In re: Phillip Michael Spencer Phillip Michael Spencer

• Court: United States Bankruptcy Appellate Panel for the Ninth Circuit
• Decided: August 11, 2017
• Docket: SC-16-1253-FBJu
• Status: Unpublished

Opinion

FILED AUG 11 2017 1 NOT FOR PUBLICATION SUSAN M. SPRAUL, CLERK U.S. BKCY. APP. PANEL 2 OF THE NINTH CIRCUIT

3 UNITED STATES BANKRUPTCY APPELLATE PANEL OF THE NINTH CIRCUIT 4 5 In re: ) BAP No. SC-16-1253-FBJu ) 6 PHILLIP MICHAEL SPENCER, ) Bk. Nos. 3:14-bk-09514-MM ) 3:14-bk-08384-MM 7 Debtor. ) _____________________________ ) Adv. Nos. 3:15-ap-90039-MM 8 ) 3:15-ap-90042-MM In re: ) 9 ) MARK S. BUCKMAN, ) 10 ) Debtor. ) 11 _____________________________ ) ) 12 NEIL F. CAMPBELL, ) ) 13 Appellant, ) ) 14 v. ) MEMORANDUM* ) 15 PHILLIP MICHAEL SPENCER; ) MARK S. BUCKMAN, ) 16 ) Appellees. ) 17 ______________________________) 18 Argued and Submitted on July 27, 2017 at Pasadena, California 19 Filed – August 11, 2017 20 Appeal from the United States Bankruptcy Court 21 for the Southern District of California 22 Honorable Margaret M. Mann, Bankruptcy Judge, Presiding 23 Appearances: Mark Scott Bagula of Bagula Riviere Coates and Associates argued on behalf of appellant; Gregory 24 S. Hood argued on behalf of appellees. 25 26 * This disposition is not appropriate for publication. 27 Although it may be cited for whatever persuasive value it may have, see Fed. R. App. P. 32.1, it has no precedential value, see 28 9th Cir. BAP Rule 8024-1. 1 Before: FARIS, BRAND, and JURY, Bankruptcy Judges. 2 INTRODUCTION 3 Creditor Neil F. Campbell appeals from the bankruptcy 4 court’s judgment on his § 523(a)(4)1 nondischargeability claim in 5 favor of chapter 7 debtors Phillip Michael Spencer and Mark S. 6 Buckman (collectively, “Debtors”). The bankruptcy court held 7 that a state court judgment on an arbitration award precluded 8 relitigation of all issues except the Debtors’ intent; after a 9 trial, it found that the Debtors misled Mr. Campbell and failed 10 to disclose certain information, but did so on the advice of 11 counsel and did not intend to commit defalcation. We discern no 12 error and AFFIRM. 13 FACTUAL BACKGROUND 14 A. The joint business venture 15 In or around 2004, the Debtors, Mr. Campbell, and Gay Reeves 16 formed Family Investment Management Group, LLC (“FIMG”), which 17 offered clients financial advice and investment services. The 18 members signed an agreement (“Operating Agreement”) governing the 19 operation of FIMG. Among other things, it dictated the proper 20 procedure in the event that a member exited the company. It also 21 provided that the parties would share equally in FIMG’s profits. 22 The arrangement later evolved (without a formal, written change 23 to the Operating Agreement) to allow each member to receive 24 monthly disbursements based on profits from their own “book of 25 26 1 Unless specified otherwise, all chapter and section 27 references are to the Bankruptcy Code, 11 U.S.C. §§ 101-1532, and all “Rule” references are to the Federal Rules of Bankruptcy 28 Procedure.

