Randy Curtis Bullock v. Bankchampaign, NA , 670 F.3d 1160 ( 2012 )

[PUBLISH]
IN THE UNITED STATES COURT OF APPEALS
FOR THE ELEVENTH CIRCUIT FILED
________________________ U.S. COURT OF APPEALS
ELEVENTH CIRCUIT
No. 11-11686 FEBRUARY 14, 2012
________________________ JOHN LEY
CLERK
D.C. Docket No. 5:10-cv-01905-IPJ,
BKCY No. 8:09-bk-84300-JAC-7
In Re: RANDY CURTIS BULLOCK,
Debtor.
___________________________________________
RANDY CURTIS BULLOCK,
Appellant,
versus
BANKCHAMPAIGN, N.A.,
Appellee.
________________________
Appeal from the United States District Court
for the Northern District of Alabama
________________________
(February 14, 2012)
Before BARKETT and PRYOR, Circuit Judges, and BUCKLEW,* District Judge.
__________________________
*Honorable Susan C. Bucklew, United States District Judge for the Middle District of Florida,
sitting by designation.
BUCKLEW, District Judge:
Appellant Randy Curtis Bullock, Debtor-Defendant in the underlying
bankruptcy adversary proceeding, appeals the district court’s decision affirming
the bankruptcy court’s determination that the Illinois judgment debt owed to
Appellee BankChampaign, N.A. is not dischargeable, pursuant to 11 U.S.C.
§ 523(a)(4). After careful review and with the benefit of oral argument, we affirm.
I. Background
In 1978, Appellant Bullock became the trustee of his father’s trust. The
trust’s sole asset was a life insurance policy on his father’s life, and Bullock and
Bullock’s four siblings were the beneficiaries. The terms of the trust provided that
Bullock, as trustee, could borrow from the trust in only two situations: (1) to pay
the life insurance premiums, and (2) to satisfy a beneficiary’s request for
withdrawal.
Despite the trust’s limitations on borrowing, Bullock borrowed from the
trust by making three loans that were secured by the cash value of the life
insurance policy. First, in 1981, upon his father’s request, Bullock borrowed
$117,545.96 for his mother so she could repay a debt that she owed to Bullock’s
father’s business. Second, in 1984, Bullock borrowed $80,257.04 for his mother
and himself to purchase certificates of deposit, which were later cashed in and
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used toward the purchase of a garage fabrication mill in Ohio. Third, in 1990,
Bullock borrowed $66,223.96 for his mother and himself to purchase real estate.
These loans were all fully repaid.
Thereafter, Bullock’s two brothers learned of the existence of the trust, and
they filed suit against Bullock in Illinois state court. In the lawsuit, Bullock’s
brothers claimed that Bullock had breached his fiduciary duty as trustee by
engaging in self-dealing via the three loans. The brothers moved for summary
judgment on that claim, and in 2002, the Illinois court granted their motion.
Specifically, the Illinois court stated that it could not “be disputed the loans made
by [Bullock] while acting as trustee are considered self-dealing transactions. All
of the loans were made to entities [Bullock] had a financial interest in or to a
relative.” [R:Tab K].
In its order awarding damages for the self-dealing, the Illinois court stated
that Bullock did “not appear to have had a malicious motive in borrowing funds
from the trust.” [R:Tab M, Ex. 7]. However, the Illinois court concluded that
“neither the facts and circumstances surrounding the loans nor the motives of
[Bullock] can excuse him from liability.” [R:Tab M, Ex. 7]. As a result, the
Illinois court determined that damages should be awarded based on the benefit that
Bullock received due to the self-dealing. The Illinois court stated that such would
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be hard to quantify, but based on its equitable powers, it determined that $250,000
represented the amount of the benefit that Bullock had received from the self-
dealing. In addition, the Illinois court ordered that Bullock pay $35,000 in
attorneys’ fees. The Illinois court also put the property obtained with the self-
dealt funds (a mill located in Ohio) under a constructive trust to secure it as
collateral for the $285,000 judgment amount. The Illinois court placed another
constructive trust on Bullock’s beneficial interest in his father’s trust as an
additional source of collateral for the judgment.
