United States District Court, D. Minnesota
In re Michael K. Doody, Debtor. David F. Larson, individually, and derivatively on behalf of DML Inc., a Minnesota corporation, and derivatively on behalf of Greeley Associates LLC, a Minnesota limited liability company, Plaintiffs-Appellants,
Michael K. Doody, Defendant-Appellee
[Copyrighted Material Omitted]
Michael D. O'Neill, Marten & Squires, P.A., St. Paul, Minnesota, and Kurt M. Anderson, Attorney at Law, Minneapolis, Minnesota, for Plaintiffs/Appellants.
Timothy Pramas, Manty & Associates, P.A., Minneapolis, Minnesota, and Karl J. Johnson, Law Office of Karl Johnson, Minneapolis, Minnesota, for Defendant/Appellee.
MEMORANDUM OPINION & ORDER
SUSAN RICHARD NELSON, United States District Judge.
Appellants/Plaintiffs appeal from a February 27, 2013 Order for Judgment and Judgment of the United States Bankruptcy Court for the District of Minnesota (" Bankruptcy Court" ) in the matter of In re Michael K. Doody, 11-BR-36098. (Order for Judgment [Doc. No. 4-16]; Judgment [Doc. No. 4-17].) For the reasons set forth herein, Appellants' appeal is denied and the Bankruptcy Court's February 27, 2013 Order for Judgment and February 27, 2013 Judgment are affirmed.
A. Procedural Background
In January 2010, Appellants/Plaintiffs filed an action in Minnesota state court against Appellee Michael Doody and two corporate defendants, asserting breach of fiduciary duty claims arising under common law and Minnesota statutes. (State Court Compl., Ex. A to Compl. [Doc. No. 4-2], Appellants' App. 1.) Just prior to the trial in that action, Appellee Michael K. Doody filed for Chapter 7 bankruptcy in the United States Bankruptcy Court for the District of Minnesota (" Bankruptcy Court" ). (Compl. ¶ 24 [Doc. No. 4-2].) Consequently, the trial in state court did not proceed. Appellants/Plaintiffs filed the underlying adversary proceeding in Bankruptcy Court on February 7, 2012, seeking an exception to the discharge in bankruptcy of Bankruptcy Debtor/Appellee Doody's alleged liabilities to Appellants/Plaintiffs pursuant to 11 U.S.C. § 727(a)(5). (Id.
¶ ¶ 43-44.) Specifically, Appellants/Plaintiffs alleged entitlement to non-discharge based on actual fraud, breach of fiduciary duty, embezzlement, and willful and malicious damage to property under 11 U.S.C. § § 523(a)(2)(A); 523(a)(4); 523(a)(6). (Id. ¶ ¶ 26-44.)
The adversary proceeding was tried before United States Bankruptcy Judge Kathleen Sanberg on February 26, 2013. The Bankruptcy Court admitted numerous exhibits and heard testimony from Appellant/Plaintiff David Larson and Appellants'/Plaintiffs' financial consultant, Debbie Larson. At the conclusion of Appellants'/Plaintiffs' case, Doody moved for judgment on partial findings pursuant to Fed. R. Bankr. P. 7052(c) and Fed.R.Civ.P. 52(c). Judge Sanberg granted Doody's motion, providing her findings and conclusions on the record. (Tr. at 267-71 [Doc. No. 6].) On February 27, 2013, the Bankruptcy Court entered an Order for Judgment and Judgment in Doody's favor, finding that Doody's debt to Appellants/Plaintiffs, if any, was not excepted from the discharge of Doody's Chapter 7 bankruptcy debt pursuant to § 523(a). (Order for Judgment at 1-2 [Doc. No. 4-16]; Judgment [Doc. No. 4-17].) Appellants/Plaintiffs filed a timely notice of appeal under 28 U.S.C. § 158(a). The Bankruptcy Court maintained jurisdiction over Doody's Chapter 7 case and the adversary proceeding pursuant to 28 U.S.C. § § 157 and 1334, and the Bankruptcy Court's Order for Judgment is a final, appealable order.
