Haig et al v. Shart et al

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UNITED STATES BANKRUPTCY COURT
CENTRAL DISTRICT OF CALIFORNIA
LOS ANGELES DIVISION
In re:
John Shart and Elke Gordon-Schardt,
Debtor(s).
CHAPTER 7
Case No.: 2:10-bk-29973-BR
Adv. No: 2:10-ap-02555-BR
MEMORANDUM OF DECISION
DETERMINING THAT IMPUTATION OF
FRAUD COMMITTED BY
DEBTOR/HUSBAND TO DEBTOR/SPOUSE
IS UNWARRANTED UNDER § 523(a)(2)(A)
Wendy Haig, Greg Sadler, and
Showcase 81, LLC,
Plaintiff(s),
v.
John Shart and Elke Gordon-Schardt,
Defendant(s).
Date: December 11, 2013
Time: 10:00 a.m.
Courtroom: 1660
255 East Temple Street
Los Angeles, CA 90012
This matter is before the Court on remand from the Bankruptcy Appellate
Panel, which stated:
. . . While we AFFIRM the bankruptcy court’s
FILED & ENTERED
JAN 29 2014
CLERK U.S. BANKRUPTCY COURT
Central District of California
BY DEPUTY CLERK	fortier
FOR PUBLICATION
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determination that Ms. Schardt was not directly liable
for fraud, we VACATE in part the bankruptcy court’s
judgment and REMAND the action to the bankruptcy
court to consider whether Ms. Schardt’s spouse’s fraud
may be imputed to her.
BAP Memorandum, 2:6 – 2:10.
For the reasons stated below, I am of the firm belief that imputation of the
fraud of John Shart to his wife Elke Gordon-Schardt is unwarranted under §
523(a)(2)(A) and is hostile to the well accepted principle that Congress intended
to enact bankruptcy law “by which the honest citizen may be relieved from the
burden of hopeless insolvency.” Neal v. Clark, 95 U.S. 704, 709 (1877).
The Origin of the Imputation of Fraud in Non-Dischargeability Proceedings
The source of the imputation of fraud to an otherwise innocent person is
Strang v. Bradner, 114 U.S. 555 (1885), a five page opinion in which the U.S.
Supreme Court held that under § 33 of the Bankruptcy Act of 1867, the fraud of
one partner could be imputed to the other partner for the purpose of exceptions to
discharge. The entire discussion of the imputation of fraud is found in the last
paragraph of the decision. Unfortunately, it is purely conclusory.
I have no quarrel with its statement that outside of bankruptcy a partner is
liable for the fraud of another partner and its citations to cases standing for that
general proposition. However, I strongly disagree with its conclusion and giant
leap that, therefore, the fraud could be imputed to the partner for purposes of
exceptions to discharge. This makes no sense to me. Of course the partners
were liable for all partnership debts. However, there was no reason to equate
liability with exceptions to discharge.
The last paragraph of the opinion states:
The only other question to be determined is whether
the defendants John B. Holland and Joseph Holland
can be held liable for the false and fraudulent
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representations of their partner, it being conceded that
they were not made by their direction nor with their
knowledge. Whether this action be regarded as one to
recover damages for the deceit practiced upon the
plaintiffs, or as one to recover the amount of a debt
created by fraud upon the part of Strang, we are of
opinion that his fraud is to be imputed, for the
purposes of the action, to all members of his firm. The
transaction between him and the plaintiffs is to be
deemed a partnership transaction, because, in addition
to his representation that the notes were for the benefit
of his firm, he had, by virtue of his agency for the
partnership, and as between the firm and those
dealing with it in good faith, authority to negotiate for
promissory notes and other securities for its use. Each
partner was the agent and representative of the firm
with reference to all business within the scope of the
partnership. And if, in the conduct of partnership
business, and with reference thereto, one partner
makes false or fraudulent misrepresentations of fact to
the injury of innocent persons who deal with him as
representing the firm, and without notice of any
limitations upon his general authority, his partners
cannot escape pecuniary responsibility therefor upon
the ground that such misrepresentations were made
without their knowledge. This is especially so when,
as in the case before us, the partners, who were not
themselves guilty of wrong, received and appropriated
the fruits of the fraudulent conduct of their associate in
business. Stockwell v. U.S. 13 Wall. 547, 548; Story,
Partn. §§ 1, 102, 103, 107, 108, 166, 168; Chester v.
Dickerson, 54 N.Y. 1; Locke v. Stearns, 1 Metc. 560;
Lothrop v. Adams, 133 Mass. 481; Blight’s Heirs v.
Tobin, 7 T. B. Mon. 617; Durant v. Rogers, 87 Ill. 508;
Colly. Partn. (Wood’s Ed.) §§ 446, 449, 450; Lindl.
Partn. (Ewell’s Ed.) § 302.
Id. at 561-62.
Eight years prior to Strang, the U.S. Supreme Court in Neal v. Clark, 95
U.S. 704 (1877) held that “fraud” means actual or positive fraud, and not just fraud
implied by law. Neal v. Clark was decided under the Bankruptcy Act of 1867.
That Act provided that “no debt created by the fraud or embezzlement of the
bankrupt, or by defalcation as a public officer, or while acting in a fiduciary
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capacity, shall be discharged under this Act.” Id. at 706.
The facts of Neal v. Clark are straightforward. Neal bought two bonds from
an estate in a transaction with the estate executor. Subsequently, Clark became
a surety of the estate and sued the executor, Neal, and others alleging that the
bonds had been sold below market value and the sale thus constituted a
fraudulent waste of estate assets. The lower court agreed, finding Neal guilty of
constructive, but not actual, fraud. After he purchased the bonds, but before Clark
filed suit, Neal was adjudicated a bankrupt under the bankruptcy law of 1867. He
therefore pleaded his bankruptcy discharge as a defense in Clark’s action
regarding the bonds.
Speaking for the Court, Justice Harlan announced that Congress intended
to enact bankruptcy law “by which the honest citizen may be relieved from the
burden of hopeless insolvency.” Id. at 709. For a debt to be non-dischargeable
because it was created by “fraud,” the fraud had to be a “positive fraud, or fraud in
fact, involving moral turpitude or intentional wrong … and not implied fraud, or
implied in law, which exist without the imputation of bad faith or immorality.” Id.
