Opinion
Bankruptcy Nos. 97-03590-W, 97-03591-W, 97-03589-W Chapter 7; Adversary Nos. 98-9002-W, 98-9003-W, 98-9004-W
July 20, 1998.
ORDER RE MOTION FOR SUMMARY JUDGMENT
On June 9, 1998, the above-captioned matter came on for hearing pursuant to assignment. Hearing was held in the Bankruptcy Court in Cedar Rapids, Iowa. Plaintiff appeared by Attorney Timothy Hamann. Debtor-Defendants appeared by Attorney Michael Dunbar. The matter before the Court is a Motion for Summary Judgment pursuant to Rule 7056 of the Federal Rules of Bankruptcy Procedure. The matter was argued and the parties were allowed to file supplemental briefs. The supplemental briefs have been filed and this matter is ready for resolution. This Court has jurisdiction to hear this Motion pursuant to 28 U.S.C. § 1334. This adversary proceeding constitutes a core proceeding under 28 U.S.C. § 157 (b)(2)(A), (E), and (O).
BACKGROUND
Each of the three Debtor-Defendants, Douglas C. Madsen, Aaron Herbert Lease, and Wayne J. Brocka filed their Chapter 7 petitions in this Court on November 21, 1997. Plaintiff Hobson Mould Works, Inc. is allegedly the successor corporation to Hobson Brothers Aluminum Foundry and Mould Works, Inc., the former employer of all three Defendants. Hobson Mould Works, Inc. (hereafter "Hobson") filed adversary complaints against the Defendants individually on January 5, 1998. Hobson seeks a determination of nondischargeability against all three Defendants under §§ 523(a)(4) and 523(a)(6) of the Code.
The uncontested record establishes that Hobson is a manufacturing company whose primary business is designing and manufacturing blow moulds which are used in the formation and manufacture of various types of products. Defendants were employees of Hobson. Mr. Lease commenced employment in 1983 and eventually became the sales and marketing manager. Mr. Brocka was hired shortly before Mr. Lease and eventually became head of the engineering department as well as a customer interface manager. Mr. Madsen was hired in 1985 and worked in various positions until ultimately becoming a customer interface manager. His primary responsibilities were dealing with customers and quoting projects. In 1990, all three Defendants signed a document entitled "Guidelines of Business Conduct". This was a wide-ranging document which dealt with conflicts of interest, confidential information, trade secrets, product design, marketing and customer lists.
In the fall of 1994, the Defendants began meeting confidentially to set up an independent business while continuing to work for Hobson. The business they were establishing had essentially the same business purpose and would eventually compete directly with Hobson. When the business was established, Defendants met with the President of Hobson for the first time in March of 1995 and informed him that they were quitting to operate the company which they had named BLM Moulds, Inc.
Plaintiff Hobson filed a lawsuit in July of 1995 in the Iowa District Court, in and for Butler County, captioned Hobson Brothers Aluminum Foundry and Mould Works, Inc., a subsidiary of Essef Corporation v. Douglas C. Madsen, Wayne J. Brocka and Aaron H. Lease, individually and as a Group, and BLM Moulds, Inc. (Butler County Law No. 18113-0795) (Bovard, J., presiding). A jury trial was held from September 3 until September 10, 1997. The lawsuit was brought under multiple theories. At the time of jury submission, however, Judge Bovard instructed on only three theories. These were: (1) breach of a contractual relationship; (2) breach of a fiduciary duty; and (3) misappropriation of trade secrets. Attached to the jury instructions were special verdict forms. For reasons unexplained in the record, the verdict forms provided for only two theories of recovery. It appears that the breach of contract and breach of fiduciary duty theories were consolidated into one verdict form called Breach of Contract of Fiduciary Duty and that the breach of fiduciary duty was alleged to be the act constituting the breach. The second theory was entitled Misappropriation of Trade Secrets.
On September 10, 1997, the jury returned a verdict in favor of Plaintiff Hobson Mould Works, jointly and severally against Defendants. The jury found liability on the breach of contract of fiduciary duty count and awarded a joint and several verdict of $300,000. The jury also awarded a joint and several verdict against the three Defendants for misappropriation of trade secrets in the amount of $500,000. The Court instructed the jury on the grounds for an award of punitive damages. The jury awarded a punitive damage verdict against Mr. Madsen in the amount of $5,000, against Mr. Brocka in the amount of $5,000 and against Mr. Lease in the amount of $10,000.
Judgment was entered by Judge Bovard on September 11, 1997. No appeal was taken. All three Defendants filed for Chapter 7 bankruptcy protection and seek discharge of these judgments. Plaintiff Hobson Mould Works, Inc. then filed adversary complaints against each Debtor seeking a determination that the jury awards are nondischargeable. On May 15, 1998, Plaintiff filed its Motion for Summary Judgment. While legally separate proceedings, they have proceeded together. For purposes of this Motion for Summary Judgment, no assertion is made that distinctions exist between these cases which merit a separate analysis. The Motion for Summary Judgment is based on the Doctrine of Collateral Estoppel. Plaintiff argues that the Iowa District Court judgment and supporting documents are beyond dispute and establish that there is no dispute as to the controlling issues and that summary judgment is warranted as a matter of law.
CHANGE OF NAME
A threshold issue presented in this case concerns the name of Plaintiff. In the State court action, the Plaintiff was Hobson Brothers Aluminum Foundry and Mould Works, Inc., a subsidiary of Essef Corporation. Plaintiff here is Hobson Mould Works, Inc. Defendants assert that this precludes summary judgment as there is no showing that Plaintiff is a successor in interest to the State court Plaintiff nor that it has standing to pursue this action.
