In re Berman

• Decision Date: 21 January 2011
• Docket Number: No. 10-1882,10-1882
• Citation: 629 F.3d 761
• Parties: In re Jay BERMAN, Debtor. Follett Higher Education Group, Inc., an Illinois corporation, Plaintiff-Appellant, v. Jay Berman, Defendant-Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

629 F.3d 761

In re Jay BERMAN, Debtor.

Follett Higher Education Group, Inc., an Illinois corporation, Plaintiff-Appellant,

v.Jay Berman, Defendant-Appellee.

No. 10-1882.

United States Court of Appeals,Seventh Circuit.

Argued Oct. 22, 2010.

Decided Jan. 21, 2011.

Leonard S. Becker, Attorney (argued), Chicago, IL, for Defendant-Appellee.

Adam B. Goodman, Attorney (argued), Goodman Law Offices LLC, Chicago, IL, for Plaintiff-Appellant.

Before KANNE, TINDER, and HAMILTON, Circuit Judges.

HAMILTON, Circuit Judge.

The bankruptcy court held that a creditor failed to prove that a debt owed to it was non-dischargeable under 11 U.S.C. § 523(a)(4), which provides that a debt will not be discharged in bankruptcy where that debtor has committed "fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny." Concluding that the creditor had not established that the debtor acted in any fiduciary capacity toward the creditor, the court entered judgment for the debtor. The district court affirmed the finding that the debt was dischargeable, as do we. We agree with our colleagues on the bankruptcy court and district court that the creditor failed to show that the debtor owed the creditor a fiduciary duty.

I. The Facts

Plaintiff-creditor Follett Higher Education Group, Inc., an Illinois corporation, manages more than 750 college bookstores nationwide. In March 2004, Follett hired Berman & Associates, Inc., an advertising brokerage firm also located in Illinois, to place advertisements on Follett's behalf. Under the terms of their contract, Follett paid Berman & Associates 110 percent of the cost of advertisements that Berman & Associates placed with media outlets around the country. Berman & Associates then disbursed payments for the advertisements to newspapers, radio stations, and billboard operators and retained the extra ten percent as the fee for its services. The two corporations renewed this arrangement yearly until Follett learned in the summer of 2006 that Berman & Associates had not paid several outstanding advertising bills. Follett was forced to pay some media outlets directly without recovering the sums intended for them that it had already given to Berman & Associates for that purpose.¹

On August 23, 2006, defendant-debtor Jay Berman, who served as president, a director, and sole shareholder of Berman & Associates, petitioned for Chapter 7 bankruptcy. In his petition, Berman listed debts incurred by Berman & Associates, including the debt owed to Follett, on his schedules of outstanding debts. Follett then filed an adversary action in Berman's bankruptcy proceedings claiming that Berman had breached a fiduciary duty owed to Follett and that, as a result, the debt it was owed was non-dischargeable pursuant to 11 U.S.C. § 523(a)(4). At the conclusion of Follett's presentation of evidence at trial, Berman moved for judgment on partial findings under Federal Rule of Bankruptcy Procedure 7052.² The bankruptcy judge granted Berman's motion, holding that Follett had failed to prove that Berman was a fiduciary as required by the statute. The bankruptcy court's decision on the dischargeability of a debt is a final judgment for purposes of appellate jurisdiction. In re Marchiando, 13 F.3d 1111, 1113-14 (7th Cir.1994). The district court affirmed the bankruptcy court's judgment and this appeal followed. We have jurisdiction to review the district court's judgment pursuant to 28 U.S.C. § 158(d).

II. Exceptions from Discharge Under Section 523(a)(4)

Under section 727 of the Bankruptcy Code, and subject to certain conditions to be fulfilled by the debtor, a bankruptcy court ordinarily will discharge a debtor's debts, releasing the debtor from liability for those debts. See 11 U.S.C. § 727. There are, however, some exceptions. Section 523(a) of the Code excludes certain debts from discharge, often, but not always, where the debt results from some sort of intentional wrongdoing by the debtor. Courts construe these exceptions narrowly, in favor of the debtor, bearing in mind the goal of bankruptcy law to give the debtor a fresh start. E.g., In re Crosswhite, 148 F.3d 879, 881 (7th Cir.1998) ("When deciding whether a particular debt falls within a § 523 exception, courts generally construe the statute strictly against the objecting creditor and liberally in favor of the debtor."). Debts will be discharged unless proven non-dischargeable by a preponderance of the evidence. See Grogan v. Garner, 498 U.S. 279, 291, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991).

