In re Strack

• Decision Date: 11 March 2008
• Docket Number: No. 07-1200.,07-1200.
• Parties: In re Bruce E. STRACK, Debtor. Kubota Tractor Corporation, a California corporation, Plaintiff-Appellant, v. Bruce E. Strack, Defendant-Appellee, and U.S. Trustee, Trustee.
• Court: U.S. Court of Appeals — Fourth Circuit

524 F.3d 493

In re Bruce E. STRACK, Debtor.

Kubota Tractor Corporation, a California corporation, Plaintiff-Appellant, v. Bruce E. Strack, Defendant-Appellee, and U.S. Trustee, Trustee.

No. 07-1200.

United States Court of Appeals, Fourth Circuit.

Argued: January 30, 2008.

Decided: March 11, 2008.

ARGUED: Ryan Ashby Shores, Hunton & Williams, Washington, D.C., for Appellant. Carolyn Louise Camardo, Marcus, Santoro & Kozak, P.C., Chesapeake, Virginia, for Appellee. ON BRIEF: R. Hewitt Pate, Hunton & Williams, Washington, D.C., for Appellant.

Before NIEMEYER, MOTZ, and DUNCAN, Circuit Judges.

Reversed by published opinion. Judge DUNCAN wrote the opinion, in which Judge NIEMEYER and Judge MOTZ joined.

OPINION

DUNCAN, Circuit Judge:

In October 2005, Appellee Bruce Strack ("Strack"), along with his wife, filed for relief under Chapter 7 of the Bankruptcy Code. Strack listed Appellant Kubota Tractor Corporation ("Kubota") as a creditor holding an unsecured judgment claim against him for approximately $124,000. Kubota later brought an adversary proceeding against the Stracks in the United States Bankruptcy Court for the Eastern District of Virginia, challenging the pending discharge of the debt under two statutory exceptions to the presumption of dischargeability: "defalcation while acting in a fiduciary capacity," under 11 U.S.C. § 523(a)(4), and "willful and malicious injury by the debtor," under 11 U.S.C. § 523(a)(6). The bankruptcy court found neither exception to apply and the debt therefore dischargeable. On appeal, the United States District Court for the Eastern District of Virginia affirmed the bankruptcy court's Opinion and Order. Because we find that the debt arose by reason of Strack's "defalcation," or nonfraudulent default, while he was acting in a fiduciary capacity, we find that § 523(a)(4) renders the debt non-dischargeable, and reverse the judgment of the district court. Having found the debt non-dischargeable under § 523(a)(4), we do not reach Kubota's claim under § 523(a)(6).

I.

The relevant facts here are not in dispute. Strack served as President and majority owner of Enterprise Equipment Inc. ("Enterprise").¹ Enterprise sold farming equipment, such as tractors, and parts for such equipment at its retail facility located in York County, Virginia. Kubota was one of the numerous agricultural machinery manufacturing companies for which Enterprise acted as an authorized dealer. In his capacity as Enterprise's President, Strack agreed to personally guarantee Enterprise's indebtedness to Kubota. In September 2003, Strack also signed Kubota's Dealer Sales and Service Agreement (the "Agreement"), which forms the basis of this appeal.

The Agreement's purpose was to renew Enterprise's "right to purchase and resell [Kubota] products." J.A. 171. Pursuant to the Agreement, Kubota sold "whole goods," or equipment, to Enterprise through a "floor-planning" arrangement.² Under such an arrangement, a dealer can purchase goods from a manufacturer without paying for the goods up front. Here, Enterprise would order a piece of equipment from Kubota for either immediate resale or to hold in its product inventory. Although no money changed hands, Enterprise's purchase of the equipment would, in substance, result in the automatic issuance of a "loan" to Enterprise from Kubota for the purchase price amount. If an interest-free promotion was in place, as appears to have frequently been the case, Kubota did not require payment of either principal or interest on this "loan" for the first several months immediately following the date of Enterprise's purchase. If no such program was in place, Enterprise was required to make interest payments during this period. Under either scenario, at the end of the period the entire purchase price became due to Kubota.

"To secure the performance and payment of all obligations of [Enterprise] to [Kubota]," Enterprise granted to Kubota a security interest in, and lien on, the equipment. J.A. 26. To further protect Kubota's interests, the Agreement prohibited Enterprise from disposing of, or selling, any equipment "except in the ordinary course of business upon customary terms for value received." J.A. 27. The following terms governing Enterprise's handling of the proceeds from these sales form the crux of this appeal:

Until [Enterprise] shall have made settlement with [Kubota] of the full amount due to [Kubota] with respect to any [equipment] disposed of by [Enterprise], [Enterprise] shall segregate the proceeds and hold the same in trust for [Kubota]. [Enterprise] shall be entitled to transfer proceeds free of trust if at, or prior to, the time of such transfer, the payment due from [Enterprise] to [Kubota] shall be assured to the satisfaction of [Kubota].

Id. (emphasis added).

