The Schmock Living Trust Dated December 7, 2020 v. SpauldingThe Schmock Living Trust Dated December 7, 2020 v. Spaulding
On September 17, 2025, Craig A. Spaulding (“Defendant“) filed a voluntary Chapter 13 petition. On December 10, The Schmock Living Trust Dated December 7, 2020 (“Plaintiff“), filed a Complaint against Defendant seeking a determination that a debt owed to Plaintiff based on Defendant‘s personal guaranty of a note is nondischargeable.
The matter before the Court is Defendant‘s Motion to Dismiss the Complaint (“Motion“).
FACTS
The Complaint seeks a determination of nondischargeability of a debt under
Plaintiff is a trust. Tracy Schmock (“Schmock“) is its trustee. Defendant is not a trustee of Plaintiff. He was the sole director and officer of Spaulding Restaurant Enterprises, Inc. (the “Corporation“).2
In April 2024, the Plaintiff and Corporation entered into a loan and Note.3 Defendant personally guaranteed the Note.
The Note provided:
- Maturity. Unless otherwise accelerated by the terms of this Note, the principal amount of this Note and all accrued but unpaid interest shall be due and payable on or before April 1, 2034 (the ”Maturity Date“).
- Payments; Manner of Payment. Beginning on May 1, 2024, and continuing on the first (1st) day of each month thereafter through and including the Maturity Date, the Company shall make payments of interest only (the ”Interest Only Payments“). The principal amount of this Note shall be paid on or before the Maturity Date. All payments of principal and interest on this Note shall be made in lawful money of the United States of America by immediately available funds to such place as Purchaser shall designate to the Company. If any payment of principal or interest is due on a day which is not a business day in the State of Wisconsin, such payment shall be due on the next succeeding business day.
- Additional Interest Payments. In addition to the Interest Only Payments described above, the Company shall pay to the Purchaser annual payments equal to seven percent (7%) (the ”NOI Interest Rate“) of the Company‘s Annual Normalized Net Operating Income for each calendar year during which any principal amounts are outstanding under this Note (the ”NOI Payments“); provided, however, the aggregate amount of the
Interest Rate plus the NOI Interest Rate for any calendar year during which principal and interest under this Note is outstanding shall not exceed Twenty-five Percent (25%) of the then outstanding principal balance measured as of the last day of the applicable year, and such limitation shall be prorated for any partial year. ”Annual Normalized Net Operating Income” means Operating Income less Operating Expenses, as each is calculated on an annual basis using the preceding twelve (12) months, where ”Operating Income” means (i) all gross income received from or attributable to food and beverages sales made in connection with the Company‘s restaurant and catering business during the twelve (12) month period preceding the date of determination, and ”Operating Expenses” mean the amount equal to the sum of all costs related to the operation of the business of the Company during the twelve (12) month period preceding the date of determination, including, but not limited to, a normalized manager‘s salary for a person with equivalent skill and experience in the Madison, Wisconsin, area used for Craig Spaulding‘s management services, a normalized amount for depreciation of assets, and other items related to the operation of the Company, such as food and beverage costs, equipment costs, employment wages, and benefits for the Company‘s employees, sales taxes, employment taxes, rent, and earnout payments, each as determined in the Company‘s reasonable discretion. The Company shall make the NOI Payments to the Purchaser within ninety (90) days after the end of each calendar year.
Plaintiff became a shareholder in the Corporation in about April 2024. Defendant was an existing shareholder and the sole director and officer of the Corporation.
The Corporation defaulted on the Note. In April 2025, Plaintiff sent a letter to the Corporation notifying it of the default, acceleration of the Note, and right to collect upon Defendant‘s personal guaranty.4
Plaintiff moved for summary judgment against Defendant and for default judgment against the Corporation.7 The next day, Defendant filed his Chapter 13 petition. Plaintiff‘s motion for summary judgment against Defendant in state court is stayed. Plaintiff obtained a default judgment (“Judgment“) against the Corporation on October 7. The Judgment totaled $262,487.01.8
The Plaintiff‘s claims under section 523(a)(4) are:
- Defendant committed defalcation while acting in a fiduciary capacity; or
- the debt is the result of embezzlement by Defendant.
