In re Zoldan

• Decision Date: 06 April 1998
• Docket Number: Adversary No. 96-5201A.,Bankruptcy No. 96 B 20879(ASH)
• Citation: 221 BR 79
• Parties: In re Alex Mayard ZOLDAN, Debtor. Robert ZOHLMAN, Plaintiff, v. Alex Mayard ZOLDAN, Defendant.
• Court: U.S. Bankruptcy Court — Southern District of New York

221 B.R. 79 (1998)

In re Alex Mayard ZOLDAN, Debtor Robert ZOHLMAN, Plaintiff, v. Alex Mayard ZOLDAN, Defendant.

Bankruptcy No. 96 B 20879(ASH), Adversary No. 96-5201A.

United States Bankruptcy Court, S.D. New York.

April 6, 1998.

COPYRIGHT MATERIAL OMITTED

Hershman & Leicher, P.C., by Harold M. Hershman, New York City, for Plaintiff.

Jeffrey L. Sapir, White Plains, NY, for Defendant-Debtor.

DECISION ON DISCHARGEABILITY UNDER 11 U.S.C. § 523(a)(4)

ADLAI S. HARDIN, Jr., Bankruptcy Judge.

On October 13, 1992 a judgment was entered in the Supreme Court of the State of New York, County of Westchester, in the amount of $304,371.78 in favor of the plaintiff in this adversary proceeding, Robert Zohlman ("Zohlman"), against defendant/debtor, Alex Mayard Zoldan ("Zoldan"). Together with statutory interest, the judgment indebtedness is approximately $414,000. On May 8, 1996 Zoldan filed a petition under Chapter 7 in this Court. Zohlman timely commenced this adversary proceeding seeking a determination that the judgment indebtedness is non-dischargeable under 11 U.S.C. § 523(a)(4). The Court has jurisdiction pursuant to 28 U.S.C. §§ 1334(a) and 157(a). This is a core proceeding under 28 U.S.C. § 157(b)(2)(I). The following are the Court's findings of fact and conclusions of law after trial under Bankruptcy Rule 7052.

Background

Zoldan and Zohlman executed an Amended and Restated Certificate of Limited Partnership and an Amended and Restated Agreement of Limited Partnership of New City Associates each dated as of May 27, 1981. New City Associates (the "Partnership") was organized to acquire, renovate and operate an existing office building located at 120 North Main Street, New City, New York (the "Office Building"). Zoldan was the sole general partner of the Partnership. Zohlman was one of six limited partners, having by far the largest limited partnership interest. Article THIRTEENTH of the Partnership Agreement provided in paragraph A that the general partner, Zoldan, "shall devote such time to the business affairs of the Partnership as shall be necessary to insure the efficient management thereof," but that Zoldan was not entitled to salary or other compensation for his services as general partner. However, paragraph B of Article THIRTEENTH, enumerating the powers of the general partner, authorized Zoldan to hire himself or any affiliate of his as "Managing Agent" of the Office Building for an annual fee not to exceed four percent of the gross income of the Building and an initial rent-up supervisory fee of $25,000. In accordance with this provision, Zoldan hired himself as Managing Agent of the Office Building and acted in that capacity at all relevant times.

The Partnership acquired, renovated, leased out and operated the Office Building, which was sold in 1987, apparently at a profit to the investors.

At some point prior to or in connection with the sale of the Office Building, Zoldan and Zohlman had a falling out. Zohlman commenced the state court action against Zoldan in the form of a "special proceeding" for an accounting, to which Zoldan consented. By order of reference dated January 15, 1988, Justice Harold L. Wood appointed Herman Geist, Esq. as Referee pursuant to Civil Practice Law and Rules § 4311 to "supervise the auditing and examination of the books and records" of the Partnership. The Referee submitted a Report of Referee dated March 30, 1992 (the "Referee's Report" or "Report").

The Referee's Report focused on fifteen specific items, lettered "A" through "O," aggregating $502,766 which were in dispute between the parties as a consequence of the examination of the Partnership books and records covering the nearly six years from 1981 through 1987. The Report set forth the Referee's conclusions with respect to each of the fifteen items, resulting in surcharges against Zoldan in the aggregate sum of $421,185. Certain credits to Zoldan resulted in a net surcharge of $289,021. The Referee's Report was approved by Justice Wood, who signed the judgment entered October 13, 1992 in the amount of $304,371.78 including interest, costs and disbursements.

Section 523(a)(4); Contentions of the Parties

Section 523(a)(4) of the Bankruptcy Code provides that a discharge under Section 727 does not discharge an individual debtor from any debt

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

There is no claim that Zoldan committed any act of embezzlement or larceny giving rise to the state court judgment. Nor is there any contention that the judgment was based upon fraud or that Zoldan committed fraud in connection with any of the transactions giving rise to the judgment.

