#2254 signed 7-22-96
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS
In Re:JAMES R. THORNE,
BRENDA L. THORNE,
CASE NO. 94-40989-7
FIRST NATIONAL BANK OF KANSAS,
JAMES R. THORNE, and
BRENDA L. THORNE,
DEFENDANTSADVERSARY NO. 95-7010
ORDER ON MOTION FOR SUMMARY JUDGMENT
This proceeding is before the Court on the debtors' motion for summary judgment. The
Thornes appear by counsel John H. Stauffer, Jr., and David N. Harger. Plaintiff First
National Bank (the Bank) appears by counsel Adra E. Burks. The Court has reviewed the
relevant pleadings and is now ready to rule.
The parties' summary judgment pleadings, along with the Bank's complaint and a document it attached to proof of claim #19 and pleading number 41 in the main case, indicate the following relevant circumstances which have led to their present dispute. For purposes of the Thornes' summary judgment motion, the Court has assumed the allegations in the Bank's complaint to be true to the extent they have not been questioned in the motion.
The Thornes were the officers and shareholders of a hog farm called Ham Hill Feeders, Inc. (Ham Hill), and were in the business of raising and fattening hogs for sale. They operated Ham Hill as their alter ego rather than as a separate legal entity. Jeff Smith had performed some accounting work for them, though the exact extent of it is disputed. Mr. Smith borrowed money from the Bank and gave it to the debtors under an agreement concerning the purchase and care of certain feeder pigs that were housed in Ham Hill's Barn #1 and Barn #2 along with pigs purchased by another person. He later provided them more money for the care of the pigs, apparently through a line of credit at the Bank. The Thornes contend Mr. Smith was financing their purchase and care of the pigs, but he contends he was buying them himself and hiring the Thornes and Ham Hill to take care of them for him. Neither side has produced a written document alleged to be this contract but neither has asserted it was an oral agreement either. Presumably based on his alleged understanding, Mr. Smith pledged the hogs to the Bank as security for his loan. One of the Bank's officers swears Mr. Thorne knew Mr. Smith had done this because whenever Mr. Thorne came to the Bank to draw on Mr. Smith's line of credit for expenses of the pigs' care, the officer had Mr. Thorne sign a document acknowledging "his security interest" in the pigs (the affidavit is unclear, but apparently the officer means to refer to the Bank's security interest). The debtors contest this allegation on the ground the officer's affidavit is based on inadmissible hearsay.
As directors, the Thornes declared dividends which Ham Hill paid to them when it was insolvent. Apparently, the Bank contends this occurred in 1992, 1993, and 1994, at a time when Ham Hill had a negative retained earnings account and a negative surplus account. Ms. Thorne did at least some bookkeeping for Ham Hill, but she allegedly did not know what retained earnings were or how they related to corporate dividends.
Without Mr. Smith's permission, the Thornes sold the pigs in Ham Hill's Barn #1 that Mr. Smith thought he owned, and paid Mr. Smith $10,000 from the proceeds but otherwise used the remainder, alleged to be about $22,000, to pay other debts, either their own or Ham Hill's; the Thornes contend they used the money solely for general operating expenses. Also without Mr. Smith's permission, the Thornes sold the pigs in Barn #2 that Mr. Smith thought he owned, but did not turn the proceeds over to Mr. Smith. These pigs were allegedly worth about $40,000 at the time they were sold. However, the Thornes allegedly either paid or agreed to pay--the complaint does not make this clear--Mr. Smith four $3,000 payments related to these pigs. The Bank claims the Thornes still owe $40,000 for the value of the Barn #2 pigs. The Bank also alleges the Thornes violated K.S.A. 21-3734 by selling the pigs and converting the proceeds to their own use despite knowing that: (1) the pigs were the Bank's collateral, and (2) they did not have Mr. Smith's or the Bank's permission to sell them.
In the event the Court should determine Mr. Smith did not actually own the pigs, the Bank alleges an alternative theory that Mr. Thorne misled Mr. Smith about their true ownership in order to convince him to invest over $44,000 in Ham Hill. Mr. Thorne also failed to disclose: (1) the extent of the Thornes' and Ham Hill's financial difficulties; (2) that money would not be held in trust but instead commingled with Ham Hill's assets; and (3) at a time when Ham Hill's creditors were not being paid, Ham Hill's money was being used to pay dividends to the Thornes and to pay Mr. Thorne's personal creditors. These failures to disclose allegedly violated K.S.A. 17-1268 of the Kansas Securities Act, and make Mr. Thorne personally liable to Mr. Smith for $22,000. The calculation of this damage amount is not clear to the Court, unless the Thornes did pay Mr. Smith the four $3,000 payments mentioned above, in which case the damage amount would seem to be Mr. Smith's $44,000 investment minus a total of $22,000 they repaid to him.