Defendant moves to dismiss this adversary proceeding. In support, Defendant says the Complaint fails to state a claim upon which relief can be granted against Defendant for embezzlement. And that the Complaint fails to state a claim upon which relief can be granted for defalcation while acting in a fiduciary capacity.9
I. Jurisdiction
This Court has jurisdiction under
II. The Complaint Must Satisfy Rule 7012(b)(6) to Survive a Motion to Dismiss.
A defense to a complaint is that it “fail[s] to state a claim upon which relief can be granted.”
When considering a
To survive a motion to dismiss, a complaint must pass a two-step inquiry. Iqbal, 556 U.S. at 678-79. First, a “complaint must describe the claim in enough detail to give the defendant fair notice of its nature.” Krook, 615 B.R. at 483 (citing Cornielsen v. Infinium Cap. Mgmt., LLC, 916 F.3d 589, 598 (7th Cir. 2019)). A complaint attacked by a
Second, a complaint must provide “enough facts to state a claim to relief that is plausible on its face.” Id. at 570. “A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Iqbal, 556 U.S. at 678. The plausibility standard asks for more than a “sheer possibility” that a defendant has acted unlawfully. Id. As noted by the Seventh Circuit, “courts must accept a plaintiff‘s factual allegations as true, but some factual allegations will be so sketchy or implausible that they fail to provide sufficient notice to defendants of the plaintiff‘s claim.” Brooks v. Ross, 578 F.3d 574, 581 (7th Cir. 2009).
Generally, the Court cannot look beyond the pleadings in ruling on a
Here, the Court must determine what allegations are necessary to show recovery is plausible under
The Complaint does not satisfy the requirements to survive a
III. Nondischargeability - 11 U.S.C. § 523(a)(4)
A. Defalcation While Acting In a Fiduciary Capacity
To state a claim for fraud or defalcation in a fiduciary capacity, the Plaintiff must allege that (1) a fiduciary relationship existed between the debtor and creditor at the time the debt was created, and (2) that the debt owed was caused by fraud or defalcation committed in the course of that fiduciary relationship. Wians, 523 B.R. at 130 (citing Follett Higher Educ. Grp., Inc. v. Berman (In re Berman), 629 F.3d 761, 766 (7th Cir. 2011)). To find a debt is nondischargeable under
The Complaint alleges Defendant committed defalcation while acting as a fiduciary.10 “‘[A] fiduciary relationship under state law in a corporate context does not a ‘fiduciary’ under
A plaintiff must show, by a preponderance of the evidence, that an express trust or a fiduciary relationship exists and that a debt was caused by the debtor‘s fraud or defalcation. Id. (citations omitted). For the purposes of
Thus, three elements are required to be established by a preponderance of the evidence:
- the existence of a trust;
- the debtor was a fiduciary of that trust when the debt was created; and
- the debt was created by defalcation.
Amundson v. Slaton (In re Slaton), 469 B.R. 814, 820 (Bankr. W.D. Wis. 2012); Hellenbrand Glass, LLC v. Pulvermacher (In re Pulvermacher), 567 B.R. 881, 886 (Bankr. W.D. Wis. 2017) (citing Baytherm Insulation, Inc. v. Carlson (In re Carlson), 456 B.R. 391, 395 (Bankr. E.D. Wis. 2011)).
Plaintiff reasons there was a breach of fiduciary duty under
The Court addresses each element in turn.
The existence of an express trust is a question of federal law. “An express or technical trust requires an explicit declaration of trust, a clearly defined trust res, and an intent to create a trust. Constructive, resulting, and implied trusts do not fall with the confines of
There is no express trust here. There are no claims that Defendant was a trustee of Plaintiff or that he was a fiduciary of the Plaintiff Trust.
The Corporation is a Wisconsin corporation. It is not a trust. Nor is there any claim that the Corporation held any fiduciary relationship with the Plaintiff and Plaintiff is not suing the Corporation. So, no express trust has been pled.