Recent U.S. Supreme Court cases make it clear that imputation of fraud
would not be proper under § 523(a)(2). Most recently, in Bullock v.
BankChampaign, N.A., 133 S.Ct. 1754 (2013), the Supreme Court held that the
term “defalcation,” as used in the section of the Bankruptcy Code excepting from
discharge a debt “for fraud or defalcation while acting in a fiduciary capacity,
embezzlement, or larceny,” requires a culpable state of mind requirement
involving knowledge of, or gross recklessness in respect to, the improper nature
of the relevant fiduciary behavior.
The Supreme Court, in reaching its decision, referred to Justice Harlan’s
opinion in Neal v. Clark:
We base our approach and our answer upon
one of this Court's precedents. In 1878, this Court
interpreted the related statutory term “fraud” in the
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portion of the Bankruptcy Code laying out exceptions
to discharge. Justice Harlan wrote for the Court:
“[D]ebts created by ‘fraud’ are associated
directly with debts created by
‘embezzlement.’ Such association
justifies, if it does not imperatively
require, the conclusion that the ‘fraud’
referred to in that section means positive
fraud, or fraud in fact, involving moral
turpitude or intentional wrong, as does
embezzlement; and not implied fraud, or
fraud in law, which may exist without the
imputation of bad faith or immorality.
Neal v. Clark, 97 U.S. 704, 709, 24 L.Ed.
586 (1878).
We believe that the statutory term “defalcation” should
be treated similarly.
Thus, where the conduct at issue does not
involve bad faith, moral turpitude, or other immoral
conduct, the term requires an intentional wrong. We
include as intentional not only conduct that the
fiduciary knows is improper but also reckless conduct
of the kind that the criminal law often treats as the
equivalent. Thus, we include reckless conduct of the
kind set forth in the Model Penal Code. Where actual
knowledge of wrongdoing is lacking, we consider
conduct as equivalent if the fiduciary “consciously
disregards” (or is willfully blind to) “a substantial and
unjustifiable risk” that his conduct will turn out to violate
a fiduciary duty. ALI, Model Penal Code § 2.02(2)(c),
p. 226 (1985). See id., § 2.02 Comment 9, at 248
(explaining that the Model Penal Code's definition of
“knowledge” was designed to include “ ‘wilful
blindness' ”). That risk “must be of such a nature and
degree that, considering the nature and purpose of the
actor's conduct and the circumstances known to him,
its disregard involves a gross deviation from the
standard of conduct that a law-abiding person would
observe in the actor's situation.” Id., § 2.02(2)(c), at
226 (emphasis added). Cf. Ernst & Ernst v.
Hochfelder, 425 U.S. 185, 194, n. 12, 96 S.Ct. 1375,
47 L.Ed.2d 668 (1976) (defining scienter for securities
law purposes as “a mental state embracing intent to
deceive, manipulate, or defraud”).
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Bullock, 133 S.Ct. at 1759-60.
The Supreme Court further stated:
Third, the interpretation is consistent with the
long-standing principle that “exceptions to discharge
‘should be confined to those plainly expressed.’ ”
Kawaauhau v. Geiger, 523 U.S. 57, 62, 118 S.Ct. 974,
140 L.Ed.2d 90 (1998) (quoting Gleason v. Thaw, 236
U.S. 558, 562, 35 S.Ct. 287, 59 L.Ed. 717 (1915)).
See Local Loan Co. v. Hunt, 292 U.S. 234, 244, 54
S.Ct. 695, 78 L.Ed. 1230 (1934); Neal, supra, at 709.
It is also consistent with a set of statutory exceptions
that Congress normally confines to circumstances
where strong, special policy considerations, such as
the presence of fault, argue for preserving the debt,
thereby benefiting, for example, a typically more
honest creditor. See, e.g., 11 U.S.C. § 523(a)(2)(A),
(a)(2)(B), (a)(6), (a)(9) (fault). See also, e.g., §
523(a)(1), (a)(7), (a)(14), (a)(14A) (taxes); § 523(a)(8)
(educational loans); § 523(a)(15) (spousal and child
support).
Id. at 1760-61.
The Supreme Court followed similar reasoning in Kawaauhau v. Geiger,
523 U.S. 57 (1998), with regard to § 523(a)(6) “willful and malicious injury.” The
Supreme Court held that only acts with the intent to cause injury are sufficient for
non-dischargeability under 523(a)(6) and “reckless” and “negligent” acts are not.
This echoes the Supreme Court holdings that intent and fault are the essential
factors for non-dischargeability (at least for § 523(a)(2)(4) and (6)).
Moreover, to deny an innocent partner of her discharge based solely on the
imputation of fraud runs counter to a basic principle of the Bankruptcy Code,
which is to give an “honest debtor” a “fresh start.” The Supreme Court recently
emphasized this underlying principle stating “This Court has certainly
acknowledged that a central purpose of the Code is to provide a procedure by
which certain insolvent debtors can reorder their affairs, make peace with their
creditors, and enjoy ‘a new opportunity in life with a clear field for future effort,
unhampered by the pressure and discouragement of preexisting debt.’” Grogan v.
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Garner, 498 U.S. 279, 286 (1991) (quoting Local Loan Co. v. Hunt, 292 U.S. 234,
244 (1934)).
In light of the Supreme Court’s recent rulings in Grogan, Geiger, and
especially Bullock, I am certain that given the opportunity today, the Supreme
Court would not impute fraud to preclude dischargeability to an otherwise innocent
partner who had no culpability other than being a partner.
Legislative History
When Congress enacted the Bankruptcy Code of 1978, it made few
changes to what was formerly § 17 of the Bankruptcy Act. Former § 17 rendered
an obligation incurred as a result of fraud non-dischargeable. The legislative
history provides that “[this] provision is modified only slightly from current section
17(a)(2). First, ‘actual fraud’ is added as a ground for exception from discharge.”
