Opinion
21-21106 Adv. Proc. 21-02031
08-29-2022
The Matter of: Clifford D. Morgan, Debtor. v. Clifford D. Morgan, Defendant. TLS Management and Marketing Services, LLC, Plaintiff,
OPINION AND ORDER ON MOTION TO DISMISS AMENDED COMPLAINT
Paul E. Singleton Judge
For the first three years, the parties' confidential, non-compete agreement went as planned. Debtor Clifford Morgan referred clients to TLS Management and Marketing Services, LLC. In exchange, TLS paid referral fees to Morgan. Then, Morgan stopped sending clients to TLS. TLS sued Morgan in Illinois state court alleging one count - breach of contract. It won a $1.2 million dollar default judgment. Shortly thereafter, Morgan filed a chapter 7 bankruptcy petition.
Now, in this adversary proceeding, TLS cites two theories under 11 U.S.C. § 523 to except the judgment from discharge. First, it cites § 523(a)(4), which excepts debts from discharge when a debtor commits: fraud or defalcation in a fiduciary capacity, embezzlement, or larceny. Second, it cites § 523(a)(6), which excepts willful and malicious conduct from discharge.
Unless noted otherwise "§" or "section" refers to 11 U.S.C., the United States Bankruptcy Code.
Morgan filed a motion to dismiss the original Complaint. The Court granted that motion but gave TLS leave to amend the Complaint. TLS filed the Amended Complaint. Now, Morgan moves to dismiss, with prejudice, the Amended Complaint. The Court grants Morgan's motion for the following three reasons:
(1) Both counts fall short of what Twombly, Iqbal, and the Seventh Circuit require.
(2) The intangible property in the agreement is not the type of property that can be converted. Therefore, the Court dismisses TLS's § 523(a)(4) larceny and embezzlement claims in Count I.
(3) On Count II, TLS's § 523(a)(6) claim, Morgan's breach of the agreement, without more, is a breach of contract and not "willful" or "malicious" conduct.
The Amended Complaint is the second complaint filed in this case. The Court dismissed the first Complaint without prejudice and gave TLS a roadmap on how to cure the original Complaint's deficiencies. TLS did not address those shortcomings. Giving TLS an additional chance to do so would be indulging a repeated failure to cure deficiencies. Therefore, the Court dismisses this case with prejudice.
I. Jurisdiction and Venue
This is an adversary proceeding, and the Court has jurisdiction under the following:
(1) 28 U.S.C. § 1334(b) (discussing district court jurisdiction over cases arising out of title 11);
(2) 28 U.S.C. § 157(a) and (b) (discussing referral of cases to bankruptcy courts and permitting bankruptcy judges to hear core proceedings);
(3) N.D. Ind. L.R. 200-1(a) (referring bankruptcy cases filed in the Northern District of Indiana to the bankruptcy court); and
(4) 28 U.S.C. § 151 (explaining bankruptcy court is a unit of district court).
This adversary proceeding is a core proceeding under 28 U.S.C. § 157(b)(2)(I) (giving bankruptcy judges the ability to determine the dischargeability of particular debts). Venue is properly placed in this Court, consistent with 28 U.S.C. § 94(a) (discussing divisions within the Northern District of Indiana) and N.D. Ind. L.B.R. B-1073-1 (addressing assignment of bankruptcy cases within this district).
II. Facts
The Court divides this fact section into two parts: (A) the facts leading to the state court judgment and (B) the facts in the complaints filed in this Court. Since this is a motion to dismiss, the Court accepts well-pleaded facts from the Amended Complaint as true and views them in the light most favorable to TLS. Demkovich v. St. Andrew the Apostle Par., Calumet City, 3 F.4th 968, 973 fn. 2 (7th Cir. 2021) (citing White v. United Airlines, Inc., 987 F.3d 616, 620 (7th Cir. 2021)); see also Gray v. Dane Cnty., 854 F.2d 179, 182 (7th Cir. 1988) ("[C]ourts must presume that all facts fairly alleged in the complaint are true."). However, "legal conclusions and conclusory allegations merely reciting the elements of the claim are not entitled to this presumption of truth." McCauley v. City of Chicago, 671 F.3d 611, 616 (7th Cir. 2011) (citation omitted).
A. Facts leading to judgment in Illinois state court
1. TLS's predecessor
Tax Law Solutions, LLC, which would later become TLS Management and Marketing Services, LLC, was located in Illinois and provided tax analysis, tax planning, and related services. [Amend. Compl., DE 28 at ¶¶ 1, 4.] In 2014, it merged with TLS Management and Marketing Services. The surviving company uses the name TLS Management and Marketing Services. [Id. at ¶ 4.] Unless noted otherwise, the Court will refer to both parties as "TLS." As successor, TLS has Tax Law's rights and obligations, including the rights under the "Confidentiality and No-Competition Agreements" (the "agreement" or "contract").
2. TLS's provision of "Confidential Information"
In June 2011, Morgan signed the agreement. [Amend. Compl.'s Exh. A, State Ct. Compl., DE 28-1 at p. 22.] TLS provided Morgan with "Confidential Information." [Id. at p. 4, ¶¶ 11-12.]
TLS did not sign the agreement. [Amend. Compl., DE 28-1 at p. 22.]
The Court will use "Confidential Information" as a term of art and with capital letters, the same way the parties defined and used it in the contract. [DE 28-1 at pp. 18-19, ¶¶ 1.2.1, 1.2.2; 1.2.3.] When the Court writes "confidential information," with lower case letters, the Court is quoting the way TLS wrote it in its Amended Complaint. [DE 28 at p. 4.]
