UNITED STATES COURT OF APPEALS for the Fifth Circuit
____________________________
NO. 91-1059 ____________________________
IN THE MATTER OF: ARCHIE BENNETT, JR.,
Debtor,
LSP INVESTMENT PARTNERSHIP, A TEXAS PARTNERSHIP, CHARLES SAPP, HOWARD BOYD, R. BRUCE LaBOON, THOMAS REIDY, H. MICHAEL TYSON, JOHN C. NABORS, GEORGE CARAMEROS, WILLIS WITT, WALTER P. ZIVLEY, CROSHAW INVESTMENT PARTNERSHIP (BY ITS AGENT, FRED E. CROSHAW), W. ROBERT BROWN, OBIE & CO., (BY ITS AGENT, FRANK A. LIDDELL, JR.), CARL GALLOWAY, DON C. QUAST, and JOE E. McLEMORE,
Appellants,
VERSUS
ARCHIE BENNETT, JR.,
Appellee.
______________________________________________________ Appeal from the United States District Court for the Northern District of Texas ______________________________________________________ April 19, 1993
ON PETITION FOR REHEARING (Opinion September 2, 5th Cir., 1992 F2d .)
Before POLITZ, Chief Judge and HIGGINBOTHAM, Circuit Judges, and PRADO1, District Judge.
PRADO, District Judge:
On the petition for rehearing filed by LSP Investment
Partnership, we hereby withdraw our prior opinion, published as LSP
1 District Judge of the Western District of Texas, sitting by designation.
1 Inv. Partnership v. Bennett (Matter of Bennett), 970 F.2d 138 (5th
Cir. 1992), and substitute the following opinion in its place.
This appeal arises out of an adversary proceeding in a
bankruptcy case2, in which the bankruptcy court entered an order
granting a discharge to the Appellee, Archie Bennett, Jr., over the
objection of the Appellants that certain of Mr. Bennett's debts
were not dischargeable. In support of their argument, the
Appellants rely solely on 11 U.S.C. § 523(a)(4), which provides
that debts resulting from a defalcation by the debtor while acting
in a fiduciary capacity are not dischargeable in bankruptcy. This
Court must decide whether Bennett, as the managing partner of the
managing partner of the limited partnership, owed a sufficient
fiduciary duty to the limited partners to satisfy the strict
requirements of 11 U.S.C. § 523(a)(4). This is a case of first
impression in this Circuit.
Standard of Review
Although this case has already been reviewed on appeal by the
district court, this Court reviews the bankruptcy court's findings
as if this were an appeal from a trial in the district court.
Killebrew v. Brewer, 888 F.2d 1516, 1519 (5th Cir. 1989). Thus,
the bankruptcy court's findings of fact are reviewed under the
clearly erroneous standard, and its conclusions of law are reviewed
de novo. Id.
2 The underlying bankruptcy proceeding, filed on November 23, 1988, by Archie Bennett, Jr., bears Case No. 388-37142 RCM-7. The adversary proceeding is No. 389-3110.
2 Background
1. Bankruptcy Court's Findings of Fact.
The facts in this case are essentially undisputed.3 In
approximately March of 1980, Bennett and the Appellants formed a
Texas limited partnership known as Mariner/Greenspoint, Ltd.
("MG"). The Appellants in this case are and were at all relevant
times, limited partners of MG. The sole general partner of MG was
another limited partnership, known as Mariner Interest No. 20, Ltd.
("No. 20"). The sole general partner of No. 20 was the Appellee,
Archie Bennett, Jr.
Under the terms of the MG partnership agreement, the general
partner, No. 20, was charged with management of the partnership and
had full, exclusive and complete authority and discretion to
manage, control and make all decisions affecting the purposes of
the partnership and to take any action required to effectuate the
purpose of the partnership. Bennett, as the sole general partner
of No. 20, was the only individual with the power or authority to
direct the affairs of No. 20 and MG, and was prohibited by the MG
partnership agreement from voluntarily withdrawing as the general
partner of No. 20.
The purpose of the MG partnership was to construct and operate
3 The Appellee expressly states that he relies on the bankruptcy court's findings of fact. Appellee's Brief, p. 3. With one partial exception, the Appellants agree that the bankruptcy court's findings of fact are correct. Appellants' Brief, p. 7. The exception, discussed below, is the Appellants' argument that the bankruptcy court erred in failing to find that the $1 million distribution by M/G to Bennett was a defalcation under 11 U.S.C. § 523(a)(4). Id. This is a mixed question of law and fact.
3 a Marriott hotel near the Greenspoint Mall in Houston, Texas. The
partnership obtained $22 million, in capital contributions and
loans, to cover the cost of constructing the hotel. The MG
partnership agreement required the general partner to contribute
cash, as necessary, for the costs of constructing, equipping and
furnishing the hotel, to the extent such costs exceeded the $22
million previously raised. As an incentive, the agreement also
provided that the general partner was eligible to receive a cash
distribution of up to $4 million if the project was completed for
less than the projected $22 million. However, prior to taking any
distribution for savings in the construction of the hotel, the
general partner was required both to construct the hotel and to
provide all equipment necessary so that it could operate as a
"first-class hotel".
At some point early on in the business venture, Bennett
retained a corporation, known as Mariner Corporation, to perform
his duties as the general partner of No. 20 and, in turn, its
duties as general partner of MG. Mariner Corporation was 100%
owned by Bennett. The officers and employees of Mariner
Corporation acted on Bennett's behalf in performing their duties
and were aware that, if the project was completed under budget, the
savings would be paid directly to Bennett.
