Personal Account, the Defendant did not admit that any of the amounts were attributable to the $2,000 which was not initially deposited with the advance. The court does not find the Defendant's testimony that he paid $2,000 to Mr. Stephens to be credible.
In May, Duff made a second payment on account of the contract, but this payment was not made to J & S. The contract provided for progress payments to be made to the Contractor, defined as J & S. [Trial Ex. 14, par. 4.] If the Owner, defined as Duff, paid a supplier, installer or service performer directly, it was entitled to deduct the payment from the price for any item on Exhibit B. [Id.] No exhibit B was attached to the trial exhibit. Instead,
The Defendant's subsequent conduct and the testimony of Mr. Stephens also contradict his explanation. The $23,000 check was dated May 23, 2008. [Trial Ex. 6.] On May 23, 2008, the $23,000 check was deposited into the Integrity Account. [See Doc. No. 98-2, Trial Ex. 11.] That same day, the Defendant wrote check no. 996 on the Integrity Account payable to himself for $10,000. [Trial Ex. 9.] This disbursement of funds to his personal use violated paragraph 5 of the Agreement. [Trial Ex. 1, para. 5 ("Payments from profits will be paid to parties after all invoices, bills, reimbursements, and debts have been paid by the company.").] On May 23, 2008, the sum of $9,500 was deposited into the Personal Account. [Trial Ex. 12, p. 5.]
Mr. Jenkins testified that the Defendant informed him that Duff had paid Vance Stephens the $23,000. The Defendant did not mention Integrity Log Homes or the Defendant's withdrawal of $10,000 from the amount paid. Mr. Jenkins testified that he was upset that Mr. Stephens had been paid for half of his work when not nearly that much had been completed. He discussed those concerns with the Defendant, but decided not to confront Mr. Stephens based upon the Defendant's assurances that Mr. Stephens would complete the work even though the payment exceeded the amount of work done.
The Defendant testified that he had told Mr. Jenkins that he would handle the dry-in and that he had meant that he would be the subcontractor for the dry-in phase. As the subcontractor, he believed he would be entitled to make a profit. All of these contentions appear to be the Defendant's internal rationalizations for taking the $10,000, because they were not expressed to Mr. Jenkins. At trial, the Defendant also testified that he took the $10,000 because he thought he was entitled to be paid back for his gas and work. The court does not find this explanation to be credible because there were two other withdrawals made from the J & S account to reimburse the Defendant for these costs. Mr. Jenkins agreed to these withdrawals and signed the checks with Mr. Schmank. [Trial Ex. 17, p. 2.] There appears to have been another procedure for handling Mr. Schmank's expenses.
The court does not find the Defendant's explanation that he was the subcontractor and was entitled to a profit for his work to be credible. The construction cost estimate
Mr. Stephens also testified that his agreement with the Defendant was to do the dry-in for "around $45,000." [Trial Ex. 20, p. 15-16, lines 15-8.] The price was to be paid in three installments, "15 to start, 15 at the second floor, and 15 when the felt was on." Based on this testimony, the difference in what would be owed to Mr. Stephens and what was budgeted was only $1,000, not $10,000. The court finds that there was no extra $10,000 in profit from the dry-in subcontract to pay the Defendant.
The proof offered at trial showed that Mr. Stephens received the following payments:
May 28, 2008 $ 6,000 [Trial Ex. 7.]
June 11, 2008 $ 5,500 [Trial Ex. 8.]
June 25, 2008 $ 2,000 [Trial Ex. 17.]
July 9, 2008 $ 3,000 [Trial Ex. 17.]
July 21, 2008 $ 4,000 [Trial Ex. 17.]
July 25, 2008 $ 1,000 [Trial Ex. 17.]
_______
Total $21,500
Mr. Schmank testified that he paid $2,000 in cash on April 25, 2015 and another $2,000 in cash between May and August when the contact ended. The Defendant stated that the second cash payment was made to Stephens' crew "so that the workers did not need to return to Kentucky to cash a check." [Doc. No. 102, Defendant's Trial Brief, p. 3.] Mr. Stephens denies receiving any funds in cash and does not recall receiving the $3,000 payment. The check for $3,000 does not have an endorsement, so there is no documentary evidence that the check was deposited or cashed by Mr. Stephens. He testified that he completed half the job and was owed about $20,000 for the work. [Trial Ex. 20, p. 25, lines 4-6.] As noted above, Mr. Jenkins' records indicate that Mr. Stephens received $21,500. [Trial Ex. 7, 8, and 17.] The court finds that Mr. Jenkins paid $10,000 to Mr. Stephens in addition to the two payments which Mr. Schmank made.
