Bullock v. BankChampaign, N.A., 133 S.Ct. 526 (U.S. October 29, 2012) [docket]
Trusts and estates cases rarely make it to the U.S. Supreme Court, so when they do it’s big news [e.g., see here]. This time around the Supreme Court’s granted cert in a case arising out of our very own 11th Circuit in Bullock v. BankChampaign, N.A. (In re Bullock), 670 F.3d 1160 (11th Cir.2012). The case involves a former trustee (Mr. Bullock) who declared bankruptcy in order to wipe away a breach of trust judgment.
Under 11 U.S.C. § 523(a)(4) a judgment entered against a fiduciary for fraud or misappropriation of trust funds (i.e., “defalcation“) is not dischargeable in bankruptcy. I’ve previously written about this rule here and here as applied both to trustees and personal representatives.
What’s interesting about this case is that all of the courts who have reviewed the facts agree the trustee’s actions giving rise to the original judgment against him actually caused no economic harm to the trust’s assets and that he apparently acted innocently at all times. For a good summary of the facts see here, here. Based on these facts, the U.S. Supreme Court’s going to have to decide what level of mens rea (if any) is necessary to trigger the non-discharge rule for defalcation by trustees.
Here’s how the “question presented” for the Supreme Court in this case was framed by the trustee:
What degree of misconduct by a trustee constitutes “defalcation” under §523(a)(4) of the Bankruptcy Code that disqualifies the errant trustee’s resulting debt from a bankruptcy discharge – and does it include actions that result in no loss of trust property?
According to the 11th Circuit’s opinion, there’s a wide split among the circuit courts as to the meaning of defalcation under § 523(a)(4).
This Court recognizes that there is a split among the circuits regarding the meaning of defalcation under § 523(a)(4). . . .
The Fourth, Eighth, and Ninth Circuits have concluded that even an innocent act by a fiduciary can be a defalcation. . . .
The Fifth, Sixth, and Seventh Circuits require a showing of recklessness by the fiduciary. . . .
The First and Second Circuits require a showing of extreme recklessness. . . .
The Third Circuit has not addressed the issue, and the Tenth Circuit has made the brief statement in an unpublished opinion that defalcation requires some portion of misconduct.
The trustee unsuccessfully argued in favor of the 1st and 2d Circuits’ “extreme recklessness” standard, which apparently would have resulted in a win for him. The 11th Circuit instead adopted the non-extreme recklessness standard applied by the 5th, 6th and 7th Circuits. The 11th Circuit held the former trustee’s judgment should NOT be discharged because even if he acted innocently, as a trustee he should have known his actions were improper, thus he acted recklessly.
Applying the recklessness standard for defalcation to the facts of the instant case, this Court concludes that the bankruptcy court was correct in determining that Bullock committed a defalcation by making the three loans while he was the trustee of his father’s trust. Because Bullock was the trustee of the trust, he certainly should have known that he was engaging in self-dealing, given that he knowingly benefitted from the loans. Thus, his conduct can be characterized as objectively reckless, and as such, it rises to the level of a defalcation under § 523(a)(4). Accordingly, the bankruptcy court’s order must be affirmed on the issue of whether the Illinois judgment debt was non-dischargeable under § 523(a)(4) as a debt arising from a defalcation while Bullock was acting in a fiduciary capacity.
What do we mean by “defalcation” as applied to fiduciaries, and should we apply a strict-liability standard for culpability or require some level of intentional malfeasance? These are fundamental questions for any trusts and estates litigator, which will make the U.S. Supreme Court’s take on this case a must-read even if (like me) you have no intention of ever setting foot in a bankruptcy court. Stay tuned for more . . .