- Category: Judge Somers
- Published on 11 September 2013
- Written by Judge Somers
Bank of Commerce & Trust Company v. Schupbach et al, 12-05047 (Bankr. D. Kan. Sep. 11, 2013) Doc. # 45
SIGNED this 10th day of September, 2013.
Designated for online use, but not print publication
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS
JONATHAN ISAAC SCHUPBACH and
AMY MARIE SCHUPBACH,
BANK OF COMMERCE & TRUST CO.,
JONATHAN ISAAC SCHUPBACH and
AMY MARIE SCHUPBACH,
CASE NO. 11-13633
ADV. NO. 12-5047
MEMORANDUM OPINION AND ORDER
DENYING COMPLAINT FOR EXCEPTION OF DEBT FROM DISCHARGE
The Complaint in this adversary proceeding was filed by Bank of Commerce &
Trust Company, Wellington, Kansas (Bank), to except from discharge under 11 U.S.C.
Case 12-05047 Doc# 45 Filed 09/10/13 Page 1 of 26
§§ 523(a)(2) and (a)(6) its claim against Debtors Jonathan I. Schupbach and Amy M.
Schupbach (collectively Debtors) and for a determination of the amount excepted from
discharge. The Court has jurisdiction.1 By Memorandum Opinion and Order issued on
June 7, 2012, the Court granted Debtors’ motion to dismiss the § 523(a)(2) count because
it was not timely filed.2 A two-day trial to the Court on the § 523(a)(6) count was held on
July 9 and 10, 2013, after which the Court took the matter under advisement. Having
carefully considered the pleadings, the evidence, the exhibits, and the statements of
counsel, the Court is now ready to rule. For the reasons stated below, the Court denies
the Complaint and finds that Bank’s claim against Debtors is dischargeable.
THE ALLEGATIONS OF THE COMPLAINT.
Bank alleges that Debtors should not be discharged from damages caused by
conversion. The conversion claim arises from six prepetition loans made by Bank to
Debtors and their company, Schupbach Investments. Each of these loans was made for
the purchase or refinance of an individual residential property.3 It is alleged that the loan
1 This Court has jurisdiction over the parties and the subject matter pursuant to 28 U.S.C.
§§ 157(a) and 1334(a) and (b), and the Standing Order of the United States District Court for the District
of Kansas that exercised authority conferred by § 157(a) to refer to the District’s bankruptcy judges all
matters under the Bankruptcy Code and all proceedings arising under the Code or arising in or related to a
case under the Code, effective July 10, 1984. Furthermore, this Court may hear and finally adjudicate this
matter because it is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(I). There is no objection to
venue or jurisdiction over the parties.
2 Dkt. 10.
3 As set forth below, the purposes of the loans as stated in the notes refer to business investment
and purchase of properties. Bank does not contend that the loan proceeds were misused when devoted to
the purchase of the property securing the specific note. This opinion therefore focuses only upon the
alleged requirement that the loan proceeds be used to renovate and repair the properties securing the
Case 12-05047 Doc# 45 Filed 09/10/13 Page 2 of 26
proceeds were advanced for the specific purpose of renovating the six homes and that
Debtors converted the loan proceeds when the proceeds were used for other purposes,
resulting in a willful and malicious injury of approximately $170,000 to Bank, within the
meaning of § 523(a)(6).
FINDINGS OF FACT.
Beginning in 2001, Debtors engaged in the business of buying, owning, and selling
homes in low income areas of Wichita, Kansas. Initially the business was conducted as a
proprietorship, which by 2004 owned up to 50 homes. Starting in about 2004, the
business was conducted through Schupbach Investments, L.L.C. (Schupbach
Investments). Jonathan Schupbach was the manager and 50% owner. Amy Schupbach
was a member and 50% owner. Both Jonathan and Amy worked full time for Schupbach
Investments, with Jonathan making the decisions about properties to purchase, renovate,
rent, and sell, and Amy maintaining the financial records.
Schupbach Investments generally purchased distressed homes for less than fair
market value, and then either rented or sold the properties. The purchase and renovation
costs were financed through various lending institutions, including Bank. Bank started
making loans to Schupbach Investments in 2004, when Clint Lawrence, currently a vice
president of Bank and through whom the Schupbachs had obtained business loans while
he was employed by another financial institution, solicited the Schupbachs’ business.
Case 12-05047 Doc# 45 Filed 09/10/13 Page 3 of 26
Although there is disagreement as to the exact number of loans,4 the evidence clearly
showed that Jonathan Schupbach had a well-established and harmonious business
relationship with Clint Lawrence and Bank. There was mutual trust, and a pattern of
business practices developed. Schupbach Investments also obtained financing from other
financial institutions, but Jonathan Schupbach generally contacted Bank to ascertain its
interest before contacting other lenders.
