In re Fairgrieves

Decision Date25 January 2010
Docket NumberAdversary No. 09-A-96182.,Bankruptcy No. 09-B-71794.
Citation426 B.R. 748
PartiesIn re Charles W. FAIRGRIEVES, IV, Debtor. Mutual Management Services, Inc., Plaintiff, v. Charles W. Fairgrieves, IV, Defendant-Debtor.
CourtU.S. Bankruptcy Court — Northern District of Illinois

COPYRIGHT MATERIAL OMITTED

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Donald P. Shriver, Shriver O'Neill & Thompson, Rockford, IL, for Plaintiff.

Jason H. Rock, Barrick Switzer Law Office, Rockford, IL, for Defendant-Debtor.

MEMORANDUM OPINION

MANUEL BARBOSA, Bankruptcy Judge.

This matter comes before the Court on a motion to dismiss filed by defendant-debtor Charles W. Fairgrieves, IV (the "Debtor") on October 7, 2009, pursuant to Fed. R.Civ.P. 12(b)(6), made applicable by Fed. R. Bankr.P. 7012.1 For the reasons set forth herein, the Court grants the Debtor's motion to dismiss.

JURISDICTION AND PROCEDURE

The Court has jurisdiction to decide this matter pursuant to 28 U.S.C. § 1334 and Internal Operating Procedure 15(a) of the United States District Court for the Northern District of Illinois. It is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(J).

FACTS AND BACKGROUND

The following facts and procedural history are taken from the Plaintiff's adversary complaint (the "Adversary Complaint") and response to the Debtor's motion to dismiss, as well as Debtor's motion to dismiss (collectively, the "pleadings"), and from all attachments to the pleadings referred to and incorporated therein. Because the matter is before the Court on a motion to dismiss, the Court accepts as true all of the factual allegations contained in the Adversary Complaint. See, e.g., Erickson v. Pardus, 551 U.S. 89, 93-94, 127 S.Ct. 2197, 167 L.Ed.2d 1081 (2007); Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555-56, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007).

At all relevant times, the Debtor served as "a fiduciary" of 10th Inning Bar and Grill, Inc., an Illinois corporation ("10th Inning").2 At some time prior to August 2007, the Plaintiff initiated "litigation" against 10th Inning.3 On August 14, 2007, the Debtor caused an auction to occur and sold the assets of 10th Inning.4 At the time of the auction, the Debtor knew of the litigation pending against 10th Inning, and knew that "an agreed judgment was expected to be entered against said corporation within weeks." The Debtor used the funds generated from the auction to make a payment on a personal obligation in his own name.5 At the time the payment was made, no judgment had been entered in the litigation against 10th Inning, but "an agreed judgment was expected to be entered against said corporation within weeks." Judgment was entered against 10th Inning on August 31, 2007, for $18,062.50 plus costs of suit. The Plaintiff at some point initiated litigation against the Debtor, and obtained a civil judgment against him individually on April 24, 2009,6 in the amount of $19,941.36 plus costs of suit.7 The Debtor filed a petition for relief under Chapter 7 of the Bankruptcy Code with the Court on April 30, 2009. The Plaintiff alleges that the Debtor's use of the proceeds of the auction to pay a personal debt "was a willful and malicious act to Plaintiffs detriment" and "constitutes fraud upon 10th Inning while Debtor acted in a fiduciary capacity to it, to the detriment of the corporation and its creditors, including Plaintiff." The Plaintiff therefore asks that the April 24, 2009, judgment, including costs and fees, be declared nondischargeable under 11 U.S.C. § 523(a)(4) or (6).

DISCUSSION

Standard under 12(b)(6)

A motion to dismiss under Fed.R.Civ.P. 12(b)(6) tests the sufficiency of the complaint, rather than the merits of the case. Dixon v. Am. Cmty. Bank & Trust (In re Gluth Bros. Constr., Inc.), 424 B.R. 379, 387-88 (Bankr.N.D.Ill.2009) (citing Gibson v. City of Chicago, 910 F.2d 1510, 1520 (7th Cir.1990)). Under Rule 12(b)(6), a court must take as true all facts alleged in the complaint and construe all reasonable inferences in favor of the plaintiff. See Murphy v. Walker, 51 F.3d 714, 717 (7th Cir.1995); In re Gluth Bros., 2009 WL 4110122, at *3.

