Sherrick v. HST Corporate Interiors, LLC

Filing 20

MEMORANDUM OPINION OF THE COURT. Signed by District Judge William L. Campbell, Jr on 5/3/2018. (DOCKET TEXT SUMMARY ONLY-ATTORNEYS MUST OPEN THE PDF AND READ THE ORDER.)(am)

IN THE UNITED STATES DISTRICT COURT FOR
MIDDLE DISTRICT OF TENNESSEE
NASHVILLE DIVISION
IN RE: PAUL W. SHERRICK,
Debtor.
PAUL W. SHERRICK,
Appellant,
v.
HST CORPORATE INTERIORS, LLC,
Appellee.

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NO. 3:17-cv-01086
JUDGE CAMPBELL

MEMORANDUM
Appellant appeals the final Bankruptcy Court’s July 6, 2017 “Order Denying Discharge”
and Memorandum Opinion (the “Order”). In the Order, the Bankruptcy Court denied Appellant's
discharge of debts under 11 U.S.C. § 523(a)(4) based on Appellant’s embezzlement, after piercing
the corporate veil of Sherrick Construction, Inc.
Appellant alleges the Bankruptcy Court erred in finding sufficient proof to pierce the
corporate veil and enforce the debt of Sherrick Construction, Inc. against Appellant, and erred in
finding Appellant committed embezzlement under 11 U.S.C. § 523(a)(4). For the reasons stated
below, the decision of the Bankruptcy Court is REVERSED, and this case is REMANDED to
the Bankruptcy Court for further proceedings consistent with this opinion.
I.

FACTS AND PROCEDURAL HISTORY

Appellant was involved in the construction and contracting business in Middle Tennessee
beginning in the early 1980s. (Doc. No. 8 at 5). In 1994, Appellant founded Sherrick Construction,
Inc. (“Sherrick Construction”) and obtained a general contractor’s license. (Id.). Appellant was the
president and sole owner of Sherrick Construction and a certified Small Business Administration
8(a) (“SBA 8(a)”) business, authorized to obtain federal contracts as a socially or economically
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disadvantaged business. (Doc. No. 1-2 at 2). In June 2011, Appellee HST Corporate Interiors, LLC
(“HST” or “Appelle”) negotiated a contract with the United States for the installation of furniture
and related items at the Hurlburt Field Child Development Center (the “Project”) in Florida, and
was directed to involve a SBA 8(a) contractor to sign the government contract. (Id.). Larry Carr, a
representative of HST, contacted the Appellant to see if Sherrick Construction could serve as the
SBA 8(a) contractor for the Project. (Id.). HST entered into a verbal contract whereby HST would
procure and install items for the Project, but Sherrick Construction would be the contracting party
with the Federal Government. (Id.). HST sent a 91-page attachment to Appellant that included
information on the Project, a detailed invoice, the proposed amount to be paid Sherrick
Construction, and the amount of the total contract. (Id.at 2-3). The total amount of the contract was
$314,500.00, and Sherrick Construction would receive $8,960.00 of that total. (Id. at 3). Sherrick
Construction served as the named SBA 8(a) contractor, and HST purchased and installed the
related items for the Project. (Id.). On February 13, 2012, Appellant emailed HST stating that he
believed the Project should be invoiced in two billings, the first one at 98% of the total billing
amount and the second at 2%. (Id. at 3-4).
Velzetta Conyers (“Ms. Conyers”) coordinated federal contract projects for Sherrick
Construction, but had no knowledge of Sherrick Construction’s involvement in the Project until
February 28, 2012. (Id. at 4). Tammy Holzapfel (“Ms. Hozapfel”), the bookkeeper for Sherrick
Construction, also had no knowledge of the Project until Ms. Conyers billed the government on
March 20, 2012. (Id.). Sherrick Construction requested payment from the government for the total
contract amount of $314,000 in two separate invoices. The government paid monies directly into
Sherrick Construction’s operating account on April 18, 2012 ($280,190.83) and August 1, 2012
($34,309.17). (Id. at 4-5).

