Clear Sky Properties LLC et al v. Roussel et al

Filing 19

ORDER that the Judgment of the Bankruptcy Court is reversed, and this case is remanded for further proceedings as provided in this Order. Signed by Judge Susan Webber Wright on 12/30/2013. (jak)

IN THE UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF ARKANSAS
LITTLE ROCK DIVISION

IN RE: BLAKE ROUSSEL and
AMANDA ROUSSEL
Debtors

CLEAR SKY PROPERTIES LLC
and LuANN DEERE
Plaintiffs
V.
BLAKE ROUSSEL
Defendant

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Bankruptcy Case No: 4:11BK14470

Adversary Proceeding No: 4:11AP01266
Appeal/
District Court No: 4:13CV00055 SWW

ORDER
Appellants Clear Sky Properties LLC (“Clear Sky”) and LuAnn Deere (“Deere”)
commenced this adversary proceeding, seeking a determination that a judgment debt of Appellee
Blake Roussel (“Roussel”) is nondischargeable in bankruptcy under 11 U.S.C. §§ 523(a)(4) and
523(a)(6) . Appellants appeal the final decision of the Bankruptcy Court,1 finding only a portion

1

The Honorable James G. Mixon, United States Bankruptcy Judge for the Eastern District
of Arkansas.

of Roussel’s judgment debt nondischargeable.2 After careful consideration, and for the reasons
that follow, the judgment of the Bankruptcy Court is reversed, and the case is remanded for
further proceedings as provided in this order.
I. Standard of Review
In bankruptcy proceedings, a district court ordinarily acts as an appellate court, reviewing
the bankruptcy court’s legal conclusions de novo, and its findings of fact under the clearly
erroneous standard. See In re Muncrief, 900 F.2d 1220, 1224 (8th Cir. 1990). This Court may
not reverse the Bankruptcy Court’s factual findings unless after reviewing the record it is left
with the “‘definite and firm conviction that a mistake has been committed.’” In re Waugh, 95
F.3d 706, 711 (8th Cir. 1996)(quoting Anderson v. City of Bessemer City, 470 U.S. 564, 573, 105
S.Ct. 1504, 1511(1985)).
II. Background
The following facts are undisputed. In August 2006, Roussel and Deere formed Clear
Sky, a member-managed limited liability company, for the purpose of opening an Exit Realty
(“Exit”) franchise in Conway, Arkansas. Exit’s business model includes a “residual income”
feature by which Exit real estate agents who bring new agents to the company earn a residual or
percentage of the sales commissions earned by their recruits. Exit divides geographical areas
into franchise territories, and only the owners of a given territory may open an Exit office within
that territory. Exit mapped Conway for two franchise territories, hereinafter “Territory A” and
“Territory B.” On August 31, 2006, Deere and Roussel entered a franchise agreement covering

2

The Bankruptcy Court found a portion of the judgment debt nondischargeable under
11 U.S.C. § 523(a)(4), and that finding is not challenged on appeal.
2

Territory A.3
Roussel and Deere served as the sole members of Clear Sky, each owning fifty percent,
and in September 2006 the company began doing business as Exit First Choice Realty (“Exit
First Choice”) in Territory A. Clear Sky’s operating agreement set forth procedures governing
the sale of members’ ownership interests, and it provided that existing members would have a
right of first refusal to buy a departing member’s share.
In early 2007, Roussel proposed that he would sell his interest in Clear Sky to Rhonda
Bletsh (“Bletsh”) and Nathan Hutchins (“Hutchins”), licensed real estate agents who worked at
the Exit First Choice office. Roussel’s negotiations with Bletsh and Hutchins fell through, he
offered to sell his interest to Deere, but she declined his offer.
In July 2008, Clear Sky moved the Exit First Choice office to a new building. Deere
purchased the building with her own money, and she leased it back to Clear Sky. On July 31,
2008, Roussel presented Deere with a document titled “Consent to Sale of Membership Interests
of Clear Sky Properties LLC,” which provided that Roussel would sell one-third of his fifty
percent interest to Bletsh and another one-third to Hutchins. However, the consent agreement
was never executed, and Deere exercised her right of first refusal on August 28, 2008. Deere
purchased two-thirds of Roussel’s interest for $52,000, making her the majority owner of Clear
Sky and leaving Roussel a sixteen percent share.
Unbeknownst to Deere, Roussel, Bletsh and Hutchins had plans to open another real
estate office in Conway. On September 12, 2008, Roussel, Bletsh, and Hutchins filed articles of

3

Deere and Roussel entered the franchise agreement with Exit sub-franchisor Exit Realty
Arkansas, which is owned by Roussel’s parents.
3

organization for Select Group Investments LLC. On October 8, 2008, Select Group Investments
LLC, entered an Exit franchise agreement covering Territory B, and Roussel notified Deere by
text message that he was opening another Exit real estate office, named Exit Realty Select, with
Bletsh and Hutchins. After Deere received Roussel’s message, she went to the Exit First Choice
office and discovered that all data had been erased from the office computers. Deere also found
files, monitors, signs, and lock boxes missing. Twelve real estate agents who worked for Exit
First Choice and the office administrator followed Roussel to Exit Realty Select.
On February 13, 2009, Deere and Clear Sky filed a civil complaint against Roussel in the
Circuit Court of Faulkner County Arkansas, alleging breach of fiduciary duty/breach of loyalty,
fraud, breach of contract, and violation of the Arkansas Franchise Practices Act. The state court
dismissed the fraud count, and the case proceeded to a jury trial on the breach of fiduciary duty
claims and Deere’s separate claim for breach of contract.
At trial, Roussel testified that before he opened Exit Realty Select with Bletsh and
Hutchins, he and Deere shared the goal of expanding Exit First Choice’s territory and purchasing
Territory B, and he acknowledged that purchasing Territory B would prevent another Exit office
from locating in Conway. Deere testified that she would never have exercised her option to
purchase two-thirds of Roussel’s fifty percent share if she had known that he had plans to open a
competing Exit office in Conway.
Clear Sky and Deere presented evidence that after Roussel formed another LLC and
opened Exit Realty Select, Clear Sky’s commission revenues dropped, and Deere contributed
$58,800 to Clear Sky. See ECF No. 1-10, at 140-144. Deere testified that she closed the Exit
First Choice office in December 2010 to “stop the losses.” ECF No. 1-21, at 470. The state

