Opinion
Case No. 16-30672 Adv. No. 16-3065
07-17-2018
In re: ROBERT S. COMBS TERESA E. COMBS, Debtors CARLA S. PERRY, Plaintiffs v. ROBERT S. COMBS, Defendant
Copies to: Jacob M. Jeffries, electronically served (Counsel for the Plaintiff) Roger E. Luring, electronically served (Counsel for the Defendant)
Chapter 7
Decision Granting in Part and Denying in Part Defendant's Motion for Summary Judgment And Denying Plaintiff's Motion for Summary Judgment
On June 28, 2016 Carla S. Perry ("Perry") filed the Complaint to Determine Dischargeability of Debt ("Complaint") against Robert S. Combs ("Combs") and his wife Teresa E. Combs. The Complaint alleges that the $75,000 arbitration award against Combs and in favor of Perry stemming from their prior business relationship is non-dischargeable under three theories: (1) willful and malicious conduct under 11 U.S.C. § 523(a)(6); (2) fraud or defalcation as a fiduciary under § 523(a)(4); and (3) larceny, embezzlement, or conversion under § 523(a)(4). Combs moved for summary judgment on all three counts, arguing that Perry could not meet the burden to prove the requisite intent, and was estopped from arguing the issue of fraud under issue preclusion. Perry also filed a motion for summary judgment on counts two and three.
Teresa Combs was dismissed by agreement of the parties on August 26, 2016. ECF No. 6.
Unless otherwise noted, all statutory references are to the Bankruptcy Code of 1978, as amended, 11 U.S.C. §§ 101-1532.
Findings of Fact
On March 23, 2012 Combs and Perry formed Champaign Properties, a Limited Liability Company (the "LLC") formed under the laws of Ohio, for the purpose of investing in real estate. Perry contributed $150,000 to the capital account of the LLC and Combs, a real estate agent, made an in-kind contribution by serving as the Managing Member and President of the LLC. As Managing Member, Combs was entrusted to make disbursements from those funds in operating the business.
From the time of the LLC's formation until he was removed as its president the following August, Combs made a string of disbursements from the LLC's capital account that were not for the benefit of the LLC. These payments included payments for food, video on demand, a glassed enclosure at his personal residence, expenses associated with properties owned by his own competing business, over $14,000 of continuing education, and payments to both his sister-in-law and his son. After requesting an accounting from Combs and the LLC, Perry terminated Combs as the manager of the LLC and the LLC and Perry filed an action in the Champaign County, Ohio, Common Pleas Court (the "State Court") against Combs seeking recovery of those funds. Combs filed an answer and counterclaims against Perry in response to the State Court Complaint. Three counts of the LLC's and Perry's State Court Complaint and Combs' counterclaims were referred to binding arbitration by the State Court in accordance with the LLC operating agreement. The arbitrator subsequently awarded $75,000 plus costs, the full amount requested, to Perry for disbursements made by Combs that were not made on behalf of the LLC (the "Arbitrator's Award" ECF No. 35-1). The Arbitrator's Award was subsequently confirmed by the State Court and a judgment was entered against Combs (the "Judgment" ECF No. 35-3).
Combs filed a Chapter 7 bankruptcy case in March 2016 and listed the Judgment in his Schedules as an unsecured, non-priority disputed debt of $75,000. Perry initiated this adversary proceeding in June 2016. Perry's complaint seeks a determination of the non-dischargeability of the debt under three separate counts. Count One alleges that Comb's misuse of the LLC's funds constituted willful and malicious conduct which resulted in harm to Perry and rendered the debt non-dischargeable under § 523(a)(6). Count Two alleges that Combs committed either fraud or defalcation while acting in a fiduciary capacity over the money at issue which rendered the debt non-dischargeable under § 523(a)(4). Finally, Count Three alleges that the Judgment debt arose due to larceny, embezzlement or conversion by Combs which rendered the debt non-dischargeable under § 523(a)(4).
The costs associated with the arbitration were scheduled separately.
Analysis
Both parties have moved for summary judgment. The parties do not dispute the existence or the amount of the Judgment debt; however, they do contest whether the arbitrator's finding that the improper disbursements made by Combs did not "r[i]se to th[e] level of harm" of fraud, embezzlement, or theft should be given preclusive effect in this dischargeability proceeding. Thus, before moving to the substance of the allegations, the court will first consider the preclusive effect of the Arbitrator's Award.
A. Jurisdiction
This court has jurisdiction pursuant to 28 U.S.C. § 1334, this is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(I), and this court has constitutional authority to enter a final judgment.
B. Summary Judgment Standard
Federal Rule of Civil Procedure 56(a), made applicable to adversary proceedings through Bankruptcy Rule 7056, sets forth the standard to address the parties' filings. It states, in part, that a court must grant summary judgment to the moving party if the movant shows that there is no genuine issue as to any material fact and the movant is entitled to judgment as a matter of law.
