The case of a former corporate officer who demanded to be
bought out for an alleged ownership interest and said some really nasty things
resulted in a split decision with Fifth Circuit Judges Edith Jones and
Catharina Haynes on opposite sides. Matter of Shcolnik, No. 10-20800
(5th Cir. 2/8/12), which can be found here
[an enhanced version of this opinion is available to lexis.com subscribers].
What Happened
This statement of facts is synthesized from the two
opinions in the case. Each judge referenced facts that the other did not. I am
taking both opinions at face value.
Scott Shcolnik was Vice-President of Capstone Associated
Services, Limited and President of Rapid Settlements, Ltd. Though the owners of
the Companies occasionally referred to him as a partner, he allegedly rejected
an offer to become an owner of Rapid. Nevertheless, he claimed to be a partial
owner and was fired. At this point, things got colorful. Shcolnik allegedly
absconded with corporate documents. He threatened to disclose alleged criminal
and regulatory violations by the two Companies if they did not "buy out" his
"ownership interests." He threatened a "doomsday plan" if Stuart Feldman, the
primary owner of the Companies did not "properly compensate" him for his
ownership interests "which appear to be worth in excess of $1,000,000." He
threatened a "massive series of legal attacks . . . which will likely leave you
disbarred, broke, professionally disgraced, and rotting in a prison cell." He
also expressed his hope that Feldman would be raped in prison.
The nasty grams* were sent on May 25 and 27, 2005. The
Companies swiftly moved for a TRO, which they obtained on May 27, 2005. The
TRO, which was later extended by agreement, prohibited Shcolnik from carrying
out his campaign of mass destruction.
*--Nasty gram is a term of art in the Austin Division of
the Western District of Texas referring to a particularly vituperative
communication. While I am not completely certain, I believe I first heard the
expression from Joe Martinec.
Six months later, the Companies instituted an arbitration
proceeding against Shcolnik, seeking a declaration that he was not an owner.
The Companies prevailed on the ownership issue, although the arbitrator noted
that the Companies had held Shcolnik out as a partner, which was characterized
as "excusable mistakes."
The Companies requested attorney's fees of $70,000 and
received an award of $50,000. The fees were awarded as "equitable and just,"
which is apparently a low standard.
Shcolnik filed for chapter 7 bankruptcy four days after
the state court confirmed the arbitration award. The Companies filed a
non-dischargeability complaint under 11 U.S.C. sections 523(a)(4)( and (a)(6).
Both parties moved for summary judgment. Bankruptcy Judge Karen Brown granted
summary judgment to Shcolnik on both claims. She conducted a trial on the
creditors' objection to discharge and ruled in favor of Shcolnik as well. The
Companies appealed the dischargeability findings to the District Court which
affirmed.
The Majority Opinion-Contumacious and
Coercive
The majority opinion, written by Chief Judge Jones and
joined in by District Judge Crone, affirmed the lower court holdings that the
claim under section 523(a)(4) was properly denied. Although the Debtor was an
officer of the Companies and owed them a fiduciary duty, the debt for
attorney's fees did not arise out of a fraud or defalcation in a fiduciary
capacity. Judge Haynes concurred in this ruling.
However, the majority opinion found that summary judgment
on the willful and malicious claim under section 523(a)(6) was premature. The
District Court had found that the Debtor's behavior was not "willful" as a
matter of law because he did not intend to impose litigation expenses on the
Companies, a contention they did not dispute.
However, Judge Jones pointed out that under Fifth Circuit
precedent, an act can be considered "willful" if there was subjective bad
intent or "an objective substantial certainty of harm." The Court noted that
"it would seem peculiar to deem an action causing injury not 'willful' when the
tortfeasor's action was in fact motivated by a desire to cause injury." Judge
Jones also noted In re Keaty, 397 F.3d 264 (5th Cir. 2005), where
sanctions for baseless litigation were found to be a willful and malicious
injury.
Having laid out this background, Judge Jones reached the
penultimate point of her opinion:
Shcolnik allegedly engaged in a course of contumacious
conduct that required the Appellants to file meritorious litigation against
him, resulting in the instant fee award; whereas in Keaty, the debtors
pursued the burdensome suit that provoked a sanctions award against them. This
is a distinction without a difference, however. It would make no sense for
the infliction of expense in litigating a meritless legal claim to constitute
willful and malicious injury to the creditor, as in Keaty, while denying the
same treatment here to the infliction of expense by a debtor's attempt to
leverage an equally baseless claim through a campaign of coercion. That
Texas law may allow the arbitrator to assess attorneys' fees in favor of a party
without specifically finding a willful and malicious injury is not conclusive.
