Schueller et al v. Balizan-Diaz et al

UNITED STATES BANKRUPTCY COURT
DISTRICT OF NEW MEXICO
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06/10/06
Dale Schueller, et al. v. Minerva J. Balizan-Diaz
04-01159
Memorandum Opinion re: [13-1] Motion For Summary Judgment by Minerva J.
Balizan-Diaz .
Received on: 2005-03-16 11:16:39.000
2005-03-16 00:00:00.000
2005-03-17 00:00:00.000
James Burke
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UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF NEW MEXICO
In re:
MINERVA J. BALIZAN-DIAZ,
Debtor. No. 7-04-12868 SL
DALE SCHUELLER, et al.,
Plaintiffs,
v. No. 04-1159 S
MINERVA J. BALIZAN-DIAZ,
Defendant.
MEMORANDUM OPINION ON DEFENDANT’S
MOTION FOR SUMMARY JUDGMENT
This matter is before the Court on Defendant’s Motion for
Summary Judgment (“Motion”)(doc. 13) and Plaintiffs’ reply
thereto (doc. 16). Plaintiffs appear through their attorney
Holt & Baggington, P.C. (Matthew P. Holt). Defendant appears
through her attorney Steve H. Mazer. This is a core
proceeding. 28 U.S.C. § 157(b)(2)(I).
PROCEDURAL ISSUES
Defendant’s Motion seeks summary judgment under
Bankruptcy Rule 7056, which adopts Fed.R.Civ.P. 56. Federal
Rule 56 states, in part:
...
(b) For Defending Party. A party against whom a
claim, counterclaim, or cross-claim is asserted or a
declaratory judgment is sought may, at any time,
move with or without supporting affidavits for a
summary judgment in the party's favor as to all or
any part thereof.
(c) Motion and Proceedings Thereon. ... The judgment
sought shall be rendered forthwith if the pleadings,
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Page -2-
depositions, answers to interrogatories, and
admissions on file, together with the affidavits, if
any, show that there is no genuine issue as to any
material fact and that the moving party is entitled
to a judgment as a matter of law.
(e) Form of Affidavits; Further Testimony; Defense
Required. Supporting and opposing affidavits shall
be made on personal knowledge, shall set forth such
facts as would be admissible in evidence, and shall
show affirmatively that the affiant is competent to
testify to the matters stated therein. Sworn or
certified copies of all papers or parts thereof
referred to in an affidavit shall be attached
thereto or served therewith. The court may permit
affidavits to be supplemented or opposed by
depositions, answers to interrogatories, or further
affidavits.
“A summary judgment motion must be supported in such a way as
to allow a bankruptcy court to credibly determine if ‘there is
no genuine issue as to any material fact and that the moving
party is entitled to a judgment as a matter of law.’” Harris
v. Beneficial Oklahoma, Inc. (In re Harris), 209 B.R. 990, 995
(10th Cir. B.A.P. 1997)(quoting Fed.R.Civ.P. 56(c).)
Although affidavits are not strictly required by
Rule 56 or case law, in practice they are usually
necessary to obtain summary judgment.... [I]t makes
sense to distinguish between affidavits that
primarily give testimony and affidavits that are
used primarily to introduce documents so that the
court may consider the documents in determining
whether material factual matter is genuinely in
dispute. A party seeking to rely on material other
than affidavits to obtain summary judgment may
nonetheless need to use an affidavit to place these
materials before the court and into the official
record. ...
In order for documents not yet part of the court
record to be considered by a court in support of or
in opposition to a summary judgment motion they must
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1 Plaintiffs did not object to the Motion’s exhibits or
move to strike them. However, under Rule 56(c), the Court
shall render a judgment if there is no genuine issue of
material fact and “the moving party is entitled to a judgment
as a matter of law.” This Court believes that a party is not
entitled to judgment as a matter of law based on inadmissible
evidence. Therefore, Plaintiffs failure to object is not
determinative.
Page -3-
meet a two-prong test: (1) the document must be
attached to and authenticated by an affidavit which
conforms to Rule 56(e); and (2) the affiant must be
a competent witness through whom the document can be
received into evidence. ...
Documentary evidence for which a proper foundation
has not been laid cannot support a summary judgment
motion, even if the documents in question are highly
probative of a central and essential issue in the
case.
Id. at 995-96 (quoting 11 James Wm. Moore et al., Moore’s
Federal Practice §§ 56.10[4][c][i] & 56.14[2][c](3d ed.
1997)(footnotes omitted.)). See also United States v. Dibble,
429 F.2d 598, 602 (9th Cir. 1970)(Unauthenticated summary
judgment exhibits are inadmissible hearsay.); White v. Wells
Fargo Guard Services, 908 F.Supp. 1570, 1579 (M.D. Ala.
1995)(Court may not consider documents not sworn or certified
as required by Fed.R.Civ.P. 56(e).)
Defendant’s Motion contains no affidavits, there are no
previous affidavits on file in this case, and the exhibits
attached to the Motion are inadmissible hearsay. Therefore,
the Court cannot consider the exhibits as part of the Motion1.
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2 Rule 12(c) provides for judgment on the pleadings “after
the pleadings are closed.” The pleadings have not closed in
this case.