In order to prevail, the movant, if bearing the burden of persuasion at trial, must establish all elements of its claim. Celotex Corp. v. Catrett, 477 U.S. 317, 331 (1986). If the burden is on the nonmovant at trial, the movant must: 1) submit affirmative evidence that negates an essential element of the nonmovant's claim or 2) demonstrate to the court that the nonmovant's evidence is insufficient to establish an essential element of the nonmovant's claim. Id. at 331-32. Thereafter, the nonmovant "must come forward with 'specific facts showing that there is a genuine issue for trial.' " Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986) (citations omitted); Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 249-50 (1986). All inferences drawn from the underlying facts must be viewed in a light most favorable to the party opposing the motion. Matsushita, 475 U.S. at 587-88. The fact that the parties have filed cross motions for summary judgment does not alter the standards for determining motions for summary judgment. See Taft Broad. Co. v. United States, 929 F.2d 240, 248 (6th Cir. 1991).
C. Issue Preclusion
On summary judgment, Combs asks the court to give preclusive effect to the Arbitrator's Award, in particular the holding that the arbitrator found that the expenditure of LLC funds did not "r[i]se to th[e] level of harm" of fraud, embezzlement or theft. (Arbitrator's Award at 1). Issue preclusion is a "fundamental precept of common-law adjudication." Corzin v. Fordu (In re Fordu), 201 F.3d 693, 702 (6th Cir. 1999) Simply put, once a question has been put before and determined by a court of competent jurisdiction, it " 'cannot be disputed in a subsequent suit between the same parties or their privies . . . .' " Id. (quoting Montana v. United States, 440 U.S. 147, 153 (1979)).
Issue preclusion applies in non-dischargeability proceedings when facts or legal issues determined in prior litigation are relevant to the elements of a creditor's § 523 claim. Grogan v. Garner, 498 U.S. 279, 284 n.11 (1991); Clark v. Springhart (In re Springhart), 450 B.R. 725, 730 (Bankr. S.D. Ohio 2011). Furthermore, the Sixth Circuit and Ohio courts have generally applied issue preclusion to arbitration awards when the subsequent proceeding is between the same parties. Central Transport v. Four Phase Systems, Inc., 936 F.2d 256, 260 (noting that federal courts ordinarily give preclusive effect to arbitrations); Ivery v. United States, 686 F.2d 410, 413-14 (6th Cir. 1982); In re Robinson, 256 B.R. 482, 488 (Bankr. S.D. Ohio 2000); and Ford Hull-Mar Nursing Home, Inc. v. Marr Knapp Crawfis & Assoc., 740 N.E.2d 729, 734 (Ohio Ct. App. 2000).
The full faith and credit statute requires federal courts, including this one, to give the same preclusive effect to a state court judgment as it would receive from other state courts. Fordu, 201 F.3d at 703 (citing 28 U.S.C. § 1738). In making this determination, "the federal court must apply the law of the state in which the prior judgment was rendered in determining whether and to what extent the prior judgment should be given preclusive effect in a federal action." Id.
In Ohio, issue preclusion applies when 1) a final judgment on the merits in the previous case has been issued after a full and fair opportunity to litigate the issue; 2) the issue was actually and directly litigated in the prior suit and the determination was necessary to the final judgment; 3) the issue in the present suit is identical to the issue in the prior suit; and 4) the party against whom estoppel is sought was a party or in privity with the party to the prior action. Sill v. Sweeney (In re Sweeney), 276 B.R. 186, 189 (B.A.P. 6th Cir. 2002). See Buckeye Union Ins. Co. v. New England Ins. Co., 720 N.E.2d 495, 501 (Ohio 1999) (citing Goodson v. McDonough Power Equip., Inc., 443 N.E.2d 978, 985 (Ohio 1983)).
In addition, "[t]o be entitled to preclusive effect, a judgment should have sufficient detail to enable a subsequent court to have a clear understanding of the prior court's ruling without having to speculate about the scope of the prior court's findings of fact and conclusions of law." Yust v. Henkel (In re Henkel), 490 B.R. 759, 781-82 (Bankr. S.D. Ohio 2013); Schmidt v. Panos (In re Panos), 573 B.R. 723, 735 (Bankr. S.D. Ohio 2017); and Simmons Capital Advisors, Ltd. v. Bachinski (In re Bachinski), 393 B.R. 522, 540 (Bankr. S.D. Ohio 2008) (" '[C]ollateral estoppel applies in bankruptcy courts only if . . . the first court has made specific, subordinate, factual findings on the identical dischargeability issue in question . . . and facts supporting the court's findings are discernible from that court's record.' " (alterations in the original) (citation omitted). However, the findings do not need to be made in any special or formal manner. Sweeney, 276 B.R. at 193-94; and Henkel, 490 B.R. 759, 777.
Here, the parties in this proceeding and the prior arbitration proceeding are identical. Further, in Ohio "an arbitration award has the same preclusive effect as a court judgment for the matters it decided," and, thus, a final judgment was rendered after the parties had a full and fair opportunity to litigate their dispute. City of Cleveland v. Ass'n of Cleveland Fire Fighters, Local 93, 485 N.E.2d 792, 798 (Ohio Ct. App. 1984) (citation omitted). Accordingly, only the second and third requirements are at issue in deciding whether the arbitrator's finding is preclusive in this proceeding: whether the issues of fraud, embezzlement, and larceny raised in this adversary proceeding are identical to the issues tried and determined in the arbitration proceeding; whether the facts and issues necessary to the determinations under § 523(a)(4) and (6) were actually and directly litigated; and whether the arbitrator's finding that Combs' conduct did not rise to the level of fraud, embezzlement or larceny was necessary to the Arbitrator's Award.
