In re Hyman

• Decision Date: 30 November 2005
• Docket Number: No. 03 B 22150 ASH.,No. 05 Civ. 2867 WCC.,03 B 22150 ASH.,05 Civ. 2867 WCC.
• Citation: 335 B.R. 32
• Parties: In re Andrew A. HYMAN, Debtor. G. Hallett Denton, as Executor of the Estate of George W. Denton, Plaintiff-Appellant, v. Andrew A. Hyman, Defendant-Appellee.
• Court: U.S. Bankruptcy Court — Southern District of New York

335 B.R. 32

In re Andrew A. HYMAN, Debtor G. Hallett Denton, as Executor of the Estate of George W. Denton, Plaintiff-Appellant, v. Andrew A. Hyman, Defendant-Appellee.

No. 03 B 22150 ASH.

No. 05 Civ. 2867 WCC.

United States Bankruptcy Court, S.D. New York.

November 30, 2005.

COPYRIGHT MATERIAL OMITTED

Greenfield, Stein & Senior, LLP, Kenneth L. Stein, Jeffery H. Sheetz, of counsel, New York City, M. Stuart Goldberg, LLC, Marc S. Goldberg, of counsel, White Plains, NY, for Plaintiff-Appellant.

Meyers Tersigni Feldman & Gray LLP, New York City, Anthony L. Tersigni, of counsel, New York City, for Defendant-Appellee.

OPINION AND ORDER

CONNER, Senior Judge.

Plaintiff-Appellant G. Hallett Denton ("Creditor"), executor of the estate of his deceased father, George W. Denton (the "Estate"), appeals the January 21, 2005 order of United States Bankruptcy Judge Adlai S. Hardin, Jr. denying Creditor's motion for summary judgment and granting the cross-motion of defendant-appellee Andrew Hyman ("Debtor") discharging Hyman's debt and dismissing Creditor's claims under Section 523(a) of the Bankruptcy Code based on collateral estoppel from the findings of the Westchester County Surrogate's Court. The issues presented on appeal under 11 U.S.C. § 523 are: (1) whether a judgment obtained in state court by a creditor against a debtor collaterally estops the debtor from relitigating certain issues in Bankruptcy Court (2) what conduct constitutes defalcation for purposes of the Bankruptcy Code; and (3) whether equal shareholders in a close corporation are fiduciaries as that term is understood under the Bankruptcy Code. We affirm the decision of the Bankruptcy Court.

BACKGROUND

In 1984, George W. Denton and Hyman began working for an insurance agency owned by Henry A. Deppe. (Hyman Aff. ¶ 3.) Deppe's insurance agency operated as a general agent of The Guardian Life Insurance Company of America ("Guardian") and marketed Guardian life insurance through a separate entity called National Pension Service, Inc. ("NPS"), which designed and administered pension plans funded by life insurance sales. (Id. ¶¶ 3-4.) By 1987, Deppe was nearing retirement and agreed to recommend that Guardian permit Denton and Hyman to replace him as general agent.¹ (Id. ¶ 5.) Guardian subsequently named Denton and Hyman as successors to Deppe's general agency. (Id. ¶ 6.)

The pair organized Denton-Hyman Agency, Inc. ("DHA") to act as general agent and became equal shareholders of the company, with Denton serving as President and Hyman as Vice President. (Id.; Stein Decl., Ex. A at 1-2.) They also formed and took equal shares in both NPS and National Pension Actuaries, Inc. ("NPA") in order to continue Deppe's pension planning and administrative companies of the same names.² (Hyman Aff. ¶ 6 & n.1; Stein Decl., Ex. A at 1-2.) Accordingly, on or about January 1, 1988, Deppe executed agreements transferring the assets of each of his companies to their respective newly-formed counterparts, as well as an agreement not to compete, for a total price of $655,234, payable in installments and personally guaranteed by Denton and Hyman jointly and severally. (Hyman Aff. ¶ 6.) In addition, DHA and NPS incurred start-up financing debts of $1.6 million, also personally guaranteed by both Denton and Hyman jointly and severally. (Id. ¶¶ 9-10.)

On February 14, 1989, Denton died unexpectedly, just over one year after he and Hyman assumed control of the enterprise. (Stein Decl., Ex. A at 2.) No shareholder or similar agreement existed governing buyout or enterprise division in the event one of the men died or left the business. (11/15/04 Hr'g Tr. at 10.) The general agency granted by Guardian to DHA automatically terminated upon Denton's death. (Hyman Aff. ¶ 11 & Ex. 2; 10/28/04 Hr'g Tr. at 24.) This "precluded the Denton estate or [DHA] from becoming a shareholder in the new general agency." (Stein Decl., Ex. A at 7.)

Immediately after Denton's death, Debtor began negotiating with Guardian to assume sole control of the DHA general agency, and, in October 1989, Guardian granted the general agency to Debtor as sole proprietor of the newly-formed Andrew A. Hyman Agency, Inc. ("AHA"). (Id., Ex. A at 2-3; Hyman Aff. ¶ 14.) Additionally, Hyman assumed control of NPS and maintained its operations, but with all life insurance proceeds on a going-forward basis being collected by AHA instead of DHA. (Hyman Aff. ¶ 16; Stein Decl., Ex. A at 2-3.) Hyman also began immediate discussions with Creditor regarding both the continuation of these businesses and the purchase of the Estate's half-interest in DHA. (Hyman Aff. ¶¶ 12-13, 16-17.) Both parties were aware that allowing the businesses to lapse would affect the amount of DHA/NPS debts for which the Estate would be responsible, as Hyman lacked sufficient funds to satisfy those debts and all debts were incurred jointly and severally. (Id. ¶ 10; 10/28/04 Hr'g Tr. at 23.) It appears that Creditor consented to Debtor's continuation of the business and actively engaged in buyout negotiations. (Stein Reply Decl., Ex. 7 at 175-76, 210.) Hyman continued running AHA until 1994, when AHA was replaced as Guardian's general agent; NPS and NPA operated with Hyman as director until April 2002, at which time their operations were outsourced. (Stein Decl., Ex. A at 3.) By this time, Hyman had paid off the entire $1.6 million debt owed by DHA and NPS, apparently through the use of monies still owed DHA in addition to funds earned by AHA. (Hyman Aff. ¶ 30.)

