SUZANNE H. BAUKNIGHT, Bankruptcy Judge.
Because Plaintiff raised before the state court a claim based in fraud and the state court's decision did not include a factual finding of fraudulent conduct, the Court finds that Plaintiff is bound by issue preclusion so that summary judgment in favor of Defendants is proper.
Plaintiff filed a Complaint in each of the foregoing adversary proceedings on October 22, 2018, asking the Court to determine that a state-court judgment in the amount of $151,670.87 entered against Defendants jointly and severally is nondischargeable pursuant to 11 U.S.C. § 523(a)(4). Defendants each filed a motion to dismiss under Rule 12(b)(6) of the Federal Rules of Civil Procedure
Defendants filed their statement of undisputed material facts on March 5, 2019 [Doc. 13], supported by a certified copy of the Complaint that was filed by Plaintiff against Defendants in Grainger County Chancery Court on February 7, 2012 ("State Court Complaint") and the Amendment to Complaint filed on August 30, 2013 ("Amended State Court Complaint") [Doc. 13-1]; the transcript of the chancellor's opinion delivered on September 19, 2013 ("State Court Opinion") [Doc. 13-2]; the Affidavits of Lester Dan Piercy and Joseph Shane Piercy [Docs. 13-3, 13-4]; and a supplemental brief in support of their collective argument that the relief sought by Plaintiff is barred by the doctrine of judicial estoppel, which incorporated arguments raised in Defendants' briefs in support of the motions to dismiss [Doc. 14; see also Doc. 7]. In response, in addition to his original responses in opposition to the motions to dismiss [Doc. 8], Plaintiff timely filed a supplemental response and brief [Doc. 15], a response to the statement of undisputed material facts [Doc. 16], and his affidavit [Doc. 16-1].
Following an analysis of the summary judgment materials filed by both parties, the Court entered its Memorandum and Order on Motion for Summary Judgment on June 12, 2019 ("Memorandum & Order") [Doc. 17], advising that it was inclined to determine that res judicata applies in this case to preclude Plaintiff from raising any claim that was or should have been raised in the state court and directing the parties, pursuant to Rule 56(f), to file briefs setting forth their respective arguments, if any, against application of the doctrine of res judicata to the Complaint and entry of summary judgment in favor of Defendants. Plaintiff filed his brief on July 5, 2019 [Doc. 19], and Defendants filed their collective brief on July 15, 2019 [Doc. 20]. This is a core proceeding. 28 U.S.C. § 157(b)(2)(I).
The resulting procedural posture, thus, is that the converted motions for summary judgment are ripe, with the record including the parties' arguments concerning res judicata, all pleadings of record in the adversary proceedings, and all attachments thereto. See Fed. R. Evid. 201(a) (applicable in bankruptcy cases and adversary proceedings pursuant to Fed. R. Evid. 1101(a), (b) and Fed. R. Bankr. P. 9017). Even though the Court thoroughly recited the facts of this case as well as the standard for summary judgment and the elements of § 523(a)(4) in the Memorandum & Order entered on June 12, 2019, they are restated and expanded herein to maintain an organized record.
The parties do not dispute the following facts, which are established by the record, including the unopposed documentation provided. On February 7, 2012, Plaintiff commenced Long v. Goins Hollow Quarry, LLC, et al., No. 2012-CH-12, in the Grainger County Chancery Court ("State Court Action"), which was brought in connection with a Contract executed by Plaintiff and Defendants on April 27, 2011. The Contract provides:
[Doc. 13-1 at 11.]
In the State Court Complaint, Plaintiff makes the following averments relevant to the instant motions:
[Doc. 13-1 at 1-3 (State Court Compl., ¶¶ 4-14) (footnotes and graphs omitted).]
In the initial State Court Complaint, Plaintiff sought the following, "[b]ased on the defendants' misconduct": (1) "a judgment against [D]efendants, jointly and severally, in the amount of $492,060, less any amounts paid before trial, with prejudgment interest at 10%"; (2) a sworn accounting; (3) an injunction against Defendants' interference with Plaintiff's right to use the partnership equipment and to have full access to business records; (4) court costs and discretionary costs to be taxed against Defendants; (5) an attorney's fee award; and (6) any other appropriate relief. [Id. at 3-4.] Plaintiff amended the State Court Complaint to seek an accounting and judicial supervision of dissolution and winding up of the partnership pursuant to Tennessee Code Annotated §§ 61-1-405(b) and 61-1-801(5) because
[Id. at 14-15 (Am. State Court Compl. ¶¶ 15-17).]
