IN RE DENTON, (Bankr.N.D.N.Y. 1999)

MEMORANDUM-DECISION AND ORDER

ROBERT E. LITTLEFIELD, JR., U.S. Bankruptcy Judge.

The current matter before the court involves Western Surety Company's (hereinafter "Plaintiff") amended complaint filed on November 17, 1998 containing three causes of action:

1) requesting a declaratory judgment that the Defendant's residuary interest in the estate of Marjorie Denton is not property of the estate.

2) requesting permission to setoff Defendant's interest in the estate of Marjorie Denton against Plaintiff's judgment claim.

3) requesting a determination that a certain debt owed Plaintiff is nondischargeable pursuant to 11 U.S.C. § 523(a)(4).

Mr. James Denton (hereinafter "Defendant") answered the complaint and raised three affirmative defenses:

On October 28, 1998, the Trustee answered the original complaint. However, according to this court's docket, the Trustee did not provide an answer to the amended complaint. The Trustee did submit pleadings in the present motion.

1) at the time of filing his petition, he owed no obligation to the Estate;

2) at the time of filing his petition he owed a contractual debt to Plaintiff pursuant to an agreement; and

3) at the time of filing his petition, he was not yet entitled to his 25% distribution share from the estate.

Plaintiff now moves for summary judgment; the court has jurisdiction via 28 U.S.C. § 157(a), 157(b)(1), 157(b)(2)(A), 157(b)(2)(I) and 1334(b).

FACTS

The parties agreed to a statement of undisputed facts filed on February 5, 1999. The court finds the following based on that statement:

1. Marjorie L. Denton died on the 5 ^th of January 1990. On or about February 23, 1990, a petition for probate of the will and proposed codicil were filed with the Warren County Surrogate's Court.

2. Defendant was named as the executor in the last will and testament of Marjorie L. Denton.

3. An order was issued by the surrogate's court granting letters testamentary to the Defendant, on August 26, 1991. This order was conditioned upon the Defendant procuring the necessary executor's bond.

4. The Defendant obtained a bond in the amount of $150,000.00 from the Plaintiff on or about September 24, 1991.

5. Defendant was appointed as the executor of Marjorie Denton's estate on September 24, 1991.

6. On August 13, 1997, the acting Surrogate Court Judge, Honorable L. Foster James, entered a decision which held that the defendant James Denton had breached his fiduciary duty to the estate of Marjorie Denton when he, among other things, engaged in self dealing and failed to pay and/or collect rent from himself and another occupant of the decedent's former residence.

7. Pursuant to Judge James' decision and order, upon payment by the Plaintiff, as surety, of the sums due from Defendant by reason of his breach of fiduciary duty as executor, "the said James W. Denton shall be released and discharged from any further liability and responsibility as such executor as to all matters embraced in his account and determined as by the within decree, subject, however, to the subrogation rights of the surety company relative to the indemnification by James W. Denton for any and all amounts, claims or demands for which James W. Denton could be held responsible pursuant to the terms of the underlying indemnity agreement."

8. As a result of his malfeasance and breach of fiduciary duty, the probate court removed the defendant as Executor of the Estate and required that he file an accounting within 30 days. On or about the 27 ^th day of September, 1995, the Defendant rendered an accounting of his activities as executor of the estate of Marjorie Denton for the period from August 26, 1991 to September 27, 1995.

9. On or about October 27, 1995, objections were filed against the September 27, 1995 accounting, setting forth numerous individual objections thereto, including the Defendant's failure to pay and collect rent on the subject real property.

10. On or about September 25, 1997, Plaintiff, in good faith and pursuant to the terms of its surety bond, issued a check made payable to "Charles H. Coffin, Administrator CTA Estate of Marjorie Denton" in the amount of $25,625.00 and deposited it in the estate's bank account.

11. Plaintiff commenced an action against the defendant in New York Supreme Court, Warren County, on or about October 27, 1997, demanding judgment against the Defendant in the amount of $25,625.00, plus fees and costs.

12. Defendant failed to answer the complaint. On or about January 9, 1998, Plaintiff was granted judgment against the Defendant in the total amount of $28,175.00, plus interest. The judgment was docketed in the Warren County Clerk's office on January 9, 1998.

13. On January 15 and January 21, 1998, copies of the judgment with Notice of Entry, together with Information Subpoenas and Restraining Notices, were forwarded to Defendant, as well as to Charles H. Coffin, the newly appointed Executor of the estate of Marjorie Denton, by Restricted Delivery, Certified Mail, Return Receipt Requested.

