Drs. Linda Massod and Terry Fayad practice together, both claim to have been embezzled by the other

Before the Court is Linda Massod's complaint seeking a determination that a debt she claims is owed to her by debtor Terry Fayad, arising from their co-ownership and operation of a joint dental practice, is excepted from discharge. Having tried the matter, I now render my decision.

I Introduction

Linda Massod and Terry Fayad, both dentists, formed a romantic relationship in the late 1980s and a professional relationship in the early 1990s. Both relationships failed in the late 1990s, when they separated from each other romantically and professionally. Their breakup was not without recriminations. Those recriminations reverberate to this day and include Massod's state court lawsuit against Fayad in 1999, Fayad's bankruptcy case in 2000, and Massod's exception to discharge complaint in 2001, the subject of this adversary proceeding.

In the adversary proceeding, Massod makes two allegations. First, she alleges that, to induce her to form a joint dental practice, Fayad falsely promised that her dental school loans would be paid from funds generated by that practice and that, relying on that false promise, she was damaged. Second, she alleges that Fayad misappropriated funds from their joint practice for himself and his brother, thereby causing the financial deterioration of the practice and consequent damage to her. Based on these allegations, Massod asks the Court to except from discharge the debt she claims Fayad owes her for the damages caused by his false promises as to her student loans and by his misappropriation of corporate funds. She grounds each request in three separate provisions of the non-dischargeability statute: § 523(a)(2)(A) regarding fraud; § 523(a)(4) regarding fraud or defalcation while acting in a fiduciary capacity; and § 523(a)(6) regarding willful and malicious injury. Fayad denies these allegations.

I tried these matters on four separate days over a period of several months. At trial, four witnesses testified: Massod, Fayad, their former accountant, and a former joint practice employee (currently employed by Massod). I admitted hundreds of pages of documents including credit card statements and bank statements. The non-party witnesses were generally credible, but the substance of their testimony was peripheral. Massod and Fayad were understandably, perhaps predictably, self-serving in their testimony. Fayad at times was not credible. After trial, I reviewed the trial documents, the testimony, the post-trial submissions, and applicable law. I now set forth my analysis, findings, and rulings.

II Framework

Massod has the burden of going forward and the burden of proof by a preponderance of the evidence as to each of the elements of the separate causes of action in her complaint. Grogan v. Garner, 498 U.S. 279 (1991). See Collier on Bankruptcy ¶ 523.04 (15th ed. rev.).

Under § 523(a)(2)(A), Massod must demonstrate that (1) Fayad made a false representation (2) which he knew at the time was false (3) and which he made with the intent and purpose of deceiving Massod (4) on which Massod justifiably relied and (5) as a result of which reliance and as a consequence of which false representation, Massod sustained a loss or damage. 11 U.S.C. § 523(a)(2)(A); In re Spigel, 260 F.3d 27, 32 (1st Cir. 2001). See Collier on Bankruptcy ¶ 523.08[1] (15th ed. rev.).

Under § 523(a)(4), Massod must demonstrate that (1) a fiduciary relationship existed between Fayad and her, and (2) Fayad committed fraud or defalcation in the course of that fiduciary relationship, (3) causing harm to Massod. 11 U.S.C. § 523(a)(4). In re Baylis, 313 F.3d 9, 17 (1st Cir. 2002). See Collier on Bankruptcy ¶ 523.10 (15th ed. rev.).

Under § 523(a)(6), Massod must demonstrate that (1) Fayad injured her (2) with either the intent to injure her or at least the intent to do an act which he was substantially certain would lead to the injury in question, and (3) the injury was wrongful, without just cause and committed in conscious disregard of his duties. 11 U.S.C. § 523(a)(6). Kawaauhau v. Geiger, 523 U.S. 57 (1991) (as to "willful"); Printy v. Dean Witter Reynolds, Inc., 110 F.3d 853, 859 (1st Cir. 1997) (as to "malicious"); Burke v. Neronha (In re Neronha), 344 B.R. 229, 231-232 (Bankr. D. Mass. 2006) (expanding on objective and subjective elements of malice). See Collier on Bankruptcy ¶ 523.12 (15th ed. rev.).

