Free Appellee's Brief - District Court of California - California

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CASE NUMBER 3:08-CV-1062-WHA UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF CALIFORNIA

HUGO NERY BONILLA, Appellant, v. ATR-KIM ENG FINANCIAL CORPORATION AND ATR-KIM ENG CAPITAL PARTNERS, INC., Appellees.

On Appeal From The United States Bankruptcy Court for the Northern District of California San Francisco Division Bankruptcy Case No. 07-30309 Adversary Proc. No. 07-3079

APPELLEES' BRIEF

MICHAEL J. BAKER (No. 56492) WILLIAM J. LAFFERTY (No. 120814) NEIL W. BASON (No. 167662) HOWARD RICE NEMEROVSKI CANADY FALK & RABKIN A Professional Corporation Three Embarcadero Center, 7th Floor San Francisco, California 94111-4024 Telephone: 415/434-1600 Facsimile: 415/217-5910 Attorneys for Appellees ATR-KIM ENG FINANCIAL CORPORATION and ATR-KIM ENG CAPITAL PARTNERS, INC.

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TABLE OF CONTENTS Page

INTRODUCTION STATEMENT OF THE BASIS FOR APPELLATE JURISDICTION ISSUE PRESENTED STANDARDS OF APPELLATE REVIEW STATEMENT OF THE CASE I. II. THE DELAWARE ACTION. THE INSTANT BANKRUPTCY PROCEEDINGS.

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ARGUMENT I. THE UNDISPUTED FACTS, IN CONJUNCTION WITH THE FINDINGS OF THE DELAWARE COURT, ESTABLISH THAT DEBTOR IS A "FIDUCIARY" WITHIN THE MEANING OF SECTION 523(A)(4). A. A "Fiduciary" Capacity Includes Not Only A Formal Written Or Statutory Trust But Also Any Sufficiently Similar Trust-Like Relationship. 1. Not every relationship of trust amounts to a fiduciary relationship under Section 523(a)(4). What is meant by an "express" or "technical" trust? There is nothing controversial in concluding that a "fiduciary capacity" under Section 523(a)(4) includes trust-like duties.

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2. 3.

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B.

As A Director Of A Delaware Corporation, Debtor Owed Trust-Like Obligations To The Corporation's Shareholders.

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1.

Delaware law has historically imposed "trust-like" duties on its directors that are at least as demanding as those in Ninth Circuit cases holding debtors to be "fiduciaries." Debtor misconstrues Cantrell. Debtor is incorrect in suggesting that the Delaware Supreme Court's decision in Bovay silently overrules the earlier Bodell decision. Debtor misapprehends the analogy to Gheewalla. Debtor misconstrues Caremark, and the bankruptcy court's brief references to Caremark.

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2. 3.

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4. 5.

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C. CONCLUSION

There Is A Trust Res And A Beneficiary In This Case.

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Cases Arnold v. Soc'y for Sav. Bancorp, Inc., 678 A.2d 533 (Del. 1996) Beneficial Indus. Loan Corp. v. Smith, 170 F.2d 44 (3d Cir. 1948), aff'd, 337 U.S. 541 (1949) Bodell v. Gen. Gas & Elec. Corp., 132 A. 442 (Del. Ch. 1926) Bovay v. H.M. Byllesby & Co., 38 A.2d 808 (Del. 1944) Bowen v. Imperial Theaters, Inc., 115 A. 918 (Del. Ch. 1922) Carrasco v. Carrasco, 422 P.2d 411 (Ariz. Ct. App. 1967) Celotex Corp. v. Catrett, 477 U.S. 317 (1986) Chapman v. Forsyth, 43 U.S. 202 (1844) Davis v. Aetna Acceptance Co., 293 U.S. 328 (1934) DeSantis v. Dixon, 236 P.2d 38 (Ariz. 1951) Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., 817 A.2d 160 (Del. 2002) Grace v. Morgan, No. Civ. A 03C05260JEB, 2004 WL 26858 (Del. Super. Jan. 6, 2004) Guth v. Loft, Inc., 5 A.2d 503 (Del. Ch. 1939) Hynson v. Drummond Coal Co., 601 A.2d 570 (Del. Ch. 1991) In re Bennett, 989 F.2d 779 (5th Cir. 1993), amended, 1993 WL 268299 (9th Cir. July 15, 1993) In re Briles, 228 B.R. 462 (Bankr. S.D. Cal. 1998) In re Cantrell, 329 F.3d 1119 (9th Cir. 2003) In re Caremark Int'l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996) 19 20, 21 9, 10, 19, 20, 21 19, 20 17 14 5 12 12 14 20, 21 21 17, 18, 19 17 15 2 3, 10, 11, 18, 19 22, 23

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In re Colton, No. 05-56430-MM, 2007 WL 1615069 (Bankr. N.D. Cal. June 4, 2007) In re Cook, 263 B.R. 249 (Bankr. N.D. Iowa 2001) In re Dawley, 312 B.R. 765 (Bankr. E.D. Pa. 2004) In re Hammond, 98 F.2d 703 (2d Cir. 1938) In re Heilman, 241 B.R. 137 (Bankr. D. Md. 1999) In re Hemmeter, 242 F.3d 1186 (9th Cir. 1991) In re Jacks, 266 B.R. 728 (9th Cir. BAP 2001) In re Lewis, 97 F.3d 1182 (9th Cir. 1996)

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In re Moskowitz, 310 B.R. 21 (Bankr. E.D.N.Y. 2004) In re Niles, 106 F.3d 1456 (9th Cir. 1997) In re Nourbakhsh, 67 F.3d 798 (9th Cir. 1995) In re OneCast Media, Inc., 439 F.3d 558 (9th Cir. 2006) In re Pedrazzini, 644 F.2d 756 (9th Cir.1981) In re Sax, 106 B.R. 534 (Bankr. N.D. Ill. 1989) In re Shoe-Town, Inc. Stockholders Litig., No. C.A. No. 9483, 1990 WL 13475 (Del. Ch. Feb. 12, 1990) In re Short, 818 F.2d 693 (9th Cir. 1987) In re Snyder, 101 B.R. 822 (Bankr. D. Mass. 1989), aff'd in part & rev'd in part on other grounds sub nom. Bornstein v. Snyder, 923 F.2d 840 (1st Cir. 1990) In re Stanifer, 236 B.R. 709 (B.A.P. 9th Cir. 1999) In re Sullivan, 217 B.R. 670 (Bankr. D. Mass. 1998) In re Teichman, 774 F.2d 1395 (9th Cir. 1985) In re Zachary Shultz, 205 B.R. 952 (Bankr. D.N.M. 1997) Keenan v. Eshleman, 2 A.2d 904 (Del. 1938) Lawrence T. Lasagna, Inc. v. Foster, 609 F.2d 392 (9th Cir. 1979) -iv-