The constructive trusts were awarded to Appellee BankChampaign
(“Bank”), which had replaced Bullock as the trustee of his father’s trust. Bullock
contends that the Bank, as trustee, has blocked his attempts to sell or lease the mill
property located in Ohio, which has prevented him from satisfying the Illinois
judgment.1
Thereafter, in 2009, Bullock filed for bankruptcy under Chapter 7 in hopes
that he could discharge the Illinois judgment debt. The Bank initiated an
adversary proceeding to determine the dischargeability of the judgment debt
pursuant to 11 U.S.C. § 523(a)(4). Section 523(a)(4) provides that debts arising
1
Because the Illinois court awarded the Bank a constructive trust over the Ohio mill,
Bullock is unable to sell or lease the mill without the approval and cooperation of the Bank.
4
from “fraud or defalcation while acting in a fiduciary capacity, embezzlement or
larceny” are not dischargeable in bankruptcy. The Bank moved for summary
judgment, arguing that the Illinois judgment debt was not dischargeable, and the
bankruptcy court granted the Bank’s motion.
Specifically, the bankruptcy court concluded that Bullock was collaterally
estopped from attacking the Illinois judgment. The Illinois court had determined
that Bullock had breached his fiduciary duty by self-dealing via the three loans.
The bankruptcy court accepted the Illinois court’s determination that Bullock had
breached his fiduciary duty by engaging in self-dealing and concluded that such
conduct amounted to fraud and defalcation. As a result, the bankruptcy court
found that the Illinois judgment was a debt arising from fraud or defalcation while
Bullock was acting in a fiduciary capacity, and as such, the judgment debt was not
dischargeable, pursuant to § 523(a)(4).
Bullock appealed the bankruptcy court’s judgment to the district court. The
district court affirmed the bankruptcy court’s decision, but it sympathized with
Bullock’s predicament—he had a judgment debt that he could satisfy only by
selling the underlying collateral, but the Bank persisted in preventing the sale.
The district court stated that it questioned the propriety of the Bank’s actions and
noted that holding collateral hostage in perpetuity is impermissible. However, the
5
district court recognized that the propriety of the Bank’s actions was not a basis
for finding that the judgment debt should be discharged. As a result, the district
court concluded that while it was “convinced [the Bank] is abusing its position of
trust by failing to liquidate the [property], this issue is not properly before this
court, but rather should [be] brought by Bullock in an action in Illinois to consider
the malfeasance of the trustee.” [R:Tab G].
Thereafter, Bullock filed the instant appeal. In this appeal, Bullock argues
that the bankruptcy court erred in two ways: (1) by concluding that the Illinois
judgment was non-dischargeable, pursuant to § 523(a)(4); and (2) by failing to
consider his affirmative defense that the Bank has acted wrongfully by impeding
his attempts to sell or lease the collateralized property.
II. Standard of Review
“Because the district court in reviewing the decision of a bankruptcy court
functions as an appellate court, we are the second appellate court to consider this
case. Thus, this Court’s review with regard to determinations of law, whether
made by the bankruptcy court or by the district court, is de novo. The district
court makes no independent factual findings; accordingly, we review solely the
bankruptcy court’s factual determinations under the ‘clearly erroneous’ standard.”
In re Colortex Indus., Inc., 19 F.3d 1371, 1374 (11th Cir. 1994) (citations
6
omitted).
III. Section 523(a)(4)
In determining whether the Illinois judgment debt should be discharged, this
Court is mindful of the purpose of the Bankruptcy Code:
A central purpose of the Bankruptcy Code is to provide an
opportunity for certain insolvent debtors to discharge their
debts and enjoy a fresh start. However, Congress has
decided to exclude from the general policy of discharge
certain categories of debts. One of these categories
includes debts incurred by fraud or defalcation while acting
in a fiduciary capacity. Such a debt is non-dischargeable
[under 11 U.S.C. § 523(a)(4)]. Congress evidently
concluded that the creditors’ interest in recovering full
payment of such debts . . . outweighed the debtors’ interest
in a complete fresh start.
Eavenson v. Ramey, 243 B.R. 160, 164 (N.D. Ga. 1999) (alterations, citations, and
internal quotation marks omitted). Furthermore, this Court must keep in mind that
exceptions to discharge, such as § 523(a)(4), must be construed narrowly, and the
burden is on the creditor to show that the exception to discharge applies. See In re
Mitchell, 633 F.3d 1319, 1327 (11th Cir. 2011) (citations omitted).
