Opinion
Bankruptcy No. 02-15160DWS, Adversary No. 02-0771
June 25, 2003
MEMORANDUM OPINION
Before the Court is the Complaint filed by Chester Tershon ("Plaintiff") against the Debtor Paul Jurewicz ("Defendant") to except from discharge under 11 U.S.C. § 523 (a)(4) certain obligations arising from certain agreements between Plaintiff and Defendant's closely held corporation, Phoenix Auto Sales, Inc. ("Phoenix") whereby Plaintiff advanced funds to Phoenix for the purchase of automobiles with the promise of repayment and the expectation of a profit upon resale of the vehicles. Plaintiff seeks to hold Defendant personally responsible for Phoenix's failure to remit the sale proceeds to him and to have the debt excepted from discharge as having been incurred by fraud while acting in a fiduciary capacity.
At the conclusion of the trial, Plaintiffs counsel withdrew his demand for relief under § 523(a)(2).
Trial of this adversary complaint was held on April 28, 2003 and the parties were to file post-trial briefs within thirty days. As no such memoranda have been filed as of this date, I will proceed to render my decision.
BACKGROUND
Viewing the Defendant's activities as presenting a good investment opportunity, the Plaintiffs cousin introduced the parties in 1997. That introduction culminated in three business transactions in which Plaintiff advanced funds to Defendant's New Jersey corporation, Phoenix in exchange for a promise of repayment with a 30% profit on the investment. The first transaction (Transaction #1) is memorialized in an agreement between Plaintiff and Phoenix dated November 20, 1997 (the "November Agreement") which provides that (1) Phoenix will purchase vehicles for resale; (2) Plaintiff will personally finance the vehicle purchases for Phoenix; (3) when the vehicles are sold, Plaintiff will be repaid the amount advanced for each vehicle plus 30% of the profit from each vehicle; and (4) Plaintiff will hold title to vehicles until sold. Exhibit P-1. The November Agreement then listed nine vehicles to which the Agreement applied. Pursuant to the November Agreement, Plaintiff advanced $22,700. In a hand interlineation on the November Agreement, Defendant noted the purchase price for each vehicle which aggregated $22,700 and the serial number for the first six cars listed. Plaintiff never received the titles to these vehicles. The second transaction ("Transaction #2) is memorialized in an addendum to the November Agreement dated December 11, 1997 (the Addendum") and involved the purchase of an additional six vehicles which would be financed partially by the Plaintiff. Exhibit P-2. The Addendum listed Plaintiffs "investment in each unit" as well as the total purchase price and reiterated Phoenix's obligation to repay the original investment plus a 30% profit. Plaintiff advanced $10,000 towards the $19,000 purchase of the additional vehicles. Plaintiff did not receive titles for these vehicles either. The third transaction ("Transaction #3") is evidenced in an informal manner. On a memo pad with the logo of "Windshields America" (the "Memo"), Defendant acknowledges receipt from Plaintiff on December 30, 1997 of $14,000 in cash and check for the purchase of two identified vehicles. Exhibit P-3. Titles to these vehicles were also not delivered to Plaintiff. Plaintiffs total investment in these three transaction was $46,700 of which he states he was repaid only $9,314, leaving a remaining obligation of $37,400
The Agreement was signed by Defendant solely as Phoenix's president.
In January 1998, Plaintiff became aware that there was a problem when he could not find the purchased vehicles. He questioned Defendant and was advised that one vehicle was sold quickly at a loss and that the other cars were being moved around since his Brownsville Motors lot in Pennsylvania where the vehicles had been stored was being sold. A visit to Defendant's Bordentown, New Jersey property ("Bordentown Collision") revealed only three of the vehicles. Moreover, as of Transaction #3, no titles had been delivered to Plaintiff. While it takes five to six weeks for titles to be processed and delivered, they should have been forthcoming shortly after Transaction #3 was concluded. When Plaintiff confronted Defendant, he was told that business was slow and he would be able to sell the cars in the spring.