If the facts are as Appellants allege, Shcolnik either had the motive to
inflict harm or acted so as to create "an objective substantial certainty of
harm" to the Appellants. Id.
Viewed in light of our precedents, there is a genuine,
material fact issue for trial. Shcolnik's behavior resulted in willful and
malicious injury if his claims of ownership were made in bad faith as a
pretense to extract money from the Appellants. See Keaty, 397 F.3d at
273 (willful and malicious injury to intentionally "pursu[e] meritless
litigation for the purpose of harassment[.]"). The litigation costs he
forced upon them are different from the million dollar claim he made against
them, but they were neither attenuated nor unforeseeable from his alleged
intentionally injurious conduct. (emphasis added).
Opinion, pp. 6-7.
The Dissent-Insulting and Demeaning Is Not
Enough
Judge Haynes concurred in the ruling on section
523(a)(4), but dissented with regard to willful and malicious injury. She cited
three grounds for dissent:
The effect of the majority opinion is to transform all
litigation precipitated by aggressive demand letters into potential "malicious"
acts for purposes of nondischargeability. Additionally, the effect of the
majority opinion is to allow an end-run around an arbitration proceeding in
which both parties willingly participated. Finally, the majority opinion
glosses over the lack of connection between the allegedly malicious acts and
the arbitration award of attorneys' fees now sought to be rendered
non-dischargeable. Because the bankruptcy and district courts reached the
correct result under our existing precedents, I would affirm.
Haynes Dissenting, p. 9.
Judge Haynes elaborated on her first point as follows:
Debtors often come to bankruptcy with judgments against
them. It is certainly not an unusual occurrence for parties to make claims in
litigation or arbitration that do not carry the day. Nonetheless, the majority
opinion transforms the ordinary litigation loser into one who has caused
"willful and malicious injury" to another. It does so, apparently, because of
the colorful language used by Shcolnik, without the assistance of legal
counsel, in his emailed demand letters that preceded litigation which in turn
was followed by the arbitration proceeding in question. So, I start there.
No doubt the e-mail letters Shcolnik wrote are insulting
and demeaning. I would not write such a document nor countenance another to do
so. However, we are not here to teach a course in professionalism or
civility. The majority opinion transforms incivility into "a campaign of
coercion" or "contumacious conduct" by ipse dixit. The question arises -
were these "nasty demand letters," in fact, "coercive" or "contumacious?" We do
not have a case setting out a test for where the quintessential demand letter
ends and the parade of horrible suggested by the majority opinion begins.
Wherever that line is, it is not crossed here, and I disagree with transforming
the regrettable unpleasantness and aggressiveness that often attend the prelude
to litigation into "coercive" or "contumacious" conduct so easily. Shcolnick's
e-mail letters, however reprehensible they undeniably are, do not. (emphasis
added).
Haynes Dissenting, p. 10.
Between judges, "ipse dixit" is a strong term.
Known as the "Bare Assertion Fallacy," it literally translates as "he himself
said it." It is used to refer to an argument that is made without any support.
The terms that were said to be ipse dixit were "coercive" and
"contumacious." "Contumacious" is defined as stubbornly defiant or rebellious,
while "coercive" means serving or intending to coerce. While contumacious is
closely associated with contempt of court, Shcolnik's words were no doubt
stubbornly defiant, but the question is "So what?" There does not seem to be a
logical connection between stubbornly defiant and willful and malicious.
Coercive is a more difficult question and I will return to that later.
Next, Judge Haynes turned to the results of the
arbitration proceeding. Noting the strong federal policy of deferring to
arbitration, she pointed out that the arbitrator had only awarded fees as
"equitable and just" rather than for wrongdoing, malice or bad faith. She also
noted that the arbitrator implicitly found that Shcolnik's position had some
merit when he found that the references to Shcolnik as a partner were
"excusable mistakes."
As to the first ground, Judge Haynes is probably wrong.