4

court also admitted into evidence a list of personal property items totaling $1,480 that, according
to Deere, were missing from the Exit First Choice office after Roussel announced that he was
opening another office with Bletsh and Hutchins. See ECF No. 1-10, at 146-148.
The state court instructed the jury regarding Roussel’s fiduciary duties as follows:
Plaintiff Clear Sky Properties LLC is a limited liability company. A limited liability
company is a type of business entity that has owners called members. At all relevant
times, Blake Roussel was a member/owner of Clear Sky Properties LLC. At all
relevant times, Plaintiff, LuAnn Deere was the other member/owner of Clear Sky
Properties LLC.
Fiduciary duty exists between a member/owner and the limited liability company
and the other member/owners. Blake Roussel, as a member, owed the following
fiduciary duties to Clear Sky . . . and . . . Deere.
An LLC member has a duty of loyalty to the company. This means that the member
will act in the best interest of the company and its members, while subordinating his
personal interests to that of the company and its members, while serving actively
within the company, or even after he severs his day-to-day relationship with the
company.
An LLC member has a duty not to do anything that might result in injury to the
company or deprive it of profit or advantage, which his skill, knowledge and ability
might personally bring to it.
An LLC member has a duty to retain and protect and develop the existing business
opportunities of the LLC.
An LLC member has a duty not to compete with the LLC.
An LLC member has a duty to discharge his duties to the company in good faith.
An LLC member has a duty to deal fairly and honestly with the LLC, and other
members, and imposes the responsibilities to fully and completely disclose any
conflicts of interest between his interests and the LLC’s interest that might make him
act in his own best interest, at the expense or to the detriment of the LLC and its
other members.
To be [effective], the disclosure must provide the whole truth without ambiguity or
reservation, and disclose all significant facts. The existence or performance of an
agreement between the parties does not prevent the existence of a fiduciary duty
5

which arises from the relationship itself.
ECF No. 1-22, at 268-270. The state court further instructed that if the jury found in Clear Sky’s
favor, it should fix the amount of money that would compensate Clear Sky for the value of any
lost income or property damage suffered as a result of Roussel’s breach of fiduciary duty. With
respect to Deere’s damages, the court instructed jurors to consider the value of monetary harm or
expense that Deere suffered as a result of the breach. See id., at 270.
The state court also instructed the jury regarding punitive damages, according to the standard
set forth under Ark. Code Ann. § 16-55-206 and Arkansas Model Jury Instruction 2218, stating as
follows:

In addition to compensatory damages for any actual loss that [Clear Sky and Deere]
may have suffered as a result of his breach of fiduciary duty, they also ask for
punitive damages from Blake Roussel. Punitive damages may be imposed to punish
a wrong-doer and to deter others from similar conduct.
In order to recover punitive damages from Blake Roussel, Plaintiffs have the burden
of proving either first, Blake Roussel knew or ought to have known in the light of the
surrounding circumstances, his conduct would naturally and probably result in
damages, and that he continued such conduct [in]4 reckless disregard of the
consequences from which malice may be inferred; or second, that Blake Roussel
intentionally pursued a course of conduct for the purpose of causing damage or both.
In arriving at the amount of damage, you may consider the financial condition of
Blake Roussel as shown by the evidence. You are not required to assess punitive
damages . . . , but you may do so if justified by the evidence.
You may also consider an award of punitive damages only if you find that [Clear Sky
4

The state court transcript records that the trial judge instructed that the plaintiffs had the
burden of proving that Blake Roussel “continued such conduct and reckless disregard of the
consequences from which malice may be inferred.” ECF No. 1-22, at 271(emphasis added).
However, the Court is confident that the state trial court instructed the jury in accordance with
Arkansas Jury Instruction 2218, which requires that the plaintiff “continued such conduct in
reckless disregard of the consequences from with malice may be inferred.” Arkansas Model Jury
Instruction 2218 (emphasis added).
6

or Deere] is entitled to recover compensatory damages.
Id. at 271-272.
The jury found that Roussel breached fiduciary duties to both Clear Sky and Deere. The
jury awarded Clear Sky $300,000 in damages, which included $111,280.60 for past lost revenue,
$73,403 for future lost revenue, $1,480 for damage to property, and $113,836.40 in punitive
damages; and it awarded Deere compensatory damages in the amount of $58,800. The jury also
found for Deere on her separate claim for breach of contract and awarded her $40,000. The trial
court entered judgment in accordance with the jury’s verdict and awarded Clear Sky and Deere
$82,611.25 in attorney’s fees and $4,912 in costs and expenses. See ECF No. 1, Attach. #9, at
87.
On July 11, 2011, Roussel and his wife filed a voluntary petition for relief under Chapter
7 of the United States Bankruptcy Code. Subsequently, Clear Sky and Deere initiated this
adversary proceeding, seeking a determination that Roussel’s judgment debt for breach of
fiduciary duty5 is excepted from discharge under 11 U.S.C. §§ 523(a)(4) and 523(a)(6).
Employing the doctrine of collateral estoppel affirmatively, Appellants moved for
summary judgment, arguing that the issues necessary for determining nondischargeability had
been litigated and resolved in the state court action. Roussel filed a response in opposition to
summary judgment, and he furnished the Bankruptcy Court an unedited copy of the state court
record. The Bankruptcy Court denied Appellants’ motion without deciding whether the state
court findings were entitled to a preclusive effect. The order denying summary judgment states,
in part, as follows:
5

As noted in the Bankruptcy Court’s memorandum opinion, the parties agree that Deere’s
damage award for breach of contract is dischargeable in bankruptcy.
7

