Kubota Tractor Corporation v. Strack ( 2008 )

Filed: May 1, 2008
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
No. 07-1200
(4:06-cv-00145-HCM)
In Re: BRUCE E. STRACK,
Debtor.
----------------------------
KUBOTA TRACTOR CORPORATION, a California
corporation,
Plaintiff - Appellant,
versus
BRUCE E. STRACK,
Defendant - Appellee,
and
US TRUSTEE,
Trustee.
O R D E R
The court amends its opinion filed March 11, 2008, as follows:
On the cover sheet, section 1 -- the status is changed from
“UNPUBLISHED” to “PUBLISHED.”
On the cover sheet, section 6 -- the status line is changed to
read, “Reversed by published opinion.”
-2-
On page 2 – the reference to the use of unpublished opinions
as precedent is deleted.
For the Court - By Direction
/s/ Patricia S. Connor
Clerk
PUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
In Re: BRUCE E. STRACK, 
Debtor.
KUBOTA TRACTOR CORPORATION, a
California corporation,
Plaintiff-Appellant,
v.  No. 07-1200
BRUCE E. STRACK,
Defendant-Appellee,
and
US TRUSTEE,
Trustee.

Appeal from the United States District Court
for the Eastern District of Virginia, at Newport News.
Henry Coke Morgan, Jr., Senior District Judge.
(4:06-cv-00145-HCM; BK-05-53453; AP-06-05002-DHA)
Argued: January 30, 2008
Decided: March 11, 2008
Before NIEMEYER, MOTZ, and DUNCAN, Circuit Judges.
Reversed by published opinion. Judge Duncan wrote the opinion, in
which Judge Niemeyer and Judge Motz joined.
2 IN RE: STRACK
COUNSEL
ARGUED: Ryan Ashby Shores, HUNTON & WILLIAMS, Wash-
ington, D.C., for Appellant. Carolyn Louise Camardo, MARCUS,
SANTORO & KOZAK, P.C., Chesapeake, Virginia, for Appellee.
ON BRIEF: R. Hewitt Pate, HUNTON & WILLIAMS, Washington,
D.C., for Appellant.
OPINION
DUNCAN, Circuit Judge:
In October 2005, Appellee Bruce Strack ("Strack"), along with his
wife, filed for relief under Chapter 7 of the Bankruptcy Code. Strack
listed Appellant Kubota Tractor Corporation ("Kubota") as a creditor
holding an unsecured judgment claim against him for approximately
$124,000. Kubota later brought an adversary proceeding against the
Stracks in the United States Bankruptcy Court for the Eastern District
of Virginia, challenging the pending discharge of the debt under two
statutory exceptions to the presumption of dischargeability: "defalca-
tion while acting in a fiduciary capacity," under 11 U.S.C.
§ 523(a)(4), and "willful and malicious injury by the debtor," under
11 U.S.C. § 523(a)(6). The bankruptcy court found neither exception
to apply and the debt therefore dischargeable. On appeal, the United
States District Court for the Eastern District of Virginia affirmed the
bankruptcy court’s Opinion and Order. Because we find that the debt
arose by reason of Strack’s "defalcation," or nonfraudulent default,
while he was acting in a fiduciary capacity, we find that § 523(a)(4)
renders the debt non-dischargeable, and reverse the judgment of the
district court. Having found the debt non-dischargeable under
§ 523(a)(4), we do not reach Kubota’s claim under § 523(a)(6).
I.
The relevant facts here are not in dispute. Strack served as Presi-
dent and majority owner of Enterprise Equipment Inc. ("Enterprise").1
1
Strack, together with his wife Stephanie Strack, owned sixty percent
of Enterprise’s stock.
IN RE: STRACK 3
Enterprise sold farming equipment, such as tractors, and parts for
such equipment at its retail facility located in York County, Virginia.
Kubota was one of the numerous agricultural machinery manufactur-
ing companies for which Enterprise acted as an authorized dealer. In
his capacity as Enterprise’s President, Strack agreed to personally
guarantee Enterprise’s indebtedness to Kubota. In September 2003,
Strack also signed Kubota’s Dealer Sales and Service Agreement (the
"Agreement"), which forms the basis of this appeal.
