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Nondischargeable Debt: Defalcation or Breach of Fiduciary Duty

Published March 14, 2014 by Sasser Law Firm

Not every debt is dischargeable in bankruptcy. Some of the more common nondischargeable debts include student loans and recent income tax debt. Another, but less common, nondischargeable debt is for defalcation of fiduciary duty. The term defalcation, though, has been defined with various nuances over the years by lower courts. In May 2013, the Supreme Court of the United States issued a unanimous opinion in the case Bullock v. Bankchampaign, NA, 133 S. Ct. 1754 (2013) addressing the meaning of defalcation in adversary proceedings in bankruptcy court.

Section 523(a)(4) of the Federal Bankruptcy Code provides that an individual cannot obtain a bankruptcy discharge from a debt “for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.” In Bullock, the Court needed to decide the scope of the term “defalcation.”  Opting for a heightened definition, the Court held that defalcation includes a culpable state of mind requirement. The state of mind must be one involving knowledge of, or gross recklessness in respect to, the improper nature of the relevant fiduciary behavior.

As to the facts of the Bullock case, in sum, the fiduciary in the case was the (nonprofessional) trustee of a trust created by his father. The trust had a single asset, an insurance policy on the father’s life. The trustee borrowed money from the trust against the insurance policy at various times and for various uses, but he always saw that all of the borrowed funds were repaid to the trust along with a required 6% rate of interest.

In 1999, the other beneficiaries of the trust, who were also the trustee’s brothers, sued him in state court and obtained a judgment against him for committing breach of fiduciary duty. The trustee did not appear to have had a malicious motive in borrowing funds from the trust and always repaid the funds, but nonetheless the trustee was involved in self-dealing and was found at fault.

The trustee could not pay the judgment against him and filed a bankruptcy case. An adversary proceeding was then brought against the trustee in bankruptcy court and it was alleged that the judgment was a nondischargeable debt. Ultimately, the Supreme Court opined that the trustee had been held to an incorrect standard for defalcation, i.e., that defalcation includes a culpable state of mind and the trustee was never found to have had that. The Supreme Court then sent the case back down to the bankruptcy court to apply the appropriate heightened standard for defalcation.

Defalcation of fiduciary duty is not a typical allegation a person might face in a bankruptcy case, and the Bullock case makes proving the allegation even more difficult. Sasser Law Firm welcomes cass defending or pursuing claims for defalcation of fiduciary duty in adversary proceedings. If you have a case in eastern North Carolina, and particularly the greater Raleigh area, and need help in any type of adversary proceeding, please do not hesitate to give us a call.

A copy of the Bullock opinion at the U.S. Supreme Court can be found be clicking here.

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