In the underlying adversary proceeding, the Bank asked the bankruptcy
court to find the Illinois judgment debt to be non-dischargeable under § 523(a)(4).
The bankruptcy court concluded that the debt was not dischargeable because the
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Bank had established that the debt arose from fraud or defalcation while Bullock
was acting in a fiduciary capacity. The parties do not dispute that the judgment
debt arose from conduct that occurred while Bullock was acting in a fiduciary
capacity (i.e., while he was the trustee of his father’s trust). Furthermore, at oral
argument, Bullock appeared to concede that he was collaterally estopped from
attacking the Illinois judgment to the extent that the Illinois court concluded that
he breached his fiduciary duty as the trustee of his father’s trust by engaging in
self-dealing via the three loans. Thus, the issue before this Court is whether the
bankruptcy court correctly characterized Bullock’s conduct as fraud and/or
defalcation under § 523(a)(4). Upon consideration, we find that Bullock’s conduct
constituted defalcation under § 523(a)(4).2
This Court has stated that a “‘[d]efalcation’ refers to a failure to produce
funds entrusted to a fiduciary” and that “the precise meaning of ‘defalcation’ for
purposes of § 523(a)(4) has never been entirely clear.” Quaif v. Johnson, 4 F.3d
950, 955 (11th Cir. 1993) (citations omitted). However, this Court has referred to
the Second Circuit’s decision in Central Hanover Bank & Trust Co. v. Herbst, 93
F.2d 510 (2d Cir. 1937), as containing “perhaps the best” analysis of the meaning
2
Because we find that Bullock’s conduct constituted defalcation under § 523(a)(4), we
need not reach the issue of whether his conduct also constituted fraud under § 523(a)(4).
8
of “defalcation” under § 523(a)(4).3 Quaif, 4 F.3d at 955; see also In re
Fernandez-Rocha, 451 F.3d 813, 817 (11th Cir. 2006).
In Central Hanover, an issue before the court was whether Herbst, who had
been appointed as a receiver for real property in a foreclosure action, had
committed a defalcation when he withdrew money that the court had awarded him
as payment for his services as receiver before the time to appeal the order
awarding him the money had expired. See Central Hanover, 93 F.2d at 511. The
Central Hanover court analyzed the bankruptcy statute that provided that debts
arising from fraud, embezzlement, misappropriation, or defalcation while acting as
an officer or in a fiduciary capacity were not dischargeable. See id. In analyzing
the meaning of defalcation, the Central Hanover court stated the following:
Whatever was the original meaning of defalcation, it must
here have covered other defaults than deliberate
malversations, else it added nothing to the words, ‘fraud or
embezzlement.’
...
In the case at bar [Herbst] had not been entirely
innocent . . . . A judge had awarded him the money, and
prima facie he was entitled to it; but he knew, or if he did
not know, he was charged with notice (having held himself
out as competent to be an officer of the court), that the
order would not protect him if it were reversed; and that it
3
The court in Central Hanover analyzed the meaning of defalcation under the predecessor
statute to § 523(a)(4).
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might be reversed until the time to appeal had expired. He
made no effort to learn from the plaintiff whether it meant
to appeal, and he did not wait until it could no longer do
so; he took his chances. We do not hold that no possible
deficiency in a fiduciary’s accounts is dischargeable; . . .
[we have said] that the misappropriation must be due to a
known breach of the duty, and not to mere negligence or
mistake. Although [misappropriation] probably carries a
larger implication of misconduct than defalcation,
defalcation may demand some portion of misconduct; we
will assume arguendo that it does.
All we decide is that when a fiduciary takes money
upon a conditional authority which may be revoked and
knows at the time that it may, he is guilty of a defalcation
though it may not be a fraud, or an embezzlement, or
perhaps not even a misappropriation.
Id. at 511, 512 (citation and internal quotation marks).
In Quaif, this Court interpreted Central Hanover as standing for the
proposition that a defalcation under § 523(a)(4) does not have to rise to the level
of fraud, embezzlement, or misappropriation.4 See Quaif, 4 F.3d at 955.