14. On May 13, 1998, prior to the filing of the Defendant's bankruptcy petition, Plaintiff's attorney delivered property executions to the Warren County Sheriff's Department after obtaining confirmation that Defendant was a 25% residuary beneficiary in the estate of Marjorie Denton.

15. On May 20, 1998, Defendant filed a petition under Chapter 7 and Nathan M. Goldberg was appointed Interim Trustee on May 27, 1998.

16. On May 14, 1998, The Warren County Sheriff attempted to serve the levy on Charles H. Coffin. The sheriff's records indicate that they were unable to serve Mr. Coffin because he was out of the country. The levy was left with Mrs. Coffin by delivering it to her at her place of employment.

17. Joan Denton, former spouse of the Defendant, has filed a claim against Defendant for child support and filed an execution with the sheriff against Defendant's distributive share on August 1, 1996. The execution was returned unsatisfied on the ground that there was nothing to levy upon; it had expired.

18. On August 12, 1998, upon motion duly noticed and with no opposition filed, this court granted an order to the Trustee directing counsel for the testamentary estate to turnover to the Trustee the funds in his possession representing the Defendant's distributive share in his mother's estate. The Trustee has possession of those funds.

DISCUSSION

A. PLAINTIFF'S FIRST CAUSE OF ACTION 11 U.S.C. § 541 (a) is entitled "Property of the estate" and provides in part:

The commencement of a case . . . creates an estate. Such estate is comprised of all the following property, wherever located and by whomever held:

1) . . . all legal or equitable interests of the debtor in property as of the commencement of the case.

The Plaintiff takes the position that it levied on the Defendant's interest in the testamentary estate prepetition and that this cuts off any legal or equitable interest of the Defendant in that estate. In support of this argument, Plaintiff states ". . . (i)t is clear that the plaintiff properly levied upon the Defendant's interest in the Estate of Marjorie Denton prior to the filing of the bankruptcy petition herein by the Defendant. Accordingly, it is respectfully submitted that the Defendant's residuary interest in the estate of Marjorie Denton is not property of the Defendant's bankruptcy estate . . ." (Plaintiff's Memorandum of Law p. 11.) The Plaintiff offers no case law or statutory interpretation in support of this conclusion.

Defendant counters by arguing that either the execution was not properly venued, or alternatively, that there was no property interest to execute on until August 28, 1998. As such, the execution expired prior to this date pursuant to CPLR § 5232(a). Ultimately, Defendant offers that even if proper, the execution would be subject to reversal under a preference theory.

CPLR § 5232 is entitled "Levy upon personal property." Subsection (a) is entitled "Levy by service of execution" and states in part: The sheriff . . . shall levy upon any interest of the judgment debtor or obligor in personal property not capable of delivery, or upon any debt owed to the judgment debtor or obligor, by serving a copy of the execution upon the garnishee, in the same manner as a summons, . . . At the expiration of ninety days after a levy is made by service of the execution, or of such further time as the court upon motion of the judgment creditor . . . has provided, the levy shall be void except as to property or debts which have been transferred or paid to the sheriff . . . or as to which a proceeding under sections 5225 or 5227 has been brought . . . N.Y. Civ.Prac. L. R. § 5232 (McKinney's 1998)

The Trustee similarly argues that the execution was fatally flawed procedurally and in any event is avoidable.

Whether a levy on behalf of a judgment creditor is perfected is determined by state law. In re Flax, 179 B.R. 408, 411 (Bankr. E.D.N.Y. 1995). CPLR § 5232(a) requires that the following must take place in order for a lien to be perfected based on a levy by service of execution:

1) there must be a judgment;

2) an execution must have been issued by the judgment creditor;

3) the sheriff must have made a levy, which is effected by service of the execution upon the garnishee; and

4) the property or debt to be seized must be transferred or paid to the Sheriff or support collection unit within 90 days after a levy is made by service of the execution. Id.

The Plaintiff did deliver a property execution to the Warren County Sheriff on May 13, 1998, but never served the estate representative because he was out of the county. Instead, the sheriff served the representative's wife at her place of business. This court will assume for purposes of this decision that the Defendant's interest in the testamentary estate is an interest in personal property "not capable of delivery" as contemplated by CPLR § 5232(a). That section provides that a copy of the execution should have been served upon the estate representative in the same manner as service of a summons as required by CPLR § 308. While the wife would presumably be a person of suitable age and discretion, she was not served at the actual place of business, dwelling place or usual place of abode of the representative of the estate. Further, it would appear that the sheriff did not mail a copy of the execution to the representative.

