Bankruptcy and Non-Dischargeability Causes of Action

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Bankruptcy and Non-Dischargeability Causes of Action

This adversary proceeding in Rennaker v. Davis, Case No. 20-04065  (Bankr. N.D. Tex., Nov. 9, 2021), involves a litany of non-dischargeability allegations – both under 11 U.S.C. §523 and §727.  Judge Mark Mullin’s opinion provides a good analysis of the various elements of various non-dischargeability causes of action.

The Debtor/Defendant in this bankruptcy adversary proceeding, Rebecca Davis (hereinafter “Debtor”), was a divorce attorney that represented the Plaintiff Kila Rennaker (“Plaintiff”) in a divorce from husband.  Plaintiff’s divorce case was filed in 2008 in a Parker County, Texas, district court.  Plaintiff had decided to retain the Debtor as her divorce attorney after an initial consultation, where she got the impression that Debtor could handle her divorce case.  Therefore, on June 12, 2008, they both executed an engagement agreement.  The initial divorce petition was subsequently filed on June 23, 2008.

At the time of Plaintiff’s retention of the Debtor, the Debtor had been a licensed and practicing attorney for three years.  At the conclusion of the litigation of the divorce action, Plaintiff obtained primary custody of the children of the marriage and the maximum amount of child support for the minor children.  However, despite these results, Plaintiff was unhappy with the Debtor’s representation of her for four state reasons laid out in her Complaint:

  1. Ms. Davis’ representation of Ms. Rennaker during an August 31, 2009, mediation (the “Mediation”) in the Divorce Action;
  2. the resulting Mediated Settlement Agreement (“MSA”) executed on August 31, 2009;
  3. the subsequent Agreement Incident to Divorce executed on September 30, 2009; and
  4. Ms. Davis’ failure to prepare, negotiate, finalize, record, and file the necessary documents to effectuate the transfer of certain property to Ms. Rennaker from her ex-husband, which were significant terms included in the Mediated Settlement Agreement, Agreement Incident to Divorce, and Final Decree of Divorce.

The MSA provided for the following three significant terms, pursuant to which Plaintiff was to obtain:

  1. Clear title to the couple’s homestead at 105 Briarwood Street, Weatherford, Texas (the “Homestead Property”);
  2. Clear title to the couple’s additional property, which included ten acres of land (the “Land”); and
  3. $8,500 worth of the Plaintiff’s ex-husband’s American Airlines Advantage Miles (the “Miles”) (together, the Homestead Property, the Land, and the Miles are referred to as the “Three Assets”).

On September 30, 2009, the parties and their respective counsel in the Divorce Action executed the Agreement incident to Divorce , which provided that the Three Assets were to be awarded to the Plaintiff “as her sole and separate property.”  Despite this, the Debtor failed to prepare, negotiate, finalize, record, and file the necessary documents to effectuate the conveyance of the Three Assets to Plaintiff.  The Debtor did not dispute that she failed to perform these responsibilities for Plaintiff.

Plaintiff discovered the failure of Debtor to effectuate transfer of the Three Assets in 2015, when she attempted to sell the Land.  When Plaintiff contacted her ex-husband in an attempt to have his interest conveyed to her, he refused to cooperate.  As a result, Plaintiff defaulted on the contract with the prospective buyer because she was not able to deliver good title, causing the sale to fall through.  When Plaintiff initially contacted the Debtor, the Debtor proceeded (procedurally incorrectly) to seek a declaratory judgment against Plaintiff’s ex-husband, which was ultimately dismissed on summary judgment.

Therefore, Plaintiff ultimately hired a new law firm, Whitaker Chalk, to represent her in obtaining clear title to the Three Assets that she should have received in 2009.  In May, 2016, Whitaker Chalk filed a petition for enforcement in the Divorce Action to obtain the relief that Plaintiff should have previously received.  Ultimately, after substantial litigation, Whitaker Chalk was successful in obtaining Plaintiff’s ex-husband’s assignments of his interests in the Three Assets to Plaintiff.  Whitaker Chalk incurred attorneys’ fees and costs in the amount of $63,082.98 specifically related to the firm’s efforts to obtain the assignments of the interests of the ex-husband in the Three Assets to Plaintiff.

On February 18, 2020, Ms. Davis filed a Chapter 13 bankruptcy case, which was later converted to Chapter 7.  Debtor generally satisfied her administrative obligations by filing the necessary schedules and appearing at a 341 creditor meeting and testifying under oath.  Despite Plaintiff’s allegations regarding the Debtor’s own divorce and corresponding sizeable settlement that Debtor allegedly failed to explain, the Court found that Ms. Davis’ testimony on this issue sufficient to meet her burden to explain satisfactorily the disposition of such assets over the past many years.

Plaintiff’s Complaint sought to liquidate all claims against the Debtor, as well seek a determination that the Debtor:  (1)  was not entitled to a discharge under 11 U.S.C. §727(a)(3) and (a)(5); and (2) was not entitled to a discharge of Plaintiff’s liquidated claims under 11 U.S.C. §523(a)(2) and (a)(4).

