In a case appealed from the Eleventh Circuit Court of Appeals, the United States Supreme Court ruled on a case involving the definition of "defalcation" in 11 U.S.C. § 523(a)(4). The case, decided yesterday, May 13, 2013, is Randy Bullock v. BankChampaign NA, 2013 U.S. LEXIS 3521 (U.S. May 13, 2013) (click here for .pdf of opinion). The issue before the Court was the definition and meaning of the term "defalcation," which is not defined in the Code. The Court held that “defalcation” in the Bankruptcy Code includes a culpable state of mind requirement involving knowledge of, or gross recklessness in respect to, the improper nature of the fiduciary behavior.
Section 523(a)(4) provides that:
(a) A discharge under section 727, 1141, 1228 (a), 1228 (b), or 1328 (b) of this title does not discharge an individual debtor from any debt— (4) for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.
The brief facts of this case are the following. In 1978, Debtor’s father established a Trust for his five children and made Debtor the trustee. The sole asset of the Trust was an insurance policy, and the Trust allowed the Debtor to borrow against the policy. Debtor subsequently borrowed money from the Trust and used the funds to purchase property and a mill for himself and his mother. Debtor repaid the borrowed funds.
Debtor’s siblings filed suit in state court, and the court held that Debtor breached his fiduciary duties in the self-dealing, albeit without malicious motive. The court awarded damages of the "benefits he received from his breaches" plus attorneys fees and costs, and appointed BankChampaign as the constructive trustee of the properties and mill. Debtor was unable to liquidate his interests to pay the judgment, and filed for Bankruptcy. The Bank sought an exception to the Debtors discharge pursuant to section 523(a)(4) based on the alleged defalcation while acting in a fiduciary capacity. The Bankruptcy Court held in favor of the Bank, and the decision was affirmed by the District Court and the Eleventh Circuit (click here for Eleventh Circuit opinion). Debtor appealed to the Supreme Court, contending that the debt should not be excepted from discharge absent ill intent or loss of trust principal. As there was a disagreement on the issue among the lower courts, the Supreme Court granted the petition.