The Agreement’s purpose was to renew Enterprise’s "right to pur-
chase and resell [Kubota] products." J.A. 171. Pursuant to the Agree-
ment, Kubota sold "whole goods," or equipment, to Enterprise
through a "floor-planning" arrangement.2 Under such an arrangement,
a dealer can purchase goods from a manufacturer without paying for
the goods up front. Here, Enterprise would order a piece of equipment
from Kubota for either immediate resale or to hold in its product
inventory. Although no money changed hands, Enterprise’s purchase
of the equipment would, in substance, result in the automatic issuance
of a "loan" to Enterprise from Kubota for the purchase price amount.
If an interest-free promotion was in place, as appears to have fre-
quently been the case, Kubota did not require payment of either prin-
cipal or interest on this "loan" for the first several months
immediately following the date of Enterprise’s purchase. If no such
program was in place, Enterprise was required to make interest pay-
ments during this period. Under either scenario, at the end of the
period the entire purchase price became due to Kubota.
"To secure the performance and payment of all obligations of
[Enterprise] to [Kubota]," Enterprise granted to Kubota a security
interest in, and lien on, the equipment. J.A. 26. To further protect
Kubota’s interests, the Agreement prohibited Enterprise from dispos-
ing of, or selling, any equipment "except in the ordinary course of
business upon customary terms for value received." J.A. 27. The fol-
lowing terms governing Enterprise’s handling of the proceeds from
these sales form the crux of this appeal:
2
Kubota also sold parts to Enterprise on "open account," under which
Enterprise could order the parts and be billed at a later date. Those sales,
however, are not relevant to this appeal.
4 IN RE: STRACK
Until [Enterprise] shall have made settlement with [Kubota]
of the full amount due to [Kubota] with respect to any
[equipment] disposed of by [Enterprise], [Enterprise] shall
segregate the proceeds and hold the same in trust for
[Kubota]. [Enterprise] shall be entitled to transfer proceeds
free of trust if at, or prior to, the time of such transfer, the
payment due from [Enterprise] to [Kubota] shall be assured
to the satisfaction of [Kubota].
Id. (emphasis added).
Kubota would conduct regular inventory audits at Enterprise’s
facility to determine whether Enterprise had sold any Kubota equip-
ment without then "segregating the proceeds" and remitting them to
Kubota. J.A. 27, 151. Enterprise frequently sold equipment in such
fashion, a breach Kubota dubs as "going out of trust," and had to
repay Kubota at the conclusion of the audits. Enterprise was able to
repay Kubota until March 2004, at which time its financial condition
deteriorated.
By July 2004, Enterprise was indebted to Kubota for nearly
$200,000. According to Strack, Enterprise was unable to repay
Kubota because all proceeds garnered were used to pay employees,
taxes, and other expenses necessary for Enterprise to remain in busi-
ness. Strack went to great lengths to try to keep Enterprise afloat,
even borrowing against the equity in his home and placing those
funds into Enterprise’s account. Strack managed to reduce Enter-
prise’s debt to Kubota to approximately $124,000 by returning parts
and inventory that Enterprise had previously purchased and by mak-
ing payments whenever possible.3 Despite these efforts, Enterprise
3
Strack also tried to find a buyer for the Kubota dealership rights, and
thought he had done so in Irvine Spurlock—the owner of another lawn
and garden company in Virginia. On July 21, 2004, Spurlock sent
Kubota’s manager a letter offering to pay up to $150,000 on Enterprise’s
debt in exchange for a new Kubota-authorized dealership encompassing
Enterprise’s territory. Kubota then provided forms to Enterprise, which
were completed by Strack, that terminated Enterprise’s Agreement with
Kubota. Strack felt that his debt with Kubota had been settled at that
time, as all Kubota equipment was removed by Kubota from Enterprise’s
IN RE: STRACK 5
ultimately went out of business, and was unable to make any further
payments to Kubota. Kubota subsequently sued Strack in the Circuit
Court for the County of York, Virginia, pursuant to his personal guar-
antee of Enterprise’s indebtedness, for the balance due under the
Agreement. In the proceedings, Strack admitted the legitimacy of the
debt and Kubota obtained a judgment against him on July 18, 2005
in the amount of $123,914.96.
