Auburn Development Corporation v. John B. Shorton

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UNITED STATES BANKRUPTCY COURT
FOR THE
DISTRICT OF MASSACHUSETTS
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
In re
JOHN B. SHORTON, 	Chapter 7
Debtor 	Case No. 06-11123-JNF
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AUBURN DEVELOPMENT CORPORATION,
Plaintiff
v. 	Adv. P. No. 06-1314
JOHN B. SHORTON
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MEMORANDUM
I. INTRODUCTION
The matter before the Court is the Complaint filed by Auburn Development
Corporation (“Auburn”) against the Debtor, John B. Shorton (“Shorton” or the “Debtor”).
Through its Complaint, Auburn seeks a determination that the Debtor, a former attorney
licensed to practice law in the Commonwealth of Massachusetts, “wrongfully, and
fraudulently converted the assets of Auburn Development Corporation, which he held in
a fiduciary capacity, for his own use.” 	The Debtor, in his Answer, denied Auburn’s
allegations. The Court conducted a trial on October 3, 2007 and October 24, 2007 at which
two witnesses testified in addition to the Debtor, and seven exhibits were introduced into
evidence.
Based upon the testimony and exhibits, the Court now makes findings of fact and
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rulings of law in accordance with Fed. R. Bankr. P. 7052.
II. FACTS
The Debtor filed a voluntary petition under Chapter 7 on April 25, 2007. Auburn
timely filed a Complaint under 11 U.S.C. § 523(a)(4).
Prior to filing his bankruptcy petition, the Debtor, while he was licensed to practice
law, represented Arthur Vallee and the Vallee Realty Trust (collectively “Vallee”). Vallee
owned a home located at 37 Stratford Road, Newton, Massachusetts (the “Property”). On
September 8, 1999, Vallee and Auburn executed a “Standard Form Purchase and Sale
Agreement” pursuant to which Vallee agreed to sell and Auburn agreed to buy the
Property for a purchase price of $350,000, subject to the acquisition of a demolition permit
and a building permit. 	The closing was originally 	scheduled for November 1, 1999
pursuant to paragraph 42 of the Agreement contained in a 	Rider which amended
paragraph 8. That paragraph also provided:
In the event the buyer has not obtained the permits described in Paragraph
40, this Agreement may be extended, at the buyer’s option, for a period of
thirty (30) days. In the event the buyer does not extend this Agreement, said
Agreement shall be terminated, all deposits shall be refunded to the buyer
and those provisions intended to survive such termination shall remain in
effect.
Auburn made a deposit of $17,500 toward the purchase price of the Property. The Debtor
was denominated escrow agent pursuant to paragraph 20 of the Agreement which
provided:
All deposits made hereunder shall be held in escrow by John B. Shorton,
IOLTA Account [sic] as escrow agent subject to the terms of this agreement
and shall be duly accounted for at the time for performance of this
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agreement. In the event of any disagreement between the parties, the escrow
agent may retain all deposits made under this agreement pending instructions
mutually given by the SELLER and the BUYER.
(emphasis supplied). 	The Rider to the Agreement contained additional provisions
pertinent to the present dispute between Auburn and the Debtor. Paragraph 39 pertained
to “Extension of Time for Performance.” It provided:
In the event the mortgage lender has not completed processing the Buyer’s
mortgage loan application or in the event the attorney for the mortgage
lender has not received authorization to proceed with the closing or has not
completed examination of the title to the premises, the time for closing in
paragraph 8 shall be extended for a period of time requested of the mortgage
lender or its attorney.
In addition, paragraph 40, which set forth the permits required for closing, and paragraph
43 also contained language relating to extensions of time for performance. Paragraph 40
provided in relevant part the following:
a) Subject to obtaining a demolition permit from the City of Newton for
removal of the structure on premises. [sic] Said permit to be applied for on
or before September 20, 1999 and diligently pursued thereafter. In the event
that a permit is not obtained, the time for closing set forth in Paragraph 8
hereto, shall be extended until said permit is granted, provided the buyer
continues to use due diligent [sic] in pursuit thereof.
b) Subject to approval of a building permit from the City of Newton
Department of Inspectional Services of 	building permit [sic] for the
construction of a two (2) family residential structure on the premises. [sic]
Said permit to be applied for on or before October 6, 1999 and diligently
pursued thereafter. In the event that a permit is not obtained, the time for
closing set forth in Paragraph 8 hereto, shall be extended until said permit is
granted, provided the buyer continues to use due diligent [sic] in pursuit
thereof.
c) In consideration of the seller granting any such extension, it is further
agreed that the cost of obtaining said demolition permit and building permit
approval shall be the sole responsibility of the buyer and the seller shall not
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be liable for any costs therefore. In addition, the buyer shall undertake to
obtain a perimeter plan . . . . 	The cost of obtaining said plan shall be the
responsibility of the buyer and the seller shall not be liable for any costs
therefore.
