Racetrac Petroleum, Inc. v. Khan (In re Khan)

• Decision Date: 30 December 2011
• Docket Number: Bankruptcy No. 10–15387.No. 1:11cv982.
• Citation: 461 B.R. 343
• Parties: In re Shakeel S. KHAN and Ayesha M. Khan.Racetrac Petroleum, Inc., Plaintiff/Appellant, v. Shakeel S. Khan and Ayesha M. Khan, Defendants/Appellees.
• Court: U.S. District Court — Eastern District of Virginia

461 B.R. 343

In re Shakeel S. KHAN and Ayesha M. Khan.Racetrac Petroleum, Inc., Plaintiff/Appellant,

v.Shakeel S. Khan and Ayesha M. Khan, Defendants/Appellees.

Bankruptcy No. 10–15387.No. 1:11cv982.

United States District Court, E.D. Virginia,Alexandria Division.

Dec. 30, 2011.

Chad Allan Mooney, Paul J. Feinman, Petty Livingston Dawson & Richards, Lynchburg, VA, for Plaintiff/Appellant.

Jeffrey Allan Vogelman, Thomas, Ballenger, Vogelman & Turner, Alexandria, VA, for Defendants/Appellees.

MEMORANDUM OPINION

T.S. ELLIS, III, District Judge.

This is an appeal from a final judgment ¹ issued by the U.S. Bankruptcy Court for the Eastern District of Virginia in an adversary proceeding brought by appellant Racetrac Petroleum, inc. against appellee Shakeel S. Khan, the Chapter 7 debtor. The central question presented on appeal is whether the Bankruptcy Court erred in concluding that Khan's debt to Racetrac was dischargeable, as it was not a debt for “defalcation while acting in a fiduciary capacity[.]” 11 U.S.C. § 523(a)(4). Because this conclusion is incorrect, the judgment of the Bankruptcy Court must be reversed.

I.

The Bankruptcy Court's judgment is based on facts found as a result of an evidentiary hearing and set forth fully in a memorandum opinion issued contemporaneously with that judgment. See Racetrac Petroleum v. Khan (In re Khan), Advers. No. 10–1431, 2011 WL 3320970 (Bankr.E.D.Va. Aug. 1, 2011) (“Mem. Op.”). On appeal, the parties do not dispute the Bankruptcy Court's factual findings, which may be succinctly summarized as follows.

Khan is a resident of Virginia and husband of Ayesha M. Khan, who remains a party in the Chapter 7 proceedings, but has been voluntarily dismissed from the adversary proceeding. Racetrac owns and operates stores that sell convenience merchandise and gasoline (“Racetrac stores”). Racetrac is the parent company of Raceway, which owns and operates a separate group of stores displaying the Raceway brand (“Raceway stores”). Operators of Racetrac stores are Racetrac employees; by contrast, operators of Raceway stores are independent contractors. Each Raceway and Racetrac store consists of a gasoline filling station and a convenience store. All gasoline sold at Raceway stores is owned and supplied by Racetrac.

Prior to the initiation of bankruptcy proceedings, Khan contracted with Racetrac to operate a Raceway store in Roanoke Rapids, North Carolina (the “Roanoke Rapids store”). Events leading to the contract began on May 24, 2007, when Khan submitted an application to Racetrac for an operator position at a Raceway store. Racetrac promptly approved Khan's application. On July 3, 2007, Khan and Racetrac executed a Gasoline Services Agreement (“GSA”) that, inter alia, set forth Khan's duties as the operator of the Roanoke Rapids store. With respect to convenience goods sales, the GSA provided that Khan would be required to maintain a minimum stock but would be entitled to all net profits of those sales.

The GSA was more detailed with respect to gasoline sales. Specifically, the GSA provided that “[t]itle to the proceeds of all sales by [Khan] of gasoline (‘Racetrac funds') shall at all times be vested in and belong to Racetrac [.]” GSA § 5(A). The GSA further provided that Khan would sell only Racetrac gasoline, which at all limes until sold would remain the property of Racetrac, not Khan, and that “any possession and control” of gasoline sales proceeds by Khan “shall be as trustee and agent for the use and benefit of Racetrac, and [Khan] shall not use Racetrac Funds for purchases, operating expenses or otherwise.” Id. Through the GSA. the parties thus agreed that Khan would not own proceeds from sales of Racetrac gasoline, but instead would keep those proceeds for Racetrac's benefit. In this respect, the GSA provided that “[Khan] acknowledges that [he] owes a duly of trust to Racetrac in the collection and safe keeping of all funds collected for such sales of fuel, and acknowledges that [he] is serving in a fiduciary relationship with Racetrac.” Id.

