ALEXANDER v. TEMPLE

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Court of Appeal, Second District, Division 7, California.

Lanz ALEXANDER, et al., Petitioners, v. SUPERIOR COURT of Los Angeles County, Respondent. John W. TEMPLE, Real Party in Interest.

No. B058204.

Decided: August 27, 1991

Rich & Ezer and Mitchel J. Ezer, Los Angeles, for petitioners. No appearance by respondent. Stearns & Clemons, Mary Stearns, James E. Clemons and Norman A. Lewin, Los Angeles, for real party in interest.

INTRODUCTION

This matter is before us after the trial court sustained a demurrer without leave to amend.

Defendant John W. Temple is the general partner of a limited partnership in which petitioners are limited partners. After Temple embezzled money from the partnership, he filed a bankruptcy petition. When petitioners received notice that they were listed as Temple's creditors, they inquired of him why they were listed as creditors. Temple informed them that the bankruptcy petition was a protective measure undertaken on the advice of counsel and that they need not be concerned about it. In reliance on Temple's statement, petitioners did not file an objection to the discharge of Temple's debts. After Temple's debts were discharged, petitioners sued Temple in state court for Temple's fraudulent representation about the meaning of the bankruptcy petition. Temple demurred to the complaint on the basis that petitioners' claim had been discharged in bankruptcy.

The issue presented is whether a cause of action for fraud will lie in state court when a fiduciary relationship exists between a debtor and creditor, the debtor makes misleading or false statements leading to the creditor's failure to object to the debtor's discharge in the federal bankruptcy court, and the debtor is subsequently discharged.

As discussed herein, we conclude that under certain circumstances, such a cause of action may be pled. Accordingly, we discharge the previously issued alternative writ of mandate and grant the petition for a peremptory writ of mandate and order the trial court to vacate its order of March 19, 1991, and to enter a new and different order sustaining the demurrer with leave to amend to state such a cause of action.

FACTUAL AND PROCEDURAL SYNOPSIS

On November 14, 1990, petitioners and others1 filed a complaint, naming real party in interest Temple and others as defendants. The complaint was superseded by the first amended complaint (“FAC”), which contains causes of action for declaratory relief, dissolution of the partnership, breach of fiduciary duty, fraud and deceit and an accounting.

Petitioners (together with the other individual plaintiffs) are the limited partners of plaintiff Desert Wind Ltd. (“Partnership”). The general partner of the Partnership is Temple.2

The FAC alleged that: on June 16, 1988, Temple filed a Chapter 7 petition in bankruptcy; on July 15, 1988, Temple filed his schedules in bankruptcy, listing petitioners as creditors having unsecured claims without priority; when petitioners received notice of the bankruptcy petition, they asked Temple, “why they had been listed by him as creditors when they knew of no claim they had against him, to which Temple responded ․ that it was a protective measure only undertaken upon the advise [sic] of counsel and these Plaintiffs need not be concerned about it”; and the representation was false and fraudulent.

The FAC alleged that the true facts were that:

“As general partner of the Partnership, Temple on behalf of the Partnership purchased seven wind turbines from [defendant] Bear Creek [Enterprises, Inc.] for a price of $150,000.00 ech [sic], total $1,050,000.00, but unbeknownst to these Plaintiffs, Temple ․ in the persona of Bear Creek had purchased the said seven wind turbines at a price of $110,000.00 each, total $770,000.00, so that under the umbrella of Bear Creek, ․ [Temple's] wholly-owned corporation, [Temple] realized a secret profit of $40,000.00 per wind turbine, total $280,000.00, upon the acquisition of the seven wind turbines for the Partnership.”

“In addition, Temple used Partnership funds secretly and without disclosure to these Plaintiffs to pay himself commissions of $136,000.00, management fees of $17,000.00 and organization fees of $15,000.00, a total of $168,000.00.”

The FAC further alleged that petitioners were ignorant of the falsity of the representation as to why they were listed as creditors in Temple's bankruptcy petition until after his discharge and that in reliance upon his false representation, they were induced to and did not file an objection to his discharge and that such reliance was justified because Temple was their fiduciary.

Temple demurred to the fourth cause of action for fraud on the basis that all the claims set forth in that cause of action had been discharged by the bankruptcy court on November 1, 1988.

