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."
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
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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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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