In re: Edward Hayes

• Decision Date: 01 August 1998
• Docket Number: Docket No. 98-5023
• Citation: 183 F.3d 162
• Parties: (2nd Cir. 1999) In Re: EDWARD W. HAYES, Debtor. THE ANDY WARHOL FOUNDATION FOR VISUAL ARTS, INC., Plaintiff-Appellant, v. EDWARD W. HAYES, Defendant-Appellee
• Court: U.S. Court of Appeals — Second Circuit

Page 162

183 F.3d 162 (2nd Cir. 1999)

In Re: EDWARD W. HAYES, Debtor.

THE ANDY WARHOL FOUNDATION FOR VISUAL ARTS, INC., Plaintiff-Appellant, v. EDWARD W. HAYES, Defendant-Appellee.

Docket No. 98-5023

August Term, 1998

UNITED STATES COURT OF APPEALS SECOND CIRCUIT

Argued October 13, 1998.

Decided July 30, 1999.

Appeal from an order of the United States District Court for the Southern District of New York (Sidney H. Stein, Judge) affirming an order of the United States Bankruptcy Court for the Southern District of New York (Cornelius Blackshear, Judge) that denied appellant's motion for summary judgment on its non-dischargeability complaint against Hayes and granted Hayes's motion to dismiss. Appellant's complaint alleged that Hayes had committed a defalcation while acting in a fiduciary capacity and thus that his debt to it should be excepted from discharge pursuant to 11 U.S.C. § 523(a)(4). The bankruptcy court held that Hayes had not acted in a fiduciary capacity within the meaning of Section 523(a)(4), and thus did not reach the question of whether his debt resulted from a defalcation. The district court affirmed for substantially the same reasons. We reverse. We hold that Hayes's debt to appellant was the result of a defalcation while acting in a fiduciary capacity. [Copyrighted Material Omitted] THOMAS J. SCHWARZ, Skadden, Arps, Slate, Meagher & Flom LLP (Michael L. Cook, Neal Jacobson, of counsel), New York, New York, for Plaintiff-Appellant.

LAURENCE MAY, Angel & Frankel (Joshua J. Angel, of counsel), New York, New York, for Defendant-Appellee.

Before: WINTER, Chief Judge, MUKASEY, ^*. District Judge, and RESTANI,^**. Judge. ^***

WINTER, Chief Judge:

The Andy Warhol Foundation for the Visual Arts, Inc. appeals from Judge Stein's affirmance of an order of the bankruptcy court dismissing the Foundation's nondischargeability complaint against Edward W. Hayes and concurrently denying its motion for summary judgment. The Foundation contended that Hayes's debt to it was governed by Bankruptcy Code ("Code") Section 523(a)(4), 11 U.S.C. §523(a)(4), which provides, inter alia, that a debt arising from a "defalcation while acting in a fiduciary capacity" is nondischargeable. The bankruptcy court found that Hayes was not "acting in a fiduciary capacity" with respect to his debt to the Foundation, and the district court affirmed. We disagree and hold that Hayes's debt to appellant resulted from a defalcation while acting in a fiduciary capacity.

BACKGROUND

The artist Andy Warhol died on February 22, 1987. Frederick W. Hughes, the executor of Warhol's estate, promptly retained Edward W. Hayes as counsel to the estate. Hayes's initial fee agreement, dated February 23, 1987, provided for a fee in the amount of 2.5% of the gross estate, measured as of the date of death. At the time, the estate was estimated to be worth about $100 million. Five weeks later, Hayes's fee agreement was amended to reduce his compensation to 2% of the gross estate to reflect the fact that the estate's value was significantly greater than initially thought. On June 25, 1987, Hayes was appointed General Counsel to the Foundation, the sole beneficiary of the estate. A year later, Hayes's fee agreement was amended yet again to pay to him an executor's commission, which is somewhat greater than the once-adjusted fee of 2%.¹. The second amended agreement, however, measured the value of assets in the estate as of the date of distribution.

Pursuant to the retainer agreement, Hayes received $4.85 million between 1987 and 1990. This was in excess of the roughly $2.5 million that he had initially expected to receive under contract, but, in light of the surrogate court's subsequent valuation of the estate at over $500 million, considerably less than the sum to which he was ostensibly entitled under the twice-amended retainer agreement. On April 24, 1992, alleging, inter alia, that "the Executor has refused to advance me portions of my attorney's fees for over two and one-half years," Hayes petitioned the New York Surrogate Court to determine the amount of his fees. He sought some $12 million pursuant to the fee agreement.

