In In re Fritz, a bankruptcy court determined whether an exception to dischargeability was present. No. 15-347950BJH, 2017 Bankr. LEXIS 930 (N.D. Tex. Bankr. April 3, 2017). Although the state court judgment jointly awarded the plaintiffs $100,000 in damages and post-judgment interest, it did not specify which of the claims pled in the underlying state court petition supported the award or otherwise allocated the damages between the plaintiffs. This failure to allocate damages among the pled claims was significant because some of the claims pled in the state court petition could have given rise to a nondischargeable judgment under § 523 of the Bankruptcy Code, while others did not.

Regarding the breach of fiduciary duty exception to dischargeability, the court noted that “A discharge under section 727 … does not discharge an individual debtor from any debt … for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.” Id. (citing 11 U.S.C. § 523(a)(4)). The court stated: “This subsection is intended to address situations where ‘debts are incurred through abuses of fiduciary positions and through active misconduct whereby a debtor has deprived others of their property by criminal acts.’” The court held that:

[O]nce the Plaintiffs establish a breach of fiduciary duty under Texas law, they still have the burden of proof to “demonstrate the existence of the requisite elements of 11 U.S.C. § 523(a)(4),” such as the existence of the fiduciary duty prior to Fritz’s breaches. Thus, to establish their claim under § 523(a)(4), the Plaintiffs must prove Fritz “engaged in fraud or defalcation while acting in a fiduciary capacity.” “Defalcation is the neglect of a fiduciary duty.”

Turning first to the existence of a fiduciary duty, the Complaint summarily states that “Fritz remained an owner, officer, and director of [the Company], and therefore owed fiduciary duties to both the [C]ompany and to Hill.” As discussed above, the Court has deemed the factual allegations in the Plaintiffs’ Complaint as true. However, the Plaintiffs’ statement that Fritz owes a fiduciary duty to the Company and Hill is a conclusion of law, not a factual allegation. Conclusions of law are the purview of the Court and, as such, the Court does not accept this legal conclusion as true. Accordingly, the Court must independently determine whether Fritz owed a fiduciary duty to Hill and/or the Company.

Taking these in order, for Hill to succeed on his § 523(a)(4) claim, he must first prove that Fritz owed him a fiduciary duty. Although the Complaint generally alleges that Fritz owed a fiduciary duty to Hill, it does not explain the basis for such a duty. Based upon the record before it, the Court can only infer that the alleged fiduciary duty is based upon Hill’s and Fritz’s positions as co-shareholders of the Company. Under Texas law, however, “a co-shareholder in a closely held corporation does not as a matter of law owe a fiduciary duty to his co-shareholder.” Because Hill has failed to prove that Fritz owed him a fiduciary duty, Hill’s § 523(a)(4) claim for fraud or defalcation while acting in a fiduciary capacity fails.

Id. (Hoggett v. Brown, 971 S.W.2d 472, 488 (Tex. App.—Houston [14th Dist.] 1997, no pet.) (no fiduciary duties between shareholders)).

The court then reviewed the dischargeability of the company’s judgment, and held that the debtor did owe fiduciary duties to the company as an officer and director. However, the court was not able to allow a discharge because the underlying judgment was not specific enough to show that the trial court awarded the judgment based on a breach of fiduciary duty claim (as opposed to a breach of contract claim).

Interesting Note: This case raises a reoccurring issue in bankruptcy discharge cases arising from fiduciary cases: specificity of a state court judgment. A plaintiff should be very careful to obtain the necessary findings to support the exception to bankruptcy discharge and also obtain a judgment that makes the required findings and specifically grants damages based on a breach of fiduciary duty claim (potentially in addition to other claims). The author refers the reader to his earlier blog post on bankruptcy and dischargeability issues arising from breach of fiduciary duty claims.