Plaintiff states that Hobson Brothers Aluminum Foundry and Mould Works, Inc. merged into Hobson Mould Works, Inc. during the course of the State court action. It says that no claim was made during the course of those proceedings that it was an inappropriate party. It claims that Defendants admitted in their answers to these adversaries that Hobson Mould Works, Inc. is a successor to Hobson Brothers Aluminum Foundry and Mould Works, Inc. Plaintiff argues that, under Iowa Code sec. 490.1106, title to all real estate and other property of a corporation is vested in the surviving corporation without reservation. It is the position of Plaintiff that it has ownership of this cause of action and the judgment and is, therefore, a proper Plaintiff.
While true that Defendants admitted in their answers that Plaintiff is a successor corporation to the State court Plaintiff, this does not resolve all questions. Issues of fact exist which require evidence to establish that the present Plaintiff is in fact a legitimate successor corporation and that all necessary steps were taken to allow Plaintiff to claim the benefit of this judgment. As there is a fact issue involved in this process, the ultimate granting of summary judgment as to all issues is precluded.
Nevertheless, the present record establishes, with some probability, that Plaintiff will be able to establish that it is a successor to Hobson Brothers Aluminum Foundry and Mould, Inc. The Court concludes that it can proceed to address the remaining issues and reserve this issue for final hearing if necessary to determine Plaintiff's standing. If Defendants can certify to the Court a good faith basis to support their position that Plaintiff is not a real party-in-interest, the issue will be set for evidentiary hearing.
SUMMARY JUDGMENT AND COLLATERAL ESTOPPEL
The standard for granting summary judgment under Rule 7056 requires that there be "no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." In considering a Motion for Summary Judgment, the Court must view the facts in the light most favorable to the party opposing the motion, giving that party the benefit of all reasonable inferences which can be drawn from the record. United States v. One 1989 Jeep Wagoneer, 976 F.2d 1172, 1176 (8th Cir. 1992).
The Motion for Summary Judgment is premised upon collateral estoppel. This Court must determine whether collateral estoppel is applicable and, if so, whether the previous proceedings provide a basis to preclude further litigation. Collateral estoppel is applied when an issue is adjudicated and then again put in issue in a subsequent case. The effect of collateral estoppel is to bind the parties in the second litigation. The purpose of collateral estoppel is to satisfy concepts of full faith and credit between federal and state courts as well as preserve judicial resources which are conserved by avoiding duplicative litigation of identical issues. Combs v. Richardson, 838 F.2d 112 (4th Cir. 1988); In re Diaz, 120 B.R. 967 (Bankr.N.D.Ind. 1989).
Collateral estoppel is applicable to bankruptcy proceedings. The Supreme Court held that collateral estoppel may be invoked in dischargeability proceedings under 11 U.S.C. § 523(a). Grogan v. Garner, 498 U.S. 279, 284 n. 11 (1991). The Court also determined in Grogan that the standard of proof to establish nondischargeability of debt is by a preponderance of evidence. The 8th Circuit Court of Appeals has similarly held the doctrine of collateral estoppel applicable in dischargeability proceedings. Lovell v. Mixon, 719 F.2d 1373 (8th Cir. 1983). The court held in Lovell that:
Under the doctrine of collateral estoppel, four criteria must be met before a determination is conclusive in a subsequent proceedings; (1) the issue sought to be precluded must be the same as that involved in the prior litigation; (2) that issue must have been actually litigated; (3) it must have been determined by a valid and final judgment; and (4) the determination must have been essential to the judgment.
Lovell, 719 F.2d at 1376. In addition to these criteria, the court determined that collateral estoppel can only be applied against a party when it is clear that the party against whom the earlier decision is being asserted had a full and fair opportunity to litigate the issue in question. Id. There is no dispute that in a proper case, Grogan and Lovell compel application of collateral estoppel. This Court must determine whether the Lovell criteria are satisfied.
The parties submitted portions of the State District Court trial transcript with the Motion for Summary Judgment. They also attached exhibits which were received in the State trial. Both parties made references in their oral arguments to these transcripts and exhibits. They also referred to language in Geiger v. Kawaauhau, 113 F.3d 848, 850 (8th Cir. 1997) ("Geiger I"), aff'd, 118 S.Ct. 974 (1998), where the Court expressed uneasiness about the procedure used by the Bankruptcy Court in its hearing on a dischargeability complaint. The Bankruptcy Court in Geiger I utilized partial trial transcripts as well as testimony in making its determinations under 11 U.S.C. § 523(a)(6). The present case is procedurally distinct. In Geiger I, the court was not presented with a summary judgment motion based on collateral estoppel. Instead, the Court held a trial and addressed whether the conduct in a medical malpractice negligence case can constitute willful and malicious conduct under the standards of § 523(a)(6).
Because the present case is presented as a Motion for Summary Judgment applying principles of collateral estoppel, the Court deems it inappropriate to utilize transcripts and exhibits tendered in the State case except for very limited purposes. To do so would require this Court to readjudicate facts based upon a partial trial transcript when the facts submitted for determination must, of necessity, already have been determined by the jury in the State court trial as this is a threshold requirement of summary judgment. If the record reveals disputed facts, the motion must be denied.
