US high court takes up bankruptcy misconduct case

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The U.S. Supreme Court will decide whether a judgment against a debtor for breaching the terms of a trust constitutes “defalcation” under the Bankruptcy Code and therefore disqualifies that debt from a bankruptcy discharge. The debtor in the case was the trustee of his father’s trust. A state court entered a judgment against the debtor for $285,000 for breaching the terms of the trust by self-dealing – specifically, making loans to himself from the trust’s assets.

The debtor later filed for bankruptcy and sought to discharge the judgment under Chapter 7. The bankruptcy court concluded that the debtor could not discharge the judgment because he had been found to have breached his fiduciary duty by engaging in self-dealing and concluded that such conduct amounted to “fraud or defalcation while acting in a fiduciary capacity, embezzlement or larceny” under §523(a)(4) of the Bankruptcy Code.

A federal district court affirmed. The 11th Circuit also affirmed, rejecting the debtor’s argument that self-dealing did not fall within the meaning of the statute.

The debtor “knowingly benefitted from the loans,” the court reasoned. “Thus, his conduct can be characterized as objectively reckless, and as such, it rises to the level of a defalcation under §523(a)(4).”

A decision from the Supreme Court is expected later this term.

Bullock v. BankChampaign, No. 11-1518 . Certiorari granted: Oct. 29, 2012.