Following trial before Chancellor Telford E. Forgety, Jr., he delivered a bench opinion (the "Bench Decision"). [Doc. 13-2.] After first finding that the Contract was entered into between Plaintiff and Defendants individually, notwithstanding that the Contract stated that it was between Plaintiff and Goins Hollow Quarry, LLC [id. at 2-4], Chancellor Forgety defined the issue before him as follows:
[Id. at 4:4-13.] He continued his analysis of the parties' arguments concerning the Contract and the primary issue, opining that:
[Id. at 4:13-5:9.]
Chancellor Forgety reviewed evidence solely concerning the meaning of "profit" and found that the Contract was to be construed in favor of Plaintiff and strictly against Defendants because it was drafted by them. [Id. at 5:11-13.] He then determined that the Contract should be interpreted to mean that Plaintiff's share was twenty-five percent of the gross profit minus the royalty to Hinkle such that Plaintiff was entitled to a judgment for the difference between what Defendants had paid to Plaintiff and what Plaintiff should have received under the gross profit calculation. [See id. at 5:16-10:9.] Important here, Chancellor Forgety also stated that he found Plaintiff's claim for lost anticipated profits speculative and he could not determine why the partnership came to an end, saying, "[Q]uite frankly, I cannot hold the preponderance of the evidence, two different views of why it came to an end, I cannot hold on the preponderance of the evidence that the Piercys breached it." [Id. at 10:13-19.] Finally, he refused to hold any party in contempt, saying "[a]t this point in time, I don't think it would serve any purpose." [Id. at 13:17-21.] Costs were assessed against Defendants. [Id. at 13:23-24.]
The Bench Decision was memorialized in the Judgment entered against Defendants on October 7, 2013, in the amount of $151,670.87 ("Judgment"), which states in its entirety the following:
[Doc. 1-1.]
As required by this Court, Defendants filed their statement of undisputed material facts [Doc. 13], to which Plaintiff responded [Doc. 16], as follows:
[Doc. 13 ¶¶ 1-7; Doc. 16 ¶¶ 1-7) (footnotes omitted).]
Plaintiff asks the Court for a determination that the Judgment is nondischargeable under 11 U.S.C. § 523(a)(4) for debts obtained by larceny, embezzlement, or through fraud or defalcation while acting in a fiduciary capacity. Specifically, Plaintiff alleges that "[b]y padlocking [Plaintiff] off the partnership property and wrongfully taking his share of the profits from the partnership, [Defendants'] debt is nondischargeable under Code § 523(a)(4)." [Doc. 1 ¶ 11.] Because, as explained below, the Court finds that Plaintiff is collaterally estopped from re-litigating the issue of fraud arising from Defendants' conduct that led to the Judgment, which factual issue, based on Plaintiff's admission, was raised before and litigated by the state court such that it would be barred from re-litigation under Tennessee law, Plaintiff cannot satisfy the fraud element required to maintain any action under § 523(a)(4), and Defendants are entitled to summary judgment as a matter of law.
Pursuant to Rule 56 of the Federal Rules of Civil Procedure, "[t]he court shall grant summary judgment if the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law." Fed. R. Civ. P. 56(c). When deciding a motion for summary judgment, the court does not weigh the evidence to determine the truth of the matter asserted but simply determines whether a genuine issue for trial exists. See Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 249 (1986). "Only disputes over facts that might affect the outcome of the suit under the governing law will properly preclude the entry of summary judgment." Id. at 248.