S. Rep. No.989, 95th Cong., 2d Sess. 77-79, reprinted in 1978 U.S.C.C.A.N.
5787, 5864. The legislative history further evidences that “Subparagraph (A) is
intended to codify current law, e.g., Neal v. Clark, 95 U.S. 704 (1887), which
interprets ‘fraud’ to mean actual or positive fraud rather than fraud implied by law.”
124 Cong. Rec. H11,095-96 (Daily Ed. Sept. 28, 1978); 124 Cong. Rec. S17,412-
13 (Daily Ed. Oct. 6, 1978) (remarks of Rep. Edwards and Sen. DeConcini).
Congress clearly approved the Neal v. Clark “actual fraud” requirement, but made
no mention of Strang v. Bradner, which held that an innocent debtor could not
discharge a debt incurred by the fraudulent actions of a partner and merely
imputed to the debtor. Congress had ample opportunity to codify Strang, just as
they had done for Neal, but Congress made no attempt to do so.
Ninth Circuit Cases
The Ninth Circuit has only dealt with the issue of imputing fraud for non-
dischargeability purposes in two cases: In re Cecchini, 780 F.2d 1440 (1986),
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and In re Lansford, 822 F.2d 902 (1987).
In In re Cecchini, a six page opinion, the Ninth Circuit found that the
debtor’s conversion of a hotel owner’s funds was non-dischargeable under §
523(a)(6) as “willful and malicious conduct.” The Court also held that the partners’
knowledge and intent was imputed to another debtor and thus non-dischargeable.
The Ninth Circuit stated:
Second, although there is no evidence in the
record concerning Robustelli’s direct involvement in
converting the funds, it is undisputed that Robustelli
and Cecchini were partners and in the ordinary course
of the business of the partnership when he converted
the funds. Robustelli, at a minimum, participated in the
benefits of the conversion, as evidenced by his
entering into the stipulated judgment in favor of
plaintiff. Therefore, applying basic partnership law,
Cecchini’s knowledge and intent are imputed to
Robustelli. [citation omitted] We find that, as to
Robustelli as well, the debt cannot be discharged.”
Id. at 1444.
The Ninth Circuit offered no analysis as to why it is proper to impute willful
and malicious conduct in a non-dischargeability context. Again, no one disputes
that under state law a person is liable for their partners “wilful and malicious
conduct,” but to impute this for non-dischargeability purposes in a bankruptcy
context is an unfounded leap. This case has generated much criticism, and less
than a year later the Ninth Circuit decided In re Lansford, 822 F.2d 902 (1987),
which appears to put in serious question the viability of Cecchini.
In re Lansford, authored by now-Supreme Court Justice Kennedy, dealt
with fraud under § 523(a)(2). The debtor and his wife sold a restaurant after
submitting fraudulent documents to the seller. The debtors later filed bankruptcy
and still owed $235,000 of unsecured debt to the sellers. The Ninth Circuit found
that both the debtor and his wife had committed fraud and therefore they could not
receive a discharge for their debt, which was created by their fraud.
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Nevertheless, Judge Kennedy, speaking for the Ninth Circuit, went out of his way
to discuss the possibility of basing non-dischargeability on agency principles, i.e.,
imputation of fraud.
Were the record devoid of evidence from which
to infer that Cecily Lansford was in some way culpably
responsible for the fraudulent financial statement, we
would be faced with the difficult legal issue of whether
her debt would nevertheless be non-dischargeable by
virtue of principles of agency. In In re Cecchini, 780
F.2d 1440 (9th Cir.1986), this court cited basic
partnership law to hold that a business partner's debt
was non-dischargeable because he had “participated
in the benefits” of his partner's misconduct, which had
been undertaken on behalf of the partnership and in
the ordinary course of business. Id. at 1444. Were we
to rely on strict agency or partnership principles, we
might be forced to conclude that Cecily Lansford's debt
is non-dischargeable regardless of her knowledge of
the fraud or her own culpability. In light of the
bankruptcy code's purpose of providing a fresh start,
see Gleason v. Thaw, 236 U.S. 558, 562, 35 S.Ct.
287, 289, 59 L.Ed. 717 (1915), and the decisions of
other circuits refusing to apply agency principles
absent some culpability on the part of the party to be
charged, see In re Walker, 726 F.2d 452, 454 (8th
Cir.1984) (per curiam); In re Bardwell, 610 F.2d 228,
229 (5th Cir.1980) (per curiam); David v. Annapolis
Banking & Trust Co., 209 F.2d 343, 344 (4th Cir.1953);
In re Lovich, 117 F.2d 612, 614-15 (2d Cir.1941), we
believe the breadth of the proposition stated in
Cecchini deserves more thorough consideration before
its application to the circumstances presented in this
case.
Lansford, 822 F.2d at 904-05.
More recently, the Ninth Circuit echoed the same sentiment in In re
Sherman, 658 F.3d 1009 (9th Cir. 2011). The question there was whether the
exception to discharge for violations of state or federal securities laws under §
523(a)(19) applies when the debtor himself is not culpable for the securities
violation that caused the debt. The debtor was an attorney who represented
some companies guilty of violating securities laws. The debtor had some of the
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companies’ money which he had not earned and was forced to disgorge. The
debtor filed bankruptcy and the issue was whether this debt was non-
dischargeable under § 523(a)(19). It is important to note that the debtor was not
found to have himself violated any of the securities laws. The Court stated:
We hold that § 523(a)(19) prevents the discharge of
debts for securities-related wrongdoings only in
cases where the debtor is responsible for that
wrongdoing. Debtors who may have received funds
derived from a securities violation remain entitled to
a complete discharge or any resulting disgorgement
order.
Id. at p. 1019.
The following analysis in Sherman indicates to me that the Ninth Circuit
would not allow imputation of fraud regarding § 523(a)(2)(A). The Court stated:
For example, 523(a)(2)(A) creates an
exception to discharge for debts “for money,
property, services, or an extension, renewal, or
refinancing of credit, to the extent obtained by ...
actual fraud.” Even though the text of the statute
does not state that the fraudulent conduct must have
been the debtor's, we have nonetheless incorporated
that assumption into our understanding of the
provision. See, e.g., Ghomeshi v. Sabban (In re
Sabban), 600 F.3d 1219, 1222 (9th Cir.2010)
(“[M]aking out a claim of non-dischargeability under §
523(a)(2)(A) requires the creditor to demonstrate ...