Where a court makes a finding on a lesser standard but does not expressly
negate the higher standard, the parties are free to establish whether the
higher standard could have been met. Archer v. Warner, 538 U.S. 314
(2003) is not completely on point, but it allowed a plaintiff who had received
a promissory note in settlement of a fraud claim to go behind the note and
prove fraud in the original transaction. However, Judge Haynes is closer on the
second point. If the arbitrator found that the Debtor did not assert a baseless
claim, then the Companies would be precluded from relitigating that point in
bankruptcy court. Here, the finding is implicit so that it is a close call.
Finally, Judge Haynes found that the connection between
the nasty emails and the arbitration proceeding was to remote to connect them.
She wrote:
Indeed, even if the e-mail letters were "coercive" or
"contumacious" and even if we ignore the lack of arbitration findings to
support the majority opinion, the undisputed facts show that any burden imposed
on Appellants by the e-mail letters was quickly removed - the purportedly
wrongful documents were sent on May 25 and 27, 2005. On May 27, 2005, the state
district court granted a temporary restraining order that was later extended
and continued by agreement throughout the litigation and arbitration, barring
Shcolnik from taking the actions Appellants claimed put them in immediate fear.
It was not until six months later that the matter was referred to the
arbitration at issue here, breaking any purported causal connection between the
claimed wrongful behavior and the fee award here at issue.
Moreover, the lack of causal connection is precisely why
the arbitrator made no specific finding of wrongfulness. Indeed, the allegedly
wrongful acts caused the arbitration of the ownership/partnership dispute, in
which case, the arbitrator's lack of a specific finding to that effect (and
findings inconsistent with that) is meaningful, or they did not, in which case,
the alleged "campaign of coercion" or "contumacious conduct" did not cause the
attorneys' fees award.
The majority opinion concludes that "Shcolnik's behavior
resulted in willful and malicious injury if his claims of ownership were made
in bad faith as a pretense to extract money from the Appellants." Maj. Op. at
7. The opinion rests on a misconstruction of Keaty. Moreover, it is
undeniable that the majority opinion's conclusion is not supported by the
record, the arbitrator's decision, or, indeed, the events that actually
transpired below. As we gave effect to the sanctions in Keaty, we should
give effect to the arbitrator's ruling here. The attorneys' fees awarded as
equitable and just in the arbitration were for resolution of the
ownership/partnership dispute, not for anything else.
Haynes Dissenting, pp. 13-14.
What It Means
This case is significant for several reasons. The fact
that two bright, articulate and conservative judges reached diametrically
opposite results shows both the independence of the judges involved and the
difficulty of the question.
The opinions by Judge Jones and Judge Haynes recall the
story of the blind men and the elephant. They are both describing the same
thing, but they are describing different parts of it. Judge Jones focused on
the apparent intent of the original emails. It is not unreasonable to construe
the emails as a blatant attempt at extortion. It would be illegal to demand
money in exchange for not releasing damaging information, so the debtor
demanded a buyout instead. However, the fact that he demanded a buyout under
the threat of destroying his former employer says volumes about his intent.
On the other hand, Judge Haynes focused more on the
disconnect between the "nasty" emails and the arbitration proceeding. Yes, the
emails were reprehensible. However, the campaign was brought to a half within
two days and the arbitration was not even commenced for another six months. The
Companies would have had a good claim for a willful and malicious injury if the
Debtor had actually used the purloined documents to wreak havoc. The Companies
probably would have had a good claim for their costs in obtaining the TRO.
However, the Companies sought to recover their attorney's fees for what Judge
Haynes characterized as "resolution of the ownership/partnership dispute, not
for anything else." While the ownership dispute may have been commenced for
sinister reasons, unlike the sanctionable conduct in Keaty, it was not
baseless.
I think Judge Haynes has the better argument. While the
opening salvos of the campaign clearly could have resulted in willful and
malicious injury, they did not. It is like someone who threatens to shoot but
after considering the consequences puts the gun down. The conduct could be
characterized as a terroristic threat, but it is not murder. Both judges are
right to focus on Keaty. However, the important question is whether the
legal position taken was baseless. If the position taken, although asserted for
ulterior motives, was not baseless, then it should not give rise to a
nondischargeable debt.
It will be interesting to see whether the en banc
court steps in to resolve the dispute.
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