Additionally, this Court in Quaif noted that some courts interpret defalcation
“more broadly, stating that even a purely innocent party can be deemed to have
committed a defalcation for purposes of § 523(a)(4).” Id. (citations omitted).
4
In Quaif, an issue before the Court was whether an agent who failed to remit insurance
premiums, and instead commingled the money with his company’s funds and used the funds to
pay his company’s operating expenses, committed a defalcation. See Quaif, 4 F.3d at 952. The
Quaif Court held that the agent’s conduct was a defalcation within the meaning of § 523(a)(4).
See id. at 955.
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This Court recognizes that there is a split among the circuits regarding the
meaning of defalcation under § 523(a)(4). The Fourth, Eighth, and Ninth Circuits
have concluded that even an innocent act by a fiduciary can be a defalcation. See
In re Uwimana, 274 F.3d 806, 811 (4th Cir. 2001) (stating that “even an innocent
mistake which results in misappropriation or failure to account” can be a
defalcation); In re Cochrane, 124 F.3d 978, 984 (8th Cir. 1997) (concluding that
defalcation does not require intentional wrongdoing; stating that it includes a
fiduciary’s innocent failure to fully account for money received); In re Sherman,
658 F.3d 1009, 1017 (9th Cir. 2011) (noting that intent to defraud is not required;
stating that defalcation includes a fiduciary’s innocent failure to fully account for
money received). The Fifth, Sixth, and Seventh Circuits require a showing of
recklessness by the fiduciary. See In re Harwood, 637 F.3d 615, 624 (5th Cir.
2011) (stating that defalcation is a willful neglect of a duty, which does not require
actual intent; it is essentially a recklessness standard); In re Patel, 565 F.3d 963,
970 (6th Cir. 2009) (stating that a defalcation requires a showing of more than
negligence; instead, the fiduciary “must have been objectively reckless in failing
to properly account for or allocate funds”); In re Berman, 629 F.3d 761, 766 n.3
(7th Cir. 2011) (stating that “defalcation requires something more than negligence
or mistake, but less than fraud”). The First and Second Circuits require a showing
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of extreme recklessness.5 See In re Baylis, 313 F.3d 9, 20 (1st Cir. 2002) (stating
that “defalcation requires something close to a showing of extreme recklessness”);
In re Hyman, 502 F.3d 61, 68 (2d Cir. 2007) (stating that defalcation “requires a
showing of conscious misbehavior or extreme recklessness”). The Third Circuit
has not addressed the issue, and the Tenth Circuit has made the brief statement in
an unpublished opinion that defalcation requires some portion of misconduct. See
In re Millikan, 188 F. App’x 699, 702 (10th Cir. 2006).
Given our Circuit’s explicit alignment with the Central Hanover case, this
Court finds that defalcation under § 523(a)(4) requires more than mere negligence.
Instead, this Court concludes that defalcation requires a known breach of a
fiduciary duty, such that the conduct can be characterized as objectively reckless.
As such, this Circuit aligns itself with the Fifth, Sixth, and Seventh Circuits, which
hold that defalcation under § 523(a)(4) requires a showing of recklessness by the
fiduciary.
Applying the recklessness standard for defalcation to the facts of the instant
case, this Court concludes that the bankruptcy court was correct in determining
that Bullock committed a defalcation by making the three loans while he was the
5
In 2007, the Second Circuit re-evaluated the position that it took in the Central Hanover
case and determined that it would align itself with the First Circuit when defining defalcation
under § 523(a)(4).
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trustee of his father’s trust. Because Bullock was the trustee of the trust, he
certainly should have known that he was engaging in self-dealing, given that he
knowingly benefitted from the loans. Thus, his conduct can be characterized as
objectively reckless, and as such, it rises to the level of a defalcation under
§ 523(a)(4). Accordingly, the bankruptcy court’s order must be affirmed on the
issue of whether the Illinois judgment debt was non-dischargeable under
§ 523(a)(4) as a debt arising from a defalcation while Bullock was acting in a
fiduciary capacity.
