IN RE SHARP, (B.A.P. 9th Cir. 1989)

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Docket Number

BAP No. NC 88-2104 MoAsP. Bankruptcy No. 987-00053. Adv. No. 987-0050.

Attorney(S)

Kevin J. Sharp, Stockton, Cal., for defendants/appellants. Ronald Sargis, Hefner, Stark Marios, Sacramento, Cal., for plaintiff/appellee.

Judges

MOOREMAN, Bankruptcy Judge:

Acts

Bankruptcy — Creditors, The Debtor, And The Estate — Debtor’S Duties And Benefits — Exceptions To Discharge

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Smart Summary

Factual and Procedural Background

Douglas Sharp was president and general manager of Mother Lode Marine ("MLM"), a business engaged in boat sales, rentals, and repairs. MLM obtained financing from Borg-Warner Acceptance Corporation ("BWAC") through an Inventory Security Agreement granting BWAC a security interest in MLM's inventory and proceeds. The agreement required MLM to remit the "cost price" of sold inventory to BWAC. Sharp established a trust account where proceeds from inventory sales were deposited, and payments to BWAC were made. Sharp was solely responsible for sales, deposits, and remittances.

In June 1986, BWAC conducted an inventory inspection and found approximately $14,000 in cost price due from sold inventory. Sharp delivered two checks to BWAC which were returned for insufficient funds; these checks were not drawn on the trust account. MLM filed a Chapter 11 bankruptcy petition in July 1986, later converted to Chapter 7. Sharp filed an individual bankruptcy petition, and BWAC filed a complaint seeking to have the debt declared nondischargeable.

After trial, the bankruptcy court held that Sharp's conduct constituted willful and malicious conversion under 11 U.S.C. § 523(a)(6), rendering the debt nondischargeable. The court found Sharp was solely responsible for handling funds and had failed to segregate proceeds as required by the security agreement. Although Sharon Sharp was named as a defendant, the nondischargeability judgment was against Douglas Sharp personally.

Legal Issues Presented

Whether Douglas Sharp committed a wrongful and intentional act constituting conversion under 11 U.S.C. § 523(a)(6).
Whether such act produced harm to BWAC.
Whether Sharp's conduct was without just cause or excuse, thereby rendering the debt nondischargeable.

Arguments of the Parties

Appellant's Arguments

No wrongful act occurred; any wrongdoing was a mistaken reliance on the accountant's calculation of the bank balance when issuing checks.
The dishonored checks were not the basis for nondischargeability.
Sharp's failure to segregate funds was excused due to the accountant's errors, the decision of other corporate officers to file bankruptcy against his objection, and being locked out of the business and prevented from paying BWAC.

Appellee's Arguments

Sharp's wrongful act was the misappropriation and conversion of BWAC's funds by failing to segregate and turn over proceeds as required by the security agreement.
Sharp made no attempt to account for the funds that should have been segregated in the trust account.
Such unexplained failure supports a finding of willful and malicious conduct under § 523(a)(6).

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
In re Manser, 99 B.R. 434 (9th Cir. BAP 1989)	Standard for nondischargeability under § 523(a)(6): wrongful and intentional act, harm produced, and lack of just cause or excuse.	Applied the three-part test to evaluate Sharp's conduct and affirmed the bankruptcy court's findings.
In re Cecchini, 780 F.2d 1440 (9th Cir. 1986)	Definition of willful and malicious conduct for nondischargeability under § 523(a)(6).	Supported conclusion that Sharp's failure to segregate funds was wrongful and intentional.
In re Pizza of Hawaii, Inc., 761 F.2d 1374 (9th Cir. 1985)	Standard of review for bankruptcy court findings (clearly erroneous for facts, de novo for law).	Guided appellate review standards applied by the Panel.
Chrysler Credit Corporation v. Rebhan, 842 F.2d 1257 (11th Cir. 1988)	Conversion of property subject to a security interest may establish nondischargeability under § 523(a)(6).	Reinforced the basis for nondischargeability due to conversion in Sharp's case.
Ford Motor Credit Co. v. Owens, 807 F.2d 1556 (11th Cir. 1987)	Similar principle regarding conversion and nondischargeability.	Supported the bankruptcy court's conclusion on wrongful and intentional conduct.
In re Posta, 866 F.2d 364 (10th Cir. 1989)	Conversion of collateral property may form basis for nondischargeability under § 523(a)(6).	Provided authority for treating conversion as nondischargeable conduct.
In re Shah, 96 B.R. 290 (Bankr. C.D. Cal. 1989)	Distinguishing case where creditor waived cash segregation protections; no nondischargeability found.	Distinguished from Sharp's case where no waiver or similar facts existed.