Accordingly, Zohlman's claim for non-dischargeability under Section 523(a)(4) is based upon the language "defalcation while acting in a fiduciary capacity." The parties differ sharply on the statutory interpretation to be accorded the words "defalcation" and "fiduciary." Zohlman contends that the relationship between partners in New York is that of fiduciaries with respect to each other by reason of Section 43 of the New York Partnership Law ("NYPL"), from which premise he asserts that all funds of the Partnership were trust funds. Zohlman argues further that "defalcation" under Section 523(a)(4) means "any failure, innocent or otherwise, by a fiduciary to account for, or pay over, trust funds."

Zoldan argues that NYPL § 43 does not create an express or technical trust, but merely a trust ex maleficio, which is not a fiduciary relationship within the meaning of Section 523(a)(4). Further, Zoldan asserts that the contract in question, at least in its relevant provisions, is simply an ordinary commercial contract for the management of property, namely the Office Building, and that the terms of the Partnership Agreement are fundamentally inconsistent with the type of fiduciary relationship contemplated by Section 523(a)(4). Zoldan argues that the term "defalcation" connotes some element of misconduct or wrongdoing and that no such element can be found in the Referee's Report, the state court order and judgment approving it or at the trial in this Court.

Governing Legal Principles

The discharge in bankruptcy

Initially, it is important to take stock of the importance of the issue before this Court. The discharge of debts or "fresh start" is undoubtedly the philosophical and practical centerpiece of the Bankruptcy Code. In one of the earliest Supreme Court decisions dealing with the Bankruptcy Act, Justice Day remarked that the systems of bankruptcy are designed to relieve the honest debtor from the weight of indebtedness which has become oppressive, and to permit him to have a fresh start in business or commercial life, freed from the obligations and responsibilities which may have resulted from business misfortunes. Wetmore v. Markoe, 196 U.S. 68, 77, 25 S.Ct. 172, 176, 49 L.Ed. 390, 394 (1904). Again in 1934 the Supreme Court said:

This purpose of the act has been again and again emphasized by the courts as being of public as well as private interest, in that it gives to the honest but unfortunate debtor who surrenders for distribution the property which he owns at the time of bankruptcy, a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt. The various provisions of the bankruptcy act were adopted in light of that view and are to be construed when reasonably possible in harmony with it so as to effectuate the general purpose and policy of the act.

Local Loan Co. v. Hunt, 292 U.S. 234, 244-45, 54 S.Ct. 695, 699, 78 L.Ed. 1230, 1235-36 (1934) (internal citations omitted) (emphasis in original). Congress reiterated this viewpoint when it passed the Bankruptcy Reform Act in 1978, commenting that discharge is "the heart of the fresh start provisions of the bankruptcy law." Matter of Martonak, 67 B.R. 727, 728 (Bankr.S.D.N.Y.1986) (quoting 11 U.S.C. § 727 H.R. no. 595, 95th Cong., 1st Sess. 384 (1977); S.R. No. 989, 95th Cong., 2d Sess. 98 (1978), U.S.Code Cong. & Admin. News 1978, pp. 5787, 5884, 5963, 6340).

It follows that non-dischargeability is "perceived to be a punitive exception to the `fresh start' policy and should be found reluctantly." Matter of Martonak, 67 B.R. at 728 (citing In re Huff, 1 B.R. 354, 357 (Bankr.D.Utah 1979); Gleason v. Thaw, 236 U.S. 558, 35 S.Ct. 287, 59 L.Ed. 717 (1915)); accord In re Harron, 31 B.R. 466, 468 (Bankr.D.Conn.1983). The courts have repeatedly stressed that the Section 523(a) exceptions to discharge must be strictly construed to comport with the "fresh start" philosophy underlying the Bankruptcy Code. In re Hunter, 780 F.2d 1577, 1579 (11th Cir.1986) ("Because of the very nature and philosophy of the Bankruptcy law the exceptions to dischargeability are to be construed strictly"); Household Finance Corp. v. Danns (In re Danns), 558 F.2d 114, 116 (2d Cir.1977) (interpreting Section 17(a), the predecessor of Section 523) ("exceptions to discharge are to be narrowly construed"); Nat'l Union Fire Ins. Co. of Pittsburgh, Pa. (In re Bonnanzio), 91 F.3d 296, 300 (2d Cir.1996); Shearson Lehman Hutton, Inc. v. Schulman (In re Schulman), 196 B.R. 688, 693 (Bankr.S.D.N.Y.1996); Kuper v. Spar (In re Spar), 176 B.R. 321, 326 (Bankr. S.D.N.Y.1994) ("To meet the goals intended under the Code, exceptions to discharge must be strictly and literally construed against the creditor and liberally construed in favor of the honest debtor"); Hudson Valley Water Resources, Inc. v. Boice (In re Boice), 149 B.R. 40, 43 (Bankr.S.D.N.Y.1992) ("Exceptions to dischargeability are construed strictly against the creditor and liberally in favor of the debtor to accomplish bankruptcy's `fresh start' goal"); Smith v. Meyers (In re Schwartz & Meyers), 130 B.R. 416, 421 (Bankr.S.D.N.Y.1991); In re Materetsky, 28 B.R. 499, 501 (Bankr. S.D.N.Y.1983); Boyle v. Abilene Lumber, Inc. (Matter of Boyle), 819 F.2d...