The State Court action involved Perry and the LLC as plaintiffs and Combs and his wife and Starfish Enterprises LLC as the defendants. Perry and Combs were the parties to the arbitration and the Arbitration Award was made in favor of Perry. Perry is the plaintiff in this adversary proceeding against Combs, the debtor and defendant to this proceeding.
Given these requirements of issue preclusion, the court finds that the arbitrator's failure to find fraud, embezzlement, or theft does not have preclusive effect on this proceeding. First, at most, only the fraud and defalcation in a fiduciary capacity non-dischargeability claims were arguably submitted to arbitration. "Arbitrators cannot decide issues which the parties have not submitted for their decision." City of Cleveland v. Ass'n of Cleveland Fire Fighters, Local 93, 485 N.E.2d 792, 798 (Ohio 1984). On October 8, 2014 the State Court filed a Journal Entry which referred the LLC's and Perry's First (Fraud and Constructive Fraud), Third (Conversion), and Fourth (Breach of Fiduciary Duty and Breach of Loyalty) Causes of Action to arbitration, in addition to Combs' counterclaims. (Judgment 1) Thus, fraud, conversion, and breach of fiduciary duty and breach of loyalty causes of action were referred to the arbitrator for arbitration. The First Cause of Action (Fraud and Constructive Fraud) and the Fourth Cause of Action (Breach of Fiduciary Duty and Breach of Loyalty) could reasonably be construed to have submitted the fraud and defalcation in a fiduciary capacity claims to the arbitrator. None of the Causes of Action from the State Court Complaint included a willful and malicious claim and, therefore, that claim without equivocation was not referred to the arbitrator.
The arbitrator's finding that the disbursements did not rise to the level of fraud, embezzlement, or theft was not necessary or essential to the Arbitrator's Award. As noted, state law claims of fraud, constructive fraud, conversion, breach of fiduciary duty, and breach of loyalty were referred to the arbitrator for arbitration. However, it cannot be determined from the Arbitrator's Award, the Judgment, or the Magistrate's Decision what claim or cause of action was the basis or were the bases for the award to Perry. The Magistrate's Decision Granting Plaintiffs' Application to Confirm Arbitration Award filed October 21, 2015 states that the arbitrator "found in favor of Plaintiff Carla S. Perry and against Defendant Robert S. Combs on the claims submitted to arbitration." ("Magistrate's Decision", ECF No. 38-1, Ex. F. at 1). The Judgment simply adopted the Magistrate's Decision. While ruling in favor of Perry, the arbitrator did not identify in his Arbitrator's Award the specific cause or causes of action from Perry's State Court Complaint upon which he was ruling in favor of Perry. The arbitrator simply identified the disbursements as having been "wrongfully and improperly made, and . . . in violation and breach of the LLC agreement," without identifying if he was making the award under either or both the Third or Fourth Causes of Action of the Complaint. Thus, the arbitrator's reference to evidence not rising to the level of fraud, embezzlement, or theft could be construed to mean that he was denying the award as to the First Cause of Action (Fraud and Constructive Fraud). However, it is unclear as to whether he was granting the award as to the Third Cause of Action (Conversion) or the Fourth Cause of Action (Breach of Fiduciary Duty and Breach of Loyalty), or both. Further, conversion is not the equivalent of embezzlement or larceny and each are defined differently with different elements. See Custom Kilns, Inc. v. Pierron (In re Pierron), 448 B.R. 228, 240 (Bankr. S.D. Ohio 2011); PRN Funding LLC v. Cole (In re Cole), 15-6034, 2015 Bankr. LEXIS 3494 at *11-13 (Bankr. N.D. Ohio Oct. 14, 2015); Fadayel v. Vonderahe (In re Vonderahe), 99-1155, 2001 Bankr. LEXIS 863 at *5-7 (Bankr. S.D. Ohio Feb. 26, 2001); and State v. Glaros, 173 N.E.2d 146, 155, (Ohio Ct. App. 1961), aff'd 180 N.E.2d 134 (1962).
Without the arbitrator's identification of the cause or causes of action for which he was finding in favor of Perry, the court cannot determine if his finding that Combs' conduct did not rise to the level of fraud, embezzlement, or theft was necessary to his award.
Next, this Court considers whether the findings on which issue preclusion is to apply are a critical and necessary part of the state court judgment. See St. Laurent, 991 F.2d at 676 . This becomes a concern when a multi-count complaint is involved. "If the judgment fails to distinguish as to which of two or more independently adequate grounds is relied on, it is impossible to determine with certainty what issues were in fact adjudicated, and the judgment has no preclusive effect." Id. Consequently, where prior litigation involves a complaint containing multiple counts that do not all allege fraud and where the judgment entered in the prior action does not specify the basis for the monetary award, it may not be possible to give the judgment preclusive effect in a § 523(a)(2) action. See Dimmitt & Owens Financial, Inc. v. Green (In re Green), 262 B.R. 557, 570-71 (Bankr. M.D. Fla. 2001) (noting that the
court cannot conclude that allegations regarding fraud are a "critical and necessary" part of a simple default judgment when both fraud and non-fraud counts were asserted in the state court complaint and there is no way to distinguish which count is the basis for the judgment).Papa v. Bolera (In re Bolera), 564 B.R. 569, 585 (Bankr. S.D. Ohio 2016); See also In re Panos, 573 B.R. 723, 738 (Bankr. S.D. Ohio 2017) ("When a state court awards damages on multiple counts, and no portion of those damages is directly allocated to any one of those multiple counts, one cannot conclude that any one of those counts is necessary to the final judgment as required by the third prong of the test for application of issue preclusion."). Accordingly, the court finds that the arbitrator's finding that the harm to Perry did not rise to the level of fraud, embezzlement, or theft was not necessary to the Arbitrator's Award.
