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In re Krause

United States District Court, N.D. Illinois, Eastern Division

September 30, 2014

In re TIMOTHY D. KRAUSE, CECILIA S. KRAUSE, and NEVELCO, INC., an Illinois corporation, Debtors.
TIMOTHY D. KRAUSE, CECILIA S. KRAUSE, and NEVELCO, INC., an Illinois corporation, Defendants/Appellants. NATIONAL UNION FIRE INSURANCE COMPANY OF PITTSBURGH, Plaintiff/Appellee, Bankruptcy Case No. 13-B-15811 Adversary No. 13 A 0901.


AMY J. ST. EVE, District Judge.

Pursuant to 28 U.S.C. § 158(a), Defendants/Appellants appeal from the judgment that the Bankruptcy Court entered in the underlying adversary action on April 30, 2014, in favor of Plaintiff/Appellee finding a debt in the amount of $714, 822.75 non-dischargeable under 11 U.S.C. §§ 523(a)(2)(A), (a)(6). The Court has jurisdiction over the present appeal pursuant to 28 U.S.C. § 158. See also Fed.R.Bankr.P. 8002. For the following reasons, the Court affirms the Bankruptcy Court's judgment.


On April 16, 2013, Nevelco, Inc. ("Nevelco"), an Illinois corporation, filed a Chapter 7 bankruptcy petition in the United States Bankruptcy Court for the Northern District of Illinois. Also on April 16, 2013, Defendant/Appellants Timothy D. Krause and Cecilia S. Krause (collectively "the Krauses") filed joint voluntary Chapter 7 petitions. Plaintiff/Appellee National Union Fire Insurance Company of Pittsburgh ("National Union") filed its Adversary Complaint to determine dischargeability of debt on June 6, 2013. After a bench trial, on April 30, 2014, the Bankruptcy Court issued its Memorandum Opinion concluding that the debt owed to National Union was nondischargeable under 11 U.S.C. § 523(a)(2)(A) and § 523(a)(6). On May 12, 2014, the Krauses filed a notice of appeal, and on May 13, 2014, National Union filed a motion to modify the April 30, 2014, Memorandum Order. The Bankruptcy Court entered a one-page Amended Order clarifying that the judgment included costs and reasonable attorney's fees on June 17, 2014.


The following facts are taken from the April 16, 2014, bench trial transcript, the trial exhibits, and the parties' stipulated facts. In 1999, the Krauses formed Nevelco as a general contracting business. Nevelco would purchase vacant lots, build homes on the property, and then sell them for a profit. The Krauses each owned 50% of Nevelco - Timothy was the president and Cecilia was the secretary and company bookkeeper. Cecilia handled the bills, credits and deposits, and balanced the checkbook. Timothy handled the field work and supervised the subcontractors.

On September 10, 2004, Nevelco purchased a vacant lot at 205 S. Maple Street in Itasca, Illinois ("Itasca Property") for the purpose building a home on the property, and thereafter, selling it for a profit. The Krauses did not intend to live at the Itasca Property. The Krauses originally obtained a short-term loan in the amount of $570, 000 from Itasca Bank & Trust ("Itasca Bank") to finance the construction costs. In 2004, Nevelco conveyed the Itasca Property to a land trust of which Itasca Bank was the trustee and Nevelco the beneficiary.

Because the Itasca Bank loan was a short-term construction loan, the Krauses refinanced the loan amount. Specifically, in November 2005, the Krauses completed a loan application, namely, the "Uniform Residential Loan Application, " to refinance the construction loan with Washington Mutual Bank ("Washington Mutual"). On the loan application, the Krauses identified themselves individually and signed as the "borrowers" listing their personal assets and liabilities. Further, the Krauses indicated that they intended to occupy the Itasca Property as their primary residence. The refinancing closed on November 8, 2005, and the loan amount was $562, 500. Both Timothy and Cecilia signed the adjustable rate promissory note ("the Note") as trustees and as individuals. The Krauses, however, were not trustees to the Itasca Bank land trust. The Note signed by the Krauses for the Washington Mutual loan included a "due-on-sale" clause that stated in relevant part:

If all or any part of the Property or any Interest in the Property is sold or transferred (or if a beneficial interest in Borrower is sold or transferred and Borrower is not a natural person) without the Lender's prior written consent, Lender may require immediate payment in full of all sums secured by this Security Instrument.

The Krauses signed the thirty-year mortgage and two riders as trustees, and the TILA disclosure statement and November 15, 2005, payoff letter to the Itasca Bank as individuals. It is undisputed that neither the title insurer nor Washington Mutual recorded the mortgage.

Nevelco completed the construction on the Itasca Property house in March 2006 and the Krauses put the house and lot up for sale. Scott and Colleen Becker purchased the home from Nevelco for $805, 000. The closing of the Itasca Property took place on March 13, 2006, at which Timothy Krause and his lawyer attended. In connection with the sale and closing, Timothy signed the closing documents in multiple capacities: (1) he signed the sales contract as Nevelco's president; (2) he signed the HUD-1 Settlement Statement on behalf of Itasca Bank as trustee; and (3) he signed the Direction to Convey as Nevelco's president.

At no time did the Krauses inform Washington Mutual of their intent to sell the Itasca Property. Nevertheless, on the HUD-1 Settlement Statement related to the Becker sale, Timothy certified that the various disclosures were "true and accurate." Also, the Krauses left the line items for existing loans and "payoff of first mortgage loan" blank. The Trust Officer from Itasca Bank signed the ALTA form stating there were no "unrecorded leases, easements or other servitudes to which the land or building, or portions thereof are subject" based on information the Krauses provided him.

The Krauses did not pay the approximately $563, 000 they owed Washington Mutual on the Itasca Property Note at the Becker closing. Instead, Timothy left the March 2006 closing with a check in the amount of $790, 367.71, rather than the expected $230, 000. On March 14, 2006, Timothy deposited the check for $790, 367.71 into a Nevelco account at Itasca Bank. On March 16, 2006, the Krauses transferred $460, 000 to an A.G. Edwards account in the name of "Timothy D. Krause Real Estate 2 Acct" that listed the Krauses' home address as the account address.

Moreover, the Krauses continued paying on the Washington Mutual Note through February 2009 and defaulted in March 2009. Washington Mutual's successor, JPMorgan Chase, did not learn of the 2006 Itasca Property sale until after the Krauses defaulted on the Note in 2009. Prior to the default, there were sufficient funds in Nevelco's accounts at Itasca Bank to pay off the Washington Mutual loan.

After learning of the default in 2009, JPMorgan Chase brought a claim against Stewart Title Guaranty Co. ("Stewart Title"), with which Washington Mutual had contracted to insure the title and conduct the 2005 re-financing closing. In turn, Stewart Title contracted with Specialty Title Services, Inc. ("Speciality Title") to conduct the closing and handle the filing of the documents. Stewart Title then settled its claim with JPMorgan Chase and brought a claim against Speciality Title. Plaintiff/Appellee National Union is the liability insurer of Specialty Title. National Union paid the claim brought against Specialty Title and succeeded to its rights as subrogee. Thus, National Union holds the rights under the Note executed by the Krauses in November 2005.


On June 21, 2013, National Union filed its adversary action in the Northern District of Illinois Bankruptcy Court to determine the dischargeability of the Krauses' obligation under the Washington Mutual Note. In Count I of the Complaint, National Union sought a finding of non-dischargeability based on false representations pursuant to 11 U.S.C. § 523(a)(2)(A). In Count II, National Union sought relief under 11 U.S.C. § 523(a)(6) based on the common law tort of conversion. ...

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