2 1 accounts.” 2 In 2007, Ms. Reeves decided to leave FIMG. The Operating 3 Agreement provided that the remaining members were to purchase 4 her interest in FIMG. They prepared a written exit agreement, 5 but Ms. Reeves never signed it. They orally agreed that, in lieu 6 of a payout or distribution, Ms. Reeves could instead take her 7 “book of accounts” when she withdrew from the business. The 8 remaining members then amended the Operating Agreement to reflect 9 that each held a one-third interest in FIMG. 10 Between 2008 and 2010, Mr. Campbell created FUTR Family 11 Management LLC and began working primarily under that company. 12 On September 18, 2010, he physically moved out of FIMG’s office. 13 He indicated that he would no longer contribute to FIMG. 14 According to the trial testimony, the Debtors consulted 15 their attorney, Paul Thomas, as to how to handle Mr. Campbell’s 16 withdrawal. He told them to proceed in the same way that they 17 handled Ms. Reeves’ departure – in other words, that they did not 18 owe Mr. Campbell anything. He told them that Mr. Campbell was 19 not entitled to receive information about FIMG’s finances and 20 that they should minimize their contact with Mr. Campbell. 21 The Debtors also testified that they consulted their 22 accountant, Jeanne Goddard, who also advised them that they did 23 not owe Mr. Campbell anything. 24 In October 2010, the Debtors (but not Mr. Campbell) executed 25 an amendment to the Operating Agreement that reduced the members 26 to only Mr. Spencer and Mr. Buckman. The amendment provided that 27 the Debtors accepted Mr. Campbell’s “voluntary withdrawal.” 28 Later, without notice to Mr. Campbell, the Debtors attempted

3 1 to convert FIMG from an LLC into a limited partnership with only 2 the Debtors as general partners. 3 After the Debtors formed the limited partnership, FIMG sent 4 Mr. Campbell a K-1 tax form that indicated that Mr. Campbell held 5 an interest in the FIMG partnership. According to Ms. Goddard, 6 the partnership issued the K-1 form by mistake. 7 Between October 2010 and May 2012, the Debtors communicated 8 with Mr. Campbell but failed to inform him that they had 9 terminated his ownership interest in FIMG or changed FIMG’s 10 corporate structure. They also did not provide him with FIMG’s 11 financial information or disclose their conversations with 12 Mr. Thomas or Ms. Goddard. 13 B. The state court arbitration 14 In June 2013, Mr. Campbell initiated arbitration proceedings 15 against the Debtors for, among other things, breach of contract, 16 breach of fiduciary duty, accounting, and constructive fraud. 17 The arbitrator held that the Debtors had wrongfully excluded or 18 expelled Mr. Campbell from FIMG and were liable for breach of 19 contract and breach of fiduciary duty. He awarded Mr. Campbell 20 over $250,000 plus interest. The state court confirmed the 21 arbitration award. 22 C. Bankruptcy proceedings 23 In late 2014, the Debtors filed individual chapter 7 24 bankruptcy petitions. Mr. Campbell filed nondischargeability 25 complaints against the Debtors in their respective cases under 26 § 523(a)(4). The bankruptcy court later consolidated the 27 adversary proceedings at Mr. Campbell’s request. 28

4 1 D. The motion to dismiss 2 The Debtors filed a motion to dismiss Mr. Campbell’s 3 complaint. The bankruptcy court held that most of the 4 arbitrator’s findings were entitled to preclusive effect, but it 5 declined to give preclusive effect to the arbitrator’s findings 6 concerning the Debtors’ intent. It noted that the arbitrator 7 found that the Debtors’ actions “clearly were done purposefully 8 (and therefore willfully) . . . to deny [Campbell] the benefits 9 of ownership as a Member of [FIMG]” which amounted “to 10 intentional misconduct violating the statutory duty of care owed 11 by one member to another[;]” yet he also found that the Debtors’ 12 actions were “fueled more by frustration, impatience with the 13 elusiveness of an exit agreement with Campbell, failure to 14 appreciate the need for strict compliance with the requirements 15 of the LLC Agreement, and perhaps an unjustified fear of being 16 sued by Campbell . . . rather than an intent to deceive.” The 17 bankruptcy court declined to give issue preclusive effect to the 18 arbitrator’s findings on the issue of intent because those 19 findings were not sufficiently clear. 20 E. The motion to amend 21 Following the bankruptcy court’s denial of the motion to 22 dismiss, the Debtors answered the adversary complaint. Shortly 23 thereafter, they filed motions for leave to amend their answers. 24 They sought to add an affirmative defense that they had 25 reasonably relied on the advice of their attorney and accountant. 26 Mr. Campbell opposed the motions to amend, arguing that the 27 Debtors’ failure to raise this defense during the arbitration 28 precluded them from raising it in the bankruptcy court and that