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Lofland v. Cahall, 118 A. 1 (Del. Ch. 1922) Meyer v. Rigdon, 36 F.3d 1375 (7th Cir. 1994) Morrison-Knudsen Co. v. CHG Int'l, Inc., 811 F.2d 1209 (9th Cir. 1987) N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92 (Del. 2007) Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2003) Petty v. Penntech Papers, Inc., 347 A.2d 140 (Del. Ch. 1975) Prestancia Mgmt. Group, Inc. v. Virginia Heritage Found., II LLC, No. Civ. A. 1032-S, 2005 WL 1364616 (Del. Ch. May 27, 2005) Price v. Wilmington Trust Co., No. Civ. A. No. 12476, 1996 WL 451318 (Del. Ch. Aug. 6, 1996), aff'd, 692 A.2d 416 (Del. 1997) Price v. Wilmington Trust Co., No. Civ. A. No. 12476, 1996 WL 560177 (Del. Ch. Sept. 3, 1996) Prof'l Hockey Corp. v. World Hockey Ass'n, 143 Cal. App. 3d 410 (1983) Ragsdale v. Haller, 780 F.2d 794 (9th Cir. 1986) Schoon v. Smith, No. 554, 2006, --A.2d--, 2008 WL 375826 (Del. Feb. 12, 2008) Shamrock Holdings, Inc. v. Polaroid Corp., 559 A.2d 257 (Del. Ch. 1989) Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985) Stegemeier v. Magness, 728 A.2d 557 (Del. 1999) Stone v. Ritter, 911 A.2d 362 (Del. 2006) United States v. Montoya, 45 F.3d 1286 (9th Cir. 1995) Vizcaino v. Microsoft Corp., 120 F.3d 1006 (9th Cir. 1997)

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Statutes 11 U.S.C. §523(a)(4) 28 U.S.C. §158(a)(1) §158(c)(1)(B) Fed. R. Civ. P. 54(b) 56(e)(2) Fed. R. Bankr. P. 7054(a) 7056 8001(e) 9021 Cal. Corp. Code §15021(1) (West 1977) (former section) 8 Del. Code §102(b)(7) Other Authorities 3 COLLIER ON BANKRUPTCY ¶523.14 (15th ed. 1996) 4 COLLIER ON BANKRUPTCY ¶523.10[1][d] (15th rev. ed. 2006) Volume B, COLLIER ON BANKRUPTCY App. 4(d) (15th rev. ed. 2006) Volume C, COLLIER ON BANKRUPTCY App. 4(d)(i) (15th rev. ed. 2006) 14 12 12 12 passim 5 4 4, 5 5 4 5 4 4 15 17

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INTRODUCTION Debtor and Appellant Hugo N. Bonilla ("Debtor") appeals from the bankruptcy court's partial summary judgment holding that a debt of approximately $24.5 million is nondischargeable because it is for "defalcation while acting in a fiduciary capacity." 11 U.S.C. §523(a)(4) ("Section 523(a)(4)"). That debt arises from a judgment of the

Delaware Court of Chancery, which was affirmed in its entirety by the Delaware Supreme Court, in favor of Appellees ATR-Kim Financial Corporation and ATR-Kim Eng Capital Partners, Inc. (collectively, "Appellees" or "ATR"). That judgment (the "Final Judgment") and the findings on which it is based are therefore issue preclusive in this adversary proceeding. In the words of the Chancery Court, Debtor "conscious[ly] disregard[ed]" his duties as a director of a Delaware corporation, PMHI Holdings Corp. (the "Delaware Holding Company"). ER Tab 1 Ex. A at *1, *19.1 The court found that Debtor did nothing to monitor, prevent or rectify the transfer by Carlos R. Araneta, the holder of 90% of the corporation's stock ("Araneta"), of virtually all of the corporation's valuable assets to his family members for no consideration, resulting in what Debtor describes on this appeal as the "de facto liquidation of the business." Appellant's Opening Brief ("AOB") at 4. In fact, Debtor helped to conceal if not implement that liquidation. ER Tab 1 Ex. A at *6, *8, *19-*21 & nn.28, 30. Because of the preclusive effect of the Delaware courts' determinations, there can no longer be any argument about these facts, or the scope of Debtor's duties as a director, or Debtor's conscious failure to perform any of the duties required of a director under Delaware corporate law. Although Debtor's opening brief quotes somewhat selectively from the facts determined by the Delaware courts, Debtor apparently does not dispute that the debt

The Appellant's Excerpts of Record ("ER") are not consecutively paginated and, rather than burden the Court with a duplicative set that is consecutively paginated, Appellees refer to the ER by tab number, followed by a page number and (when available) line numbers.

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resulted from "defalcation." See AOB at 2 (statement of issues on appeal).2 Debtor also concedes that, "as the director of a Delaware corporation, [D]ebtor owed fiduciary duties to the corporation's shareholders and to the corporation." AOB at 1. Those fiduciary duties run directly to Appellees, who held a 10% equity interest in the looted corporation. Debtor's sole argument on this appeal is that, despite his admission that he owed "fiduciary" duties to Appellees under Delaware law, he is not a "fiduciary" under Section 523(a)(4). See AOB at 2 (statement of issues on appeal) and passim. Even with respect to this legal issue, the parties appear to agree on the fundamental doctrinal basis by which courts should determine whether a debt is nondischargeable under Section 523(a)(4). The parties agree, for example, that not every "fiduciary" relationship is included within the meaning of Section 523(a)(4)'s exception of discharge of debts incurred as a result of "defalcation while acting in a fiduciary capacity." Neither constructive trusts nor broadly defined "fiduciary-type relationships" that are not "trust-like" are sufficient to invoke the penalties of nondischargeability of a debt. Rather, the duties imposed on the debtor by state law must arise from what the cases call an "express" or "technical" trust. Those cases require only, as the bankruptcy court correctly held, that (a) the debtor's duties must have been imposed before the occurrence of and without reference to the wrongdoing that caused the debt and (b) the duties, which are not limited to those imposed by a formal trust document or statute, must be "substantially similar" to such formal trust duties, meaning that there must be an identifiable trust res and identifiable beneficiaries, and the debtor must be subject to the duties of loyalty, good faith, and honesty in caring for the trust res. See ER Tab 7 at 2:10-19, 4:20-24. Debtor had exactly such duties under Delaware law.

"Defalcation is broadly defined to include any behavior by a fiduciary, including innocent, negligent, and intentional defaults of fiduciary duty resulting in failure to provide a complete accounting." In re Briles, 228 B.R. 462, 467 (Bankr. S.D. Cal. 1998).

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Debtor ascribes two alleged errors to this holding: he argues that the bankruptcy court, by misreading a Ninth Circuit case (Lewis) (AOB at 20-22), invented a new and unwarranted "substantially similar" test to determine whether an express or technical trust existed, and he claims that somehow the bankruptcy court should have applied another Ninth Circuit case interpreting California law (Cantrell) to hold that his duties under Delaware law do not amount to those of an "express" or "technical" trust (AOB at 13-20). Debtor completely misapprehends both the bankruptcy court's rulings and

binding authority in the Ninth Circuit and Delaware. As numerous courts, in the Ninth Circuit and throughout the country, have recognized, "express" or "technical" trusts include not only trusts that arise from a formal trust agreement or statute, but also from trust relationships under common law and "trustlike" relationships if they are substantially similar to more formal trusts. This is not a "new" test, departing from Ninth Circuit precedent (AOB at 1, 21)--to the contrary, several Ninth Circuit cases have used the phrases "similar," "substantially similar," or "trust-like" to describe the required duties, or have stated that the relationship must "exhibit characteristics of the traditional trust relationship." Moreover, the bankruptcy court correctly interpreted the Ninth Circuit cases in the only way that makes sense: since the Ninth Circuit has held more than once that partners, for example, can be "fiduciaries," despite the absence of any formal trust document or statutory trust, the only way to reconcile these holdings with the Ninth Circuit's references to "express" or "technical" trusts is to apply a functional test that looks to whether the debtor's duties at the time of the defalcation were trust-like or substantially similar to the duties of a trustee under a more formal trust. The alternative to this functional test would be, in the bankruptcy court's words, a "formalistic taxonomy." ER Tab 17 at 3:25-26. As for Debtor's actual duties under state law, he does not dispute that Delaware law applies, and yet somehow he believes it was error for the bankruptcy court not to have applied a Ninth Circuit case interpreting California law. In fact, Delaware law

