Defalcation is an act of misappropriating funds that were entrusted to a person. The person who is entrusted with the funds is called the fiduciary. For instance, your friend wins $2.0 million in the lottery. He gives you the money and asks you to manage the money for him for one year. You give him a cyanide smoothie when it’s time for you to return the money to him. The smoothie kills him. Instead of managing the money for him, you gambled the money away at Las Vegas. His relatives file a lawsuit against you to collect the $2.0 million plus damages of $500,000. You file for Chapter 7 relief because you cannot pay the $2.5 million they are asking for. The relatives file an adversary complaint objecting to the discharge of the $2.5 million arguing that you defalcated as a fiduciary; therefore the debt is not dischargeable. Are they correct? Well, this question is really irrelevant because you are going to jail for the rest of your life for murder. Remember the cyanide smoothie?

Section 523(a)(4) of the bankruptcy code states that debts arising from “fraud or defalcation while acting in a fiduciary capacity, embezzlement or larceny” are not dischargeable.

The U.S. Supreme Court on October 29, 2012 granted certiorari in a non-dischargeability case, Bullock v. BankChampaign. The 11th Circuit Court of Appeals held in the decision below, In re Bullock, that “defalcation” within the meaning of Section 423(a)(4) requires a showing of recklessness by the fiduciary. The question before the Supreme Court is, “What degree of misconduct by a trustee constitutes ‘defalcation’ under Section 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?” The trustee in the question refers to the debtor, who was the trustee of his father’s trust. The sole asset of the trust was a life insurance policy. The trust had borrowing restrictions which the debtor disregarded when he borrowed from the trust on three occasions. And even though he repaid the loans in full, the debtor’s siblings and fellow beneficiaries under the trust sued him because of his self-dealing. “What self-dealing are you talking about? My financial consultant, Mr. Bernie Madoff, has advised me that there was nothing morally and legally wrong with what I did…” the debtor said.