In re Whiters

• Decision Date: 02 February 2006
• Docket Number: Bankruptcy No. 04-65856 JPK.,Adversary No. 05-6001.
• Parties: In re Leroy Deon WHITERS, Debtor. Bank Calumet, Plaintiff, v. Leroy Deon Whiters, Defendant.
• Court: United States Bankruptcy Courts. Seventh Circuit. U.S. Bankruptcy Court — Northern District of Indiana

337 B.R. 326

In re Leroy Deon WHITERS, Debtor.

Bank Calumet, Plaintiff, v. Leroy Deon Whiters, Defendant.

Bankruptcy No. 04-65856 JPK.

Adversary No. 05-6001.

United States Bankruptcy Court, N.D. Indiana, Hammond Division.

February 2, 2006.

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Rebecca Hoyt Fischer, Lewis C. Laderer, Laderer & Fischer, P.C., South Bend, IN, for Plaintiff, Bank Calumet.

David Dabertin, Hammond, IN, for Defendant, Leroy Deon Whiters.

JUDGMENT DETERMINING DISCHARGEABILITY OF INDEBTEDNESS

J. PHILIP KLINGEBERGER, Bankruptcy Judge.

This adversary proceeding was commenced by a complaint filed by the plaintiff Bank Calumet ("Calumet") against Leroy Deon Whiters ("Whiters ") on January 3, 2005. Whiters is the debtor in a Chapter 7 case filed under case number 04-65856 in the United States Bankruptcy Court for the Northern District of Indiana, Hammond Division. Whiters appeared by counsel in the adversary proceeding and filed his answer to the complaint on January 12, 2005. Following customary pretrial proceedings, trial in case was held to the bench on September 8, 2005.

The Court has jurisdiction over this adversary proceeding pursuant to 28 U.S.C. § 1334(a), 28 U.S.C. § 157(a) and N.D.Ind.L.R. 200.1. This adversary proceeding is a "core proceeding" as defined by 28 U.S.C. § 157(b)(2)(L), and thus this Court has jurisdiction to enter a final judgment on the complaint.

In this case, Bank Calumet seeks a determination that all, or a portion of, its claim against Whiters is excepted from discharge under 11 U.S.C. § 523(a)(4) and 11 U.S.C. § 523(a)(6).

The Court must first address the legal framework on which Bank Calumet must build its case, a relatively easy task with respect to 11 U.S.C. § 523(a)(4), but an extremely difficult and convoluted endeavor with respect to 11 U.S.C. § 523(a)(6).

A. 11 U.S.C. § 523(a)(4)

As applicable to this case, 11 U.S.C. § 523(a)(4) states:

(a) A discharge under section 727 . . . of this title does not discharge an individual debtor from any debt—

(4) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.

As the statue states in straightforward terms, one of three legal theories may be utilized to seek to except a "debt"¹ from discharge: (1) if the debt arose from fraud or defalcation while acting in a fiduciary capacity: or (2) if the debt arose from an act of embezzlement; or (3) if the debt arose from an act of larceny.

The "fiduciary capacity" designated in 11 U.S.C. § 523(a)(4) was defined by the United States Supreme Court long ago. In Davis v. Aetna Acceptance Co., 293 U.S. 328, 55 S.Ct. 151, 153-154, 79 L. Ed. 393 (1934), it was stated (interestingly enough, in a case involving the alleged conversion of a security interest in a motor vehicle):

The respondent contends that, irrespective of willfulness or malice, the petitioner is within the exception declared by subdivision 4; his liability arising, it is said, from his fraud or misappropriation while acting in a fiduciary capacity. The meaning of these words has been fixed by judicial construction for very nearly a century. Chapman v. Forsyth, 2 How. 202, 43 U.S. 202, 11 L. Ed. 236 (1844), decided in 1844, is a decision to the effect that, within the meaning of a like provision in the Act of 1841 (5 Stat. 440), a factor does not act in a fiduciary capacity; the statute "speaks of technical trusts, and not those which the law implies from the contract." 2 How. at page 208, 11 L.Ed. 236. The scope of the exception was to be limited accordingly. Through the intervening years that precept has been applied by this court in varied situations with unbroken continuity. Neal v. Clark, 95 U.S. 704, 24 L. Ed. 586; Hennequin v. Clews, 111 U.S. 676, 682, 4 S. Ct. 576, 28 L. Ed. 565; Noble v. Hammond, 129 U.S. 65, 68, 9 S. Ct. 235, 32 L. Ed. 621; Upshur v. Briscoe, 138 U.S. 365, 11 S. Ct. 313, 34 L. Ed. 931; Crawford v. Burke, supra; Tindle v. Birkett, supra. Cf. Cronan v. Cotting, 104 Mass. 245, 6 Am.Rep. 232; Clair v. Colmes, 245 Mass. 281, 139 N.E. 519. It is not enough that, by the very act of wrongdoing out of which the contested debt arose, the bankrupt has become chargeable as a trustee ex maleficio. He must have been a trustee before the wrong and without reference thereto. In the words of Blatchford, J.: "The language would seem to apply only to a debt created by a person who was already a fiduciary when the debt was created." Upshur v. Briscoe, supra, at page 378 of 138 U.S., 11 S.Ct. 313, 318. Was petitioner a trustee in that strict and narrow sense?

