Niles, In re

• Decision Date: 12 February 1997
• Docket Number: No. 95-55968,95-55968
• Citation: 106 F.3d 1456
• Parties: , 37 Collier Bankr.Cas.2d 644, 30 Bankr.Ct.Dec. 453, Bankr. L. Rep. P 77,266, 97 Cal. Daily Op. Serv. 1013, 97 Daily Journal D.A.R. 1496 In re Jeannie NILES, Debtor. Rita G. OTTO, Appellant, v. Jeannie NILES, Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1456

106 F.3d 1456

65 USLW 2583, 37 Collier Bankr.Cas.2d 644,

30 Bankr.Ct.Dec. 453,

Bankr. L. Rep. P 77,266,

97 Cal. Daily Op. Serv. 1013,

97 Daily Journal D.A.R. 1496

In re Jeannie NILES, Debtor Rita G. OTTO, Appellant, v. Jeannie NILES, Appellee.

No. 95-55968.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted Nov. 7, 1996.

Decided Feb. 12, 1997.

Timothy D. Principe, Blackmar, Stevens & Principe, San Diego, CA, for appellant.

William J. Howell, San Diego, CA, for appellee.

Appeal from the United States District Court Southern District of California, Marilyn L. Huff, District Judge, Presiding. D.C. No. CV-94-00020-MLH, Bkcy. No. 92-90977-H7.

Before: FERNANDEZ and HAWKINS, Circuit Judges, and SCHWARZER, ^* Senior District Judge.

SCHWARZER, Senior District Judge:

This appeal calls on us to determine who bears the burden of proof in a nondischargeability proceeding under 11 U.S.C. § 523(a)(4) brought by a creditor alleging "defalcation while acting in a fiduciary capacity." We must also decide whether loans by a client to his real estate agent and not repaid are nondischargeable under § 523(a)(4).

I. FACTUAL AND PROCEDURAL BACKGROUND

Appellant Rita G. Otto and her husband Dr. Evan L. Otto invested their retirement money in real estate, using appellee Jeannie Niles as a broker and property manager. Niles bought and sold property at Dr. Otto's direction. Niles also collected rents and loan payments for the Ottos, secured tenants for their rental properties, and made payments on their behalf for loans, taxes, insurance, and maintenance and cleaning of the properties.

Niles also acted as a property manager for several other people. The funds collected on behalf of all her clients went into the same property management account; the expenses for all the properties she managed were paid out of the same account. Niles also withdrew from this account property management fees of about ten percent of the gross rents received. For the Ottos, as for her other clients, she kept separate ledgers, reflecting their respective balances in the account.

In early 1990, Dr. Otto decided to retire. He asked Niles to inform the Ottos of the status of their real estate holdings and income. Niles told the Ottos that she had borrowed, lost, or misappropriated around $130,000 of their retirement money. The next day Dr. Otto committed suicide.

Mrs. Otto obtained a state court judgment against Niles by stipulation, based on the breach of a settlement agreement that purported to resolve a number of Otto's claims against her. Niles then filed for bankruptcy under Chapter 7, seeking discharge of her debt to Otto. Otto filed an adversary proceeding, contending that Niles' debt was not dischargeable because it resulted from defalcation by a fiduciary.

At the trial in the bankruptcy court, Otto made certain claims arising out of Niles' handling of the property management account: ¹ (1) for an interest payment of $2,600 she allegedly received from one of Otto's borrowers and retained; (2) for four installments of $3,333 on a personal loan she had taken from Otto that were not paid, but that she accounted for as paid in full; (3) for $3,579.60 allegedly taken from an account when Niles changed a positive balance of $2,011.51 to a negative balance of $1,568.09 by enclosing it in parentheses; and (4) for a $7,000 commission to which she was not entitled. The bankruptcy court found these items, aggregating $16,512.93, to be "bookkeeping errors" and dischargeable. The court also found that a check for $8,914 received on behalf of the Ottos and deposited by Niles into her personal account rather than into the property management account, was nondischargeable under § 523(a)(4).

Otto also asserted claims arising out of personal loans by the Ottos to Niles and payment to her of "prepaid commissions." Niles repaid some of these borrowed funds, but continued to borrow more. At the time the bankruptcy petition was filed, Niles owed approximately $49,000 in loans and another $40,000 in "prepaid commissions." Otto contended that the failure to repay these amounts was a defalcation by a fiduciary. The court found them to be dischargeable loans.

The bankruptcy court entered judgment for Otto in the amount of $8,914.59 and the district court affirmed. Otto now appeals. We have jurisdiction under 28 U.S.C. §§ 158(d) and 1291. We review issues of law de novo and findings of fact for clear error. Feder v. Lazar (In re Lazar), 83 F.3d 306, 308 (9th Cir.1996).

II. DISCHARGEABILITY OF CLAIMS RELATING TO THE PROPERTY MANAGEMENT ACCOUNT

A debt is nondischargeable under 11 U.S.C. § 523(a)(4) where "1) an express trust existed, 2) the debt was caused by fraud or defalcation, and 3) the debtor acted as a fiduciary to the creditor at the time the debt was created." Klingman v. Levinson, 831 F.2d 1292, 1295 (7th Cir.1987).

