WASHINGTON, D.C. - (Mealey's) The U.S. Supreme Court on
May 13 unanimously vacated and remanded a case involving a bank's claim that a
debtor who had acted as trustee for his father's insurance trust was guilty of
defalcation for making loans to himself during the time he had control of the
trust, ruling that the 11th Circuit U.S. Court of Appeals needed to review the
case to determine if it should apply the higher standard of "defalcation"
outlined by the high court (Randy Curtis Bullock v. BankChampaign, No.
11-1518, Chapter 7, U.S. Sup.)
subscribers may access Supreme Court briefs and the opinion for this case).
Randy Curtis Bullock filed for Chapter 7 bankruptcy in
the U.S. Bankruptcy Court for the Northern District of Alabama.
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.
11 U.S. Code Section 523
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).
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
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, had argued at the
Supreme Court that the case at hand "presents one of the most confounding
questions of bankruptcy law" and contended that "defalcation" is an undefined
term in the Bankruptcy Code, which contains more than 100 defined terms,
without a plan or contemporary meaning.
Arguing for BankChampaign, Ben D. Bensinger had told the
Supreme Court that Bullock's actions constituted self-dealing that was a
reckless breach of his fiduciary duty of loyalty and, therefore, it was a
Justice Stephen G. Breyer, writing for a unanimous U.S.
Supreme Court, said that the term "defalcation" in 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. Moreover, while
"defalcation" has been an exception to discharge in a bankruptcy statute since
1867, legal authorities have long disagreed about its meaning, the Supreme
The panel said that Congress first included the term
"defalcation" as an exception to discharge in a federal bankruptcy statute in
1867 and that legal authorities have disagreed about its meaning "almost ever
since." Similarly, courts of appeals have long disagreed about the mental
state that must accompany the bankruptcy related definition of "defalcation,"
the Supreme Court added.
"In resolving these differences, we note that this longstanding
disagreement concerns state of mind, not whether 'defalcation' can cover a
trustee's failure (as here) to make a trust more than whole," the Supreme Court
concluded. "We consequently shall assume without deciding that the statutory
term is broad enough to cover the latter type of conduct and answer only the
'state of mind' question."
The Supreme Court held that "where the conduct at issue
does not involve bad faith, moral turpitude, or other immoral conduct, the term
requires an intentional wrong. 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."
The Supreme Court added said it included "reckless
conduct of the kind set forth in the Model Penal Code." Furthermore,
where actual knowledge of wrongdoing is lacking, we consider conduct as
equivalent if the fiduciary "consciously disregards a substantial and
unjustifiable risk" that his conduct will turn out to violate a fiduciary duty,
the panel said.
In this case, the 11th Circuit applied a standard of "objectiv[e]
reckless[ness]" to facts presented at summary judgment, the Supreme Court said.
"We consequently remand the case to permit the court to determine whether
further proceedings are needed and, if so, to apply the heightened standard
that we have set forth."
Byrne is with Sutherland Asbill & Brennan in Atlanta. Bensinger is with
Baker Donelson Bearman Caldwell & Berkowitz in Birmingham, Ala.
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