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On July 7, 2012, HST contacted Ms. Conyers requesting an update on payment from the
Project and asked if Sherrick Construction received payment from the government. (Id. at 5). Ms.
Conyers requested an invoice from HST on July 9, 2012 and August 8, 2012, and HST provided
the invoice on August 8, 2012. (Id.). On January 24, 2013, five months after Sherrick Construction
received full payment from the government, HST notified Ms. Conyers that HST had never
received full payment for the Project. (Id.).
On May 31, 2012, after receiving the first payment for the Project from the government,
Appellant transferred $73,161 from Sherrick Construction’s account to pay his past due personal
income taxes for 2010. (Id.). From July 2012 to September 2012, Appellant transferred another
$24,550 from Sherrick Construction to pay his personal income tax debt. (Id.). According to Ms.
Holzapfel, Sherrick Construction also paid $75,000 to $100,000 in the first part of 2012 for payroll
taxes because the company did not have sufficient funds when the taxes were due. (Id. at 6).
Sherrick Construction was also subjected to an insurance audit, which cost Sherrick Construction
between $45,000 and $50,000. (Id.). Due to Sherrick Construction’s SBA 8(a) certification
expiration in 2011 and sequestration of discretionary spending imposed by the Federal
Government in 2012, numerous awarded bids for Sherrick Construction were never commenced
or were cancelled. (Doc. No. 8 at 5-6, 13). This lead to severe cash issues and Sherrick
Construction’s inability to pay HST for the Project. (Id. at 13).
HST filed a lawsuit against Appellant and Sherrick Construction in the Chancery Court for
the State of Tennessee. (Doc. No. 1-2 at 6). On January 12, 2016, Appellant and Sherrick
Construction field for relief under Chapter 11, which stayed the Chancery Court litigation. (Id.).
On May 3, 2016, the Bankruptcy Court allowed Appellant and Sherrick Construction to convert
their cases to Chapter 7 proceedings. (Id.). HST filed adversary complaints to determine the

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dischargeability of the debt owed by Sherrick Construction to HST. (Id.). The dischargeability
action against Sherrick Construction was dismissed by agreed order. (Id.).
On February 1, 2017, the Bankruptcy Court conducted a one-day trial to determine the
dischargeability of the debt owed to HST by Appellant. (Doc. No. 8 at 15). On July 6, 2017, the
Bankruptcy Court entered an Order and Memorandum Opinion finding that: (1) Appellant owed a
debt to HST by piercing the Sherrick Construction corporate veil; and (2) HST’s claim was not
dischargeable because Appellant embezzled funds in order to pay personal expenses under 11
U.S.C. § 523(a)(4). (Doc. No. 1-2). On July 19, 2017, Appellant timely filed a notice of appeal.
II.

STANDARD OF REVIEW

The Court reviews the Bankruptcy Court’s findings of fact for clear error, and its
conclusions of law de novo. Rembert v. AT&T Univ. Card Serv. (In re Rembert), 141 F.3d 277,
280 (6th Cir. 1998). A factual finding is clearly erroneous when the reviewing court is left with
the definite and firm conviction on the entire evidence that a mistake has been made. Id. If a mixed
question of law and fact exists the court “must break it down into its constituent parts and apply
the appropriate standard of review for each part.”Wesbanco Bank Barnesville v. Rafoth (In re
Baker & Getty Fin. Servs., Inc.), 106 F.3d 1255, 1259 (6th Cir.1997).
III.

ISSUES ON APPEAL

Whether the Bankruptcy Court erred in finding sufficient proof to pierce the corporate veil
and enforce the debt of Sherrick Construction against Appellant, and whether the Bankruptcy
Court committed clear error in finding Appellant committed embezzlement pursuant to 11 U.S.C.
§ 523 (a)(4).

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IV.

