364 B.R. 220 (Bkrtcy.E.D.Va. 2007), 05-77916, In re Hathaway

• Citation: 364 B.R. 220
• Party Name: In re William E.K. HATHAWAY, II, Debtor. OSB Manufacturing, Inc., Plaintiff, v. William E.K. Hathaway, II, Defendant.
• Case Date: March 06, 2007
• Court: United States Bankruptcy Courts, Fourth Circuit

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364 B.R. 220 (Bkrtcy.E.D.Va. 2007)

In re William E.K. HATHAWAY, II, Debtor.

OSB Manufacturing, Inc., Plaintiff,

v.

William E.K. Hathaway, II, Defendant.

Bankruptcy No. 05-77916-SCS.

Adversary No. 06-07030-SCS.

United States Bankruptcy Court, E.D. Virginia, Norfolk Division.

March 6, 2007

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Timothy V. Anderson, Law Offices of Anderson Good, P.C., Virginia Beach, VA, for Plaintiff.

Dale V. Berning, Berning Law, Virginia Beach, VA, for Debtor/Defendant.

MEMORANDUM OPINION

STEPHEN C. ST. JOHN, Bankruptcy Judge.

This matter came before the Court upon the Complaint to Determine Dischargeability of Debt under §§ 523(a)(2) and (a)(4) of the Bankruptcy Code, filed by OSB Manufacturing, Inc. ("OSB") in the above-captioned matter. At the conclusion of the trial, the Court took this matter under advisement. The Court has jurisdiction over these proceedings pursuant to 28 U.S.C. §§ 157(b)(2) and 1334(b). Venue is proper pursuant to 28 U.S.C. §§ 1408 and 1409. Upon consideration of the evidence, arguments presented by counsel at the trial, and pleadings submitted, the Court makes the following findings of fact and conclusions of law.

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I. PROCEDURAL HISTORY

William E.K. Hathaway, II ("Hathaway") filed, by counsel, a petition under Chapter 7 of the Bankruptcy Code on November 25, 2005. The § 341 Meeting of Creditors was held on December 20, 2005. On February 14, 2006, a Complaint to Determine Dischargeability of Debt owed to OSB under §§ 523(a)(2) and (a)(4) was filed, which commenced the above-captioned Adversary Proceeding. Hathaway received a Chapter 7 Discharge on February 28, 2006.

OSB's Complaint alleges that it is a pre-petition unsecured non-priority creditor in Hathaway's pending bankruptcy case. OSB claims that Hathaway incurred debt against OSB through his fraudulent use of a corporate American Express card and Visa check card. OSB claims that Hathaway made unauthorized personal charges on both cards, and embezzled United States Currency belonging to OSB. OSB's Complaint prays that the Court determine the dischargeability of a claim of $45,000.00 against Hathaway, inclusive of attorney fees and court costs. Hathaway filed an Answer to the Complaint on May 24, 2006. ¹

Hathaway alleges that personal use of the American Express and Visa Check cards was authorized pursuant to the corporate operating agreement, and in lieu of his collecting a salary from the company. Hathaway alleges that the debt owed to OSB was a result of a settlement agreement which he claims was to release him from all claims by OSB, including claims of fraudulent transactions and embezzlement. Hathaway asserts several affirmative defenses to the Complaint including the equitable defenses of estoppel and unclean hands. ² Hathaway prays that the Complaint be dismissed with prejudice and requests an award of attorney fees and costs.

Several discovery and pre-trial motions were filed in this case and litigated prior to commencing the trial. ³ Prior to trial, the parties stipulated that OSB's complaint alleges nondischargeability of debt on three grounds; the first two grounds are under § 523(a)(2) for making personal charges with two company credit cards without OSB's knowledge, consent or approval;

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and the third is under § 523(a)(4) for theft and embezzlement of currency without OSB's knowledge, consent or approval. Additionally, there were several pre-trial evidentiary objections made by both OSB and Hathaway. ⁴

II. FINDINGS OF FACT

Steven G. Worrell ("Worrell") is President and shareholder of OSB Manufacturing, Inc. ("OSB"), a snowboard manufacturing and screen-print t-shirt company with its principal place of business in Virginia Beach, Virginia. Tr. at 47, 121; Def. Ex. A-5, Minutes of Stockholders Meeting: August 29, 2006, dated Aug. 29, 2005. ⁵ OSB was formed approximately 12 years ago and was managed by both Worrell and his former partner, David A. Barnes ("Barnes"). Tr. at 138. During their partnership, Worrell and Barnes split the duties of the company; Worrell dealt with production, while Barnes dealt with the business affairs. Tr. at 139. After Barnes left to pursue his surfboard career, Worrell was left as sole shareholder of the company. Tr. at 138. In February 2004, Worrell was introduced to William E.K. Hathaway, II ("Hathaway"), through a mutual friend. Tr. at 43. Hathaway was looking to acquire a t-shirt company at the time. Tr. at 138. Shortly after their initial meeting, Hathaway and Worrell entered into discussions regarding Hathaway acquiring part of the business. Tr. at 138.