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establishes both an actual trust relationship between corporate directors and shareholders and, alternatively, a trust-like relationship sufficient to create a "fiduciary" duty within the meaning of Section 523(a)(4). In particular, there is no question that Debtor had fiduciary duties at the most basic level to protect minority shareholders from the de facto liquidation of the business and the transfer of its assets to the majority shareholder's family without consideration. For all of these reasons, the duties imposed on Debtor as a director under Delaware law are those of a "fiduciary." Having committed defalcation while acting as a fiduciary, Debtor's debt to ATR is nondischargeable. STATEMENT OF THE BASIS FOR APPELLATE JURISDICTION On January 2, 2008, the bankruptcy court, Hon. Thomas E. Carlson presiding, entered its Partial Summary Judgment on Fourth Cause of Action and Rule 54(b) Certification (the "Rule 54(b) Judgment"). See Fed. R. Civ. P. 54(b); Fed. R. Bankr. P. 7054(a). Debtor timely filed a notice of appeal on January 9, 2008.3 On January 29, 2008, Appellees filed a timely Statement of Election to Have Appeal Heard by the District Court. See Fed. R. Bankr. P. 8001(e); 28 U.S.C. §158(c)(1)(B). On March 5, 2008, this Court issued an order denying Debtor's request to certify this appeal directly to

That notice of appeal actually refers to the "decision" of the bankruptcy court (a) denying Debtor's motion to reconsider denial of his motion to dismiss and (b) granting Appellees' motion for partial summary judgment. ER Tab 20 at 1:24-28. This is technically incorrect, because (a) one appeals from a judgment, not a "decision" (Fed. R. Bankr. P. 9021), (b) the only certification under Rule 54(b) was as to the partial summary judgment (not the denial of Debtor's motion to reconsider his motion to dismiss) and (c) a denial of a motion to dismiss is not a final, appealable judgment. Morrison-Knudsen Co. v. CHG Int'l, Inc., 811 F.2d 1209, 1214 (9th Cir. 1987). Appellees believe that Debtor intended to appeal solely from the Rule 54(b) Judgment (among other things, Debtor's opening brief on this appeal only sets forth the standard of appellate review of an order granting summary judgment). See AOB at 3. Cf. In re OneCast Media, Inc., 439 F.3d 558, 561 (9th Cir. 2006) (standard of review for denial of a motion for reconsideration is "abuse of discretion"). Accordingly, this brief addresses the Rule 54(b) Judgment and does not separately address the bankruptcy court's decision to deny Debtor's motion for reconsideration. If this Court is inclined to believe for any reason that the bankruptcy court's "decision" regarding the motion for reconsideration is either a final judgment or an interlocutory judgment as to which review is proper, then Appellees would respectfully request an opportunity to brief the issue.

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the Ninth Circuit.4 This Court has jurisdiction to hear the appeal from the Rule 54(b) Judgment under 28 U.S.C. §158(a)(1) because that judgment is final, by virtue of the certification under Rule 54(b). ISSUE PRESENTED Does a director of a Delaware corporation, who is found to have "consciously" disregarded his fiduciary duties under Delaware law and who thereby facilitates the transfer of the corporation's assets to third parties for no consideration at the expense of the minority shareholder, commit a defalcation while acting in a "fiduciary" capacity within the meaning of 11 U.S.C. §523(a)(4)? STANDARDS OF APPELLATE REVIEW Appellees agree with Debtor that the standard of review is de novo, and therefore this District Court applies the same legal standards that controlled the bankruptcy court. In re Nourbakhsh, 67 F.3d 798, 800 (9th Cir. 1995). This Court must therefore

determine, viewing the evidence in the light most favorable to the party opposing summary judgment, whether there are any genuine issues of material fact and whether the bankruptcy court correctly applied the relevant substantive law. Once the moving party meets that initial burden, the burden shifts to the party opposing summary judgment to come forth with specific evidence to show that a genuine issue of material fact exists. Fed. R. Civ. P. 56(e)(2) (incorporated by Fed. R. Bankr. P. 7056); Celotex Corp. v. Catrett, 477 U.S. 317, 323-25 (1986). Debtor has presented no such evidence.

Debtor's opening brief states his view that it would have been more appropriate to have this appeal heard by the Bankruptcy Appellate Panel ("BAP") than this Court, because of the former's "extensive familiarity with dischargeability issues." AOB at 2. Appellees believe that this Court is well equipped to assess questions of Delaware law, which are at the heart of this appeal (see Ex. A hereto at 1:21-24) and is both familiar with and fully capable of addressing dischargeability issues that are related thereto.

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STATEMENT OF THE CASE I. THE DELAWARE ACTION. The Delaware Chancery Court's findings are issue preclusive in this adversary proceeding, as the bankruptcy court held. ER Tab 17 at 4:9-5:4. Debtor did not

challenge that holding in his AOB, or his Statement of Issues on Appeal (see Ex. B hereto), so that issue is not before this Court. In any event, the bankruptcy court is correct. See In re Zachary Shultz, 205 B.R. 952, 955 (Bankr. D.N.M. 1997); In re Dawley, 312 B.R. 765, 776 (Bankr. E.D. Pa. 2004). On June 3, 2004, ATR commenced an action in the Delaware Chancery Court against Debtor, Araneta and Berenguer--the directors of the Delaware Holding Company--entitled ATR-Kim Eng Financial Corp., et al. v. Carlos R. Araneta, Hugo Bonilla, et al., C.A. No. 489-N (Del. Ch. 2006). ER Tab 1 Ex. A at *7. ATR asserted claims for damages against these directors for breaches of their fiduciary duty to ATR. After a trial of that action, the Delaware Chancery Court issued a lengthy Memorandum Opinion articulating its findings of fact and conclusions of law. ER Tab 1 Ex. A.5 As further detailed therein, Araneta "breached his duty of loyalty by

impoverishing the Delaware Holding Company for his own personal enrichment" and Debtor and Berenguer also breached their fiduciary duties to ATR because of their complicity in Araneta's misfeasance: "Having assumed the important fiduciary duties that come with a directorship in a Delaware corporation, [Debtor] Bonilla and Berenguer acted as--no other word captures it so accurately--stooges for Araneta, seeking to please him and only him, and having no regard for their obligations to act loyally towards the corporation and all of its stockholders." Id. at *1. Although Debtor makes some effort to characterize his involvement in the looting

This Section is based entirely on the comprehensive findings of the Delaware Chancery Court in that Memorandum Opinion. In the interests of expedition, those findings will not be repeated here in as much detail as in the excerpts of record. See, e.g., ER Tab 4 at 3:21-8:18.

