573 B.R. 13
Bankr. D. Mass.2017Background
- Lisa (Elizabeth) Reed and David Zak entered a loan-modification venture in 2009; Zak incorporated Loan Modification Group, Inc. (LMG) and also controlled Zak Law Offices, P.C. (ZLO).
- Reed supplied client lists, agents, and operations; she and Zak agreed to split profits 50/50 and Reed received payments (often through nominees) from the business.
- Reed was expelled from LMG in January 2010; litigation followed: Reed won a jury verdict against LMG for partnership profits (affirmed by the First Circuit), and she later sued Zak alleging transfers of LMG assets to ZLO to defeat her partnership claim.
- The Commonwealth of Massachusetts sued Zak, resulting in a final judgment, penalties, restitution, and findings that Zak controlled LMG/ZLO and personally participated in unlawful practices; Zak was later disbarred.
- In Zak’s bankruptcy adversary, Reed sought nondischargeability under 11 U.S.C. § 523(a)(2)(A), (a)(4), (a)(6); the bankruptcy court found (based on trial evidence and judicially noticed state/federal decisions) that Zak was the alter ego of LMG, personally liable for conversion/defalcation of Reed’s partnership profits.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Personal liability / veil piercing | Reed: Zak was de facto partner/alter ego of LMG and must be held personally liable for partnership profits and transfers to ZLO | Zak: No personal liability; he was not a partner and did not foresee later consequences of transfers | Court: Pierced LMG’s veil; Zak was alter ego/partner and personally liable for partnership profits owed to Reed |
| § 523(a)(4) — fiduciary/defalcation | Reed: As partner Zak had fiduciary duties; his diversion of partnership profits was defalcation while acting in a fiduciary capacity | Zak: Business justification for winding down LMG; no fiduciary defalcation by him personally | Court: Partners are fiduciaries; Zak breached fiduciary duty (defalcation under Bullock) — debt ($324,000) nondischargeable under § 523(a)(4) |
| § 523(a)(6) — willful & malicious injury (conversion) | Reed: Zak intentionally and wrongfully exercised control over Reed’s partnership profits and deprived her of them | Zak: Actions were business-driven (regulatory exposure) not intended to injure Reed | Court: Zak willfully and maliciously converted Reed’s share (intentional dominion and wrongful deprivation) — debt nondischargeable under § 523(a)(6) |
| § 523(a)(2)(A) — actual fraud / fraudulent conveyance | Reed: Transfers of LMG assets/revenues to ZLO were fraudulent conveyances and constitute actual fraud under Husky — debt traceable to fraud | Zak: Transfers were part of wind-down; could not have intended later events; no actual-fraud debt traceable to him personally | Court: Reed proved fraud/transfer scheme and veil-piercing facts but failed to trace specific fraud proceeds to Zak personally for § 523(a)(2)(A); claim not proven |
Key Cases Cited
- Bullock v. BankChampaign, N.A., 569 U.S. 267 (U.S. 2013) (defalcation requires intent or conscious disregard; reckless conduct can qualify)
- Kawaauhau v. Geiger, 523 U.S. 57 (U.S. 1998) (§ 523(a)(6) requires actual intent to cause injury; reckless or negligent injuries not covered)
- Husky Int’l Elecs., Inc. v. Ritz, 136 S. Ct. 1581 (U.S. 2016) (actual fraud under § 523(a)(2)(A) can include participation in fraudulent transfers; recipient of transfers may obtain assets by fraud)
- Loan Modification Group, Inc. v. Reed, 694 F.3d 145 (1st Cir. 2012) (jury and appellate findings: partnership existed between Reed and LMG; expelled partner entitled to share of profits)
- Morley v. Ontos, Inc. (In re Ontos, Inc.), 478 F.3d 427 (1st Cir. 2007) (piercing corporate veil/alter-ego doctrine under Massachusetts law)