Page -4-
A motion based on one or more pleadings alone is the
equivalent of a motion to dismiss under Fed.R.Civ.P. 12(b)(6)
or 12(c)2. 10A Wright, Miller, and Kane, Fed. Prac. & Proc.
Civ. 3d § 2722 (1998 & Supp. 2004); Aldera Corp. v. MJ
Research Inc., 297
F.Supp.2d 459, 460 (D. Ct. 2004). Therefore, the Court will
treat the Motion as one to dismiss under Rule 12(b)(6).
When deciding a motion to dismiss under Rule 12(b)(6),
the Court must accept all well-pleaded allegations as true,
Albright v. Oliver, 510 U.S. 266, 268 (1994), and draw all
reasonable inferences in favor of the pleader, Scheuer v.
Rhodes, 416 U.S. 232, 236 (1974). A complaint should not be
dismissed for failure to state a claim unless it appears
beyond doubt that the plaintiff can prove no set of facts in
support of his or her claim which would entitle plaintiff to
relief. Conley v. Gibson, 355 U.S. 41, 45-46 (1957). "The
issue is not whether a plaintiff will ultimately prevail but
whether the claimant is entitled to offer evidence to support
the claims. Indeed it may appear on the face of the pleadings
that a recovery is very remote and unlikely but that is not
the test." Scheuer, 416 U.S. at 236.
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3 Defendant argues that because causes of action under
523(a)(2) and 523(a)(4) are not broken out in the complaint
specifically, it should be dismissed. While the Court agrees
that the complaint, filed by previous counsel, is difficult to
follow, under Fed.R.Civ.P. 8(e) and (f) no technical forms of
pleading are required and pleadings should be construed to do
substantial justice. Therefore, it will not be dismissed on
those grounds.
Page -5-
THE COMPLAINT
Plaintiffs allege that $210,940.08 remains due on a state
court Default Judgment, and that they discovered that this
debt is based in part upon money being obtained by Defendant
under false pretenses, false representations and actual fraud,
while Defendant was acting in a fiduciary capacity for
Plaintiffs3. Plaintiffs allege that Plaintiffs and Defendants
entered into an agreement before September 14, 1998 to operate
a business for profit as a New Mexico limited liability
company (“LLC”). The LLC was never formed, but the parties
started the business anyway. Defendant was to be in full
charge of the business. Plaintiffs did not participate in
managing the business. On four different specified dates
Plaintiffs loaned a total of $45,000 to Defendant, which was
deposited into the business account. These amounts, as well
as other amounts given by check in an amount to be determined,
were to be used by Defendant in capitalizing the business.
Based on information Plaintiffs obtained in the state court
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4 11 U.S.C. § 523 provides, in part:
(a) A discharge under section 727... of this title
does not discharge an individual debtor from any
debt–
...
(2) for money, property, services, or an extension,
renewal, or refinancing of credit, to the extent
obtained by--
(A) false pretenses, a false representation, or
actual fraud, other than a statement respecting
the debtor's or an insider's financial
condition;
...
(4) for fraud or defalcation while acting in a
(continued...)
Page -6-
case, they allege “upon information and belief” that Defendant
diverted the funds to her own use by transferring the money to
her sole proprietorship and then to herself and her husband.
Plaintiffs also allege “upon information and belief” that
Defendant diverted revenue from the business by using the
business’ funds to purchase inventory for her sole
proprietorship and by registering business sales as sole
proprietorship sales.
Plaintiffs seek a determination that the $45,000 loaned
was an extension of credit obtained under false pretenses,
false representations, or fraud, and constitutes defalcation
as a fiduciary or embezzlement. Plaintiffs also seek a
determination that the diversion of sales revenues is a
defalcation by a fiduciary or embezzlement. Plaintiffs cite
both 11 U.S.C. § 523(a)(2) and 11 U.S.C. § 523(a)(4)4.
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4(...continued)
fiduciary capacity, embezzlement, or larceny...
5 The Archer court specifically rejected the “novation
theory” applied by the Fourth Circuit. 538 U.S. at 320.
Under this theory, a settlement converts a potentially
nondischargeable tort claim into a dischargeable contract
claim. Archer v. Warner (In re Warner), 283 F.3d 230, 236
(4th Cir. 2002).
Page -7-
DEFENDANT’S MOTION
Defendant’s Motion has two main arguments. First, it
argues that under the principles of res judicata and
collateral estoppel, because the original and amended state
court complaints that resulted in the Default judgment made no
allegations to support a Section 523 claim, the Plaintiff is
now precluded by the Default Judgment from raising those
issues in this adversary. Second, it argues 1) that the
complaint fails to state a claim because fraud was not pled
specifically and 2) that the complaint does not state a cause
of action for breach of fiduciary duty or embezzlement. These
will be addressed in turn.