On October 14, 2005, the Stracks filed for Chapter 7 relief and
listed Kubota as a creditor. Kubota later filed an adversary proceeding
with the bankruptcy court, alleging that such debt should be non-
dischargeable under one of two exceptions to the presumption of dis-
chargeability: defalcation by a fiduciary, 11 U.S.C. § 523(a)(4),4 or
willful and malicious injury by the debtor, 11 U.S.C. § 523(a)(6).5
The bankruptcy court rejected Kubota’s arguments and found the debt
dischargeable. Specifically, the court found that (1) the Agreement
did not unequivocally create an "express trust" between Kubota and
Enterprise and therefore the debt did not arise while Strack was acting
as a fiduciary for the purposes of § 523(a)(4);6 and (2) Strack’s efforts
store and Strack did not hear from Kubota for several months. Strack
later learned, however, that the deal between Spurlock and Kubota fell
through and Kubota still held Enterprise liable for the accrued debt. Feel-
ing still obligated to repay Kubota even after the Agreement was termi-
nated, Strack subsequently admitted the legitimacy of the debt in a state
court proceeding. Kubota was thus able to obtain the judgment against
Strack that forms the predicate of this dispute.
4
Section 523(a)(4) prohibits the discharge of any debt "for fraud or
defalcation while acting in a fiduciary capacity, embezzlement, or lar-
ceny."
5
Section 523(a)(6) prohibits the discharge of any debt "for willful and
malicious injury by the debtor to another entity or to the property of
another entity."
6
The bankruptcy court also recapitulated its earlier holding that "the
term ‘fiduciary’ as used in § 523(a)(4) [is restricted to] ‘the class of fidu-
ciaries including trustees of specific written declarations of trust [i.e.
express trusts], guardians, administrators, executors or public officers
and, absent special considerations, [does not] extend to the more general
class of fiduciaries such as agents, bailees, brokers, factors and part-
6 IN RE: STRACK
to repay Kubota negated the "willful" requirement of § 523(a)(6).
Kubota appealed the bankruptcy court’s judgment, unsuccessfully, to
the United States District Court for the Eastern District of Virginia.
This appeal followed.
II.
Kubota maintains that the bankruptcy court and district court erred
in finding that Strack’s debt was not excepted from discharge under
either § 523(a)(4) or § 523(a)(6). "We review the judgment of a dis-
trict court sitting in review of a bankruptcy court de novo, applying
the same standards of review that were applied in the district court."
Three Sisters Partners, LLC v. Harden (In re Shangra-La, Inc.), 167
F.3d 843, 847 (4th Cir. 1999). Thus, here, we examine the bankruptcy
court’s conclusions of law de novo and its findings of fact for clear
error. See Fed. R. Bankr. P. 8013; IRS v. White (In re White), 487
F.3d 199, 204 (4th Cir. 2007).
Generally, "all legal obligations of the debtor, no matter how
remote or contingent" are potentially dischargeable in bankruptcy. See
H.R. Rep. No. 95-595, at 309 (1977); see also Nunnery v. Rountree
(In re Rountree), 478 F.3d 215, 219 (4th Cir. 2007). Congress, how-
ever, has provided, in 11 U.S.C. § 523, several limited exceptions to
this presumption of dischargeability, which we must construe nar-
rowly "to protect the [Bankruptcy Act’s] purpose of providing debtors
a fresh start." In re Biondo, 180 F.3d 126, 130 (4th Cir. 1999).
ners.’" J.A. 156-57 (quoting E.L. Hamm & Assocs., Inc. v. Sparrow (In
re Sparrow), 306 B.R. 812, 828 (Bankr. E.D. Va. 2003). This court has
not yet had the opportunity to determine, in a published opinion, the
proper contours of the term "fiduciary" as used in § 523(a)(4). But see
Harrell v. Merchant’s Express Money Order co. (In re Harrell), 173
F.3d 850, at *3 (4th Cir. 1999)(unpublished table decision) (holding that
"under [§ 523(a)(4)], a fiduciary is limited to instances involving express
or technical trusts"). Here, the dispute concerns only whether an express
trust was created, which, as both parties acknowledge, is clearly suffi-
cient to establish a fiduciary relationship for the purposes of § 523(a)(4).
