Opinion
No. 12-10331 A.P. No. 12-1085
09-04-2012
In re GEORGE and KARLA SCHIKORE, Debtor(s). PAGANINI ELECTRIC COMPANY, Plaintiff(s), v. GEORGE and KARLA SCHIKORE, Defendant(s).
GLORIA L. FRANKLIN, CLERK
U.S BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
Memorandum on Motion to Dismiss
In its complaint, plaintiff Paganini Electric Company ("PEC") alleges that Chapter 7 debtors and defendants George and Karla Schikore were officers and directors of Schikore Construction, Inc. PEC alleges that it did work for the corporation, that the corporation was the alter ego of the Schikores, and that the Schikores diverted funds that should have been paid to it. The complaint alleges that PEC's $210,000.00 default judgment against the Schikores is nondischargeable pursuant to § 523(a)(2), § 523(a)(4) and § 523(a)(6) of the Bankruptcy Code.
The Schikores have moved for dismissal of the complaint, alleging that it fails to state facts constituting nondishchargeable conduct. PEC has conceded that the complaint fails under § 523(a)(2) and § 523(a)(6), but claims that it states facts sufficient to establish liability under § 523(a)(4) for defalcation in a fiduciary capacity. The court does not agree.
It has long been the law in this circuit that contractors are not liable under § 523(a)(4) for failure to apply construction funds to subcontractors. In re Pedrazzini, 644 F.2d 756, 758 (9th Cir. 1981). PEC's only argument seeking to circumvent Pedrazzini is that the corporation was insolvent when the diversion occurred, that upon insolvency the Schikores became trustees for the corporate creditors, and therefore PEC's judgment is nondischargeable. The only authority cited for this position is In re Jacks, 266 B.R. 728 (9th Cir. BAP 2001). There are several problems with this argument.
The first problem with reliance on Jacks is that the complaint does not allege any of the facts of that case. It only alleges that the Schikores "converted funds they held as constructive trustees for PEC" which were "impressed with a trust for the purpose of paying suppliers of labor and material." This claim is barred by Pedrazzini.
The second problem is a breakdown in logic. Even if any of the funds allegedly withdrawn by the Schikores were impressed with a trust, that does not mean that PEC's entire judgment is nondischargeable. The Schikores would only be liable to PEC for PEC's share of the total "defalcated." Thus, if the Schikores withdrew $100,000.00 from the corporation when it was insolvent and had $1,000,000.00 in total debt, PEC's damages would only be $20,000.00 on account of the"defalcation," not the total amount of its judgment.
The third problem is that Jacks is no longer good law. As Judge Taylor has pointed out in her thorough decision so holding in In re Moeller, 466 B.R. 525, 533 (Bkrtcy.S.D.Cal. 2012), current California law makes it clear that the fiduciary relationship between creditors and corporate principals after insolvency fails to support a § 523(a)(4) exception to discharge. As Judge Taylor notes, the intervening decision of the California Court of Appeal in Berg & Berg Enterprises, LLC v. Boyle, 178 Cal.App.4th 1020 (2009), makes it clear that under current California law "neither an express nor technical trust is created when the trust fund doctrine applies." Id.
Because state law determines when a trust is created, Berg undercut the legal theory upon which Jacks was based. Federal courts are generally bound by intermediate state appellate court decisions when interpreting state law. In re Watts, 298 F.3d 1077, 1082 (9th Cir. 2002). While it is possible that a current BAP panel might still consider itself bound by Jacks, the parties can of course avoid this merely be seeking district court review.
For the foregoing reasons, the motion to dismiss will be granted. Counsel for the Schikores shall submit an appropriate form of order.
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Alan Jaroslovsly
U.S. Bankruptcy Judge