The Confidential Information included things such as: business methods and procedures, prospective clients and agent lists, marketing channels and relationships, technical information, business plans, and identities of contractors and consultants. [Id. at p. 4.] The Confidential Information also included, a "copyrighted binder filled with hundreds of pages of Tax Law Solutions, LLC's specific tax-planning strategies, as well as implementation documents for those tax-planning strategies, sales materials and techniques, and contract templates." [Id. at p. 5.] In addition to giving Morgan Confidential Information, TLS trained Morgan to understand tax and financial planning techniques. [Id. at p. 4, ¶ 11.] This training would allow him to solicit prospective clients for TLS. [Id. at p. 5.] Morgan would then refer clients to TLS. [DE 28 at ¶¶ 13-15.]
3. Governing law
The agreement provides in that, in the event of a dispute, Illinois law governs. [DE 28-1 at p. 22, ¶ 4.11.]
4. Breaking the agreement
Initially, from June 2011 to July 2014, Morgan performed under the agreement. [Id. at pp. 2, 6.] Then, he broke the contract when he failed to solicit clients for and refer them to TLS. [Id. at p. 6, ¶¶ 21-24.] Morgan used TLS's videos to promote the same tax planning and related services TLS offered and continued to use TLS's Confidential Information. [DE 28 at ¶¶ 5, 23; DE 28-1 at pp. 5-6, ¶¶ 18, 19, 22.]
5. TLS's default judgment in state court
TLS sued Morgan in state court in DuPage County, Illinois. [DE 28 at ¶ 5.] The state court complaint alleged one count against Morgan - breach of contract. [DE 28-1 at pp. 2-3.] That complaint did not allege fraud, defalcation, embezzlement, larceny, theft, conversion, or willful or malicious conduct. [Id.] The state court complaint included the parties' contract as an exhibit. [DE 28-1 at pp. 18-22.] TLS won a $1.2 million default judgment against Morgan. [DE 28 at ¶¶ 7-9; State Ct. Judgment, DE 28-2 at p. 2.]
B. The first Complaint and Amended Complaint in this Court
1. Dismissal of first Complaint without prejudice
TLS's first Complaint alleged the $1.2 million dollar judgment it obtained against Morgan should be excepted from discharge on three grounds: (1) fraud, under § 523(a)(2); (2) fraud, embezzlement, or larceny under § 523(a)(4); and/or (3) willful and malicious conduct under § 523(a)(6). [Compl., DE 1.] Morgan moved to dismiss the Complaint with prejudice. [Amended Mot. to Dismiss, DE 14; Amend. Brief, DE 15.]
The Court granted Morgan's motion and explained its reasoning, including highlighting the issues with TLS's dischargeability claims. [Op. and Order, DE 26 at pp. 1, 3-9.] The Court explained, that for § 523(a)(4) arguments, the three types of fraudulent activity plaintiffs could allege are (1) fraud or defalcation while acting in a fiduciary capacity, (2) embezzlement, or (3) larceny. [Id. at pp. 7-9.] The Court granted Morgan's motion to dismiss but gave TLS leave to file an amended complaint. [Id. at p. 1.]
2. The two-count Amended Complaint
In the Amended Complaint, TLS alleges the Court should not discharge Morgan's debts in accordance with § 523(a)(4) and § 523(a)(6). [DE 28 at pp. 3, 4.]
a) Count I: section 523(a)(4)
TLS lists facts it claims demonstrate Morgan violated § 523(a)(4) (which excepts debts from discharge when a debtor commits: fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny). Those facts are the following:
(1) Morgan misappropriated and "intentionally and fraudulently" used TLS's "training materials, confidential information, copyrighted materials, implementation strategies, [and] sales materials" without TLS's permission. [Id. at ¶¶ 6, 14, 16.]
(2) Morgan did not return "confidential information, and similar such actions raised in the [state court] Complaint." [Id. at ¶ 6.]
(3) TLS "entrusted" Morgan with confidential information, which included, "voluminous, copyrighted binder containing hundreds of pages of documents, thereby allowing Defendant to implement tax-planning strategies, market Defendant's business, and generate business for Defendant and Plaintiff." [Id. at ¶¶ 12-13.]
(4) Morgan had no right to use the confidential information unless he was working with or for TLS. [Id. at ¶ 16.]
(5) TLS "justifiably relied upon Defendant's false representations." [Id. at ¶ 17.]
b) Count II: section 523(a)(6)
For its § 523(a)(6) claim (which excepts debts from discharge for willful and malicious behavior), TLS alleges:
(6) Morgan had no right to use the confidential information to market or advertise tax planning services without referring clients to TLS. [Id. at ¶¶ 20, 21, 24.]
(7) Morgan created "the image that Defendant, despite failing to generate business for Plaintiff, was actively working and not in the breach of the parties' agreement." [Id. at ¶ 24.]
(8) "Defendant was aware, having signed the parties' agreement, that such information was confidential." [Id. at ¶ 25.]
(9) "Defendant's actions were intentional and willful and done with the malicious intent to deceive Plaintiff into believing that Defendant was not in breach of the parties' agreement." [Id. at ¶ 26.]
(10) "Such actions were in conscious disregard of Defendant's duties under the parties' agreement and constitutes conversion and theft under Indiana law." [Id. at ¶ 27.]
(11) "Such actions were done with the intent to deceive Plaintiff into believing that Defendant had not absconded its duties under the parties' agreement." [Id. at ¶ 28.]
Some of the facts listed in Count II seem like they could apply to the facts in Count I. For example, TLS states Morgan disregarded his duties and committed theft, and conversion, under Count II, its § 523(a)(6) claim. These facts seem like they could apply to fraud while acting in a fiduciary capacity, embezzlement, or larceny. These actions would be § 523(a)(4) claims. In the Analysis portion of this Opinion, the Court will address each of these 11 allegations. Infra IV(A)(1) at Table 3.
Fraud is defined below. Infra III(C)(1).
