Opinion
Bky. No. 01-32044 ELF Adv. No. 01-1252
10-11-2011
In re: BERNARD A. ROEMMELE, Debtor. PHILIP J. VON KAHLE, Successor Receiver on behalf of Professional Resources International, Inc., a/k/a PRSI, Inc., Plaintiff, v. BERNARD A. ROEMMELE, Defendant.
Chapter 7
MEMORANDUM
I. INTRODUCTION
In this adversary proceeding, Plaintiff, the court-appointed Receiver ("the Receiver") for Professional Resources Systems, Inc. ("PRSI"), filed a complaint ("the Complaint") seeking a determination that the debt owed by Bernard A. Roemmele ("the Debtor") is nondischargeable. The debt that is the subject of this proceeding was liquidated by a consent judgment entered in a state court lawsuit that PRSI brought against the Debtor and CitX Corporation ("CitX"), a business entity controlled by the Debtor.
Presently pending are cross motions for summary judgment on the Receiver's §523(a)(4) claim, which is the sole remaining claim in this adversary proceeding. Based on the motions and the supporting evidentiary materials, I conclude that there are no issues of material fact, the Receiver has failed to meet his burden of proof and the Debtor is entitled to the entry of summary judgment.
The Receiver's Complaint also included a nondischargeability claim under §523(a)(2) and objections to discharge under several subsections of 11 U.S.C. §727(a). These other claims were resolved either by motion or agreement of the parties before the filing of the present cross motions for summary judgment. See Part II, C, infra.
II. BACKGROUND
A. CitX and PRSI
The Debtor was the Chief Executive Officer of CitX, a Delaware corporation that formerly provided internet-based services and related computer technology. PRSI is a Nevada corporation currently in receivership pursuant to a decree issued in 15th Judicial Circuit Court of Palm Beach County, Florida. PRSI was primarily engaged in the sale of small office/home office computer technology systems and e-commerce business opportunities to the general public.
CitX filed a voluntary chapter 11 bankruptcy petition in this court on July 3, 2001. (See Bky No. 01-19604). CitX converted its case to a chapter 7 on September 24, 2001.
CitX entered into a series of agreements with PRSI in August and September 1999: a Marketing Alliance Agreement, a Software Licensing Agreement, and a Contractual Agreement (collectively, "the PRSI Agreements"). The purpose of the PRSI Agreements was to establish a business relationship in which CitX would develop and provide the necessary computer and internet technology to construct an internet-based shopping mall for PRSI's home-based and small business customers, in a multilevel marketing arrangement. Pursuant to the terms of the PRSI Agreements, PRSI agreed to pay CitX a fee for its services that was not to exceed $2,200.00 weekly and an annual software licensing fee of $100,000.00. By the end of 1999, PRSI had paid over $700,000.00 to CitX under the contracts.
PRSI marketed and offered a Small Office/ Home Office package ("the SOHO Package") that allowed customers to participate in a members-only intranet shopping mall. For a $295.00 fee, members were provided with a "cybershingle" or store web page and other related e-commerce tools, such as electronic mail accounts and electronic fund transfers, that were to be provided by CitX under the PRSI Agreements.
On January 4, 2000, the Florida Attorney General filed a complaint in the Circuit Court of the 15th Judicial District for Palm Beach County ("the Florida Litigation") seeking an injunction against PRSI alleging that PRSI was operating a pyramid scheme designed to defraud members of the public. Subsequently, PRSI terminated operations and the Receiver was appointed. Also, the Florida Attorney General later joined CitX and the Debtor as defendants in the Florida Litigation.
The Plaintiff, Philip J. Von Kahle is the successor to the original receiver, Lewis B. Freeman, and was substituted as the plaintiff in this proceeding by the Order dated January 31, 2011. (Doc. #247).
B. The State Court Judgment
In June 2000, the Receiver instituted an action in the Pennsylvania Court of Common Pleas, Bucks County ("the CP Court") to enjoin the Debtor and CitX from using PRSI's customer list and to recover the approximately $700,000.00 that was paid to CitX under the PRSI Agreements. After a trial, the CP Court entered a final decree ("the Final Decree") determining that the Receiver was the sole owner of PRSI's customer list. The CP Court enjoined the Debtor and CitX from using the customer list and ordered that the list be turned over to the Receiver by a specified date.
There were several other defendants in the state court action.
The CP Court made the following findings of fact, inter alia:
42. During the parties' relationship, PRSI provided certain information to CitX for use by CitX in performing its contractual obligations to PRSI.(Receiver's Mot., Ex. F).
44. CitX also obtained information concerning PRSI's customers without PRSI's or the Receiver's consent.
45. The customer information consists of each customer's name, address, phone number, fax number, e-mail address and business name (the "Protected Data").
