The Mountbatten Surety Company Inc v. Kelly et al

UNITED STATES BANKRUPTCY COURT
EASTERN DISTRICT OF NEW YORK
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In re:
BRIAN KELLY, 	Case No. 03-87094-511
Debtor. 	Chapter 7
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MOUNTBATTEN SURETY COMPANY,
INC., 	Adv. Proc. No. 04-8038-511
Plaintiff,
-against-
BRIAN KELLY,
Defendant.
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MEMORANDUM DECISION AND ORDER
(RE: MOTION OF DEFENDANT KELLY FOR SUMMARY JUDGMENT)
Before 	the 	Court 	is 	the 	motion 	of 	Brian 	Kelly 	(the 	“Debtor” 	or
“Defendant”) for summary judgment in an adversary proceeding to except from
discharge, pursuant to § 523(a)(4) of the Bankruptcy Code, a debt arising from a
contract to indemnify the issuer of surety bonds on a construction project that the
Debtor’s 	construction 	company 	failed 	to 	complete. 	Mountbatten 	Surety
Company, Inc. (“Mountbatten” or “Plaintiff”) has filed opposition to the motion
stating it requires additional discovery in order to oppose the summary judgment
motion. As set forth below, Mountbatten’s request for discovery will be allowed,
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albeit on a limited basis, and the Court will deny Plaintiff’s motion without prejudice
to renew after discovery is completed.
Background
The Debtor is the president, sole shareholder and officer of National
Lath & Plaster, Inc. (“National Lath”), a construction contractor. 	In 1998,
Mountbatten issued surety bonds on behalf of National Lath while it was a sub-
contractor for a project at the American Museum of Natural History that began in
October or November of 1998 (the “Museum Project”). 	The Debtor signed an
indemnity 	agreement 	whereby 	he 	personally 	guaranteed 	repayment 	to
Mountbatten on any amounts it had to pay out on the bonds.
From 	March 	1999 	through 	September 	2000, 	the 	Debtor 	was
incarcerated 	as 	a 	result 	of 	being 	convicted 	of 	criminally 	violating 	federal
environmental laws on work unrelated to the Museum Project. During the time of
the Debtor’s incarceration, National Lath continued its work on the Museum
Project. 	In the Debtor’s absence, the company was run by Doug Schwartz
(“Schwartz”), an employee, with the assistance of Larry Kelly, the Debtor’s father.
The pleadings allege that the Debtor communicated with both Schwartz and his
father while incarcerated, but the record is not clear as to the frequency or extent
of the contact. Thus, it is unclear what role, if any, the Debtor played with regard
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to the operations, management and billing practices of National Lath while
incarcerated. 	The 	Debtor 	contends 	that 	he 	played 	no 	role 	and 	had 	no
responsibilities. National Lath disagrees and urges that, to the contrary, the Debtor
maintained an active participation in the business affairs of the company.
National Lath defaulted on payments to suppliers and laborers of the
Museum 	Project, 	triggering 	Mountbatten’s 	liability 	on 	the 	surety 	bonds.
Mountbatten took over financial management of National Lath upon the default,
approximately in mid-September 1999 (while the Debtor was in prison), and also
caused the general contractor, Morse Diesel, to make payments directly to
Mountbatten’s agent, HMS Dreadnought, Inc.
Mountbatten paid $370,821.23 in excess of what it received from Morse
Diesel and sued in state court to recover from the Debtor, National Lath and other
parties to the indemnification agreement. In June 2003, the state court granted
Mountbatten summary judgment and in September 2003, signed and entered a
judgment in the amount of $584,860.17, representing the principal amount owed
plus interest and attorney’s fees. 	As a result of the judgment obtained by
Mountbatten, the Debtor sought relief under Chapter 7 of the Bankruptcy Code on
October 30, 2003.
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The Instant Adversary Proceeding
The indemnification agreement provides for the creation of an express
trust, the res comprised of the funds received by National Lath on account of the
Museum Project; the funds were to be held for the specific purpose of paying
suppliers and laborers for the project. Mountbatten is designated as a beneficiary
of the trust. 	Mountbatten alleges trust funds were impermissibly used to pay
general operating expenses of National Lath (other than payroll taxes), and that
the Debtor as president of National Lath was responsible for any diversion of trust
funds. Mountbatten thus commenced this adversary proceeding on January 30,
2004, to except from discharge the debtor’s debt on the basis of the breach or
defalcation of the Debtor’s fiduciary duty to use funds received by National Lath
only for those purposes specified in the indemnity agreement. Mountbatten also
seeks 	a 	determination 	that 	the 	amount 	of 	the 	non-dischargeable 	debt 	is
$581,744.64, plus attorney fees and interest from August 11, 2003.