[T]he parties have submitted over 2000 pages of documents . . . most of which are
irrelevant to the proceeding . . . . Obviously, this matter can best be resolved by trial
on the merits in this Court which will consider only matters relevant to the issues in
the bankruptcy proceedings. . . Trial on the merits of this core proceeding will be
held as originally scheduled . . . .
ECF No. 1-28.
After denying Appellants’ motion, the Bankruptcy Court held a two-day trial at which it
heard evidence regarding the testimony and documentary evidence admitted during the during
the state court jury trial. The Bankruptcy Court permitted additional testimony that was not part
of the state court record on the ground that it was relevant to the show Roussel’s state of mind.
See ECF No. 1-38, at 27 (Tr. at 258). In its final order, the Bankruptcy Court summarized that
additional testimony as follows:

Bletsh testified that there was never any intent to harm Clear Sky when Bletsh,
Hutchins, and Roussel opened up Exit Select. Bletsh and Hutchins testified that
they believed there were benefits to having two Exit offices owned in Conway
because it could strengthen the Exit brand. Bletsh explained that under the Exit
system, Deere would continue to receive any residual due her as a result of any agent
she initially sponsored, regardless of which Exit office the agent operated from.
Roussel testified that Deere received ten percent of the commission in residuals on
all of Bletsh and Hutchins' sales.
Bletsh and Roussel testified that there were ongoing discussions regarding trying
not to harm Clear Sky because the public perceives both Exit offices as one entity.
Hutchins testified that he had no recollection of any such discussions.
Scott Jones (Jones) was initially an associate broker at Clear Sky. Bletsh asked
Jones to be the principal broker for Exit Select until she could get her license. Jones
testified that he initially was concerned about there being two Exit offices in Conway
but his concerns were assuaged when he discovered that Exit initially designated
Conway to add two franchises to the town. Jones also testified that Exit Select
would be better off if Clear Sky did well because the public links the two offices as
one.
There was a list of items presented to the jury in state court that Deere alleges were
taken when the new office was opened. (Pl. Ex. 17.) Bletsh, Hutchins, Roussel and
8

Jones all testified that items on the list that were taken were taken by mistake and
returned to Deere.
Deere testified that the mass defection of her agents to Exit Select was financially
devastating. Bletsh, Hutchins, Roussel and Jones all testified that no agents were
solicited to leave Clear Sky, rather they all came on their own accord.
In re Roussel, 483 B.R. 915, 921 (Bankr. E.D. Ark. 2012).
The Bankruptcy Court determined that only a portion of Roussel’s judgment
debt–specifically, the $1,480 award to Clear Sky for property damage--is excepted from
discharge under § 523(a)(4) and that the remainder of the debt is dischargeable in bankruptcy.
Appellants appealed the Bankruptcy Court’s judgment and elected to have the appeal heard by
this court, pursuant to 28 U.S.C. § 158(c)(1)(A).
III.
The Bankruptcy Court’s memorandum opinion does not clearly delineate findings
regarding the application of collateral estoppel and the merits of Appellants’ claims. However it
is clear that, in addition to determining that the doctrine of collateral estoppel did not apply, the
Bankruptcy Court assessed testimony that was not part of the state court record and made an
independent determination as to whether Roussel’s judgment debt is nondischargeable under
§§ 523(a)(4) and 523(a)(6). On appeal, Appellants argue that the Bankruptcy Court failed to
give the state court findings the preclusive effect required under the doctrine of collateral
estoppel and erred in finding that Roussel’s judgment debt, with the exception of the award for
property damage, fails to qualify for an exception to discharge under §§ 523(a)(4) and
523(a)(6).
A. Section 523(a)(4)
Section 523(a)(4) of the Bankruptcy Code provides that “a discharge [in bankruptcy]

9

does not discharge an individual debtor from any debt . . . for . . . defalcation while acting in a
fiduciary capacity . . . . ” 11 U.S.C. § 523(a)(4). Nondischarge under § 523(a)(4) requires a
showing of two elements: (1) the existence of a fiduciary relationship between the debtor and the
objecting party and (2) a defalcation committed by the debtor in the course of that fiduciary
relationship. See Jafarpour v. Shahrokhi (In re Shahrokhi), 266 B.R. 702, 707 (8th Cir. BAP
2001). Appellants argue that both elements were decided in their favor in state court action and
that the Bankruptcy Court was bound, under the doctrine of collateral estoppel, to declare the
state court judgment nondischargeable under § 523(a)(4).
Collateral estoppel applies in bankruptcy discharge proceedings to bar the relitigation of
factual or legal issues that were determined in a prior state action. It is a “general and
well-settled rule that a judgment, not set aside on appeal or otherwise, is equally effective as an
estoppel upon the points decided, whether the decision be right or wrong.” Reed v. Allen, 286
U.S. 191, 201, 52 S.Ct. 532, 534 (1932)(citations omitted). The full faith and credit statute, 28
U.S.C. § 1738,6 requires federal courts to give the same preclusive effect to state court judgments
as the state from which the judgment emerged. See In re Bullard, 449 B.R. 379, 384 (8th Cir.
2011)(citations omitted). The elements of collateral estoppel in Arkansas are as follows: (1) the
issue sought to be precluded must be the same as that involved in the prior litigation; (2) that
issue must have been actually litigated; (3) the issue must have been determined by a valid and
final judgment; and (4) the determination must have been essential to the judgment. See id.
As the Bankruptcy Court acknowledged in its final order, it is undisputed that the
6

Title 28 U.S.C. § 1738 provides, in relevant part, that the “Acts, records and judicial
proceedings” of any State “shall have the same full faith and credit in every court within the
United States . . . as they have by law or usage in the courts of such State . . . from which they
are taken.”
10

following questions of state law were actually litigated and answered in the affirmative in the
state court proceeding: (1) whether Roussel owed fiduciary duties to Clear Sky and Deere; (2)
whether Roussel breached his fiduciary duties to Clear Sky and Deere; (3) whether Roussel’s
fiduciary breach was a proximate cause of damages to Clear Sky and Deere; and (4) whether
Clear Sky was entitled to punitive damages as a result of Roussel’s fiduciary breach. Without
question, the foregoing issues were actually litigated in state court, and the determination of
those issues was essential to a valid and final judgment. The critical question here is whether the
elements necessary for nondischarge under § 523(a)(4)–that is, the existence of a fiduciary
relationship and defalcation–are the same as the issues already determined in state court.
(1)