The CP Court also made the following conclusions of law in support of its decision, inter alia:
21. The Receiver possesses the only right, title and/or interest in, and to, the Protected Data.(Id.)
22. CitX wrongfully misappropriated the Protected Data.
23. CitX has wrongfully refused to return the Protected Data to the Receiver.
In February 2001, after the entry of the Final Decree, the parties entered into a settlement agreement ("the Settlement Agreement") and consent judgment. Under the Settlement Agreement, the Debtor and CitX agreed to the entry of a consent judgment against them in the amount of $700,000.00, the satisfaction of which, could be made by tendering $300,000.00 in monthly installments of $25,000.00. CitX and the Debtor defaulted on the Settlement Agreement after tendering two (2) payments and the Receiver filed the consent judgment for $700,000.00 ("the State Court Judgment") in the CP Court.
C. The Debtor's Bankruptcy and Adversary Proceeding
This is an uncharacteristically old bankruptcy case and adversary proceeding. The Debtor filed his voluntary chapter 7 bankruptcy petition on August 23, 2001. The Receiver commenced this adversary proceeding a few months later by filing the Complaint on December 26, 2001. The Complaint alleged several causes of action against the Debtor under sections 523(a) and 727(a) of the Bankruptcy Code. The Debtor filed an amended answer ("the Amended Answer") in response to the Complaint on February 26, 2002. (Doc. #5).
The parties filed their first set of cross motions for summary judgment on April 15, 2004. (Doc. #s. 110 & 114). After argument, the court granted the Debtor's summary judgment motion on the Receiver's §523(a)(2)(B) claim but denied it as to all other claims. The court also denied the Receiver's summary judgment motion, but, with the Debtor's consent, the Receiver voluntarily dismissed the §§727(a)(6) and (7) claims. (See Order dated February 17, 2005, Doc. #156). Shortly thereafter, the court approved a stipulation filed by the parties to stay all pre-trial deadlines pending resolution of the Debtor's criminal trial in the United States District Court for the Southern District of Florida ("the Florida Criminal Proceeding"). (Doc. # 168).
Nearly two (2) years later, on June 5, 2006, the court scheduled a status hearing, which resulted in the entry of a comprehensive pretrial order and new pre-trial deadlines. (See Doc. #'s 173, 177).
Prior to the undersigned's appointment to the bench on February 14, 2006 the bankruptcy case and the adversary proceeding were assigned to the Honorable Kevin J. Carey, then sitting as a bankruptcy judge in this district. Judge Carey is now a bankruptcy judge in the District of Delaware.
On January 12, 2007 the Receiver filed its second motion for summary judgment ("the Receiver's Motion"). (Doc. # 184). The Debtor filed a response to the Receiver's Motion on April 11, 2007. (Doc. # 209). Following oral argument on the Motion, the Receiver, with the court's consent, withdrew all of the remaining objections to discharge under 11 U.S.C. §727, see (Doc. # 222), leaving only the Receiver's §523(a)(4) claim. Shortly thereafter, on August 27, 2007, on request of the Receiver, the court again stayed the adversary proceeding pending the outcome of the Debtor's appeal from his criminal conviction in the Florida Criminal Proceeding. (Id.).
The Debtor was initially represented by counsel in this adversary proceeding. On February 7, 2007, the court granted counsel's motion for leave to withdraw. (Doc. # 194). Thereafter, the Debtor has been acting pro se.
The Receiver advised the court that a criminal restitution order in excess of $14.6 million and a separate forfeiture order of $480,000.00 were entered against the Debtor as a result of the Debtor's criminal conviction. In requesting the stay of the adversary proceeding, the Receiver suggested that if the criminal conviction and restitution order were affirmed on appeal, he was unlikely to pursue his §523(a)(4) nondischargeability claim.
Notwithstanding the suspension of this adversary proceeding, the Debtor moved for summary judgment on the §523(a)(4) claim on July 31, 2008 ("the Debtor's Motion"). (Doc. # 227). Shortly after the Debtor's filing, consistent with its prior order of August 27, 2007, the court placed the Debtor's Motion in suspense. (Doc. # 230).
On December 6, 2010, the Debtor moved to terminate the stay of the adversary proceeding. (Doc. # 237). After a hearing, the court granted the motion and set a briefing schedule on both parties' second summary judgment motions. (Doc. # 251). Briefing was completed on June 14, 2011. The Motions are ripe for disposition.
III. LEGAL STANDARDS
A. Summary Judgment
Summary judgment is appropriate when the "pleadings, the discovery and disclosure materials on file, and any affidavits show that there is no genuine issue as to any material fact and that the movant is entitled to judgment as a matter of law." Fed. R. Civ. P. 56(c).
