Bankruptcy is intended to provide a fresh start and discharge outstanding debt.  But some debt is not dischargeable in bankruptcy.  A Virginia bankruptcy court held last week that a judgment against the debtor for intentional trade secret misappropriation is not dischargeable.

Summary of the case.  La Bella Dona Skin Care, Inc. obtained a $207,000 judgment in a Virginia state court against its ex-employee Harton for conduct that the court held to be willful and malicious misappropriation of La Bella Dona’s trade secrets.  Thereafter, she filed a voluntary petition for a Chapter 13 bankruptcy adjudication.  In the bankruptcy proceeding, La Bella Dona filed an adversary proceeding seeking a determination that the judgment debt was not dischargeable in bankruptcy.  After Harton answered the adversary complaint, admitting most of the salient facts but asserting that the debt was dischargeable, La Bella Dona moved for judgment on the pleadings.  The motion argued that the doctrine of res judicata precluded her from challenging the state court holding that the misappropriation was willful and malicious, and that such conduct is not dischargeable under the Bankruptcy Code.  Last week, the bankruptcy court granted the motion and held that the findings made and judgment entered by the state court could not be re-litigated by Harton in the bankruptcy court.  In re Harton (La Bella Dona Skin Care, Inc. v. Harton), Ch. 13 Case No. 12-36221-KRH (Adversary Proceeding No. 13-3028-KRH) (Bkrcy Court, E.D. Va., Oct. 1, 2013).

State court decision.  The bankruptcy court found that the following facts were uncontested:  La Bella Dona conducted what the bankruptcy court called a “med-spa business.”  While Harton still was employed by La Bella Dona, she incorporated a competing salon.  A few days later, after La Bella Dona’s salon had closed for the day, she entered the salon and accessed her employer’s computer.  She printed out both the appointment schedule for the next 60 days and contact information for her employer’s clients.  Then, Harton opened her own salon nearby.  Using La Bella Dona’s contact list, she mailed postcards to 2,000 of its clients and stated on the postcards: “We’ve Moved – same faces – new location.”  She also phoned or emailed each client who had a confirmed, upcoming appointment.  Many cancelled their appointments with :La Bella Dona and came to Harton’s salon.  La Bella Dona sued her in state court which concluded that she had willfully and maliciously misappropriated her former employer’s trade secrets.

The Bankruptcy Code.  Section 523(a)(6) of the Code (11 U.S.C. §523(a)(6)) provides that “a debt for willful and malicious injury by the debtor” is excepted from the discharge provisions.  However, that section has been held not to apply to Chapter 13 bankruptcies.  Section 523(a)(4), which has been held to apply in any bankruptcy proceeding, states that a debt resulting from embezzlement or larceny is not dischargeable, but the state court did not find that Harton committed “embezzlement or larceny.” 

The bankruptcy court’s decision.  Citing bankruptcy court cases from other jurisdictions, the Virginia bankruptcy court held that a state court judgment for knowing misappropriation of trade secrets constitutes “larceny” as that word is used in §523(a)(4).   Consequently, the judgment debt against Harton is enforceable notwithstanding her adjudication as a bankrupt.

Takeaways.  The decision in La Bella Dona is harsh but understandable.  The Bankruptcy Code does not relieve all intentional wrongdoers from the consequences of their misconduct.  When a victim of trade secret misappropriation obtains a money judgment (in addition to or in lieu of injunctive relief), a finding that the miscreant acted willfully and maliciously may serve to protect the money judgment against being discharged by the debtor’s bankruptcy adjudication.