Page 29 - John Hundley 2013

Bankruptcy Law Roundup

Sharp Thinking

No. 94 Perspectives on Developments in the Law from The Sharp Law Firm, P.C. July 2013

“Defalcation” Exception to Bankruptcy Discharge

Requires At Least Gross Recklessness, Court Holds

The term “defalcation” in § 523(a)(4) of 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, the U.S. Supreme Court held recently.

Section 523(a)(4) 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 a long-
awaited decision, the Supreme Court held that the “defalcation” clause “includes a culpable state of
mind requirement akin to that which accompanies application of the other terms in the same statutory
phrase.” Bullock v. BankChampaign, N.A., __ U.S. __, 133 S.Ct. 1754 (2013).

In Bullock, petitioner’s father established a trust for the benefit of petitioner and his siblings, and
made petitioner the trustee. Petitioner borrowed funds from the trust three times; all borrowed funds
were repaid with interest. His siblings obtained a judgment against him in state court for breach of
fiduciary duty, though the court found no apparent malicious motive. After the petitioner filed for
bankruptcy, the respondent opposed discharge of petitioner’s state-court-imposed debts, and the
Bankruptcy Court held that the debts were not dischargeable pursuant to § 523(a)(4).

Noting that dictionaries and legal authorities have disagreed as to the state of mind required for
“defalcation,” the court based its decision on precedent interpreting “fraud” in the discharge-exception
statute. “[W]here the conduct at issue does not involve bad faith, moral turpitude, or other immoral
conduct, the term requires an intentional wrong,” the court said. “We include as
intentional not only conduct that the fiduciary knows is improper but also reckless
conduct of the kind that the criminal law often treats as the equivalent. Thus, we
include reckless conduct of the kind set forth in the Model Penal Code. Where
actual knowledge of wrongdoing is lacking, we consider conduct as equivalent if
the fiduciary ‘consciously disregards’ (or is willfully blind to) ‘a substantial and
unjustifiable risk’ that his conduct will turn out to violate a fiduciary duty.”

Debt Cancellation A Proper Punitive Damage for Stay Violation

Cancellation of a bankruptcy debtor’s debt to a wrongfully repossessing creditor is an appropriate
punitive damage under § 362(k) of the Bankruptcy Code, a federal district court in Alabama has held.

In Credit Nation Lending Serv., LLC v. Nettles, 489 B.R. 239 (N.D. Ala. 2013), the creditor had
repossessed the debtors’ vehicle post-petition with knowledge of the bankruptcy, had refused to

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Sharp Thinking is an occasional newsletter of The Sharp Law Firm, P.C. addressing developments in the law which may be of interest. Nothing contained in Sharp
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