Court: United States Bankruptcy Court, E.D. Arkansas; October 4, 1989; Us Bankruptcy; United States Bankruptcy Court
The Court is addressing a Second Motion for Summary Judgment from the Plaintiff in an adversary proceeding aimed at determining the dischargeability of a debt. The Plaintiff argues that a prior Chancery Court ruling found the Defendant guilty of fraudulent acts and defalcation as Trustee of the Ollie Harold Morgan Trust, resulting in a substantial loss to the trust. The Plaintiff contends that this judgment, which falls under 11 U.S.C. § 523(a)(4), should not be dischargeable and invokes res judicata to prevent relitigation of the issues already determined by the state court.
In opposition, the Defendant denies the allegations and claims that the Chancery Court's decree is null and void due to violations of the automatic stay under 11 U.S.C. § 362. The Defendant also argues that res judicata and collateral estoppel do not apply because the Chancery Court did not properly apply the standard of proof and that there are material facts in dispute.
Both parties submitted briefs supporting their positions, but the Court decided to focus on the Defendant's argument regarding the validity of the Chancery Court ruling. Consequently, the Motion for Summary Judgment is denied without prejudice, allowing for the possibility of renewal in the future.
The Plaintiff contends that the automatic stay under the Bankruptcy Code does not invalidate actions taken by the state court, specifically the signing and filing of a formal decree after the bankruptcy case was initiated. He cites two bankruptcy court decisions, In Re Wilson and In Re Anderson, which support his view that a formal written decision made post-petition does not violate the automatic stay provisions of 11 U.S.C. 362(a)(1). These courts held that the stay should not extend to state court judicial acts and noted that activities in the state case had concluded, allowing the court to issue a decision based on prior oral findings.
However, the Court in this case does not agree with those precedents and is not prepared to rule that the state court's actions were automatically exempt from the stay or that the decree is null and void. Instead, it acknowledges that while the actions may be voidable, this determination is fact-specific and should be assessed on a case-by-case basis. The Court retains the authority to annul the automatic stay under 11 U.S.C. 362(d) and indicates a willingness to do so to validate the state court's actions or to permit the entry of a final order post-petition.
As a result, the Motion for Summary Judgment is denied without prejudice. The Plaintiff subsequently files a second Motion for Summary Judgment requesting a ruling that a $175,255.43 debt owed by the defendant is non-dischargeable under 11 U.S.C. 523(a)(4), referring to findings from a prior Chancery Court ruling that determined the defendant committed fraudulent acts leading to the loss of trust assets. The Plaintiff argues that these issues were central to the prior state court determination, which involved the defendant as a party.
On May 12, 1989, the court lifted the automatic stay to permit the plaintiff's application to the Chancery Court of St. Francis County, Arkansas, seeking post-petition ratification of a prior Decree issued during the stay. The Chancery Court ratified this Decree on June 8, 1989, with the final order entered on June 14, 1989. The principle of res judicata prevents the court from relitigating any issues that were or could have been addressed in the state court, as all relevant facts have been judicially determined, leaving no genuine issue of material fact.
To support the motion, the plaintiff references authenticated copies of the Chancery Court Decree, the complete trial court record (excluding a box of exhibits retained by the Arkansas Supreme Court), and an Abstract and Brief of Appellate filed on November 6, 1987. These documents were either attached to a prior Motion for Summary Judgment or filed concurrently and are designated as Exhibits A, B, and C.
Additionally, the plaintiff provides as Exhibit D a certified copy of the Chancery Court’s Order ratifying findings from an earlier Decree. The defendant opposes the motion, requesting a trial in the bankruptcy court and referring to an initial brief for support. The court must assess whether the previous civil non-jury fraud determination affects the current bankruptcy proceeding under 11 U.S.C. § 523(a). The debtor claims that the state court applied a lesser standard of proof for fraud than the clear and convincing evidence standard required by federal law, arguing for a new trial on the fraud issue. The Chancery Court Chancellor issued a Memorandum Opinion post-trial, which did not clarify the standard of proof used in concluding that the debtor defrauded the plaintiff. The state court’s prior order had temporarily removed the debtor as executor of a decedent's estate due to misconduct.
