492 B.R. 274
9th Cir. BAP2013Background
- Harold Pemstein sued his brother Martin Pemstein in state court for disputes over the HMS Properties partnership and related entities.
- The state court issued a 2005 Decision primarily ordering dissolution of the entities; in 2010 Harold obtained a money judgment against Martin for $696,218.03 for breach of fiduciary duties in rent collection, with $295,871 principal and $400,347.03 interest.
- The 2010 Judgment found breach of Martin's duty of care in collecting rent; Harold appealed the judgment via a post-2009 trial posture that preceded bankruptcy filings.
- Martin and Diana Pemstein filed Chapter 11; Harold filed an adversary proceeding seeking nondischargeability under § 523(a)(4) based on alleged fiduciary breaches related to partnership duties.
- bankruptcy court denied Harold’s § 523(a)(4) claim; Harold appealed, arguing that defalcation does not require actual receipt of funds and that issue preclusion may apply; the panel reversed and remanded in light of Bullock.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether § 523(a)(4) defalcation requires actual receipt of funds. | Pemstein: defalcation includes failure to account for funds; need not prove receipt. | Pemstein: defalcation limited to funds actually received and misaccounted. | No; defalcation is broader than mere receipt. |
| Whether the 2010 State Court Judgment can support issue preclusion in the bankruptcy case. | Pemstein: state‑court findings on fiduciary duties may preclude relitigation. | Pemstein: preclusion not available due to narrow defalcation scope. | Remand for full issue preclusion analysis consistent with the defalcation standard. |
| What is the appropriate mental-state standard for defalcation under § 523(a)(4) after Bullock? | Pemstein: no Bullock consideration at this stage; defalcation sufficient with broader standard. | Pemstein: standard unclear; may require heightened intent under Bullock on remand. | Remand to consider Bullock’s heightened standard. |
Key Cases Cited
- Ragsdale v. Haller, 780 F.2d 794 (9th Cir. 1986) (fiduciary relationship requisite for § 523(a)(4) applies in dischargeability)
- In re Lewis, 97 F.3d 1182 (9th Cir. 1996) (defalcation includes failure to account, not limited to misappropriation)
- In re Niles, 106 F.3d 1456 (9th Cir. 1997) (agency must account for funds received by principal)
- In re Hemmeter, 242 F.3d 1186 (9th Cir. 2001) (defalcation contours not fully defined; broader than simple misappropriation)
- Davis v. Aetna Acceptance Co., 293 U.S. 328 (1934) (defalcation is not limited to conversion; involves fiduciary breach of accounting)