Mariner Corporation obtained bids for the construction of the
hotel from a number of general contractors. All of the bids
initially submitted were at least $1 million over the budgeted
amount of $22 million. After these bids were received, Mariner
4 Corporation entered into negotiations with one of the contractors,
Eaves Construction. Subsequently, Eaves dropped its bid price by
$1 million and was awarded the contract. Eaves was not able to
obtain a bond on the project, however, due to its lack of financial
strength and lack of a sufficient track record on large projects.
Bennett told Eaves that it could have the job without a bond, if it
reduced its general contractor's fee by one-half. Eaves agreed and
reduced its fee by an additional $250,000.
The hotel was completed on time, and opened in January of
1981. At that time Bennett made a $1 million distribution to
himself, for completing the project for less than the budgeted $22
million.
Subsequently, several problems with the hotel came to light.
First, in approximately April of 1981, mildew began to occur in the
guest rooms of the hotel. This mildew was evidently caused by a
"negative pressure" problem, which in turn was caused by the design
of the heating, ventilation, and air conditioning (HVAC) system in
the hotel.4 As a result of the mildew problem, virtually all of
the guest rooms in the hotel had to be revinyled and resheetrocked
twice, during 1981 and 1982.5
4 "Negative pressure" in a building occurs when more air is exhausted from the building than is made up with conditioned air. The result is that warm, humid air will be drawn into the building to equalize the pressure. 5 The record indicates that, prior to completion of the hotel, in November of 1980, Bennett was made aware that another Marriott hotel, the Brookhollow Marriott, which had substantially the same HVAC system design as the Greenspoint Marriott, had begun to experience similar mildew problems.
5 The bankruptcy court found that the mildew problem at the
hotel was a continuous construction problem that the general
partner had an obligation to fix and pay for under the terms of the
MG partnership agreement. The court found that the first round of
repairs was performed at the expense of the general contractor.
The second round, however, was charged, by the general partner, to
the partnership earnings. The limited partners' share of this cost
was $72,000.
The bankruptcy court also reviewed numerous equipment leases
that were entered into by the general partner for the purpose of
providing various types of equipment to the hotel. The court found
that, under the partnership agreement, the general partner had an
obligation to equip and furnish the hotel with the $22 million
budgeted amount. The court found, with respect to some but not all
of these leases, that the general partner had charged them to the
partnership, instead of paying for them out of the construction
budget. The court also found that Bennett had failed to properly
disclose these leases to the limited partners, or to obtain their
approval for them. The court determined that the amount wrongfully
charged to the limited partners for these equipment leases was
$832,204.40.
2. Bankruptcy Court's Conclusions of Law.
The bankruptcy court concluded that the misapplication of
partnership funds to pay for the mildew repairs and the equipment
leases described above were the result of defalcations by the
general partner of MG in the total amount of $904,204.40. The
6 court also found that No. 20, as the sole general partner of MG,
was a fiduciary to the limited partners of MG, for purposes of
section 523(a)(4). The bankruptcy court noted that while Texas
courts have not extended the partnership relationship generally to
encompass the type of fiduciary duty envisioned by section
523(a)(4), an exception exists for the managing partner of a
partnership, who owes to his co-partners, "one of the highest
fiduciary duties recognized in law." (Citing Huffington v.
Upchurch, 532 S.W.2d 576 (Tex. 1976); Crenshaw v. Swenson, 611
S.W.2d 886 (Tex.Civ.App.--Austin 1980, writ ref'd n.r.e.)).
The bankruptcy court also found, however, that Bennett, as the
general partner of the general partner, did not owe a fiduciary
duty to the limited partners of MG. The bankruptcy court stated:
No. 20 was the fiduciary of MG and only it had an express, technical, preexisting trust relationship with MG, even though Bennett was the managing partner of No. 20.
The bankruptcy court found that Bennett's individual liability
to the limited partners of MG came into effect only by reason of
the breach by No. 20, and pursuant to the Uniform Partnership Act
(UPA) which provides, "[a]ll partners are liable jointly and
severally for all debts, and obligations of the partnership . . .
." Tex.Rev.Civ.Stat.Ann. art. 6132b, § 15 (Vernon 1979). The court
reasoned that while the UPA made Bennett liable for No. 20's
partnership "obligations", it did not create a fiduciary
relationship between Bennett and the limited partners of MG.
Accordingly, the bankruptcy court granted a discharge to Bennett of
all debts, including those which it found to have resulted from
7 defalcations by No. 20, while acting in a fiduciary capacity.
3. District Court's Order.
The district court, in a brief opinion, affirmed the order of
the bankruptcy court granting a discharge to Bennett, but for a
different reason. The district court stated:
Though Bennett was the managing partner of the limited partnership, and Texas courts have imposed a higher degree of fiduciary duty on managing partners, they have done so in the context of constructive, rather than technical, trusts. (Citing Huffington v. Upchurch, 532 S.W.2d 576 (Tex. 1976); Crenshaw v. Swenson, 611 S.W.2d 886 (Tex.Civ.App.--Austin 1980, writ ref'd n.r.e.)).
Thus, the district court concluded that the high level of
fiduciary duty imposed on managing partners of a partnership under
Texas law, only arose in the context of a constructive trust and,
since constructive trusts are insufficient as a matter of law to
meet the express trust requirements of section 523(a)(4), the
district court affirmed the order of the bankruptcy court granting
a discharge to Bennett.