The account statements of Mr. Jenkins show that Mr. Jenkins funded the last four payments made to Mr. Stephens which total $10,000. His records show that the $3000 was paid to Mr. Stephens. Had the funds from the Duff payment to "Log Homes Builders" not been taken by the Defendant, there would have been funds available to pay Mr. Stephens from the Duff $23,000 payment.
The next draw request prepared by the Defendant and submitted for payment in June had not been paid by Duff by early July, and the Defendant began advocating that J & S stop work. After consultation with the Defendant, Mr. Jenkins made a decision to continue. The Defendant testified that he tried to reach Mr. Duff on numerous occasions and received no response, making him further concerned
At this meeting, Mr. Jenkins saw the project which he described as being in disarray. He saw trash, rusted or damaged building materials which appeared to have been left out in the weather and learned that Mr. Stephens had refused to continue work until he was paid. Mr. Jenkins questioned Mr. Dixon about why that was Mr. Stephens' position when he had received half the money, but the dry-in was not half complete. He then called Mr. Stephens and learned that Mr. Stephens had not received the $23,000. He testified that it dawned on him that something else was wrong and that he suspected his part-ner was taking money. He moved quickly to retain an attorney and file suit in Bradley County Chancery Court for a restraining order and to dissolve the partnership. [Trial Ex. G and H.]
Mr. Jenkins later informed Duff that he was closing down the partnership and worked out an arrangement with Duff to complete the work up to the percentage for which J & S had been paid. Duff agreed to pay for any additional amounts that were expended to get the construction to that point, except for the dry-in. The proof was unclear whether the residence was completed. Mr. Stephens testified that he continued work until the felt on the roof was installed. The Defendant offered a substitute trustee's deed which reflects that the property was foreclosed by the mortgage holder in February of 2010, and the foreclosure bid was $180,000 by Community Trust Bank. [Trial Ex. C.] Community Trust Bank, Inc. later sold the house in September of 2013 for $130,000. [Trial Ex. D, p. 3.] No additional proof was offered as to whether Duff had the financial ability to complete the project.
The appropriate party to charge with breach of the construction contract is unclear. Although there was testimony that Duff was not paying within ten days of receiving the invoice, there was no evidence that J & S sent any notice of default to Duff. Mr. Jenkins stated that there was not a payment breach by Duff because not enough work had been done to have required more money to be paid. He, however, did not state what the percentage was that had been completed nor did the Plaintiffs offer any proof that Duff had the wherewithal to complete the project. Finally, the contract termination letter dated August 8, 2008 which listed the defaults of the contractor does not provide the required seven days to cure the defaults. [Trial Ex. 18.] Duff appears to rely on conversations which he had had with Mr. Jenkins that lead the owner to believe that J & S was repudiating the contract. [Id.] The Defendant testified that he received the lawsuit filed by Plaintiffs before he received the termination letter. He did not take any action because he was restrained from any contact with the building site, Duff, or the partnership records.
The Plaintiffs offered a spread sheet showing their out of pocket expenses for J & S totaled $98,279.68. Of that amount, J & S admits that it received from Duff, $87,332.18 excluding the $23,000 for the dry-in. Of the receipts, J & S advanced $13,500 to the Defendant bringing the out of pocket losses for the partnership to $24,447.50. [Trial Ex. 17, p. 1.] Without the $13,500 advance, the loss is $10,952.50.
The Plaintiffs also request attorneys' fees and possible punitive damages. The Plaintiffs filed a lawsuit in Chancery Court
The Defendant alleges that the Plaintiff withdrew $47,485.19 from the partnership account on November 28, 2008. The Defendant did not file a counterclaim for any portion of these funds based on the terms of the Agreement. The court does not find that there was any evidence that the Defendant made any financial contributions to the project or to the bank account of J & S.
28 U.S.C. §§ 157 and 1334, as well as the general order of reference entered in this district provide this court with jurisdiction to hear and decide this adversary proceeding. The Plaintiffs' action regarding the dischargeability of particular debts is a core proceeding. See 28 U.S.C. § 157(b)(2)(I).