B. Factual Background
Appellant David Larson testified that he met Appellee Michael Doody (" Doody" ) while Larson was getting a haircut at a salon operated by Doody's wife, Carrie Doody. (Tr. at 11 [Doc. No. 6].) Michael
Doody encouraged Larson to invest with him in a remodeling business venture. (Id.) Larson, who was then working as a natural gas fitter and service technician at Xcel Energy, had performed home remodeling work in the past. (Id. 8-9.) Larson invested in the proposed remodeling project on a single house, making approximately $1,500 in profit. (Id. at 13.) Doody suggested that they continue working together and referred Larson to an attorney to assist in the process of incorporation. (Id. at 14.)
Larson incorporated Appellant DML, Inc. (" DML" ) as a Minnesota Domestic Business corporation with the Minnesota Secretary of State under Minn. Stat. § 302A in April 2004. (Id. at 15.) Three thousand shares of stock were issued for DML, with Larson the sole shareholder at all times. (Id. at 150.) Although DML was originally incorporated as a real estate investment company, Larson testified that it was ultimately a home remodeling company. (Id. at 27.) Larson was DML's CEO and President. (Id. at 114.)
In the summer of 2004, Larson and Doody attended a " Real Estate 101" conference together in Detroit. (Id. at 16.) Larson later completed a similar class offered by Doody. (Id.) Shortly after Larson completed Doody's course, Doody suggested that they go into the home remodeling business together. (Id. at 21.) Larson testified that he made it clear that he wanted a 50/50 partnership and that he did not want to be limited to construction work. (Id. at 22.)
In terms of their business arrangement, Larson testified to his understanding that he was to oversee day-to-day operations, including performing the role of project manager on construction jobs, while Doody was to perform office work such as bookkeeping, payroll, and accounts receivable. (Id. at 23-25.) Doody sketched out this contemplated business structure on paper shortly after Larson had incorporated DML. (Id. at 26; Pls.' Ex. 2, Pls.' App. at 124-25.) The sketch, which Larson himself described as " chicken scratch," listed " Finance" as an area under Doody's oversight. (Tr. at 24; 26 [Doc. No. 6].) Larson testified that after the sketch was made, he and Doody agreed to go into business 50/50. (Id.) The record contains no evidence showing that Larson changed the status of DML with the Minnesota Secretary of State from a business corporation to a partnership, nor that any stock was issued to Doody, although Doody later indicated that he possessed a 50% stock ownership interest in DML on a 2005 IRS K-1 form. (Id. at 30; Pls.' Ex. 3, Pls.' App. at 126-28.)
Doody was responsible for preparing DML's 2005 tax return, with the assistance of an accountant. (Tr. at 27 [Doc. No. 6].) The address noted on DML's 2005 tax return was Michael Doody's personal address in Arden Hills, Minnesota. (Id. at 29.) While Larson considered Doody to be the " money guy" (id. at 34), Larson conceded some involvement in DML's finances, including determining DML's financial policies. (Id. at 118.) Beginning in 2005, Doody managed DML's finances using a program called Quickbooks. (Id. at 34.) Larson acknowledged that he had twenty-four-hour access to Quickbooks information via the Internet. (Id. at 118.) Larson also agreed that from 2005-2008, he had the power to guarantee or co-sign loans for DML and that he possessed the authority to countersign checks throughout DML's history. (Id. at 120.) In addition to Doody's bookkeeping work, because Doody possessed a master plumber's license, he often performed plumbing work when DML required such work on its remodeling projects. (Id. at 82; 146.)
Early on, Larson reported that DML was busy and that he was " swamped." (Id. at 41.) DML's tax returns showed a steady increase in gross receipts and sales over a three-year period. (Id. at 40.) Because of the long hours he was working, Larson engaged in a daily conversation with Michael Doody about when Larson could expect to see a return on his investment in DML. (Id. at 44.) Doody encouraged Larson to keep working and that success would not " come easy." (Id. at 45.) Larson conceded that there are no guarantees in life. (Id. at 132.) On the bookkeeping side, Doody also found it difficult to keep up with the volume of work and eventually approached Larson about obtaining bookkeeping assistance for DML. (Id. at 35.) Beginning in August 2006, Doody's sister, Vicki Born Doody (" Born Doody" ), was hired as a bookkeeper. (Id. at 37.) While Larson felt obliged to hire Born Doody because of her relationship to Doody, Larson acknowledged that Born Doody possessed an appropriate bookkeeping background and he agreed to hire her. (Id. at 128-29.) The other candidate whom Larson had considered for the bookkeeping position was one of Larson's relatives. (Id. at 35.)