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of the assets of the Delaware Holding Company as more "passive" and less blameworthy than that of Araneta (AOB at 4-6), the record of Debtor's malfeasance and the conscious disregard of his duties is extensive. Among other things, the Delaware Chancery Court found that Debtor was a director of the Delaware Holding Company at all relevant times (ER Tab 1 Ex. A at *9), that "[o]ne cannot accept the important role of director in a Delaware corporation and thereafter consciously avoid any attempt to carry out one's duties" (id. at *19), that "[o]ne of the most important duties of a corporate director is to monitor the potential that others within the organization will violate their duties," but that Debtor and Berenguer never "considered, let alone implemented," any monitoring system to detect such violations (id. at *19-*20). The Delaware court further found as follows: [B]oth Berenguer and [Debtor] Bonilla testified that they entirely deferred to Araneta in matters relating to the Delaware Holding Company. . . . Bonilla . . . explain[ed] that to him Araneta and the Delaware Holding Company were basically one and the same and that he took the word of Araneta as being the word of the company. [Citation.] Moreover, when pressed regarding whether he would undertake an independent inquiry if told to act by Araneta, Bonilla responded, "Why should I ask him all these questions? He's telling me they have already agreed . . . . It's not like I'm going to go out there and check on him, doesn't make sense." [Citation] . . . . Put in plain terms, it is no safe harbor to claim that one was a paid stooge for a controlling stockholder. Berenguer and Bonilla voluntarily assumed the fiduciary roles of directors of the Delaware Holding Company. For them to say that they never bothered to check whether the Delaware Holding Company retained its primary assets and never took any steps to recover the LBC Operating Companies once they realized that those assets were gone is not a defense. To the contrary, it is a confession that they consciously abandoned any attempt to perform their duties independently and impartially, as they were required to do by law. Their behavior was not the product of a lapse in attention or judgment; it was the product of a willingness to serve the needs of their employer, Araneta, even when that meant intentionally abandoning the important obligations they had taken on to the Delaware Holding Company and its minority stockholder, ATR. (ER Tab 1 Ex. A at *20-*21 (footnote omitted)) Debtor also helped to conceal Araneta's and his own wrongdoing. When ATR, "[s]tarved for information," brought an action seeking to compel disclosures, Araneta told Debtor, "Don't mind it," and instructed him "not to provide the requested information." ER Tab 1 Ex. A at *6 & n.28. No information was provided until ATR

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obtained a court order requiring disclosure of corporate records, and only after ATR deposed Debtor were the most damning documents turned over. ER Tab 1 Ex. A at *6. The Delaware Chancery Court's Final Judgment (ER Tab 1 Ex. B) held Debtor, Araneta and Berenguer jointly and severally liable for damages to ATR in the amount of $24,490,422.50, plus post-judgment interest accruing at a rate of 11.25 percent per annum. Id. at 1-2. That judgment is now final for all purposes.6 II. THE INSTANT BANKRUPTCY PROCEEDINGS. On March 16, 2007, Debtor filed his voluntary Chapter 7 petition. ATR timely filed this adversary proceeding and in the Fourth Claim for Relief, the subject of this appeal, ATR seeks a determination that the debt arising from the Delaware court's Final Judgment is nondischargeable because it arises from "fraud or defalcation while acting in a fiduciary capacity," under Section 523(a)(4).7 ER Tab 1 at 13 ¶76. On August 31, 2007, Debtor filed a motion to dismiss this claim, arguing that there is no basis to find Debtor a fiduciary under that statute. After briefing and a regularly noticed hearing, the bankruptcy court issued a memorandum decision denying that motion (ER Tab 7) and finding that Debtor, when acting in his capacity as a director of a Delaware corporation, was a fiduciary within the meaning of Section 523(a)(4). The court noted that "[w]hether a debtor is a fiduciary within the meaning of Section 523(a)(4) is a question of federal law," which requires that: (a) the debtor must have been subject to the duties of a trustee before, and without reference to, the wrongdoing that gave rise to the debt and (b) the duties imposed on the debtor must be those imposed on the trustee of an express or technical trust. Thus, there must be an
6

The Delaware Supreme Court affirmed the Final Judgment in a two-page summary decision "on the basis of and for the reasons assigned by the Court of Chancery in its [Memorandum Opinion] decision dated December 21, 2006." ER Tab 1 Ex. C. at 1-2. On January 29, 2007, ATR entered the Final Judgment of the Delaware Chancery Court in California in Alameda County Superior Court, as a sister-state judgment. See ER Tab 10 Ex. 4. 7 The Complaint in this adversary proceeding also seeks a declaration that Debtor is not entitled to a discharge, in three additional claims. ER Tab 1.

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identifiable trust res, identifiable beneficiaries and the debtor must be subject to the duties of loyalty, good faith and honesty in caring for the trust res. ER Tab 7 at 2:10-22. The court then stated that "[w]hether a debtor is subject to the duties just described is primarily a matter of state law" and the requisite duties can be imposed by agreement, state statute, or state case law. Id. at 2:23-3:2. The court concluded that numerous Delaware decisions refer to directors as trustees, and impose on directors the highest duties of loyalty, honesty and fair dealing in all matters concerning the management of corporate assets. Id. at 3:3-8. Furthermore, Delaware cases impose this fiduciary duty prior to, and without reference to, any misconduct by the director. The court quoted from the opinion in Bodell v. General Gas & Electric Corp., 132 A. 442, 447 (Del. Ch. 1926), as follows. It is not always necessary for [directors] to reap a personal profit or gain a personal advantage in order for their actions in performance of their quasi trust to be successfully questioned. Trustees owe not alone the duty to refrain from profiting themselves at the expense of their beneficiaries. They owe the duty of saving their beneficiaries from loss. (ER Tab 7 at 3:10-13 (quoting Bodell)) Noting that Delaware court decisions do not, however, equate corporate directors with trustees in all respects, and that the courts refer to directors as "trustees," "quasitrustees" or as not "trustees in every sense," the court (ER Tab 7 at 3:18-4:19) posed the question whether "in addition to preexisting the wrong, the fiduciary duty must be identical to that of a trustee in every technical respect?" Id. at 4:18-19. The court answered this question in the negative: I conclude that the fiduciary duty must preexist the trust, and must be substantially similar to the role of a trustee, in that there must be a trust res, identifiable beneficiaries, and clear notice of the duties of loyalty, honesty, and fair dealing toward the beneficiaries in all matters affecting the trust res. In [In re] Lewis, [97 F.3d 1182, 1185 (9th Cir. 1996)] the Ninth Circuit found partners to be fiduciaries under section 523(a)(4) upon the basis of state-court decisions that imposed on partners the duties of loyalty, honesty, and fair dealing. One of the decisions Lewis relied upon described the duties of a partner as merely "similar to a trustee's," and the other decisions cited failed to use the term trustee at all in describing the duties of a partner. In addition, Lewis noted with approval language in Collier stating that the duties of the fiduciary need only be "substantially similar" to those imposed on trustees. [Quotation omitted.]

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As noted above, the director of a corporation organized under Delaware law is subject to duties substantially similar to those imposed on the trustee of an express or technical trust, and those duties arise before and without reference to any wrongdoing. The director of a Delaware corporation is therefore a fiduciary within the meaning of section 523(a)(4). (ER Tab 7 at 4:20-5:7 (footnote and citations omitted; emphasis added)) Debtor filed a motion for reconsideration of the court's ruling on his motion to dismiss. ER Tab 8. ATR filed a motion for summary judgment based on the court's ruling that Debtor is a fiduciary within the meaning of Section 523(a)(4). These two motions were heard together and on December 17, 2007, the bankruptcy court issued a Memorandum Re Defendant's Motion For Reconsideration And Plaintiffs' Motion For Summary Judgment. ER Tab 17. That Memorandum states in part: Defendant first argues that this court did not give proper deference to the decision of the Ninth Circuit in Cal-Micro, Inc., v. Cantrell (In re Cantrell), 329 F.3d 1119 (9th Cir. 2003). Because Cantrell relied upon a California Supreme Court decision stating that a corporate officer is an agent rather than a trustee under California law, I find Cantrell to be of little relevance to the present case involving a Delaware director. Defendant next argues that the decisions of the Delaware Supreme Court imposing trustee-like duties on corporate directors are inapposite because they involved instances in which the corporation was insolvent or the director improperly benefited from the act in question. This argument is unpersuasive for two reasons. First, Defendant cites no Delaware decision holding that a corporate director has trustee-like duties only where the corporation is insolvent or the director benefits. At the same time, a decision of the Delaware Chancery Court imposed trustee-like duties on corporate directors where there was no showing of insolvency or improper benefit. Bodell v. General Gas & Electric Corp., 132 A. 442, 447 (Del. Ch. 1926). Second, a recent decision of the Delaware Supreme Court holds that the fiduciary duties owed shareholders are the same as those owed creditors upon insolvency. It is well settled that directors owe fiduciary duties to the corporation. When a corporation is solvent, those duties may be enforced by its shareholders, who have standing to bring derivative actions on behalf of the corporation because they are the ultimate beneficiaries of the corporation's growth and increased value. When a corporation is insolvent, however, its creditors take the place of the shareholders as the residual beneficiaries of any increase in value. * * *