The Debtor argues that the Plaintiffs Adversary Complaint does not adequately plead the claims for relief, and should therefore be dismissed under Rule 12(b)(6). Under Rule 8(a), a pleading for a claim for relief must contain "a short and plain statement of the claim showing that the pleader is entitled to relief." Fed. R.Civ.P. 8. The "Rule reflects a liberal notice pleading regime, which is intended to focus litigation on the merits of a claim rather than on technicalities that might keep plaintiffs out of court." Brooks v. Ross, 578 F.3d 574, 580 (7th Cir. Aug.20, 2009) (citing Swierkiewicz v. Sorema N.A., 534 U.S. 506, 514, 122 S.Ct. 992, 152 L.Ed.2d 1 (2002)). The focus of the Rule is to "give the defendant fair notice of what ... the claim is and the grounds upon which it rests." Brooks, 578 F.3d at 581 (citing Erickson v. Pardus, 551 U.S. 89, 93, 127 S.Ct. 2197, 167 L.Ed.2d 1081 (2007)). While this does not require "detailed factual allegations," a "formulaic recitation of the elements of a cause of action will not do." Ashcroft v. Iqbal, ___ U.S. ___, 129 S.Ct. 1937, 1949, 173 L.Ed.2d 868 (May 18, 2009). Instead, the complaint must contain "enough facts to state a claim to relief that is plausible on its face." Twombly, 550 U.S. at 570. The plausibility standard is not a "probability standard," but it is higher than mere possibility, so the well-pleaded facts cannot be "merely consistent with a defendant's liability," but must demonstrate a plausible "entitlement to relief." Iqbal, 129 S.Ct. at 1949 (citing Twombly, 550 U.S. at 556-57). As the Seventh Circuit Court of Appeals has stated, "courts must accept a plaintiffs factual allegations as true, but some factual allegations will be so sketchy or implausible that they fail to provide sufficient notice to defendants of the plaintiffs claim." Brooks, 578 F.3d at 581.

Section 523(a)(4)Claim

Under Section 523(a)(4), "(a) A discharge under section 727 ... does not discharge an individual debtor from any debt. ... (4) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny." 11 U.S.C.A. § 523(a)(4) (West 2009). The meaning of these terms is a question of federal law. Delic v. Brown (In re Brown), No. 08-A-00936, 2009 WL 2461241, at *5 (Bankr. N.D.Ill. Aug. 11, 2009) (citing In re McGee, 353 F.3d 537, 540 (7th Cir.2003)). "Fraud" for purpose of this exception has generally been interpreted as involving intentional deceit, rather than implied or constructive fraud. Brown, 2009 WL 2461241, at *5 (citing In re Tripp, 189 B.R. 29 (Bankr. N.D.N.Y.1995); In re McDaniel, 181 B.R. 883 (Bankr.S.D.Tex.1994); 4 COLLIER ON BANKRUPTCY 523.101a (15th ed.2008)).

"Defalcation" is not defined in the Bankruptcy Code, but the term "defalcation" has been used in the Bankruptcy Code since 1841. Meyer v. Rigdon, 36 F.3d 1375, 1382-83 (7th Cir.1994) (citing Central Hanover Bank & Trust Co. v. Herbst, 93 F.2d 510, 511 (2d Cir.1937)). It has sometimes been defined by courts as the misappropriation of funds held in trust for another in any fiduciary capacity, and the failure to properly account for such funds. See In re Burke, 405 B.R. 626 (Bankr. N.D.Ill. June 10, 2009) (citing Strube Celery & Vegetable Co., Inc. v. Zois (In re Zois), 201 B.R. 501, 506 (Bankr.N.D.Ill. 1996)). Intent to misappropriate is not required, but the misappropriation must be more than mere negligence or mistake. In re Burke, 405 B.R. at 649 (citing Meyer, 36 F.3d at 1385). The Seventh Circuit has held that defalcation requires at least reckless conduct. Meyer, 36 F.3d at 1385; Brown, 2009 WL 2461241, at *5; 4 COLLIER, 523.101b.

The Plaintiff alleges that the Debtor breached his fiduciary duty to 10th Inning by using its assets for his own purposes when he caused the auction proceeds to be used to repay an indebtedness owed by himself alone. Although the Plaintiff might have been indirectly harmed by such breach, the Plaintiff, as a mere judgment creditor of 10th Inning, would not normally have standing to assert such a breach. However, in the Plaintiffs response to the Debtor's motion to dismiss and at oral argument, the Plaintiff argued that, since 10th Inning was insolvent at the time of the transfer, the Debtor, as a director of an insolvent corporation, owed a fiduciary duty to the corporation's creditors, including the Plaintiff.

Not all fiduciary relationships fall within the purview of § 523(a)(4). O'Shea v. Frain (In re Frain), 230 F.3d 1014, 1016 (7th Cir.2000)(citing In re Woldman, 92 F.3d 546, 547 (7th Cir. 1996)). The Seventh Circuit has found that a fiduciary relationship exists for purposes of section 523(a)(4) when there is an express trust or when there is "a difference in knowledge or power between fiduciary and principal which ... gives the former a position of ascendancy over the latter." In re Marchiando, 13 F.3d 1111, 1116 (7th Cir.1994); see also In re Woldman, 92 F.3d 546, 547 (7th Cir.1996) ("Section 523(a)(4) reaches only those fiduciary obligations in which there is substantial inequality in power or knowledge."). Thus, a lawyer-client relationship, a director-shareholder relationship, and a managing partner-limited partner relationship all require the principal to "repose a special confidence in the fiduciary." Burke, 398 B.R. at 625 (quoting In re Frain, 230 F.3d at 1017). A fiduciary relation qualifies under § 523(a)(4) only if it "imposes real duties in advance of the breach." In re Frain, 230 F.3d at 1017 (quoting Marchiando, 13 F.3d at 1116) (lottery agent not a "fiduciary"). Therefore, the fiduciary's obligation must exist prior to the alleged wrongdoing. Id. (citing Marchiando, 13 F.3d at 1116). Because the obligation must exist prior to the wrongdoing, a "constructive trust ... will not qualify for purposes of § 523(a)(4)." In re Frain, 230 F.3d at 1017.

Under Illinois law, "directors...

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