The Thornes filed a chapter 7 bankruptcy on June 23, 1994, and Mr. Smith did so later that year. Christopher J. Redmond was appointed as the trustee in Mr. Smith's case. On December 10, not wanting to expend estate money to pursue a dischargeability complaint against the Thornes, Mr. Redmond executed an assignment to the Bank of Mr. Smith's claims against the Thornes; the Bank agreed to give the trustee any money it recovered over and above its note, interest, costs, and attorney's fees. The Thornes recite a number of allegations concerning the granting of extensions of time to object to the dischargeability of their debts, but do not ultimately make any argument that seems to rely on these asserted facts. Acting as Mr. Redmond's assignee, the Bank filed a complaint objecting to the discharge of the claims it had obtained from Mr. Redmond.
The Bank's complaint had alleged causes of action under 11 U.S.C.A. §523(a)(2), (a)(4), and (a)(6), but the Bank has now dropped its claim under §523(a)(2) and its larceny claim under §523(a)(4). The Thornes have now moved for summary judgment, arguing: (1) the trustee's assignment of Mr. Smith's claims to the Bank is invalid under Kansas law; (2) the Thornes owed Mr. Smith no fiduciary duty covered by §523(a)(4); and (3) neither of the Thornes made any material misrepresentation or factual omission that Mr. Smith relied on in deciding to reach his agreement with Ham Hill.
The Bank's complaint also alleges a cause of action under 11 U.S.C.A. §727(a)(4),
contending the Thornes should be denied a discharge because they made a false oath in
their schedules by claiming a 40-acre parcel as their homestead even though they have
since admitted they never lived there. This part of the complaint is not addressed by the
Thornes' motion for summary judgment.
DISCUSSION AND CONCLUSIONS
Federal Rule of Civil Procedure 56, governing grants of summary judgement, is made
applicable to bankruptcy proceedings by Federal Rule of Bankruptcy Procedure 7056.
FRCP 56 provides that this Court must grant summary judgment "if the pleadings,
depositions, answers to interrogatories, and admissions on file, together with the affidavits,
if any, show that there is no genuine issue as to any material fact and that the moving party
is entitled to a judgment as a matter of law." In considering a motion for summary
judgment, the Court must examine all the evidence in the light most favorable to the party
against whom summary judgment is sought. Summary judgment is inappropriate if an
inference can be deduced from the facts which would allow the nonmovant to prevail. The
court must consider factual inferences tending to show triable issues in the light most
favorable to the existence of those issues. Where different ultimate inferences may properly
be drawn, summary judgment should be denied. United States v. O'Block, 788 F.2d 1433,
1435 (10th Cir. 1986).
The Thornes first make a legal attack on the bankruptcy trustee's assignment of Mr. Smith's claims to the Bank. Relying on Heinson v. Porter, 244 Kan. 667, 673-75 (1989), and other cases, they argue the assignment is invalid because the claims the Bank is asserting are all tort claims which cannot be assigned under Kansas law. The Bank responds that the claims all arise from Mr. Smith's contractual relationship with the Thornes, and so, although the Thornes' torts are necessary to make the debt nondischargeable, Mr. Smith's contract and related tort claims are assignable under Kansas case law. It relies on Newell v. Krause, 239 Kan. 551 (1986); Hewey v. Fouts, 91 Kan. 680, 683 (1914), and Fanson v. Linsley, 20 Kan. 235 (1878).
While Kansas courts have sometimes declared in categorical terms that torts are not
assignable, see, e.g., Heinson v. Porter, 244 Kan. 667, 673-75 (1989), they have actually
indicated that torts can in fact be assigned to the extent that the assignee may recover
whatever benefits the tortfeasor obtained by committing the tort, see Allis Chalmers Mfg.
Co. v. Security Elev. Co., 140 Kan. 580 (1934); Hewey v. Fouts, 91 Kan. 680 (1914); Fanson
v. Linsley, 20 Kan. 235 (1878); In re Mid America Broadcasting, 45 B.R. 507, 510-11
(Bankr.D.Kan. 1984). Here, the Bank seeks only to recover the value of the pigs which,
allegedly, the Thornes improperly retained for themselves, or the money Mr. Thorne
obtained from Mr. Smith through misrepresentation. The Thornes attack on the validity
of the assignment must fail.
B. Nondischargeability Under § 523(a)(4)
The Thornes next contend the Bank cannot show that in their dealings with Mr. Smith, they acted in a fiduciary capacity within the meaning of 11 U.S.C.A. §523(a)(4). Section 523 states:
(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt--
. . . .
(4) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny;
Debtors correctly argue that the "fiduciary capacity" required by this provision is a matter of federal law, and includes only fiduciary duties arising out of a pre-existing express or technical trust, not those arising out of an implied, resulting or constructive trust. In re Romero, 535 F.2d 618, 621 (10th Cir. 1976); In re Talcott, 29 B.R. 874, 878 (Bankr.D.Kan. 1983). In response, the Bank contends Kansas statutes make the directors of an insolvent corporation liable as fiduciaries to the corporation's creditors if the directors pay unlawful dividends, citing K.S.A. 17-6420 and -6424(a). The Bank also points out that Kansas courts have imposed a constructive trust in favor of creditors on dividends paid to shareholders while a corporation is insolvent, see Carson v. Davidson, 248 Kan. 543 (1991), but as just noted, constructive trusts do not come within this portion of §523(a)(4).
