KSB

12-10357 Rich (Doc. # 54)

In Re Rich, 12-10357 (Bankr. D. Kan. Apr. 16, 2013) Doc. # 54

Click here for the pdf document.

---

__________________________________________________________________________
SO ORDERED.
SIGNED this 16th day of April, 2013.

 

DESIGNATED FOR ON-LINE PUBLICATION BUT NOT PRINT PUBLICATION

IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS

IN RE:
)
DANNY MARTIN RICH ) Case No. 12-10357
MARY BETH RICH ) Chapter 13
)
Debtors. )

____________________________________)

ORDER OVERRULING TRUSTEE’S OBJECTION
TO HOMESTEAD EXEMPTION

Married Kansas debtors are entitled to exempt their homestead from execution by general
creditors.1 The extent of the permitted exemption is measured in acres, not dollars, and a debtor’s
homestead may have unlimited value . . . until that debtor seeks bankruptcy protection. Then federal
law caps the “amount of interest” that the debtor has “acquired” in the homestead within the 1,215

1 KAN. STAT. ANN. § 60-2301 (2012 Supp.).
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days preceding the filing at $146,450.2 But federal law also provides that § 522 “shall apply
separately” to each debtor in a joint case, subject to certain limitations.3 Dan and Mary Beth Rich
acquired their homestead within the 1,215 days before they filed their joint bankruptcy case. To do
so, they allegedly used sale proceeds from their previous homestead, along with funds from Dan’s
IRA, savings, and the proceeds of construction loans.4 At the petition date, they considered the home
to be worth $509,500 and it was encumbered by $205,868 in secured debt, leaving “equity” of
$303,632. The trustee objects to their exemption because their equity exceeds the $146,450 cap.
Because the debtors are each entitled to “apply separately” the provisions of § 522 under subsection
(m), each debtor’s homestead interest is capped at $146,450, meaning their total exemption is
capped at $292,900. As there is nothing in the record to help me determine how much (if any) of the
remaining $10,732 equity was acquired with the proceeds of the debtors’ former homestead as §
522(p)(2)(B) provides, the Trustee’s objection to their homestead exemption must be overruled.5

Jurisdiction

Objections to claimed exemptions are contested, core proceedings under 28 U.S.C. §
157(b)(2)(B) and this Court may exercise subject matter jurisdiction per 28 U.S.C. § 1334 and §
157(a) and (b)(1).

2 11 U.S.C. § 522(p)(1). Effective April 1, 2013 the dollar amount of the cap increased to
$155,675 but because this case was commenced prior to the dollar adjustment, the cap remains at
$146,450 for this case. See § 104(c).

3 11 U.S.C. § 522(m).

4 Dkt. 45, p. 3.

5 The chapter 13 trustee appears by her attorney Karin Tollefson. Debtors appear by

their counsel William H. Zimmerman, Jr.
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Factual Summary6

Dan and Mary Beth Rich filed this joint bankruptcy case on February 24, 2012; October 27,
2008 is 1,215 days prior to filing. They sold their former homestead on Lakeview Road in
Hutchinson, Kansas, in October of 2008. In late June of 2009, they purchased land on East 69th
Avenue in Hutchinson and built a home there, completing construction in 2010, well within the
1,215 day period. The stipulations state that there remains “a factual issue” about the source of the
funds to purchase the land and build the house and the amount of funds from each source.7 But as
this matter was submitted on stipulations and no one requested an evidentiary hearing, the record
is now closed, leaving us with no record concerning how much, if any, of what the debtors realized
on their old house went into the new one.8 When they filed this case, they scheduled the home as
having a value of $509,500 and as being encumbered by two mortgages with an aggregate balance
of $205,868. The parties stipulate that the debtors’ equity in the home was $303,632 at the date of
filing.

Analysis

Burden of Proof

In bankruptcy, a properly-claimed exemption is presumed valid unless a party in interest

6 The parties submitted this contested matter on stipulations, see dkt. 40.

7 Dkt. 40, ¶s 9 and 15.

8 Section 522(p)(2)(B) creates a safe harbor for calculating the “amount of interest”
acquired within the 1,215 day period where the interest is transferred from debtors’ previous
residence (acquired prior to the 1,215 day period) into the current residence. In other words, the
§ 522(p)(1) cap does not apply to equity that debtors rollover from a previous residence. See In
re Blair, 334 B.R. 374 (Bankr. N.D. Tex. 2005); In re Wayrynen, 332 B.R. 479 (Bankr. S.D. Fla.
2005); In re Presto, 376 B.R. 554 (Bankr. S.D. Tex. 2007).

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objects.9 As the party objecting to the exemption here, the Trustee bears the “burden of proving that
the exemption was not properly claimed.”10 Kansas exemption laws are construed liberally in favor
of exemption.11 Because the parties agreed with each other to submit this matter on stipulations, I
regard them as the only facts proven in the case and disregard the additional facts alleged by the
Trustee and the debtors in their memoranda.12

Joint Cases, State Law, and the § 522(p) Cap

Kansas families are permitted to exempt either one acre in town or 160 acres of farming land
in the country as their exempt homestead.13 They must reside on the land so designated.14 Kansas
courts have traditionally concluded that married Kansas debtors and joint tenants are entitled to only
one homestead.15 In general, the bankruptcy courts sitting in Kansas have followed suit. In In re

9 Fed. R. Bankr. P. 4003(b).

10 Fed. R. Bankr. P. 4003(c); In re Ginther, 282 B.R. 16, 19 (Bankr. D. Kan. 2002). See
also, Dkt. 23 (Trustee’s Objection).

11 In re Ginther, 282 B.R. at 19.

12 See Dkt. 45, pp. 3-4. Moreover, none of the additional facts alleged are supported by
an affidavit or other citation to the evidentiary record or exhibits such as real estate closing or
settlement statements and bank records to demonstrate the source of funds and amounts
transferred. Id. at ¶s 5, 6 and 7. The debtors’ additional unsupported facts in their brief are
similarly undocumented and should be likewise ignored. See Dkt. 50, p. 2, ¶s 2 and 3.

13 KANS. CONST. art. 15, § 9; KAN. STAT. ANN. § 60-2301 (2012 Supp).

14 Both the constitutional provision and the state statute require the designated property to
be “occupied as a residence.”

15 See Atchison Savings Bank et al. v. Wheeler’s Administrator, 20 Kan. 625 (1878) (The
law does not recognize two homesteads for one family.) The Kansas constitutional homestead
provision requires the homestead to be occupied as a residence “by the family of the owner.”
Art. 15, § 9. The Kansas statutory version, on the other hand, requires occupancy “by the owner
or by the family of the owner, or by both the owner and family thereof.” § 60-2301. See also,
Commerce Bank of Kansas City v. Odell, 16 Kan. App. 2d 704, 827 P.2d 1205 (1992) (joint

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Sauer, I held that married debtors who had separated shortly before filing could not each claim an
exempt one acre residence in separate Kansas cities.16 I relied on the plain language of the
homestead act in reaching that conclusion. That statute states –

[A] homestead to the extent of 160 acres of farming land, or of one acre within the
limits of an incorporated town or city, or a manufactured home or mobile home,
occupied as a residence by the owner or by the family of the owner, or by both the
owner and family thereof, together with all the improvements on the same, shall be
exempted from forced sale under any process of law, and shall not be alienated
without the joint consent of husband and wife, ***.17
The statute plainly speaks of there being one homestead (“a homestead,” “a residence,” etc.). By
comparison, other Kansas exemption statutes confer an exemption upon “every” debtor. For
example personal property exemptions permit – “Every person residing in this state shall have
exempt . . . the following articles of personal property . . . .”18

The Kansas state courts have long recognized that families are only entitled to one
homestead, first doing so in 1878.19 More recently, the Kansas Court of Appeals held that joint
tenants in a 240 acre tract can not each claim one-half of the tract exempt.20 Relying on the words

tenants could claim exempt their interest in only one homestead exemption of 160 acres); Cole v.
Coons, 162 Kan. 624, 178 P.2d 997 (1947)(Under Kansas law, fact that ownership of property is
by co-tenancy does not deny the cotenants the rights to claim a homestead in the property; one
cotenant cannot establish homestead to the exclusion of other cotenants).

16 403 B.R. 722, 730 (Bankr. D. Kan. 2009).

17 KAN. STAT. ANN. § 60-2301 (2012 Supp) (Emphasis added).

18 KAN. STAT. ANN. § 60-2304(a).

19 Atchison Sav. Bank v. Wheeler’s Adm’r, supra.

20 Commerce Bank of Kansas City v. Odell, supra. See also Nelson v. Stocking, 154 Kan.

676, 121 P.2d 215 (1942) (Debtor with one-fourth interest in 281 acres may only claim as
exempt one-fourth of 160 acres).

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“to the extent of 160 acres” as contained in the statute, that court concluded that only each cotenant’s
interest in the 160 acres (or one acre in town) could be claimed exempt.21

To be sure, not all judges sitting in Kansas have reached this conclusion. In In re Hall, Judge
Karlin of this court overruled a chapter 7 trustee’s objection to joint debtors’ claiming as exempt
separate dwellings on a 1.33 acre tract in an incorporated town.22 She concluded that the Halls had
each “legitimately established a separate homestead pursuant to Kansas law because both dwellings
qualified as homesteads.”23 The facts in Hall differ from the facts in this case: Dan and Mary Beth
Rich only inhabit one dwelling and, at Kansas law, even under the Hall rule, they are only entitled
to claim one homestead.

Bankruptcy law likewise provides for debtors to claim assets exempt from their bankruptcy
estates. Section 522 outlines the scope of those exemptions. Section 522(b)(1) provides that “an
individual debtor” can exempt either property listed in subsection (b)(2) or (b)(3). Subsection (b)(2)
allows an individual debtor to claim exemptions under a comprehensive scheme of so-called “federal
exemptions” as listed in § 522(d) while subsection (b)(3) permits the debtor to elect the state law
exemptions in his or her state of domicile. Subsection (b)(1) adds the limitation that debtors in joint

21 Commerce Bank of Kansas City, 16 Kan. App. 2d at 708.

22 395 B.R. 722 (Bankr. D. Kan. 2008).

23 Id. at 731. Judge Karlin limited her decision in Hall to its admittedly unusual facts. In
that case the married debtors jointly owned a 1.33 acre tract within city limits. Debtors conceded
that they were limited to 1 acre and would claim the acre upon which the improvements were
located. Two structures were located on the tract – a house occupied by the wife and children
and a mobile home occupied by the husband. The husband had lived apart from his family and
moved into the mobile home two years prior to filing bankruptcy because a finding of child
abuse had prohibited him from residing with his family. The evidence established that the
debtors intended to live in these separate residences on a permanent basis, just as they had done
for more than two years.

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cases must both elect either the state or federal exemptions; one debtor cannot elect state exemptions
while the other debtor chooses federal ones.

Section 522(b)(2) allows states to opt out of the federal scheme by not specifically
authorizing its citizens to choose it. By enacting KAN. STAT. ANN. § 60-2312(a) (2005), the Kansas
legislature has opted out, meaning that Kansans filing bankruptcy cases must use the state law
exemptions.24

Section 522(m) provides –

(m) Subject to the limitation in subsection (b), this section shall apply separately with
respect to each debtor in a joint case.
The “limitation in subsection (b)” likely refers to the requirement that joint debtors elect either
federal or state exemptions, although some courts and commentators have concluded that this
provision is without meaning in cases involving debtors who hail from opt out states. Norton’s
bankruptcy treatise categorically states that joint debtors claiming state exemptions can’t double
them where state law does not provide separate exemptions.25 Collier’s treatise counters that joint
debtors can each “stack” their exemptions, noting a Circuit split. It references an Eighth Circuit
Court of Appeals case, In re Stevens, as authority holding that the “limitation in subsection (b)”
language was added by Congress to refer to the limitation on spouses claiming different exemption

24 With some exceptions, see KAN. STAT. ANN. § 60-2312(b) (Authorizing debtors to
claim the federal exemptions that are set out in § 522(d)(10)).

