Northbay Wellness Group v. Michael Beyries

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
NORTHBAY WELLNESS GROUP, INC., No. 13-17381
a corporation,
Appellant, D.C. No.
3:11-cv-06255-
v. JSW
MICHAEL KENNETH BEYRIES,
Appellee. OPINION
Appeal from the United States District Court
for the Northern District of California
Jeffrey S. White, District Judge, Presiding
Argued and Submitted—January 14, 2015
San Francisco California
Filed June 5, 2015
Before: Milan D. Smith, Jr., Jacqueline H. Nguyen,
and Michelle T. Friedland, Circuit Judges.
Opinion by Judge Friedland
2 NORTHBAY WELLNESS V. BEYRIES
SUMMARY *
Bankruptcy
The panel reversed the district court’s affirmance of the
bankruptcy court’s conclusion that a judgment debt was not
nondischargeable under 11 U.S.C. § 523(a)(4) as a debt for
fraud or defalcation while acting in a fiduciary capacity.
The debt was for the chapter 7 debtor’s breach of
contract and conversion of a legal defense trust fund for
Northbay Wellness Group, operator of a medical marijuana
dispensary. The debtor served on Northbay’s board of
directors and acted as its attorney. The bankruptcy court
held that under the doctrine of unclean hands, Northbay’s
illegal marijuana sales prevented it from obtaining relief
under § 523(a)(4). The panel reversed because the debtor’s
wrongdoing outweighed Northbay’s and because application
of the unclean hands doctrine to absolve an attorney of
responsibility for stealing from his client would be contrary
to the public interest.
*
This summary constitutes no part of the opinion of the court. It has
been prepared by court staff for the convenience of the reader.
NORTHBAY WELLNESS V. BEYRIES 3
COUNSEL
Lisa L. Gygax (argued), Law Offices of Lisa L. Gygax,
Forestville, California, for Appellant.
Jon C. Chandler (argued), David N. Chandler, Sr., and David
N. Chandler, Jr., Law Offices of David N. Chandler, Santa
Rosa, California, for Appellee.
OPINION
FRIEDLAND, Circuit Judge:
Attorney Michael Beyries stole $25,000 from his client,
a medical marijuana dispensary known as Northbay
Wellness Group (“Northbay”). Beyries later filed for
bankruptcy, and Northbay sought a determination that the
$25,000 was a nondischargeable debt. The bankruptcy court
recognized that debts arising from theft are typically
nondischargeable, but it applied the doctrine of unclean
hands to hold that Northbay’s illegal marijuana sales
prevented Northbay from obtaining relief. Because
Beyries’s wrongdoing outweighs Northbay’s, and because
application of the unclean hands doctrine to absolve an
attorney of responsibility for stealing from his client would
be contrary to the public interest, we reverse. 1
1
We address Northbay’s other arguments in a concurrently filed
memorandum disposition.
4 NORTHBAY WELLNESS V. BEYRIES
I. Background
Northbay Wellness Group operated as a California
medical marijuana dispensary in 2005 and 2006 under the
leadership of Dona Frank. Michael Beyries served on
Northbay’s board of directors and received $5,000 per
month to act as its attorney. In addition to the monthly
payments, Northbay entrusted Beyries with at least $25,000
of its marijuana sales revenue as a legal defense trust fund,
for use in the event that a Northbay employee, board
member, or patient was arrested on marijuana-related
charges. Northbay made the trust fund payments to Beyries
in cash. Although Beyries assured Frank that he was
keeping track of the trust fund deposits, Beyries never
provided Frank with a receipt or other record of the funds.
On June 14, 2006, Beyries resigned from his roles at
Northbay “effective immediately” and absconded with the
$25,000 trust fund.
In February 2008, Northbay and Frank sued Beyries in
California state court, alleging, among other things,
conversion of the legal defense trust fund and breach of
contract. A jury found against Beyries on both counts and
awarded Northbay $25,000 for conversion and $319,430.96
for breach of contract, as well as $5,000 in punitive damages.
