Tag Archives: non-dischargeability

July 21, 2015

Ninth Circuit Holds Public Policy Prevents Attorney from Defending Client’s Fraud Claim Under the Unclean Hands Doctrine

Client, with the assistance of its attorney, engages in illegal conduct.  Client places money received from its illegal conduct in the attorney’s trust account.  Attorney absconds with these illegal funds.  When the client brings a non-dischargeability action in the attorney’s bankruptcy case, may the attorney defend the action under the unclean hands doctrine because the funds he stole were gained by the client through its own illegal conduct?  As a matter of public policy, the Ninth Circuit has answered this question in the negative.  In Northbay Wellness Group, Inc. v. Beyries (In re Beyries), 2015 WL 3529634 (9th Cir. 2015), the attorney, Michael Beyries, served on Northbay Welness’ board of directors and acted as its counsel.  Northbay engaged in business in California as a medical marijuana dispensary, a business illegal under federal law.  Northbay deposited $25,000 into Beyries’ trust account to hold for use as a legal defense fund for Northbay and its employees.  Beyries stole the money, resigned from Northbay’s board, and absconded. 

Eventually Beyries filed bankruptcy, and Northbay filed a non-dischargeability action for the theft of its trust funds.  Although it found that such conduct would result in a judgment of non-dischargeability, the bankruptcy court dismissed the adversary proceeding because the funds held by Beyries in trust were the proceeds of Northbay’s own illegal conduct.  The U.S. District Court affirmed the dismissal, but the Ninth Circuit reverse. 

The Ninth Circuit’s opinion was based on public policy grounds.  The court noted that a plaintiff seeking a denial of the discharge of his debt must come to the court “with clean hands,”  and a plaintiff who does not cannot obtain a judgment of non-dischargeability.  However, the court noted that a defendant wrongdoer cannot always “retain the profits of his wrongdoing merely because the plaintiff himself is possibly guilty of transgressing the law.”  In addition, the court held that the unclean hands doctrine should not be strictly enforced when doing so would frustrate an important public policy.  Consequently, courts are required to balance the plaintiff’s wrongdoing against that of the defendant.  In the present case, Beyries was on Northbay’s board of directors and, in the court’s opinion, therefore as guilty of the illegal conduct as was Northbay.  Significantly, Beyries was Northbay’s attorney, owing it a fiduciary duty to maintain the funds placed with him in trust by his client:  “A lawyer’s ‘[m]isappropriation of a client’s prop is a gross violation of general morality likely to undermine public confidence in the legal profession and therefore merits severe punishment.’”  (citing Greenbaum v. State Bar, 544 P.2d 921, 928 (Cal. 1976). 

Weighing the relative wrongdoing, the court determined that the doctrine of unclean hands cannot prevent recovery of funds stolen from a client.  As a result, the Ninth Circuit held the bankruptcy court abused its discretion in dismissing Northbay’s complaint for non-dischargeability.

September 14, 2012

Ninth Circuit Holds that Non-Dischargeability Actions are not Subject to Arbitration

The Ninth Circuit Court of Appeals recently rejected two creditors’ creative contention that he was entitled to have his claim that the debtor’s debt to him should be denied a discharge under § 523 for fraud in connection with a contract containing an arbitration clause resolved through arbitration
proceedings.  In Matter of Eber, 2012 WL 2690744 (9th Cir. 2012), the creditors and the debtor entered into an agreement relating to the construction and operation of the debtor’s beauty salon in Las Vegas.  The agreement required that all disputes arising under the agreement would be arbitrated in New York.  After disputes arose, the creditors commenced an arbitration proceeding against the debtor asserting claims for breach of contract, fraud and breach of fiduciary duty.

After the debtor filed bankruptcy, the creditors filed a complaint seeking a denial of the debtor’s discharge of the claims alleged against him under § 523.  The creditors filed a motion to compel
arbitration of the issues of liability and damages, but agreed that the bankruptcy court could determine the issue of dischargeability.  The creditors argued that liability and damages were non-core matters which were arbitrable.  The Circuit Court agreed with the bankruptcy court and the district court that the fraud claims asserted by the creditors could not be so finely parsed.  First,
any finding by the arbitration panel adverse to the debtor on liability and damages would be binding on the debtor under the doctrine of collateral estoppel.  Consequently, although the issue of dischargeabilty would technically be decided by the bankruptcy court, for all intents and purposes, dischargeability would be determined by the findings and conclusions of the arbitration panel, in abrogation of the bankruptcy court’s exclusive jurisdiction over dischargeability actions under § 523(a)(2).

