LaPointe Ex Rel. Brown & LaPointe Development, Inc. v. Brown (In Re Brown)LaPointe Ex Rel. Brown & LaPointe Development, Inc. v. Brown (In Re Brown)
MEMORANDUM OF DECISION
Bеfore the court is the verified complaint of Normand R. LaPointe (“LaPointe”), on behalf of Brown & LaPointe Development, Inc. (“B & L”), 1 seeking to establish that debts owed to B & L by the debtor, Jack R. Brown (“Brown”), are non-dischargeable pursuant to 11 U.S.C. § 523(a)(4).
This is a core proceeding over which this court has jurisdiction under 28 U.S.C. § 157(b)(2)(I). This memorandum sets forth the court’s findings of fact and conclusions of law. 2
Findings of Fact
LaPointe and Brown have been acquaintances for over twenty years. Beforе 1988, Brown sold real estate, managed apartments, built homes, and sold small equip
In June 1988, Brown and LaPointe agreed to purchase and develop real estate known as Mudgett Hill in Vassalboro, Maine. Although they commenced the venture before incorporating, B & L was formed to carry out the project. Initially they intended to construct two residential homes, and, after their sale, to invest the return in additional building and development activities. The two agreed that, ultimately, B & L’s profits would be divided evenly between them.
Brown and LaPointe agreed that B & L would purchase construction materials and supplies from LaPointe’s lumber yard. Brown contributed approximately $10,-000.00 as start-up capital. LaPointe, whose credit was essentiаl to obtaining bank financing, contributed no cash to the venture, but agreed to guaranty B & L’s bank loans. LaPointe made it clear that he had no time for involvement with the business’s day-to-day operations. Brown was given complete operational control. He secured the required permits, supervised construction and kept the corporate books.
B & L obtained a $250,000.00 line of crеdit commitment from Augusta Federal Savings Bank (“Augusta Federal”). The credit line, to be used exclusively for B & L’s activities, was secured by a mortgage on the Mudgett Hill property. On September 23, 1988, the bank funded the line of credit. Brown was B & L’s contact with Augusta Federal. He and his wife had signing authority for corporate checks and, at Brown’s direction, either of them could request bank drafts or fund transfers to the B & L checking account. Thus, Brown was entrusted to hold and manage B & L’s business assets and to utilize them and B & L’s credit fund to carry out corporate activities.
During the period that B & L undertook the Mudgett Hill development, Brown's other business commitments strained his personal finances. He completed his Stevens Road residence late in 1987 and was building a second house on the adjacent lot. His obligation to LaPointe for purchase of the Stevens Road parcel was not yet satisfied; he and his wife were exрanding a floral business; and he undertook renovations of several rental properties he owned.
In March of 1989 Augusta Federal authorized a $50,000.00 increase to the B & L line of credit. 4 At about the same time, B & L purchased property located on Hunt Road in Vassalboro. It established a $100,-000.00 line of credit and a business checking account with Fleet Bank (“Fleet”) to finance acquisition and development of the Hunt Road property.
From the corporation’s checking accounts funded by the lines of credit Brown regularly wrote checks for a variety of expenses. Some related directly to B & L’s development activities. Many did not. Brown regularly applied funds drawn from the lines of credit, through the corporate checking accounts at Augusta Federal
5
In addition, during the course of Mud-gett Hill construction, Brown engaged in kick-back schemes with two contractors, Peter Brown and Bob Burns, diverting corporate funds to his own account. He also took for himself a total of $1,658.81 paid by John Nored for wood cut and removed from the Mudgett Hill property; paid himself salary from B & L’s funds; and, having failed to remit withholding taxes, left B & L with $4,830.85 in tax liabilities.
Although the facts of the transactions are uncontested, Brown defends claiming
Conclusions of Law
1. The Legal Standard.
At issue is whether Brown is obligated to B & L as a consequence of his use, or misuse, of corporate assets and, if so, whether the obligations are excepted from discharge by § 523(a)(4), which provides that debts “for fraud or defalcation while acting in a fiduciary сapacity, embezzlement, or larceny ...” will not be discharged. The determinative issue is whether Brown’s conduct constituted “defalcation in a fiduciary capacity.” 7
a. Burden of Proof.
B & L must prove the elements of a § 523(a) exception to discharge by a preponderance of the evidence.
Grogan v. Garner,
— U.S. -,
b. Defalcation.
