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In Re Ingalls

2010 WL 624089 (Bkrtcy. Ct. D. N.J. 2010) (Unpublished)

BANKRUPTCY; FRAUD; FIDUCIARY DUTIES — In bankruptcy, a creditor may seek to have a debt declared non-dischargeable if the creditor can prove five elements based on fraud or prove that the debtor was a fiduciary and had fraudulently misappropriated funds.

A customer hired an interior design company to perform work at its home. The customer paid three deposits of $50,000, each to be used to purchase furnishings at the house. When the interior designer’s business faltered, the company’s principal used a portion of the deposit for other business expenses and not to purchase the furniture on the customer’s behalf. The customer sued the company and its principal in state court and they reached a settlement agreement which required the company to pay back a portion of the amount due. It also provided that the customer would be entitled to a judgment for the full amount if the company defaulted on the agreed-upon payments. Some time later, the company ceased operations and the principal and her husband filed for a Chapter 7 bankruptcy. The customer filed an adversary complaint, objecting to the discharge of their debt, but the complaint was rejected. The Court was puzzled by the customer’s failure to try to pierce the corporate veil and thereby try to find the principal liable for the company’s debt. Instead, the customer relied on the principal’s signing of the settlement agreement in her individual capacity. To the Court, this was not a basis to hold the principal liable in her individual capacity and therefore the debt was not a personal liability. Since it was not a personal liability, it was not part of the debtor’s estate. The Court also found that even if the principal’s signing of the settlement agreement were sufficient to hold her liable, the debt would still be dischargeable.

According to the Court, a creditor may seek to have a debt declared non-dischargeable if the creditor can prove that: (1) the debtor obtained money, property or services through a material misrepresentation; (2) at the time, the debtor knew the representation was false or had a reckless disregard for the truth; (3) the debtor made the representation with the intent to deceive; (4) the creditor relied on the misrepresentation; and (5) the debtor’s conduct was the proximate cause of the creditor’s loss. In order to prevail, a creditor must show that the fraudulent conduct occurred at the inception of the debt to induce the creditor to give money or property. Here, the Court found that the principal did not intend to defraud the customer. In fact, the company actually provided the required design services, consulted with the customer, and purchased furnishings ordered by the customer until the business faltered.

The Court also rejected the customer’s allegation that the principal was a fiduciary, and that by misappropriating funds that were to be used to pay for furniture, she had engaged in fraud. The Bankruptcy Code excepts from discharge: (1) fraud while acting as a fiduciary; (2) defalcation while acting as a fiduciary; (3) embezzlement; and (4) larceny. The Court noted that for the customer to be successful, the first two categories required a finding that the principal was a fiduciary of the customer. However, it held that, under the Bankruptcy Code, the meaning of “fiduciary” was limited to express or technical trusts and that the duties must be independent of any contractual obligations between the parties, which was not the case here. The Court also rejected the customer’s argument that a fiduciary relationship arose between the design company and its customers once the company became insolvent. The Court found no evidence that the company was insolvent at the time the money was misappropriated.

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