As a result of Plaintiffs "hounding him," on October 9, 1998 Defendant signed a document in favor of Plaintiff evidencing his persona) obligation for $29,000 which would be repaid in full the earlier of approval of a working capital loan or December 31, 1998 (the "1998 Note"). Exhibit P-5. Attached is a listing of "collateral assets" which were represented to be free and clear of any liens. The attachment itemizes fifteen pieces of machinery and equipment of Bordentown Collision aggregating $51,700 in value. After the 1998 Note was signed, payments were made to Plaintiff, initially on Phoenix checks and when it ceased operating in the third quarter of 1999, by Defendant personally. Finally, on September 21, 2000, Defendant signed individually and as Phoenix's president a promissory note in favor of Plaintiff in the amount of $30,000 to be repaid in monthly installments of $1,200 beginning September 20, 2000. Additionally the document recites that Defendant "absolutely and unconditionally guarantees all obligations under this Promissory Note" (the "2000 Note"). Exhibit D-1. While the payment history was not elicited, Plaintiff contends that the balance presently due him is $17,600. Defendant contends he made $20,000 in additional payments on the promissory note.
The document reads "I Paul Jurewicz of Phoenix Auto Sales, Inc. owe . . ." and is signed by him personally. All prior documents were entered into by Phoenix and signed by Defendant as its president.
This is without regard to certain air conditioning units given to Plaintiff by Defendant which Plaintiff contends have no value.
Plaintiff stated that he does not know what happened to all the vehicles. In addition to the one sold at a loss, he was paid $1,850 for two cars and found a third in the Defendant's driveway. Defendant testified that other than the car in his driveway which is not operable, the vehicles were sold. Some were sold at a loss and others at a profit but Defendant had to do work on some, and Phoenix incurred expenses. Defendant has never accounted for the sales. When questioned as to what happened to all the sales proceeds, Defendant acknowledged that $10,000 to $12,000 was transferred to Bordentown Collision in an unsuccessful attempt to save that business which ultimately closed in March 1999.
On the issue of the undelivered titles, Defendant stated that he would have had to turn them over upon any sale of the vehicles. Since Plaintiff never picked up the titles due to his busy schedule, Defendant assumed he would be satisfied with the proceeds of the sales which he would receive when the titles were delivered to the new buyers.
DISCUSSION
A.
As a threshhold matter, Plaintiff asks that I find that Defendant is obligated for the debt incurred by Phoenix, a New Jersey corporation. Plaintiff advances two theories in support of this legal judgment: i.e., the alter ego theory and the participation theory. Much of the evidence went to this issue. However, as I find that the debt sought to be excepted from discharge was not incurred by fraud while acting in a fiduciary capacity, it is irrelevant whether the Defendant can be held personally responsible for the acts of the corporation. Accordingly, this Memorandum Opinion will focus on that disputed issue.
I need not resort to these legal fictions to find Defendant personally liable for the debt owed by Phoenix. While the obligations under the Agreement, Addendum and Memo were clearly undertakings of Phoenix, not Defendant personally, that changed when Defendant executed the 1998 and 2000 Notes. Perhaps Plaintiff seeks the collapsing of the corporate shell in order to attribute the conduct of Phoenix in making the Agreement, Addendum and Memo to Defendant.
Many of the facts established were illustrative of any closely held corporation and as such would not warrant the piercing of the corporate veil. The fact that the corporation which has no other employees, officers and directors can only act through Defendant is not fatal nor is the fact that Defendant observed no corporate formalities to enter into the investment transactions with Plaintiff. Nor would I be convinced to pierce the corporate veil by reason of Phoenix's use of investment funds to buy the business inventory. Indeed the Defendant capitalized the corporation with $30,000 to secure licenses and initial inventory. Whether that was sufficient is unclear on this record. However, the fact that Defendant was using proceeds of Phoenix sales to attempt to solve the financial problems of Bordentown Collision, another corporation Defendant owned, strongly suggests disregarding the corporate form. That conclusion is not undercut by the fact that Phoenix had its own tax identification number and filed tax returns so long as Defendant is handling corporate assets without regard to corporate integrity.