25 Hon. William L. Norton, Jr. and William L. Norton III, 3 NORTON BANKR. L. & PRAC.
§ 56:4 (3d ed. 2012).

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schemes in joint cases.26 That limitation was added to § 522(b) in 1984.27

In 2005 as part of the Bankruptcy Abuse Prevention and Consumer Protection Act, Congress
added § 522(p), ostensibly to stem perceived abuses of state law unlimited homestead exemptions.28
That provision provides that any “amount of interest” a debtor “acquires” in a homestead in the
1,215 days preceding filing is capped at $146,450.29 Not counted in this “amount of interest” is any
equity that the debtor received from the sale of a prior homestead and transferred into the debtor’s
current homestead.30 In the present case, the debtors argue that their homestead cap should be
$292,900 because § 522(m) applies the entire section separately to each debtor in a joint case. The
Trustee counters that because Kansas state law limits debtors to one homestead, the debtors’
argument must fail.

The debtors have the better argument here. While the Kansas Constitution and statute limit
married debtors to a single homestead, the only state law limitation is on quantity of land. The
debtors don’t seek to exempt more than 160 acres, nor do they ask to be permitted to each retain a
separate, non-contiguous tract like the debtors in Sauer. Instead, they ask to stack the caps imposed
upon each of them by § 522(p)(1). This is what § 522(m) contemplates. While § 522(b)(3) avails the

26 Alan N. Resnick and Henry J. Sommer, 4 COLLIER ON BANKRUPTCY ¶ 522.04[5] (16th
ed. 2013). See Stevens v. Pike County Bank (In re Stevens), 829 F.2d 693 (8th Cir. 1987).

27 Bankruptcy Amendments and Federal Judgeship Act of 1984, 98 Stat. 333, PUB. L. NO.
98-353, § 306.

28 By § 522(p)(1)’s reference to exemptions elected under “subsection (b)(3)(A),” the
exemption cap applies to state law homestead exemptions. Section 522(b)(3)(A) itself provides
that state law exemptions are subject to subsection (p).

29 § 522(p)(1).

30 § 522(p)(2)(B).

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debtors of an unlimited value Kansas homestead exemption, subsection (p) limits the value of that
exemption in bankruptcy.31 Subsection (m) applies that cap to each of them, meaning that each
debtor’s share of the homestead is value-capped at $146,450.

The Bankruptcy Appellate Panel for the Tenth Circuit held as much in In re Nestlen. 32 In that
case, Oklahoma joint debtors were permitted to stack their subsection (p) caps. The panel in that
case concluded that § 522(p) is a federal dollar limitation on a state law right that applies to each
debtor under subsection (m).33 As in Kansas, the Oklahoma homestead exemption has unlimited
value, but is limited in size to one acre in a city or town and 160 acres in the country.34 There is no
reason to distinguish Nestlen from the debtors’ case here – each joint debtor is entitled to the dollar
value limit of their homestead exemption.35

Concluding that the cap applicable to the joint debtors here is $292,900 should not end the
inquiry. Even applying the stacked caps, the debtors still have over $10,000 in home equity to which
the Trustee or the unsecured creditors might stake a claim. But the Rule 4003(b) allocation of the

31 The value cap imposed by § 522(p)(1) only applies to debtors “electing” state law
exemptions. The federal “homestead” exemption contains its own value cap. See § 522(d)(1).

32 Dykstra Exterior, Inc. v. Nestlen (In re Nestlen), 441 B.R. 135 (10th Cir. BAP 2010).

33 Id. at 143, concluding that state law is irrelevant to the application of subsection (m) to
§ 522(p); whether the cap should be doubled for joint debtors by virtue of subsection (m) is a
question of federal law.

34 OKLA. CONST. art. 12, § 1-3; OKLA. STAT. ANN. tit. 31, §§ 1(A)(1) and 2.

35 See also, In re Gentile, 483 B.R. 50 (Bankr. D. Mass. 2012) (Massachusetts homestead
exemption was capped by § 522(p)(1) but joint debtors may “stack” the capped exemption under
§ 522(m)); In re Rasmussen, 349 B.R. 747, 758 (Bankr. M.D. Fla. 2006) (As a result of
application of § 522(m) to § 522(p), each debtor in joint case may claim the cap amount
exempt); In re Cook, 460 B.R. 911 (Bankr. N.D. Fla. 2011); 4 COLLIER ON BANKRUPTCY, supra
at ¶ 522.13[4].

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burden of proof closes the case. The Trustee had the burden to prove that the debtors were not
entitled to exempt their homestead’s equity. The only stipulated fact concerning the sources of the
debtors’ homestead equity is that a factual issue remains as to the source or sources of it. In the
absence of a stipulation that specifically details how much, if any, of the former homestead’s equity,
Dan’s IRA, and the debtors’ other savings contributed to the remaining $10,732 of equity in the new
homestead, I cannot determine the “amount of interest” acquired by the debtors during the 1,215 day
look back period.36

The Trustee’s objection to the debtors’ exemption of their homestead is therefore
OVERRULED.
# # #

36 It is therefore also unnecessary to reach the debtors other argument concerning the
exempt character of IRA funds.

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12-11696 Stull (Doc. # 29)

In Re Stull, 12-11696 (Bankr. D. Kan. Mar. 28, 2013) Doc. # 29

Click here for the pdf document.

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SO ORDERED.
SIGNED this 27th day of March, 2013.

 

 

PUBLISHED

IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS

IN RE: )
)
QUINCY RAY STULL ) Case No. 12-11696
) Chapter 13
Debtor. )

____________________________________)

ORDER DENYING CONFIRMATION OF CHAPTER 13 PLAN

Chapter 13 allows debtors to propose plans that discriminate between holders of unsecured
claims so long as the discrimination is not “unfair.”1 This means that for appropriate reasons, debtors
may propose to pay one unsecured claim on more favorable terms than another. The Code expressly
forbids the payment of interest on an unsecured nondischargeable claim unless all of the other

1 11 U.S.C. § 1322(b)(1). Unless otherwise indicated, all statutory references are to the
Bankruptcy Code, as amended, Title 11 U.S.C. § 101 et seq.

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allowed claims are paid in full.2 Quincy Stull proposes to treat his nondischargeable student loan
more favorably than his other unsecured creditors by paying it in full with interest over the plan’s
duration. While this proposed discrimination may be “fair,” his proposal to pay interest on the
student loan claim without paying the other unsecured creditors in full violates § 1322(b)(10) and
cannot be approved. Accordingly, confirmation of his plan must be DENIED.3

Facts4

Quincy Stull filed this chapter 13 case on June 22, 2012. He is an above-median debtor. He
proposed to pay the Trustee 60 payments of $385 per month.5 His monthly disposable income as
calculated on Form B22C, Line 59 is $129.01.6 He owes $3,722 to the U.S. Department of
Education on a student loan that the parties agree would be excepted from his discharge under §
1328(a)(2) and § 523(a)(8). The parties stipulated that unsecured claims in the case, including the
student loan claim, total $20,861.7 Stull proposes that he will pay his projected disposable income

2 § 1322(b)(10).

3 The chapter 13 trustee Laurie B. Williams appears by her staff attorney Karin N.
Tollefson. The debtor appears by his counsel, David P. Eron.

4 The Trustee and the debtor stipulated to the facts that govern this decision and these
findings, except as noted, are based on that stipulation. See Dkt. 25.

5 Dkt. 25-2 (Stipulation Ex. B)

6 This monthly amount multiplied by 60 equals an unsecured pot of $7,740.60 as set
forth in the debtor’s plan, paragraph 1.c. The stipulations provide that non-student loan general
unsecured creditors will receive $8,440.90, a difference of some $700 that is unexplained. The
Court’s calculations herein will utilize the stipulated $8,440.90 figure.

7 Subtracting the amount of the secured claim filed in the case from the total amount of
the claims shown on the Claims Register yields a remainder that is $10 less than what the
stipulation provides. This difference appears to be attributable to the varying amount of the
student loan debt. The proof of claim shows a student loan debt of $3,722 while the plan and
Schedule F list the student loan debt at $3,732. For purposes of the calculations in this opinion,

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into the plan for the benefit of the unsecured creditors, but that the student loan claim will be paid
separately from additional funds. The student loan will be paid in full, plus interest at 4.75 per cent.8
According to the stipulations, the non-student loan unsecured creditors will receive $8,440 or a
dividend of 40.462 percent if the debtor is permitted to separately pay the student loan as proposed.9
The stipulations do not reflect what the remaining terms of the two student loans are, nor is there
any information in the record concerning the amount of the scheduled payments due on the loans.
The absence of this information makes it unclear whether the plan treatment of the student loan debt
is proposed under § 1322(b)(5) as a cure and maintenance of long term debt.

The stipulated dividend calculation seems to be incorrect. If the non-student loan creditors
whose claims total $17,139 ($20,861 - $3,722) receive $8,440, their dividend will be 49.24 percent
while the student loan creditor’s dividend will be 100 percent plus interest. On the other hand, if the
student loan creditor were to participate in the unsecured distribution, the total dividend would be

40.46 percent,10 yielding the non-student loan creditors $6,934 and the student loan creditor
the Court accepts the figure of $20,861 for total general unsecured claims and will utilize $3,722
as the amount of the student loan debt.

8 The U.S. Department of Education’s proof of claim in the amount of $3,722.27 states
that the contract rate on this claim is only 2.39%. See Claim No. 6-1 at Dkt. 25-3 (Stipulation Ex.
C). Nothing in the briefs explains the difference between that and what the debtor proposes to
pay.

9 The parties stipulate the admissibility of Exhibit D, the Trustee’s “Plancalc” table
showing what claimants may expect to receive on their claims. See Dkt. 25-4. (What is unclear
here is that the Plancalc refers to the student loan claim being paid separately and the unsecured
claims being paid based on a total amount of $20,861 while the body of the stipulation (and the
claims register) reflect that the whole unsecured pool, including the student loan, only totals
$20,861. For the purposes of this order, I will assume that $20,861 represents all of the allowed
unsecured claims including the student loan claim.

10 $8,440 ÷ $20,861 = 40.46%.

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$1,506.11 If the debtor were somehow prohibited from paying “discretionary” income toward the
student loan, at discharge, he would still owe the U.S. Department of Education about $2,216 plus
accrued interest.12 Thus, the effect of the proposed discriminatory treatment is to direct $2,216 of
the debtor’s disposable income toward a nondischargeable claim and to reduce the unsecured
creditors’ dividend by about 9 percent.13

The Trustee argues that this treatment amounts to unfair discrimination that is barred by §
1322(b)(1) and § 1325(a)(1). She also notes that as the debtor is not paying his claims in full, the
student loan claim should not receive interest under § 1322(b)(10). The debtor suggests that his
interest in receiving a fresh start, combined with the fact that he is paying exactly what the Code
requires him to pay the unsecured creditors, makes the discrimination permissible. His brief makes
no mention of the § 1322(b)(10) problem.

Analysis

Unfair Discrimination under § 1322(b)(1).

The Trustee’s principal objection to the plan is that it unfairly discriminates among
unsecured claims by paying the nondischargeable claim in full while paying the rest of the unsecured
creditors pro rata. The debtor essentially argues that because he proposes to pay the unsecured
creditors all that they are required to be repaid under the Bankruptcy Code – his projected disposable
income – he should be permitted to pay the student loan in full. He suggests that the adoption of

11 The non-student loan debt comprises 82.16% of total general unsecured claims
($17,139 ÷ 20,861) and 82.16% of an $8,440 distribution equals $6,934. The student loan debt
comprises 17.84% of the general unsecured claims ($3,722 ÷ $20,861) and 17.84% of the $8,440
distribution equals $1,506.

12 $3,722 - $1,506 = $2,216.

13 49.24% - 40.46% = 8.78%

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BAPCPA displaces the courts’ prior formulations for determining whether unfair discrimination has
occurred. The Trustee says that any dividend differential that favors a nondischargeable debt
unfairly discriminates against the unsecured creditors and should be barred.