A. Res Judicata and Collateral Estoppel
Plaintiff’s Memorandum in Opposition to Defendants Motion
for Summary Judgment (doc. 16) correctly states the current
bankruptcy law on res judicata and collateral estoppel. Under
Archer v. Warner, 538 U.S. 314 (2003)5 and Brown v. Felsen,
442 U.S. 127 (1979), it does not matter if a state court
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6 Specifically, Archer v. Warner (In re Warner), 283 F.3d
230 (4th Cir. 2002) was reversed by the Supreme Court at 538
U.S. 314 (2003). Monsanto Co. v. Trantham (In re Trantham),
286 B.R. 650 (Bankr. W.D. Tenn. 2002) was reversed by the
Sixth Circuit Bankruptcy Appellate Panel at 304 B.R. 298 (6th
Cir. BAP 2004). Oltman v. West (In re West), 157 B.R. 626
(Bankr. N.D. Ill. 1993) was affirmed by the Seventh Circuit at
22 F.3d 775, 777 (7th Cir. 1994) by applying the novation
theory, so is no longer good law. Cheripka v. Republic Ins.
Co. (In re Cheripka), 1991 WL 276289 (3rd Cir. 1991) was
vacated by the Third Circuit on January 22, 1992 in an
unpublished opinion, and therefore is no longer good law.
Page -8-
lawsuit fails to allege the elements of a dischargeability
complaint, and, after settlement or judgment, if a bankruptcy
is filed, the bankruptcy court is free to look behind the
settlement or judgment to see if the underlying debt was one
that would be nondischargeable. Defendant’s cases to the
contrary were either reversed or are overruled.6 Therefore,
even if Defendant’s exhibits, which have not been considered,
showed that the state court complaint did not contain Section
523 allegations, Defendant’s motion should be denied.
B. Failure to State a Claim
1. The Rule 9(b) motion.
Federal Rule of Civil Procedure 9(b) states “In all
averments of fraud or mistake, the circumstances constituting
fraud or mistake shall be stated with particularity. Malice,
intent, knowledge, and other condition of mind of a person may
be averred generally.” Defendant, citing American Express
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7 A dismissal under Rule 9(b) is treated as a motion to
dismiss for failure to state a claim under Rule 12(b)(6).
Seattle-First National Bank v. Carlstedt, 800 F.2d 1008, 1011
(10th Cir. 1986).
Page -9-
Travel Related Services Co., Inc. v. Henein, 257 B.R. 702, 706
(E.D. N.Y. 2001), claims that this rule requires a complaint
to set forth the alleged fraudulent statements, identity of
the speaker, time and place of the statements, and nature of
the misrepresentation. Defendant, citing Madison-Onondaga
Corp. v. Kanaley (In re Kanaley), 241 B.R. 795, 803 (Bankr.
S.D. N.Y. 1999), also claims that Rule 9 prohibits pleading
fraud or misrepresentation based “on information and belief.”
Because the complaint fails to specify some of the
requirements of Henein and makes two statements based on
information and belief, Defendant asks the Court to dismiss7.
The Tenth Circuit strictly adheres to a “relaxed pleading
standard” for Rule 9(b). Scheidt v. Klein, 956 F.2d 963, 967
(10th Cir. 1992). Rule 9(b) should be read in conjunction with
Rule 8 which calls for pleadings to be simple, concise, and
direct and to be construed as to do substantial justice.
Schwartz v. Celestial Seasonings, Inc., 124 F.3d 1246, 1252
(10th Cir. 1997). Rule 9(b) requires only the identification
of the “circumstances constituting fraud.” Id.
[There is a ] distinction between the pleading of
the "circumstances of the fraud," as required by the
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8 The forms approved by Fed.R.Civ.P. 84 illustrate how
minimal can be the allegations in a complaint and still be
sufficient. The substantive allegations of several of the
forms comprise no more than one or two sentences. Judge
Easterbrook’s standard is similarly minimal (but more
memorable):
Fed.R.Civ.P. 9(b) requires the plaintiff to state
“with particularity” any “circumstances constituting
fraud”. Although states of mind may be pleaded
generally, the “circumstances” must be pleaded in
detail. This means the who, what, when, where and
(continued...)
Page -10-
rule, and the pleading of "facts." Although
circumstances may consist of facts, the obligation
to plead circumstances should not be treated as
requiring allegations of facts in the pleading, and
neither Rule 8 nor Rule 9(b) requires fact pleading,
although, realistically, that often will be the
easiest way to present the necessary material
regarding the alleged fraud.
5A Wright, Miller, and Kane, Fed. Prac. & Proc. Civ. 3d § 1298
(1998 & Supp. 2004)(footnotes omitted.) Furthermore,
allegations of fraud may be based on information and belief
when the facts in question are particularly within the
opposing party’s knowledge and the complaint sets forth the
factual basis for that belief. Scheidt, 956 F.2d at 967;
Kanaley, 241 B.R. at 803. “Simply stated, a complaint must
set forth the time, place and contents of the false
representation, the identity of the party making the false
statements and the consequences thereof.” Schwartz, 124 F.3d
at 1252. (Citations and quotation marks omitted.) “Mere
conclusory allegations of fraud” are insufficient. Id.8
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8(...continued)
how: the first paragraph of any newspaper story.
Dileo v. Ernst & Young, 901 F.2d 624, 628 (7th Cir. 1990),
cert. denied, 498 U.S. 941.
Page -11-
The Court finds that the complaint in this case meets the
requirements of Rule 9(b). It identifies a single defendant
and there is no question regarding the identity of the
speaker. It states that the parties entered into an agreement
to operate together a business for profit. It specifically
lists four transfers of funds to defendant, the dates, and the
identity of the accounts into which the funds were deposited.