Beyries filed for Chapter 7 bankruptcy in September
2010 and listed Northbay as a creditor holding an unsecured,
nonpriority claim for the total $349,430.96 awarded in the
California judgment. Shortly thereafter, Northbay and Frank
commenced an adversary proceeding against Beyries in the
United States Bankruptcy Court for the Northern District of
NORTHBAY WELLNESS V. BEYRIES 5
California, alleging that the state-court award was
nondischargeable under 11 U.S.C. § 523(a). 2
After holding a trial, the bankruptcy court concluded that
Beyries’s misappropriation of the $25,000 legal defense
trust fund ordinarily would be nondischargeable pursuant to
§ 523(a)(4) of the Bankruptcy Code, which provides that a
debt “for fraud or defalcation while acting in a fiduciary
capacity” may not be discharged. 11 U.S.C. § 523(a)(4).
Nevertheless, the court held that the doctrine of unclean
hands precluded any judgment for Northbay because
2
Specifically, Northbay and Frank relied upon the following
provisions of 11 U.S.C. § 523:
(a) A discharge under section 727, 1141, 1228(a),
1228(b), or 1328(b) of this title does not discharge an
individual debtor from any debt—
....
(2) for money . . . to the extent obtained by—
(A) false pretenses, a false representation, or
actual fraud . . .
....
(4) for fraud or defalcation while acting in a
fiduciary capacity . . .
....
(6) for willful and malicious injury by the debtor
to another entity or to the property of another
entity[.]
6 NORTHBAY WELLNESS V. BEYRIES
Northbay created the trust fund using the proceeds of illegal
marijuana sales. The court accordingly dismissed the
adversary proceeding.
Northbay appealed to the United States District Court for
the Northern District of California, which affirmed the
bankruptcy court’s ruling, agreeing that the doctrine of
unclean hands foreclosed relief. This timely appeal
followed.
II. Standard of Review
We review a district court’s decision in an appeal from
the bankruptcy court de novo. Mano-Y & M, Ltd. v. Field
(In re The Mortgage Store, Inc.), 773 F.3d 990, 994 (9th Cir.
2014). In doing so, we apply the same standard of review to
the bankruptcy court’s decision as did the district court. Id.
We review findings of fact for clear error and conclusions of
law de novo. Id.
We review application of the unclean hands doctrine for
abuse of discretion. Seller Agency Council, Inc. v. Kennedy
Ctr. for Real Estate Educ., Inc., 621 F.3d 981, 986 (9th Cir.
2010). A trial court—here, the bankruptcy court—“abuses
its discretion if it does not apply the correct law or if it rests
its decision on a clearly erroneous finding of material fact.”
Jeff D. v. Otter, 643 F.3d 278, 283 (9th Cir. 2011) (internal
quotation marks omitted).
III. Unclean Hands
A plaintiff asking a court for equitable relief “must come
with clean hands.” Johnson v. Yellow Cab Transit Co., 321
U.S. 383, 387 (1944). Specifically, the doctrine of unclean
hands requires that a plaintiff “shall have acted fairly and
NORTHBAY WELLNESS V. BEYRIES 7
without fraud or deceit as to the controversy in issue.”
Ellenburg v. Brockway, Inc., 763 F.2d 1091, 1097 (9th Cir.
1985). Because bankruptcy courts are courts of equity,
Young v. United States, 535 U.S. 43, 50 (2002), a plaintiff
deemed to have unclean hands cannot obtain a judgment of
nondischargeability. See Republic of Rwanda v. Uwimana
(In re Uwimana), 274 F.3d 806, 810 (4th Cir. 2001) (“A
plaintiff with unclean hands is not entitled to relief from a
court of equity in the form of an order denying the
dischargeability of debt.” (internal quotation marks
omitted)), abrogated on other grounds by Bullock v.
