UNITED STATES BANKRUPTCY APPELLATE PANEL FOR THE FIRST CIRCUIT ___________________________________

BAP NO. MW 99-107 ___________________________________

IN RE: AARON H. WATMAN, Debtor. ___________________________________

LAWRENCE GROMAN, Plaintiff-Appellant,

v.

AARON H. WATMAN, Defendant-Appellee.

___________________________________

Appeal from the United States Bankruptcy Court for the District of Massachusetts [Hon. James F. Queenan, Jr., U.S. Bankruptcy Judge]

____________________________________

Before

GOODMAN, CARLO and DEASY, U.S. Bankruptcy Judges.

___________________________________

Joseph S.U. Bodoff, Stephanie Kahn and Shechtman & Halperin on brief for appellant.

Peter J. Haley and Gordon & Wise L.L.P. on brief for appellee.

___________________________________

June 30, 2000

___________________________________ Per Curiam

The plaintiff appeals from an order issued by the United

States Bankruptcy Court granting the debtor’s motion to dismiss a

complaint objecting to discharge under

(a)(2) and

(a)(7) and seeking to except the debt from discharge pursuant to

(a)(6). For the reasons set forth below, we affirm as

to the dismissal of the claim related to excepting the debt from

discharge and reverse as to the objections to discharge under §§

727(a)(2) and 727(a)(7).

JURISDICTION AND STANDARD OF REVIEW

The Bankruptcy Appellate Panel has jurisdiction to review

final decisions of the United States Bankruptcy Court pursuant to

. See also Sanford Institution for Savings v.

Gallo,

(1st Cir. 1998). In determining whether a

complaint should be dismissed under Fed. R. Civ. P. 12(b)(6), made

applicable by Fed. R. Bankr. P. 7012, the court must take the

factual allegations of the complaint as true and construe them in

the light most favorable to the plaintiff. Berniger v. Meadow

Green-Wildcat Corp,

(1st Cir. 1991)(citations

omitted). Appellate review of a dismissal under Rule 12(b)(6) is

plenary. Miranda v. Ponce Fed. Bank,

(1st Cir.

1991).

2 BACKGROUND

The debtor, Aaron H. Watman (“Watman”), filed a voluntary

petition for relief under Chapter 7 on March 22, 1999. On August

27, 1999, Lawrence Groman (“Groman”) filed a complaint objecting to

Watman’s discharge under

(a)(2) and (a)(7) and

seeking to except the same debt from discharge pursuant to

(a)(6).1

Groman’s complaint alleged that Groman was the sole owner of

all of the stock in Childrens Dental Associates of Lowell

(“Childrens Dental”). Complaint Objecting to Discharge at ¶ 4.

Groman agreed to sell all of the stock to Watman for the sum of

$437,783.15.

The parties agreed to a payment schedule and

Watman and Childrens Dental became jointly liable on the

obligation.

In August of 1997, Watman and Childrens Dental

defaulted on the obligation.

. Groman sued Watman and

Childrens Dental and obtained judgment against them in the amount

of $437,918.00.

. Thereafter, Watman caused

Childrens Dental to cease its operations and diverted the patients

and records to a separate dental practice that Watman

simultaneously established in his own name.

.a. Prior

1 Groman’s complaint also sought to except a debt from discharge pursuant to

(a)(4) and to obtain a declaratory judgment that claims arising out of Watman’s post-petition conduct were not affected by the discharge. The count under section 523(a)(4) was withdrawn in response to the motion to dismiss. The count seeking declaratory relief is not the subject of this appeal.

3 to ceasing operations, Watman caused Childrens Dental to prepay one

month of office rent, equipment leases, and health insurance

premiums.

.e. Watman also caused Childrens Dental to

make a distribution to him, in addition to his salary, in the

amount of $2,000.00.

.f.

Watman was a member of a partnership that owned the building

which housed the dental practice.

.b. Watman canceled

Childrens Dental’s lease and began operating in the same space

which Childrens Dental had occupied.

.b.-12.c. Watman

hired all of Childrens Dental’s employees and began using the

equipment and other personal property of Childrens Dental without

compensation to Childrens Dental.