Before BAPCPA was enacted, many courts weighed in on whether discriminatory treatment
favoring a nondischargeable student loan was fair and passed muster under § 1322(b)(1). As both
parties note, “unfair discrimination” is not defined in the Code, leaving courts to divine or devise
tests to determine whether the discriminatory treatment is indeed unfair. This Court visited that topic
in 2003 in In re Mason. 14 There I reviewed the different tests advanced by various courts and applied
the “Baseline Test” found in In re Bentley as the one that best reflected the aims of the Code as it
existed then.15 The baseline test assesses whether, despite the differences in treatment, the plan offers
each class benefits and burdens that are equivalent to what it would receive at the baseline, the
discrimination can be permitted.16 The baseline is defined by the treatment the creditors in the
disadvantaged class would receive without the separate classification. This requires determining
whether the plan honors the four Code-based principles of (i) equality of distribution; (ii) the non-
priority of student loans; (iii) whether the contributions to those loans are mandatory or optional;
and (iv) whether the debtor’s interest in gaining a fresh start justifies the discrimination. Because
student loans are not accorded statutory priority, anything they receive over what they would take
in a pro rata distribution without the discrimination, should come from assets not required to be

14 300 B.R. 379 (Bankr. D. Kan. 2003).
15 Id. at 384 (describing the baseline test) and 387 (finding the baseline test “most loyal to
the objective goals and motivations of Chapter 13 and the Bankruptcy Code.”)
16 In re Bentley, 266 B.R. 229, 240 (1st Cir. BAP 2001).
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contributed to the plan and thus not detract from the unsecured creditors’ take.17 Otherwise, the
unsecured creditors would bear the burden of paying the nondischargeable claim.

Nothing in the enactment of BAPCPA renders the Bentley test obsolete. BAPCPA
significantly altered the discretion that judges once wielded when determining whether a debtor was
devoting his or her disposable income to a plan by defining what above-median debtors pay their
unsecured creditors as their projected disposable income (PDI). Congress decreed that, for above-
median debtors, PDI is determined by a mechanical test found in § 707(b)(2) and (3) and applied
to chapter 13 by § 1325(b)(2) and (3). But the 2005 amendments did not displace the equal
distribution concept, nor did they prioritize student loans. And by imposing mechanically-
determined projected disposable income requirements on above-median debtors, § 1325(b) actually
makes it easier to determine whether these debtors are committing disposable or discretionary
income to their nondischargeable obligations by liquidating the amount of disposable income the
debtors must pay to the unsecured creditors.

As it must, Stull’s plan proposes committing all of his PDI to his unsecured creditors. The
stipulated total amount proposed to be paid to the unsecured creditors is $8,440, yielding the nonstudent
loan creditors a dividend of 49 percent. But Stull generates more income than the disposable
income calculation yields. So, using funds other than his PDI, Stull proposes to pay the $3,722
student loan claim in full with interest, yielding a 100 percent dividend to that creditor. Because he
is not using PDI, the non-student loan creditors will receive not a dime less than they would at the
baseline while the student loan will be paid in full.

A summary comparison of the effect on unsecured creditors under the proposed plan

17 Id. at 243.
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treatment and the treatment without separately classifying the student loan claim, is set forth below:

Proposed Plan Treatment:
Total student loan debt $3,722
Total non-student loan unsecured debt: $17,139
Proposed distribution to non-student loan unsecured debt: $8,440
% Dividend to non-student loan unsecured creditors 49.24%
% Dividend to student loan creditor (paid separately) 100.00%
Baseline Treatment Without Separate Classification:
Total student loan debt: $3,722
Total non-student loan unsecured debt $17,139
Total unsecured debt $20,861
Proposed distribution to total unsecured debt $8,440
% Dividend to unsecured creditors 40.46%

As this comparison demonstrates, the non-student loan unsecured creditors are better off under the
proposed plan treatment than at the baseline.

Several courts have approved this outcome in above-median debtor cases. In In re Sharp, a
case in the District of Colorado, several sets of debtors proposed to pay their student loans pro-rata
with the other unsecured creditors and to make additional payments outside their plans from income
other than the disposable income they had committed to the plan.18

That these Debtors have excess income for student loan payments is a function of the

historical PDI calculation imposed by BAPCPA, rather than any attempt to evade the

18 415 B.R. 803 (Bankr. D. Colo. 2009).
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payment of their PDI.19
In Sharp, the Trustee did not complain about the extra-plan payment with discretionary income;
rather the complaint concerned forcing the unsecured creditors to share the pro rata distribution with
the student loan creditors. The court there held that the pro rata student loan payments were also
permissible because the loans were unsecured claims that the debtor could pay under § 1322(b)(1)
(allowing a class of unsecured claims to be designated) and long term debt payments that could be
made under § 1322(b)(5) (allowing the cure of any default and maintaining of any payments on
debts whose last payment will be due after the plan’s final payment is due).20

Another bankruptcy judge in the District of Colorado has held to the contrary, albeit on
different facts. In In re Kubeczko, the below-median debtor proposed to pay current student loan
monthly payments as payments on a long-term debt under § 1322(b)(5) while also paying the student
loan creditor pro rata with the other unsecured creditors inside the plan.21 This debtor had no
disposable income. Over the life of the 36-month plan, the student loan creditor would have received
a 47% dividend while the other unsecured creditors would only get 0.27%. By comparison, paying
the student loan creditor pro rata without discriminating against the unsecured creditors would yield
everyone a dividend of 8.06%. The court concluded that even if a student loan is eligible to be
treated as a long term debt under § 1322(b)(5), the treatment still has to pass muster under §

19 Id. at 812.

20 Id. See also In re Abaunza, 452 B.R. 866 (Bankr. S.D. Fla. 2011) (what above median
debtors are required to pay under means test is “essentially the pot” that unsecured creditors
must receive; as long as they receive it, paying a non-dischargeable claim from funds not in the
“pot” is permissible).

21 2012 WL 2685115 (Bankr. D. Colo., July 6, 2012) (Tallman, C.J.).

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1322(b)(1) – any discrimination among classes cannot be unfair.22 The hardship to the unsecured
class as a whole must be balanced against the harm suffered by the debtor if the proposed treatment
were disapproved. In Kubezcko, the dividend received by the student loan creditor was 47 times that
received by the dischargeable creditors and therefore violated § 1322(b)(1) even though it complied
with § 1322(b)(5).23

In our case, the Trustee suggests that Kubezcko supports denying Stull the opportunity to pay
his student loan from funds outside the pot. But because Kubezcko is a below-median debtor, his
case is distinguishable. Because a below median debtor necessarily pays his unsecured creditors his
disposable income based upon income and actual expenses rather than upon a projection derived
from the means test, he may have no “discretionary” income.24 Whatever he pays the student loan
will necessarily diminish what he can pay the other unsecured creditors.

The proposed treatment also yields the unsecured creditors funds in excess of the baseline.
If the student loans were paid pro rata with the other unsecured claims, all would receive a 40
percent. Under Stull’s proposed plan, the non-student loan creditors would receive a dividend of 49
percent. I hold on these facts that a similarly situated above-median debtor may separately classify

22 See also In re Boscaccy, 442 B.R. 501 (Bankr. N.D. Miss. 2010) (analyzing three cases
where debtor separately classified student loan debt under § 1322(b)(5)’s cure and maintenance
of long term debt to determine whether they unfairly discriminated against general unsecured
creditors in violation of § 1322(b)(1)).

23 There is nothing in the record in the present case that indicates what the amount of the
contractual payments on the student loan is, nor can I tell that the last payment will come due
after the last plan payment. Section 1322(b)(5) may well not even apply here.

24 Cf. § 1325(b)(2)(A)(i) versus § 1325(b)(3). Only to the extent that a below median
income debtor’s current monthly income (CMI), a historical figure, differs from a debtor’s actual
income on Schedule I would the possibility of discretionary income exist. But in Kubezcko, the
below median debtor had no “discretionary income.”

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and pay a non-dischargeable obligation from income he or she earns in excess of the projected
disposable income that must be committed to the unsecured pot. If that were the extent of the
treatment proposed for the student loan creditor here, it would be approved.

But it isn’t. Stull also proposes to pay the Department of Education interest on its non-
dischargeable claim. This § 1322(b)(10) clearly prohibits. Added by BAPCPA in 2005, that
subsection provides that a plan may–

. . . provide for the payment of interest accruing after the date of the filing of the

petition on unsecured claims that are nondischargeable under section 1328(a),

except that such interest may be paid only to the extent that the debtor has

disposable income available to pay such interest after making provision for full

payment of all allowed claims;25
This language is plain: in the absence of “full payment of all allowed claims,” an unsecured non-
dischargeable claim may not receive interest. In Kubezcko, the debtor proposed to pay interest on
the student loan claims, arguing that paying interest was a necessary component of curing the default
and maintaining the payments on this long-term debt.26 The court there concluded that the later-
enacted and very specific terms of (b)(10) trump the earlier and more general provisions of §
1322(b)(5).27

25 § 1322(b)(10). See generally Keith M. Lundin & William H. Brown, CHAPTER 13
BANKRUPTCY, 4TH EDITION, § 459.1, SEC. REV. July 26, 2007, www.Ch13online.com.

26 Section 1322(b)(5), the long-term debt provision, permits a debtor to cure any default
and maintain original contract payments on any unsecured or secured claim for which the final
payment is due after the last plan payment is due.

27 2012 WL 2685115 at *6 (noting (b)(10)’s “severely limiting” effect of any treatment of
a nondischargeable unsecured debt in a chapter 13 plan that involves the payment of interest on
the debt). As a matter of statutory interpretation, where two provisions cannot be harmonized,
the later enacted, more specific will control over the earlier, more general statute. Id.; In re
Edmonds, 444 B.R. 898, 902 (Bankr. E.D. Wis.) (Stating that (b)(10) is “very clear in its
wording.”).

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In In re Freeman, one bankruptcy court concluded that § 1322(b)(5) and (b)(10) presented
an irreconcilable conflict and led that court to conclude that (b)(5) was the more specific provision
and controlled over the more general (b)(10).28 But the court appears to reason that applying (b)(10)
would render (b)(5) superfluous. It stated:

. . . the Court concludes that Congress intended to permit the cure and maintenance
of long-term unsecured debts, notwithstanding the applicability of section
1322(b)(10). As noted above, prohibiting the payment of interest on
nondischargeable debts would make the cure and maintenance of any long-term debt
impermissible. Such a result could not have been intended by Congress.29

While it is true that a long-term debt treated under (b)(5) is nondischargeable by virtue of §
1328(a)(1), only unsecured nondischargeable debt is subject to (b)(10).30 And (b)(10) is not an
outright proscription on payment of post-petition interest on an unsecured nondischargeable debt;
payment of interest is conditioned upon paying all allowed claims in full. In short, the Freeman
court’s statement that (b)(10) “would make the cure and maintenance of any long-term debt
impermissible,” simply reads and applies (b)(10) beyond its plain language.31 I conclude that (b)(5)
and (b)(10) are not irreconcilable and choose to enforce the plain language of (b)(10) where
applicable.

28 2006 WL 6589023 at *2 (Bankr. N.D. Ga. 2006) (Congress intended to permit the cure
and maintenance of long-term unsecured debts, notwithstanding § 1322(b)(10)). See also, In re
Webb, 370 B.R. 418 (Bankr. N.D. Ga. 2007) (following Freeman, and concluding that § 1322
(b)(5) controlled over less specific provision (b)(10); section 1322(b)(10) “is inapplicable” to
proposed treatment of maintaining direct payments on long-term student loan debts).

29 Freeman at *2. [Emphasis added]

30 For example, § 1322(b)(10) would not be implicated in the situation where a debtor
proposes to cure and maintain a secured home mortgage under § 1322(b)(5).

31 See Cameron M. Fee, An Attempt at Post-Mortem Revival, AM. BANKR. INST. J. (July
2012) questioning the reasoning of Freeman.