Defendants, the moving parties, bear the burden of proving, based on the record before the Court, that they are entitled to judgment as a matter of law because there is no genuine dispute concerning any material fact, such that the defenses alleged are factually unsupported. Celotex Corp. v. Catrett, 477 U.S. 317, 323-24 (1986). The burden then shifts to Plaintiff to prove that there are genuine disputes of material fact for trial; however, he may not rely solely on allegations or denials contained in the pleadings because reliance on a "mere scintilla of evidence in support of the nonmoving party will not be sufficient." Nye v. CSX Transp., Inc., 437 F.3d 556, 563 (6th Cir. 2006); see also Matsushita Elec. Indus. Co., Ltd. v. Zenith Radio Corp., 475 U.S. 574, 586 (1986). The facts and all resulting inferences are viewed in a light most favorable to Plaintiff as non-movant, with the Court to decide whether "the evidence presents a sufficient disagreement to require submission to a [fact-finder] or whether it is so one-sided that one party must prevail as a matter of law." Anderson, 477 U.S. at 243. Nevertheless, when "the record taken as a whole could not lead a rational trier of fact to find for the non-moving party, there is no `genuine issue for trial.'" Matsushita, 475 U.S. at 587 (citations omitted).
Nondischargeability under § 523(a)(4) requires a showing that the debt was incurred by embezzlement, larceny, or fraud or defalcation while acting in a fiduciary capacity. Within the scope of § 523(a)(4), embezzlement is "the fraudulent appropriation of property by a person to whom such property has been entrusted or into whose hands it has lawfully come." Brady v. McAllister (In re Brady), 101 F.3d 1165, 1172-73 (6th Cir. 1996). Larceny is also the fraudulent misappropriation of funds; however, it differs from embezzlement because possession of the property was never lawful. See First Nat'l Bank v. Simerlein (In re Simerlein), 497 B.R. 525, 537 (Bankr. E.D. Tenn. 2013). Finally, fraud or defalcation while acting in a fiduciary capacity encompasses both embezzlement and larceny, as well as the failure to properly account for any funds, but may only be the basis for a nondischargeable debt if the plaintiff proves "(1) a pre-existing fiduciary relationship; (2) breach of that relationship; and (3) resulting loss." Patel v. Shamrock Floorcovering Servs., Inc. (In re Patel), 565 F.3d 963, 968 (6th Cir. 2009). This prong "includes a culpable state of mind requirement akin to that which accompanies application of the other terms in the same statutory phrase[:] . . . one involving knowledge of, or gross recklessness in respect to, the improper nature of the relevant fiduciary behavior." Bullock v. BankChampaign, N.A., 569 U.S. 267, 269 (2013). Additionally, within the Sixth Circuit, a fiduciary relationship is found only in "those situations involving an express or technical trust relationship arising from placement of a specific res in the hands of the debtor." R.E. Am., Inc. v. Garver (In re Garver), 116 F.3d 176, 180 (6th Cir. 1997). Finally, "[e]xceptions to discharge under the Bankruptcy Code are to be strictly construed in favor of the debtor." Goodmar, Inc. v. Hamilton (In re Hamilton), 306 B.R. 575, 582 (Bankr. W.D. Ky. 2004) (citing Rembert v. AT&T Universal Card Servs., Inc. (In re Rembert), 141 F.3d 277, 281 (6th Cir. 1998)).
As the Court signaled in its Memorandum & Order, because Chancellor Forgety's Bench Decision and the subsequent Judgment do not reference that Defendants committed fraud of any kind against Plaintiff even though Plaintiff raised it in the State-Court Complaint, summary judgment in favor of Defendants appears to be appropriate based on res judicata (or collateral estoppel, also known as issue preclusion
As explained by the Sixth Circuit decades ago:
Spilman v. Harley, 656 F.2d 224, 227-28 (6th Cir. 1981).
Moreover, although the Supreme Court has held that claim preclusion does not apply to dischargeability actions, it has expressly explained that issue preclusion — or collateral estoppel — does apply in nondischargeability actions. See Grogan v. Garner, 498 U.S. 279, 284-85 (1991) ("If the preponderance standard also governs the question of nondischargeability, a bankruptcy court could properly give collateral estoppel effect to those elements of the claim that are identical to the elements required for discharge and which were actually litigated and determined in the prior action.").
In re Earnest, No. 11-36044, 2013 WL 795399, at *3 (Bankr. N.D. Ohio Mar. 1, 2013) (quoting Gilbert v. Ferry, 413 F.3d 578, 580 (6th Cir. 2005)).
