“Traditionally, trials of family conflicts often involve emotion and controversy, yet are short on reason, logic and admissible evidence. These adversary proceedings share these traits.” Thus, began Judge Larry Kelly’s Memorandum Opinion in which he sought to sort out the tangled mother-daughter disputes in Rose Douso Petro v. Irene E. Holland, et al, Adv. No. 06-6001, 06-6002 and 06-6004 (Bankr. W.D. Tex. 1/12/07). This opinion is significant both because it was one of Judge Kelly’s final opinions prior to retirement (after 20+ years on the bench) and because it offers an object lesson in the difficulty in translating informal family dealings into legal proceedings.
In better times, Irene Holland was married to Scottie Holland and Irene’s parents advanced money to her. These borrowings were later documented in a promissory note in the amount of $305,000 in 1988. The debt was evidenced by a note which was payable on November 1, 1993 or when the Hollands sold a piece of property they owned in San Antonio. Seven years later, the Hollands sold the San Antonio property but neglected to pay off the note. According to Irene’s mother Rose Petro, they also failed to inform her of the sale. Rose contended that she did not learn of the sale until spring 2002, some 14 years after the date of the loan and seven years after the sale.
In the spring of 2003, the Hollands sold a residence they owned in Hawaii for $1.6 million. Around the same time, they divorced. In connection with the divorce, the Hollands agreed that Rose would receive $286,568.53 out of the sales proceeds to be paid on her note. Judge Kelly noted that there is no explanation for why they chose this amount rather than the full face amount of the note (although apparently this is what Irene believed was owing). The Title Company issued the check payable to Rose, but wrote it in care of Irene. It is not explained why the check went to Irene. However, a lot of subsequent litigation could have been avoided if the check had gone straight to Rose. In apparent violation of the divorce agreement, Irene returned the check to the title company and requested that it be voided. In its place, she requested that four new checks be issued. One of the four checks was issued to Rose in the amount of $110,000 and was received by Rose. In a development which would become important later, Irene contended that Rose gave her permission to do this.
Rose was not happy when she found out what had happened. In June 2004, she sued Irene, Scottie and the title company in District Court in Bell County. The state court found that it lacked jurisdiction over the title company and dismissed all claims against it. Irene engaged Waco attorney John Montez and filed bankruptcy during the October 2005 bankruptcy rush. At this point, adversary proceedings began to get filed left and right. Rose removed the state court litigation to bankruptcy court where it was assigned Adv. No. 06-6001. She then filed a complaint against Irene seeking to except her debt from discharge under Sec. 523(a)(2), (4) and (6) and objecting to Irene’s general discharge under Sec. 727(a)(2)-(5). This became Adv. No. 06-6002. Scottie filed his own adversary proceeding based on breach of the Agreement Incident to Divorce, which was docketed as Adv. No. 06-6004. Prior to trial, Scottie settled his claims against Irene as well as Rose’s claims against him. Thus, the sole issues which remained for trial were Rose’s claims against Irene.
Prior to trial, it appeared as though Irene had not gone out of her way to repay the note to her parents. However, it was unclear whether this would translate into a non-dischargeable debt.
Before determining whether the debt was non-dischargeable, the court had to decide whether there was even an enforceable debt. The promissory note was due within four years after the property sold. Since the property was sold on March 29, 2000, the deadline to file suit would have expired on March 29, 2004, approximately three months before suit was actually filed. The court found that Irene had not fraudulently concealed the sale of the property from her mother and that her mother knew about the sale by 2002. As a result, the court concluded that the original debt was barred by limitations. However, under Texas law, a debt barred by limitations can be revived by a written agreement signed by the obligor. Even though Rose was apparently unaware of the terms of the Agreement Incident to Divorce, the Court found that Rose was a third party beneficiary of this agreement and that it was sufficient to revive the debt. Thus, but for Irene and Scottie’s agreement to provide for Rose in their divorce, the debt would have been unenforceable and the court’s opinion would have been much shorter.
Having overcome the limitations defense, Rose still needed to prove one of the grounds for non-dischargeability which she alleged.
The court had no trouble dispatching the fraud ground under Sec. 523(a)(2). There was simply no evidence that Irene had made a false representation at the time that the note was executed or that Rose had relied upon any false representation. Since Rose did not know about the Agreement Incident to Divorce, it was not possible for her to rely upon this agreement as a false representation. While Irene very likely made a false representation to Scottie, she wisely resolved her dispute with him.