Court's Reasoning and Analysis

The court applied the established three-part test for nondischargeability under 11 U.S.C. § 523(a)(6): whether Sharp committed a wrongful and intentional act, whether the act caused harm, and whether it was without just cause or excuse. The court found that Sharp's failure to segregate and remit the proceeds to BWAC, as required by the security agreement, constituted conversion and was willful and malicious. Sharp's unexplained failure to account for or segregate the funds supported the conclusion that his conduct was wrongful and intentional. The court rejected Sharp's argument that the dishonored checks or other circumstances excused his conduct, noting that even assuming these contentions were true, they did not justify the failure to segregate the proceeds. The court distinguished this case from In re Shah, where the creditor had waived segregation protections and the debt was found dischargeable. Applying the clearly erroneous standard to factual findings and de novo review to legal conclusions, the Panel affirmed the bankruptcy court's judgment.

Holding and Implications

The bankruptcy court's judgment holding the approximately $14,000 debt nondischargeable under 11 U.S.C. § 523(a)(6) is AFFIRMED.

The direct effect of this decision is that Douglas Sharp remains personally liable for the debt to BWAC, and the debt cannot be discharged in bankruptcy due to his willful and malicious conversion of funds. The opinion does not establish new precedent beyond affirming the application of existing legal standards to the facts of this case.

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In re Douglas Carl SHARP and Sharon Louise Sharp, Debtors. BORG-WARNER ACCEPTANCE CORPORATION, Plaintiff/Appellee, v. Douglas Carl SHARP and Sharon Louise Sharp, Defendants/Appellants.

MOOREMAN, Bankruptcy Judge:

This appeal arises out of the bankruptcy court's Judgment which held that a certain debt totaling approximately $14,000 was nondischargeable under 11 U.S.C. § 523(a)(6).

FACTS

Douglas Sharp was the president and general manager of Mother Lode Marine ("MLM"), which was involved in the business of boat sales, rentals and repairs. In order to purchase inventory, MLM obtained financing from appellee Borg-Warner Acceptance Corp. ("BWAC"). Pursuant to the financing agreement, MLM executed an Inventory Security Agreement granting BWAC a security interest in collateral, inventory and proceeds of the inventory. Under the terms of the security agreement, MLM was required to remit to BWAC the "cost price" of each item of financed inventory upon the sale thereof. In his capacity as president/general manager, Mr. Sharp established a "trust" account into which all proceeds from the sale of MLM's inventory were deposited and payments to BWAC were disbursed. Mr. Sharp was the only person responsible for the sale of inventory, the deposit of the sale proceeds and the remittance of the proceeds to BWAC.

In June 1986, BWAC conducted a regular inventory inspection or "floor check" of MLM and it was determined that inventory had been sold by MLM in which the cost price of approximately $14,000 was due BWAC. At that time, Mr. Sharp delivered two checks to BWAC which were later returned for non-sufficient funds. These checks had not been written on the "trust account."

In July, 1986, MLM filed a Chapter 11 petition which was later converted to Chapter 7. Eventually, Mr. Sharp also filed his individual bankruptcy petition, wherein the underlying complaint seeking to have the debt held nondischargeable was filed against Mr. Sharp by BWAC.

After a trial on the matter, the bankruptcy court concluded that Mr. Sharp's conduct constituted a conversion and was "willful and malicious" conduct thereby rendering the debt nondischargeable pursuant to § 523(a)(6). The bankruptcy court based its conclusions on the undisputed facts that Mr. Sharp was the sole person responsible for the receipt and disposition of funds and that Mr. Sharp had failed to segregate the sale proceeds as required by the security agreement.

Although Mrs. Sharp was named as a defendant, the judgment holding the underlying debt nondischargeable, held that the judgment was against Mr. Sharp personally.