Schupbach Investments filed for relief under Chapter 11 of the Bankruptcy Code
on May 16, 2011. Jonathan and Amy Schupbach filed for relief on July 16, 2011, under
Chapter 13, but the case was later converted to Chapter 11. Schupbach Investments’
schedule A listed 165 parcels of real property, 39 of which were mortgaged to Bank.
Bank filed a proof of claim for $748,748.72 against the Schupbachs.5
The six loans which are the basis for the conversion claim were made over a two-
and-half-year period and involve single residential properties requiring improvements
before being rented. The dates and the amounts of the loans, and the addresses and the
purchase prices of the Wichita properties mortgaged to secure the loans are: September
4 Jonathan Schupbach testified that in 2010 there were 42 different loans outstanding with Bank
and 20 to 30 loans had previously been retired. Clint Lawrence testified that he originated 35 to 40
Schupbach loans, and 32 of these were secured by individual homes. Jonathan Schupbach testified that
there were 30 to 50 loans with Bank secured by individual homes. Clint Lawrence testified that Bank
made 15 to 20 loans to Schupbach Investments to finance properties needing improvements; it appears
that all but six of these loans were repaid.
5 Case no. 11-13633, claim 22-1.
Case 12-05047 Doc# 45 Filed 09/10/13 Page 4 of 26
18, 2007 loan for $41,600, secured by 2611 E. 13th Street,6 purchased for $5,000;7
February 12, 2009 loan for $39,000, secured by 1539 N. Hillside,8 purchased for $6,000;9
June 29, 2009 loan for $36,000, secured by 1524 N. Lorraine,10 purchased for $2,000;11
July 14, 2009 loan for $45,750, secured by 1753 N. Chautauqua,12 purchased for
$13,500;13 March 25, 2010 loan for $37,500, secured by 434 S. Illinois,14 purchased for
$18,500;15 and April 9, 2010 loan for $33,750, secured by 1504 N. Erie,16 purchased for
Each of the six loans was originated in accord with the customary procedures used
by Bank and Schupbach Investments when Schupbach Investments desired financing to
be secured by a home needing renovation. Jonathan Schupbach would contact Clint
6 Exh. 3.
7 Exh. 17.
8 Exh. 4.
10 Exh. 5.
11 Exh. 17.
12 Exh. 6.
13 Exh. 17.
14 Exh. 7.
15 Exh. 17.
16 Exh. 8.
17 Exh. 17.
Case 12-05047 Doc# 45 Filed 09/10/13 Page 5 of 26
Lawrence. If Bank was interested in making the loan, Clint Lawrence would contact the
appraiser whom he used for Wichita properties and who valued approximately 10 homes
per year for loans to Schupbach Investments, resulting in the appraiser’s being very
familiar with Jonathan Schupbach and his business. Bank would instruct the appraiser to
value the subject property as if the needed renovations and repairs had been completed.
Then Jonathan Schupbach would show the property to the appraiser and inform him that
he intended to make the “usual” renovations, meaning such things as roof repair, painting,
new siding, new HVAC, and floor covering. Jonathan Schupbach did not provide the
appraiser with a list of anticipated improvements for each property, but the appraisal
report for each property included a list prepared by the appraiser of anticipated repairs.
For example, the appraisal for the East 13th Street property states, “Owner is totally
redoing the home inside and out. New electrical, new plumbing, new bath fixtures, dry
wall, insulation, new porch, paint and siding. Storage shed,”18 and the appraisal for the
North Hillside property states, “New paint inside and out, carpet being replaced, new
appliances, heat and air as needed, plumbing as needed and electrical as needed.”19 The
appraiser became comfortable with Jonathan Schupbach and his intent to make the
Bank would then loan Schupbach Investments an amount equal to 70% to 80% of
the appraised value of the selected property for various terms, some for twenty years and
18 Exh. 3, Bates-stamp no. E13ST000019.
19 Exh. 4, Bates-stamp no. NHILLST000036.
Case 12-05047 Doc# 45 Filed 09/10/13 Page 6 of 26
some for one year. Each loan was evidenced by a promissory note executed by Debtors
personally and on behalf of Schupbach Investments.20 The improvements enumerated in
the appraisal report were not stated in the note. Each note would be secured by a
mortgage of the subject residential property executed by Debtors on behalf of Schupbach
Investments. No additional collateral was pledged, and the loans were not cross-
collateralized. Debtors did not sign the appraisal report but were provided an opportunity
to receive a copy of the report before closing. There is no evidence with respect to any of
the six loans that Debtors requested a copy or that a copy was provided to them before the
closing. As to the six loans in issue, both Jonathan Schupbach and Amy Schupbach
testified that they did not receive a copy of the appraisal report before executing the note
for any of the properties.
When each of the six loans was made, the loan amount, usually less some loan
costs, was disbursed to Schupbach Investments by a cashier’s check in a lump sum. The
proceeds were deposited into Schupbach Investments’ general business account at another
bank. There was no requirement or expectation by Clint Lawrence that the proceeds
would be segregated from other funds. Bank no made attempt to retain a security interest
in the loan proceeds.