B.
Section 523(a)(4) creates an exception from discharge for debts "for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny." The question of whether a debt is dischargeable under section 523(a)(4) is a question of federal law, Tudor Oaks Ltd. Partnership v. Cochrane (In re Cochrane), 124 F.3d 978, 984 (8th Cir. 1997), but courts also look to state law to determine whether the requisite trust relationship has been established. Fowler Brothers v. Young (In re Young), 91 F.3d 1367, 1371 (10th Cir. 1996).
The cases uniformly hold that section 523(a)(4) "governs fraud or defalcation while acting in a fiduciary capacity, and embezzlement or larceny while not acting in a fiduciary capacity." Fox v. Shervin (In re Shervin), 112 B.R. 724, 730 (Bankr. E.D. Pa. 1990). There is no contention or evidence that defalcation, embezzlement or larceny are implicated here. Thus the focus of this adversary proceeding is whether the debt should be discharged for "fraud while acting in a fiduciary capacity."
While Phoenix is a New Jersey corporation which had operated in New Jersey, both Plaintiff and Defendant are Pennsylvania residents. The record is silent as to where the three transactions at issue were negotiated and consummated. The cars were titled in New Jersey and stored before sale in both Pennsylvania and New Jersey. I raised with counsel the appropriate choice of law to govern this dispute and had anticipated it would be discussed in the parties' briefs which, as I noted above, were never filed. in argument at the conclusion of trial, Plaintiff cited several Pennsylvania cases presumably viewing this state's law as controlling. The only issue of state law is whether an express or technical trust has been created for the Defendant's benefit. That question is answered in the negative under both Pennsylvania and New Jersey law which use the same test to determine the existence of an express or technical trust. See page 8 infra.
In order for a plaintiff to meet his burden under the fiduciary prong of § 523(a)(4), plaintiff must prove that 1) the debtor was acting in a fiduciary capacity; 2) while acting in that capacity, the debtor engaged in fraud or defalcation. Fowler Brothers, 91 F.3d at 1371;Windsor v. Librandi, (In re Librandi), 183 B.R. 379, 382 (M.D. Pa. 1995). Whether applied to fraud or defalcation, the term "fiduciary capacity" is generally narrower under bankruptcy law than in general legal practice. The traditional common law definition of "fiduciary" is far too broad for the purposes of bankruptcy law. Instead, a fiduciary relationship will be found only where an express trust exists. Librandi, 183 B.R. at 382. Further, the term "fiduciary capacity" under § 523(a)(4) is very narrowly defined. The fiduciary (debtor) must hold an express or technical trust on behalf of the beneficiary (creditor). Pennsylvania Manufacturers' Association Insurance Co. v. Desiderio (In re Desiderio), 213 B.R. 99, 102-03 (Bankr. E.D. Pa. 1997). The fiduciary relationship must have existed prior to or independent of the particular transaction from which the debt arose. The debt must be due to the fiduciary acting in that capacity. A trust ex maleficlo, imposed because of the act of wrongdoing out of which the debt arose, is insufficient to establish the requisite fiduciary relationship. Shervin, 112 B.R. at 730-31; Stone v. Feldman (In re Feldman), 111 B.R. 481, 486 (Bankr. E.D. Pa. 1990). See also Librandi, 183 B.R. at 384 (a general fiduciary obligation is insufficient to establish a fiduciary relationship under this section, because an express trust with a definable res is lacking). In Pennsylvania, an express trust is established when three elements are present: 1) an intent to create a trust, 2) an ascertainable res, and 3) a beneficiary. Sherwin v. Oil City Nat. Bank, 229 F.2d 835 (3d Cir. 1956) (deriving elements from the Restatement of Trusts § 2 in accordance with Pennsylvania law);Shervin, 112 B.R. at 734 (following Sherwin). New Jersey courts apply the same test. Declaration of Trust by Catanio, 703 A.2d 988, 991 (N.J. Super 1997) (following Restatement (Second) of Trusts § 2).
