Bankruptcy – Arbitration – Collateral estoppel

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Where a plaintiff obtained an arbitration award over home renovation work performed by a defendant Chapter 7 debtor, the plaintiff is not entitled to summary judgment on the basis of the arbitration award, but the debtor is not entitled to judgment on the pleadings, as the plaintiff has pleaded facts to support her claims under 11 U.S.C. section523(a)(2)(A) and (a)(4).

No preclusive effect

“In May 2011, Theresa Matthews contracted with Christian D. Nealon Builders, Inc. (‘CNB’) — a company wholly owned and operated by the Debtor — as a general contractor to oversee extensive construction and renovation work to be done on her home. At the time she executed the contract with CNB, Matthews provided the Debtor with a check in the amount of $101,020.00 (the ‘Initial Deposit’). …

“While most of the Arbitration Award findings focused on the defective and substandard work performed by CNB and the Debtor, the Arbitrator also made the following statement: ‘[The Debtor] was given $101,020 deposit by Theresa Matthews. It was given with the understanding that an ESCROW ACCOUNT would be opened with said funds.’ Arbitration Award, Complaint Exhibit C (emphasis in original). …

“On July 18, 2014, Matthews timely commenced an adversary proceeding objecting to both the discharge of her particular claim and to the Debtor’s discharge in its entirety. Through Counts I and II of the Complaint, Matthews objects to the dischargeability of her claim under sectionsection523(a)(2)(A) (as a debt incurred by fraud or misrepresentation) and (a)(4) (as a debt incurred as a result of fraud or defalcation while acting in a fiduciary capacity, embezzlement or larceny), respectively. …

“The Court agrees with the Debtor that the Arbitration Award has no preclusive effect in the present action on the issue of whether the parties agreed that the Initial Deposit and subsequent payments by Matthews were to be placed in an escrow account and used only for expenses related to the Matthews project. Quite simply, any conclusion reached by the Arbitrator regarding the existence of an escrow account, as reflected in the one relevant portion of the Arbitration Award quoted above, was not essential to the Arbitration Award. It is clear from the award that the Arbitrator based his decision on the Debtor’s negligence and poor workmanship, and not on any particular claim that funds from an escrow account were misused. Indeed, the Arbitration Award specifically states that the amount of damages awarded to Matthews was not based on the amount of any particular unauthorized withdrawal(s), but rather ‘on the amount of additional money that [Matthews] has to expend to correct [the] construction errors.’

“Absent a preclusive finding that an escrow account was created and misused by the Debtor — an allegation that underpins the Summary Judgment Motion filed by Matthews — there remains a disputed issue of fact regarding the parties’ intentions with respect to the Initial Deposit, later payments by Matthews, and the circumstances under which those funds could be used. And because that highly material issue of fact remains to be determined, the Court must deny the Summary Judgment Motion.”

Sufficient pleadings

“For the reasons that follow, however, the Court does not agree with the Debtor’s contention that Matthews has failed to adequately plead claims under sectionsection523(a)(2)(A) and (a)(4). Although her Summary Judgment Motion hinged on the preclusive effect of the Arbitrator’s finding that an escrow account existed, the Complaint and exhibits attached thereto contain allegations sufficient to state claims for nondischargeability under sectionsection523(a)(2)(A) and (a)(4), regardless of whether the Arbitration Award’s statement has preclusive effect in this proceeding. …

“The Debtor would have the Court interpret the pleadings as alleging the existence of an escrow account based solely on the statement in the Arbitration Award quoted above. And, having found that that statement has no preclusive effect here, the Court should dismiss the Complaint on grounds that the contract between Matthews and CNB refers to the Initial Deposit only as a ‘deposit,’ without reference to any restrictions on its use by CNB or the Debtor. But in the post-hearing arbitration brief attached to the Complaint, Matthews clearly alleges that the Debtor and Matthews orally agreed to create an escrow account to hold the deposit and future payments.

“Under Massachusetts law, an escrow agreement need not be reduced to writing, but may be an oral agreement between the parties, later enforceable against the parties for its breach. … The factual allegation that the parties reached an oral agreement regarding the disposition of funds paid by Matthews is sufficient, taken with the other allegations in the Complaint and associated documents and pleadings, to state claims for nondischargeability of the debt owed by the Debtor to Matthews under sectionsection523(a)(2)(A) and (a)(4). …

“… Taking Matthews’s allegations as a whole, the pleadings state a plausible claim that the Debtor took money from Matthews (either (or both) the Initial Deposit and subsequent payments) having promised to use those funds for particular purposes but having no intent to actually do so. Matthews buttresses her claim of fraudulent intent by pointing to allegedly false invoices presented to her throughout the project to justify the draws against her payments. She states that she relied on the Debtor’s misrepresentations in continuing to make progress payments and that she was ultimately damaged by the misrepresentations, as she would not have continued to finance the project had she known of the actual use to which her funds were put. These allegations are sufficient to state a claim for nondischargeability of some portion of the debt owed by the Debtor to Matthews to the extent incurred by fraud or misrepresentation, pursuant to section523(a)(2)(A). …

“The existence of an escrow agreement between the Debtor and Matthews would arguably give rise to a technical trust under Massachusetts law, creating the type of fiduciary obligation encompassed by section523(a)(4) of the Code. …

“Accordingly, the allegation that the parties orally agreed that the Debtor would create an escrow account to hold funds received from Matthews sufficiently states a claim that the Debtor was acting in a fiduciary capacity with respect to those funds within the meaning of section523(a)(4).

“Matthews also sufficiently alleges facts to support a claim that the Debtor’s actions with respect to her funds and the escrow account amounted to a ‘defalcation’ within the meaning of the Code. …

“Even if Matthews cannot establish that the Debtor was bound by an agreement to hold her funds in escrow, she has further pled sufficient facts to support a claim of embezzlement under section524(a)(4). …”

In Re: Nealon, Christian (Lawyers Weekly No. 04-040-15) (18 pages) (Boroff, J.) (USBC) (Chapter 7 Case No. 14-40719; Adversary Proceeding No. 14-4069) (July 2, 2015).

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