III Facts

Here are the facts established at trial. In the early 1990s, Massod had a developing dental practice as a solo practitioner, with a patient roster, an office, and an independent business operation. She also had limited financial and business experience and substantial student loans. At that time, Fayad had no independent practice but rather was employed as a dentist by the City of Cambridge, Massachusetts. Fayad occasionally assisted Massod in her practice. He had considerably more business experience and financial expertise than Massod, or so he represented to her. At that time, Massod and Fayad were engaged in an on-going, established romantic and domestic relationship. At some point in that time period, Fayad suggested that they form a joint dental practice, and they did so. They became co-owners of the professional corporation through which that practice was conducted. They agreed-upon their respective practice areas and conducted their practice in accordance with that agreement. They also agreed-upon their respective corporate titles and roles, with Massod as president and principal marketer and Fayad as treasurer, keeper of the corporate books, and manager of the corporate finances (as well as Massod's personal finances). They agreed to share equally in the profits of the practice. They also agreed that Massod's student loans would be repaid through revenues generated by the practice; they did not at first reduce this agreement to a writing. This repayment commitment was a major factor for Massod in her consideration of, and agreement to, the joint practice arrangement, and one upon which she relied. Massod and Fayad provided working capital for the operation of the practice primarily through the use of personal credit cards. In a somewhat atypical and unbusinesslike practice, they employed these credit cards for personal and business expenditures, paying the card billings with corporate funds and directing their accountant at year end as to the allocation of business and personal credit expenditures for income, tax reporting, tax treatment, and financial statement purposes. Fayad instituted and indeed insisted upon this practice, and he did so with Massod's acquiescence and trust. While their testimony differed on this subject, Massod credibly testified that Fayad maintained sole possession and control over the corporate and practice books and records, and that he resisted Massod's efforts to review those books and records herself or to engage professionals to review and maintain them. Although she lacked access to these books and records, she nonetheless observed both growth in the practice, which was evident from the increasing patient roster, and, at the same time, signs of financial distress in the business: collection calls, delayed payrolls, balky suppliers, limited income, and unpaid student loans.

Fayad's brother Hidar had financial dealings with Fayad personally and with the corporation. During 1995-1999, the corporation paid substantial sums to Hidar, either directly or through the credit card accounts. Fayad contends that the payments to or on account of Hidar were in repayment of loans or for services rendered. Massod disputes that any loans or services were rendered by Hidar, and she contends that she never authorized any such recompense to Hidar. Hidar did not testify at trial. The documentation is not conclusive. Massod's testimony on this subject was credible. Fayad's was not credible. I find that Fayad diverted corporate funds to Hidar without any consideration from Hidar, financial or otherwise.

In July 1997, Fayad and Massod caused the corporation to make an agreement with Massod. The agreement was intended to implement the student loan repayment promise that was a key consideration in Massod's decision to proceed with the joint practice. Under the agreement, the corporation would re-deploy corporate revenues resulting from the retirement of various corporate office equipment leases toward repayment of Massod's student loans. The agreement also provided that Massod and Fayad, under certain circumstances relating to the financial performance of the practice, would consider using excess cash flow from the practice for such student loan repayment. These corporate repayment obligations were secured by the grant of a security interest in the corporate equipment. Fayad refused to attend to the paperwork, namely, the issuance of a promissory note and the execution and recordation of the requisite financing statement necessary to render such corporate obligation and collateral commitment perfected and hence meaningful. Moreover, he failed to provide the financial information regarding the performance of the practice upon which the use of excess cash flow for student loan repayment would be based. In any case, Massod's student loans were not repaid, at least not from corporate revenues in accordance with the Fayad's promise and the written agreement. Fayad explains his refusal to complete the student loan deal on the breach in their personal relationship, having "caught her cheating."

In February 1999, three relevant events occurred. First, Massod had occasion to review a corporate bank statement that aroused her concern and confirmed her suspicion that the finances of the practice were not being handled properly or being reported to her accurately.Second, Fayad discovered that Massod was engaged in a relationship with another man, by his testimony causing an immediate breach in his relationship with Massod. And third, Fayad left Massod and promptly established a romantic and domestic relationship with another woman whom he married several months later. Thereafter, Massod and Fayad maintained their joint practice until, commencing in July 2000, Fayad opened his own office, developed a practice, and established a marital residence.