The loan proceeds were used for the general business expenses of Schupbach
20 The Debtors do not contest their liability on the notes. The affairs of Debtors and Schupbach
Investments were commingled. Neither Bank nor Debtors raised any issues concerning such
commingling or the failure to maintain the separateness of the individuals and the limited liability
company. At trial, it was assumed that the actions of Debtors were the actions of Schupbach Investments
and vice versa.
Case 12-05047 Doc# 45 Filed 09/10/13 Page 7 of 26
Investments. Some of the withdrawals from the account were for Debtors’ personal
expenses, such as home mortgage payments and utility costs. But Debtors, who worked
full time for Schupbach Investments, were not paid salaries and regarded use of company
funds for their personal expenses as their compensation. Salaries paid Debtors would
have been regarded as business expenses; payment of personal expenses in lieu of salaries
should also be so regarded. Further, examination of the bank statements shows that there
were sufficient deposits from sources other than Bank’s loans to cover the personal
expenses. The Court therefore rejects Bank’s position that the proceeds were used in part
for purposes other than the business of Schupbach Investments.
Amy Schupbach, who maintained the financial records, could not identify any
specific expenditures for improvements to the six mortgaged properties, but she did
testify that some of the ongoing expenses, such as for contractors whom Schupbach hired
to repair and maintain the company’s properties, could have spent time on some of the six
homes. Jonathan Schupbach testified that although he disagreed with some of the specific
renovations listed on the appraisal reports, he intended to renovate the properties
mortgaged to secure the six loans. As a business practice, Schupbach Investments made
repairs on an as-needed basis. Easy turnaround homes were repaired first, and repair of
those needing significant work was deferred. In 2010, Jonathan Schupbach estimated that
there were 18 homes in line for repairs, and that although he intended to repair the six
homes financed by Bank, all the company’s resources were being devoted to other
properties. As to the six homes, the electrical service at 2611 E. 13th Street was
Case 12-05047 Doc# 45 Filed 09/10/13 Page 8 of 26
improved, the 1524 N. Lorraine property was cleaned out and secured, and broken
windows were repaired at 434 S. Illinois and 1504 N. Erie.
Bank contends that the loan proceeds of each of the six loans were to be used
exclusively for the renovation of the home securing each note. Clint Lawrence referred to
the loans as “construction loans” and testified that if the entire proceeds were not used for
the intended purpose, they were to be returned. Clint Lawrence testified that he and
Jonathan Schupbach discussed structuring loans to be secured by single residences to
require the submission of receipts for work performed, but rejected this method as
impractical because Schupbach Investments’ business model made it nearly impossible to
document expenditures on individual properties. Bank made approximately 20 loans
secured by individual residences requiring renovations in accord with the procedures
discussed herein; of these, it appears that all were paid or refinanced, except for the six
which are the subject of this litigation.
The amount of each loan was determined by the appraised value; the cost of
anticipated repairs was not estimated, and the amount loaned was not related to the cost of
the upgrades. The appraisal reports are the only documents in the loan files listing
intended improvements. Nothing in the loan documents required the borrower to present
invoices, make a report as to completed renovations, or complete the renovations by a
certain date. The properties were not inspected by Bank. Clint Lawrence testified that it
was not his practice to inquire whether improvements had been made, since he had no
reason to believe that they would not be. He could not recall any specific conversations
Case 12-05047 Doc# 45 Filed 09/10/13 Page 9 of 26
with Debtors about devoting the loan proceeds to the improvements. Jonathan Schupbach
testified that he never discussed specific improvements with Clint Lawrence.
The only provisions in the loan documents signed by Debtors or provided to them
before closing that relate to the use of the loan proceeds are “purpose of loan” sections of
the notes. Those provisions read as follows: “Refinance and Improve Business
Investment”;21 “Refinance Property 1539 N Hillside — Wichita”;22 “Business Investment
1524 N Lorraine”;23 “Business Investment 1753 N Chautauqua”;24 “Business Investment
Purchase and Improvement”;25 and “Business Investment Purchase and Improvement
1504 N Erie.”26 The notes include integration clauses. The first two loans provide: “All
parties signing below acknowledge receiving a completed copy of this Note and related
documents, which contain the complete and entire agreement between Lender and any
party liable for payment under this Note. No variation, condition, modification, change
or amendment to this Note or related documents shall be binding unless in writing and
signed by all parties.”27 The last four notes provide: “No amendment or modification of
this Note is effective unless made in writing and executed by you and me. This Note and