Under Rule 56, made applicable to this adversary proceeding pursuant to Fed. R. Bankr. P. 7056, the moving party is entitled to judgment as a matter of law if the court finds that the motion alleges facts which, if proven at trial, would require a directed verdict in favor of the movant. Fitzpatrick v. City of Atlanta, 2 F.3d 1112, 1115 (11th Cir. 1993). If the moving party meets this initial burden, the responding party may not rest on the pleadings, but must designate specific factual averments through the use of affidavits or other permissible evidentiary material which demonstrate a genuine issue of material fact to be resolved at trial. Celotex Corp. v. Catrett, 477 U.S. 317, 324 (1986); Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247-50 (1986).
The court's role is not to weigh the evidence, but to determine whether there is a disputed, material fact for resolution at trial. Anderson, 477 U.S. at 249. A genuine issue of material fact is one in which the evidence is such that a reasonable fact finder could return a verdict for the non-moving party. Id. at 248. The court must view the underlying facts and make all reasonable inferences therefrom in the light most favorable to the party opposing the motion. Pennsylvania Coal Ass'n v. Babbitt, 63 F.3d 231, 236 (3d Cir. 1995); United States v. 717 South Woodward St., 2 F.3d 529, 533 (3d Cir. 1993).
The parties' respective burdens of proof play an essential role in determining the merits of a summary judgment motion. Where the movant is the plaintiff and has the burden of proof at trial, the movant must show that no reasonable jury could find for the non-moving party. Fitzpatrick, 2 F.3d at 1115. The movant "must produce enough evidence to justify a directed verdict in its favor in order to meet its initial burden." Nat'l State Bank v. Fed. Reserve Bank of New York, 979 F.2d 1579, 1582 (3d Cir. 1992); see also In re Newman, 304 BR. 188, 193 (Bankr. E.D. Pa. 2002). Thus, in order to prevail on his Motion, the Receiver must come forward with sufficient evidence to establish each element of his non-dischargeability claim under §523(a)(4) and demonstrate that the Debtor has not come forward with evidence to create a triable factual dispute as to any element of the claim.
Where the moving party does not have the burden of proof on the underlying claim that is the subject of the summary judgment motion (and usually, that is the defendant), the movant has the initial burden of showing the absence of a genuine issue of material fact. Newman, 304 B.R. at 193-94 (quoting Adams v. Consolidated Rail Corp., 1994 WL 383633, *1-*2 (E.D. Pa. July 22, 1994)). However, the movant is not required to support its motion with affidavits or other materials to negate the plaintiff's claim. Id. Therefore, the Debtor must establish either that the Receiver has not supported one or more elements of his claim under §523(a)(4) with sufficient evidence or that the undisputed evidence negates an element of the Receiver's claim.
B. Dischargeability Under Section 523(a)(4)
The central purpose of the Bankruptcy Code is to give the honest debtor a fresh start, unburdened by the weight of preexisting debt. See, e.g., In re Cohen, 54 F.3d 1108, 1113 (3d Cir. 1995); In re Marques, 358 B.R. 188, 193 (Bankr. E.D. Pa. 2006). Thus, the statute's exceptions to the discharge of indebtedness are strictly construed against creditors. E.g., Cohen, 54 F.3d at 1113; In re Glunk, 2011 WL 3555604, *11 (Bankr. E.D. Pa. Aug. 11, 2011); Marques, 358 B.R. at 193.
The party seeking an exception to discharge bears the burden of proof. In re Stamou, 2009 WL 1025161, *3 (Bankr. D.N.J. Mar. 19, 2009); In re Marcet, 352 B.R. 462, 468 (Bankr. N.D. Ill. 2006). Each element of the non-dischargeability claim must be established by a preponderance of the evidence. Grogan v. Garner, 498 U.S. 279, 288-89 (1991).
Section 523(a)(4) provides:
A discharge under section 727 . . . of this title does not discharge an individual debtor from any debt-11 U.S.C. §523(a)(4).
(4) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny;
This exception to discharge is logically divided into two parts.
1.
The first part of §523(a)(4) is the "fiduciary prong" and it requires the creditor to establish that the debtor (1) was in a fiduciary relationship with the creditor, and (2) committed fraud or defalcation within the scope of that fiduciary relationship. E.g., In re Tyson, 450 B.R. 514, 522 (Bankr. E.D. Pa. 2011); Marques, 358 B.R. at 194.