Same Issue–Fiduciary Duty of Loyalty

Whether a fiduciary relationship exists for purposes of § 523(a)(4) is a question of federal
law, and it has long been held that a debtor acts in a fiduciary capacity in the bankruptcy context
only if he serves in a technical or express trust. See In re Cochrane, 124 F.3d 978, 984 (8th Cir.
1997)(citing Lewis v. Scott, 97 F.3d 1182, 1185 (9th Cir. 1996)). The statute “‘speaks of
technical trusts, and not those which the law implies from the contract.’” In re Nail, 680 F.3d
1036, 1039(quoting Davis v. Aetna Acceptance Co., 293 U.S. 328, 333, 55 S.Ct. 151 (1934) and
Chapman v. Forsyth, 43 U.S. 202, 208, 2 How. 202 (1844)). “It is not enough that, by the very
act of wrongdoing out of which the contested debt arose, the bankrupt has become chargeable as
a trustee ex maleficio. He must have been a trustee before the wrong and without reference
thereto.” Davis v. Aetna Acceptance Co., 293 U.S. 328, 333, 55 S.Ct. 151 (1934).
The rule that § 523(a)(4) applies only in cases of special or technical trusts, as opposed to
implied or constructive trusts, prevents an expansive application of § 523(a)(4) that would except

11

ordinary commercial debts from discharge in bankruptcy.7 The technical trust requirement does
not, however, require the that debtor serve as a trustee under a formal trust agreement. See In re
Hayes, 183 F.3d 162, 169 (2nd Cir. 1999)(“Notably, the Court in Chapman spoke of “special
trusts” not in the modern sense of a legal relationship where a party (the trustee) is the legal
owner of property beneficially held on behalf of others, but more generally of the class of
relationships in which special trust is bestowed upon a party.”).
Federal law dictates the boundaries of § 523(a)(4), but fiduciary relationships satisfying
the statute can be created by state statute, common law, or contract. See In re Thompson, 686
F.3d 940, 944 -945 (8th Cir. 2012)(citing In re Long, 774 F.2d 875, 878 (8th Cir. 1985)). For
example, the Eighth Circuit has held that the attorney-client relationship, without more,
constitutes a fiduciary relationship within the meaning of § 523(a)(4), see In re Cochrane, 124
F.3d 978, 984 (8th Cir. 1997), and that a “statute or other state law rule may create fiduciary
status in [a corporate] officer which is cognizable in bankruptcy proceedings.” In re Long, 774
F.2d 875, 878 (8th Cir. 1985). And in Laughter v. Speight, 16 F.3d 287 (8th Cir. 1994), the Court
of Appeals found that a state court judgment “rendered in the context of an accounting on
7

The precept that § 523(a)(4) applies only to express or technical trusts comes from a
long line of cases beginning with Chapman v. Forsyth, 43 U.S. 202, 2 How. 202, 11 L.Ed. 236
(1844), where the Supreme Court held that a factor who sold goods on behalf of the owner and
was contractually bound to hold the money for the owner’s use was not a fiduciary under
bankruptcy law. The Bankruptcy Act in effect at the time excepted from discharge debts
“created in consequence of the defalcation as a public officer, or as executor, administrator,
guardian, or trustee, or while acting in any other fiduciary capacity,” Bankruptcy Act of 1841,
ch. IX, § 2, 5 State 441 (1841)(repealed 1843). The Chapman Court noted that the statute’s
specifically itemized exceptions, e.g., defalcation as a public officer, executor, administrator, or
trustee, “are not cases of implied but special trusts, and the ‘other fiduciary capacity’ mentioned,
must mean the same class of trusts.” Chapman, 43 U.S. at 208. The Court concluded: “The act
speaks of technical trusts, and not those which the law implies from the contract. A factor is not,
therefore, within the act.” Id. The Supreme Court remarked that a contrary interpretation
“would have left but a few debts on which the [bankruptcy] law could operate.” Id.
12

dissolution of a partnership, was quite plainly based on a finding that the debtor had committed a
defalcation in the context of a fiduciary relationship.” Laughter, 16 F.3d at 287.
Here, the state court did not charge Roussel with fiduciary duties under a constructive or
implied trust theory. The court instructed the jury that Roussel owed fiduciary duties to both
Clear Sky and Deere at all relevant times,8 and the undisputed evidence established that Roussel
was a member of Clear Sky before, during, and after he sold a portion of his Clear Sky interest
to Deere and started another LLC and a competing Exit real estate office.
The state court instructed the jury that Roussel owed Clear Sky and Deere the duty of
loyalty, meaning that he would “act in the best interest of the company and its members, while
subordinating his personal interests to that of the company and its members, while serving
actively with the company, or even after he [severed] his day-to-day relationship with the
company.” ECF No. 1-22, at 269 (State Tr. at 1406). The court further instructed that Roussel
owed Clear Sky and Deere additional duties, which are generally deemed subsidiary to the duty
of loyalty, including the duty not to compete against the LLC, the duty to deal fairly and
honestly with the LLC and its members and disclose conflicts of interest, and the duty to refrain
from action that might result in injury to the company or deprive it of profit or advantage.
In determining whether Roussel’s duty of loyalty compared to the fiduciary requirement
under § 523(a)(4), the Bankruptcy Court focused on the identity of a “definable res” and the
nature of the damages awarded in state court. The Bankruptcy Court associated Clear Sky’s
award for lost revenue and Deere’s award for monetary harm with the duty of loyalty, but it