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N. Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92, 101-02 (Del. 2007) (emphasis and quotations in original) (footnotes omitted). In this context, the Delaware decisions holding that directors become trustees for creditors upon insolvency become direct support for the conclusion that directors are trustee[s] for shareholders while the corporation is solvent. Defendant argues finally that this court erred in relying upon the "substantially similar" test stated in Lewis v. Scott (In re Lewis), 97 F.3d 1182 (9th Cir. 1996), asserting that Lewis is an "anomaly" among Ninth Circuit decisions otherwise interpreting section 523(a)(4) very narrowly. This court is persuaded that the functional approach of Lewis is sound. Reliance on formalistic taxonomy has lead the Ninth Circuit to the somewhat curious conclusion that a director of a California 1 corporation is a fiduciary for creditors when the corporation is insolvent, but is not a fiduciary for the director's 2 prime constituents, shareholders, when the corporation is not insolvent. North American Catholic [Gheewalla], decided by the court most widely recognized for its expertise in corporate governance, suggests that a functional, interest-based approach is appropriate for any analysis of the fiduciary duties of a director under Delaware law.
1

Lawrence T. Lasagna, Inc. v. Foster, 609 F.2d 392, 396 (9th Cir. 1979) (director of insolvent corporation organized under California law is fiduciary for purposes of section 35(a)(4), predecessor to section 523(a)(4)); Nahman v. Jacks (In re Jacks), 266 B.R. 728, 737 (9th Cir. BAP 2001).

Cantrell, 329 F.3d at 1127. (ER Tab 17 at 2:5-4:7 (emphases in original)) Having found that Debtor is a "fiduciary" as a matter of law, the Court then ruled that the remaining question is whether his wrongful acts as found by the Delaware Chancery Court amount to a "defalcation." The bankruptcy court ruled that they do, because Debtor, "while acting in a fiduciary capacity," was "unable to account for property placed under his charge, and the property was lost due to [his] failure to follow instructions imposed upon him by law regarding the protection of that property." ER Tab 17 at 4:22-5:4 (citing In re Niles, 106 F.3d 1456, 1460-62 (9th Cir. 1997)). ARGUMENT I. THE UNDISPUTED FACTS, IN CONJUNCTION WITH THE FINDINGS OF THE DELAWARE COURT, ESTABLISH THAT DEBTOR IS A "FIDUCIARY" WITHIN THE MEANING OF SECTION 523(a)(4). Debtor argues that by requiring that the duties of a Delaware corporate director be merely "substantially similar" to those of a trustee, the bankruptcy court fashioned an entirely new test, and departed from governing law in the Ninth Circuit. Debtor also -11-

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contends that there was no pre-existing "trust" relationship between the Debtor and ATR of the type required by Section 523(a)(4). Debtor is wrong on both counts. A. A "Fiduciary" Capacity Includes Not Only A Formal Written Or Statutory Trust But Also Any Sufficiently Similar Trust-Like Relationship. Whether a

The Bankruptcy Code does not define the word "fiduciary."8

relationship is a "fiduciary" one within the meaning of Section 523(a)(4) is a question of federal law, but that determination relies upon whether the requisite trust relationship exists under state law. Ragsdale v. Haller, 780 F.2d 794, 795 (9th Cir. 1986). 1. Not every relationship of trust amounts to a fiduciary relationship under Section 523(a)(4).

In a seminal case the Supreme Court held that "a factor, who retains the money of his principal," is not a "fiduciary" because "[i]f the act embrace such a debt, it will be difficult to limit its application," and although commercial transactions involve an element of trust, the word "fiduciary" must be construed to speak of "technical trusts" not "those which the law implies . . . ." Chapman v. Forsyth, 43 U.S. 202, 208 (1844). Similarly, Congress cannot have meant to include constructive trusts and other remedies ex maleficio9 to come within the word "fiduciary," because that would also elevate ordinary debts to the status of nondischargeable debts: It is not enough that, by the very act of wrongdoing out of which the contested debt arose, the bankrupt has become chargeable as a trustee ex maleficio. He must have been a trustee before the wrong and without reference thereto. (Davis v. Aetna Acceptance Co., 293 U.S. 328, 333 (1934) (construing predecessor to Section 523(a)(4)))
Debtor argues, quoting legislative history, that Congress' intent was to "include in the category of non-dischargeable debts a conversion under which the debtor willfully and maliciously intends to borrow property for a short period of time . . . ." AOB at 12 (quoting H.R. Rep. No. 595, 95th Cong., 1st Sess., at 364) (reprinted in Volume C, COLLIER ON BANKRUPTCY, App. 4(d)(i), at 4-1501 (15th rev. ed. 2006)). That legislative history relates to the superseded House of Representatives version of the bill, which only excepted debts for "embezzlement or larceny." See 4 COLLIER ¶523.10[1][d] n.6 (quoting House bill H.R. 8200, reprinted in Volume B, COLLIER App. 4(d), at 4-928). The final version of Section 523(a)(4) includes debts for "defalcation while acting in a fiduciary capacity," which is the clause at issue on this appeal. 9 Ex maleficio means, literally, "after the wrongdoing," as opposed to duties imposed before the wrongdoing and without reference thereto. See Lewis, 97 F.3d at 1185.
8

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Following these Supreme Court precedents, the lower courts have had to determine which relationships of trust and fidelity amount to "fiduciary" relationships for nondischargeability purposes. The typical terminology is stated by the Ninth Circuit: The broad, general definition of "fiduciary" is inapplicable in the dischargeability context. Instead, the fiduciary relationship must be one arising from an express or technical trust that was imposed before and without reference to the wrongdoing that caused the debt. (Lewis, 97 F.3d at 1185 (citation omitted; emphasis added)) 2. What is meant by an "express" or "technical" trust?

