In re Nail
| Decision Date | 15 April 2011 |
| Docket Number | BAP Nos. 10–6057,10–6061. |
| Citation | 446 B.R. 292 |
| Parties | In re Elizabeth E. NAIL, Debtor.Arvest Mortgage Company, Plaintiff–Appellee,v.Elizabeth E. Nail, Defendant–Appellant.In re Elizabeth E. Nail, Debtor.Arvest Mortgage Company, Plaintiff–Appellant,v.Elizabeth E. Nail, Defendant–Appellee. |
| Court | U.S. Bankruptcy Appellate Panel, Eighth Circuit |
OPINION TEXT STARTS HERE
Theresa L. Pockrus, argued, Fayetteville, AR, for appellant/cross-appellee.Sara E. Heck, argued, Burton E. Stacy, Jr., on the brief, Bentonville, AR, for appellee/cross-appellant.Before SCHERMER, FEDERMAN and VENTERS, Bankruptcy Judges.SCHERMER, Bankruptcy Judge.
Elizabeth E. Nail appeals from the judgment of the bankruptcy court determining that her failure to turn over $46,016.25 in lawsuit settlement proceeds to Arvest Mortgage Company and the Federal National Mortgage Association (together, “Creditor”) resulted in a non-dischargeable debt pursuant to 11 U.S.C. § 523(a)(4). The Creditor cross-appeals, arguing that the bankruptcy court should have found the non-dischargeable debt to be $65,000, the gross amount of the settlement. We have jurisdiction over this appeal and cross-appeal. See 28 U.S.C. § 158(b). For the reasons set forth below, we reverse.
As framed by the parties, the issues on appeal are: (1) whether the Debtor assigned to the Creditor the proceeds of a settlement that the Debtor received from a lawsuit against the builders of a house she purchased; and (2) whether the Debtor's failure to remit such proceeds to the Creditor is excepted from the Debtor's discharge pursuant to 11 U.S.C. § 523(a)(4) as a debt for defalcation by the Debtor while acting in a fiduciary capacity.1 The issue presented by the cross-appeal is whether the Debtor was entitled to reduce the debt excepted from her discharge.
A threshold issue, however, is whether the settlement proceeds of $65,000 were captured as “Miscellaneous Proceeds” under the terms of the mortgage that the Debtor executed in favor of Arvest National Bank (“Arvest”). We hold that the settlement proceeds were not, in fact, Miscellaneous Proceeds as defined in the mortgage. We further hold that, if the settlement proceeds are determined to be Miscellaneous Proceeds arising from a tort action, they could not be validly assigned to Arvest under Arkansas law. Finally, we hold that, if the settlement proceeds are determined to be Miscellaneous Proceeds under either a contract or tort theory, the Arkansas statutes relied on by the bankruptcy court did not create a trust giving rise to a fiduciary duty under § 523(a)(4) that would require the Debtor to pay the settlement proceeds to the Creditor. Therefore, there is no basis for a non-dischargeable debt under § 523(a)(4). Having reached these conclusions, we need not consider the issue raised in the cross-appeal.
The Debtor obtained a loan from Arvest in 2006 to purchase a newly constructed residence and executed a promissory note and mortgage (the “Mortgage”) in favor of Arvest. After purchasing the house, the Debtor discovered certain construction defects but was unable to persuade the builders to remedy them. At about the same time, according to Arvest, the Debtor began missing her mortgage payments. Although it declined to join in a lawsuit against the builders, Arvest granted the Debtor two consecutive six-month forbearance periods beginning in February 2007 so she could prosecute an action against the builders. The parties agree that the Debtor's state court lawsuit against the builders alleged tort and contract causes of action.2 According to Arvest, the Debtor did not resume making her mortgage payments to Arvest after the forbearance periods expired.
The Debtor settled the state court lawsuit in January 2008 after arbitration. She received $65,000 from the builders.3 While Arvest was aware of the state court lawsuit, it maintains that it did not learn of the settlement and the Debtor's receipt of the $65,000 until some six months later, in July 2008. The Debtor did not remit any of the settlement proceeds to Arvest. Rather, she spent the proceeds to pay attorneys fees for the state court lawsuit, to pay for repairs and remodeling on her new home, and to pay credit card debt.
The Debtor filed a voluntary petition for relief under Chapter 13 of Title 11 of the United States Code (the “Bankruptcy Code”) on April 28, 2009.
Arvest obtained relief from the automatic stay in the Debtor's bankruptcy case and completed a judicial foreclosure that it had commenced pre-petition on the property. Arvest purchased the property at the foreclosure sale and then transferred title of it to Federal National Mortgage Association (“Fannie Mae”). Arvest stated that the price it paid to purchase the property at the foreclosure sale was less than the amount owed by the Debtor on the loan.