8

Under Arkansas law, the determination of the existence of a fiduciary duty in a
particular relationship is a matter of law, and it is error to submit that issue to the jury. See Long
v. Lampton, 324 Ark. 511, 524, 922 S.W.2d 692, 700 (1996).
13

associated Clear Sky’s award for property damage with the duty of care,9 a duty that was not
referenced in the state court’s jury instructions.
The Bankruptcy Court found that the duty of loyalty “is simply not the type of fiduciary
duty to which § 523(a)(4) refers”and that “the jury award for breach of fiduciary duty regarding .
. . lost revenue . . . and the amount awarded to Deere for breach of fiduciary duty . . . is
dischargeable pursuant to § 523(a)(4).” In re Roussel, 483 B.R. 915, 923 (Bankr. E.D. Ark.
2012). Citing In re Nail, 680 F.3d 1036 (8th Cir. 2012), the Bankruptcy Court reasoned that a
fiduciary duty under § 523(a)(4) is created and defined by the property at issue and that
Roussel’s duty of loyalty was not associated with a “definable res.” According to the Bankruptcy
Court, it was bound to “look at the ‘res’ and examine what the duties are.” In re Roussel, 483
B.R. 915, 923 (Bkrtcy. E.D. Ark. 2012). The Bankruptcy Court concluded that Appellants failed
to point to a definable res associated with Roussel’s duty of loyalty, stating as follows:
The Plaintiffs argue that the ‘definable res’ include the assets of the limited liability
company, i.e., “the agents, Roussel’s relationship as a managing member with those
agents, Roussel’s relationship with the Exit franchisers, and Roussel’s own efforts
as a salesman.” (Pl.’s Closing Trial Brief). This is not a “definable res” for purposes
of § 523(a)(4). This Court finds that people, relationships, and efforts do not make
a valid res for purposes of § 523(a)(4).
Id.
9

The Bankruptcy Court found that Clear Sky property that was missing or damaged after
Roussel left Exit First Choice qualified as a “definable res” and that Roussel breached a duty of
care with regard to that property. Based on the jury award for damage to Clear Sky property, the
Bankruptcy Court found that “Roussel committed a defalcation regarding Clear Sky’s property”
and that the corresponding damage award for $1,480 was nondischargeable under § 523(a)(4).
Appellants do not contest the Bankruptcy Court’s decision that Roussel’s judgment debt for
property damage is nondischargeable. Appellants argue, however, that the Bankruptcy Court’s
findings are inconsistent. According to Appellants, “If Roussel was acting in a fiduciary
capacity as it related to any damage, he was acting in a fiduciary capacity for all purposes.” ECF
No. 6 at 18.
14

The Court finds that the Bankruptcy Court placed too much emphasis on a “definable
res” requirement. The value of experienced employees, business opportunities, and expected
future revenue contribute the goodwill of a company, which although intangible, qualifies as a
business asset. The Court also disagrees that the Eighth Circuit’s decision in In re Nail mandates
that the existence of a fiduciary relationship in this case depends on the identification of a
“definable res.”
In the case of In re Nail, the Eighth Circuit considered whether a state statute imposed
fiduciary duties for the purpose of § 523(a)(4). The statute in question prescribed the legal effect
when a party to an assigned account in good faith pays an assignor rather than the unknown
assignee, and it provided that “the assignor ... shall be a trustee of any sums so paid and shall be
accountable and liable to the prior assignee thereof.” In re Nail, 680 F.3d 1036, 1039 (8th Cir.
2012)(quoting Ark. Code Ann. § 4–58–105(b)(2)). The Eighth Circuit noted that the so-called
trust created by the statute had a “purely nominal existence” until the debtor failed to remit
proceeds to the proper party and that the debtor was not a trustee “before the wrong and without
reference thereto.” In re Nail, 680 F.3d at 1041(citing Davis v. Aetna Acceptance Co., 293 U.S.
328, 333, 55 S.Ct. 151 (1934)). Under those circumstances, the Eighth Circuit found that “the
mere use of the word ‘trustee,’ when viewed in the context of the statute as a whole, does not
reflect a legislative intent to create the kind of express or technical trust required in the strict and
narrow sense under § 523(a)(4).” Id.
In reaching its decision, the Court of Appeals noted: “[T]o meet the requirements of
§ 523(a)(4), a statutory trust must (1) include a definable res and (2) impose ‘trust-like’ duties.”
Id. (citing Matter of Tran, 151 F.3d 339, 342–43 (5th Cir.1998)).
15

But the requirement of a

“definable res” with respect to a statutory trust merely serves to ensure that the alleged trust
exists before and without reference to the wrong. Unlike In re Nail, this case does not involve a
statutorily-created “trust” that imposes ex post facto trustee duties as a remedial measure in the
context of an ordinary commercial transaction. The duty of loyalty owed by Roussel pre-existed
and was independent of the wrongful conduct that gave rise to his judgment debt.10
“‘An issue may be ‘actually’ decided even if it is not explicitly decided, for it may have
constituted, logically or practically, a necessary component of the decision reached in the prior
litigation.’” In re Smith, 270 B.R. 544, 548 (Bankr. D. Mass. 2001)(citing Grella v. Salem Five Cent
10

Under Arkansas law, the duty of loyalty owed by a managing member of an LLC to the
LLC and its members exists upon creation of the LLC and without reference to wrongful
conduct. The Arkansas Small Business Entity Tax Pass Through Act authorizes the organization
of limited liability companies in the state. Among its provisions, the Act provides: “Unless
displaced by particular provisions of this chapter, the principles of law and equity supplement
this chapter.” Ark. Code Ann. 4-32-1304(b). Subchapter 4 of the Arkansas LLC Act addresses
the duties of care and loyalty that a party with management authority owes the LLC and its
members. Regarding the duty of loyalty, unless otherwise provided in a company’s operating
agreement, Ark. Code Ann. § 4-32-402(2) requires a member or manager of an LLC to account
to and hold as trustee for the LLC any secret profits derived from any transaction connected to
the conduct or winding up of the LLC or from the use of confidential or proprietary information
or other matters entrusted to the member or manager because of his status. See Ark Code Ann.
§ 4- 32-402(2).
Commentary to the Prototype Act upon which the Arkansas Act is based explains that §
4-32-402(2) embodies the duty of loyalty set forth under § 21(1) of the Uniform Partnership Act
(“UPA”). See Frances S. Fendler, A License to Lie, Cheat, and Steal? Restriction or
Elimination of Fiduciary Duties in Arkansas Limited Liability Companies, 60 Arkansas Law
Review 643, 679 (2007)(citations omitted). The Arkansas Supreme Court has interpreted §
21(1) broadly. See St. Joseph's Regional Health Center v. Munos, 934 S.W.2d 192, 326 Ark.
605 (1996)(observing that partners must observe utmost good faith toward each other in all of
their transactions from time they begin negotiations with each other to complete settlement of
partnership affairs); White v. Hickey, 651 S.W.2d 467, 8 Ark. App. 264 (1983)(same); Creswell
v. Keith, 235 Ark. 653, 655-656, 361 S.W.2d 542, 544 (1962)(reaffirming prior cases
emphasizing the trust relationship existing between partners and observing that one partner owes
to the other the duty to make full and complete disclosure of assets and liabilities before
purchasing his interest).
16