Both embezzlement and larceny are defined below. Infra III(C)(2) and (3) respectively.
III. Rules, Principles, and Statues
A. Federal Rules of Bankruptcy Procedure and Federal Rules of Civil Procedure
1. Fed. R. Bank. P. 7008 and Fed.R.Civ.P. 8
Under Fed. R. Bank. P. 7008, Fed.R.Civ.P. 8 applies to adversary proceedings. Rule 8(a)(2) provides, "[a] pleading that states a claim for relief must contain a short and plain statement of the claim showing that the pleader is entitled to relief." See also E.E.O.C. v. Concentra Health Servs., Inc., 496 F.3d 773, 776 (7th Cir. 2007).
2. Fed. R. Bank. P. 7009 and Fed.R.Civ.P. 9
Fed. R. Bank. P. 7009 states Fed.R.Civ.P. 9 applies to adversary proceedings. Rule 9 addresses pleading special matters, and 9(b) addresses fraud. Rule 9(b) states, "[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake." See also AnchorBank, FSB v. Hofer, 649 F.3d 610, 615 (7th Cir. 2011).
3. Fed. R. Bank. P. 7012 and Fed.R.Civ.P. 12(b)(6)
Pursuant to Fed. R. Bank. P. 7012, Fed.R.Civ.P. 12 applies to adversary proceedings. Rule 12(b)(6) states a party may move to dismiss a case "for failure to state a claim upon which relief can be granted." See also Concentra Health Servs., Inc., 496 F.3d at 776. The moving party has the burden of persuasion. Marcure v. Lynn, 992 F.3d 625, 631 (7th Cir. 2021).
4. Fed. R. Bank. P. 7015 and Fed.R.Civ.P. 15
Fed. R. Bank. P. 7015 states Fed.R.Civ.P. 15 applies to adversary proceedings. Rule 15(a)(2) addresses amended pleadings and states courts "should freely give leave [to amend] when justice so requires." The Supreme Court stated, "this mandate is to be heeded." Foman v. Davis, 371 U.S. 178, 182 (1962). The Seventh Circuit explained, "[o]rdinarily, however, a plaintiff whose original complaint has been dismissed under Rule 12(b)(6) should be given at least one opportunity to try to amend her complaint before the entire action is dismissed." Runnion ex rel. Runnion v. Girl Scouts of Greater Chicago & Nw. Indiana, 786 F.3d 510, 519 (7th Cir. 2015).
Still, district courts "have broad discretion to deny leave to amend where there is undue delay, bad faith, dilatory motive, repeated failure to cure deficiencies, undue prejudice to the defendants, or where the amendment would be futile." Gonzalez-Koeneke v. West, 791 F.3d 801, 807 (7th Cir. 2015) (quoting Arreola v. Godinez, 546 F.3d 788, 796 (7th Cir. 2008)). Plaintiffs who fail to cure their complaints' deficiencies, after trial courts grant them leave to do so, may have their case dismissed. Lee v. Ne. Illinois Reg'l Commuter R.R. Corp., 912 F.3d 1049, 1051, 1053 (7th Cir. 2019) (affirming trial court's decision to deny plaintiff's request to file a third amended complaint).
B. General bankruptcy principles
1. Fresh start and how to construe § 523(a)
The Supreme Court and the Seventh Circuit explain the purpose of bankruptcy and § 523(a). First, the Supreme Court stated: "One of the main purposes of the federal bankruptcy system is to aid the unfortunate debtor by giving him a fresh start in life, free from debts, except of a certain character." Lamar, Archer & Cofrin, LLP v. Appling, 138 S.Ct. 1752, 1758 (2018) (internal quotation marks and alterations omitted). The Seventh Circuit explained § 523(a) of the Bankruptcy Code lists eighteen categories of debts that are excepted from discharge. Matter of Crosswhite, 148 F.3d 879, 881 (7th Cir. 1998). Generally, courts "construe the statute strictly against the objecting creditor and liberally in favor of the debtor in order to give the debtor a better chance at a fresh start." Id. at 881; In re Trentadue, 837 F.3d 743, 749 (7th Cir. 2016) ("In our analysis, however, we remember that 'exceptions to discharge are to be [construed] strictly against a creditor and liberally against the debtor.'") (alterations in the original).
2. Simple breach of contract claims and dischargeability
Normally, a pre-petition, breach of contract debt is dischargeable. See generally In re Case, 636 B.R. 852, 865 (Bankr. S.D. Fla. 2022); In re Baker, No. 7-07-12292 SR, 2008 WL 753738, at *4 (Bankr. D. N.M. Mar. 19, 2008) ("Breach of covenant not to compete was not willful and malicious so debt arising therefrom was dischargeable.") (internal citation omitted). If a debt is discharged, a creditor may not collect on that debt. Section 524(a)(1).
C. Dischargeability under § 523(a)(4): fraud or defalcation, embezzlement, or larceny
For § 523(a)(4) claims, plaintiffs must prove there was: (a) fraud or defalcation while acting in a fiduciary capacity, (b) embezzlement, or (c) larceny. These are separate, distinct causes of action with different elements. In re Suhadolnik, No. ADV 08-7115, 2011 WL 2413561, at *4 (Bankr. C.D. Ill. June 15, 2011).
1. Fraud or defalcation claim: fiduciary relationship required
For a fraud or defalcation claim under § 523(a)(4), plaintiffs must show there was a fiduciary relationship. Stoughton Lumber Co. v. Sveum, 787 F.3d 1174, 1175-76 (7th Cir. 2015). Federal law determines whether a fiduciary relationship exists. In re McGee, 353 F.3d 537, 540 (7th Cir. 2003). "The fiduciary capacity required by § 523(a)(4) requires something more than a debtor-creditor relationship." In re Brown, 399 B.R. 44, 46 (Bankr. N.D. Ind. 2008).