Numerous opinions issued by the Ninth Circuit (not just Lewis) construe the requirement of an "express" or "technical" trust to require only the exclusion of constructive trusts and other trusts ex maleficio, and not to require a formal trust document or statutory trust. See, e.g., In re Hemmeter, 242 F.3d 1186, 1189-90 (9th Cir. 1991); Lewis, 97 F.3d at 1185; Ragsdale, 780 F.2d at 796. For this reason, many Ninth Circuit cases refer to "trust-like" obligations (In re Teichman, 774 F.2d 1395, 1399 (9th Cir. 1985)), relationships that exhibit "characteristics of the traditional trust relationship" (Hemmeter, 242 F.3d at 1189-90 (quoting In re Pedrazzini, 644 F.2d 756, 758 (9th Cir. 1981) (emphasis added)), and relationships that are "similar" or "substantially similar" to more formal trusts (Lewis, 97 F.3d at 1186 & n.1 (citations omitted)). In Lewis, for example, the Ninth Circuit begins the analysis by restating the "express" or "technical" trust requirement but interprets these words essentially to mean ("[i]n other words") the requirement that the fiduciary duties must arise "before and without reference to" the wrongdoing at issue (as opposed to trust duties ex maleficio): [T]he fiduciary relationship must be one arising from an express or technical trust that was imposed before and without reference to the wrongdoing that caused the debt. In other words, It is not enough that by the very act of wrongdoing out of which the contested debt arose, the bankrupt has become chargeable as a trustee ex maleficio. He must have been a trustee before the wrong and without reference thereto. (Lewis, 97 F.3d at 1185 (summarizing Ragsdale and Davis; citations omitted; emphasis added))

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Lewis then holds that a partner under Arizona law is such a "trustee," not because they are formal trustees but because Arizona cases use "similar" language to the California case law in describing the actual duties between partners: Arizona case law employs similar language [to the California cases] in describing the duties owed between partners. For instance, the Arizona Supreme Court has stated: "The relation of partnership is fiduciary in character, and imposes upon the members of the firm the obligation of the utmost good faith in their dealings with one another with respect to partnership affairs, of acting for the common benefit of all the partners in all transactions relating to the firm business, and of refraining from taking any advantage of one another by the slightest misrepresentation, concealment, threat or adverse pressure of any kind." DeSantis v. Dixon, 72 Ariz. 345, 236 P.2d 38, 41 (1951) (quoting 68 C.J.S., Partnership, §76). (Lewis, 97 F.3d at 1186 (emphasis added)) What is "similar" about Arizona and California case law, as summarized in Lewis, is not the use of the word "trustee" but the actual duties imposed on partners. In fact, the word "trustee" appears only once in Lewis' summary of Arizona case law: in a quotation stating that a partner's position is "similar to a trustee's." Lewis, 97 F.3d at 1186 (quoting Carrasco v. Carrasco, 422 P.2d 411, 413 (Ariz. Ct. App. 1967) (emphasis added)). In addition, as the bankruptcy court observed, Lewis notes with approval

language in Collier stating that the duties of the fiduciary need only be "substantially similar" to those imposed on trustees. Lewis, 97 F.3d at 1186 n.1 (quoting then-current language in 3 Collier on Bankruptcy ¶523.14 n.8 (15th ed. 1996)). Debtor attempts to characterize Lewis as an aberration, but the above-quoted Ninth Circuit decisions show that it is simply one of numerous consistent decisions that speak of "trust-like" obligations and duties "substantially similar" to or "characteristic[]" of a "traditional trust relationship." Hemmeter, 242 F.3d at 1190; Pedrazzini, 644 F.2d at 758; Teichman, 774 F.2d at 1399; Lewis, 97 F.3d at 1185-86. Debtor relies on Ragsdale (AOB at 20-22) but that case is entirely consistent with the above analysis. The Ninth Circuit in Ragsdale initially refers to an "express" or

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"technical" trust but immediately clarifies that the point of these requirements is to eliminate trusts ex maleficio (Ragsdale, 780 F.2d at 796), and the remainder of the decision takes a functional approach. First, Ragsdale holds that partners are not

fiduciaries under California statutory law, even though the California statute at issue specifically uses the word "trustee"--which shows that Ragsdale goes beyond the mere taxonomy of looking to whether or not state law uses the word "trustee."10 Second, Ragsdale examines the duties of partners under California case law before concluding that they are fiduciaries under Section 523(a)(4). Id. at 796-97. The Ninth Circuit's approach is well summarized by the BAP: The "technical" or "express" trust requirement includes relationships in which trust-type obligations are imposed pursuant to statute or common law. Accordingly, state statutes and case law are examined to determine whether they impose traditional trust-like relationships prior to and without reference to the wrong which created the debt. (In re Stanifer, 236 B.R. 709, 714 (B.A.P. 9th Cir. 1999) (citations omitted; emphasis added)) 3. There is nothing controversial in concluding that a "fiduciary capacity" under Section 523(a)(4) includes trust-like duties.

First, if Congress had intended to restrict a "fiduciary" to persons acting as a trustee under a formal trust document or statutory trust it could have said so. It did not. Second, the Ninth Circuit's functional approach is the majority view: Most courts today . . . recognize that the "technical" or "express" trust requirement is not limited to trusts that arise by virtue of a formal trust agreement, but includes relationships in which trust-type obligations are imposed pursuant to statute or common law. (In re Bennett, 989 F.2d 779, 784-85 (5th Cir. 1993), amended on other grounds, 1993 WL 268299 (9th Cir. July 15, 1993) (citing Ninth Circuit and other cases)11)
The statute at issue in Ragsdale provided at that time: Every partner must account to the partnership for any benefit, and hold as trustee for it any profits derived by him without the consent of the other partners from any transaction connected with the formation, conduct, or liquidation of the partnership or from any use by him of its property. (Cal. Corp. Code §15021(1) (West 1977) (as quoted in Ragsdale, 780 F.2d at 796)) 11 See also, e.g., In re Colton, No. 05-56430-MM, 2007 WL 1615069, at *3 (Bankr. N.D. Cal. June 4, 2007) ("in some instances, a state statute or common law doctrine may impose trustlike obligations that are sufficient to satisfy the requirements of an express trust") (emphasis (continued . . . )
10

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The bankruptcy court aptly summarized the requirements for establishing a "fiduciary" duty under Section 523(a)(4): I conclude that the fiduciary duty must preexist the trust, and must be substantially similar to the role of a trustee, in that there must be a res, identifiable beneficiaries, and clear notice of the duties of loyalty, honesty, and fair dealing toward the beneficiaries in all matters affecting the trust res. (ER Tab 7 at 4:20-24 (emphasis in original)) In light of the longstanding practice in the Ninth Circuit and elsewhere to apply this functional test, Debtor's assertion that the bankruptcy court erred by creating a wholly "new" test for trust relationships (AOB at 1, 21) clearly has no merit. B. As A Director Of A Delaware Corporation, Debtor Owed Trust-Like Obligations To The Corporation's Shareholders.

Having determined that the existence of an express or technical trust could be established by relevant (in this case, Delaware) case law, the bankruptcy court then correctly held, as discussed below, that the duties of a director under Delaware law are indeed "substantially similar" to the role of a formal trustee, that there is a trust res (the corporation's assets) and that Debtor had clear notice of his duties of loyalty, honesty and fair dealing towards the stockholders. ER Tab 7, 17, 22 at 7:3-8, 9:1-10:20. 1. Delaware law has historically imposed "trust-like" duties on its directors that are at least as demanding as those in Ninth Circuit cases holding debtors to be "fiduciaries."

A fundamental principle of Delaware law is "that directors are responsible for managing the business and affairs of a Delaware corporation and, in exercising that responsibility, they are charged with an unyielding fiduciary duty to the corporation and its shareholders." Shamrock Holdings, Inc. v. Polaroid Corp., 559 A.2d 257, 269 (Del.

( . . . continued) added); In re Moskowitz, 310 B.R. 21, 30 (Bankr. E.D.N.Y. 2004) ("Technical or express trusts include relationships where trust-type obligations are imposed pursuant to statute or common law"); In re Cook, 263 B.R. 249, 255 (Bankr. N.D. Iowa 2001) ("[t]he `technical' or `express' trust requirement is not limited to trusts that arise by virtue of a formal trust agreement, but includes relationships in which trust-type obligations are imposed pursuant to statute or common law"); In re Sullivan, 217 B.R. 670, 675 (Bankr. D. Mass. 1998) ("A technical trust is a trust that is imposed by law and may arise either by statute or common law").