Kubota would conduct regular inventory audits at Enterprise's facility to determine whether Enterprise had sold any Kubota equipment without then "segregating the proceeds" and remitting them to Kubota. J.A. 27, 151. Enterprise frequently sold equipment in such fashion, a breach Kubota dubs as "going out of trust," and had to repay Kubota at the conclusion of the audits. Enterprise was able to repay Kubota until March 2004, at which time its financial condition deteriorated.

By July 2004, Enterprise was indebted to Kubota for nearly $200,000. According to Strack, Enterprise was unable to repay Kubota because all proceeds garnered were used to pay employees, taxes, and other expenses necessary for Enterprise to remain in business. Strack went to great lengths to try to keep Enterprise afloat, even borrowing against the equity in his home and placing those funds into Enterprise's account. Strack managed to reduce Enterprise's debt to Kubota to approximately $124,000 by returning parts and inventory that Enterprise had previously purchased and by making payments whenever possible.³ Despite these efforts, Enterprise ultimately went out of business, and was unable to make any further payments to Kubota. Kubota subsequently sued Strack in the Circuit Court for the County of York, Virginia, pursuant to his personal guarantee of Enterprise's indebtedness, for the balance due under the Agreement. In the proceedings, Strack admitted the legitimacy of the debt and Kubota obtained a judgment against him on July 18, 2005 in the amount of $123,914.96.

On October 14, 2005, the Stracks filed for Chapter 7 relief and listed Kubota as a creditor. Kubota later filed an adversary proceeding with the bankruptcy court, alleging that such debt should be non-dischargeable under one of two exceptions to the presumption of dischargeability: defalcation by a fiduciary, 11 U.S.C. § 523(a)(4),⁴ or willful and malicious injury by the debtor, 11 U.S.C. § 523(a)(6).⁵ The bankruptcy court rejected Kubota's arguments and found the debt dischargeable. Specifically, the court found that (1) the Agreement did not unequivocally create an "express trust" between Kubota and Enterprise and therefore the debt did not arise while Strack was acting as a fiduciary for the purposes of § 523(a)(4);⁶ and (2) Strack's efforts to repay Kubota negated the "willful" requirement of § 523(a)(6). Kubota appealed the bankruptcy court's judgment, unsuccessfully, to the United States District Court for the Eastern District of Virginia. This appeal followed.

II.

Kubota maintains that the bankruptcy court and district court erred in finding that Strack's debt was not excepted from discharge under either § 523(a)(4) or § 523(a)(6). "We review the judgment of a district court sitting in review of a bankruptcy court de novo, applying the same standards of review that were applied in the district court." Three Sisters Partners, LLC v. Harden (In re Shangra-La, Inc.), 167 F.3d 843, 847 (4th Cir.1999). Thus, here, we examine the bankruptcy court's conclusions of law de novo and its findings of fact for clear error. See Fed. R. Bankr.P. 8013; IRS v. White (In re White), 487 F.3d 199, 204 (4th Cir.2007).

Generally, "all legal obligations of the debtor, no matter how remote or contingent" are potentially dischargeable in bankruptcy. See H.R.Rep. No. 95-595, at 309 (1977); see also Nunnery v. Rountree (In re Rountree), 478 F.3d 215, 219 (4th Cir.2007). Congress, however, has provided, in 11 U.S.C. § 523, several limited exceptions to this presumption of dischargeability, which we must construe narrowly "to protect the [Bankruptcy Act's] purpose of providing debtors a fresh start." In re Biondo, 180 F.3d 126, 130 (4th Cir.1999). Kubota's claim turns on the applicability of two such exceptions, § 523(a)(4) and § 523(a)(6). As the party challenging dischargeability, Kubota bears the burden of proving the debt non-dischargeable by a preponderance of the evidence. See Grogan v. Garner, 498 U.S. 279, 291, 111 S.Ct. 654, 112 L.Ed.2d 755 (1991).

A.

We first address Kubota's argument that § 523(a)(4), excepting from discharge those debts "for fraud or defalcation" committed by one "acting in a fiduciary capacity," proscribes the discharge of Strack's debt. To prevail under this provision, a creditor must ordinarily make a two-part showing: (1) that the debt in issue arose while the debtor was acting in a fiduciary capacity; and (2) that the debt arose from the debtor's fraud or defalcation. Pahlavi v. Ansari (In re Ansari), 113 F.3d 17, 20 (4th Cir.1997). Here, the second criterion, "defalcation," or non-fraudulent default, is not in dispute.⁷ However, since Kubota is attempting to prevent the discharge of Strack's debt based on his guarantee of Enterprise's indebtedness, Kubota must demonstrate not only that Enterprise defalcated while acting in a fiduciary capacity for Kubota, but also that Enterprise's actions can be attributed to Strack. See Airlines Reporting Corp. v. Ellison (In re Ellison), 296 F.3d 266, 270-71 (4th Cir. 2002) (requiring more than the existence of a fiduciary duty on behalf of the corporation to find that the corporation's officers' indebtedness,...