It states that the funds “were to be used by the defendant in
capitalizing [the business]”, but that she diverted the funds
to her own use. These allegations, together, put Defendant on
notice of the nature of the claims and allow her to defend
against them. They sufficiently describe the “circumstances
of fraud.”
The complaint has two allegations “upon information and
belief.” The first, ¶ 4(g), states that while the funds were
to be used by Defendant to capitalize the business, “Defendant
on information and belief obtained during the course of
litigation in New Mexico Third Judicial Court instead diverted
the funds to her own use.” The second, ¶ 4(h) states that
upon information and belief, defendant diverted revenues from
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Page -12-
the business and registered sales from the business as sales
attributable to her own business. These allegations are not
of fraudulent statements by the Defendant capable of being
identified as to time, place, or location. Rather, these are
actions which, if proven, can possibly establish the fraud of
earlier representations. Therefore, they can be construed as
allegations of intent or purpose of Defendant’s actions, and
under Rule 9(b) can be averred generally. Furthermore, the
acts alleged in these two paragraphs are peculiarly within
Defendant’s knowledge, and Plaintiffs should be given the
opportunity for discovery. The complaint will not be
dismissed under Rule 9(b).
2. Breach of fiduciary duty; Embezzlement.
a. Fiduciary Duty.
In Employers Workers’ Compensation Assoc. v. Kelley (In
re Kelley), 215 B.R. 468, 471-72 (10th Cir. BAP 1997), the
Tenth Circuit Bankruptcy Appellate Panel discussed fiduciary
duty:
Section 523(a)(4) of the Bankruptcy Code excepts
from discharge any debt "for fraud or defalcation
while acting in a fiduciary capacity." The Tenth
Circuit recently explained the meaning of "fiduciary
capacity" in this provision.
The existence of a fiduciary relationship under
§ 523(a)(4) is determined under federal law.
However, state law is relevant to this inquiry.
Under this circuit's federal bankruptcy case
law, to find that a fiduciary relationship
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Page -13-
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.
Thus, an express or technical trust must be
present for a fiduciary relationship to exist
under § 523(a)(4). 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." [Allen v.
Romero (In re Romero)], 535 F.2d [618,] 621
[(10th Cir. 1976)].
Fowler Bros. v. Young (In re Young), 91 F.3d 1367,
1371-72 (10th Cir. 1996)(additional citations
omitted). We are, of course, obliged to apply this
narrow view of the fiduciaries who are covered by §
523(a)(4).
The Kelley court also noted that state statutes often, but not
always, impose trusts on persons held to be fiduciaries as a
matter of law based on their relationships. Id. at 473. See
also Van de Water v. Van de Water (In re Van de Water), 180
B.R. 283, 289 (Bankr. D. N.M. 1995)(“The trust requirement is
not limited to trusts arising out of a formal agreement, but
includes relationships in which trust-type obligations are
imposed pursuant to statute or common law.”)(Citation
omitted.) A state statute must meet three requirements to
trigger section 523(a)(4)’s fiduciary status: (1) the trust
res must be defined by the statute, (2) the statute must spell
out the fiduciary duty, and (3) the statute must impose a
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Page -14-
trust on funds prior to the act creating the debt. Kelley,
215 B.R. at 473.
The Court will examine the complaint in light of these
factors. First, the Court notes that the existence of a
fiduciary duty is a question of law, not a fact that can be
pled. Van de Water, 180 B.R. at 289 (Fiduciary capacity is a
question of federal law; the general definition of fiduciary
is too broad in the dischargeability context.); Fowler
Brothers, 91 F.3d at 1371 (“The existence of a fiduciary
relationship under § 523(a)(4) is determined under federal
law.”) Therefore, the Court will disregard the Complaint’s
conclusory allegations that Defendant was acting in a
fiduciary relationship and look to the well-pled facts to see
if the complaint alleges facts that could indicate such a
relationship.
The complaint does not allege any facts to support the
existence of an express trust. Therefore, Plaintiffs must
rely on a trust imposed by state statute or common law. The
only facts alleged that could support this are: (1) Plaintiff
Dale Schueller and Defendant entered into an agreement to
operate a business for profit to be qualified as a LLC
(¶4(a)), (2) Defendant failed to execute the paperwork to
cause the LLC to come into existence, but they proceeded with
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Page -15-
their business relationship, Plaintiffs took no part in the
business, and Defendant was in full charge of the business
(¶4(b)), (3) Funds were advanced to Defendant to capitalize
the business but she diverted them to her own use (¶4(g)), (4)
Defendant diverted revenues from the business and sales from
the business to her own business (¶4(h)), and (5) Defendant
rendered the business a hollowed-out hulk (¶4(i)).
Taking the allegations of the complaint as true, there
was an intent to do business as an LLC that never organized.
Under New Mexico law, this creates a partnership. § 54-1A-202
NMSA 1978 (“[T]he association of two or more persons to carry
on as co-owners a business for profit forms a partnership,
whether or not the persons intend to form a partnership.”)