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Case 12-11696 Doc# 29 Filed 03/27/13 Page 11 of 12

Stull makes no argument in support of paying interest here. The statute’s “full payment”
language seems incapable of another interpretation and is in accord with basic bankruptcy
distribution principles. It is inequitable to allow a nondischargeable claim interest while refusing to
pay the other creditors in full when, unlike the other unsecured creditors, the student loan claim
holder will have the means of collection after the plan is complete. Because the Stull plan runs afoul
of this provision, it cannot be confirmed.32

In conclusion, while the plan does not unfairly discriminate by providing for this above
median debtor to pay his student loan claim from funds he receives in excess of his projected
disposable income, his added offer to pay interest on the student loan while only partially paying
the other allowed claims cannot be permitted under § 1322(b)(10). Confirmation is DENIED; the
debtor may submit an amended plan consistent with the provisions of this Order within 21 days of
its entry.

# # #

32 In re Edmonds, supra (payment of post-petition interest on student loan debt not
permitted by § 1322(b)(10) when not all unsecured claims will be paid in full).

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Case 12-11696 Doc# 29 Filed 03/27/13 Page 12 of 12

 

10-05243 Duggins et al v. Bratt (Doc. # 145)

Duggins et al v. Bratt, 10-05243 (Bankr. D. Kan. Mar. 29, 2013) Doc. # 145

Click here for the pdf document.

---

SO ORDERED.
SIGNED this 28th day of March, 2013.

 

 

PUBLISHED

IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS

IN RE: )
)
KIMBERLY DAWN BRATT, ) Case No. 10-12055
) Chapter 7
Debtor )

_______________________________________)

)
TODD DUGGINS and )
WILLIAM F. CUMMINGS, Receiver for )
Shanannigans, L.L.C., )

)
Plaintiffs )
vs. ) Adversary No. 10-5243

)
KIMBERLY DAWN BRATT, )
)
Defendant. )
_______________________________________)

MEMORANDUM OPINION

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Case 10-05243 Doc# 145 Filed 03/28/13 Page 1 of 24

Introduction

Sometime in his life, nearly every guy wishes he could own a bar. When Todd Duggins met
Dean Bratt, he realized that wish. Dean invited Duggins and Clifford Lewis to invest in a south
Wichita club called Shanannigans. The three formed a limited liability company to acquire the club
from another limited liability company owned by Dean and Kim Bratt, Bratt Investments, L.L.C.
When Dean and Duggins fell out, Duggins placed the bar in receivership. Bratt Investments filed
a chapter 11 case here and, when that effort failed, Dean and Kim filed a chapter 7 case. When Dean
failed to follow court orders, he was dismissed from that case, leaving Kim, who was never a
member of the Shanannigans LLC, on the hook both as a debtor and as a defendant in Duggins’ and
the state court receiver’s action for exceptions to discharge based upon actual fraud and fiduciary
defalcation.

When a debtor has incurred a debt by actual fraud or false representation, that debt may be
excepted from her discharge under § 523(a)(2)(A), if the debtor actually made false representations
on which her creditor justifiably relied. If that debtor commits an act of defalcation while standing
in a fiduciary relationship to the creditor, that debt is excepted, too. This adversary proceeding
involves determining whether defendant Kimberly Bratt, the last defendant standing in this case,
defrauded Todd Duggins by inducing him to invest in the Shanannigans bar with her husband and
Clifford Lewis. It also requires me to determine if Kim, who was the secretary, but not a member
of Shanningan’s, L.L.C., the entity that owned the bar, had a sufficient fiduciary capacity to the
company to support its defalcation claim under § 523(a)(4).

Claims and Summary Ruling

The plaintiffs in this nondischargeability action assert separate claims against Kim Bratt.

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Plaintiff Duggins, a one-third member and officer of Shanannigans, L.L.C., contends that Kim
fraudulently induced him to invest $25,000 and become a member of the LLC, in violation of 11

U.S.C. § 523(a)(2)(A). Plaintiff Cummings (the “Receiver”), asserts a claim on behalf of the LLC
under 11 U.S.C. § 523(a)(4), claiming that Kim committed defalcation while acting in a fiduciary
capacity by converting corporate assets and failing to account for funds and property that belonged
to the LLC.
Because Duggins failed to prove by a preponderance of the evidence that Kim made false
representations or otherwise engaged in actual fraud with the intent to deceive him, Kim is entitled
to judgment on his § 523(a)(2) claim. The Receiver failed to show that Kim had the requisite
fiduciary capacity to support a claim under § 523(a)(4) where no funds or property of the LLC had
been entrusted to her and she had neither a technical nor an express trust relationship with the LLC.
Kim is entitled to judgment on that claim, too.1

Jurisdiction

The plaintiffs’ § 523(a) claims to except debtor’s debt from her discharge are core
proceedings under 28 U.S.C. § 157(b)(2)(I) over which this Court may exercise subject matter
jurisdiction.2

Facts3

This adversary proceeding began in November of 2010 with plaintiffs’ nondischargeability

1 At the two-day trial of this matter in February, 2013, the plaintiffs appeared by their
attorney Joseph H. Cassell. Defendant Kimberly Bratt appeared pro se.
2See 28 U.S.C. § 1334 and § 157(b)(1).
3 The Court has incorporated the parties stipulations of fact contained in the final pretrial
order. Adv. Dkt. 105.
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Case 10-05243 Doc# 145 Filed 03/28/13 Page 3 of 24

claims being asserted against Kim Bratt and her husband Dean Bratt, who at that time was also a
debtor in the Bratts’ joint bankruptcy case.4 After Dean twice failed to appear for his first meeting
of creditors, the chapter 7 trustee moved to dismiss his bankruptcy case and that motion was granted
on July 18, 2012. As Dean was no longer seeking a chapter 7 discharge, this proceeding was moot
as to him, so I dismissed him as a defendant sua sponte. 5 Dean’s dismissal left Kim as the sole
defendant here, though his role in the events giving rise to the complaint remains important.

Kim and Dean are married. Each owns a one-half interest in Bratt Investments, L.L.C. (Bratt
Inv).6 Bratt Inv holds and manages a number of real estate properties and was itself a chapter 11
debtor.7 Among those properties was a bar called Magoo’s. Sometime in 2007, Bratt Inv acquired
a commercial strip center where it intended to open and operate Shanannigan’s Bar and Grill

4 The Bratts initially filed a chapter 11 case in June of 2010. It was converted to a
chapter 7 case on February 6, 2012.

5 See Bankr. Dkt. 230; Adv. Dkt. 99. As Dean had been dismissed from the chapter 7
case, he could not expect to receive a discharge in any event.

6 To further complicate the prosecution and trial of this adversary proceeding, Kim and
Dean are in the process of divorcing but, as of the date of trial, that action is incomplete and
remains pending. Kim was represented by counsel in this adversary proceeding until January of
2013 when her attorney withdrew. The final pretrial order was entered in October of 2012, while
Kim was represented. See Adv. Dkt. 105.

7 Bratt Investments filed a chapter 11 small business bankruptcy in this Court on August
20, 2010 (Case No. 10-12851). At a confirmation hearing conducted on April 21, 2011, the
Court confirmed Bratt Investments’ plan, but no confirmation order was ever prepared or
entered. By September, the U.S. Trustee had filed a motion to convert or dismiss the case
because the debtor failed to filed monthly reports or to pay its quarterly fees. At the hearing on
that motion on November 10, I directed that a confirmation order be entered in 14 days or the
case would be dismissed. At a further hearing on December 8, in the absence of a confirmation
order or the filing of the missing reports, I ordered the case dismissed and an order of dismissal
was entered on December 16, 2011. The case was closed in June of 2012.

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(hereafter referred to as Shanannigan’s East or SBG).8 This property was encumbered by a first
mortgage loan in favor of Meritrust Credit Union (formerly Boeing Wichita Credit Union).

In late 2007 or early 2008, Dean invited Duggins and Clifford Lewis to invest in the SBG
venture and become one-third “partners” with him. Dean asked Duggins to invest $25,000 in SBG.
In early 2008, the three partners formed Shanannigan’s L.L.C. to own and operate the bar. At the
first annual meeting of members of the LLC on January 11, 2008, Dean announced that he would
sell a third of the company each to Duggins and Lewis, effective January 1, 2008, making the three
men equal one-third members of the LLC. At that meeting, Dean was elected president of the LLC,
Lewis was elected vice-president, Duggins was elected treasurer, and Kim, who was not a member,
became secretary. Kim had no equity or other direct legal interest in the bar.

Bratt Inv had acquired the SBG property sometime in the fall of 2007. Lewis Lewis had
assisted in some remodeling work that was done prior to SBG’s opening on January 18, 2008. Bratt
Inv sold SBG to Shanannigan’s LLC, subject to the Meritrust mortgage, under a contract for deed
dated April 21, 2008. The terms and conditions of the contract stipulated that, among other things,
Dean Bratt would have “operational control” of the bar. Shanannigan’s opened for business on
January 18, 2008, well before the contract was signed and closed. Duggins paid his $25,000
investment to Bratt Inv in June, 2008.9

Duggins worked daily at SBG from the time it opened until February of 2010, departing a
month before the bar closed. During the first year of SBG’s operations, Kim worked there, too,

8 In addition to SBG, Guardian Interlock was a tenant at one end of this strip center and
had a monthly rent obligation of $500, payable to SBG.

9 See KAN. STAT. ANN. § 17-7686(c) recognizing that an individual may be admitted as a
member of a LLC and receive a LLC interest without making a contribution.

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Case 10-05243 Doc# 145 Filed 03/28/13 Page 5 of 24

handling daily bookkeeping and management functions. In the spring of 2009, either Bratt Inv or
Dean and Kim as individuals opened a second Shanannigan’s on the west side of Wichita (hereafter
referred to as SW). Duggins and Lewis had no ownership interest or involvement in the west bar.
Kim ran the SW bar after it opened.

In 2009, Duggins sued Dean in state district court to gain access to the books and records of
the LLC. In that case, the state court appointed William F. Cummings the receiver for the company.
The state court receivership case remained pending at the time of trial of these nondischargeability
claims.

Before meeting Dean and getting into the club business, Duggins had operated a cement
flatwork business for more than 20 years. He closed that business in order to devote his attention to
SBG. He had no prior experience in the restaurant or bar business. He met Dean through a mutual
friend sometime in late 2007 or early 2008. According to Duggins, the three owners’
“understanding” was that each LLC member would be “working partners,” even though, as noted
above, the terms and conditions of the contract for deed on the property between Bratt Inv and
Shanannigans, LLC granted Dean “operational control” of Shanannigans.10

 Duggins ran the kitchen and cooked during the day shift. Dean typically worked during the
lunch hour. Kim also worked and supervised the day shift with Duggins, handling the daily
bookkeeping for SBG, payment of vendors, and preparing the payroll. Cliff worked and ran SBG
during the night shift. The bookkeeping consisted of “day sheets” that tallied cash in and out of the
cash registers. These sheets were closed out after each shift. Cash was deposited at Meritrust

10 The Terms and Conditions, signed by Duggins but not Lewis, were dated June 10,
2008. Ex. A, p. 2.

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Case 10-05243 Doc# 145 Filed 03/28/13 Page 6 of 24

nightly. In June of 2008, Kim or Dean hired Virginia Boyd Accounting to prepare compilations of
the company’s accounts; Kim was the principal contact with Boyd Accounting. Periodically,
someone from Virginia Boyd Accounting would pick up the day sheets and prepare a running record
of the business’s income and expenses. Duggins had no contact with Boyd Accounting until the
summer of 2009 when he inquired about the status of his 2008 K-1 statement he needed to prepare
his individual 2008 tax return.11

Duggins was SBG’s treasurer, but he performed no duties typically associated with that
office other than occasionally writing or signing checks to vendors when deliveries were made to
the bar. All three members of the LLC plus Kim had check signing authority, but Kim wrote the
vast majority of the checks. For the first several months of SBG’s operations, deposits and checks
were commingled with Bratt Inv business activities and run through the Bratt Inv checking account.
Kim says she was opposed to this practice but that Dean had directed it. Duggins had access to the
financial records of SBG, but says that because he was new to the restaurant and bar business, he
was unfamiliar with the day sheets or other financial records that Kim maintained. He was never
trained to perform the daily bookkeeping function but he would periodically inquire of Kim how
SBG was doing and whether they “were making any money.” He had access to the check register
and could ascertain the checks being written.

