Reed Konnerth & Capers N. Am. LLC v. Fugett (In re Fugett)

In re: RICHARD LEE FUGETT, Debtor.

REED KONNERTH and CAPERS NORTH AMERICA LLC, Plaintiffs, v. RICHARD LEE FUGETT, Defendant.

Case No. 15 B 41034

Adv. No. 16 A 196

UNITED STATES BANKRUPTCY COURT NORTHERN DISTRICT OF ILLINOIS EASTERN DIVISION

March 16, 2017

Chapter 7

Judge Pamela S. Hollis

MEMORANDUM OPINION

This matter comes before the court on the motion of Defendant Richard Lee Fugett to dismiss the complaint filed against him by Plaintiffs Reed Konnerth and Capers North America LLC. For the reasons stated below, the court grants the motion to dismiss Counts I, II and IV. The motion to dismiss Count III is granted with leave to amend.

SUMMARY

The issues that brought the parties to this court began with a dispute over a software business. Intelligent Solutions, Inc., ("ISI") along with several LLCs, developed, marketed and sold certain software known as CAPERS. Apparently the CAPERS software is used by public safety and other municipal entities, although the complaint provides few details.

Neither does the complaint provide many details regarding the relationships among the people involved in the case. About five years ago, two of the ISI shareholders (Tyson Garbrecht, Denis Williams) sued the other two shareholders (Richard Fugett, Michael Koziol) as well as a third defendant (Reed Konnerth) in state court. Konnerth's relationship to the others is not clear from the complaint, but he was the sole member of Capers Worldwide and Capers North America, two entities that were involved in the CAPERS software business.

In the course of the shareholder lawsuit, the state court entered an order prohibiting Fugett, Koziol and Konnerth from doing anything outside the ordinary course of ISI's business. Nevertheless, within the next year, the Internal Revenue Service levied on ISI for failure to pay employment taxes. Fugett and Koziol were held in contempt of court. The complaint does not explain why there were no ramifications for the third defendant, Konnerth.

Amid promises that the tax debt would be paid, the parties decided to settle. They entered into several agreements to memorialize their settlement. Essentially Konnerth bought everyone out in return for the CAPERS software, although Garbrecht and Williams got a copy of the software and a license to use it. Fugett and Koziol agreed, among other terms, to pay the employment tax debt for which they had been held in contempt. The state court lawsuit was dismissed.

Koziol paid about half the tax debt by liquidating his 401(k). Despite promises that he would do the same, Fugett only made a few small payments. Less than three months after the parties settled they were back in court on Konnerth's motion to enforce the settlement. It is not clear from the complaint why Fugett's co-defendant brought the motion to enforce rather than the plaintiffs, Garbrecht and Williams.

In any event, the state court granted the motion to enforce. Fugett then tried vacating the settlement, but the state court denied his request. He asked for further time to pay the tax debt,and eventually filed for relief under the Bankruptcy Code. At least $200,000 of the tax debt remains unpaid.

Fugett's bankruptcy filing prompted Konnerth to file this dischargeability action. Konnerth argues that Fugett's failure to pay the tax debt resulted in approximately $200,000 worth of damages to him, and that those damages are nondischargeable for two reasons. First, despite his promises in the settlement documents, Fugett never intended to pay the tax debt. And second, because the tax debt arose from a contempt order, it is per se nondischargeable as the result of a willful and malicious injury.

BACKGROUND

Plaintiffs allege as follows:

ISI Shareholder Lawsuit Filed in State Court

Tyson Michael Garbrecht and Denis Williams filed suit in the Circuit Court of Will County against Richard Fugett, Reed Konnerth and Michael Koziol. This suit involved disagreements regarding ownership of stock in IS1 and breaches of fiduciary duty. Fugett, Konnerth and Koziol filed counterclaims. Complaint ¶ 8-9. ISI's books showed that 10,000 shares of common stock had been authorized, with Fugett owning 5,500 shares, Koziol and Garbrecht each owning 2,000 shares and Williams owning 500 shares, but the parties disputed whether this was accurate. Complaint, Ex. F (the "Settlement Agreement").

In the course of that litigation, the Will County Court ordered that Fugett, Koziol, Konnerth and ISI "shall not take any actions by the Board of Directors of ISI to incur debt, dilute shares or stock, take distributions or transfer firm assetfs] including wasting or disposing of the assets that are outside the ordinary course of business; until further order of Court. . .". Complaint, Ex. A (the "July 2013 Order").

About a year and a half later, the Will County Court appointed a custodian for ISI. Complaint ¶ 11.