BankChampaign, N.A., 133 S. Ct. 1754, 1758–59 (2013). 3
The Supreme Court has emphasized, however, that the
doctrine of unclean hands “does not mean that courts must
always permit a defendant wrongdoer to retain the profits of
his wrongdoing merely because the plaintiff himself is
possibly guilty of transgressing the law.” Yellow Cab, 321
U.S. at 387. Rather, determining whether the doctrine of
unclean hands precludes relief requires balancing the alleged
wrongdoing of the plaintiff against that of the defendant, and
“weigh[ing] the substance of the right asserted by [the]
3
Federal law governs whether nondischargeability is barred by
unclean hands. See Grogan v. Garner, 498 U.S. 279, 283–84 (1991)
(“The validity of a creditor’s claim is determined by rules of state law.
Since 1970, however, the issue of nondischargeability has been a matter
of federal law governed by the terms of the Bankruptcy Code.” (citation
and footnote omitted)); Shaver v. Shaver, 736 F.2d 1314, 1316 (9th Cir.
1984) (“Because of the federal interests reflected in the Bankruptcy Act,
the courts look to federal law to determine whether an obligation is . . .
nondischargeable.” (internal quotation marks omitted)).
8 NORTHBAY WELLNESS V. BEYRIES
plaintiff against the transgression which, it is contended,
serves to foreclose that right.” Republic Molding Corp. v.
B.W. Photo Utils., 319 F.2d 347, 350 (9th Cir. 1963). In
addition, “the clean hands doctrine should not be strictly
enforced when to do so would frustrate a substantial public
interest.” EEOC v. Recruit U.S.A., Inc., 939 F.2d 746, 753
(9th Cir. 1991). 4
The bankruptcy court failed to conduct the required
balancing, instead concluding solely from the fact that
Northbay had engaged in wrongful activity that the doctrine
of unclean hands applied. In so doing, the bankruptcy court
made an error of law, and thus abused its discretion.
Had the bankruptcy court weighed the parties’ respective
wrongdoing, it necessarily would have concluded that
Beyries’s wrongdoing outweighed Northbay’s, both as to
harm caused to each other and as to harm caused to the
public.
Beyries was on Northbay’s board of directors and
partnered in Northbay’s business, so he was as responsible
as Northbay for its illegal marijuana sales. That illegal
4
In EEOC, we upheld an injunction despite the plaintiff agency’s
wrongdoing because denying the injunction “would disserve the public
interest in eliminating age, sex, and race discrimination in employment
and would punish the innocent victims of discrimination for the errors of
the EEOC.” 939 F.2d at 754. The defendant corporation’s wrongdoing
in engaging in employment discrimination was a greater wrong than the
agency’s alleged violation of Title VII’s confidentiality provisions. Id.
at 752–53.
 NORTHBAY WELLNESS V. BEYRIES 9
activity must be attributed to both parties in the weighing of
wrongdoing, so it does not tip the balance in either direction.
The bankruptcy court appears to have believed that
Northbay’s use of cash to create the trust fund, and its failure
to carefully count and document that cash, were additional
forms of wrongdoing by Northbay. But Northbay’s use of
cash is unsurprising given that, until February 2014, the
federal government had not authorized banks to do business
with marijuana sellers in states that had legalized marijuana
sales. 5 Northbay’s use of cash was (at the time) part and
parcel to conducting illegal marijuana sales, which, as
discussed, was wrongdoing attributable to Beyries as well.
And to the extent that no one documented the exact cash
deposits, it was Beyries’s responsibility to maintain those
records. See Cal. Rules of Prof’l Conduct R. 4-100(B)(3)
(2013) (requiring that members of the California bar
“[m]aintain complete records of all funds, securities, and
other properties of a client coming into the possession of the
member or law firm and render appropriate accounts to the
client regarding them”). Thus, if relevant to the balance of
wrongdoing at all, Beyries’s failure to properly account for
his client’s money weighs against Beyries.
