City of Zeigler v. Uhls (In re Uhls)
| Docket Number | Bk. 21-40406,Adv. 21-04015 |
| Decision Date | 29 June 2023 |
| Parties | In Re: DENNIS L. UHLS, Debtor. v. DENNIS L. UHLS, Defendant. CITY OF ZEIGLER, ILLINOIS, Plaintiff, |
| Court | U.S. Bankruptcy Court — Southern District of Illinois |
This matter is before the Court on the Amended Complaint for Determination of Dischargeability of Debt filed by Plaintiff City of Zeigler, Illinois (hereinafter "Adversary Complaint" or "Adversary Proceeding") seeking a judgment denying the dischargeability of a debt owed to the City of Zeigler, Illinois (the "City") by Debtor/Defendant Dennis L. Uhls ("Uhls") under 11 U.S.C. §523(a)(2)(A) on the basis of fraud, and under 11 U.S.C. §523(a)(4) for larceny. The Adversary Complaint also seeks a denial of Uhls' discharge under 11 U.S.C §727(a)(3) for destruction of records. With respect to the dischargeability claim under 11 U.S.C §523(a)(2)(A), the City asks the Court to impute the fraudulent acts of the City treasurer upon Uhls, its independent auditor, pursuant to Bartenwerfer v Buckley, 598 U.S. ___, 143 S.Ct. 665 (2023).
Uhls was a certified public accountant retained by the City to perform annual audits of City financial statements. During Uhls' tenure as auditor, an employee of the City, treasurer Ryan Thorpe ("Thorpe"), embezzled in excess of $300,000.00 from the City. Thorpe pled guilty to federal criminal charges relating to the embezzlement.[1] The City then filed a civil complaint in the Franklin County, Illinois Circuit Court against both Thorpe and Uhls (hereinafter "State Court Complaint" or "State Court Proceeding"). As to Thorpe, the City alleged in Count I of the State Court Complaint that Thorpe "stole, converted and misappropriated taxpayers' dollars." As to Uhls, the City alleged in Count II of the State Court Complaint, titled "Professional Negligence," that Uhls "negligently and carelessly failed to exercise such due care" in conducting his audits as would have allowed him to discover Thorpe's actions.[2] The City further alleged in Count III of the State Court Complaint, "Spoliation of Evidence," that Uhls "owed a duty to preserve material evidence to any potential litigation including but not limited to materials relating to his audits for the City of Zeigler" and "negligently and/or recklessly breached his duty to preserve the above-stated evidence by destroying it."[3]
During discovery in the State Court Proceeding, Uhls was unable to produce his audit papers and attested in interrogatory answers that he had destroyed the documents. The Circuit Court entered an Order for Sanctions on November 23, 2020 finding it "unreasonable that the Defendant would destroy documents after the Defendant was aware that Ryan Thorpe had misused city funds in September, 2017."[4] The Court further found that "Defendant's actions are willful and obstructive and that the Defendant has specifically prevented the City from obtaining records which are highly probative evidence and may relate to the liability of the Defendant."[5] As a sanction, the Circuit Court imposed remedies afforded under Illinois Supreme Court Rule 219(c) for violation of discovery rules, by striking all Uhls' pleadings and ordering that a default judgment be entered.[6] On January 19, 2021, the Circuit Court entered a judgment in favor of the City and against Uhls and Thorpe on the State Court Complaint in the amount of $431,216.31 plus an additional $5,384.00 in attorney's fees against Uhls pursuant to the Order for Sanctions.[7]
On September 24, 2021, Uhls filed a Chapter 7 Petition in this Court. The City then brought this Adversary Proceeding seeking a denial of dischargeability of the state court judgment under 11 U.S.C. §523(a)(2)(A) (fraud), and 11 U.S.C. §523(a)(4) (larceny), and a denial of Uhls' discharge under 11 U.S.C. §727(a)(3) (destruction of documents). In "Count I -Actual Fraud," the City alleged that "Uhls was an active participant in Thorpe's embezzlement scheme and conspired with Thorpe to embezzle said monies" adding that "Uhls' refusal to participate in the underlying action prevented the City of Zeigler from obtaining discovery which it reasonably believes would have shown said fraudulent activity."[8] Uhls denied the allegations and further asserted that the debt he owed to the City "was created due to a judgment for professional negligence."[9]
In "Count II - Larceny," the City alleged that [10] Uhls denied the allegations.[11] In "Count III - Destruction of Documents," the City alleged that "[a]fter the institution of the case against Uhls in state court, Uhls destroyed his business file maintaining all the records of his transactions as well as his supposed review of City actions." The City further asserted that "Uhls' destruction of his file was a willful and conscious attempt to conceal his role in the embezzlement" and that the City's "ability to prove its claim both in this case and in the underlying civil case, were materially impacted by Uhls' intentional destruction of his business records."[12] Uhls denied those allegations.[13]
