TLS Mgmt. & Mktg. Servs. v. Morgan (In re Morgan)

OPINION AND ORDER ON MOTION TO DISMISS AMENDED COMPLAINT

Paul E. Singleton Judge

For the first three years, the parties' confidential, non-compete agreement went as planned. Debtor Clifford Morgan referred clients to TLS Management and Marketing Services, LLC. In exchange, TLS paid referral fees to Morgan. Then, Morgan stopped sending clients to TLS. TLS sued Morgan in Illinois state court alleging one count - breach of contract. It won a $1.2 million dollar default judgment. Shortly thereafter, Morgan filed a chapter 7 bankruptcy petition.

Now, in this adversary proceeding, TLS cites two theories under 11 U.S.C. § 523^[1] to except the judgment from discharge. First, it cites § 523(a)(4), which excepts debts from discharge when a debtor commits: fraud or defalcation in a fiduciary capacity, embezzlement, or larceny. Second, it cites § 523(a)(6), which excepts willful and malicious conduct from discharge.

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Morgan filed a motion to dismiss the original Complaint. The Court granted that motion but gave TLS leave to amend the Complaint. TLS filed the Amended Complaint. Now, Morgan moves to dismiss, with prejudice, the Amended Complaint. The Court grants Morgan's motion for the following three reasons:

(1) Both counts fall short of what Twombly Iqbal, and the Seventh Circuit require

(2) The intangible property in the agreement is not the type of property that can be converted. Therefore, the Court dismisses TLS's § 523(a)(4) larceny and embezzlement claims in Count I

(3) On Count II, TLS's § 523(a)(6) claim Morgan's breach of the agreement, without more, is a breach of contract and not "willful" or "malicious" conduct.

The Amended Complaint is the second complaint filed in this case. The Court dismissed the first Complaint without prejudice and gave TLS a roadmap on how to cure the original Complaint's deficiencies. TLS did not address those shortcomings. Giving TLS an additional chance to do so would be indulging a repeated failure to cure deficiencies. Therefore, the Court dismisses this case with prejudice.

I. Jurisdiction and Venue

This is an adversary proceeding, and the Court has jurisdiction under the following:

(1) 28 U.S.C. § 1334(b) (discussing district court jurisdiction over cases arising out of title 11);

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(2) 28 U.S.C. § 157(a) and (b) (discussing referral of cases to bankruptcy courts and permitting bankruptcy judges to hear core proceedings);

(3) N.D. Ind. L.R. 200-1(a) (referring bankruptcy cases filed in the Northern District of Indiana to the bankruptcy court); and

(4) 28 U.S.C. § 151 (explaining bankruptcy court is a unit of district court).

This adversary proceeding is a core proceeding under 28 U.S.C. § 157(b)(2)(I) (giving bankruptcy judges the ability to determine the dischargeability of particular debts). Venue is properly placed in this Court, consistent with 28 U.S.C. § 94(a) (discussing divisions within the Northern District of Indiana) and N.D. Ind. L.B.R. B-1073-1 (addressing assignment of bankruptcy cases within this district).

II. Facts

The Court divides this fact section into two parts: (A) the facts leading to the state court judgment and (B) the facts in the complaints filed in this Court. Since this is a motion to dismiss, the Court accepts well-pleaded facts from the Amended Complaint as true and views them in the light most favorable to TLS. Demkovich v. St. Andrew the Apostle Par., Calumet City, 3 F.4th 968, 973 fn. 2 (7th Cir. 2021) (citing White v. United Airlines, Inc., 987 F.3d 616, 620 (7th Cir. 2021)); see also Gray v. Dane Cnty., 854 F.2d 179, 182 (7th Cir. 1988) ("[C]ourts must presume that all facts fairly alleged in the complaint are true."). However, "legal conclusions and conclusory allegations merely reciting the elements of the claim are not entitled to this presumption of truth." McCauley v. City of Chicago, 671 F.3d 611, 616 (7th Cir. 2011) (citation omitted).

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A. Facts leading to judgment in Illinois state court

1. TLS's predecessor

Tax Law Solutions, LLC, which would later become TLS Management and Marketing Services, LLC, was located in Illinois and provided tax analysis, tax planning, and related services. [Amend. Compl., DE 28 at ¶¶ 1, 4.] In 2014, it merged with TLS Management and Marketing Services. The surviving company uses the name TLS Management and Marketing Services. [Id. at ¶ 4.] Unless noted otherwise, the Court will refer to both parties as "TLS." As successor, TLS has Tax Law's rights and obligations, including the rights under the "Confidentiality and No-Competition Agreements" (the "agreement" or "contract").

