In re Kraus
| Decision Date | 01 February 1984 |
| Docket Number | Adv. No. 83-0259.,Bankruptcy No. 83-00627 |
| Citation | 37 BR 126 |
| Parties | In re Charles S. KRAUS, Debtor. Frances HOLMES, Plaintiff, v. Charles S. KRAUS, Defendant. |
| Court | U.S. Bankruptcy Court — Eastern District of Michigan |
Bruce A. Newman, P.C., Anthony J. Mansour, Flint, Mich., for plaintiff.
Carl L. Bekofske, Flint, Mich., for defendant/debtor.
Introduction:
The plaintiff, Frances Holmes, (plaintiff) filed her complaint to determine the nondischargeability of a state court judgment which she had obtained in the principal amount of $58,000, plus costs, interest, and attorney's fee against the debtor-defendant, Charles S. Kraus, (debtor) on May 27, 1983. The debtor filed his Chapter 7 petition on July 19, 1983.
The findings of fact made by the state court judge in support of his judgment are difficult to separate from his summary of the trial testimony. The following findings of fact are adopted for the purpose of this adversary proceeding:
1). The debtor was the owner/operator of a filling station and automotive repair facility for a number of years, including the time period during which the underlying dispute arose.
2). The parties to this dispute entered into two written business agreements.
3). The first agreement, dated October 20, 1978, provided for a loan from the plaintiff to the debtor's business in the amount of $29,000. This loan was to be paid back within six to nine months, and the debtor agreed to be personally liable for repayment.
4). On May 22, 1979, the parties entered into a second agreement in which the defendant sold a one-third interest in his business to the plaintiff for the sum of $50,000. The plaintiff was to receive one-third of the business's profits with a guaranteed annual return of $4,000; she was not, however, granted any interest in the real estate of the business. The $29,000 previously loaned to the debtor by the plaintiff was applied to the purchase price and the plaintiff paid the outstanding balance of $21,000.
5). At the time of the second agreement, the debtor represented to the plaintiff that the business had a going concern value of $150,000 and generated annual profits of $10,000 to $18,000 over the past fifteen years. These figures materially misrepresented the financial condition of the business —it had earned either small profits or incurred losses in the years immediately preceding the agreements. The debtor's business records were incomplete and inaccurate.
6). The debtor did not file an appropriate partnership or assumed name certificates to reflect the plaintiff's acquisition of an interest in the business.
7). The debtor failed to furnish the plaintiff financial statements covering the operations of the business.
8). No distributions of profits or guaranteed payments were ever made to the plaintiff.
9). The debtor paid himself a salary from the cash flow of the business even though there was no provision in the second agreement authorizing such withdrawals.
10). The following disbursements made by the debtor were in breach of the provisions of the second agreement.
Shortages Per Accounting $23,247.00
Dairy Queen Payments 19,058.41
Political Contributions 120.00
Citizens Bank Gas Station
Expenses 21,672.95
Van Payments 4,815.83
Sorscher Payment 2,682.00
Roof Repair 1,560.78
Miscellaneous Loans 1,317.94
Illegible Check 4,724.34
Miscellaneous Draw 600.00
__________
$79,799.25
Based upon these findings of fact, the state court concluded that the second contract formed a joint venture and that as a matter of law the debtor had breached his fiduciary duties owed to the plaintiff as a joint venturer. Damages were awarded to the plaintiff in the principal amount of $58,000, plus costs, interest and attorney fees.
Analysis:
The plaintiff seeks to have her claim determined to be non-dischargeable under 11 U.S.C. § 523(a)(4):
This subsection of the Code has been construed by the Sixth Circuit in Carlisle Cashway, Inc. v. Johnson (In re Johnson) 691 F.2d 249 (6th Cir.1982).1 In Johnson, the plaintiff sought to have a debt determined to be non-dischargeable when the debtor made payments under a construction contract in violation of the Michigan Building Contract Fund Act, M.C.L.A. §§ 570.151-153. The Sixth Circuit reversed the bankruptcy and district courts' rulings that the debt was dischargeable. The court restated the criteria for defining and applying "fiduciary capacity" under § 523(a)(4). Initially, the court noted that the definition of fiduciary in bankruptcy is a matter of federal law, "although state law is important in determining when a trust relationship exists." 691 F.2d at 251 (footnote omitted). The court then held:
The term "fiduciary" applies only to express or technical trusts, which are imposed on transactions by operation of law as a matter of equity. Moreover, the requisite trust relationship must exist prior to the act creating the debt and without reference to it. State statutes which impose a trust ex-maleficio are not within the scope of section 17(a)(4) since such trusts only arise upon an act of misappropriation.
Id. at 251-52 (citations omitted). In applying this rule to the facts in Johnson, the Sixth Circuit found that the Michigan Building Contract Fund Act created a true trust relationship with statutorily imposed fiduciary duties:
The Michigan Building Contract Fund Act imposes a "trust" upon the building contract fund paid by any person to a contractor or subcontractor for the benefit of the person making the payment, contractors, laborers, subcontractors and materialmen. The contractor or subcontractor receiving the payments is the "trustee". The statute imposes a duty upon the trustee to use the money in the building contract fund to first pay laborers, subcontractors and materialmen on the particular project for which the funds were deposited before he uses the fund for any other purpose. Any contractor or subcontractor, who, with intent to defraud, retains or uses any portion of the building contract fund for any purpose other than to first pay the trust beneficiaries, is guilty of a felony in appropriating trust funds to his own use. The appropriation by a contractor or subcontractor of any monies in the building contract fund before the payment of monies due or to become due trust beneficiaries, is evidence of intent to defraud. That the statute does not mandate any particular form or procedures in handling trust funds neither undercuts the validity of the trust nor renders the statute unconstitutionally vague. The Building Contract Fund Act may give rise to a civil cause of action as well as criminal penalties.
Id. at 252 (citations omitted).
This Court cannot agree with the state court that the contract between these parties created a joint venture relationship.2 In Berger v. Mead, 127 Mich.App. 209, 338 N.W.2d 919 (1983), the Michigan Court of Appeals reiterated the six elements of a joint venture:
Id. at 214-15, 338 N.W.2d 919.
The state court record does not support the conclusion that these parties intended to create a joint venture. The express limitation to a single transaction to be conducted as a joint venture is missing.
The court admits that the relationship between these parties is difficult to define; it more closely conforms to the statutory definition of partnership:
M.C.L.A. § 449.6(1). This Court, therefore, holds that the May 22 agreement between the parties created a partnership.
This conclusion is supported by both statutory and case law authority. In a case on point, the Michigan Supreme Court held that an agreement to share in the profits of a business constitutes strong evidence of intent to form a partnership. Corey v. Cadwell, 86 Mich. 570, 49 N.W. 611 (1891). In Corey, the plaintiff originally loaned money to the defendant to enable the defendant to purchase a tract of timber; the loan was to be repaid with interest. When the defendant later wished to obtain further capital from the plaintiff to buy timber, the parties agreed that instead of repayment of these loans with interest that the "net proceeds . . . either from sale of land, lumber, timber, or shingles, after paying the amount contributed by the plaintiff, and all expenses of manufacturing, transportation, and sale, shall be equally divided between the parties." Id. at 572, 49 N.W. 611. Thus, as in this case, a transaction originally structured as a loan became a partnership when the lender stopped receiving loan payments and instead agreed to a sharing of the business profits.
The rule in Corey has been restated in more modern cases to mean that the sharing of profits, while not conclusive, is prima facie evidence of a partnership under Michigan...
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