Analysis
1. Fiduciary Duty Under Section 523(a)(4)
The Bankruptcy Code provides in pertinent part as follows:
(a) 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 . . . .
11 U.S.C. § 523(a)(4).
The first issue that we address is whether the scope of the
fiduciary duty owed by the managing general partner of a limited
partnership to the limited partners is sufficient to meet the
8 narrow requirements of section 523(a)(4). Next, we must decide if
such a duty also applies to the managing partner of the managing
partner.
A number of courts have addressed the issue of whether a
partner generally owes the type of fiduciary duty contemplated by
section 523(a)(4) to his co-partners. The courts are split on this
issue with approximately half finding that such a fiduciary duty is
owed,6 and the other half finding that it is not.7
6 See, e.g., Lewis v. Short (In re Short), 818 F.2d 693, 695-96 (9th Cir.1987) (Washington law); Ragsdale v. Haller, 780 F.2d 794, 796 (9th Cir.1986) (California law); Longo v. McLaren (In re McLaren), 136 B.R. 705, 714 (Bankr. N.D. Ohio 1992); Gravel v. Chris J. Roy, A Law Corp. (In re Chris J. Roy), 130 B.R. 214 (Bankr. W.D.La. 1991); Beebe v. Schwenn (In re Schwenn), 126 B.R. 351 (D. Colo. 1991); Getaz v. Stewart (In re Stewart), 123 B.R. 817 (Bankr.W.D.Tenn. 1991); Brown v. McKay (In re McKay), 110 B.R. 764 (Bankr.W.D.Pa. 1990); Susi v. Mailath (In re Mailath), 108 B.R. 290, 293-94 (Bankr. N.D.Okla. 1989); In re Guy, 101 B.R. 961, 986-91 (Bankr. N.D.Ind.1988) In re Cramer, 93 B.R. 764, 767-68 (M.D. Fla.1988) Lee v. Crosswhite (In re Crosswhite), 91 B.R. 156 (Bankr.M.D.Fla. 1988); Stone v. Stone (In re Stone), 90 B.R. 71, 79-80 (Bankr. S.D.N.Y.), aff'd, 94 B.R. 298, 302-03 (S.D.N.Y.1988), aff'd, 880 F.2d 1318 (2nd Cir. 1989); In re Dino, 82 B.R. 184, 186 (Bankr. D.R.I.1988); In re Owens, 54 B.R. 162, 164-65 (Bankr. D.S.C.1984); In re Kraus, 37 B.R. 126, 129 (Bankr.E.D.Mich.1984). See also In re Weiner, 95 B.R. 204, 206-07 (Bankr.D. Kansas 1989) (although no fiduciary relationship between partners generally, the sole managing partner had responsibilities commonly associated with trustee and was therefore a fiduciary under section 523(a)(4)); In re Hurbace, 61 B.R. 563, 565-66 (Bankr.W.D.Tex.1986) (holding that there was insufficient fiduciary relationship between equal co- partners to meet requirements of section 523(a)(4), but indicating, in dicta, that managing partner's fiduciary duties probably sufficient). 7 Rolley v. Spector (In re Spector), 133 B.R. 733 (Bankr. E.D.Penn 1991); Blashke v. Standard (In re Standard), 123 B.R. 444 (Bankr.N.D.Ga. 1991); Sulphur Partnership v. Piscioneri (In re Piscioneri), 108 B.R. 595 (Bankr.N.D.Ohio 1989); Stahl v. Lang (In re Lang), 108 B.R. 586 (Bankr.N.D.Ohio 1989); Coleman v. Choisnard (In re Choisnard), 98 B.R. 37 (Bankr.N.D.Okl. 1989); Medved v. Novak, (In re Novak), 97 B.R. 47 (Bankr. D.Kan. 1987); In re Lewis, 94 B.R. 406, 410 (Bankr. E.D.Va. 1988); In re Stone, 91
9 The seminal case in this Circuit interpreting the discharge
provision at issue is Angelle v. Reed (In re Angelle), 610 F.2d
1335 (5th Cir. 1980).8 In Angelle we reviewed a line of Supreme
Court cases discussing and interpreting similar discharge
provisions contained in prior versions of the bankruptcy laws. We
held that the concept of fiduciary under 11 U.S.C. § 523(a)(4) is
narrowly defined, applying only to technical or express trusts, and
not those which the law implies from the contract. Id., (quoting
Chapman v. Forsyth, 2 U.S. (How.) 202, 207, 11 L.Ed. 236, 238
(1844)). In addition, the requisite trust relationship must exist
prior to the act creating the debt and without reference to that
act. Id., (citing Upshur v. Briscoe, 138 U.S. 365, 378, 11 S.Ct.
313, 317, 34 L.Ed. 931, 936 (1890)). In other words, the trust
giving rise to the fiduciary relationship must be imposed prior to
any wrongdoing. The debtor must have been a trustee before the
wrong and without any reference to it. Ragsdale v. Haller, 780
F.2d 794, 796 (9th Cir. 1986). Thus, a constructive trust is not
B.R. 589, 594 (D.Utah 1988); Dreyfoos v. Ryan (In re Ryan), 90 B.R. 554 (Bankr.S.D.Fla. 1988); In re Braudis, 86 B.R. 1001, 1004 (Bankr.W.D.Mo.1988); In re Clemens, 83 B.R. 945, 951 (Bankr.N.D. Ohio 1988); In re Napoli, 82 B.R. 378, 382-83 (Bankr.E.D.Pa.1988); In re Elliott, 66 B.R. 466, 467 (Bankr.S.D.Fla.1986); In re Holman, 42 B.R. 848, 850-51 (Bankr.E.D.Mo.1984).