Sav. Bank, 42 F.3d 26, 30-31 (1st Cir. 1994)). In this case, the Court finds that Roussel’s fiduciary
duty of loyalty to Clear Sky and Deere, as determined by the state court, is equivalent to a finding
that he acted in a fiduciary capacity as required under § 523(a)(4). Accordingly, relitigation of that
particular issue is precluded under the doctrine of collateral estoppel.
(2)

Same Issue - Defalcation

The second element required to find the state court judgment nondischargeable under
§ 523(a)(4) is that Roussel committed a defalcation while acting in his fiduciary capacity.
Because the Bankruptcy Court found that Roussel’s fiduciary duty of loyalty did not qualify as a
fiduciary duty under § 523(a)(4), it never addressed whether Roussel’s fiduciary breach
amounted to a defalcation under § 523(a)(4).
The undisputed evidence presented in state court established that Roussel sold some of
his interest in Clear Sky without informing Deere that he would compete with Clear Sky, and
that Roussel, while a member of Clear Sky, engaged in direct competition with the LLC without
obtaining Deere’s consent. The state jury found that Roussel breached his fiduciary duty of
loyalty to both Clear Sky and Deere, and it is clear that a fiduciary’s breach of the duty of loyalty
comes within the ambit of conduct that qualifies as a “defalcation” under § 523(a)(4). See
Bullock v. BankChampaign, N.A., — U.S. —, 133 S. Ct. 1754, 1760 (2013)(noting that the term
“defalcation” as commonly used and as Congress might have understood it, can encompass a
breach of fiduciary obligation that involves neither conversion, nor taking and carrying away
another’s property, nor falsity)(citing Black's Law Dictionary 479 (9th ed. 2009)); see also In re
Baylis, 313 F.3d 9, 20 (1st Cir. 2002)(“Defalcation may be presumed from breach of the duty of
loyalty, the duty not to act in the fiduciary’s own interest when that interest comes or may come

17

into conflict with the beneficiaries’ interest); In re Cochrane, 124 F.3d 978, 984 (8th Cir.
1997)(holding that debtor’s conduct resulting in a state court judgment for breach of fiduciary
duties, including the failure to disclose his stake in an investment aimed at buying out his client’s
failing business, fell within the fiduciary defalcation to discharge). But the inquiry does not end
there because not every debt that arises from a breach of a fiduciary duty amounts to a
defalcation for purposes of § 523(a)(4).
The Eighth Circuit has held that a finding of “defalcation” under § 523(a)(4) does not
require evidence of intentional wrongdoing. See In re Cochrane, 124 F.3d 978, 984 (8th Cir.
1997). During the pendency of this appeal, however, the Supreme Court issued a decision in
Bullock v. BankChampaign, N.A., — U.S. —, 133 S.Ct. 1754 (2013), holding that the term
“defalcation” under § 523(a)(4) “includes a culpable state of mind requirement” which involves
the “knowledge of, or gross recklessness in respect to, the improper nature of the relevant
fiduciary behavior.” Bullock, 133 S. Ct. at 1756.11
11

In Bullock, the debtor acted as trustee of a trust established by his father for the benefit
of the debtor and his siblings. See Bullock v. BankChampaign, N.A., — U.S. —, 133 S.Ct. 1754,
1757 (2013). While serving as trustee, the debtor borrowed funds from the trust and repaid the
funds with six percent interest. Id. The debtor’s siblings sued him for breach of fiduciary duty
in state court, and the trial court ruled that the debtor’s act of self-dealing constituted a breach of
his fiduciary duty as trustee. The state court noted that the debtor “[did] not appear to have had a
malicious motive in borrowing funds from the trust” but “neither the facts nor the circumstances
. . . excused him from liability .” In re Bullock, No. 09-84300-JAC-7, 2010 WL 2202826, *3
(Bankr. N. D. Ala. May 27, 2010). For the purpose of securing payment of the judgment, the
state court imposed a constructive trust on the debtor’s interest in the original trust, and
BankChampaign served as trustee for all of the trusts. See Bullock, 133 S. Ct. at 1757.
The debtor sought discharge in bankruptcy, and BankChampaign opposed discharge on
collateral estoppel grounds, arguing that the state court’s findings met the elements for
nondischarge under § 523(a)(4). See In re Bullock, No. 09-84300-JAC-7, 2010 WL 2202826, *1
(Bankr. D. Ala. May 27, 2010). The bankruptcy court granted the motion and found the
judgment debt nondischargeable.
18

In a unanimous decision, the Bullock Court held that “where the conduct at issue does not
involve bad faith, moral turpitude, or other immoral conduct, the term [defalcation] under
§ 523(a)(4)] requires an intentional wrong.” Id. at 1759. The Court included as intentional, “not
only conduct that the fiduciary knows is improper but also reckless conduct of the kind that the
criminal law often treats as the equivalent.” Id. Quoting the Model Penal Code, the Court
stated: “Where actual knowledge of wrongdoing is lacking, we consider conduct as equivalent if
the fiduciary ‘consciously disregards’ (or is willfully blind to) ‘a substantial and unjustifiable
risk’ that his conduct will turn out to violate a fiduciary duty.” Id.(quoting ALI, Model Penal
Code

