In Re Chavez
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- Before:
- Clark
DECISION ON COMPLAINT TO DETERMINE DISCHARGEABILITY OF DEBT AND DENY DISCHARGE OF DEBTOR
LEIF M. CLARK, Bankruptcy Judge.
CAME ON for hearing the Complaint of the Resolution Trust Corporation to Deter
FACTUAL BACKGROUND
Sun Country Savings Bank of New Mexico, F.S.B. (SCSB) is a federally insured bank which, like many banks in the Southwest, experienced financial difficulties during the period from 1984 to 1986. As a result of these difficulties, the Federal Home Loan Bank Board (FHLBB) assigned a supervisory agent in order to assist SCSB in remaining a viable institution. Regulations issued by the FHLBB placed limits on the amounts SCSB could lend out.
In early 1985, a group of potential investors approached the debtor, as an officer and director of SCSB, communicating a possible interest in purchasing the bank through a premium stock offer of $17.50 per share for the directors’ shares. The debtor expressed an interest in the offer, however, the original investment group fell through. Still enticed by the idea of a change in ownership, the debtor contemplated creating a local group to purchase the bank on similar terms.
In board meetings, the debtor and the other directors decided that they needed to secure greater control of the bank through a smaller group of shareholders. In order to facilitate the smaller shareholder group, the board elected to increase their share of ownership by purchasing authorized unissued stock from SCSB’s reserves and outstanding stock from current shareholders. 1
Pursuant to this plan, the debtor sold over 10,000 of his personal shares to the other members of the board for the premium price of $17.50 per share. After this sale, in order to regain his percentage of control, the debtor purchased 12,258 of the authorized unissued shares for the par value of $8.00 per share and 5000 additional unissued shares at $11.00 per share. The debtor also orchestrated transactions with the other directors for their purchases of SCSB stock. The debtor and the other directors substantially increased their holdings in SCSB through purchases of authorized unissued shares at $8.00 per share and of certain outstanding shares at the premium $17.50 per share.
In order to assist in the purchase of these large numbers of shares, the debtor arranged for loans to the directors from SCSB and from El Paso Federal Savings and Loan Association (El Paso). A loan of $99,998.25 was made to each of the directors from SCSB for the initial purchase of the new shares. 2 Additionally, the debt- or coordinated a series of loans from El Paso to facilitate the purchase of the remaining shares. 3
At the end of all stock transactions, the debtor, the other directors, and the McDowell group had purchased a total of 66,000 shares of the outstanding stock at the premium $17.50 per share. Included among the 66,000 shares sold at the premium were approximately 14,000 owned either’ by the debtor or his family members. Another 62,000 of the authorized but unissued shares were purchased at the par value of $8.00 per share.
The loans that the debtor secured from El Paso eventually matured; however, the directors did not immediately repay the obligations. El Paso indicated to the debtor that the SCSB stock, which had been pledged for the loans, would be foreclosed upon if the directors did not repay the obligation. Fearing that El Paso would gain control over SCSB with the acquisition of the pledged securities, the debtor organized a second series of loans from SCSB to each of the directors for the purpose of retiring the El Paso loans. The loans to the directors totaled over $220,000 each. 6 To acquire these loans, the debtor had the directors sign blank notes which represented their liability to SCSB. The primary loan terms were then filled in after the monies were advanced.
The total amount of the SCSB loans to the directors was insufficient to completely satisfy the liability to El Paso, so the debt- or appropriated $342,406.80 of SCSB funds in order to completely satisfy the debt. The debtor neither filled out any loan applications, nor sought board approval. The El Paso loans were retired, releasing the pledged securities back to the control of the directors.
In July of 1985, pursuant to the representations made by the debtor to the McDowell group, the debtor orchestrated five loans to the group totalling over $500,000. In May of 1985, the FHLBB had issued a supervisory agreement to SCSB which further limited the amount of loans to one borrower, other than directors, to $250,000.