This illustrates an important distinction between “fraud” in the popular sense and the legal sense. If I make a promise to pay you with the best of intentions and then later make a capricious and whimsical decision not to pay, even though I had the ability to do so, you would feel defrauded. However, legally this constitutes nothing more than a breach of contract. The essence of fraud is a false representation made with bad intent which is relied upon by the other party to their detriment. If the representation is originally made with good intent, all the subsequent bad faith in the world will not transform the original representation into fraud. Thus, where the original promise is made honestly and there is subsequent bad conduct, the plaintiff must be able to show a subsequent false representation which they relied upon.
In a series of informal dealings over a lengthy period of time, such as in this case, proving anyone’s intent at the outset is nearly impossible.
Fraud or Defalcation in a Fiduciary Capacity
Fraud or defalcation in a fiduciary capacity under Sec. 523(a)(4) did not present much difficulty either. A fiduciary under federal law requires a much higher standard than under state law. A federal fiduciary must be akin to a trustee. The mother-daughter bond simply does not rise to this level. Judge Kelly found that there were no other factors, such as control over Rose’s finances, which would give rise to a fiduciary relationship. An argument could have been made that the Agreement Incident to Divorce imposed trustee-like duties upon Irene with respect to the cashiers check which was later voided. However, this claim would have likely failed based on Irene’s unrebutted testimony that Rose gave her permission to use the funds.
The claim for embezzlement failed for the reason that the funds from the real estate closing were never property of Rose. In order for embezzlement to take place, there must be an appropriation of another person’s property for the debtor’s benefit with fraudulent intent. Here, Irene exercised control over a cashiers check made payable to Rose. However, once again, the popular wisdom parts company with the legal test. Under Texas law, a cashier’s check remains the property of the person who purchased it until it is delivered. Judge Kelly found that because the check for $286,568.53 was never delivered to Rose, it was never her property. Thus, while it looks bad that Irene canceled out the check and didn’t give the funds to Rose, it didn’t constitute embezzlement.
Willful and Malicious Injury
Finally, Judge Kelly found that the claim for willful and malicious injury under Sec. 523(a)(6) failed. Of all the claims, this one appeared to have the greatest chance of success. If the court had believed that Irene had voided the cashiers check from the real estate closing for the purpose of harming Rose, then the court might have been able to find willful and malicious injury. However, Irene testified at trial that she had oral permission from Rose to void the check. This testimony came out on direct examination from Rose’s attorney and was not rebutted. As a result, the testimony stood without contradiction and was accepted by the court. The result might have been different on a claim by Scottie, since he was certainly harmed by the failure to pay Rose. However, he had already settled with Rose and Irene prior to trial.
This case shows why the bankruptcy discharge is an imperfect screen for unethical or immoral behavior. Some observers would probably conclude that Irene behaved badly, or at least selfishly. Despite the fact that she had received a huge sum of money from her parents and signed a written promise to pay, she always found other things to spend her money on when she had the opportunity. Her conduct in agreeing to repay her mom out of the Hawaii sales proceeds and then voiding the check appears to constitute double dealing. Thus, it could be argued that good lawyering and weak laws helped Irene escape her just desserts.
However, a counter argument can be made that this was much ado about nothing. Irene’s parents did not treat the “loan” like a business transaction. They apparently advanced funds first and documented the transaction later. According to Irene, the note was never intended to be collected, but would be used to adjust the sisters’ share of the inheritance later. As found by Judge Kelly, the note would have been barred by limitations and become unenforceable were it not for Irene and Scottie’s decision to include it in the Agreement Incident to Divorce. While the decision to void the cashier’s check looks bad, the unrebutted testimony about verbal consent supports an inference that the mother may have initially approved the transaction and then changed her mind.
This case is a good example of why informal dealings based on trust make for bad legal cases. Rose could have protected herself if she had tried to enforce the note when it matured or when she found out about the sale of the San Antonio property. She did not do so, perhaps hoping that her daughter would eventually do the right thing. Or perhaps she never intended to enforce the note at the time it came due and only changed her mind after the fact. The Court had an unenviable job in trying to sort all the sort out the mother-daughter brawl. However, the resulting opinion provides a good primer on the law of dischargeability.