Prior to trial on the Adversary Complaint, the parties filed their Exhibit Lists and Witness Lists. Included among Uhls' proposed exhibits were audit work papers for the City of Zeigler audits for the years 2012 through 2016. The City filed an Objection to Defendant's Exhibits seeking to bar the admission of the audit work papers on the basis that Uhls had previously stated in the State Court Proceeding and during discovery in this Adversary Proceeding that he had destroyed the documents. Uhls filed a Response to the City's Objection stating that he had recently found a CD containing the work papers and had been unaware that he had the CD until February, 2023. He further argued that the City must prove that he destroyed records from which his financial condition or business transactions might be ascertained and that the exhibits were relevant to that issue. The City's Witness List included Ryan Thorpe, the former City treasurer. Uhls filed a Motion to Bar Thorpe as a witness on the basis that he was not previously disclosed during discovery.
The parties also submitted pre-trial briefs. In its brief, the City argued that because Uhls' pleadings were stricken in the State Court Proceeding and a default judgment entered, Uhls is barred in this Adversary Proceeding from challenging any of the allegations made by the City in the State Court Complaint. According to the City, that establishes all the facts necessary for it to carry its burden of proof on all counts of the Adversary Complaint. Further, as to Count I, "Fraud" pursuant to §523(a)(2)(A), the City introduced a new argument. Relying on the recent Supreme Court opinion Bartenwerfer v. Buckley, 598 U.S. ___, 143 S.Ct. 665 (2023), the City argued that Uhls need not have been an active participant in Thorpe's fraud for his debt to be nondischargeable. Uhls emphasized in his pre-trial brief that the City had alleged professional negligence and spoliation of evidence in the State Court Proceeding, but had not alleged fraud or embezzlement, nor did the Circuit Court's Judgment Order contain any findings of fraud, larceny, embezzlement or conspiracy to commit a crime by Uhls.
At trial, the City conceded Uhls' Motion to Bar Thorpe as a witness and proceeded with Uhls as its only witness. Uhls' attorney elicited additional testimony from Uhls on cross-examination. Uhls testified that he served as the City's independent auditor from 2004 through 2016, and in that role was obligated to express an opinion as to the accuracy of the City's financial statements. He testified that it was not part of his role as an independent auditor to detect fraud. As part of his annual audit, Uhls reviewed bank statements, among other documents. Uhls acknowledged that Thorpe only provided him copies of the City bank statements in 2013, rather than original statements. He stated that he advised the City Finance Commissioner of that fact and requested the originals. He testified that he did not receive the original statements and noted that information in his work papers. None of the testimony at trial established any relationship or collusion between Uhls and Thorpe.
Uhls explained that he kept his audit work papers in both paper and CD form, and that it was his practice to shred the paper records three years after each audit. He confirmed that he had shredded the paper records for the City audits on that schedule. As to the CD form of the audit papers, Uhls testified that he could not find the CD containing the City audits until February, 2023 when he searched through boxes he had stored in his mother's garage following the sale of his home in April, 2022. He acknowledged that he did not produce the work papers in the State Court Proceeding and that he had testified during his December, 2022 deposition in this Adversary Proceeding that the documents had been destroyed. He expressed regret that he had not found the CD sooner as he believed it would have allowed him to prevail in the State Court Proceeding. Uhls agreed with counsel for the City that he was a fiduciary for the City, but testified that he had no knowledge that Thorpe was embezzling funds from the City. The City's Exhibits were entered into evidence without objection. After the City rested its case, counsel for Uhls asked the Court to enter judgment against the City and in favor of Uhls on all Counts, asserting that the City had failed to...
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