Arcane bankruptcy term gets clarity from Justices

On Behalf of | May 20, 2013 | Chapter 7 Bankruptcy |

Words have a way of becoming obscure over time. This should come as no surprise to Texas readers. Considering that codified law goes back thousands and thousands of years, words are bound to fall into disuse and their meaning forgotten.

This can cause problems in the law, though. How are we supposed to apply the tenets that are intended if we don’t know what they mean. This is an issue that has swirled around the word “defalcation” in the context of bankruptcy in the United States for more than 100 years. Recently, though, the U.S. Supreme Court brought the term into the 21st century.

The decision potentially helps one Illinois man in a Chapter 7 bankruptcy petition. It should also help pave the way to clarity in some bankruptcy cases going forward.

Defalcation has been a term in bankruptcy code since 1841. What it does is bar a person with fiduciary responsibilities over assets from getting bankruptcy protection if there is evidence of “fraud or defalcation.” The meaning of fraud is pretty straight forward, but the meaning of defalcation had gotten lost.

Writing for the court in a unanimous decision, Justice Stephen Breyer declared that defalcation should be taken to be similar to fraud. Specific to this case, it appears to work in favor of the individual seeking bankruptcy protection. Fraud does not seem to be apparent and a bankruptcy court has been told to reexamine the case.

At issue is the Illinois man’s request to discharge debt he was ordered to pay in connection with a legal fight with two brothers. The man had been the sole trustee of a $1 million trust created when his father died. At various times, he issued some loans. Two he benefited from personally.

He paid back all the money with interest, but his brothers sued him for breach of fiduciary duty and a court ordered him to pay nearly $300,000 in penalties. The man now seeks to have that debt erased, but lower courts have rejected the request under the fraud or defalcation provision.

Because the man’s actions didn’t deprive the trust of any money, his attorney claims there was no fraud. And with that, he should expect to be able to erase of the debt in a rehearing before the bankruptcy court.

Source: Thomson Reuters News & Insight, “Justices finally say what ‘defalcation’ means,” Lawrence Hurley, May 14, 2013