21 Exh. 3, Bates-stamp no. E13ST000002.
22 Exh. 4, Bates-stamp no. NHILLST000002.
23 Exh. 5, Bates-stamp no. LORRAINE000004.
24 Exh. 6, Bates-stamp no. CHAUT000004.
25 Exh. 7, Bates-stamp no. S.ILLINOIS000004.
26 Exh. 8, Bates-stamp no. ERIE00003.
27 Exh. 3, Bates-stamp no. E13ST000002; Exh. 4, Bates-stamp no. NHILLST000002.
Case 12-05047 Doc# 45 Filed 09/10/13 Page 10 of 26
the other Loan Documents are the complete and final expression of the agreement.”28
“Loan Documents” is defined to mean “all the documents executed as a part of or in
connection with the Loan.”29
In middle or late 2009, Clint Lawrence spoke with Jonathan Schupbach on the
phone about the 13th Street property because it was in an area where the City of Wichita
was buying properties for road improvements. He learned for the first time that the
property had not been repaired, except for electrical work, even though the loan had been
made in 2007. Clint Lawrence testified he assumed that Schupbach Investments had the
loan proceeds, except those used to buy supplies for the intended renovations of the 13th
Street property, in its bank account.
Even though Bank had notice in 2009 that the improvements to the 13th Street
property listed in the 2007 appraisal had not been made, Bank continued to make loans,30
and did not change its loan documentation or monitoring procedures. Clint Lawrence did
not inquire of Debtors about the status of renovation of the six properties until late 2010,
when Schupbach Investments was headed for bankruptcy. Debtors never represented to
Bank that the improvements had been completed.
Neither of Debtors understood the purpose of the loans as stated in the notes to
28 Exh. 5, Bates-stamp no. LORRAINE000007; Exh. 6, Bates-stamp no. CHAUT000007; Exh. 7,
Bates-stamp no. S.ILLINOIS000006; and Exh. 8, Bates-stamp no. ERIE000005.
29 Exh. 5, Bates-stamp no. LORRAINE000002; Exh. 6, Bates-stamp no. CHAUT000002; Exh. 7,
Bates-stamp no. S.ILLINOIS000003; and Exh. 8, Bates-stamp no. ERIE000002.
30 The 434 S. Illinois and 1504 N. Erie loans were made in 2010.
Case 12-05047 Doc# 45 Filed 09/10/13 Page 11 of 26
mean that the proceeds were to be held apart from the company’s other assets and devoted
solely to renovations of the mortgaged homes. Jonathan Schupbach testified that he
believed the funds were provided for use in the operations of Schupbach Investments and
that he was to do what he saw fit to run the business. Although he intended to eventually
make the repairs on the financed homes, he did not understand the proceeds to be
earmarked for this purpose and did not discuss the use of the loan proceeds with Clint
Lawrence until October 12, 2010, when bankruptcy was imminent. Amy Schupbach
testified she understood that the purpose of the loans was to fund Schupbach Investments’
business, which was the purchase, improvement, rental, and sale of distressed real estate
in low income areas of Wichita, and that the loans provided funds for the company to
continue in business. She executed the loan documents at her home when they were
presented to her by Jonathan Schupbach. Clint Lawrence could not recall having met
with Amy Schupbach regarding the six loans. There was no evidence that she ever met
with the appraiser.
Bank’s dischargeability complaint is premised upon the Schupbachs’ alleged
conversion of the loan proceeds because they were not used for the intended purpose of
renovating the six properties. For each of the six properties, damages were calculated by
subtracting the purchase price and estimated closing costs of $1,000 from the loan
proceeds. The total damages claimed are $172,000.31 Although Bank received the six
31 Exh. 17. At trial, Clint Lawrence testified that the amount claimed in that exhibit should be
reduced by $6,000 to reflect closing costs.
Case 12-05047 Doc# 45 Filed 09/10/13 Page 12 of 26
properties from Schupbach Investments during the bankruptcy case, the values of the
properties either on the date of filing or when received by Bank were not considered in
the damages calculation.
A. Preliminary matters.
There are two preliminary matters which need to be addressed. First, Bank
contends that Debtors’ Answer to the Complaint binds them to Bank’s view as to the
purpose of the six loans. For each of the loans, the Complaint alleges that the loan was
made, that the purpose of the loan was to make the renovations listed in the appraisal
report for the property, and that based upon the representations and personal guarantees of
the Schupbachs, Bank made a loan to Schupbach Investments “to renovate, modify and
improve the property” securing the note.32 In their Answer, Debtors admitted these
factual allegations and that they “knew that the loan proceeds . . . were required to be
used on the homes that Schupbach Investments purchased.33 Bank argues that “[w]hile
defendants contend that they believed these loan proceeds would be used for any purpose,
without restriction, they are bound by the admissions in their Answer that the purpose of
these loans was for the renovation, modification and improvement of the six (6) homes
