Professor Kenneth N. Klee on the Supreme Court's Holding in Bullock v. BankChampaign, N.A., 569 U.S. __, 2013 U.S. LEXIS 3521 (May 13, 2013)

Professor Kenneth N. Klee on the Supreme Court's Holding in Bullock v. BankChampaign, N.A., 569 U.S. __, 2013 U.S. LEXIS 3521 (May 13, 2013)

 Professor Kenneth Klee analyzes the May 13, 2013 Supreme Court ruling in Bullock v. BankChampaign, N.A. (In re Bullock) which settled a longstanding circuit split concerning the meaning of the word "defalcation" in the Bankruptcy Code exception to discharge in § 523(a)(4) by holding that "defalcation" requires a mental state of "gross recklessness."

Excerpt:

In a unanimous opinion authored by Justice Breyer, the Court held that the "defalcation" exception to discharge in section 523(a)(4) of the Bankruptcy Code requires a mental state of "gross recklessness." Bullock v. BankChampaign, N.A., 569 U.S. __, 2013 U.S. LEXIS 3521, at *5 (May 13, 2013) [an enhanced version of this opinion is available to lexis.com subscribers]. Relying heavily on a 135-year-old precedent and the canon of noscitur a sociis, the Court held that the term "defalcation," like its "statutory neighbors"-fraud, larceny, and embezzlement-should be construed to require a heightened standard of culpability. See id. at *11-14. Under the Court's new standard, "defalcation" requires either actual knowledge of wrongdoing or conscious disregard of a "substantial and unjustifiable risk." Id. at *12-13. In so holding, the Court reaffirmed the longstanding principle that exceptions to discharge are to be construed narrowly.

Legal Background:

As a general rule, an individual debtor is entitled to a discharge under the Bankruptcy Code. See 11 U.S.C. §§ 727, 1141(d), 1228(a), 1228(b) & 1328(b). Section 523(a), however, enumerates certain categories of debt that are non-dischargeable. In particular, section 523(a)(4) excepts from discharge "any debt - . . . for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny." 11 U.S.C. § 523(a)(4).

Prior to the Bullock case, the Supreme Court had not addressed the meaning of "defalcation" under § 523(a)(4), nor had it offered any guidance about the mental state that must be present in order for a fiduciary's actions to be characterized as "defalcation." "The lower courts have long disagreed about whether 'defalcation' includes a scienter requirement and, if so, what kind of scienter it requires." Bullock, 2013 U.S. LEXIS 3521, at *8. The First and Second Circuits require a showing of "extreme recklessness," which is akin to the scienter requirement in federal securities law. See, e.g., Rutanen ex rel. Quevillon v. Baylis (In re Baylis), 313 F.3d 9, 20 (1st Cir. 2002); Denton ex rel. Denton v. Hyman (In re Hyman), 502 F.3d 61, 68 (2d Cir. 2007). By contrast, the Fourth, Eighth, and Ninth Circuits hold that negligence or even an "innocent mistake" resulting in misappropriation or failure to account is sufficient to constitute defalcation. See, e.g., Republic of Rwanda v. Uwimana (In re Uwimana), 274 F.3d 806, 811 (4th Cir. 2001); Tudor Oaks Ltd. P'ship v. Cochrane (In re Cochrane), 124 F.3d 978, 984 (8th Cir. 1997); Blyler v. Hemmeter (In re Hemmeter), 242 F.3d 1186, 1191 (9th Cir. 2001). The Fifth, Sixth, Seventh, and Eleventh Circuits use an "objective recklessness" standard, which falls somewhere between extreme recklessness and mere negligence and requires a known breach of fiduciary duty. See, e.g., Schwager v. Fallas (In re Schwager), 121 F.3d 177, 185 (5th Cir. 1997); Patel v. Shamrock Floorcovering Servs., Inc. (In re Patel), 565 F.3d 963, 970 (6th Cir. 2009); Follett Higher Educ. Grp., Inc. v. Berman (In re Berman), 629 F.3d 761, 765 n.3 (7th Cir. 2011). The Supreme Court granted certiorari in Bullock to resolve this multi-direction circuit split.

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Lexis.com subscribers can access enhanced versions of the opinions and annotated versions of the statutes cited in this article:

Bullock v. BankChampaign, N.A., 569 U.S. __, 2013 U.S. LEXIS 3521 (May 13, 2013)

11 U.S.C. § 727, § 1141, § 1228, § 1328, § 523

Rutanen ex rel. Quevillon v. Baylis (In re Baylis), 313 F.3d 9 (1st Cir. 2002)

Denton ex rel. Denton v. Hyman (In re Hyman), 502 F.3d 61 (2d Cir. 2007)

Republic of Rwanda v. Uwimana (In re Uwimana), 274 F.3d 806 (4th Cir. 2001)

Tudor Oaks Ltd. P'ship v. Cochrane (In re Cochrane), 124 F.3d 978 (8th Cir. 1997)

Blyler v. Hemmeter (In re Hemmeter), 242 F.3d 1186 (9th Cir. 2001)

Schwager v. Fallas (In re Schwager), 121 F.3d 177 (5th Cir. 1997);

Patel v. Shamrock Floorcovering Servs., Inc. (In re Patel), 565 F.3d 963 (6th Cir. 2009);

Follett Higher Educ. Grp., Inc. v. Berman (In re Berman), 629 F.3d 761 (7th Cir. 2011)

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