At the hearing on the demurrer, after noting that the Bankruptcy Act is inequitable in a lot of instances, the court concluded that it did not have the jurisdiction to go beyond the fact of the discharge and sustained the demurrer without leave to amend.

Petitioners filed a petition for a writ of mandate to direct the court to set aside its order sustaining the demurrer without leave to amend and to enter instead an order overruling said demurrer.

DISCUSSION

Because of the unique issue presented by this case, we make an exception to the policy of only reviewing rulings on pleadings on appeal from the final judgment and grant review of the ruling sustaining the demurrer without leave to amend by way of a petition for a writ of mandate. (Babb v. Superior Court (1971) 3 Cal.3d 841, 851, 92 Cal.Rptr. 179, 479 P.2d 379.)

“In reviewing an order sustaining a demurrer without leave to amend, ‘the allegations of the complaint must be liberally construed with a view to attaining substantial justice among the parties.’ [Citation.] If it is reasonably possible that plaintiff can cure a defective complaint by amendment, or that the pleading liberally construed can state a cause of action, the court should not sustain a demurrer without leave to amend.” (Heckendorn v. City of San Marino (1986) 42 Cal.3d 481, 486, 229 Cal.Rptr. 324, 723 P.2d 64.) The facts discussed in this opinion are those alleged in the FAC.

I. Allegations of FAC

Petitioners are limited partners in the Partnership of which Temple was the general partner. After Temple filed a bankruptcy petition, petitioners received notice that they were listed as his creditors having unsecured claims. Thereafter, petitioners contacted Temple and inquired “why they had been listed by him as creditors when they knew of no claim they had against him, to which Temple responded ․ that it was a protective measure only undertaken upon the advise [sic] of counsel and [petitioners] need not be concerned about it.”

After Temple's debts were discharged, petitioners found out that he had made a secret profit by purchasing wind turbines for the Partnership from Temple's own wholly-owned corporation. Temple purchased seven turbines for the Partnership for $150,000, after having purchased them for his corporation for $110,000, for a total profit of $280,000. Furthermore, Temple secretly used Partnership funds to pay himself commissions of $136,000, management fees of $17,000 and organization fees of $15,000.

It is apparent that petitioners are alleging that they were defrauded by Temple twice--once when he committed defalcations against the Partnership (the underlying fraud or defalcations), and second when he told them that they need not be concerned about his bankruptcy petition (the false representation).

II. Bankruptcy Law

Petitioners contend that since the fraud on which the fourth cause of action is predicated occurred after Temple filed his bankruptcy petition, and since a bankruptcy discharge only discharges claims extant on the bankruptcy filing date, they should have a state cause of action so that Temple cannot use the Bankruptcy Act as a shield to avoid the consequences of fraud, embezzlement and misappropriation of funds entrusted to him as a fiduciary.

The purpose of the Bankruptcy Act (11 U.S.C. §3 101 et seq.) is to provide debtors with a fresh start and to prohibit state laws which conflict with or frustrate that purpose. (Perez v. Campbell (1971) 402 U.S. 637, 648-652, 91 S.Ct. 1704, 1710-1713, 29 L.Ed.2d 233.) “A discharge in bankruptcy releases the bankrupt from liability upon all his provable debts which existed when the petition in bankruptcy was filed [citations] and which were duly scheduled as such in the bankruptcy proceeding.” (Terzian v. California Cas. Indem. Exch. (1969) 3 Cal.App.3d 90, 96, 83 Cal.Rptr. 255.)

“Discharge and dischargeability are two entirely separate issues in a bankruptcy proceeding. A Chapter 7 discharge relieves a debtor from all dischargeable debts that the debtor owed on the date of the order for relief. 11 U.S.C. § 727(b). The grounds for denying the dischargeability of a debt are set forth in 11 U.S.C. §§ 523(a) and (b). The grounds for denying a Chapter 7 debtor a discharge are set forth in 11 U.S.C. § 727(a).” (In re Shelton (Bankr. N.D.Ill.1986) 58 B.R. 746, 748.)