they sought to purchase.”34
32 Dkt. 1.
33 Dkt. 13.
34 Dkt. 42 at 11, n. 4.
Case 12-05047 Doc# 45 Filed 09/10/13 Page 13 of 26
Although the Court has difficulty understanding why Debtors admitted the factual
allegations of the Complaint and the allegation that they “knew . . . the proceeds . . . were
required to be used on the homes that Schupbach Investments had purchased,” it declines
to find that the Answer limits the Court’s ability to consider Debtors’ understanding of
the purposes of the loans. The purposes of the loans alleged in the Complaint are more
general than Bank’s position at trial, during which it essentially contended that the loans’
purposes required that the proceeds be earmarked for renovation. This shift of position is
similar to the subtle difference in the understandings of Bank and Debtors as to the loans’
purposes, as reflected in the testimony and exhibits discussed below. Justice would not
be served by foreclosing Debtors’ ability to contest Bank’s understanding of the purposes
of the loans and the allowed use of the proceeds. The duty of the Court is to resolve the
controversy between the parties, not to parse the meaning of admissions in the Answer.35
Second, as stated above, the claim alleged in Count I of the Complaint for denial
of the discharge of a debt for false pretenses, false representations, and actual fraud under
§ 523(a)(2), was dismissed as untimely. The evidence in this case is such that the most
natural way to view a possible denial of discharge is from the perspective of fraud, but
this temptation must avoided. The only claim before the Court is for denial of discharge
of Bank’s claim of damages from a willful and malicious injury to Bank’s property based
35 The Court also notes that even if the admissions in the Answer were broadly construed to mean
that Bank had a property interest in the loan proceeds sufficient to find that Debtors’ failure to use the
proceeds for the admitted purposes constituted a conversion, denial of discharge would nevertheless be
precluded because of the absence of a willful and malicious injury.
Case 12-05047 Doc# 45 Filed 09/10/13 Page 14 of 26
upon alleged conversion.
B. Denial of discharge under § 523(a)(6) for a debt for willful and malicious
injury from conversion.
Subsection 523(a)(6), the basis for Bank’s remaining dischargeability claim,
provides as follows:
(a) A discharge under section . . . 1141 . . . of this title does
not discharge an individual debtor from any debt —
. . .
(6) for willful and malicious injury by the debtor to
another entity or to the property of another entity.
The Supreme Court has held that this subsection encompasses “only acts done with the
actual intent to cause injury.”36 The fact that the word “willful” modifies the word
“injury” indicates that “nondischargeability takes a deliberate or intentional injury, not
merely a deliberate or intentional act that leads to injury.”37 Without proof of both a
willful act and malicious injury, the objection to discharge fails.38 “The term ‘malicious’
requires proof ‘that the debtor either intend the resulting injury or intentionally take
action that is substantially certain to cause the injury.’”39 “[M]ost courts have held that an
injury inflicted intentionally and deliberately, and either with the intent to cause the harm
complained of, or in circumstances in which the harm was certain or almost certain to
36 Kawaauhau v. Geiger, 523 U.S. 57, 61 (1998).
37 Id. (emphasis in original).
38 Panalis v. Moore (In re Moore), 357 F.3d 1125, 1129 (10th Cir. 2004).
39 Id. (quoting Hope v. Walker (In re Walker), 48 F.3d 1161, 1164 (11th Cir. 1995)).
Case 12-05047 Doc# 45 Filed 09/10/13 Page 15 of 26
result from the debtor’s act, constitutes willful and malicious conduct under section
523(a)(6).”40 The burden of proof is upon the creditor to establish by a preponderance of
the evidence that the debt is nondischargeable.41
A debt for an injury caused by conversion may be nondischargeable under
§ 523(a)(6), if it is willful and malicious.42 “But a willful and malicious injury does not
follow as of course from every act of conversion, without reference to the circumstances.
There may be a conversion which is innocent or technical, an unauthorized assumption of
dominion without willfulness or malice.”43
Conversion is defined as “the unauthorized assumption or exercise of the right of
ownership over goods or personal chattels belonging to another to the exclusion of the
other’s rights.”44 A security interest may be converted.45 Likewise cash may be the
property which is the subject of a claim of conversion,46 such as when funds are placed in
40 4 Collier on Bankruptcy, ¶ 523.12 at 523-93 (Alan N. Resnick & Henry J. Sommer, eds.-inchief,
16th ed. 2013).
41 Grogan v. Garner, 498 U.S. 279, 283-91 (1991).
42 C.I.T. Financial Servs., Inc., v. Posta (In re Posta), 866 F.2d 364, 367 (10th Cir. 1989).
43 Davis v. Aetna Acceptance Co., 293 U.S. 328, 332 (1934).
44 Moore v. State Bank of Burden, 240 Kan. 382, 386, 729 P.2d 1205, 1210 (1986).
45See Davis v. Aetna Acceptance, 293 U.S. at 331-33; Farmers State Bank v. FFP Operating
Partners, L.P., 23 Kan. App. 2d 712, 715, 935 P.2d 233, 235 (1997).