Collateral estoppel "`promotes finality, conserves judicial resources, and prevents inconsistent decisions,' by barring `the same parties or their privies from relitigating in a later proceeding legal or factual issues that were actually raised and necessarily determined in an earlier proceeding.'" Bowen ex rel. Doe v. Arnold, 502 S.W.3d 102, 107 (Tenn. 2016) (citations omitted).
Spilman, 656 F.2d at 228; see also Booth v. Kirk, 381 S.W.2d 312, 315 (Tenn. Ct. App. 1963) ("[M]aterial facts or questions which were in issue in a former action, and were there admitted or judicially determined, are conclusively settled by a judgment rendered therein, and . . . such facts or questions become res judicata and may not again be litigated in a subsequent action between the same parties." (citation omitted)).
The question that federal courts must ask is whether a state court would give preclusive effect to a judgment; if so, the federal court must follow suit. See Migra, 465 U.S. at 81. Under Tennessee law, collateral estoppel includes five elements:
Mullins v. State, 294 S.W.3d 529, 535 (Tenn. 2009) (citations omitted); see also Bowen, 502 S.W.3d at 106 (stating that whether collateral estoppel applies is a question of law and, therefore, "summary judgment is an appropriate vehicle for resolving the same").
Of these elements, the Court states, without further explanation, that the third and fourth collateral-estoppel elements are not disputed: the Judgment, which was entered on October 7, 2013, and not appealed, is final and the parties to both the State Court action and this adversary proceeding are the same and/or in privity.
"Both the intent and the actual misappropriation necessary to prove embezzlement may be shown by circumstantial evidence . . ., [and] the Plaintiff must prove fraud in fact, involving moral turpitude or intentional wrong, rather than implied or constructive fraud." WebMD v. Sedlacek (In re Sedlacek), 327 B.R. 872, 880-81 (Bankr. E.D. Tenn. 2005) (citations and quotation marks omitted); see also Bombardier Capital, Inc. v. Tinkler (In re Tinkler), 311 B.R. 869, 876-77 (Bankr. D. Colo. 2004); In re Hamilton, 306 B.R. at 582. Fraudulent intent can be deduced by examining "the facts and circumstances surrounding the act." Estate of Harris v. Dawley (In re Dawley), 312 B.R. 765, 779 (Bankr. E.D. Pa. 2004) (citation omitted)); see also Powers v. Powers (In re Powers), 385 B.R. 173, 179-80 (Bankr. S.D. Ohio 2008) ("The fraud element may also be satisfied by a showing of deceit . . ., but such intent can be inferred from the relevant circumstances.").
"The term `fiduciary capacity' [in § 523(a)(4)] . . . does not modify the word[ ] `embezzlement.'" Cardwell v. Hester (In re Hester), 559 B.R. 472, 477 (Bankr. W.D. Ky. 2016). That is, the lawful entrustment of property involved in embezzlement does not require the existence of a fiduciary relationship. See In re Sedlacek, 327 B.R. at 880. Also, "a mere lien or security interest does not rise to the level of ownership sufficient to support a claim under § 523(a)(4)'s embezzlement provision." Hulsing Hotels Tenn., Inc. v. Steffner (In re Steffner), 479 B.R. 746, 766 (Bankr. E.D. Tenn. 2012); see also Kraus Anderson Capital, Inc. v. Bradley (In re Bradley), 507 B.R. 192, 200 (B.A.P. 6th Cir. 2014) ("As owner of the collateral, the debtor remained the owner of its proceeds, even though both the collateral and its proceeds were subject to a security interest. No person can embezzle from himself." (citation omitted)).
Plaintiff's Complaint clearly avers that Defendants fraudulently withheld partnership profits from him and alleges that the Judgment was awarded against Defendants for their fraudulent conduct so that the Judgment is nondischargeable. In addition, he adamantly states in his response to Defendants' statement of undisputed facts, which asserts that the state court was silent as to fraud or defalcation while acting in a fiduciary capacity, that the State-Court Complaint alleged Defendants' fraudulent behavior by mentioning the diversion of funds. [Doc. 16 ¶ 4.) Indeed, Plaintiff asserts that that the diversion of funds was "what the case was about [and that Defendants] argued at trial that they didn't owe Long anything, [but] the court specifically rejected that argument." [Id.]
