$900K Judgment Against Supervising Broker Dischargeable in Bankruptcy Despite Agent’s Fraud.

In a lengthy and well-reasoned opinion, the 9^th Cir. Bankruptcy Appellate Panel concluded that where the broker was unaware of the agent’s fraud, the state court judgment against the broker was dischargeable and the broker was entitled to a “fresh start” after his bankruptcy.

WHY THIS IS IMPORTANT: This is a significant victory for real estate and mortgage brokers because the court discarded the “receipt of the benefits” test, which had been the doctrine favored by the Ninth Circuit.  This means that even though the broker received a share of the commission from the agent’s wrongful conduct, and even though the broker was found jointly and severally liable by the state court for the acts of the agent, because he didn’t know or have reason to know of the agent’s fraud, the broker was able to discharge the judgment in his bankruptcy.

FACTS OF THE CASE:  Mr. Huh is licensed by the CalBRE as a real estate broker.  Mr. Jay Kim was a sales agent engaged in real estate activities under Mr. Huh’s broker license.   Kim sold plaintiff Sachan a grocery store in Long Beach with a number of representations that later turned out to be false.  Kim received a commission of $38K and Huh received $1K on the Sachan purchase.[i] Sachan ultimately lost hundreds of thousands of dollars on the transaction, sued Kim and won a state court judgment against Kim.  Later, Sachan sought to amend the Judgment to add Huh.  The state court concluded that since the underlying conduct required Huh’s license, Huh was jointly and severally liable with Kim.  Huh filed bankruptcy and Sachan brought a 523(a) adversary proceeding to prevent Huh from discharging the judgment.[ii]

REASONING: The opinion was thirty pages long and contained a number of various tests previously employed by the Supreme Court and by other circuits.  Finally, the U.S. Bankruptcy Appellate Panel of the Ninth Circuit concluded that “imputed” liability is not enough to bar the debtor from his discharge. The Court also gave weight to the recent Supreme Court decision on the 523 exception[iii] in cases of fraud or defalcation where the debtor’s state of mind had to be “culpable” and “involving knowledge of, or gross recklessness in respect to, the improper nature of the relevant fiduciary behavior.” Here, there was no evidence that Mr. Huh knew of the plaintiff’s purchase or any of Kim’s representations until after the close of escrow.  Accordingly, in light of the creditor failing to prove that Huh knew or should have known, the Court declined to bar Mr. Huh’s discharge solely on the basis of the Principal/Agent relationship.

AUTHOR’S COMMENT:  It’s unclear whether the plaintiff’s counsel proffered any expert witness testimony to the effect that Huh, as the broker, should have known of the transaction.  Even then, it is possible that would still be considered to be mere negligence and not rise to the level of culpability needed to bar discharge of the judgment.

The Court was careful to say that even though, in this circumstance, more was required to establish a fraud exception than simply a principal/agent relationship, “We are not comfortable concluding that under no circumstances can the fraud of an agent be imputed to his principal…”