There is no dispute with respect to the first and third elements. The bankruptcy court found--correctly--that Niles was acting as a fiduciary with respect to the property management account and this is not disputed. Because Niles collected rents for the Ottos in her capacity as a licensed real estate broker, Cal.Bus. & Prof.Code § 10131(b) (defining real estate broker), and was required either to pay those funds directly to the Ottos or to hold them in a trust fund account in accordance with the Ottos' instructions, she was the trustee of an express trust. Cal.Bus. & Prof.Code § 10145(a)(1); Batson v. Strehlow, 68 Cal.2d 662, 674, 68 Cal.Rptr. 589, 441 P.2d 101 (1968) ("The law imposes on a real estate agent 'the same obligation of undivided service and loyalty that it imposes on a trustee in favor of his beneficiary.' "); Cal.Civ.Code § 2322(c). Thus, "the fiduciary relationship ... [arose] from an express or technical trust that was imposed before and without reference to the wrongdoing that caused the debt." Lewis v. Scott (In re Lewis), 97 F.3d 1182, 1185 (9th Cir.1996) (citing Ragsdale v. Haller, 780 F.2d 794, 796 (9th Cir.1986)).

It is the remaining element, the occurrence of a defalcation, that poses the problem in this case. Although the bankruptcy court found that a fiduciary relationship existed, it rendered judgment for Niles on all but one claim, finding the only defalcation to have occurred when Niles accepted $8,914 on behalf of the Ottos, then kept the money. The bankruptcy judge found, with respect to the amounts of $7,000 and $9,512.93, that Niles had adequately explained them, that she did not receive the funds, and that they were merely bookkeeping errors. ² The court's oral findings continued:

Mrs. Niles testified the rents went into the trust account, the management account. There's been no rebuttal testimony. The evidence is that she put the money in a trust account and paid the bills. I don't have any evidence to the contrary. I don't have an accountant. I don't have a CPA. I don't have an operator [sic, expert?] coming in saying: "Your Honor, that's not the case. I can tell you--I can show you right now there's a check that didn't go in."

Otto contends that the bankruptcy judge erred in failing to impose the burden on Niles to prove that she complied with her fiduciary duty, i.e., that she did not commit a defalcation. The bankruptcy judge was, of course, entitled to assess the credibility of the witnesses and to accept Niles's testimony while rejecting Otto's. But here the court also rested its decision on gaps in Otto's evidence rather than on preference for Niles' testimony. We thus cannot say that the court's assignment of the burden of proof in this case, if it was error, was harmless. See Battaglia v. United States (In re Battaglia), 653 F.2d 419, 423-24 (9th Cir.1981) (error regarding assignment of burden of proof required reversal where decision rested on gaps in testimony); Larez v. Holcomb, 16 F.3d 1513, 1518 (9th Cir.1994) (errors in assigning burden of proof ordinarily require reversal). We must therefore determine where the burden lies to prove defalcation.

Federal law defines what constitutes a defalcation: it is a "misappropriation of trust funds or money held in any fiduciary capacity; [the] failure to properly account for such funds." Lewis, 97 F.3d at 1186 (quoting Black's Law Dictionary 417 (6th ed. 1990)). Federal law also governs the allocation of the burden of proof to establish nondischargeability. See Grogan v. Garner, 498 U.S. 279, 283-84, 111 S.Ct. 654, 657-58, 112 L.Ed.2d 755 (1991). In Grogan, the Court determined that the language of § 523, as well as its legislative history and its predecessor, 11 U.S.C. § 35 (1976 ed.), are silent with respect to the standard of proof for the discharge exceptions. Id. at 286, 111 S.Ct. at 659. Similarly they are silent on the issue of who has the burden of proof under § 523(a)(4). Compare 11 U.S.C. § 523 with id. § 362(g) (assigning burdens of proof in motion for relief from stay), § 363(o) (assigning burdens of proof in motion for use of property); Bankr.Rule 4005 (assigning burden to creditor objecting to discharge under 11 U.S.C. § 727). Looking to case law, we find few decisions dealing with the issue of allocation of the burden to establish nondischargeability under § 523(a)(4). In Coburn Co. of Beaumont v. Nicholas (In re Nicholas), 956 F.2d 110, 114 (5th Cir.1992), the court, without discussion, stated that "the burden [rests] on the creditor to prove that the debt falls within the § 523(a)(4) exception." In Cappella v. Little (In re Little), 163 B.R. 497 (Bankr.E.D.Mich.1994), however, the court held that under both state and federal law the burden of proof of defalcation rests on the debtor/fiduciary. Cf. Semilof v. Waskew (In re Waskew), 191 B.R. 34, 37-39 (Bankr.S.D.N.Y.1995) (applying state law in imposing burden of production on debtor); Erie Materials, Inc. v. Oot (In re Oot), 112 B.R. 497, 501 (Bankr.N.D.N.Y.1989) (same). ³

In the absence of evidence that, by amending the Bankruptcy Act in 1970 and adopting...