U.S. Supreme Court Hears Arguments in Case of Debtor’s Alleged Defalcation

U.S. Supreme Court Hears Arguments in Case of Debtor’s Alleged Defalcation

WASHINGTON, D.C.- The U.S. Supreme Court today heard oral arguments in a case involving a bank's claim that a debtor who had acted as trustee for his father's insurance trust acted recklessly and was guilty of defalcation for making loans to himself during the time he had control of the trust (Randy Curtis Bullock v. BankChampaign, No. 11-1518, Chapter 7, U.S. Sup.) (lexis.com subscribers may access Supreme Court briefs for this case).

Randy Curtis Bullock filed for Chapter 7 bankruptcy in the U.S. Bankruptcy Court for the Northern District of Alabama. 

Insurance Trust

Prior to his bankruptcy, Bullock had been appointed the trustee of his father's life insurance trust, and during the time he held that position, Bullock took out three loans from the trust.  Despite the fact that the loans were all repaid with interest, Bullock's two brothers - two of the five beneficiaries of the trust - sued Bullock in the Vermilion County, Ill., Circuit Court, alleging breach of fiduciary duty.

The Circuit Court did not find that Bullock committed a knowing or deliberate breach of fiduciary duty, but it granted summary judgment in favor of Bullock's brothers because the fully repaid loans were deemed self-dealing transactions and, thus, breaches of fiduciary duty under Illinois law. 

Bullock filed his bankruptcy petition shortly after that ruling, and BankChampaign, as successor trustee, filed an adversary proceeding in the Bankruptcy Court, seeking a ruling that Bullock's obligations under the Illinois judgment were nondischargeable under 11 U.S. Code Section 523(a)(4).

11 U.S. Code Section 523

The Bankruptcy Court granted BankChampaign's motion for summary judgment dismissal, and Bullock appealed to the U.S. District Court for the Northern District of Alabama, which affirmed. Bullock appealed to the 11th Circuit U.S. Court of Appeals, which affirmed yet conceded that among the circuit courts, there is a split regarding the definition of "defalcation." 

Bullock appealed to the Supreme Court, arguing that the high court needs to rule on the case to resolve the split among the federal appellate courts. 

Bullock's attorney, Thomas M. Byrne, argued that the case at hand "presents one of the most confounding questions of bankruptcy law,"in that it seeks to determine the meaning of "defalcation," which is found in 11 U.S. Code Section 523(a)(4).

Byrne contended that "defalcation" is an undefined term in the Bankruptcy Code, which contains more than 100 defined terms, and that there is no plain contemporary, ordinary meaning that the parties can resort to with respect to interpretation because "defalcation" is not in common use.

Recklessness Alleged

Byrne argued that a showing of extreme recklessness at least is required as to the charges that Bullock engaged in self-dealing. There is uncontradicted evidence that Bullock did not know that making a loan to his mother at his father's request would somehow run afoul of the law, Byrne contended.

Justice Ruth Bader Ginsburg asked Byrne about the other loans that Bullock made to himself, to which Byrne replied: "These are two loans that went into the business created by the father and the mother, the garage building business. That's where the proceeds went. And so it would have been a surprise, we say, to the average person to learn that there was a legal problem with those loans."

Arguing for BankChampaign, Ben D. Bensinger said Bullock's actions constituted self-dealing that was a reckless breach of his fiduciary duty of loyalty; therefore, it was a defalcation.

Bensinger maintained that the moment Bullock made those loans, there was "an absolute certainty" that there would be a conflict of interest, and a reasonable person would not have made those loans because the risk was so high.

Intent

Moreover, Bensinger argued that a finding of embezzlement requires some sort of specific mental intent, an intent to deceive or to defraud. Defalcation, however, does not require that same mental intent, and that is borne out by the historyof the Bankruptcy Act, Bensinger added.

Defalcation was first added to the Bankruptcy Act in 1841, and it was simply an exception to discharge for defalcation, Bensinger said. There was no mention of fraud, there was no mention of embezzlementand there was no mention of larceny, he added.

It wasn't until the enactment of the Bankruptcy Act of 1867 that Congress added an exception to discharge for embezzlement and for fraud, Bensinger said.

Justices Steven G. Breyer and Antonin Scalia challenged Bensinger's contention that Bullock acted recklessly.Justice Sonya Sotomayor pressed further, saying that if the trust received all of its money back,she wondered how anyone could argue that there was a case of defalcation or recklessness.

Byrne is with Sutherland Asbill & Brennan in Atlanta. Bensinger is with Baker Donelson Bearman Caldwell & Berkowitz in Birmingham, Ala.

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