Paragraph 43, captioned “Post-Termination Agreements,” provided in relevant part:
In the event this Agreement is terminated because of the buyer’s inability to
obtain the permits described in Paragraph 40 hereof:
a. The parties may extend the terms of this Agreement by
mutual agreement;
b. The buyer shall have a right of first refusal upon the sale of
said property. . . .
The Agreement was conditioned upon obtaining both a demolition permit and a
building permit. In paragraph 41 of the Agreement, Vallee and Auburn recognized that
obtaining those permits might be troublesome and require extension of the time for
performance. They stated the following:
The buyer and the seller are aware that residents of the 37 Stratford Road
neighborhood are publicly opposed to the sale of the property by the seller
to a buyer who is intent upon demolishing the existing single family
structure and constructing a two-family residential structure on the site. Said
residents have publicly threatened to file an amendment to the zoning
ordinance to prohibit such construction. The parties are aware and recognize
that the neighbors may object to the hearing before the Newton Historic
Commission for a demolition permit and their opposition may result in a
dely in obtaining such a permit. The seller and the buyer hereby specifically agree
that the seller desires to sell the property and the buyer desires to buy the property
and to proceed immediately with the construction of a two-family residential unit at
the earliest, most practical, reasonable date and, recognizing the difficulties set forth
above, the parties agree to work together to achieve such sale.
(emphasis supplied).
Auburn and Vallee executed three formal extensions of the Agreement. The first
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extension was executed on October 29, 1999 and the last extension was executed on
November 24, 1999. 	In the last extension, the parties agreed to extend the time for
performance until December 8, 1999. The Agreement, however, did not specifically require
the parties to execute written extension agreements.
The parties’ recognition of neighborhood opposition was well-founded. Although
both Robert P. Flaherty (“Flaherty”), Auburn’s principal, and Peter J. Harrington, Esq.
(“Harrington”), Auburn’s attorney, testified that Auburn fully cooperated in the process
of obtaining the requisite permits, Alfonso L. Ferrera (“Ferrera”) commenced an action
against Vallee and the Planning Board of the City of Newton on December 21, 1999 in the
Middlesex Superior Court, Department of the Trial Court. In mid-October, 2000, Vallee
succeeded in obtaining dismissal of the suit. Approximately two years later, however, on
September 10, 2002, the Superior Court entered a judgment annulling the endorsement of
the City Engineer dated October 29, 1999 and remanded the matter to the Newton Planning
Board for further proceedings.
Events intervened to render the Superior Court’s judgment moot. On January 23,
2002, Vallee sold the Property to a third party unrelated to Auburn. Between the time
Ferrera commenced suit in the Superior Court and the time Vallee sold the Property to a
third party, Vallee and Auburn cooperated in pursuing the demolition and building
permits pursuant to paragraph 41 of their Agreement. 	For example, on June 21, 2000,
William and Patricia O’Brien entered into a lease agreement for the Property, captioned
“Tenancy at Will Lease.” Flaherty testified that Ms. O’Brien is his sister-in-law and that the
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lease was intended to defray costs associated with the permitting process.
In the summer of 2000, the Debtor was involved in a proceeding to revoke his
license to practice law before the Board of Bar Overseers for conduct unrelated to the
conduct involved in the instant matter. On October 21, 2000, the Debtor was disbarred.
The Debtor testified that he had incurred substantial legal fees in representing Vallee,
noting that the Agreement involved a considerable amount of litigation and time spent in
meetings with neighbors and City officials. 	With his disbarment pending, the Debtor
stated that he approached Vallee with a proposal pursuant to which he would withdraw
the $17,500 from his IOLTA account to set off against the legal fees which Vallee owed him.