.c. One week after

transferring the dental practice to his own name, Watman set up a

corporation known as Lowell Dentistry for Children, P.C. (“Lowell

Dentistry”) and operated with the patients, patient records,

employees, equipment and other personal property, which had

previously belonged to Childrens dental.

.d. Over the

course of these events, on March 22, 1999, Watman filed a voluntary

petition under Chapter 7 and on March 24, 1999, Childrens Dental

filed a voluntary petition for relief under Chapter 11.

.

Groman alleged that Watman’s actions constituted a transfer,

removal, destruction, mutilation or concealment of assets with the

intent to hinder, delay or defraud Groman within the meaning of 11

(a)(2) and warranted a denial of his discharge.

. Groman also alleged that Childrens Dental was an insider

of Watman and Watman’s actions constituted a transfer, removal,

destruction, mutilation or concealment of assets of an insider in

Childrens Dental’s bankruptcy case, warranting the denial of

Watman’s discharge pursuant to

(a)(7).

. Finally, Groman alleged that Watman’s actions constituted

willful and malicious injury to another entity or the property of

another entity within the meaning of

(a)(6) and thus

should be declared nondischargeable.

Watman filed a motion to dismiss the complaint for failure to

state a claim under Fed. R. Bankr. P. 7012 and Fed. R. Civ. P.

12(b)(6). Watman essentially argued that to succeed in a

dischargeability action the property transferred must have been

property of the debtor. Since Watman was not the owner of the

property owned by Childrens Dental as a corporation, he claimed

that he can not be held liable for the transfer or diminution of

the property of Childrens Dental. As to the willful and malicious

injury, Watman argues that to sustain a cause of action under §

523(a)(6), Groman must show more than a knowing breach of contract.

On November 29, 1999, after a hearing, the bankruptcy court

granted Watman’s motion to dismiss concluding that

(a)(2) and 727(a)(7) require a transfer of the debtor’s assets

and that the complaint only alleged a transfer of Childrens

5 Dental’s assets. Under § 523(a)(6), the bankruptcy court concluded

that any intentional and malicious injury alleged was to Childrens

Dental’s property not to Groman’s property. Groman filed a timely

notice of appeal.

DISCUSSION

Willful and Malicious Injury

Section 523(a) of the Bankruptcy Code provides that an

individual debtor may not receive a discharge of certain types of

debts.

(a). Subsection (a)(6) excepts from

discharge debts “for willful and malicious injury by the debtor to

another entity or to the property of another entity . . .”

(a)(6).

In an effort to resolve divergent views among the various

circuits regarding the proper interpretation of § 523(a)(6), the

United States Supreme Court has recently spoken on the issue. In

Kawaauhau v. Geiger,

(1998), the Court held that in

order to succeed on a § 523(a)(6) action, a plaintiff must show

that the debtor acted with an intent to cause injury rather than

merely intentionally committing an act that results in injury.

See Kawaauhau,

. The Court of Appeals for the First

Circuit has recently applied this standard. See Roumeliotis v.

Popa (In re Popa),

(1st Cir. 1998). In taking a

restrictive view of § 523(a)(6), the Kawaauhau Court explicitly

stated that a “knowing breach of contract” would not fall under §

6 523(a)(6)’s umbrella. See Kawaauhau,

(citing the

Eighth Circuit’s decision below,

(1997) (en

banc)). That is, a mere intentional breach of contract will not

trigger § 523(a)(6) when not accompanied by an intent to cause

injury.2

Section 523(a)(6) applies to two alternative forms of willful

injury: (1) injury to another entity (which, pursuant to § 101(15),

can include a person); or (2) injury to another entity’s property.

See

(a)(6). As the bankruptcy court noted, the

plaintiff cannot succeed on a § 523(a)(6) claim based on injury to

property given that any injury was to property owned by Childrens

2 Many courts establish a clear demarcation between tort and contract claims in applying § 523(a)(6). Such courts categorically hold that § 523(a)(6) applies to the former, but not the latter. See, e.g., Petralia v. Jercich (In re Jercich),