Generally, courts have interpreted the term "fiduciary" in §523(a)(4) to mean a person in a relationship of trust or confidence that arises from an express or technical trust on behalf of the beneficiary-creditor. In re Coley, 433 B.R. 476, 495 (Bankr. E.D. Pa. 2010) (citing authorities); accord In re Dawley, 312 B.R. 765, 777 (Bankr. E.D. Pa. 2004). A fiduciary relationship that is imposed by operation of law because of the debtor's wrongful conduct, i.e., a trust ex maleficio, is insufficient under §523(a)(4). Coley, 433 B.R. at 495; In re Moran, 413 B.R. 168, 185 (Bankr. D. Del. 2009). For a §523(a)(4) nondischargeability claim to lie, the fiduciary duty must have arisen prior to and without regard to the wrongful behavior that created the debt. E.g., Coley, 433 B.R. at 496; Marques, 358 B.R. at 194; In re West, 339 B.R. 557, 566 (Bankr. E.D.N.Y. 2006).
Once the creditor has established the threshold issue of a fiduciary relationship between the debtor and the creditor, the creditor must then prove that the debtor committed fraud or defalcation. Fraud involves "intentional deceit, rather than implied or constructive fraud." E.g., In re Youngblood, 2009 WL 1232103, *10 (Bankr. S.D. Tex. Apr. 29, 2009) (quoting In re Swor, 2008 WL 938940 *5 (Bankr. S.D. Tex. Apr.4, 2008)). Defalcation is a "failure to account for funds entrusted to a fiduciary." In re Storie, 216 B.R. 283, 287 (B.A.P. 10th Cir. 1997) (collecting cases); Tyson, 450 B.R. at 524-25.
For a discussion of the scienter requirement for defalcation and the three lines of authority that seemingly has emerged, see Tyson, 450 B.R. at 524-25.
2.
The second, "non-fiduciary" prong of §523(a)(4) does not require proof of an existing fiduciary relationship between the debtor and creditor. See Tyson, 450 B.R. at 522; Stamou, 2009 WL 1025161 at *6. In objecting to the dischargeability of a debt under the non-fiduciary prong of §523(a)(4), the plaintiff must prove that the debtor committed embezzlement or larceny, as those terms are defined by federal common law. See, e.g., In re Burke, 416 B.R. 136, 145 (Bankr. E.D. Pa. 2009).
"To prove a debtor committed embezzlement within the meaning of § 523(a)(4), a plaintiff must establish that: (1) the debtor was entrusted; (2) with property; (3) of another; (4) which the debtor misappropriated for his own use; and (5) with fraudulent intent." Tyson, 450 B.R. at 522-23; Burke, 416 B.R. at 145 (quoting In re House, 2007 WL 2126260, at *4 (Bankr. N.D. Ill. 2007)); Stamou, 2009 WL 1025161, at *6.
Larceny is the "fraudulent and wrongful taking and carrying away of the property of another with the intent to convert such property to the taker's use without the consent of the owner." In re Clayton, 198 B.R. 878, 884 (Bankr. E.D. Pa. 1996) (quoting In re Graham, 194 Bankr. 369, 374 (Bankr. E.D. Pa. 1996)); accord In re Schlessinger, 208 Fed. App'x 131, at *2 (3d Cir. 2006); In re Kiesewetter, 391 B.R. 740, 748 & n.3 (Bankr. W.D. Pa. 2008); In re Shreve, 386 B.R. 602, 606 (Bankr. W.D. Va. 2008).
The difference between larceny and embezzlement is the manner in which the property comes into the possession of the person alleged to have fraudulently misappropriated it. Embezzlement occurs when the misappropriation takes place after the property lawfully comes into the hands of the party; larceny occurs when the original taking was unlawful. See Burke, 416 B.R. at 145; In re Hatch, 2009 WL 3208694, at *6 (Bankr. E.D. Pa. Sept. 30, 2009).
IV. DISCUSSION
A. §523(a)(4) - The Fiduciary Prong
Under the fiduciary prong of §523(a)(4), the threshold issue is whether the Debtor was a fiduciary when he committed the acts that the Receiver alleges were wrongful. The Debtor argues that the Receiver has not satisfied his burden of production in opposing summary judgment because the Receiver has not come forward with any competent evidence that the Debtor was a fiduciary to CitX and/or PRSI. The Debtor acknowledges that the parties entered into a business and contractual relationship through the PRSI Agreements. However, the Debtor characterizes PRSI as nothing more than a customer of CitX and represents in his brief that the PRSI Agreements contained no express or implied fiduciary obligation between CitX and PRSI. (Debtor's Mem. of Law at 20).
Ultimately, the Debtor contends that the summary judgment record is devoid of any evidence suggesting that he personally was in a fiduciary relationship with respect to PRSI or its customers. I agree.