Count One:  Negligence

Count One of Plaintiff’s Complaint asserted a cause of action against the Debtor for negligence.  The Court noted the elements of, including that a plaintiff must show that

  1. there was a duty;
  2. that duty was breached; and
  3. damages resulted as a proximate cause of that breach

The Court found that the credible and uncontroverted evidence established that the Debtor:  (i) had a duty to Plaintiff; (ii) breached that duty; and (iii) proximately caused Plaintiff’s resulting damages.  The Court found that the damages associated with the Debtor’s negligence included the following components (collectively, the “Liquidated Damages”):

  1. $10,000 resulting from the breach of the 2015 sale agreement regarding the Land;
  2. the Whitaker Chalk attorneys’ fees and costs in the amount of $63,082.98; and
  3. the attorney fees Debtor charged Plaintiff for the Mediation through the entry of the Final Decree of Divorce in the amount of $2,000, for total damages suffered by Plaintiff in the amount of $75,082.98.

Count Two:  Breach of Fiduciary Duty

Count Two of Plaintiff’s Complaint alleged that Debtor breached her fiduciary duty to Plaintiff as an attorney working in the course and scope of her employment as an attorney in her dealings with Plaintiff.  The Court noted that a breach of fiduciary duty occurs under Texas law when:

(i)               the plaintiff and defendant had a fiduciary relationship;

(ii)              the defendant breached that fiduciary relationship to the plaintiff, and

(iii)            the defendant’s breach resulted in (a) injury to the plaintiff or (b) benefit to the defendant.

The Court noted that, in Texas, attorneys owe their clients a fiduciary duty as a matter of law.

After analysis of the uncontroverted facts, the Court found that Plaintiff satisfied her burden to establish that Debtor breached her fiduciary duty to Plaintiff and established a claim for breach of fiduciary duty.  The damages for the breach of fiduciary duty were the identical Liquidate Damages in the amount of $75,082.98.

Count Three:  Violations of the Deceptive Trade Practices Act

Pursuant to Count Three, Plaintiff alleged that she was  “consumer” under the Texas Deceptive Trade Practices Act (“DTPA”) who had acquired services from the Debtor and that the Debtor had engaged in “false, misleading, or deceptive acts or practices,” including the “the failure to disclose information concerning goods or services which was known at the time of the transaction into which the consumer would not have entered had the information been disclosed.”  Plaintiff contended that Debtor further violated the DTPA because she failed to disclose that she lacked the necessary experience to adequately represent Plaintiff in her divorce case. Finally, Plaintiff contended that the Debtor committed an “unconscionable action or course of conduct.”

The Court found that the Plaintiff failed to present sufficient credible evidence to satisfy her burden that the Debtor committed or made any “false, misleading, or deceptive acts or practices.” Further, Plaintiff failed to present sufficient credible evidence to establish that Ms. Davis knowingly or intentionally committed “any unconscionable action or course of action.” Rather, the Court found that the overwhelming and uncontroverted evidence established that Debtor failed to complete the required legal work to consummate the terms of the Mediated Settlement Agreement, Agreement Incident to Divorce, and Final Decree of Divorce on behalf of the Plaintiff, but that Debtor’s failure to take such actions did not rise to the level of knowing or intentional conduct necessary to satisfy the elements for a DTPA cause of action.

Count Four:  Non-Dischargeability under §727(a)(5)

At this point, the court turned to the issues of non-dischargeability alleged by Plaintiff – first under §727 of the Bankruptcy Code.  As an initial point, non-dischargeability under §727 differs markedly from non-dischargeability under §523 based on one critical distinction—namely, a finding of non-dischargeability under §727 results in a Debtor failing to obtain their discharge in total.  To the contrary, a finding of non-dischargeability under §523 results in a debtor’s failure to obtain a discharge with respect to that creditor plaintiff’s debt only.

A plaintiff asserting a § 727(a)(5) count carries the initial burden to show that the defendant possessed substantial, identifiable assets that are now unavailable for distribution to creditors.  Once the unavailable assets are established, the burden shifts to the debtor to show a satisfactory explanation of the disposition of such assets.

The Court first noted that neither the Chapter 13 Trustee or the Chapter 7 Trustee raised an issue or alleged that Ms. Davis had failed to explain satisfactorily any loss of assets or deficiency of assets in her bankruptcy case. Second, the Court found that the testimony of Ms. Davis satisfactorily explained that she spent those funds over the course of nearly a decade to supplement her income from her law practice.

Therefore, the Court found that Plaintiff failed to satisfy her burden to establish that the Debtor had substantial assets that are no longer available for creditors. Moreover, the Court found that the Debtor  satisfactorily explained the disposition of her prior assets. Therefore, Plaintiff’s claim under § 727(a)(5) was denied.

