Opinion
Case No. 11-16717 Adversary Case No. 11-1202
10-25-2013
In Re WILLIAM PATRICK KING Debtor MAZAK CORPORATION Plaintiff v. WILLIAM P. KING Defendant
This document has been electronically entered in the records of the United States Bankruptcy Court for the Southern District of Ohio.
IT IS SO ORDERED.
_______________
Jeffery P. Hopkins
United States Bankruptcy Judge
Chapter 7
Judge Hopkins
MEMORANDUM OF DECISION
We are asked in this adversary proceeding to decide, in essence, whether a high-level employee who surreptitiously did business with his employer can obtain a discharge of a judgment debt for nearly three and a half million dollars by seeking protection from his creditors under chapter 7 of the Bankruptcy Code. The bankruptcy laws do not afford such protections to debtors and, because this Court is bound by those laws, nor will we. The decision on whether certain funds, which are being held in trusts, must be returned remains for future determination by a court having jurisdiction over that issue. All we decide today is that the debt arising from a judgment rendered by the United States District Court for Eastern Division of Kentucky in a prior case is nondischargeable.
SUMMARY OF THE PROCEEDINGS
The Court conducted a three-day trial. Following the filing of the transcript, see Doc. 110, the parties filed post-trial briefs. See Docs. 115, 116, 117, and 118.
Hereafter, all references to the transcript will be identified as "Tr. at ___" and all references to exhibits will be identified as "Pl. Ex. ___" or "Def. Ex. ___." In addition to the transcript and the exhibits, four depositions were admitted into evidence. A fifth deposition was admitted as Pl. Ex. 23. All references to depositions will be identified by the last name of the deponent followed by "Dep. at ___."
THE PARTIES
The Plaintiff, Mazak Corporation ("Mazak"), is a manufacturer, distributer, and seller of machine tools (Tr. at 101-10 to 101-15). Mazak employed the Defendant, William P. King ("King"), from 1990 through 2003, and afterwards as a paid consultant under a contract until 2005 (Tr. at 100-7 to 100-12). While employed at Mazak, King worked as a senior manager as its controller and vice president of finance where he became privy to much of Mazak's internal confidential financial information, which King would later use to unlawfully enrich himself. (Tr. at 100-13 to 100-15).
MAZAK'S JUDGMENT
On October 31, 2007, the United States District Court for the Eastern District of Kentucky ("District Court") issued an order finding that as a matter of law King had breached his fiduciary duty to Mazak. Nearly four years later, on April 4, 2011, Mazak obtained a $3,472,896 judgment ("Judgment") against King (Tr. at 170-8 to 170-12). The Judgment is predicated upon King's failure to fully disclose his ownership interest in two companies that did substantial business with Mazak during his employment, United International of Cincinnati, LLC and W.T. Financial and Associates, LLC (Pl. Ex. 1). The prolonged period between the orders establishing liability and damages (October 31, 2007 to April 4, 2011) resulted from a stay of the civil case in District Court pending a criminal investigation and conviction of King in a Kentucky state court, in a matter also related to Mazak.
During cross examination, King admitted to a conviction for theft by deception, a felony under Kentucky law. (Tr. at 236-5 to 236-13). Paragraph 212 of Mazak's complaint (Doc. 1) further states that King was sentenced to five years probation, ordered to pay a $50,000 fine and restitution to Mazak in the amount of $38,184. In Schedule F of his bankruptcy petition, King lists a fine for $50,000 incurred in November 2010 owed to the Kenton Circuit Clerk in Covington, Kentucky. In pretrial proceedings, this Court determined that evidence of the felony conviction was admissible under Fed. R. Evid. 609(a)(2) since the crime, theft by deception, involved elements of dishonest acts or false statements.
After the April 2011 Judgment, Mazak resumed collection efforts against King and his wife, Mary Lynn King, by instituting proceedings in federal court in Kentucky and Ohio state court. In an effort to stop the collection lawsuits, King filed a chapter 7 petition seeking protection from his creditors under the bankruptcy laws on November 9, 2011.
According to his bankruptcy the Schedules, King does not own any real estate, and the majority of his assets are held in separate trusts, presumably the William P. King Trust and Mary Lynn King Trust. Both trusts were claimed as exempt under Ohio law in the bankruptcy case. Mazak's objection to King's claim that the retirement accounts were exempt was overruled. See Doc. 36 in Case No. 11-16717. Later, Mazak filed a pleading, signed by the chapter 7 Trustee, labeled the Trustee's Abandonment of Property [of ] (a) Fraudulent Transfer Causes of Action against Debtor William Patrick King and Mary Lynn King, Individually and in Their Respective Capacities as Trustee of the Wm. P. King Trust and the Mary Lynn King Trust, and (b) the Federal Court Remedy for Imposition of a Constructive Trust. See Doc. 60 in Case No. 11-16717. By virtue of this pleading, the Trustee abandoned "any and all recovery pursued by Mazak associated with the State Court Case and District Court Case." See id.; see also 11 U.S.C. §554 (a)("the trustee may abandon any property of the estate that is burdensome to the estate or that is of inconsequential value and benefit to the estate"); Morlan v. Universal Guaranty Life Ins. Co., 298 F.3d 609, 618 (7th Cir. 2002)(discussing abandonment). Because of the abandonment by the chapter 7 Trustee, only Mazak can assert claims against the trust property in the State and prior District Court cases.
On the same day as the bankruptcy filing, and in response to it, Mazak filed a motion in District Court seeking to impress a constructive trust over all assets under King's custody or control and for an order requiring that those funds be turned over. See Doc. 38 in Case No. 11-16717. However, the District Court denied the motion finding that the imposition of a constructive trust was mooted by King's bankruptcy filing.
Mazak met with a similar fate in state court in Ohio when the bench trial on the fraudulent transfer action against King and his wife, which had been scheduled to begin on December 19, 2011, was abruptly cancelled. On August 12, 2012, while the bankruptcy case and adversary proceeding were pending, the Sixth Circuit came down with its decision in Mazak Corp. v. King, 2012 WL 3590817 (6th Cir. Aug. 22, 2012), affirming in full the District Court. That decision spoiled one of King's last hopes of overturning the Judgment requiring him to pay damages to Mazak, leaving the possibility of obtaining a discharge in bankruptcy as one of the last resorts. ( Pl. Ex. 33).
On September 9, 2013, Mazak filed a Notice of Death of Debtor's spouse Mary Lynn King, and asked the State Court to sequester assets in the Mary Lynn King Trust. The long delayed bench trial in the State Court Case is apparently set to begin later this year. See Case Doc. 66 and Exhibit A, thereto. Prior to this decision, the Court granted Mazak's motion for relief from the automatic stay. Thus, Mazak can pursue the State Court Case and District Court Case. See Doc. 57 in Case No. 11-16717. See In re Morris, 260 F.3d 654, 666 (6th Cir. 2001) ("imposition of a constructive trust might be appropriate when property in bankruptcy was not subject to distribution to creditors and so did no implicate the rationale of ratable distribution."); see also In re McCafferty, 96 F.3d 192, 197 (6th Cir. 1996)(The imposition of a constructive trust pursuant to state law may be appropriate when "[i]t would not diminish the pro rata share of any other creditors of the debtor."). Because of a tolling agreement entered between Mazak and King, the State Court Case is not time-barred.
To preserve the Judgment, Mazak filed the present adversary proceeding seeking a ruling excepting the $3,472,896 Judgment debt from discharge under 11 U.S.C. § 523(a)(2)(A) and (6). If Mazak prevails, it can continue to pursue lawsuits in Ohio and Kentucky uninhibited by the notion that the Judgment awarded by the District Court has been discharged in bankruptcy. However, if King prevails he will, in effect, have evaded the Sixth Circuit's determination, under Kentucky law, that "[p]rofits realized by an agent in the execution of his agency belong to the principal in the absence of an agreement to the contrary." Mazak Corp. v. King, 2012 WL 3590817 at *5 (6th Cir. Aug. 22, 2012). (Pl. Ex 33).
THE HOLDING
Upon review of all the evidence presented, and after carefully considering all of the arguments of counsel, both written and oral, and the credibility and demeanor of all witnesses who testified, we hold that the Judgment against King, for $3,472,896, affirmed by the Sixth Circuit in Mazak Corp. v. King, is nondischargeable pursuant to 11 U.S.C. § 523(a)(2) and (6). To allow King to shirk liability by discharging the Judgment debt under the circumstances presented here, we believe, would subvert the deterrent efficacy of Kentucky tort law without serving a fundamental policy that has informed the bankruptcy laws in our nation for over two centuries of affording a "fresh start" only to an "honest but unfortunate debtor." See Grogan v. Garner, 498 U.S. 279, 287 (1991). The reasons supporting our decision follow.
The Supreme Court of Kentucky has stated that "[i]t is the purpose of all tort law to compensate one for harm caused by another and to deter future wrongdoing." Giuliani v. Guiler, 951 S.W. 2d 318, 321 (Ky. 1997).
THE ISSUE
The bankruptcy question presented concerns whether Mazak's Judgment debt is nondischargeable pursuant to § 523(a)(2)(A) or (6), which provide, in part:
A discharge under section 727 . . . of this title does not discharge an individual debtor from any debt-Mazak bears the burden of proof by a preponderance of the evidence. Grogan v. Garner, 498 U.S. at 291. Exceptions to discharge are strictly construed against the creditor. In re Rembert, 141 F.3d 277, 281 (6th Cir. 1998).