(B.A.P. 9th Cir. 2000) (“[T]he exception from discharge for debts arising from willful and malicious injury has been applied to tort claims, not contract claims.”). Indeed, the Kawaauhau decision is capable of such a broad interpretation given its directive that § 523(a)(6) should not apply to knowing breaches of contract. However, a close reading of Kawaauhau reveals a less sweeping distinction. In excepting knowing breaches of contract from the purview of § 523(a)(6), the Kawaauhau Court intended to show that a mere intentional contract breach would not implicate § 523(a)(6) without more. The entire thrust of the Kawaauhau decision is the distinguishing of intentional actions that result in injury (which do not trigger § 523(a)(6)) from actions that are intended to cause injury (which do trigger § 523(a)(6)). A knowing breach of contract on its own, which is an intentional act, would therefore not be subject to a § 523(a)(6) action. However, if a party intentionally breached a contract and, in doing so, also intended to cause injury, a § 523(a)(6) action could arguably be made out. Although a distinction between tort and contract claims in the context of § 523(a)(6) is appealing given its ease of application, such a distinction without more seems over-inclusive.

7 Dental and not the plaintiff. Nothing in the record indicates

that, subsequent to the stock sale, the plaintiff had any property

rights in any of the assets later transferred by the debtor, the

act that is alleged to have caused injury.3

Although the plaintiff cannot show an injury to property,

taking the facts in the light most favorable to the plaintiff, he

could show an injury to an entity, namely the plaintiff. If the

facts are taken as true and all reasonable inferences resolved in

the plaintiff’s favor, it appears that the plaintiff could show

that in transferring the assets of Childrens Dental, the debtor

intended to injure the plaintiff. However, the plaintiff’s §

523(a)(6) claim fails for an alternative reason.

Section 523(a)(6) clearly provides that its exception to

discharge applies to “any debt . . . for willful and malicious

injury. . . .”

(a)(6). Accordingly, to trigger §

523(a)(6), a debt must arise from a willful and malicious injury.

In other words, there must be a clear link between the debt and the

injury complained of. The quintessential § 523(a)(6) action,

therefore, is an intentional tort, the commission of which gives

3 In fact, nothing in the record indicates that the plaintiff took a security interest in any of Children Dental’s stock or assets in an effort to secure his note. If the plaintiff was a secured creditor, there might be an argument that the debtor committed the tort of conversion in later fraudulently transferring assets of Childrens Dental and therefore injured the plaintiff’s property. Cf. Huntington Nat’l Bank v. Parton (In re Parton),

(Bankr. S.D. Ohio 1991).

8 rise to a consequent debt. See, e.g., Kawaauhau,

-

60. However, in the instant case, there is no such link between

the debt and the alleged injury. The debt at issue arose years

before the alleged injurious transfer of assets by the debtor. The

debtor’s transfer of Children Dental’s assets did not give rise to

the instant debt sought to be excepted from discharge. Section

523(a)(6)’s requisite link is therefore not present. Accordingly,

we affirm the bankruptcy court’s dismissal of Count IV of Groman’s

complaint.

Transfer of Property of the Debtor

The Bankruptcy Code provides that:

(a) The Court shall grant the debtor a discharge, unless-- (2) the debtor, with intent to hinder, delay, or defraud a creditor . . . has transferred, removed, destroyed, mutilated, or concealed, or has permitted to be transferred, removed, destroyed, mutilated, or concealed–- (A) property of the debtor, within one year before the date of the filing of the petition; . . .

(a)(2)(A).

The bankruptcy court found that the complaint alleged a

fraudulent transfer of assets owned by Children’s Dental, but that

it did not allege a transfer of the debtor’s assets. Hearing

Transcript, November 29, 1999 at pp. 16-17. The court concluded

that § 727(a)(2)(A) requires a prepetition transfer by the debtor

of the debtor’s assets. Id. at p. 17.

We agree with the bankruptcy court’s reading of § 727(a)(2)(A)

to require the debtor to transfer property of his own. See Mcorp

9 Management Solutions, Inc. v. Thurman (In re Thurman),

(10th Cir. 1990); Rothman v. Beeber (In re Beeber),

(Bankr. E.D.N.Y. 1999); Cambridge Tempositions, Inc. v.

Cassis, III (In re Cassis, III),

(Bankr.

N.D.Iowa 1998); World Plus, Inc. v. Bonham (In re Bonham),

(Bankr. D.Alaska 1998); BPS Guard Services, Inc. v. Woodhead

(Matter of Woodhead),

(Bankr. D.Neb. 1994);

Riumbau v. Colodner (In re Colodner),

(Bankr.