[that] the debtor made representations; ... that at the
time he knew they were false; [and] that he made
them with the intention and purpose of deceiving the
creditor.” (emphasis added)); Citibank v. Eashai (In
re Eashai), 87 F.3d 1082, 1086 (9th Cir.1996) (“[T]o
prove actual fraud, a creditor must establish ... that
the debtor made the representations....” (emphasis
added)). In fact, we have recently suggested that the
debtor's involvement in the fraudulent activity might
be the only relevant consideration in determining
whether the exception applies. See Sabban, 600
F.3d at 1222 (holding that a debtor need not have
received a benefit from the fraudulent activity in order
for § 523(a)(2)(A) to prevent a discharge).
We have read § 523(a)(4) in a similar fashion.
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Although the statute only prohibits the discharge of
debts “for fraud or defalcation while acting in a
fiduciary capacity, embezzlement, or larceny”—
again, without any mention that the misconduct must
have been by the debtor—we have strongly
suggested that it applies only in cases where the
debtor is responsible for the misconduct. See, e.g.,
CalMicro, Inc. v. Cantrell (In re Cantrell), 329 F.3d
1119, 1128 (9th Cir.2003) (rejecting a claim under §
523(a)(4) because the defendant was not a
fiduciary).
A contrary reading of these provisions would
extend the discharge exceptions to the “honest but
unfortunate debtor,” Local Loan Co. v. Hunt, 292
U.S. 234, 244, 54 S.Ct. 695, 78 L.Ed. 1230 (1934), in
cases where the debtor was unwittingly involved
with, and unknowingly received benefits from, a
wrongdoer. For example, suppose we had not
construed § 523(a)(2)(A) to apply only in those cases
where the debtor committed the fraud. Suppose,
further, that a bank loaned money to an innocent
person under the express condition that the loan be
guaranteed by a third party who had greater assets.
If the third party lies about his assets in order to
qualify to be the guarantor, then the borrower will
have, in effect, obtained “money ... by ... false
pretenses, a false representation, or actual fraud,”
even if she did not know or have reason to know
about the guarantor's misconduct. If she is
subsequently unable to repay her loan and is driven
to bankruptcy, we think it would contravene the “fresh
start” purposes of the system to deny her a discharge
on the basis of a third party's misconduct.
Admittedly, nothing in the text of any of these
provisions makes it clear that the exceptions should
apply only to debtors who are responsible for the
wrongdoing that caused the debt. However, the
government's rule would require us to adopt the
opposite presumption: that exceptions should be
applied broadly unless expressly confined to guilty
debtors. We do not think the structure of § 523,
taken alone, enables us to resolve this question. We
must therefore examine § 523(a)(19) in light of the
purposes of the Bankruptcy Code.
. . .
Although § 523(a)(19)'s text and structure do
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not resolve the dispute before us, we believe that
guidance from Supreme Court, as well as our
previous opinions, strongly favor the bankruptcy
court's interpretation of the statute. At the core of the
Bankruptcy Code are the twin goals of ensuring an
equitable distribution of the debtor's assets to his
creditors and giving the debtor a “fresh start.” See
BFP v. Resolution Trust Corp., 511 U.S. 531, 563,
114 S.Ct. 1757, 128 L.Ed.2d 556 (1994). Put simply,
the Bankruptcy Code accomplishes this goal by
including the bulk of the debtor's property in the
bankruptcy estate, see 11 U.S.C. § 541(a),
distributing that property to creditors in accordance
with various provisions of the Code, and finally
discharging the debtor's remaining debts unless
those debts either fall into an exception or there is
reason to deny a discharge altogether, see id. §
727(a). Accordingly, the exceptions to discharge
enumerated in § 523 necessarily prevent a debtor
from receiving a completely fresh start, as the debt
remains a burden even after all other debts are
legally satisfied.
With this in mind, the Supreme Court has
adopted a rule of construction interpreting exceptions
to discharge narrowly. See Kawaauhau v. Geiger,
523 U.S. 57, 62, 118 S.Ct. 974, 140 L.Ed.2d 90
(1998) (“[E]xceptions to discharge should be
confined to those plainly expressed” (internal
quotation marks omitted)); Jett v. Sicroff (In re
Sicroff), 401 F.3d 1101, 1104 (9th Cir.2005); see also
4 COLLIER ON BANKRUPTCY ¶ 523.05 (2010) (“In
determining whether a particular debt falls within one
of the exceptions of § 523, the statute should be
strictly construed against the objecting creditor and
liberally in favor of the debtor. Any other construction
would be inconsistent with the liberal spirit that has
always pervaded the entire bankruptcy system.”).
We also recognize that the Bankruptcy Code “limits
the opportunity for a completely unencumbered new
beginning to the ‘honest but unfortunate debtor.’ ”
Grogan v. Garner, 498 U.S. 279, 286–87, 111 S.Ct.
654, 112 L.Ed.2d 755 (1991). Taken together, these
two basic principles suggest that exceptions to
discharge should be limited to dishonest debtors
seeking to abuse the bankruptcy system in order to
evade the consequences of their misconduct.
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Likewise, if we adopt the government’s
interpretation of § 523(a)(19), an innocent recipient
of funds obtained by another party’s participation in a
securities violation can not only be ordered to
disgorge, but must also continue paying off that debt
even if he becomes insolvent and is forced to file for
bankruptcy. Although we do not dispute Colello’s
conclusion that a court may order recipients of these
funds to disgorge any funds that remain in their
possession, we do not think Congress wanted to
immunize these debts from discharge in bankruptcy,
when the debtor has not been found guilty of any
wrongdoing.
Sherman, 658 F.3d at 1014-16.
Even if Strang Were Still Viable, It Must Be Strictly Limited to the Imputation of
Fraud to an Actual Partner Under Applicable Law
In our case at hand, the BAP affirmed my determination that Ms. Schardt
was not directly liable for fraud. Therefore, even if we were to assume, arguendo,
that fraud may be imputed to a partner for § 523(a)(2)(A) purposes, no such
imputation would be proper for Ms. Schardt under the facts of this case.