The Receiver alleged in the Complaint that the "Debtor was a fiduciary to CitX and to CitX and Debtor's creditors as Debtor was entrusted with the funds transferred by PRSI and the general public." (Complaint ¶78). The funds were then earmarked "for the particular purpose of creating the SOHO's and other products promised under the purported agreements." (Id. ¶79). The Receiver further alleged that the "Debtor, through CitX, collected the funds from PRSI and from the general public by fraudulent conduct and deceit, and with the intent to defraud." (Id. ¶90).
The allegations in the Paragraphs 78-79 and 90 of the Complaint point to the PRSI Agreements as the source of any fiduciary duties the Debtor may have owed to PRSI. The Receiver's theory appears to be that, as a result of the contractual relationship between CitX and PRSI, the Debtor (as the director and CEO of CitX) owed a fiduciary duty to CitX and to the creditors of CitX (PRSI, in particular) and that the Debtor breached that fiduciary duty when he failed to use the funds for their intended purpose under the PRSI Agreements (i.e., to construct the SOHO's).
The flaw in the Receiver's response to the Debtor's Motion is that although the Receiver has alleged the existence of a fiduciary relationship in his initial pleading, he has not countered the Debtor's Motion with any evidence of the existence of an express trust. There is no evidence of any agreement requiring CitX (or the Debtor) to hold in trust any of the funds paid by PRSI pending their use for their intended purpose. Evidence of this nature is necessary
I use the word "response" advisedly. The Receiver did not advance any specific arguments in opposition to the Debtor's Motion. Rather, he requested that his Motion and brief in support of the Motion be treated as a response. (See Doc. #254). The Receiver's Motion and memorandum of law did not address the fiduciary prong of §523(a)(4).
under Pennsylvania law:
The following elements must be present for an express trust to exist under Pennsylvania law: (1) an express intention to create a trust; (2) an ascertainable res; (3) a sufficiently certain beneficiary; and (4) a trustee who "owns" and administers the res for the benefit of the beneficiary.In re Brockway Pressed Metals, Inc., 363 B.R. 431, 440 (Bankr. W.D. Pa. 2007) (citing
authorities).
The Receiver has not made the PRSI Agreements part of the evidentiary record. This is fatal to his defense on the issue. Without the PRSI Agreements, it is impossible to determine if the Agreements created an express trust under state law sufficient for purposes of §523(a)(4). Review of the precise terms in the parties' agreement is especially critical because "the §523(a)(4) discharge exception is not designed to apply to debts arising from ordinary commercial or contractual relationships." Coley, 433 B.R. at 496.
The Receiver has not referenced any documents other than the PRSI Agreements that purport to create a fiduciary duty or relationship between the Debtor/CitX and PRSI or produced any evidence that creates an issue of material fact with respect to this element of the claim. Therefore, I conclude that summary judgment should be entered in favor of the Debtor on the fiduciary prong under §523(a)(4).
Under 11 U.S.C. §523(a)(4), an express or technical trust also may be "based on relationships in which trust type obligations are imposed pursuant to statute or common law," In re Ishmael, 2008 WL 80040, at *5 (Bankr. E.D. Pa. Jan. 7, 2008) (quoting In re Librandi, 183 B.R. 379, 382 (M.D. Pa. 1995)), provided that the statute imposes specific trust duties with respect to a trust res, see In re Ramonat, 82 B.R. 714, 719 (Bankr. E.D. Pa. 1988). Pennsylvania law imposes fiduciary duties upon a director of a corporation; however, most courts have held that these fiduciary duties imposed by operation of law do not rise to the level of imposing a technical trust for purposes of 11 U.S.C. §523(a)(4). See Dawley, 312 B.R. at 779, n.20 (15 Pa. C.S.A. § 512 imposes general fiduciary duties of confidence, trust, loyalty, and good faith on director of corporation but not the trust-like duties that evidence a technical trust); see also Villas at Bailey Springs Homeowners Ass'n v. Laricci, 2011 U.S. Dist. LEXIS 112321,* 8 (M.D. Pa. Sept. 30, 2011) (majority of recent decisions in Third Circuit have held that general fiduciary duties of corporate officers and directors are insufficient to establish fiduciary capacity under § 523(a)(4)). In any event, in responding to the Debtor's Motion, the Receiver has not asserted that the Debtor was a fiduciary by operation of law.
B. §523(a)(4) - The Non-Fiduciary Prong
In his Motion, the Receiver advances both an embezzlement theory and a larceny theory in support of his request for a determination of nondischargeability under §523(a)(4).