During the year and a half following their domestic separation in February 1999, Fayad and Massod practiced together in the same office and under the joint practice banner. By both accounts, the forced professional proximity was awkward and strained. Not surprisingly, they engaged in a series of acrimonious encounters and disputes regarding the practice. These concerned the disposition of corporate assets, the collection and disbursement of corporate receivables, the maintenance of the patient roster, and access to the corporate books and records. As noted, Massod sued Fayad in state court for breach of contract, breach of fiduciary duty, and an accounting. In that action, they executed a stipulation and injunction intended to regulate the joint practice under the eye of a custodian (who is no longer active in that action). Ultimately, burdened by debt, Fayad commenced the underlying bankruptcy case on June 29, 2000. In the bankruptcy case, he listed $238,164 in nonpriority unsecured debts, a substantial portion of which comprised credit card debt to various issuers. The state court litigation, like Fayad's bankruptcy, awaits the outcome of this adversary proceeding.

IV Rulings

Here are my rulings.

A. Misuse and Misappropriation of Corporate Funds

Each party contends that the other misappropriated practice funds primarily through the use of corporate-funded credit cards for unauthorized personal expenditures. Certainly, their business practice — funding working capital and personal needs through personal credit cards — is particularly susceptible to such misuse. Their strategy at trial as to this matter consisted of presenting what appears to be virtually all of the credit card bills and bank statements for the period in question, together with their respective characterizations of a selection of such charges as instances of the alleged misappropriation, presumably calling upon the Court to render a decision based upon an extrapolation of such charges to encompass a substantially greater sum. While it is Massod's burden to make that case in this litigation, neither she nor Fayad has done so. Both used the credit cards, and did so both for corporate and personal purposes. Disentangling and examining each and every such charge for a determination of misuse may be possible but that has not been attempted, much less accomplished by either party. To the extent that evidence on this issue was presented, it tended to favor Massod in that she credibly explained the particular charges brought forward by Fayad. Nonetheless, with the exception noted below, Massod has not proved by a preponderance of the evidence Fayad's misappropriation of the vast sums she claims in her complaint.

B. Defalcation in a Fiduciary Capacity

A discharge exception under § 523(a)(4) based on defalcation while acting in a fiduciary capacity requires a demonstration that Fayad acted in a fiduciary capacity in his dealings with Massod. Fayad and Massod did owe each other duties of good faith and loyalty. However, as co-owners, they enjoyed equal rights and powers with respect to the corporation and the joint practice, even if Massod ceded control of important aspects of her personal and professional life to Fayad, at least for a while. That acquiescence is not enough to warrant the conclusion that either was acting in the requisite fiduciary capacity. See In re Carlson, 334 B.R. 626, 629 (Bankr. C. D. Ill. 2005). Thus, in the absence of such fiduciary capacity, Massod has not established by a preponderance of the evidence one of the elements of her defalcation causes of action. Accordingly, the causes of action relating to the student loans and the misappropriation of corporate funds under § 523(a)(4) fail.

C. Fraud Regarding the Student Loans

Further, Massod has not proved by a preponderance of the evidence that Fayad made a false representation when he agreed, in 1994, to cause her student loans to be repaid from their joint practice. Nor has she established that he did so when he caused the corporation to enter into the collateralized repayment agreement, in 1997. Nothing he said or did at either time establishes that he did not intend to perform the student loan repayment commitment at the time he agreed to do so. He may have broken his promise and breached his agreement subsequently; however, the evidence does not support the conclusion that he engaged in fraud in making either the promise or the agreement. Accordingly, the cause of action relating to the student loans under § 523(a)(2)(A) fails.

D. Fraud Regarding Hidar

Massod contends that Fayad's liability to her, arising from his diversion of corporate funds to Hidar, is excepted from discharge under § 523(a)(2)(A) as a debt arising from fraud or a false representation because Fayad falsely represented to her that his brother Hidar provided loans and services to the corporation and that the diversion of corporate funds to Hidar constituted the repayment of such loans and recompense for such services. The evidence shows only that Fayad did divert corporate funds to Hidar, and that Fayad, to cover up this diversion, falsely represented to Massod that the payments to Hidar were compensation for value provided by Hidar to the corporation. The evidence fails to establish a requirement of § 523(a)(2)(A): that her reliance on the misrepresentation was a cause of the damage suffered. Here, the damage was caused by the diversion itself. The misrepresentation served to cover-up the wrongfulness of the diversion, but Massod has not demonstrated that it caused the diversion in the first instance. Accordingly, liability arising from the diversions to Hidar is not excepted from discharge under § 523(a)(2)(A).