. . .
(2) for money [or] property . . . to the extent obtained by-
(A) false pretenses, a false representation, or actual fraud[;]
. . .
(6) for willful and malicious injury by the debtor to another entity or to the property of another entity[.]
JURISDICTION
The Court has jurisdiction over this action pursuant to 28 U.S.C. § 1334(a) and (b). This proceeding arises in a case referred to this Court by the Standing Order of Reference entered in this District and is determined to be a core proceeding pursuant to 28 U.S.C. §157(b)(2)(I). The Court is authorized to enter final judgment in this proceeding. This memorandum constitutes the Court's findings of fact and conclusions of law under Fed. R. Bankr. P. 7052.
FINDINGS OF FACT
MAZAK'S MANAGEMENT
During King's employment with Mazak, Brian Papke ("Papke") acted as president of Mazak and Takashi Okita ("Okita") acted as senior executive vice president and chief financial officer (Tr. at 110-9 to 110-15; Tr. at 339-4 to 339-17). Papke, Okita, and King were members of the senior executive team of Mazak, a company with approximately 1,000 employees (Pl. Ex. 3; Tr. at 103-12 to 103-17; Tr. at 397-20).
As controller, King was responsible for the implementation of financial controls for Mazak (Tr. at 107-13 to 107-18). Several functions of Mazak's business reported to King, including finance, accounting, tax, insurance, and computer operations (Tr. at 103-18 to 106-14). King reported to Okita and Papke (Tr. at 107-19 to 108-8). Okita reported to Papke (Pl. Ex. 3). Papke reported to Mazak's parent company in Japan ("Yamazaki") (Tr. at 360-11 to 360-14).
FINANCING PURCHASES FROM MAZAK
Because of the expense of the machinery it produces, Mazak assists customers who need to finance purchases from Mazak (Tr. at 114-14 to 115-12). Through the mid-1990's, Mazak contracted with two finance companies to provide this assistance: CIT Equipment Finance ("CIT") and Orix (Tr. at 118-22 to 119-12). Mazak would qualify customers, execute the financing paper with the customer, and assign the paper to CIT or Orix, who funded the purchase (Tr. at 120-14 to 120-19). If the customer defaulted, Mazak had to repurchase the paper from CIT or Orix (Tr. at 120-20 to 121-2). The obligation to repurchase default accounts is known as recourse liability (Tr. at 120-20 to 121-5).
Beginning in 1996, Mazak explored alternatives for customer financing (Tr. at 123-13 to 123-23). Mazak wanted the benefits of third-party financing without the burden of recourse liability (Tr. at 123-13 to 123-23). In 1997, Mazak started to consider the creation of a financing subsidiary (Tr. at 123-13 to 123-23). Mazak considered two types of subsidiaries: (1) a captive finance company, wholly-owned by Mazak; and (2) a hybrid finance company, jointly owned by Mazak and a third party (Tr. at 507-4 to 507-12). With the captive subsidiary, Mazak would assume all the risk and benefit from all the rewards (Tr. at 508-4 to 508-6). With the hybrid subsidiary, the subsidiary would shop Mazak referrals among multiple finance companies to obtain the best deal on recourse liability and interest rate (Tr. at 508-13 to 508-20).
King preferred a captive finance company (Tr. at 508-21 to 509-5). King traveled to Japan in January of 1997 and presented the idea to Yamazaki's leadership (Tr. at 124-2 to 124-7). Terry Yamazaki, the president of Yamazaki, rejected the idea (Tr. at 124-7 to 124-11).
During the course of 1997 King became the leading proponent for the formation of a hybrid subsidiary to be known as Mazak Financial Group, Ltd. ("MFG") (Tr. at 273-18 to 273-19; Tr. at 368-9 to 368-12; Tr. at 371-19 to 371-210). Yamazaki eventually approved this idea (Tr. at 410-17 to 410-19). On April 1, 1998, Mazakjoined with United International of Cincinnati, LLC ("United") to form MFG (Pl. Ex. 22). Mazak and United each owned a fifty percent interest in MFG (Pl. Ex. 22).
MFG significantly reduced Mazak's recourse liability (Tr. at 201-23 to 202-1). It also provided tax benefits (Tr. at 210-2). MFG enabled Mazak to claim the depreciation and passive losses from sales, whereas the taxable income would be attributed to United (Tr. at 210-10 to 210-18).
A CLOSER LOOK AT 1997:
EXPLORING POTENTIAL PARTNERS FOR A HYBRID SUBSIDIARY
Following Yamazaki's rejection of a captive subsidiary, King and Okita further explored the formation of a hybrid subsidiary (Tr. at 124-15 to 124-17). King assumed the lead in finding the business partner that offered the best deal for Mazak (Pl. Ex. 11). Okita served as the liaison between Mazak and Yamazaki to obtain the parent's approval (Tr. at 273-11 to 273-13).
Mazak solicited proposals from six entities, including CIT and Orix (Pl. Ex. 11). Mazak received three responses.
In the early part of 1997, Mazak spent several months evaluating a partnership with a tool company called Sencorp (Tr. at 124-21 to 127-18). Sencorp had its own financing subsidiary called Star (Tr. at 125-6 to 125-11). Mazak considered a proposal whereby Mazak would obtain a joint ownership interest in Star (Tr. at 128-11 to 128-13). Star, in turn, would provide financing for Mazak customers (Tr. at 126-24 to 127-1). Mazak rejected the proposal because it gave Sencorp the majority interest and control (Tr. at 541-17 to 542-2). Mazak insisted on retaining control over any hybrid subsidiary it formed (Tr. at 541-23 to 542-2).
In April of 1997, Mazak received an informal proposal from a company called Tokai Financial Services, Inc. ("Tokai") (Tr. at 539-13 to 539-20). Negotiations stalled and Tokai never offered a formal proposal (Pl. Ex. 11).
United was the only other entity to submit a proposal. The record suggests that United made its proposal sometime prior to October 28, 1997 (Pl. Ex. 11). On that date, King sent a memo to Papke and Okita (Pl. Ex. 11). The memo summarized the proposals received (Pl. Ex. 11). Without expressly identifying United as the proponent, King stated that one of three proposals met all of Mazak's criteria (e.g., minimal capital investment, limited recourse, tax benefits, and control) (Pl. Ex. 11). The memo then outlined the benefits of a hybrid subsidiary to be identified as MFG (Pl. Ex. 11).
MAZAK'S CONTACT AT UNITED
United communicated with Mazak through Louis J. Seta ("Seta"), a member of United. Seta was no stranger to Mazak. He had enjoyed a close relationship with Mazak for more than two decades (Tr. at 271-24 to 272-4). In the 1970's, while working for a bank, Seta arranged the funding necessary to move Mazak's operations from New York to Kentucky (Tr. at 272-7 to 272-16). Yamazaki appreciated and respected Seta ever since (Tr. at 272-16 to 272-17).
DUE DILIGENCE
King, Okita, and Papke reviewed the United proposal on December 3, 1997 (Tr. at 170-8 to 170-12). Although Mazak was familiar with Seta, Mazak did not know as much about United. Consequently, Mazak had some questions about United (Pl. Ex. 13). Later that day, King sent a letter to Seta (Pl. Ex. 13). The letter asked Seta to identify, among other things, United's partners and the finances behind United (Pl. Ex. 13).
Seta responded with a December 10, 1997 letter to King and Okita (Pl. Ex. 14). Seta stated numerous reasons why he believed United would benefit Mazak (Pl. Ex. 14). He also expressed concerns about the confidentiality of negotiations between United and Mazak (Pl. Ex. 14). Before disclosing his financial partners, Seta asked Mazak to sign a confidentiality agreement and provide a letter of interest and intent (Pl. Ex. 14).
Okita signed a confidentiality agreement provided by Seta ( Pl. Ex. 16). Four days later, on December 19, 1997, Okita sent a memo to Papke and copied King (Pl. Ex. 17). Okita prepared and attached a summary of the benefits of forming MFG, including financial projections (Pl. Ex. 17). The memo proposed that Okita meet with Yamazaki to obtain final approval (Pl. Ex. 17).
On January 5, 1998, Seta sent a letter to Okita identifying four individual partners, in addition to Seta, and three lenders that United used as funding sources (Pl. Ex. 19). The four individual partners were identified as Richard Spoor, Neil Budelsky, Donald Kochan, and Joseph Rippe (Pl. Ex. 19).
FORMATION OF MFG
Okita sent a letter of intent to Seta on January 6, 1998 (Pl. Ex. 21). United and Mazak executed an operating agreement for MFG, effective April 1, 1998 (Pl. Ex. 22). Both members of MFG, United and Mazak, each obtained a fifty percent interest and contributed $100,000 of capital to the new entity (Pl. Ex. 22).
WHAT PAPKE AND OKITA DID NOT KNOW:
A S ECOND L OOK AT THE S ELECTION P ROCESS
Unknown to Papke and Okita, United was more than an ordinary finance partner to King. King possessed an ownership interest in United, along with Mazak's credit manager Tim Fisher ("Fisher"), who also happened to be Seta's brother-in-law (Tr. at 114-1 to 114-6).