The Complaint attaches the Note.12 The Note does not create or identify the existence of a fiduciary relationship. It contains a personal guaranty provision.13 A plain reading of its provisions does not establish a fiduciary relationship between the parties. Nor does it demonstrate an intent to create a trust.
The nature of the parties’ transaction was funds in exchange for a loan to the Corporation. While the Complaint refers to an investment to acquire shares, an investment does not generally create a trust. Neither does a loan.
2. Implied fiduciary relationship
There is no written agreement evidencing a fiduciary relationship, so Plaintiff resorts to arguing there is an implied fiduciary relationship. In other words, that “a technical trust relationship may be created by state statute or common law doctrines that impose trust-like obligations on a party sufficient to render the debtor a fiduciary within the meaning of
Plaintiff appears to argue that the mere shareholder relationship created a trust-like relationship for the purpose of paying the Note. But
The Seventh Circuit has found fiduciary relationships under certain circumstances. As observed by the court in In re McGee, a city ordinance which required security deposits to be separate from other funds, as well as a disparity in power governing those funds, constituted an “economic relation” that imposed fiduciary obligations under
A subset of fiduciary relationships that fall under
These situations are “characterized by disparities in the knowledge or economic status of the participants, the fiduciary having the superior status and/or knowledge to the defrauded creditor victim.” Zamora v. Jacobs (In re Jacobs), 403 B.R. 565, 575 (Bankr. N.D. Ill. 2009) (citing McGee, 353 F.3d at 540). Relationships such as “a lawyer-client relationship, a director-shareholder relationship, and a managing partner-limited partner relationship all require [a] principal to ‘repose a special confidence in the fiduciary.‘” Deady v. Hanson (In re Hanson), 432 B.R. 758, 774 (Bankr. N.D. Ill. 2010), aff‘d, 470 B.R. 808 (N.D. Ill. 2012) (quoting Marchiando, 13 F.3d at 1116).
But the fiduciary obligation must exist before the alleged wrongdoing. Id. Because the obligation must exist prior to the wrongdoing, a “constructive trust . . . will not qualify for purpose of
Defendant, on the other hand, contends Plaintiff does not properly allege Defendant acted in a fiduciary capacity with regard to Plaintiff as a creditor (emphasis added).17 Defendant maintains that Plaintiff has failed to show a “separate and distinct injury from other members” of the Corporation that would give rise to a direct claim against Defendant rather than a derivative claim against the Corporation.18
The Complaint does not show any “separate and distinct injury” from any of the other creditors of the Corporation that would give rise to a direct claim against the Defendant. Flynn v. Merrick, 881 F.2d 446, 449 (7th Cir. 1989). And the Complaint does not claim there was a fiduciary relationship between the Plaintiff and Defendant at the time the guaranty was signed. The apparent
Moreover, even if there were a fiduciary relationship, it did not exist before the debt that is the subject of this adversary proceeding was incurred. The debt was created in April 2024. The acts complained of were:
- no access to records and accounts from April 2024 to February 2025;
- no payment to Plaintiff on or after March 1, 2025;
- closure of the Corporation‘s restaurant after February 2025;
- using funds of the Corporation in December 2024 to pay for car, cell phone, and credit card bills; and
- withdrawals of cash from the Corporation‘s Accounts.19
The Complaint contains no allegation that Plaintiff requested or was denied access to records or accounts. The failure to make a payment to the Plaintiff on the Note does not evidence anything more than failure to pay a debt to a creditor. Businesses fail. In this case, the Corporation eventually closed the restaurant. Allegations of failure of a business that owed money to a creditor do not, as set out in the Complaint, state factual allegations of a breach of a fiduciary duty.
While the alleged breach of Defendant using corporate funds for personal benefit might have resulted in reduced recovery by Plaintiff as a judgment
At best, for officers and directors to have a fiduciary duty to creditors, a corporation must be both insolvent and no longer a going concern. Beloit Liquidating Tr. v. Grade, 2004 WI 39, ¶ 42, 270 Wis. 2d 356, 383, 677 N.W.2d 298, 311. The Complaint does not allege the Corporation was insolvent and no longer a going concern while Defendant was the director and officer of the Corporation. Nor, more to the point, that it was at the time the debt was incurred in April 2024. To the contrary, six payments were made to Plaintiff after the Loan was made.