8 In the Angelle case we construed section 17a(4) of the former Bankruptcy Act, 11 U.S.C. § 35(a)(4). We have previously noted that while the language of section 523(a)(4) does not precisely parallel that of the predecessor statute, 11 U.S.C. § 35(a)(4), the two statues are similar enough that decisions construing the prior statute are applicable to section 523(a)(4). Boyle v. Abilene Lumber, Inc., 819 F.2d 583, 587 (5th Cir. 1987).
10 sufficient to create a fiduciary relationship for purposes of the
discharge provisions of the Bankruptcy Act. Angelle, 610 F.2d at
1339; Ragsdale, 780 F.2d at 796.
In determining whether a particular debtor was acting in a
fiduciary capacity for purposes of section 523(a)(4), the Court
must look to both state and federal law. The scope of the concept
of fiduciary under 11 U.S.C. § 523(a)(4) is a question of federal
law; however, state law is important in determining whether or not
a trust obligation exists. Angelle, 610 F.2d at 1339.
There has been some disagreement among the courts as to what
exactly is meant by the requirement that there be a "technical
trust" to satisfy section 523(a)(4). Most courts today, however,
recognize that the "technical" or "express" trust requirement is
not limited to trusts that arise by virtue of a formal trust
agreement, but includes relationships in which trust-type
obligations are imposed pursuant to statute or common law. See
e.g. Moreno v. Ashworth, 892 F.2d 417, 421 (5th Cir. 1990) (officer
of a corporation owed common law fiduciary duty to corporation and
stockholders sufficient to satisfy requirements of section
523(a)(4)); Lewis v. Short (In re Short), 818 F.2d 693, 695-96 (9th
Cir.1987) (Washington common law imposed trustee-like duties on
partners of partnership); Ragsdale v. Haller, 780 F.2d 794, 796
(9th Cir.1986) (California common law imposed trustee-like duties
on all partners of a partnership); Carey Lumber Company v. Bell,
615 F.2d 370, 374 (5th Cir. 1980) (Oklahoma Lien Trust statutes
created an express trust). Thus, the trust obligations necessary
11 under section 523(a)(4) can arise pursuant to a statute, common law
or a formal trust agreement.
2. Fiduciary Duties of Managing Partners Under Texas Law.
The controlling law in this case is Texas law. Therefore,
this Court must look to Texas law in order to determine what
obligations are imposed on the managing general partner of a
limited partnership with respect to the limited partners. The
Court must then decide whether the obligations imposed under state
law are sufficient to meet the federal law requirements of
"fiduciary capacity" under section 523(a)(4).
In addressing this issue, both the bankruptcy court and the
district court below referred to and relied on the case of In re
Hurbace, 61 B.R. 563 (Bankr. W.D.Tex. 1986). In that case,
involving a general partnership, the court addressed the issue of
whether the debtor should be denied a discharge under section
523(a)(4) for a judgment entered against him in state court for his
failure to account to one of his former partners for certain
partnership funds. Id. at 564-65. The Hurbace court looked to the
Texas version of the Uniform Partnership Act (UPA), in order to
determine whether the requisite trust relationship existed for
purposes of section 523(a)(4). The court focused on the following
language:
Every partner must account to the partnership for any benefit, and hold as trustee for it any profits derived by him without the consent of the other partners from any transaction connected with the formation, conduct, or liquidation of the partnership or from any use by him of its property.
Tex.Rev.Civ.Stat.Ann. art. 6132b, § 21 (Vernon 1979). The court
12 stated that the phrase "hold as trustee" did not establish a
technical or express trust for purposes of section 523(a)(4). More
to the point, the court found that, "[u]nder the Texas statute, the
trust arises only when the partner derives profits without the
consent of the other partners. Therefore, the statute would fall
within the ambit of a trust ex maleficio specifically excluded from
the purview of nondischargeable debts under § 523(a)(4)." In re
Hurbace, 61 B.R. at 566. The Hurbace court's interpretation of the
UPA is in accord with those decisions cited above in which this UPA
provision has been held not to satisfy the requirements of section
523(a)(4). See e.g., Medved v. Novak, (In re Novak), 97 B.R. 47
(Bankr. D.Kan. 1987).
Only one circuit court has addressed the issue of the
fiduciary obligations of a partner in the context of a section
523(a)(4) claim. In the case of Ragsdale v. Haller, 780 F.2d 794
(9th Cir. 1986), the Ninth Circuit held that, under California law,
the partners in a partnership did owe one another the type of
fiduciary duty contemplated by section 523(a)(4). Id., at 796-97.
The court found that, while the California partnership statute only
created a trust ex maleficio, the California state courts had
imposed additional duties on the partners in a partnership:
In California, partners are trustees for each other and in all proceedings connected with the conduct of the partnership every partner is bound to act in the highest good faith to his co-partner and may not obtain any advantage over him in the partnership affairs by the slightest misrepresentation, concealment, threat or adverse pressure of any kind.
Id. at 796. (Quoting Leff v. Gunter, 33 Cal.3d 508, 514, 658 P.2d
740, 744, 189 Cal.Rptr. 377, 381 (1983)). The court concluded that
13 the obligations imposed by the California courts were "more than
just a fiduciary relationship created in response to some
wrongdoing; California has made all partners trustees over the
assets of the partnership." Id. As a result, the court held that
the debtor's debt to his partner was not dischargeable.9 Id.