United was formed on June 30, 1997 (Pl. Ex. 7). Three months earlier, on March 24, 1997, King sent a memo to Fisher (Pl. Ex. 4). The memo referenced the Sencorp proposal and asked: "[h]ow would United International fill the role of Sencorp[?] . . . Let's have lunch and discuss." (Pl. Ex. 4).
The very next day, Seta, who was then working as a salesperson for a hazardous waste remediation company, wrote a letter to Papke (Tr. at 133-13 to 133-23; Seta Dep. at 7-4 to 7-13). The letter begins with the sentence: "It has been a while, but I do look forward to renewing my relationship at Mazak." (Pl. Ex. 5). According to the letter, King and Fisher told Seta of "the phenomenal growth" of Mazak under Papke's leadership (Pl. Ex. 5). Seta said he was affiliated with United International, L.L.P., a firm with "extensive international and domestic contacts," and requested an opportunity to discuss financing options with Papke (Pl. Ex. 5). As cited, Seta sent his letter months before United was ever formed.
The record references several purported entities, other than United, that contain the words "United International" in the entity's name. For example, Seta's letter references United International, L.L.P. There is no record that any of these other purported entities were formally created under applicable state law. The Court will hereafter refer to all such purported entities as "United." That is certainly the impression given to Mazak, that it was dealing with the same entity at all times. (Tr. at 382-19 to 383-8; Tr. 396-3 to 396-7).
At the time of United's formation in June of 1997, its members were Seta, King, Fisher, and Seta's wife (Pl. Ex. 8). King and Fisher began as "Option Members," each possessing the option to purchase a one-third interest (Pl. Ex. 8). Prior to exercising the options, King and Fisher were entitled to compensation from United through consulting agreements that they executed with United on July 11, 1997 (Pl. Ex. 10). King and Fisher were each entitled to one-third of the net earnings of United (Pl. Ex. 10). King did not disclose any of this information to Mazak (Tr. at 151-9 to 153-16).
Seta sent a letter to Okita on November 21, 1997 (Pl. Ex. 12). The letter explained that the legal structure of a limited liability corporation gave Seta the ability to "leverage the capital of United and one or more of its' [sic] partners who have supplied capital in other United ventures" (Pl. Ex. 12). In reality, however, at the time Seta sent the November 1997 letter: (1) no other individuals had contributed capital to United other than Seta and his wife; and (2) United had no other business ventures apart from the one it was seeking to undertake with Mazak (Tr. at 166-9 to 167-17). Seta concluded by requesting a confidentiality agreement because "my partners are all very cautious" (Pl. Ex. 12). Unknown to Okita and Papke, King had edited this document for Seta prior to its delivery to Okita (Tr. at 169-10 to 169-12).
On December 22, 1997, King sent a memo to Fisher and Seta (Pl. Ex. 17). King attached Okita's December 19, 1997 letter to Papke (Pl. Ex. 17). King said to Fisher and Seta: "According to the attached, Okita has come up with the concept (he is taking full ownership) and expects to discuss at Headquarters. I will keep you informed." (Pl. Ex. 17).
King also edited the January 5, 1998 letter from Seta to Okita, identifying United's partners and financial resources (Tr. at 186-2 to 186-5). A draft of the letter stated that United "uses" different partners for different transactions (Pl. Ex. 20). King changed the letter to reflect that United "consists of" different partners for different transactions (Tr. at 190-15 to 191-23). Subsequently, Seta sent the letter to Okita (Tr. at 185-22 to 186-1; Tr. at 191-24 to 192-5). Not surprising, King never told Papke or Okita that he helped Seta draft the letter (Tr. at 192-9 to 192-11).
King, Fisher, Seta, and Mrs. Seta executed a second operating agreement for United, dated April 1, 1998, the same date that United and Mazak executed the operating agreement for MFG (Tr. at 198-3 to 198-12). United's second operating agreement revealed the following ownership structure of United: a 33% interest held by King, a 33% interest held by Fisher, a 32% interest held by Seta, and a 1% interest held by Mrs. Seta (Tr. at 198-13 to 198-16).
By including the events unknown to Papke and Okita in italicized and bold print, the summary of the 1997-1998 negotiations between Mazak and United can be restated as follows:
W.T. FINANCIAL AND ASSOCIATES, LLC
Mazak's business grew rapidly during the 1990's (Janiszewski Dep. at 16:48 to 17:09; Janiszewski Dep. at 22:42 to 22:44). Increased sales led to an increased demand upon Mazak to service its machines (Janiszewski Dep. 17:10 to 17:30). Mazak contracted with vendors to meet the service needs of Mazak customers (Tr. at 675-4 to 675-12). Mazak enjoyed a risk-free profit margin arising from this relationship (Tr. at 679-14 to 679-19).
Originally, Mazak billed the customer for the service work provided by the vendor (Tr. at 671-19 to 671-21). However, by 1995 to 1996, Mazak was structured for the tracking and collection of capital receivables exceeding $100,000, not small receivables related to service, parts, and accessories (Tr. at 671-13 to 671-23). Inefficiencies in the collection of small receivables led Mazak to write off a large portion of these receivables (Tr. at 672-11 to 672-12).
Papke, Okita, King, and Mazak's national service manager, Robert Janiszewski, decided to outsource collections for service. Mazak selected W.T. Financial and Associates, LLC ("WT") to fill the role (Tr. at 676-15 to 676-18). WT was owned by Terri Andrews, who formerly worked for Mazak in collections (Def. Ex. D-1). WT handled Mazak's sservice collections from 1997 to 2000 (Tr. at 679-4 to 679-6). Mazak discontinued the relationship, after concluding that it was not receiving enough revenue from the arrangement (Tr. at 406-21 to 407-1).
WHAT PAPKE AND OKITA DID NOT KNOW:
A SECOND LOOK AT THE SELECTION OF WT
Papke and Okita thought Andrews was the sole owner of WT (Tr. at 280-12 to 280-18; Tr. at 385-2 to 385-3). Unknown to Papke and Okita, King and Janiszewski also possessed interests in WT (Def. Ex. D-1). King, Janiszewski, and Andrews formed WT on July 1, 1997 ( Def. Ex. D-1). King and Janiszewski each owned a 45% interest and Andrews owned a 10% interest (Def. Ex. D-1).
Janiszewski retired from Mazak in 2000 (Janiszewski Dep. at 4:00 to 4:05). The retirement occurred following Papke's discovery of kickbacks to Janiszewski (Tr. at 386-6 to 386-8). Papke gave Janiszewski the choice between retirement and termination (Tr. at 387-7 to 387-13). Janiszewski chose retirement (Janiszewski Dep. at 10:53 to 11:03). This occurred several years before Mazak learned that King and Janiszewski held ownership interests in WT (Tr. at 387-14 to 388-1).
Besides the kickbacks, a service manager that reported to Janiszewski was selling drills to Mazak (Tr. at 386-8 to 386-12). When Papke learned of this, he identified it as a conflict and gave the employee an ultimatum: leave the company or stop selling the drills (Tr. at 386-16 to 386-20). The employee left the company (Tr. at 386-21 to 386-22).
ANNUAL DISCLOSURE TO MAZAK AUDITORS BY MAZAK MANAGEMENT
Mazak's management team submitted an annual letter to its auditors in connection with the audit of Mazak's financial statements (Tr. at 735-13 to 735-23; Pl. Ex. 34; Pl. Ex. 53). The record contains two of these letters, signed by Papke, Okita, and King, confirming representations made during the 2002 and 2003 audits of Mazak (Pl. Ex. 34; Pl. Ex. 53). Among other things, the letters state that management is unaware of any fraud involving management or employees with internal control responsibilities (Pl. Ex. 34; Pl. Ex. 53).
During cross-examination by Mazak, King admitted that the annual letter effectively asked the question of whether King possessed an interest in United and WT.
Q. Mr. King, you've been asked several times if anybody ever asked you about your ownership interest and you've said, "Well, nobody ever asked me." Isn't it fair to say that the management representation process, that letter that happens every year, it's you, it's the management team at Mazak talking to the auditors. Isn't that in effect the auditors asking that very question?(Tr. at 735-13 to 735-20). King also admitted that he never disclosed his United and WT ownership interests to Mazak's auditors (Tr. at 735-21 to 736-8).
A. Yeah, I think it would be.
KING COACHES SETA
SUBSEQUENT TO FORMATION OF MFG
Okita sent an email to Seta in September of 2003, asking questions about United and MFG (Pl. Ex. 27). Seta forwarded the email to King with the message: "FYI" (Pl. Ex. 27). King responded to Seta as follows:
Go ahead and tell him that you found . . . the oldest agreement, one signed by Papke, and you are forwarding it to him. Tell him, yes you have agreements with Wells, TCF, and you have done deals with Citicapital, DLL, AT&T, US Bancorp, Northwest, and many other banks. Tell him you have many relationships and that(Pl. Ex. 27 (emphasis added)). Seta later testified that United's only client was Mazak/MFG (Seta Dep. at 23-14 to 23-22).
you have many other vendors that you deal with . . . in a variety of structures . . . none of whom are limited to Mazak, as all your structures involve limiting exposure for the vendors you represent, including Mazak . . . not just Mazak, ask him what numbers he is looking for, as you are confused by his request . . . knowing Tim and you already gave him TCF and Wells numbers a few weeks ago.