Under New Mexico law partners have statutory and common law
fiduciary duties to each other. Fate v. Owens, 130 N.M. 503,
509 (Ct. App.), cert. denied, 130 N.M. 484, 27 P.3d 476
(2001). However,
Courts of the Tenth Circuit have uniformly held that
the [Uniform Partnership Act] does not create the
kind of fiduciary relationship required by §
523(a)(4). [Medved v. Novak (In re ] Novak [)], 97
B.R. [47] at 59 [(Bankr. D. Kan. 1987)] (UPA only
creates a trust after the partners derive profits
without the consent of the partnership, and the
trust created is therefore that sort of trust ex
maleficio which is not included within the purview
of § 523(a)(4)); Beebe v. Schwenn (In re Schwenn),
126 B.R. 351 (D. Colo. 1991)(UPA does not create
fiduciary relationship); Susi v. Mailath (In re
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Page -16-
Mailath), 108 B.R. 290 (Bankr. N.D. Okla. 1989)
(Oklahoma statutory law governing general partners
does not create the requisite trust relationship);
In re Weiner, 95 B.R. 204 (Bankr. D. Kan. 1989)(UPA
does not create fiduciary relationship); see also
Ragsdale v. Haller, 780 F.2d 794, 796 (9th Cir.
1986).
Holaday v. Seay (In re Seay), 215 B.R. 780, 786 n.4 (10th Cir.
BAP 1997). The provision of New Mexico’s Uniform Partnership
Act (“UPA”) which establishes standards of conduct is § 54-1A-
404 NMSA 1978, which provides in part:
(a) The only fiduciary duties a partner owes to the
partnership and the other partners are the duty of
loyalty and the duty of care set forth in
Subsections (b) and (c).
(b) A partner's duty of loyalty to the partnership
and the other partners is limited to the following:
(1) to account to the partnership and hold as
trustee for it any property, profit or benefit
derived by the partner in the conduct and
winding up of the partnership business or
derived from a use by the partner of partnership
property, including the appropriation of a
partnership opportunity;
(2) to refrain from dealing with the partnership
in the conduct or winding up of the partnership
business as or on behalf of a party having an
interest adverse to the partnership; and
(3) to refrain from competing with the
partnership in the conduct of the partnership
business before the dissolution of the
partnership.
(c) A partner's duty of care to the partnership and
the other partners in the conduct and winding up of
the partnership business is limited to refraining
from engaging in grossly negligent or reckless
conduct, intentional misconduct or a knowing
violation of law.
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9 Furthermore, any statutory duty in this subsection is to
the partnership, not the partners. (“to account to the
partnership and hold as trustee for it ...” § 54-1A-404(b)(1)
NMSA 1978)(emphasis added). A Section 523(a)(4) plaintiff
must prove (1) a fiduciary relationship between the plaintiff
and the debtor, and (2) fraud or defalcation committed by the
debtor “in the course of that fiduciary relationship.” Fowler
Brothers, 91 F.3d at 1371.
Page -17-
Section 54-1A-404(a) creates general fiduciary duties between
partners as set forth in subsections (b) and (c). Section 54-
1A-404(b)(1) creates a trust. The rest of subsections (b) and
(c) require the partner to “refrain” from certain activities.
These latter subsections do not create a trust. Compare
Fowler Brothers, 91 F.3d at 1371 (“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.” (Emphasis added)).
The Section 404(b)(1) trust does not meet all three
standards set forth in Kelley, 215 B.R. at 473, so does not
implicate Section 523(a)(4). Section 404(b)(1) does identify
the trust res, i.e., the property, profit or benefit derived
by a partner from the use of partnership property. However,
Section 404(b)(1) fails to spell out any fiduciary duties9.
Compare Kelley, 215 B.R. at 473 (Oklahoma statute that made
insurance brokers responsible “in a fiduciary capacity” for
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10 Plaintiffs’ complaint in this case alleges that the LLC
was never formed. Because the Court is treating this matter
as a motion to dismiss, those allegations are assumed true.
Defendant’s Summary Judgment Motion’s inadmissible exhibits
attempt to show that the LLC was, in fact, organized.
Defendant’s brief claims the LLC was organized. Plaintiffs’
Memorandum in Opposition at page 9 appears to concede the
formation of the LLC: “Schueller was a member of WildShooz
Too!, and has been damaged as a result of a breach to the
entity. ... He is alleging that [Debtor], who owed a fiduciary
duty to the company, purposely and willfully misdirected money
that was intended to go to the limited liability company into
her own business pursuits, causing injury to the members.”
Defendant’s exhibits also included an unsigned Operating
Agreement for the LLC, but the brief admitted that it was
unknown whether it was ever signed.
Even if the LLC were organized, the Court’s analysis is
the same (absent an operating agreement to the contrary). The
(continued...)
Page -18-
all funds received and stated that the broker “shall not
mingle any such funds” does not sufficiently define fiduciary
duties to bring it within Section 523(a)(4).) The statute
also does not impose a trust on funds prior to the act
creating the debt; rather, the trust results from the
partner’s improper use of the property which is the very act
creating the debt. Compare Romero, 535 F.2d at 621 (“Further,
the fiduciary relationship must be shown to exist prior to the
creation of the debt in controversy.”) and 535 F.2d at 622
(“[T]he obligations and duties imposed under § 67-35-26,
supra, were binding upon Romero prior to any dealings he had
with Allen.”) Therefore, the simple fact that the parties
were in a partnership10 does not establish a fiduciary duty for
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10(...continued)
parties argue whether § 53-19-13 limits Defendant’s duties.
