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Bankruptcy Court Holds Officer Personally Liable for Corporation’s Debt and Refuses to Discharge It
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August 30, 2010
By Lauren Charneski
David Morrison was the president and principal shareholder of Morrison Excavation, Inc. After Morrison filed a personal Chapter 7 bankruptcy proceeding, the Bankruptcy Court held him personally liable for and refused to discharge a $549,773.63 debt his company incurred when it abandoned a construction project. The court determined that Morrison had made fraudulent representations on behalf of his company during the bidding process for the abandoned project. The decision was affirmed on appeal.
The court rulings rested on the following facts:
On February 6, 2002, Morrison’s CPA and business adviser informed him that Morrison Excavation was “in serious financial trouble.” The CPA told Morrison that Morrison Excavation was cash broke, was way behind in payments to vendors, was collecting money before jobs were finished and lacked money to pay bills from completed jobs and that vendors were filing liens.
On February 14, 2002, Morrison Excavation submitted a bid for a subcontract with Western Builders.
On February 15, 2002, Morrison Excavation’s bookkeeper found an $857,000 accounting error overstating the company’s accounts receivable. When corrected, the accounting records revealed that Morrison Excavation was insolvent. The bookkeeper testified that she told Morrison this news “around February 15.” Morrison testified he was not made aware of the error until more than a month later, at the end of March.
On February 22, 2002, in evaluating Morrison Excavation’s bid, Western Builders requested a copy of Morrison Excavation’s financial statement. Morrison personally faxed to Western Builders a financial statement indicating that Morrison Excavation was financially solvent because the $857,000 accounts payable error had not been corrected in the faxed statement. Morrison testified that he was unaware the records contained an error at the time he faxed them.
On March 6, 2002, Western Builders entered into a subcontract with Morrison Excavation.
After entering into the subcontract, Morrison Excavation requested that Western Builders make advance payments, ostensibly to allow Morrison Excavation to pay second tier subs and suppliers. Morrison used some of the money to pay off liens from other jobs and used company funds to pay off his home equity loan and to give himself a big raise. Within five months, Morrison Excavation abandoned the Western Builders job. In order to finish the work, Western Builders spent $500,000 more than its subcontract price with Morrison Excavation for a replacement contractor and to pay off liens.
About two years later, Morrison filed for personal bankruptcy, and Western Builders commenced an adversary proceeding pursuant to 11 USC §523(a)(2)(B) to determine the non-dischargeability of the debt owed to it.
The U.S. Bankruptcy Court for the Western District of Texas found that Morrison personally committed fraud, held him personally liable and entered a money judgment against him for the debt. Morrison appealed, and the U.S. District Court for the Western District of Texas affirmed. Morrison appealed again to the U.S. Court of Appeals for the 5th Circuit. It affirmed. In re Morrison, 555 F.3d 473 (5th Cir. 2009).
The appeals court held that the Bankruptcy Court had jurisdiction to enter a money judgment, not just declare the debt non-dischargeable; that the debt in question was non-dischargeable; and that there was sufficient evidence that Morrison had engaged in misrepresentations and fraudulent behavior to warrant holding him personal liable for Morrison Excavation’s debt.
The appeals court found the evidence showed that the debt was the result of Morrison’s misrepresentations and fraudulent behavior, not simply the result of Morrison Excavation’s financial status.
In holding Morrison personally liable, the appeals court looked to case law from Texas and to Texas statutes imposing personal liability on corporate officers who make misrepresentations or commit fraudulent or tortious acts while in the service of their corporation. It held that the Bankruptcy Court could properly look to the use of a false financial statement and to the totality of the circumstances to infer intent.
The court distinguished Morrison’s conduct from that of a corporate officer in another case, who was found not liable. In that case, the court found that non-payment of debts resulted from the company’s weak financial condition and not from the actions of the corporate officer. Indeed, the corporate officer there took a pay cut as a result of company’s financial troubles while Morrison nearly doubled his salary. See, e.g. Holloway v. Skinner, 898 S.W.2d 598 (Tex. 1995).
The appeals court rejected Morrison’s contention that he was unaware of the error until after he had faxed Morrison Excavation’s financial records to Western Builders. The court noted that Morrison Excavating’s bookkeeper testified she remembered telling Morrison about the error around February 15. Another employee remembered overhearing a conversation between Morrison and the bookkeeper regarding the accounting error at about that time.
The appeals court rejected Morrison’s argument that 11 USC §523(a)(2)(B), which governs non-dischargeability, did not extend to this debt because Morrison Excavation was the provider of services, not a recipient of them. The statute applies to “money, property, services, or an extension, renewal, or refinancing of credit.” The court held that the plain language of the statute does not require a particular type of transaction and that the purpose of the statute is to govern transactions in which the debtor’s fraud resulted in a loss of property to the creditor. The fact that Morrison Excavation had contracted to provide services rather than to obtain them did not shield Morrison Excavation’s debt from non-dischargeability.
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