Tell him every letter you wrote regarding the financial, and every letter you wrote regarding the amendments, plus every letter you and he exchanged regarding MFG, represents minutes and official correspondence . . . again ask what exactly he is looking for . . . give him any by laws you have . . . but ask him what by laws he needs, as Mazak is 50% owner . . . both sides can construct that which they need.
The record contains three other emails from Seta to King over the next few months (Pl. Ex. 28; Pl. Ex. 29; Pl. Ex. 31). The emails contain copies of correspondence, apparently drafts, from Seta to Mazak (Pl. Ex. 28; Pl. Ex. 29; Pl. Ex. 31). Seta tells King: "I am thinking of sending the following" or "Call me after review" ( Pl. Ex. 29; Pl. Ex. 31). In one instance, King replied to Seta by saying: "looks good - go with it." (Pl. Ex. 28).
PAPKE SUSPICIONS ABOUT KING
Papke eventually became suspicious about King's involvement with United and WT.
By email dated August 29, 2003, Papke said to Okita: "The implication that [King], Beckmann, [Seta] and [Fisher] might be involved in some scheme from the beginning seems to be even stronger than the doubts that I once held. As you know, I have never really found anything but have just been suspicious. If it were found to be true, you and I have been tricked for quite some time." (Def. Ex. J-3). Eight days later, in another email, Papke said to Okita: "I still don't understand the complete Seta, Fisher, King, Beckmann relationship. It may be OK but looks suspicious." (Def. Ex. E-3).
At some unknown time, Papke initiated an investigation into the ownership of WT when he became suspicious of King's involvement. The investigation, carried out by Michael Vogt ("Vogt"), vice president of human resources, did not uncover a link to King, even though Papke testified that he did not recall asking vogt to investigate the ownership of WT (Tr. at 406-5 to 406-9). vogt testified, in his January 2007 deposition admitted into the record, that Papke charged him with this task (vogt Dep. at 89-8 to 90-16). vogt could not recall when Papke initiated the investigation (vogt Dep. at 89-5).
The Court finds Vogt's recollection of the WT investigation to be more accurate than Papke's. First, Vogt testified six years earlier than Papke. Second, Vogt provided a detailed description of the event. The Court does not believe that Papke intentionally misstated facts or that he was being untruthful. We simply conclude that Papke did not remember this event, in 2013, as well as Vogt remembered it in 2007 - some six years closer in time to when the incident would have occurred. Sometime in 2005 or 2006, after King left Mazak, Papke informed Vogt that Papke had established a link between WT and King (Vogt Dep. at 93-7 to 93-21).
MAZAK DISCOVERS KING'S INTEREST
Following his employment with Mazak, King provided consulting services to Mazak as an independent contractor (Tr. at 101-4 to 101-9). King worked in this capacity until May 31, 2005 (Tr. at 101-4 to 101-9). The following month, Mazak discovered the interests that King and Fisher had in United. The discovery occurred while reviewing a United tax return produced in litigation between Mazak and United (Tr. at 382-19 to 383-8; Tr. 396-3 to 396-7). The next business day, Papke fired Fisher (Tr. at 383-9 to 383-14).
MAZAK SEEKS PRODUCTION OF COMPUTER RECORDS
King maintained possession of two Mazak computers subsequent to May 31, 2005 (Tr. at 708-13 to 709-7). On June 9, 2005, Mazak subpoenaed King in the lawsuit between Mazak and United (Tr. at 240-21 to 241-11). Among other things, the subpoena required the production of electronic data, including hard discs and computer memory (Tr. at 240-21 to 241-11). On June 14, 2005, Mazak's counsel wrote a letter to King's counsel (Pl. Ex. 26). The letter stated: "Your client has indicated that he will turn [the computers] over, but try as we might, we cannot get him to allow us to come to his home to pick them up, nor can we convince him to drop them off at Mazak." (Pl. Ex. 26). The letter demanded the immediate return of Mazak's computers (Pl. Ex. 26).
KING DELETES COMPUTER FILES
King returned the computers to Mazak on June 17, 2005 (Tr. at 243-2 to 243-6). Before returning the computers, King purchased and applied a software product to delete all data from both hard drives (Tr. at 243-16 to 243-23). The product wrote over all hard drive files, permanently destroying the underlying data (Tr. at 243-24 to 244-3).
CONCLUSIONS OF LAW
ELEMENTS OF § 523(a)(6)
Debts for "willful and malicious injury" are nondischargeable under § 523(a)(6). A debt is discharged unless both willfulness and maliciousness are established. In re Markowitz, 190 F.3d 455, 463 (6th Cir. 1999). Willfulness requires proof that the actor desired to cause the injury or believed that the injury was substantially certain to result. Id. at 464. Maliciousness requires an act done "in conscious disregard of one's duties or without just cause or excuse." Wheeler v. Laudani, 783 F.2d 610, 615 (6th Cir. 1986).
§ 523(a)(6) ANALYSIS
A. King Injured Mazak
Section 523(a)(6) requires an "injury." Courts define the term as any invasion of a creditor's legal rights or the infliction of an actionable wrong. In re Best, 109 F.App'x 1, 4-8 (6th Cir. 2004); Larsen v. Jendusa-Nicolai, 442 B.R. 905, 914 (E.D. Wis. 2010), aff'd, 677 F.3d 320 (7th Cir. 2012). The Judgment, affirmed by the Sixth Circuit, provides that King breached his fiduciary duty to Mazak. Consequently, King invaded Mazak's rights or, at the very least, he inflicted an actionable wrong against Mazak.
1. Damages
King conflates the statutory requirement of "injury" with the concept of damages. According to King, Mazak cannot prevail under § 523(a)(6) because Mazak failed to prove that it suffered any monetary damages. Or, stated another way, according to King, Mazak received the benefit of its bargain even though King secretly owned the companies that did business with his employer and had not fully disclosed that fact.
Section 523(a)(6) does not require proof of actual damages. The plain language of § 523(a)(6) clearly states that §727, as it applies in this case, does not discharge "any debt . . . for willful and malicious injury by the debtor[.]" 11 U.S.C. § 523(a)(6)(emphasis added); see also 11 U.S.C. § 101(12)(defining "debt" as "liability on a claim"). Therefore, all liability traceable to a willful and malicious injury is nondischargeable. HER, Inc. v. Barlow (In re Barlow), 478 B.R. 320, 333-34 (Bankr. S.D. Ohio 2012)(statutory damages, without proof of actual damages, are nondischargeable under § 523(a)(6)); see also Jendusa-Nicolai v. Larsen, 677 F.3d 320, 324 (7th Cir. 2012)("We can't find an appellate case on this precise point — the nondischargeability of a claim for loss of consortium derivative from a willful and malicious injury. But that it is not dischargeable follows directly not only from the cases dealing with punitive damages but also from cases that hold that debts arising from wrongful-death suits are not dischargeable even when the creditor fighting discharge is not the victim of the wrongful death but the victim's estate or the estate's representative."); In re Suarez, 400 B.R. 732, 740 (B.A.P. 9th Cir. 2009)("We conclude that attorneys fees and costs awarded to a judgment creditor in relation to a debtor's underlying willful and malicious contemptuous conduct, even when no compensatory judgment debt exists, constitute a nondischargeable debt under section 523(a)(6).").
In Barlow, the creditor held a federal court judgment against the debtor for statutory damages under the Anticybersquatting Consumer Protection Act. In the federal court action, the creditor did not prove any actual damages. Following the debtor's chapter 7 petition, the creditor commenced an action to determine the dischargeability of the debt under § 523(a)(6). On summary judgment, the debtor argued that the creditor sustained no "injury" because there was no proof of actual damages in the federal court litigation. The Barlow court cited several decisions where judgments for statutory damages were held to be nondischargeable debts for willful and malicious injury. Finding no authority to the contrary, Barlow rejected the debtor's argument that proof of actual damages is required to prove "injury" under § 523(a)(6). Barlow, 478 B.R. at 333-34.
King relies upon Hernandez v. Nunez (In re Nunez), 400 B.R. 869 (Bankr. S.D. Fla. 2008). In Nunez, a creditor sued the debtor and a related business called Healthy Bones for fraud and breach of contract. The creditor obtained a default judgment and attempted to execute on the judgment. The debtor filed a motion to set aside the writ of execution, arguing that the assets to be seized belonged to another related business called Newco or an individual named Pulido. The debtor attached an affidavit by Pulido, stating that the debtor was only a part owner of the assets. The affidavit, which later proved to be false, temporarily interfered with execution. The creditor eventually obtained an amended default judgment against the debtor, Healthy Bones, Newco, and Pulido. Thereafter, the creditor executed on the assets. When the debtor filed a bankruptcy petition, the creditor filed a dischargeability action. According to the creditor, § 523(a)(6) applied because the debtor interfered with execution by filing the Pulido affidavit. Although the affidavit delayed execution, the bankruptcy court found no "injury" because the creditor eventually executed on the judgment.
Nunez is distinguishable. Unlike Barlow, there was no debt traceable to a willful and malicious injury. The debt in Nunez was the balance owed on the default judgment after execution. That debt was related to the default judgment for fraud and breach of contract. It did not arise because of the willful and malicious conduct alleged by the creditor (i.e., the fraudulent affidavit that interfered with execution). It predated the affidavit. On the other hand, no debt arose from the fraudulent affidavit because the creditor eventually executed on the judgment. In this action, unlike Nunez, the debt (i.e., the Judgment) arose from King's conduct that is alleged to constitute a willful and malicious injury-the breach of fiduciary duty.
