United States District Court, Northern District of Illinois, Eastern Division
April 29, 2003
GLORIA NELSON, ET AL., PLAINTIFF,
BERTHA MCGEE, DEFENDANT.
The opinion of the court was delivered by: Milton I. Shadur, Senior United States District Judge.
MEMORANDUM OPINION AND ORDER
Gloria Nelson and her mother Linda Mitchell (collectively "Nelson-Mitchell") appeal from the judgment of the Bankruptcy Court that rejected their adversary Complaint against debtor Bertha McGee ("McGee"). In that proceeding Nelson-Mitchell had sought to exclude, from McGee's discharge via her voluntary Chapter 7 bankruptcy petition, the pre-bankruptcy debt that McGee had owed to them. This appeal calls for the application of customary appellate standards of review, requiring examination of the Bankruptcy Court's factual findings for clear error and its conclusions of law de novo (see, e.g., In re UNR Indus., Inc., 986 F.2d 207, 208 (7th Cir. 1993)). This Court has done so, and that review clearly calls for reversal in favor at Nelson-Mitchell.
Because there are really no facts in dispute, the issues posed by the current appeal can be resolved by a de novo legal analysis alone. What follows is a statement of the factual background necessary for that purpose.
Nelson-Mitchell were McGee's tenants in Section 8 housing located at 8159 West Houston, Chicago, Illinois. They delivered a $2,500 security deposit to her in two cash installments. Initially McGee kept the deposit in a strongbox at her own residence, but when she later consulted with a lawyer about possibly evicting Nelson-Mitchell as tenants, he told her that she should have put the security deposit in an interest-bearing account — and she did so.
That was good advice. In the City of Chicago, all landlords obligations with respect to all residential tenants' security deposits are exceedingly stringent, and they are spelled out in detail in Chicago Municipal Code §§ 5-12-080 to 5-12-082 (those sections are part of the Chicago Residential Landlord and Tenant Ordinance).*fn1 Although a photocopy of all of the cited sections is attached as Ex. 1 to this opinion, Code § 080(a) is particularly worth quoting here:
A landlord shall hold all security deposits received by
him in a federally insured interest-bearing account in
a bank, saving and loan association or other financial
institution located in the State of Illinois. A
security deposit and interest due thereon shall
continue to be the property of the tenant making such
deposit, shall not be commingled with the assets of the
landlord, and shall not be subject to the claims of any
creditor of the landlord or of the landlord's
successors in interest, including a foreclosing
mortgagee or trustee in bankruptcy.
When in the latter part of 2000 Nelson-Mitchell decided not to renew their lease and to move out instead, McGee preempted that step by filing a forcible detainer action in the Circuit Court of Cook County, seeking to evict them and to collect what she claimed to be unpaid rent. Nelson-Mitchell moved out of the premises and asked McGee for the return of the security deposit. When she refused, Nelson-Mitchell filed not only an Answer but also a multi-count Counterclaim in the Circuit Court lawsuit, with Count TV seeking damages for McGee's failure to return the security deposit (Code § 080(f) provides for damages of twice the amount of the deposit), and with Count V seeking the addition of interest (Code § 080(f) also provides for the tenant's recovery of interest, while Code § 081 specifies the interest rate for that purpose).
While the Circuit Court lawsuit was pending, McGee (who later testified before the Bankruptcy Court in this adversary proceeding that "I didn't think I was going to lose"*fn2) somehow decided that the money had become hers to do with as she wished, so she took the money out of the bank account and put it to her own use in December 2001. At the very beginning of January 2002 Nelson-Mitchell filed a summary judgment motion in the Circuit Court, a motion that the state court judge decided in their favor in all respects in February 2002. Nelson-Mitchell were held to owe nothing whatever to McGee in rent, and judgment on the Counterclaim was entered in their favor and against McGee for $5,000 plus interest of $270.50.