On top of the illegal activity shared with Northbay,
Beyries is also responsible for much more. Beyries stole
5
See Treas. Guidance FIN-2014-G001 (Feb. 14, 2014); Dep’t of
Justice, Memorandum for All United States Attorneys, Guidance
Regarding Marijuana Related Financial Crimes (Feb. 14, 2014),
available at http://www.justice.gov/sites/default/files/usao-wdwa/
legacy/2014/02/14/DAG%20Memo%20-%20Guidance%20Regarding
%20Marijuana%20Related%20Financial%20Crimes%202%2014%201
4%20%282%29.pdf.
10 NORTHBAY WELLNESS V. BEYRIES
$25,000 from his client. A lawyer’s “[m]isappropriation of
a client’s property is a gross violation of general morality
likely to undermine public confidence in the legal profession
and therefore merits severe punishment.” Greenbaum v.
State Bar, 544 P.2d 921, 928 (Cal. 1976) (in bank) (internal
quotation marks omitted). As the California Supreme Court
has emphasized, theft from a client is “an offense which
involves moral turpitude and clearly warrants disbarment in
the absence of extenuating circumstances.” Persion v. State
Bar, 509 P.2d 524, 527 (Cal. 1973) (in bank) (internal
quotation marks omitted); see also Cal. Bus. & Prof. Code
§ 6106 (“The commission of any act involving moral
turpitude, dishonesty or corruption . . . constitutes a cause for
disbarment or suspension.”). Indeed, the California State
Bar disbarred Beyries because of the very conduct at issue
here. See In re Michael Kenneth Beyries, Case No. 11-O-
15899-PEM, at 3–6 (State Bar Ct. Cal. Sept. 25, 2014),
available at http://members.calbar.ca.gov/courtDocs/11-O-
15899-3.pdf. In the balance of wrongdoing, Beyries thus
fares much worse than Northbay. 6
Allowing Beyries to avoid through bankruptcy his
responsibility for misappropriating his client’s money would
undermine the public interest in holding attorneys to high
6
The Seventh Circuit has likewise concluded that theft may be a
greater wrong than illegal drug sales for purposes of applying the
doctrine of unclean hands. In Kaye v. Rose (In re Rose), 934 F.2d 901
(7th Cir. 1991) (per curiam), the Seventh Circuit held that the unclean
hands doctrine did not prevent the plaintiff from enforcing a judgment
requiring the return of stolen funds, even though the plaintiff may have
acquired the stolen funds through illegal drug sales. Id. at 904 n.4.
NORTHBAY WELLNESS V. BEYRIES 11
ethical standards. 7 Recognizing the critical importance of
enforcing lawyers’ obligations to their clients, we previously
have held that “[w]hen a lawyer has by immoral or illegal
conduct violated his professional obligations to his client, an
action by the client to recover the lawyer’s fee will not be
barred on the lawyer’s plea that the client also engaged in
immoral or illegal conduct.” Estrada v. Speno & Cohen, 244
F.3d 1050, 1061 n.1 (9th Cir. 2001) (internal quotation
marks and citation omitted). We similarly now hold that the
doctrine of unclean hands cannot prevent recovery of funds
stolen from a client by his or her lawyer.
IV. Conclusion
For the foregoing reasons, the bankruptcy court abused
its discretion by applying the doctrine of unclean hands to
bar Northbay’s request for a judgment of
nondischargeability.
REVERSED and REMANDED.
7
Because an action for breach of fiduciary duty is an action in equity,
see Stebbins v. Crocker Citizens Nat’l Bank (In re Ahlswede), 516 F.2d
784, 788 (9th Cir. 1975), extending the doctrine of unclean hands to
situations like that at issue here would not only allow lawyers to
discharge debts arising from thefts from clients, but could also block
wronged clients’ suits against their lawyers for breaches of fiduciary
duties.