Opinion
FINDINGS OF FACT AND CONCLUSIONS OF LAW AFTER TRIAL ON 11 U.S.C. § 523(a)(4) CLAIM AND ORDER THEREON
ROBERT KWAN, Bankruptcy Judge.
Trial of this matter after remand commenced on May 29, 2014, and continued on May 30, 2014. Plaintiff, Harold Pemstein ("Plaintiff" or "Harold"), appeared and was represented by attorney Christopher L. Blank. Defendant, Martin Pemstein ("Defendant" or "Martin"), appeared and represented himself.
The following constitutes the court's findings of fact and conclusions of law in compliance with Federal Rule of Bankruptcy Procedure 7052. Any finding of fact that should be properly characterized as a conclusion of law and any conclusion of law that should be properly characterized as a finding of fact should be considered as such.
This court has reviewed the proposed findings of fact and conclusions of law submitted by the parties after trial at the court's request and the objections thereto. Having considered the evidence received at trial, and the written and oral arguments of the parties, the court has exercised independent review of the proposed findings of fact and conclusions of law, and finds that it substantially agrees with the proposed findings of fact and conclusions of law submitted by Plaintiff, so that it can and does adopt a number of such proposed by Plaintiff as its own as discussed herein.
I. FINDINGS OF FACT
1. Martin and Harold are brothers and were business partners with respect to a partnership known as HMS Properties. Joint Pre-Trial Order, Statement of Admitted Facts, Docket 16, Paragraph 4, Page 2, line 4 ("Plaintiff and Defendant Martin are brothers, and were business partners"). Defendant Martin Pemstein's Trial Declaration, Docket 25, Paragraph 2, page 2, line 7 ("Harold and I are brothers and former business partners").
2. The debt arose out of Martin's service as a general partner for HMS. Defendants' Post-Trial Brief, Docket 34, Page 3, lines 18-22 ("At trial, Martin and Harold testified they were 50% owners of HMS Properties, a general partnership. California partners are fiduciaries within the meaning of § 523(a)(4)' In re Lewis, (9th Cir. 1996) 97 F.3d 1182, 1186. Thus, the Judgment [referring to the 2010 Judgment of the Superior Court of California for the County of Orange, the Honorable Peter Polos, Judge, presiding] would be non-dischargeable if it were the result of Martin's fraud or defalcation' while acting as a partner of HMS Properties." Emphasis added. ).
3. Harold obtained a judgment against Martin for $696,218.03 on January 5, 2010 ("2010 Judgment"). Joint Pre-Trial Order, Statement of Admitted Facts, Docket 16, Paragraph 5, page 2, lines 7-8; 2010 Judgment, Exhibit P-1.
4. The 2010 Judgment is final and has res judicata effect. Joint Pre-Trial Order, Statement of Admitted Facts, Docket 16, Paragraphs 11 and 12, page 2, lines 19 and 20.
5. The 2010 Judgment states that "Martin Pemstein breached his duty of due care to Harold in the collection of rent on behalf of HMS Properties." 2010 Judgment, Exhibit P-1; Defendant Martin Pemstein's Trial Declaration, Docket 25, Paragraph 3, page 2, lines 14-16.
6. The 2010 Judgment was based on the Superior Court's finding that Martin breached his "duty of care" in the collection of rent. That is the equivalent of a finding that Martin engaged in "grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law" while acting as a trustee over partnership assets. Bankruptcy Appellate Panel ("BAP") Statement of Decision, Docket 69, page 5, lines 7-15.
A. Facts Established at Trial after Remand.
7. Martin had sole and actual control of the collection of rents of HMS and acted intentionally with respect to the collection of rent of HMS. Trial Testimony of Martin Pemstein, May 30, 2014, 11:00 A.M.-11:08 A.M. and 12:02 P.M.-12:03 P.M.
8. Martin acted knowingly with respect to the collection of rent of HMS. Trial Testimony of Martin Pemstein, May 30, 2014, 11:00 A.M.-11:08 A.M. and 12:02-12:03 P.M.
9. Martin knowingly and intentionally acted for the benefit of Pemma Corporation ("Pemma"), the tenant of HMS, to the detriment of HMS and his brother Harold, with respect to the collection and expenditure of rent owed by Pemma to HMS and by HMS to Harold. Trial Testimony of Martin Pemstein, May 30, 2014, 11:05 A.M.-11:08 A.M. and 11:46 A.M.-11:58 A.M. and 12:02 P.M.-12:05 P.M. Martin made intentional and conscious decisions not to collect higher rent for HMS from Pemma despite the requests of his brother and partner, Harold, considering the interests of Pemma over HMS, both of which he controlled, leading to the damages incurred by Harold as determined by the Superior Court. Id.
10. Martin has a background and college coursework in accounting as well as work experience as a staff accountant. Trial Testimony of Martin Pemstein, May 29, 2014, 12:02 P.M. to 12:04 P.M.