The only other published decision that King cites in support of his argument is Adams v. Zentz (In re Zentz), 157 B.R. 145 (Bankr. W.D. Mo. 1993). Zentz does not require actual damages. Like Barlow, Zentz looks to whether the debt is related to a willful and malicious injury. Zentz addressed whether a state court award of attorney's fees, without any other damages, could be excepted from discharge under § 523(a)(6). Zentz did not create a per se rule that attorney's fees, standing alone, are never excepted from discharge. Instead, the court looked to whether the attorney's fees were related to the alleged willful and malicious injury. See Zentz, 157 B.R. at 149-50 (considering whether the attorney's fees were "a result of," "intended to compensate" for, or "on account of," the willful and malicious injury). B. King Acted Willfully
King argues that § 523(a)(6) is inapplicable because he never intended to harm Mazak. King would have this Court believe that he intended only to benefit Mazak from his conduct, despite his accrual of substantial "secret profits" from doing business with his employer that he carefully never disclosed.
Intent to harm or benefit is irrelevant. Under § 523(a)(6), the term "willful" modifies the term "injury." Kawaauhau v. Geiger, 523 U.S. 57, 61 (1998). The question is whether the debtor intended the injury, the invasion of the creditor's legally protected right on an abstract level, as opposed to any resulting damage. ABF, Inc. v. Russell (In re Russell), 262 B.R. 449, 454 (Bankr. N.D. Ind. 2001)(cited by Best, 109 F.App'x at 4); see also Larsen v. Jendusa-Nicolai, 442 B.R. 905, 914 (E.D. Wis. 2010), aff'd, 677 F.3d 320 (7th Cir. 2012); In re Markowitz, 190 F.3d 455, 464 (6th Cir. 1999) ("only acts done with the intent to cause injury . . . can cause willful and malicious injury.")(emphasis added); Id. at 465 ("we do not believe that there is a sufficient basis to show that Markowitz intended injury")(emphasis added).
An injury is willful if "the actor desires to cause the consequences of his act, or believes that the consequences are substantially certain to result from it." Id. at 464. The act, in this case, was "King['s] fail[ure] to disclose that he was simultaneously serving as a corporate officer [of Mazak] and receiving payments from a company [United and WT] with which the corporation did substantial business." Mazak v. King, 2012 WL 3590817 at *3. The consequences of his act, and the injury to Mazak, was King's breach of fiduciary duty. Thus, the question becomes whether King intended to breach his fiduciary duty or whether he believed it to be a substantially certain result of his actions.
At the very least, King knew that a breach of his fiduciary duty was substantially certain to result from his actions. King knew that undisclosed conflicts were impermissible. Moreover, from his position in management, Kind had to be generally aware that the punishment for conflicts of interests by Mazak employees was swift and very often led to firing. King's career biography, published on the website of a subsequent employer, says that King served as Mazak's "'organization consciousness' by developing and enforcing corporate policies." (Pl. Ex. 2). Similarly, King testified that he: (1) was responsible for creating policies to control Mazak; and (2) developed the framework for Mazak's policies (Tr. at 107-2 to 107-18). According to the testimony of Janiszewski, Mazak's Business Ethics Policy states: "Mazak employees shall not engage in activities that produce, or reasonably appear to produce, a conflict between the personal interests of the employee and the interests of the company." (Janiszewski Dep. at 44:56 to 45:15). Janiszewski testified that King authored this policy (Janiszewski Dep. at 44:22 to 44:28). At the conclusion of King's employment by Mazak, King negotiated and obtained a separation agreement that purportedly released King from all claims, including conflicts of interest and insufficient corporate disclosure. (Def. Ex. A-1). Why bargain for such a release, unless King knew that undisclosed conflicts were impermissible?
Fully knowing that undisclosed conflicts were impermissible, King intentionally concealed his interests in United and WT. King sent the December 3, 1997 letter to Seta, copied to Papke and Okita, asking Seta to identify United's partners for Mazak. King knew this information. Why not provide the information himself unless he intended to conceal his ownership? King edited the January 5, 1998 letter from Seta to Mazak, prior to delivery, which falsified information related to the identities of United's partners. The letter named Richard Spoor, an attorney at Taft, Stettinius and Hollister, Neil Budelski, Executive Vice President Northside Bank & Trust, Dr. Donald Kochan, Senior Vice President, Transamerica Business Credit and Joseph Rippe, a partner with Rippe & Kingston, CPA when, in fact, none of these individuals were members or actual owners of United. Again, King knew the true owners of United. Why mislead Mazak about United's owners unless King intended to conceal his interest? King also conceded that Mazak's auditors effectively asked, on an annual basis, whether King owned interests in United and WT. Notwithstanding, King never disclosed his interests to the auditors over the course of several years. Why not, unless King intended to conceal his interests?
Finally, there is no evidence more probative of substantial certainty than King's deletion of all data on two Mazak computers. King was substantially certain that his nondisclosure violated Mazak's legal rights and inflicted an actionable wrong. Therefore, King destroyed all evidence that could have been discovered on two Mazak computers in his possession. See Digital Commerce, Ltd. v. Sullivan (In re Sullivan), 305 B.R. 809, 823 (Bankr. W.D. Mich. 2004)(debtor's destruction of emails pertaining to his breach of fiduciary duty to employer established willfulness by substantial certainty under § 523(a)(6)). C. King Acted Maliciously
Because King knew that undisclosed conflicts were impermissible, King's nondisclosure was done in conscious disregard of his fiduciary duty to Mazak. Nothing else contained in the record in this case reveals a just cause or any other legitimate excuse for King's actions. See Sullivan, 305 B.R. at 823 (noting that court had "little trouble" concluding that a debtor's breach of fiduciary duty was malicious); see also Lou Robustelli Marketing Servs., Inc. v. Robustelli (In re Robustelli), 430 B.R. 709, (Bankr. N.D. Ga. 2010)(debtor's breach of fiduciary duty was malicious). D. Summary
In sum, because it is a debt for willful and malicious injury, King's $3,472,896 debt to Mazak is nondischargeable under § 523(a)(6). See Jendusa-Nicolai v. Larsen, 677 F.3d 320, 324 (7th Cir. 2012)("whatever the semantic confusion, we imagine that all courts would agree that a willful and malicious injury, precluding discharge in bankruptcy of the debt created by the injury, is one that the injurer inflicted knowing he had no legal justification and either desiring to inflict the injury or knowing it was highly likely to result from his act. To allow him to shirk liability by discharging his judgment debt in those circumstances would undermine the deterrent efficacy of tort law without serving any policy that might be thought to inform bankruptcy law.")(emphasis original).
ELEMENTS OF § 523(a)(2)(A)
Section 523(a)(2)(A) excepts from discharge debts for money or property obtained by, among other things, a false representation or actual fraud. A. False Representation
A false representation is established if: (1) the debtor obtained money through a material misrepresentation or omission that, at the time, the debtor knew was false or made with gross recklessness as to its truth; (2) the debtor intended to deceive the creditor; (3) the creditor justifiably relied on the false representation; and (4) its reliance was the proximate cause of loss. In re Rembert, 141 F.3d 277, 280-81 (6th Cir. 1998); Ohio Bureau of Workers' Compensation v. Damron (In re Damron), 457 B.R. 662, 665-66 (Bankr. S.D. Ohio 2011). B. Actual Fraud
Actual fraud does not require a misrepresentation or misleading omission. In re Vitanovich, 259 B.R. 873, 877 (B.A.P. 6th Cir. 2001)(citing McClellan v. Cantrell, 217 F.3d 890, 893 (7th Cir. 2000)). It includes "any deceit, artifice, trick, or design involving direct and active operation of the mind, used to circumvent and cheat another." Vitanovich, 259 B.R. at 877.
Like a false representation, actual fraud also requires proof of intent. See id. (Actual fraud is established if "a debtor intentionally engages in a scheme to deprive or cheat another of property or a legal right."). Case law is less clear when it comes to the remaining elements of actual fraud. Some courts suggest that reliance may not be a required element. In re Fox, 370 B.R. 104, 117 (B.A.P. 6th Cir. 2007)(citing McClellan, 217 F.3d at 894). However, the Supreme Court held that justifiable reliance is an element of an actual fraud claim. See Field v. Mans, 516 U.S. 59 (1995). Consequently, this Court agrees with those holding that "[a]ctual fraud entails a course of conduct intended to deceive, justifiable reliance, and proximate cause." JGR Assocs., LLC v. Brown (In re Brown), 442 B.R. 585, 601 (Bankr. E.D. Mich. 2011).
PRECLUSIVE EFFECT OF MAZAK'S JUDGMENT UNDER § 523(a)(2)(A)
Mazak moved for summary judgment in this action, under § 523(a)(2) only, arguing that King was precluded from relitigating the findings of fact that support its Judgment. This Court held that the Judgment precluded King from litigating only one finding: the finding that King failed to disclose his ownership interest in United and WT and that this omission was material. See Doc. 82 at 8-9. The action proceeded to trial on all other issues.
§ 523(A)(2)(A) ANALYSIS
A. King Omitted Material Facts
The omission of a material fact satisfies the first prong of Rembert if the debtor had a duty to disclose the omitted information. Damron, 457 B.R. at 665; Baker v. Wentland (In re Wentland), 410 B.R. 585, 595 (Bankr. N.D. Ohio 2009).