CPLR § 308 is entitled "Personal service upon a natural person" and provides in part that personal service shall be made by one of four methods:
1) personal delivery to person to be served;

2) by delivering the summons within the state to a person of suitable age and discretion at the actual place of business, dwelling place or usual place of abode of the person to be served and by either mailing the summons to the person to be served at his or her last known residence or by mailing the summons by first class mail to the person to be served at his or her actual place of business . . .

3) by delivering the summons within the state to the agent for service of the person to be served as designated under rule 318 . . .

4) where service under paragraphs one and two cannot be made with due diligence, by affixing the summons to the door of either the actual place of business, dwelling place or usual place of abode within the state of the person to be served and by either mailing the summons to such person at his or her last known residence or by mailing the summons by first class mail to the person to be served at his or her actual place of business . . . N.Y. Civ. Prac. L. R. § 308 (McKinney's 1998)

Since service was not proper as annunciated by the third Flax test supra, there was no effective levy. Additionally, even if service had been proper, the levy would have expired; nothing was transferred to the sheriff within 90 days and no proceeding was commenced as required under CPLR §§ 5225 or 5227. Thus, the Defendant's interest in the testamentary estate was property of the bankruptcy estate when the petition was filed.

B. PLAINTIFF'S SECOND CAUSE OF ACTION

The right of setoff is found at 11 U.S.C. § 553. This section is not an independent source of setoff rights. It merely preserves for the benefit of the creditor any right to setoff that the creditor had under applicable nonbankruptcy law. In re Westchester Structures, Inc. 181 B.R. 730, 738-39 (Bankr. S.D.N.Y. 1991) (citations omitted). Additionally, whether or not to allow a setoff is a decision that rests within the sound discretion of the bankruptcy court. In re Bay State York Co., Inc., 140 B.R. 608 (Bankr. D. Mass. 1992).

Section 553 states, in part,: . . . (t)his title does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debtor that arose before the commencement of the case under this title against a claim of such creditor against the debtor that arose before the commencement of the case. . . .

As stated above, the second cause of action requests permission to setoff Defendant's interest in the estate of Marjorie Denton against Plaintiff's judgment. Plaintiff argues that it has been subrogated to the rights of the estate and, as such, meets the three requirements for setoff as set forth in Posey v. U.S. Dept. of Treasury — IRS, 156 B.R. 910, 914 (Bankr. W.D.N.Y. 1993):

1) Plaintiff has a prepetition claim against the debtor;

2) Plaintiff has a prepetition debt owed to the debtor; and

3) The claim and debt are mutual obligations.

The Defendant counters by stating that while Plaintiff meets the first and third paragraphs of the Posey test, there was no prepetition debt owed to the Defendant by the Plaintiff. The Trustee argues that not only was there no obligation owed to the Defendant by the Plaintiff, but also there was no mutuality present in that the Plaintiff's obligation was to the estate, not to the Defendant. The Trustee cites In re Communicall Cent., Inc. 106 B.R. 540, 541 (Bankr. N.D. ILL. 1989), for the proposition that mutuality must be strictly construed. In order for debts to be mutual they must be in the same right and between the same parties, standing in the same capacity. Id. The mutual debt and the mutual credit between the debtor and the creditor must exist at the time of the filing of the petition. Id.

black's law dictionary revised fourth edition defines "debt" as:

A sum of money due by certain and express agreement; as by bond for a determinate sum, or bill or note, a special bargain, or a rent reserved on a lease, where the amount is fixed and specific, and does not depend upon any subsequent valuation to settle it.

Debt is defined in 11 U.S.C. § 101(12) as "liability on a claim."

In the instant case, while there is clearly a debt due to Plaintiff from the Defendant there is no reciprocal obligation due Defendant from Plaintiff. The only obligation of Plaintiff was its debt due to the testamentary estate based on the bonding relationship which was paid during the year prior to the filing.

The Plaintiff states in its memorandum of law that "The doctrine of subrogation enables one who pays the debt of another to stand in the shoes of the latter party and assert whatever rights that party held." (Plaintiff's Memorandum of Law p. 9) The Plaintiff cites In re Denby Stores, Inc. 86 B.R. 768 (Bankr. S.D.N.Y. 1988), which cites to the United States Supreme Court case of Pearlman v. Reliance Ins. Co., 371 U.S. 132 (1962), as authority for the above quote.

In Pearlman, a contractor working on a government project went bankrupt. The government had withheld certain funds due the contractor to ensure the contractor's performance. After the filing, the trustee and the surety of the bankrupt both made claims on the withheld funds. The majority opinion, voicing the plaintiff's sound byte about subrogation, found that the surety was entitled to the funds which was a perfectly reasonable, equitable and logical result. Plaintiff, however, attempts to turn Pearlman on its ear and raise the concept of subrogation to an entirely new level by arguing that Pearlman is authority for the proposition that Plaintiff may be supplanted for the estate's liability to Defendant in order to "create" its own debt to Defendant to satisfy the second Posey requirement. This artificial, illusory "debt" fails the strict requirements needed to establish the basis for setoff and, as such, Plaintiff's second cause of action fails.