From the period beginning around 1984 to the present, SCSB experienced financial difficulty much like many of the savings institutions in the Southwest. Because of the initial financial distress, the FDIC placed the bank under conservatorship during the time that the debtor was president and CEO. On March 17, 1989, the debtor filed a voluntary petition for protection under Chapter 7 of the Bankruptcy Code. The FDIC consequently filed an adversary proceeding challenging the dischargeability of the debtor’s debts to SCSB on September 26,1989. In May of 1990, the Office of Thrift Supervision appointed the RTC as receiver for SCSB due to the bank’s increasing problems. The RTC is continuing
ISSUES PRESENTED
The issues presently before this court are whether the claims alleged by the RTC for the debts which arose due to the actions of the debtor are nondischargeable under
7.
Dischargeability under
In determining dischargeability questions under
a.
To establish a cause of action under
The debtor made representations to numerous parties which were indeed false. However, to determine liability at this adversarial proceeding, we must ascertain whether or not the debtor actively made false representations to the RTC or FDIC with the specific intent to deceive. In responding to the Cease and Desist Order issued by the FHLBB, the debtor assured them that SCSB would agree not to violate the lending restrictions placed upon them. 7 The evidence offered by the RTC, although compelling, is not sufficient to prove that the debtor made such a representation with the intent to deceive. In fact, the dealings with the McDowell group occurred almost a year prior to the Cease and Desist Order. Therefore, the RTC cannot prove that the debtor made fraudulent statements to the FHLBB concerning the McDowell loans.
The Cease and Desist Order and other supervisory letters from the FHLBB were concerned mostly with loans to Oscar Garcia and his associated businesses. The RTC offered no evidence that the McDowell group was in any way connected with Oscar Garcia. Furthermore, neither the order nor any of the supervisory letters mentioned the McDowell group specifically. Consequently, the intentional element of deception was not shown. In order to prove that the debtor had the intent to deceive, the evidence would have had to have shown that while agreeing not to violate the Cease and Desist Order, the debtor was, at that moment, contemplating or working on a transaction which he knew was a violation of the Cease and Desist prohibitions. The evidence at hand does not establish such intent.
The evidence also does not show that the debtor personally received money because of the representations. The mere fact that a liability arises as a consequence of the false representation is not sufficient on its own.
Rudstrom v. Sheridan,
122 Minn. 262, 142 N.W. 313, 314 (1913). The debtor here did not receive money on account of his representations to the FDIC. In order to show a violation of
The third element of
b.
A “willful and malicious” act, however, does not include acts resulting in a reckless disregard or even gross negligence. See, e.g., In re Compos, 768 F.2d 1155, 1158 (10th Cir.1985); In re Scarlata, 127 B.R. 1004, 1013 (N.D.Ill.1991); In re Guy, 101 B.R. 961, 981 (Bankr.N.D.Ind.1988). Courts have held as reckless disregard an action which involves a high degree of awareness of the probability for injury but which does not necessarily cause such injury. Cf. Seidenstein v. National Medical Enterprises, 769 F.2d 1100, 1104 (5th Cir.1985) (defining “reckless disregard” in defamation cases).
In
Tinker v. Colwell,
the United States Supreme Court defined the standard for “willful and malicious” in bankruptcy cases as including a “wilful [sic] disregard of what one knows to be his duty.”
Tinker v. Colwell,
193 U.S. 473, 487, 24 S.Ct. 505, 509, 48 L.Ed. 754 (1903). Subsequent cases interpreting
Tinker
equated this “willful disregard” with reckless disregard and loosened the “willful and malicious” standard for several years. In 1985, the Tenth Circuit effectively overruled this lightened standard, holding that recent Congressional amendments clearly indicated that “willful” meant deliberate or intentional.
See In re Compos,
768 F.2d 1155, 1157-58 (10th Cir.1985);
see also
H.R.Rep. No. 595, 95th Cong., 1st Sess. 365 (1977),
reprinted in,
1978 U.S.C.C.A.N. 5787, 5963, 6320-21 (indicating that reckless disregard is insufficient for “willful” injury under
The Fifth Circuit breaks down the cause of action for
c.
The test to determine whether the debt created by a fiduciary falls within the exception to discharge of
i. Existence of a Fiduciary Duty
The savings and loan crisis is well known throughout the country at this point in time. The state and federal governments will bear the costs of the losses, as well as the American people in general. An exhor-bitant amount of money will be needed in order to restore the stability in the banking and saving and loan industry. The mismanagement and self-dealing engaged in by many of the officers and directors of these failed institutions directly contributed to their failure.