2. TLS's provision of "Confidential Information"

In June 2011, Morgan signed the agreement.^[2] [Amend. Compl.'s Exh. A, State Ct. Compl., DE 28-1 at p. 22.] TLS provided Morgan with "Confidential Information." [Id. at p. 4, ¶¶ 11-12.]^[3]

The Confidential Information included things such as: business methods and procedures, prospective clients and agent lists, marketing channels and relationships, technical information, business plans, and identities of contractors and consultants. [Id. at p. 4.] The Confidential Information also included, a "copyrighted binder filled with hundreds of pages of Tax Law Solutions, LLC's

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specific tax-planning strategies, as well as implementation documents for those tax-planning strategies, sales materials and techniques, and contract templates." [Id. at p. 5.] In addition to giving Morgan Confidential Information, TLS trained Morgan to understand tax and financial planning techniques. [Id. at p. 4, ¶ 11.] This training would allow him to solicit prospective clients for TLS. [Id. at p. 5.] Morgan would then refer clients to TLS. [DE 28 at ¶¶ 13-15.]

3. Governing law

The agreement provides in that, in the event of a dispute, Illinois law governs. [DE 28-1 at p. 22, ¶ 4.11.]

4. Breaking the agreement

Initially, from June 2011 to July 2014, Morgan performed under the agreement. [Id. at pp. 2, 6.] Then, he broke the contract when he failed to solicit clients for and refer them to TLS. [Id. at p. 6, ¶¶ 21-24.] Morgan used TLS's videos to promote the same tax planning and related services TLS offered and continued to use TLS's Confidential Information. [DE 28 at ¶¶ 5, 23; DE 28-1 at pp. 5-6, ¶¶ 18, 19, 22.]

5. TLS's default judgment in state court

TLS sued Morgan in state court in DuPage County, Illinois. [DE 28 at ¶ 5.] The state court complaint alleged one count against Morgan - breach of contract. [DE 28-1 at pp. 2-3.] That complaint did not allege fraud, defalcation, embezzlement, larceny, theft, conversion, or willful or malicious conduct. [Id.] The state court complaint included the parties' contract as an exhibit.

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[DE 28-1 at pp. 18-22.] TLS won a $1.2 million default judgment against Morgan. [DE 28 at ¶¶ 7-9; State Ct. Judgment, DE 28-2 at p. 2.]

B. The first Complaint and Amended Complaint in this Court

1. Dismissal of first Complaint without prejudice

TLS's first Complaint alleged the $1.2 million dollar judgment it obtained against Morgan should be excepted from discharge on three grounds: (1) fraud, under § 523(a)(2); (2) fraud, embezzlement, or larceny under § 523(a)(4); and/or (3) willful and malicious conduct under § 523(a)(6). [Compl., DE 1.] Morgan moved to dismiss the Complaint with prejudice. [Amended Mot. to Dismiss, DE 14; Amend. Brief, DE 15.]

The Court granted Morgan's motion and explained its reasoning, including highlighting the issues with TLS's dischargeability claims. [Op. and Order, DE 26 at pp. 1, 3-9.] The Court explained, that for § 523(a)(4) arguments, the three types of fraudulent activity plaintiffs could allege are (1) fraud or defalcation while acting in a fiduciary capacity, (2) embezzlement, or (3) larceny. [Id. at pp. 7-9.] The Court granted Morgan's motion to dismiss but gave TLS leave to file an amended complaint. [Id. at p. 1.]

2. The two-count Amended Complaint

In the Amended Complaint, TLS alleges the Court should not discharge Morgan's debts in accordance with § 523(a)(4) and § 523(a)(6). [DE 28 at pp. 3, 4.]

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a) Count I: section 523(a)(4)

TLS lists facts it claims demonstrate Morgan violated § 523(a)(4) (which excepts debts from discharge when a debtor commits: fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny). Those facts are the following:

(1) Morgan misappropriated and "intentionally and fraudulently" used TLS's "training materials, confidential information, copyrighted materials, implementation strategies, [and] sales materials" without TLS's permission. [Id. at ¶¶ 6, 14, 16.]

(2) Morgan did not return "confidential information, and similar such actions raised in the [state court] Complaint." [Id. at ¶ 6.]

(3) TLS "entrusted" Morgan with confidential information, which included, "voluminous, copyrighted binder containing hundreds of pages of documents, thereby allowing Defendant to implement tax-planning strategies, market Defendant's business, and generate business for Defendant and Plaintiff." [Id. at ¶¶ 12-13.]

(4) Morgan had no right to use the confidential information unless he was working with or for TLS. [Id. at ¶ 16.]

(5) TLS "justifiably relied upon Defendant's false representations." [Id. at ¶ 17.]

b) Count II: section 523(a)(6)

For its § 523(a)(6) claim (which excepts debts from discharge for willful and malicious behavior), TLS alleges:

(6) Morgan had no right to use the confidential information to market or advertise tax planning services without referring clients to TLS. [Id. at ¶¶ 20, 21, 24.]

(7) Morgan created "the image that Defendant, despite