In re Patel

• Citation: 565 F.3d 963
• Decision Date: 12 May 2009
• Docket Number: No. 08-1265.,08-1265.
• Parties: In re Sameer B. PATEL, Debtor. Sameer B. Patel, Defendant-Appellant, v. Shamrock Floorcovering Services, Inc., Plaintiff-Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (6th Circuit)

565 F.3d 963

In re Sameer B. PATEL, Debtor Sameer B. Patel, Defendant-Appellant, v. Shamrock Floorcovering Services, Inc., Plaintiff-Appellee.

No. 08-1265.

United States Court of Appeals, Sixth Circuit.

Argued: April 29, 2009.

Decided and Filed: May 12, 2009.

ARGUED:

Dean R. Nelson, Jr., Charles J. Taunt & Associates, Birmingham, Michigan, for Appellant. Nik Lulgjuraj, Darnell & Lugjuraj, Chelsea, Michigan, for Appellee.

ON BRIEF:

Dean R. Nelson, Jr., Erika D. Hart, Charles J. Taunt & Associates, Birmingham, Michigan, for Appellant. Nik Lulgjuraj, Darnell & Lugjuraj, Chelsea, Michigan, for Appellee.

Before: MARTIN, SUHRHEINRICH, and GIBBONS, Circuit Judges.

OPINION

BOYCE F. MARTIN, JR., Circuit Judge.

Bankruptcy is designed to give debtors a "fresh start." Ordinarily, whatever assets a debtor has are allocated among his creditors and, even though they rarely cover all liabilities, he emerges with no outstanding debts. But there are exceptions: some debts are not dischargeable, and among these are debts arising from a "defalcation while acting in a fiduciary capacity." 11 U.S.C. § 523(a)(4). This appeal presents the question whether the defendant, Sameer Patel—corporate officer, 50% shareholder, and day-to-day administrator of a "contractor" under the Michigan Builders Trust Fund Act, MICH. COMP. LAWS § 570.151—is a fiduciary such that § 523(a)(4) prevents him from discharging his debt because he breached his fiduciary duty to plaintiff Shamrock Floorcovering. Because Patel was a fiduciary and breached his duties by "defalcation," we affirm the district court's ruling that his debt to Shamrock is not dischargeable.

I.

Empire Limited Partnership, owned and operated by Patel's father, decided to build homes on some of its land plots in Pittsfield Township, Michigan. Sameer Patel was president and 50% shareholder of Empire Builders of Michigan, Inc., the home construction project's general contractor. In this role he handled day-to-day operations: Empire Builders contracted, worked with, and paid subcontractors. And payment was organized as follows: subcontractors sent invoices to Empire Builders, which were then submitted to Empire Limited Partnership. To cover payments, the partnership requested funds under its line of credit from Huntington National Bank. Empire Limited Partnership would then turn over funds to Empire Builders, which paid the subcontractors and covered other expenses.

Yet this arrangement began falling apart after Huntington Bank imposed additional borrowing restrictions on the partnership. In 1998 Huntington required Empire Limited to refinance the Pittsfield construction project's funding by selling unrelated lots to a third-party, but that transaction's closing was delayed, so payments owed piled up. And, in November, Empire Builders, Patel's company, sent plaintiff Shamrock a letter stating that it would pay the $47,058 Empire Builders owed it. When the sale of the unrelated properties was finally complete, the proceeds were placed in escrow and Shamrock received $11,000 in payment. The remainder was scheduled for future payment.

Over the next year Shamrock continued work, and, in August 1999, Patel wrote to Shamrock stating that money Empire Builders owed it was held in escrow and would soon be released, so that Shamrock could expect its money "ASAP." And, two months later, Shamrock agreed to waive the $8,400.00 owed to it in exchange for a promise that $7,048.00 would remain a continuing obligation of Empire Builders and Sameer Patel personally. Soon thereafter, however, Huntington Bank pulled its line of credit. As a result, the home construction project—and both Empire Builders and Empire Limited Partnership themselves—collapsed. The partnership sold the rest of its undeveloped lots and abandoned the remaining phases of the construction project. Shamrock was never paid what it was owed, including the $7,048.00 Patel had personally agreed to pay.

So in 2000 Shamrock sued Empire Builders and Sameer Patel in Michigan state court alleging: (1) breach of contract; (2) fraud/innocent misrepresentation; (3) account stated; (4) action on personal guarantee; and (5) fraudulent conveyance. Shamrock obtained a default judgment in 2003 against Empire Builders and Patel individually for $81,171.79-$73,529.00 in damages and $7,642.79 in interest.

Patel then filed for personal Chapter 7 bankruptcy and listed Shamrock's $81,171.79 state court judgment against Empire Builders and himself as a debt to be discharged. Shamrock brought an adversary proceeding, filing a complaint to contest dischargeability. Patel brought a motion for summary judgment, arguing that the debt was dischargeable. The bankruptcy court ruled that the debt was dischargeable because 11 U.S.C. § 523(a)(4) did not apply.¹ The district court reversed, holding that Patel breached the fiduciary duties he owed Shamrock by failing to account for and pay funds—a "defalcation." Patel appeals.

