568 B.R. 299
Bankr. W.D. Wis.2017Background
- Hebl and Windeshausen became 50/50 members of an LLC operating a bar; they were also romantically involved and lived together for ~3.5 years. Each had equal signatory authority and access to books and records.
- Hebl alleged Windeshausen diverted substantial LLC funds to his personal use and to his sole-owned construction company, Kaizen; she sued in state court for breach of contract and conversion and obtained an arbitration award of $310,000 (award did not specify grounds or itemize amounts).
- Windeshausen filed chapter 7 bankruptcy; Hebl filed an adversary complaint seeking a determination that the arbitration award (debt) is nondischargeable under 11 U.S.C. § 523(a)(4).
- At trial, evidence showed Windeshausen had draws totaling $191,625.08 (2007–2010); Hebl’s deposits over a similar period totaled about $49,800 and she received cash/loans from family and made payments to buy out the prior member.
- Court found no express/technical trust (no fiduciary under § 523(a)(4)), and Hebl failed to prove embezzlement or larceny (no unlawful initial taking, no proven fraudulent intent, and insufficient proof of amount owed).
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether Windeshausen acted in a fiduciary capacity (§ 523(a)(4) trust/defalcation) | Hebl: LLC membership duties and division of labor created fiduciary obligations making any misappropriation nondischargeable | Windeshausen: Members were coequals with equal access and authority; no express or technical trust existed | Court: No fiduciary capacity—no express/technical trust under federal law; § 523(a)(4) fiduciary exception not met |
| Whether Windeshausen embezzled or committed larceny under § 523(a)(4) | Hebl: Defendant fraudulently appropriated funds entrusted to him and converted them for personal use | Windeshausen: As co-owner with lawful withdrawal rights and Hebl’s acquiescence, funds were not unlawfully taken; some withdrawals paid joint living expenses or business-related costs | Court: No embezzlement/larceny—initial possession was lawful, Hebl acquiesced for years, and fraudulent intent/intentional wrong not proven |
| Existence and amount of a nondischargeable debt | Hebl: Arbitration award reflects a debt for misappropriated funds (roughly $310,000); her summaries of bank flows support amount | Windeshausen: Arbitration award lacks factual basis and Hebl’s summaries lack supporting documents; actual reconciliations show different numbers | Court: Plaintiff failed to prove amount by preponderance; arbitration award lacked statement of basis and Hebl’s calculations were unsupported; at best difference in draws ~ $28,327 but not proven as nondischargeable debt |
| Whether arbitration award is nondischargeable | Hebl: Award entered in state arbitration should be excepted from discharge under § 523(a)(4) | Windeshausen: Bankruptcy law requires proof of trust/embezzlement and amount; arbitration award alone is insufficient | Court: Award is dischargeable—Hebl failed to meet burden under § 523(a)(4) on fiduciary status, embezzlement/larceny, and amount |
Key Cases Cited
- In re Weber, 892 F.2d 534 (7th Cir. 1989) (defines embezzlement under § 523(a)(4) as fraudulent appropriation by one to whom property was entrusted)
- Estate of Cora v. Jahrling (In re Jahrling), 816 F.3d 921 (7th Cir. 2016) (fiduciary-capacity requirements for § 523(a)(4) claims)
- O’Shea v. Frain (In re Frain), 230 F.3d 1014 (7th Cir. 2000) (federal-law definition of fiduciary for § 523(a)(4): inequality of knowledge/power)
- In re Marchiando, 13 F.3d 1111 (7th Cir. 1994) (requires substantial inequality in power for § 523(a)(4) fiduciary finding)
- In re Woldman, 92 F.3d 546 (7th Cir. 1996) (§ 523(a)(4) reaches only narrow fiduciary obligations, not nominal trusts arising after wrongdoing)
- Grogan v. Garner, 498 U.S. 279 (1991) (plaintiff must prove nondischargeability by a preponderance of the evidence)