In re Bailey: A Divorce Restraining Order to Preserve Business Proceeds Does Not Create a § 523(a)(4) Express Trust, and Setoff Rights Alone Do Not Establish “Cause” for Stay Relief

1. Introduction

These consolidated appeals in In re: Steven K. Bailey arose out of a contentious Kentucky divorce between Steven K. Bailey (the chapter 13 debtor) and Rebecca Bailey (the creditor; later substituted by her estate’s personal representative). During the divorce, a state family-court restraining order required business proceeds from the parties’ jointly operated company, Tri-State Roofing and Remodeling, Inc. (“Tri-State”), to be placed into a “business account” and preserved pending further court order. Steven failed to comply, was held in contempt, and the family court ultimately entered a $160,000 judgment in favor of Rebecca, representing half of approximately $320,000 in business income that should have been segregated.

After Steven filed chapter 13, Rebecca pursued nondischargeability in an adversary proceeding under: (i) 11 U.S.C. § 523(a)(4) (defalcation while acting in a fiduciary capacity, and related theories), and (ii) 11 U.S.C. § 523(a)(5) (domestic support obligation). Following an earlier remand from the Bankruptcy Appellate Panel (“BAP”)—which held judgment on the pleadings was inappropriate on certain claims—the bankruptcy court tried the remanded issues and ruled for the debtor. Rebecca also sought stay relief to pursue an asserted setoff against real property.

The BAP (Chief Judge Bauknight, with Judges Gustafson and Merrill) affirmed across the board, emphasizing that the creditor failed to carry her evidentiary burdens at trial and repeatedly failed to present developed legal arguments both below and on appeal.

2. Summary of the Opinion

  • § 523(a)(4) defalcation: The BAP affirmed the finding that the divorce restraining order did not create an “express or technical trust” under Kentucky law; therefore, no “fiduciary capacity” existed as required for defalcation.
  • § 523(a)(5) domestic support obligation: The BAP affirmed the finding that the creditor failed to prove the $160,000 judgment was “in the nature of alimony, maintenance, or support” under Sixth Circuit standards.
  • Evidentiary ruling: The BAP affirmed exclusion of the state family-court judge’s deposition testimony on parol evidence/relevance grounds.
  • Stay relief and setoff: The BAP affirmed denial of stay relief, holding that a claimed setoff right—without developed argument showing “cause” under § 362(d)(1) and without establishing setoff elements under nonbankruptcy law—was insufficient.
  • Post-confirmation/plan issues and deed conveyance: Several issues were deemed waived due to lack of developed appellate argument, and the order compelling execution of a deed was affirmed because the creditor failed to establish any setoff right justifying noncompliance with the confirmed plan.

3. Analysis

3.1 Precedents Cited (and How They Shaped the Decision)

A. Appellate jurisdiction and finality in bankruptcy

  • Ritzen Grp., Inc. v. Jackson Masonry, LLC and Bullard v. Blue Hills Bank: The BAP relied on these Supreme Court decisions to frame bankruptcy finality: orders are “final” when they dispose of discrete disputes within the larger case.
  • Church Joint Venture, L.P. v. Bedwell (In re Blasingame) and Geberegeorgis v. Gammarino (In re Geberegeorgis): Cited for the proposition that orders fully disposing of an adversary proceeding are final and appealable.
  • In re Blasingame and Cattin v. Gen. Motors Corp.: Used to explain that an appeal from a final judgment brings up prior non-final rulings (including evidentiary rulings) for review.

B. Standards of review and mixed questions

  • Kraus Anderson Cap., Inc. v. Bradley (In re Bradley) and Bank of Montreal v. Off. Comm. of Unsecured Creditors (In re Am. HomePatient, Inc.): Provide the framework for separating legal questions (de novo) from factual findings (clear error) in dischargeability litigation.
  • U.S. Bank N.A., Trustee ex rel. CWCapital Asset Mgmt. v. Vill. at Lakeridge, LLC and Doe v. Boland (In re Boland): Reinforce that the standard for a mixed question depends on whether the inquiry is primarily legal or factual.
  • Anderson v. City of Bessemer City, N.C. and King v. Zamiara: Support the deference owed to plausible trial-court factfinding, especially where two permissible views of the evidence exist.

C. § 523(a)(4) defalcation and the “fiduciary capacity” requirement

  • Long v. Piercy (In re Piercy), Bd. of Trs. of the Ohio Carpenters' Pension Fund v. Bucci (In re Bucci), and Commonwealth Land Title Co. v. Blaszak (In re Blaszak): These cases supply the controlling Sixth Circuit elements for defalcation—most importantly, a preexisting fiduciary relationship rooted in an express or technical trust involving a specific trust res.

The BAP’s affirmance turned on this line of authority: even clear misconduct (here, violating an order to segregate funds) does not become “defalcation while acting in a fiduciary capacity” unless the creditor proves an express/technical trust and the debtor’s fiduciary role within it.

