Double Bogey, L.P. v. Enea, 794 F.3d 1047 (9th Cir. 2015) (Double Bogey)
In Double Bogey, L.P. v. Enea, 794 F.3d 1047 (9th Cir. 2015) ("Double Bogey"), the U.S. Court of Appeals for the Ninth Circuit held in a published opinion that the debtors, who were the sole officers and shareholders of a corporation, could not have their debts determined non-dischargeable under 11 U.S.C. Section 523(a)(4) solely on the basis that the debtors were found to be the alter ego of the corporation under applicable California law. The Ninth Circuit determined that California’s alter ego doctrine acts as a procedural mechanism rather than providing for "trust-like" obligations that would create a fiduciary relationship.
Issues raised in Double Bogey as to whether California common law doctrines can impose a fiduciary relationship under 11 U.S.C. Section 523(a)(4) are of continuing importance. During January 2016, the Ninth Circuit, in an unpublished decision in Yin v. Tatung Co. (In re Houng), 2016 WL 145841 (9th Cir. 2016), interpreted Double Bogey and determined that the "trust fund doctrine," a California common law doctrine, creates a fiduciary relationship within the meaning of Section 523(a)(4).
Facts:
Paul and Sylvester Enea created and owned Appian Construction, Inc. (the "Corporation"). The Eneas were also the Corporation’s only officers. The Corporation managed two real estate development projects – 1221 Monticello L.L.P., as a general partner, and Monterrosa, L.L.C. as the managing member. Double Bogey, L.P. (the "Investor") invested $4 million in Monticello as its limited partner, and $1 million in Monterrosa as a non-managing member.
The Investor did not recover its investment, and after the Corporation failed to provide an accounting, the Investor filed a state court action against the Corporation and the Eneas. The Eneas ("Debtors") and the Corporation each filed bankruptcy under Chapter 7 approximately one year later.
The Investor initiated an adversary action against Debtors, alleging: (1) The Corporation was the Investor’s fiduciary; (2) The Corporation was liable for the Investor’s lost principal and profits; (3) such liabilities were created by the Corporation’s defalcation; (4) liabilities created by a fiduciary’s defalcation are non-dischargeable under Section 523(a)(4); and (5) the Debtors were liable for such non-dischargeable debt by way of their own defalcation or as alter egos of the Corporation.
The bankruptcy court found that the Corporation was a fiduciary of the Investor and that Debtors were alter egos of the Corporation. However, the bankruptcy court entered judgment in favor of Debtors – finding that a determination that the Debtors were the alter egos of the Corporation was insufficient to hold that Debtors were fiduciaries of the Investor. The district court affirmed the bankruptcy court, as did the Ninth Circuit.
Reasoning:
The Ninth Circuit began its analysis noting that it has adopted a narrow definition of fiduciary – in that the fiduciary relationship must be one arising from an express or technical trust imposed before, and without reference to, the wrongdoing that caused the debt. See In re Cantrell, 329 F.3d 1119, 1125 (9th Cir. 2003). The Ninth Circuit stated that it may consult state law when interpreting whether one is a fiduciary under Section 523(a)(4), but such a relationship will only be found when the non-bankruptcy law clearly and expressly imposes trust-like obligations.
The Ninth Circuit further stated that common-law doctrines, such as California’s alter ego doctrine, rarely impose trust-like obligations to create a fiduciary relationship under Section 523(a)(4) – and that constructive, resulting, or implied trusts never satisfy this element. As stated in the opinion, "California’s alter ego doctrine does not explicitly create a trust relationship, either by raising existing legal duties or otherwise. Nor does it come into operation prior to wrongdoing – rather it merely operates to hold an individual liable for his corporation’s already-existing debt. Instead of creating, enforcing, or expounding on substantive duties, California’s alter ego doctrine merely acts as a procedural mechanism by which an individual can be held jointly liable for the wrongdoing of his or her corporate alter ego." Double Bogey at 1051-1052. The Ninth Circuit determined that since California’s alter ego doctrine results in adding judgment debtors post-liability, and does not impose trust-like obligations prior to the liability, it does not create a fiduciary relationship under Section 523(a)(4).
Subsequent Ninth Circuit Case:
In Houng v. Tatung Co. (In re Houng), 2016 WL 145841 (9th Cir. 2016), the Ninth Circuit, in an unpublished decision, considered a non-dischargeability claim under 11 U.S.C. § 523(a)(4), and whether a fiduciary duty arising from the "trust fund doctrine" (the California doctrine holds that assets of a corporation become a trust fund for the benefit of creditors upon insolvency – see Berg & Berg Enter., LLC v. Boyle, 100 Cal.Rptr.3d 875, 893 (Cal. App. 2009)) creates a fiduciary relationship within the meaning of Section 523(a)(4). The Ninth Circuit determined in Houng that the trust fund doctrine did qualify as such a fiduciary relationship, notwithstanding dicta in Double Bogey that common law doctrines "rarely impose the trust-like obligations sufficient to create a fiduciary relationship" subject to nondischargeability in Section 523(a)(4). Houng at 2. The Ninth Circuit stated that Double Bogey simply states that cases "have long held-that for a fiduciary relationship to satisfy § 523(a)(4), it must exhibit characteristics of a traditional trust relationship and must arise prior to the wrongdoing at issue." Houng at 2.
Commentary:
Given the Ninth Circuit’s narrow definition of a fiduciary under Section 523(a)(4), the court’s reasoning and ultimate ruling is not surprising. However, the court’s ruling was narrowly limited to a determination of whether California’s alter ego doctrine alone can create a fiduciary relationship under the Bankruptcy Code – leaving open the possibility of using a finding of alter ego to support other grounds for nondischargeability – such as embezzlement or larceny under Section 523(a)(4), or willful and malicious injury to property under Section 523(a)(6). In addition, the Ninth Circuit’s decision in the Houng case following on Double Bogey makes it likely that there will be more cases exploring whether other California common law doctrines qualify to create a fiduciary relationship within the meaning of Section 523(a)(4).
[this case analysis is reprinted from the State Bar of California Insolvency Committee e-newsletter, written by their authors]