Express Trusts and Bankruptcy Discharge: some Quick Hits

Adas v. Rutkowski, 2013 WL 6865417 (N.D.Ill. 2013), illustrates the confluence of Federal bankruptcy law and state law fiduciary duty and express trust principles in a case involving a failed construction partnership.

The plaintiff and bankrupt debtor (defendant) formed a partnership to buy real estate, build a house  on it and split the profits once the house was sold.

The venture failed and the plaintiff got stuck with a sizeable deficiency judgment in a lender’s foreclosure suit.  After the defendant filed for bankruptcy, the plaintiff objected to defendant’s discharge based on defendant’s lengthy pattern of keeping plaintiff in the dark about the failed venture’s finances.  The bankruptcy court agreed and the defendant appealed.

Held: Affirmed.  Defendant’s obligation to plaintiff is nondischargeable.

Rules/Reasoning:

Normally, a bankruptcy filing gives a debtor a reprieve from creditor collection efforts and forgives (or “discharges”) most of his debts. 

An exception is where the bankrupt debtor engages in fraud, defalcation, embezzlement or larceny.  11 U.S.C. §. 523.

The creditor must show (1) an express trust or fiduciary relationship between the debtor and creditor, and (2) that the debt was caused by fraud or defalcation.  Defalcation equals (roughly) intentional conduct that’s more than negligence but less than fraud.  * 4, 8.

Express Trust – State and Federal Law

The court held that the parties’ business relationship constituted an express trust. 

In Illinois, an express trust exists where (1) there is an intent to create a trust, (2) definite subject matter or trust property, (3) trust beneficiaries, (4) a trustee, (5) a specific trust purpose, and (6) delivery of trust property to the trustee. 

While trusts are normally manifested in a writing (such as a will or property deed), it doesn’t have to be and a trust can be shown through circumstantial evidence. 

The Federal courts view the trust hallmarks as (1) segregation of funds (no commingling, e.g.), (2) management of the funds by an intermediary, and (3) the entity that controls the trust funds or property has only bare legal title to the funds.  *6.

The court found the evidence established a trust arrangement between the parties.  There was an intent to create a trust, trust property (loan funds), subject matter (the house), a trustee (defendant), a beneficiary (plaintiff) and delivery of the trust property.  *5.

Fiduciary Duty

The Court also blocked defendant’s discharge because defendant breached his fiduciary duties to the plaintiff.  Federal law defines a fiduciary relationship as one where there is an imbalance of power between parties and a stronger party takes advantage of weaker one.

Here, the defendant occupied a position of power and influence over the plaintiff and abused the position by excluding the plaintiff from all aspects of the parties business. *7.

Defalcation

Finally, the Court refused to discharge defendant’s debt to plaintiff because of the defendant’s “defalcation.”  

Defalcation applies where a debtor’s conduct is intentional or criminally reckless.  The conduct must go beyond negligence, doesn’t rise to the level of fraud, but still requires subjective intent. 

Defendant’s conduct easily met the defalcation standard.  He engaged in a pattern of secretive and ethically challenged business activity by submitting inflated sworn statements and phantom receipts, commingling funds, and hiding project data from the plaintiff.   *8-9.  

Comments:

(1)  An express trust will exist where someone gives money or property to another with explicit directions as to how to apply those funds; and no writing is required;

(3) a creditor can defeat a bankrupt debtor’s discharge if it can show the debtor intentionally or recklessly violates an obligation to the creditor – even if the debtor’s conduct doesn’t rise to the level of fraud.

 

7th Circuit Bounces Chicago Bull’s Legend’s Defamation Suit

Freepress_art_160_20080307145114In Pippen v. NBCUniversal Media, the 7th Circuit upheld the District Court’s dismissal of former hoops diety Scottie Pippen’s false light defamation complaint. Pippen sued NBC after several internet media outlets falsely reported that he filed for bankruptcy protection. The Northern District dismissed his claims on the basis that he failed to prove that the online media accounts were defamatory on their face and also couldn’t show actual malice by the defendant. The Seventh Circuit affirmed.