Larson, Doody and Born Doody were issued U.S. Bank/Bremer Bank credit cards for DML. (Id. at 69.) When Doody or Larson incurred a credit card expense for DML, or a cash expense, DML would reimburse them. (Id. at 145.)
At some point during their DML working relationship, Doody approached Larson about investing in Appellant Greeley Associates, LLC (" Greeley" ), one of Doody's business ventures, in a deal involving apartments. (Id. at 77.) Because Larson did not understand the technicalities of the transaction necessary for Larson to obtain funding, he granted Doody a limited power of attorney. (Id. at 77-78.) Larson invested in the Greeley transaction, for which he received a seven percent ownership interest. (Id.) Larson understood that it was an investment and agreed that " there's a risk in everything." (Id. at 133.) Larson also granted Doody a power of attorney for the purpose of helping Larson renegotiate the terms of repayment of Larson's personal credit card debt. (Id. at 99.)
At some point in 2007, Larson became aware of delinquencies in DML's tax obligations. (Id. at 51.) Larson testified that Doody informed him about the tax problems (id. at 52), however, Doody told an IRS agent the opposite: that it was Larson who told Doody. (Pls.' Ex. 10, Pls.' App. at 137.) Larson testified that the early communications from the IRS were sent to Doody's home address. (Tr. at 53; 63 [Doc. No. 6].) By April 9, 2007, a notice addressed to DML was sent to DML's leased office space (id.), and by July 2, 2007, a notice addressed to DML was sent to Larson's personal address in Lino Lakes. (Id. at 54.) Larson testified that he thought Doody was dealing with the IRS, based on his understanding of the division of responsibilities. (Id. at 55.)
Regardless of who first knew of DML's tax problems, there is no dispute that at some point during 2007, both Doody and Larson were aware that DML was delinquent in its taxes. (Id. at 124-25.) Larson testified that he, Doody, and Born Doody held numerous meetings in 2007 to discuss DML's tax delinquency. (Id. at 123; 126.) During 2007 and 2008, Larson, Doody, and Born Doody exchanged many emails, discussing DML's financial issues in detail. (Id. at 39-40.) Larson acknowledged that Born Doody's business practice was to let Larson and Doody know of DML's obligations with respect to taxes, expenses, and bills. (Id. at 162.) If Born Doody had a question about an expense,
she would ask either Larson or Doody for more information and clarification. (Id. at 158-59.) DML attempted to collect funds from outstanding accounts receivable in order to pay DML's tax obligations. (Id. at 124.) Larson assisted in these collection efforts. (Id. at 113.) In addition, Larson testified that he had some involvement with accounts payable because creditors complained that Born Doody would not return their calls, and would consequently call Larson. (Id. at 113.) During the time that the delinquent taxes were increasing, other obligations of DML, including payroll, were being paid. (Id. at 127.) Larson agreed that he played a role in authorizing such payments. (Id.) Larson himself continued to receive his own pay from DML every two weeks. (Id. at 129-30.)
Even though at one point DML posted gross sales of over $ 1 million, it was ultimately unable to generate significant profit. (Id. at 39-40.) Larson testified that over the course of 2007, DML's money crunch steadily worsened. (Id. at 156.) Compounding DML's financial difficulties, the real estate market experienced a downturn in 2008. (Id. at 109.) Larson also conceded that DML had problems with its projects running over budget. (Id. at 151.) In 2008, DML ceased business operations. (Id. at 98.)
Although Larson had believed that he and Doody were 50/50 partners in DML, he learned otherwise. Larson testified that in 2010 he learned that Doody held no business interest in DML. (Id. at 49.) Larson's sister, Debbie Larson, who is an accountant, performed an audit of DML's finances on her brother's behalf. (Id. at 75.) Debbie Larson reviewed certain DML records and noticed the change in Doody's business interest to 0%. (Id. at 49.) As noted earlier, although DML's business corporation status -- listing Larson as the sole DML shareholder -- was never changed to a partnership or to reflect any changes in shareholders, on a 2005 IRS K-1 form, Doody indicated that he possessed a 50% stock ownership interest in DML. (Id. at 30; Pls.' Ex. 3, Pls.' App. at 126-28.) On a 2006 IRS K-1 form, Doody indicated that he possessed a 40% stock ownership interest in DML, ...