116 F.3d 176 (6th Cir. 1997), 96-3447, In re Garver

Docket Nº:96-3447.
Citation:116 F.3d 176
Party Name:In re Theodore M. GARVER, Debtor. R.E. AMERICA, INC., Plaintiff-Appellee, v. Theodore M. GARVER, Defendant-Appellant.
Case Date:June 19, 1997
Court:United States Courts of Appeals, Court of Appeals for the Sixth Circuit

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116 F.3d 176 (6th Cir. 1997)

In re Theodore M. GARVER, Debtor.

R.E. AMERICA, INC., Plaintiff-Appellee,


Theodore M. GARVER, Defendant-Appellant.

No. 96-3447.

United States Court of Appeals, Sixth Circuit.

June 19, 1997

Argued April 22, 1997.

Eric H. Zagrans (argued and briefed), Elyria, OH, for Defendant-Appellant.

Richard G. Hardy (argued and briefed), Ulmer & Berne, Cleveland, OH, for Plaintiff-Appellee.

Before: JONES, SUHRHEINRICH, and SILER, Circuit Judges.


SUHRHEINRICH, Circuit Judge.

In this case we must decide whether a state court jury decision holding attorney Theodore Garver ("Garver") liable to R.E. America, Inc. ("REA") for $600,000 under breach of contract and fiduciary duty is dischargeable under the United States Bankruptcy Code ("Bankruptcy Code"). The bankruptcy court refused to discharge the debt, holding that it was the result of defalcation by Garver. 1 The district court affirmed. For the following reasons, we REVERSE.


    Garver is an attorney and former partner in the Cleveland, Ohio office of Jones, Day, Reavis & Pogue. As a tax specialist, Garver developed numerous long term clients, including REA. In late 1989, while acting as counsel to REA, Garver proposed a business transaction between REA and himself to acquire a struggling company which needed an infusion of capital and new management. REA agreed to participate in Garver's proposed venture. Under their agreement, each party would contribute $600,000 for 50% ownership in a company called A.A. Gage ("Gage"). When the transaction was completed, however, REA had invested $600,000 in exchange for an unsecured promissory note in the amount of $600,000 executed by Garver on behalf of the Fostoria Braude Corporation, a holding company which Garver controlled. 3 Fostoria Braude, in turn, owned 100% of the Gage stock. Garver, meanwhile, had contributed only $17,500 toward the purchase of Gage.

    During the following year, Gage became insolvent and filed for bankruptcy in late 1991. As a result, REA lost its investment and sued Garver in state court, alleging legal malpractice, breach of contract, and fraud. Specifically, REA alleged that Garver, as a business

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    partner in the transaction, breached his contractual duty to contribute $600,000 to acquire Gage and, as attorney for REA, breached various fiduciary duties owed to REA under the attorney-client relationship. In the state court trial, Garver testified that he never intended to contribute $600,000 to the venture. Rather, according to Garver, the deal only required him to contribute his "sweat equity" to Gage. Thus, under Garver's version of the agreement REA carried nearly the entire financial risk of the deal. Not surprisingly, the jury believed REA and concluded that Garver: 1) committed legal malpractice by breaching unspecified fiduciary duties owed to REA as his client and 2) breached his contract with REA to contribute $600,000 to the venture. The jury also specifically found that Garver had not committed fraud. The jury then awarded REA $600,000 in damages. 4

    Garver subsequently filed a voluntary petition under Chapter 7 of the Bankruptcy Code. REA, as a judgment creditor, responded by filing this adversary proceeding in the bankruptcy court to determine whether Garver could discharge his debt to REA. The dischargeability of Garver's obligation turned entirely upon whether the state court judgment was the result of "defalcation" within the meaning of 11 U.S.C. § 523(a)(4). The

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    bankruptcy court, holding that the debt did result from defalcation, refused to discharge it. The district court affirmed and Garver appeals the district court decision.


    In considering an appeal from a district court decision which is on appeal from a bankruptcy court, this court independently reviews the bankruptcy court's findings of fact for clear error and its conclusions of law de novo. Longo v. McLaren (In re McLaren), 3 F.3d 958, 961 (6th Cir.1993).

    Although many debts are dischargeable under the Bankruptcy Code, § 523(a)(4) provides that "a discharge under [the Bankruptcy Code] does not discharge an individual debtor from any debt ... for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny." 11 U.S.C.A. § 523(a)(4) (West 1993 & Supp.1997). It is undisputed that no embezzlement or larceny occurred in this case and the state court jury specifically found no fraud. Therefore, to avoid discharge of the debt in bankruptcy, REA must show by a preponderance of the evidence that the debt was incurred through defalcation while acting in a fiduciary capacity. See Grogan v. Garner, 498 U.S. 279, 291, 111 S.Ct. 654, 661, 112 L.Ed.2d 755 (1991) (adopting preponderance of the evidence standard for § 523(a) discharges).

    The federal courts are not in perfect agreement as to the requirements necessary to prove defalcation under § 523(a)(4). A review of the cases reveals that the courts generally agree that defalcation requires: 1) a fiduciary relationship; 2) breach of that fiduciary relationship; and 3) a resulting loss. They often differ, however, as to the nature of the fiduciary relationship necessary to trigger the defalcation provision of § 523(a)(4).

    Some federal courts construe the term "fiduciary capacity" found in the defalcation provision of § 523(a)(4) narrower than they construe the term "fiduciary relationship" as used in the legal profession generally. Fowler Bros. v. Young (In re Young), 91 F.3d 1367, 1372 (10th Cir.1996) (holding general fiduciary duties of confidence, trust, loyalty, and good faith insufficient to establish the necessary fiduciary relationship for purposes of § 523(a)(4)); Clark v. Allen (In re Allen) 206 B.R. 602, 606 (Bankr.M.D.Fla.1997) (noting that the traditional meaning of the term fiduciary is far too broad for bankruptcy...

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