In re: John Emil Alle and Mary Reilly Alle
CC-16-1412-LTaKu
9th Cir. BAPSep 29, 2017Background
- In 2006 John and Mary Alle, Earl and Starla Gales, and Robert and Lois Oppenheim formed Shadow Mountain Properties, LLC (SMP) to buy and operate a 12-unit rental property; each couple held one‑third; Alle was the managing member under the operating agreement (OA).
- Plaintiffs (Gales and Oppenheim) contributed $400,000 each (total $800,000); HFT carried back an $800,000 loan; Alle had authority over day‑to‑day management, accounting, bank withdrawals, and was required by the OA to provide monthly reports, bank statements, and distributions.
- From 2009–2011 SMP suffered cash‑flow problems; Alle stopped providing regular financial reports and distributions, and bank records showed withdrawals and expenditures that appeared to benefit Alle personally.
- A notice of default and subsequent foreclosure by HFT occurred in late 2011; Plaintiffs later sued in state court for breach, fiduciary duty, fraud, conversion, and accounting; the Alles filed chapter 7 just before trial and Plaintiffs brought an adversary seeking nondischargeability under 11 U.S.C. § 523(a)(4) (defalcation and embezzlement) and § 523(a)(2)(A) (fraud).
- The bankruptcy court granted summary judgment for Plaintiffs on § 523(a)(4) defalcation and embezzlement, awarded $800,000 plus fees; the BAP affirmed that a qualifying trust and fiduciary relationship existed but reversed and remanded because the bankruptcy court failed to find the requisite mental state and causation for defalcation, and misapplied damages for embezzlement/defalcation.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether a qualifying fiduciary/trust relationship existed under § 523(a)(4) | OA and Cal. law made Alle a fiduciary (managing member) and created a trust res (property/profits) | Alle disputed scope of res but conceded manager role | Held: Qualifying trust existed under California law and Alle was a fiduciary (AFFIRMED) |
| Whether debt was nondischargeable for defalcation under § 523(a)(4) | Alle’s failure to account and alleged misappropriation caused Plaintiffs’ $800,000 loss | Alle argued no requisite culpable state of mind and causation not proven | Held: Bankruptcy court erred — it did not find the required intent (knowledge/gross recklessness) nor adequately connect breaches to Plaintiffs’ damages; summary judgment on defalcation VACATED/REMANDED |
| Whether debt was nondischargeable for embezzlement under § 523(a)(4) | Misappropriation of SMP funds = embezzlement supporting $800,000 award | Embezzlement damages should be limited to value of misappropriated funds, not initial investment | Held: Grant of summary judgment on embezzlement was erroneous as to damages; $800,000 award unsupported (REVERSED/REMANDED) |
| Whether $800,000 (initial investment) was proper damages measure | Plaintiffs sought $800,000 as full nondischargeable recovery | Alle argued damages measure was incorrect; only misapplied trust res should be nondischargeable | Held: Bankruptcy court failed to make findings on proper damages measure under California law; remanded to determine correct damages |
Key Cases Cited
- Bullock v. BankChampaign, N.A., 133 S. Ct. 1754 (2013) (defalcation requires culpable mental state: knowledge or gross recklessness)
- Ragsdale v. Haller, 780 F.2d 794 (9th Cir. 1986) (partners are trustees over partnership assets for § 523(a)(4) purposes)
- Lewis v. Scott (In re Lewis), 97 F.3d 1182 (9th Cir. 1996) (defalcation includes misappropriation or failure to account by fiduciary)
- Otto v. Niles (In re Niles), 106 F.3d 1456 (9th Cir. 1997) (burden shifts to fiduciary to account fully once entrustment shown)
- Bigelow v. Stephens (In re Bigelow), 271 B.R. 178 (9th Cir. BAP 2001) (elements for defalcation under § 523(a)(4))