Utnehmer v. Crull (In re Utnehmer)

Summarized by Hilda Montes de Oca , U.S. Bankruptcy Court, Central District of California
12 years 4 months ago

Citation:

2013 WL 5573198 (B.A.P. 9th Cir. October 10, 2013)

Tag(s):

Ruling:

Applying California partnership law, the Bankruptcy Appellate Panel ("B.A.P.") reversed the bankruptcy court because it erred when it decided that a partnership existed between the debtor defendant and plaintiff creditor based upon the terms of a loan agreement. As there was no partnership, the debtor owed no fiduciary obligations to the creditor. The B.A.P. further found that the bankruptcy court used the wrong mens rea standard for defalcation. As a result, the bankruptcy court erred in determining that debtor’s debt to creditor was excepted from discharge as a defalcation by a fiduciary pursuant to § 523(a)(4).

Procedural context:

Appeal from an order of the bankruptcy court judgment that the debt owed by the debtors to judgment creditor was excepted from discharge pursuant to § 523(a)(4) because a partnership relationship existed between the debtor and the judgment creditor.

Facts:

Plaintiffs, judgment creditors, were long-term acquaintances of Defendant, the debtor. Sometime in 2005, after a phone conversation, Defendant sent Plaintiff a packet of documents, which included a loan agreement for $100,000, secured by a deed of trust on real property. The parties agreed that $50,000 of the initial $100,000 loan was intended to be super[s]eded by execution of a formal operating agreement which would recharacterize this $50,000 of the Plaintiff’ interest as an investors’ equity interest in a limited liability company to be formed, with a annual preferred return, and a percentage participation in profits on a prorated basis. At the time of the exchange of these documents, the documents for formation of the limited liability company, and the operating agreement, were supposedly being drafted. The promissory note executed by the parties consistent with the Loan Agreement, however, make no reference to the loan agreement’s provision for recharacterizing $50,000 of the money to be loaned as an equity interest at some later time. After Defendant defaulted on the loan agreement, Plaintiffs obtained a default state court judgment for the balance due under the Note. Defendant, and his spouse, then filed a voluntary chapter 7 petition. Plaintiffs filed an adversary complaint to determine dischargeability. The bankruptcy court applied the defalcation standard of Lewis v. Scott (In re Lewis), 97 F.3d 1182 (9th Cir. 1996); that is, defalcation “includes innocent, as well as intentional or negligent defaults so as to reach the conduct of all fiduciaries who were short in their accounts.” The B.A.P. found that the bankruptcy court’s application of In re Lewis was in error. Lewis held that defalcation includes “innocent, as well as intentional or negligent defaults so as to reach the conduct of all fiduciaries who were short in their accounts.” Id. at 1185 (internal citations omitted). The B.A.P. recognized that the mens rea standard in Lewis was abrogated by the United States Supreme Court in Bullock v. BankChampaign, N.A., 133 S. Ct. 1754 (2013) (requiring that a defendant have a knowledge of, or gross recklessness in respect to, the improper nature of the relevant fiduciary behavior for the trial court to find defalcation). The B.A.P. further held that the terms of the loan agreement did not support a finding of a partnership between Defendant and Plaintiffs under California law. The B.A.P.’s reading of the loan agreement showed that, at some future point in time (i.e., upon the “execution of a formal operating agreement” for a yet-to-be formed limited liability company), a portion of Plaintiffs’ loan would be “recharacterized” as an equity interest. Applying California law, the B.A.P. held that “where the parties purport to establish a partnership to engage in business at a future time or upon the happening of a contingency, the partnership does not come into being until the time specified or until the contingency is removed.” Solomont v. Polk Development Co., 245 Cal. App. 2d 488, 496 (Cal. Ct. App. 1966). Because the loan agreement did not indicate any intent to form a partnership or LLC at the time it was signed, nor at any point before the execution of the operating agreement or LLC formation, the loan agreement was insufficient to find that Debtor and Plaintiffs formed a partnership. Without a partnership, Debtor did not owe Plaintiffs a fiduciary duty as defined by § 523(a)(4).

Judge(s):

Hon. Jim D. Pappas; Hon. Randall L. Dunn; Hon. Meredith A. Jury; (U.S. Bankruptcy Appellate Panel, Ninth Circuit). Appeal from a ruling by the Hon. Alan Jaroslovsky (Chief Bankruptcy Judge, Northern District of California)

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