This section, however, deals with the liability of members and
managers of an LLC to third parties for debts and liabilities
of the LLC. Plaintiffs are not claiming the LLC owes them
anything in this adversary proceeding. This section does not
apply. Furthermore, this section states: “Nothing in this
section shall be construed to immunize any person [note: not
just member or manager] from liability for the consequences of
his own acts or omissions for which he otherwise may be
liable.”
Section 53-19-16 is more relevant and provides, in part:
...
B. a member who is vested with particular management
responsibilities by the articles of organization or
an operating agreement or a manager shall not be
liable, responsible or accountable in damages or
otherwise to the limited liability company or to the
other members solely by reason of his act or
omission on behalf of the limited liability company
in his capacity as a member having particular
management responsibilities or as a manager, unless
such act or omission constitutes gross negligence or
willful misconduct;
...
D. every member who is vested with particular
management responsibilities by the articles of
organization or an operating agreement and every
manager shall account to the limited liability
company and hold as trustee for it any profit or
benefit he derives from:
...
(2) any use by such member or manager of the
company's property, including confidential or
proprietary information of the limited liability
company or other matters entrusted to him as a
result of his status as a member or manager
unless: ...
This statute is very similar to § 54-1A-404(b)(1) dealing with
a partner’s duty to hold as trustee any property, profit or
benefit derived from a use of partnership property. While it
does identify a trust res, it fails to prescribe any fiduciary
duties and the trust does not arise until there is an improper
(continued...)
Page -19-
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10(...continued)
use. See Kelley, 215 B.R. at 473. Therefore, whether the LLC
was organized or not, the result would be the same. There is
no trust for Plaintiffs.
11 In addition to satisfying the prerequisites
for constitutional standing, a plaintiff
must also meet, generally speaking, the
requirements of prudential standing, a
judicially-created set of principles that,
like constitutional standing, places
"limits on the class of persons who may
invoke the courts' decisional and remedial
powers." Warth [v. Selden], 422 U.S. [490]
at 499, 95 S.Ct. 2197 [(1975)]; see also
Allen [v. Wright], 468 U.S. [737] at 751,
104 S.Ct. 3315 [(1984)] (describing
(continued...)
Page -20-
the purposes of the Bankruptcy Code on Defendant’s part. The
Court therefore concludes that Plaintiffs’ section 523(a)(4)
claim for defalcation while acting in a fiduciary capacity
should be dismissed for failure to state a claim.
Defendant also argues that any fiduciary responsibility
that existed would only be to the business, not to Plaintiffs.
Defendant’s Memorandum in Support of Motion for Summary
Judgment, doc. 13, exhibit A, p. 8. This argument is based on
language in a disregarded Exhibit to the Motion and New Mexico
statutes regarding LLC’s. While the Court has not considered
the exhibit and in this motion to dismiss the Court deems that
no LLC was formed, this argument does raise prudential
concerns that the Court must address11. Bankruptcy Rule 7017
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11(...continued)
prudential standing as "judicially
self-imposed limits on the exercise of
federal jurisdiction"). Under a prudential
standing inquiry, a party that has
satisfied the requirements of
constitutional standing may nonetheless be
barred from invoking a federal court's
jurisdiction. Bennett [v. Spear], 520 U.S.
[154] at 163, 117 S.Ct. 1154 [(1997)];
Warth, 422 U.S. at 499, 95 S.Ct. 2197.
Like its constitutional counterpart,
prudential standing establishes three
conditions a party must overcome before
invoking federal court jurisdiction.
First, a plaintiff must assert his "own
rights, rather than those belonging to
third parties." Sac & Fox Nation [of
Missouri v. Pierce], 213 F.3d [566] at 573
[(10th Cir. 2000)]; see also Warth, 422 U.S.
at 499, 95 S.Ct. 2197 (explaining that a
plaintiff "cannot rest his claim to relief
on the legal rights or interests of third
parties").
Board of County Commissioners of Sweetwater County v.
Geringer, 297 F.3d 1108, 1112 (10th Cir. 2002).
Page -21-
provides that Fed.R.Civ.P. 17 applies in adversary
proceedings. Rule 17(a) states, in part:
Real Party in Interest. Every action shall be
prosecuted in the name of the real party in
interest. ... No action shall be dismissed on the
ground that it is not prosecuted in the name of the
real party in interest until a reasonable time has
been allowed after objection for ratification of
commencement of the action by, or joinder or
substitution of, the real party in interest; and
such ratification, joinder, or substitution shall
have the same effect as if the action had been
commenced in the name of the real party in interest.