The concept of “defalcation” is broad. Under § 523(a)(4), it comprehends the slightest misconduct, negligence or ignorance; it does not require intentional wrongdoing.
In re Reeves,
c.Fiduciary Capacity.
Although the notion of defalcation is expansive, embracing innocent cоnduct, § 523(a)(4)’s discharge exception is narrowly limited by the requirement that the defalcation take place “in a fiduciary capacity.”
See In re Gans,
The classic notion of a fiduciary is that of one who undertakes to act disinterestеdly, in his beneficiary’s best interest.
In re Waning,
A fiduciary relationship within the meaning of underlying state or federal law is necessary to create “fiduciary capacity” for purposes of § 523(a)(4),
In re Lane,
As the sole, active officer of B & L, Brown, who agreed to keep the books of the corporation, to administer the line of credit and to manage the checking accounts, was entrusted with B & L’s assets. Among Brown, LaPointe and B & L, the intent to create a trust relationship was clear. Brown undertook to use the corporation’s resources solely for advancement of the corporation’s interests, not for personal gain. Given Brown’s unfettered control of and access to its assets, his relationship to B & L was in substance no different than that of a trustee to its trust, a guardian to its ward. 9
2. Applying the Standard.
a. Personal Expenses.
Brown is liable to the corporation for the debts he incurred when he appropriated corporate assets to pay personal expenses. The obligations result from defalcations while acting in a fiduciary capacity and are therefore excepted from discharge under § 523(a)(4). It is without import that Brown may somehow have believed he had the “authority” to pay such expenses with corporate funds, that he may have intended to repay the corporation at a future time, or that LaPointe may have had the opportunity to discover and to object to Brown’s actiоns. Defalcation exists where a debtor has misapplied property or funds entrusted to him, even under a mistaken belief that he was authorized to do so.
In re Burgess,
Brown’s explanations and justifications for his actions are, for the most part, unbelievable. That B & L, a corporation without cash flow, would authorize Brown not only to draw a salary, but also to use its funds to complete construction of his personal residence, to pay his home and car loans, to pay his credit cards and to provide cash for undefined “travel” expenses, strains credulity too far. 10
b. Kick-Back Payments.
At Brown’s insistence, Peter Brown and Bob Burns Construction, contractors working at Mudgett Hill, inflated their bills to B & L. Bob Burns Construction added $1,000.00 in labor costs to its invoice. B & L paid the “corrected” invoice in full. About one week later, Bob Burns wrote a check to Brown for $1,000.00 on account of the “overpayment.”
Jack Brown also requested that Peter Brown mark up his invoices. After receiving $21,000.00 in payment of inflated bills, Peter Brown wrote checks back to Jack Brown. Brown admits that he wrongfully obtained at least $9,000.00 of corporate funds in this fashion.
Such conduct clearly amounts to defalcation while acting in a fiduciary capacity. The resulting $10,000.00 obligation will not be discharged.
c. Nored Checks.
Brown also appropriated $1,658.81 paid to him by John Nored for wood cut and removed from corporate lands. He acknowledged that, after clearing property, Nored tеndered checks to him in payment for the wood he removed. Brown claimed he cashed Nored’s checks and paid one-half of the proceeds to La-Pointe. LaPointe denies receiving the money. The court discredits Brown’s version of events and finds that Brown kept this money, rightfully the corporation’s, and put it to his own uses. The debt will not be discharged. 12
d. Office Rental.
Brown paid $1,125.00 to Riverside Floral, a business he and his wife owned, ostensibly to rent an office on the premises for B & L. There were only two such payments. 13 The court finds there was no bona fide office lease, let alone an authorized lease. The “rental” payments represent yet another abuse of Brown’s fiduciary position to appropriate the funds entrusted to his case. The debt will not be discharged.
e. Salary.
B & L asserts that Brown paid himself an unauthorized salary from corporate funds. Brown testified that he understood he was authorized to take a salary as compensation for managing corporate activities, including the developments on Mudgett Hill and Hunt Road.
With few exceptions, Brown drew a weekly salary from the corporation from the outset.