11 U.S.C. § 727 provides for discharge from debt unless excepted from discharge pursuant to 11 U.S.C. § 523. 11 U.S.C. § 727(b). 11 U.S.C. §§ 523(a)(2)(A), in turn, states in relevant part:
11 U.S.C. § 523(a)(2)(A). The creditor must prove by a preponderance of the evidence that a debt is nondischargeable under 11 U.S.C. § 523. See Grogan v. Garner, 498 U.S. 279, 287, 111 S.Ct. 654, 659, 112 L.Ed.2d 755 (1991). Exceptions to discharge are narrowly construed in the debtor's favor. See Monsanto Co. v. Trantham (In re Trantham), 304 B.R. 298, 306 (B.A.P. 6th Cir.2004).
The Sixth Circuit has held that to demonstrate nondischargeability pursuant to 11 U.S.C. § 523(a)(2)(A), a creditor must prove four elements:
Rembert v. AT & T Universal Card Servs., Inc. (In re Rembert), 141 F.3d 277, 280-81 (6th Cir.1998). A creditor bears the burden of demonstrating these elements by a preponderance of the evidence. Id. at 281.
In In re Vitanovich the Sixth Circuit Bankruptcy Appellate Panel addressed the meaning of "actual fraud" within the context of § 523(a)(2)(A):
In re Vitanovich, 259 B.R. at 877 (quoting Gerad v. Cole (In re Cole), 164 B.R. 951, 953 (Bankr.N.D.Ohio 1993)) (other quotation omitted).
With respect to the first element of "material misrepresentation," courts in this Circuit have held that "`material misrepresentations' are `substantial inaccuracies of the type which would generally affect a lender's or guarantor's decision.'" Whitaker v. Koenig, 418 B.R. 265, 271 (E.D.Tenn.2009) (quoting Haney v. Copeland (In re Copeland), 291 B.R. 740, 761 (Bankr.E.D.Tenn.2003)).
With respect to the element of material misrepresentation, the court does not find that the Defendant made any misrepresentations about his need and his use for the $13,000 advance. He disclosed his financial difficulties to his partner who knew that there was a risk that the project would not be successful. The Defendant spent the money to pay his bills and his living expenses as he represented that he would. There being no misrepresentation, the court finds that the Plaintiffs have failed to prove the first element of their claim for the $13,500 advance. The court also does not find that this first advance was part of a scheme to defraud the Plaintiffs with respect to the project generally. Duff existed and there was a subdivision it was developing. Mr. Jenkins, after becoming aware of the problems with the payments to Integrity, proceeded to work with Duff to mitigate what he perceived to be the partnership's damages for failing to complete the project. The court does not find that the contract was part of a scheme to defraud Mr. Jenkins. It appears to have been a genuine contract which was ultimately an unsuccessful real estate project started in the spring of 2008—a time when many real estate projects were failing. The Plaintiffs have not shown by a preponderance of the evidence that the Defendant's representations about Duff and the contract were part of a fraudulent scheme to induce Mr. Jenkins to enter into the partnership.
The court also does not find that there was any fraud with respect to the Plaintiff s claim of profits from the job. The contract existed and the Plaintiffs offered no evidence that the Defendant offered any information regarding the nature of the project or the costs to complete that were untrue. He did make statements about Duff having financial difficulties which the Plaintiffs chose to disregard. The Plaintiffs did not refute the fact that the real estate was foreclosed by the lender who had extended credit to Duff; nor did they prove that Duff would have and could have completed the project but for Defendant's failure to manage the construction. Duff did continue to work with Mr. Jenkins after the Defendant stopped work. It appears from the testimony of Mr. Jenkins and the contents of the termination letter that Mr. Jenkins made a business
The element of misrepresentation is present in the second claim for the funds used by the Defendant taken from the $23,000 check. The Defendant admits that he gave Duff the instructions to write the check to his company. That act allowed him to control the disbursement of those funds without the participation of Mr. Jenkins. He misrepresented to his partner that the check had gone to Vance Stephens. He did not disclose that he had taken $10,000 of it the day he received it. The court finds that the Plaintiffs have proven misrepresentation as to $11,500, which is the amount the Defendant used for his personal expenses from the check.
In determining whether the second element, the intent to deceive, has been proven courts consider whether "`the totality of the circumstances `presents a picture of deceptive conduct by the debtor which indicates an intent to deceive the creditor.'" Whitaker, 418 B.R. at 272 (quoting In re Copeland, 291 B.R. at 766) (other quotation omitted).