Notwithstanding that the State-Court Complaint [Doc. 13-1 ¶ 12] supports Plaintiff's claim that Defendants engaged in "misconduct" and intentionally withheld funds that should have been paid to Plaintiff, there is no reference to fraud or a "diversion of funds" in either the Bench Decision or the Judgment itself. [Docs. 1-1; 13-2.] Instead, Chancellor Forgety's analysis indicates a perception that Plaintiff's claim was merely for breach of contract and that "the biggest issue in the case" was the interpretation of the term "profits" in the Contract. [Doc. 13-2 at 4.] Chancellor Forgety then construed the Contract in favor of Plaintiff and strictly against Defendants because Defendants drafted it [Doc. 13-2 at 5:11-13]. He accepted Plaintiff's definition of profit — that only the royalty owed to Hinkle under the Assignment Agreement, and not all other costs of the operation, were proper deductions from total sales receipts before division among the partners. The dollar amount of the Judgment resulted from the court's re-calculation of the profits (under the adjudicated definition) divided among the four partners under the terms of the Contract. [See id. at 5:16-10:9.]
Critically for purposes of § 523(a)(4), Chancellor Forgety made no mention of "diversion of funds" or fraud and, in fact, stated that he was unsure "that either side had carried the preponderance of the evidence to prove that the other side was the one that breached the agreement." [Id. at 10:23-11:2.] He also refused to hold Defendants in contempt. [See id. 13:17-21.] Thus, notwithstanding that Plaintiff alleged fraudulent activity in the State-Court Complaint and the facts as presented here were tried before the State-Court, Chancellor Forgety's finding that Defendants breached the agreement was limited to their failure properly to calculate and pay Plaintiff's share from the partnership operations under the applicable definition of profits.
In the Memorandum & Order, citing binding Sixth Circuit law, the Court stated that because there was no express or technical trust, Plaintiff cannot sustain a theory of defalcation or fraud by a fiduciary. Plaintiff appears to argue in his supplemental brief, relying on a treatise [Doc. 19 at 5], that this Court should disregard the Sixth Circuit's long-standing requirement that fraud or defalcation by a fiduciary requires an express or technical trust. Plaintiff argues, instead, that "[t]he exclusion of partners from the operation of Code § 523(a)(4) by some courts ignores the fact that general partners do repose trust in one another, which rises to a fiduciary relationship not found in an ordinary commercial relationship." [See id. (quoting § 57.28 Partners as Fiduciaries, 3 Norton Bankr. L. & Prac. 3d § 57.28).] This Court, however, must follow the Sixth Circuit's interpretation of what constitutes defalcation by a fiduciary under § 523(a)(4), and the Sixth Circuit has reiterated on many occasions that § 523(a)(4) requires an express or technical trust so that "the existence of a state law `agent-principal relationship standing alone is insufficient to establish the type of fiduciary duty contemplated by § 523.'" In re Wigger, 595 B.R. at 257 (quoting Commonwealth Land Title Co. v. Blaszak (In re Blaszak), 397 F.3d 386, 391 (6th Cir. 2005)).
The requirements concerning § 523(a)(4) that bind this Court were succinctly summarized by the Bankruptcy Court for the Southern District of Ohio:
Simmons Capital Advisors, Ltd. v. Bachinski (In re Bachinski), 393 B.R. 522, 532 (Bankr. S.D. Ohio 2008); see also In re Patel, 565 F.3d at 968 ("Establishing an `express' trust is straightforward. The creditor must demonstrate: `(1) an intent to create a trust; (2) a trustee; (3) a trust res; and (4) a definite beneficiary.'" (quoting In re Blaszak, 397 F.3d at 391-92)). Because the undisputed facts of this case do not support a finding that there was an express or technical trust sufficient to prove that the parties were in the type of fiduciary relationship required to proceed under the defalcation prong of § 523(a)(4) as defined by the Sixth Circuit, Plaintiff's argument to the contrary fails.