S.D.N.Y. 1992). Notwithstanding, we conclude that the bankruptcy

court failed to consider the allegations of Groman’s complaint,

wherein he specifically alleged a transfer of property first from

Childrens Dental to Watman and second a transfer from Watman to

Lowell Dentistry. The facts are not clear as to the form in which

Watman held the assets after the transfer from Childrens Dental to

himself, but the allegations are not that Watman established Lowell

Dentistry and caused the transfer of Childrens Dental’s assets

directly to Lowell Dentistry. The complaint states that Watman

diverted patients (and their records) from Childrens Dental to a

separate dental practice that Watman established in his own name.

Complaint Objecting to Discharge at ¶ 12.a. The complaint also

alleges that Watman hired all of Childrens Dental’s employees and

began his own dental practice with the equipment and personal

property of Childrens Dental. Id. at ¶ 12.c. The complaint

thereafter alleges that Watman then set up Lowell Dentistry and

10 transferred the patients, patient records and other assets to

Lowell Dentistry. Id. at ¶ 12.d. Based on these allegations, we

conclude that Groman’s complaint states a cause of action under

(a)(2)(A).

Transfer in Connection with Case of an Insider

Section 727(a)(7) provides that a Chapter 7 debtor will not

receive a discharge when:

the debtor has committed any act specified in paragraph (2), (3), (4), (5), or (6) of this subsection, on or within one year before the date of the filing of the petition, or during the case, in connection with another case, under this title or under the Bankruptcy Act, concerning an insider.

(a)(7). The application of § 727(a)(7) has been

explained as follows:

Section 727(a)(7) extends the basis for denial of discharge to the debtor’s misconduct in a substantially contemporaneous related bankruptcy case. Thus if the debtor engages in objectionable conduct in a case involving [an insider], the debtor may be denied a discharge in the debtor’s own case.

King et al., Collier on Bankruptcy ¶ 727.10 (15th rev. ed. 1998).

The plaintiff alleges that the debtor should be denied a discharge

pursuant to § 727(a)(7) because he committed acts prohibited by §

727(a)(2) in connection with Childrens Dental’s Chapter 11 case.

Accordingly, to trigger § 727(a)(7), the plaintiff must show: (1)

the debtor engaged in activities prohibited by § 727(a)(2) in

connection with Childrens Dental’s bankruptcy case; and (2) that

Childrens Dental is an insider.

11 In cases in which a debtor is an individual, an insider

includes a “corporation of which the debtor is a director, officer,

or person in control.”

(31)(A)(iv). The debtor was

the sole officer and shareholder, and wholly owned and controlled

Childrens Dental. Thus, Childrens Dental qualifies as an insider

of the debtor for purposes of § 727(a)(7). Accordingly, the debtor

will be denied a discharge if he committed any of the acts

prohibited by § 727(a)(2) with respect to Childrens Dental’s case.

The bankruptcy court found that § 727(a)(7), when coupled with

§ 727(a)(2), requires a “transfer by the debtor of the debtor’s

assets.” Hearing Transcript, November 29, 1999 at 17. The court

found that Groman’s complaint was insufficient because it did not

allege a transfer of Watman’s assets but rather that Watman caused

the transfer of Childrens Dental’s assets. See id. In other

words, the court, in applying § 727(a)(2) as coupled with §

727(a)(7), uncoupled the two provisions by analyzing them

independently. Such a position is at odds with the vast majority

of case law interpreting §§ 727(a)(7) and (a)(2), which links the

two provisions by allowing an individual debtor’s discharge to be

denied when he or she transfers, removes, destroys, mutilates, or

conceals property of an insider corporation in violation of §

727(a)(2) when the insider corporation is the subject of a separate

bankruptcy case. See, e.g., In re Krehl,

(7th Cir.

1996) (individual debtor’s discharge properly denied for removing,

12 concealing and transferring property belonging to bankruptcy estate

of insider corporation); Barclays/American Business Credit, Inc. v.

Adams (In re Adams),

(6th Cir. 1994) (individual debtor

properly denied a discharge pursuant to § 727(a)(2), by

incorporation through § 727(a)(7), for transferring accounts

receivables of corporation with intent to hinder or delay

collection of debt), cert. denied,

(1995); Commerce

Bank & Trust Co. v. Burgess (In re Burgess),

(1st Cir.