A superior knowledge of day-to-day operations is not sufficient to establish a position of ascendancy under a disparate knowledge/status approach. Frain, 230 F.3d at 1017. While a substantial concentration of power under the corporation‘s internal structure may create a fiduciary duty under
The Complaint alleges Defendant had sole access, control, signing authority and use of the corporate bank accounts. It says Plaintiff held a 20% shareholder interest in the Corporation. Taken as true, this could suggest unequal status. There is, however, no assertion that Plaintiff was denied access to information after requesting it. Nor is there a claim that it was unequal status that created the debt to Plaintiff.
The Complaint asserts a fiduciary relationship exists under Wisconsin corporate law. It alleges Defendant, as president of the Corporation, had a fiduciary duty to use corporate assets to pay the debts of the Corporation, including the Note.20 Under a state law approach, fiduciary duties may have arisen after Plaintiff became a stockholder in the Corporation. But that does not mean there were any fiduciary duties owed to Plaintiff at the time the debt was created or that imposed a trust on corporate assets giving rise to Plaintiff‘s claim as a creditor.
If it did, an extension of that theory would suggest that all revenue of a company is a trust to be used solely to pay creditors. Further, that every owner of a business is required to maintain good financial records as a type of fiduciary obligation to creditors or other owners.
While a fiduciary relationship may arise under state law, this does not automatically create a fiduciary relationship under federal bankruptcy law. It is
Without more, Defendant‘s alleged position as president of the Corporation does not create the formality or intent necessary to show a fiduciary relationship for the purposes of
3. Defalcation
“Defalcation” occurs when a party misappropriates funds held in trust for another in a fiduciary capacity and fails to properly account for such funds. “Defalcation has also been defined as ‘a failure to account for money or property that has been entrusted to another.‘” Wians, 523 B.R. at 130 (citing Hanson, 432 B.R. at 775); Green v. Pawlinski (In re Pawlinski), 170 B.R. 380, 389 (Bankr. N.D. Ill. 1994).
The Supreme Court has held that a finding of defalcation under
To establish a claim for defalcation, the plaintiff must establish that (1) the debtor acted as a fiduciary to the creditor at the time the debt was created, and (2) the debt was caused by fraud or defalcation. Berman, 629 F.3d at 766. Fraud for purposes of
An objective standard is used to determine defalcation. Pawlinski, 170 B.R. at 389. Mere negligence is not defalcation. Meyer v. Rigdon, 36 F.3d 1375, 1382-85 (7th Cir. 1994). Hence, to establish that a debt is nondischargeable for reason of fraud or defalcation while acting in a fiduciary capacity, the creditor must establish, by a preponderance of the evidence, the existence of an express trust or a fiduciary relationship and a debt caused by the debtor‘s defalcation. Grogan v. Garner, 498 U.S. 279, 291 (1991); Woldman, 92 F.3d at 547.
No debt was caused by Defendant‘s defalcation. If taken as true, the allegations fail to satisfy the requirement of stating a claim. The debt existed on April 10, 2024. The Corporation made six payments to Plaintiff on the Note between May 2024 and February 2025.21 Thus, the debt that is evidenced by the Note existed in April 2024.
The actions complained of by Plaintiff related to Defendant‘s payment of personal obligations like a cell phone, food or transportation, and withdrawal of funds from the Corporation. Those acts were not acts creating a debt to Plaintiff. They occurred after the debt was created and after various payments had been made to Plaintiff.
Additionally, the Complaint insufficiently pleads defalcation. “Defalcation” pertains to a failure to produce funds entrusted to a fiduciary. 4
The Complaint does not allege particular facts that show “a culpable state of mind” to prove Defendant committed defalcation. The Complaint does not detail knowledge of improper behavior or gross recklessness with respect to any fiduciary duty. The Complaint posits Defendant‘s failure to maintain any corporate accounting records was likely an effort to conceal his misappropriation.22 This allegation is conclusory. Mere conclusory allegations are insufficient. Plaintiff cannot survive a 12(b)(6) motion by simply reciting labels, conclusions, or formulaic elements of a cause of action. Plaintiff does not provide specific facts as to Defendant‘s state of mind during the alleged wrongdoing.