5 1 the defense also lacked merit. 2 The bankruptcy court held that the Debtors did not need to 3 raise the advice-of-counsel issue in the state court or in their 4 answer in the adversary proceeding. The court quoted Bisno v. 5 United States, 299 F.2d 711, 719-20 (9th Cir. 1961): “Advice of 6 counsel is not regarded as a separate and distinct defense but 7 rather as a circumstance indicating good faith which the trier of 8 fact is entitled to consider on the issue of fraudulent intent.” 9 F. Trial 10 Following a two-day trial on the limited issue of intent, 11 the bankruptcy court held that the Debtors did not have an intent 12 to defalcate. The bankruptcy court found that the Debtors 13 consulted their attorney and accountant as to how they should 14 handle Mr. Campbell’s departure from FIMG. It found that they 15 had presented Mr. Thomas and Ms. Goddard with “all material facts 16 regarding Campbell’s changing relationship with FIMG[,]” and it 17 found that the Debtors relied upon their advice in good faith. 18 Ms. Goddard informed the Debtors that they “did not owe Campbell 19 any money.” Mr. Thomas “was emphatic that Campbell had 20 voluntarily withdrawn and was no longer an owner of FIMG when 21 Campbell moved his office on September 18, 2010.” The court 22 found that, “[e]ven though Thomas’ advice and understanding of 23 the Operating Agreement was incorrect, Debtors believed in good 24 faith the advice was correct and proper and acted accordingly.” 25 The bankruptcy court found that the Debtors’ statements to 26 Mr. Campbell (and their silence) were “misleading” but not 27 fraudulent and were “motivated by a fear of litigation, and not 28 an intent to harm Campbell.”

6 1 Based on these findings, the bankruptcy court concluded that 2 the Debtors 3 did not knowingly or even recklessly, create a risk of harm to Campbell since they honestly, if erroneously, 4 believed he would not be harmed by the termination of FIMG. This belief was based on the advice of their 5 counsel and accountant, since Debtors also believed Campbell had intentionally withdrawn from FIMG on 6 September 18, 2010. Debtors did not believe that they would benefit at his detriment since he had no interest 7 of value to appropriate for themselves. They did not intend to cheat Campbell. 8 9 Mr. Campbell timely filed a notice of appeal. 10 JURISDICTION 11 The bankruptcy court had jurisdiction pursuant to 28 U.S.C. 12 §§ 1334 and 157(b)(2)(I). We have jurisdiction under 28 U.S.C. 13 § 158. 14 ISSUE 15 Whether the bankruptcy court erred in determining that the 16 Debtors’ obligation to Mr. Campbell was not excepted from 17 discharge under § 523(a)(4). 18 STANDARDS OF REVIEW 19 In bankruptcy discharge appeals after trial, we review the 20 bankruptcy court’s findings of fact for clear error and 21 conclusions of law de novo, and we apply de novo review to mixed 22 questions of law and fact. Oney v. Weinberg (In re Weinberg), 23 410 B.R. 19, 28 (9th Cir. BAP 2009), aff’d, 407 F. App’x 176 (9th 24 Cir. 2010) (citation omitted). De novo review requires that we 25 consider a matter anew, as if no decision had been rendered 26 previously. United States v. Silverman, 861 F.2d 571, 576 (9th 27 Cir. 1988). 28 We review the bankruptcy court’s findings of fact for clear

