Opinion
22-31221 Adv. 23-3003
08-28-2023
In re: EARL G. HARRIS JEANETTE C. HARRIS, Debtor. v. Jeanette C. Harris, Defendant. Ohio Attorney General, Plaintiff,
Chapter 7
DECISION GRANTING IN PART AND DENYING IN PART DEFENDANT'S MOTION TO DISMISS COMPLAINT TO DETERMINE DISCHARGEABILITY (DOC. 10)
GUY R. HUMPHREY, UNITED STATES BANKRUPTCY JUDGE
This matter is before the court on Defendant's Motion to Dismiss Complaint to Determine Dischargeability Pursuant to 11 U.S.C. § 523(a)(7) for Judgment on State Law Claim ("Motion") (doc. 10); Response and Memorandum in Opposition of Plaintiff State of Ohio to Defendant Harris' Motion to Dismiss ("Response") (doc. 16); and Defendant's Reply to Plaintiff's Response to Defendant's Motion to Dismiss Complaint to Determine Dischargeability Pursuant to 11 U.S.C. § 523(a)(7 ) ("Reply") (doc. 21). The defendant, Jeannette Harris, asks the court to dismiss this adversary proceeding because the claims raised by the plaintiff, the State of Ohio, are not covered under Bankruptcy Code § 523(a)(7) and the statutory deadline to raise them under § 523(a)(4) has passed. For the reasons stated, the court grants the Motion as to Count I and denies the Motion as to Counts II-IV.
I. Jurisdiction
This court has jurisdiction to determine this adversary proceeding pursuant to 28 U.S.C. § 1334(b), and the standing General Order of Reference in this district entered in accordance with 28 U.S.C. § 157(a). The matter is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(A) and (I) and the court has Constitutional authority to determine the matter. Stern v. Marshall, 564 U.S. 462 (2011).
II. Procedural History
Debtor Jeannette Harris ("Harris") and her husband filed a joint bankruptcy petition under Chapter 7 on August 31, 2022. The State of Ohio ("the State") later commenced this adversary proceeding and filed its Complaint to Determine Dischargeability Pursuant to 11 U.S.C. § 523(a)(7) for Judgment on State Claims ("the Complaint") (doc. 1). Harris filed a motion to strike certain exhibits attached to the complaint (doc. 8), which this court previously denied (doc. 18), and the instant motion to dismiss the complaint (doc. 10). The State has indicated that it intends to voluntarily dismiss the first count, a strict liability claim based on Ohio Revised Code § 9.39. Docs. 16. After the parties completed briefing, the court took the matter under advisement.
III. Factual Background
From approximately 2008 to 2012, Harris was involved in the operation and management of several public community schools known as the Richard Allen Academies ("the Schools") and two related management entities, the Institute of Management and Resources ("IMR") and the Institute of Charter School Management and Resources ("ICSMR") (collectively, "the Management Entities"). Doc. 1, ¶¶ 5, 8, 14-19. Harris helped to found the Schools and Management Entities and held executive roles within these organizations during this time period. Id. Specifically, Harris formed the Schools' corporate entities, filed documents with the Ohio Secretary of State and the Internal Revenue Service that identified her as the Schools' president, and exercised control over the Schools' finances. Id. at ¶ 8. During the same time period, Harris also held positions as IMR's CEO, president, and director. Id. at ¶ 17. Harris signed contracts between the Schools and IMR on behalf of IMR. Id. at ¶¶ 8, 17. Harris also served as the president of ICMSR during this time. Id. at ¶ 19. Both the Schools and the Management Entities identified Harris as a president and officer on filings submitted to the Internal Revenue Service during the relevant time period. Id. at ¶¶ 8, 17, 19.
