Century 21 Balfour Real Estate v. Menna

UNITED STATES COURT OF APPEALS
FOR THE FIRST CIRCUIT

No. 93-1767
IN RE

PHILIP G. MENNA

CENTURY 21 BALFOUR REAL ESTATE,

Plaintiff, Appellant,

v.

PHILIP G. MENNA,

Defendant, Appellee.

APPEAL FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MAINE

[Hon. D. Brock Hornby, U.S. District Judge]

Before

Torruella, Cyr and Stahl,

Circuit Judges.

Daniel L. Cummings, with whom Norman, Hanson & DeTroy was on

brief for appellant.
John E. Geary for appellee.

February 10, 1994

CYR, Circuit Judge. Plaintiff-appellant Century 21
CYR, Circuit Judge.

Balfour Real Estate ("Balfour") commenced an adversary proceeding

to determine whether its claim against defendant-appellee Philip

G. Menna is dischargeable in bankruptcy. The bankruptcy court

ruled against Balfour, the district court upheld the ruling, and

we now affirm.

I

BACKGROUND

Menna retained Balfour to sell his business. Following

the sale, the buyers, Robert and Brenda Pawloski, brought a state

court action against Menna and Balfour for fraud and negligent

misrepresentation, respectively, and Balfour cross-claimed

against Menna for equitable indemnification. The jury found

Menna and Balfour jointly and severally liable and awarded the

Pawloskis $128,500 in compensatory damages. The state court

entered judgment for Balfour on its cross-claim for

indemnification against Menna because Balfour's mere negligence

made it less culpable than Menna, whose conduct had been found

fraudulent. The Pawloskis thereafter recovered $110,000 from

Balfour on their judgment.

After Menna filed a voluntary chapter 7 petition,

Balfour commenced an adversary proceeding against Menna to have

its $110,000 indemnification claim against Menna declared nondis-

chargeable, pursuant to Bankruptcy Code 523(a)(2)(A) (debt

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"for money . . . to the extent obtained by . . . actual fraud")

and 523(a)(6) (debt "for willful and malicious injury by the

debtor to another entity"), 11 U.S.C. 523 (a)(2)(A), (a)(6)

(1993). On the cross-motions for summary judgment the bankruptcy

court ruled that Balfour's indemnification claim is discharge-

able, see Century 21 Balfour Real Estate v. Menna (In re Menna),

152 B.R. 5, 6 (Bankr. D. Me. 1993), and the district court

summarily affirmed.

II

DISCUSSION

A. Standard of Review

We review the grant of summary judgment de novo,

employing the same standards incumbent on the bankruptcy court,

in order to determine whether "'the pleadings, depositions,

answers to interrogatories, and admissions on file, together with

the affidavits, if any, show that there is no genuine issue as to

any material fact and that the moving party is entitled to

judgment as a matter of law.'" Gaskell v. The Harvard Coop.

Soc'y, 3 F.3d 495, 497 (1st Cir. 1993) (quoting Fed. R. Civ. P.

56(c)); see also Fed. R. Bankr. P. 7056. Although all reasonable

inferences are to be drawn in favor of the nonmoving party, "[a]s

to any essential factual element of its claim on which the

nonmovant would bear the burden of proof at trial, its failure to

come forward with sufficient evidence to generate a trialworthy

issue warrants summary judgment to the moving party." Ralar

Distribs., Inc. v. Rubbermaid, Inc. (In re Ralar Distribs.,

3

Inc.), 4 F.3d 62, 67 (1st Cir. 1993); see also Milton v. Van Dorn

Co., 961 F.2d 965, 969 (1st Cir. 1992).