A. Dischargeability

“‘Bankruptcy Rule4 4007(c) provides complaints to determine the dischargeability of certain debts under § 523 of the Bankruptcy Code must be filed within 60 days of the first date set for the meeting of the creditors. If under Rule 4007(c) a complaint alleging that a debt is nondischargeable under § 523(a)(2) (fraud or false financial statements), § 523(a)(4) (fraud or defalcation by a fiduciary, embezzlement or larceny) or § 523(a)(6) (willful and malicious injuries to persons or property), is filed late all debts which might otherwise be nondischargeable under those provisions are in fact discharged regardless of how good a case for nondischargeability a creditor might have on the merits.5 Once the Rule 4007(c) time has elapsed,6 a properly scheduled creditor can never raise the question of the nondischargeability of a claim on any of these grounds in the Bankruptcy Court or in any other forum.”’ (In re Cover (Bankr.S.D.Ohio 1989) 97 B.R. 375, 377-378.)

“The result is automatic and sometimes leads to harsh results. However, Congress intended to establish a system whereby certain types of nondischargeable claims would be automatically cut off after a relatively short period of limitations in order to prevent debtors from being harassed by creditors after their claims had been discharged in bankruptcy. Congress meant to cure the abuse whereby debtors were routinely sued by creditors long after bankruptcy by creditors claiming that their claims were not discharged because of fraud or a false financial statement.” (Id., at p. 378.)

There is no recourse for a party who fails to either file a timely complaint objecting to the dischargeability of a debt under section 523, subdivisions (a)(2), (a)(4) or (a)(6) or to move in a timely fashion for an extension of the period within which to file such a complaint. (In re Shelton, supra, 58 B.R. 746, 749.)

Accordingly, because Temple listed petitioners as creditors on his bankruptcy petition (they concede that they received notice of that listing and did not file a complaint objecting to the discharge of Temple's debts), Temple was discharged of all debts to petitioners incurred prior to the commencement of his bankruptcy case.

B. Discharge

In pertinent part, the Bankruptcy Code provides that on request of a creditor, the bankruptcy court shall revoke a discharge if “such discharge was obtained through the fraud of the debtor, and the requesting party did not know of such fraud until after the granting of such discharge.” (§ 727, subd. (d)(1).) The code further provides that a creditor “may request a revocation of a discharge--[¶] (1) under subsection (d)(1) of this section within one year after such discharge is granted.” (§ 727, subd. (e).)

Bankruptcy courts have strictly construed the statute governing revocation of a discharge. Section 727, subdivision (e)(1) is not a mere statute of limitations, but an essential prerequisite to the proceeding, and a creditor must request revocation within one year after the discharge was granted. (In re Barrup (Bankr.D.Vt.1985) 53 B.R. 215, 219; In re Santos (Bankr.D.R.I.1982) 24 B.R. 688, 689.)

Petitioners did not file a complaint to revoke Temple's discharge within the one year period available for such relief under the Bankruptcy Act. Accordingly, petitioners have no remedy for Temple's frauds under the Bankruptcy Act. We note that the effect of the order of discharge would be to void any judgment obtained against Temple with respect to the discharged debts. (In re Levy (Bankr.N.D.Cal.1988) 87 B.R. 107, 109-110.)

As already discussed, it is also obvious that petitioners have no remedy under the Bankruptcy Act for Temple's acts. We agree in principle with petitioners' contention that Temple is using the Bankruptcy Act as a shield to protect himself from the effects of his fraud. However, in order to fashion a remedy, we must address at least two aspects of the Bankruptcy Act which seems to preclude any state relief. First, the issue of whether or not revocation of a discharge is the exclusive remedy for fraud in the procurement of a discharge. Second, the issue of whether or not the bankruptcy courts have exclusive jurisdiction to determine the dischargeability of a debt.

III. Revocation as an Exclusive Remedy

Petitioners argue that their action is for a separate act of fraud and not a claim that Temple procured his discharge through fraud. Temple argues that the alleged post-petition fraud is based on the type of acts which section 727 was designed to cover.

A. Elements to Revoke

Generally, in order to revoke a discharge under section 727, subdivision (d)(1), a creditor must show (1) the discharge was procured by fraud, (2) the creditor lacked knowledge of the fraud prior to the discharge, and (3) sufficient grounds existed which would have prevented the discharge, had they been known and presented at that time. (In re Ping (Bankr.E.D.Ky.1988) 96 B.R. 96, 97; In re Leach (W.D.Ark.1961) 197 F.Supp. 513, 520.)