Follett argues that the debt owed to it should be excepted from discharge on the basis of Berman's and Berman & Associates' alleged "defalcation while acting in a fiduciary capacity." 11 U.S.C. § 523(a)(4). ³ To establish that a debt isnon-dischargeable under section 523(a)(4), a creditor must show (1) that the debtor acted as a fiduciary to the creditor at the time the debt was created, and (2) that the debt was caused by fraud or defalcation. See In re Frain, 230 F.3d 1014, 1019 (7th Cir.2000); Klingman v. Levinson, 831 F.2d 1292, 1295 (7th Cir.1987). Here, the parties dispute the first requirement: whether there existed a fiduciary relationship that could render the debt to Follett non-dischargeable. The bankruptcy judge found none. Distinguishing this case from prior cases where fiduciary duties were found, Judge Goldgar determined that Berman & Associates' role as Follett's agent in purchasing advertising did not amount to a fiduciary relationship. The judge also concluded that even if the corporate parties' relationship could be considered fiduciary, Follett had not established any kind of obligation between Follett and Jay Berman, the individual debtor, nor had it shown that Berman & Associates was Berman's alter ego. Not finding any fiduciary obligation on Berman's part, the bankruptcy court entered judgment in Berman's favor.

We apply the same standard of review as the district court, examining the bankruptcy court's legal findings de novo and its findings of fact for clear error. Ojeda v. Goldberg, 599 F.3d 712, 716 (7th Cir.2010); Frain, 230 F.3d at 1017; Peterson v. Scott (In re Scott), 172 F.3d 959, 966 (7th Cir.1999). Where the trial court correctly states the law, its determination of whether the facts met the legal standard will be disturbed only if it is clearly erroneous. See Pinkston v. Madry, 440 F.3d 879, 888 (7th Cir.2006).

Unlike most claims of non-dischargeability, this case presents an added challenge for Follett because it contracted with Berman & Associates, not with Jay Berman, the individual debtor. Berman & Associates is not the debtor before us. Jay Berman is, and his debts are subject to discharge unless Follett has proven an exception. Follett offers two theories for holding that the debt is not dischargeable. Neither is persuasive.

A. Officer of an Insolvent Corporation

Follett argues first that Jay Berman owed a fiduciary duty to the creditors of Berman & Associates because he was an officer and director of an insolvent corporation. Under Illinois law, like the law of many states, a corporate officer or director assumes a fiduciary duty toward the corporation, its shareholders, and, upon the corporation's insolvency, also to its creditors. See, e.g., Atwater v. American Exchange National Bank of Chicago, 152 Ill. 605, 38 N.E. 1017, 1022 (1893) ("directors ... occupy a fiduciary relation towards the creditors when the corporation becomes insolvent"); Paul H. Schwendener, Inc. v. Jupiter Electricity Co., 358 Ill.App.3d 65, 293 Ill.Dec. 893, 829 N.E.2d 818, 828 (2005) ("once a corporation becomes insolvent, the fiduciary duty of an officer is extended to the creditors of the corporation"); see also 5 William L. Norton, Jr., Norton Bankruptcy Law & Practice § 96:4 (3d ed. 2010) (majority view is that insolvency places corporate assets in trust for corporate creditors, and in some jurisdictions the fiduciary duty of directors shifts to include creditors).

Follett argues that this duty under state law amounts to a fiduciary duty for purposes of federal bankruptcy law under section 523(a)(4). Accepting this argument, in the absence of proof of fraud, would go a long way toward imposing non-dischargeable personal liability on corporate officers and directors for general corporate debts of faltering corporations.

This theory has divided bankruptcy and district courts. Adopting the theory, for example, seeSalem Services, Inc. v. Hussain (In re Hussain), 308 B.R. 861, 867-68 (Bankr.N.D.Ill.2004) (accepting theory but finding no defalcation); Energy Products Engineering, Inc. v. Reuscher (In re Reuscher), 169 B.R. 398, 402-03 (S.D.Ill.1994) (accepting theory and reversing bankruptcy court's dismissal of complaint); see also Berres v. Bruning (In re Bruning), 143 B.R. 253, 256 (D.Colo.1992) (holding that a fiduciary obligation arises upon insolvency and falls within section 523(a)(4)'s ambit). Other courts have adopted a more limited view, recognizing that the Supreme Court has construed the scope of a fiduciary relationship under section 523(a)(4) more narrowly than state law does for other purposes. See, e.g., Murphy & Robinson Investment Co. v. Cross (In re Cross), 666 F.2d 873, 880-81 (5th Cir. Unit B 1982) (concluding that an officer did not owe the corporation's creditor any fiduciary duty within the meaning of section 523(a)(4)); Economic Development Growth Enterprises Corp. v. McDermott (In re McDermott), 434 B.R. 271, 281 (Bankr.N.D.N.Y.2010), appeal docketed, No. 6:10-CV-0696 (N.D.N.Y. June 17, 2010) (determining that fiduciary obligations of officers of insolvent corporations are insufficient for the purposes of section 523(a)(4)); First Options of Chicago, Inc. v. Kaplan (In re Kaplan), 162 B.R. 684, 704-06 (Bankr.E.D.Pa.1993) (rejecting the premise that an officer's debt would be non-dischargeable as a result of the corporation's wrongdoing, despite state law making the officer a fiduciary).

In this case, the bankruptcy court...