The Hurbace court declined to follow the Ragsdale decision,
finding that the Texas courts had not imposed the same type of
fiduciary duties on partners as the California courts. In re
Hurbace, 61 B.R. at 566. The court observed that:
It is only when viewing the position of managing partners do Texas courts venture to impose the type of fiduciary duty described in Ragsdale. (Citations omitted).
Id. The court concluded:
. . . in the present case dealing not with a managing partner vis-a-vis general partners but with equal co-partners, the scope of fiduciary duty described in Ragsdale is not applicable . . . [and] . . . § 523(a)(4) insofar as it relates to a debtor acting in a fiduciary capacity does not apply to the failure of partners to account.
Id. Therefore, the court in Hurbace held that under Texas law,
there was not a sufficient fiduciary duty between equal co-partners
of a general partnership to satisfy the requirements of section
523(a)(4).
However, the case at bar does not involve equal co-partners,
as the Hurbace case did. In this case the Court must decide first
whether, under Texas law, the scope of fiduciary duty owed by a
general partner to limited partners meets the express trust
9 Subsequently, the Ninth Circuit held that, under Washington law, partners were also fiduciaries for purposes of section 523(a)(4). Lewis v. Short (In re Short), 818 F.2d 693, 695-96 (9th Cir.1987).
14 requirements of section 523(a)(4), and second, whether such a duty
exists for or can be imputed to the managing partner of the
managing partner.
The Appellants argue that the Texas courts have long held that
a partner in complete control of a partnership, whether the general
partner of a limited partnership or the managing partner of a
general partnership, owes one of the highest fiduciary duties known
at law to his partners. The Appellee, on the other hand, relying
on the opinion of the district court, argues that, while the Texas
courts have imposed a very high level of fiduciary duty on managing
partners, they have done so only in the context of constructive
trusts and, therefore, by definition these obligations are
insufficient to meet the express trust requirements of the
bankruptcy discharge provisions.10
The Texas Supreme Court case of Huffington v. Upchurch, 532
S.W.2d 576 (Tex. 1976), is generally cited as the primary authority
for the imposition of trustee-like duties on the managing partner
of a partnership. The Huffington case did involve the imposition
of a constructive trust. Id. at 577. Likewise, the two cases
10 In support of its holding, the district court relied in part on the case of CRL of Maryland, Inc. v. Holmes, 117 B.R. 848 (Bankr.D. Md. 1990). The court in Holmes held that a statutory trust cannot be a technical trust for purposes of section 523(a)(4) in the absence of the execution of a formal trust agreement between the parties because the creation of an express trust depends upon the intention of the parties and can never be created by statute alone. CRL of Maryland, Inc. v. Holmes, 117 B.R. at 853. This Circuit has not taken such a technical approach to the interpretation of section 523(a)(4), see e.g. Moreno v. Ashworth, 892 F.2d 417, 421 (5th Cir. 1990), and does not find that such an approach is warranted in this case.
15 cited by the court in Huffington in support of the proposition that
managing partners owe the highest level of fiduciary obligation to
their co-partners, were also constructive trust cases. See Smith
v. Bolin, 153 Tex. 486, 271 S.W.2d 93 (1954); McDonald v. Follett,
142 Tex. 616, 180 S.W.2d 334 (1944).
However, contrary to Bennett's contention, this principle has
not been limited to cases involving constructive trusts. In Cook
v. Peacock, 154 S.W.2d 688 (Tex.Civ.App.--Eastland 1941, writ ref'd
w.o.m.), a case involving an action for a partnership accounting,
the court observed that "[t]he duty of a partner in control of . .
. a business is analogous to that of a trustee." Id., at 691. See
also Conrad v. Judson, 465 S.W.2d 819, 828 (Tex.Civ.App.--Dallas
1971, writ ref'd n.r.e.), cert. denied, 405 U.S. 1041 (1972);
Johnson v. Buck, 540 S.W.2d 393, 412-13 (Tex.Civ.App.--Corpus
Christi 1976, writ ref'd n.r.e.); Cf. Johnson v. J. Hiram Moore
Ltd., 763 S.W.2d 496, 499 (Tex.App.--Austin 1988, writ denied);
Veale v. Rose, 657 S.W.2d 834, 837 (Tex.App.--Corpus Christi 1983,
writ ref'd n.r.e.).
In Watson v. Limited Partners of WCKT, Ltd., 570 S.W.2d 179
(Tex.Civ.App.--Austin 1978, writ ref'd n.r.e.), a case brought for
breach of fiduciary duty, the court held:
In a limited partnership the general partner, acting in complete control, stands in the same fiduciary capacity to the limited partners as a trustee stands to the beneficiaries of the trust. (Citations omitted).
Id., at 182. And in the Crenshaw case, discussed at length below,
the court stated:
It is axiomatic that a managing partner in a general
16 partnership owes his co-partners the highest fiduciary duty recognized in the law.
Crenshaw v. Swenson, 611 S.W.2d 886, 890 (Tex.Civ.App.--Austin
1980, writ ref'd n.r.e.).
This Court has previously observed, in deciding whether tax
attributes associated with certain commercial real estate should be
attributed to a corporation or a partnership, that the duty a
general partner owes to limited partners is analogous to that owed
by a trustee to trust beneficiaries. Moncrief v. United States,
730 F.2d 276, 285 (5th Cir. 1984) (Citing Crenshaw v. Swenson, 611
S.W.2d 886 (Tex.Civ.App.--Austin 1980, writ ref'd n.r.e.)).
