Recent Bankruptcy Decision Regarding Non-Dischargeability of Arbitration Award
By Mitchell S. Ostwald
In Owens v. Miller, 240 B.R. 566 (U.S.B.C. , W.D. Mo. ), the Court considered: 1) could representations by the broker that he would invest the claimant's money in capital preservation investments, while in fact he invested in speculative investments, make the arbitration award obtained by the investors nondischargeable in the broker's bankruptcy; and 2) could the broker's fraud be imputed to the principals of the broker-dealer so as to make the award nondischargeable to the principal of the broker-dealer as well. The Owens court found both the debt of the broker and the debt of the principals nondischargeable.
An investor filed an arbitration claim against the broker and the firm. The arbitration panel issued an award against the broker and the principal finding the liability to be joint and several. Thereafter, the broker filed for bankruptcy relief.
The Court noted that under Section 523(a)(2)(A) of the Bankruptcy Code, a bankruptcy discharge does not discharge a debtor from any debt where money or services were obtained by false pretenses, a false representation or actual fraud. In order to have the debt be nondischargeable, the creditor must show that: 1) the debtor made the representation; 2) that the debtor knew at the time the representation was false; 3) the representation was made intentionally with the purpose of deceiving the creditor; 4) that the creditor justifiably relied on such representation; and 5) that the creditor sustained a loss as a proximate result of the representation.
The Court made an important statement applicable to brokers. It said, "The intent element of Section 523 does not require a finding of malevolence or personal ill-will; all it requires is a showing of an intent to induce the creditor to rely and act on the misrepresentations in question. "
Of importance to the broker-dealer was whether the court would consider the dischargeablitiy of the debt for the principal of the broker-dealer. The Court noted that under controlling U.S. Eighth Circuit jurisprudence, in order for an agent's fraud to be imputed to the principal, the creditor is required to show that the principal knew or should have known of the agent's fraud or that the principal was recklessly indifferent to his agent's fraud.
The broker-dealer argued that because Section 20(a) of the Securities and Exchange Act imposes liability based on mere negligence of the controlling person (See, Drobbin v. Nicolet Instrument Corp. 631 F. Supp. 860 (S.D.N.Y. 1986)), that nondischargebility under Section 523 cannot be based under 20(a) because Section 523 requires fraud. The Court did not agree to the argument, holding that the broker was its agent and that was sufficient for nondischargeability under Section 523.
Whether another decision similar to this will be decided under California law is yet to be known. It is, however, significant because the court noted there was no contrary authority.
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