Consistent with the GSA, the parties agreed to a practice wherein all proceeds that Khan collected from gasoline sales would be deposited in a bank account from which Racetrac could make regular withdrawals or “sweeps” to collect those proceeds. Specifically, proceeds from the sales of both convenience goods and gasoline would be deposited in real time into a single bank account established in the name of “M–Mart” and accessible by Khan and Racetrac (the “Account”). This arrangement enabled customers wishing to purchase gasoline and convenience goods simultaneously to do so in a single credit or debit transaction without re-swiping their cards. Pursuant to this agreed practice, Racetrac on a daily basis would receive a report of that day's total gasoline sales and then sweep the Account for the amount of those sales minus 3.5 cents per gallon sold, which Khan would keep as a service fee. In other words, for every gallon of Racetrac gasoline that Khan sold at the Roanoke Rapids store, Racetrac would be entitled to the per-gallon price set by Racetrac less a 3.5 cent service fee for Khan that would remain in the Account. In sum, Khan owned proceeds from convenience goods sales (plus the service fee), while Racetrac owned proceeds from gasoline sales (less the service fee).²

Khan began operating the Roanoke Rapids store in September 2007. At that time, Khan was not yet prepared to move from Virginia to North Carolina, Thus, with Racetrac's permission, Khan arranged to have his brother, Adeel Khan, operate the store on a daily basis in Khan's absence. Adeel Khan operated the store without incident until May 2008. After Racetrac's May 14, 2008 attempted sweep of the Account was unsuccessful owing to insufficient funds in the account, a Racetrac representative visited the store to confront Adeel Khan concerning the $4,151.68 deficiency and, as a result, received a certified check from Adeel Khan in that amount.

Barely two weeks later, events occurred that gave rise to the instant adverse action. After Memorial Day weekend 2008, Racetrac discovered that (i) the store had closed for business, (ii) many gasoline purchases made before the closing had not been properly recorded, and (iii) some unidentified person had transferred a total of $164,000 out of the Account during May 25–29, 2008. ³ Based on records, Racetrac determined that $256,807.13 in gasoline sales proceeds attributable to that weekend had gone missing. To this day, attempts to locale Adeel Khan and the missing proceeds have been unsuccessful. ⁴

On June 25, 2010, Khan and his wife filed a joint petition for bankruptcy pursuant to Chapter 7 of the Bankruptcy Code, 11 U.S.C. §§ 701 et seq. Racetrac filed this adversary proceeding on October 3, 2010 seeking a determination that Khan's debt to Racetrac in the amount of the missing gasoline proceeds was not dischargeable on the grounds that, infer alia, the debt was for (i) a defalcation while acting in a fiduciary capacity under 11 U.S.C. § 523(a)(4), and (ii) a willful and malicious injury by Khan to Racetrac's property under 11 U.S.C. § 523(a)(6). After an evidentiary hearing and post-trial briefing, the Bankruptcy Court concluded that because the GSA “did not evidence an intent to create a trust,” the fiduciary defalcation exception did not render Khan's debt to Racetrac non-dischargeable. Mem. Op. 12–13. The Bankruptcy Court apparently found it significant, if not dispositive, that the proceeds from convenience goods sales and gasoline sales were comingled in a single bank account, and that neither the GSA nor any other agreement required that gasoline sales proceeds be segregated from convenience goods sales proceeds. See Mem. Op. 11–13. The Bankruptcy Court then entered judgment in favor of Khan. See Racetrac Petroleum v. Khan (In re Khan), Advers. No, 10–1431 (Bankr. E.D.Va. Aug. 1, 2011) (Judgment). This appeal followed. The matter has been fully briefed and argued, and is now ripe for disposition.

II.

At issue on appeal is whether the Bankruptcy Court was correct in concluding that Khan's debt to Racetrac was not a debt for “defalcation while acting in a fiduciary capacity” and therefore did not fall within this exception to dischargeability. 11 U.S.C. § 523(a)(4). Whether Khan acted “in a fiduciary capacity” with respect to the gasoline sales proceeds is an issue of federal law that presents “a question of statutory interpretation reviewed de novo on appeal,” ⁵ The Fourth Circuit has not “elaborate[d] on the question” of “the proper contours of the term ‘fiduciary’ as used in § 523(a)(4),” but it has recognized that the creation of an express trust under state law “is clearly sufficient to establish a fiduciary relationship for the purposes of § 523(a)(4).” Kubota Tractor Corp. v. Strack (In re Strack), 524 F.3d 493, 497 n. 6 (4th Cir.2008). In this respect, because “the creation of an express trust can give rise to the requisite fiduciary duty under § 523(a)(4).” federal law instructs seeking “guidance” from the pertinent state law governing express trusts. Id. at 498. In other words, if a debtor has acted as a trustee under state law with respect to properly out of which a debt arises, then the debtor will also have acted in a fiduciary capacity under federal law with respect to the debt. Thus, whether Khan's debt to Racetrac falls within the federal-law fiduciary-defalcation exception turns on whether the facts—essentially undisputed here ⁶—establish the creation of a state-law express trust.

At the threshold, the parties dispute which state's law concerning creation of express trusts should be consulted. Racetrac argues that the GSA explicitly requires the application of Georgia law; Khan responds that because Racetrac did not raise the choice-of-law issue below, the argument must be considered waived for purposes of this appeal.⁷ The Bankruptcy Court's heavy reliance on Strack, which applied...