Virginia’s Uniform Trade Secrets Act Given New Teeth under Bankruptcy Code Sec. 523(a)(4)

A recent decision from the United States Bankruptcy Court for the Eastern District of Virginia provides new teeth for businesses that bring claims under the Virginia Uniform Trade Secrets Act.  In this decision, the Bankruptcy Court held that a state court finding of willful and malicious misappropriation of trade secrets incorporates all of the elements necessary to support a determination that the debt is nondischargeable in a subsequently-filed bankruptcy case.  Often, businesses that have been harmed by having their valuable intellectual property stolen were frustrated in enforcing judgments after the perpetrators declared bankruptcy and sought to have the judgments discharged.  But in this decision, the Bankruptcy Court stopped the judgment debtor’s effort cold, holding that the judgment was nondischargeable.

In La Bella Dona Skin Care, Inc. v. Harton (In re Harton)*, Adv. P. No. 13-03028-KRH (E.D. Va. Bankr. Oct. 1, 2013), the plaintiff, a med-spa salon, previously obtained a state court judgment against the defendant, a Virginia resident, for willful and malicious misappropriation of trade secrets under relevant provisions of the Virginia Trade Secrets Act.  The actions of the defendant giving rise to the judgment were egregious.  While still employed with the plaintiff, defendant started her own competing salon.  Days after her new business was organized, she entered her employer’s offices after hours, accessed its computer, and printed out a customer contact list and three months’ worth of scheduled appointments.  Using the customer list, the defendant mailed over 2,000 postcards to the plaintiff’s existing customers, leading the customers to believe that the plaintiff’s business moved to a new location.  She then contacted customers with scheduled appointments to get them to change in favor of the defendant’s new and competing salon.  The dollar value of the scheduled appointments exceeded $100,000.

The state court found that the defendant “did not rightly access the client list,” and that her use of a master password to obtain after-hours access to plaintiff’s computer was unauthorized.  The state court also found that the misappropriation occurred while defendant was still an employee and that the misappropriated list was used to contact and mislead a large number of plaintiff’s clients.  From these facts, the state court concluded that the misappropriation was both willful and malicious.

Defendant subsequently commenced a Chapter 13 case in the Bankruptcy Court.  The plaintiff in turn filed a complaint against the defendant in the bankruptcy court seeking a determination that the judgment awarded by the state court was nondischargeable under 11 U.S.C. §523(a)(4), which excepts from discharge any debt resulting from embezzlement or larceny.  Plaintiff then filed a motion for judgment on the pleadings pursuant to Federal Rule 12(c), contending that the pleadings alone clearly demonstrated that there existed no material issue of fact that needed to be tried, that defendant was collaterally estopped from re-litigating the issues previously adjudicated in the state court, and that the state court judgment incorporated all of the elements necessary for a determination of nondischargeability.

The defendant argued that “willful and malicious” torts are not excepted from discharge in Chapter 13 cases.  In fact, Chapter 13 expressly excludes the provisions of section 523(a)(6) of the Bankruptcy Code, which excepts from discharge debts for “willful and malicious injury.”  But the bankruptcy court found that the state court determination of “willful and malicious misappropriation” fell within the scope of section 523(a)(4), regardless of the applicability of section 523(a)(6).  The bankruptcy court noted that: “Bankruptcy courts are not bound by the state law definition of larceny but may follow federal common law.  Under federal common law, larceny is the felonious taking of another’s personal property with the intent to convert it or deprive the owner of the same.”  While the defendant’s intentional tort shared all of the elements of the kind excepted from discharge under section 523(a)(6), the court found that it contained one additional element that placed it squarely within the provisions of section 523(a)(4): defendant’s realization of the value of the property that she took for her own benefit.  A “knowing theft” therefore satisfied the requirements of larceny within the meaning of section 523(a)(4).

Since the state court’s determination of willful and malicious misappropriation of the plaintiff’s client list was sufficient to establish the elements essential to defendant’s liability for larceny under section 523(a)(4), the defendant was precluded from re-litigating the issues in the Bankruptcy Court.  The state court judgment was therefore held to be nondischargeable.  This decision provides new teeth to claims under the Virginia Uniform Trade Secrets Act and puts defendants on notice that they may not seek the refuge of bankruptcy if they are found liable under the Act.