Further, in Moreno v. Ashworth, 892 F.2d 417, 421 (5th Cir.
1990), we held that the debtor, who was an officer of a
corporation, owed a fiduciary duty to that corporation and its
stockholders. We found that because the debtor had entered into
certain self-dealing transactions while an officer of the
corporation, the debts arising from these transactions were not
dischargeable under the provisions of 11 U.S.C. § 523(a)(4). Id.
Because the role of an officer or director of a corporation with
respect to the shareholders is analogous to the role of managing
partner of a limited partnership with respect to the limited
partners, Moreno, by analogy, supports the argument that the
managing partner of a limited partnership owes a sufficient
fiduciary duty to the limited partners to satisfy the requirements
of section 523(a)(4).
Significantly, the specific duties imposed by the Texas courts
on managing partners pursuant to this line of cases are the same as
17 those imposed on trustees. They include the duty of loyalty,
Huffington, 532 S.W.2d at 579, and the duty to "deal with one
another with the utmost good faith and most scrupulous honesty."
Johnson, 763 S.W.2d at 499. As the court in Crenshaw stated, when
a general partner is in complete control of the assets and affairs
of a limited partnership:
[His] conduct must be measured by standards exacting the utmost fidelity . . . . Not only is it [the general partner's] duty to administer the partnership affairs solely for the benefit of the partnership, he is not permitted to place himself in a position where it would be for his own benefit to violate this duty.
Crenshaw, 611 S.W.2d at 890.
We find, as the Ninth Circuit did in Ragsdale, that these
obligations are more than a fiduciary relationship created in
response to some wrongdoing. Texas law clearly and expressly
imposes trust obligations on managing partners of limited
partnerships and these obligations are sufficient to meet the
narrow requirements of section 523(a)(4).
However, this is only the first step in the analysis, because
it is undisputed that Bennett was not the managing partner of MG.
He was instead, the managing partner of the managing partner of MG.
Therefore, this Court must now address the more difficult question
of whether Texas law imposes these same trust-type obligations on
the managing partner in a two-tiered partnership arrangement, i.e.
the managing partner of the managing partner.
In support of their argument that Bennett did owe a trustee's
fiduciary obligation to the limited partners of MG, the Appellants
rely on the case of Crenshaw v. Swenson, 611 S.W.2d 886
18 (Tex.Civ.App.--Austin 1980, writ ref'd n.r.e.). They argue that
both the facts and the court's analysis in that case support the
proposition that under Texas law a general partner of a general
partner of a limited partnership owes a fiduciary duty of loyalty
to the limited partners. Because Crenshaw is the only case that
arguably supports the Appellants' contention it merits further
discussion.
The Crenshaw case was a suit for breach of fiduciary duty, and
involved a limited partnership known as Rolling Hills Majestic
Homes (Group I), Ltd. This limited partnership was formed for the
purpose of constructing and selling four homes in Austin, Texas.
The general partner of this limited partnership was another
partnership, known as Occidental Syndicated Investments
(Occidental). The original partners in Occidental were Elizabeth
Swenson, Robert Johnson and James Cooper. Id., at 888. Elizabeth
Swenson, the defendant in the Crenshaw case, was therefore a
general partner of the general partner of a limited partnership; a
relationship clearly analogous to that of Archie Bennett vis-a-vis
the MG limited partnership.
In Crenshaw, the limited partnership agreement provided that
the limited partners would contribute capital to the partnership,
a portion of which was to be used to purchase tracts of land for
development. Title to these tracts was held by Swenson
Corporation, a corporation wholly owned by Elizabeth Swenson and
her husband, Vernor Swenson. After the lots were purchased from
Swenson Corporation, the limited partnership attempted to obtain a
19 construction loan to finance the building of houses on the lots.
The lender refused to make the loan to the limited partnership, but
agreed to lend the money to Swenson Corporation. As a result, the
lots were transferred back to the Swenson Corporation so that the
property could be used as security for the construction loan. Id.
Subsequently, a variety of problems developed with respect to
the construction and sale of the houses. The partnership sustained
losses, and the limited partners were left empty-handed and
disgruntled. The limited partners then brought suit against
Elizabeth Swenson for breach of fiduciary duty. Id. at 888-889.
The Crenshaw court decided the case based on the law of trusts
stating:
It is axiomatic that a managing partner in a general partnership, owes his co-partners the highest fiduciary duty recognized in the law. In a limited partnership, the general partner acting in complete control stands in the same fiduciary capacity to the limited partners as a trustee stands to the beneficiaries of the trust. We must then, in deciding this case, do so under the laws applicable to trusts.
Crenshaw, 611 S.W.2d at 890. The court phrased the legal issue as
whether "the trial court erred in failing to find that appellee,
Elizabeth Swenson, breached her fiduciary duty of loyalty to the
partnership and to the limited partners." Id.
The court reviewed the particular facts of the case and
observed that, "a conveyance of partnership property was made and
the proceeds from the sale . . . were deposited in the Swenson
Corporation . . . without the knowledge or consent of [the limited
partners]". Id., at 891. The court also noted that, "the Swenson
Corporation was the general contractor in absolute control of the
20 partnership's destiny and . . . Elizabeth Swenson had the right to
the exclusive listing when the finished product was sold . . . "
Id. Taking these facts together, the court concluded that "the
case takes on an aura of self-dealing which this Court is unable to
condone." Id. The court then held that Ms. Swenson had breached
her fiduciary duty of loyalty to the limited partners as a matter
of law, and that these limited partners were entitled to equitable
restitution of their investment in the limited partnership. Id.
