Fifth Circuit Finds Attorneys’ Fee Award Potentially Non-Dischargeable

The United States Court of Appeals for the Fifth Circuit has issued its first 2012 opinion addressing dischargeability under Section 523 of the Bankruptcy Code.  In In re Shcolnik, the Fifth Circuit reversed a lower court’s summary judgment, finding that there was a potential fact issue regarding dischargeability of an attorneys’ fee award arising out of an arbitration proceeding.  2012 U.S. App. LEXIS 2609 (5th Cir. 2012).

The debtor was a former employee of the creditor.  He had been terminated after asserting claims he was a partial owner of the creditor company.  The creditor alleged that he had “absconded with various documents” and also had engaged in an effort to force a “buyout” of his purported ownership interests, allegedly threatening, among other things, “a massive series of legal attacks…”

In response to those assertions, the former employer initiated arbitration, seeking a finding that the debtor had no such ownership.  The result was a finding that the debtor did not own an interest in any of the companies, and the arbitrator awarded the creditor $50,000 in attorneys’ fees.

The Chapter 7 followed, and the former employer filed an adversary proceeding alleging that the attorneys’ fee award was nondischargeable under Sections 523(a)(4) (defalcation in a fiduciary capacity) and (a)(6) (willful and malicious injury) of the Bankruptcy Code.

The Fifth Circuit found no fact issue on fiduciary defalcation.  The Court noted that although defalcation does not require fraud or embezzlement, but only “willful neglect of duty,” the attorneys’ fee award arose not out of any breach of fiduciary duty, but rather the post-termination threats and campaign of what the Fifth Circuit called “coercion.”

Regarding 523(a)(6), however, the Court cited previous authority under which a debt for sanctions imposed because of a debtor’s pre-petition litigation tactics arose was found nondischargeable.  In re Keaty, 397 F.3d 264 (5th Cir. 2005).

In Keaty, the purported harassment was carried out through “baseless litigation” in which the debtor was the plaintiff.  Shcolnik presented somewhat of a mirror image (the litigation was commenced by the creditor); however, the Court found this to be a distinction without a difference.  Taking the facts as presented by the creditor, the Court observed that the debtor “either had the motive to inflict harm or acted so as to create ‘an objective substantial certainty of harm’ to the Appellants.”  In other words, the Court could find that the debtor’s behavior resulted in a willful and malicious injury (the attorneys’ fee award) if his claims of ownership were made in bad faith and “as a pretense to extract money” from the creditor.

For earlier Fifth Circuit authority on Section 523 issues implicated by Shcolnik, see In re Gupta, 394 F.3d 347 (5th Cir. 2004)(Section 523(a)(4):  misappropriation by persons in traditional fiduciary capacities); In re Williams, 337 F.3d 504 (5th Cir. 2003)(Section 523(a)(6):  “objective substantial certainty of harm or a subjective motive to cause harm”).

*Roger Cox, a shareholder with the Underwood Law Firm, is Board Certified in Business Bankruptcy Law (and formerly Board Certified in Commercial/Real Estate Law) by the Texas Board of Legal Specialization.  Mr. Cox regularly represents lending institutions in foreclosures, workouts, and formal bankruptcy proceedings.  This article is for general information only and is not intended as legal advice.

This column is published for informational purposes only. It should not be construed as legal advice and is not intended to create an attorney client relationship. The views expressed are those of the author and do not necessarily reflect the views of the author’s law firm or its individual partners.

Share this post