The evidence of what Duggins was told to induce his investment or who told it to him is
scant at best. He testified that Dean introduced him to Kim and that she was present when Dean told
him that SBG was subject to no debt other than the Meritrust first mortgage. Dean told him that in

11 Schedule K-1 is issued by a partnership or LLC to report a partner or member’s share
of income, deductions, credits, etc.

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Case 10-05243 Doc# 145 Filed 03/28/13 Page 7 of 24

exchange for his investment of $25,000, Duggins would become a one-third “partner” in the
business. He later learned that the ad valorem taxes on the property were in arrears, but even after
learning that, he remitted his investment in June of 2008.12 Though he testified that he “worked
more with Kim than with Dean,” Duggins could not clearly identify any representations that Kim
made to him at any time before Shanannigans, L.L.C. was formed, before the January 11, 2008
annual meeting, the bar’s opening, or before he paid in his investment.

Clifford Lewis’s testimony supports a finding that Kim made no representations to Duggins
or Lewis to induce their investment. Lewis had worked for Dean at Bratt Inv’s bar, Magoo’s, and
had always wanted to own his own business. After Dean obtained the Shanannigans property in
October of 2007, he invited Lewis to become an owner. Lewis contributed construction and
remodeling labor to prepare the bar to open. All of Lewis’s discussions concerning investment were
with Dean, none were with Kim. Lewis did not meet Duggins until after SE opened. Lewis paid his
investment in January of 2008. Because Dean credited him with “sweat equity” for the work he’d
performed in the preceding fall, his cash contribution was limited to $10,000. As with Duggins, Kim
made no direct representations to Lewis concerning his investment.

Cash control was loose, to say the least. One former employee testified that she was
permitted to take cash advances from the register and often did so. Employees frequently paid
vendors with checks that Kim signed in blank and left in the register. Kim paid several of her
personal credit card bills with SBG checks, but claimed that the purchases on the bills were for items
used at SE. There were several instances where it appeared SBG checks were used to pay expenses

12 Duggins actually paid the $25,000 by a check dated June 10, 2008 payable to Bratt Inv
and negotiated by Dean on June 11, 2008.

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Case 10-05243 Doc# 145 Filed 03/28/13 Page 8 of 24

incurred at rental properties owned by Bratt Inv. And, after Bratt Inv acquired and opened
Shanannigan’s West, Duggins and Lewis suspected that SBG funds had been diverted to support the
cost of opening the other bar. Duggins’s review of the SBG check register in the spring of 2009 led
him to suspect that there were several questionable transactions, including what appeared to be
expending SBG funds for goods and services used by SW. There also appears to have been some
trading back and forth between the bars, particularly of labor and inventory.

In 2009, after Duggins had examined the SBG check register, Duggins became concerned
about the business’s direction and asked to see the company’s books. When he was unable to see
the books, he filed the state court receivership litigation on which part of this complaint is based and
obtained control of the accounting records from Virginia Boyd Accounting. Duggins left SBG in
February of 2010. A month later, the bar closed. During his 26 months of work at SBG, Duggins
never drew a wage or salary and received no draw or distribution from the LLC.

Much of the plaintiffs’ case focused on numerous account transactions large and small in an
effort to prove Kim’s alleged defalcation of SBG funds and property. There is little question that
Kim wrote checks on the SBG account for items and expenses not associated with or attributable
to Shanannigans business. But, Kim did not occupy the express or technical trust relationship with
the LLC that would support excepting her debt to the receiver from her discharge under § 523(a)(4).
Given that she was not a fiduciary within the meaning of that section, no detailed findings of fact
concerning the extent of the alleged defalcation debt need be made here.13

Analysis

13 This finding is not a finding that defalcation of some sort did or did not occur. The
receiver only alleged that Kim committed fraud or defalcation while in a fiduciary capacity. He
did not plead a cause of action for larceny or embezzlement.

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Case 10-05243 Doc# 145 Filed 03/28/13 Page 9 of 24

1.
Debtor Kim Bratt did not actually defraud Todd Duggins nor fraudulently induce
his investment in Shanannigans, L.L.C. under § 523(a)(2)
Section 523(a)(2)(A) provides that if a debtor contracts a debt by making a false statement
upon which her creditor justifiably relies, that debt may be excepted from the debtor’s discharge.
Likewise, a debt incurred by actual fraud or false pretense is excepted from debtor’s discharge.14
Duggins claims that Kim made false statements of material fact to induce him to invest $25,000 in
the Shanannigans enterprise and to become a one-third owner and member in the LLC. What he
stated he would prove in the pretrial order differed significantly from the evidence produced at trial.
In the pretrial order, Duggins asserts:

Defendant represented to Duggins that if he made the $25,000.00 investment,
Duggins (i) would be the company Treasurer and have control of, and responsibility
for, the company’s books and records, (ii) that Shanannigans did not have any debt
except payment on its purchase contract for the real estate (actually payment on Bratt
Investments, LLC’s underlying mortgage to Meritrust Bank) where Shanannigans
and tenant Guardian Interlock were located, (iii) that Duggins would be provided a
business prospectus/plan and (iv) that Duggins would be provided a complete
accounting for the company’s business activities from January through June 2008.
None of the above occurred.15

At trial, Duggins offered no evidence concerning representations (iii) and (iv). With regard to the
alleged representation that the company had no debt, Duggins testified that he was told that
Shanannigans only owed the mortgage against the real estate that it assumed when it acquired the
bar from Bratt Inv under the contract for deed. Duggins identified two additional debts that were
not disclosed to him, an unpaid bill owed to a flooring contractor who worked on the remodel of the

14 Diamond v. Vickery (In re Vickery), ___ B.R. ___, 2013 WL 979099; BAP No. 12-051
(10th Cir. BAP Mar. 13, 2013) (liability under § 523(a)(2) is not limited to a misrepresentation
but includes the broader conduct of actual fraud or false pretense as an independent basis for
liability).

15 Adv. Dkt. 105, pp. 5-6.

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Case 10-05243 Doc# 145 Filed 03/28/13 Page 10 of 24

premises in 2007 prior to SBG’s opening and unpaid real estate taxes for 2007 of approximately
$5,000. This is all the evidence of misrepresentations of company debt he offered. He could not
definitively link the misrepresentations to Kim. Duggins met Dean through a mutual friend.
Sometime later, Dean introduced Duggins to Kim. Duggins did not identify which statements were
attributed to Dean or whether any of them were attributable to Kim. He implied that Kim was
present when the representations were made, but he could not articulate when and where the
representations were made other than they occurred prior to the opening of the bar and grill in
January. He did not carry his burden of proving that Kim fraudulently induced him to invest.

With respect to the alleged representations in (i) that Duggins would be the treasurer and
have financial control, Duggins indeed was elected treasurer of the LLC at the January 11, 2008
annual meeting. At all times, he had check signing authority. As noted before, Kim was elected
secretary. Duggins testified that Kim retained charge of the books because he had no prior
experience running a bar or restaurant and was unfamiliar with the types of records and forms
utilized by SBG. The parties apparently contemplated that Kim would “train” Duggins on the
company’s books and records, but that never occurred. Either Duggins and Kim were unable to
cooperate on the financial aspects of the operations and the transition of the bookkeeping function
to Duggins or Duggins did not have the time to perform financial duties while running SBG’s day
shift. Duggins candidly admitted that he had on-site access to the check register and other financial
records but that he did not comprehend most of the books and records due to his inexperience in
the restaurant/bar business.

Serving the fresh start objective of bankruptcy, exceptions to discharge should be narrowly

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construed and any doubts resolved in Kim’s favor.16 To prevail on his actual fraud claim under §
523(a)(2), Duggins had to prove by a preponderance of the evidence that Kim made a
misrepresentation of a material fact with the intent to deceive Duggins, that Duggins relied upon the
misrepresentation, that his reliance was justifiable, and that Kim’s representation caused him to
sustain a loss.17 As applied to the evidence here, the existence of the first element – a
misrepresentation by Kim – is, at best, vague and inconclusive. Duggins provided little detail of the
circumstances surrounding the alleged representations – the “who, what, where, and when” of the
representations. And when placed in the context that Duggins would be going into business with
Kim’s husband, that Duggins was introduced to Dean through a third party, and that he was
introduced (at some unspecified point) to Kim by her husband, Duggins failed to present a
compelling or even a credible case of fraud on the part of Kim. It is not sufficient to impute fraud
upon Kim by her holding the office of secretary or the fact that she was the spouse of Dean. And
nothing in the evidentiary record shows that Dean was acting as Kim’s agent.18 In short, Kim, not
her husband, must have made the actual misrepresentations to Duggins or somehow participated in
the fraud. The Court is simply not persuaded by the evidence that Kim, having met Duggins second

16 In re Kaspar, 125 F.3d 1358, 1361 (10th Cir. 1997).

17 Fowler Bros. v. Young (In re Young), 91 F.3d 1367, 1373 (10th Cir. 1996); Grogan v.
Garner, 498 U.S. 279, 287 (1991) (Section 523(a) discharge exceptions are subject to the
preponderance of the evidence standard of proof.).

18 See Columbia State Bank, N.A. v. Daviscourt (In re Daviscourt), 353 B.R. 674, 686-87
(10th Cir. BAP 2006) (Court would not impute debtor-husband’s fraud upon defendant-debtorspouse
to except guarantee of company line of credit from discharge, even where the defendant
spouse was a 50% owner and officer of the company, without some additional evidence that the
debtor-spouse intended her husband to act as her agent.); First New Mexico Bank v. Bruton (In re
Bruton), 2010 WL 2737201 at *5-*6 (Bankr. D. N.M. July 12, 2010) (LLC husband-member’s
fraud would not be imputed to LLC wife-member).

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hand and not a proposed partner with him, made any misrepresentations to Duggins with the
requisite intent to deceive Duggins into investing in the venture.19

Even if Kim were found to have made the representations, there is no evidence of Duggins’
reliance. In Field v. Mans, the Supreme Court addressed the reliance element in a § 523(a)(2) case,
adopting the less stringent, subjective “justifiable reliance” standard.20 Under that standard, Duggins
had no duty to investigate the accuracy of the representations unless they were patently false and
their falsity was apparent to him at the time they were made. For example, if Duggins had been
shown or provided financial records prior to his investment that reflected debt other than the
mortgage, his reliance would not be justified. Before determining whether his reliance was
justifiable, the Court must consider whether he relied at all.21 Again, the evidence is non-existent.
The Court heard no evidence that if Duggins had known these other debts existed or knew that he
would not have responsibility for SBG’s books and financial records, he would not have made the
investment. Discontinuing his flat work business suggests some level of reliance, but Duggins never
stated that had he known of the additional debts or that he would not be given responsibility for the
financial records of the company, he would not have acted as he did. In fact, six months passed
between the time he became treasurer of the LLC and when he actually made his $25,000
investment. He had access to the financial records during all that time. Moreover, Duggins was

19 The totality of the circumstances do not suggest that if the representations were made,
they were intended to deceive Duggins or that Kim knew the statements were false when made.

20 516 U.S. 59, 66 (1995) (“The question here is what, if any, level of justification a
creditor needs to show above mere reliance in fact in order to exempt the debt from discharge
under § 523(a)(2)(A).”).

21 Id. at 70 (borrowing from common law fraud principles in interpreting the reliance
element of § 523(a)(2)(A), the Supreme Court noted that “both actual and ‘justifiable’ reliance
are required.”)

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present and helping to operate Shanannigans on a daily basis, working side by side with Kim.22
Duggins failed to satisfy his burden of proof on the § 523(a)(2)(A) fraud discharge exception.