As asserted by the Bank, K.S.A. 17-6420 provides that corporate directors may declare and pay dividends out of the corporation's surplus or its net profits for the current or preceding fiscal year. However, K.S.A. 17-6424(a) provides in pertinent part:
In case of any willful or negligent violation of the provisions of K.S.A. 17-6410, 17-6423 or
17-6603, the directors under whose administration the same may happen shall be jointly
and severally liable, at any time within three (3) years after paying such unlawful dividend
or after such unlawful stock purchase or redemption, to the corporation, and to its
creditors in the event of its dissolution or insolvency, to the full amount of the dividend
unlawfully paid, or to the full amount unlawfully paid for the purchase or redemption of
the corporation's stock.
(Emphasis added). As shown by this quotation, 17-6424 does not apply to dividends paid in violation of 17-6420. The Bank offers no other theory under which the Thornes were fiduciaries of Mr. Smith. Consequently, the Thornes' motion must be granted to the extent the Bank relies on their alleged fiduciary capacity.
The Bank correctly points out that its complaint also alleges sufficient facts to state a claim
under 11 U.S.C.A. §523(a)(4) for embezzlement and that the Thornes' motion does not
address this claim. The Bank has alleged that Mr. Smith bought certain pigs and hired the
Thornes to feed, care for, and house them, but that the Thornes sold them and used the
proceeds for their own purposes. The Tenth Circuit has said for purposes of §523(a)(4),
"[E]mbezzlement is defined under federal common law as 'the fraudulent appropriation of
property by a person to whom such property has been entrusted or into whose hands it has
lawfully come.'" Klemens v. Wallace (In re Wallace), 840 F.2d 762, 765 (10th Cir. 1988)
(quoting Great American Ins. Co. v. Graziano (In re Graziano), 35 B.R. 589, 594
(Bankr.E.D.N.Y. 1983), which was quoting Gribble v. Carlton (In re Carlton), 26 B.R. 202,
205 (Bankr.M.D.Tenn. 1982)). This portion of the Bank's complaint is not affected by the
C. Securities Fraud
The alternative theory on which the Bank relies is based on allegations Mr. Thorne either misrepresented or omitted material facts to induce Mr. Smith to invest in Ham Hill's hog operation. The Thornes correctly point out that Mrs. Thorne is not alleged to have participated in this improper activity. Mr. Thorne's actions are alleged to have violated K.S.A. 17-1268, which provides in pertinent part:
(a) Any person, who offers or sells a security in violation of K.S.A. 17-1254 or 17-1255 or offers or sells a security by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made in the light of the circumstances under which they are made not misleading (the buyer not knowing the untruth or omission) and who does not sustain the burden of proof that such person did not know and in the exercise of reasonable care could not have known of the untruth or omission, is liable to the person buying the security from such person.
The Thornes rely on Mr. Smith's deposition testimony as proof that no evidence exists that could show Mr. Thorne violated this statute.
In the deposition, Mr. Smith was asked to identify "every misrepresentation that Mr. Thorne made to you," or questions of similar import; some of the questions seem to have asked him to read the Bank's complaint and explain what certain paragraphs in it were referring to. The Thornes then assume Mr. Smith's answers provide all the possible evidence the Bank could offer to support its claim that Mr. Thorne violated K.S.A. 17-1268(a), and proceed to explain why they think those answers could not prove the statute was violated. This argument, of course, is completely misguided. As the Bank points out, it overlooks that the statute condemns factual omissions as well as misrepresentations. Perhaps more fundamentally, the argument assumes that Mr. Smith is a legal expert who can be required at a deposition to identify from memory everything Mr. Thorne did that might constitute a misrepresentation, and that the Bank is bound by that testimony. As the Court reads the complaint, the count concerning this Kansas statute alleges a number of omissions or misrepresentations, the most basic of which is that Mr. Thorne did not disclose that Mr. Smith would not own the pigs and instead led him to believe that he would. Yet Mr. Smith--perhaps not surprisingly since he is not a lawyer--apparently was unable to discern this basic assertion when he read the complaint at the deposition. In essence, the Thornes ask the Court to rule that the Bank is bound by a non-lawyer's legal opinion, rendered off the top of his head during a deposition. If this is ever appropriate, it can only be when a plaintiff is representing himself. This part of the Thornes' motion must be denied.
For these reasons, the Court concludes: (1) the Bank has standing to assert its claims as assignee, (2) the Bank has failed allege or show it might be able to prove that the Thornes owed a fiduciary duty to Mr. Smith, although it may still try to prove they embezzled his property, and (3) the Thornes have failed to show the Bank has no evidence that might prove Mr. Thorne violated K.S.A. 17-1628. The Thornes' summary judgment motion is therefore granted in part and denied in part.
IT IS SO ORDERED.
Dated at Topeka, Kansas, this _____ day of July, 1996.
JAMES A. PUSATERI