In exchange, Vallee would assume responsibility for Auburn’s deposit because he had a
certificate of deposit in excess of the amount of the deposit. The Debtor testified:
I set off, I set - - after I discussed this with my attorney and obtained advice
from my attorney, who was representing me, and I also spoke with Mike - -
Mr. Fredrickson of the Board of Bar Overseers and asked if something - - that
could be done. Maybe I didn’t get the right advice at that time, . . . but I did
it honestly, sincerely, and based on advised [sic] of counsel, and told Mr.
Harrington that Mr. Vallee was going to be responsible for the deposit, and
Mr. Vallee sent a letter to . . . 	Mr. Harrington indicating that he was
responsible for the deposit and to deal directly with him from - - from then
on.
According to the Debtor, he advised Auburn’s counsel, Harrington, that he intended to use
some of the deposit toward his bills and that Harrington agreed to the proposal.
Additionally, the Debtor produced an unsigned “Notice,” dated February 11, 2001,
pursuant to which Vallee purportedly advised Auburn that it breached the Agreement and
that he intended to retain the deposit as liquidated damages, adding the following: “Also,
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Paragraph 21 of the Agreement provided:1
If the BUYER shall fail to fulfill the BUYER’S agreements herein, all
deposits made hereunder by the BUYER shall be retained by the SELLER
as liquidated damages which shall be sellers [sic] sole remedy at law or in
equity.
Because Vallee assigned his interest in the deposit to Auburn, according to2
Harrington, he was no longer able to proceed before the Clients’ Security Board.
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you are responsible for all costs/fees incurred by the seller who at all times acted diligently
and in good faith under his obligations of said contract. Fees incurred are in addition to
liquidated damages.”1
Although the Debtor testified that he had an agreement with Vallee about Auburn’s
deposit and the payment of his outstanding legal fees, he admitted that Vallee filed an
application with the Clients’ Security Board of the Supreme Judicial Court asking for the
return of the amount of the deposit. 	Moreover, Auburn commenced an action against
Vallee and the Debtor in the Newton District Court with respect to the deposit. Auburn
dismissed the action against Vallee after obtaining an assignment of Vallee’s interest in the
deposit. According to Harrington, Auburn based its decision to dismiss the action against
Vallee upon his affidavit in which he represented that “he never received any money, nor
had he ever agreed to set off any portion of the security deposit against the debt, or
obligation between himself, the trust, or any other person, including John B. Shorton.” 2
Both Harrington and Flaherty unequivocally denied that Auburn breached the
Agreement, and they denied receiving any notice from Vallee that Auburn was in default
with respect to its obligations under the Agreement. Specifically, Harrington testified that
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neither he nor his client received the “Notice” dated February 11, 2001 pursuant to which
Vallee purportedly advised Auburn that it was in default under the Agreement and liable
for liquidated damages in the amount of the deposit and other costs. Harrington also
testified that the Debtor did not notify him that he intended to set off the deposit against
his legal fees and that he would never have authorized such a transaction.
Additionally, Harrington and Flaherty denied knowing that Shorton was disbarred
in October of 2000, although they learned of his disbarment at a later time. Harrington
stated that he and Auburn learned about Shorton’s disbarment about the same time that
his client learned about the January 23, 2002 sale by Valle to a third party.
III. DISCUSSION
In Farley v. Romano (In re Romano), 353 B.R. 738 (Bankr. D. Mass. 2006), this Court
summarized the law applicable to section 523(a)(4) of the Bankruptcy Code. The Court
stated:
Section 523(a)(4) of the Bankruptcy Code provides that “[a] discharge under
section 727 . . . of this title does not discharge an individual debtor from any
debt . . . for fraud or defalcation while acting in a fiduciary capacity,
embezzlement, or larceny.” 11 U.S.C. § 523(a)(4). With respect to a
defalcation, both the existence of a fiduciary relationship and the defalcation
must be proven by a preponderance of the evidence. See Rutanen v. Baylis
(In re Baylis), 313 F.3d 9, 17 (1st Cir.2002); Grogan, 498 U.S. at 286-287, 111
S.Ct. 654. 	In Baylis, the court observed the following with respect to
fiduciary capacity:
Some years ago, the Supreme Court noted that under §
523(a)(4), the exception for fiduciary capacity applies only to
express trusts, and not to equitable trusts created by the
debtor’s conduct. Davis v. Aetna Acceptance Co., 293 U.S. 328,
333, 55 S.Ct. 151, 79 L.Ed. 393 (1934). . . .