2.
Did Debtor Kim Bratt commit a defalcation while acting in a fiduciary capacity,
rendering her debt nondischargeable under § 523(a)(4)?
The Receiver claims that Kim converted SBG’s funds and personal property and diverted
some of it to Bratt Inv for use on their rental properties, to Shanannigans West, or to her personal
use. If proven, these conversion contentions might support an exception to her discharge under §
523(a)(6), but the Receiver did not plead that theory nor was it made part of the final pretrial order.
Instead, the Receiver relied entirely on § 523(a)(4), alleging only that Kim committed defalcation
while acting in a fiduciary capacity.23

Section 523(a)(4) specifically excepts from discharge, debts that are incurred “for fraud or
defalcation while acting in a fiduciary capacity, embezzlement, or larceny.”24 A defalcation under
this discharge exception is a debtor-fiduciary’s failing to account for funds or property that were
entrusted to him or her in violation of a defined fiduciary duty.25 Proving this exception requires
demonstrating that a fiduciary relationship existed between the debtor and the objecting party and

22 Moreover, if the alleged misrepresented facts were so important to Duggins, the Court
questions why he proceeded to work compensation-free for over two years. If he truly relied on
the representations, one would expect much swifter reaction to the manner in which SBG was
being operated and his apparent lack of financial control.

23 Adv. Dkt. 105, pp. 11, § 7.1.D and 12, § 8. See Patrons State Bank & Trust Co. v.
Shapiro, 215 Kan. 856, 528 P.2d 1198 (1974) (corporate officer is personally liable for acts that
constitute conversion of property belonging to another, even though the acts were committed
while acting as an officer of the corporation).

24 11 U.S.C. § 523(a)(4).

25 Antlers Roof-Truss & Builders Supply, et al. v. Storie (In re Storie), 216 B.R. 283, 288
(10th Cir. BAP 1997).

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that the debtor committed the defalcation in the course of that fiduciary relationship.26 Once the
creditor makes this showing, the burden shifts to the fiduciary to account for the entrusted property.27

a.
Controlling Tenth Circuit law requires showing the existence of an express
or technical trust to support a § 523(a)(4) fiduciary defalcation claim.
While Kim may have had general fiduciary duties to the LLC under state law, whether she
was a fiduciary for § 523(a)(4) purposes is a matter of federal law. Applying controlling Tenth
Circuit authority makes clear that the Receiver’s § 523(a)(4) claim falls short. In Fowler Bros. v.
Young, the Tenth Circuit noted that the fiduciary relationship required by § 523(a)(4) is different
from a general fiduciary relationship recognized by state law.28 The Fowler Bros. court described
the distinction:

Under this circuit’s federal bankruptcy case law, to find that a fiduciary relationship
existed under § 523(a)(4), the court must find that the money or property on which
the debt at issue was based was entrusted to the debtor. [citations omitted]. Thus, an
express or technical trust must be present for a fiduciary relationship to exist under
§ 523(a)(4). [citations omitted]. Neither a general fiduciary duty of confidence, trust,
loyalty, and good faith, . . . , nor an inequality between the parties’ knowledge or
bargaining power, . . ., is sufficient to establish a fiduciary relationship for purposes
of dischargeability. ‘Further, the fiduciary relationship must be shown to exist prior
to the creation of the debt in controversy.’ 29

Thus, as a matter of bankruptcy law, § 523(a)(4) contemplates a trust relationship that is narrower
than the general duty of one in a fiduciary relationship. It may be an express trust, defined in a
written or oral agreement that created the relationship and identified the property held in trust (the

26 Watson v. Parker (In re Parker), 264 B.R. 685, 700 (10th Cir. 2001).
27 Storie, 216 B.R. at 288.
28 Fowler Bros. v. Young (In re Young), 91 F.3d 1367, 1371 (10th Cir. 1996) (question of

fiduciary status is one of federal law but state law is relevant to the inquiry.).
29 Id. at 1371-72 (interior citations omitted).
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res), the trustee, and the trustee’s duties with respect to the res. Or, it may be a technical trust that
is imposed by statute.30 The statute must define the res, spell out the fiduciary duties of the party
to whom the trust property is entrusted, and the trust must have arisen on the res before the debtor
took the action that created the debt.31 The trust relationship must be imposed by the law rather than
implied from it.32 Unless the trust is an express or technical one, other relationships from which
general fiduciary duties might be implied by state law principles will not support a defalcation claim
under§ 523(a)(4). For example, a general attorney-client relationship has been found insufficient
to establish the fiduciary relationship required under § 523(a)(4).33 Neither is a partnership
relationship unless there is an express agreement or a state law creating a trust relationship.34

b. There was no express trust relationship between Kim Bratt and
Shanannigans LLC.
The Receiver offered no documentary or other evidence to show that an express trust had

30 In re Parker, 264 B.R. at 700, citing Allen v. Romero (In re Romero), 535 F.2d 618,
621 (10th Cir. 1976) (discussing the requisite fiduciary capacity under the Bankruptcy Act’s
predecessor to § 523(a)(4)).

31 In re Kelley, 215 B.R. 468 (10th Cir. BAP 1997); In re Merrill, 252 B.R. 497 (10th Cir.
BAP 2000). See e.g., In re Tatro, 387 B.R. 833, 840 (Bankr. D. Kan. 2008) (State natural
guardian statute, KAN. STAT. ANN. § 59-3053(a), imposed trust relationship that satisfied §
523(a)(4)).

32 Allen v. Romero (In re Romero), 535 F.2d 618, 621-622 (10th Cir. 1976).

33 Fowler Bros., supra; Parker, 264 B.R. at 700.

34 Smolen v. Hatley (In re Hatley), 227 B.R. 757, 760 (10th Cir. BAP 1998) (partners did
not have an express, written agreement establishing fiduciary relationship and neither Oklahoma
common law or Uniform Partnership Act created a trust relationship sufficient to satisfy §
523(a)(4)); Holaday v. Seay (In re Seay), 215 B.R. 780, 786-87 (10th Cir. BAP 1997) (same); In
re Zanetti-Gierke, 212 B.R. 375, (Bankr. D. Kan. 1997) (Under Kansas law, the statutory
provision delineating partners’ accountability as fiduciaries, KAN. STAT. ANN. § 56-321(a)
(1994) did not create a technical or express trust and therefore partners are not fiduciaries for
purposes of § 523(a)(4)).

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been created. None of the LLC’s organic documents were offered as evidence at trial.35 While an
operating agreement was referenced in the first annual meeting minutes, it was not offered either.
Ordinarily that document would set out the identity of the manager, terms of governance, and duties
and liabilities of the members, manager, and officers of the company.36 The operating agreement
may have created an express trust, but it is absent from the record.

c.
Kim Bratt’s position as secretary of Shanannigans LLC did not impose a
technical trust on her or render her a § 523(a)(4) fiduciary;
The Kansas Revised Limited Liability Company Act governs the establishment and operation
of limited liability companies in Kansas.37 If a technical trust had been imposed upon Kim by statute,
it would be found in the LLC Act. There is no default provision in the Act that entrusts the funds
or property of the LLC to the members, the manager or the officers. Nor does any provision
delineate the attributes of a trust, articulate trust duties, or otherwise establish a trust relationship
among members and the manager. While § 17-7688 of the Act comes closest by addressing a
member’s or manager’s liability to third parties and recognizing a member or manager’s potential
liability to the limited liability company, it does not expressly create a trust relationship.38 KAN.
STAT. ANN. § 17-7698 provides that, unless provided otherwise by the operating agreement, a
member or manager may delegate the power to manage and control the business of the LLC to an

35 See KAN. STAT. ANN. § 17-7673 (requiring articles of organization for formation of a
limited liability company);

36 See KAN. STAT. ANN. § 17-7668(b).

37 KAN. STAT. ANN. § 17-7662 to 17-76,142 (2007 and 2011 Supp.)

38 The Court notes that no reference is made in this statute to enforcing an “officer’s”
liability to the company, see § 17-7688(c), though as noted infra, members and managers may
delegate rights and duties to officers. KAN. STAT. ANN. § 17-7698.

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officer. No evidence suggested that any of the members “delegated” management and control of the
company to Kim. And, while KAN. STAT. ANN. § 17-76,134 indirectly recognizes that a member,
manager or “other person” may have fiduciary duties in law or equity to the other members or to the
company, those duties may be expanded or restricted by provisions in an operating agreement.39

The parties stipulated in the pretrial order that Duggins, Lewis, and Dean Bratt “were one
third equal partners [sic] in Shanannigans.”40 The minutes of the first annual meeting of the
members of the LLC recite the members’ proportionate ownership interests and note the election
of officers. The minutes refer to an operating agreement, but do not identify the manager or member-
manager of the LLC.41 Without the operating agreement in evidence, whether Kim’s duties as
secretary included trust duties cannot be determined.42 Without the direct imposition of fiduciary
duties on Kim by the operating agreement or by statute, no technical trust arose.

The Receiver primarily relies on Kansas case law to contend that Kim’s status as secretary
of Shanannigans LLC satisfies the fiduciary relationship requirement of § 523(a)(4).43 Kansas

39 As noted in In re Zanetti-Gierke, supra, the Kansas statutory provision recognizing a
partner’s accountability as a fiduciary did not create a technical or express trust as required by §
523(a)(4). See also, In re Novak, 97 B.R. 47, 59 (Bankr. D. Kan. 1988).

40 Adv. Dkt. 105. Technically, the “owners” of a limited liability company are its
members, and are not “partners” per se.

41 Ex. 1. A limited liability company may be managed by its members or by a manager.
In re Metcalf Assocs.-2000, 42 Kan. App. 2d 412, 213 P.3d 751 (2009); KAN. STAT. ANN. § 177693
and § 17-7663(k).

42 The Kansas general corporation code requires a corporation to have at least one officer
who transcribes the minutes of the meetings. KAN. STAT. ANN. § 17-6302(a).

43 See Diederich v. Yarnevich, 40 Kan. App. 2d 801, 196 P.3d 411 (2008) (Under Kansas
law, directors and officers of professional corporation have a strict fiduciary duty to act in the
best interests of the corporation and its stockholders, requiring officers and directors to work for
the general interests of the corporation.); Newton v. Hornblower, Inc., 224 Kan. 506, 582 P.2d

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corporate directors and officers owe a strict fiduciary duty to the corporation and its shareholders,
but that fiduciary relationship is a general duty to act in the best interests of the corporation and in
good faith. Standing alone, it does not rise to the technical trust relationship described by Fowler
Bros. Kansas courts have recognized that a member-manager of a limited liability company has a
similar general fiduciary duty to the company and its other members.44 No Kansas statutes or cases
equate this general duty with the entrustment of company money or property to an officer or create
a trust relationship and the accompanying fiduciary capacity necessary to support a finding of a
fiduciary relationship under § 523(a)(4).45 Without a statute defining the res, and the duties of the
fiduciary with respect to it, the Receiver cannot demonstrate that a technical trust has been imposed.
Whatever fiduciary duty Kansas law implicates for corporate directors and officers is a general one,
far short of the technical trust that Tenth Circuit authority requires in support of a defalcation
exception to discharge under § 523(a)(4).

d.
Even if Tenth Circuit law relieves a corporation from demonstrating an
express or technical trust in § 523(a)(4) cases, that exception does not
apply here.
Two judges of this court have recognized what amounts to an exception to the “express or

1136 (1978) (recognition of same rule in context of a general corporation).

44 See Emprise Bank v. Rumisek, 42 Kan. App. 2d 498, 215 P.3d 621 (2009) (Membermanager
of limited liability company owed fiduciary duty to other members of company.).

45 Cf. In re Kalinowski, 482 B.R. 334 (10th Cir. BAP 2012) (Individual chapter 7 debtor
who controlled and acted as de facto manager of construction company organized as a limited
liability company and was subject to the New Mexico Construction Industries Licensing Act that
proscribed diversion of funds paid to the limited liability company to other construction projects,
stood in a fiduciary capacity for purposes of § 523(a)(4).). See also, Speer v. Dighton Grain,
Inc., 229 Kan. 272, 624 P.2d 952 (1981) (corporate officer is not personally liable for
conversion committed by corporation or one of its officers merely by virtue of holding office;
corporate officer must participate in or breach duty owed to owner of property to be held liable).