Facts of This Case
As articulated by the BAP in its Memorandum, the facts are as follows:
FACTS
Ms. Haig and Mr. Sadler are a married couple
who lived in Santa Fe, New Mexico. They are active
equestrians, own horses, and participate in horse
shows.
Ms. Schardt is married to John Hans Shart
(“Mr. Shart” and, together with Ms. Schardt,
“Debtors”). Mr. Shart lives in Lynville, Tennessee;
Ms. Schardt resides in Acton, California. Mr. Shart is
the 100 percent owner of Malibu Equestrian Estates,
Inc. (“MEE”). Mr. Shart and MEE operated a horse-
related business under the business name
Greystone Equestrian Center (“Greystone”) in
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Lynville, Tennessee. The 85-acre parcel where
Greystone operates is owned jointly by Mr. Shart and
Ms. Schardt (the “Farm”). Ms. Schardt is an attorney
with a law practice in Acton, California.
From 2002 through 2008, Creditors purchased
horses from Shart or MEE. Until early 2007, all of
the purchased horses were boarded at facilities in
New Mexico not affiliated with Mr. Shart or MEE.
Ms. Haig and Mr. Shart developed both a
business relationship and friendship from 2002
through 2008. Ms. Haig would purchase horses and
rely on Mr. Shart for training advice. They met
socially, with Ms. Haig occasionally staying at
Greystone.
Even in the early period of their relationship,
there was considerable confusion over Mr. Shart’s
billing for the purchase and care of Creditors’ horses.
On or about November 22, 2006, Ms. Haig sent Mr.
Shart a letter, listing payments she had made to
Mr. Hart or MEE between May 2005 and September
2006 totaling $1,849,000.00, alleging that the
payments were a combination of purchases and
loans, and asking Mr. Shart’s help in identifying the
purpose of each payment.
In February 2007, Ms. Haig and Mr. Shart
attended a horse show in Gulfport, Mississippi.
While at the Gulfport show, Ms. Haig agreed to have
at least the majority of her horses boarded and
trained at Greystone. Between March 2007 and
December 2008, Creditors boarded on average
twenty to twenty-five horses at Greystone.
On or about January 23, 2007, Ms. Haig
allegedly purchased two motor homes, paying
$245,495.00 for the first (“Motor Home 1") and
$240,973.00 for the second (“Motor Home 2"). The
purchases were negotiated and implemented with
the dealer by Mr. Shart. Title to Motor Home 1 was
placed in Ms. Haig’s name, but title to Motor Home 2
was placed in Mr. Shart’s name. Ms. Haig would
later claim that she instructed Mr. Shart to place title
to both motor homes in her name.
In 2007, Mr. Shart constructed a barn to
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house some of Creditors’ horses (the “Barn”) and to
provide living quarters for Ms. Haig during Greystone
visits and to provide four suites for grooms. It is
disputed whether Mr. Shart or Ms. Haig provided the
funds for the Barn’s construction. Ms. Haig also
argued that Mr. Shart promised to construct the Barn
as an incentive for Creditors to board the horses at
Greystone.
On May 10, 2007, Jerry and Beverly Flowers
recorded a deed transferring a fourteen-acre parcel
adjacent to the Farm to Mr. Shart (the “Flowers
Land”). Title was vested in Mr. Shart, but the parties
dispute whether Debtors or Creditors provided the
funds for the purchase of the Flowers Land, and
whether title should have been vested in Mr. Shart or
Ms. Haig.
On September 14, 2007, Ms. Haig allegedly
paid $162,250.43 for the purchase of a Kenworth
truck. Mr. Shart negotiated the purchase with the
dealer. Title to the truck was placed in the name of
Greystone. In her testimony, Ms. Haig alleged that,
although she authorized Mr. Shart to negotiate the
purchase of the truck, she expressly instructed him to
title the truck in her name.
Between 2007 and 2009, there were
continuing disputes between Debtors and Creditors
regarding boarding fees, documentation on invoices,
and the authority of Mr. Shart to sell horses stabled
by Creditors at Greystone. In one instance, two of
Creditors’ horses were sold by Mr. Shart on
December 18, 2008. Ms. Haig was present and
objected to the sale. Given the parties’ escalating
disagreements, on January 7-9, 2009, Creditors’
representatives traveled to the Farm to pick up the
remaining horses. Mr. Shart demanded payment
from Creditors of alleged and disputed arrearages
before releasing the horses, and eventually ordered
Creditors’ representatives to leave without
recovering the horses.
On February 9, 2009, Creditors sued Mr.
Shart, Ms. Schardt, and MEE in state court. Haig v.
Shart, dkt. no. 4394 (Chancery Ct., Giles Cnty.,
Tennessee, February 9, 2009). The complaint
alleged that the defendants made multiple
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misrepresentations to Creditors regarding the
acquisition and sale of horses, and that there were
disputed expenses for trade shows, construction
costs, real estate, personal property acquisitions, and
other matters related to the defendants’ activities on
behalf of Creditors. Notably, the complaint focused
on the actions of Mr. Shart, and only sought recovery
against Ms. Schardt for “unjust enrichment.” On
March 9, 2009, the Tennessee Chancery Court
entered an Agreed Temporary Injunction, prohibiting
Debtors from selling any additional horses or
personal property owned by Creditors, including the
Kenworth truck.
Creditors’ representatives returned to the
Farm on March 5, 2009, to remove the remaining
horses and personal property of Creditors. Mr. Shart
permitted them to remove eleven horses and some
other items of property.
By April 2009, Creditors had determined that
at least five of their horses were still stabled at
Greystone. The state court entered an order
granting Creditors possession of the horses, their
request for injunctive relief, and authorization to
inspect the Greystone premises. The bankruptcy
court would ultimately find that Creditors never
recovered seven of their horses.
In November 2009, Mr. Shart sold the
Kenworth truck to MHC Kenworth for $80,000.
Debtors filed a chapter 11 petition in the
Central District of California on May 18, 2010.