*Redmon, Peyton & Braswell, LLP represented La Bella Dona Skin Care in the state court action for actions against the debtor and other individuals for misappropriation of trade secrets.

La Bella Dona Skin Care, Inc-v-Erika Brooke Harton-Opinion (PDF)

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Making New Law, the EDVA Bankruptcy Court Allows a Debtor Corporation to Sue its Own Successor

The Bankruptcy Court of the Eastern District of Virginia recently extended the reach of trustees standing in the shoes of debtor corporations to pursue assets that were transferred to successor entities prior to a bankruptcy petition. Judge Keith L. Phillips of the Richmond Division did not let the lack of prior precedent stand in his way, stating, “Although there appears to be no Virginia case specifically stating that a corporate entity may pursue a successor liability claim against its alleged successor in interest, there is also no case that prohibits such an application of successor liability theory.” This new precedent will be useful to creditors and trustees that seek to recover assets that have been transferred to new, successor entities, leaving behind only liabilities with the previous entity.

In In re: Anderson & Strudwick, Inc., Adv. Proc. No. 14-03175-KLP (E.D. Bkr. Apr. 8, 2015), the bankruptcy trustee, standing in the shoes of the Chapter 7 debtor corporation, asserted a claim for successor liability against Counterclaim Defendants Sterns Agee Group, Inc. and Sterne, Agee & Leach, Inc. (together, “Sterne Agee”). A successor liability claim seeks to tag a new entity with the liability of a previous entity, and it is an exception to the general rule of limited corporate liability. As a practical matter, these fact-intensive claims often appear alongside fraudulent conveyance claims and are frequently invoked by creditors attempting to collect on prior judgments or obligations against entities that have sold their assets in bulk.

According to the trustee’s counterclaim, Stern Agee purchased most, if not all, of the assets from the debtor three years prior to the debtor being put into involuntary bankruptcy. In addition to the asset purchase, Sterne Agee allegedly hired most of the debtor’s employees, including all but one of the debtor’s former directors. All of the debtor’s branch office managers allegedly moved over to similar positions at Sterne Agee. The debtor’s previous president and CEO allegedly became a senior managing director at Sterne Agee, and the majority of the debtor’s sales force also allegedly moved to Sterne Agee. Finally, the trustee alleged that Sterne Agee published a press release stating that it would continue service of the debtor’s customers, and the customers would see no change from their previous experience with the debtor.

Stern Agee’s purchase agreement with the debtor, however, excluded all liabilities of the debtor that were not necessary for the continued operation of the debtor’s business, according to the Counterclaim. This left the debtor with no remaining assets with which to operate its business or pay its remaining liabilities, and this led to the Trustee’s claim for successor liability against Sterne Agee.

Sterne Agee moved to dismiss the trustee’s claim on the grounds that Virginia law did not authorize a claim by a corporation against its own successor entity (normally, successor liability claims are brought by the third-party creditors of the defunct entity). Judge Phillips, after citing the alleged connections described above between the debtor and Sterne Agee, held that these allegations sufficiently stated a claim for successor liability. He then examined whether the debtor could bring such a claim against its own successor entity and concluded that no prior Virginia case law prevented the trustee’s claim. The judge relied upon prior Fourth Circuit precedent in Steyr-Daimler-Puch of Am. Corp. v. Pappas, 852 F.2d 132, 135-36 (4th Cir. 1988) which held that if state law authorizes an alter ego claim by a corporation, then that claim passes into the bankruptcy estate and to the trustee after a petition is filed. Judge Phillips analogized an alter ego claim to a successor liability claim, and finally concluded that the successor liability claim was not specific to any one creditor and any recovery would only benefit the bankruptcy estate (and all creditors). Thus, Judge Phillips allowed the odd situation of a debtor entity asserting a successor liability claim against its own successor.

There will be no appellate review of Judge Phillips’s decision because the parties ultimately settled their claims prior to trial. Thus, the judge’s decision will stand, and it provides a useful tool for creditors and trustee counsel looking to assert successor liability claims involving Virginia state law.