1. Procurement by fraud

Bankruptcy courts define a “fraud of the debtor” for the purposes of section 727 as one which would warrant revocation of the discharge. (In re Jones (Bankr.S.D.Ill.1987) 71 B.R. 682, 684.) Any fraud which will defeat discharge may be utilized to revoke the discharge on the ground that it was obtained through fraud. (Keeble v. Sulmeyer (9th Cir.1961) 290 F.2d 127, 129; In re Leach, supra, 197 F.Supp. 513, 519.)

In Jones, the court noted that the creditor must allege fraud of the debtor in obtaining the discharge, not fraud of the debtor vis-a-vis the creditor. (In re Jones, supra, 71 B.R. 682, 684.) In Jones, the creditor sought to revoke the discharge because of alleged fraud in the sale of collateral in which the creditor had a secured interest. The court reasoned that the alleged fraud was one committed against the creditor, not a fraud devised to procure a discharge of all debts owed by the debtors. (Ibid.)

Although in Leach, the court ultimately held that the discharge had not been obtained by fraud, it reasoned that a discharge was obtained by fraud where it appeared that the bankrupt was guilty of such acts as would sustain a civil action for fraud and deceit by making statements that were either knowingly false or fraudulent or made so recklessly as to warrant a finding that he acted fraudulently. (In re Leach, supra, 197 F.Supp. at p. 519.) The court observed that: ““‘A false representation does not amount to fraud at law unless it be made with a fraudulent intent. There is, however, a fraudulent intent if a man, either with a view of benefiting himself or misleading another into a course of action, makes a representation which he knows to be false or which he does not believe to be true.””’ (Ibid.)

In Keeble v. Sulmeyer, supra, 290 F.2d 127, the court held that false oaths regarding the execution of a deed of trust justified revocation of the bankruptcy discharge. In In re Orenduff (N.D.Okla.1964) 226 F.Supp. 312, the court held that the debtor's failure to disclose certain material relating to the debtor's property was fraud in the procurement of the discharge and revoked the discharge.

In the instant case, it appears to us that the second fraud was fraud vis-a-vis the creditor and not fraud in the procurement of the discharge. However, since it is arguable that Temple's false representation indirectly led to the procurement of his discharge because of the lack of objections, we will discuss the remedy of revocation in more detail.

2. Knowledge of the fraud gained after the discharge is granted

Petitioners alleged that they discovered the underlying fraud after Temple had had his debts discharged in bankruptcy.

3. Facts warranting revocation of the discharge

“Under § 14(c) [an earlier version of § 727(a)] of the Act, the bankruptcy court must grant the bankrupt's discharge unless one of eight possible grounds for the denial of a discharge is established. [Citation.] If none of those eight grounds is alleged and proved, then the bankrupt cannot be denied a discharge and his discharge cannot be revoked.” (Original emphasis; fns. omitted.) (In re Cantwell (Bankr.E.D.Pa.1982) 17 B.R. 639, 643.)

Unlike the false statements in Leach and Keeble which related to grounds set out in section 727, subdivision (a), petitioners have not alleged facts falling within any of the eight grounds set out in section 727(a). (See § 727, subd. (a) and discussion in Historical and Revision Notes, 11 U.S.C.A. (1979 ed.) § 727, pp. 81-82.) Thus, even if we view Temple's statement as being fraud in the procurement of the discharge in a general sense, it was not the type of fraud listed in section 727, subdivision (a). Therefore, it was not “fraud of the debtor” such as would have warranted revocation of Temple's discharge and is not the type of act which section 727, subdivision (a) is designed to cover. The cases cited by Temple to establish that proposition are inapposite as they do not involve the type of fraud perpetuated here by his misleading petitioners about the existence of a claim against Temple.

The Bankruptcy Act provides the exclusive method of revocation. (In re Smith (D.C.Tex.1929) 31 F.2d 299, 300.) “It excludes all other methods in other courts, if the invalidity is based on the grounds specified in the statute.” (Ibid.)

At least one bankruptcy court, recognized that section 727, subdivisions (d) and (e) could not govern all post-petition misconduct. (In re Meo (Bankr.M.D.Pa.1988) 84 B.R. 24, 28.) The question then becomes whether the remedy (revocation) given by the Bankruptcy Act is the exclusive remedy available to a defrauded creditor for post-petition misconduct relating to the petition itself.

Our research revealed one case which discusses a similar issue in detail--Poillon v. Lawrence et al. (1879) 77 N.Y. 207. In Poillon, the debtor had obtained a discharge after legally changing his name and conveying real property to his wife in fraud of his creditors. The creditors had no knowledge of such change of name or notice of the bankruptcy proceeding until just prior to the commencement of the state action, which was after the debt had been discharged.