46 Commerce Bank, N.A., v. Chrysler Realty Corp., 76 F. Supp. 2d 1113, 1118 (D.Kan. 1999).
Case 12-05047 Doc# 45 Filed 09/10/13 Page 16 of 26
the custody of another for a specific purpose and diverted to a different use.47 However ,
there is no action “for conversion of a mere debt or chose in action. Hence, where there is
no obligation to return identical money, but only a relationship of debtor and creditor, an
action for conversion of the funds representing the indebtedness will not lie against the
C. Bank has not sustained its burden to show Debtors converted Bank’s
In this case, Bank claims a debt for injury from conversion, but the Court finds
that Debtors did not convert Bank’s property. The pretrial order states, “Plaintiff
contends that defendants willfully and maliciously injured the plaintiff by intentionally
placing at risk, using, misappropriating and/or converting plaintiff’s collateral for their
benefit resulting in damage to the plaintiff.”49 In its trial brief, Bank contends the
evidence demonstrates a conversion of the loan proceeds because “(a) the purpose of each
loan was to renovate, modify and improve these [six] homes; (b) that the only collateral
securing each loan was the home itself . . . ; and (c) that little, if any, of the Bank’s loan
proceeds were used to improve these properties.”50
The evidence is inadequate to establish injury from conversion of collateral.
47 Dillard v. Payne, 615 S.W.2d 53, 55 (Mo. 1981) (diversion of funds advanced by client to
attorney with instructions to place in trust account for use to cover actual costs of legal action).
48 Temmen v. Kent-Brown Chevrolet Co., 227 Kan. 45, 50, 605 P.2d 95, 99 (1980) (quoting 18
Am. Jur. 2d, Conversion § 10).
49 Dkt. 37 at 2.
50 Dkt. 42 at 9-10.
Case 12-05047 Doc# 45 Filed 09/10/13 Page 17 of 26
Bank’s presentation of evidence and its damage calculations were based solely upon the
theory that the property converted was the cash proceeds of the six loans. Yet, there is no
evidence that Bank even attempted to retain a security interest in the cash proceeds.
Rather, it is uncontroverted that the six properties were the sole collateral for Bank’s
loans. There is no evidence and no contention that Debtors exercised rights with respect
to the mortgaged homes inconsistent with Bank’s interest as mortgagee. Debtors did not
convert Bank’s collateral.51
Debtors also did not convert the loan proceeds. As stated above, an essential
element of conversion is an interference with the plaintiff’s interest in the property
allegedly converted. In this case, that element is lacking. The loan proceeds were
distributed to Schupbach Investments by cashiers’ checks. When delivered, they ceased
to be Bank’s property.52 Debtors cannot be liable to Bank for converting property in
which Bank had no interest.
Bank seeks to overcome the foregoing deficiency in its conversion claim by
asserting that a conversion occurred when the loan proceeds were used for purposes other
51 Debtors did fail to improve Bank’s collateral, but the Court has not been provided with any
authority that failure to enhance collateral constitutes a conversion of the collateral.
52 Maneval v. Davis (In re Davis), 155 B.R. 123, 131 (Bankr. E.D. Va. 1993) (where plaintiffs
delivered check to debtor made payable to him personally and received in return shares of stock in
company debtor owned, check no longer belonged to plaintiffs and could not be subject of conversion
claim against debtor); Taylor v. Sanders (In re Sanders), 105 B.R. 111 (Bankr. M.D. Fla. 1989) (where
plaintiff wrote check to lease brokerage corporation to pay off purchase option of car and lease brokerage
corporation commingled check proceeds with other funds and never paid lessor for car title, plaintiff
could not sue for conversion because once check was delivered to corporation, it was no longer property
of plaintiff); P & S X-ray Co., Inc., v. Dawes (In re Dawes), 189 B.R. 714, 721 (Bankr. N.D. Ill. 1995)
(under law of conversion, once check is delivered, monies no longer belong to maker of check).
Case 12-05047 Doc# 45 Filed 09/10/13 Page 18 of 26
than those for which they were loaned. The Court finds this conversion theory to be
valid. In re Atkins53 is an example of a case applying this theory. Debtor Atkins and his
company borrowed $332,065 for the purchase of 337 specific scooters for inventory, to
be comprised of three brands, 200 Moderna, 72 Kina, and 65 Barcelona. The scooters
were to be collateral for the loan. Debtor executed a note which specified the use of the
loan proceeds and represented he would use the proceeds only to purchase the 337
scooters. However, he purchased only 290 scooters (182 Moderna, 54 Kina, and 54
Barcelona) and failed to retain the remaining loan proceeds. The misuse of the loan
proceeds was found to be willful and malicious. The claim on the note was excepted
from discharge under § 523(a)(6).