The Management Entities held contracts to provide services to the Schools and were paid for those services with public funds. Id. at ¶¶ 14-19. These contracts were awarded without a competitive bidding process. Id. at ¶ 15. IMR acted as the management company for each of the Schools from July 1, 2006 to June 30, 2012 and received $19,834,985.34 in payments during that time. Id. at ¶ 14. ICMSR held lease contracts with the Schools and received payments for lease-related services. Id. at ¶ 18. During Harris' tenure, annual and special audits of the Schools conducted by the Ohio Auditor of State ("the Auditor") concluded that the Management Entities received overpayments of public funds during the 2008-2012 fiscal years. Id. at ¶¶ 20-27. The Auditor subsequently issued Findings for Recovery against the Management Entities, the Schools' treasurer, and a bonding company. Id.
In November 2017 the Ohio Attorney General sued Harris, the Management Entities, and other parties in the Montgomery County Court of Common Pleas (the "State Court" and the "State Court Litigation"). Id. at ¶ 7; Doc. 16 at 4-6; Doc. 10 at 2-3 (citing State ex. rel. Ohio Attorney General v. Jeanette Harris et al., Case No. 2017-CV-05140). After Harris filed her bankruptcy petition, the State dismissed her from the State Court Litigation without prejudice and asked the state court to continue the case without Harris. Doc. 16 at 5-6.
The State Court entered an order staying the State Court Litigation on October 13, 2022 due to Harris' bankruptcy filing.
IV. Standard for Motion to Dismiss for Failure to State a Claim Upon Which Relief Can Be Granted
Rule 12(b)(6), incorporated here by Federal Rule of Bankruptcy Procedure 7012(b), allows a defendant to move to dismiss a complaint for failure to state a claim upon which relief can be granted. Fed.R.Civ.P. 12(b)(6). To survive the motion, a complaint need only contain "a short and plain statement" of facts sufficient to support a plausible claim for relief. Fed.R.Civ.P. 8(a)(2); Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). Detailed factual allegations are not required at this stage. Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555 (2007). When determining whether to grant a motion to dismiss, the court accepts all factual allegations pled in the complaint as true and makes any inferences in favor of the non-moving party. DBI Invs., LLC v. Blavin, 617 Fed.Appx. 374, 380 (6th Cir. 2015). However, the court does not afford such treatment to conclusory statements or claims that amount to "[t]hreadbare recitals of the elements of a cause of action." Iqbal, 556 U.S. at 678.
V. Legal Analysis
The Complaint asserts four counts - (1) strict liability under Ohio Revised Code § 9.39, (2) breach of fiduciary duty, (3) the faithless servant doctrine, and (4) nondischargeability under § 523(a)(7) (Counts II & III are herein referred to as "the State Law Claims"). The State has since conceded the first count. Doc. 16 at 1 ("The State intends to voluntarily dismiss the strict liability claims based on R.C. 9.39."). Harris argues that the State has failed to state a claim upon which relief can be granted because its nondischargeability claim is not covered by § 523(a)(7) and cannot be brought under the correct subsection - § 523(a)(4) - because the statutory time to do so has now expired. The court will address each of these contentions in turn.
The third count is incorrectly labelled as "Count II." In this decision, the court will refer to the breach of fiduciary claim as Count II, and the faithless servant doctrine claim as "Count III."
At the outset, however, the court notes that Harris' Motion does not directly challenge whether the Complaint adequately states claims for breach of fiduciary duty or recovery under the faithless servant doctrine. Harris never addresses whether she was a fiduciary or breached a duty owed to the Schools. Harris instead argues that the State Law Claims cannot be found nondischargeable under § 523(a)(7) because it is inapplicable - the claims fall under subsection (a)(4) exclusively. And the time to bring an (a)(4) claim has now expired. The State contends that its claims are properly raised under § 523(a)(7), and thus the § 523(c) deadline is irrelevant. As explained below, the court agrees with the State. However, because the pleading adequacy of the State Law Claims is foundational to determining that of the nondischargeability claims, the court will begin by addressing them.