The court finds that the Plaintiffs have proven that the Defendant had the intent to defraud them. The Defendant testified that Integrity Log Homes had stopped doing business before he entered into the Agreement. That was not the case. The Defendant opened new bank accounts for Integrity Log Homes when he first received the advance. He then disbursed the money, which he had received to pay the dry-in subcontractor, from the account to himself in violation of the terms of the Agreement. He tried to explain away any deceptive intent by testifying that he immediately told Mr. Jenkins that Duff had paid $23,000 for the dry-in. The court would have found that persuasive if the Defendant had been as candid about the payee on the check and how the funds were distributed as he had been in describing his need for an advance. He did not tell Mr. Jenkins that he instigated the change in procedure so that the check would be payable to his business rather than the partnership. He misled Mr. Jenkins about who had control of the money. He told Mr. Jenkins that Vance Stephens had been paid and that he should not worry because Vance would do the work. He never told Mr. Jenkins that he believed that he was entitled to additional profits as the subcontractor and had taken $10,000 for himself. When the second draw was not paid, the Defendant blamed the problems on Mr. Duff's inaccessibility rather than disclose that the project was behind schedule and he had no more money with which to pay Mr. Stephens. He would not disclose Mr. Stephens phone number to Mr. Jenkins so that the accounting for Mr. Stephens's payments could be reconciled. All of this appears to be an effort to cover up the use of funds that were to have been used to pay Mr. Stephens. The court finds this course of activity was an effort to conceal his actions at a time when he was having financial difficulty. The court finds that asking Duff to pay the subcontractor directly, using the funds, and concealing this all from Mr. Jenkins demonstrate the requisite intent to defraud.
With respect to the element of justifiable reliance in § 523(a)(2)(A), the Sixth Circuit in In re Rembert noted that justifiable reliance is a subjective standard. 141 F.3d at 280, n. 2. The Sixth Circuit has also provided guidance regarding factors to consider when analyzing justifiable reliance. See BankBoston Mortgage Corp. v. Ledford (In re Ledford), 970 F.2d 1556,
970 F.2d at 1560. In In re Ledford the Sixth Circuit explained its decision to require the demonstration of reliance by the creditor, even though the requirement is not made explicit in the statute.
970 F.2d at 1559-60 (citing Northern Trust Co. v. Garman (In re Garman), 643 F.2d 1252, 1256 (7th Cir.1980); Martin v. Bank of Germantown (In re Martin), 761 F.2d 1163, 1166 (6th Cir.1985), abrogated on other grounds by Grogan, 498 U.S. 279, 111 S.Ct. 654, 112 L.Ed.2d 755). The district court in Whitaker noted that, with respect to justifiable reliance, creditors "must prove that they actually relied on [a debtor's] representations and, based upon the facts and circumstances known to them at the time, that their reliance was justifiable." 418 B.R. at 273 (citing Haney, 291 B.R. at 767).
The court finds that the Plaintiffs have proven that Mr. Jenkin's relied on the Defendant's misrepresentations and that the reliance was reasonable. The Defendant had been honest about his financial situation and his representations about the project had been reviewed by Mr. Jenkins. The two parties had worked together on the budget for the project and the contract with Duff. The Defendant was charged with managing the project and had obtained the services of Mr. Stephens. The Defendant came forward with the information that the payment had been made to Mr. Stephens. When the Defendant offered the explanation about the check to Vance Stephens, there was no reason for Mr. Jenkins to believe that this was not the truth. Defendant also assured Mr. Jenkins that Mr. Stephens would complete the job when Mr. Jenkins suggested getting in touch with Mr. Stephens directly.
The final element is the existence of damages proximately caused by the misrepresentation. To demonstrate proximate cause, a creditor must prove a "`direct link between the alleged fraud and
11 U.S.C. § 523(a)(4) states in relevant part: "A discharge under section 727 . . . of this title does not discharge an individual debtor from any debt . . . (4) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny. . . ." 11 U.S.C. § 523(a)(4). Federal common law will determine the meaning of the terms in Section 523(a)(4). See SmithKline Beecham Corp. v. Lam (In re Lam), No. 06-68805-MGD, 2008 WL 7842072, at *3 (Bankr.N.D.Ga. Mar. 27, 2008) (citing Kaye v. Rose (In re Rose), 934 F.2d 901 (7th Cir.1991); In re Wallace, 840 F.2d 762 (10th Cir.1988)) (other citations omitted). The creditor must prove by a preponderance of the evidence that a debt is nondischargeable under 11 U.S.C. § 523. See Grogan v. Garner, 498 U.S. 279, 287, 111 S.Ct. 654, 659, 112 L.Ed.2d 755 (1991).