In addition, even if the fraud and defalcation issues were submitted to the arbitrator and the arbitrator's finding that the harm did not rise to the level of fraud, embezzlement, or theft was necessary to his determining those issues, there is little evidence that those claims were "directly determined." While the transcript and the Magistrate's Decision show that the parties presented some evidence and argument on these issues, there is not sufficient information from which this court can conclude that the identical issues of fraud or defalcation in a fiduciary capacity as described by § 523(a)(4) were actually litigated and determined through the arbitration. The Magistrate's Decision simply states that:
There was argument presented at the hearing that these disbursements were fraudulently made or constituted embezzlement or theft. I cannot find from the evidence that the disbursements rose to this level of harm. For the most part, the disbursements were made openly and fully and properly recorded, which, in effect, allowed Perry to track the disbursements and demonstrate their impropriety. The disbursements, however, were not for or on behalf of the LLC, were wrongfully and improperly made, and were in violation and breach of the LLC agreement.(Arbitrator's Award 1). The arbitrator's decision did not identify, or individually analyze the elements of fraud, embezzlement, or larceny that were applied, therefore it is impossible to determine whether the identical issues of fraud or defalcation under § 523(a)(4) were directly determined. See Sweeney at 192-195; and Hinze v. Robinson (In re Robinson), 242 B.R. 380, 387 (Bankr. N.D. Ohio 1999). The arbitrator's bare finding that Combs' conduct does not "r[i]se to th[e] level of harm" of fraud, embezzlement, or theft without more specific findings and analysis of the evidence presented at the arbitration hearing does not provide the court with sufficient information from which this court can conclude that the arbitrator applied the elements of fraud or embezzlement under § 523(a)(4) in making his award.
"The 'fraud' required under § 523(a)(4) is 'fraud in fact, involving moral turpitude or intentional wrong.' " Cash Am. Fin. Servs. v. Fox (In re Fox), 370 B.R. 104, 115-16 (B.A.P. 6th Cir. 2007) (quoting Driggs v. Black (In re Black), 787 F.2d 503, 507 (10th Cir. 1986)). Ohio law provides a more restrictive definition of fraud than that required by § 523(a)(4). Id. To establish fraud under Ohio law, one must prove: "(1) a representation or, where there is a duty to disclose, concealment of fact; (2) which is material to the transaction at hand; (3) made falsely, with knowledge of its falsity, or with such utter disregard and recklessness as to whether it is true or false that knowledge may be inferred; (4) with the intent of misleading another into relying upon it; (5) justifiable reliance upon the representation or concealment; and (6) a resulting injury proximately caused by the reliance." Id. (citation omitted).
"Embezzlement" for purposes of § 523(a)(4) is defined as " 'the fraudulent appropriation of property by a person to whom such property has been entrusted or into whose hands it has lawfully come' " and requires the establishment of the following elements: (1) the entrustment of property to the bankruptcy debtor, (2) the appropriation of the property by the debtor for a use other than that for which it was entrusted, and (3) the circumstances indicate fraud." Cash Am. Fin. Servs. v. Fox (In re Fox), 370 B.R. 104, 115-16 (B.A.P. 6th Cir. 2007) (quoting Brady v. McAllister (In re Brady), 101 F.3d 1165, 1172-73 (6th Cir.1996)). The fraud required under § 523(a)(4) embezzlement prong encompasses "any deceit, artifice, trick, or design involving direct and active operation of the mind, used to circumvent and cheat another." Id. (quoting Melon Bank v. Vitanovich (In re Vitanovich), 259 B.R. 873, 877 (B.A.P. 6th Cir. 2001)).
"Larceny" for purposes of § 523(a)(4) is "the fraudulent and wrongful taking and carrying away of the property of another with intent to convert such property to the taker's use without the consent of the owner." Duley v. Thompson (In re Thompson), 528 B.R. 721, 739 (S.D. Ohio 2015) (citation omitted).
While, as previously noted, the results of an arbitration proceeding may have preclusive effect on later litigation, such as in this litigation, application of such results in the context of a bankruptcy dischargeability proceeding is difficult due to the very nature of arbitration. Application of the Arbitrator's Award in this proceeding bears out that difficulty. As an alternative dispute resolution mechanism, one of the reasons to proceed with arbitration is to save time and money. Time and money is saved through the less formal and more expedient addressing of the dispute. Unfortunately, the stream-lined procedures and decision-making process involved in most arbitrations removes the detail, such as the specific findings of fact and conclusions of law, necessary to the application of collateral estoppel to non-dischargeability claims under § 523. See Nester v. Nester, Nos. 94APF09-1359, 94APF09-13601995, Ohio App. LEXIS 2174 (Ohio Ct. App. May 23, 1995):
Thus, one of the very purposes for findings of fact and conclusions of law, assuming a party properly moves for these findings, is to enable the appellate court to review the factual and legal conclusions of the trial court. . . . However, Ohio law recognizes "that when parties agree to submit their disputes to binding arbitration, they have bargained for the arbitrator's determination concerning the issues submitted and agree to accept the result regardless of its legal or factual accuracy." . . .
