Bullock v. BankChampaign, N.A.

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LII note: The U.S. Supreme Court has now decided Bullock v. BankChampaign, N.A..

Randy Bullock filed for bankruptcy in 2009 to discharge a judgment debt from a 1999 lawsuit brought by his brothers. His brothers had sued him for breach of fiduciary duty as trustee of their father's trust. Bullock was appointed trustee in 1978, and without the beneficiaries' knowledge, took three loans from the trust, which he ultimately paid back in full. In 2002, an Illinois state court awarded the brothers damages of $285,000, concluding that Bullock did not appear to have malicious intent, but that he indisputably engaged in self-dealing, thus violating his fiduciary duty. After filing for bankruptcy, BankChampaign, N.A., who was appointed successor trustee, sued Bullock pursuant to 11 U.S.C. § 523(a)(4), claiming that he could not discharge the judgment debt because it arose from a "defalcation." The court concluded that Bullock's self-dealing constituted defalcation, and the district court and Eleventh Circuit affirmed. The Supreme Court's decision will determine what level of misconduct by a trustee rises to "defalcation" under the Bankruptcy Code.

Questions as Framed for the Court by the Parties 

What degree of misconduct by a trustee constitutes "defalcation" under § 523(a)(4) of the Bankruptcy Code that disqualifies the errant trustee's resulting debt from a bankruptcy discharge - and does it include actions that result in no loss of trust property?



What is the definition of “defalcation” under § 523(a)(4) of the Bankruptcy Code?



In 2009, Randy Bullock filed for bankruptcy in the United States Bankruptcy Court for the Northern District of Alabama. Bullock sought to discharge an Illinois court’s judgment debt against him stemming from a lawsuit brought by his brothers in 1999. Bullock's brothers claimed that he breached his fiduciary duty as trustee of their father's trust by engaging in unlawful self-dealing.

Randy Bullock was appointed trustee of his father's trust in 1978. The trust's sole asset was a life insurance policy on the life of his father, Curt Bullock. The trust named Randy and his four siblings as beneficiaries, and permitted Randy to borrow from the trust for only two reasons: (1) to pay his father's life insurance premiums, and (2) to satisfy a beneficiary's request to withdraw from the trust. Despite these borrowing limitations, Bullock borrowed from the trust on three separate occasions to help his mother repay a debt, to purchase a garage fabrication mill, and to purchase real estate, respectively. Bullock fully repaid the loans, which totaled $264,026.96.

Bullock's brothers learned of the existence of the trust after Randy repaid the loans. In 1999, they sued him in Illinois state court for breaching his fiduciary duty as trustee of their father's estate. In 2002, the state court granted the brothers' motion for summary judgment, concluding that Randy did not have a malicious motive, but that his loans were indisputably "self-dealing transactions." The state court awarded the brothers $285,000 in damages, and placed Bullock's property gained from self-dealing and his interest in his father's trust into two constructive trusts to serve as collateral. The constructive trusts were awarded to Respondent BankChampaign ("Bank"), who was named the successor trustee of the father's trust.

In 2009, Bullock filed for bankruptcy in federal bankruptcy court. In response, the Bank sued Bullock, arguing that his judgment debt was not dischargeable pursuant to 11 U.S.C. § 523(a)(4), which prohibits discharge of debts arising from “fraud or defalcation while acting in a fiduciary capacity.” The bankruptcy court granted the Bank’s motion for summary judgment, concluding that Bullock’s self-dealing amounted to fraud and defalcation. Bullock appealed to the district court, which affirmed the bankruptcy court’s decision. Bullock then appealed to the Eleventh Circuit Court of Appeals.

The Eleventh Circuit affirmed, but recognized a circuit split regarding the meaning of defalcation under the Bankruptcy Code. The court aligned itself with the Fifth, Sixth, and Seventh Circuits, which require “a showing of recklessness by the fiduciary.” The court concluded that defalcation requires “a known breach of a fiduciary duty, such that the conduct can be characterized as objectively reckless.” The court then found that Bullock committed a defalcation because, as trustee, he should have known that his conduct was self-dealing, and thus, objectively reckless.

The Supreme Court granted Bullock’s petition for a writ of certiorari to determine what level of conduct rises to “defalcation,” and whether it includes actions that did not result in loss of trust property.