ANALYSIS

“Bankruptcy is both a creditor’s remedy and a debtor’s right.” In Re Patel, 565 F.3d 963,
967 (6th Cir. 2009). The primary purpose of bankruptcy is to grant the debtor a “fresh start,” and
discharges are to be strictly construed against the creditor and literally in favor of the debtor. See
In Re Keeney, 227 F.3d 679 (6th Cir. 2000). While discharging debts can sometimes cause harm
to creditors, there are statutory exceptions construed to exclude certain debts from discharge. In
Re Patel, 565 F.3d at 967. A creditor has the burden to prove, by a preponderance of the evidence,
that a debt should not be discharged. Id.
The Bankruptcy Court found Appellants debt nondischargeable under 11 U.S.C. §
523(a)(4) for embezzlement and rejected HST’s claims under 11 U.S.C. § 523 (a)(2)(A), (a)(6),
and (a)(14). Neither Appellant or Appellee requests this Court to review the Bankruptcy Court’s
rejection of the non-dischargeability arguments under 11 U.S.C. § 523 (a)(2)(A), (a)(6), or (a)(14),
therefore the only issue properly preserved on appeal is whether the Bankruptcy Court erred in
finding that the Appellant committed embezzlement under 11 U.S.C. § 523(a)(4).
A. Embezzlement Under 11 U.S.C. § 523(a)(4)
Appellant asserts the Bankruptcy Court erred in finding that he was not entitled to a
discharge because he embezzled HST’s funds under Section 523(a)(4). Specifically, Appellant
argues the evidence presented to the Bankruptcy Court did not establish a prima facie case for
embezzlement.
Under 11 U.S.C. § 523(a)(4), “a discharge can be denied for a debt for fraud or defalcation
while acting in a fiduciary capacity, embezzlement, or larceny.” In re Morse, 504 B.R. 462, 47071 (Bankr. E.D. Tenn. Jan. 10, 2014) (emphasis added). “Embezzlement under 11
U.S.C. § 523(a)(4) is defined as ‘the fraudulent appropriation of property by a person to whom

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such property has been entrusted or into whose hands it has lawfully come.’” In re Batson, 568
B.R. 281, 289 (Bankr. M.D. Tenn. Feb. 28, 2017) (citing Brady v. McAllister (In re Brady), 101
F.3d 1165, 1172–73 (6th Cir. 1996)). The fraud element of Section 523(a)(4) is “fraud in fact,
involving moral turpitude or intentional wrong” and requires “proof of the debtor's fraudulent
intent in taking the [creditor's] property.” Cash Am. Fin. Servs., Inc. v. Fox (In re Fox), 370 B.R.
104, 116 (6th Cir. BAP 2007). A creditor must prove all elements for embezzlement by a
preponderance of the evidence. In re Batson, 568 B.R. at 289-90; see also In re Fox, 370 B.R. at
116.
The Bankruptcy Court found a preponderance of the evidence supported a finding of
embezzlement by the Appellant. (Doc. No. 1-2 at 15). Based on testimony and evidence at trial,
the Bankruptcy Court found no dispute that HST’s funds for the Project were lawfully entrusted
to Appellant and Sherrick Construction, and those funds were used for other purposes. (Id.). The
Bankruptcy Court found Sherrick Construction served as the SBA 8(a) contractor on the Project
for a fee and HST performed all the work. (Id.). The majority of the funds were to go to HST after
the government paid Sherrick Construction. (Id.). Appellant did not notify HST when the payments
were received, but instead used the funds to pay his overdue personal income taxes, Sherrick
Construction’s payroll taxes, and fees related to an insurance audit. (Id. at 16). The Bankruptcy
Court found circumstantial evidence to indicate fraud because the Appellant needed HST’s funds
to pay his expenses, thus Sherrick Construction no longer had the funds to pay HST. (Id.). By the
end of August 2012, Sherrick Construction’s bank account balance was $24,131.82, and the
Bankruptcy Court noted this was before the government sequester in December of 2012. (Id.).
On appeal, Appellant challenges the Bankruptcy Court’s findings on each of the elements
for embezzlement. First, Appellant states that Sherrick Construction was not entrusted with any