1992) (individual Chapter 7 debtor could be denied a discharge

pursuant to §§ 727(a)(2)(A) and 727(a)(7) for transferring proceeds

from insider corporation’s accounts receivable to debtor’s personal

checking account if the transfers were made with the intent to

hinder, delay or defraud creditors); Mercantile Bank of Joplin N.A.

v. Nicsinger (In re Nicsinger),

(W.D. Missouri 1992)

(individual debtor properly denied discharge pursuant to §

727(a)(7) for transferring account receivable of insider

corporation to third party with intent to hinder, delay or defraud

a creditor); 718 Arch Street Assoc., Ltd. v. Blatstein (In re

Main),

(Bankr. E.D. Pa. 1997) (individual Chapter 7

debtor who orchestrated fraudulent transfer of insider

corporation’s assets through collusive foreclosure sale denied

discharge pursuant to §§ 727(a)(2)(a) and 727(a)(7)), aff’d in part

& rev’d & remanded in part on other grounds sub nom,

(E.D. Pa. 1998), remanded portions reinstated,

13 (Bankr. E.D. Pa. 1998); Consumers United Capital Corp. v. Greene

(In re Greene),

(Bankr. D. Md. 1996) (individual debtor

denied a discharge for causing the transfer of insider

corporation’s assets with intent to hinder creditor’s collection

efforts); First City Bank-Central Park v. Powell (In re Powell),

(Bankr. W.D. Tex. 1988) (individual debtor denied a

discharge pursuant to § 727(a)(7) for failing to account for the

deterioration of an insider corporation’s inventory or preserve the

corporation’s records); Chicago Title Ins. Co., Inc. v. Mart (In re

Mart),

(Bankr. S.D. Fla. 1987) (individual debtor

denied discharge pursuant to § 727(a)(7) for actions in

transferring assets of corporation, in which individual was

insider, with the intent to hinder, delay or defraud creditor of

corporation); Kunce v. Kessler (In re Kessler),

(Bankr.

D. Kan. 1985) (individual debtor denied a discharge under §

727(a)(7) for concealing funds of insider corporation).

Based on the weight of authority supporting the plaintiff’s

interpretation of §§ 727(a)(7) and (a)(2), and the clear purpose of

§ 727(a)(7), we conclude that to deny a discharge under § 727(a)(7)

in connection with § 727(a)(2), the following must be shown:

1. The debtor transferred, removed, destroyed, mutilated, or concealed, or has permitted such things to be done to, property of an insider, where the insider is the subject of a separate bankruptcy proceeding;

2. Such action was done with an intent to hinder, delay, or defraud a creditor or an officer of the estate charged with custody of property under the Bankruptcy Code; and

14 3. Such action was done during the case of the debtor whose discharge is under attack, or within one year preceding such a case.

See Schwartz v. Goodman (In re Goodman),

(Bankr.

E.D. Pa. 1998) (stating that the time limits provided for by §

727(a)(7) relate to the bankruptcy case of the debtor whose

discharge is at issue and not the insider’s case). In his

complaint, Groman alleged that Watman transferred patients,

records, funds, employees, equipment, and other personal property

of Childrens Dental to himself and then to a separate corporation

with the intent to hinder, delay, or defraud Groman. Given that

Childrens Dental is the subject of a Chapter 11 proceeding, we

conclude that these allegations clearly state a cause of action

pursuant to § 727(a)(7) in connection with § 727(a)(2). Taking the

allegations of the complaint as true, we conclude that Watman’s

actions in orchestrating the transfer of Childrens Dental’s

property are exactly the type of conduct prohibited by § 727(a)(7)

in conjunction with § 727(a)(2).

15 CONCLUSION

The bankruptcy court erred in concluding that the plaintiff’s

complaint failed to state causes of action under

(a)(2) and 727(a)(7). Accordingly, we REVERSE AND REMAND the

bankruptcy court’s order granting the debtor’s motion to dismiss

the adversary complaint for further proceedings consistent with

this opinion. We AFFIRM the bankruptcy court’s dismissal of Count

IV of the complaint wherein the plaintiff alleged that the claim

should be excepted from discharge pursuant to

(a)(6).

SO ORDERED.

16