Bankruptcy Interruption Calls for Gross Negligence

     WASHINGTON (CN) – A showing of gross recklessness is necessary to block a man from obtaining a bankruptcy discharge of his debt, the Supreme Court ruled Monday.
     Randy Curtis Bullock owes the debt to his brothers in connection to a 1999 judgment they won against him for breach of fiduciary duty.
     In that case, an Illinois court had found that Bullock had engaged in self-dealing as trustee of an account set up to guard his father’s life insurance policy.
     The trust named Bullock and his four siblings as beneficiaries, and it set limits on how Bullock could borrow account funds. Bullock violated those terms, albeit without a malicious motive, in three transactions that contravened the policy but were all fully repaid.
     Bullock had engaged in the first transaction, upon his father’s request, so that his mother could repay a debt that she owed to the patriarch’s business. The second transaction allowed Bullock and his mother to purchase certificates of deposit, which they later cashed in and used to buy a garage fabrication mill in Ohio.
     The third transaction likewise helped Bullock and his mother buy real estate.
     Bullock failed to liquidate his interests in the mill and other constructive trust assets, and then filed for Chapter 7 bankruptcy in 2009.
     BankChampaign, which serves as trustee on the constructive trusts that the court placed on Bullock’s interest in the mill and the original trust, then initiated an adversary proceeding pursuant to a 523(a)(4), a section of federal bankruptcy law that rejects attempts to discharge a bankruptcy debt arising from “fraud or defalcation while acting in a fiduciary capacity, embezzlement or larceny.”
     After the bankruptcy court granted BankChampaign summary judgment, a federal judge in Alabama reluctantly affirmed.
     The 11th Circuit affirmed as well, noting that there is a split among federal appeals courts as to the definition of defalcation.
     While some circuits have characterized innocent acts by a fiduciary as defalcation, others require a showing of recklessness or even extreme recklessness.
     The Supreme Court vacated that holding Monday, finding that defalcation includes a culpable state of mind, “involving knowledge of, or gross recklessness in respect to, the improper nature of the relevant fiduciary behavior.”
     “Thus, where the conduct at issue does not involve bad faith, moral turpitude, or other immoral conduct, the term requires an intentional wrong,” Justice Stephen Breyer wrote for the unanimous panel. “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. Thus, we include reckless conduct of the kind set forth in the Model Penal Code. Where actual knowledge of wrongdoing is lacking, we consider conduct as equivalent if the fiduciary ‘consciously disregards’ (or is willfully blind to) ‘a substantial and unjustifiable risk’ that his conduct will turn out to violate a fiduciary duty. That risk ‘must be of such a nature and degree that, considering the nature and purpose of the actor’s conduct and the circumstances known to him, its disregard involves a gross deviation from the standard of conduct that a law-abiding person would observe in the actor’s situation.'”
     Since the circuit panel applied a standard of “objective recklessness,” the Supreme Court instructed it to determine on remand “whether further proceedings are needed and, if so, to apply the heightened standard that we have set forth.”

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