D. § 523(a)(5) domestic support obligations

  • Long v. Calhoun (In re Calhoun) and Fitzgerald v. Fitzgerald (In re Fitzgerald): The BAP restated the Sixth Circuit’s four-part analysis for deciding whether an obligation not labeled as support is nonetheless “in the nature of support,” focusing on intent and the actual effect of providing necessary support.
  • In re Thomas: Reinforces the Calhoun/Fitzgerald framework and the non-debtor’s burden of proof.

E. Evidentiary discretion

  • Graf v. Morristown-Hamblen Hosp. Ass'n: Provided the abuse-of-discretion standard for reviewing the exclusion of deposition testimony.

F. Automatic stay relief and setoff doctrine

  • State Bank of Florence v. Miller (In re Miller): Cited for the abuse-of-discretion standard on stay-relief rulings.
  • Laguna Assocs. Ltd. P'ship v. Aetna Cas. & Sur. Co. (In re Laguna Assocs. Ltd. P'ship) and Indus. Ins. Servs., Inc. v. Zick (In re Zick): Cited for the proposition that “cause” under § 362(d)(1) is a case-by-case discretionary inquiry.
  • I.R.S. v. Shultz (In re Shultz): Central to the BAP’s stay-relief analysis—rejecting the notion that the mere existence of a setoff right automatically constitutes “cause” to lift the stay.
  • Ky. Cent. Ins. Co. v. Brown (In re Larbar Corp.): Used to explain § 553 setoff as preserving (not creating) a creditor’s prepetition right to offset mutual prepetition debts.
  • Citizens Bank of Md. v. Strumpf and Studley v. Boylston Nat'l Bank: Provide the classic definition and rationale for setoff—netting mutual obligations to avoid circular payments.

G. Plan confirmation and binding effect

  • Salt Creek Valley Bank v. Wellman (In re Wellman) and In re Crady: Invoked to support the binding effect of a confirmed plan and related compliance obligations.
  • United Student Aid Funds, Inc. v. Espinosa: Cited for the proposition that confirmation orders can bind creditors even where legal error exists, if notice was provided and the creditor failed to object or appeal.

H. Waiver by undeveloped argument

  • McPherson v. Kelsey, Citizens Awareness Network, Inc. v. United States Nuclear Regulatory Comm'n, Est. of Barnwell v. Grigsby, and In re Prather: These cases were used to justify treating issues as waived where a party offers only skeletal, perfunctory references without developed reasoning.
  • Nyamusevya v. CitiMortgage, Inc. (In re Nyamusevya): Used for the rule that arguments not raised below are ordinarily not considered on appeal.

3.2 Legal Reasoning

A. Why the creditor lost under § 523(a)(4): no express/technical trust proven

The BAP accepted that Steven violated the state restraining order and that Rebecca suffered a loss, but that did not resolve the dispositive § 523(a)(4) question: whether Steven was acting in a “fiduciary capacity” arising from an express or technical trust with a defined trust res. Applying In re Blaszak, the bankruptcy court required proof of: (1) intent to create a trust, (2) a trustee, (3) a trust res, and (4) a definite beneficiary.

The restraining order was treated as the purported trust-creating instrument, and the bankruptcy court found it did not establish the required elements:

  • No clear trust intent in the text: the order did not employ trust terminology (trust, trustee, fiduciary, beneficiary, escrow). The absence of labels was not dispositive by itself, but it aligned with the broader absence of trust structure.
  • No definite beneficiary entitlement stated: the order preserved assets “until further orders,” but did not confer a present entitlement to identified proceeds on Rebecca (or anyone) at the time the order was entered.
  • No trustee administration described: the order functioned as a preservation injunction rather than a directive imposing trustee-like administration of a segregated res for a beneficiary.

Critically, the BAP stressed that the creditor’s attempt on appeal to reframe the case as involving a “technical trust” arising from statutes and corporate-officer duties was waived because it was not meaningfully raised and developed in the bankruptcy court. The opinion also underscored that the prior remand did not establish a trust as “law of the case”; it merely held that judgment on the pleadings was premature and required further proceedings and document review.

B. Why the creditor lost under § 523(a)(5): failure to prove “in the nature of support”

Under § 523(a)(5) and § 101(14A), the court’s task was to determine whether the $160,000 judgment—entered as part of divorce litigation and alongside a separate $250 monthly maintenance award—was actually “in the nature of alimony, maintenance, or support.” Using the In re Calhoun / In re Fitzgerald analysis, the bankruptcy court required evidence of: (1) intent to create support, and (2) actual effect of providing necessary support (with potential reasonableness inquiry thereafter).

The BAP affirmed the finding that the creditor’s trial presentation failed at the evidentiary level. The court emphasized what was missing: proof of the parties’ respective financial circumstances, income/expenses, the valuation and practical effect of property allocations, and how the $160,000 would function as necessary support rather than as property equalization for diverted business proceeds. The creditor’s argument that Kentucky maintenance statutes required consideration of property awards did not, without more, convert a property-division judgment into a nondischargeable support obligation.

