A debt “for fraud or defalcation while acting in a fiduciary capacity” cannot be discharged in an individual bankruptcy case. 11 U.S.C. §523(a)(4). The precise scope of the term, “fiduciary,” within the meaning of this section is a question of federal law, In re Hayes, 183 F.3d 162, 166 (2d Cir. 1999), which is said to be “more restrictive” than “the traditional common law definition.” In re Richey, 103 B.R. 25, 31 (Bankr. D. Conn. 1989). Nonetheless, “state law can be an important factor in determining whether someone acted in a fiduciary capacity under Section 523(a)(4).” Hayes, 183 F.3d at 166.
The recent decision of the Connecticut District Court in In re Snyder, Civ. Action No. 3:17-cv-00840 (SRU), 2018 WL 1914923 (D. Conn. April 23, 2018), provides some clarity as to how a fiduciary relationship for purposes of this provision can be established. In Snyder, the creditors seeking non-dischargeability of their debt were Joseph and Nancy Murphy, who were related by marriage to the Debtor, Scott Snyder, whose spouse, Doreen (a joint Debtor with Scott), was Joseph’s sister.
Scott Snyder was a developer of custom luxury homes. The Murphys first invested $100,000 with him for a project to build two luxury homes in Haworth, New Jersey, and later invested $275,000 for a project to build a luxury home on Bible Street in Greenwich, Connecticut. The investments were made under an oral agreement whereby Scott Snyder promised a return of the Murphys’ investment plus 20%. The Haworth houses were sold for $1.4 million and $1.3 million, respectively, but no funds were returned to the Murphys. The funds the Murphys invested for the Bible Street property were instead used by the Snyders to purchase other properties in Demarest, New Jersey without the knowledge of the Murphys. Those houses were also sold, but no funds were returned to the Murphys. While not entirely clear on this point, the record also established that the Snyders used at least $20,000 of the funds invested by the Murphys for personal expenditures. There was also a reference in the decision to the Snyders using the account into which the Murphys’ funds were deposited “to withdraw more than $10,000 in cash and pay off more than $50,000 in credit card debt.”
The Murphys sued the Snyders in the U.S. District Court in the Eastern District of New York and obtained a default judgment on their breach of contract claim as a sanction for repeated violations by the Snyders of their discovery obligations. Although finding a fiduciary relationship between the Snyders and the Murphys based on their close relationship, which was one of trust, and which also involved a joint venture, the District Court did not enter judgment on the Murphys’ breach of fiduciary claim on the ground that it was duplicative of the breach of contract claim. The judgment was in the amount of $450,000.
The Snyders later filed a Chapter 7 bankruptcy and the Murphys filed an action to determine their judgment to be nondischargeable. In their action, the Murphys moved for summary judgment and argued that the judgment they obtained in New York should be given collateral estoppel effect on their claim for fraud or defalcation while acting in a fiduciary capacity. The Bankruptcy Court agreed with that argument and held the judgment was nondischargeable on the basis that the same issues that were found in the prior New York action were binding in the Murphys’ action under §523(a)(4).
On appeal, the Connecticut District Court held that collateral estoppel could not apply to the New York court’s finding of a fiduciary relationship between the parties because it was not “necessary” to its ultimate judgment, which was simply based on breach of contract. The District Court, however, culled the record on summary judgment and found as a matter of law that the Snyders were in a fiduciary capacity relative to the Murphys within the meaning of §523(a)(4).
The basis of its ruling was two-fold. First, it held that the Snyders were fiduciaries for the Murphys under New York law because of the parties’ close relationship and the trust the Murphys placed in the Snyders relative to the business venture, and because under New York law, joint venturers owe fiduciary duties to one another. Second, the District Court held that the fiduciary relationship that was in effect under state law also satisfied the federal law standard under §523(a)(4), which it held was a relationship that “‘involve[s] a difference in knowledge or power between fiduciary and principal which gives the former a position of ascendancy over the latter’.” Snyder, 2018 WL 1914923 at *9 (quoting In re Hayes, 183 F.3d 162, 167 (2d Cir. 1999)).
Although the Second Circuit in Hayes stated that such “a difference in knowledge or power” was “a common link” in the relationships that were expressly covered in a predecessor provision to §523(a)(4), Section 1 of the Bankruptcy Act of 1841, Hayes, 183 F.3d at 167, it never explicitly held that this was the standard to apply when determining if one is a fiduciary under §523(a)(4). The Snyder decision now explicitly so holds.
The District Court also held that the Snyders committed a “defalcation” by spending the Murphys’ money for personal expenses, which it found was at least $20,000 but “could be much more” based on the Snyders’ acknowledgement that after the Murphys’ funds were deposited into a virtually empty account, they withdrew more than $30,000 to pay credit card debt and two months later withdrew $18,000 more for the same purpose. It also held that the Snyders’ purchase of the Demarest, New Jersey properties with $275,000 of the Murphys’ money was a defalcation because those funds were earmarked by the parties’ agreement for purchase of the Bible Street property in Greenwich. In both instances, it was held that the Snyders satisfied the standard for defalcation established by Bullock v. BanChampaign, 569 U.S. 267, 269 (2013), which is that the fiduciary must at least have “consciously disregarded (or have been willfully blind to) a substantial and unjustified risk that his conduct would turn out to violate a fiduciary duty.” As a result, the District Court held that the entire New York federal judgment was nondischargeable.
The decision in Snyder clarifies the federal standard for “fiduciary capacity” under §523(a)(4) and suggests that many of the commonly understood “fiduciary relationships” under state law may indeed satisfy that standard.
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