1. embezzlement
In his Memorandum of Law in support of his Motion, the Receiver argues that the Debtor embezzled $700,000.00 that PRSI paid to CitX pursuant to the PRSI Agreements in late 1999. According to the Receiver, the Debtor, as the CEO of CitX, was "authorized to receive and handle the funds from PRSI for the specific purpose of creating the SOHO Packages and other internet products as promised under the [PRSI] [A]greements." (Receiver's Mem. of Law at 9). The Receiver argues that because of his position and control over the corporation, the Debtor had the ability to access and direct the flow of funds into and out of CitX's corporate accounts. (Id.). The Debtor exploited his position of authority and "rather than utilizing the funds for their proper purpose, the [Debtor] and CitX wrongfully misappropriated the funds with the intent to defraud innocent customers." (Id.).
The Receiver identified two (2) disbursements CitX made on the heels of its receipt of two (2) $240,000.00 payments from PRSI in mid-December 1999. CitX made a payment of $196,773.58 to a third party to settle an unrelated lawsuit. (Id., Ex. A at 115). CitX made another payment of approximately $80,000.00 to officers and employees of CitX for salary and year end bonuses. (Id.).
Based upon these facts, the Receiver theorizes that the Debtor embezzled the funds because neither PRSI nor its customers, received the products to which they were entitled under the PRSI Agreements and the Debtor has been convicted of multiple acts of fraud. (Id.).
The Receiver's reliance on the Debtor's conviction in the U.S. District Court for the Southern District of Florida to establish the Debtor's fraudulent intent in the handling of the funds CitX received from PRSI is misplaced. The Debtor was convicted of RICO violations, conspiracy to commit mail fraud and/ or wire fraud, conspiracy to commit money laundering, and stock fraud. Although the criminal case referenced the business arrangement between CitX and PRSI, the operative set of facts that gave rise to the Debtor's conviction related to the Debtor's fraudulent misrepresentations to induce investors to purchase stock in CitX and was not based upon the funds received from PRSI. Fraudulent activity in connection with one transaction does not establish that an individual acted with fraudulent intent in a separate transaction. See Fed. R. Evid. 404(b) (evidence of other wrongful acts "is not admissible to prove the character of a person in order to show action in conformity therewith," but may be admissible for other purposes); In re Robidoux, 116 B.R. 320, 325 (D. Mass. 1990) ("Evidence admissible under Fed. R. Evid. 404(b) may assist a party in carrying its burden of persuasion but, standing alone, cannot satisfy a party's burden of going forward").
The Debtor disputes that he or CitX had any contractual obligation to use the funds received under the PRSI Agreements for any specific purpose or that he had a duty to PRSI to ensure how the funds were used. (Debtor's Opp'n to Receiver's Mot. for Summ. J. at 10). The Debtor further disputes that he had sole access to the funds in CitX's corporate accounts or that he directly benefitted from the payments made by PRSI to CitX. (Debtor's Opp'n, Roemmele Aff. ¶(23). The Debtor explains that the funds received from PRSI were entered as sales revenue in CitX's corporate records and "used to develop and provision the products and services purchased by PRSI, and used by CitX in the genera[l] operations of its business." (Id.).
As stated earlier, there are five (5) elements to a nondishchargeability claim under §523(a)(4) based on embezzlement: (1) the debtor was entrusted; (2) with property; (3) of another; (4) which the debtor misappropriated for his own use; and (5) with fraudulent intent. The Receiver has failed to meet his burden on two of the required elements of embezzlement: misappropriation and fraudulent intent.
First, the Receiver has not shown that the Debtor and/or CitX misappropriated the funds from PRSI. The Receiver alleged that the funds paid to CitX under the PRSI Agreement were required to be used solely for the creation of the SOHO's. Again, without the PRSI Agreements in evidence it is impossible to ascertain whether the funds were earmarked for a specific purpose pursuant to the contracts. See In re Belfry, 862 F.2d 661, 663 (8th Cir. 1988) (plaintiff must establish that debtor was not lawfully entitled to use funds for purposes for which they were in fact used). Furthermore, the Receiver does not cite to any other evidence, documentary or otherwise, that outlines the Debtor's or CitX's responsibilities with regard to the use of the funds.
I refer here to the Debtor and CitX interchangeably based on the "participation theory of liability." Under Pennsylvania law, a corporate officer can be held liable for the tortious acts of the corporation if the officer participated in the wrongful conduct. See e.g., In re Balko, 382 B.R. 717, 725 (Bankr. W.D. Pa. 2008); Wicks v. Milzoco Builders, Inc., 503 Pa. 614, 621 (Pa. 1983) (under participation theory, liability is not predicated on finding that corporation is mere alter ego of individual corporate officer, rather liability attaches where record establishes individual's participation in tortious activity); see also, In re Morrison, 555 F.3d 473 (5th Cir. 2009) (debtor personally liable for nondischargeable debt incurred by company he controlled). Because I conclude that no embezzlement occurred on other grounds, I need not determine whether the participation theory is applicable here.