The court held that the remedy of revocation was exclusive only when the invalidity of the discharge was based on one or more of the grounds specified in the Bankruptcy Act and that a discharge might be attacked by a creditor in a state court action to recover a debt for fraud which was not specified and which did not necessarily affect its validity except as to that creditor. (Id., at pp. 213-214.)

Section 5120 of the Bankruptcy Act as it was then in effect provided that a discharge could be annulled if the fraud was discovered within two years of the discharge; however, in Poillon, the fraud was not discovered until nearly five years after the discharge. (Id., at p. 213.) The court noted that: “it is evident that such a fraud as that alleged ․ must always be successful, if knowledge of it can be kept from the creditors until the two years have elapsed.” (Ibid.) The court observed that: “It certainly could not have been the intention of the bankruptcy act to provide that whatever fraud or artifice the bankrupt might resort to for the purpose of keeping knowledge of the proceedings from a particular creditor, or preventing him from opposing them, the discharge should nevertheless be valid as to such creditor.” (Id., at p. 215.)

The court concluded that: “the particular matters provided for in section 5120, which go to annul the discharge in toto, shall be litigated in the United States courts, and that the principles which prevailed before the passage of the act, giving to creditors protection in the courts in which they prosecute their claims, against a discharge which the defendant ought not in law or morals to be permitted to set up against their particular claims, are not abrogated, so long as their enforcement by the State courts does not interfere with the jurisdiction which has been specially reserved to the United States courts, over certain classes of frauds, nor with the power of those courts to adjudge a discharge void as to all creditors.” (Id., at pp. 215-216.)

We conclude that petitioners are likewise not seeking to revoke Temple's discharge, a remedy only available in federal courts, but essentially what they seek is to have the discharge declared invalid as to them. Since the fraud is so closely connected to the bankruptcy petition, it is an oversimplification to state that petitioners are seeking damages for a separate act of fraud, especially since the damages they seek will be for the amounts of the underlying fraud.

Federal courts have fashioned remedies other than those provided in the Bankruptcy Act. Federal courts have determined that a bankruptcy court may use its equity powers and revoke a discharge for other than fraud. (Rash v. Metzger (3rd Cir.1929) 31 F.2d 424, 426; In re Boissonnault (1st Cir.1969) 415 F.2d 1371, 1373.)

Furthermore, federal courts have held that prior to a discharge, a creditor might apply for leave to file an untimely objection to the dischargeability of a debt when the fraud of the debtor had led the creditor to believe that it had no objection. (Richey v. Ashton (9th Cir.1944) 143 F.2d 442, 443.) In this case, in addition to committing the defalcations against the Partnership, Temple's second fraud led petitioners to believe that they had no objection to his discharge (i.e., that they had no claim against him). However, unlike the creditors in Richey, petitioners did not discover the frauds until after Temple had been discharged. Since petitioners have no remedy under the Bankruptcy Act, we would be condoning unacceptable misconduct if we were to leave them without a remedy.

B. Dischargeability of the Underlying Debt

“As a general practice, bankruptcy courts have merely determined whether the bankrupt is entitled to a discharge and have left ‘the effect of the discharge upon a particular claim for determination when the discharge is pleaded as a defense to the enforcement of such claim.”’ (Martin v. Martin (1970) 2 Cal.3d 752, 759, 87 Cal.Rptr. 526, 470 P.2d 662.) In the present case, the state court was not called upon to discharge Temple's debts, but rather to determine the effect of Temple's discharge, i.e., whether or not the discharge covered the debt alleged in the FAC.

Petitioner's argument is that but for the second fraud, they would have filed timely objections to the determination of dischargeability. Petitioners acknowledge that the question of whether a fraud was committed requires a determination that if all the facts had been known, would the bankruptcy court have excepted petitioner's claim from discharge under section 523, subdivision (a)(4). Temple argues that state courts do not have jurisdiction to determine the dischargeability of section 523, subdivisions (a)(2), (a)(4) or (a)(6) debts and that a state court cannot determine whether the claimed debt would have been discharged by the bankruptcy court.