The court determined that Randall Morgan should be permanently removed from his position as trustee due to numerous violations of fiduciary duties, including perjury, breach of loyalty, mingling trust funds with personal funds, self-dealing, inadequate record keeping, improper expenditures, and unauthorized borrowing. Evidence indicated a willful intention to deplete the trust estate, leading the court to conclude that Morgan failed to fulfill his legal obligations. Consequently, the court denied him any compensation, asserting that the burden of proof for his compliance with fiduciary duties rested with him, not the beneficiaries, which he could not demonstrate. The Chancellor's opinion did not initially characterize Morgan's actions as fraudulent; this characterization emerged in the final decree prepared by the prevailing party. The document also notes the ambiguity surrounding the burden of proof for fraud under Section 523(a) of the Bankruptcy Code, with various circuit courts adopting differing standards. Only the Fourth Circuit has established the preponderance of the evidence as the required standard for fraud claims under this section.
The majority rule is to apply the clear and convincing standard of proof in bankruptcy cases concerning fraud, as established in Matter of Van Horne, 823 F.2d 1287. Various circuits support this standard, referencing bankruptcy court decisions and citing 3 Collier on Bankruptcy, which states the clear and convincing standard is appropriate without further explanation. Some circuits argue this standard is necessary to overcome the presumption of innocence, while others provide no rationale for their preference for a stricter standard. The Circuit in question maintains that this standard aligns with the policy of providing debtors a fresh start and should be broadly construed in their favor.
The court rejects the Fourth Circuit’s argument for a preponderance of the evidence standard, asserting that the legislative history suggests Congress intended for fraud to require clear and convincing evidence. It argues that the Fourth Circuit’s interpretation undermines the fresh start policy by allowing exceptions to discharge without a heightened standard. The court emphasizes that the burden of proof lies with the creditor to demonstrate that a debt qualifies for discharge exceptions per section 523, supported by various bankruptcy case precedents.
The court concludes that prior state court rulings do not preclude re-evaluating the fraud issue under the bankruptcy standard, as the burden of proof in the state court may not have aligned with the bankruptcy requirements. After reviewing motions and responses, the court decides to deny the motion for summary judgment and proceed to trial on the remaining issues.
The Second Motion for Summary Judgment is denied. The court issues a memorandum opinion under Rule 52(a) of the Arkansas Rules of Civil Procedure (ARCP) regarding the case of Ollie Morgan, who died testate on February 6, 1984. His nephew, Randall Morgan, was appointed personal representative after the will was probated. Following his appointment, exceptions to the inventory were filed, leading to Randall Morgan’s temporary removal on May 5, 1985, due to substantial debts owed to the estate, a ruling currently under appeal.
The court emphasizes that removing a trustee is a serious action requiring clear proof of necessity, especially when the trustee held the decedent's confidence. A trustee can be removed if their actions are detrimental to beneficiaries, and the decision rests on the court's discretion. Grounds for removal are detailed in Section 107 of the Restatement of Trusts. Randall Morgan was previously removed as executor due to misconduct. Evidence of his actions includes perjury, breach of loyalty, mingling of funds, self-dealing, inadequate record-keeping, improper expenditures, misappropriation, unauthorized borrowing, and other fiduciary violations.
The court concludes that Randall Morgan's actions demonstrate a clear disregard for his fiduciary duties and an intent to harm the trust estate. Consequently, the court permanently removes him as trustee, citing his failure to uphold the trust's terms and his unfitness for the role.
The Court has discretion to deny a trustee compensation in cases of breach of trust, considering factors such as the trustee's good faith, the nature of the breach (intentional, negligent, or faultless), whether the breach affected the entire trust or only part of it, any resultant losses, and the value of the trustee's services to the trust. In this case, the trustee's intentional mismanagement of the trust leads to a denial of compensation, not as a penalty but because of inadequate performance of duties.