See Davis v. Aetna Acceptance Co., 293 U.S. 328, 333-34 (1934). Thus,
because the reach of the term "fiduciary" is not squarely presented here,
we decline to elaborate on the question further.
IN RE: STRACK 7
Kubota’s claim turns on the applicability of two such exceptions,
§ 523(a)(4) and § 523(a)(6). As the party challenging dischargea-
bility, Kubota bears the burden of proving the debt non-dischargeable
by a preponderance of the evidence. See Grogan v. Garner, 498 U.S.
279, 291 (1991).
A.
We first address Kubota’s argument that § 523(a)(4), excepting
from discharge those debts "for fraud or defalcation" committed by
one "acting in a fiduciary capacity," proscribes the discharge of
Strack’s debt. To prevail under this provision, a creditor must ordinar-
ily make a two-part showing: (1) that the debt in issue arose while the
debtor was acting in a fiduciary capacity; and (2) that the debt arose
from the debtor’s fraud or defalcation. Pahlavi v. Ansari (In re
Ansari), 113 F.3d 17, 20 (4th Cir. 1997). Here, the second criterion,
"defalcation," or non-fraudulent default, is not in dispute.7 However,
since Kubota is attempting to prevent the discharge of Strack’s debt
based on his guarantee of Enterprise’s indebtedness, Kubota must
demonstrate not only that Enterprise defalcated while acting in a fidu-
ciary capacity for Kubota, but also that Enterprise’s actions can be
attributed to Strack. See Airlines Reporting Corp. v. Ellison (In re
Ellison), 296 F.3d 266, 270-71 (4th Cir. 2002) (requiring more than
the existence of a fiduciary duty on behalf of the corporation to find
that the corporation’s officers’ indebtedness, based on their guaran-
tees of the corporation’s debt, was for "fraud or defalcation while act-
ing in a fiduciary capacity" under § 523(a)(4)).
The courts below rejected Kubota’s claim because of their view
that Kubota failed to make the preliminary showing that a fiduciary
7
To be defalcation for purposes of 11 U.S.C. § 523(a)(4), an act need
not "rise to the level of . . . ‘embezzlement’ or even ‘misappropriation.’"
In re Ansari, 113 F.3d at 20. "[N]egligence or even an innocent mistake
which results in . . . [the] failure to account is sufficient." Republic of
Rwanda v. Uwimana (In re Uwimana), 274 F.3d 806, 811 (4th Cir.
2001). Here, Enterprise, by Strack’s instruction, failed to remit the pro-
ceeds from the sale of Kubota equipment as required by the Agreement,
instead using the funds for Enterprise’s own expenses. Thus, both Enter-
prise’s and Strack’s actions constitute defalcation.
8 IN RE: STRACK
relationship existed between it and Enterprise. Kubota urges us to
reverse that finding, arguing that the Agreement created an express
trust between the parties, giving rise to a fiduciary duty on behalf of
Enterprise to protect the proceeds from the sale of Kubota equipment.8
In finding that a mere debt, and not a trust, was created, the bank-
ruptcy court, Kubota asserts, erred by improperly focusing on the
chattel itself—the equipment—rather than on the "proceeds flowing
from the sale of the chattel." Appellant’s Br. at 26. This "error," in
Kubota’s view, was perpetuated by the district court. With due respect
for those courts’ analyses, we agree with Kubota.
As both parties acknowledge, the creation of an express trust can
give rise to the requisite fiduciary duty under § 523(a)(4). See Davis,
293 U.S. at 334. The parties also agree that in determining whether
such a trust was established, we look to the law of the Commonwealth
of Virginia, where the trust was allegedly created, for guidance. See
Am. Bankers Ins. Co. v. Maness, 101 F.3d 358, 363 (4th Cir. 1996)
("[W]hile federal law creates the bankruptcy estate, . . . state law,
absent a countervailing federal interest, determines whether a given
property falls within this federal framework.").