Indeed, absent a provision to the contrary, the validity of an arbitration award is unaffected by the lack of a formalized statement of findings of fact and conclusions of law.
For these reasons, the court finds that the fraud, embezzlement, and larceny issues were not actually litigated in the arbitration proceeding.
D. Count One: Willful and Malicious Injury
Section 523(a)(6) of the Code provides in relevant part that "[a] discharge under section 727 . . . of this title does not discharge an individual debtor from any debt . . . for willful and malicious injury by the debtor to another entity or to the property of another entity." For an injury to be willful, the debtor must have "desire[d] to cause the consequences of his act or believe[d] that the consequences are substantially certain to result from his actions." Markowitz v. Campbell (In re Markowitz), 190 F.3d 455, 464 (6th Cir. 1999) (quoting Kawaauhau v. Geiger, 523 U.S. 57, 61 (1998); See also Dardinger v. Dardinger (In re Dardinger), 566 B.R. 481, 493 (Bankr. S.D. Ohio 2017) ("And for an injury to be 'malicious,' the debtor must have acted 'in conscious disregard of [his] duties or without just cause or excuse.' " (citing Wheeler v. Laudani, 783 F.2d 610, 615 (6th Cir. 1986)) and Schafer v. Rapp (In re Rapp), 375 B.R. 421, 436 (Bankr. S.D. Ohio 2007)).
Perry's Complaint points to numerous payments made from the LLC's capital account for non-business purposes, including payments for the benefit of Starfish Enterprises LLC ("Starfish"), an entity owned by Combs also engaged in real estate investment, relatives, and home improvements. (ECF No. 35 at 6). In his memorandum in opposition, Combs argues that he believed that all these payments were due to either his own inexperience or negligence. (ECF No. 38 at 7). Combs supports his contention that these payments were not made with fraudulent intent by asserting that all payments were made transparently through the LLC's bank account and that Perry had access to the records of these accounts. Id. Combs also affirmed that he informed Perry of his side business with Starfish. While conceding that he did harm to Perry, Combs argues that this transparency proves that he believed he was making legitimate business purchases, or else he never would have openly recorded them. Perry denies that she had access to the bank records or that Combs informed her of his competing business. (Transcript 55-56, ECF No. 33). Moreover, even if all the misappropriations in question were made with complete transparency, the clearly inappropriate nature of some of these payments suggests that Combs' openness may have been the result of Perry's inattentiveness, rather than his own belief in his justification. Accordingly, there is a genuine dispute of material fact as to whether Combs intended to cause the losses suffered by Perry and in conscious disregard of his own duties without just cause or legal excuse.
E. Combs was not a fiduciary for purposes of § 523(a)(4) and so Summary Judgment is granted to Combs as to Count 2
Section 523(a)(4) denies debtors a discharge for any debts arising from defalcation while the debtor was acting in a fiduciary capacity. The defalcation exception applies when there is "(1) a pre-existing fiduciary relationship, (2) a breach of that relationship, and (3) resulting loss." Patel v. Shamrock Floorcovering Servs., Inc. (In re Shamrock Floorcovering Servs., Inc.), 565 F.3d 963, 968 (6th Cir. 2009) (citing Bd. of Trustees v. Bucci (In re Bucci), 493 F.3d 635, 642 (6th Cir.2007)). Whether a pre-existing fiduciary relationship exits is a question of federal law, "although state law is important in determining when a trust relationship exists." Carlisle Cashway, Inc. v. Johnson (In re Johnson), 691 F.2d 249, 251 (6th Cir. 1982) (citing Pedrazzini v. Runnion (In re Pedrazzini), 644 F.2d 756, 758 (9th Cir. 1981)).
Although Johnson construes § 17(a)(4) of the Bankruptcy Act, the Sixth Circuit has applied its reasoning to defalcation exception of § 523(a)(4) of the modern Code. See Patel, 565 F.3d at 968.
"The Sixth Circuit construes the term 'fiduciary capacity' found in the defalcation provision of § 523(a)(4) more narrowly than the term is used in other circumstances" In re Bucci, 493 F.3d at 639. "[I]t does not apply to someone who merely fails to meet an obligation under a common law fiduciary relationship" Id. at 640. But rather, only " 'the existence of a pre-existing express or technical trust whose res encompasses the property at issue' can give rise to a defalcation-based nondischargeability claim under § 523(a)(4)." Perry v. Ichida (In re Ichida), 434 B.R. 852, at 860-61 (Bankr. S.D. Ohio 2010) (quoting Commonwealth Land Title Co. v. Blaszak (In re Blaszak), 397 F.3d 386, 391 (6th Cir.2005)). Finally, the Sixth Circuit precedent is clear that "a statute may create a trust for purposes of § 523(a)(4) if that statute defines the trust res, imposes duties on the trustee, and those duties exist prior to any act of wrongdoing." In re Bucci, 493 F.3d at 640.