The Circuit Court then addressed the issue of how to reconcile the Federal Arbitration Act with the Bankruptcy Code.  The court noted that disputes involving the Bankruptcy Code and the FAA often “present a conflict of near polar extremes; bankruptcy policy exerts an inexorable pull towards centralization while arbitration policy advocates a decentralize approach towards dispute
resolution.”  Looking to the U.S. Supreme Court’s decision in Shearson/Am. Express, Inc. v. McMahon, 482 U.S. 220, 226 (1987), the Ninth Circuit noted that, in determining if Congress intended to override the FAA’s policy favoring arbitration in a particular case, a court must examine: (1) the text of the statute, (2) its legislative history, and (3) whether an inherent conflict between arbitration and the underlying purposes of the statute exist.

The Ninth Circuit went on to state that it had previously found no evidence in the text of the Bankruptcy Code or in the legislative history suggesting that Congress intended to create an exception to the FAA in the Bankruptcy Code. Determining that whether a dispute is core or non-core is
not dispositive of the issue, the Ninth Circuit went on to hold that a bankruptcy court has discretion to decline to enforce an otherwise applicable arbitration provision only if arbitration would conflict with the underlying purposes of the Bankruptcy Code.  The Circuit Court agreed with the bankruptcy and district courts in holding that allowing arbitration of issues of liability and damages on the fraud claims in question would result in the arbitrator’s deciding issues that are so closely intertwined with dischargebility and, therefore, would conflict with the underlying purposes of the Bankruptcy Code. 

August 17, 2012

Ninth Circuit BAP Holds that Stern v. Marshall does not Preclude Bankruptcy Courts from Entering Final Money Judgments in Non-Dischargeability Actions

In its decision in Deitz v. Ford (In re Deitz), 469 B.R. 11 (9th Cir. BAP 2012), the Bankruptcy Appellate Panel for the Ninth Circuit recently ruled that the U.S. Supreme Court’s decision in Stern v. Marshall does not preclude a bankruptcy court from entering a money judgment against a debtor in connection with ruling that the debt involved is excepted from discharge under § 523 of the Bankruptcy Code.  The court began its analysis at 28 U.S.C. § 1334(b), which grants exclusive subject matter jurisdiction to district courts over bankruptcy matters and with 28 U.S.C. § 157(a), which authorizes district courts to refer bankruptcy proceedings to bankruptcy judges.

The Ninth Circuit BAP read the Stern decision narrowly, and concluded that a narrow reading of the
decision was compelled by the decision itself.  The BAP noted that the Supreme Court in Stern ruled that a bankruptcy court, as an Article I court, “lacked the constitutional authority to enter a final judgment on a state law counterclaim that is not resolved in the process of ruling on a creditor’s
proof of claim.”  Stern v. Marshall, 131 S. Ct. 2594, 2620 (2011).  The BAP stated that the Stern decision addressed only one particular subsection of 28 U.S.C. § 157—specifically, § 157(b)(2) dealing with counterclaims by the estate against persons filing claims against the estate.  Further, the BAP noted that Chief Justice Roberts in Stern stated that the Court’s ruling was a narrow one, limited to counterclaims of the estate that are not resolved in connection with resolution of the creditor’s proof of claim, and that the Court’s decision should have “few practical consequences” on the handling of
bankruptcy cases.  Id. at 2619-2620.

In analyzing other post-Stern decisions by courts that concluded a bankruptcy court lacked  jurisdiction to enter a money judgment in the case before them, the BAP concluded that in all
of those instances, the matter involved a situation where the trustee or debtor was seeking to recover property from the defendant to augment the estate.  None involved a non-dischargeability action in which the creditor sought to reduce his claim to a sum certain in addition to seeking to have it declared non-dischargeable.  The BAP considered this difference to be significant.  In addition, the court noted that other courts dealing with the issue of whether a bankruptcy court has jurisdiction to enter a final monetary judgment in connection with a non-dischargeability action had come to the same conclusion it did—that such jurisdiction is present.  In re Boricich, 464 B.R. 335, 337 (Bankr. N.D. Ill. 2011); In re Soo Bin Kim, 2011 WL 2708985 (Bankr. W.D. Tex. 2011).

The BAP also relied on the pre-Stern decision by the Ninth Circuit Court of Appeals in Cowen v. Kennedy (In re Kennedy), 108 F3.d 1015 (9th Cir. 1997) for its conclusion that the bankruptcy
court had jurisdiction to enter a final money judgment in connection with the creditor’s dischargeability action.  In Kennedy the Ninth Circuit concluded that a bankruptcy court did have jurisdiction to enter a final money judgment in connection with a creditor’s complaint for non-dischargeability, joining all of its sister circuits who had issued opinions on the issue.  The BAP considered the decision in Kennedy to be binding and not irreconcilable with the Supreme Court’s decision in Stern.