McGee, by then having dissipated all of the funds, proceeded in March 2002 to file a voluntary petition under Chapter 7. That proceeding resulted in her discharge. And as stated earlier, Nelson-Mitchell's adversary Complaint, which sought to challenge the dischargeability of McGee's indebtedness arising out of what has been described here, was turned down by the Bankruptcy Court after an evidentiary hearing. This timely appeal followed.
One of the provisions of 11 U.S.C. § 523 ("Section 523") that specify the exceptions to discharge in bankruptcy is at issue here. Here is Section 523(a)(4):
A discharge under section 727, 1141, 1228(a), 1228(b),
or 1328(b) of this title does not discharge an
individual debtor from any debt —
(4) for fraud or defalcation while acting in a
fiduciary capacity, embezzlement, or larceny.
Because no fraud or embezzlement or larceny on McGee's part has been charged by Nelson-Mitchell, the outcome-determinative issues on this appeal hinge on the meaning of "defalcation" and "fiduciary capacity."
Both of those concepts have been addressed by our Court of Appeals in Meyer v. Rigdon, 36 F.3d 1375 (7th Cir. 1994). As for "defalcation," the extended treatment in Meyer, id. at 1382-85 (drawing on the seminal opinion by Judge Learned Hand in Central Hanover Bank & Trust Co. v. Herbst, 93 F.2d 510, 511-12 (2d Cir. 1937)) concluded that the "mere negligent breach of a fiduciary duty is not a `defalcation'" (id. at 1385 (emphasis in original)), but that some added element such as a "willful" or "reckless" failure on the debtor's part to come up with the money is necessary (id.) That poses no difficulty here: There can be no question that McGee's refusal to return her tenants' property, the security deposit, merited such a pejorative characterization.
As for the other necessary component of nondischargeability under Section 523(a)(4), Meyer, id. at 1382 confirms that "[t]he existence of a fiduciary relationship is a question of federal law."*fn3 On that score In re Marchiando, 13 F.3d 1111, 1115 (7th Cir. 1994) (most citations omitted) fleshes out the scope of the "fiduciary duty" concept:
The high standard of loyalty and care that the law
imposes on trustees is encapsulated in the term
"fiduciary duty." Once it entered the law's bank of
concepts, it became available for use in situations
that, while not involving trusts in a formal sense,
seemed to call for the imposition of the same high
standard. Restatement (Second) of Trusts § 2,
comment b (1959). So a lawyer is deemed the fiduciary
of his client, even if he does not manage a fund
entrusted to him by the client, and a managing partner
is a fiduciary of the limited partners, corresponding
to shareholders of a corporation, although again there
is no trust in the conventional sense. Yet a further
extension of the fiduciary concept — the use of
the concept of "constructive trust" (where
"constructive" bears its usual legal meaning of "no")
to impose the fiduciary duty of a trustee on a person
who is not a trustee — has been held not to come
within the reach of section 523(a)(4). Davis v. Aetna
Acceptance Co., 293 U.S. 328, 333, 55 S.Ct. 151, 153,
79 L.Ed. 393 (1934). Resulting and implied trusts are
out too. And a debtor who has given his creditor a
"trust receipt" to secure the loan is not a fiduciary
for purposes of the statute.
Having thus explained the distinction between the presence and absence of fiduciary capacity, Marchiando, id. at 1115-16 goes on to identify the line of demarcation in this fashion:
The key to knitting the cases into a harmonious whole
is the distinction stressed in Davis and other cases
between a trust or other fiduciary relation that has an
existence independent of the debtor's wrong and a trust
or other fiduciary relation that has no existence
before the wrong is committed. A lawyer's fiduciary
duty to his client, or a director's duty to his
corporation's shareholders, pre-exists any breach of
that duty, while in the case of a constructive or
resulting trust there is no fiduciary duty until a
wrong is committed.