In this case, Perry argues that Ohio Revised Code ("ORC") § 1705.281(B), which defines a member's duty of loyalty to the LLC, establishes a trust for the purposes of § 523(a)(4). That subsection provides that:
(B) A member's duty of loyalty to the limited liability company and the other members is limited to the following:
(1) To account to the limited liability company and hold as trustee for the limited liability company any property, profit, or benefit derived by the member in the conduct and winding up of the limited liability company's business or derived from a use by the member of the limited liability company's property, including the appropriation of a limited liability company opportunity;
Ohio Rev. Code § 1705.281.
ORC § 1705.081 prohibits the operating agreement from eliminating the statutory duty of loyalty, but allows the operating agreement to "identify activities that do not violate the duty of loyalty." The Operating Agreement identifies one such activity: "The President and General Manager is a licensed Real Estate agent and those activities related to those responsibilities will not be considered self-dealing even when it involves collecting commissions for real estate sales involving the Company." (Champaign Properties, LLC Operating Agreement, ¶8.2 ECF No. 35-2.)
ORC § 1705.081 prohibits the operating agreement from eliminating the statutory duty of loyalty, but allows the operating agreement to "identify activities that do not violate the duty of loyalty." The Operating Agreement identifies one such activity: "The President and General Manager is a licensed Real Estate agent and those activities related to those responsibilities will not be considered self-dealing even when it involves collecting commissions for real estate sales involving the Company." (Champaign Properties, LLC Operating Agreement, ¶8.2 ECF No. 35-2.)
ORC § 1705.081 prohibits the operating agreement from eliminating the statutory duty of loyalty, but allows the operating agreement to "identify activities that do not violate the duty of loyalty." The Operating Agreement identifies one such activity: "The President and General Manager is a licensed Real Estate agent and those activities related to those responsibilities will not be considered self-dealing even when it involves collecting commissions for real estate sales involving the Company." (Champaign Properties, LLC Operating Agreement, ¶8.2 ECF No. 35-2.)
No court has ruled on whether ORC § 1705.281 creates a trust sufficient for the purposes of the defalcation exception. However, limited liability companies are a relatively recent innovation modeled after the far older concept of partnership. Most states have enacted a limited liability company act based upon one version or another of the Uniform Limited Liability Company Act, which were in turn is based upon either the Uniform Partnership Act ("UPA"), or the Revised Uniform Partnership Act ("RUPA"). Thus, while there is a paucity of cases interpreting ORC § 1705.281, it can still be analyzed against the backdrop of the history of limited liability company and partnership law.
There are generally two forms of statutory duty of loyalty requirements: UPA-type loyalty and RUPA-type loyalty. UPA-type loyalty is based upon the duty of loyalty as exemplified by the UPA, which provides that:
Of course, not all duty of loyalty statutes are based on UPA or RUPA. Indeed, Arizona's LLC Act does not contain an express duty of loyalty. Arizona Auto Spa 4, LLC v. Spreiser (In re Spreiser), No. 4:12-ap-01988-EWH, 2014 WL 2860981, *13 (Bankr. D. Ariz. June 23, 2014) (Ariz. Rev. Stat. § 29-654 not sufficient to create a technical trust).
Every partner must account to the partnership for any benefit, and hold as trustee for it any profits derived by him without the consent of the other partners from any transaction connected with the formation, conduct, or liquidation of the partnership or from any use by him of its property.UPA § 21(1) (emphasis added). Courts analyzing UPA-type loyalty have generally found that it creates an ex maleficio trust coming into being after the act of deriving profits from the partnership without the consent of the other partners. Consequently, most courts have found UPA-type loyalty to be insufficient for the purposes of § 523(a)(4)'s fiduciary capacity requirement.
In re Deerman, 482 B.R. 344, 373 (Bankr. D.N.M. 2012) (New Mexico LLC Act, N.M.S.A. 1978 § 53-19-16(D)); Tweedie v. Hermoyian (In re Hermoyian), 466 B.R. 348, 385 (Bankr. E.D. Mich. 2012) (Michigan UPA, Mich. Comp. Laws § 449.21(1)); Moses v. Duncan (In re Duncan), No. 10-11859-M, 2011 WL 6749054, at *18 (Bankr. N.D. Okla. Dec. 22, 2011) (Oklahoma LLC Act, 18 O.S. § 2016(5)); Murray v. Woodman (In re Woodman), 451 B.R. 31, 40 (Bankr. D. Idaho 2011) (Idaho LLC Act, Idaho Code § 53-622(2)).
On the other hand, RUPA-type loyalty is invoked by broader statutory language:
(1) to account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partner:
RUPA § 409. The majority of courts considering this section have found that it does create a statutory trust sufficient for the purposes of § 523(a)(4) on the theory that the trust is formed without regard to any bad act. For instance, the Bankruptcy Court for the District of Montana held that Montana's similar loyalty statute:(A) in the conduct or winding up of the partnership's business;
(B) from a use by the partner of the partnership's property; or
(C) from the appropriation of a partnership opportunity;
(1) defines the trust res: "any property, profit, or benefit derived by the member in the conduct or winding up of the company's business or derived from a use by the member of the company's property;" (2) spells out the trustee's fiduciary duties: "account to the company and to hold as trustee for it;" and (3) imposes a trust on the funds prior to the act which created the debt: the obligation arises with membership in the LLC and does not depend on any subsequent conduct. Therefore, Montana law creates an express trust, recognized by federal law for purposes of § 523(a)(4).Blixseth v. Blixseth (In re Blixseth), 459 B.R. 444, 459 (Bankr. D. Mont. 2011) (reviewing MCA § 35-8-310). The Blixseth court distinguished several older cases analyzing UPA-type loyalty statutes, explaining that with that language "the trust arises only when the LLC member acts without consent. Such a statute creates a trust ex maleficio." Id. at 460. But RUPA-type language "contains no similar qualification on the imposition of the trustee relationship." Id. While the statute at issue here, ORC § 1705.281, is closely modeled on the RUPA duty of loyalty, the court does not believe it creates a sufficient fiduciary capacity.