A. The Complaint Sufficiently States a Claim for Breach of Fiduciary Duty
The elements for breach of fiduciary duty include: "(1) the existence of a fiduciary duty; (2) the failure to observe the duty; and (3) an injury resulting proximately therefrom." DPLJR, Ltd. v. Hanna, 8th Dist. Cuyahoga, No. 90883, 2008-Ohio-5872, ¶ 19 (Ohio Ct. App. 2008) (citing Strock v. Pressnell, 527 N.E.2d 1235, 1243 (Ohio 1988)); see Liquidating Tr. of the Amcast Unsecured Creditor Liquidating Tr. v. Baker (In re Amcast Indus. Corp.), 365 B.R. 91, 110 (Bankr. S.D. Ohio 2007) (similar). "A fiduciary is a person having a duty, created by his undertaking, to act primarily for the benefit of another in matters connected with his undertaking." Lutz v. Chitwood, 337 B.R. 160, 172 (S.D. Ohio 2005) (quoting Strock, 527 N.E.2d at 1243-244)) (internal quotation marks omitted); see Hanick v. Ferrara, 161 N.E.3d 1, 22 (Ohio Ct. App. 2020) (similar). A fiduciary relationship encompasses "a duty of good faith, a duty of loyalty, a duty to refrain from self-dealing, and a duty of disclosure." Maas v. Maas, 161 N.E.3d 863, 872 (Ohio Ct. App. 2020); see Unencumbered Assets, Tr. V. JP Morgan Chase Bank (In re Nat'l Century Fin. Enters.), 617 F.Supp.2d 700, 718 (S.D. Ohio 2009) (stating that a "corporate officer . . . has a fiduciary relationship to the corporation and carries a duty not to waste or mismanage corporate funds."). Further, an employee has a duty to act "in the utmost good faith and loyalty toward his . . . employer." Berge v. Columbus Community Cable Access, 736 N.E.2d 517, 549 (Ohio Ct. App. 1999) (quoting Connelly v. Balkwill, 116 N.E.2d 701. 707 (Ohio 1954)).
The Complaint alleges that Harris was an officer or employee of the Schools from at least 2008 to 2012 and was highly compensated for her work. Doc. 1, ¶¶ 8, 35-42. Her relationship with the Schools was that of a fiduciary. Id. at ¶ 43. Harris breached her fiduciary duty to the Schools when she acted as an executive of the Management Entities, accepted compensation from the Management Entities, and took actions on their behalf contrary to her fiduciary duty to the Schools. Id. at ¶¶ 51-53. During her tenure, the Schools mismanaged public funds and failed to abide by State law. Id. at ¶¶ 20-27, 52-53. In addition, the Management Entities were awarded contracts without a competitive bidding process. Id. at ¶ 15. The Schools and the State were injured when the Management Entities received overpayments of public funds. Id. at ¶¶ 25-26, 51-53. Because the State has sufficiently pled facts which, if true, support each element of a breach of fiduciary duty claim, the court denies Harris' motion to dismiss Count II of the Complaint.
B. The Complaint Sufficiently States a Faithless Servant Doctrine Claim
In Ohio, the faithless servant doctrine is a theory of recovery which "requires a disloyal and deceitful employee to forgo his compensation during such period of 'faithlessness.'" Sun Bldg. Ltd. P'ship v. Value Learning & Teaching Acad., Inc., 175 N.E. 3d 10, 24 (Ohio Ct. App. 2021) (quoting Fin. Dimensions, Inc. v. Zifer, Nos. C-980960 and C-980993, 1999 Ohio App. LEXIS 5879, at *25, 1999 WL 1127292, at *8 (Ohio Ct. App. Dec. 10, 1999)). To state a claim for recovery under this doctrine, the plaintiff must allege facts demonstrating (1) that the defendant was an employee or agent of the principal, (2) that the employee acted in breach of the duty of loyalty, (3) and that the employee received compensation during this time period. Sun Bldg. Ltd. P'ship v. Value Learning & Teaching Acad., No. A1404504, 2018 Ohio Misc. LEXIS 2, at *25-26, 2018 WL 1678061, at *10-11 (Ohio Com. Pl. Mar. 26, 2018), aff'd in part and rev'd in part on other grounds, 175 N.E. 3d 10 (Ohio Ct. App 2021). The plaintiff need not demonstrate specific intent to defraud or actual harm to the principal. Id. The faithless servant doctrine is applicable to corporate officers and community school officials. Id. (citing Bd. of Educ. of Theodore Roosevelt Pub. Cmty. Sch. v. Conners, No. A1204384, 2014 Ohio Misc. LEXIS 91, at *13 (Ohio Ct. Com. Pl. July 25, 2014)).