Fraud, under § 523(a)(4), "has generally been interpreted as involving intentional deceit, rather than implied or constructive fraud." In re Hanson, 432 B.R. 758, 774 (Bankr. N.D.Ill. 2010), aff'd, 470 B.R. 808 (N.D. Ill. 2012) (citations omitted). "'Defalcation' refers to the misappropriation of funds entrusted to one - a form of embezzlement." Stoughton Lumber, 787 F.3d 1176. Unlike fraud, defalcation does not require a false statement. Id.
2. Embezzlement: fraudulent appropriation
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." Matter of Weber, 892 F.2d 534, 538 (7th Cir. 1989) (citation omitted). A creditor must show by a preponderance of evidence that: (1) the debtor appropriated funds for his or her own benefit, and (2) the debtor did so with fraudulent intent or deceit. Grogan v. Garner, 498 U.S. 279, 287-88 (1991). Embezzlement "requires fraud in fact, involving moral turpitude or intentional wrong, rather than implied or constructive fraud." In re Gumieny, 8 B.R. 602, 605 (Bankr. E.D. Wis. 1981) (citing Neal v. Clark, 95 U.S. 704, 709 (1877)). Whether conduct constitutes embezzlement, and is therefore, non-dischargeable, is a question of federal law. Weber, 892 F.2d at 539.
3. Larceny: felonious intent when taking property
The difference between larceny and embezzlement depends on timing. Moore v. United States, 160 U.S. 268, 269-70 (1895). With embezzlement, the original taking is lawful or with the owner's consent. Id. With larceny, the wrongdoers have "felonious intent" when they initially take the property. Id. at 270. "Larceny is proven for § 523(a)(4) purposes if the debtor has wrongfully and with fraudulent intent taken property from its owner." Matter of Rose, 934 F.2d 901, 903 (7th Cir. 1991) (citation omitted); see also In re Wish, 472 B.R. 763, 782 (Bankr. N.D.Ill. 2012) (defining larceny as "felonious taking of another's personal property with intent to convert it or deprive the owner of the same" and citing 4 Collier on Bankruptcy section 532.10[2] (15th ed. rev. 2008)). Larceny is a matter of federal common law. Wish, 472 B.R. at 782.
Federal common law is "[t]he body of decisional law derived from federal courts when adjudicating federal questions and other matters of federal concern …" COMMON LAW, Black's Law Dictionary (11th ed. 2019).
D. Dischargeability under § 523(a)(6): willful and malicious conduct
The Supreme Court stated, "debts arising from recklessly or negligently inflicted injuries do not fall within the compass of §523(a)(6)." Kawaauhau v. Geiger, 523 U.S. 57, 64 (1998). A plaintiff must prove the debtor: (1) willfully and (2) maliciously (3) injured the plaintiff. First Weber Group, Inc. v. Horsfall, 738 F.3d 767, 774 (7th Cir. 2013). To demonstrate willfulness, a plaintiff must show the debtor acted with the specific intent to injure the plaintiff. Gerard v. Gerard, 780 F.3d 806, 811 (7th Cir. 2015) (citation omitted). Simply demonstrating recklessness or negligent infliction of injuries is insufficient. Geiger, 523 U.S. at 64.
E. Twombly and Iqbal: Supreme Court guidance on sufficient pleadings
Two Supreme Court cases, (1) Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007) and (2) Ashcroft v. Iqbal, 556 U.S. 662 (2009), address 12(b)(6) motions.
1. Twombly's 12(b)(6) guidance
a) Twombly's holding and facts
In Twombly, the Supreme Court: concluded the plaintiffs did not have sufficient facts for their claims to be plausible, dismissed their complaint, and reversed the Second Circuit. Twombly, 550 U.S. at 570. The plaintiffs filed a class action suit against regional telephone companies. Id. at 550. The plaintiffs stated the companies: engaged in "parallel conduct," thereby limiting competition from start-up regional rivals; provided inferior connections; and agreed not to compete with one another. Id. at 549, 550, 551. The district court found the claims of parallel business conduct, without more, was insufficient to state a claim and dismissed the complaint. Id. at 552. The Second Circuit reversed the district court. Id. at 553.
The Supreme Court explained the plaintiffs did not provide enough facts to state a claim that was plausible on its face. Id. at 570. Although allegations of parallel conduct were consistent with conspiracy, that conduct was just a rational business strategy Id. at 554. Twombly's conclusory allegation of the companies' agreement was insufficient to show illegality. Id. at 557. Plaintiffs failed to "nudge [ ] their claims across the line from conceivable to plausible," so the Supreme Court dismissed their complaint. Id. at 570.
b) Principles from Twombly
Twombly provides the following helpful principles:
• Mere legal conclusions are insufficient. A complaint "requires more than labels and conclusions, and a formulaic recitation of the elements of a cause of action will not do." Id. at 555 (citation omitted).
• Mere suspicion is not enough. Plaintiffs must have more than a statement of facts that merely creates a suspicion of a legally cognizable right of action. Id.
• Conclusory statements are insufficient. A stand-alone, bare assertion of conspiracy, like "parallel conduct," without more, is not enough. Id. at 556-57.
• Allegations must be more than possible; they must be plausible. A complaint needs "factual enhancement," and plaintiffs must nudge their claims across "the line between possibility and plausibility." Id. at 557, 570.
• Trial courts should consider discovery costs and demand pleading specificity before allowing a case to proceed. Discovery in antitrust cases can be expensive, and "a district court must retain the power to insist upon some specificity in pleading before allowing a potentially massive factual controversy to proceed." Id. at 558 (citation omitted).