Following commencement of the adversary proceeding, the parties
engaged in motion practice, including a motion by Plaintiff to file an amended
complaint which was subsequently approved by the Court by Order dated May
3, 2004. On May 14, 2004, Defendant simultaneously filed an Amended Answer and
a Summary Judgment Motion.
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Defendant’s Summary Judgment Motion
The Debtor has moved for summary judgment pursuant to Rule 56 of
the Federal Rules of Civil Procedure (as made applicable to adversary proceedings
by Rule 7056 of the Federal Rules of Bankruptcy Procedure), requesting the
complaint be dismissed entirely and the debt be declared dischargeable, or
alternatively, the debt be excepted from discharge only to the extent Mountbatten
can show the Debtor personally received “office and supervision” compensation
out of the funds paid to National Lath to be held in trust.
The Debtor argues the only fact alleged by Mountbatten which, if
proven, could support a finding of nondischargeability is that trust funds were used
to pay general operating expenses of National Lath, not including payroll taxes.
According to the Debtor, Mountbatten seeks to prove this allegation by relying
upon a “Schedule of Manpower” for the Museum Project that includes, for each
of the four weeks from November 27, 1999 to December 18, 1999, the allotment of
ten hours of compensable work under the heading of “office and supervision.” The
Debtor argues that because this was during the time he was in prison, it is not
possible for him to have participated in the alleged defalcation. He also argues
that he had no knowledge of the diversion of the trust funds. 	In any event, the
Debtor points out the “Schedule of Manpower” was sent with a cover letter
expressing that it was for the purpose of allowing Mountbatten to make the
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payments, since Mountbatten had taken over financial management of the
Museum project in September 1999.
Mountbatten counters that, notwithstanding that he was in prison, the
Debtor continued to be a part of the management of National Lath and so knew
of the requests for the payment of salaries for “office and supervision” personnel
which 	had been 	done 	allegedly in 	violation 	of 	the 	indemnity agreement.
Moreover, Mountbatten claims that even if Debtor had no knowledge of the
overhead payments, he participated in them because he faced personal liability
for the salaries of the supervisory and non-labor personnel. 	According to
Mountbatten, the Debtor faced this personal liability because he was the sole
shareholder of National Lath and claims not paid by Mountbatten could have
been asserted against National Lath under NY Bus. & Corp. Law § 630, which makes
a sole shareholder, such as the Debtor, personally liable for certain claims. 	For
these reasons, Mountbatten argues that the Debtor would have clearly benefitted
personally by payments from the trust funds.
Mountbatten also contends that it is entitled to seek discovery to
determine the total amount of payments, the recipients of the payments and what
similar payments were made prior to September 1999 (when Mountbatten took
over financial management of National Lath). Mountbatten justifies this request by
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1
There is some dispute as to why discovery did not proceed at that point in time.
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reasoning that if there was a practice of making these payments after September
1999, such a practice must have existed prior to that time.
The general contractor on the Museum project, Morse Diesel, began
making 	payments 	to 	National 	Lath 	as 	early 	as 	October 	1998, 	disbursing
approximately $350,000 by February 1999. From March 1999, when the Debtor was
first 	incarcerated, until 	September 	1999, when 	Morse 	Diesel 	began 	paying
Mountbatten directly, approximately another $448,000 was disbursed.
For his part, Debtor disagrees and asserts in his affidavit that he did not
receive any “office and supervision” compensation while in prison, or at any time
prior to his incarceration. 	See Affidavit of Brian Kelly, annexed to Motion for
Summary Judgment, ¶¶ 4 - 7.
Mountbatten alleges that Debtor’s counsel refused to allow discovery
prior to making the motion for summary judgment 1 , and cites Fed. R. Civ. Pro. 56(f)
and the relevant caselaw for the proposition that a motion for summary judgment
should 	not 	be 	decided 	prior 	to 	the 	completion 	of 	discovery. 	However,
Mountbatten has not submitted an affidavit from anyone with personal knowledge
of the facts, having only submitted affirmations of counsel. The Debtor vigorously
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opposes any discovery by Mountbatten, wanting to prevent what he characterizes
as a “fishing expedition,” particularly considering that Mountbatten had access to
the books and records of National Lath since the time when it took over financial
management of the Museum Project, and again during the discovery phase of the
State Court action. The Debtor argues that no evidence has been presented that
indicates that any funds received by National Lath were paid to supervisory or non-
labor personnel prior to the Debtor’s incarceration. And even had there been any
such payments, the Debtor contends, there would have been no breach of the
indemnity agreement or his fiduciary duties because National Lath was current on
its obligations at that time. It is the position of the Debtor that it is Mountbatten,
through its agent HMS Dreadnought, which actually made the “office and
supervision” payments after taking control of the financial management, and that
it would be inequitable to deny his discharge for payments he did not authorize or
as to which he had no knowledge.