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Ch. 1989) (internal quotations omitted).12 That "unyielding fiduciary duty" includes the subsidiary duties of care, loyalty and good faith (Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006)) and grows directly from the experience of Delaware courts interpreting the law of trusts. "[T]he fiduciary duty of corporate directors is a court created duty that historically springs from equity's experience with trusts and trustees." Hynson v. Drummond Coal Co., 601 A.2d 570, 575 (Del. Ch. 1991); see also In re Zachary Shultz, 205 B.R. 952, 958 (Bankr. D.N.M. 1997) ("Delaware courts have held corporate directors to high fiduciary standards and have even described the fiduciary obligation in terms of a trust"). Indeed, directors are often referred to as "trustees" by Delaware courts. See, e.g., Keenan v. Eshleman, 2 A.2d 904, 908 (Del. 1938) ("As directors, they [the defendants therein] were trustees for the stockholders, and the utmost good faith and fair dealing was exacted of them"). Even if directors are not trustees in every respect,13 the courts of that state have long analogized directors' obligations to those of trustees: Clearly directors of a corporation stand in a position of trustees with the stockholders, Lofland v. Cahall, 13 Del.Ch. 384, 118 A. 1 (1922); Bowen v. Imperial Theaters, Inc., . . . 13 Del.Ch. 120, 115 A. 918 (1922), and the utmost good faith and fair dealing are required of them, especially where their individual interests are concerned. (Petty v. Penntech Papers, Inc., 347 A.2d 140, 143 (Del. Ch. 1975) (emphasis added))
See also Smith v. Van Gorkom, 488 A.2d 858, 872 (Del. 1985); Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914, 938 (Del. 2003) ("The fiduciary duties of a director are unremitting"); Guth v. Loft, Inc., 5 A.2d 503, 510 (Del. Ch. 1939) (director's duties include the "most scrupulous observance of his duty" to "protect the interests of the corporation committed to his charge"). A Delaware director's fiduciary duties are also recognized by the statutes of that state. See, e.g., 8 Del. Code §102(b)(7) (a certificate of incorporation may contain "[a] provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director . . .") (emphasis added). 13 For example, for purposes of self-dealing (which is not an issue as to the Debtor in this case), Delaware law has different standards for corporate directors and trustees. See Stegemeier v. Magness, 728 A.2d 557, 562 (Del. 1999) (directors are not "equated" with trustees for purposes of self-dealing and can engage in self-dealing if their actions are approved by the board or shareholders). Similarly, courts have held that the relationship between a corporate director and a shareholder is not as "thoroughly rooted" in the concepts of reliance and trust as a pure trustor-trustee relationship might be. Price v. Wilmington Trust Co., No. Civ. A. No. 12476, 1996 WL 451318, at *4 (Del. Ch. Aug. 6, 1996), aff'd, 692 A.2d 416 (Del. 1997); see also Price v. Wilmington Trust Co., No. Civ. A. No. 12476, 1996 WL 560177, at *2 (Del. Ch. Sept. 3, 1996) (noting that directors and trustees are different in the degree of trust that the law requires).
12

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Thus, the "unyielding" fiduciary duties that a director of a Delaware corporation owes to the corporation and its shareholders are exactly the kind of "trust-like" obligations that courts rely upon in applying Section 523(a)(4). Indeed, it is hard to imagine a meaningful difference between the obligations imposed on the business partner in Lewis--e.g., acting in the "the utmost good faith" toward each other (Lewis, 97 F.3d at 1186)--and those that are imposed on corporate directors under Delaware case law. See Guth, 5 A.2d at 510 (requiring "the most scrupulous observance of his duty, not only affirmatively to protect the interests of the corporation committed to his charge, but also to refrain from doing anything that would work injury to the corporation"). In both cases, the applicable case law recognized a heightened responsibility, analogous to the law of trusts, that governs the actor's conduct. 2. Debtor misconstrues Cantrell.

Debtor asserts that the bankruptcy court erred by not "following" the Ninth Circuit's opinion in Cantrell. Debtor argues that because the corporate officer therein was found not to be a "trustee" for the corporation's shareholders under California law, therefore a director of a Delaware corporation (like Debtor) cannot be a trustee under Delaware law. But Cantrell is entirely inapposite to the questions before this Court. The Ninth Circuit in Cantrell concluded that it was compelled to follow "the California Supreme Court's unambiguous holding in Bainbridge that directors and officers are not trustees with respect to corporate assets." Cantrell, 329 F.3d at 1126 n.4 (emphasis added). Cantrell also held that California directors are not fiduciaries because their obligations arise out of the law of agency and the corporate assets are not held in trust (or at least, a "statutory" trust, which was the only sort of trust that the plaintiff therein apparently relied upon).14
Cantrell, 329 F.3d at 1125-26 ("while not arguing that an express trust existed between it and Cantrell, Cal-Micro [the party seeking nondischargeability] does claim that under California law a corporate officer is a statutory trustee with respect to corporate assets" and "Cal-Micro cites to several California cases that have held that a corporate officer is a fiduciary of the (continued . . . )
14

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Delaware courts, by contrast, have explicitly rejected the notion that corporate directors are agents of the corporation,15 and numerous Delaware courts have held that corporate assets are held in trust or quasi-trust and that directors can be trustees or quasitrustees. Nothing in Cantrell is contrary to the bankruptcy court's analysis.16 3. Debtor is incorrect in suggesting that the Delaware Supreme Court's decision in Bovay silently overrules the earlier Bodell decision.

Debtor also ascribes "error" to the bankruptcy court's reliance on Bodell, 132 A. 442, 447, as authority for the proposition that Delaware law imposes "trust-like duties" on corporate directors, rather than on the later-decided Delaware Supreme Court which stated that directors of Delaware corporations are not trustees in "all" of their relations with shareholders. Bovay v. H.M. Byllesby & Co., 38 A.2d 808, 813 (Del. 1944).

( . . . continued) corporation. But these cases merely specify that officers owe fiduciary duties in their capacity as agents of a corporation; they fail to hold that officers are trustees of a statutory trust with respect to corporate assets") (emphasis added; citations omitted). 15 See Arnold v. Soc'y for Sav. Bancorp, Inc., 678 A.2d 533, 539-40 (Del. 1996) ("Directors . . . do not act as agents of the corporation . . . . A board of directors, in fulfilling its fiduciary duty, controls the corporation, not vice versa) (citations and footnote omitted); accord Zachary Shultz, 205 B.R. at 959 (holding that "it would be an analytical anomaly to treat corporate directors as agents of the corporation [under Delaware law] when they are acting as fiduciaries of the stockholders in managing the business and affairs of the corporation"). This facet of Delaware law also has been recognized by the Ninth Circuit. See Vizcaino v. Microsoft Corp., 120 F.3d 1006, 1021 (9th Cir. 1997) ("Under Delaware's corporations law, however, the board of directors directs the affairs of the business but is not an agent of the corporation"). 16 This Court should also reject Debtor's invitation to conclude that because (a) Cantrell held that directors of California corporations are not trustees, and (b) some California cases have stated that some of the fiduciary duties imposed on directors of Delaware corporations are similar to the duties of directors of California corporations (e.g., Prof'l Hockey Corp. v. World Hockey Ass'n, 143 Cal. App. 3d 410, 414 (1983)), therefore it must be true that directors of Delaware corporations are not trustees. AOB at 17. As the Bankruptcy Court held, and as is demonstrated herein, numerous cases in Delaware have established that directors of Delaware corporations have duties that are at least substantially similar to a trustee's duties, and this Court can review and interpret those authorities without resort to the Debtor's "transitive" theories of precedence. As Debtor himself admits (AOB at 16), the Delaware Supreme Court has recently stated that directors' fiduciary duties stem from their "quasi-trustee" relationship with shareholders. Schoon v. Smith, No. 554, 2006, --A.2d--, 2008 WL 375826, at *5 (Del. Feb. 12, 2008). That statement was dicta (the holding of the case was that directors do not have standing to sue derivatively), but in making that statement Schoon was quoting Guth, 5 A.2d at 510, which requires of a director "the most scrupulous observance of his duty, not only affirmatively to protect the interests of the corporation committed to his charge, but also to refrain from doing anything that would work injury to the corporation."