2. Iqbal's refinement of Twombly
Two years after Twombly, the Supreme Court decided Iqbal.
a) Iqbal's holding and facts
In Iqbal, the Supreme Court reversed the Second Circuit and held plaintiff Iqbal did not include sufficient details to survive a motion to dismiss. Iqbal, 556 U.S. at 666, 687. Iqbal claimed FBI Director Robert Mueller and Attorney General John Ashcroft targeted him and subjected him to harsh prison conditions because of his race, religion, or national origin. Id. at 666, 668-69. Iqbal alleged Mueller and Ashcroft knew of and condoned the prison's environment. Id. at 669. Ashcroft was "the 'principal architect' of the policy, and Mueller was 'instrumental' in adopting and executing it." Id. (internal quotation marks in original). The Court held the allegations were: "bare assertions," "formulaic recitation of the elements," and parallel to the conspiracy allegations in Twombly. Id. at 681. The allegations were insufficient to state a claim for which relief could be granted. Id. at 687.
b) Principles from Iqbal
Iqbal, provides the following helpful legal principles:
• Complaints must have facial plausibility. The facts must state a claim that is "plausible on its face" and allows the court to draw reasonable inferences that the defendant is responsible for alleged misdeeds. Id. at 678, 687.
• Merely alleging harm is not sufficient. Plaintiff's allegation he was harmed, without more, is insufficient. Id. at 677-78.
• Conclusory, threadbare labels are insufficient. In addition, a "pleading that offers labels and conclusions or a formulaic recitation of the elements of a cause of action will not do … Threadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice." Id. at 678. (internal quotation marks removed).
• Legal conclusions are not entitled to the presumption of truth. Conclusory allegations are "disentitle[d] …to the presumption of truth." Id. at 681.
F. The Seventh Circuit's adoption of Twombly and Iqbal
In Brooks v. Ross, 578 F.3d 574 (7th Cir. 2009) and Swanson v. Citibank, N.A., 614 F.3d 400 (7th Cir. 2010), the Seventh Circuit adopted and applied Twombly and Iqbal.
1. Brooks v. Ross: insufficient facts alleged
In Brooks, the Seventh Circuit affirmed the district court's dismissal of Brooks' complaint. Brooks, 578 F.3d at 577, 582. Brooks, a prison review board member, was prosecuted for official misconduct and wire fraud. Id. at 578. He was acquitted. Id. He filed a civil suit and alleged fellow board members and others conspired against him. Id. Brooks stated they knowingly, intentionally, and maliciously prosecuted him in retaliation for his exercise of constitutionally protected rights. Id. at 582. Like the complaints in Twombly and Iqbal, the Seventh Circuit held Brooks' complaint was "nothing more" than a "formulaic recitation of the cause of action," insufficient to state a claim. Id.
2. Swanson v. Citibank: sufficient facts alleged
Swanson demonstrates how a plaintiff can survive a motion to dismiss. Swanson, 614 F.3d 400. In Swanson, the Seventh Circuit reversed the district court's dismissal of plaintiff Swanson's Fair Housing Act claim against Citibank. Id. at 407. Swanson was black. Id. at 402. Citibank rejected her loan application. Id. at 403. She alleged defendants denied her application based on race and in violation of the Fair Housing Act. Id. at 402-03. She also alleged the defendants intentionally undervalued her home because of her race. Id. at 403. She submitted that a third-party appraisal valued her home at $240,000, which was higher than Citibank's $170,000 valuation. Id. at 403. The Seventh Circuit determined she provided sufficient facts to survive a 12(b)(6) motion, and it commented on the expenses of discovery: "[t]he costs of discovery are often asymmetric … and one way to rein them in would be to make it more difficult to earn the right to engage in discovery." Id. at 405, 407. Thus, Swanson exemplifies facts that are sufficient to survive a motion to dismiss and suggests plaintiffs should earn the right to engage in discovery.
3. Principles from Brooks and Swanson
Taking Brooks and Swanson together, the Seventh Circuit provides guidance to the trial courts about the proper way to analyze a motion to dismiss. Two takeaways are:
• Formulaic recitations of the cause are insufficient. A plaintiff must do more than simply state the elements. Brooks, 578 F.3d at 582.
• The cost of discovery should be considered. A way to rein in discovery costs is to require a party earn the right to engage in discovery. Swanson, 614 F.3d at 405.
G. Synthesizing Twombly, Iqbal9 Brooks, and Swanson
The tables below summarize the Supreme Court cases and Seventh Circuit cases addressed above. Table 1 summarizes the Supreme Court and Seventh Circuit's analysis of sufficient complaints. The table identifies key allegations from the complaints and explains the holdings/results. Table 2 consolidates the principles from those cases. The Court will use these tables to compare TLS's allegations in its Amended Complaint. Infra IV(A)(1) at Table 3.
Table 1: Summary of Court Decisions Addressing Complaint Sufficiency
Case
Complaint Allegation
Holding/Result
BellAtl. Corp. v. Twombly, 550 U.S. 544 (2007)
Defendant companies unlawfully engaged in parallel conduct, provided inferior connections, and agreed not to compete.
Holding: Without additional specifics, the allegations are conclusory and insufficient. Result: The Supreme Court dismissed the complaint.
Ashcroft v. Iqbal, 556 U.S. 662 (2009)
Defendant Attorney General Ashcroft was the principal architect of policies targeting Iqbal because of his race/rehgion, and defendant FBI Director Mueller was instrumental in adopting and executing policies in
Holding: Formulaic recitations of the elements are insufficient. Result: The Supreme Court dismissed the complaint.
Table 1: Summary of Court Decisions Addressing Complaint Sufficiency
Case
Complaint Allegation
Holding/Result
retaliation for his exercise of constitutionally protected rights.
Brooks v. Ross, 578 F.3d 574 (7th Cir. 2009)
People engaged in a conspiracy and knowingly, intentionally, and maliciously prosecuted plaintiff Brooks.
