In re Spivey

• Decision Date: 22 November 2010
• Docket Number: Bankruptcy No. 5:08-bk-73400,Adversary No. 5:08-ap-7201
• Citation: 440 B.R. 539
• Parties: In re Herschel and Marsha SPIVEY, Debtors. Robert and Nancy Lewis; WLH, LLC, Plaintiffs v. Herschel and Marsha Spivey, Individually and as Members of Doo Wop, LLC, Defendants.
• Court: U.S. Bankruptcy Court — Western District of Arkansas

440 B.R. 539

In re Herschel and Marsha SPIVEY, Debtors.Robert and Nancy Lewis; WLH, LLC, Plaintiffs

v.Herschel and Marsha Spivey, Individually and as Members of Doo Wop, LLC, Defendants.

Bankruptcy No. 5:08-bk-73400.

Adversary No. 5:08-ap-7201.

United States Bankruptcy Court,

W.D. Arkansas,

Fayetteville Division.

Nov. 22, 2010.

Donald E. Wilson, Attorney at Law, Fayetteville, AR, Kenneth R. Shemin, Shemin Law Firm, PLLC, Rogers, AR, for Plaintiffs.

Gail Inman-Campbell, Gail Inman-Campbell, PLC, Harrison, AR, for Defendants.

MEMORANDUM OPINION AND ORDER

BEN T. BARRY, Bankruptcy Judge.

The plaintiffs, Robert and Nancy Lewis, filed their adversary proceeding on December 18, 2008, to determine the dischargeability of debts under 11 U.S.C. § 523, allegedly owed to them by the debtors, Herschel and Marsha Spivey, and to deny the discharge of the debtors under 11 U.S.C. § 727. The Court scheduled the trial for September 1, 2010. At the beginning of trial, the Lewises advised the Court they were only going to pursue their § 523(a)(2)(A) and (a)(4) causes of action and were dismissing their § 727 cause of action. Additionally, the Lewises dismissed Doo Wop, LLC as a party defendant.

I. Background

The Lewises and the Spiveys first met in the 1970s and became friends over the intervening years. In 2001, the Spiveys discussed with the Lewises their idea of building a series of carwashes in Northwest Arkansas based on a "Happy Days" 1950s theme. According to Mr. Lewis, the Spiveys approached the Lewises with a business plan and a request for financial assistance. The parties agreed that the Lewises would provide the financial backing and the Spiveys would provide the day-to-day management and bookkeeping for the carwashes. After further discussion, the parties agreed to go into business and formed Doo Wop, LLC, a limited liability company [Doo Wop]. The first carwash was completed at the end of 2001. In 2002, two additional carwashes were built and another carwash was purchased and renovated. Finally, in 2004, another carwash was purchased and renovated.

As discussed in more detail below, the Lewises began to have differences with the Spiveys concerning the way the carwashes were being operated and the books were being handled. After many discussions, which did not resolve the differences, the Lewises were ready to sell either Doo Wop entirely, or, at least, their interest in Doo Wop. Because of continuing differences, the Lewises filed suit against the Spiveysin Washington County Circuit Court in January 2007. On the day before the scheduled state court trial, the Spiveys filed their voluntary chapter 7 bankruptcy petition.

II. Jurisdiction

The Court has jurisdiction over this matter under 28 U.S.C. § 1334 and 28 U.S.C. § 157, and it is a core proceeding under 28 U.S.C. § 157(b)(2)(I). The following opinion constitutes findings of fact and conclusions of law in accordance with Federal Rule of Bankruptcy Procedure 7052.

III. Preliminary Matters

A. Standing

At the beginning of trial, counsel for the Spiveys objected to the standing of the Lewises to bring a complaint under § 523(a)(4) and maintained a continuing objection to standing throughout the pendency of the trial. Counsel argued that if funds from Doo Wop were improperly used, then, because the funds belonged to Doo Wop, Doo Wop would be the party in interest and the proper party to bring the action. According to the Spiveys, the complaint should be a derivative action in the name of Doo Wop. The Court overruled the Spiveys' objection at trial; however, upon further consideration, the Court sustains the objection and grants the Spiveys' motion to dismiss the § 523(a)(4) cause of action for lack of standing.

Under the Spiveys' argument, the Lewises did not have standing to bring this lawsuit under § 523(a)(4) because the alleged damage was damage to Doo Wop, not the Lewises individually. Judge Richard Arnold stated the issue of standing succinctly:

That a plaintiff must have standing in order to pursue a lawsuit is firmly rooted in our constitutional history, and requires that a plaintiff allege a judicially cognizable and redressable injury. As the Supreme Court has said, "In essence the question of standing is whether the litigant is entitled to have the court decide the merits of the dispute or of particular issues." Warth v. Seldin, 422 U.S. 490, 498, 95 S.Ct. 2197, 45 L.Ed.2d 343 (1975). To have standing, a plaintiff must allege an injury that is fairly traceable to the defendant's conduct, and the requested relief must be likely to redress the alleged injury.