The Sixth Circuit has explained that:
Brady v. McAllister (In re Brady), 101 F.3d 1165, 1172-73 (6th Cir.1996), abrogated on other grounds as explained in National Devel. Servs. v. Denbleyker (In re Denbleyker), 251 B.R. 891 (Bankr. D.Colo.2000) (quoting Gribble v. Carlton (In re Carlton), 26 B.R. 202, 205 (Bankr. M.D.Tenn.1982) and Moore v. United States, 160 U.S. 268, 269, 16 S.Ct. 294, 295, 40 L.Ed. 422 (1895)) and (citing Ball v. McDowell (In re McDowell), 162 B.R. 136, 140 (Bankr.N.D.Ohio 1993)). To demonstrate embezzlement a creditor must prove all three elements: "(1) `that he entrusted his property to the debtor,' (2) that `the debtor appropriated the property for a use other than that for which it was entrusted,' and (3) that `the circumstances indicate fraud.'" Cash America Fin. Servs., Inc. v. Fox (In re Fox), 370 B.R. 104, 115-16 (B.A.P. 6th Cir.2007) (quoting In re Brady, 101 F.3d at 1173). With respect to the third element, the Sixth Circuit has noted:
In re Fox, 370 B.R. at 116 (quotations and citations omitted). Circumstantial evidence of fraud is sufficient, but the court must have some evidence of the deceit or scheme to find fraudulent intent. In re Fox, 370 B.R. at 116-17.
This ground for denying dischargeability does not apply to either the claim for the $13,000 advance or the lost profits. It does, however, serve as an alternative basis for the finding that the $11,500 is a nondischargeable debt. Mr. Jenkins entrusted the Defendant with the obligation to manage the project and to obtain payment for the partnership. The Defendant instructed Duff to make the payment to another business, one which he could control without the oversight of his partner. The court has previously found that the circumstances demonstrate an intent to deceive Mr. Jenkins. The use of the funds was for a use other than paying Mr. Stephens. As to the $11,500, all of the elements for embezzlement have been proven. Although the court finds that the misrepresentation regarding the payment of Mr. Stephens to have generated only $10,000 in damages based on the proof, the court finds that this ground provides a basis for finding an additional $1,500 in damages. Had the $23,000 been deposited to the J & S account, there would have been funds to repay the advance, since there were no partnership profits.
The same could be said of a finding that $11,500 was lost due to the Defendant's defalcation under section 523(a)(4). With respect to defalcation while acting in a fiduciary capacity, the Sixth Circuit has provided that the preponderance of the evidence must establish: "(1) a pre-existing fiduciary relationship, (2) a breach of that relationship, and (3) resulting loss." Patel v. Shamrock Floorcovering Services, Inc. (In re Patel), 565 F.3d 963, 968 (6th Cir.2009) (citing Board of Trustees v. Bucci (In re Bucci), 493 F.3d 635, 642 (6th Cir.2007)). In Bucci, the court had found that "the defalcation provision applies to `only those situations involving an express or technical trust relationship arising from placement of a specific res in the hands of the debtor'" In re Bucci, 493 F.3d 635, 639-40 (6th Cir.2007)(quoting In re Garver, 116 F.3d 176, 180 (6th Cir.1997). The Court further cautioned 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.'" In re Patel, 565 F.3d at 968 (quoting Davis v. Aetna Acceptance Co., 293 U.S. 328, 331, 55 S.Ct. 151, 79 L.Ed. 393 (1934)).
The Plaintiffs rely on the existence of a partnership to establish a pre-exiting fiduciary relationship. They cite the Defendants failure to deliver the $23,000 check from Duff to the partnership account as the act of wrong doing that constitutes a breach of that duty. The Defendant's use of $11,500 of those funds for his own use rather than satisfaction of the obligations for the dry-in resulted in the loss.