Holding: Mere recitations of the elements are insufficient. Result: The Seventh Circuit dismissed the complaint.
Swanson v. Citibank, N.A., 614 F.3d 400 (7th Cir. 2010)
Defendants discriminated against a Black loan applicant when they denied her application.
Holding: The plaintiffs higher appraisal, in contrast to the bank's lower appraisal, was sufficient information to survive a motion to dismiss. Result: The Seventh Circuit concluded the complaint was sufficient.
Table 2: Legal Principles from Supreme Court and Seventh Circuit
Principle
Case
(1) Mere legal conclusions and suspicion are insufficient.
Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007)
(2) Conclusory statements, threadbare labels, and formulaic recitation of the cause are insufficient.
Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007) Ashcroft v. Iqbal, 556 U.S. 662 (2009) Brooks v. Boss, 578 F.3d 574 (7th Cir. 2009)
(3) Allegations must be more than possible; they must be facially plausible.
Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007) Ashcroft v. Iqbal, 556 U.S. 662 (2009)
(4) Merely alleging harm is not sufficient.
Ashcroft v. Iqbal, 556 U.S. 662 (2009)
(5) The cost of discovery should be considered.
Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007) Swanson v. Citibank, N.A., 614 F.3d 400 (7th Cir. 2010)
IV. Analysis
Overview of the Analysis
This case is about the debt Morgan owes to TLS after Morgan broke the contract. Breaking a contract is not an exception to discharge listed in § 523(a). In accordance with Seventh Circuit case law, the Court construes the statute in Morgan's favor and against TLS. As movant, Morgan has the burden of persuasion. Morgan has met his burden. Therefore, the Court grants the motion to dismiss with prejudice.
The Court divides the Analysis portion of this Opinion into four sections, A-D. Those sections explain the following:
(A)The Amended Complaint falls short of the pleading specificity the Supreme Court and Seventh Circuit require.
(B)Count I's § 523(a)(4) claim, that Morgan embezzled or committed larceny, must be dismissed because the Confidential Information he allegedly took is not the type of property that can be converted under Illinois law.
(C)Count II's § 523(a)(6) claim, that Morgan willfully and maliciously caused TLS injury, fails because, without more, a mere breach of contract is neither willful nor malicious; and
(D)After having an opportunity to amend, TLS did not fix the original Complaint's deficiencies, so the Court dismisses this Amended Complaint with prejudice.
A. The Court dismisses this case because both of TLS's § 523(a) arguments lack the specificity Twombly, Iqbal, and the Seventh Circuit require.
TLS's arguments fail for the following four reasons:
(1)TLS's Amended Complaint is like the facts in the cases where the Supreme Court and Seventh Circuit determined the complaints were deficient and unlike Swanson, where the Seventh Circuit determined the complaint was sufficient.
(2)TLS violates the discovery principles from Twombly and Swanson.
(3)TLS has not pled there was a fiduciary relationship between it and Morgan, and therefore has not demonstrated sufficient facts to present a § 523(a)(4) fraud or defalcation argument.
(4)TLS states Morgan initially followed the contract, and therefore, TLS has not successfully pled a larceny claim.
1. The Amended Complaint's allegations are dislike Swanson and like Twombly, Iqbal, and Brooks.
TLS's allegations are unlike the facts in Swanson. Swanson pointed at the appraisal to show discrimination. TLS offers no similar evidence for either of its counts. As an example, it alleges Morgan made false representations. However, TLS never indicated what those representations were. Instead, its allegations are like the plaintiffs in Twombly, Iqbal, and Brooks. Table 3 draws the parallels from each of TLS's § 523(a) facts; compares them to Twombly, Iqbal, and Brooks; explains the principles the allegations violate; and provides this Court's findings.
| Table 3: Comparing TLS's allegations to Twombly, Iqbal, and Brooks | |||
| Amended Complaint's Allegation | Analogous Allegation from Twombly, Iqbal, and Brooks | Principle the Amended Complaint Violates | This Court's Finding |
| (5) TLS justifiably relied on Morgan's false representations. | Defendants subjected Iqbal to harsh prison conditions. | Merely alleging harm is insufficient. Mere legal conclusions and conclusory statements are insufficient. | This statement alleges harm and is conclusory. TLS never identifies how TLS justifiably relied on Morgan or the false representations Morgan allegedly made. |
| (6) Morgan had no right to use Confidential Information. | See row 4 above. | See row 4 above. | See row 4 above. |
| (7) Morgan created the image that he was not breaching the agreement. | Government officials targeted Iqbal because of his race and religion. Brooks alleged that people were in a conspiracy against him. | Mere legal conclusions and conclusory statements are insufficient. Allegations must have facial plausibility, and recitation of elements is not sufficient. | This allegation is conclusory. It also lacks details because it never explains how Morgan created this image. |
| (8) Morgan was aware the information was confidential. | Twombly alleged the defendants engaged in parallel conduct. | Mere legal conclusions and conclusory statements are insufficient. | This conclusory statement is like the “parallel conduct” allegation. The statement only suggests illegality. TLS needs more details. |
| Table 3: Comparing TLS's allegations to Twombly, Iqbal, and Brooks | |||
| Amended Complaint's Allegation | Analogous Allegation from Twombly, Iqbal, and Brooks | Principle the Amended Complaint Violates | This Court's Finding |
| (9) Morgan's actions were intentional, willful, and with malicious intent. | Government officials targeted Iqbal because of his race and religion. Brooks alleged that people were in a conspiracy against him. | Mere legal conclusions and conclusory statements are insufficient. | Without additional facts, this allegation is conclusory, and it merely recites the elements. |
| (10) Morgan consciously disregarded his duties under the agreement and committed theft and/or conversion. | Twombly alleged the defendants engaged in parallel conduct. | Mere legal conclusions and conclusory statements are insufficient. | TLS uses buzzwords that suggests two different parts of § 523(a)(4). Disregarding his duties implies fraud in a fiduciary capacity. Theft and/or conversion implies embezzlement or larceny. TLS is simply reciting elements and making conclusory statements and does not provide sufficient facts. |
| (11) Morgan acted with the intent to deceive TLS that Morgan had not “absconded” his duties under the agreement. | Twombly alleged the defendants engaged in parallel conduct. | Mere legal conclusions and conclusory statements are insufficient. | This conclusory statement is like the “parallel conduct” allegation. Both statements only suggest illegality but offer nothing more. |
Allegations in rows 4 and 6 seem to be repetitive. TLS repeated the allegations in Counts I and II of the Amended Complaint.