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313 F.3d at 17, n.3. In Moore v. Murphy (In re Murphy), 297 B.R. 332
(Bankr.D.Mass.2003), the court reiterated the observation of the First Circuit:
“[t]he definition of ‘fiduciary’ for purposes of § 523(a)(4) has been narrowly
construed. The term applies only to relationships arising out of express or
technical trusts, and not to trusts that are implied in law as a remedy.” Id. at
348. As a result, the existence of fiduciaries duties alone does not establish
fiduciary capacity for purposes of § 523(a)(4), Denton v. Hyman (In re
Hyman), 	320 	B.R. 	493, 	510 	(Bankr.S.D.N.Y.2005), 	aff’d 	335 	B.R. 	32
(S.D.N.Y.2005), although “[m]ost courts today . . . recognize that the
‘technical’ or ‘express’ trust requirement is not limited to trusts that arise by
virtue of a formal trust agreement, but includes relationships in which
trust-type obligations are imposed pursuant to statute or common law.” LSP
Inv. Partnership v. Bennett (In re Bennett), 989 F.2d 779, 784-85 (5th Cir.1993),
cert. denied, 510 U.S. 1011, 114 S.Ct. 601, 126 L.Ed.2d 566 (1993).
Romano, 353 B.R. at 761.
The first issue that the Court must decide is whether the Debtor held Auburn’s
deposit in an express trust. In Aranha v. Eagle Fund, Ltd. (In re Thornhill Global Deposit
Fund, Ltd.), 245 B.R. 1 (Bankr. D. Mass. 2000), aff’d 247 F.3d 328 (1st Cir. 2001), the court
summarized Massachusetts law with respect to escrow agreements. It stated:
In Massachusetts, the term “escrow” can be used with respect to written
instruments as well as to deposits of money. See Childs v. Harbor Lounge of
Lynn, Inc., 357 Mass. 33, 35, 255 N.E.2d 606 (1970); Kaarela v. Birkhead, 33
Mass.App.Ct. 410, 412-13, 600 N.E.2d 608 (1992). The sparse Massachusetts
case law thus defines a deposit in escrow to mean “to deliver it to a third
party to be held until the performance of a condition or the happening of a
certain event.” Childs, 357 Mass. at 35, 255 N.E.2d 606. The third party
escrow agent becomes the fiduciary of both the depositor and the grantee;
she can not remain the agent of either in regards to the deposited funds. See
Birkhead, 33 Mass.App.Ct. at 412-13, 600 N.E.2d 608. The escrow agent has
a duty to keep the deposit and can not dispose of it except pursuant to the
terms of the underlying agreement. See id.
245 B.R. at 12.
The Court finds that paragraph 20 of the Agreement created an express trust which
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imposed fiduciary duties upon the Debtor to place Auburn’s deposit in his IOLTA account,
to account for Auburn’s deposit, and to retain the deposit in the event of a disagreement
“pending instructions mutually given by the SELLER and the BUYER.” (emphasis supplied).
Indeed, IOLTA stands for “Interest on Lawyers’ Trust Accounts,” and Rule 1:15(a)(1)of the
Massachusetts Rules of Professional Conduct defines trust property as “property of clients
or third person that is in a lawyer’s possession in connection with a representation and
includes property held in any fiduciary capacity in connection with a representation
whether as trustee, agent, escrow agent, guardian, executor, or otherwise.” Thus, the Court
finds that the Debtor held Auburn’s deposit in an express trust account and that the
Agreement imposed fiduciary duties upon him as escrow agent with respect to his
handling of the deposit in the escrow account.
The next issue is whether the Debtor committed a defalcation while acting in a
fiduciary capacity. In Rutanen v. Baylis (In re Baylis), 313 F.3d 9 (1st Cir.2002), the First
Circuit 	examined 	the 	level 	of 	culpability 	required 	for 	a 	debt 	to 	be 	declared
nondischargeable under section 523(a)(4) with respect to a defalcation while acting in a
fiduciary capacity. 	It stated “defalcation must mean something other than fraud and
different from ‘willful and malicious injury,” and it must be measured objectively. Id. at
17. The First Circuit explained:
Defalcation may be presumed from breach of the duty of loyalty, the duty
not to act in the fiduciary’s own interest when that interest comes or may
come into conflict with the beneficiaries’ interest:
A trustee occupies a position in which the courts have fixed a
very high and very strict standard for his conduct whenever
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his personal interest comes or may come into conflict with his
duty to the beneficiaries. As long as he is not acting in his own
interest the standard fixed for his behavior is only that of a
reasonable degree of care, skill, and caution. But when the
trustee acts in his own 	interest in connection with the
performance of his duties as trustee, the standard of behavior
becomes more rigorous. In such a case his interest must yield
to that of the beneficiaries.