As stated previously, King is bound by the District Court's finding, affirmed by the Sixth Circuit, that he failed to disclose his ownership interests in United and WT and that this omission was material. See Doc. 82 at 8-9. King had an unconditional duty under Kentucky law to fully disclose to Mazak the nature and extent of any profits he received from, and any ownership interests he held in, these businesses. See Mazak Corp. v. King, 2012 WL 3590817 (6th Cir. Aug. 22, 2012)(citing Aero Drapery of Ky., Inc. v. Engdahl, 507 S.W.2d 166 (Ky. 1974)); (Pl. Ex. 33). B. Known to be False
A debtor knows of the falsity of an omission where the omission creates a false impression that is known by the debtor. Dominion Virginia Power v. Robinson (In re Robinson), 340 B.R. 316, 346 (Bankr. E.D. Va. 2006).
King knew his omissions created a false impression. Indicative is King's December 22, 1997 memo to Fisher and Seta, wherein King states: "Okita is coming up with the concept (he is taking full ownership) . . . I will keep you informed." Likewise, King testified that his failure to disclose his United and WT interests to auditors would be considered an irregularity that effectively denied the existence of such ownership interests (Tr. at 721-18 to 721-21; Tr. at 740-24 to 741-5). Notwithstanding, King knowingly created that false impression for all who reviewed or signed the annual letter, including Papke and Okita. C. Made With Intent to Deceive
A subjective standard is used to determine whether the debtor intended to deceive. Rembert, 141 F.3d at 281. Subjective intent may be inferred from circumstantial evidence. Redmond v. Finch (In re Finch), 289 B.R. 638, 643 (Bankr. S.D. Ohio 2003). Courts must "consider whether the circumstances, as viewed in the aggregate, present a picture of deceptive conduct by the debtor which indicates an intent to deceive the creditor." Id.
An examination of the totality of circumstances in this case presents a picture of deceptive conduct by King, indicative of an intent to deceive.
1. United
King and Fisher discussed United's replacement of Sencorp before Seta even approached Mazak about United. Seta approached Mazak about United after hearing of Mazak's phenomenal growth from King and Fisher, who happened to be Seta's brother-in-law. During negotiations between United and Mazak: (1) King wrote the October 28, 1997 memo to Papke and Okita, suggesting that United submitted the only qualified proposal; (2) King edited the November 21, 1997 letter from Seta to Mazak, prior to delivery, which falsely suggested that United had other ventures; (3) King sent the December 3, 1997 letter to Seta, copied to Papke and Okita, asking Seta to identify United's advantages and partners for Mazak; (4) King sent the December 22, 1997 memo to Fisher and Seta, noting that "Okita is coming up with the concept . . . I will keep you informed"; and (5) King edited the January 5, 1998 letter from Seta to Mazak, prior to delivery, which incorrectly identified United's partners and intentionally misled Okita concerning the true ownership of United. Years after the formation of MFG when concerns began surfacing about United, King told Seta how to respond to Okita's questions, advising Seta to reference other United clients that did not exist, and how to correspond with other members of Mazak's management, who were his bosses.
The most damning piece of evidence revealing King's true intentions is the December 3, 1997 letter from King to Seta. The letter provides, in part:
Dear Lou:
Brian [Papke], Mr. Okita and I reviewed your position this morning and a number of questions were asked:
1. Why Lou Seta and United, why not Sencorp?
2. What finances stand behind United?
3. Who are United's partners?
4. What advantage does United provide Mazak?
I agree, these questions need to be answered. Please review this letter with your associates and take proper steps to reconcile our inquiry. . . .(Pl. Ex. 13). If King had no intent to deceive Mazak, then why did any of these questions need to be asked of Seta? Why didn't King answer them himself? He knew all of the answers. Instead of providing the answers himself, he perpetuated the deceit by sending the letter to Seta and copying the letter to Papke and Okita.
2. WT
The record concerning WT is not as detailed as United's. Nevertheless, when viewing the totality of circumstances, we conclude that King's activities surrounding his involvement with WT demonstrate, beyond any mere coincidence, a pattern and practice of deception.
WT was structured much like United. Both were owned and controlled by: (1) King; (2) a Mazak insider; and (3) an outsider familiar to Mazak, acting as the face of the company. The insiders (Fisher for United and Janiszewski for WT) and outsiders (Seta for United and Andrews for WT) were different. King was the constant. The two companies were formed within a day of one another. Both companies' interactions with Mazak fell under King's oversight as Mazak's controller and vice president of finance.
In addition, King intentionally did not disclose his interest in WT to Mazak's auditors. When cross-examined, King admitted that an annual disclosure letter to the auditors, which he signed, effectively asked whether he possessed an interest in United and WT. Unsurprising, King chose not to disclose his interest in either.
These facts, combined with King's intentional destruction of the hard drives on his company computers, on the eve of their delayed return, circumstantially, present a picture of deceptive conduct indicative of an intent to deceive. D. Alternatively, for Purposes of Actual Fraud, King Engaged in a Scheme Intended to Deceive Mazak
The scheme necessary to establish actual fraud includes "any deceit, artifice, trick, or design involving direct and active operation of the mind, used to circumvent and cheat another." Vitanovich, 259 B.R. at 877. King engineered this very type of scheme.
United and WT were structured similarly. Both were vendors designed to meet a Mazak need. The needs related to financing and accounting, aspects of Mazak's business delegated to King's management and supervision. Both United and WT communicated with Mazak through a familiar face, someone with a prior relationship to Mazak. Unknown to Mazak, both were co-owned by King and another Mazak employee. The two constants: King and a scheme to leverage King's knowledge of, and position of trust with, Mazak.
King used this scheme to deceive Mazak. For the reasons previously discussed, King intended to deceive Mazak with the scheme. E. Mazak Justifiably Relied
Justifiable reliance is more than actual reliance. Finch, 289 B.R. at 644. Yet, it is much less stringent than reasonable reliance. Miller v. Bauer (In re Bauer), 290 B.R. 568, 579 (Bankr. S.D. Ohio 2003). It is a subjective standard that looks to the factual circumstances between the parties instead of a community standard. Id. It imposes no duty to investigate, even if an investigation would have revealed the fraud. Lawson v. Conley (In re Conley), 482 B.R. 191, 208-09 (Bankr. S.D. Ohio 2012). However, the creditor is "required to use his senses, and cannot recover if he blindly relies upon a misrepresentation the falsity of which would be patent to him if he had utilized his opportunity to make a cursory examination or investigation." Field v. Mans, 516 U.S. 59, 71 (1995).
Mazak relied on King's nondisclosure. Okita emphatically and very credibly testified that he never would have pursued the business arrangement with United if he knew about King's ownership interest (Tr. at 276-10 to 276-15). Papke testified that Mazak never would have proceeded with United or WT had it known that King owned an interest in these companies (Tr. at 383-15 to 383-17; Tr. at 388-18 to 388-20). This is consistent with Papke's firing of: (1) Fisher as soon as Papke learned of Fisher's interest in United; and (2) Janiszewski due, in part, to a conflict unrelated to WT. The Court finds Okita and Papke's testimony extremely credible in light of these corroborating facts.
Mazak's reliance was justifiable. Given the size of Mazak's operations, Papke had to rely on others to manage different components of the business. Papke trusted King to manage financing and accounting, which included oversight of Mazak's relations with United and WT (Tr. at 361-12 to 361-15; Tr. at 379-5 to 379-9; Tr. at 416-21 to 416-24). In the process, neither Papke nor Okita turned a blind eye to anything that would have revealed King's omissions upon a cursory examination. To the contrary, Papke initiated the investigation into the ownership of WT when he became suspicious of King's involvement. The investigation did not uncover a link to King.
1. Mazak's Knowledge of King's Interests
King suggests that Mazak knew of his interests and therefore Mazak did not rely upon King's nondisclosure.
a. Knowledge From King Disclosure
If Mazak knew of King's interests, it did not learn of them from King. We have already concluded that King is bound by the District Court's determination that he failed to disclose his interests to Mazak. King testified that Okita knew of King's ownership interest in WT because King told Okita about it. Again, the District Court's Judgment precludes King from re-litigating that same issue. The fact is, King never disclosed his ownership interests to Mazak.
b. Papke's Knowledge Apart From King Disclosure
Janiszewski testified, by deposition, of a 2000 meeting between Papke, Janiszewski, and Vogt (Janiszewski Dep. at 5:20 to 5:45). According to Janiszewski, Papke accused Janiszewski of a conflict of interest involving WT and King (Janiszewski Dep. at 5:45 to 7:22). Papke and Vogt, on the other hand, testified that Papke did not learn of King's interest in WT until sometime after King's departure from Mazak in 2005. The Court finds Papke and Vogt's testimony to be more credible than Janiszewski's testimony.
c. Okita's Knowledge Apart From King Disclosure
King testified that Okita told King to take an ownership interest in United. Okita testified, unsurprisingly, that he never told King to take an ownership interest in United (Tr. at 274-19 to 275-4). King admitted during cross-examination that he had been convicted of theft by deception, a felony under Kentucky law. Pursuant to Fed. R. Evid. 609(a)(2), that conviction is probative upon the issue of King's character for truthfulness. In weighing the conflicting testimony, and based on the demeanor of these two witnesses, the Court finds the testimony of Okita far more credible than that of King's. That King continues to insist that he somehow disclosed his ownership interests in WT or United to Mazak officials, in the face of his concession in District Court that he did not, further undermines King's credibility.
d. Other Evidence of Mazak Knowledge
There is no other evidence that Mazak knew of King's interests prior to King's departure from Mazak.