7 1 error. Honkanen v. Hopper (In re Honkanen), 446 B.R. 373, 378 2 (9th Cir. BAP 2011). A factual finding is clearly erroneous if, 3 after examining the evidence, the reviewing court “is left with 4 the definite and firm conviction that a mistake has been 5 committed.” Anderson v. City of Bessemer City, 470 U.S. 564, 573 6 (1985). The bankruptcy court’s choice among multiple plausible 7 views of the evidence cannot be clear error. United States v. 8 Elliott, 322 F.3d 710, 714 (9th Cir. 2003). 9 The availability of issue preclusion is reviewed de novo, 10 but “[i]f issue preclusion is available, the decision to apply it 11 is reviewed for abuse of discretion.” Lopez v. Emergency Serv. 12 Restoration, Inc. (In re Lopez), 367 B.R. 99, 103 (9th Cir. BAP 13 2007) (citations omitted). To determine whether the bankruptcy 14 court has abused its discretion, we conduct a two-step inquiry: 15 (1) we review de novo whether the bankruptcy court “identified 16 the correct legal rule to apply to the relief requested” and 17 (2) if it did, whether the bankruptcy court’s application of the 18 legal standard was illogical, implausible, or without support in 19 inferences that may be drawn from the facts in the record. 20 United States v. Hinkson, 585 F.3d 1247, 1262–63 & n.21 (9th Cir. 21 2009) (en banc). 22 DISCUSSION 23 A. Section 523(a)(4) excepts from discharge debts arising from fraud or defalcation and requires a culpable state of mind. 24 25 Section § 523(a)(4) excepts from discharge any debt “for 26 fraud or defalcation while acting in a fiduciary capacity 27 28

8 1 . . . .”2 “The creditor must establish three elements for 2 nondischargeability under this provision: (1) an express trust; 3 (2) that the debt was caused by fraud or defalcation; and 4 (3) that the debtor was a fiduciary to the creditor at the time 5 the debt was created.” Nahman v. Jacks (In re Jacks), 266 B.R. 6 728, 735 (9th Cir. BAP 2001) (citation omitted). 7 In order to prove defalcation, the creditor must establish a 8 “culpable state of mind . . . involving knowledge of, or gross 9 recklessness in respect to, the improper nature of the relevant 10 fiduciary behavior.” Bullock v. BankChampaign, N.A., 133 S. Ct. 11 1754, 1757 (2013). The conduct must involve bad faith, moral 12 turpitude, other immoral conduct, or an intentional wrong 13 (meaning conduct that the fiduciary knows is improper or if the 14 fiduciary “consciously disregards” or is willfully blind to “a 15 substantial and unjustifiable risk” that his conduct will violate 16 a fiduciary duty). Id. at 1759. 17 B. The bankruptcy court properly held a trial on the limited issue of Mr. Campbell’s intent. 18 19 Mr. Campbell argues that the bankruptcy court should have 20 applied issue preclusion to the question of the Debtors’ intent 21 because the arbitrator “unequivocally” found that the Debtors 22 “acted intentionally when they breached their fiduciary duty.” 23 We disagree. 24 Because the judgment in question was rendered by a 25 California court, the California law of preclusion applies. 26 2 27 Section 523(a)(4) also covers debts for embezzlement or larceny, but Mr. Campbell did not claim that the Debtors’ actions 28 amounted to either embezzlement or larceny.

9 1 Plyam v. Precision Dev., LLC (In re Plyam), 530 B.R. 456, 462 2 (9th Cir. BAP 2015) (citing Harmon v. Kobrin (In re Harmon), 3 250 F.3d 1240, 1245 (9th Cir. 2001)). Under California law, 4 issue preclusion applies if a five-part test is satisfied: 5 (1) the issue must be identical to the issue litigated in the 6 prior proceeding; (2) the issue must have been actually 7 litigated; (3) the issue must have been necessarily decided in 8 the prior proceeding; (4) the decision in the prior proceeding 9 must be final and on the merits; and (5) the party against whom 10 preclusion will be applied must be the same as, or in privity 11 with, the original party. Sturgeon-Garcia v. Cagno, 567 B.R. 12 364, 370 (N.D. Cal. 2017). Moreover, there is an “‘additional’ 13 inquiry into whether imposition of issue preclusion in the 14 particular setting would be fair and consistent with sound public 15 policy.” Khaligh v. Hadaegh (In re Khaligh), 338 B.R. 817, 16 824-25 (9th Cir. BAP 2006), aff’d, 506 F.3d 956 (9th Cir. 2007) 17 (citations omitted) (applying California law). 18 “The party asserting issue preclusion has the burden of 19 proving these requirements have been met, and ‘reasonable doubts 20 about what was decided in the prior action should be resolved 21 against the party seeking to assert preclusion.’” 22 Sturgeon-Garcia, 567 B.R. at 370 (quoting In re Honkanen, 23 446 B.R. at 382). 24 Mr. Campbell selectively cites the arbitrator’s findings 25 that the Debtors acted “purposefully (and therefore willingly)” 26 and engaged in “intentional misconduct violating the statutory 27 duty of care owed by one member to another.” Normally, these 28 findings would be preclusive as to a debtor’s intent. But the