Courts are also split as to the burden of proof a plaintiff bears in a section 523(a)(4) action. Some courts hold that a plaintiff must prove the existence of a fiduciary relationship with clear, precise and convincing evidence, Shervin, 112 B.R. at 730, Stone v. Feldman (In re Feldman), 111 B.R. 481, 485 (Bankr. E.D. Pa. 1990), but need only prove the defalcation itself by a preponderance of the evidence. Feldman, 111 B.R. at 485. Other courts hold plaintiff to the lower preponderance standard when proving the fiduciary element as well. See Librandi, 183 B.R. at 382. As I conclude the Plaintiff has not met the lower standard, I need not determine which is applicable here.
None of the cases using the term "technical trust" defined this concept. However, some cases discussed that a trust could also be imposed by statute, which would also give rise to a finding of a fiduciary relationship. It could be, then, that a "technical trust" is one imposed by statute.
Plaintiff claims that the fiduciary relationship that subjects Defendant to liability under 524(a)(4) arises from his agreement that Plaintiff hold the vehicle titles. From this undertaking, he concludes that Defendant breached a fiduciary duty when he failed to title the vehicles in his name and pay the profits to him. I respectfully disagree and conclude that the threshhold requirement of fiduciary status is not present under these facts. Defendant has neither established nor indeed contended that a fiduciary relationship existed before or is independent from the transactions in which the debts arose. The debt was created by the advance of funds pursuant to the Agreement, Addendum and Memo. The conduct complained of was the subsequent failure to deliver the titles as security. As noted above, even if a trust ex maleficio could be imposed because of the act of wrongdoing out of which the debt arose, it would be insufficient to prove a claim under § 524(a)(4).
In any event, I find no evidence of an express trust having been created. Significantly, there is no express indication by the Defendant to establish a trust. Rather it appears that the relationship between Plaintiff and Defendant was one of debtor and creditor with the vehicles being the contemplated collateral offered as security for the debt. The failure to deliver the titles was a breach of the parties' agreement not a breach of any express or technical trust. See Brown v. Heister (In re Heister), 290 B.R. 665, 672-73 (Bankr. N.D. Iowa 2003). The vehicles were not being administered for the benefit of Plaintiff but rather were being resold for the benefit of Plaintiff and Defendant who were to share the net profit of such sales, if any, on a 30-70 basis.
In Heister, the plaintiff supplied antiques tractors to the debtor to refurbish for sale with a portion of the proceeds remitted to the plaintiff. The debtor, as here, failed to make the contractual payments. Finding the transaction a contract for sale, the court held that the debtor did not stand in a fiduciary relationship with the plaintiff. While he failed to pay a legal debt, his conduct did not constitute embezzlement or larceny. The court also rejected a claim under § 523(a)(6) because there was no evidence that the debtor who the court found acted willfully, also acted maliciously in failing to remit the proceeds. Plaintiff here has not pleaded § 523(a)(6) or argued for its application. That section which is often invoked where collateral is converted has its own heightened standards of proof requiring the Court to find "willful and malicious injury to the property of another entity."Kawaauhau v. Geiger, 523 U.S. 57, 118 S.Ct. 974 (1988) (actor must intend consequences of act, not simply act itself). While this legal theory was not pursued here, I note that Defendant testified that he did not intend to deceive Plaintiff and thus the requisite maliciousness is not evidenced.
Section 525(a)(4) requires fraud while acting in a fiduciary capacity. Absent both elements being established, the Plaintiff cannot prevail. As he has failed to prove fiduciary capacity, I need not discuss whether the conduct that gave rise to the debt was fraudulent. Accordingly, judgment shall be entered in favor of Defendant, and the debt to Plaintiff shall not be excepted from discharge. An Order consistent with the foregoing Memorandum Opinion shall issue.