Supreme Court Decisions

Defalcation? (Yes that’s a real word)

2013 May 16 by

A debt may not be discharged in bankruptcy if it was the result of “defalcation.” What in the world is that? Is that even a word?

Well … the terms is not defined in the bankruptcy code. (Way to go congress!) And there has been enough confusion over the term for our United States Supreme Court to issue a ruling on its definition.

In 13 years of bankruptcy practice this word has come up once. It was in a recent case against a client of ours who had allegedly mishandled funds while handling his parent’s estate after they died. The Colorado Bankruptcy Court, in that case, found that our client’s behavior fell within the term “defalcation.” We appealed, in part, because we knew the Supremes had take up the same issue and would have a ruling on it this year.

Robin Miller with Consumer Bankruptcy Abstracts & Research has published a summary/excepts of the Supreme Court’s decision issued earlier this week. (By the way, you may need a dictionary to read this too. It’s good lawyerly writing).

Supreme Court holds that “defalcation” in Code § 523(a)(4) requires culpable state of mind:

Observing that “[t]he lower courts have long disagreed about whether ‘defalcation’ includes a scienter requirement and, if so, what kind of scienter it requires,” the Supreme Court, in a unanimous decision by Justice Breyer, held that “defalcation,” for the purpose of the discharge exception found at Code § 523(a)(4), includes a culpable state of mind requirement involving knowledge of, or gross recklessness in respect to, the improper nature of the relevant fiduciary behavior. Noting that, in Neal v. Clark, 95 U.S. 704, 24 L.Ed. 586 (1878), the Court had construed “fraud” as meaning “positive fraud, or fraud in fact, involving moral turpitude or intentional wrong, … and not implied fraud, or fraud in law, which may exist without the imputation of bad faith or immorality,” the Court concluded that the statutory term “defalcation” should be treated similarly.

This interpretation does not make the word identical to its statutory neighbors, the Court said. As commonly used, “embezzlement” requires conversion, and “larceny” requires taking and carrying away another’s property. “Fraud” typically requires a false statement or omission. “Defalcation,” as commonly used (hence as Congress might have understood it), can encompass a breach of fiduciary obligation that involves neither conversion, nor taking and carrying away another’s property, nor falsity. Nor are embezzlement, larceny, and fiduciary fraud simply special cases of defalcation as so defined. Code § 523(a)(4) makes clear that embezzlement and larceny apply outside of the fiduciary context, while “defalcation,” unlike “fraud,” may be used to refer to nonfraudulent breaches of fiduciary duty.

Bullock v. BankChampaign, N.A., 2013 WL 1942393 (May 13, 2013)

Any Questions? Clear as Mud?

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