Debtors indicated in their schedule A that they
owned the Barn and the Flowers Land. Schedule F
listed a disputed, contingent, and unliquidated debt
to Creditors for $1 million. On September 21, 2010,
the bankruptcy court converted Debtors’ case to a
chapter 7 case, and a trustee was appointed.
Creditors filed a proof of claim in the
bankruptcy case on January 21, 2011, in the amount
of $2,600,000. Debtors objected to the claim on
June 3, 2011, arguing that they did not owe the
money.
Meanwhile, on August 23, 2010, Creditors
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filed an adversary proceeding against Debtors. As
amended on March 9, 2011, Creditors’ complaint
alleged that Debtors made misrepresentations to
Creditors with the intent of deceiving them into
paying $1.1 million to construct the Barn and
purchase the Flowers Land, among other things, and
that this debt should be excepted from discharge
under § 523(a)(2)(A). The complaint further alleged
that Debtors had engaged in fraud or defalcations as
fiduciaries related to the $1.1 million, and that the
debt should be excepted from discharge under §
523(a)(4). Finally, the complaint asserted that
Debtors willfully, maliciously, and intentionally injured
the Creditors and converted their property and the
resulting debt should be excepted from discharge
under § 523(a)(6). In an answer filed on April 6,
2011, Debtors generally disputed these allegations.
On December 29, 2011, the bankruptcy court
approved the parties’ Joint Pretrial Order both setting
forth undisputed facts (which are incorporated in this
factual discussion), and outlining the disputed issues
of fact and law.
Over several months, the bankruptcy court
conducted a five-day consolidated trial concerning
Debtors’ objection to Creditors’ claim, and Creditors
§ 523(a) complaint, which concluded on July 25,
2012. In addition to the documentary evidence
submitted by the parties, the bankruptcy court heard
testimony from numerous witnesses, including Ms.
Haig, Mr. Sadler, Mr. Shart and Ms. Schardt.
After listening to the parties’ closing
arguments, the bankruptcy court orally announced its
decision. In part, the court stated that Mr. Shart’s
“credibility, quite frankly, is zero as far as I’m
concerned. . . . It was clear to me that he will say
and did say at any time in this case what he wanted
to.” Trial Tr. 101:14-23, July 25, 2012. The court
then concluded that it agreed with all arguments
made by Creditors that Mr. Shart had intentionally
made false statements to Haig. Trial Tr. 102:1-2.
The court examined each component of Creditor’s
claim, ruling which components would be allowed,
which would be excepted from discharge, and which
would not.
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As to Creditors’ § 523(a) claims against Ms.
Schardt, the bankruptcy court concluded that she
had not been actively involved in the fraudulent
behavior and representations of Mr. Shart: “Other
than let’s say at the end helping with e-mails and
things, I don’t think she had anything to do with the
actual transactions which are the basis for the claims
as well as nondischargeability.” Trial Tr. 100:21-25.
Having concluded that she had nothing to do with the
false representations or fraudulent activity of Mr.
Shart, the bankruptcy court determined that
Creditors’ claims against her would not be excepted
from discharge. In particular, as to Creditors’
arguments that Ms. Schardt could be held liable
because a spouse’s fraud can be imputed to the
other spouse under principles of agency and
partnership, the court ruled “I don’t think there’s any
imputation[.]” Trial Tr. 100:3-4. The court provided
no explanation and made no findings to support that
ruling, except to question the correctness of the
Panel’s decision in Tsurukawa v. Nikon Precision,
Inc. (In re Tsurukawa), 287 B.R. 515 (9th Cir. BAP
2002) (Tsurukawa II).
On September 13, 2012, the bankruptcy court
entered a judgment in favor of Creditors and against
Mr. Shart for $860,726.43 as a debt excepted from
discharge under § 523; although the judgment did
not specify which subsection of that statute applied.
The judgment also declared that Creditors’ claims
against Ms. Schardt were discharged.
Creditors filed a timely appeal on September
27, 2012, challenging only that part of the Judgment
holding that their claims against Ms. Schardt were
not excepted from discharge.
BAP Memorandum at 2:11 – 8:22.
Although I stated that “the BAP got it wrong” and that I would not follow its
decision in In re Tsurukawa, 287 B.R. 515 (9th Cir. BAP 2002) (Tsurukawa II), the BAP
noted “this Panel is bound to follow and enforce its own published decisions in
subsequent appeals. In re Sierra Pac. Broadcasters, 185 B.R. 575, 577, n. 7 (9th Cir.
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BAP 1995).” Id. at 13:15 – 13:19.
Even Under Tsurukawa II, It Would Not Be Proper to Impute Mr. Shart’s Fraud to His
Wife Elke Gordon-Schardt
The BAP’s Memorandum spelled out its holding in Tsurukawa II:
The teachings of Tsurukawa II can be summarized in
three principles:
First, marriage alone is not sufficient to impute fraud
from one spouse to another. A business partnership
between a debtor and spouse for denial of discharge
purposes exists where “the debtor assumed an active role in
the [spouse’s business] that goes beyond merely holding a
community property interest in [the spouse’s] business and
performing minor services in that business.” Tsurukawa II,
287 B.R. at 521.
Second, “fraud may be imputed to a spouse under
agency/partnership principles in a § 523(a)(2)(A) action.” Id.
at 525. Whether an agency or partnership sufficient to justify
imputation of fraud to a spouse exists is a question to fact to
be decided under state law. California law applies in this
case. A California partnership is "an association of two or
more persons to carry on as co-owners a business for profit."
CAL. CORP. CODE § 16101(7) (2013). Whether parties have
entered into a partnership relationship, rather than some
other form of relationship, is a question of fact “to be
determined by the trier of fact from the evidence and
inferences to be drawn therefrom” and depends on whether
they intended to share in the profits, losses and the
management and control of the enterprise. See Bank of Cal.
v. Connolly, 36 Cal. App. 3d 350, 364 (Cal. Ct. App. 1973);
Nelson v. Abraham, 177 P.2d 931, 933 (Cal. 1947).
Property co-ownership of any sort, as well as profit-sharing,
are factors which tend to establish partnership. But see
Holmes v. Lerner, 88 Cal. Rptr. 2d 130, 138 (Cal. Ct. App.