10 1 arbitrator also found that the Debtors’ actions were the result 2 of “frustration, impatience . . . failure to appreciate the need 3 for strict compliance with the requirements of the Operating 4 Agreement and perhaps unjustified fear of being sued by 5 Mr. Campbell.” He went on to state that “it does not appear that 6 any non-disclosure was done with intent to deceive . . . . 7 [T]heir actions betray more of a simple ignorance of and perhaps 8 cavalier attitude toward the formalities of business organization 9 and governance.” 10 Given these contradictory findings, the bankruptcy court did 11 not abuse its discretion in declining to apply issue preclusion 12 to the arbitrator’s findings on intent. It did not need to give 13 issue preclusive effect to an unclear or ambiguous decision: “The 14 discretionary aspect of issue preclusion is settled as a matter 15 of federal law. . . . Thus, reasonable doubts about what was 16 decided in a prior judgment are resolved against applying issue 17 preclusion.” In re Lopez, 367 B.R. at 107-08 (noting that 18 “California law is consistent with federal law on the question of 19 discretionary application of issue preclusion”); see Catholic 20 Soc. Servs., Inc. v. I.N.S., 232 F.3d 1139, 1152 (9th Cir. 2000) 21 (“[W]hen a decision in prior litigation is unclear, that decision 22 does not preclude subsequent litigation on that issue.”); Genesis 23 VJ, Inc. v. Nguyen (In re Nguyen), BAP No. CC-11-1379-LaPaMk, 24 2012 WL 603680, at *7 (9th Cir. BAP Feb. 17, 2012) (“As a matter 25 of fairness, when faced with serious questions about the scope of 26 a ruling, the bankruptcy court should err on the side of caution 27 and avoid applying issue preclusion when a state court’s exact 28 determination is ambiguous.”).

11 1 California law is equally clear that courts have broad 2 discretion to apply issue preclusion: “In California, issue 3 preclusion is not applied automatically or rigidly, and courts 4 are permitted to decline to give issue preclusive effect to prior 5 judgments in deference of [sic] countervailing considerations of 6 fairness.” In re Lopez, 367 B.R. at 108. In other words, even 7 if the arbitrator’s findings were clear, the bankruptcy court had 8 broad discretion to refuse to give his findings issue preclusive 9 effect. 10 The bankruptcy court properly resolved doubts about the 11 arbitrator’s findings against Mr. Campbell, the party asserting 12 issue preclusion. The bankruptcy court did not err when it 13 required additional litigation. 14 C. The Debtors could properly rely on the advice of counsel and established that they did so in good faith. 15 16 Mr. Campbell argues that (1) the bankruptcy court should not 17 have allowed the Debtors to argue that they relied on the advice 18 of their attorney and accountant and (2) the court erred in 19 finding that they relied on such advice. We discern no error. 20 1. The Debtors were entitled to assert their reliance on the advice of their attorney and accountant. 21 22 Mr. Campbell argues that the Debtors were precluded3 from 23 asserting an advice-of-counsel defense because they did not raise 24 3 “Issue preclusion” is the modern term for “collateral 25 estoppel,” while “claim preclusion” is the modern term for “res 26 judicata.” Mr. Campbell uses the term “res judicata” without distinguishing between issue preclusion and claim preclusion and 27 cites cases that deal with both issue preclusion and claim preclusion. We assume that Mr. Campbell intends to invoke issue 28 preclusion because claim preclusion cannot apply in this context.