This position is supported by applicable state law and "state law is important in determining when a trust relationship exists." Carlisle Cashway, Inc. v. Johnson (In re Johnson), 691 F.2d 249, 251 (6th Cir.1982)). See also, Baker v. Wentland (In re Wentland), 410 B.R. 585, 597 (Bankr.N.D.Ohio 2009) (noting that "the determination of whether an express
The parties entered into a part-nership agreement and signed the agreement in Tennessee. [See Doc. No. 98-1, Trial Ex. 1.] The agreement provides that the company will do business at the Defendant's address in Tennessee. Under the Tennessee Revised Uniform Partnership Act, the law of the jurisdiction in which a partnership has its chief executive office governs relations among the partners and between the partners and the partnership. Tenn.Code. Ann. 61-1-106(a). Tenn.Code Ann. §§ 61-1-101 et seq. ("RUPA") states that partners owe each other fiduciary duties of loyalty and care. The Act provides:
Tenn.Code Ann. § 61-1-404(a)-(f). The Tennessee legislature enacted the current version of RUPA in 2001. In Anderson v. Wilder, a case decided in 2003 following the enactment of RUPA, the court outlined the parameters of fiduciary duties between partners under Tennessee law:
Anderson v. Wilder, No. E2003-00460-COA-R3-CV, 2003 WL 22768666, at *4 (Tenn.Ct.App. Nov. 21, 2003) (quoting Lightfoot v. Hardaway, 751 S.W.2d 844, 849 (Tenn.Ct.App.1988)).
Having found a pre-existing fiduciary relationship recognized by the applicable state law, the court finds that the Plaintiffs have met the first element of a claim for defalcation. With respect to the second and third elements, the court has previously found that the instruction to pay Integrity Log Homes rather than J & S and the deposit of money into the Integrity account rather than into the partnership account, as required by the Agreement, were violations of his express partnership obligations. The court has also found that the subsequent use of the funds for personal rather than partnership use, and the Defendant's efforts to conceal his receipt of the $23,000 sufficiently proved the Defendant's intent. Finally, the court has also found that the loss was $11,500.
11 U.S.C. §§ 523(a)(6) states in relevant part:
11 U.S.C. §§ 523(a)(2)(A), 523(a)(6). The same standards of proof and narrow construction apply to this cause of action as they did with fraud and misrepresentation. The creditor must prove by a preponderance of the evidence that a debt is nondischargeable under 11 U.S.C. § 523. See Grogan v. Garner, 498 U.S. at 287, 111 S.Ct. at 659. Exceptions to discharge are narrowly construed in the debtor's favor. See Monsanto Co. v. Trantham (In re Trantham), 304 B.R. 298, 306 (B.A.P. 6th Cir.2004).
Whether a debt is dischargeable pursuant to 11 U.S.C. § 523(a)(6) is determined by analyzing federal law. See e.g., J & A Brelage, Inc. v. Jones (In re Jones), 276 B.R. 797, 800-01 (Bankr. N.D.Ohio 2001) (citing Call Federal Credit Union v. Sweeney (In re Sweeney), 264 B.R. 866, 870 (Bankr.W.D.Ky.2001); Hinze v. Robinson (In re Robinson), 242 B.R. 380, 388 (Bankr.N.D.Ohio 1999)). 11 U.S.C. § 523(a)(6) provides that a debt that is both willful and malicious is nondischargeable. See 11 U.S.C. § 523(a)(6). "[T]he judgment must be for an injury that is both willful and malicious. The absence of one creates a dischargeable debt." Markowitz v. Campbell (In re Markowitz), 190 F.3d 455, 463 (6th Cir. 1999). The U.S. Supreme Court has addressed the meaning of "willful" within the context of § 523(a)(6). Kawaauhau v. Geiger, 523 U.S. 57, 118 S.Ct. 974, 140 L.Ed.2d 90 (1998). As summarized by the Sixth Circuit:
In re Markowitz, 190 F.3d at 464 (quoting Geiger, 523 U.S. at 61-62, 118 S.Ct. at 977). Following the lead of the Supreme Court in Geiger, the Sixth Circuit held that "unless the actor desires to cause consequences of his act, or . . . believes that the consequences are substantially certain to result from it,' he has not committed a `willful and malicious injury' as defined under § 523(a)(6)." In re Markowitz, 190 F.3d at 464. Such analysis requires a subjective inquiry into the debtor's state of mind. See Whitaker, 418 B.R. at 275. Mere proof of conversion is not sufficient to satisfy the requirements of § 523(a)(6). See In re Jones, 276 B.R. at 801.
Proof of willful behavior must often be demonstrated through the use of circumstantial evidence. See In re Jones, 276 B.R. at 802. The bankruptcy court in In re Jones noted that "willful" behavior can "be indirectly established by the creditor demonstrating the existence of two facts: (1) the debtor knew of the creditor's lien rights; and (2) the debtor knew that his conduct would cause injury to those rights." Id.