1999) (holding that sharing of profits is one evidence of
partnership, but not a required element).
Each partner is an agent of the partnership for the
purpose of its business. CAL. CORP. CODE 16301(a) (2013).
Each partner acts as principal for himself or herself and as
agent for the copartners in the transaction of partnership
business. Tufts v. Mann, 2 P.2d 500, 503 (Cal. 1931). In
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addition, "a general partner's liability is the same as that of a
principal for the fraud of his agent while acting within the
scope of his authority." Pearson v. Norton, 230 Cal. App. 2d
1, 14-15 (Cal. Ct. App. 1964) (finding partner-wife liable for
partner-husband's fraud in sale of partnership property).
Third, it is not necessary to prove “any knowledge on
the ‘innocent’ debtor’s part of the fraudulent conduct” for
imputed liability purposes. Id. at 525. Of course, if the
debtor participated directly in the spouse’s fraud, that could
be grounds for finding direct liability rather than imputed
liability. Id. at 527.
BAP Memorandum at 17:4 – 18:20.
The BAP then referenced eight instances in which the evidence might be sufficient to
impute the actions of Mr. Shart to Ms. Schardt as follows:
In this case, evidence was presented which the
bankruptcy court could review in determining the existence
of an agency or partnership between Debtors sufficient to
impute liability for the fraudulent actions of Mr. Shart to Ms.
Schardt. For example, the evidence showed that: (1) Ms.
Schardt may have prepared and mailed allegedly fraudulent
accounting statements to Ms. Haig (testimony of John
Sharp, an assistant to Ms. Haig and former vice
president/general manager with Hilton International);
(2) Ms. Schardt may have maintained one bank account and
check register for Mr. Shart’s business and assisted in
preparation of tax returns (testimony of Ms. Schardt); (3) Ms.
Schardt may have made handwritten notes on billing
disputes with Creditors and forwarded them to Mr. Shart
(testimony of Ms. Schardt); (4) Ms. Schardt may have
reviewed and edited Mr. Shart’s responses to the billing
disputes (testimony of Ms. Schardt); (5) Ms. Schardt may
have directed her bookkeeper to ignore Ms. Haig’s
complaints about her bills (testimony of Ms. Schardt); (6) Ms.
Schardt may have provided advice to Mr. Shart in his
negotiations with Ms. Haig (deposition of Ms. Haig);
(7) Ms. Schardt may have prepared some of the bills sent to
Ms. Haig (deposition of John Sharp); (8) Ms. Schardt signed
letters on Greystone letterhead relating to Greystone
business matters.
BAP Memorandum at 18:21 – 19:15.
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I will address all eight instances that the BAP referenced above:
1. Ms. Schardt may have prepared and mailed the fraudulent accountings at
issue in this case: It is true that Ms. Schardt mailed a package to defendant, but it has
not been proven to me what part, if any, she had in preparation of the accountings.
Further, any involvement she had occurred in 2009, which was approximately two
years after the fraud took place in 2007.
2. Ms. Schardt may have maintained one bank account and check register of
Mr. Shart’s business and assisted in preparation of tax returns: Apparently, prior to
2005, Ms. Schardt and her assistant entered some information in a check register for
Malibu, but it is not clear at all the extent of the information. Further, this has no effect
of establishing her as a partner. Her involvement was merely through a joint bank
account they opened prior to Mr. Shart moving to Tennessee. She used this account
to withdraw money and make wire funds to Mr. Shart when he was in Germany. This
is simply evidence of a married couple and does not in any way give rise to a
partnership. Similarly, she merely acted as a messenger to occasionally bring
documents to Mr. Shart’s accountant, who was located in California.
3. Ms. Schardt may have made handwritten notes on billing disputes with
creditors and forwarded them to Mr. Shart: As defendant points out, there is no
evidence that Ms. Schardt forwarded any handwritten notes. Further, the timing of this
alleged involvement was approximately two years after the fraud had been committed.
Ms. Schardt simply acted as a spouse who happened to be an attorney and helped out
her husband.
4. Ms. Schardt may have reviewed and edited Mr. Shart’s responses to the
billing disputes: I am not satisfied that Ms. Schardt did anything more than she claims
to have done, i.e., having helped her husband by correcting the grammar and wording
of his letters.
5. Ms. Schardt may have directed her bookkeeper to ignore Ms. Haig’s
complaints about her bill: All the evidence shows is that Ms. Schardt gave the
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bookkeeper some practical advice on how she runs her business. She advised her
husband’s bookkeeper not to change any of the billing simply because a client disputes
it. Further, this alleged involvement was in 2009, approximately two years after the
fraud had been committed. There is no evidence that she acted as a partner by
advising the bookkeeper about her billing policies.
6. Ms. Schardt may have provided advice to Mr. Shart in his negotiations
with Ms. Haig: There is no evidence that shows Ms. Schardt provided her husband
with advice. Again, even if she did, it would have been long after the fraud had been
committed and in a capacity as a spouse, who was also an attorney, trying to help her
husband, not as a partner.
7. Ms. Schardt may have prepared some of the bills sent to Ms. Haig: There
is simply no evidence that proves that Ms. Schardt prepared some of the bills.
8. Ms. Schardt signed letters on Greystone letterhead relating to Greystone’s
business matters: All the evidence shows is that in 2009, much after the fraud had
been committed and litigation started, Ms. Schardt sent out a copy of the complaint.
Further, the fact that the letter may have been hate-filled is irrelevant to the issue of her
being a partner. The facts do not support the conclusion that Ms. Schardt was a
partner with her husband in the business.
In summary, it is undisputed that the fraudulent acts carried out by Mr. Shart did
not involve Ms. Schardt. Ms. Schardt’s limited involvement only began on February 9,
2009, after the lawsuit in Tennessee began. The fraudulent misrepresentation that Mr.
Shart committed had occurred in 2007, approximately two years earlier. Clearly, Ms.
Schardt was not directly liable for fraud and was not a partner or agent with her
husband in his business.