Thus TLS's allegations resemble the cases where the Supreme court and the Seventh Circuit have dismissed deficient complaints. TLS's threadbare allegations fail to nudge its claims pass the line from conceivable to plausible. Its allegations are more like Twombly, Iqbal, Brooks, and less similar to Swanson. Therefore, the Court dismisses both counts.
2. Discovery principles from the Supreme Court and Seventh Circuit mandate this Court dismiss both counts.
Principles from Twombly and Swanson indicate this Court, a unit of the Northern District of Indiana, should dismiss this case. Twombly and Swanson cautioned trial courts to be mindful of discovery costs. Twombly stated a district court must retain the power to insist upon specificity in pleading before allowing a potentially massive factual controversy to proceed. Swanson required plaintiffs to earn the right to engage in discovery. TLS must have more specificity in its pleadings. It must earn its right to discovery. Permitting it to proceed with discovery without more specificity contravenes bankruptcy's fresh start principle. Therefore, the Court dismisses the Amended Complaint.
3. Count I, section 523(a)(4): TLS omits facts about a fiduciary relationship, which is an element required to prove fraud or defalcation.
A section 523(a)(4) fraud or defalcation claim requires a plaintiff to prove it had a relationship with a debtor. The mere debtor-creditor affiliation is insufficient. Here, TLS fails to plead facts demonstrating that at the time of their interactions, there was a fiduciary relationship. Now, after the state court judgment, the parties have a debtor-creditor association. This present relationship is not enough for a fraud or defalcation claim. The Court finds it unnecessary to discuss fraud, including pleading fraud under Fed.R.Civ.P. 8(a) or defalcation. Even if TLS presented sufficient facts to demonstrate fraud or defalcation, those facts are immaterial since TLS and Morgan were not in a fiduciary relationship at the time of their agreement.
4. The Court dismisses TLS's larceny claim on its face because the Amended Complaint alleges Morgan initially abided by the contract.
Larceny requires actors to have "felonious intent" when they take the property. Here, those facts do not exist. TLS cannot show felonious intent because for the first three years, Morgan performed. He did what he was supposed to do under the agreement.
B. The Court dismisses Count I's embezzlement and larceny claims because the intangible property the Amended Complaint describes is not the type of property that can be converted under Illinois law.
This section of the Analysis addresses the embezzlement and larceny portions of § 523(a)(4). TLS alleges Morgan unlawfully retained its Confidential Information. However, Illinois does not recognize this type of property as property that can be converted. Therefore, the Court dismisses TLS's embezzlement and larceny claims.
Before addressing Illinois property law, a threshold issue is whether Illinois or Indiana law applies. As a general matter, federal courts addressing diversity jurisdiction apply the choice-of-law rules for the state of which it sits. In re Jafari, 569 F.3d 644, 648 (7th Cir. 2009). Bankruptcy courts are different. Id. Bankruptcy courts' jurisdiction arises from federal bankruptcy law, not diversity. Id. "[T]here is a tension as to whether bankruptcy courts follow federal common law choice-of-law principles or the forum state's choice-of-law principles," and the Seventh Circuit has not decided whether bankruptcy courts should follow federal common law choice-of-law principles or the forum state's choice-of-law principles. Id. at 648-49.
1. Why Illinois law applies to this case
Unless the Bankruptcy Code states otherwise, bankruptcy courts apply the relevant state law. Id. (citing Butner, 440 U.S. at 48). Consistent with Jafari, the default rule is that this Court should apply Indiana law because this Court sits in Indiana. Indiana choice-of-law rules provide that Indiana law applies, unless the parties agree otherwise: "Absent an effective choice-of-law by the parties, the question is decided by the courts of the state in which the lawsuit is pending." Emps. Ins. of Wausau v. Recticel Foam Corp., 716 N.E.2d 1015, 1024 (Ind.Ct.App. 1999). Here, there is no absence of effective choice-of-law. The parties' contract states Illinois law applies. Accordingly, the Court examines Illinois law in considering property under § 523(a)(4).
2. State property law in bankruptcy cases
In bankruptcy cases state law governs the validity of most property rights. Jafari, 569 F.3d at 648 (citing Butner, 440 U.S. at 54). Accordingly, for § 523(a) purposes, state law determines what is property. In re Reyes, No. 09 A 1277, 2010 WL 2757180, at *3 (Bankr. N.D.Ill. July 13, 2010) (citing In re Vitogiannis, No. 08 B 04144, 2009 WL 1372065, at *11 fn. 10 (Bankr. N.D.Ill. May 15, 2009)).