E. Willful and Malicious Injury Regarding the Diversion of Corporate Funds

Massod also contends that Fayad's liability to her, arising from his diversion of corporate funds to Hidar, is excepted from discharge under § 523(a)(6) as a debt for willful and malicious injury to another entity. The injury includes both diminution in the value of her interest in the corporate joint practice and an increase in her own personal liability as a result of the consequent failure of the corporation. Massod has satisfied the requirements of § 523(a)(6) as to these transfers. I find that Fayad made the transfers with at least substantial certainty that they would harm both the corporation and Massod as a one-half owner. He clearly understood as well that every dollar diverted to Hidar diminished the value of the corporation and of Massod's interest in it. The injury to Massod was therefore "willful" within the meaning of § 523(a)(6) and the Kawaauhau decision. The payments to Hidar were also objectively wrongful in that they were not proper or authorized corporate expenditures, they served no corporate purpose, and they were not sanctioned by any agreement or understanding between himself and Massod. Moreover, Fayad clearly understood the wrongfulness of these diversions. The injury was therefore both objectively wrongful and made with conscious disregard of that wrongfulness, and it was thus "malicious" within the meaning of § 523(a)(6). The Court therefore concludes that Fayad's liability to Massod for diversion of corporate funds to Hidar is excepted from discharge under § 523(a)(6) as a debt for willful and malicious injury to another entity.

F. Willful and Malicious Injury Regarding the Student Loans

Massod also contends that Fayad's liability to her for failing to implement the student loan agreement — by failing to effectuate the corporation's obligations (i) to make payments on her student loans and (ii) to give her a promissory note and security interest to secure the corporation's obligation to her — is excepted from discharge under § 523(a)(6) as a debt for willful and malicious injury to another entity. I find that Massod has carried her burden of proof as to this count.

Fayad's non-implementation of the student loan agreement injured Massod in two ways. First,by his failure to cause the corporation to make payments on the student loans, she was injured to the extent of payments that the corporation should have made but did not make, plus interest, penalties, and other finance charges that Massod incurred as a result of the nonpayment. Second, in failing to cause the corporation to give Massod a promissory note and security interest, he deprived her of a right to look to assets of the corporation as security for enforcement of the corporate obligation to pay her student loans. Fayad contends that, given the collapse of the joint practice, the security interest would have been subject to avoidance by the corporation's creditors as a fraudulent conveyance; therefore, he urges, its value would have been negligible and his failure to cause the corporation to give Massod a security interest was not injurious to Massod. This argument, however, goes only to the extent of damages, which is not an issue before me. (Fayad does not contend that it was a factor he considered in his decision not to effectuate the student loan agreement, and I find it was not a factor.) In addition, Fayad has not established that the grant of a security interest would have been a fraudulent as to creditors, especially if he had effectuated it when he should have. There is no evidence that the grant of a security interest would have rendered the corporation insolvent or left it insufficiently capitalized. In any event, whatever the vulnerability of the security interest to avoidance, she had a right to the lien, and he had the obligation to cause the corporation to provide it.

Fayad testified that he did not implement the student loan agreement because he had caught Massod cheating on him. I find that his non-implementation of the agreement was deliberate, a considered refusal to carry out his obligation as an officer of the corporation, with full knowledge that it would injure her and indeed intent to injure. This was simple retaliation. The wilfulness of the injury is therefore established.

Fayad was also aware of the student loan agreement, of the corporation's obligations under that agreement, and of his own obligation, as the corporate officer responsible for implementation of the agreement, to effectuate the corporation's obligations thereunder. I therefore conclude that the injury was wrongful and inflicted in conscious disregard of a known duty: it was "malicious" within the meaning of § 523(a)(6). The Court therefore concludes that Fayad's liability to Massod for failing to implement the student loan agreement is excepted from discharge under § 523(a)(6) as a debt for willful and malicious injury to another entity.

V Conclusion

In accordance with the foregoing findings and rulings, the Court concludes that Fayad's liability to Massod for diversion of corporate funds to Hidar and for failing to implement the student loan agreement is excepted from discharge as a debt for willful and malicious injury. The Court makes no determination as to the existence or extent of the underlying liability; Massod may establish and enforce the underlying liability in another court of appropriate jurisdiction. All other counts in the complaint must be dismissed. A separate judgment will enter accordingly.

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