14
Initially B & L paid him $500.00 weekly. Brown later increased his gross salary to $650.00, so that he netted
As the active managing principal of B & L, Brown was authorized to receive salary payments at a rеasonable level. LaPointe has not contended that the amount B & L paid Brown as salary was unreasonable and has introduced no evidence to show that the value of Brown’s services was less than he was paid. Moreover, LaPointe and B & L permitted Brown to continue to take a salary for a period after they came to suspect kick-backs and personal expense payments, thus eliminating any argument that authority to take a salary terminated prior to the last regular salary check Brown took. 17
After May 25, 1989, corporate checks written to Brown issued irregularly, in widely varying amounts, 18 and were drawn against Fleet, rather than Augusta Federal. Brown could only say that the post-May 25 checks were for “salary or personal expenses.” By May 25, LaPointе clearly had made known his dissatisfaction with Brown’s activities and any previously granted authority to take a salary was revoked. Brown’s change in salary payment practices from May 25 forward evidence his knowledge that a salary was no longer authorized and his intention to circumvent the prohibition. Such action constitutes defalcation while acting in a fiduciary capacity.
Thus, although Brown has no obligation to repay the $17,974.43 in salary he drew prior to May 25, 1989, he is obligated, and shall remain obligated, to repay the $3,875.00 he drew from the Fleet account from that date forward.
f. Withholding Taxes.
From twenty-seven salary checks Brown caused B & L to “withhold” $4,069.17 against state and federal tax liabilities. Although the withholdings were “booked,” funds were never set aside. As a consequence, B & L owed taxing authorities at least $4,069.17 in payroll taxes when LaPointе took over. 19
At issue here is not the dischargeability of Brown’s personal liability for unpaid withholding taxes.
Cf. In re Coleman,
There is no direct evidence whether funds were available to make the withhold-ings at the time liability accrued. However, because the corporation continued to expend funds throughout the relevant period, one must conclude that it had the ability to fund its withholding tax obligations. Brown simply failed to set the money aside.
Although it has been held that a corporate offiсer’s failure to withhold and pay taxes constitutes a debt for defalcation while acting in a fiduciary capacity,
20
such
B & L must ultimately deal with its withholding tax liabilities. Brown must repay the funds he misappropriated to his own ends. But even assuming Brown’s failure to pay the taxes leads to his personal liability to the corporation, the record does not sustain the conclusion that Brown should be denied a discharge of that liability.
B & L is entitlеd to judgment against Brown for the following amounts:
1. Personal Expenses Paid With Corporate Funds: $37,132.25
2. Kick-Back Payments 10,000.00
3. Nored Payments 1,658.81
4. Office Rental 1,125.00
5. Unauthorized Salary 3,875.00
$53,791.06
Brown’s $53,791.06 debt to B & L is excepted from discharge pursuant to 11 U.S.C. § 523(a)(4).
Judgment will be entered accordingly.
Notes
. See F.R.Bankr.P. 7023.1. This memorandum treats B & L as the plaintiff.
. See F.R.Bankr.P. 7052.
. LaPointe financed the sale without a mortgage or other security.
. LaPointe was informed of and agreed to the increase.
.B & L asserts that Brown drew the following checks on the corporate account at Augusta Federal to pay personal expenses:
Check # Amount Payee
AFSB Account
106 682.45 Hussey Hardware
107 1,519.82 Zimba, Co.
108 3,000.00 Jerry Chase
115 1.422.00 Currier Shelving
119 645.00 Waterworks
120 450.00 Riverside Floral
124 130.90 Mobil Oil
125 363.32 Central Plate Glass
129 1,222.35 AFSB
144 148.20 Mobil Oil
146 250.00 J. Brown
148 158.00 Priscilla Brown
149 978.34 AFSB
170 185.25 Servicemaster
184 500.00 Cash (travel)
199 675.00 Riverside
203 184.15 Gold Card
204 159.30 Mobil Oil
215 140.00 J. Brown
272 327.80 GMAC
287 327.80 GMAC
297 118.97 Mobil Oil
. B & L alleges that the following payments were drawn on the corporate account at Fleet to pay for Brown’s personal expenses.
Check # Amount Payee
Fleet Bank Account
1,000.00 Dan Bailey
439.87 Hydro-Repair Inc.
105 481.27 Maine Instrument Flight School
107 935.50 Small’s Truck Service
111 800.00 Carl Cote
113 151.29 Basket Buys
118 1,000.00 Williston Mosher
120 320.05 Clark Marine
125 186.24 Northeast
128 1,500.00 Williston Mosher
129 22.31 Williston Mosher
137 119.00 Genesis Landscaping
136 80.00 Bill Perry
141 21.37 CMP
. Section 523(a)(4)’s alternative grounds for nondischargeability, "larceny" and “embezzlement,” are satisfied, as well, with regard to at least one transaction. See infra n. 12.