Plaintiff’s Request for Limited Discovery is Warranted
As a result of the simultaneous filing of Defendant’s Amended Answer
and the Defendant’s Summary Judgment Motion, which is permissible under Fed.
R. Bankr. Pro. 7056 and Fed. R. Civ. Pro. 56, Plaintiff was not given the opportunity
to conduct any discovery which Plaintiff argues is necessary to respond to the
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2
The Second Circuit has outlined certain pleading requirements to be set forth in an
affidavit in order for a court to grant relief under FRCP 56(f). See Burlington Coat Factory
Warehouse Corp. v. Esprit De Corp., 769 F.2d 919 (2d Cir. 1985). 	Upon review of the
Affirmation of Robert J. Stone, Jr., Esq., in Opposition to Motion for Summary Judgment at
paragraphs 9 through 12, this Court finds that the factors outlined by the Second Circuit
in Burlington have been substantially satisfied. Consequently, given that there has been
substantive compliance with this rule, the Court will look to the substance of the pleadings
over the form of same and waive the requirement.
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Summary Judgment Motion. 	Federal Rules of Civil Procedure Rule 56(f) provides
in pertinent part that
[s]hould it appear from the affidavits of a party opposing the motion
that the party cannot for reasons stated present by affidavit facts
essential to justify the party's opposition, the court may refuse the
application for judgment or may order a continuance to permit
affidavits to be obtained or depositions to be taken or discovery to be
had or may make such other order as is just.
Fed. R. Civ. Pro. 56(f).2
Based upon the record presented as of this point, it is doubtful that
additional discovery will yield any facts that will shed light on the issues raised by
Defendant’s motion. 	This is especially so given the breadth of litigation in state
court that has preceded this adversary proceeding and the Plaintiff’s actual
knowledge of National Lath’s business affairs acquired during the period when
Mountbatten had financial control of the Museum Project. 	Nonetheless, in the
interests of ensuring that the record is complete, the Court believes that limited
discovery should take place at this stage of the proceedings. As Bankruptcy Judge
Beatty observed,
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[a] “bare assertion that the evidence supporting a plaintiff's allegation
is in the hands of the defendant is insufficient to justify a denial of a
motion for summary judgment under Rule 56(f). Rule 56(f) cannot be
relied upon to defeat a summary judgment motion ‘where the result
of a continuance to obtain further information would be wholly
speculative.’” 	Contemporary Mission, Inc. v. United States Postal
Service, 648 F.2d 97, 107 (2d Cir.1981) (citations omitted); see also
Paddington, 34 F.3d at 1138 (discovery inappropriate where party
opposing discovery seeks “to find out if it has a claim, rather than that
it has a claim for which it needs additional discovery”); Waldron v.
Cities Service Co., 361 F.2d 671, 673 (2d Cir.1966)(denying Rule 56(f)
discovery where “plaintiff sought to engage in still another ‘fishing
expedition’ in the hope that he could come up with some tenable
cause of action”), aff'd. 391 U.S. 253, 88 S.Ct. 1575, 20 L.Ed.2d 569
(1968).
In re Rockefeller Center Properties, 272 B.R. 524, 552 -53 (Bankr. S.D.N.Y. 2000).
Accordingly, the parties will be allowed to take discovery limited to the
issues raised in connection with the Defendant’s summary judgment motion, which
discovery should be completed by December 31, 2006. Thereafter, the Defendant
may renew his motion for summary judgment.
CONCLUSION
For all these reasons, the Plaintiff’s request to conduct discovery is
granted as set forth herein. 	Further, the Court denies the Defendant’s summary
judgment 	motion 	without 	prejudice 	to 	renew 	following 	the 	completion 	of
discovery. 	A further pre-trial conference will take place on January 17, 2007 at
10:00 a.m. at which time the Court will hear the summary judgment motion if the
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same is renewed by Defendant. In the event that no motion is made, the Court will
confer with the parties to schedule dates for trial.
The clerk is directed to serve a copy of this Memorandum Decision and
Order upon each of the affected parties.
IT IS SO ORDERED.
/s/ Melanie L. Cyganowski
Hon. Melanie L. Cyganowski, U.S.B.J.
Dated: 	Central Islip, NY
October 20, 2006
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