This case concerns the meaning of "defalcation" under section 523(a)(4) of the Bankruptcy Code. The Supreme Court's decision will aid the federal courts in deciding what level of conduct rises to defalcation, and thus, whether certain kinds of debt may be discharged. Bullock argues that the Supreme Court should define "defalcation" in accordance with the Bankruptcy Code's "fresh start" policy. Accordingly, Bullock asserts that "defalcation" requires "conscious misbehavior or extreme recklessness" by a fiduciary. BankChampaign ("Bank") argues that any act of self-dealing by a trustee is a violation of the duty of loyalty, and thus, constitutes defalcation.

Purpose of 11 U.S.C. § 524(a)(4)

Bullock argues that the Bankruptcy Code is based on a "fresh start" policy. One of its main goals, Bullock explains, is to relieve honest people from the "weight of oppressive indebtedness." Thus, Bullock claims, the Supreme Court has previously limited exceptions of dischargeable debt to those clearly stated in the Code, and has consistently resisted efforts to expand the definition of "defalcation." In support of Bullock, Professor G. Eric Brunstad, Jr. argues that the fresh start policy is so important to bankruptcy law that the Code prevents people from waiving the right to discharge when they incur debt. Moreover, Brunstad contends that the fresh start policy is important to the whole nation because it helps avoid the problem of a having a perpetual class of indebted individuals.

The Bank responds that the rights of a trust's beneficiaries outweigh a debtor's privilege of discharging his debt. The Bank argues that Congress included the defalcation exception to protect beneficiaries and to maintain fiduciaries' duty of loyalty. The Bank claims that allowing Bullock's interest in a fresh start to outweigh these principles would undermine Congress' objective. In support of the Bank, the United States argues that the Court has recognized that certain problems override a debtor's interest in a fresh start. One example, the United States claims, is creditors' interest in fully recovering debts. Moreover, the United States asserts that the Court has recognized the importance of deterring trustees from "dividing [their] loyalties" and strictly enforcing rules designed to prevent breaches of loyalty.

Conduct Constituting "Defalcation"

Bullock argues that the Court should define "defalcation" as requiring "conscious misbehavior or extreme recklessness" by a fiduciary. Bullock claims that this interpretation is most consistent with bankruptcy law's goal of providing a fresh start. In contrast, Bullock asserts that the standards adopted by other federal circuits–"objectively reckless" and "mere negligence"–are so expansive as to betray Congress' intent. Bullock explains that the other offenses in §523(a)(4)–fraud, embezzlement, and larceny–all require wrongful intent. Moreover, Bullock urges the court to adopt the higher mental state standard because it parallels the heightened "wrongful intent" requirement in securities law. Professor Brunstad also urges a narrow interpretation, arguing that Congress intended defalcation to mean acts of "serious malfeasance." Noting that the Code's discharge exceptions are driven by either the "type of debt" or the "type of fault," Brunstad contends that defalcation falls into the latter category, and thus requires a serious act involving some fault.

In response, the Bank argues that Bullock's conduct constitutes defalcation under any of the three standards. Because a trustee's highest duty is loyalty to the trust's beneficiaries, the Bank reasons that any act of self-dealing is a breach of loyalty, and thus, a defalcation. Further, the United States argues that a breach of duty occurs when a trustee takes the trust's assets without authorization, even if there is ultimately no loss. Thus, the United States asserts, the fact that Bullock repaid the loans in full does not insulate him from charges of defalcation. The Bank also emphasizes that the duty of loyalty is the highest known to law, and that breaches of the duty are some of the most serious offenses recognized by law. As such, the Bank argues that if the Bankruptcy Code's defalcation exception did not include breaches of loyalty, then nothing would count as a defalcation.



When a person files for bankruptcy under Chapter 7, he may discharge some of the debts he owes, but under Section 523(a)(4), he may not discharge a debt acquired “for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.” Here, the definition of “defalcation” is at issue, because federal courts disagree as to what are its necessary elements, beyond that defalcation “refers to a failure to produce funds entrusted to a fiduciary.” The Court of Appeals for the Eleventh Circuit used an objective test, finding that a person has engaged in defalcation when he knew or should have known that, as the trustee of his family’s trust, he was engaging in self-dealing when he knowingly benefited from loans made from the assets of the trust. While Petitioner Bullock argues that the Eleventh Circuit employed the wrong test to identify defalcation, thereby erroneously refusing to let him discharge his debt in bankruptcy, Respondent BankChampaign ("Bank") counters that the lower courts properly identified Bullock’s defalcation and appropriately prevented him from discharging his associated debt.