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However, a review of Delaware case law demonstrates that numerous courts have held that corporate directors occupy trust-like positions. For example, the Delaware Supreme Court recently held that "efforts by a fiduciary to escape a fiduciary duty, whether by a corporate director or officer or other type of trustee, should be scrutinized searchingly." Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., 817 A.2d 160, 168 (Del. 2002) (emphasis added). This follows the longstanding rule that "[t]he officers and directors of a Delaware corporation are trustees for its stockholders under Delaware law." Beneficial Indus. Loan Corp. v. Smith, 170 F.2d 44, 57 (3d Cir. 1948), aff'd, 337 U.S. 541 (1949) (emphasis added). It is true that, as Bovay states, directors are not necessarily trustees "in a strict and technical sense, in all of their relations with the corporation, its stockholders and creditors." Bovay, 38 A.2d at 813 (emphasis added) (holding that directors are not trustees of an express trust and therefore can benefit from the statutes of limitations applicable to claims in a court of law, rather than equity). But just as clearly "[t]he language of the Court is to be interpreted in the light of the situations presented" (id. at 813) and in many situations directors are regarded as trustees or quasi-trustees, particularly where there are no questions of business judgment involved. For example, "directors are regarded as trustees in the matter of the disposal of unissued stock" and "[i]t is not always necessary for them to reap a personal profit or gain a personal advantage in order for their actions in performance of their quasi trust to be successfully questioned." Bodell, 132 A. at 444, 446 (issuance of "additional shares of such stock at less than the fair value thereof" violated directors' duty) (citations omitted). Accordingly, as the bankruptcy court itself noted, a strict reading of the opinion in Bovay as suggested by the Debtor ignores both the flexible approach taken by that court as well as the particular context of that ruling, and it is inaccurate to assert, as Debtor does, that

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Bovay overrules Bodell and the numerous other Delaware cases holding that corporate directors occupy trust-like positions.17 4. Debtor misapprehends the analogy to Gheewalla.

Debtor also asserts that it was error for the bankruptcy court to rely on the recent Delaware case North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 930 A.2d 92, 101-02 (Del. 2007) ("Gheewalla") for the proposition that Delaware directors are imposed with trustee-like duties, because the case neither held that corporate directors are trustees nor did it "expand" director's duties. AOB at 19; ER Tab 17 at 2:25-3:19. However, the Debtor misapprehends the bankruptcy court's point. Gheewalla held that while creditors of an insolvent corporation do not have standing to assert direct claims against the directors, they would have standing to assert derivative claims against directors, similar to the derivative claims that shareholders would have were the corporation solvent. Gheewalla, 930 A.2d at 101-02. Because numerous cases hold that directors, upon insolvency, hold the assets of the corporation in trust for the creditors, and because Gheewalla holds that the scope of that duty is no different whether the corporation is solvent or insolvent (the duty merely runs to a different constituency--creditors instead of shareholders), the bankruptcy court concluded, logically, that Gheewalla strongly supports the proposition that the directors
See, e.g., Gotham Partners, 817 A.2d at 168; Beneficial Indus. Loan Corp. v. Smith, 170 F.2d at 57; Bodell, 132 A. at 444, 446; In re Shoe-Town, Inc. Stockholders Litig., No. C.A. No. 9483, 1990 WL 13475, at *7 (Del. Ch. Feb. 12, 1990) (characterizing directors as "quasi trustees[;] . . . a director will be held as a trustee for the corporation he has undertaken to represent") (citations omitted); Grace v. Morgan, No. Civ. A 03C05260JEB, 2004 WL 26858, at *2 (Del. Super. Jan. 6, 2004) (holding that the "classic examples" of "a special relationship of trust [that] exist[s] between the parties sufficient to establish the fiduciary duty" include "the trustee responsible for the trust res for the beneficiary and the corporate officer or director responsible to shareholders"); Prestancia Mgmt. Group, Inc. v. Virginia Heritage Found., II LLC, No. Civ. A. 1032-S, 2005 WL 1364616, at *6 (Del. Ch. May 27, 2005) (same). Although courts are not unanimous on the issue, numerous courts applying the laws of other states agree that corporate directors are fiduciaries for purposes of Section 523(a)(4). See, e.g., Meyer v. Rigdon, 36 F.3d 1375, 1382 (7th Cir. 1994); In re Hammond, 98 F.2d 703, 705 (2d Cir. 1938); In re Snyder, 101 B.R. 822, 835 (Bankr. D. Mass. 1989), aff'd in part & rev'd in part on other grounds sub nom. Bornstein v. Snyder, 923 F.2d 840 (1st Cir. 1990). See also ER Tab 4 at 17 n.10 (citing and quoting additional cases).
17

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have trustee-type duties to the shareholders. In any event, the bankruptcy court's analogy to Gheewalla is hardly of consequence given the strong support in the Delaware case law for the proposition that directors are trustees. 5. Debtor misconstrues Caremark, and the bankruptcy court's brief references to Caremark.

Debtor complains that "contrary to" the bankruptcy court's alleged "assertions," In re Caremark Int'l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996) does not state explicitly that directors are trustees, or that the corporation's assets are the trust res, and does not specifically use the term "trust." AOB at 17-18. This argument is without merit. As an initial matter, it is at least anomalous for the Debtor to complain about the bankruptcy court's reliance on a case that the court neither cited nor referred to in its written decisions or judgment (ER Tabs 7, 17, 18, 19) and that it referred to only briefly at oral argument. ER Tab 22 at 9:8, 12:3. Moreover, assuming that the bankruptcy court "relied" on Caremark, Debtor's criticism still misses the mark. The point of the bankruptcy court's mention of Caremark during oral argument was that corporate directors have a duty to monitor for wrongdoing, which is merely one aspect of their fiduciary duties under Delaware law. ER Tab 22 at 8:4-9:13. Caremark's refinement of these duties does not obviate the overarching concept that Delaware directors "know very, very clearly that they have fiduciary duties. They know very clearly that what they're charged with is the care and management of corporate property." Id. at 9:1-4. The "trust-like" nature of directors' duties has been set forth in numerous Delaware cases preceding Caremark, which remain controlling. It is anomalous for Debtor to argue (AOB at 12) that some documentary "notice" of those duties was required, and the sole case on which Debtor relies for that proposition (In re Heilman, 241 B.R. 137 (Bankr. D. Md. 1999)), specifically acknowledges that it is out of step with "a majority of decisions," including Ninth Circuit authority, which recognize that trusts

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Case 3:08-cv-01062-WHA

Document 13

Filed 05/27/2008

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can be imposed by law, not just by contract. Id. at 160 & n.19 (citing, inter alia, Ragsdale, 790 F.2d at 796-97 and In re Short, 818 F.2d 693 (9th Cir. 1987)). Nor is it of any consequence that Caremark and the Delaware Chancery Court's opinion did not use the word "trustee" or expressly hold that the corporate assets were he