B. Applicable Law

Exceptions to discharge are narrowly construed in

furtherance of the Bankruptcy Code's "fresh start" policy and the

claimant must show that its claim comes squarely within an

exception enumerated in Bankruptcy Code 523(a). See Commerce

Bank & Trust Co. v. Burgess (In re Burgess), 955 F.2d 134, 136-37

(1st Cir. 1992); see also Werner v. Hofman, 5 F.3d 1170, 1172

(8th Cir. 1993); LSP Inv. Partnership v. Bennett (In re Bennett),

970 F.2d 138, 148 (5th Cir. 1992); Stackhouse v. Hudson (In re

Hudson), 859 F.2d 1418, 1425 (9th Cir. 1988). Section 523(a)(2)-

(A) excepts from discharge "any debt . . . for money, property,

[or] services . . . to the extent obtained by false pretenses, a

false representation, or actual fraud." Bankruptcy Code 523-

(a)(2)(A), 11 U.S.C. 523(a)(2)(A).1 The complaint alleges

that Balfour's claim against Menna is "based on indemnification,"

and "thus based upon [Menna's] fraudulent conduct toward the

Pawloskis," as evidenced by the Pawloskis' fraud judgment against

Menna. (Emphasis added.) Section 523(a)(6) further excepts from

discharge "any debt . . . for willful and malicious injury by the

debtor to another entity or to the property of another entity."

Id. 523(a)(6), 11 U.S.C. 523(a)(6). The complaint alleges

1The claimant in a nondischargeability proceeding under
523(a)(2)(A) must prove fraud by a preponderance of the evi-
dence. See Grogan v. Garner, 498 U.S. 279, 287-90 (1991).

4

that Balfour's indemnification claim is "based upon [Menna's]

malicious conduct toward the Pawloskis," as evidenced by the

Pawloskis' $25,000 punitive damages verdict against Menna.

(Emphasis added.) Balfour concedes, however, that it presented

no competent evidence that Menna either acted with malice toward,

or intended to defraud, Balfour.2

Balfour principally complains that the bankruptcy court

failed to recognize that section 523(a) does not require a

showing that the claimant was the direct or immediate target of

the debtor's fraudulent intent or malicious conduct. Therefore,

it argues, since Menna exposed both Balfour (Menna's equitable

indemnitee) and the Pawloskis to the $128,500 loss, Balfour's

claim for equitable indemnification is one "for money . . .

obtained by [the debtor's] actual fraud," or "for willful and

malicious injury by the debtor to another entity." Were it

otherwise, Balfour says, dishonest debtors like Menna who embroil

less culpable third parties like Balfour in their fraudulent

schemes could easily subvert the Code's central strategy of

restricting the "fresh start" discharge to "honest but unfor-

tunate" debtors. Local Loan Co. v. Hunt, 292 U.S. 234, 244

(1934) (emphasis added); see also Brown v. Felsen, 442 U.S. 127,

2We are not persuaded by Balfour's contention that it should
have been given an opportunity to prove that Menna's fraudulent
intent or malicious conduct was directed toward Balfour. The

district court correctly noted that the complaint made no such
allegation, nor did Balfour assert such an argument before the
bankruptcy court. See Mark Bell Furniture Warehouse, Inc. v.

D.M. Reid Assocs., Ltd. (In re Mark Bell Furniture Warehouse,

Inc.), 992 F.2d 7, 9 (1st Cir. 1993) (arguments not raised in

bankruptcy court cannot be raised for first time on appeal).

5

128 (1979) (same); H.R. Rep. No. 595, 95th Cong., 1st Sess. 125,

reprinted in 1978 U.S.C.C.A.N. 5963, 6086 (same).

We conduct plenary review of the bankruptcy court's

construction of the legislative language "debt for" em-

ployed in Bankruptcy Code 523(a). The Travelers Ins. Co. v.

Cambridge Meridian Group, Inc. (In re Erin Food Servs., Inc.),

980 F.2d 792, 799 (1st Cir. 1992). First, we underscore that

section 523(a) does not employ the terms adopted in Balfour's

paraphrase "debt based upon" nor does the statutory lan-

guage remotely suggest that nondischargeability attaches to any

claim other than one which arises as a direct result of the

debtor's misrepresentation or malice.3 Moreover, Balfour cites

no case in which it has been argued, let alone decided, that the

nonfraud-based indemnification claim of an entity whose negli-

gence has combined with the fraud of its joint tortfeasor to

cause injury to a third party is nondischargeable in the bank-

3The parties devote considerable attention to whether both
the Balfour and the Pawloski "claims" derive from the same

"debt," or from two distinct "debts." However, neither the

Bankruptcy Code's austere definitions, see Bankruptcy Code

101(11), 11 U.S.C. 101(11) ("debt" is "liability on a
claim"), 101(4)(A), 11 U.S.C. 101(4)(A) ("claim" is "a right
to payment, whether or not such right is reduced to judgment"),
nor the broad pronouncements on the common law principles of
equitable indemnification, see Northeast Bank of Lewiston &

Auburn v. Murphy, 512 A.2d 344 (Me. 1986), afford helpful insight

into the substantive concerns presently at issue. We will not
reverse a bankruptcy court's grant of discharge relief except for
reasons both "real and substantial." See In re Burgess, 955 F.2d

at 137.