B. Embezzlement - 11 U.S.C. § 523(a)(4)
The Plaintiff argues, in the alternative, that the debt owed under Defendant‘s guaranty is nondischargeable as an embezzlement. The term “embezzlement” in the Bankruptcy Code is a federal law concept. So federal law, not state law, controls its meaning in
Embezzlement is the “fraudulent appropriation of property by a person to whom such property has been entrusted or into whose hands it has lawfully come.” In re Weber, 892 F.2d 534, 538 (7th Cir. 1989) (quoting Moore v. United States, 160 U.S. 268, 269 (1895)). The elements of embezzlement are: (1) property of another lawfully originally obtained by a person; (2) that is misappropriated, used or consumed for a purpose other than what it was entrusted; and (3) with fraudulent intent. Bombardier Capital, Inc. v. Tinkler (In re Tinkler), 311 B.R. 869, 876 (Bankr. D. Colo. 2004); First Delaware Life Ins. Co. v. Wada (In re Wada), 210 B.R. 572, 576 (B.A.P. 9th Cir. 1997).
Plaintiff argues Defendant took funds that were in the possession of the Corporation, and the use of those funds was the equivalent of a fraud. Further that those funds were Plaintiff‘s property.
In this situation, courts have recognized an additional element, particularly where standing is at issue: that the property owned by another is rightfully in the possession of the defendant. Cox v. Corona (In re Corona), 657 B.R. 554, 565 (Bankr. N.D. Ga. 2024). “Standing to bring an embezzlement claim under
The Complaint does not plausibly allege that Plaintiff owned the property Defendant allegedly embezzled. Money came into the hands of the Corporation from its business operations and business transactions. Taken as true, the Complaint alleges that funds from the Corporation then came into the hands of Defendant over a period of time. Thus, there is no allegation that Defendant used funds belonging to the Plaintiff. Instead, on its face the Plaintiff simply says that Defendant used funds of the Corporation and, instead, should have paid a debt.
Plaintiff conflates its status as a creditor and that of a shareholder. It seeks payment of unpaid amounts under the Note and guaranty. Its theory is
There is not a claim belonging to Plaintiff. That claim, if any, would belong to the owner of the funds - the Corporation. Plaintiff has not asserted a claim on behalf of the Corporation and all its creditors. It simply assumes that it owned the receipts of the Corporation and so it should have been paid on its Note. Based on that assumption, Plaintiff theorizes the use of corporate funds by Defendant must be a theft of Plaintiff‘s money. Taken to its logical conclusion, it would mean that all creditors could assert claims for embezzlement of a corporation‘s funds if the manager of a corporation received any compensation when the creditor was not paid.
It is undisputed there was a loan and that Plaintiff was a shareholder in the Corporation. The Complaint states Plaintiff had a 20% shareholder interest in exchange for a $200,000 investment in the Corporation. Plaintiff may have had an interest in the Corporation. That simply represents a stake in the business - its profits and equity, if any.
Further, the Plaintiff‘s funds were not entrusted to the Defendant for a specified purpose. See Brady v. McAllister (In re Brady), 101 F.3d 1165, 1173 (6th Cir. 1996). The money was loaned to the Corporation to be used in its business. The loan was made in April 2024. The business was operating at the time and bringing in some revenue. It was also, as is the case with any restaurant, incurring expenses.
Plaintiff says the funds should not have been paid to or on behalf of Defendant. It merely complains the Plaintiff wasn‘t paid interest-only payments after December 2024.23 While no NOI payments were made to Plaintiff, there is no claim that any NOI existed.
It is undisputed that Defendant did not take a salary from the Corporation in 2024 or 2025 although he was entitled to do so under the Note. Instead, he took what he referred to as draws at times. These were used to pay various personal expenses including a cell phone bill, gas and personal transportation, dining, and a draw of approximately $25,000 over the period at issue.