This Court must determine whether the State court judgment satisfies the criteria of collateral estoppel as a matter of law. The appropriate record for examination includes the jury instructions, verdict forms, special interrogatories, and judgment entry order of Judge Bovard. These documents define the law which was applied and the findings which were made by the jury in entering its verdict. Looking beyond these documents negates the jury verdict and renders summary judgment or collateral estoppel inappropriate. Therefore, consideration of the summary judgment motion and collateral estoppel doctrine will be based on the previously listed documents. The Court has admittedly drawn a limited number of facts from the trial transcript. This was done, not to determine disputed facts, but to frame the issues and define, to a limited extent, uncontested elements of collateral estoppel. Because the Court is limiting its examination to the jury instruction and subsequent verdict forms, the concerns expressed in Geiger I are not present here.
PLAINTIFF'S THEORIES
Plaintiff asserts that the State judgment based on breach of contract of fiduciary duty is nondischargeable under that portion of § 523(a)(4) which denies a discharge based on "defalcation while acting in a fiduciary capacity". Plaintiff also seeks denial of discharge of this count of the State court judgment under § 523(a)(6) asserting a "willful and malicious injury".
Plaintiff seeks denial of a discharge of the State court judgment based on misappropriation of trade secrets under that portion of § 523(a)(4) which denies a discharge based on "larceny". Finally, Plaintiff seeks denial of a discharge on this count based on § 523(a)(6) asserting a "willful and malicious injury".
SECTION 523(a)(6)
Plaintiff seeks to apply § 523(a)(6) to both the breach of fiduciary duty claim and the misappropriation of trade secrets claim. This section states in applicable part:
(a) A discharge under § 727 . . . of this title does not discharge an individual debtor from any debt
. . .
(6) for willful and malicious injury by the debtor to another entity or to the property of another entity.
As explained in Geiger I, § 523(a)(6) dates to the Bankruptcy Act of 1898. 113 F.3d at 851. Beginning in 1904, the U.S. Supreme Court provided an expansive reading to the predecessor of § 523(a)(6) in the Act, making it relatively easy to deny discharge of willful and malicious conduct. Tinker v. Colwell, 193 U.S. 473 (1904). The Tinker court held that the willful and malicious standard was satisfied if Debtor committed a wrongful act intentionally, without just cause or excuse. Arguably, this standard was broadened even more by the U.S. Supreme Court in McIntyre v. Kavanaugh, 242 U.S. 138 (1916). The Court concluded:
It is urged that the malice referred to in the exception is malice towards the individual personally, such as is meant, for instance, in a statute for maliciously injuring or destroying property, or for malicious mischief, where mere intentional injury without special malice toward the individual has been held by some courts not to be sufficient. . . . We are not inclined to place such a narrow construction upon the language of the exception. We do not think the language used was intended to limit the exception in any such way. It was an honest debtor, and not a malicious wrongdoer, that was to be discharged.
McIntyre, 242 U.S. at 142.
When the Code was enacted in 1978, Congress made it clear that the terms willful and malicious in § 523(a)(6) should be limited to more egregious conduct. Geiger I, 113 F.3d at 851-52. While some courts continued to apply the broader standard of Tinker, other courts, including the Eighth Circuit which had previously drawn a minimal distinction between the willfulness and the maliciousness standard of § 523(a)(6), began to more precisely redefine these terms by holding that a discharge should enter unless the debtor intentionally inflicted an injury. In re Long, 774 F.2d 875, 881 (8th Cir. 1985); In re Minihan, 794 F.2d 340, 343 (8th Cir. 1986). This view was ultimately held to be correct. Kawaauhau v. Geiger, 118 S.Ct. 974 (1998) ("Geiger II").
In Geiger II, the Supreme Court concluded that: "The word `willful' in a(6) modifies the word `injury', indicating that nondischargeability takes a deliberate or intentional injury, not merely a deliberate or intentional act that leads to injury." Geiger II, 118 S.Ct. at 977. The Court went on to state:
Moreover, as the Eighth Circuit observed, the a(6) formulation triggers in the lawyer's mind the category "intentional torts," as distinguished from negligent or reckless torts. Intentional torts generally require that the actor intend "the consequences of an act," not simply "the act itself." Restatement (Second) of Torts § 8A, comment a, p. 15 (1964).
Id. at 977 (emphasis in original). Thus, the U.S. Supreme Court adopted the Eighth Circuit's reasoning in Geiger I that:
We, therefore, think that the correct rule is that a judgment debt cannot be exempt from discharge in bankruptcy unless it is based on what the law has for generations called an intentional tort, a legal category that is based on "the consequences of an act rather than the act itself".
Geiger I, 113 F.3d at 849.
The Supreme Court resolved the case through analysis of the willfulness standard and did not address how the maliciousness component of the statute may be satisfied. The Eighth Circuit did identify this issue in its earlier opinion and stated:
Finally, we observe that in this case we hold only that for a judgment debt to be nondischargeable under the relevant statutory provision, it is necessary that it be based on the commission of an intentional tort. We believe, as we have said, that the debtor's conduct cannot otherwise be said to be "willful." We express no view, however, on the question of whether it is sufficient for nondischargeability that the judgment be for an intentional tort. We note in this connection that 11 U.S.C. § 523(a)(6) requires that the injury be both "willful and malicious" before an entitlement to the exception to discharge arises. In In re Long, 774 F.2d at 881, we held that for a creditor to establish that the debtor acted maliciously, it was necessary to show that debtor's conduct was "targeted at the creditor"; and, since the debtor in that case (though he was an intentional tortfeasor) was not acting with the purpose to harm creditors, we concluded that he was not acting maliciously. Id. at 882. Since it is not necessary to a decision in this case that we decide the meaning of the word "malicious" and the bearing, if any, that the interpretation given to that word might have on the dischargeability of a judgment debt, we have no occasion to discuss the matter, and thus we venture no opinion on it.