DISCUSSION

In a case similar to the instant appeal, the Bankruptcy Appellate Panel recently set forth the recognized standard that for purposes of § 523(a)(6), the issues to be determined are: "1-whether the appellant committed a wrongful and intentional act; 2-whether such action produced harm; and 3-whether such action was without just cause or excuse." In re Manser, 99 B.R. 434, 436, (9th Cir. BAP 1989) (citing In re Cecchini, 780 F.2d 1440, 1443 (9th Cir. 1986)). In light of the above issues, this Panel will apply a clearly erroneous standard of review to the bankruptcy court's findings of fact and a de novo standard of review to conclusions of law. See, e.g. Bankruptcy Rule 8013; In re Pizza of Hawaii, Inc., 761 F.2d 1374, 1377 (9th Cir. 1985).

In the instant case, the appellant Mr. Sharp contends that no wrongful act occurred and that at most he mistakenly relied on the bank balance calculated by his accountant in issuing the checks which were eventually dishonored. Issuance of the dishonored checks, however, was not the basis of the bankruptcy court's finding of nondischargeability. Rather, the appellant's wrongful act was the misappropriation and conversion of the BWAC's funds by his failure to segregate and turn over said funds as required by the security agreement. Mr. Sharp made no attempt at the trial on the matter or in his brief before this Panel to account for the monies which should have been segregated into the trust account for payment to BWAC. Nor does Mr. Sharp dispute that he failed to segregate the funds into the trust account as required by the security agreement. Such unexplained failure is sufficient to support the bankruptcy court's conclusion that Mr. Sharp's actions were wrongful and intentional as required by § 523(a)(6) and In re Cecchini. See In re Manser, 99 B.R. at 436; Chrysler Credit Corporation v. Rebhan, 842 F.2d 1257 (11th Cir. 1988); Ford Motor Credit Co. v. Owens, 807 F.2d 1556, 1559-60 (11th Cir. 1987).

It is generally recognized that the conversion of property subject to a creditor's security interest may form the basis for a nondischargeability cause of action under § 523(a)(6). See In re Posta, 866 F.2d 364, 367 (10th Cir. 1989); Chrysler Credit Corp. v. Rebhan, 842 F.2d 1257, 1262-64 (11th Cir. 1988); In re Shah, 96 B.R. 290, 295 (Bankr.C.D.Cal. 1989).

This important fact is a major distinguishing point between the instant case and the recent case of In re Shah, 96 B.R. 290, 295 (Bankr.C.D.Cal. 1989), involving a similar complaint for nondischargeability. In a well reasoned decision clarifying Cecchini, Judge Zurzolo determined that the secured creditor was not entitled to a nondischargeability judgment under § 523(a)(6) because, "Defendants deposited Plaintiff's cash proceeds collateral in their general business account, as they always had done. They used those commingled funds to pay ordinary expenses of their business, including, at one point, completely repaying Plaintiff." Id. (emphasis added). Additionally, the bankruptcy court in Shah determined that the Plaintiff had waived its "cash segregation protections." Id. None of these important factors appear to have been established in the instant case.

The appellant next argues that his actions should be excused from a finding of nondischargeability because of: 1-the accountant's mistakes as to the balance in the account from which the checks were written to pay BWAC; 2-the decision of the other officers to file a bankruptcy over his objection; and 3-the decision of the "other corporate officers to lock [him] out of the business and to remove his ability to pay BWAC." Even assuming that Mr. Sharp sufficiently established the above contentions, they would not necessarily constitute a sufficient justification or excuse for Mr. Sharp's failure to segregate the proceeds from the sale of the inventory subject to the BWAC's security agreement.

Mr. Sharp's unexplained failure to retain the proceeds into the trust account and then remit those funds to BWAC support a conclusion that Mr. Sharp knew or reasonably should have known, that his actions would "necessarily produce harm." Cecchini, 780 F.2d 1443; In re Shah, 96 B.R. 290, 295 (Bankr.C.D.Cal. 1989). Accordingly, this Panel cannot say that the bankruptcy court's findings are clearly erroneous. We, therefore, conclude that the bankruptcy court did not err in holding the instant debt nondischargeable pursuant to § 523(a)(6).

Based on the foregoing, the judgment of the bankruptcy court is AFFIRMED.