Justices Take Up Dispute Over ‘Defalcation’

WASHINGTON (CN) - The Supreme Court agreed Monday to consider whether a man can discharge a judgment debt that he can satisfy only with a property sale kept in limbo.

Randy Curtis Bullock is in a bind after an Illinois court found that he had engaged in self-dealing as trustee of an account set up to guard his father's life insurance policy in 1978.

The trust named Bullock and his four siblings as beneficiaries, and it set limits on how Bullock could borrow account funds.

An Illinois court found that Bullock had violated those terms, albeit without a malicious motive, in three transactions. The 11th Circuit described those loans against the policy, which are all fully repaid.

"First, in 1981, upon his father's request, Bullock borrowed $117,545.96 for his mother so she could repay a debt that she owed to Bullock's father's business," the federal appeals court wrote. "Second, in 1984, Bullock borrowed $80,257.04 for his mother and himself to purchase certificates of deposit, which were later cashed in and used toward the purchase of a garage fabrication mill in Ohio. Third, in 1990, Bullock borrowed $66,223.96 for his mother and himself to purchase real estate."

BankChampaign, which replaced Bullock as trustee of the 1978 trust, was awarded the constructive trusts.

Bullock says that the bank has blocked his attempts to sell or lease the mill property located in Ohio, which has prevented him from satisfying the Illinois judgment.

Hoping to discharge the debt, Bullock filed for Chapter 7 bankruptcy in 2009, but the bank initiated an adversary proceeding pursuant to a 523(a)(4), a section of federal law that provides that rejects attempts to discharge a bankruptcy debt that arises 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 District Court stated that it questioned the propriety of the bank's actions and noted that holding collateral hostage in perpetuity is impermissible," the 11th Circuit explained. "However, the District Court recognized that the propriety of the bank's actions was not a basis for finding that the judgment debt should be discharged. As a result, the District Court concluded that while it was 'convinced [the bank] is abusing its position of trust by failing to liquidate the [property], this issue is not properly before this court, but rather should [be] brought by Bullock in an action in Illinois to consider the malfeasance of the trustee.'"

The 11th Circuit affirmed that decision noting that there is a split among federal appeals courts as to the definition of defalcation, which the bankruptcy court used to characterize Bullock's self-dealing conduct.

While some circuits have characterized innocent acts by a fiduciary as defalcation, others require a showing of recklessness or even extreme recklessness.

"Applying the recklessness standard for defalcation to the facts of the instant case, this court concludes that the bankruptcy court was correct in determining that Bullock committed a defalcation by making the three loans while he was the trustee of his father's trust," the 11th Circuit said. "Because Bullock was the trustee of the trust, he certainly should have known that he was engaging in self-dealing, given that he knowingly benefitted from the loans. Thus, his conduct can be characterized as objectively reckless, and as such, it rises to the level of a defalcation under § 523(a)(4). Accordingly, the bankruptcy court's order must be affirmed on the issue of whether the Illinois judgment debt was non-dischargeable under § 523(a)(4) as a debt arising from a defalcation while Bullock was acting in a fiduciary capacity."

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