The Appellants assert that because Elizabeth Swenson was a
general partner of the general partner of the limited partnership,
and because the appellate court held that she owed the limited
partners the fiduciary obligations of a trustee, the case stands
for the proposition that under Texas law a general partner of a
general partner owes fiduciary responsibilities directly to the
underlying limited partners.
Bennett disagrees with the Appellants' interpretation of
Crenshaw. He argues that Crenshaw is distinguishable because,
[W]hen all of the other general partners of Occidental Syndicated Investments resigned from the partnership, that action effected a dissolution of the separate partnership entity leaving only Swenson to act in an individual capacity as the general partner of the limited partnership.
Brief of Appellee Archie Bennett, Jr., at pp. 18-19.
While the court in Crenshaw does note that "[s]ubsequent to
the execution of the partnership agreement, both Robert Johnson and
James Cooper resigned as general partners," it does not indicate
when this occurred. Crenshaw, 611 S.W.2d at 888. Nor does the
court suggest anywhere in its opinion that this fact was relevant
21 to the conclusions it reached. In fact, in describing the critical
transfer of property that forms the basis for the conclusion that
Elizabeth Swenson breached her fiduciary duty to the limited
partners, the court states that "the general partners transferred
title to the lots back to the Swenson Corporation . . . ." Id.
This indicates that, at least at the time the alleged breach
occurred, Ms. Swenson was not acting individually as the general
partner of the limited partnership. To the contrary, the statement
that the "general partners transferred title . . ." indicates that
the transfer was effected by Occidental, as the general partner of
the limited partnership. Therefore, Bennett's attempt to
distinguish Crenshaw is not persuasive.
What this Court finds significant is the Crenshaw court's
analysis of why the managing partner of the managing partner in
that case owed a fiduciary obligation to the underlying limited
partners. In analyzing the duties that Ms. Swenson owed to the
limited partners, the Crenshaw court focused on the nature of the
business relationship as a whole, in which one person, Elizabeth
Swenson, in her various roles as general partner of the general
partner, owner of the corporation hired to accomplish the
construction project, and the real estate broker authorized to sell
the properties when completed, exercised almost total control over
the project. This high level of control, over the project and the
limited partners' investments, appears to have been critical in
persuading the Crenshaw court that Ms. Swenson owed a fiduciary
duty to the limited partners.
22 In reviewing the line of cases that gave rise to the rule in
Texas that the managing partner of a partnership owes to his co-
partners the highest fiduciary obligations known at law, it is
clear that the issue of control has always been the critical fact
looked to by the courts in imposing this high level of
responsibility.
In Huffington v. Upchurch, 532 S.W.2d 576 (Tex. 1976), the
case generally cited as establishing the common law rule in Texas
that the managing partner of a partnership owes to his copartners
one of the highest fiduciary duties recognized at law, the Texas
Supreme Court cited three cases in support of its holding: Smith
v. Bolin, 153 Tex. 486, 271 S.W.2d 93 (1954), MacDonald v. Follett,
142 Tex. 616, 180 S.W.2d 334 (Tex. 1944), and Meinhard v. Salmon,
249 N.Y. 458, 164 N.E. 545 (1928).
Smith v. Bolin involved a partnership in which the respondent,
Bolin, was the "business manager". Smith v. Bolin, 271 S.W.2d at
94. Bolin, individually, had entered into renewal leases of
certain oil and gas properties that had previously been leased by
the partnership. He was sued by his partners for breach of
fiduciary duty. The parties disagreed about whether the
partnership was still in existence at the time Bolin entered into
the disputed transactions, but the court, in reversing the summary
judgment granted to Bolin by the trial court, quoted extensively
from the opinion in Meinhard v. Salmon, and held that "[a]s
managing partner of their partnership enterprise, respondent owed
his partners even a greater duty of loyalty than is normally
23 required." Id. at 96. The critical fact underlying this "greater
duty of loyalty than is normally required," was the greater degree
of control that one partner (i.e., the managing or business
partner) had over the operation of the partnership and hence the
investment of the other partners.
Likewise, in Meinhard v. Salmon, a case cited extensively in
Texas and elsewhere for establishing the fundamental fiduciary duty
rules governing managing partners, Justice Cardozo focused on the
control that one "coadventurer" exercised over the business
enterprise at issue:
The very fact that Salmon was in control with exclusive powers of direction charged him the more obviously with the duty of disclosure . . .
Meinhard v. Salmon, 164 N.E. 545, 547 (N.Y. Court of Appeals 1928).
The court observed:
[T]here may be no abuse of special opportunities growing out of a special trust as manager or agent . . . . Salmon had put himself in a position in which thought of self was to be renounced, however hard the abegnation. He was much more than a coadventurer. He was a managing coadventurer. For him and for those like him the rule of undivided loyalty is relentless and supreme. (Citations omitted).