In this case, the court does not find that the Plaintiffs have proven that the Defendant willfully caused the loss of the $13,000 advance or the failure of the project and the subsequent loss of profits. The court does find that the taking of the $23,000 from Duff and depositing it to Integrity Log Homes was willful.
A malicious injury occurs "when a person acts in conscious disregard of their duties or without just cause or excuse." In re Jones, 276 B.R. at 803 (citing Gonzalez v. Moffitt (In re Moffitt), 254 B.R. 389, 396 (Bankr.N.D.Ohio 2000)). A finding of maliciousness does not require a determination of ill-will or specific intent. See In re Trantham, 304 B.R. at 308. However, malice requires the finding of a level of conduct beyond negligent or reckless behavior. West Michigan Community Bank v. Wierenga (In re Wierenga), 431 B.R. 180, 185 (Bankr.W.D.Mich.2010) (citation omitted); see also, JP Morgan Chase Bank, NA v. Algire (In re Algire), 430 B.R. 817, 823 (Bankr.S.D.Ohio 2010); Geiger, 523 U.S. at 64, 118 S.Ct. 974. A creditor may prove the element of maliciousness by demonstrating that "(1) the debtor has committed a wrongful act, (2) the debtor undertook the act intentionally, (3) the act necessarily causes injury, and (4) there is no just cause or excuse for the action." In re Algire, 430 B.R. at 823 (citing Vulcan Coals, Inc. v. Howard, 946 F.2d 1226, 1228 (6th Cir.1991), abrogated on other grounds as explained in In re Slosberg, 225 B.R. 9, 18 n. 10 (Bankr.D.Me. 1998)).
In National Sign and Signal v. Livingston the district court explained that the § 523(a)(6) exception applies where the injury invades a creditor's legal rights. 422 B.R. 645, 653 (W.D. Mich.2009) (citing Steier v. Best (In re Best), 109 Fed.Appx. 1, 6 (6th Cir.2004)). The district court quoted the Sixth Circuit decision in In re Best noting:
Livingston, 422 B.R. at 653 (quoting In re Best, 109 Fed.Appx. at 6). The court in Livingston noted that there are three elements that a creditor must demonstrate to state a claim under § 523(a)(6): "(1) the debtor's conduct was willful and malicious, (2) it suffered an invasion of its legal rights or to the legal rights to its property, and (3) the invasion was caused by the debtor's conduct." 422 B.R. at 653 (citing CMEA Title Agency v. Little (In re Little), 335 B.R. 376, 383 (Bankr.N.D.Ohio 2005)).
As to the $23,000, the court notes that $11,500 has been proven to have been used to pay Mr. Stephens for his work. The use of those funds in that manner was not in violation of the partnership's legal rights to those funds. The partnership received the benefit of those funds. Of the remaining, $11,500, a check for $10,000 was written to the Defendant personally and $9,500 was deposited into his account on the same day that $10,000 left the Integrity Homes Account. [Trial Ex. 1 and 12.] In addition, he spent funds from the Integrity Log Homes account at convenience stores, department stores, clothing stores, and a tanning salon. The court finds these appear to be personal charges. The Defendant testified that he paid the remaining $1,500 from the $23,000 to Mr. Stephens in cash, but the court finds that the information in the Integrity Log Homes account does not bear that out. The court finds that the Debtor willfully and maliciously converted $11,500 of the $23,000 paid by Duff.
The excuse given by the Defendant for the use of the money for his personal benefit was that he was entitled to part of the money as his compensation as the dry-in subcontractor. His efforts to cover up his action in diverting the funds contradict this rationalization for taking the money. The court does not find the debtor's testimony about his reason for believing he was not violating Mr. Jenkins's and the part-nership's right to those funds to be credible. Although the court finds that the Defendant willfully and maliciously harmed the Plaintiffs, the court has already awarded damages of the $11,500 based on other grounds. The court will award no additional damages based on willful and malicious injury.
The Plaintiffs also seek punitive damages. Tennessee courts maintain that "an award of punitive damages is limited to `the most egregious cases' and is proper only where there is clear and convincing proof that the defendant has acted either `intentionally, fraudulently, maliciously, or recklessly.'" Rogers v. Louisville Land Co., 367 S.W.3d 196, 211 n. 14 (Tenn.Sup.Ct.2012) (citing Goff v. Elmo Greer & Sons Constr. Co., 297 S.W.3d 175, 187 (Tenn.Sup.Ct.2009) and Hodges v. S.C. Toof & Co., 833 S.W.2d 896, 901 (Tenn. Sup.Ct.1992)). Punitive damages "are intended to `punish a defendant, to deter him from committing acts of a similar nature, and to make a public example of him.'" Goff, 297 S.W.3d at 187. A bankruptcy court may award punitive damages for a Section 523(a)(6) claim if it finds that the standard for punitive damages under state law has been met. See e.g. In re Hall, No. 12-3026, 2013 WL 1739658, at *2-5 (Bankr.E.D.Tenn. Apr. 23, 2013).