For other courts finding that RUPA-type loyalty statutes are sufficient to create a trust for § 523(a)(4) purposes. See Kern v. Taylor (In re Taylor) 551 B.R. 506, 520 (Bankr. M.D. Ala. 2016) (Alabama LLC Act, ALA. Code §§ 10-12-21(f)(1)); Jenkins v. Schmank (In re Schmank), 535 B.R. 243, 262 (Bankr. E.D. Tenn. 2015) (Tennessee RUPA Tenn. Code Ann. § 61-l-404); General Retirement Sys. of the City of Detroit v. Dixon (In re Dixon), 525 B.R. 827 (Bankr. N.D. Ga. 2015) (Delaware RUPA, 6 Del. C. § 15-404); Errez v. Auburn Ace Holdings, LLC (In re Errez), No. C10-1018 RSM, 2010 WL 5185399, at *2 (W.D. Wash. Dec. 16, 2010) (Washington RUPA as applicable to LLCs, RCW 25.05.165(2)(a)). However, unpublished decisions in at least one district have found RUPA-type loyalty statutes to be insufficient for the purposes of § 523(a)(4). See Bar-Am v. Grosman (In re Grosman), 6:05-bk-10450-KSJ, 2007 WL 1526701, *16 (Bankr. M.D. Fla. May 22, 2007) (Florida's RUPA based LLC Act "does not establish any type of express or technical trust as required by Section 523(a)(4).") (examining Florida Statute Section 608.4225). --------
The Ohio Supreme Court has not ruled on the nature of the putative trust formed by § 1705.281. But, in Peterson v. Teodosio, the Ohio Supreme Court interpreted the similar duty of loyalty owed within partnerships as codified by ORC § 1775.20(A), the UPA-based predecessor of the current RUPA-based version codified at § 1776.44(B)(1). 297 N.E.2d 113, 120 (Ohio 1973). Peterson involved a request for an accounting and the imposition of a constructive trust by the estate of the deceased partner well after the normal 10 year statute of limitations for such actions. Id. at 161-163. The plaintiff argued that the claim was not barred because the trust created by § 1775.20 was a "continuing and subsisting" trust, which was exempted from the statute of limitations. Id. at 171. The Court reasoned that a "continuing and subsisting" must "arise[] by reason of a manifested intention to create it", as opposed to constructive trusts, which "are imposed irrespective of intention. 'They are distinct concepts. They are not two species of a single genus.' " Id. at 120 (quoting 5 Scott on Trusts (3 Ed.), 3416, Section 462.1). In reviewing the language of ORC § 1775.20 the Court held that "that section does no more than enunciate the fiduciary character of the partnership relationship, from formation through liquidation, the breach of which may be the basis of a constructive trust." Id. (citing Fouchek v. Janicek, P.2d 783 (Or. 1950); Unif. Partnership Act § 21 cmt. (Unif. Law Comm'n 1914)). The official comments to the Revised Uniform Limited Liability Company Act reinforce this interpretation in the context of ORC § 1705.281. There the drafters contrasted a person subject to the duty of loyalty with "an actual trustee" and explained that "[t]he phrase 'hold as trustee' dates back to UPA (1914) § 21 and reflects the availability of disgorgement remedies, such as a constructive trust." Unif. Limited Liability Company Act § 409 cmt. (b)(1) (Unif. Law Comm'n 2006).
Thus, while the language of the statute may have changed, the reasoning of the Ohio Supreme Court and the drafters of the Revised Limited Liability Company Act, that Ohio's duty of loyalty statute authorizes the imposition of a constructive trust as a remedy to a breach of the duty of loyalty, has not changed. Thus, the statute creates a constructive, or ex maleficio trust, not an express trust. Because Combs was not the trustee of an express or technical trust, the court holds that Combs was not acting within a fiduciary capacity for purposes of § 523(a)(4), and therefore the defalcation exception to discharge is not applicable.
F. Count Three: Larceny , Embezzlement, or Conversion
Section 523(a)(4) also excepts from discharge any debt arising from embezzlement or larceny. Combs moved for summary judgment on the issue of larceny and Perry offered no argument to the contrary. Both parties moved for summary judgment under the theory of embezzlement.
