Case Type:
Case Status:
BAP No. AZ-22-1140-LSF (9th Circuit, Mar 07,2023) Not Published
The Ninth Circuit's Bankruptcy Appellate Panel held the bankruptcy court properly dismissed with prejudice a judgment creditor's claim to except a debt from the debtors' discharge based on embezzlement under 11 U.S.C. § 523(a)(4). The state court's judgment against the debtors referenced in the adversary complaint did not include the requisite findings to support issue preclusion. And, the property at issue did not belong to, and thus was not embezzled from, the judgment creditor. Thus, the amended complaint did not allege a plausible claim.
Procedural context:
After the debtors sought bankruptcy protection, the Unruhs commenced an adversary proceeding against them, seeking to except the judgment debt from their discharge under 11 U.S.C. § 523(a)(2)(A) and (B). The bankruptcy court granted a summary judgment to the Unruhs' based on issue preclusion, but the BAP reversed on appeal as the state court judgment and record did not support that ruling. On remand, the complaint was amended to add a claim under 11 U.S.C. § 523(a)(4) for embezzlement and to name El Dorado Liquidation Associates, LLC as the plaintiff (as the Unruhs assigned the state court judgment to El Dorado). The debtors successfully moved to dismiss the embezzlement claim for lack of standing as Archery owned the allegedly embezzled property. Debtors later obtained a summary judgment on the § 523(a)(2) claims. El Dorado appealed to the BAP from both rulings but pursued only the bankruptcy court's order dismissing the § 523(a)(4) claim. The BAP, reviewing that ruling de novo, concluded the bankruptcy court did not err in disregarding the state court judgment and finding the amended complaint failed to allege a plausible § 523(a)(4) claim.
Debtors Daron and Deborah Mack owned Absolute Archery LLC, a retail archery business. Carter and Julie Unruh loaned Archery a total of $140,000. The notes required Archery to maintain a total inventory value of over $150,000 or it would be in default. The Unruhs received a lien on Archery's inventory and the debtors personally guaranteed the debt. Archery stopped operating after a few years. The last financial statement the Unruhs received a few months before Archery's closure stated it had $205,687 in inventory. After Archery's closure, the debtors allegedly represented its remaining inventory had a cost value of $97,509, offered it to the Unruhs as partial payment of the debt, and proposed a plan to repay the remainder. The Unruhs later found the inventory was worth $60,932.44 and asserted the debtors defrauded them based, at least in part, on this discrepancy. The Unruhs filed a state court complaint against the debtors and Archery asserting fraud and other claims. The $150,616.30 default judgment entered against all the defendants included neither findings of fact nor specification of the claim(s) forming the basis for the award. Debtors then filed a chapter 7 bankruptcy petition in the U.S. Bankruptcy Court for the District of Arizona.

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