Reasoning: The two species of defamation (basically, a false statement published to a third party that is harmful) are: (1) defamation per quod – which requires a plaintiff to show that false statements caused him financial harm; and (2) defamation per se – statements so harmful on their face that damages to the plaintiff recipient are presumed (no proof of money injury is required).  Per se defamation includes false statements that plaintiff committed a criminal act, has a loathsome disease, lacks competence or integrity in his profession or false statements which impede a plaintiff in the pursuit of his trade or profession.  Bryson v. News America Publications, Inc., 174 Ill.2d 77 (1996).

Rejecting Pippen’s per se defamation claim, the Seventh Circuit held that a false media account of a personal bankruptcy was not equivalent to an outright false accusation that Pippen lacked ability in his trade or was somehow immoral.  NBCUniversal, p. 3.  Pippen’s post-NBA career includes public speaking appearances, product endorsements and working as a television basketball analyst.  A media report that he filed bankruptcy does not impugn his ability to carry out these jobs.  Id., p. 4.

The Court also found that Pippen’s defamation per quod claim failed.  While Pippen’s allegations of lost product endorsements and speaking engagement opportunities did satisfy the special damages pleading requirement for per quod defamation, his claim was defeated because he couldn’t show actual malice

Since Pippen is a public figure, he must show (i) defendant’s knowledge of falsity; or (ii) its reckless disregard for the truth of the published statement.  Id., p. 5; New York Times Co. v. Sullivan, 376 U.S. 254, 279-80 (1964).  The Court looked to U.S. Supreme Court precedent in rejecting Pippen’s argument that a failure to investigate whether he truly filed bankruptcy was enough to show a reckless disregard for the truth.  NBCUniversal, p. 6; Harte-Hanks Communications, Inc. v. Connaughton, 491 U.S. 657, 688 (1989).  The Court also discarded Pippen’s claim that the media outlets’ failure to retract the bankruptcy report after Pippen e-mailed them that he didn’t file bankruptcy demonstrated actual malice: a determination made at the time of publication.

Finally, the Court reaffirmed Illinois’ single publication rule, codified in 740 ILCS 165/1 (the Uniform Single Publication Act), ruling that defamation is “complete” at the time of the first publication and that subsequent repostings or publications do not trigger fresh libel (written defamation) claims.  NBCUniversal, p. 6.  Applying the single-publication rule to digital publications, the Court looked to other States’ precedents and adopted the policy argument that the rule should apply to online publishers.  Otherwise, the Court wrote, it would give rise to a never-ending multiplicity of suits against online media sources  exposing them to “potentially limitless liability.”  Id., p. 8.  On this point, the court shot down Pippen’s assertion that the single-publication rule shouldn’t apply to online media since they can easily retract erroneous information (with a click of a button). 

On the republication issue (defendant republishes a defamatory story) the Court did imply that if the defendant took an affirmative, independent action that republished a defamatory story, this could give rise to a defamation claim.  However, here, the Seventh Circuit (sitting in diversity) predicted that Illinois’ highest court wouldn’t deem the “passive maintenance of a web site” a republication for libel purposes.  Id., p. 9.

Conclusion: Apparently, one of the prices of fame (I wouldn’t know !) is that it’s hard for a public figure to state a defamation case against a printed or digital media source.  The case illustrates how high a proof burden the actual malice standard is for a celebrity/public figure plaintiff.  It surprises me that if a defamation plaintiff proves to a defendant that a defendant’s statement is false and the defendant fails to retract it (i.e. keeps it on the website), this will not show knowledge of falsity.  It seems to beg the question as to what conduct of a defendant does satisfy the knowledge of falsity or reckless disregard actual malice standard.  Lastly, the Court’s single-publication holding should be welcome news to Internet media sources since it protects them from potentially non-stop defamation claims with each day that a false story persists giving rise   to a fresh limitations period.

Link to opinion:

 http://www.isba.org/cases/7thcircuit/2013/08/21/pippenvnbcuniversalmediallc