Gibson, Marjorie v. Kreischer, Thomas et al

Filing 9

ORDER affirming decision of Bankruptcy Court. Signed by District Judge Barbara B. Crabb on 6/13/2016. (jls)

IN THE UNITED STATES DISTRICT COURT
FOR THE WESTERN DISTRICT OF WISCONSIN
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - MARJORIE E. GIBSON,
OPINION AND ORDER
Defendant-Appellant,
15-cv-783-bbc
v.
THOMAS KREISCHER, VICKY KREISCHER,
and MARJAC, INC.,
Plaintiffs-Appellees.
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - The question in this bankruptcy appeal is whether appellees Thomas Kreischer, Vicky
Kreischer and Marjac, Inc. are entitled to a finding as a matter of law that a $200,000 claim
they have against appellant Marjorie Gibson is nondischargeable under 11 U.S.C. §
523(a)(4), which applies to debts incurred as a result of “fraud or defalcation while acting
in a fiduciary capacity, embezzlement, or larceny.” Relying on a Minnesota state court
default judgment against appellant and in favor of appellees, the bankruptcy court found
that appellees had proven the elements for both embezzlement and defalcation while acting
in a fiduciary capacity.
Appellant challenges the bankruptcy court’s decision on two grounds. First, appellant
argues that the state court judgment does not include the necessary findings needed to prove
as a matter of law a claim for embezzlement or defalcation while acting in a fiduciary
capacity. In the alternative, appellant argues that it would be “fundamentally unfair” to give

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preclusive effect to the state court judgment. Because I conclude that the state court
judgment includes the necessary findings to prove embezzlement under § 523(a)(4) and that
appellant has failed to show that she was treated unfairly by the state court, I am affirming
the judgment of the bankruptcy court.

OPINION
Like so many legal disputes, this one arose out of a business relationship that did not
turn out as the parties had hoped.

Both appellant and appellees were independent

contractors for FedEx, each with their own delivery routes. In response to new requirements
imposed by the company, the parties decided to join forces and create a new company,
Marjac, Inc. The crux of appellees’ underlying claim is that appellant began embezzling
revenue from Marjac and using it for her own companies instead of giving appellees their fair
share. (Appellees brought other claims as well, but they are outside the scope of the appeal.)
Appellees sued appellant in Minnesota state court, where the case went to trial, after
multiple delays caused by appellant’s conduct. (The state court complaint is not part of the
record, so it is not clear what each of appellees’ claims were.) Appellant failed to appear in
court on the third day of trial, even though the court had warned her about the consequences
of failing to appear. The court granted appellees’ motion for a default judgment and
awarded damages to appellees, including $200,487 for appellant’s retention of revenue that
belonged to appellees.

Accompanying the judgment were 50 findings of fact and 10

conclusions of law.

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When appellant filed for bankruptcy protection in the United States Bankruptcy
Court for the Western District of Wisconsin, appellees initiated an adversarial proceeding
in which they argued that the $200,000 award of damages was nondischargeable under 11
U.S.C. § 523(a)(4). The bankruptcy court agreed and granted appellees’ motion for
summary judgment, concluding that appellant’s conduct qualified as “embezzlement” and
“defalcation while acting in a fiduciary capacity,” so she could not discharge the debt.
Because I agree with appellees that appellant’s conduct qualifies as embezzlement, I am
affirming the bankruptcy court’s judgment. This makes it unnecessary to decide whether
appellant’s conduct qualifies as “defalcation while acting in a fiduciary capacity.”
Both the parties and the bankruptcy court cite Matter of Weber, 892 F.2d 534,
538-39 (7th Cir. 1989), for the elements of embezzlement under § 523(a)(4): (1) the
debtor appropriated funds for his or her own benefit; and (2) the debtor did so with
fraudulent intent or deceit. Appellant does not deny that she appropriated funds for her
own benefit, but she says that there was insufficient evidence for the bankruptcy court to
find as a matter of law that she acted fraudulently. Rather, she says, the bankruptcy court
should have denied appellees’ motion for summary judgment and allowed the case to proceed
to trial to determine her intent.
In reaching a contrary conclusion, the bankruptcy court relied exclusively on the
Minnesota state court’s findings of fact and conclusions of law. The bankruptcy court
framed the question as one of issue preclusion. (Neither side argues that the court should
have considered the related doctrine of claim preclusion, so I do not consider that question.)