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Page -22-
The complaint, ¶4(h) alleges that Defendant diverted
revenue from the business by using the business to purchase
inventory for her separate business, and by registering sales
of the business as sales attributable to her separate
business. Paragraph 6 alleges that these diversions of
revenues and inventory is a violation of her fiduciary duty of
loyalty and trust to the plaintiffs. In Plaintiff’s
Memorandum in Opposition to Defendant’s Motion for Summary
Judgment, doc. 16, at 9, Plaintiffs argue that Schueller, as a
member of the business, was damaged as a result of breach to
the entity; and that Defendant, who owed a fiduciary duty to
the company, purposely and willfully misdirected money that
was intended to go to the business into her own business
pursuits, “causing injury to the members” of the business.
These appear to be “derivative claims.” “Generally, a
derivative claim is one brought on behalf of a legal entity,
such as a corporation or partnership to assert a right
belonging to [that entity] or to redress a wrong done to it.
Recovery generally goes to the entity harmed, rather than to
individuals.” Losey v Norwest Bank of New Mexico, N.A.
(Matter of Norwest Bank of New Mexico, N.A.), 134 N.M. 516,
524-25, 80 P.3d 98, 106-07 (Ct. App.), cert. denied, 134 N.M.
723, 82 P.3d 533 (2003) (Citations and internal punctuation
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Page -23-
omitted.); Meyer v. Fleming (In re Chicago, R.I. & P. Ry.
Co.), 327 U.S. 161, 167 (1946):
[Stockholders’ derivative suits] are likewise suits
to enforce a corporate claim. They are one of the
remedies which equity designed for those situations
where the management through fraud, neglect of duty
or other cause declines to take the proper and
necessary steps to assert the rights which the
corporation has. The stockholders are then allowed
to take the initiative and institute the suit which
the management should have started had it performed
its duty. The corporation is a necessary party.
City of Davenport v. Dows, 18 Wall. 626, 21 L.Ed.
938. Hence, it is joined as a defendant. But it is
only nominally a defendant, since any judgment
obtained against the real defendant runs in its
favor.
(Footnote omitted.)
“Whether a complainant is the real party in interest
under state law is generally resolved by inquiring whether he
or she has standing under state law.” Swanson v. Bixler, 750
F.2d 810 (10th Cir. 1984). Therefore, the Court will look to
New Mexico cases to determine if Plaintiffs have standing
under state law to assert these claims. The general rule in
New Mexico is that a real party in interest is one who owns
the right being enforced or who is in a position to discharge
the defendant from liability. Moody v. Stribling, 127 N.M.
630, 634, 985 P.2d 1210, 1214 (Ct. App.), cert. denied, 127
N.M. 389, 981 P.2d 1207 (1999)(citing Edwards v. Mesch, 107
N.M. 704, 706, 763 P.2d 1169, 1171 (1988)).
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Page -24-
In New Mexico, a partnership is an entity distinct from
its partners. § 54-1A-201 NMSA 1978. Property acquired by a
partnership is property of the partnership and not of the
partners individually. § 54-1A-203 NMSA 1978. Property is
presumed to be partnership property if purchased with
partnership assets. § 54-1A-204(c) NMSA 1978. A partner is
not a co-owner of partnership property and has no interest in
partnership property. § 54-1A-501 NMSA 1978. A partner has a
duty to the partnership to account for and hold as trustee any
property, profit or benefit derived by the partner from a use
of partnership property. § 54-1A-404(b)(1) NMSA 1978. A
partnership may maintain an action against a partner for a
breach of the partnership agreement or for the violation of a
duty to the partnership. § 54-1A-405(a) NMSA 1978. A partner
may maintain an action against the partnership or another
partner to enforce the partner’s individual rights. § 54-1A-
405(b) NMSA 1978.
These statutes suggest that the Plaintiffs are not the
proper parties to assert damages for the alleged diversions of
inventory or revenues. The complaint clearly states that it
was the business’ property that was being used for Defendant’s
sole proprietorship. Plaintiffs had no direct interest in
this property. Defendant had a duty to the business to
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Page -25-
account and hold the property, profit or benefit as trustee
for the business. And, the business can bring an action
against Defendant. Plaintiffs are not in a position to
discharge Defendant from liability to the business. See Fate,
130 N.M. at 509, 27 P.3d at 996:
It is well settled in New Mexico that shareholders
of a corporation may bring a derivative action on
behalf of the corporation to assert a right
belonging to the corporation or to redress a wrong
done to it. Marchman v. NCNB Tex. Nat'l Bank, 120
N.M. 74, 81-83, 898 P.2d 709, 717-18 (1995).
Similarly, our Supreme Court has stated the same
principle in the context of a general partnership:
[A] partnership is empowered to sue or to be
sued in the name of the partnership, and a cause
of action accruing to the partnership, for
damages to partnership property or interests,
belongs to the partnership rather than to
individual partners. For these reasons, a
partner cannot bring suit as an individual on a
claim belonging to the partnership.
First Nat'l Bank v. Sanchez, 112 N.M. 317, 325, 815
P.2d 613, 621 (1991) (citations omitted). New
Mexico has recently reiterated the principle that
when an action is brought to enforce a right
belonging to, or redress a wrong done to, a
partnership, the action should be brought
derivatively in the partnership's name. GCM, Inc.
[v. Kentucky Central Life Ins. Co.], 1997-NMSC-052,
¶¶ 19-20, 24-27, 124 N.M. 186, 947 P.2d 143 (stating
that if a duty is owed to the partnership, then only
the partnership can sue for a breach of such duty).