Next, the Court will evaluate the claims between Randall Morgan and the trust, determining whether he owes the trust or vice versa. A trustee's powers are defined by the trust's terms and the settlor's intentions, which are interpreted broadly. The settlor established the trust to ensure the support and maintenance of his daughter, Teresa Lynne Morgan, emphasizing the preservation of assets and responsible financial management. The trust mandates that the trustee use discretion in disbursing funds for Teresa's necessities, while also allowing access to the trust's principal for emergency needs. Additionally, Randall has been farming lands that will be conveyed to the trust, alongside existing lease agreements.
The trustee acknowledges his role as fiduciary and expresses trust in his own good faith. He is required to submit an annual accounting of the trust’s receipts and disbursements to the Chancery Court of St. Francis County, Arkansas. At the trust's inception, the assets included cash, a certificate of deposit, unsold crops, machinery, and unencumbered land. However, within a year, all cash and the certificate of deposit were depleted, a $100,000 mortgage was placed on previously debt-free land without court approval or beneficiary consent, and substantial interest accrued on this unauthorized debt. The trustee's minimal contributions to the beneficiary, totaling $1,500 for funeral and clothing expenses, contrast sharply with significant payments made to himself.
The trustee has a duty to align his actions with the settlor's intentions and must prove compliance with his fiduciary responsibilities, not the beneficiary. The court noted a lack of documentation and accurate accounting from the trustee, which undermines his credibility. Under the Restatement of Trusts, the trustee must maintain clear accounts of all transactions, and failure to do so results in doubts being resolved against him. Any costs stemming from this failure are charged to the trustee personally, not the trust. The trustee's records are deemed suspect, particularly regarding invoices for hired machinery and discrepancies in tree replacement in the orchard. Furthermore, his claim that expenditures were made to save the land is contradicted by insufficient income generated to cover mortgage and tax obligations. The court references precedent indicating trustees cannot seek reimbursement for unauthorized improvements that do not demonstrably enhance the property’s value.
The trustee's request for indemnity and approval of substantial expenditures for land improvements is denied by the Court. While some work was acknowledged, the expenditures were deemed imprudent and unauthorized, resulting in significant detriment to the trust's assets. A trustee is only entitled to indemnity if the trust benefits from incurred expenses. The Court ruled against the former trustee's claims for indemnity for improper expenditures, specifically noting that expenses related to saving land in Cross County lacked authorization and did not confer any benefits to the estate. However, $10,000 was approved for specific ditch work and reclamation in St. Francis County, along with a $1,000 offset for related expenses. The Court noted that Ollie Morgan had previously received trust funds but found the evidence provided inconclusive regarding his awareness and approval of the trustee's actions. Testimony from interested parties was not deemed credible. The Court emphasized that a trustee is accountable for any breaches of duty and will be charged with interest accordingly. It concluded by indicating the need to address remaining issues of standing and leasing matters promptly, with the potential for a Receiver to be granted authority for the upcoming farm year if necessary. The opinion will be filed with the Clerk and added to the official record.
Hearings regarding the accounting of Randall Morgan, Trustee of the Ollie Harold Morgan Trust, concluded on January 21, 1986. Randall Morgan was present with his attorneys, while Lucille Morgan and Teresa Morgan, beneficiaries of the Trust, were represented by their respective attorneys. Following extensive testimony and evidence, the Court issued a memorandum opinion on February 26, 1986, which is incorporated into the record.
The Court confirmed the prior temporary order removing Randall Morgan as Trustee and made this removal permanent. DeLoss McKnight was appointed as the new Trustee with full powers as per the original Trust document from July 19, 1983.
The Court found Randall Morgan liable for fraudulent and illegal conduct during his tenure as Trustee, resulting in a surcharge against him. After accounting for certain expenses he incurred for trust property improvements, the total amount due to the Trust and Teresa Morgan was determined to be $175,255.43, with a 10% interest rate applicable until paid. The Court retains jurisdiction to address any further issues regarding leases and contracts involving Randall Morgan. The order was signed on April 2, 1986, by Chancellor John M. Pittman.