Defendant was entitled to compensation from the Corporation. It was corporate income used by him, not property of the Plaintiff.
Finally, to prevail the Plaintiff must plead facts that would demonstrate a culpable state of mind to prevail on an embezzlement claim. Bullock, 569 U.S. at 269; see also Hebl v. Windeshausen (In re Windeshausen), 568 B.R. 299, 308 (Bankr. W.D. Wis. 2017), aff‘d sub nom., Hebl v. Windeshausen, 590 B.R. 871 (W.D. Wis. 2018).
One cannot embezzle his own property. Adamo v. Scheller (In re Scheller), 265 B.R. 39, 54 (Bankr. S.D.N.Y. 2001). If the Plaintiff owned the Corporation‘s money, then Defendant did as well. Plaintiff expected the Corporation to pay Operating Expenses. The Note says that Defendant was entitled to distributions from the Corporation in the form of compensation. The Additional Interest Payments section of the Note defines “Operating Expenses” to mean:
[T]he amount equal to the sum of all costs related to the operation of the business of the Company during the twelve (12) month period preceding the date of determination including, but not limited to, a normalized manager‘s salary for a person with equivalent skill and experience in the Madison, Wisconsin, area used for Craig Spaulding‘s management services, a normalized amount for depreciation of assets, and other items related to the operation of the Company, such as food and beverage costs, equipment costs, employment wages, and benefits for the Company‘s employees, sales taxes, employment taxes, rent, and earnout payments, each as determined in the Company‘s reasonable discretion.24
So Defendant was entitled to certain payments, benefits, or wages at the same level or terms as similar experienced managers in Madison.
The Complaint suggests that payments to or for Defendant that were not “normalized manager‘s salary” were related to the second element of embezzlement. According to the Complaint, Defendant did not pay the monthly interest-only payment or the NOI payment in December 2024. Those were debt payments and not Operating Expenses.
- DoorDash and personal dining expenses
- Rides on Lyft, gas, and other personal transportation expenses
- A personal car loan
- Repairs for a vehicle
- Personal credit cards
- Monthly cell phone bill
Additionally, the Complaint asserts Defendant withdrew $25,000 in cash from the corporate checking account in December 2024. While these amounts were not paid as salary, there is not a claim that the sum of these payments were in excess of the wages and benefits of managers in Madison with similar experience.
The Complaint does not satisfy the third element - whether Defendant embezzled the funds with fraudulent intent or deceit. When alleging fraud, a Complaint must meet the heightened pleading standard required by
Fraudulent intent has been defined as the debtor‘s knowledge that he has no right to use the property. Krook, 615 B.R. at 485-86 (citing FNA Grp., Inc. v. Arvanitis (In re Arvanitis), 523 B.R. 633, 639 (Bankr. N.D. Ill. 2015)). Plaintiff may also show the fraudulent intent element of embezzlement by circumstantial evidence. For instance, embezzlement is shown where a debtor had sole access to the creditor‘s funds and surreptitiously took them for his own benefit, despite knowing that the creditor wanted the funds returned. Jacobs, 403 B.R. at 575.
Plaintiff pleads Defendant failed to save receipts documenting the use of corporate funds to determine whether any of the charges identified above was a legitimate business purpose. The failure to maintain receipts, standing alone, is not sufficient.
Fraudulent intent or deceit must be pled with particularity.
The Complaint also asserts Defendant used his position as president of the Corporation to gain access to corporate funds which he used to pay his
The Complaint does not plead with the requisite particularity embezzlement under
CONCLUSION
For these reasons, the Complaint fails to state a claim for relief under
The Complaint does not survive Defendant‘s
This decision constitutes findings of fact and conclusions of law under Bankruptcy Rule 7052 and Rule 52 of the Federal Rules of Civil Procedure.
A separate order consistent with this decision will be entered.
Dated: June 16, 2026
BY THE COURT:
Hon. Catherine J. Furay
U.S. Bankruptcy Judge