Novartis Seeds, Inc. v. Monsanto Co., 190 F.3d 868, 871 (8th Cir.1999) (emphasis added). The question before the Court related to standing is whether the Lewises, individually, are entitled to have the Court decide the merits of their dispute with the Spiveys, or whether the action needs to (or can only) be brought as a derivative action.

The Court could not locate any cases that address a derivative cause of action related to limited liability companies in Arkansas. However, a number of Arkansas corporate law and partnership cases discuss the direct/derivative distinction and provide substantial guidance. See, e.g., Golden Tee, Inc. v. Venture Golf Sch., Inc., 333 Ark. 253, 969 S.W.2d 625 (1998); Brandon v. Brandon Const. Co., 300 Ark. 44, 776 S.W.2d 349 (1989). The general rule that has developed relates to whether the plaintiff has been injured directly or independently of the corporation or partnership. Golden Tee, 969 S.W.2d at 628. The Lewises would have standing to bring the § 523(a)(4) cause of action if they could assert " 'a direct injury to the shareholder distinct and separate from harm caused to the corporation.' " Id. at 629 (quoting Hames v. Cravens, 332 Ark. 437, 966 S.W.2d 244 (1998)); see also Brandon, 776 S.W.2d at 352 ("a shareholder may sue to redress injuries received by him regardlessof whether the same wrong may have injured the corporation").

The Lewises have alleged and proved to the Court that the Spiveys were either paid, or obligated Doo Wop to pay, management fees. Taking into consideration Mr. Spivey's testimony that the Spiveys did not put any money into Doo Wop and never authorized any money be paid to the Lewises, and Ms. Spivey's testimony that the Lewises' investments in Doo Wop were considerably more than the Spiveys', the Court finds that the Lewises have asserted a direct injury separate and distinct from any injury suffered by Doo Wop with regard to the Lewises' § 523(a)(2)(A) cause of action. However, the Court cannot find a direct injury with regard to their § 523(a)(4) cause of action. Under § 523(a)(4), the bankruptcy code excepts from discharge any debt "for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny." 11 U.S.C. § 523(a)(4). This subsection is comprised of three separate exceptions: (1) fraud or defalcation while acting in a fiduciary capacity, (2) embezzlement, and (3) larceny.¹ To establish standing the Lewises must prove they suffered a direct injury as a result of either a fiduciary relationship that existed between the Lewises and the Spiveys, or embezzlement.

1. Fiduciary as Corporate Officer/Specific Statute

The Spiveys argued that the first exception under § 523(a)(4), which relates to a breach of fiduciary duty, should be dismissed for lack of an express trust creating the fiduciary duty. The Lewises argued that a fiduciary duty was created by the fact that Mr. Spivey was the managing member of Doo Wop. It appears that both parties are correct.

The determination of a fiduciary relationship under § 523(a)(4) is a question of federal law. Tudor Oaks Ltd. P'ship v. Cochrane (In re Cochrane), 124 F.3d 978, 984 (8th Cir.1997). The federal law relating to § 523(a)(4) is clear and well established: " '[t]he fiduciary relationship must be one arising from an express or technical trust that was imposed before and without reference to the wrongdoing that caused the debt.' " Id. (quoting Lewis v. Scott, 97 F.3d 1182, 1185 (9th Cir.1996)). A fiduciary relationship could also arise through a statute or other state law rule creating fiduciary status that is "cognizable" in bankruptcy proceedings. Barclays Am./Bus. Credit, Inc. v. Long (In re Long), 774 F.2d 875, 878 (8th Cir.1985) (citing Davis v. Aetna Acceptance Co., 293 U.S. 328, 333, 55 S.Ct. 151, 79 L.Ed. 393 (1934)). The Long court further recognized that "there are cases charging individuals, by virtue of their corporate officer status, with the corporation's fiduciary duties. To the extent these cases hold that a statute or other state law rule may create fiduciary status in an officer which is cognizable in bankruptcy proceedings, we agree." Id. (citations omitted).

In this case, there was no express or technical trust imposed among the members of Doo Wop; nor does theOperating Agreement constitute a trust agreement. However, Arkansas case law recognizes an officer's or director's fiduciary relationship to a corporation, predicated on the fact that the officer or director voluntarily accepted the position of trust. Taylor v. Terry, 279 Ark. 97, 649 S.W.2d 392, 392-93 (1983) (recognizing a fiduciary duty related to "corporate opportunity"). By analogy, a managing member of a limited liability company may also have a fiduciary relationship with the limited liability company by virtue of his position. Also, under the Arkansas Small Business Entity Tax Pass Through Act, in some instances a member or manager of a limited liability company must "hold as trustee" for the company any profit or benefit derived by that person from certain transactions or use of the company's property. Ark.Code Ann. § 4-32-402(2) (Repl.2001).² Both Arkansas case law and an Arkansas statute support the creation of a fiduciary relationship in the absence of an express or technical trust. See also Bell v. Collins (In re Collins), 137 B.R. 754, 756 (Bankr.E.D.Ark.1992) (finding that Arkansas's long...