2A id. § 170.25. As with the other fault-based exceptions, fault may be
presumed from the circumstances, here a violation of the duty of loyalty.
313 F.3d at 20-21.
The Court finds that the Debtor committed a defalcation while acting in a fiduciary
capacity. Not only did he breach the express terms of the escrow, he was acting in his own
self-interest when he elected to utilize Auburn’s deposit for the payment of his outstanding
legal fees at a time when he was aware that he was about to lose his license to practice law
in the Commonwealth. Vallee’s certificate of deposit over which he had unfettered control
was not a substitute for or equivalent to a trust account.
The Debtor was obligated to act as a fiduciary for his client, Vallee, and Auburn with
respect to Auburn’s deposit. His unilateral decision to set off Auburn’s deposit against the
legal fees owed to him by Vallee was a breach of his fiduciary duty and contrary to the
express terms of paragraph 20 of the Agreement. His action was motivated by self-interest,
and his testimony that Vallee’s certificate of deposit was an adequate substitute was both
unsubstantiated by corroborating evidence as to its existence and amount and, more
significantly, incredible.
The Debtor attempted to justify his unilateral action with respect to Auburn’s
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deposit with reference to Auburn’s alleged breach of the Agreement. 	His testimony,
however, was unpersuasive. Although the parties executed several documents extending
the time for performance, and paragraph 8 of the Agreement provided that “time is of the
essence,” paragraph 39 and the provisions of paragraphs 40, 41, and 43, all of which were
set forth in the Rider to the Agreement, contradict that provision. The Agreement, as a
whole, reflects the parties’ intention to work together to resolve the issues pertaining to
acquisition of the permits and neighborhood opposition. The parties’ execution of various
extension agreements was superfluous in view of the provisions expressing their intention
to extend the time of performance until the permits were obtained. Indeed, paragraph 43
of the Agreement provided that even after termination “[t]he parties may extend the terms
of this Agreement by mutual agreement” if Auburn was unable to obtain the permits.
Thus, the Court finds that the Agreement was not terminated because of the absence of
written extensions or breach of the Agreement by Auburn. On the contrary, it appears that
Vallee breached the Agreement by failing to provide Auburn with a right of first refusal
in advance of conveying the Property to a third party on January 23, 2002 pursuant to
paragraph 43 of the Agreement.
Although the Debtor produced a Notice, which he testified Vallee signed and mailed
to Auburn in his presence, that Notice, which was dated February 11, 2001, was provided,
if at all, approximately four months after his disbarment and approximately six months
after he testified the he exchanged Auburn’s deposit for Vallee’s certificate of deposit. In
the spring and summer of 2000, the parties were working together to resolve the various
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issues relating to the permitting process. Vallee and the O’Briens had executed a Tenancy
at Will Agreement and the litigation in the Middlesex Superior Court was proceeding with
the involvement of the Debtor who had succeeded in obtaining dismissal of Ferrera’s
Complaint just days before his disbarment. Thus, if Auburn breached the Agreement, it
did so after the Debtor applied its deposit to his legal fees. The Debtor applied the deposit
to his legal fees without notice to Auburn of his intention to do so, without providing
Auburn with an opportunity to object to the termination of the escrow, without notice to
Auburn that it was in breach of its commitments under the Agreement, and without
providing Auburn with an opportunity to enforce paragraph 20 of the Agreement. The
Debtor’s conduct violated the duty of loyalty described in Baylis, 313 F.3d at 20, and
constituted a defalcation while acting in a fiduciary capacity.
IV. CONCLUSION
In view of the foregoing, the Court finds the Debtor’s obligation to Auburn is
nondischargeable pursuant to 11 U.S.C. § 523(a)(4). The Court shall enter judgment in favor
of Auburn and against the Debtor.
By the Court,
Joan N. Feeney
United States Bankruptcy Judge
Dated: December 3, 2007
cc: John B. Shorton, N. Jeannette Robinson, Esq.
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