Id. at 548. Therefore, again in the Meinhard case the fact of
control or management is vital to the court's analysis.11
11 The Court located only one other case in which an issue similar to the one at bar was decided in a bankruptcy context. In Park v. Moorad, 132 B.R. 58 (Bankr.Okla.1991), the debtor was the president, director and sole shareholder of a corporation, which in turn was the general partner of a limited partnership. Id. at 60. At issue in Park was whether the debtor as an individual should be granted a discharge of debts owed by the corporation to the limited partners. The bankruptcy court was not persuaded by the argument that only the corporation as the managing partner owed a fiduciary duty to the limited partners and denied the discharge, under section 523(a)(4), stating that the debtor would not be allowed to
24 The Crenshaw court, analyzing the issue in a manner consistent
with the way in which Texas jurisprudence has developed in this
area, concluded that Ms. Swenson, the managing partner of the
managing partner of the limited partnership, owed to the limited
partners the highest fiduciary duty known at law, a duty analogous
to that owed by a trustee to the beneficiaries of the trust.
Crenshaw, 611 S.W.2d at 890. Therefore, based on the holding in
Crenshaw and the cases cited therein, we find that Bennett, as the
managing partner of the managing partner, owed to the MG limited
partners "the highest fiduciary duty recognized in the law." We
find further that this fiduciary obligation is sufficient to meet
the requirements of Section 523(a)(4).
3. Defalcation and Damages.
A defalcation is a willful neglect of duty, even if not
accompanied by fraud or embezzlement. Moreno v. Ashworth, 892 F.2d
417, 421 (5th Cir. 1990). Therefore, any debts incurred by Bennett
as a result of the willful neglect of his duties as the managing
partner of the managing partner of the MG limited partnership are
not dischargeable. 11 U.S.C. § 523(a)(4).
The Appellants argue that the bankruptcy court erred in its
determination of the amount of Bennett's non-dischargeable debt in
several ways. First, they argue that the court erred in
"hide beneath a corporate shell when he so completely controlled the corporate actions, representations and decisions that in effect it had no life without him." Id. at 63. Once again, the court focused on the control exercised by one person over the investments of others.
25 calculating the amount of debt not dischargeable based on actual
damages ( i.e. based on specific defalcations found by the
bankruptcy court) instead of granting them restitution of their
entire investment. This argument is without merit. While
restitution is a permissible method of recovery for breach of
fiduciary duty, it is not the only one. Watson v. Limited Partners
of WCKT, Ltd., 570 S.W.2d 179, 182 (Tex.Civ.App.--Austin 1978, writ
ref'd n.r.e.). Actual damages are also a permissible remedy for
breach of fiduciary duty, Preston Carter Co. v. Tatum, 708 S.W.2d
23 (Tex.App.--Dallas 1986, writ ref'd, n.r.e.), as is a suit for an
accounting and exemplary damages, Manges v. Guerra, 673 S.W.2d 180
(Tex. 1984). We find that the method the bankruptcy court employed
to calculate Bennett's non-dischargeable debt in this case was
permissible under Texas law, and therefore, was not error.
In accordance with the findings and calculations of the
bankruptcy court, $72,000 worth of repairs on the HVAC system and
$832,204.40 worth of equipment leases were improperly charged to
the limited partners. By making these improper charges Bennett
willfully neglected his duties to the limited partners and we find
that these charges constitute defalcations by Bennett while acting
in a fiduciary capacity, and as such are not dischargeable pursuant
to 11 U.S.C. § 523(a)(4).
The Appellants also argue that the bankruptcy court exceeded
its authority in calculating damages at all, since the Appellants
were only seeking a ruling on the dischargeability of the debt in
the adversary proceeding. This contention is also without merit.
26 It is customary for a bankruptcy court to determine both liability
and the measure of damages in a proceeding to determine the
dischargeability of a debt. See e.g. Jordan v. Southeast National
Bank (Matter of Jordan), 927 F.2d 221 (5th Cir. 1991); Shaver
Motors, Inc. v. Mills (In re Mills), 111 B.R. 186 (Bankr. N.D. Ind.
1988); Medved v. Novak (In re Novak), 97 B.R. 47 (Bankr. D. Kans.
1987). In addition, in their Complaint to Determine
Dischargeability of Debt, the Appellants asked the bankruptcy court
to enter judgment for them in the full amount of their investment.
Thus, the issue of the amount of debt not dischargeable was
properly before the bankruptcy court and it was not error for it to
rule on that issue.
Finally, the Appellants argue that the bankruptcy court erred
in failing to find that the $1 million distribution to Bennett was
also a defalcation. On this point we agree with the Appellants.
Under Texas law, a fiduciary who breaches his duties forfeits his
right to compensation as a matter of law. Kinzbach Tool Co., Inc.
v. Corbett-Wallace Corp., 160 S.W.2d 509, 514 (Tex. 1942); Douglas
v. Aztec Petroleum Corp., 695 S.W.2d 312, 318 (Tex.App.--Tyler,
1985, no writ); Anderson v. Griffith, 501 S.W.2d 695, 702
(Tex.Civ.App.--Fort Worth 1973, writ ref'd n.r.e.). In addition,
it was an act of self dealing and a breach of the duty of good
faith and fair dealing for Bennett to have paid himself the $1
million distribution when at the same time he improperly charged
more than $800,000 in equipment leases to the limited partners.
Thus, the $1 million distribution was also a defalcation by Bennett
27 and is not dischargeable pursuant to 11 U.S.C. § 523(a)(4).
28 Conclusion
In conclusion, we find that the question of the non-
dischargeability of Bennett's debts to the limited partners under
11 U.S.C. § 523(a)(4) was wrongly decided. We therefore reverse
the decisions of the bankruptcy and district courts on that issue
and render judgment in favor of the limited partners in the amount
of $1,904,204.40.
REVERSED and RENDERED.