In 1990, Congress passed the Crime Control Act. Contained within the act, Congress provided for an amendment to the Bankruptcy Code which would affect treatment of the debts incurred by these institution directors.
Section 101(33)(A) defines the term “institution-affiliated party” as that given in section 3(u) of the Federal Deposit Insurance Act.
Combining the two definitions for purposes of
Alternatively, even if
The fiduciary duty under
Prior to the addition of subsection (e) to
New Mexico law considers any corporate director or officer a fiduciary of that corporation.
ii. Definition of “Fraud or Defalcation”
The definition of “fraud” for purposes of 523(a)(4) is the same as fraud with respect to 523(a)(2). See In re Tsamasfyros, 940 F.2d 605, 607 (10th Cir.1991); Black, 787 F.2d at 505. An active misrepresentation must be made to a party which, in turn, relies on that misrepresentation in giving the debtor property or money. In the case at hand, because the debtor did not meet the specific intent requirements for fraud under 523(a)(2), he also does not meet the fraud requirements for 523(a)(4).
While “fraud” is a relatively common legal term having a more steadfast definition, “defalcation” is not. The modern definition of “defalcation,” for bankruptcy purposes, emanates from the case of
Central Hanover Bank & Trust v. Herbst,
93 F.2d 510 (2d Cir.1937). In delivering the opinion for the Second Circuit Court of Appeals, Judge Learned Hand defined “defalcation” as a much broader term than “embezzlement” or “misappropriation.” He premised this statement on the fact that the original section where “defalcation” first appeared, appeared with “embezzlement” and “fraud.” He reasoned that “it
Modern cases interpret Central Hanover’s definition of “defalcation” closely to Judge Hand’s idea. They have upheld the proposition that “defalcation” is a much broader term than misappropriation or fraud. See, e.g., In re Johnson, 691 F.2d 249, 254-55 (6th Cir.1982); In re Reeves, 124 B.R. 5, 8 (Bankr.D.N.H.1990); In re Hirsch, 101 B.R. 364, 366 (Bankr.S.D.Fla.1989); In re Guy, 101 B.R. 961, 984-85 (Bankr.N.D.Ind.1988). The broadening definition lengthens the list of actions constituting a “defalcation” to now include negligent, innocent, ignorant, or simple defaults or actions which breach fiduciary duties. See In re Twitchell, 72 B.R. 431, 434-35 (Bankr.D.Utah 1987), rev’d, 91 B.R. 961 (D.Utah 1988), rev’d, 892 F.2d 86 (10th Cir. 1989).
Hi. Fiduciary Duties
Generally, two duties exist under a fiduciary relationship: the duty of care, and the duty of loyalty. See, e.g., Gearhart Industries, Inc. v. Smith Internat‘l, Inc., 741 F.2d 707, 719 (5th Cir.1984) (dividing the duty of care into duty of care and duty of obedience); Imperial Group (Texas), Inc. v. Scholnick, 709 S.W.2d 358, 363 (Tex.App.—Tyler 1986, writ ref’d n.r.e.). The duty of care involves the director’s diligence and competence in running the corporation. See Gearhart, 741 F.2d at 720-21; McCollum v. Dollar, 213 S.W. 259, 261 (Tex.Comm’n App.1919, holding approved) (establishing reasonable prudent person standard). The duty of loyalty addresses conflicts of interest and prohibits any self-dealing at the expense of the corporation. See Gearhart, 741 F.2d at 719. Combined, they yield the general premise that the director must act solely for the benefit of the corporation, a statement common to trust relationships. See, e.g., Gearhart, 741 F.2d at 719-21; Scholnick, 709 S.W.2d at 362-63; Hughes v. Houston Northwest Medical Center, 680 S.W.2d 838, 843 (Tex.App.—Houston [1st Dist.] 1984, writ ref’d n.r.e.), cert. denied, 474 U.S. 1020, 106 S.Ct. 571, 88 L.Ed.2d 555. Breaches of these duties may arise where the director engages or promotes activities which are detrimental to the corporation. See McCollum, 213 S.W. at 261. Further, a breach may occur where the director seizes an opportunity which the corporation could have profited from. See, e.g., Gearhart, 741 F.2d at 719-20; Scholnick, 709 S.W.2d at 363.