Geiger I, 113 F.3d at 853-54.
It is now clear that in order to satisfy the willfulness component of § 523(a)(6), the conduct in question must be an intentional act traditionally defined as an intentional tort. Intent, as used in the Restatement (Second) of Torts, refers to the consequences of a tortious act rather than the act itself. The Restatement (Second) of Torts defines intent as follows: "The word `intent' is used throughout the Restatement of this Subject to denote that the actor desires to cause consequences of his act, or that he believes that the consequences are substantially certain to result from it." Restatement (Second) of Torts § 8A (1964).
If the record establishes that the conduct complained of is an intentional tort, the willfulness component of § 523(a)(6) is satisfied. It appears probable that something additional is necessary to satisfy the maliciousness component of § 523(a)(6). The Eighth Circuit strongly suggests that the "something" necessary to satisfy the maliciousness component is a showing that the tortious conduct was "targeted at the creditor". Long, 774 F.2d at 881. This Court concludes that if the intentional tort standard is satisfied and the conduct was targeted at the creditor, the requirements of § 523(a)(6) are satisfied. See In re Dziuk, 218 B.R. 485, 488 (Bankr.D.Minn. 1998).
ANALYSIS § 523(a)(6) (MISAPPROPRIATION OF TRADE SECRETS)
Plaintiff asserts that the State jury verdict finding liability of the respective Defendants for misappropriation of trade secrets warrants denial of dischargeability under § 523(a)(6). The Court will apply the collateral estoppel doctrine to the State court judgment relating to the misappropriation of trade secret theory of liability.
First, the issues sought to be precluded in the present case must be identical to those involved in the State court litigation. Plaintiff based one count of its State court action upon a theory of misappropriation of trade secrets. These trade secrets were customer lists and costing data which were valuable to Plaintiff in its sales and manufacturing process. The applicable criteria under § 523(a)(6) require that the conduct be "malicious and willful". The willfulness standard is satisfied if the tort in question is an intentional tort. Intent denotes a desire by Defendants to cause the consequences of their acts. Misappropriation of trade secrets is an intentional tort. See Micro Data Base Systems, Inc. v. Dharma Systems, Inc., 1998 WL 272761, at *3 (7th Cir. May 28, 1998); U.S.M. Corp. v. Marson Fastener Corp., et al, 467 N.E.2d 1271 (Mass. 1984); Lane v. Commonwealth, et al, 517 N.E.2d 1281 (Mass. 1988).
Judge Bovard instructed the jury that, to establish misappropriation of a trade secret, Plaintiff was required to prove that the customer list and/or quote list maintained by Plaintiff were trade secrets when they were acquired by the respective Defendants. Plaintiff was required to also prove that Defendants misappropriated these trade secrets and that the misappropriation caused damage to Plaintiff. Finally, Plaintiff was required to prove the nature and extent of the damage. Plaintiff sought actual and punitive damages. The Court defined the measure of actual damages for misappropriation as the amount that would reimburse Plaintiff for the amount of actual loss, if any, caused by the misappropriation. The Court also instructed that if Plaintiff established the requisite elements of misappropriation and established that it was entitled to actual damages, the jury was to consider whether Defendants' misappropriation was willful and malicious as it related to the possible award of punitive damages. The Court defined "willful" as an act which was done voluntarily, intentionally, and with the specific intent to commit such act. The Court defined "malicious" as an act done when the main reason for doing the act was ill-will, hatred or wrongful motive. The Court instructed that if the jury determined that Defendants acted intentionally, without excuse and in violation of a known legal duty to Hobson, the jury could conclude that the act was done maliciously.
The elements of misappropriation instructed by Judge Bovard are recognized by Iowa case law. Basic Chemicals, Inc. v. Benson, 251 N.W.2d 220, 226 (Iowa 1977). The essential elements of misappropriation of trade secrets under Iowa law are similar, if not identical, to the elements established by the Eighth Circuit. E.W. Bliss Co. v. Struthers-Dunn, Inc., 408 F.2d 1108 (8th Cir. 1969).
The jury found that Plaintiff established all requisite elements of the claim of misappropriation of trade secrets and awarded actual damages in the amount of $500,000. In addition, the jury found, by way of a special interrogatory, that Plaintiff established that the misappropriation of trade secrets was willful and malicious as the State court defined those terms. It found that Plaintiff established by a preponderance of clear, convincing and satisfactory evidence that the conduct of each respective Defendant constituted willful and wanton disregard for the rights of another and specifically found, in a special interrogatory, that the conduct of each individual Defendant was directed specifically at Plaintiff. The jury assessed punitive damages against Defendant Madsen in the amount of $5,000, against Defendant Brocka in the amount of $5,000 and against Defendant Lease in the amount of $10,000.
Based on the jury instructions and the answers made by the jury in the special interrogatories, the Court is able to establish on this record that the tort of misappropriation of trade secrets is an intentional tort. It is the conclusion of this Court that the tort of misappropriation of trade secrets is an intentional tort and, under the record made, the "willfulness" component of § 523(a)(6) is satisfied.
An additional showing must be made to satisfy the "maliciousness" component of § 523(a)(6). This Circuit has held that:
We are convinced that if malice, as used in § 523(a)(6), is to have any meaning independent of willful it must apply only to conduct more culpable than that which is in reckless disregard of creditors' economic interests and expectancies, as distinguished from mere legal rights. Moreover, knowledge that legal rights are being violated is insufficient to establish malice, absent some additional "aggravated circumstances," under Davis and its recent progeny.