The surrogate court found Hayes's retainer agreement, as amended, unenforceable because it contained no ceiling or limiting provision. See In re Estate of Warhol, 629 N.Y.S.2d 621, 624 (Surr. Ct. 1995). However, it then undertook an independent valuation of Hayes's services and concluded that they were worth $7.2 million, see id. at 627, based in part on its view that Hayes's services were not merely legal but akin to those of an executor, see id. at 625. Upon appeal, the Appellate Division reduced the valuation of Hayes's services to $3.5 million. See In re Determination of Legal Fees Payable by Estate of Warhol, 637 N.Y.S.2d 708, 709 (App. Div. 1996) ["Estate of Warhol"]. It expressly disagreed with the surrogate court's analogy to executorial functions in setting the fee, see id. at 710 (noting that executorial services "may not properly be considered in the setting of the legal fee"), and further explained its reduction of the fee award by noting that "Hayes was not a specialist in the relevant field and . . . the award would compensate him at an exorbitant hourly rate," id. The effect of the Appellate Division's judgment was that Hayes now owed the estate $1.35 million of the $4.85 million he had previously been paid. The estate assigned this judgment to the Foundation on August 2, 1996.

On August 23, 1996, Hayes filed for bankruptcy. On December 9, 1996, the Foundation filed its complaint seeking to have Hayes's obligation to it declared nondischargeable under Code Section 523(a)(4). Hayes moved to dismiss the complaint, and the Foundation cross-moved for summary judgment. The bankruptcy court granted Hayes's motion to dismiss and denied the Foundation's cross-motion for summary judgment. The court found that there was no "express or technical trust established between Debtor and the Foundation" and thus that Hayes was not "acting in a fiduciary capacity at the time he incurred his $1.35 million deficit to the Foundation." In re Hayes, No. 96 B. 44536, at 12, 17 (Bankr. S.D.N.Y. Apr. 16, 1997) (transcript of hearing). The district court affirmed on substantially the same reasoning, holding that Hayes was not "a trustee of an 'express' or 'technical' trust," in part because "the bankruptcy court found that Hayes had not received 'advance pay for future services,' but instead 'received legal fees as approved by the surrogate's court for services rendered.'" See In re Hayes, 97 Civ. 4240, at 3-5 (Mar. 11, 1998) (Opinion and Order) ["Hayes I"]. The Foundation then moved for reconsideration of the district court's opinion on the ground that it had incorrectly applied a deferential standard of review to the bankruptcy court's findings of fact. The Foundation's motion was granted, but the district court, applying de novo review, again affirmed. See In re Hayes, 97 Civ. 4240, at 3 (Apr. 13, 1998) (Order) ["Hayes II"]. The Foundation then brought the present appeal.

DISCUSSION

The record is somewhat ambiguous as to whether the bankruptcy court dismissed the Foundation's complaint under Bankruptcy Rule 7012 or 7056. SeeIn re Hayes, No. 96 B. 44536, at 17 (claim "dismissed for failing to state a cause of action upon which relief may be granted"); Hayes II, at 1 ("The bankruptcy court . . . dismissed the Foundation's complaint pursuant to Fed. R. Civ. P. 12(b)(6) and 56 . . . ."); see also Pani v. Empire Blue Cross Blue Shield, 152 F.3d 67, 75-76 (2d Cir. 1998) (court may convert motion to dismiss to one for summary judgment); Morelli v. Cedel, 141 F.3d 39, 45 (2d Cir. 1998) ("Consideration of matters outside the pleadings converts the defendant's motion to dismiss into a summary judgment motion."). Because the bankruptcy court's decision was made in the context of a ruling on the Foundation's motion for summary judgment and the court took note of the parties' submissions, we construe the court's decision as a grant of summary judgment under Bankruptcy Rule 7056. Summary judgment is appropriate only if the pleadings and submissions, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law. See Sutera v. Schering Corp., 73 F.3d 13, 15-16 (2d Cir. 1995).

Code Section 523 provides in pertinent part that "[a] discharge . . . 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. § 523(a)(4) (hereinafter, the "defalcation exception"). The Foundation's contention is that the attorney-client relationship is a fiduciary one and that Hayes's failure to repay unearned funds paid to him under an unenforceable fee agreement constitutes a "defalcation" within the meaning of Section 523. The bankruptcy and district courts disagreed. Using very similar reasoning, these courts held that "a debtor acts in a fiduciary capacity only as trustee of an 'express' or 'technical' trust, not as trustee of a constructive or implied trust imposed as a matter of equity." Hayes I, at 2 (citing, inter alia, Davis v. Aetna Acceptance Co., 293 U.S. 328, 333 (1934)). Thus, "[o]nly where the attorney in such a relationship is required . . . to hold property in an 'express or technical trust' does the requisite fiduciary relationship exist for purposes of section 523(a)(4)." Id. at 3.

Although the precise scope of the defalcation exception is a question of federal law, its application frequently turns upon obligations attendant to relationships governed by state law. For example, state law can be an important factor in determining whether someone acted in a fiduciary capacity under Section 523(a)(4). See, e.g., In re Black, 787 F.2d 503, 506 (10th Cir. 1986), abrogated on other grounds by Grogan v. Garner, 498 U.S. 279, 283 n.7 (1991); In re Johnson, 691 F.2d 249, 251 (6th...