3. Specific taking of property required under Illinois law
Both embezzlement and larceny require taking property. Weber, 892 F.2d at 538; Moore, 160 U.S. at 269-70. Under Illinois law, conversion requires specific property. Sutherland v. O'Malley, 882 F.2d 1196, 1200 (7th Cir. 1989). "[T]he general rule is that conversion will not lie for money represented by a general debt or obligation." Id. (alteration in original, quoting In re Thebus, 483 N.E.2d 1258, 1261 (Ill. 1985)). "Only if the money at issue can be described as 'specific chattel' - in other words, 'a specific fund or specific money in coin or bills' - will conversion lie." Eagle Forum v. Phyllis Schlafly's Am. Eagles, 451 F.Supp.3d 910, 917 (S.D. Ill. 2020) (quoting United BizJet Holdings, Inc. v. Gulfstream Aerospace Corp., 318 F.Supp.2d 680, 681 (N.D. Ill. 2004)). Conversion of intangible rights is not an actionable cause. Am. Nat. Ins. Co. v. Citibank, N.A., 543 F.3d 907, 910 (7th Cir. 2008) (citing Janes v. First Federal Savings & Loan Ass'n., 297 N.E.2d 255, 260 (Ill.App.Ct. 1973) (aff'd in part, rev'd in part 312 N.E.2d 605 (Ill. 1974)).
Here, TLS alleges Morgan took Confidential Information. The Confidential Information includes things such as business methods and procedures, prospective clients and agent lists, marketing channels and relationships, technical information, business plans, and identities of contractors and consultants. This type of property is intangible property and not specific chattel or a specific fund. It is not the type of property that can be converted under Illinois law and is facially implausible. Therefore, the Court dismisses Count I's embezzlement and larceny claims.
C. The Court dismisses Count II because intentional breach of contract is not "willful" or "malicious" conduct under § 523(a)(6).
1. Section 523(a)(6): how courts have treated breach of contract claims
For a § 523(a)(6) claim, a creditor must prove the debtor caused an injury and the debtor did so willfully and maliciously. First Weber Group, Inc. v. Horsfall, 738 F.3d 767, 774 (7th Cir. 2013). The Supreme Court held in Geiger that reckless or negligent acts are insufficient for § 523(a)(6) claims - debtors must intend "the consequences of an act." Kawaauhau v. Geiger, 523 U.S. 57, 61-62 (1998) (emphasis and quotation marks in original, citation omitted). In dicta, the Court stated expanding § 523(a)(6) to include intentional acts where the injury was unintended would capture activities such as the "knowing breach of contract." Id. at 62. Such a broad construction "would be incompatible with the 'well-known' guide that exceptions to discharge 'should be confined to those plainly expressed.'" Id. (quoting Gleason v. Thaw, 236 U.S. 558, 562 (1915)).
In Horsfall and Pickens, the Seventh Circuit addressed § 523(a)(6) and breach of contract claims. Horsfall, 738 F.3d at 776; In re Pickens, 234 F.3d 1273 (table), 2000 WL 1071464 (7th Cir. Aug. 1, 2000). Both cases can be distinguished from this case because those cases were decided after a trial. Horsfall, 738 F.3d at 776; Pickens, at *1. This Opinion addresses TLS's Amended Complaint before trial and discovery.
Several bankruptcy courts, including two in this Circuit, have dismissed § 523(a)(6) breach of contract claims at the pleading stage. See e.g. In re Pagan, 564 B.R. 324, 326 (Bankr. N.D.Ill. 2017); In re Braverman, 463 B.R. 115, 119 (Bankr. N.D.Ill. 2011). The Pagan and Braverman courts dismissed the § 523(a)(6) breach of contract claims before discovery commenced. Pagan, 564 B.R. at 325; Braverman, 463 B.R. at 121. This Court is not aware of any district court or bankruptcy court in the Northern District of Indiana that has dismissed a § 523(a)(6) claim at the pleading stage. Whether a § 523(a)(6) allegation can be dismissed before discovery appears to be a case of first impression for this Court.
2. Section 523(a)(6): Applying case law to the Amended Complaint
Morgan's breach of contract is not a willful or malicious act. Like the Seventh Circuit in Horsfall and Pickens, this Court dismisses TLS's § 523(a)(6) breach of contract claim. Like the Pagan and Braverman courts, this Court dismisses the claim before discovery and a trial starts. As Geiger explained, exceptions to discharge should be tailored narrowly to what § 523(a) lists. Section 523(a)(6) does not state a breach of contract claim is excepted from discharge. Further, as Geiger explained in dicta, a "knowing breach of contact" claim should be dischargeable. Like the Pagan and Braverman courts, this Court finds it is appropriate to dismiss TLS's claim at the pleading stage. Therefore, the Court grants Morgan's motion to dismiss the second count.
D. The Court dismisses this case with prejudice because TLS has failed to fix the first Complaint's deficiencies.
Consistent with the Seventh Circuit's ruling in Runnion, the Court already gave TLS an opportunity to address the shortfalls of its original Complaint. Runnion, 786 F.3d at 519. The Court provided detailed analysis on how the first Complaint was deficient. TLS failed to cure those deficiencies. Accordingly, the Court exercises its discretion and grants Morgan's motion to dismiss with prejudice.
V. Conclusion
This is a breach of contract case, and TLS has not shown enough facts to except Morgan's debt from discharge. Thus, the Court grants Morgan's 12(b)(6) motion. TLS's Amended Complaint has three problems. First, Twombly, Iqbal, and the Seventh Circuit require plaintiffs to plead sufficient facts. TLS has not included facts to nudge its claims from conceivable to plausible. Second, the intangible property TLS alleges Morgan took is not the type of property that can be converted under Illinois law. Therefore, its claims of embezzlement and larceny fail. Third, TLS cannot state a claim for relief under § 523(a)(6) because breach of contract is not the type of behavior § 523(a)(6) was meant to prevent.
When the Court dismissed the original Complaint, it explained the Complaint's shortcomings. It gave TLS a chance to fix the issues and TLS failed to do so.
Accordingly, the Court:
(1) GRANTS Morgan's Motion to Dismiss [DE 29];
(2) DISMISSES this case with prejudice; and
(3) VACATES the hearing on the Motion to Dismiss. [DE 37.]
So ORDERED.