Under Virginia law, "[a]n express trust is based on the declared
intention of the trustor," manifested either in writing or through the
parties’ actions. Leonard v. Counts, 272 S.E.2d 190, 194 (Va. 1980);
see also Woods v. Stull, 30 S.E.2d 675, 682 (Va. 1944) ("In order to
constitute an express trust there must be either explicit language to
that effect or circumstances which show with reasonable certainty that
a trust was intended to be created."). Although the parties’ use of the
word "trust" is to be given great weight, it is not determinative. See
Exec. Comm. v. Shaver, 135 S.E. 714, 716 (Va. 1926); see also
Broaddus, 26 S.E.2d at 36 (Va. 1943) (recognizing that an express
8
As will be discussed further below, under Virginia law, an express
trust is created when the parties affirmatively manifest an intention that
certain property be held in trust for the benefit of a third party. See Peal
v. Luther, 97 S.E.2d 668, 669 (Va. 1957). If such a trust is created, the
beneficiary of the trust "is equitable owner of the trust property. If the
trustee transfers the trust property . . ., or if the trustee becomes insol-
vent, the beneficiary is still entitled to the property." Broaddus v.
Gresham, 26 S.E.2d 33, 35-36 (Va. 1943).
IN RE: STRACK 9
trust can be established without use of any "technical words"). All
that is necessary is the "unequivocal" intent "‘that the legal estate [be]
vested in one person, to be held in some manner or for some purpose
on behalf of another.’" Old Republic Nat’l Title Ins. Co. (In re
Dameron), 155 F.3d 718, 722 (4th Cir. 1998) (quoting Broaddus, 26
S.E.2d at 35). At bottom, "[i]f the intention is that the money shall be
kept or used as a separate fund for the benefit of the payor or a third
person, a trust is created. If[, however,] the intention is that the person
receiving the money shall have the unrestricted use thereof, being lia-
ble to pay a similar amount whether with or without interest to the
payor or to a third person, a debt is created." Broaddus, 26 S.E.2d at
37.
In sum, whether an express trust was created between Kubota and
Enterprise depends on the intent of the parties as evinced by the
Agreement. As noted above, the Agreement provided that if Enter-
prise sold a piece of equipment to a third party before it remitted to
Kubota the total payment due for that equipment, Enterprise "shall
segregate the proceeds [from the sale] and hold the same in trust for
[Kubota]." J.A. 27 (emphasis added). Enterprise was entitled to use
or transfer the proceeds "free of trust" only when Kubota was repaid
to its "satisfaction." Id. (emphasis added). In addition to twice using
the word "trust" to describe the interest in question, this language "un-
equivocally show[s] an intention" that Enterprise take possession of
the proceeds, segregate them from its own funds, and "h[o]ld" them
"on behalf of," Kubota. In re Dameron, 155 F.3d at 722 (internal quo-
tations omitted). Although this provision forms a relatively small part
of the Agreement, it demonstrates, "with reasonable certainty," the
intent to establish an express trust. See Woods, 30 S.E.2d at 682.
Because such a trust was created, we find the existence of a fiduciary
relationship between Enterprise and Kubota with respect to the sales
proceeds. See id.; In re Ellison, 296 F.3d at 270-71 (acknowledging
that a fiduciary relationship existed between two corporations when
the agreement between them provided that sales proceeds "were the
‘property of the carriers,’ to be ‘held in trust’ by [the debtor] ‘until
satisfactorily accounted for.’").
Notwithstanding the above express language, the bankruptcy court
determined that the Agreement was insufficient to create an express
trust, relying primarily on the Supreme Court’s decision in Davis, 293
10 IN RE: STRACK
U.S. at 333-34. The Davis Court, applying the law of Illinois, found
that a writing characterized as a "trust receipt" was insufficient to
transform an ordinary debtor-creditor relationship into a fiduciary
relationship. 293 U.S. at 333-34. The bankruptcy court here held that
because the Agreement between Enterprise and Kubota, like the
agreements forming the basis of the relationship between the parties
in Davis, provided for title to the equipment to pass to Enterprise and
for Kubota to retain merely a security interest in it, the Agreement
created a standard debtor-creditor relationship, not an express trust.
The district court agreed.
