Opinion analysis: Justices protect discharge for “innocent” trustee
on May 14, 2013 at 11:35 am
Bullock v. BankChampaign, N.A. is a case in which the oral argument had little to do with the final opinion. The dispute involves an exception to the bankruptcy discharge for debts incurred through “defalcation.” Generally, an individual who files for bankruptcy is discharged from any continuing personal obligation to pay preexisting debts. This means that creditors can take their collateral, but ordinarily they can no longer pursue the bankrupt. The discharge is subject, however, to exceptions for a variety of debts that involve specified forms of misconduct. The question in this case is whether the claim here falls within an exception for “defalcation”; if it does, the claim would survive his bankruptcy.
All agree on the basic facts: that petitioner Randy Bullock borrowed funds from a trust for which he was trustee, that he invested the funds for his own benefit, that he repaid the funds with interest, and that he earned (and retained) considerable (more than $250,000) profits from the investments. All agree that Bullock did not in fact know that he violated trust law when he borrowed from the trust for his personal use; the lower courts nevertheless concluded that his retention of those profits amounted to “defalcation,” and thus refused to permit him to use the bankruptcy process to discharge his obligation to repay them.
Although the Court did not directly render judgment in Bullock’s favor (sending the case back to the Eleventh Circuit for reconsideration), it did strongly suggest that the lower courts were insufficiently protective of the bankrupt. Specifically, the Court adopted a standard for recklessness drawn verbatim from the Model Penal Code. Under that standard, Bullock should lose his discharge not only if he had actual knowledge that he was violating trust law, but also if he consciously disregarded or was willfully blind to a substantial and unjustifiable risk that his conduct would turn out to violate a fiduciary duty. Given the factual setting summarized above, it is difficult to believe that the lower courts will adhere to their decision against Bullock.
The brief opinion by Justice Breyer for a unanimous Court avoided almost all of the questions that seemed so interesting to the Justices at the argument. For example, there is nothing in the opinion about the content of “defalcation” – whether it is so closely related to the etymological meaning from the Latin defalcare that it requires something to have been taken (or “lopped off” from) the corpus of the trust. Nor did the Court resolve the murky question of whether a trust can be said to suffer a loss when the trustee profits from investing funds borrowed from the trust, but repays the borrowed funds to the trust at the specified interest rate. Rather, the Court assumed that such conduct was defalcation, and almost reached out to decide the question on which it granted review: the circuit-splitting problem of defining the requisite intent.
Perhaps most surprising was Justice Breyer’s failure to give any weight to the point he made so persuasively at oral argument: that the terms parallel to defalcation in the statute (embezzlement and larceny) do not require any knowledge of the wrongfulness of the act, but rather only an intention to commit the act that is wrongful. Instead, he resolved the case as a simple matter of specifying the requisite intent when Congress has failed to do so, trumpeting the virtues of adopting a well-recognized standard like the one found in the Model Penal Code.
I close by noting that this is the first time in more than fifteen years that the Court has rejected an argument from the Office of the United States Trustee (in the Department of Justice) calling for broad enforcement of the exceptions to discharge. What has so often seemed to be an automatic victory for the government turned out not to be one this time.
PLAIN LANGUAGE: This case involves a personal bankruptcy, which usually discharges all the debts of the bankrupt individual. The bank in this case argued that a particular debt could not be discharged because the trustee of a family trust committed “defalcation” when he profited from investing funds he borrowed from the trust. It turns out, although the trustee did not know it at the time, that this kind of investment violates basic principles of trust law. The Court said, however, that the bankrupt individual (the trustee) still could discharge the debt, unless the he knew, or recklessly disregarded the risk, that this kind of conduct was wrongful.