C. Excluding the divorce judge’s deposition: parol evidence and relevance

The creditor sought to admit deposition testimony from the family-court judge to “clarify” intent behind the divorce judgment. The bankruptcy court excluded it, finding (i) no ambiguity in the decree was identified, and (ii) the creditor did not show how the testimony explained a specific term or supplied a consistent additional term. On abuse-of-discretion review (per Graf v. Morristown-Hamblen Hosp. Ass'n), the BAP affirmed, noting also that the “incompleteness” argument (because the decree did not address bankruptcy law) misunderstands the inquiry: nondischargeability turns on the nature of the obligation created by the decree, not on whether the state court anticipated bankruptcy litigation.

D. Stay relief and setoff: “cause” must be shown; setoff must be established

The creditor sought stay relief to pursue setoff involving real property and argued in broad terms that setoff is favored. The bankruptcy court denied relief (without prejudice), finding the motion lacked developed argument as to: (a) the applicable § 362(d) standard, and (b) the existence of a setoff right under nonbankruptcy law.

The BAP affirmed and relied heavily on I.R.S. v. Shultz (In re Shultz): even if a setoff right exists and is preserved by § 553, that does not automatically constitute “cause” to lift the stay under § 362(d)(1). Moreover, § 553 preserves only mutual prepetition debt obligations; the creditor did not adequately explain how an obligation to execute a deed was a “mutual debt” suitable for netting against the monetary judgment.

The BAP also rejected the creditor’s claim that the bankruptcy court held plan confirmation barred setoff categorically; the bankruptcy court expressly noted that if a legal and factual basis for setoff were later established, § 553 would protect it.

3.3 Impact

  • Divorce injunctions vs. bankruptcy “trusts”: The decision draws a practical line between state-court preservation orders (restraining orders/injunctions intended to maintain the status quo) and the express/technical trusts required for § 523(a)(4) defalcation. Creditors seeking nondischargeability must prove trust formation elements—not merely wrongdoing or contempt.
  • Property equalization is not presumptive support: Even where a state court considers property allocation when awarding maintenance, creditors must still prove the Calhoun/Fitzgerald factors—especially the actual support function of the obligation.
  • Limits on “intent” testimony from the issuing judge: The affirmed exclusion signals that attempts to re-characterize divorce awards through later judicial testimony face significant hurdles absent ambiguity or a recognized basis to admit extrinsic evidence.
  • Setoff strategy in chapter 13 requires careful briefing: The opinion reinforces that (i) stay relief requires a showing of “cause”, and (ii) setoff requires a clear demonstration of mutual debts and supporting nonbankruptcy law—coupled with an explanation of why equitable discretion favors setoff.
  • Procedure matters: The repeated waiver holdings, anchored in McPherson v. Kelsey and Nyamusevya v. CitiMortgage, Inc. (In re Nyamusevya), highlight that nondischargeability and stay-relief outcomes can turn as much on record development and argument preservation as on underlying equities.

4. Complex Concepts Simplified

  • Nondischargeable debt: A debt that survives bankruptcy; the debtor remains liable after discharge.
  • § 523(a)(4) “defalcation while acting in a fiduciary capacity”: Not every breach of duty qualifies. In the Sixth Circuit, the fiduciary duty must arise from an express or technical trust (a defined relationship with a trust res and identifiable beneficiary), not merely from general duties or court orders.
  • Express trust elements (as applied here): Clear intent to create a trust, a trustee, specific property held in trust (res), and a beneficiary. A restraining order telling parties not to dissipate assets typically preserves property; it does not automatically create a trust relationship.
  • Domestic support obligation (DSO): A bankruptcy term for support-like obligations (alimony/maintenance/child support) that are not dischargeable. Courts look at substance (intent and effect), not labels.
  • Parol evidence rule: A doctrine limiting extrinsic evidence to interpret a written agreement/order, especially where the writing is unambiguous and integrated.
  • Automatic stay and “cause”: Filing bankruptcy triggers an injunction stopping collection actions. A creditor must show “cause” to lift it; “cause” is discretionary and fact-specific.
  • Setoff (§ 553): A netting mechanism for mutual prepetition debts. The Bankruptcy Code generally preserves setoff rights that exist under nonbankruptcy law, but the creditor must prove the right and still justify any requested stay relief.
  • Waiver by inadequate briefing: Courts will not build arguments for a party. Merely citing cases or asserting conclusions without analysis can forfeit the issue.

5. Conclusion

In re Bailey reinforces three practical rules in Sixth Circuit bankruptcy litigation: (1) a state divorce restraining order directing segregation/preservation of business proceeds does not, without proof of trust elements, create the express/technical trust needed for § 523(a)(4) defalcation; (2) property-division judgments are not transformed into § 523(a)(5) support obligations absent evidence showing intent and actual support function under In re Calhoun and In re Fitzgerald; and (3) asserting setoff requires more than invoking § 553—creditors must prove mutual-debt setoff under applicable law and separately show “cause” for stay relief. Overlaying all of this is a procedural takeaway: litigants must build an evidentiary record and present developed arguments in the trial court and on appeal, or risk waiver and affirmance.