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technical trust” requirement that neither Fowler Bros. nor any subsequent Tenth Circuit case have
discussed. In the Kansas bankruptcy court cases, the judges held that where the plaintiff asserting
the § 523(a)(4) claim is the corporation itself, the plaintiff need not show the existence of an express
or technical trust because an officer’s general fiduciary obligation is sufficient to sustain the
objection under § 523(a)(4). In In re Karr, Judge Somers concluded that the relationship of a
corporate officer to a corporation “commonly imposes a fiduciary relationship.”46 He noted that past
courts have concluded that “it has been long settled” that officers are fiduciaries of their
corporations, both under § 523(a)(4) and its predecessor, § 17(a)(4) of the Bankruptcy Act of 1898.47
Accordingly, when a corporation itself, rather than a creditor or shareholder, objects to the discharge
of a corporate officer’s debt to it, no express or technical trust is required.48 In re Cowley supports
this proposition, holding that “with respect to the first element [express or technical trust], it has long
been settled that a corporate officer is a “fiduciary” of the corporation, within the meaning of §
523(a)(4) and § 17(a)(4), its predecessor section under the Bankruptcy Act of 1898.”49 Cowley also
concludes that Kansas law “defines corporate officers as fiduciaries of the corporation” and calls
upon Pepper v. Litton as support for its general proposition that officers’ and directors’ fiduciary

46 442 B.R. 785, 801 (Bankr. D. Kan. 2011), citing Leah A. Kahl and Peter C. Ismay,
Exceptions to Discharge for Fiduciary Fraud, Larceny, and Embezzlement, 7 J. Bankr. L. &
Prac. 119, 122 (1998).

47 Id. at 801-02.

48 Id. at 802-03.

49 In re Cowley, 35 B.R. 526, 528-29 (Bankr. D. Kan. 1983). Cowley predates the Fowler
Bros. decision and no other Tenth Circuit authority since Fowler even references, far less
approves, this “corporate plaintiff” exception.

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obligations may be enforced by corporations and their bankruptcy trustees.50 Judge Berger has
reached a similar conclusion in In re Markley. 51

But other courts in the Tenth Circuit have rejected the corporate plaintiff exception as being
contrary to Fowler Bros. In In re Green, 52 the debtor was the former vice president, secretary and
director of a corporation and ran it day-to-day. The corporation sought to except from debtor’s
discharge a debt allegedly incurred by the debtor’s self-dealing, breach of fiduciary duty, and
conversion of corporate property. The New Mexico bankruptcy court applied the Fowler Bros.
narrow view of fiduciaries covered by § 523(a)(4), requiring the existence of an express or technical
trust.53 It concluded that there was no trust. It found that no provision in New Mexico’s Business
Corporation Act makes directors or officers of a corporation a trustee of corporate assets;
corporations themselves have the power to own and hold real and personal property. Even though
New Mexico’s Act “arguably recognize[s] a generalized fiduciary duty of officers and directors to
the corporation,” it did not specify any specific fiduciary duties that they must exercise over any
specific assets.54 The bankruptcy court also rejected debtor’s argument that the existence of a

50 Id., citing Delano v. Kitch, 542 F.2d 550 (10th Cir.1976); Parsons Mobile Products,
Inc. v. Remmert, 216 Kan. 256, 531 P.2d 428 (1975); Newton v. Hornblower, 224 Kan. 506, 582
P.2d 1136 (1978). See also Pepper v. Litton, 308 U.S. 295, 306, 60 S. Ct. 238, 245, 84 L. Ed.
281 (1939) (Bankruptcy trustee of corporation may seek to subordinate claim of director or
officer who has violated fiduciary duties to corporation; this case was not a § 523(a)(4) discharge
exception case).

51 460 B.R. 793 (Bankr. D. Kan. 2011). See also In re Jenkins, 462 B.R. 822 (Bankr. D.
Kan. 2011) (Berger, J.).

52 386 B.R. 865 (Bankr. D. N.M. 2008).

53 Id. at 869.

54 Id. at 870. New Mexico’s statute governing the duties of directors, provided: “A
director shall perform his duties as a director . . . in good faith, in a manner the director believes

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general fiduciary duty, standing alone, suffices for § 523(a)(4) liability.

This Court is bound by Tenth Circuit case law such as In re Romero and In re Young

[Fowler Bros.], both of which require the existence of an express or technical trust

before finding a fiduciary duty that is subject to Bankruptcy Code section 523(a)(4).

There is no express trust in this case, and there is no technical or statutory trust
arising from New Mexico’s Business Corporation Act.55
Karr and Markley present fact patterns that differ significantly from ours. In both cases, the

debtors were either sole or dominant shareholders, directors, and officers of their corporations. In
both cases, the debtors essentially controlled all corporate activity, including accounts. In Karr, the
debtor made misrepresentations to the other board members. In Markley, the debtor lived out of the
corporate accounts. Here, Kim was one of several officers, but was not a member or manager of the
company, and did not participate in the massive pattern of misconduct like that found in Karr and
Markley. Whatever financial responsibility she had for the company did not come by virtue of her
office. By contrast, Dean was a member of the LLC and wielded “operational control,” suggesting
that he was the de facto member-manager of the company.56

Without a statutory provision that defines the trust res, imposes a trust relationship on the
trust property, designates a member, manager or “other person” as trustee, or describes the
“trustee’s” duties with respect to the trust property, I cannot conclude that the law imposed a
fiduciary duty on Kim with respect to the funds and property of the LLC that would sustain a §
523(a)(4) action.

to be in or not opposed to the best interests of the corporation and with such care as an ordinarily
prudent person would use under similar circumstances in a like position.” Id. at 871, n. 2.

55 Id. at 871. See also, In re Steele, 292 B.R. 422 (Generic fiduciary duties of trust,
loyalty, good faith and fair dealing that director of closely-held corporation owed to minority
shareholder did not rise to level of fiduciary relationship of kind required by § 523(a)(4)).

56 Ex. A, p. 2.

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e.
The Receiver only pled a fiduciary defalcation claim under § 523(a)(4); he
did not assert a claim for embezzlement or larceny.
Finally, § 523(a)(4) sanctions not only a fiduciary’s fraud or defalcation, but also debtor’s
commission of embezzlement or larceny. These two alternative prongs of § 523(a)(4) do not require
proof of a fiduciary relationship, but they do require proof of a certain mental state.57 The Receiver
did not allege either embezzlement or larceny in the final pretrial order; he only asserted a claim
based upon fiduciary fraud or defalcation.58 Indeed no reference at all was made to embezzlement
or larceny. Nor does the record suggest that an embezzlement or larceny claim was tried by the
implied consent of the parties. The Tenth Circuit Bankruptcy Appellate Panel recently reaffirmed
that such consent is only implied when “a party introduces evidence on the new issue or fails to
object when the opposing party introduces such evidence.”59 Nor did the Receiver move to amend
the pleadings to conform to the evidence at trial which is the way to raise a claim that was not
initially pled.60 Moreover, there is no evidence of the elements of embezzlement and larceny,
including Kim’s intentional misconduct, in the record. Allowing such an amendment would be

57 In re Zanetti-Gierke, 212 B.R. at 380 (embezzlement or larceny is actionable regardless
of debtor’s fiduciary status). In the case of larceny, the creditor must prove debtor wrongfully
took property of another without the other’s consent and with the intent to convert the property
to debtor’s own use. Embezzlement differs from larceny in that the debtor’s original taking was
lawful and then fraudulently appropriated. Both require a showing that debtor intended to
convert the property to his or her own use. Id. at 381.

58 In addition, plaintiff’s trial brief clearly articulates that Kim’s debt should be excepted
from discharge under the fiduciary fraud or defalcation prong of § 523(a)(4). No mention of
embezzlement or larceny is made in the trial brief. See Adv. Dkt. 124.

59 Diamond v. Vickery (In re Vickery), ___ B.R. ___, 2013 WL 979099 at *10; BAP No.
12-051 (10th Cir. BAP Mar. 13, 2013).

60 See Fed. R. Civ. P. 15(b)(2); Vickery at *10, citing Green Country Food Mkt., Inc. v.
Bottling Group,LLC, 371 F.3d 1275, 1281 (10th Cir. 2004) (Conforming the pleadings to the
evidence is within the trial court’s discretion.).

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unjust and constitute unfair surprise – particularly to an unrepresented debtor. Pursuit of a §
523(a)(4) embezzlement or larceny claim would have required the Receiver to prove that Kim
intended to appropriate SBG’s funds and property to her own use. Kim was never placed on notice
that she was being accused of that.61

Conclusion

Todd Duggins failed to prove that Kim Bratt made false representations that induced him to
invest in Shanannigans, L.L.C. Likewise, the Receiver failed to show that Kim Bratt had the
requisite fiduciary capacity to support a claim of defalcation under § 523(a)(4). While state law civil
wrongs may have been committed by Kim Bratt or by others not party to this action, there is no basis
for excepting the debts claimed by Duggins and the Receiver from Kim Bratt’s discharge. Judgment
should therefore be entered for Kim Bratt on the complaint and costs taxed to the plaintiffs. A
judgment on decision will issue this day.

# # #

61 In contrast, a defalcation requires no mental culpability on the part of debtor and
includes conduct that does not rise to the level of embezzlement or larceny. Storie, 216 B.R. at
287-89 (debtor-fiduciary need not subjectively intend to breach her fiduciary duty); Merrill, 252

B.R. at 506.
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Case 10-05243 Doc# 145 Filed 03/28/13 Page 24 of 24

 

12-05056 Wiebe et al v. Kansas Dept of Labor (Doc. # 38)

Wiebe et al v. Kansas Dept of Labor, 12-05056 (Bankr. D. Kan. Jan. 28, 2013) Doc. # 38

Click here for the pdf document.

---

__________________________________________________________________________
SO ORDERED.
SIGNED this 25th day of January, 2013.

 

PUBLISH

IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS

IN RE:

)
REGINALD WIEBE ) Case No. 12-10109
TIFFANY A. WIEBE ) Chapter 7

Debtors. )
____________________________________)

)
REGINALD WIEBE )
TIFFANY A. WIEBE )
)
Plaintiffs, )
v. ) Adversary No. 12-5056
)

KANSAS DEPARTMENT OF LABOR )
)
Defendant. )
____________________________________)

ORDER GRANTING SUMMARY JUDGMENT
IN FAVOR OF KANSAS DEPARTMENT OF LABOR
AND DENYING PLAINTIFFS’ MOTION FOR SUMMARY JUDGMENT

Kansas workers compensation law requires that qualifying employers maintain workers
compensation insurance coverage with third-party carriers to fund the payment of claims of their

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Case 12-05056 Doc# 38 Filed 01/25/13 Page 1 of 9

employees who are injured on the job.1 Employers who knowingly fail to maintain that insurance are
subjected to several forms of liability, including the repayment of any amount that the state workers
compensation fund must pay for the medical treatment of their employee2 and a civil penalty that is
double the amount of any unpaid insurance premiums and that are payable to the state and credited to
the fund.3 Employers who knowingly make false statements in connection with providing or proving
the existence of this insurance can also be held liable for civil penalties for fraud and abuse.4 The
Bankruptcy Code excepts from discharge debts that arise from penalties payable to and for the benefit
of a government unit and that are not compensation for actual pecuniary loss.5 Here, Reginald and
Tiffany Wiebe operated a trucking concern, but knowingly failed to maintain their workers
compensation insurance. When one of their employees was injured on the job, he was forced to recover
his medical expenses from the Workers Compensation Fund because the Wiebes’ and their trucking
company were uninsured. The Kansas Department of Labor penalized them $123,696 for failing to
maintain workers compensation insurance as required by statute. Because that penalty is non-
compensatory in nature, it should be excepted from their discharge under 11 U.S.C. § 523(a)(7).

Jurisdiction

This proceeding to determine the dischargeability of the penalty debtors owe the Kansas
Department of Labor is a core proceeding under 28 U.S.C. § 157(b)(2)(I) over which this Court may

1 KAN. STAT. ANN. § 44-505.

2 KAN. STAT. ANN. § 44-532a(a).

3 KAN. STAT. ANN. § 44-532(d). The knowing failure to maintain insurance coverage is also a

class A misdemeanor. § 44-532(c).

4 KAN. STAT. ANN. § 44-5,120(d)(4)(A), (d)(15), and (g).

5 11 U.S.C. § 523(a)(7).