Concerning whether the issue of fraud was actually litigated and necessary to a final judgment, the Tennessee Supreme Court has held:
Mullins, 294 S.W.3d at 536 (citations omitted).
Rule 9.02 of the Tennessee Rules of Civil Procedure requires that "the circumstances concerning fraud . . . shall be stated with particularity[, although m]alice, intent, knowledge, and other conditions of mind of a person may be averred generally." As further explained by the Advisory Commission Comments to Rule 9.02, "[t]he requirement in Rule 9.02 . . . is not intended to require lengthy recital of detail. Rather, the Rule means only that general allegations of fraud . . . are insufficient; the pleader is required to particularize, but by the `short and plain' statement required by Rule 8.01."
Plaintiff strongly urges that his State Court Complaint pleaded fraud. He asserts the following in response to Defendants' statement of undisputed material facts:
[Doc. 16-1 ¶¶ 2-7.]
The record, including Plaintiff's assertions, reflects that the parties had the opportunity to and did fully litigate the facts presented by the State Court Action. Chancellor Forgety rendered his Bench Decision, which was memorialized into the Judgment (which was drafted and submitted for entry by Plaintiff's counsel), and neither reflects a factual finding sufficient to support a claim under § 523(a)(4). Indeed, Chancellor Forgety's ruling includes a contrary factual finding: "[Q]uite frankly, I cannot hold the preponderance of the evidence, two different views of why it came to an end, I cannot hold on the preponderance of the evidence that the Piercys breached it." [Doc. 13-2 at 10:13-19.] Because the facts averred by Plaintiff in the State Court Action and this adversary proceeding and the subsequent allegations of Defendants' fraud are the same and the parties actually litigated the issue of fraud, the first and second elements of collateral estoppel are met.
Finally, the collateral-estoppel requirement that the parties had a full and fair opportunity to litigate the factual issue in the prior proceeding differs from the "actually litigated" element in that it focuses on the parties themselves rather than the issues. See Mullins, 294 S.W.3d at 538. When as here, the plaintiff is the party to be precluded, "it is appropriate to consider (1) the procedural and substantive limitations placed on the plaintiff in the first proceeding, (2) the plaintiff's incentive to litigate the claim fully in the first proceeding, and (3) the parties' expectation of further litigation following the conclusion of the first proceeding." Id., 294 S.W.3d at 538-39.
Plaintiff was not limited by the Chancery Court from alleging and arguing any facts to support his contention that Defendants "diverted" funds and otherwise acted fraudulently in connection with their contract. Additionally, he was fully incentivized to litigate his claims that Defendants acted fraudulently in their "diversion of funds," among other things. Finally, the facts were presented to Chancellor Forgety with the expectation that he would fully decide the outcome of the State Court Action. There would have been no expectation by the parties that any further litigation between them concerning these facts would arise and, in fact, the Judgment, which was prepared by Plaintiff's counsel and entered by Chancellor Forgety in October 2013, was not appealed or otherwise challenged. Based on the record, the actually-litigated requirement is also met.
Although the law is clear that dischargeability is not within the province of a state court, such rule is not determinative here. The state court was presented with the question of whether Defendants acted fraudulently by their "diversion of funds," and it clearly answered in the negative because Chancellor Forgety's entire decision is based on his perception that the dispute was merely a breach of contract created by a difference of opinion about the definition of "profits." Thus, under the doctrines of full faith and credit intertwined with res judicata — incorporating therein both claim and issue preclusion — Plaintiff is precluded from re-litigating the factual issue of fraud before this Court because he would be precluded from re-litigating it under Tennessee law. Accordingly, because Plaintiff cannot show fraud, even examining the record in a light most favorable to him, the Court finds that there is no genuine issue of material fact concerning the issue of fraud, without which Plaintiff cannot sustain a cause of action for embezzlement or larceny under § 523(a)(4). Further, no actual or constructive trust existed as necessary to establish the third prong of a § 523(a)(4) claim — defalcation while acting in a fiduciary capacity. Accordingly, summary judgment will be granted in favor of Defendants.
An Order consistent with this Memorandum will be entered.