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The court recognized that, under 28 U.S.C. § 1738, a federal court must give a state court
judgment “the same preclusive effect that the state courts that issued the judgments would
give them,” DeGuelle v. Camilli, 724 F.3d 933, 936-37 (7th Cir. 2013), which means that
the Minnesota standard for issue preclusion (also known as collateral estoppel) applies. That
standard has four elements: (1) the issue was identical to one in a prior adjudication; (2)
there was a final judgment on the merits; (3) the estopped party was a party or in privity
with a party to the prior adjudication; and (4) the estopped party was given a full and fair
opportunity to be heard on the adjudicated issue. Illinois Farmers Ins. Co. v. Reed, 662
N.W.2d 529, 531 (Minn. 2003). Appellant does not deny that the state court judgment
satisfies the second and third elements. However, with respect to the first element, appellant
argues that the state court never decided whether she acted fraudulently. Alternatively, she
argues that it would be unfair to give preclusive effect to the state court judgment because
that court attempted to craft its findings of fact with the purpose of preventing her from
discharging her debts.
I disagree with both of appellant’s arguments. With respect to the question whether
the state court found that appellant acted fraudulently, the state court included in its
judgment an express finding that appellant “committed fraud against the Krieshers . . . when
she . . . retained the earnings and value of the Krieshers’ two routes while effectively freezing
them out of the company.” Appellant’s Appx., dkt. #5-1, at 139.
Appellant does not deny that the state court’s finding is preclusive. However, she
notes that the bankruptcy court declined to rely on that portion of the state court judgment

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on the ground that it was not clear whether the “fraud” mentioned in the state court
judgment was the type of fraud that would satisfy § 523(a)(4). The bankruptcy court’s
concern was that § 523(a) has a more restrictive intent requirement than Minnesota law, so
a finding of fraudulent intent under Minnesota law would not necessarily be the equivalent
of fraudulent intent under § 523(a). In particular, the bankruptcy court cited a case from
the Court of Appeals for the First Circuit for the proposition that fraudulent intent under
§ 523(a)(4) requires intentional conduct as well as two cases from federal courts in
Minnesota for the proposition that negligence is sufficient to show fraudulent intent under
Minnesota law. Compare In re Sherman, 603 F.3d 11, 13 (1st Cir. 2010) (Souter, J.) (“[T]o
amount to embezzlement, conversion must be committed by a perpetrator with fraudulent
intent, . . . [for] example . . . by using entrusted money for the recipient's own purposes in
a way he knows the entrustor did not intend or authorize. It is knowledge that the use is
devoid of authorization, scienter for short, that makes the conversion fraudulent and thus
embezzlement.”) (internal citations omitted), with Schwartz v. Renville Farmers Co-op
Credit Union, 44 B.R. 266, 268 (D. Minn. 1984) (“Minnesota allows simple negligent
misrepresentation to support an action for fraud.”), and In re Carothers, 22 B.R. 114
(Bkrtcy. D. Minn.1982) (“[A] simple negligent misrepresentation will support an action for
fraud.”).
If the bankruptcy court is correct that § 523(a) and Minnesota law define fraudulent
intent differently, that would present a problem for the appellees. When concluding that
the state court found that appellant acted fraudulently under § 523(a)(4), the bankruptcy