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exercise jurisdiction under 28 U.S.C. § 1334 and § 157(b)(1).

Stipulated Facts

The Wiebes and the Kansas Department of Labor filed cross motions for summary judgment
that are based upon a stipulated set of facts as set forth in the parties’ agreed pretrial order.6 The Court
accepts those facts as uncontroverted for the purpose of deciding the summary judgment motions.7

Debtors Reginald and Tiffany Wiebe operated a trucking concern called Wiebe Trucking, Inc.
Reginald was the president and Tiffany was the secretary/treasurer. Incorporated in 2002, the
corporation lapsed in July of 2007 after it failed to file its annual report with the Kansas Secretary of
State. In November of 2007, the Kansas Department of Labor requested proof from the debtors that
they had worker’s compensation insurance, but the debtors did not respond. They likewise did not
answer a follow-up request from the Department. In fact, they were uninsured and had been since May
of that year.

In June, 2007, their employee was injured while loading cattle and was hospitalized. He incurred
medical expenses of $5,320. Mrs. Wiebe first represented to the employee and the hospital that she had
worker’s compensation coverage; when her former insurer denied coverage because the insurance had
been cancelled for non-payment, she instead stated that the Wiebes would pay the employee’s expenses.
That never happened, either. When the Wiebes failed to respond to the Department’s request for
verification of insurance, and after the employee made a claim against the Fund, the Department

6 See Adv. Dkt. 19. Many of those stipulations derive from the Order entered by the State of
Kansas, Division of Workers Compensation following an administrative hearing held in 2009 on the
Wiebes failure to maintain workers compensation insurance. See Adv. Dkt. 7-1 (Initial Order
attached to the State’s answer in this adversary proceeding.).

7 Adv. Dkt. 27 and 29. The State of Kansas appears by its counsel Heather Wilke of the
Kansas Department of Labor. The debtors Reginald and Tiffany Wiebe appear by their counsel
Jeffrey L. Willis.

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referred charges against the Wiebes’ under the applicable statutes. After an administrative law hearing,
the Wiebes were found to have knowingly and intentionally failed to maintain workers compensation
insurance in violation of Kansas law and were assessed a civil penalty of $123,966 and restitution of
$5,320. The administrative law judge also concluded that the Wiebes had committed acts of fraud and
abuse pursuant to § 44-5,120 when they first misrepresented to the employee’s care-givers that they were
insured and later represented that they would pay for his care. The Department levied further penalties
in the amount of $16,000 under that section. The parties stipulate that the $16,000 penalty is excepted
from the debtors’ discharge. Likewise, the parties agree that the $5,320 restitution order is dischargeable.
The Wiebes did not appeal the administrative law judge’s order and it is final.

Debtors filed this adversary proceeding to obtain a determination that the $123,966 penalty
should not be excepted from their discharge because, as they argue, it is compensatory. They ground
their argument on the idea that because the penalty is based upon the debtors’ actual insurance
premiums, it is intended to account for the Fund’s costs in being the compensation insurer of last resort.
There being no factual disputes, we focus on what is purely a legal issue: whether the § 44-532(d) penalty
is “compensation for actual pecuniary loss” and therefore subject to discharge under § 523(a)(7). I
conclude that the penalty is non-compensatory as a matter of law.

Summary Judgment Standards

In the absence of a factual dispute, all that remains to be decided is whether the uncontroverted
facts entitle either of the moving parties to judgment as a matter of law. The fact that both parties have
moved for summary judgment permits the Court to assume that no evidence needs to be considered
other than that submitted by the parties, but it does not necessarily compel the entry of summary

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judgment if disputes of material fact remain.8 Likewise, if the facts presented are insufficient to grant
judgment as a matter of law, summary judgment must be denied.9 Thus, the Court must determine
whether those facts that the parties have stipulated to are sufficient for it to conclude as a matter of law
that one of the parties is entitled to judgment.10 Here, where the facts are not in dispute and the parties
only disagree whether the penalty imposed by the State was compensatory for actual pecuniary loss and
the dispute requires the Court to interpret and apply the undisputed facts to § 523(a)(7), summary
disposition is appropriate.

Analysis

Worker’s compensation laws provide an orderly means of giving employees recourse for injuries
they incur on the job.11 These laws displace the civil tort liability system for these workers and relieve
them from the common-law master-servant doctrine that traditionally held employers immune from suit
for work-related injuries. The backbone of the workers compensation system is the requirement that

8 Atlantic Richfield Co. v. Farm Credit Bank of Wichita, 226 F.3d 1138, 1148 (10th Cir. 2000)
(denying summary judgment for either movant due to the existence of disputed material facts). See
also Newcap Ins. Co. v. Employers Reinsurance Corp., 295 F. Supp. 2d 1229, 1238 n. 3 (D. Kan. 2003)
(legal standard does not change if cross-motions for summary judgment are filed; each party has the
burden of establishing the absence of genuine disputes of material fact and entitlement to judgment
as a matter of law).

9 Reed v. Bennett, 312 F.3d 1190 (10th Cir. 2002) (trial court erred in granting summary
judgment solely on the basis of non-movant’s failure to file a timely response; trial court is still
required to determine whether the movant is entitled to judgment as a matter of law).

10 Buell Cabinet Co. v. Suduth, 608 F.2d 431, 433 (10th Cir. 1979) (Cross-motions for summary
judgment are to be treated separately; the denial of one does not necessarily require the grant of the
other.)

11 See KAN. STAT. ANN. § 44-501b (2011 Supp.) and § 44-505 (2000). Unless otherwise noted,
all statutory references are to the Kansas Statutes Annotated, and particularly to the Kansas Workers
Compensation Act codified in chapter 44, article 5 (2000 and 2011 Supp.).

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employers either secure insurance to pay compensation claims or that they self-insure.12 Section 44-532
of the Kansas law requires not only that employers maintain insurance coverage, but also that they
confirm that coverage to the Kansas Department of Labor, Division of Workers Compensation on a
regular basis. If the employer fails to secure and maintain the insurance, § 44-532(d) provides for the
assessment of a penalty of $25,000 or twice the employer’s annual insurance premium, whichever is
greater. When the penalty is assessed and collected, the Department is required to deposit it in the state
treasury to be credited toward the Workers Compensation Fund.13

The Fund is established by § 44-566a and is largely composed of assessments that the
Department makes annually on insurers and insurance pools to pay the Fund’s liabilities.14 Among those
liabilities are payments of medical expenses and lost wages for the benefit of an employee whose
employer is uninsured.15 An employee may apply for those benefits and if the Fund pays an award, it
has a subrogation claim against the employer to recover what it paid out of the Fund.16 Unlike the civil
penalty exacted under § 44-532(d), the restitution award under § 44-532a(b) appears designed to
compensate the Fund for the costs it incurs in paying benefits that the employer’s insurance would have
paid, had the employer maintained the insurance required by law.

Determining whether a penalty is compensatory for the purposes of section 523(a)(7) involves
deciding whether its establishment is “rooted in the traditional responsibility of a state to protect its

12 § 44-532(b) (2011 Supp.)
13 § 44-532(g).
14 § 44-566a(a) and (b)(1) (2011 Supp.).
15 §§ 44-532a(a), 44-566a(e)(2).
16 § 44-532a(b).

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citizens.”17 The Supreme Court has held that even criminal restitution that is based on the extent of the
damage caused by a defendant to his or her victim may be categorized as a penalty for (a)(7) purposes
if it is part of the defendant’s punishment for violating the law or other rules and is nondischargeable.18
In In re Troff, the Tenth Circuit Court of Appeals concluded that a court-imposed restitution obligation
could not be discharged even though the debtor’s restitution payments were forwarded to the crime
victim.19 As the Circuit court succinctly stated, “[t]he Supreme Court held [in Kelly] that restitution
obligations imposed as part of a criminal sentence were not dischargeable under § 523(a)(7) because
principles of federalism do not permit a bankruptcy court to interfere with a state criminal sentence.”20

Here, there can be no quarrel that the double-premium civil penalty for not maintaining
insurance coverage is “rooted in the traditional responsibility of a state to protect its citizens.” This
penalty is unrelated to restitution of the kind the Department assesses when the Fund is forced to
intervene and pay an employee’s medical expenses. In this case, the Department concedes that
restitution of the $5,320 incurred by the Fund for the employee’s medical expenses is indeed
compensatory and therefore dischargeable. By contrast, the penalty for failing to maintain insurance is
not designed to compensate either the employee or the Department; instead, state law requires that it
be imposed as a punishment when an employer is shown to have failed to maintain the necessary

17 Kelly v. Robinson, 479 U.S. 36, 52, 107 S. Ct. 353, 93 L.Ed. 2d 216 (1986) (quoting the
bankruptcy court and holding that any condition, including restitution, that a state criminal court
imposes as part of a criminal sentence is excepted from discharge under § 523(a)(7)).

18 Id. at 50, 52-53.

19 In re Troff, 488 F.3d 1237 (10th Cir. 2007).

20 Id. at 1239 [Emphasis added.].

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insurance.21 The penalty’s calculation is not tied in any way to any costs that the Department incurs, nor

is it related to any pecuniary loss by the Fund.22 The penalty is simply a multiplier of the employer’s

annual insurance premium and bears no relationship to the Department’s or the Fund’s pecuniary loss.

Its purpose is plainly penal. Without it, the backbone of the workers compensation system would break

because the system’s administration is predicated on employers carrying workers compensation

insurance. Allowing them to flaunt the insurance requirement without consequence would leave the

workers compensation law without teeth. Indeed, failing to carry this insurance is a crime in Kansas.23

Nothing in the record or the law supports the Wiebes’ view that the failure-to-maintain penalty

is designed to compensate the State for the high cost of being the compensation insurer of last resort.

The Department has a separate means of recovering its direct cost of paying an injured employee’s

claims under KAN. STAT. ANN. § 44-532a(b). This buttresses the conclusion that the penalty assessment

for failing to maintain insurance is indeed penal in nature and not compensatory.

Because the § 44-532(d) penalty is non-compensatory and payable to a governmental unit, it

21 Hill v. Kansas Dept. of Labor, 42 Kan. App. 2d 215, 210 P.3d 647 (2009), aff’d in part, 292
Kan. 17, 248 P.3d 1287 (2011) (Workers Compensation Division has no discretion to decline to
impose a civil penalty when violation of the statute is proven).

22 The Fund itself is funded by annual assessment on workers compensation insurers each
June 1 and is administered by the commissioner of insurance. See § 44-566a; In re Payne, 27 B.R. 809,
812 (Bankr. D. Kan. 1983) (noting that the Fund receives the bulk of its money from assessments
made against all insurance carriers and is designed to cover all claims against the Fund arising
because an employer was not insured.). See also State Bar of Michigan v. Doerr (In re Doerr), 185 B.R. 533
(Bankr. W.D. Mich. 1995) (Costs assessed against attorney after his license was revoked in attorney
disciplinary action were nondischargeable where state’s attorney disciplinary system was not
dependent on reimbursed costs for its continued operation and costs constitute a “fine, penalty or
forfeiture” that are not equated to pecuniary loss); In re Betts, 149 B.R. 891 (Bankr. N.D. Ill. 1993),
aff’d 157 B.R. 631 (N.D. Ill. 1993) (same); In re Haberman, 137 B.R. 292 (Bankr. E.D. Wis. 1992)
(same); Richmond v. New Hampshire Supreme Court Committee on Professional Conduct, 542 F.3d 913 (1st Cir.
2008) (same; costs were assessed to deter attorney misconduct).

23 An employer’s violation of the insurance requirement constitutes a class A misdemeanor.
See § 44-532(c).

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should be excepted from the debtors’ discharge. The Department is therefore entitled to summary
judgment.24 For the same reasons, the Wiebes’ cross-motion for summary judgment must be denied.
A judgment on decision will enter this day.

# # #

24 See In re Tauscher, 7 B.R. 918 (Bankr. E.D. Wis. 1981) ($3,100 civil penalty assessed by
Secretary of Labor against employer for child labor violations of the Fair Labor Standards Act were
nondischargeable under § 523(a)(7).)

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