C. PLAINTIFF'S THIRD CAUSE OF ACTION:

Section 523(a)(4) provides that a chapter 7 discharge does not relieve the Defendant of a debt incurred "for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny." Plaintiff specifically charges that Defendant incurred a debt via a defalcation while acting as a fiduciary. Plaintiff states in its Reply Memorandum of Law dated February 12, 1999 that "The plaintiff has repeatedly alleged and proven and the Defendant and the Trustee have stipulated that the Defendant engaged in acts of malfeasance and breach of fiduciary duty, which acts were the basis for his discharge as Executor of the Estate, and the sole reasons why plaintiff was forced to pay on the surety bond. It is difficult to envision a more clear case for a finding of defalcation against a fiduciary than those presented by the parties herein." (emphasis in original) (Reply Memorandum of Law p. 34.)

Defendant's attorney responds by stating that at worst, Defendant is guilty of breach of contract not a defalcation nondischargeable under section 523(a)(4). Additionally, Defendant argues that Plaintiff has forfeited any subrogation rights it had via the election of remedies doctrine.

In his answer to the amended complaint, Defendant admitted that he breached his fiduciary duties as executor of the Estate of Marjorie Denton, as well as his obligations to plaintiff under the terms of a certain bond agreement [Defendant's Answer p. 1 No. 1 ]. Defendant further admitted that as a result of his misconduct, Plaintiff was required to pay to the Estate of Marjorie Denton, on behalf of the Defendant, the amount of $25,625.00. [Defendant's Answer p. 1 No. 1]. Additionally, as stated supra, the parties have stipulated that:

1. Defendant is guilty of malfeasance and breach of fiduciary duty to the testamentary estate. (Statement of Undisputed Facts ¶ 6.)

2. Plaintiff was subrogated to the testamentary estate's claim against the Defendant upon payment by Plaintiff to the testamentary estate (Statement of Undisputed Facts ¶ 9.)

For Plaintiff to prevail, Defendant must be responsible for more than merely innocent or negligent acts. In re Ellenbogan 218 B.R. 709 (Bankr. SDNY 1998). In the instant case, it is conceded that Defendant is chargeable with malfeasance.

black's law dictionary fifth edition defines malfeasance as:

Evil doing; ill conduct. The commission of some act which is positively unlawful; the doing of an act which is wholly wrongful and unlawful; the doing of an act which person ought not to do at all or the unjust performance of some act which the party had no right or which he had contracted not to do. Comprehensive term including any wrongful conduct that affects, interrupts or interferes with the performance of official duties.

Thus, Defendant's actions would be properly termed a "defalcation" vis a vis the testamentary estate.

Defendant claims, however, that this defalcation is of little solace to Plaintiff because, even though it is conceded that Plaintiff is subrogated to the testamentary's estate claim against the Defendant, Plaintiff has elected its remedy and is somehow barred from pursuing its claim in this court. Defendant reasons that Plaintiff "chose to only sue on the breach of contract cause of action and cannot now assert that its claim is a non-dischargeable debt for defalcation." (Defendant's Memorandum of Law p. 2.) Defendant cites no case law or statutory interpretation as authority for this position. Instead, Defendant refers this court to Professor Siegel's treatise on New York Practice wherein the author states that the election of remedies doctrine "is a harsh and arbitrary principle designed only to prevent vexatious litigation, and the courts have held that it should not be extended." See: David D. Siegel, NEW YORK PRACTICE, 2^nd Ed. 1991. There is no vexatious litigation here. This is the denouement of the drama begun in Warren County Supreme Court wherein Plaintiff alleged that "Defendant James Denton breached his agreements with the Plaintiff, when he willfully neglected to discharge his fiduciary duties to the decedent's estate in an acceptable manner." (Plaintiff's State Court Complaint ¶ 13.)

Thus, the admitted malfeasance and breach of fiduciary duty of the Defendant provides the basis for a finding of nondischargeability pursuant to 11 U.S.C. § 523(a)(4).

In sum, the court finds:

1) The Defendant's interest in the testamentary estate is property of the estate.

2) Plaintiff is not entitled to setoff.

3) Defendant's obligation to plaintiff is nondischargeable pursuant to 11 U.S.C. § 523(a)(4).