The court does not find that punitive damages are warranted in this case. The Defendant will not receive a discharge for the $11,500 he obtained. The court does not find that this case falls into a
The Plaintiffs have also requested attorneys' fees. The court previously indicated that it would hold an additional hearing on attorney's fees in the event it determined that there was a nondischargeable debt. The court finds that there may be a right to collect attorney fees based on the analysis below and will therefore set a hearing to determine the basis for and the amount of the fees to be awarded.
In re Kirk, 525 B.R. 325, 330-31 (Bankr. W.D.Tex.2015).
In Cohen v. de la Cruz, the U.S. Supreme Court held that attorneys' fees could be awarded in a Section 523 nondischargeability claim, if such damages were supported by an underlying state law. 523 U.S. 213, 223, 118 S.Ct. 1212, 1219, 140 L.Ed.2d 341 (1998). However, as one bankruptcy court explained, "it is clear that Cohen itself does not create an independent right to attorney's fees for the benefit of a party who prevails in a Section 523 dischargeability proceeding. Instead, it clarifies that attorney's fees supported by statute are included in the debt that may be determined to be non-dischargeable." Headrick v. Atchison (In re Atchison), 255 B.R. 790, 793 (Bankr.M.D.Fla. 2000) (citing Cohen, 523 U.S. 213, 118 S.Ct. 1212). Thus, a plaintiff is not entitled to attorneys' fees merely because of success on a nondischargeability claim.
Where there is no specific statute or contractual right to attorneys' fees, Tennessee law follows the American rule pertaining to the award of attorneys' fees with only a few limited exceptions. See Pullman Standard, Inc. v. Abex Corporation, 693 S.W.2d 336 (Tenn.Sup.Ct.1985). In Pullman, the Tennessee Supreme Court noted that "[w]e continue to adhere to the rule in Tennessee that attorneys' fees are not recoverable in the absence of a statute or contract specifically providing for such recovery, or a recognized ground of equity. . . ." Id. at 338. The Court also noted two exceptions to this general rule, the indemnity rule and the independent tort rule. With respect to the indemnity rule, the court held "that the right of indemnity which arises by operation of law, based upon the relationship of the parties . . . includes the right to recover attorneys' fees and other litigation costs which have been incurred by the indemnitee in litigation with a third party." Id. The Court also adopted the independent tort theory exception, explained in the following way: "`where the natural and proximate consequence of a tortious act of defendant has been to involve plaintiff in litigation with a third person, reasonable compensation for attorneys' fees incurred by plaintiff in such action may be recovered as damages against the author of the tortious act.'" Id. at 340 (quoting 42 A.L.R.2d 1183 (1956)). This court will give Mr. Jenkins an opportunity to offer additional evidence on whether he is seeking attorney fees under either of these theories.
The Plaintiffs claim that they have another basis for an award of fees under Tennessee law, citing Francis v. Barnes, No. W2012-02316-COA-R3-CV, 2013 WL
Francis v. Barnes, No. W2012-02316-COA-R3CV, 2013 WL 5372851, at *11 (Tenn. Ct.App. Sept. 23, 2013).
Francis involved an action to set aside a real property transfer based on a claim of undue influence and intentional misrepresentation by the transferees. The trial court found fraud and awarded attorney's fees. The Tennessee Court of Appeals has also allowed attorney fees where a fiduciary has breached his duty in order to benefit himself.
Martin v. Moore, 109 S.W.3d 305, 313 (Tenn.Ct.App.2003).
This court has also found the taking of the $11,500 from the Duff payment for the dry-in to be a breach of fiduciary duty by misrepresentation. The court finds that under Tennessee law related to damages arising from misrepresentation, the Plaintiffs are entitled to attorney fees. The court will set a hearing to determine the amount of fees incurred for these claims.
The Plaintiffs have demonstrated all of the elements required under §§ 523(a)(2)(A), 523(a)(4), and 523(a)(6) by a preponderance of the evidence at trial with respect to damages of $11,500. The
A separate order will be entered.