II.

We directly review a bankruptcy court's order when appealed from a district court. Rogan v. Bank One, Nat'l Ass'n (In re Cook), 457 F.3d 561, 565 (6th Cir.2006). We review findings of fact under the clearly erroneous standard and conclusions of law de novo. Id.

A.

Bankruptcy is both a creditor's remedy and a debtor's right. Discharging a bankrupt party's debts is central to bankruptcy's purpose of providing a "fresh start" to filers. But discharging debts sometimes harms creditors, so there are statutory exceptions. Some debts are not dischargeable because of their type, e.g., 11 U.S.C. § 523(a)(1) (taxes or customs duties); id. § 523(a)(14)(tax), id. § 523(a)(5) (alimony and child support), and others are not dischargeable because of public policy, e.g., id. § 523(a)(2) (obtaining money, goods, or services by fraud or falsehood); id. § 523(a)(6) (wilful or malicious injury); id. § 523(a)(9) (death or injury caused by driving under the influence of alcohol or drugs). The provision construed here excludes from discharge debts incurred from "fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny." Id. § 523(a)(4).

This exception for "defalcation while acting in a fiduciary capacity" follows from Congress's desire to protect trust relationships: when the bankrupt is a trustee and the creditor a trust beneficiary, § 523(a)(4) points the needle away from discharge; it is yet another example of the law's imposition of high standards of loyalty and care on trustees. See Commonwealth Land Title Co. v. Blaszak (In re Blaszak), 397 F.3d 386, 391 (6th Cir.2005); Davis v. Aetna Acceptance Co., 293 U.S. 328, 331, 55 S.Ct. 151, 79 L.Ed. 393 (1934).²

A debt is non-dischargeable as the result of defalcation when a preponderance of the evidence establishes: (1) a pre-existing fiduciary relationship, (2) a breach of that relationship, and (3) resulting loss. Bd. of Trustees v. Bucci (In re Bucci), 493 F.3d 635, 642 (6th Cir.2007). In Davis, the Supreme Court instructed that the term "fiduciary capacity" is narrower here than it is in some other contexts: section 523(a)(4) covers only "express" or "technical trusts" and not trusts arising out of "the very act of wrongdoing." 293 U.S. at 333, 55 S.Ct. 151. These "constructive trusts," which arise ex maleficio (at the time the wrong is done), do not satisfy the "fiduciary capacity" requirement because the debtor was not "a trustee before the wrong." Id.

Establishing an "express" trust is straightforward. The creditor must demonstrate: "(1) an intent to create a trust; (2) a trustee; (3) a trust res; and (4) a definite beneficiary." In re Blaszak, 397 F.3d at 391-92. But Shamrock does not allege an express trust and instead claims the existence of a "technical trust" flowing from duties imposed on Patel by the Michigan Builders Trust Fund Act. See MICH. COMP. LAWS § 570.151. In Carlisle Cashway, Inc. v. Johnson (In re Johnson), this Court held that the MBTFA satisfied the necessary "requirement that the trust exist separate from the act of wrongdoing" as a matter of federal law, and thus MBTFA "contractors" are fiduciaries to their subcontractors under § 523(a)(4). 691 F.2d 249, 251-52 (6th Cir.1982). But see In re Marchiando, 13 F.3d 1111 (7th Cir.1994) (holding that Illinois lottery law did not create sufficient "fiduciary relationship" despite professing to create a trust).

But Johnson dealt with an individual. The general contractor here, Empire Builders of Michigan, was, by contrast, a corporation of which Patel was president, 50% shareholder, and day-to-day administrator. To the bankruptcy court, this distinction made all the difference—it held that, unless Shamrock provided evidence supporting a "piercing the corporate veil" or "alter ego" theory, then Patel personally did not owe Shamrock any fiduciary duty that could be breached and therefore the debt was dischargeable. It went on to find that Shamrock could prove neither theory. The district court disagreed, however, and held that such an analysis was unnecessary because Patel directly owed Shamrock a fiduciary duty as a "contractor" under the MBTFA.

The district court got it right. Although federal law generally governs, Johnson held that "contractors" under the MBTFA are fiduciaries under § 523(a)(4), id. at 255-57, so the issue is whether Patel was a "contractor" under the MBTFA, a state-law question. "Contractor" is not expressly defined in the Act, which states:

In the building construction industry, the building contract fund paid by any person to a contractor, or by such person or contractor to a subcontractor shall be considered by this act to be a trust fund, for the benefit of the person making the payment, contractors, laborers, subcontractors, or materialmen, and the contractor or subcontractor shall be considered the trustee of all funds so paid to him for building construction purposes.

MICH. COMP. LAWS § 570.151 (emphasis added). The Act requires the "contractor" "to first pay laborers,...