Arvest Mortgage Co. v. Nail

Citation: 680 F.3d 1036Docket: No. 11-2018

Court: Court of Appeals for the Eighth Circuit; June 5, 2012; Federal Appellate Court

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Elizabeth E. Nail obtained a loan from Arvest Mortgage Company to purchase a new home, executing a promissory note and mortgage. In April 2009, she filed for Chapter 13 bankruptcy. Following this, Arvest purchased the property at a foreclosure sale for significantly less than her outstanding debt and initiated an adversary proceeding to declare the mortgage debt nondischargeable under 11 U.S.C. § 523(a)(2) and (4). The bankruptcy court granted a directed verdict for Ms. Nail on the § 523(a)(2) claim but found $65,000 of her debt nondischargeable under § 523(a)(4), asserting she held this amount as settlement proceeds in a fiduciary capacity under Arkansas law. 

The Bankruptcy Appellate Panel (BAP) reversed this decision, leading Arvest to appeal, asserting that Ms. Nail committed fraud or defalcation while acting in a fiduciary capacity and embezzlement under § 523(a)(4). The court reviewed the BAP’s legal conclusions de novo and determined that the Arkansas statute did not establish the necessary fiduciary relationship and that Ms. Nail had not committed embezzlement. 

The relevant provisions of § 523(a) outline exceptions to dischargeable debts for fraud or defalcation in a fiduciary capacity, embezzlement, or larceny. Arvest bore the burden of proof in demonstrating that Ms. Nail’s actions met these exceptions. After moving into her home, Ms. Nail discovered structural defects and sued the builders, with Arvest granting her a loan forbearance during the litigation. Upon failing to resume payments post-forbearance, foreclosure proceedings were initiated. 

During the foreclosure process, it was revealed that the builders had settled for $65,000. After Ms. Nail filed for bankruptcy, Arvest sought relief to proceed with the foreclosure. The mortgage included a provision for "Miscellaneous Proceeds," encompassing any settlements for property damage. However, Ms. Nail used the settlement for personal expenses rather than applying it to her mortgage. The bankruptcy court initially ruled the proceeds were Miscellaneous Proceeds and that her failure to apply them constituted defalcation, thus making them nondischargeable. 

The BAP reversed this, citing three reasons: Arvest did not prove the proceeds were Miscellaneous Proceeds, the proceeds stemmed from tort claims which Arkansas law prohibits assigning, and neither the mortgage agreement nor the state law created the necessary fiduciary relationship for nondischargeability under § 523(a)(4).

Arvest's appeal centers on two exceptions under Section 523(a)(4): defalcation while acting in a fiduciary capacity and embezzlement. For defalcation to bar discharge, the debtor must have acted as a fiduciary prior to the wrongdoing, as defined by judicial precedent that distinguishes between technical trusts and implied trusts from contracts. The determination of a fiduciary relationship is governed by federal law and typically arises from an express or technical trust established by contract. 

Cases indicate that mere contractual obligations between a secured lender and borrower do not necessarily create a fiduciary capacity under 523(a)(4). Specifically, the Supreme Court's ruling in Davis illustrates that a mortgagor does not become a trustee for a mortgagee simply due to the duties outlined in a mortgage-like document. The Eighth Circuit has similarly affirmed that contractual agreements are more contractual than fiduciary in nature. 

In this instance, the bankruptcy court and the Bankruptcy Appellate Panel (BAP) correctly rejected Arvest's argument that the mortgage document constituted an express trust, as it merely facilitated a contractual assignment of proceeds. Arvest shifted its focus on appeal to Arkansas Code 4-58-105(b)(2), which states that Ms. Nail became a trustee of the settlement proceeds. However, establishing a fiduciary relationship under 523(a)(4) requires that a state statute creates a definable trust with specific duties, and it is insufficient for a statute to simply label a relationship as a trust or fiduciary. Previous rulings have clarified that not all statutes creating obligations lead to a fiduciary relationship for bankruptcy purposes.

Careful analyses of various state lienholder protection statutes reveal inconsistent outcomes regarding 11 U.S.C. § 523(a)(4). Notable cases include In re Nicholas (Texas), Matter of Angelle (Louisiana), and Carey Lumber Co. v. Bell (Oklahoma), which illustrate the differing interpretations of fiduciary relationships under these statutes. The distinction emphasized in Davis between trusts that exist independently of a debtor's wrongdoing and those that do not arise until after a wrong is crucial. For example, in Matter of Marchiando, the Seventh Circuit determined that the Illinois Lottery Law did not create a fiduciary relationship under § 523(a)(4) because the trust's existence was contingent on a failure to remit ticket sales. Similarly, in In re McGee, a municipal ordinance created fiduciary duties regarding tenant security deposits, establishing a fiduciary relationship.

In contrast, the Arkansas statute at issue, Ark.Code 4-58-105(b)(2), was found by the Bankruptcy Appellate Panel (BAP) not to impose the strict fiduciary duties required by § 523(a)(4). The statute merely dictates the legal effect of payments made in good faith to an assignor and does not mandate trust-like duties, such as fund segregation. The trust associated with the proceeds only had a nominal existence until Ms. Nail failed to remit them to the assignee. Therefore, the term "trustee" within the statute does not indicate legislative intent to create a true fiduciary relationship, leading to the conclusion that the $65,000 debt was not nondischargeable under the fiduciary capacity clause of § 523(a)(4).

Regarding embezzlement, which involves the fraudulent appropriation of property entrusted to someone, Arvest contends that the debt falls under this category as well. However, the bankruptcy court did not address this issue since it found defalcation in a fiduciary context. While Arvest preserved the embezzlement argument on appeal, no error was perceived in the BAP's handling of the matter.

Arvest asserts that Ms. Nail embezzled settlement proceeds entrusted to her under the mortgage assignment and Ark.Code 4-58-105(b)(2). The Bankruptcy Appellate Panel (BAP) ruled these proceeds were not Miscellaneous Proceeds, favoring Ms. Nail on the embezzlement issue. The analysis requires clarification, as embezzlement cannot occur concerning one’s own property. Citing In re Belfry, the legal principle holds that an assignment to a secured creditor does not transfer ownership but rather creates a security interest. In In re Phillips, it was determined that the borrower retained ownership of the funds, which were subject to the bank's security interest; therefore, embezzlement could not occur, and the debt was deemed dischargeable under section 523(a)(4). Similarly, Arvest’s transaction with Ms. Nail was treated as a security interest, thus making her alleged breach of contract a dischargeable offense rather than nondischargeable embezzlement. The BAP's conclusion that the $65,000 debt was not nondischargeable under the embezzlement provision of 523(a)(4) is affirmed. Additionally, while Arvest likened its assignment provisions to a fiduciary relationship established in Morgan v. Amer. Fid. Fire Ins. Co., this assertion lacks factual merit and is outside the scope of the issues presented. Lastly, the BAP's determination that the settlement proceeds were not classified as Miscellaneous Proceeds and could not be assigned under Arkansas law is not addressed, as the lack of fiduciary capacity resolves Arvest's claim.