Prior to the 1970 change in the Bankruptcy Act, state courts had concurrent jurisdiction to determine the dischargeability of a debt. (Grogan v. Garner (1991) 498 U.S. 279, 111 S.Ct. 654, 658, fn. 10, 112 L.Ed.2d 755; Brown v. Felsen (1979) 442 U.S. 127, 129-130, 99 S.Ct. 2205, 2208-2209, 60 L.Ed.2d 767.) For example, in Treadwell v. Holloway (1873) 46 Cal. 547, 548-549, the California Supreme Court determined that a debt resulting from a fraudulent fiduciary transaction had been not discharged.

The legislative history of Rule 4007 indicates that: “The bankruptcy court has exclusive jurisdiction to determine dischargeability of [§ 524, subds. (a)(2), (a)(4) or (a)(6)] debts. If a complaint is not timely filed, the debt is discharged.” (Advisory com. note, 11 U.S.C.A. (1984 ed.) Rule 4007, p. 480.)

In Brown, the bankruptcy court had held that a prior state court proceeding, which did not establish that the debtor had committed fraud, and the principles of res judicata barred the creditor from offering additional evidence to prove the nature of the underlying debt. Referring to the principle of exclusive jurisdiction, the Supreme Court held that res judicata did not bar the creditor from offering additional evidence to meet the defense of discharge as a contrary rule would force premature federal issues on the state court and would frustrate the command of the Bankruptcy Act that only honest debts be discharged. (Brown v. Felsen, supra, 442 U.S. at pp. 131-139, 99 S.Ct. at pp. 2209-2213.) Brown, and the other cases cited by Temple for the proposition that the bankruptcy courts have the exclusive jurisdiction to determine dischargeability, are all cases addressing the issue of the application of res judicata or collateral estoppel because of a prior state action.

Here, we are faced not with a prior state action, but a state action taking place after the debtor has been discharged. State courts are called upon and often do apply federal law. (E.g. Dice v. Akron, C. & Y.R. Co. (1952) 342 U.S. 359, 360, 72 S.Ct. 312, 313, 96 L.Ed. 398.) In this case, the court was not called upon to except a debt from discharge, but to determine whether the bankruptcy court would have done so had the issue been presented to it. We conclude that this determination does not conflict with the exclusive jurisdiction of the bankruptcy court.

The elements of actionable fraud are: “(1) that defendant made a material representation; (2) that it was false; (3) that he made it when he knew it was false, or made it recklessly, without any knowledge of its truth and as a positive assertion; (4) that he made it with the intention that it should be acted upon by plaintiff; (5) that plaintiff acted in reliance upon it; and (6) that he thereby suffered injury.” (Yellow Creek Logging Corp. v. Dare (1963) 216 Cal.App.2d 50, 56, 30 Cal.Rptr. 629.)

In order to prove the elements of the second fraud, in addition to proving that Temple made the alleged misrepresentation and the alleged “true facts” of the underlying fraud, to establish reliance and injury, the court would have to determine if petitioners had filed a timely objection and if the true facts had been known, the bankruptcy court would have excepted the debt for the underlying fraud from discharge.7

Pursuant to state law, as a general partner, Temple stood in a fiduciary role to petitioners. “‘Partners are trustees for each other, and in all proceedings connected with the conduct of the partnership every partner is bound to act in the highest good faith to his copartner and may not obtain any advantage over him in the partnership affairs by the slightest misrepresentation, concealment, threat or adverse pressure of any kind.”’ (Yeomans v. Lysfjord (1958) 162 Cal.App.2d 357, 361-362, 327 P.2d 957.) A bankruptcy court sitting in California recognized that under California law partners are fiduciaries for the purposes of section 523, subdivision (a)(4). (In re Flick (Bankr.S.D.Cal.1987) 75 B.R. 204, 206.)

The Bankruptcy Act provides that debts “for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny” are not discharged under section 727. (§ 523, subd. (a)(4).) Under the Bankruptcy Act, defalcation means “‘the failure of a fiduciary to account for money received in his fiduciary capacity.”’ (Ivy v. Plyler (1966) 246 Cal.App.2d 678, 683, 54 Cal.Rptr. 894.) To constitute defalcation there must be a showing of bad faith or misconduct, as distinguished from negligence or mistake. (Id., at p. 684, 54 Cal.Rptr. 894.)