Long, 774 F.2d at 881. The Court then went on to state that:
. . . we believe that nondischargeability turns on whether the conduct is (1) headstrong and knowing ("willful") and, (2) targeted at the creditor ("malicious"), at least in the sense that the conduct is certain or almost certain to cause financial harm.
Id. at 881. To satisfy the "maliciousness" component, there must be some showing that the conduct was targeted at Plaintiff. Though rarely as clearly stated as in this case, this record establishes in the verdict forms that the conduct of each individual Defendant was targeted at Plaintiff. The jury was specifically asked: "Was the conduct of the defendant directed specifically at Hobson?" and the jury answered: "Yes" as to each Defendant. (Jury Instructions, Special Interrogatory No. 4). It is the conclusion of this Court that the issues involved in the State court action involving misappropriation of trade secrets and the willfulness and malicious standards set forth in § 523(a)(6) are identical and satisfy the first element of collateral estoppel.
Second, the issues under examination were actually litigated. The Court has been provided with the jury instructions and verdict forms. The issues defined by Judge Bovard and presented to the jury were the legal issues necessary to be resolved by the jury to achieve a verdict. The verdict forms are specific and walk the jury through each step of the process. All requisite issues in the misappropriation of trade secrets litigation in State court were actually litigated in this case.
Third, the Court must determine whether the judgment presented is valid and final. The matter was tried in State court before a jury for in excess of one week. There is nothing in this record to indicate that the verdict form returned by the jury was incorrect. Based upon the verdict forms, Judge Bovard entered a judgment setting out the amounts awarded by the jury. The judgment was not appealed. The judgment was entered in September of 1997 and any appeal period has expired. The judgments entered in State court are final. It is the conclusion of this Court that the judgment entered by Judge Gilbert Bovard on the basis of the jury verdict constitutes a valid and final judgment.
Fourth, the Court must determine whether the identical issues were essential to the judgment. Plaintiff premised its cause of action, both for actual as well as punitive damages, upon the willful and malicious conduct of Defendants. Without the findings made in the special verdict forms, as well as the interrogatories, punitive damages could not have been awarded. It was possible that the trial judge could have submitted this case to the jury for a determination of liability and a determination of actual damages without punitive damages. However, the trial judge determined that punitive damages were appropriate for submission and the jury supported that view by making an award of punitive damages. As such, the jury found that actual and punitive damages were based upon willful and malicious conduct by Defendants. All damages resulting from willful and malicious conduct, whether actual or punitive, are construed as damages arising from the conduct at issue and are viewed the same for purposes of this analysis. In re Miera, 926 F.2d 741 (8th Cir. 1991). It is the determination of this Court that the fourth requirement of collateral estoppel is satisfied and that all findings made in this case concerning misappropriation of trade secrets were essential to the entry of the judgment and not peripheral in any legal sense.
The court in Lovell requires, in addition to the foregoing criteria, that this Court make a determination that Defendants had a fair and full opportunity to litigate all issues in dispute. To a large extent, the conclusion is contained in the prior criteria. This Court has a portion of the trial transcript as well as the jury instructions and verdict forms. While the Court has not reviewed the testimony to make factual determinations independently of the jury, it is obvious from even the partial record submitted that all parties were represented by competent counsel. The trial established a full and complete record of all the conduct in question over a period in excess of one week. It is apparent from the record that this case was strenuously litigated at all stages. There is nothing to indicate that Defendants were provided with anything other than a completely full and fair opportunity to raise all issues. This Court concludes that Defendants had every reasonable opportunity to litigate these issues to a final conclusion.
ANALYSIS § 523(a)(6) (BREACH OF CONTRACT OF FIDUCIARY DUTY)
Plaintiff seeks to preclude dischargeability of the breach of fiduciary duty verdict asserting that the conduct was willful and malicious as defined in § 523(a)(6). As previously discussed Plaintiff must establish that the "willful and malicious" standard under Bankruptcy law has been satisfied in the prior litigation.
The count called "Breach of Contract of Fiduciary Duty" was postured as a breach of contract action in the State court litigation. It was not pled as fraud or other intentional tort. As pled and instructed to the jury, it is a breach of contract claim with the breach of the written agreement constituting the breach of contract. Nowhere in the jury instructions defining these terms is there any reference to conduct which can be construed as an intentional tort as defined by Geiger II. Additionally, the verdict forms do not require findings which carry with them the notion of intentional tort.
Plaintiff appears to acknowledge this void but attempts to bolster its position by borrowing definitions and elements from the misappropriation of trade secrets count to satisfy the higher standard under this count. This is inappropriate. Each count is a separate cause of action and the Court must look solely to the issues involved in the breach of contract of fiduciary duty count to determine whether the issues decided are identical to those sought to be precluded here.
Without utilizing language or elements from the misappropriation count, this count is devoid of any conduct approaching the standard necessary to satisfy the willfulness portion of § 523(a)(6). Likewise, absent the definitions and the verdict forms in the misappropriation of trade secrets count, there is nothing in this count which would establish that this conduct was directed toward Plaintiff. As such, there is no support in the State court record for the proposition that the willful and malicious standard of § 523(a)(6) is the same as that involved in the breach of contract claim in the State court litigation. As the Court finds that the first element of collateral estoppel has not been satisfied, it is not necessary to address the remaining elements.
SECTION 523(a)(4)
Plaintiff seeks to apply § 523(a)(4) to both the breach of fiduciary duty component as well as the misappropriation of trade secrets claim. This Code section states in applicable part:
(a) A discharge under § 727 . . . of this title does not discharge an individual debtor from any debt
. . .