11. During the relevant period, Martin was in charge of the operations and finances of both Pemma and HMS. Trial Testimony of Martin Pemstein, May 29, 2014, 12:04 P.M. to 12:05 P.M., May 30, 2014, 11:00 A.M.-11:08 A.M.
12. The state court found that Martin Pemstein "breached his duty of care to Harold Pemstein in the collection of rent on behalf of HMS Properties. 2010 Judgment, Exhibit P-1.
13. Exhibit 107 is the Plaintiff's Brief in Lieu of Closing Argument which was submitted by Harold's attorney to Judge Polos after the conclusion of testimony in the State Court trial.
14. Exhibit 107 was submitted not to prove any of the facts stated in the brief, but to explain the basis for the state court judgment by Judge Polos, who adopted the computations of damages of the state court expert witness.
15. In his state court Brief in Lieu of Closing Argument, Harold stated that the State Court's appointed expert Jamie Holmes had concluded that HMS had actual profits from rental income of $384,124.00 during the relevant period, and Harold's unpaid share of that income was $192,062.00. Plaintiff's Brief in Lieu of Closing Argument, Exhibit 107, pg 134:15-18; State Court Reporter's Transcript, September 15, 2009, Exhibit 110 pg. 103-105; see also, Trial Testimony of Martin Pemstein, May 30, 2014, 11:17-11:25 A.M.
16. In his state court Brief in Lieu of Closing Argument, Harold stated that expert witness David Hahn concluded that Martin did not collect a market rate of rent from the tenant Pemma, which was controlled by Martin. Harold's closing brief says that David Hahn testified that the shortfall in fair rental value for HMS properties was $207,618.00. Harold's share of that forgone profit was $103,809.00. Harold then combined those numbers to establish that Martin owed Harold $295,871.00. Plaintiff's Brief in Lieu of Closing Argument, Exhibit 107 pg 135-136.
17. The Superior Court by Judge Polos awarded Harold against Martin damages of $295,871.00 in principal and $400,347.03 in interest in the 2010 Judgment. 2010 Judgment, Exhibit P-1; see also, Defendant Martin Pemstein's Trial Declaration, Docket 25, Exhibit A, Opinion of the District Court of Appeal at page 6 ("In its judgment, the court gave Harold exactly what he requested in his closing argument brief with respect to the collection of rent ($295,871.00 in principal and $400,347.03 in interest for a total of over $696,000).").
18. Martin testified that the Superior Court by Judge Polos found him to have been negligent in the handling of the rents. Defendant Martin Pemstein's Trial Declaration, Docket 25, Paragraph 3, page 2, line 16 ("The Court found that I was negligent in my duty to collect rent."); see also, Trial Testimony of Martin Pemstein, May 29, 2014, 12:05 P.M. to 12:07 P.M.
19. At trial, Martin has specifically testified that he was NOT negligent in his handling of the rents of HMS. Trial Testimony of Martin Pemstein, May 30, 2014, 12:02 P.M.
20. Martin testified that it would be wrong to make distributions to one partner and not the other. Trial Testimony of Martin Pemstein, May 30, 2014, 12:18 P.M.-12:21 P.M.
21. Martin acknowledged that it would be unfair to HMS and its partners for Pemma to pay less than a market rate of rent. Trial Testimony of Martin Pemstein, May 30, 2014, 11:07 A.M.-11:11 A.M.
22. Martin testified at trial that he acted deliberately and knowingly with respect to the way he handled the collection of rents of HMS. Trial Testimony of Martin Pemstein, May 30, 2014, 12:02 P.M.-12:04 P.M.
23. Martin testified that he was aware that he had a fiduciary duty to both Pemma and HMS to treat each one fairly. Trial Testimony of Martin Pemstein, May 30, 2014, 11:46 A.M.
II. CONCLUSIONS OF LAW
24. Issue preclusion applies in bankruptcy debt dischargeability proceedings to preclude relitigation of nonbankruptcy court findings that are relevant to dischargeability of debt. Grogan v. Garner, 498 U.S. 279, 284 n. 11, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991); Pemstein v. Pemstein (In re Pemstein), 492 B.R. 274, 281 (9th Cir. BAP 2013).
25. Issue preclusion bars relitigation of an issue or fact that (1) is identical to a fact or issue determined in an earlier proceeding, (2) was actually decided by a court in an earlier action, (3) was necessary to the judgment in such action, (4) there was a final judgment on the merits, and (5) the parties were the same or in privity. Lopez v. Emergency Service Restoration, Inc. (In re Lopez), 367 B.R. 99, 104 (9th Cir. BAP 2007), citing Harmon v. Kobrin (In re Harmon), 250 F.3d 1240, 1245 (9th Cir.2001); In re Pemstein, 492 B.R. at 281.