1. Larceny
"For purposes of § 523(a)(4), larceny is defined as 'the fraudulent and wrongful taking and carrying away of the property of another with intent to convert such property to the taker's use without the consent of the owner.' " Meade v. Pinkerman (In re Alwood), 531 B.R. 182, 189 (Bankr. N.D. Ohio 2015) (citing Graffice v. Grim (In re Grim), 293 B.R. 156, 165-66 (Bankr. N.D. Ohio 2003). "Embezzlement differs from larceny in that the debtor's original acquisition of possession of the property was lawful." Lawson v. Conley (In re Conley), 482 B.R. 191, 210 (Bankr. S.D. Ohio 2012) (quoting Chapman v. Pomainville, 254 B.R. 699, 705 (Bankr. S.D. Ohio 2000)). Here, it is uncontroverted that Combs, as managing partner, was lawfully in possession of the LLC's funds. Therefore larceny is not at issue in this case and the court finds in favor of Combs on this count.
2. Embezzlement
Embezzlement for the purposes of § 523(a)(4) is defined by federal law as:
the fraudulent appropriation of property by a person to whom such property has been entrusted or into whose hands it has lawfully come. A creditor proves embezzlement by showing that he entrusted his property to the debtor, the debtor appropriated the property for a use other than that for which it was entrusted, and the circumstances indicate fraud.Dantone v. Dantone (In re Dantone), 477 B.R. 28, 39 (B.A.P. 6th Cir. 2012) (citing Brady v. McAllister (In re Brady), 101 F.3d 1165, 1172-73 (6th Cir.1996). Combs does not deny that he was entrusted with the money, or that he spent at least some of the money inappropriately. (ECF No. 38 at 6). Thus the only dispute remaining between the parties is whether the "circumstances indicate fraud."
"[E]mbezzlement claims under § 523(a)(4) require 'proof of the debtor's fraudulent intent in taking the [creditor's] property.'" Cash Am. Fin. Servs., Inc. v. Fox (In re Fox), 370 B.R. 104, 116 (B.A.P. 6th Cir. 2007) (quoting Miller v. J.D. Abrams, Inc. (In re Miller), 156 F.3d 598, 602-03 (5th Cir. 1998)) In the context of § 523(a)(4), fraudulent intent " 'encompass[es] any deceit, artifice, trick, or design involving direct and active operation of the mind, used to circumvent and cheat another.' " Id. (quoting Mellon Bank, N.A. v. Vitanovich (In re Vitanovich), 259 B.R. 873, 877 (B.A.P. 6th Cir. 2001). "[T]he debtor's fraudulent intent may often be shown by circumstantial evidence.' " Id. (quoting WebMD Practice Servs., Inc. v. Sedlacek (In re Sedlacek), 327 B.R. 872, 880-81 (Bankr. E.D. Tenn. 2005)) "On the other hand, a debtor's fraudulent intent might be negated by circumstantial evidence showing 'that the debtor used [the creditor's property] openly, without attempting to conceal, and had reasonable grounds to believe he had the right to so use.' Id. at 117 (quoting In re Weber, 892 F.2d 534, 539 (7th Cir. 1989)).
Perry points to a long list of misappropriations by Combs, including payments to his son and sister-in-law, payments for the benefit of Starfish, and $14,000 of charges for continuing education over the course of a year. Combs claims that he believed all the misappropriations were legitimate business expenses, loans made with Perry's knowledge and approval, or at worst, the result of his negligence. He supports his claims by noting that all payments were made openly using checks and a debit card. Yet, the parties dispute whether the payments were made openly, thus the court is not prepared to grant summary judgment for either party on this count and finds that a material issue of fact exists for trial as to this count.
Conclusion
For the reasons stated, Defendant Combs' motion for summary judgment is granted as to Count 2 and denied as to Counts 1 and 3. Plaintiff Perry's Motion for Summary Judgment is denied.
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.
/s/ _________
Guy R. Humphrey
United States Bankruptcy Judge Dated: July 17, 2018 Copies to: Jacob M. Jeffries, electronically served
(Counsel for the Plaintiff) Roger E. Luring, electronically served
(Counsel for the Defendant)
Nester at *11-12 (citations omitted). See also United Paperworkers Int'l Union v. Misco, Inc., 484 U.S. 29, 38 (1987) (noting that "the speedy resolution of grievances by private mechanisms would be greatly undermined" if courts inappropriately rejected arbitrator's determinations and that "as long as the arbitrator is even arguably construing or applying the contract and acting within the scope of his authority, that a court is convinced he committed serious error does not suffice to overturn his decision."); and Wachovia Secs., Inc. v. Gangale, 125 F. Appx. 671, 677 (6th Cir. 2005) (quoting Cleveland v. Fraternal Order of Police, Lodge No. 8, 603 N.E.2d 351, 352 (Ohio Ct. App. 1991) ("When parties agree to submit their dispute to binding arbitration, they agree to accept the result, regardless of its legal or factual accuracy.")) The clash between the speedy and economical principles of arbitration and the requirements of collateral estopppel is magnified by the fact that because exceptions to discharge under § 523 are limits on a debtor's ability to obtain a fresh start, the § 523 exceptions to discharge are to be narrowly construed for the benefit of the debtor. See Rembert v. AT&T Universal Card Servs. (In re Rembert), 141 F.3d 277, 281 (6th Cir. 1998); and Weidle Corp. v. Leist (In re Leist), 398 B.R. 595, 601 (Bankr. S.D. Ohio 2008). Thus, the need to match up the arbitrator's findings of fact to the elements of § 523 discharge exceptions cuts against the efficacy of arbitration under these circumstances.