Pursuant to federal law, “a partner who has engaged in conduct proscribed by the [Bankruptcy] Act, either on behalf of the partnership or on his own behalf, is not entitled to a discharge.” (Charles Edward & Associates v. England (9th Cir.1962) 301 F.2d 572, 574.) Accordingly, we conclude that as pled, Temple committed acts which would lead to the exception from discharge of the debt to petitioners.

In In re Braun (Bankr.D.Or.1986) 84 B.R. 192, creditors filed a complaint to recover a nondischargeable debt based on a forged check. The creditors had not learned that the debt was based on a forged check until after the date to file objections to the dischargeability of any debts had past. The court noted that creditors had notice of the bankruptcy and were listed on the debtor's schedules. (Id., at p. 193.) The court reasoned that: “On its face, § 523(a)(3)(B) precludes creditors ․ who receive notice or have actual knowledge of the bankruptcy case in time to file a nondischargeability complaint, from filing an untimely § 523(a)(2), (4), or (6) complaint, notwithstanding the fact that the nature of their debt fails to appear on the debtor's schedules.” (Original emphasis.) (Id., at p. 194.) As an alternative ground, the court held that the debt was properly listed and the debtor was not required to confess to a forgery in order to alert the creditor. (Ibid.)

Generally, upon notice of being listed on a bankruptcy schedule, a creditor must act to protect its interest by filing an objection. Temple cites Braun, Shelton and Cover for the proposition that there is an absolute bar to the late filing of a complaint to determine dischargeability even where the creditor has been misled by the debtor. However, those cases are inapposite because of the fiduciary relationship involved in the instant case. Temple's statement to petitioners abrogated the normal effect of notice by misleading them about the existence of their claim against him.

Our decision comports with observation of the United States Supreme Court that: “a central purpose of the [Bankruptcy] Code is to provide a procedure by which certain insolvent debtors can reorder their affairs, make peace with their creditors, and enjoy ‘a new opportunity in life with a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.’ [Citation.] But in the same breath that we have invoked this ‘fresh start’ policy, we have been careful to explain that the Act limits the opportunity for a completely unencumbered new beginning to the ‘honest but unfortunate debtor.”’ (Grogan v. Garner, supra, 111 S.Ct. 654, 659.) Given the double fraud, Temple is anything but an honest unfortunate debtor.

At this point, we must add a caveat based on our observation that the FAC does not state on what date Temple made the false representation to petitioners. It is apparent that if Temple's statement was made after the 60 days within which to file an objection to the dischargeability of a debt, then petitioners failure to file an objection was not due to any reliance on Temple. Accordingly, rather than issuing a writ of mandate ordering the trial court to overrule the demurrer, we issue such a writ ordering the trial court to enter an order sustaining the demurrer with leave to amend.

DISPOSITION

The alternative writ is discharged. A peremptory writ of mandate is issued ordering the trial court to vacate its order of March 19, 1991, sustaining the demurrer without leave to amend and ordering the court to enter a new and different order sustaining the demurrer with leave to amend. Petitioners to recover costs on appeal.

FOOTNOTES

1.  Temple failed to list four of the limited partners as creditors. Those four individuals are suing Temple in a separate cause of action for breach of fiduciary duty.

2.  In their petition, petitioners contend that Temple was replaced as a general partner by plaintiff Desert Windmill, Inc., but that dispute is not relevant to the present petition.

FN3. Unless otherwise indicated, section references are to title 11 of the United States Code..  FN3. Unless otherwise indicated, section references are to title 11 of the United States Code.

4.  Rule references are to the Bankruptcy Rules, which are found in title 11 of the United States Code.

5.  Certain other kinds of debts, e.g., taxes and custom duties, debts to unlisted creditors and spousal and child support debts, are not discharged. (§ 523, subds. (a)(1), (a)(3), & (a)(5).)

6.  Prior to the expiration of the period to file such a complaint, a creditor may move for an extension of the period within which to file the complaint. (Rules 4007(d) & 9006(b)(3).)

7.  Temple acknowledges that should a creditor sue his attorney for malpractice for failing to file a complaint to determine the dischargeability of a debt in a bankruptcy proceeding, the state court is competent to determine federal law relating to that determination. Temple argues that situation is different because the debtor is not involved, only the creditor and a third party. We see no difference from the determination of dischargeability necessary in this case as it is not a bankruptcy proceeding.

WOODS, Associate Justice.

LILLIE, P.J., and JOHNSON, J., concur.

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