The controlling legal principle is that "[g]enerally, when there is no security interest involved, monies received by a debtor belong to the debtor and their subsequent use by a debtor is not considered embezzlement." In re Dorado, 400 B.R. 304, 310 (Bankr. D.N.M. 2008) (quoting In re Hrim, 196 B.R. 237, 242 (Bankr. N.D.N.Y. 1993)); accord In re Storms, 28 B.R. 761, 765 (Bankr. E.D.N.C. 1983) ("Where the parties' conduct indicates a debtor-creditor relation, funds that come into the hands of the debtor belong to him and his subsequent use of them is not embezzlement"). As the party with the burden of proof, the Receiver was required to come forward with credible evidence to support his contention that the Debtor and CitX had a contractual obligation to segregate the funds and ensure that they were utilized only for the PRSI project. He has failed to meet that burden.
In fact, the only evidence in the record is to the contrary. The Debtor submitted what might be characterized as a self-serving affidavit stating that the funds were treated as general sales funds of CitX and there were no restrictions contained within the PRSI Agreements that limited CitX's use of the funds to the PRSI project. (See Debtor's Opp'n, Roemmele Aff. ¶23). The Receiver had ample opportunity to supplement the evidentiary record, rebut the Debtor's affidavit and, at the very least, create an issue of material fact. He chose not to do so.
Second, the Receiver failed to establish that the Debtor and CitX acted with fraudulent intent. With his basic premise being that the funds were to be used for the specific purpose of creating the SOHO's, the Receiver would have the court infer a fraudulent intent solely from the "fact" that no SOHO's were ever delivered.
The Receiver submitted excerpts of the deposition testimony of Frank Garone ("Garone"), a CitX executive vice president, from November 17, 2003, and Lewis B. Freeman ("Freeman"), the Receiver's predecessor, from December 12, 2003, in support of this allegation. (Receiver's Mot., Ex. B at 87, Ex. C at 40). The testimony of Garone and Freeman does not support the Receiver's allegation that no SOHO's were delivered. The deposition testimony excepts are such that it is impossible to tell with any certainty to whom or what the questions refer and have little or no evidentiary value on this issue.
The Debtor moved to "suppress" the deposition testimony of Garone arguing that he was denied the right to cross examine Garone after Garone asserted his Fifth Amendment right against self incrimination. (See Doc. #201). The Debtor's Motion to Suppress will be denied as moot because I have not relied upon Garone's testimony and I am entering a dispositive order in the Debtor's favor.
Assuming arguendo, that no SOHO's were delivered, that alone does not conclusively establish fraudulent intent on the part of the Debtor and CitX. The Debtor submitted his affidavit in opposition to the Receiver's Motion, stating that indeed CitX made preparations for the set up of an initial 16,000 cybershingle website hosting platforms that were readied for activation in late December 1999. (Debtor's Opp'n, Ex., Roemmele Aff. ¶24). The Debtor further states that "CitX provisioned approximately 8,000 Cybershingle website platforms before being order to stop providing such services by the Bucks County court, in response to the litigation efforts of the Plaintiff." (Id.). In the Bucks County complaint, the Receiver concedes as much, alleging that partial web sites were produced and relies on the fact that the Debtor and CitX began beta testing the PRSI SOHO's in late December 1999 in support of his request for an injunction. (Receiver's Mot., Ex. E, ¶ 29).
The uncontroverted evidence in the record is that the Debtor and CitX were making preparations and moving forward on construction of the SOHO's in late 1999 and there is no evidence in record that the PRSI Agreements required that certain phases of the project be completed by a scheduled time frame or that there was a date certain in which the SOHO Packages were to be completed and available for PRSI's customers. Thus, there is no evidence to permit the court to find that the Debtor and CitX had no intention of fully performing under the PRSI Agreements and therefore, misappropriated the funds received from PRSI with a fraudulent intent.
2.
Finally, the Receiver argues that the Debtor's larceny of the PRSI customer list renders the State Court Judgment nondischargeable under §523(a)(4). In support of this argument, the Receiver relies upon the CP Court's findings of fact and conclusions of law made in the Final Decree.
The CP Court found that PRSI had compiled the information comprising the customer list and provided it to CitX for use in performing its contractual obligations under the PRSI Agreements. (Receiver's Mot., Ex. F). The CP Court went on to find that the Receiver had the only right, title and interest in the customer list and CitX had wrongfully misappropriated the list and wrongfully refused to return the list to the Receiver. (Id.).