In the present case, the debtor breached both the duty of care and the duty of loyalty. The debtor arranged loans to the other directors and the McDowell group in violation of the federal limitations established by the FHLBB. He approved loans from SCSB knowing that they were to be used to purchase SCSB stock, also in violation of federal regulations. He also extended loans to the McDowell group that he promised to rescind if they decided to get out of certain transactions. Additionally, he appropriated over $300,000 from SCSB’s reserves without authorization. Clearly, the actions of the debtor here do not constitute those of a prudent person acting within a duty of care to a lending institution.
The debtor’s stock transactions also violated his fiduciary duties by seizing the opportunity of SCSB to raise more capital through sales of the unissued stocks at the premium price. Instead, the debtor took the opportunity to sell his own stock at the premium price while replenishing his holdings through purchases of the unissued stock at less than half of his selling price. Such actions clearly constitute self-dealing on the debtor’s part and therefore a breach of his duty of loyalty.
II. Denial of Discharge under
As noted previously, the requirements for discharge are construed generously in favor of the debtor. Any claim for denying discharge therefore, must be “real and substantial.”
In re Burgess,
955 F.2d 134, 137 (1st Cir. Jan. 31, 1992).
In the case at hand, the debtor did not transfer, remove, or destroy any property with the intent to hinder, delay, or defraud SCSB. Further, the RTC offered no evidence that the debtor made any false oaths with the specific intent to defraud SCSB. The debtor did fail to keep a record of the appropriated money at SCSB; however,
A debtor should be granted a discharge unless to do so would be an injustice; it is for this reason that
CONCLUSION
“Bankruptcy courts are inherently courts of equity. It is a well known legal maxim that ‘[h]e who comes into equity must come with clean hands.’ ”
In re Grier,
124 B.R. 229, 234 (Bankr.W.D.Tex.1991) (quoting D. Dobbs, Handbook on the Law of Remedies 45-46 (1973)). The debtor, Raymond D. Chavez, comes to this court seeking to discharge a debt arising from transactions which occurred while acting as a fiduciary at SCSB. In light of the foregoing, the court finds that Raymond Chavez’s conduct amounted to a breach of his fiduciary duties to SCSB and accordingly constituted defalcation while acting as a fiduciary. The court, therefore, orders that pursuant to
All findings may be construed as conclusions and vice versa. All issues shall be deemed disposed. Judgment will be entered consistent with this decision.
Notes
. Prior to 1985, SCSB had increased, the number of shares authorized for sale. This newly authorized stock would retain the same par value as the existing stock, which was $8.00 per share.
. At all times during the debtor‘s transactions, regulations limited the total aggregate amount of loans to directors at $100,000.
. The seven directors borrowed from El Paso the following sums:
1) Raymond Chavez: $312,500;
2) Mary Jane Garcia: $100,000;
3) Vivian Dominguez: $312,500;
4) James Fergason: $312,500;
5) Larry Fields: $312,500;
6) Clarence Fielder: $100,000;
7) Estella Evans: $100,000.
a portion of these loans were used to retire the SCSB loans made for the purchase of the initial new shares.
. The eight people consisted of: E.T. and Claudia LaFore, Mannie Ortiz, Paul Noland, Ralph and Sally Neel, and Jack and Elisa McDowell.
. In fact, one of the eight, Paul Noland, left the deal and surrendered his stock. The debtor cancelled Mr. Noland‘s obligation on the stock loan which totaled $165,534.25. Therefore, the stock which Mr. Noland purchased through the loan for an average price of $12.75, half at $17.50 and half at $8.00, was bought back by SCSB for approximately $14.00 per share.
.A series of three individual loans were made to each director. The individual loans did not exceed $100,000, but the aggregate did.
. The FHLBB issued a Cease and Desist Order in which SCSB was instructed not to make any more loans to an Oscar Garcia or any relation to him. In the response letter, Raymond Chavez represented to the FHLBB that SCSB would no longer loan to Mr. Garcia and that they would conform to all of the mandates issued by the FHLBB. These representations do not constitute the false representations or pretenses as described
supra,
therefore do not constitute violations of