(4) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.
This section addresses three different types of conduct for which discharge can be denied. Hobson is asserting that discharge of the breach of fiduciary duty claim should be denied under the "fraud or defalcation while acting in a fiduciary capacity" clause of § 523(a)(4). It seeks to deny discharge of the misappropriation of trade secrets claim under that part of § 523(a)(4) dealing with "larceny". It is the position of Hobson that misappropriation of trade secrets constitutes larceny, thereby warranting denial of discharge of that part of the judgment.
DEFALCATION IN FIDUCIARY CAPACITY (§ 523(a)(4))
A debt for "defalcation while acting in a fiduciary capacity" is excepted from discharge under § 523(a)(4). In determining whether a debt is nondischargeable, the Court must resolve two issues. First, the Court must determine whether Debtor was acting in a fiduciary capacity and second, whether a defalcation occurred. In re Kondora, 194 B.R. 202 (Bankr.N.D.Iowa 1996).
The term "fiduciary" in § 523(a)(4) applies only to trustees of express or technical trust. Long, 774 F.2d at 878. Whether a relationship is a fiduciary one within the meaning of § 523(a)(4) is a question of Federal law. In re Cochrane, 124 F.3d 978, 983 (8th Cir. 1997). A fiduciary relationship must be one arising from an express or technical trust that was imposed prior to and without reference to the wrongdoing that caused the debt. Id. As the Eighth Circuit stated in Long:
The Code does not reach constructive trustees, designated as such because of misconduct. We recognize that there are cases charging individuals, by virtue of their corporate officer's status, with the corporation's fiduciary duties. (citations omitted). To the extent these cases hold that a statute or other State law rule may create fiduciary status in an officer which is cognizable in bankruptcy proceedings, we agree. We question, however, the propriety of imposing a corporation's fiduciary duties on a stockholder-employee in the absence of such a local rule, and decline to do so outside the special contexts in which the doctrine arose.
Long, 774 F.2d at 878. It is the substance of the transaction rather than the labels assigned by the parties, which determines whether a fiduciary relationship exists.
The second element requires a determination whether debtor's conduct constitutes defalcation. Defalcation is evaluated by an objective standard. Kondora, 194 B.R. at 208. Defalcation is construed broadly and does not necessarily involve misconduct. In re Smith, 72 B.R. 61, 63 (Bankr.N.D.Iowa 1987). In Cochrane, the Eighth Circuit cited with approval the following language contained in Lewis v. Scott, 97 F.3d 1182, 1186 (9th Cir. 1996):
Defalcation is defined as the misappropriation of trust funds or money held in any fiduciary capacity; [the] failure to properly account for such funds. Under § 523(a)(4), defalcation "includes the innocent default of a fiduciary who fails to account fully for money received." . . . An individual may be liable for defalcation without having the intent to defraud.
Cochrane, 124 F.3d at 984.
LARCENY (523(a)(4))
A debt for larceny is nondischargeable under § 523(a)(4). The Federal common law definition of larceny is used to determine dischargeability under this section. In re Rose, 934 F.2d 901, 903 (7th Cir. 1991). Larceny is defined as:
The actual or constructive taking away of property of another without the consent and against the will of the owner or possessor with the intent to convert the use of the property to the use of someone other than the owner.
In re McCoy, 189 B.R. 129, 135 (Bankr.N.D.Ohio 1995). Larceny has also been defined as:
the fraudulent and wrongful taking and carrying away the property of another with intent to convert such property to the taker's use without the consent of the owner.
In re Graziano, 35 B.R. 589, 594 (Bankr.E.D.N.Y. 1983).
The central issue in this analysis is whether misappropriation of trade secrets constitutes larceny. There is no Federal statute which expressly prohibits misappropriation of trade secrets. However, there are several related criminal offenses which have been used to prosecute the theft of trade secrets: The National Stolen Property Act ( 18 U.S.C. § 2311 et. seq.); the Travel Act ( 18 U.S.C. § 1952); the Mail Fraud Act (18 U.S.C. § 1321); the Wire Fraud Act ( 18 U.S.C. § 1343); The Copyright Act ( 18 U.S.C. § 506); and the RICO Act ( 18 U.S.C. § 1961 et. seq.). None of these Acts, however, specifically makes larceny of trade secrets a crime with specific identifiable elements. Likewise, Iowa does not have a specific criminal statute which applies directly to the theft of trade secrets though the general theft statute (Iowa Code sec. 714.1) may well be sufficiently broad to cover the theft of trade secrets. The general rule is that misappropriation by definition constitutes an actual or constructive taking away of property of value from another without their consent and, as such, a finding in a jury verdict of misappropriation, therefore, falls within the definition of larceny under § 523(a)(4). McCoy, 189 B.R. at 135.
ANALYSIS § 523(a)(4) (BREACH OF FIDUCIARY DUTY)
Plaintiff asserts that the judgment entered in State court on the "breach of contract of fiduciary duty" count is nondischargeable under that part of § 523(a)(4) relating to "defalcation while acting in a fiduciary capacity". The Court must first evaluate whether the issues sought to be precluded are the same as those involved in the State litigation. Plaintiff asserts that both the existence of a fiduciary relationship and defalcation are established in the State court record.