6

ruptcy of the fraudulent tortfeasor.4 Given the strict con-

struction afforded all dischargeability exceptions under section

523(a), see In re Burgess, 955 F.2d at 137, we have been provided

with neither authority nor reason to extend the statutory lan-

guage as urged by Balfour.

Second, Balfour wrongly presumes that exceptions to

discharge serve only to penalize the debtor. Rather, as a

function of its essentially equitable nature, a nondischarge-

ability determination under section 523(a) is designed concomi-

tantly to protect the inculpable creditor, cf. H.R. Rep. No. 595,

supra, at 130, reprinted in 1978 U.S.C.C.A.N. at 6091 ("The

premise of [ 523(a) (2)(B)] is that a creditor that extended

credit based on misinformation or fraudulent information trans-

mitted by the debtor should be protected.") (emphasis added).

Thus, the legislative purposes served by sections 523(a)(2) and

523(a)(6) are at once retributive and protective.

Section 523(a)(2) requires showings by the claimant

that (1) the debtor knowingly or recklessly made a material

misrepresentation with intent to deceive the creditor; and (2)

the creditor "reasonably" relied on the misrepresentation to its

4Balfour asserts neither subrogation rights nor assignment
of the Pawloskis' nondischargeable claim. See, e.g., Bankruptcy

Code 509(a), 11 U.S.C. 509(a); McCain Foods, Inc. v. Gerard,

489 A.2d 503, 504 (Me. 1985) (state law doctrine of equitable
subrogation). Compare, e.g., In re Fields, 926 F.2d 501, 504

(5th Cir.) (creditor who pays debtor's taxes is subrogated to
IRS's nondischargeable claim under 523(a)(1)), cert. denied,

112 S. Ct. 371 (1991), with National Collection Agency, Inc. v.

Trahan, 624 F.2d 906, 907 (9th Cir. 1980) (reaching opposite

result under Bankruptcy Act).

7

detriment. In re Burgess, 955 F.2d at 140; see also Longo v.

McLaren (In re McLaren), 3 F.3d 958, 961 (6th Cir. 1993) (reli-

ance must be the "proximate cause" of claimant's loss). If

section 523(a)(2) had been intended simply to deter all bad faith

conduct by the debtor irrespective of its effect upon the partic-

ular creditor, as Balfour's argument impliedly assumes, there

would have been no need to condition the creditor's right to a

nondischargeability ruling on a showing of reasonable reliance.5

Even assuming arguendo that an equitable indemnitee's vicarious

injury might satisfy the first constituent element of the "fraud"

test under section 523(a)(2), thereby generally establishing bad

faith or misconduct on the part of the debtor, Balfour nonethe-

less must make the "reasonable reliance" showing required under

section 523(a)(2) that it reasonably and detrimentally

relied on Menna's misrepresentations.6

5The legislative history of the Bankruptcy Reform Act of
1978 confirms that 523(a)(2)(A) deliberately abandoned a purely

retributive purpose. Bankruptcy Act 17a.(2), as amended, 11

U.S.C. 35(a)(2) (1964), the predecessor to 523(a)(2), con-
tained no explicit requirement that the creditor's reliance be
"reasonable." See BancBoston Mortgage Corp. v. Ledford (In re

Ledford), 970 F.2d 1556, 1559 (6th Cir. 1992), cert. denied, 113

S. Ct. 1272 (1993). Moreover, under former Bankruptcy Act
14c.(3), as amended, 11 U.S.C. 32(c)(3), obtaining money or

credit on a materially false financial statement constituted a
ground for denial of the debtor's general discharge, not merely

for establishing the nondischargeability of the particular debt
or debts incurred as a consequence of the fraudulent conduct.
See Philip Shuchman, The Fraud Exception in Consumer Bankruptcy,

23 Stan. L. Rev. 735, 739 (1971).

6Just as 523(a)(2) requires that the debtor's fraud be
assessed in light of its effect upon the creditor, section
523(a)(6), which simultaneously uses the phrase "debt for" in
reference to an analogous form of debtor "misconduct" (i.e.,

malice), must require that an indemnitee make some minimal

8

C. Summary Judgment

Reasonable reliance is an issue of fact, see Coston v.