.
See Rosenthal v. Rosenthal,
.
Cf. In re Cross,
The lower courts did not consider whether § 17(a)(4) also requires that the bankrupt owe a fiduciary duty to the claimant that exists prior to and independent of the alleged misconduct, as would be the case where a corporation seeks to hold its оwn bankrupt officer accountable for his misappropriation or defalcations of corporate funds (i.e., whether § 17(a)(4) applies to officers only when their corporation or other fiduciary beneficiary is the claimant.) (Emphasis added.)
Not every breach of fiduciary duty constitutes defalcation "while acting in a fiduciary capacity" for purposes of § 523.
See In re Hammond,
.Brown attempts to explain away some of the payments by arguing that, once the line of credit was funded, he could recover the working capital he previously paid in to the corporation. The assertion is belied, among other things, by
.The total is comprised of the sum of the Augusta Federal checks (less checks numbered 120 and 199 — office rent) set forth supra n. 3; the sum of Fleet Bank checks listed supra n. 4; and bank draft payments for Stevens Road excavation work (O.D. Lee); Stevens Road electrical work (D.W. Brown); Stevens Road plumbing (J. Boivin); Stevens Road concrete (Williams Construction); and for reimbursement of Stevens Road insulation expenses.
. The timber оn corporate lands was a portion of the assets entrusted to Brown. Appropriating Nored’s stumpage payment also constituted “embezzlement” within the meaning of § 523(a)(4).
See, e.g., In re Littleton,
. See checks 120 ($450.00), 129 ($675.00), supra n. 5.
. The following Augusta Federal checks evidence weekly salary payments to Brown:
Date Check No. Amount
07/28/88 104 $500.00
08/05/88 109 500.00
08/12/88 110 500.00
08/18/88 116 500.00
08/28/88 118 $500.00
08/31/88 121 500.00
09/08/88 123 500.00
09/16/88 132 500.00
09/30/88 138 500.00
10/08/88 147 497.69
10/13/88 154 497.69
10/21/88 155 497.69
10/28/88 159 497.69
11/04/88 163 499.29
11/09/88 179 499.29
11/19/88 185 499.29
11/25/88 195 499.29
11/30/88 202 499.29
12/09/88 209 499.29
12/16/88 220 499.29
12/22/88 222 499.29
12/29/88 223 499.29
02/04/89 252 499.29
02/10/89 254 499.29
03/10/89 268 499.29
03/17/89 271 499.29
03/24/89 277 499.29
03/30/89 281 499.29
04/07/89 284 499.29
04/07/89 285 499.29
04/21/89 288 499.29
04/29/89 289 499.29
05/06/89 294 499.29
05/09/89 295 499.29
05/10/89 302 499.29
05/25/89 303 499.29
$17,974.43
. Brown testified that the following checks written on the corporation’s account at Fleet were for salary or persоnal expenses:
Date Check No. Amount
05/25/89 103 $ 250.00
06/01/89 106 300.00
06/16/89 115 1,500.00
06/21/89 117 200.00
06/28/89 119 100.00
07/21/89 126 150.00
07/28/89 127 100.00
08/11/89 132 100.00
08/16/89 133 100.00
08/22/89 134 100.00
08/24/89 135 200.00
08/29/89 138 75.00
09/01/89 139 250.00
09/08/89 142 200.00
09/15/89 144 250.00
$3,875.00
. The upshot of one meeting, held at LaPointe’s lumber yard office, was Brown’s assurance that he would “take care of things” and LaPointe's agreement to leave him in office.
. Cf. Restatement (Second) of Agency § 112 (termination of authority upon serious breach of loyalty or acquisition of adverse interest.)
. See n. 15 supra.
. The $4,069.17 figure is the total of withhold-ings booked but never made. Additionаl tax obligations likely accrued when salary was paid to Brown without even acknowledging the obligation to withhold. See text at nn. 14-15, supra and 26 U.S.C. §§ 3102(a); 3401 et seq.
.See In re Twitchell,
. Of course, Brown’s failures may have caused B & L to owe additional amounts in interest and penalties. However, there is no evidence as to what, if any, increase in tax liability B & L faced as a result of delayed payment.
. Indeed, to the extent that wrongful expenditures of corporate funds were the reason that B & L's taxes went unpaid, to deny a discharge on account of the unpaid taxes could lead to double recovery.