What the Bankruptcy Judge did in this instance — apart from focusing on whether the decision of another Bankruptcy Court in Massachusetts (in a case on which counsel for Nelson-Mitchell sought to rely) had or had not been impaired by some later decisions out of that same court, something that could of course scarcely be considered as controlling in this case*fn4
— was to look at the lease between the parties and to say:
I can't find any language in the form lease which
indicates clearly there was any intent between the
parties or among the parties of an intent to create a
trust with regard to the security deposit.
I find no intent to create a trust in the face of the
document, nor any specifications of a trust purpose
imposing fiduciary obligations on Ms. McGee under the
terms of the lease and addendum.
But with all due respect, that gives the wrong answer because it asks the wrong question. What that approach ignores entirely is that the Chicago City Council has specifically decreed that the provisions of Code §§ 080 through 082 are an integral part of every lease that covers Chicago residential property of the type involved here, thus defining a vital aspect of the relationship between McGee as landlord and Nelson-Mitchell as tenants.*fn5
Here is the relevant portion of Code § 010:
This chapter applies to, regulates and determines
rights, obligations and remedies under every rental
agreement entered into or to be performed after the
effective date of this chapter, for a dwelling unit
located within the City of Chicago, regardless of where
the agreement is made, subject only to the limitations
contained in Section 5-12-020 [which limitations were
not relevant or applicable to the lease here]. This
chapter applies specifically to rental agreements for
dwelling units operated under subsidy programs of
agencies of the United States and/or the State of
Illinois, including specifically, programs operated or
subsidized by the Chicago Housing Authority and/or the
Illinois Housing Development Authority to the extent
that this chapter is not in direct conflict with
statutory or regulatory provisions governing such
All of that being so, it is frankly difficult to imagine a more express statement of a fiduciary duty running from McGee to Nelson-Mitchell than that embodied in their landlord-tenant relationship under Code § 080(a) and its related provisions — a duty that really qualifies as an express trust created by the parties' entry into their rental agreement that by definition includes that duty (or even if not, a duty that imposes the same "high standard of loyalty and care" (Marchiando, 13 F.3d at 1115)). It is a duty whose existence antedated and was independent of McGee's later wrong (id.), and McGee breached that duty both willfully and recklessly (to return to the concept of "defalcation").
It follows without question that the decision of the Bankruptcy Court must be reversed. McGee's discharge in bankruptcy does not encompass her debt to Nelson-Mitchell, which remains an outstanding and enforceable obligation.
Because the Bankruptcy Court reached the opposite conclusion, it had no occasion to consider the proper measure of the indebtedness if, as this Court has decided, it is nondischargeable. As stated earlier, the Circuit Courts judgment in conformity with the provisions of the Code — and hence the amount of McGee's pre-bankruptcy indebtedness to Nelson-Mitchell — was for twice the amount of the security deposit itself ($5,000 rather than $2,500) as well as for interest on that sum.
Just last month the United States Supreme Court, in Archer v. Warner, 71 U.S.L.W. 4249 (U.S. 2003), held that a debt embodied in a settlement agreement, which had resolved an earlier claim that money had been obtained by fraud, continued to retain the same fraud-tainted character so as to be nondischargeable in bankruptcy. That is essentially a reconfirmation of the principle announced in the unanimous opinion in Cohen v. de la Cruz, 523 U.S. 213 (1998). Cohen held that the Section 523(a) exceptions from discharge, when they speak of "debt for" a particular type of liability, "connot[e] broadly any liability arising from the specified object" (id. at 220). And just as that led to the conclusion that a state court judgment that trebled the fraudulent amount at issue in Cohen provided the measure of nondischargeability there, by parity of reasoning McGee's nondischargeable debt is the full amount of the Circuit Court judgment: $5,270.50.
For the reasons stated in this opinion, this Court reverses the Bankruptcy Court's decision. It holds that McGee's entire debt to Nelson-Mitchell, the sum of $5,270.50, was not discharged as the result of McGee's discharge in bankruptcy and remains fully enforceable post-bankruptcy.