In this case, the Court finds the evidence regarding the limitations upon the use of
the loan proceeds provided by Bank to Schupbach Investments is insufficient to support a
claim of conversion. The notes state the purposes of the six loans as follows: “Refinance
and Improve Business Investment”;54 “Refinance Property 1539 N Hillside - Wichita”;55
“Business Investment 1524 N Lorraine”;56 “Business Investment 1753 N Chautauqua”;57
53 Randall v. Atkins (In re Atkins), 458 B.R. 858 (Bankr. W.D. Tex. 2011).
54 Exh. 3, Bates-stamp no. E13ST000002.
55 Exh. 4, Bates-stamp no. NHILLST000002.
56 Exh. 5, Bates-stamp no. LORRAINE000004.
57 Exh. 6, Bates-stamp no. CHAUT000004.
Case 12-05047 Doc# 45 Filed 09/10/13 Page 19 of 26
“Business Investment Purchase and Improvement”;58 and “Business Investment Purchase
and Improvement 1504 N Erie.”59 Bank asserts these terms mean that the loan proceeds
were to be segregated from other assets of Schupbach Investments and were to be used
only for the repair of the specific properties. Debtors contend that the stated purposes
allowed use of the proceeds for the general business purposes of Schupbach Investments,
which were the purchase and improvement of homes, including those mortgaged to secure
the particular loans. In other words, the parties agree that the loan proceeds were to be
used for Debtors’ business; the disagreement is only about whether the proceeds of the six
loans could be used for this general purpose, or whether the proceeds of each of the six
loans were to used exclusively for the renovation of the property securing the specific
The Court finds that the purposes stated in the notes are ambiguous, in that both
Bank’s and Debtors’ readings are reasonable interpretations of the notes. Therefore, to
ascertain if the use of the proceeds was limited to the repair of the specific properties
which secured each note, the Court considers the other loan documents, the circumstances
surrounding the making of the loans, and the actions of the parties after the loans were
The notes are the only documents purporting to state the purposes of the loans, and
they do not enumerate the anticipated repairs. The only documents in the loan files
58 Exh. 7, Bates-stamp no. S.ILLINOIS000004.
59 Exh. 8, Bates-stamp no. ERIE00003.
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addressing the specific improvements for each property are the appraisal reports. But
they were not signed by the borrower or Debtors, and there is no evidence that Debtors
received copies before the execution of the notes. The appraisal reports are therefore
excluded from consideration as a part of Schhupbach Investments’ agreements with Bank
by the integration clauses contained in each of the notes. Further, the lists of repairs in
the appraisal reports were drafted by the appraiser and not assented to by Jonathan
Schupbach or Bank. Clint Lawrence instructed the appraiser to value the properties as if
the repairs had been made; he did not consider the value of the properties without the
repairs or the cost of the repairs, which was never estimated. Clint Lawrence did not
discuss the repairs needed on each property with Jonathan Schupbach. The loan
documents did not state a date by which repairs were to be completed or require evidence
that repairs were made. There was no provision that precluded commingling the loan
proceeds with other assets of Schupbach Investments and no requirement that Schupbach
Investments return any funds not used for repairs.
Although Clint Lawrence testified that he regarded the loans as construction loans,
his conduct does not support this interpretation of the transactions. He testified that he
and Jonathan Schupbach discussed structuring loans to be secured by single residences to
require the submission of receipts for work performed, but rejected this method as
impractical because Schupbach Investments’ business model made it nearly impossible to
document expenditures on individual properties. The loan documents contain no
restriction on deposits of the loan proceeds, which were disbursed in lump sums by
Case 12-05047 Doc# 45 Filed 09/10/13 Page 21 of 26
cashiers’ checks. Bank made 20 or more loans to Schupbach Investments secured by
individual properties needing improvements without requiring an accounting of the use of
the proceeds; most were paid in full or refinanced; it appears that only the six were
outstanding on the date of filing. Neither Clint Lawrence nor Jonathan Schupbach could
recall any conversation about restrictions on the use of the proceeds. According to
Jonathan Schupbach, Clint Lawrence focused his attention on the general business health
of Schupbach Investments, not the condition of any specific property. Amy Schupbach
had no discussions with Clint Lawrence in which she was informed that the proceeds of
the six loans were to be devoted only to the repair of the home securing each loan, rather
than to the general business expenses of Schupbach Investments.
Bank’s evidence is insufficient for the Court to conclude that the use of the loan
proceeds was restricted in such a way that Schupbach Investments’ use of the proceeds
for general business purposes constituted a conversion. The relationship between Bank
and Debtors is that of creditor-debtor; Debtors have no liability for conversion.
D. The evidence is insufficient to conclude that Debtors willfully and
maliciously injured Bank.
Finally, even assuming that (1) the loan agreements required Schupbach
Investments to use the loan proceeds exclusively for the improvement of the mortgaged
properties, (2) such requirement was breached when the proceeds were used for general
business purposes, and (3) Debtors are liable to Bank for conversion, Bank has not
sustained its burden to prove that the alleged injury from conversion was willful and
Case 12-05047 Doc# 45 Filed 09/10/13 Page 22 of 26
malicious, as required for the debt to be excepted from discharge under § 523(a)(6).
