Kubota Tractor Corp. v. Strack , 524 F.3d 493 ( 2008 )

UNPUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
No. 07-1200
In Re: BRUCE E. STRACK,
Debtor.
----------------------------
KUBOTA TRACTOR CORPORATION, a California
corporation,
Plaintiff - Appellant,
versus
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Reversed by unpublished opinion. Judge Duncan wrote the opinion,
in which Judge Niemeyer and Judge Motz joined.
ARGUED: Ryan Ashby Shores, HUNTON & WILLIAMS, Washington, 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.
Unpublished opinions are not binding precedent in this circuit.
2
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: “defalcation 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).
3
I.
The relevant facts here are not in dispute. Strack served as
President and majority owner of Enterprise Equipment Inc.
(“Enterprise”).1 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 manufacturing 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
purchase and resell [Kubota] products.” J.A. 171. Pursuant to the
Agreement, 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
1
Strack, together with his wife Stephanie Strack, owned sixty
percent of Enterprise’s stock.
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
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 frequently been the
case, Kubota did not require payment of either principal 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 payments
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 disposing of, or selling, any equipment “except in the
ordinary course of business upon customary terms for value
received.” J.A. 27. The following terms governing Enterprise’s
handling of the proceeds from these sales form the crux of this
appeal:
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].
5
Id. (emphasis added).
Kubota would conduct regular inventory audits at Enterprise’s
facility to determine whether Enterprise had sold any Kubota
equipment 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
business. 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
Enterprise’s debt to Kubota to approximately $124,000 by returning
parts and inventory that Enterprise had previously purchased and by
making payments whenever possible.3 Despite these efforts,
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
6
Enterprise 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 guarantee 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 dischargeability: 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
Kubota equipment was removed by Kubota from Enterprise's 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. Feeling still obligated to repay Kubota even after the
Agreement was terminated, 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 larceny.”
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.”
7
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 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
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 fiduciaries 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
partners.’” 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 sufficient 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.
8
under either § 523(a)(4) or § 523(a)(6). “We review the judgment
of a district 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, however, has provided, in 11 U.S.C. § 523, several
limited exceptions to this presumption of dischargeability, which
we must construe narrowly “to protect the [Bankruptcy Act’s]
purpose of providing debtors a fresh start.” In re Biondo, 180
F.3d 126, 130 (4th Cir. 1999). Kubota’s claim turns on the
applicability of two such exceptions, § 523(a)(4) and § 523(a)(6).
As the party challenging dischargeability, 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
9
one “acting in a fiduciary capacity,” proscribes the discharge of
Strack’s debt. To prevail under this provision, a creditor must
ordinarily 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 fiduciary 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
guarantees of the corporation’s debt, was for “fraud or defalcation
while acting in a fiduciary capacity” under § 523(a)(4)).
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 proceeds from the sale of
Kubota equipment as required by the Agreement, instead using the
funds for Enterprise’s own expenses. Thus, both Enterprise’s and
Strack’s actions constitute defalcation.
10
The courts below rejected Kubota’s claim because of their view
that Kubota failed to make the preliminary showing that a fiduciary
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 bankruptcy 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
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 insolvent, the
beneficiary is still entitled to the property.” Broaddus v.
Gresham, 26 S.E.2d 33, 35-36 (Va. 1943).
11
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 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
12
unrestricted use thereof, being liable 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
Enterprise 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 “unequivocally
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
quotations 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
13
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 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 Enterprise’s holding of title to the
14
equipment would preclude the finding of a trust relationship
between the parties with respect to that equipment, Davis still
would not foreclose the existence of an express trust with respect
to the proceeds from the sale of that equipment. Furthermore, 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 receiving the money [has] the
unrestricted use thereof, being liable [only] to pay a similar
amount . . . to the payor,” id., Enterprise was not entitled 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
defalcation while it was acting in a fiduciary relationship with
Kubota, we must now determine whether Strack’s personal
15
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
shareholders of a West Virginia corporation. The debtors’
corporation entered into an express trust agreement with another
corporation, ARC, giving rise to a fiduciary relationship between
the two entities. The debtors 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
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.
16
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 corporation, has the same
duty of fidelity which arises in dealings between a trustee and a
beneficiary of the trust.”). We therefore conclude, 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
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).
17
III.
For the foregoing reasons, the judgment of the district court
is
REVERSED.
18