On May 14, 2004, Worrell and Hathaway executed a Shareholder's Agreement, which stated that in exchange for a transfer of $55,000.00 to Worrell, Hathaway would acquire half of the stock in OSB, making him a co-owner and officer of the company. ⁶ The Shareholder's Agreement provided generally for compensation of the company Managers. ⁷ No specific dollar

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amount was stated in the Shareholder's Agreement; however, Hathaway received a bi-weekly gross salary of $1,300.00 shortly after becoming a participant in the company. Tr. at 49, 52. Powers of the Managers were governed under the Shareholder's Agreement. Each Manager was generally authorized to make decisions on behalf of the corporation regarding transactions in the ordinary course of business; however, the approval of both Hathaway and Worrell was required when making decisions outside of the ordinary course of business. Tr. at 60-61; Pl.Ex. 9, Shareholder Agreement, dated May 14, 2004, page 3.

Prior to Hathaway entering the company in 2004, OSB had demonstrated consistent losses, but such losses had gradually decreased, prompting Hathaway to invest in the company. Tr. at 49. When Hathaway became a shareholder and manager of OSB, he concentrated his efforts in marketing and sales. Much like the prior arrangement between Worrell and Barnes, Worrell concentrated his efforts on production, and relied on Hathaway to manage the business, taking care of "the office, the books, the phone, mailing, billing." Tr. at 128. Prior to Hathaway's arrival, Worrell had maintained records by hand, and both his payroll and tax preparation were handled by outside agencies. Tr. at 129. Worrell only used a computer to provide printed invoices for customers, using a 2003 version of Quickbooks(R). Tr. at 128. After Hathaway became a manager, the payroll service was discontinued in order to be managed internally, and Hathaway maintained records through Quickbooks(R) 2004, software which he purchased with OSB funds. Tr. at 129. Hathaway was also responsible for opening an American Express Corporate Credit Card Account, with a credit line of $5,000.00, shortly after joining the company. Tr. at 123. Two credit cards, one for each Worrell and Hathaway, were issued with Worrell's caveat that the cards were to be used for "emergency purposes." Tr. at 123, 168-69. Additionally, Hathaway arranged for the issuance of Visa check cards, which were to be drawn on the SouthTrust Corporate Bank Account for OSB. Tr. at 124. These check cards, according to Worrell, were supposed to be used for business trips or in case of emergency. Tr. at 124, 168-69. Worrell testified that he never used either his American Express or the Visa check card. Tr. at 123-24, 149-50. Worrell did not review either the American Express or the SouthTrust Bank statements, besides occasionally leafing through the check ledger, leaving that portion of the business to be settled and maintained by Hathaway, while Worrell spent a majority of his time on the production floor. Tr. at 151-53. Despite the credit and check cards, most business was conducted through company checks, which generally required signatures of both Hathaway and Worrell. ⁸ Tr. at 131. However, as illustrated by the SouthTrust bank statements submitted to the Court, once Hathaway became a Manager, several transactions were made through other means. Pl.Ex. 58, Bank Statements from SouthTrust Bank, Small Business Checking, dated Jan. 31, 2004 to May 31, 2005. After examining the SouthTrust bank statements, it appears that a separate category of transactions is listed for online transactions. ⁹ While tangible checks remained

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the most common method of payment for OSB, there was a significant rise in online transactions, as illustrated in Exhibit 58, the SouthTrust bank statements.

At this point, the testimony of the events and understandings which transpired following Hathaway's entrance into the company is divergent. According to Hathaway, aside from corporate documents, there was never any formal understanding regarding what charges could be placed on the corporate credit and debit cards. Tr. at 53. His interpretation of the Shareholder's Agreement was that he was "authorized to use the money as [he] saw fit." Tr. at 59. There was no expense ledger maintained to track the various credit card transactions. Tr. at 56. Instead, all transactions were "openly discussed" between Hathaway and Worrell. Tr. at 58. Hathaway testified that roughly two months after he became a shareholder, he was informed that OSB would not be able to sustain his bi-weekly salary, and so his salary was suspended. Tr. at 53. According to Hathaway, because the business was in "chaos," the managers could deem "normal course of business" to be whatever was necessary. Tr. at 62. Therefore, to offset his lack of salary he was authorized to use both the American Express card and Visa Check Card to make personal charges, an arrangement which Hathaway testified was once again "openly discussed" with Worrell. Tr. at 62.

According to the American Express credit card statements submitted to the Court, a majority...