Count Five:  Non-Dischargeability under  §727(a)(3)

A court may deny a debtor a discharge when the debtor has concealed, destroyed, mutilated, falsified, or failed to keep or preserve any recorded information, including books, documents, records, and papers, from which the debtor’s financial condition or business transactions might be ascertained, unless such act or failure to act was justified under all of the circumstances of the case.  Here, the Court once again first noted that neither the Chapter 13 Trustee nor the Chapter 7 Trustee raised an issue or alleged that the Debtor concealed, destroyed, mutilated, falsified, or failed to keep or preserve any recorded information, including books, documents, records, and papers from which her financial condition or business transactions might be ascertained.

The Court next considered the Plaintiff’s contention that the Debtor had failed to produce certain bank statements from her law firm’s IOLTA account as a basis for a finding that the Debtor had concealed information.  The Court found that the Debtor had raised timely objections to Plaintiff’s discovery requests and that Plaintiff never sought or received an order from Court compelling production of the requested documents.  Therefore, the Debtor was not required to respond to the requests.

Finding that Plaintiff had failed to present any credible evidence that the Debtor had, in fact, failed to keep or preserve sufficient financial records, the court denied Plaintiff’s claim under §727(a)(3).

Count Six:  Non-Dischargeability of Plaintiff’s Debt under  §523(a)(2)

Turning to the non-dischargeability provisions focused solely on Plaintiff’s debt, the Court first analyzed Plaintiff’s asserted cause of action under §523(a)(2) related to debts owed for money to the extent obtained by fraud, false pretenses, or false promises.

Starting with actual fraud, the Court noted the elements of action fraud, including:

  1. the debtor knowingly made a false representation;
  2. the debtor intended the representation to deceive the creditor;
  3. the creditor actually and justifiably relied on the representation; and
  4. the creditor sustained a loss as a proximate result of its reliance on the false representation.

Despite Plaintiff’s complaints regarding the failure of the Debtor to disclose how many years she had been practicing, the court found that the evidence did not establish that the Debtor ever misrepresented her legal or case experience leading up to or during her representation of the Plaintiff.  Similarly, the court found that Plaintiff failed to establish that the Debtor ever intended to deceive her or had a reckless disregard for the truth when she made representations to the Plaintiff.  Therefore, the Court found that Plaintiff’s claim for actual fraud under §523(a)(2) failed.

The Court next turned to false pretenses and false representation.  False pretenses and a false representation requires a creditor to prove

(i)               the existence of a knowing and fraudulent falsehood;

(ii)              that the fraudulent falsehood described past or current facts, and

(iii)            that the creditor justifiably relied upon the fraudulent falsehood.

The Court first found that Plaintiff to establish Debtor made a knowing and fraudulent statement.  Based on that failure, the Court denied Plaintiff’s claim under §523(a)(2) for false pretense or false representation.

Count Seven:  Non-Dischargeability of Plaintiff’s Debt under  §523(a)(4)

Finally, the Court turned to §523(a)(4), which provides for non-dischargeability of a debt for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.  Since the Complaint raised no allegations regarding fraud, embezzlement, or larceny, the Court focused solely on whether Debtor committed defalcation while acting in a fiduciary capacity.

To prevail on this count, the Plaintiff first has to establish the existence of a fiduciary relationship.  Finding, as it already had, that an attorney has a fiduciary relationship with their client as a matter of law, the Court had no problem finding the existence of a fiduciary relationship.

The Court then turned to the “defalcation” component of the cause of action.  “Defalcation” requires a fiduciary engage in intentionally wrong conduct.  Conduct is intentionally wrong when the fiduciary either (a) knows the conduct is improper or (b) engages in grossly reckless conduct.

Looking first at whether Debtor’s conduct was knowingly improper, the Court found that there was no evidence in the record to suggest that Ms. Davis knowingly engaged in her improper conduct.  Therefore the Court turned to a determination of whether Debtor’s conduct was grossly reckless.

Where actual knowledge of wrongdoing is lacking, conduct is considered as equivalent if the fiduciary “consciously disregards (or is willfully blind to) a substantial and unjustifiable risk” that such conduct would violate a fiduciary duty.  Bullock v. BankChampaign, N.A., 569 U.S. 267, 273–74 (2013).   A conscious disregard involves “a gross deviation from the standard of conduct that a law-abiding person would observe in the actor’s situation.”  Id.  Here, the Court found that Ms. Davis completely failed to take the necessary steps to implement the terms of the MSA, the Agreement Incident to Divorce, and the Final Decree of Divorce regarding the Three Assets. As a fiduciary, Ms. Davis was tasked to complete the required legal work to consummate the terms of the MSA, the Agreement Incident to Divorce, and the Final Decree of Divorce on behalf of her client.  Consequently, the Court found that the Debtor’s failure to take the obvious and necessary actions on behalf of Plaintiff was a gross deviation from the standard of conduct expected of an attorney in her situation.

Finding that Plaintiff had satisfied her burden to establish that Debtor engaged in grossly reckless conduct sufficient to establish defalcation while acting in a fiduciary capacity under § 523(a)(4), the Court found that Plaintiff’s claim in the Liquidated Damages amount of $75,082.98 constitutes a debt that was excepted from discharge.