We think plainly he was not, though multiplicity of documents may obscure his relation if the probe is superficial. The only writing at all suggestive of a trust is the one that is characterized as a trust receipt. What effect would be given to it if it stood alone there is no occasion to consider. It does not stand alone, but is a member of a group which must be read with a collective meaning. The note, the chattel mortgage, the trust receipt, and the bill of sale were made at the same time. We must view them all together. Clearly the respondent's only interest in the car was as security for the debt; this is the central fact, the co-ordinating element, that unifies the whole transaction. The bill of sale may seem to make the creditor a purchaser; whatever its recitals, it is a mortgage in another form. Whittemore v. Fisher, 132 Ill. 243, 24 N.E. 636. The trust receipt may state that the debtor holds the car as the property of the creditor; in truth, it is his own property, subject to a lien. Barchard v. Kohn, 157 Ill. 579, 585, 586, 41 N.E. 902, 29 L.R.A. 803. The substance of the transaction is this, and nothing more, that the mortgagor, a debtor, has bound himself by covenant not to sell the mortgaged chattel without the mortgagee's approval. The resulting obligation is not turned into one arising from a trust because the parties to one of the documents have chosen to speak of it as a trust. Cf. In re Butts (D.C.) 120 F. 966, 971; Bloomingdale v. Dreher (C.C.A.) 31 F.2d 93. The relation would be no different if the duty had been stated in terms of covenant alone without descriptive epithet. A mortgagor in possession before condition broken is not a trustee for the mortgagee within the meaning of this statute, though he has charged himself with a duty to keep the security intact. Cf. Ten Eyck v. Craig, 62 N.Y. 406, 422.

In In re Frain, 230 F.3d 1014 (7th Cir.1994), the United States Court of Appeals for the Seventh Circuit has somewhat broadened the concept of "fiduciary capacity" from that described by the Supreme Court in Davis. However, the critical factor is still that a "fiduciary relationship" pre-existed the purported wrong; all Frain does is to state that a fiduciary relationship can arise from other than an express trust, in that case due to the unique relationship among shareholders in a closely-held corporation and the disproportionate power wielded by one of those shareholders in relation to the other two. The circumstance in which a person obtains a loan from a bank and grants the bank a security interest in collateral to secure the loan indebtedness does not create a fiduciary relationship within the meaning of 11 U.S.C. § 523(a)(4).

We next come to the concepts of "embezzlement" and "larceny". The principal distinction between "embezzlement" and "larceny" is the manner in which the debtor came into possession of the property which is alleged to be the subject of the conduct giving rise to either of those wrongs. "Larceny" involves a concept in which the debtor has wrongfully acquired property of which another person or entity is the owner; "embezzlement" is a concept in which the debtor is legally and consensually in possession of property owned by another which the debtor then diverts to purposes in contravention of another's ownership interest. In either case, the critical factor is a debtor's dealing with property of which another person or entity is the owner. As stated in In re Tinkler, 311 B.R. 869, 876-877 (Bankr. D.Colo. 2004):

Section 523(a)(4) provides that "[a] discharge under section 727 . . . of this title does not discharge an individual debtor from any debt . . . for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny." 11 U.S.C. § 523(a)(4).

BCI has specifically declined to take the position that the debt is non-dischargeable on account of fraud or defalcation while acting in a fiduciary capacity. Instead, it claims that Grand Lake's use of the sale proceeds from the rental machines for its own purposes, and its failure to immediately pay over those proceeds to BCI upon sale of those machines, constitutes embezzlement or larceny under § 523(a)(4).

"Larceny is proven for § 523(a)(4) purposes if the debtor has wrongfully and with fraudulent intent taken property from its owner." Kaye v. Rose (In re Rose), 934 F.2d 901, 902 (7th Cir.1991). The key difference between embezzlement and larceny is that "larceny requires that the funds originally come into the Debtor's hands unlawfully." Webber v. Giarratano (In re Giarratano), 299 B.R. 328, 338 (Bankr.D.Del. 2003). Certainly, whatever BCI's rights may be, the proceeds from the sale of the rental snowmobiles came into Grand Lake's hands lawfully. Therefore, Larceny is not at issue.

"For purposes of establishing nondischargeability under section 523(a)(4), embezzlement is defined under federal common law as `the fraudulent appropriation of property by a person to whom such property has been entrusted or into whose hands it has lawfully come.'" Klemens v. Wallace (In re Wallace), 840 F.2d 762, 765 (10th Cir.1988) (citations omitted). "This definition breaks down into five elements: 1. Entrustment (property lawfully obtained originally); 2. Of property; 3. Of another; 4. That is misappropriated (used or consumed for a purpose other than that for which it was entrusted); 5. With fraudulent...