26. The Full Faith and Credit Act, 28 U.S.C. § 1738, requires that federal courts give state court judgments the same preclusive effect those judgments would enjoy under the law of the state in which the judgment was rendered. Lopez, supra, 367 B.R. at 105, citing 28 U.S.C. § 1738; In re Pemstein, 492 B.R. at 281.
27. California law applies issue preclusion based on the establishment of the same five elements listed above. Baldwin v. Kilpatrick (In re Baldwin), 249 F.3d 912, 917-918 (9th Cir.2001), citing Lucido v. Superior Court, 51 Cal.3d 335, 340 (1990); In re Pemstein, 492 B.R. at 281.
28. "Once a party... has won a final victory on an issue, it is entitled to avoid relitigation of that issue in any other forum. The bankruptcy court's otherwise broad powers do not include the power to reject a party's invocation of collateral estoppel on an issue fully and fairly litigated in another court." In re Bugna, 33 F.3d 1054, 1058 (9th Cir. 1994).
29. In the prior trial of this matter, all of the elements of issue preclusion were established as to the amount of the debt, the identity of the debtor, the identity of the creditor, and that the debt arose out of the debtor's breach of his duty of care owed to his partner Harold with respect to the collection of rent of HMS.
30. Therefore, Martin is precluded in the trial on remand from asserting that no debt was owed to Harold.
31. Martin is precluded in the trial on remand from asserting that he did not breach his duty of care with respect to the collection of rent of HMS.
32. Martin is precluded in the trial on remand from asserting that Harold was not damaged by Martin's breach of his duty of care.
33. Martin is precluded in the trial on remand from asserting that he did not owe a fiduciary duty to Harold.
34. Martin is precluded in the trial on remand from asserting that he did not breach his fiduciary duty of care to Harold with respect to the collection of rents of HMS.
35. Martin is precluded in the trial on remand from asserting that the debt owed to Harold based on Martin's breach of his duty of care was anything other than the $696,218.03 amount of the 2010 Judgment.
36. On remand, the only unresolved issue after applying the doctrine of issue preclusion that this court must determine is whether Martin's misconduct amounted to defalcation. See In re Pemstein, 492 B.R. at 281-284.
The court does not reach the alternative theory argued by Harold that issue preclusion applies to the determination of Martin's scienter to establish a defalcation based on the state court's judgment. Although not reaching the alternative theory, the court is not sufficiently persuaded that the state court's judgment under California Corporations Code, § 16404(c), implicitly finding that Martin was at least grossly negligent in the collection of rent satisfies the scienter standard of gross recklessness to establish a defalcation under 11 U.S.C. § 523(a)(4) as set forth in Bullock v. BankChampaign, N.A., 133 S.Ct. at 1757. This determination is best left for another day.
37. In Bullock v. BankChampaign, N.A., 133 S.Ct. 1754 (2013) the United States Supreme Court held that some level of culpable knowledge is necessarily a part of the definition of defalcation. Proof of scienter is required. "[K]knowledge of, or gross recklessness in respect to, the improper nature of the relevant fiduciary behavior" is required. Id. at 1757.
38. The 2010 Judgment was based on the finding that Martin had breached his duty of care to Harold. Under California law, this finding necessarily means that the state court found that Martin had engaged in "grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law" while acting as a trustee over partnership assets. California Corporations Code § 16404(c). And, as specifically stated in the 2010 Judgment, that conduct related to the "collection of rent on behalf of" the partnership. BAP Statement of Decision, Docket 69, page 5, lines 7-15; In re Pemstein, 492 B.R. at 278. "Defalcation includes the failure by a fiduciary to account for money or property that has been entrusted to him." In re Pemstein, 492 B.R. at 282 (citations omitted).
39. This court determines that the preponderance of the evidence received at the trial of this matter on remand establishes that Martin's breach of his duty of care to Harold in the collection of rent amounted to defalcation based on his intentional acts.
40. Because Martin has specifically testified that (1) he was NOT negligent in his handling of the rents of HMS, (2) if he had done the things that Judge Polos determined he had done, those things would be wrongful, and (3) he acted deliberately and knowingly with respect to the way he handled the collection of rents of HMS; therefore, there is no basis for determining that Martin's conduct with respect to the collection of rent was innocent or merely negligent, and based on the findings of facts described above, the court finds that his conduct was intentional.
41. Therefore, the debt represented by the 2010 Judgment against Martin is nondischargeable pursuant to 11 U.S.C. § 523(a)(4).
42. Although Diana Pemstein is named as a defendant in this adversary proceeding, she was not named in the 2010 Judgment, and she has no personal liability for this debt.
III. ORDER
Counsel for Harold is ordered to submit a proposed judgment consistent with these findings of fact and conclusions of law within 30 days of the date of entry of these findings of fact and conclusions of law.
IT IS SO ORDERED.