The Complaint alleges that Harris was an employee and officer of the Schools who received compensation from the Schools, and that she took actions in breach of her duty of loyalty while employed. Doc. 1, ¶¶ 34-56. Harris acted adversely to her employer's interests when she acted as the president of the Management Entities while simultaneously employed by the Schools. Id. During that time, the Management Entities were awarded service contracts with the Schools without participation in a competitive bidding process and received improper disbursements of public funds. Id. Because the State has sufficiently supported this count, the motion to dismiss is denied as to the third count.
C. The State's § 523(a)(7) Claim Is Sufficiently Pled
The Sixth Circuit has articulated a three-pronged test to determine whether a debt is nondischargeable under § 523(a)(7). The debt (1) "must be for a fine, penalty, or forfeiture"; (2) "must be payable to and for the benefit of a governmental unit"; and (3) must not be "compensation for actual pecuniary loss." Ohio v. Lee (In re Lee), 611 B.R. 303, 309 (Bankr. S.D. Ohio 2019) (quoting In re Hollis, 810 F.2d 106, 108 (6th Cir. 1987)) (emphasis added); see also Richmond v. N.H. Supreme Court Committee On Prof. Conduct, 542 F.3d 913, 917 (1st Cir. 2008)) (similar). The State has sufficiently pled facts to plausibly demonstrate that it holds an unliquidated claim which would be payable to the State of Ohio, a governmental unit. Because the State's claims have not yet been liquidated, it is impossible for the State to plead specific facts demonstrating the context of any judgment on those claims that would support its assertion that an award would not be compensation for actual pecuniary loss. See generally Lee, 611 B.R. at 309-12. However, because the court finds that the State has adequately pled facts to support the underlying State Law Claims and established a sufficient legal basis to conclude that these claims, once liquidated, would be nondischargeable under § 523(a)(7), the court denies Harris' motion to dismiss the fourth count.
D. The Court Will Not Determine Whether the State's Claims are Nondischargeable as a Matter of Law
To the extent that the State, in its Response, invites the court to determine that faithless servant doctrine claims asserted by a governmental unit are in general nondischargeable under § 523(a)(7), the court declines to do so. The third prong of the § 523(a)(7) test requires the court to "look to the context in which the penalty [was] imposed to determine whether its purpose is truly compensatory." Disciplinary Bd. v. Feingold (In re Feingold), 730 F.3d 1268, 1275 (11th Cir. 2013); see SEC v. Hodge (In re Hodge), 216 B.R. 932, 936-38 (Bankr. S.D. Ohio 1998) (determining that a civil penalty and disgorgement debt owed to the SEC were nondischargeable under § 523(a)(2)(a) and (a)(7) after a court adjudicated the litigation and entered a finding of fraud); Lee, 611 B.R. at 308-09 (noting that the state court had entered judgment on the faithless servant doctrine claim and other claims after substantial litigation in which the debtors actively participated). This context includes the nature of the proceeding, any findings made by a trial court or agency, the purpose or benefit of the award or judgment, and to whom the amount will be paid. See New Hampshire v. Dargon (In re Dargon), 638 B.R. 25, 29-32 (Bankr. D. Mass. 2022) (determining that an administrative restitution order was dischargeable because it was payable to the impacted individuals rather than to a government entity); Jellinek v. Forlander (In re Jellinek), 645 B.R. 293, 296 (Bankr. S.D. Cal. 2022) (discussing the criminal or civil nature of a proceeding that resulted in a restitution order as part of the (a)(7) nondischargeability analysis); Norton v. Town of S. Windsor (In re Norton), 622 B.R. 538, 551 (Bankr. D. Conn. 2020) (stating that the court "weighed the particular circumstances surrounding the penalty assessed" in determining nondischargeability). Because the claims have not yet been liquidated, the court cannot conclude that they are nondischargeable as a matter of law.