Ms. Schardt’s Level of Involvement Does Not Rise to the Level of Mrs. Tsurukawa in
Tsurukawa II
The BAP remanded this case back to me to make findings as I have done
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above. Even if we were to accept the BAP’s opinion in Tsurukawa II that “fraud may be
imputed to a spouse under agency/partnership principles in a §523(a)(2)(A) action”, our
case is starkly distinguishable from Tsurukawa II.
The court in Tsurukawa II found that the wife’s involvement in her husband’s
business was extensive and on a steady continuous basis. The court pointed to the
following factors, among others, that evidence a “business partner”. First, in the
creation of the business the debtor went together with her husband to apply for a
business license. Second, the debtor opened a bank account for the company and
designated herself as the sole signatory. Third, the debtor made an initial contribution
to the business from her bank account. Fourth, the debtor wrote hundreds of checks
and regularly balanced the account. Fifth, the debtor represented herself as the sole
owner of the business on tax returns.
Conversely, in our case, Ms. Schardt’s involvement in the business, as stated
above, was minimal and limited to her capacity as a wife, who was also an attorney.
The business was established by Mr. Shart alone, and he was the sole owner of the
business. Ms. Schardt was not involved in the day to day operations and did not even
live in Tennessee where the ranch was located. The fact that Ms. Schardt may have
reviewed notes and letters sent to creditor and advised Mr. Shart with regard to the
dispute is not indicative of a “business partner.”
Plaintiffs mistakenly point to the fact “that unlike the wife in Tsurukawa, who was
simply a homemaker and mother, Mrs. Schardt … was an aggressive and well-
educated practicing attorney who performed substantial activities for the business.”
Plaintiff’s argument is not supported by the facts. The key test according to the BAP in
Tsurukawa II is facts that show a level of involvement that justifies a determination that
the spouses were “business partners.” In Tsurukawa II, the debtor/wife had participated
in numerous business activities that demonstrate a business partner (see above).
Conversely, Ms. Schardt’s participation was limited to assisting her husband,
approximately two years after her husband’s fraud, in the very limited manner in her
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capacity as an attorney-wife and not as a business partner.
CONCLUSION
I conclude that due to the development of the law regarding exceptions to discharge,
both statutory and decisions of the Supreme Court, that Strang v. Bradner, is no longer good
law and therefore the fraud of John Shart may not be imputed to his wife, Elke Gordon-
Schardt under § 523(a)(2)(A).
Nevertheless, to the extent that Strang is still viable, it should be strictly limited to its
facts. Finally, even under Tsurukawa II, the facts do not support the imputation of Mr. Shart’s
fraud to his wife.
The facts of this case highlight how inappropriate it is to impute the fraud of one person
to another under § 523(a)(2)(A). Having to sift through numerous facts under partnership
principles, unrelated to any actual fraud by the debtor is a very slippery slope, and is clearly
not what Congress had in mind when it enacted § 523(a)(2)(A).
In this case, the facts are that the involvement of Ms. Schardt with the affairs of Mr.
Shart took place approximately two years after Mr. Shart’s fraud. Even if the debtor magically
became the partner of her husband in 2009, she was clearly not his partner when the fraud
occurred in 2007. I am unaware of any law which imposes under partnership principles
liability on a person, prior to that person becoming a partner.
Date: January 29, 2014
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This form is mandatory. It has been approved for use by the United States Bankruptcy Court for the Central District of California.
June 2012 F 9021-1.1.NOTICE.ENTERED.ORDER
NOTICE OF ENTERED ORDER AND SERVICE LIST
Notice is given by the court that a judgment or order entitled (specify): MEMORANDUM OF DECISION
DETERMINING THAT IMPUTATION OF FRAUD COMMITTED BY DEBTOR/HUSBAND TO
DEBTOR/SPOUSE IS UNWARRANTED UNDER SECTION 523(a)(2)(A)
was entered on the date indicated as AEntered@ on the first page of this judgment or order and will be
served in the manner stated below:
1. SERVED BY THE COURT VIA NOTICE OF ELECTRONIC FILING (NEF) B Pursuant to controlling
General Orders and LBRs, the foregoing document was served on the following persons by the court via
NEF and hyperlink to the judgment or order. As of 1/29/2014, the following persons are currently on the
Electronic Mail Notice List for this bankruptcy case or adversary proceeding to receive NEF transmission
at the email addresses stated below.
Jesse S Finlayson jfinlayson@fwtrl.com, wmills@fwtrl.com
United States Trustee (LA) ustpregion16.la.ecf@usdoj.gov
Jason Wallach jwallach@gladstonemichel.com
Service information continued on attached
page
2. SERVED BY THE COURT VIA UNITED STATES MAIL: A copy of this notice and a true copy of this
judgment or order was sent by United States mail, first class, postage prepaid, to the following persons
and/or entities at the addresses indicated below:
Elke Gordon-Schardt
Law Office of Elke Gordon Schardt
44319 Lowtree Ave
Lancaster, CA 93534
John Shart
c/o Kimberly Carpenter
790 Blooming Grove Road
Pulaski, TN 38478
Patricia R. Young
PERRONE & YOUNG
109 Westpark Drive Ste 330
Brentwood TN 37027
T. Larry Edmondson
Law Offices of T. Larry Edmondson
800 Broadway Third Floor
Nashville TN 37203
Case 2:10-ap-02555-BR Doc 100 Filed 01/29/14 Entered 01/29/14 11:36:45 Desc
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This form is mandatory. It has been approved for use by the United States Bankruptcy Court for the Central District of California.
June 2012 F 9021-1.1.NOTICE.ENTERED.ORDER
Service information continued on attached
page
3. TO BE SERVED BY THE LODGING PARTY: Within 72 hours after receipt of a copy of this judgment
or order which bears an AEntered@ stamp, the party lodging the judgment or order will serve a complete
copy bearing an AEntered@ stamp by United States mail, overnight mail, facsimile transmission or email
and file a proof of service of the entered order on the following persons and/or entities at the addresses,
facsimile transmission numbers, and/or email addresses stated below:
Service information continued on attached
page
Case 2:10-ap-02555-BR Doc 100 Filed 01/29/14 Entered 01/29/14 11:36:45 Desc
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