From 1989 to 1994, Creditor and Debtor engaged in lengthy, arms length negotiations in which both parties were advised by competent professionals concerning Hyman's purchase of the Estate's half-interest in the defunct DHA. (Id. ¶¶ 19-25 & Ex. 10; Stein Reply Decl., Ex. 7 at 176-77, 181-82, 210.) When these negotiations failed to produce an agreement, Creditor filed a shareholder derivative claim against Debtor in Westchester County Surrogate's Court. (Hyman Aff. ¶ 20.) That court issued a post-trial decision dated December 21, 2002, and Decree dated April 23, 2003, requiring Hyman to pay roughly $2.7 million to DHA for profits collected by AHA after Denton's death. (Stein Decl., Exs. A & B.) The Appellate Division affirmed the Surrogate's Court's decision on April 12, 2004. (Id., Ex. E ¶ 19.)

However, before the Surrogate's Court issued its Decree, Debtor filed for Chapter 11 protection in recognition of his inability to pay the anticipated judgment; the case was converted to Chapter 7. (Stein Decl., Ex. E ¶ 10.) Consequently, Creditor filed a claim in Debtor's bankruptcy case seeking an order fixing and allowing the Estate's claim in the amount of the Surrogate's Court's judgment and an order excepting the debt from discharge under 11 U.S.C. §§ 523(a)(2), (4) and (6). Creditor and Debtor each filed motions and cross-motions for summary judgment, which resulted in an oral decision by Bankruptcy Judge Hardin rejecting a number of Creditor's claims but establishing a schedule leading to a trial on the merits of Creditor's claim under Section 523(a)(4). Before trial, Creditor voluntarily dismissed with prejudice the nondischargeability claim under 523(a) in order to forego a trial and immediately proceed with an appeal regarding the issue of collateral estoppel based upon the Surrogate's Court's decision. Judge Hardin accordingly issued an appealable, final decision and order on January 21, 2005, which this Court now addresses. This Court has jurisdiction over this appeal pursuant to 28 U.S.C. § 158.

DISCUSSION

I. Standard of Review

On appeal, a bankruptcy court's legal conclusions are reviewed de novo. See In re Dawnwood Props./78, 209 F.3d 114, 116 (2d Cir.2000). However, the bankruptcy court's findings of fact cannot be set aside unless they are clearly erroneous. See FED. R. BANKR. 8013; In re Dawnwood, 209 F.3d at 116; see also Gulf States Exploration Co. v. Manville Forest Prods Corp. (In re Manville Forest Prods. Corp.), 896 F.2d 1384, 1388 (2d Cir.1990).

On a claim of nondischargeability under § 523(a)(4), the Supreme Court has held that the burden is on the party claiming nondischargeability, and the appropriate level of proof is a preponderance of the evidence. See Grogan v. Garner, 498 U.S. 279, 285, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991); In re Hambley, 329 B.R. 382, 396 (Bankr.E.D.N.Y.2005). Exceptions to dischargeability should be literally and strictly construed against the creditor and liberally in favor of the debtor. See, e.g., Gleason v. Thaw, 236 U.S. 558, 562, 35 S.Ct. 287, 59 L.Ed. 717 (1915) ("In view of the well-known purposes of the bankrupt law, exceptions to the operation of a discharge thereunder should be confined to those plainly expressed...."); Household Fin. Corp. v. Danns (In re Danns), 558 F.2d 114, 116 (2d Cir.1977); Cmty. Mut. Sav. Bank v. Landrin (In re Landrin), 173 B.R. 307, 310 (Bankr.S.D.N.Y.1994). This comports with the "fresh start" policy underlying the Bankruptcy Code. See, e.g., Wetmore v. Markoe, 196 U.S. 68, 77, 25 S.Ct. 172, 49 L.Ed. 390 (1904) ("Systems of bankruptcy are designed to relieve the honest debtor from the weight of indebtedness which has become oppressive, and to permit him to have a fresh start in business or commercial life, freed from the obligation and responsibilities which may have resulted from business misfortunes."); Rupert v. Krautheimer (In re Krautheimer), 210 B.R. 37, 46 (Bankr.S.D.N.Y.1997) ("The concept of the discharge is, without question, the `holy grail' of the Bankruptcy Code."). "Thus, non-dischargeability is `perceived to be a punitive exception to the "fresh start" policy and should be found reluctantly.'" In re Krautheimer, 210 B.R. at 46 (quoting Matter of Martonak, 67 B.R. 727, 728 (Bankr.S.D.N.Y.1986)).

II. Collateral Estoppel

Creditor's sole claim on appeal is that the Bankruptcy Court erred by not finding collateral estoppel based upon the finding of breach of fiduciary duty by the Westchester...