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property of HST because the proceeds from the Project were owned by Sherrick Construction.
(Doc. No. 8 at 34). Appellant asserts HST knew the government would pay the funds to Sherrick
Construction and therefore Sherrick Construction was entitled to use those funds. (Id. at 38).
Second, Appellant argues HST did not present any proof that Appellant intended for Sherrick
Construction not to pay HST once the government paid for the Project, thus Appellant lacked
fraudulent intent. (Id. at 35-36). Instead, Appellant took a distribution of available funds from
Sherrick Construction, which he solely owns, before he received an invoice from HST. (Id. at 37).
Finally, Appellant argues he intended for Sherrick Construction to pay HST, Appellant attempted
to keep Sherrick Construction solvent in order to repay its debts, and he sought alternative funding
to pay HST. (Id. at 42). Appellee responds by arguing Appellants actions were intentional acts of
fraud, and the evidence shows Appellant never intended to pay HST its money. (Doc. No. 12 at
20).
This Court finds no evidence that Appellee lawfully entrusted property to Sherrick
Construction. To demonstrate embezzlement a creditor must prove all three elements, and the
circumstances in this case do not satisfy the first element. In Re Fox, 370 B.R. 104, 115-16 (B.A.P.
6th Cir. 2007). The Bankruptcy Court found that when payments were received for the Project, the
Appellant knew that Sherrick Construction was not entitled to keep the entire amount and the funds
from the government were lawfully HST’s and entrusted to Appellant. (Doc. No. 1-2 at 15). This
Court disagrees. The facts at trial established Sherrick Construction may have owed money to HST
under an agreement, but Sherrick Construction was not entrusted with any property of Appellee.
In the case of In Re Bucci, 493 F.3d 635 (6th Cir. 2007), the Court of Appeals found
“[embezzlement] involves an express or technical trust relationship arising from placement of a
specific res in the hands of the debtor.” (emphasis added). Tennessee Court have held that, “a mere

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lien or security interest does not rise to the level of ownership sufficient to support a claim under §
523(a)(4)'s embezzlement provision.” Hulsing Hotels Tenn., Inc. v. Steffner (In re Steffner), 479
B.R. 746, 766 (Bankr. E.D. Tenn. 2012); see also Kraus Anderson Capital, Inc. v. Bradley (In re
Bradley), 507 B.R. 192, 200 (B.A.P. 6th Cir. 2014) (“As owner of the collateral, the debtor
remained the owner of its proceeds, even though both the collateral and its proceeds were subject
to a security interest. No person can embezzle from himself.”).
Sherrick Construction was the true owner of the funds received from the Federal
Government. While HST was entitled to a majority of the funds, the money was entrusted to
Sherrick Construction by the government, not HST. The Court finds the evidence presented to the
Bankruptcy Court did not establish that Appellee entrusted property to Sherrick Construction.
Instead, the Appellant simply owed Appellee a debt that was never paid. Appellant correctly
asserts the Project funds were deposited into Sherrick Construction’s operating account and was
commingled with other funds, making the proceeds fungible and placing HST in the same position
as any other Sherrick Construction creditor. (Doc. No. 8 at 39). The Court finds the Bankruptcy
Court committed clear error because Appellee failed to establish a prima facie case of
embezzlement under 11 U.S.C. § 523 (a)(4).
B. Piercing the Corporate Veil
Appellant further argues the Bankruptcy Court erred in finding proof that Appellant owed
a debt to HST by piercing the Sherrick Construction corporate veil. Appellant states there is no
evidence that Appellant used his control of Sherrick Construction to defraud HST, and therefore
only Sherrick Construction should be liable for HST’s debt. However, due to the Court’s findings
that the Bankruptcy Court committed clear error in denying Appellant’s discharge, the Court finds
no basis to conduct a separate analysis of this issue.

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V.

CONCLUSION

After applying the relevant standard of review, the Bankruptcy Court incorrectly relied in
HST’s favor on the issue of non-dischargeability under 11 U.S.C. § 523(a)(4). Accordingly, the
Bankruptcy Court’s Order and Memorandum Opinion entered July 6, 2017 is REVERSED, and
the case is REMANDED to the Bankruptcy Court for further proceedings consistent with this
Memorandum.
It is so ORDERED.
____________________________________
WILLIAM L. CAMPBELL, JR.
UNITED STATES DISTRICT JUDGE

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