In so holding, however, both the bankruptcy court and the district
court failed to recognize two critical distinctions between this case
and Davis. First, in Davis, the creditor was claiming the existence of
a trust with respect to the chattel—the automobile. Here, the proper
focus is on the proceeds from the sale of the chattel. Even if Enter-
prise’s holding of title to the equipment would preclude the finding
of a trust relationship between the parties with respect to that equip-
ment, Davis still would not foreclose the existence of an express trust
with respect to the proceeds from the sale of that equipment. Further-
more, and more critically, the language of the Agreement here, unlike
the incidental labeling of a document as a "trust receipt" in Davis, in
no uncertain terms demonstrates "the intention . . . that the [proceeds]
. . . be kept or used as a separate fund for the benefit of [Kubota]."
See Broaddus, 26 S.E.2d at 36-37 (comparing the intent necessary to
create a trust with that necessary to create an ordinary debt). Unlike
in a standard debtor-creditor relationship, in which "the person receiv-
ing the money [has] the unrestricted use thereof, being liable [only]
to pay a similar amount . . . to the payor," id., Enterprise was not enti-
tled to treat the proceeds as its own and use them as it wished. Rather,
Enterprise was required to separate the proceeds, hold them for
Kubota’s benefit, and use them only once Kubota allowed. See J.A.
27. Thus, we find that the Agreement gave rise to an express trust and
a consequent fiduciary relationship between Enterprise and Kubota,
notwithstanding the guidance of Davis.
B.
Having concluded that the debt arose due to Enterprise’s defalca-
tion while it was acting in a fiduciary relationship with Kubota, we
IN RE: STRACK 11
must now determine whether Strack’s personal indebtedness to
Kubota, arising out of his guarantee of Enterprise’s debt, is therefore
non-dischargeable under § 523(a)(4). We need not labor long over
this issue, however. The facts of this case are analogous to those in
our decision in In re Ellison, 296 F.3d 266, and therefore must yield
the same result.9
In In re Ellison, the debtors were officers, directors, and sharehold-
ers of a West Virginia corporation. The debtors’ corporation entered
into an express trust agreement with another corporation, ARC, giv-
ing rise to a fiduciary relationship between the two entities. The debt-
ors also agreed to personally guarantee their corporation’s
indebtedness to ARC. The debtors’ corporation later breached the
trust agreement and amassed a significant debt. When the debtors
subsequently filed for bankruptcy under Chapter 7, ARC challenged
the dischargeability of the debt under § 523(a)(4). This court found
the debt non-dischargeable based on the following factors: (1) the
debtors personally guaranteed the indebtedness; (2) the indebtedness
arose due to defalcation or "the breach of a fiduciary relationship
between the two corporations"; (3) the debtors "were personally
responsible for the conduct that gave rise" to their corporation’s
breach or defalcation; and (4) the debtors "conduct amounted to a
breach of their fiduciary duty" to their corporation. Id. at 270-71.
The same "confluence" of factors present in In re Ellison exists
here. See id. at 271. First, Strack personally guaranteed Enterprise’s
debt to Kubota. Second, as determined above, the indebtedness arose
from Enterprise’s defalcation or failure to remit the proceeds to
Kubota as the Agreement required. Third, Strack was personally
responsible for this defalcation by willfully violating the Agreement
and using the proceeds owed to Kubota for other purposes. And,
finally, this wrongful conduct constituted a breach of the fiduciary
duty that Strack owed to Enterprise as the corporation’s President. See
Adelman v. Conotti Corp., 213 S.E.2d 774, 779 (Va. 1975) ("Under
Virginia law an officer of a corporation, in his dealings with the cor-
9
We note that this court’s decision in In re Ellison was based, in part,
on West Virginia law. However, Virginia law on this subject does not
differ substantially from that of West Virginia. Thus, we find a similar
outcome to be warranted here.
12 IN RE: STRACK
poration, has the same duty of fidelity which arises in dealings
between a trustee and a beneficiary of the trust."). We therefore con-
clude, like this court did in In re Ellison, that Strack’s indebtedness
to Kubota arose from his "defalcation while acting in a fiduciary
capacity" and is therefore excepted from discharge in bankruptcy
under 11 U.S.C. § 523(a)(4).10
III.
For the foregoing reasons, the judgment of the district court is
REVERSED.
10
Because we find Strack’s debt non-dischargeable under § 523(a)(4),
we do not reach Kubota’s alternative argument under § 523(a)(6).