The term "fiduciary" is given a narrow application under the Code. Long, 775 F.2d at 878. The State court defined "fiduciary duty" as follows:
Concerning proposition no. 1 of Instruction No. 14, a fiduciary relationship is a relationship of trust and confidence on a subject between two persons. One of the persons is under a duty to act for or give advice to the other on that subject. Confidence is placed on one side, and domination and influence result on the other. Circumstances that may indicate the existence of a fiduciary relationship include the acting of one person for another, the having and exercising of influence over one person by another, the placing of confidence by one person in another, the dominance of one person by another, the inequality of the parties, and the dependence of one person upon another None of these circumstances is more important than another. It is for you to determine from the evidence whether a fiduciary relationship existed between the parties.
State Court Jury Instruction No. 15.
The record reveals that all three Defendants were employees of Hobson. None were directors or corporate officers. Under the instruction provided by the State trial court, the jury was allowed to find a fiduciary relationship using a broader standard than allowed under Bankruptcy law. Bankruptcy law requires the fiduciary relationship under § 523(a)(4) to be based upon an express or technical trust. The findings of the jury in this case do not approach the level required to establish the existence of a fiduciary relationship under the strict standards required by this section. The record supports the conclusion that the fiduciary relationship, as defined by the State court, was based upon a breach of a written agreement entered into between Defendants and Hobson. However, a breach of this agreement is a breach of contract. Such agreements are contractual rather than fiduciary and are outside the scope of the fiduciary relationship recognized in Bankruptcy law. Long, 774 F.2d at 879. As such, Hobson has failed to establish the existence of a fiduciary relationship as defined in § 523(a)(4).
As the Court has concluded that no fiduciary relationship existed, Plaintiff cannot establish collateral estoppel as a matter of law. As such, the issues relating to defalcation do not affect the resolution of this issue. However, the Court will briefly address this second element of § 523(a)(4).
Defalcation, unlike breach of fiduciary duty, is a term given a broad meaning. It need not reach the level of embezzlement or misappropriation. In re Sigler, 196 B.R. 762, 764 (Bankr.W.D.Ky. 1996). An individual may be liable for defalcation without having the specific intent to defraud. Cochran, 124 F.3d at 984. Previously in this opinion, the Court discussed and concluded that both larceny under § 523(a)(4) and willful and malicious injury under § 523(a)(6) were established by the record made in the State court action. It may be reasonable to conclude, therefore, that defalcation, which requires a lesser finding, may be established in this record. To establish a defalcation, it is only necessary that a financial loss be caused by an individual acting in a fiduciary capacity. In the State court action, the Court found that Hobson sustained actual damages in the amount of $300,000 which was caused by Defendants' breach of duty. It may, therefore, be appropriate to conclude, under the broad definition of defalcation, that this element is satisfied if a fiduciary relationship exists. However, for the reasons previously discussed, this Court has concluded that there does not exist a fiduciary relationship as defined under bankruptcy law and, therefore, defalcation also cannot occur without the prerequisite finding of a fiduciary relationship.
In summary, the Court finds that Plaintiff has failed to establish that the fiduciary status of Defendants is identical to that which was involved in the prior litigation. The issue relating to "defalcation" also is not satisfied for the reasons set out in this opinion. Therefore, the jury verdict under the theory of "breach of contract of fiduciary duty" does not have collateral estoppel effect in this proceeding as neither of the elements of this § 523(a)(4) issue are identical to those involved in the prior litigation.
ANALYSIS § 523(a)(4) (LARCENY)
Plaintiff asserts that the jury verdict assessing liability to the respective Defendants for misappropriation of trade secrets warrants denial of dischargeability under that part of § 523(a)(4) based on "larceny".
First, the Court must determine whether the jury instructions and verdicts satisfy the definition of larceny. To do so, the item taken must be a cognizable property interest. Trade secrets are considered valuable property interests which are the subject of legal protection. The trial court held that:
a trade secret is any program or compilation of information which . . . has independent economic value, actual or potential from not being generally known to, and not being readily ascertainable through proper means by, other persons able to gain economic value from its disclosure or use . . . .
(State Court Jury Instruction No. 17). It is the determination of this Court that trade secrets are property interests and that the State court definition carries with it the mandatory conclusion, in the jury verdict, that trade secrets are property interests with value worthy of protection.
Second, the act of larceny requires an actual or constructive taking of a property interest. The State jury instructions required that the jury find that Defendants misappropriated a trade secret. The State trial court instructed the jury that:
a trade secret is misappropriated if it is . . . used by a person who, at the time of use, knows the trade secret is acquired under circumstances requiring its secrecy to be maintained or its use limited.
(State Court Jury Instruction No. 18). The State court instructed the jury that "a substantial element of secrecy must exist, so that, except for the use of improper means, there would be difficulty in acquiring the information". (State Court Jury Instruction No. 17). The jury found that Defendants misappropriated the property thereby satisfying the "taking" component of larceny.
Common law larceny requires that the taking be without the consent and against the will of the owner of the property interest. The jury instructions require a finding by the jury that "except for the use of improper means, there would be difficulty in acquiring the property". (State Court Jury Instruction No. 17). It was, therefore, necessary for the jury to find liability that the taking was nonconsensual.
The final element of common law larceny requires that the taking be with the intent to convert the use of the property to the use of someone other than the owner. The State court instructed the jury that: "A trade secret is misappropriated if it is . . . used by a person who, at the time of use, knows the trade secret is acquired under circumstances requiring its secrecy to be maintained or its use limited." (State Court Jury Instruction No. 18). This jury instruction required a finding that the conduct of Defendants was willful. The State court instructed the jury that: "An act is `willfully' done if done voluntarily, intentionally, and with the specific intent to commit such an act." (State Court Jury Instruction No. 19).