The Internal Revenue Service, Illinois Department of Revenue and Illinois Department of Employment Security subsequently levied against ISI for failure to pay certain employment taxes (the "ISI Tax Debt") and issued a lien on ISI's assets. Complaint ¶¶ 12 and 13.

The Will County Court Enters an Order of Contempt against Fugett and Koziol

Following the tax levy, Garbrecht and Williams filed a petition to issue a rule to show cause, and the Will County Court held an evidentiary hearing. The court found Fugett and Koziol in contempt of the July 2013 Order. Complaint ¶ 14. The complaint contains no allegations regarding the evidence heard by the Will County Court, and no explanation of why Konnerth, who was also bound by the July 2013 Order, was not held in contempt. A copy of the petition to issue the rule is not attached to the complaint.

On December 23, 2014, the Will County Court ordered "Fugett and Koziol, jointly and severally, to pay funds to ISI's Custodian, not available from current ISI revenue, necessary to satisfy the payment of all scheduled obligations under existing agreement [sic] as set forth below or amended agreement, related to the payroll taxes incurred during the period prior to the Court appointing the Custodian for ISI . . . the existing payment schedule is $ 10,000 due 12/28/14, $10,000 due 1/28/15 and the balance due 2/28/15." Complaint, Ex. E (the "Contempt Order").

As of December 2014, the ISI Tax Debt totaled approximately $505,603.54. Complaint ¶ 16.

Over the next few months, Fugett and Koziol paid $50,000 to the IRS, and negotiations ensued to extend the payment date on the remaining balance. Complaint ¶¶ 18-23.

Encouraged by these negotiations and Fugett's and Koziol's preparations to make a lump-sum payment of the balance, plaintiffs Garbrecht and Williams as well as co-defendant Konnerth contemplated settlement of the Will County Court litigation. Complaint ¶ 24.

Fugett gave Konnerth certain assurances that his negotiations with the IRS were in good faith, and that as a result Fugett would be able to obtain a source of funding that would not otherwise be available to pay his portion of the ISI Tax Debt. Complaint ¶ 25.

The parties discussed several settlement options during the winter and spring of 2015. One settlement option was the sale of ISI's assets. Such a sale would allow the continued servicing of approximately 50 police and fire departments through licenses of CAPERS software. Konnerth attempted to retain the key employees who would provide services following such a sale. Complaint ¶¶ 27-28.

If Fugett and Koziol paid the ISI Tax Debt, they would not only purge their contempt, but also release the lien on ISI's assets and allow for a global settlement. Complaint ¶ 26.

The Parties Settle Their Differences and the Will County Lawsuit is Dismissed

In April 2015, the parties to the Will County litigation entered into a settlement agreement that resolved the suit, and the court dismissed the complaint. Settlement Agreement and Complaint ¶ 39.

The documents that resolved the Will County litigation were: the Settlement Agreement (Complaint, Ex. F); the Stock Purchase Agreements (Complaint, Exs. G and H); the Asset Purchase Agreement (Complaint, Ex. 1); the Membership Interest Pledge Agreements (Complaint, Exs. J and K); and a Dismissal Order from the Will County Court (Complaint, Ex. L).

The settlement basically provided for Fugett and Koziol to buy out Garbrecht's and Williams' interests in ISI. Complaint ¶¶ 30-31. How would Fugett and Koziol make the payments? Capers North America LLC and Capers Worldwide - both solely owned by Konnerth - would purchase the software, contracts and accounts receivable that made ISI valuable. The scheduled payments for those assets would be made directly to Garbrecht and Williams, satisfying Fugett's and Koziol's obligation to them. Complaint ¶ 33; Asset Purchase Agreement.

As security for the payments, Konnerth pledged his membership interests in Capers North America and Capers Worldwide. Complaint ¶ 36; Membership Interest Pledge Agreements.

One of the conditions precedent to Konnerth's purchase of ISI's software, contracts and accounts receivable was that Fugett and Koziol had to pay off the ISI Tax Debt:

Immediately upon execution of this Letter, Koziol and Fugett shall transfer such of their assets in their respective 401k retirement accounts to the IRS as representing their personal liability for such. Seller [ISI and Capers LLC] and Buyer [Capers North America and Capers Worldwide] shall enter into negotiations to resolve the current IRS obligation in order to provide Purchaser with assets that are free of any liens. Nothing herein limits the Seller's ability to sell other assets to satisfy the IRS lien.

Asset Purchase Agreement at § 6(c) ("Purchaser" is not defined.) See also the Stock Purchase Agreements at Section 7 (in which Fugett and Koziol agreed that they would ensure that the ISI Tax Debt would be paid and any lien removed by September 1, 2015, subject to negotiations over a reasonable extension of time).

The Settlement Agreement listed ten events of default,...