IV. Affirmative Defense
Bullock also argues that the bankruptcy court erred in failing to consider his
affirmative defense that the Bank has acted wrongfully by impeding his attempts
to sell or lease the collateralized property. Bullock cites Heller v. Lee, 474 N.E.2d
856 (Ill. App. Ct. 1985), in support of his argument that the Bank’s conduct has
been wrongful.
In Heller, the plaintiffs obtained a judgment of more than $44,000 against
the defendants. See id. at 857. The defendants had put up a bond consisting of a
$15,000 certificate of deposit and a deed to real property appraised at $50,000.
See id. After the judgment was affirmed on appeal, the plaintiffs moved to release
the bond, and the plaintiffs applied the $15,000 certificate of deposit to the
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outstanding judgment. See id. Thereafter, the defendants moved under an Illinois
statute for a release from the judgment due to the plaintiffs acquiring the deed to
the real property via the release of the bond. See id. While the court found that
the defendants did not satisfy the requirement for release from judgment under the
Illinois statute, the court found that the defendants were entitled to equitable relief
and stated the following:
The plaintiffs contend that they took the property as
security for eventual cash payment of the judgment. We
agree. But, as matters now stand, the plaintiffs can sit on
the property indefinitely and institute supplemental
proceedings to recover the rest of the judgment. Thus the
plaintiffs have the use and enjoyment of a valuable piece of
property while the defendants, who put the property up as
bond expecting it to satisfy the judgment, are not only
deprived of the property, but may also be compelled to dig
even deeper in order to pay the judgment. Such a result is
inequitable. The plaintiffs have received a windfall at the
defendants’ expense. If, as the plaintiffs contend, the
transfer of the real estate was intended to secure the
judgment, then by taking the deed, the plaintiffs acquired
only a lien. Rather than proceed against the defendants to
recover the judgment, the equitable solution is for the
plaintiffs to foreclose on their lien by selling the property.
We are guided in this result by the maxim that equity
regards as done that which ought to be done. The parties
intended the property to secure the judgment. Therefore,
the property should be used to satisfy the judgment.
. . . The cause is remanded and the trial court is
directed to sell the property, apply the proceeds to the
judgment, and remit the excess, if any, to the defendants.
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Id. at 858.
Thus, based on Heller, Bullock argues that the Bank’s actions regarding the
collateral in this case have been wrongful and inequitable. Bullock takes this
argument a step further and contends that because the bankruptcy court is a court
of equity, and because the Bank has come to the bankruptcy court with unclean
hands due to its wrongful conduct, the bankruptcy court should deny the Bank its
requested relief of non-dischargeability. See Matter of Garfinkle, 672 F.2d 1340,
1347 n.7 (11th Cir. 1982) (“The doctrine [of unclean hands] is applicable in a
court of equity to deny a plaintiff the relief he seeks even though his claim might
otherwise be meritorious. The principles of equity govern the exercise of a
bankruptcy court’s jurisdiction.”).
Bullock, however, has not cited any cases in which a court found a debt met
the requirements of non-dischargeability under § 523(a) but ultimately concluded
that the debt was dischargeable due to the creditor’s unclean hands. Therefore, this
Court concludes that the district court correctly determined that the propriety of
the Bank’s actions is not a basis for finding that the Illinois judgment debt should
be discharged. Instead, this Court agrees with the district court’s statement that
while it was “convinced [the Bank] is abusing its position of trust by failing to
liquidate the [property], this issue is not properly before this court, but rather
15
should [be] brought by Bullock in an action in Illinois to consider the malfeasance
of the trustee.” [R:Tab G].
This Court notes that if it accepted Bullock’s argument and concluded that
the judgment debt was dischargeable, Bullock would ultimately pay nothing more
on the debt, as the debt would be discharged. However, if Bullock goes back to
the Illinois court and raises the issue of the Bank’s inequitable conduct, the Illinois
court may order the Bank to liquidate the collateral, and as a result, it is possible
that the Bank could be paid from the sale and that the judgment debt could be
reduced or eliminated.6 Thus, having Bullock go to the Illinois court to raise the
issue of the Bank’s inequitable conduct would likely lead to the most equitable
resolution of the situation.
V. Conclusion
Accordingly, the decision of the bankruptcy court is AFFIRMED.
6
The market value of the collateral is not in the record before this Court.
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