Arvest then brought an adversary proceeding in the Debtor's bankruptcy case. It asserted causes of action against the Debtor under 11 U.S.C. § 523(a)(2)(A), based on false pretenses, false representation or actual fraud, and under 11 U.S.C. § 523(a)(4) for fraud or defalcation while acting in a fiduciary capacity or for embezzlement or larceny.4 The Debtor moved to dismiss the complaint for failure to prosecute in the name of Fannie Mae as the real party in interest. During the trial, the bankruptcy court granted the Debtor's motion for a directed verdict on the § 523(a)(2)(A) cause of action.5
On April 9, 2010, the bankruptcy court entered an order determining that a debt owed from the Debtor to the Creditor was excepted from the Debtor's discharge pursuant to 11 U.S.C. § 523(a)(4), based on the Debtor's defalcation while acting in a fiduciary capacity. It determined that the settlement proceeds were assigned to the Creditor pursuant to a provision of the Mortgage assigning all “Miscellaneous Proceeds” to the Creditor. In response to Arvest's argument that the Mortgage document created an express trust, the court explained that despite the fact that “there is no language in the [M]ortgage that specifically creates a trust and § 523(a)(4) does not reach constructive trusts ... there is ... an express trust recognized under Arkansas law and in accord with the terms of the [M]ortgage.” The court did not find fraudulent intent by the Debtor in her use of the settlement proceeds, but determined that the Debtor committed defalcation while acting in a fiduciary capacity. It did not decide whether the Debtor had embezzled the settlement funds.
The bankruptcy court also determined that even though Arvest had standing to bring its cause of action, it was not the real party in interest based on its transfer of the property to Fannie Mae after the foreclosure sale. It noted that, according to a representative from Arvest, after title to the property was transferred to Fannie Mae, Arvest's only interest in the adversary proceeding was “whether Fannie Mae is going to absorb the loss.” The court required Arvest to provide a copy of the order to Fannie Mae “in sufficient time to allow Fannie Mae to ratify, join or be substituted in [the] adversary proceeding,” explaining that if Fannie Mae did not comply, the Debtor's motion to dismiss would be granted. Fannie Mae filed its declaration of ratification on May 6, 2010.
Also in the April 9, 2010 order, the bankruptcy court indicated that it would enter a judgment against the Debtor and in favor of the Creditor for the amount of $65,000, subject to a reduction for the Debtor's expenses and costs incurred in the state court lawsuit. For this purpose, the court required the Debtor to file an accounting of her costs and expenses.
On July 16, 2010, the bankruptcy court entered an order accepting an accounting submitted by the Debtor, in part, subject to certain disallowed expenses specified at the hearing, and indicating that it would enter a separate judgment.6 The bankruptcy court entered a judgment, incorporating its April 9, 2010 and July 16, 2010 orders, in favor of Arvest and Fannie Mae and against the Debtor in the amount of $46,016.25 ($65,000 less the Debtor's approved fees and expenses in obtaining the settlement), plus interest at the highest rate allowed by law.
We review the bankruptcy court's findings of fact for clear error, and its conclusions of law and conclusions regarding mixed questions of law and fact de novo. DeBold v. Case, 452 F.3d 756, 761 (8th Cir.2006) (citation omitted). The bankruptcy court's interpretation of state law is reviewed de novo. Luxton v. U.S., 340 F.3d 659, 662 (8th Cir.2003) (citation omitted); Kuelbs v. Hill, 615 F.3d 1037, 1041 (8th Cir.2010), cert. denied, ––– U.S. ––––, 131 S.Ct. 1679, 179 L.Ed.2d 616 (2011); Reuter v. Fields (In re Reuter) 443 B.R. 427, 433 (8th Cir. BAP 2011) (citation omitted).
The ultimate issue in this case, as the parties have argued, concerns whether the Debtor owed a debt to the Creditor that was non-dischargeable under 11 U.S.C. § 523(a)(4), which provides that a bankruptcy discharge does not discharge a debt “for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.” However, to reach that ultimate issue, we must determine whether the settlement proceeds were “Miscellaneous Proceeds” as defined in the Mortgage, whether the settlement proceeds (assuming they constituted “Miscellaneous Proceeds”) could be validly assigned to Arvest, and (again assuming they constituted “Miscellaneous Proceeds”) whether the Arkansas statutes established an express trust meeting the requirements of § 523(a)(4).
According to the Creditor and the bankruptcy court, the settlement proceeds were assigned to the Creditor under the Mortgage. The Creditor further maintains that a debt for the amount of the settlement proceeds (without subtracting the Debtor's expenses and costs in the state court lawsuit) is excepted from the Debtor's discharge as the bankruptcy court determined, based...
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