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court relied on specific findings of fact accompanying the state court’s judgment rather than
the state court’s more general conclusion that appellant committed fraud. However, as the
bankruptcy court recognized in another portion of its opinion, Minnesota state courts do
not give preclusive effect to findings unless those findings were essential to the judgment.
State Farm Mutual Automobile Insurance Co. v. Lennartson, 872 N.W.2d 524, 534 (Minn.
2015). If negligent behavior was sufficient to hold appellant liable under Minnesota law,
then the state court’s findings of fact regarding appellant’s intent were not necessary to the
judgment and have no preclusive effect.
However, I see no need for a remand because I disagree with the bankruptcy court’s
initial premise that the standard for fraudulent intent is more stringent under § 523(a) than
it is under Minnesota law. A Minnesota treatise was the only authority cited by the courts
in Schwartz and Carrothers for the proposition that a showing of negligence is sufficient to
prove fraud under Minnesota law. My own review of the case law revealed a different view.
In Florenzano v. Olson, 387 N.W.2d 168, 173 (Minn. 1986), the Supreme Court of
Minnesota made it clear that negligence is not sufficient to prove fraud: “Fraud is
distinguished from negligence by the element of scienter required. Fraud is an intentional
tort and scienter is an essential element. . . . Fraudulent intent is, in essence, dishonesty or
bad faith. What the misrepresenter knows or believes is the key to proof of intent.”
Under Florenzano, Minnesota’s description of fraudulent intent is no less restrictive
than the standard imposed by § 523(a)(4). Both standards require proof of scienter, which
is the party’s knowledge that he is being dishonest.

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Thus, by finding that appellant

committed fraud when she retained the revenue that belonged to appellees, the state court
necessarily found that appellant knew that she was acting without authorization. Although
my reasoning differs from that of the bankruptcy court, it is well established that an
appellate court may affirm on an alternative ground that is argued by the prevailing party.
Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 38-39 (1989).
Appellant’s remaining argument is that it would be “fundamentally unfair” to give
preclusive effect to the state court’s judgment. In support of a “fundamental fairness”
standard, appellant cited In re Dollie's Playhouse, Inc., 481 F.3d 998, 1001 (7th Cir. 2007),
which prompted appellees to object on the ground that Minnesota law, not Seventh Circuit
law, is controlling. Appellees are correct, but the debate is academic because Minnesota’s
standard for issue preclusion requires fairness as well. Illinois Farmers Insurance, 662
N.W.2d at 531 (element of issue preclusion is that “the estopped party was given a full and
fair opportunity to be heard on the adjudicated issue”).
In support of her argument that the state court treated her unfairly, appellant cites
a portion of the transcript in which the judge was discussing with appellees’ counsel the
content of a proposed default judgment. In particular, the judge stated, “I think that the
language of any order that I sign should be couched in the fact that the Court views this as
intentional conduct that should not be dischargeable in bankruptcy.” Appellant’s Appx., dkt.
#5-1, at 50. Appellant argues that the court’s “improper and unusual instruction . . . cast
a pall of doubt over the findings of fact incorporated in the judgment, because one cannot
help but question whether they are supported by evidence presented in court, or whether

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they were formulated for the purpose of fulfilling the judge’s instruction: to prevent
[appellant] from discharging the claims in bankruptcy.” Appellant’s Br., dkt. #5, at 17.
Even if I agree with appellant that it was “improper and unusual” for the state court
judge to give appellees’ counsel the instruction he did, I do not see how the instruction
unfairly prejudiced appellant. To begin with, plaintiff does not challenge the accuracy of any
particular finding of fact made by the state court judge. In any event, appellant does not
deny that appellees were entitled to a default judgment for fraud for her retention of earnings
that belonged to appellees. Because I have concluded that such a finding was sufficient to
compel a conclusion that appellant’s debt is nondischargeable under § 523(a)(4), it would
make no difference to the outcome of this appeal if some of the state court’s subsidiary
findings turned out to be wrong.

ORDER
IT IS ORDERED that the judgment of the bankruptcy court is AFFIRMED.
Entered this 13th day of June, 2016.
BY THE COURT:
/s/
BARBARA B. CRABB
District Judge

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