Claim for Aiding and Abetting Fraud or
Breach of Fiduciary Duty by Debtor’s Principal

The State Bank and Trust Company v. Spaeth (In re Motorwerks, Inc.), --- B.R. ----, 2007 WL 2027807 (Bankr. S.D. Ohio 2007) (J. Walter). The bank filed a complaint for declaratory judgment against the trustee. In response, the trustee answered, but also filed counterclaims against the state, asserting causes of action for fraudulent transfers, preferential transfers, aiding and abetting fraud, aiding and abetting breach of fiduciary duty, equitable subordination, and objection to proofs of claim filed by the bank. The bank filed a motion to dismiss, alleging that the trustee’s counterclaims failed as a matter of law. The causes of action to be discussed herein include the aiding and abetting claims.

The Court was required to determine whether the trustee had standing to bring his aiding and abetting counterclaims against the bank. The trustee utilized 11 U.S.C. § 544(a) as his purported source of standing to bring state law claims for aiding and abetting fraud and aiding and abetting breach of fiduciary duty. The Court recognized that a trustee’s standing to pursue litigation against third parties derives from several sources, including that the trustee stands in the shoes of the debtor by bringing an action belonging to the bankruptcy estate. Here, the trustee did not assert standing as a successor in interest to the debtor, but, instead, as a creditor. The Court found that § 544(a) does not give a trustee the right to bring creditor causes of action for aiding and abetting, quoting the following from a Second Circuit case “. . . A bankruptcy trustee has no standing generally to sue third parties on behalf of the estate’s creditors, but only may assert claims held by the bankrupt corporation itself.” The Court noted that this principle can be traced back to the Supreme Court decision of Caplin v. Marine Midland Grace Trust Co. of New York, 406 U.S. 416 (1972).

The Court recognized that there are those courts that have concluded that the “rights and powers” language of § 544(a) does broaden a trustee’s powers beyond avoidance actions, allowing the trustee to file any claim, including tort claims, that a creditor with a lien or creditor’s bill might possess. However, the Court stated that this is a minority view, and it has several flaws. First, the Court noted that the Sixth Circuit continues to follow the Caplin case. Second, there is nothing explicit in § 544(a) allowing a trustee to bring tort claims on behalf of injured creditors. Third, the legislative history of § 544(a) did not support the trustee’s position. Accordingly, the Court concluded that § 544(a) did not expand the trustee’s abilities to bring actions beyond avoidance actions, and thus, the trustee did not have standing to bring creditors’ tort actions under state law such as the aiding and abetting claims.

Lien Interest Under Ohio Land Registration Act

Menninger v. Accredited Home Lenders (In re Morgeson), --- B.R. ----, 2007 WL 2119009 (B.A.P. 6th Cir. 2007). The Chapter 7 Trustee filed an adversary proceeding to determine the validity and extent of the creditor’s mortgage interest against the debtors’ real estate, which was subject to the Ohio Land Registration Act. The debtors executed a mortgage in favor of the creditor. The mortgage provided that the husband and wife were borrowers and mortgagors under the security instrument. The husband signed the mortgage document granting a mortgage on his full one-half interest in the property. The wife signed the mortgage, however, below her signature was a notation stating “spouse, signing only to release her dower interest.” The accompanying certificate of acknowledgement contained the same language. Upon recordation, the Hamilton County Recorder placed a notation on the certificate of title for the property, pursuant to R.C. § 5309.48, indicating that the creditor held a mortgage against the “present owner” of the property, thus failing to indicate that the wife had released only her dower interest.

On appeal, the BAP acknowledged that the Ohio Land Registration Act, known as Torrens Law, created a system by which title to land is registered, not recorded as under traditional recording laws. The purpose of the Act was “to create an absolute presumption that the certificate of registration and the registrar’s office at all times speaks the last word as to the title, thus doing away with secret liens and hidden equities” and creating an indefeasible title, excepting only those claims and encumbrances noted therein. It was designed to provide notice to bona fide purchasers and not to notify owners of encumbrances against their land.

The BAP noted that while Ohio courts have upheld certificates of title as conclusive evidence as to the state of the title when, for example, the holder of an encumbrance seeks to enforce an unregistered charge against a third party who was without notice, the goal of the Act was not to aid a mortgage company in expanding contractual rights against owners of registered land or bankruptcy trustees who equate to bona fide purchasers. Resorting to basic contract law, the Court found that the wife had signed the mortgage to only release her dower interest and a notary had acknowledged her signature. The language of the contract was clear, there was no inconsistency contained therein, and the creditor was a party to the contract and it failed to object to the restrictive dower language. Accordingly, on appeal, the BAP affirmed the Bankruptcy Court’s decision and held that because the mortgage document contained a notation that the wife was signing the mortgage only to release her dower interest, the creditor’s mortgage interest extended only to the husband’s one-half interest in the property, despite the certificate of title stating otherwise.

§ 523(a)(4) - Defalcation While Acting in a Fiduciary Capacity

Board of Trustees of the Ohio Carpenters’ Pension Fund on Behalf of the Ohio Carpenters’ Pension Fund v. Bucci (In re Bucci), --- F.3d ----, 2007 WL 1891736 (6th Cir. 2007). The Sixth Circuit was presented with the question of whether 11 U.S.C. § 523(a)(4) excludes from discharge a debt that an employer owes for failing to contribute to employee benefit funds.

The debtor had signed a Collective Bargaining Agreement requiring his company to make monthly contributions to pension and fringe benefit funds. The debtor admitted that he failed to contribute to the funds for over a year, and the boards of trustees for the funds filed an adversary proceeding against the debtor attempting to except the unpaid employer contributions from discharge as a debt attributable to defalcation while acting in a fiduciary capacity.

In analyzing the issue, the Court started by reiterating that it construes the term “fiduciary capacity” found in the defalcation provision of § 523(a)(4) more narrowly than the term has been used in other circumstances, limiting its application to express or technical trusts and refusing to extend it to constructive or implied trusts imposed by operation of law as a matter of equity. To determine whether an express or technical trust exists, the Court stated that a creditor must demonstrate the following: (1) an intent to create a trust, (2) a trustee, (3) a trust res, and (4) a definite beneficiary. The Court found that the intent to create a trust can be met by showing that a statute defines the trust res, imposes duties on the trustee, and those duties exist prior to any act of wrongdoing.

In the present case, the Court found that the debtor had only a contractual obligation to pay the employer contributions pursuant to the Collective Bargaining Agreement, therefore, it was not enough, as a debtor must hold funds in trust for a third party to satisfy the fiduciary relationship element of the defalcation provision of § 523(a)(4). No evidence established that the debtor was a trustee of the employer contributions, therefore, the defalcation provision of § 523(a)(4) did not apply. Accordingly, the boards of trustees for the funds lost.

COMMENT: With this decision, the Sixth Circuit continues its extremely narrow interpretation of the phrase “defalcation while acting in a fiduciary capacity” under § 523(a)(4). Any attorney who believes that the facts of his or her case fall under this exception to discharge would be well off to have an alternate theory. In the case of 401k funds which don’t make it into the 401k, there could easily be a fraud exception present if employees were promised that the money would go into the 401k. Also, there could be a larceny claim since the employer is essentially stealing the employee’s money.