§ 2.02(2), p. 226 (1985)). The Court added: “That risk ‘must be of such a nature and

degree that, considering the nature and purpose of the actor’s conduct and the circumstances
known to him, its disregard involves a gross deviation from the standard of conduct that a lawabiding person would observe in the actor’s situation.” Id.
The state court’s jury instructions permitted the jury to award punitive damages if the
plaintiff proved one or both of the following aggravating factors: (1) that Roussel knew or ought

On appeal, the district court affirmed, and the Eleventh Circuit affirmed the district court.
Regarding the state of mind required for defalcation, the Court of Appeals held that § 523(a)(4)
requires more than negligence and “requires a known breach of a fiduciary duty, such that the
conduct can be characterized as objectively reckless,” In re Bullock, 670 F.3d 1160, 1166 (11th
Cir. 2012), and that the debtor’s conduct met that standard. The Court reasoned that because the
debtor served as trustee “he certainly should have known that he was engaging in self-dealing,
given that he knowingly benefitted from the loans. Thus, his conduct can be characterized as
objectively reckless, and as such, it rises to the level of a defalcation under § 523(a)(4).”
Id.(emphasis added).
Because the Eleventh Circuit applied a standard of objective recklessness, rather than the
gross recklessness standard announced in Bullock, the Supreme Court remanded stating: “We . . .
remand the case to permit the court to determine whether further proceedings are needed and, if
so, to apply the heightened standard that we have set forth.” Id. at 1761.
19

to have known in the light of surrounding circumstances that his conduct would naturally and
probably result in damages, and that he continued such conduct in reckless disregard of the
consequences from which malice may be inferred or (2) that Roussel intentionally pursued a
course of conduct for the purpose of causing damage. Given the disjunctive nature of the jury
instruction, it is impossible, but unnecessary, to know the jury’s specific finding.
Under Bullock, the crucial inquiry is whether the fiduciary knows that his conduct will
violate the applicable standard of care. A conscious disregard of or willful blindness to a
substantial and unjustifiable risk that conduct will breach a duty satisfies the knowledge
requirement, and whether a risk is substantial and unjustified depends on the fiduciary’s purpose
and the circumstances known to him. The first aggravating factor set forth in the state jury
instructions required the jury to find that malice may be inferred from the defendant’s conduct
and his reckless disregard of the consequences. This standard is more stringent than the
objectively reckless standard that the Bullock decision rejects. Furthermore, the second and
alternative aggravating factor requires the jury to find that the defendant intentionally caused
damage and therefore meets the statutory requirement for nondischargeability. Accordingly, the
Court finds that the requisite state of mind for defalcation was actually litigated and decided in
state court.
For the reasons stated, the Court finds that Roussel is collaterally estopped from
contesting whether his judgment debt for damages to Clear Sky and Deere is nondischargeable
under § 523(a)(4). Accordingly, the portion of Roussel’s judgment debt awarding compensatory
and punitive damages for breach of fiduciary duty is nondischargeable under § 523(a)(4), and the
Bankruptcy Court’s determination to the contrary is reversed.

20

B. Section 523(a)(6)
Pursuant to 11 U.S.C. § 523(a)(6), debts “for willful and malicious injury by the debtor to
another entity or to the property of another entity” are nondischargeable. The terms “willful”
and “malicious” connote two distinct elements, and both must be proven by a preponderance of
the evidence. See In re Porter, 539 F.3d 889, 893 (8th Cir. 2008).
In the context of § 523(a)(6), the word “willful” modifies the word “injury,” thus
nondischargeability requires a deliberate or intentional injury, not merely a deliberate or
intentional act that leads to an injury. See Kawaauhau v. Geiger, 523 U.S. 57, 6, 118 S.Ct. 974
(1998). Debts resulting from injuries caused by reckless or negligent conduct fail to satisfy the
willfulness standard--at the least, willfulness requires a showing that the debtor knows that the
consequences were certain, or substantially certain, to result from his conduct. See In re Porter,
539 F.3d 889, 894 (8th Cir. 2008)(citing In re Patch, 526 F.3d 1176, 1180 (8th Cir. 2008)). The
separate malice requirement mandates a heightened level of culpability and requires a showing
that the debtor’s willful conduct was “‘targeted at the creditor . . . at least in the sense that the
conduct is certain or almost certain to cause . . . harm.’” In re Scarborough, 171 F.3d 638, 641
(8th Cir. 1999)(quoting In re Miera, 926 F.2d 741, 743–44 (8th Cir. 1991)).
Clear Sky maintains that the state court’s punitive damage award establishes that all
damages awarded to Clear Sky for breach of fiduciary duty are excepted from discharge under
§ 523(a)(6). The Bankruptcy Court disagreed because it found that the state court’s jury
instructions did not require a finding that Clear Sky’s injury was both “willful and malicious.”
After concluding that the doctrine of collateral estoppel had no application, the Bankruptcy
Court specifically addressed the question of Roussel’s state of mind and found as follows:

21

There was no proof offered that Roussel intended a deliberate or intentional injury.
Rather, the proof offered was that Roussel could harm Deere’s business by causing
the failure of Clear Sky. There was also no substantial certainty that Deere would
be financially harmed by Roussel opening another franchise. Rather, proof was
offered that Exit initially mapped Conway for two franchises. Nothing in the
record or in the state court record suggests that Roussel, Bletsh, or Hutchins ever
solicited agents to leave Deere’s franchise. The Plaintiffs were unable to show that
Roussel intentionally invaded any of Deere’s legally protected interests or
intentionally harmed Deere. The Plaintiffs did not prove by a preponderance that
Roussel incurred the state court judgment as a result of a willful and malicious injury
to Deere.
In re Roussel, 483 B.R. 915, 924 -925 (Bankr. E.D. Ark. 2012)
Appellants’ precise argument is that a finding of either or both of the aggravating factors
set forth in the state court’s punitive damage instruction amounts to a finding of malice and that
Roussel’s willfulness was established by the undisputed fact that at all relevant times, he knew
that he was a managing member of Clear Sky. This Court agrees with both assertions.
The state court’s jury instruction permitted an award of punitive damages only if the jury
found that Roussel intentionally pursued a course of conduct for the purpose of causing damage
or that he acted with such conscious indifference to consequences that malice could be inferred.
Regardless of the jury’s exact finding, the award of punitive damages shows that the jury found,
at the very least, that Roussel’s conduct was certain or almost certain to result in damage or harm
to Clear Sky, which meets the “malicious injury” requirement under § 523(a)(6). See In re
Porter, 539 F.3d 889, 894 (8th Cir. 2008)(quoting In re Nangle, 274 F.3d 481, 484 (8th Cir.
2001)(quoting In re Long, 774 F.2d 875, 881 (8th Cir.1985)(“Maliciousness is conduct ‘targeted
at the creditor ... at least in the sense that the conduct is certain or almost certain to cause ...
harm.’”). Accordingly, Roussel is collaterally estopped from contesting whether his judgment
debt for compensatory and punitive damages to Clear Sky is for a “malicious injury” under

22

§ 523(a)(6).
Contrary to the Bankruptcy Court’s findings, this Court finds that the “willful . . . injury”
requirement is also met. The scope of a “willful . . . injury” under § 523(a)(6) is not confined to
circumstances in which the debtor desires to bring about the harmful consequences of his
conduct. “It is enough ‘[i]f the debtor knows that the consequences are certain, or substantially
certain, to result from his conduct.’” In re Porter, 539 F.3d 889, 894 (8th Cir. 2008)(quoting In re
Patch, 526 F.3d 1176, 1180 (8th Cir. 2008)).
Here, the undisputed evidence leaves no question that Roussel knew that his conduct
would give rise to the injury at issue–the breach of his duty of loyalty to Clear Sky.12 Roussel’s
own testimony shows that he was aware that he was a member of Clear Sky when he purchased
Territory B on behalf of Select Group Investments LLC, when he opened a competing Exit realty
office in Conway, and when he engaged in direct competition with Clear Sky--all without
Deere’s consent. Furthermore, Roussel’s own testimony demonstrated that he knew that Clear
Sky had an interest in purchasing Territory B and preventing another Exit office from opening in
Conway. After careful review of the entire record, the Court finds that the Bankruptcy Court
clearly erred in its assessment of whether Roussel willfully breached his fiduciary duty to Clear
Sky. Accordingly, the decision of the Bankruptcy Court on the issue of the dischargeability
under § 523(a)(6) should be, and hereby is, reversed.

12

“The plain language of § 523(a)(6) requires courts applying the exemption to first
determine exactly what ‘injury’ the debt is ‘for,’ and then determine whether the debtor both
‘willful[ly] and malicious[ly]’ caused that ‘injury.’” In re Patch, 526 F.3d 1176, 1181 (8th Cir.
2008). Here, the injury giving rise to the portion of the judgment debt awarding Clear Sky actual
and punitive damages is Roussel’s breach of the fiduciary duty of loyalty owed to Clear Sky, but
the Bankruptcy Court’s analysis focuses on whether Roussel, Bletsh, and Hutchins intended
financial harm to Deere.
23

C. Attorney’s Fees and Costs
The state court awarded Appellants $82,611.25 in attorney’s fees and $4,912 in costs. In
support of their motion for a fee award , Appellants argued that Clear Sky’s operating agreement
provided that in any dispute arising between Clear Sky members, the losing party would pay the
prevailing party reasonable costs and expenses, including attorney’s fees. See ECF No. 1-9, at
59-60. Appellants also claimed a right to attorney’s fees under Ark. Code Ann. § 16-22-308,
which provides:
In any civil action . . . for . . . breach of contract, unless otherwise provided by law
or contract which is the subject matter of the action, the prevailing party may be
allowed a reasonable attorney’s fee to be assessed by the court and collected as cost.
Ark. Code Ann. § 16-22-308(emphasis added). In a two-sentence order, the state court granted
the motion for fees and costs, stating: “Based on the arguments in the Motion and Brief, the
Motion is hereby GRANTED . . . . ” See ECF No. 1-9 at 87.
Consistent with the state court’s order, the Bankruptcy Court attributed Appellants’ fee
award to the operating agreement fee provision or Ark. Code Ann. § 16-22-308. The
Bankruptcy Court reasoned that because the state court awarded fees and costs based on
“contract or breach of contract, which is dischargeable in Bankruptcy[,]” In re Roussel, 483
B.R. 915, 925 (Bankr. E.D. Ark. 2012), Appellants’ fee award was also dischargeable in
bankruptcy.
“Ancillary obligations such as attorneys’ fees . . . may attach to the primary debt;
consequently, their status depends on that of the primary debt.” In re Hunter, 771 F.2d 1126,
1131 (8th Cir. 1985)(citation omitted)(emphasis added). The Eighth Circuit has held that when
parties have included a provision authorizing recovery of attorney’s fees in a contractual

24

agreement, and those fees are incurred in connection with a debt determined to be
nondischargeable in bankruptcy, the creditor may be entitled to recover such fees as part of the
nondischargeable debt. See In re Alport, 144 F.3d 1163, 1168 (8th Cir. 1998)(“The Ritters’
attorney fees were properly included in the nondischargeable debt . . . because attorney’s fees
provided by contract, like accrued interest, can become part of the debt.”). Accordingly, on
remand, the Bankruptcy Court should consider whether the fee provision set forth in Clear Sky’s
operating agreement renders all or any part of Appellants’ fee award part of the
nondischargeable debt in this case.
IV.
For the reasons stated, the judgment of the Bankruptcy Court is reversed and the case is
remanded for further proceedings addressing whether the fee provision set forth in Clear Sky’s
operating agreement renders all or any part of Appellants’ fee award part of the
nondischargeable debt.
IT IS SO ORDERED THIS 30th DAY OF DECEMBER, 2013.

/s/Susan Webber Wright
UNITED STATES DISTRICT JUDGE

25