As stated by the Supreme Court, “[t]here is no doubt that an act of conversion, if
willful and malicious, is an injury to property within the scope of this exception [the
predecessor to § 523(a)(6)]. . . . But a willful and malicious injury does not follow as of
course from every act of conversion, without reference to the circumstances. There may
be a conversion which is innocent or technical, an unauthorized assumption of dominion
without willfulness or malice.”60
As to the willful element, “nondischargeability takes a deliberate or intentional
injury, not merely a deliberate or intentional act that leads to injury.”61 The debtor must
desire the consequences of his act or believe that the consequences are substantially
certain to follow.62 “Willful injury may be established by direct evidence of specific
intent to harm a creditor or the creditor’s property.”63 “Willful injury may also be
established indirectly by evidence of both the debtor’s knowledge of the creditor’s
[interest in the property converted] and the debtor’s knowledge that the conduct will
cause particularized injury.”64
Bank’s evidence is inadequate to prove a willful injury by either Jonathan or Amy
60 Davis v. Aetna Acceptance Co., 293 U.S. at 332.
61 Kawaauhau v. Geiger, 523 U.S. at 61.
62 Panalis v. Moore, 357 F.3d at 1129.
63Mitsubishi Motors Credit of Amer. v. Longley (In re Longley), 235 B.R. 651, 657 (10th Cir.
BAP 1999) (citing Posta, 866 F.2d at 367).
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Schupbach. There is no direct evidence of intent to injure. Rather, both Debtors credibly
testified that they intended to repay the loans and believed they were using the loan
proceeds in accord with the terms of the loan agreements. Likewise, there is no indirect
evidence of willful injury. Assuming the loan proceeds were Bank property
notwithstanding Bank’s payment of the proceeds to Schupbach Investments, the evidence
does not establish that Debtors had knowledge of Bank’s interest. Further, Debtors had
no knowledge that their conduct in using the loan proceeds for the general business
operations of Schupbach Investments would cause injury to Bank’s property.
In contrast to the definition of “willful,” the definition of “malicious” for purposes
of § 523(a)(6) has not been authoritatively declared by the Supreme Court. The Tenth
Circuit has stated that “the term ‘malicious’ requires proof ‘that the debtor either intend
the resulting injury or intentionally take action that is substantially certain to cause the
injury,’”65 but this blurs the distinction between “willful” and “malicious.” The Tenth
Circuit has also stated that “evidence of the debtor’s motives, including any claimed
justification or excuse, must be examined to determine whether the requisite ‘malice’ in
addition to ‘willfulness’ is present.”66 A commentator has observed that “[t]he element of
malice distinguishes nondischargeable intentional torts from ordinary intentional tort
65 Panalis v Moore, 357 F.3d at 1129 (quoting Hope v. Walker (In re Walker), 48 F.3d 1161, 1164
(11th Cir. 1995)).
66 Dorr, Bentley & Pecha, CPA’s, P.C, v. Pasek (In re Pasek), 983 F.2d 1524, 1527 (10th Cir.
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Assuming a conversion, Bank’s evidence fails to show a malicious injury, however
defined. There was absolutely no evidence that Debtors intended to injure Bank. Debtors
intended to repair the residences and to pay the loans. There is no basis to conclude that
any injury to Bank was substantially certain to follow from Schupbach Investments’ use
of the loan proceeds for its general business operations. Prior loans from Bank for repair
of residences had been paid or refinanced, even though the loan proceeds were not
dedicated to the repair of the specific property securing the note. Assuming a conversion,
it was an ordinary tort; it was not malicious.
For the foregoing reasons, the Court denies Bank’s claim for denial of discharge of
its claim for conversion damages under § 523(a)(6). Bank’s evidence is insufficient to
find that Debtors caused injury to Bank by converting Bank’s property and, even if the
evidence were sufficient to find such an injury, Bank has not proven that any damages it
suffered were the result of a willful and malicious injury, as required for denial of
discharge of its claim under § 523(a)(6). Bank’s claim of nondischargeability for false
pretenses, false representations, and actual fraud under § 523(a)(2) was previously
dismissed as untimely. Finding no basis for denial of discharge, the Court concludes the
count of the Complaint for determining the amount excepted from discharge is moot.
67 3 William L. Norton, Jr., and William L. Norton III, Norton Bankruptcy Law & Practice 3d,
§ 57:44 at 57-125 (Thomson Reuters 2013).
Case 12-05047 Doc# 45 Filed 09/10/13 Page 25 of 26
Therefore, Bank is not entitled to any of the relief sought in the Complaint, and Debtors
are entitled to judgment in their favor.
The foregoing constitutes Findings of Fact and Conclusions of Law under Rule
7052 of the Federal Rules of Bankruptcy Procedure which makes Rule 52(a) of the
Federal Rules of Civil Procedure applicable to this proceeding. A judgment based upon
this ruling will be entered on a separate document as required by Federal Rule of
Bankruptcy Procedure 7058 which makes Federal Rule of Civil Procedure 58 applicable
to this proceeding.
IT IS SO ORDERED.
# # #
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