Bank of Malvern (In re Coston), 991 F.2d 257, 260-61 (5th Cir.

1993) ( 523(a)(2)), on which Balfour would have borne the burden

of proof at trial. Yet it presented no evidence whatever from

which the bankruptcy court could have determined whether Balfour

actually or reasonably relied on Menna's misrepresentations when

it communicated the unspecified misinformation about the pending

sale to the Pawloskis. Indeed, the record is even devoid of

evidence of the circumstances surrounding the November 1987 sale

transaction, the nature, duration or history of the Menna-Balfour

business relationship, or whether Balfour might have detected or

thwarted Menna's misrepresentations by "minimal investigation."

See BancBoston Mortgage Corp. v. Ledford (In re Ledford), 970

F.2d 1556, 1560 (6th Cir. 1992) (summarizing various indicia of

"reasonable" reliance under 523(a)(2)), cert. denied, 113 S.

Ct. 1272 (1993).

Moreover, Balfour may well have been collaterally

estopped from litigating the "reasonableness" of any reliance on

evidentiary showing that its injury was not proximately caused by

its own intervening conduct. See In re La Flamme, 14 B.R. 21, 25

(Bankr. 1st Cir. 1981) (the meaning of a particular Code section
must be discerned from an examination of the overall structure

and policy of the statutory provision).
Since Balfour produced no evidence which would permit an
assessment of the contribution its own intervening conduct made
to its injury, see infra Section II.C, we need not define with

precision the level of creditor "inculpability" required under
section 523(a)(6), nor distinguish that standard from the "rea-
sonable reliance" showing required under section 523(a)(2).

9

Menna's misrepresentations. See 1B James W. Moore, Jo D. Lucas,

Thomas S. Currier, Moore's Federal Practice 0.419 [3.-4], at

649-50 (2d ed. 1992); Grogan v. Garner, 498 U.S. 279, 287 (1991)

(collateral estoppel applies in 523(a) proceeding where prior

judgment required same or greater burden of proof). Under Maine

law, the Pawloskis' negligent misrepresentation claim against

Balfour required proof that, inter alia: (1) Balfour supplied

information to the Pawloskis as "guidance" in their business

transaction, (2) the Pawloskis justifiably relied on the informa-

tion; and (3) Balfour failed to exercise reasonable care or

competence in obtaining or communicating the information."

Jordan-Milton Mach., Inc. v. F/V Teresa Marie, II, 978 F.2d 32,

36 (1st Cir. 1992) (citing Chapman v. Rideout, 568 A.2d 829 (Me.

1990) (adopting Restatement (Second) of Torts 552(1))).

Balfour argues, nonetheless, that collateral estoppel

does not bar its claim because the requisite "reasonable care"

showing for negligent misrepresentation under Maine law, and the

"reasonable reliance" showing required under section 523(a)(2)-

(A), are not necessarily coextensive; that is, the former con-

cerns Balfour's duty to the Pawloskis, not its duty to Menna.

Even so, Balfour gains nothing. If the two legal standards do

diverge, as Balfour argues, the two state court judgments simply

are not probative of Balfour's "reasonable reliance,"7 and

7Balfour's judgment for indemnification against Menna did
not necessarily depend on whether Balfour's reliance was "reason-

able" but on whether Balfour was less culpable than Menna. See

Northeast Bank, 512 A.2d at 350-51.

10

Balfour had the burden of producing some competent evidence from

which the bankruptcy court could find reasonable reliance. On

the other hand, if the standards do not diverge, collateral

estoppel barred Balfour's present contention as a matter of law.

See Ralar, 4 F.3d at 67.

Affirmed.

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