Bankruptcy Exceptions

Jan 17th, 2013 By: Paul Hibner
Topics: Bankruptcy Exceptions


Under the Bankruptcy Code, a debtor may discharge several types of debt through bankruptcy. Under certain circumstances, however, a creditor may have a debt owed to him excepted from discharge, and the debtor will remain liable to pay said debt. For example, a debt may be excepted from discharge if the debt wasfor money or property obtained by “false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s or an insider’s financial condition... .” 11 USCS § 523(a)(2)(A). Likewise,a debt is not dischargeable in bankruptcy for money or property obtained by “willful and malicious injury by the debtor to another entity or to the property of another entity… .” 11 USCS § 523 (a)(6). Below, we examine one scenario where a debt may be excepted from discharge: fraud or defalcation while acting in a fiduciary capacity.

A debt may be excepted from discharge in bankruptcy for money or property obtained by “fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny… .”11 USCS § 523(a)(4). “Defalcation can be distinguished from fraud and embezzlement on the basis that subjective, deliberate wrongdoing is not required to establish defalcation, though some degree of fault is required.” Follett Higher Educ. Group, Inc. v. Berman (In re Berman), 629 F.3d 761, 766 (7th Cir. 2011). Black’s Law Dictionary defines “defalcation” as a “failure to meet an obligation” or “a non-fraudulent default.” Black’s Law Dictionary 479 (9th ed. 2009).

Unlike common law in civil cases, however, “‘[n]either a general fiduciary duty of confidence, trust, loyalty, and good faith, nor an inequality between the parties’ knowledge or bargaining power, is sufficient to establish a fiduciary relationship for purposes of dischargeability.’... ‘Further, the fiduciary relationship must be shown to exist prior to the creation of the debt in controversy.’” Smolen v. Hatley (In re Hatley), 1999 U.S. App. LEXIS 22421, 4-5 (10th Cir. Okla. 1999)(unpublished). Rather, a technical or express trust must exist for the purposes of exception from dischargeability. Zohlman v. Zoldan, 226 B.R. 767, 774 (S.D.N.Y. 1998).

Several courts have found such a trust relation may exist among business partners. Gupta v. E. Idaho Tumor Institute, Inc. (I n re Gupta), 394 F.3d 347, 352 (5th Cir. Tex. 2004 ) (“[i]t would appear that, at least as to the duty to account for money owed to the partnership, a partner's duties may constitute a preexisting, express or technical trust... .”); Rogers v. Stacy, 63 N.M. 317, 319 (1957)(“[a] trust relation exists among partners… and it is the duty of a managing partner to keep true and correct books of accounts showing the firm business and render a full and complete account of all trans actions relating to partners hip affairs.”);Gillett v. Chavez, 12 N.M. 353, 371 (1904)(a trust relation exists between partners); Lewis v. Scott (In re Lewis), 97 F.3d 1182, 1185 (9th Cir. 1996)(“a partnership embodies an ‘express’ or ‘technical’ trust relationship, rather than a trust ex maleficio, within the meaning of section 523(a)(4).”).

As shown above, a debtor in bankruptcy who owes debts to his business partners may have those debts excepted from discharge if such debt arises through defalcation.