Based on the CP Court's Final Decree, the Receiver seeks to apply the doctrine of collateral estoppel to preclude the Debtor from challenging whether he or CitX committed larceny of the customer list.
Under Pennsylvania law, in order for collateral estoppel to apply, five elements must be met:
"The preclusive effect of a state court judgment in a subsequent federal lawsuit generally is determined by the full faith and credit statute, which provides that state judicial proceedings 'shall have the same full faith and credit in every court within the United States . . . as they have by law or usage in the courts of such State . . . from which they are taken.'" Marrese v. American Academy of Orthopaedic Surgeons, 470 U.S. 373, 380 (1985) (quoting 28 U.S.C. § 1738).
(1) an issue is identical to one that was presented in a prior case;
(2) there has been a final judgment on the merits of the issue in the prior case;
(3) the party against whom the doctrine is asserted was a party in, or in privity with a party in, the prior action;
(4) the party against whom the doctrine is asserted, or one in privity with the party, had a full and fair opportunity to litigate the issue in the prior proceeding; and
(5) the determination in the prior proceeding was essential to the judgment. E.g., In re Jacobs, 381 B.R. 147, 161 (Bankr. E.D. Pa. 2008) (citing Cohen v. Workers' Comp. Appeal Bd. (City of Philadelphia), 589 Pa. 498, 909 A.2d 1261, 1264 (Pa. 2006)).
If the issues determined in the CP Court's final decree include all of the elements of larceny, the State Court Judgment may be held nondischargeable in the Debtor's bankruptcy case. See In re McDowell, 2010 WL 3790318, * 5 (Bankr. E.D. Tenn. Sept. 22, 2010).
As stated earlier, larceny includes the following elements: (1) a fraudulent and wrongful taking; (2) of another's property; (3) with intent to convert; (4) without the owner's consent. The Debtor is entitled to summary judgment on this claim because the Receiver has offered no evidence that the Debtor's conduct took place with the requisite scienter (i.e., fraudulent intent).
The CP Court found that CitX "wrongfully misappropriated the Protected Data." (Receiver's Mot., Ex. F, Conclusion of Law No. 22). However, the concepts of "wrongfulness" and "fraudulent are neither the same nor interchangeable. For example, a misappropriation of another party's property that occurs due to a good faith dispute about the parties' respective contractual rights may be "wrongful" in the sense that the conduct violates a contractual obligation. But the mere "wrongful" breach of contract does not establish that the party had the specific intent to commit larceny, as required under §523(a)(4). See In re Graham, 194 B.R. 369, 374 (Bankr. E.D. Pa. 1996) (suggesting that the larceny prong of §523(a)(4) requires proof of a specific intent to defraud).
Here, the CP Court merely found the CitX appropriation of PRSI's property "wrongful" and made no findings regarding the Debtor's state of mind. Indeed, it does not appear that the Debtor's intent in refusing to return the Protected Data to PRSI was even an issue that was "actually litigated" in the CP Court litigation. Thus, the CP Court's findings provide no factual support for the scienter element of the nondischargeability claim for larceny under §523(a)(4).
Under Pennsylvania law, to prevail on a claim for a permanent injunction, a plaintiff must prove a "clear right to relief" for an injury that cannot be compensated by an award of damages. Wellspan Health v. Bayliss, 869 A.2d 990, 995 (Pa. Super. Ct. 2005).
Because the Receiver relies solely on the potential preclusive effect of the CP Court decision and the decision did not address the scienter requirement, the Receiver has not met his burden on one of the elements of the larceny theory. In effect, there is no evidence from which a reasonable factfinder could conclude that CitX's misappropriated the Protected Data with the specific intent of converting PRSI's property. The existing record establishes nothing more than that PRSI defeated CitX and the Debtor in a contractual dispute.
Nor does it appear that a finding regarding the Debtor's scienter was "necessary" to the court's decision. See generally Ginsburg ex rel. The Vertical Group v. Birenbaum, 2009 WL 304045, at *7 (W.D. Pa. Feb. 9, 2009) (collateral estoppel does not apply unless it is apparent on record that prior court's determination was "critical and necessary" to its decision).
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V. CONCLUSION
For the reasons set for above, the Receiver did not meet his evidentiary burden of proving that any debt owed to him by the Debtor should be held nondischargeable under §523(a)(4). Accordingly, the Debtor's Motion for Summary Judgment will be granted and the Receiver's Motion for Summary Judgment will be denied. An appropriate order will be entered.
ERIC L. FRANK
U.S. BANKRUPTCY JUDGE