E. The State Law Claims Are Not Time Barred
Harris asserts that the State's breach of fiduciary duty and faithless servant doctrine claims can be asserted only under § 523(a)(4) and are not covered by § 523(a)(7). While these claims might have been excepted from discharge under § 523(a)(4), Harris contends that they are now barred under that subsection because the State filed the instant dischargeability action after the deadline for §523(a)(4) claims expired. See Fed.R.Bankr.P. 4007(c) ("[A] complaint to determine the dischargeability of a debt under § 523(c) [applicable to § 523(a)(2), (4), and (6) claims] shall be filed no later than 60 days after the first date set for the meeting of creditors . . . .").
Bankruptcy Code § 523 states in relevant part:
(a) A discharge under section 727 . . . does not discharge an individual debtor from any debt-
(4) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny;
(7) to the extent such debt is for a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit, and is not compensation for actual pecuniary loss, other than a tax penalty-
(A) relating to a tax of a kind not specified in paragraph (1) of this subsection; or
(B) imposed with respect to a transaction or event that occurred before three years before the date of the filing of the petition[.]11 U.S.C. § 523(a)(4) and (7). Harris argues that because the State's claims could have been filed under § 523(a)(4), they cannot be brought under (a)(7). This is incorrect. In Andrews v. Michigan Unemployment Insurance Agency, the Sixth Circuit rejected this argument and concluded that claims which are covered by multiple subsections of § 523(a) may be brought under either applicable provision. 891 F.3d 245, 250-51 (6th Cir. 2018). The court explained:
[A]side from the general proposition that nondischargeability provisions should be construed against creditors, Debtors cite no authority for the proposition that a particular debt may be covered by only one of § 523(a)'s subsections. To the contrary, Husky International Electronics, Inc. v. Ritz, 136 S.Ct. 1581, 194 L.Ed.2d 655 (2016), makes clear that the various subsections of § 523(a) are not necessarily mutually exclusive. . . . [T]he debt can be both nondischargeable under § 523(a)(2) and dischargeable under § 523(a)(7). . . . Subsection 523(a)(2) provides that "any debt" arising from fraud is excepted from discharge. A finding
that the debt here arises from fraud perpetuated against the Agency makes § 523(a)(2) applicable in these cases. Thus, because the debt falls into § 523(a)(2), it is nondischargeable as "any debt" arising from fraud, regardless of whether the debt could also fit under § 523(a)(7).Id. at 250-51. When a government entity holds a claim for a breach of fiduciary duty by a government official, subsections (a)(4) and (a)(7) may be equally applicable. But this conclusion does not render either subsection superfluous. See Husky International Electronics, Inc. v. Ritz, 578 U.S. 355, 364 (2016) (stating that a dual coverage interpretation of § 523(a) does not create redundancy because the two subsections can still be read as "meaningfully different"). Subsection (a)(4) broadly addresses claims that might arise in both public and private settings but is also limited in that it applies only when a claim arises from a breach of fiduciary duty. In contrast, subsection (a)(7) addresses penalties assessed by government entities because there is a public interest in punishing offenders and deterring future offenses. Thus, a claim falling under both subsections may be pled under either, and the fact that the limitations period has expired as to one of those subsections does not preclude the pursuit of the claim under the alternative subsection.
VI. Conclusion
For these reasons, the motion to dismiss is granted as to Count I but denied as to the remaining counts. The court will enter a separate order consistent with this decision.
Copies to:
Counsel for Plaintiff Jeanette C. Harris, 3300 Governors Trail, Kettering, Ohio 45409 (Defendant)
Courtesy Copy to:
Myers & Frayne Co., LPA, 18 W. First Street #200, Dayton, Ohio 45402