2. Mazak's Suspicions About King
Even if Mazak did not know of King's interests prior to his departure from the company, King believes that Papke's suspicions defeat Mazak's claims of justifiable reliance. According to King, Mazak failed to act upon its suspicions, proving that Mazak did not care about King's conflicts. The Court disagrees. First, and most importantly, there is no evidence of any suspicion at the time Mazak entered into the relationships with United and WT. That time, critically, is the point at which justifiable reliance is measured. See Monarch Capital Corp. v. Bath (In re Bath), 442 B.R. 377, 397 n.8 (Bankr. E.D. Pa. 2010)(reliance measured at time when access to funds occurs). Second, Papke did not ignore his suspicions. He acted on them. For example, he ordered the investigation of WT's ownership structure by Vogt, Mazak's head of human resources. Third, Papke cared about conflicts and took swift action when he learned of them. He fired Fisher and gave Janiszewski's subordinate an ultimatum, stop selling to Mazak or leave.
Moreover, as a matter of law, suspicions do not defeat justifiable reliance unless the misrepresentation or omission would have been "patent" upon a "cursory examination." See Field, 516 U.S. at 71. In light of the entire record, a cursory examination would not have made King's omissions patent. To the contrary, Mazak performed considerable due diligence before partnering with United. King's omissions were far from patent. Importantly, King, a trusted high level manager, played the role of double agent and was able to conceal his wrongdoing from other key managers at Mazak for an extended period. Later, Papke instructed Vogt to investigate whether a link existed between King and WT's ownership. The investigation did not reveal a patent link.
3. January 5, 1998 Letter From Seta to Okita
King goes to great lengths to establish that Mazak did not rely on the January 5, 1998 letter from Seta to Okita. The argument misses the point. The issue is not whether Mazak relied upon the letter. The issue is whether Mazak relied upon King's nondisclosure. King had an unqualified duty under Kentucky law to disclose his ownership interests in United and WT, from the very start of any business relationship between the companies. For example, on June 30, 1997, King became an option member of United with the right to purchase a one-third interest in United. Similarly, on July 11, 1997, King executed a consulting agreement with United that provided for compensation equal to one-third of United's net earnings. Had King immediately and fully disclosed this information to Mazak, as he was legally required to do under Kentucky law, the Court has no doubt that Mazak would have immediately terminated the negotiations with United. Although United did not submit a proposal to Mazak until approximately October of 1997, United entered into a consulting agreement with Mazak in May of 1997. Therefore, a clear conflict existed, accompanied by a duty of complete disclosure, at the very moment that King became an option member of United and executed a consulting agreement with United. F. Mazak Sustained Loss or Damages
Section 523(a)(2) applies when property is "obtained" by fraudulent conduct. See § 523(a)(2); Rembert, 141 F.3d at 280-81. To prevail under § 523(a)(2)(A), a creditor must prove a loss or damages proximately caused by fraud.
King contends that Mazak was not damaged by his conduct in this case. According to King: "No clients or customers were taken, no trade secrets were misappropriated, and no opportunities were lost. Mazak lost nothing." Doc. 116 at 3.
Mazak's attorneys counter by arguing that King did obtain something from Mazak. Mazak contends that the profits that King received from United and WT belonged to Mazak under Kentucky law. Property rights in bankruptcy are governed by state law. Butner v. United States, 440 U.S. 48, 55 (1979). Therefore, Kentucky law governs the property rights of the parties. See Pl. Ex. 33 (Decision of Sixth Circuit). In support, Mazak cites the Judgment and the Sixth Circuit's Decision. Both cite Kentucky law for the proposition that profits realized by an agent "belong" to the principal unless otherwise agreed. See e.g., Stewart v. Kentucky Paving Co., Inc., 557 S.W.2d 435, 437 (Ky. Ct. App. 1977)("Profits realized by an agent in execution of his agency belong to the principal in the absence of an agreement to the contrary.").
1. King Obtained Money or Property From Mazak
The Court must ascertain based on the evidence of record whether King obtained funds from Mazak by fraud within the meaning of § 523(a)(2). In making the argument that Mazak did not lose money or property, King relies on In re Sabban, 600 F.3d 1219 (9th Cir. 2009) and In re Rountree, 478 F.3d 215 (4th Cir. 2007).
The case before us puts to the test the elasticity of §523(a)(2)(A) towards combating against a creditor being prevented from securing compensatory recovery for losses occasioned by fraud. As the Supreme Court observed in Cohen when addressing the scope of §523(a)(2)(A), it is "'unlikely that Congress . . . would have favored the interest in giving perpetrators of fraud a fresh start over the interest in protecting victims of fraud.'" Cohen v. De La Cruz, 523 U.S. 213, 223 (1998) (quoting Grogan, 498 U.S. at 287.)
In the instant case, King contends that since he did not receive any money from Mazak he is insulated from the reach of §523(a)(2)(A). King attempts to focus the discussion away from the fraudulent scheme used to induce Mazak initially to do business with WT and United towards the financial services each of the companies provided Mazak. King argues that Mazak received the benefit of its bargain under the contracts with WT and United. In King's view, Mazak lost nothing, but rather prospered from the arrangements with the two entities he secretly owned and profited from. The question we must resolve therefore is: Does a debtor who engaged in fraudulent conduct by employing trickery and omission of material facts "obtain" money in the form of "secret profits" from a creditor such that the debt is excepted from discharge under § 727?
King likens his conduct in the instant case to the debtor in Sabban, a case in which the Ninth Circuit found that a judgment creditor's debt was not excepted from discharge under 523(a)(2)(A). There , the debtor, a majority partner of a remodeling business, told a homeowner that the business was a licensed contractor. To the contrary, the business was not licensed. The homeowner sued the debtor under a state statute providing for the recovery of all compensation paid to an unlicensed contractor, without proof of actual damages or fraud. The state court entered judgment for the homeowner, even though it found no damages to exist. As it turns out, the contractor had paid licensed subcontractors to repair improper work that he had performed in an amount above what the homeowner had paid him, leaving the homeowner completely whole. In bankruptcy, the homeowner filed a complaint to determine dischargeability under § 523(a)(2)(A), suing solely under the provisions of a California statute that allowed a homeowner to recover what he or she had paid a contractor who had misrepresented whether he was licensed. On appeal, the Ninth Circuit addressed the sole issue of whether the judgment constituted a loss or damages proximately caused by the debtor's misrepresentation. The Ninth Circuit concluded that the judgment was dischargeable because: (1) the homeowner did not sustain any actual damages; and (2) liability under the state statute was not predicated upon fraud.
King also cites Rountree for the proposition that his nondisclosure in this case did not result in any injuries or damages to Mazak.
In Rountree, Pamela Nunnery ("Nunnery") sued Eric Baucom ("Baucom") for damages related to an automobile accident. Baucom's insurer hired June Rountree ("Rountree") to investigate the validity and extent of Nunnery's injuries. Rountree befriended Nunnery and encouraged Nunnery to engage in strenuous activities. Rountree videotaped Nunnery as she was water skiing, jet skiing, and riding horses. The insurer used the footage to defend Nunnery's suit. Subsequently, Nunnery sued Rountree. Nunnery obtained a judgment for intentional and negligent infliction of emotional distress. Rountree filed a bankruptcy petition. Nunnery filed a dischargeability complaint pursuant to § 523(a)(2)(A). The bankruptcy court entered judgment for Nunnery. The district court reversed because Rountree "obtained" nothing by her actions. The Fourth Circuit identified the issue as "whether the law requires that the debtor have fraudulently obtained something from the creditor or that the debtor simply have engaged in fraud that results in a debt owed to the creditor." Rountree, 478 F.3d at 222. According to the Fourth Circuit, the debtor must obtain something from the creditor by fraud. Id. It affirmed the district court because Rountree obtained nothing from Nunnery. Id. Instead, Rountree's fraud merely resulted in a debt to Nunnery. Id.
In reaching its decision the Rountree court stated:
Congress intended § 523(a)(2) to protect creditors who were tricked by debtors into loaning them money or giving them property, services, or credit through fraudulentId. at 219-20.
means. In Nunnery's case, Rountree's fraud may have injured her, but Rountree did not commit the fraud in order to obtain anything in the sense contemplated by § 523(a)(2).
Although King's argument is compelling, this Court concludes that his reliance on Rountree and Sabban is misplaced.
Unlike Rountree and Sabban, King committed "actual fraud in the transaction" and obtained "possession of" and the "disposal of" money, that the Sixth Circuit referred to as "secret profits" which belonged to Mazak. See In re Perkins, 298 B.R. 776, 790-91(Bankr. D. Utah 2003)(citing Webster's Third New International Dictionary Unabridged (1986), which defines "obtain" as "'to gain or attain possession or disposal of usually by some planned action or method.'"). These facts, alone, distinguish the instant case from Saban and Rountree, where the creditors, though injured by fraud, lost no property or money.