Under Federal Rule 17(a) the Court will allow Plaintiffs
to amend their complaint to include the real party in
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12 This discussion is also applicable if it turns out that
the LLC was organized. LLC’s are separate legal entities. §
53-19-10(A) NMSA 1978. Property acquired by an LLC is
property of the LLC and not of the members, and the members
have no interest in LLC property. § 53-19-29(A) NMSA 1978.
Property is presumed to be LLC property if it is purchased
with LLC funds. § 53-19-29(E) NMSA 1978. A managing member
or a manager must account to the LLC and hold as trustee for
it any profit or benefit derived from use of the LLC’s
property. § 53-19-16(D)(2) NMSA 1978. Suits can be brought
by or against an LLC in its own name. § 53-19-57 NMSA 1978.
A member of an LLC is not a proper party to a proceeding by or
against the LLC unless the object is to enforce the member’s
right against or liability to the LLC. § 53-19-14 NMSA 1978.
Suits on behalf of an LLC may be brought “in the name of the”
LLC by authorized members or managers. § 53-19-58 NMSA 1978.
These statutes suggest that members of LLC’s cannot sue
individually for LLC claims. While New Mexico courts have not
yet addressed this issue, other jurisdictions so find. See,
e.g., General Technology Applications, Inc. v. Exro LTDA, 388
F.3d 114, 119 (4th Cir. 2004)(Member of LLC could not enforce
LLC’s rights for member individually; “Virginia strictly
adheres to the derivative-claim rule.”); Paclink
Communications Int’l, Inc. v. Superior Court of Los Angeles
County, 90 Cal.App.4th 958, 964, 109 Cal.Rptr.2d 436, 440 (Ct.
App. 2001):
In this case, the essence of plaintiffs' claim is
that the assets of PacLink-1 were fraudulently
transferred without any compensation being paid to
the LLC. This constitutes an injury to the company
itself. Because members of the LLC hold no direct
ownership interest in the company's assets (Corp.
Code, § 17300), [That section provides: "A
membership interest and an economic interest in a
limited liability company constitute personal
property of the member or assignee. A member or
assignee has no interest in specific limited
liability company property."] the members cannot be
directly injured when the company is improperly
deprived of those assets. The injury was
essentially a diminution in the value of their
membership interest in the LLC occasioned by the
(continued...)
Page -26-
interest12 if they decide to pursue litigation of the diversion
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12(...continued)
loss of the company's assets. Consequently, any
injury to plaintiffs was incidental to the injury
suffered by PacLink-1.
(Holding that trial court demurrer should be sustained because
plaintiffs had no standing to sue other than by a derivative
action. Id. at 966-67, 109 Cal.Rptr.2d at 442.)
Page -27-
claims as derivative claims.
b. Embezzlement.
"Embezzlement, for purposes of 11 U.S.C. § 523 'is
the fraudulent appropriation of property by a person
to whom such property has been entrusted, or into
whose hands it has lawfully come, and it requires
fraud in fact, involving moral turpitude or
intentional wrong, rather than implied or
constructive fraud.' " United States Life Title
Insurance Co. v. Dohm (In re Dohm), 19 B.R. 134, 138
(Bankr. N.D. Ill.1982) (quoting American Family
Insurance Group v. Gumieny (In re Gumieny), 8 B.R.
602, 605 (Bankr. E.D. Wis.1981)).
Driggs v. Black (In re Black), 787 F.2d 503, 507 (10th Cir.
1986). A debtor may not discharge a debt, pursuant to Section
523(a)(4), based on fraud or defalcation which arose while he
or she was acting in a fiduciary capacity, or embezzlement or
larceny whether or not he or she was acting in a fiduciary
capacity. Merrywell v. Barwick (In re Barwick), 24 B.R. 703,
705 (Bankr. E.D. Va. 1982).
The complaint in this case states a cause of action for
embezzlement. It alleges transfers of funds to Defendant to
be used for a specific purpose, and intentional misuse of
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Page -28-
those funds for Defendant’s own purposes. The embezzlement
claims will not be dismissed.
CONCLUSION
For the reasons set forth above, the Court will enter an
order (1) Denying that portion of Defendant’s Motion for
Summary Judgment on the grounds of res judicata or collateral
estoppel, (2) Denying that portion of Defendant’s Motion for
Summary Judgment under Rule 9(b), (3) Granting that portion of
Defendant’s Motion that seeks dismissal of the Section
523(a)(4) claim regarding fraud or defalcation in a fiduciary
capacity, (4) Giving Plaintiffs 30 days to take steps to bring
into this action the real party in interest regarding claims
for diversions of revenues and sales, and (5) Denying
Defendant’s Motion that seeks dismissal of the Section
523(a)(4) claims regarding embezzlement.
Honorable James S. Starzynski
United States Bankruptcy Judge
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Page -29-
I hereby certify that on March 16, 2005, a true and correct
copy of the foregoing was electronically transmitted, faxed,
delivered, or mailed to the listed counsel and/or parties.
Matthew P Holt
PO Box 2699
Las Cruces, NM 88004-2699
Steve H Mazer
122 10th St NW
Albuquerque, NM 87102-2901
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