12 1 it during the earlier arbitration. He cites various out-of- 2 circuit cases and cases standing for the general proposition that 3 defenses not raised in an earlier proceeding can be precluded in 4 subsequent litigation. 5 However, the Ninth Circuit has explicitly held that 6 “[a]dvice of counsel is not regarded as a separate and distinct 7 defense but rather as a circumstance indicating good faith which 8 the trier of fact is entitled to consider on the issue of 9 fraudulent intent.” Bisno, 299 F.2d at 719. In the context of 10 bankruptcy and dischargeability, the Ninth Circuit has stated: 11 It is true that “[g]enerally, a debtor who acts in reliance on the advice of his attorney lacks the intent 12 required to deny him a discharge of his debts.” That reliance, however, must be “in good faith.” This court 13 has held that the advice of counsel claim is not a separate defense, but rather “a circumstance indicating 14 good faith which the trier of fact is entitled to consider on the issue of fraudulent intent.” 15 16 Maring v. PG Alaska Crab Inv. Co. LLC (In re Maring), 338 F. 17 App’x 655, 658 (9th Cir. 2009) (internal citations and emphasis 18 omitted). 19 Based on the well-settled rule in the Ninth Circuit, the 20 Debtors did not need to plead advice of counsel as an affirmative 21 defense. A debtor may raise advice of counsel as evidence of its 22 good faith and to negate an allegation of fraudulent intent. In 23 other words, it is of no consequence that the Debtors did not 24 affirmatively assert their reliance on Mr. Thomas’ and 25 Ms. Goddard’s advice in the arbitration proceeding or earlier in 26 the bankruptcy case. 27 Mr. Campbell states, “[t]o introduce a new ‘issue’ at trial 28 contradicted the earlier order of the Bankruptcy Court that only

13 1 one issue would be tried.” But there was only one issue: whether 2 the Debtors had the necessary intent to commit fraud or 3 defalcation. They were entitled to argue that they did not have 4 such intent because they relied on the advice of their counsel. 5 2. The court properly found that the Debtors relied on Mr. Thomas’ advice. 6 7 Mr. Campbell also contends that the bankruptcy court’s 8 factual findings about advice of counsel were wrong. He claims 9 that the Debtors did not follow their attorney’s advice and there 10 is no evidence that he even provided such advice. But the 11 court’s findings were based on the consistent testimony of the 12 Debtors, Mr. Thomas, and Ms. Goddard, which the court found 13 credible. The court did not clearly err in determining that the 14 Debtors properly sought and relied upon the advice of counsel. 15 D. The bankruptcy court properly considered and rejected Mr. Campbell’s arguments regarding failure to account. 16 17 Mr. Campbell also contends that the bankruptcy court erred 18 when it neglected to consider whether the Debtors intentionally 19 failed to account. He is wrong. 20 The bankruptcy court addressed the communications between 21 the Debtors and Mr. Campbell and the Debtors’ failure to disclose 22 certain information to Mr. Campbell. The bankruptcy court 23 disapproved of the Debtors’ conduct, stating that it was 24 “regrettable,” “misleading,” and marked by “some prevaricating 25 and less than candid conduct.” Thus, Mr. Campbell is wrong that 26 the bankruptcy court ignored the accounting issue. 27 Mr. Campbell asserts that, even if the bankruptcy court 28 ruled on the failure to account, it applied the wrong legal

14 1 standard because the Debtors admitted that they were motivated by 2 fear of litigation. But the bankruptcy court made clear that the 3 Debtors’ desire to avoid litigation with Mr. Campbell caused them 4 to rely on Mr. Thomas’ and Ms. Goddard’s advice; it did not rule 5 that a fear of litigation excuses an intent to defalcate. The 6 bankruptcy court did not misapply any legal standard. 7 E. There is no merit to the alleged factual errors. 8 Mr. Campbell identifies a smattering of alleged errors or 9 omissions in the court’s factual findings. We have carefully 10 reviewed the record, and we hold that none of these purported 11 mistakes amounts to clear error. 12 Mr. Spencer further argues that the bankruptcy court 13 improperly ignored evidence that would support his case. Simply 14 stated, Mr. Campbell is upset that the bankruptcy court did not 15 accept his version of events. There is no indication that the 16 bankruptcy court “ignored” evidence; it weighed the competing 17 pieces of evidence and decided which were more plausible. 18 CONCLUSION 19 The bankruptcy court did not err. Accordingly, we AFFIRM. 20 21 22 23 24 25 26 27 28