After forming WT and United, for the sole purpose of defrauding Mazak, King gained possession of money, which was the "[p]rofits realized by an agent in the execution of his agency." See Stewart v. Kentucky Paving Co., Inc., 557 S.W.2d 435, 437 (Ky. Ct. App. 1977). From the instant King received those funds they belonged legally to Mazak. Id. Further, despite having an obligation to turnover the money to his principal, King continued to hold and use the funds. Plainly, it was unlawful for King to possess the fund or keep them at his disposal. Thus, every time King received a distribution from WT or United, it was predicated not only upon him breaching his fiduciary duty, but also upon him attaining possession and control of money belonging to Mazak. By concealing his ownership in WT and United and maintaining possession of the secret profits, contrary to his fiduciary obligations, throughout the execution of his scheme, King fraudulently obtained money from Mazak.
2. Constructive Trust and Comity
We are also unpersuaded by King's attempts to frame this issue as one that must be resolved under the law of constructive trusts. See In re Omegas Group, Inc., 16 F.3d 1443 (6th Cir. 1994). This case is not unlike litigation where a defendant files for bankruptcy in the midst of litigation on a state law claim other than fraud and the action is stayed by the provisions of §362(a). A creditor is not foreclosed from a later determination by the bankruptcy court that what occurred was fraudulent and therefore nondischargeable, even though a judgment reached by another court in an earlier trial against the debtor may be based on a non-fraud-based state law claim. See Banks 263 F.3d 862, 868 (9th Cir. 2001).
In due course, after the decision in this case resolving the nondischargeability of the Judgment debt, the district court or state court will decide whether a constructive trust over assets under King's custody or control, namely the William P. King Trust and Mary Lynn King Trust, is warranted. However, that matter is not now before this Court and we needn't resolve those issues today. Our sole task in this adversary proceeding is to determine whether King's conduct underlying the Judgment debt falls within the exception to discharge under §523(a)(2)(A). G. Damages or Loss Proximately Caused by Fraud
A number of bankruptcy courts have found it appropriate to look to the Restatement when analyzing damages pursuant to § 523(a)(2)(A). See In re Carlson, 426 B.R. 840, 859 (Bankr. D. Idaho 2010)(citing Field v. Mans and stating that when analyzing §523(a)(2)(A)'s reliance component, the Supreme Court looked to the Restatement (Second) of Torts as "the most accepted distillation of the common law of torts."); Perkins, 298 B.R. at 791 (applying the Restatement (Second) of Torts §549 to calculate damages under §523(a)(2)(A)); see also SG Homes Assocs., LP v. Marinucci, 718 F.3d 327, 336 (4th Cir. 2013)(approving of bankruptcy court's application of Maryland's "flexibility theory" under which a victim of fraudulent misrepresentation can elect between out-of-pocket expenses or benefit-of-the-bargain damages); In re Gilmartin, 459 B.R. 720, 725 (B.A.P. 8th Cir. 2011)(applying Missouri law in a nondischargeability action under §523(a)(2)(A) which primarily follows the benefit-of-the-bargain damages rule unless circumstances warrant a court applying the out-of-pocket expense rule for measuring damages).
The Court notes that "Ohio courts have generally followed, whether specifically noted or not, the principles set forth in the Restatement (Second) of Torts when discerning the propriety and amount of damages in fraud cases." Auto Chem Laboratories Inc. v Turtle Wax, Inc., 2010 WL 3769209, at *7 (S.D. Ohio Sept. 24, 2010). Kentucky courts also apply the Restatement of Torts when determining whether damages are appropriate in fraud cases and the amount of damages, if any, that should be awarded. United Parcel Service Company v. Rickert, 996 S.W. 2d 464, 470 (Ky. 1999); Sanders, Inc. v. Chesmotel Lodge, Inc., 300 S.W.2d 239 (Ky. 1957)(applying Restatement of Torts in assessing whether person suffered injuries from fraud and the amount of damages he is entitled to recover).
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The applicable section of the Restatement (Second) of Torts, §549, provides as follows:
(1) The recipient of a fraudulent misrepresentation is entitled to recover as damages in an action of deceit against the maker the pecuniary loss to him of which the misrepresentation is a legal cause, includingRestatement (Second) of Torts § 549 (1977).
(a) the difference between the value of what he has received in the transaction and its purchase price or other value given for it; and(2) The recipient of a fraudulent misrepresentation in a business transaction is also entitled to recover additional damages sufficient to give him the benefit of his contract with the maker, if these damages are proved with reasonable certainty.
(b) pecuniary loss suffered otherwise as a consequence of the recipient's reliance upon the misrepresentation.
Mazak relies exclusively on the Judgment as proof of damages traceable to fraud. Mazak highlights the existence of a "specific debt" that King owes Mazak. Because there is a "specific debt," according to Mazak, the entire Judgment is excepted from discharge under Cohen. See Doc. 117 at 3. We agree.
Cohen addressed the question of whether § 523(a)(2)(A) is limited to the value of the property obtained by fraud. Specifically, whether an award of treble damages is nondischargeable under the statute. The Supreme Court held that § 523(a)(2)(A) is not limited to the value of the property "obtained by" fraud and therefore an award of treble damages can be excepted from discharge. Cohen, 523 U.S. at 215. When construing the language of § 523(a)(2)(A), the Supreme Court stated: "the phrase thereby makes clear that the share of money, property, etc. that is obtained by fraud gives rise to a nondischargeable debt. Once it is established that specific money or property has been obtained by fraud, however, 'any debt' arising therefrom is excepted from discharge." Cohen, 523 U.S. at 218.
King fraudulently induced Mazak into entering contracts with WT and United in order to have those companies perform financial services in an area he supervised, also breaching his fiduciary duty. King's nondisclosure which Mazak relied upon to its detriment resulted in multiple distributions from United and WT to their members, including King, of money that belonged to Mazak. This debt was liquidated as reflected in the Judgment rendered by the District Court in the breach of fiduciary action for $3,472,896. These funds or "secret profits," as referred to by the Sixth Circuit, also represent the loss Mazak suffered "resulting from fraud" or "traceable to fraud" under Cohen.
CONCLUSION
For the foregoing reasons, the Judgment is nondischargeable pursuant to § 523(a)(2) and § 523(a)(6). The Court will enter a judgment to this effect. Copies to: Susan M. Argo
sargo@graydon.com
Reuel D. Ash
rash@ulmer.com
| SUMMARY OF SELECTION PROCESS | |
| The 1997-1998 negotiations between Mazak and United can be summarized as follows: | |
| Prior to October 28, 1997 | United submits proposal to Mazak. |
| October 28, 1997 | King memo to Papke/Okita, suggesting that United submitted only proposal that meets all of Mazak criteria. |
| December 3, 1997 | Papke/Okita/King review United proposal. |
| December 3, 1997 | King letter to Seta, requesting identification of United's partners and financial backing. |
| December 10, 1997 | Seta letter to King/Okita, requesting confidentiality agreement and letter of intent before disclosure. |
| December 15, 1997 | Okita signs confidentiality agreement. |
| December 19, 1997 | Okita memo to Papke, summarizing benefits of MFG and proposing that Mazak present to Yamazaki for final approval. |
| January 5, 1998 | Seta letter to Okita, identifying United's partners as Messrs. Spoor, Budelsky, Kochan, and Rippe. |
| January 6, 1998 | Okita letter of intent to Seta. |
| April 1, 1998 | Effective date of operating agreement for MFG, executed by Mazak and United. |
SUMMARY OF SELECTION PROCESS: REVISITED
| March 24, 1997 | King memo to Fisher: "How would United International fill the role of Sencorp? |
| March 25, 1997 | Seta [currently employed selling hazardous waste remediation products] letter to Papke: "It has been a while." Heard of "phenomenal growth" from King and Fisher. Currently affiliated with United, a firm with "extensive international and domestic contacts." |
| June 30, 1997 | Formation of United. King is an option member. |
| July 11, 1997 | King executes consulting agreement with United. |
| Prior to October 28, 1997 | United submits proposal to Mazak. |
| October 28, 1997 | King memo to Papke/Okita, suggesting that United submitted only proposal that meets all of Mazak criteria. |
| November 21, 1997 | Seta letter to Okita: LLC enables Seta to "leverage the capital of United and one or more of its' [sic] partners who have supplied capital in other United ventures [United had no other ventures]." King edits letter prior to delivery. |
| December 3, 1997 | Papke/Okita/King review United proposal. |
| December 3, 1997 | King letter to Seta, requesting identification of United's partners and financial backing. |
| December 10, 1997 | Seta letter to King/Okita, requesting confidentiality agreement and letter of intent before disclosure. |
| December 15, 1997 | Okita signs confidentiality agreement. |
| December 19, 1997 | Okita memo to Papke, summarizing benefits of MFG and proposing that Mazak present to Yamazaki for final approval. |
| December 22, 1997 | King memo to Fisher and Seta: "Okita is coming up with the concept (he is taking full ownership) ... I will keep you informed." |
| January 5, 1998 | Seta letter to Okita, identifying United's partners as Messrs. Spoor, Budelsky, Kochan, and Rippe. King edits letter prior to delivery. |
| January 6, 1998 | Okita letter of intent to Seta. |
| April 1, 1998 | Execution of United's second operating agreement: King becomes a 33% member of United. |
| April 1, 1998 | Effective date of operating agreement for MFG, executed by Mazak and United. |