In order to return a verdict against Defendants, it was necessary that the jury determine that the respective Defendants intended to convert this property interest to their own use. The fact that the jury awarded a substantial amount of actual damages under this theory carries with it the conclusion that Defendants converted this property interest. It is the conclusion of this Court that the issues involved in the State court action involving misappropriation of trade secrets and the elements of common law larceny are identical and satisfy the first requirement of collateral estoppel.
The remaining components of collateral estoppel require that the issues were actually litigated, that the judgment is valid and final, and that the issues litigated were essential to the judgment. In addition, the Court must find that Defendants had a fair and full opportunity to litigate all issues in question. The Court has previously discussed these criteria. It is not necessary to fully address them again and it is sufficient to observe that all necessary issues were actually litigated, the judgment is valid and final, the issues which were decided were essential to the judgment, and Defendants had a fair and full opportunity to litigate all issues in question.
Thus, the judgment entered in State court under a theory of misappropriation of trade secrets is nondischargeable in this case under § 523(a)(4). SeeIn re Balta, 151 B.R. 506 (Bankr.E.D.Mo. 1993); In re McCoy, 189 B.R. 129 (Bankr. N.D. Ohio 1995).
PUNITIVE DAMAGES
Defendants assert that the verdict forms and special interrogatories relating to the award of punitive damages were not essential to the judgment and, therefore, cannot be utilized to make issue determinations as to the underlying dischargeability of the claim. Secondly, they appear to argue that the punitive damages portion of this claim is severable and dischargeable notwithstanding any nondischargeability issues relating to actual damages.
The manner in which the jury instructions were written and the manner in which the verdict forms were constructed reveals that punitive damages were under consideration only on that count of the State action relating to misappropriation of trade secrets. Punitive damages were not an option for the jury under the breach of contract of fiduciary duty count. This Court has determined that the jury verdict and subsequent judgment entry on the misappropriation of trade secrets count is nondischargeable in this case under both § 523(a)(4) (larceny) and § 523(a)(6).
The State trial court determined that this was a case in which the jury should be allowed to consider whether punitive damages should be awarded. In so doing, the trial court provided guidance on the issue of punitive damages to the jury in their deliberations. The trial court's jury instructions were not appealed and are an integral part of the misappropriation of trade secrets cause of action. It is the conclusion of this Court that all the jury instructions relating to this theory of recovery were integral to the jury's verdict and subsequent award of damages and punitive damages. As such, any definitions or other language contained in the State court's instructions or verdict forms which establish that issues were conclusively determined can be utilized by this Court in making collateral estoppel determinations.
The Court must finally determine whether the punitive damages award is severable from the compensatory component of the State court judgment in the misappropriation of trade secrets count. It is the nature of the act which gives rise to the liability. If it is determined that the nature of the act was willful and malicious, then all liability resulting from that conduct is likewise nondischargeable under § 523(a)(6) whether it is actual compensation or in the nature of punitive damages. Miera, 926 F.2d at 745. This Court has determined that the misappropriation of trade secrets was willful and malicious. Therefore, the nondischargeability determinations are applicable not only to compensatory damages but also to punitive damages. Coen v. Zick, 458 F.2d 326 (9th Cir. 1972); In re Diaz, 120 B.R. 967 (Bankr.N.D.Ind. 1989); In re Raymon (Williams v. Raymon), No. 92-11849LC, Adv. No. 93-1004LC, slip op. at 7 (Bankr. N.D. Iowa, Aug. 11, 1993); In re Kayser (Kayser v. Kayser), No. L92-00760W, Adv. No. L92-0119W, slip op. at 3 (Bankr.N.D.Iowa, Jan. 29, 1993). The punitive damages awarded arose out of the same conduct giving rise to the compensatory damages claim. Therefore, not only are the actual damages awarded nondischargeable, but also the punitive damages.
SUMMARY
For the reasons set forth in this opinion, it is the conclusion of this Court that collateral estoppel applies to that count of the State court judgment which awarded damages to Plaintiff Hobson under a theory of misappropriation of trade secrets. Punitive damages were awarded only under the count entitled "Misappropriation of Trade Secrets". All requisite findings were met to satisfy collateral estoppel under that cause of action. The jury's findings satisfy both the "willful and malicious" standard of § 523(a)(6) and larceny under § 523(a)(4). All damages awarded on the misappropriation of trade secrets count, including punitive damages, are nondischargeable.
Further, it is the conclusion of this Court that the requirement of identity of issues has not been satisfied as to the second count of the State court action brought as "Breach of Contract of Fiduciary Duty". The Court finds that there exists no identity of issues under either § 523(a)(4) or § 523(a)(6) and, therefore, collateral estoppel does not apply to this count and summary judgment is inappropriate.
As the issue concerning identity of Hobson Mould Works, Inc. and Hobson Brothers Aluminum Foundry and Mould Works, Inc. remains unresolved, this order will be considered as interim pending resolution of that issue.
WHEREFORE, this order will be considered as interim pending resolution of the threshold issue concerning identity of the Plaintiff in the State court action and Plaintiff in the present adversary proceedings.
FURTHER, within 14 days of the date of this order, counsel for Defendants shall file a pleading with this Court stating whether a good faith issue exists as to identity of these corporations. If counsel for Defendants can certify a legitimate controversy on this issue, the issue will be defined in that filing.
FURTHER, if the Court determines that a good faith controversy exists as to the corporate entities, the matter will be set for trial solely on that issue at the earliest possible date.
FURTHER, upon resolution of that issue, the Court will issue a final order incorporating the issues resolved here.
SO ORDERED this 20th day of July, 1998.