Circuits Split Over Mental State Required for Defalcation

Bullock argues that the Eleventh Circuit’s interpretation of defalcation under an objective recklessness standard is inappropriate. Instead, Bullock advocates for the more rigorous standard of extreme recklessness used by the First and Second Circuits, which requires a trustee’s conscious misbehavior and wrongful intent in order to find defalcation. Bullock reasons that a trustee who demonstrates an “extreme departure from the standards of ordinary care” has engaged in defalcation, whereas a trustee who consciously takes a risk with the assets of the trust has not. Making such a distinction, Bullock explains, upholds the proper objectives of Section 523(a)(4) and bankruptcy law generally, which are to provide a debtor with a fresh start and to withhold financial relief, in the form of a discharge, only from true wrongdoers who inflict serious harm. Bullock emphasizes the difference between liability and dischargeability, arguing that to impose an automatic denial of discharge in every case of liability arising from a trustee’s breach of fiduciary duty would be “overkill.” According to Bullock, the extreme recklessness standard for defalcation ensures relief for those who deserve it and denies relief to those who have engaged in such serious misconduct that to grant a discharge would unfairly deprive their creditors of the right to recovery.

Besides considering the underlying policies of bankruptcy law, Bullock asserts that the wording of Section 523(a)(4) lends itself to an objective recklessness standard for defalcation. Bullock refers to the concept of noscitur a sociis, which advises that a word acquires a more precise meaning based on the “neighboring words with which it is associated.” Accordingly, notes Bullock, because Section 523(a)(4) groups “defalcation” with words such as “fraud,” “embezzlement,” and “larceny,” which each requiring a finding of wrongful intent, every word in the statutory clause should also require this same mental state to deceive.

Bullock contends that the breach of fiduciary duty for which the Illinois court entered a judgment against him does not amount to defalcation when a court applies the proper standard of extreme recklessness. Bullock concedes that Illinois state law may presume when he engages in self-dealing that he is liable for breach of fiduciary duty, but he argues that this objective test does not carry over to federal bankruptcy law because evidence of self-dealing is not enough for a court to presume that he has engaged in defalcation. Instead, Bullock asserts that to find defalcation, the Bank had to prove Bullock’s extreme recklessness in self-dealing. He points out that the Bank never showed the requisite mental state, which would involve proving that Bullock knew that the three loans he made from his family’s trust were improper. Further, Bullock explains that when he made an improper loan in his capacity as trustee, his action was a bona fide mistake of law. He asserts that he should have the opportunity to prove that he did not willfully violate trust law.

In contrast, the Bank advocates against choosing any one existing standard for the mental state required to establish defalcation. Instead, the Bank asserts that a debtor who engages in self-dealing can always be said to commit a defalcation because he has breached the duty of loyalty. Under the Bank’s reasoning, because the duty of loyalty is a trustee’s most fundamental duty to trust beneficiaries, a self-dealing trustee is held to such a strict standard that his act of self-dealing may be deemed extremely reckless. The Bank notes that even if courts use the extreme recklessness standard supported by Bullock and the First and Second Circuits, they will come to the same finding of defalcation as concluded by the Eleventh Circuit. As the Bank indicates, a trustee who makes loans to benefit himself has departed in an extreme sense from the clear standard of care to which he is held. Further, the Bank notes that Bullock also satisfies the less stringent test of objective recklessness because making a loan from trust property was willful and thus clearly reckless because of his significant obligations to trust beneficiaries.

Moreover, the Bank criticizes Bullock’s argument in favor of reading Section 523(a)(4) to support bankruptcy law’s fresh start above other policies. Rather than promoting a debtor’s interest in discharging his debts, the Bank instead focuses on the protection of creditors’ rights when creditors are trust beneficiaries. The Bank notes that legislators intend to maintain the high standards of loyalty that are expected from trustees. To define defalcation in a way that allows trustee debtors to discharge the debts they incur by way of breach of fiduciary duties would override legislative intent.

Requirement of Loss of Trust Assets

Bullock notes that separate from a consideration of mental state, defalcation under Section 523(a)(4) requires a “failure to account” for entrusted funds or a “shortage in accounts.” Because Bullock repaid each of the loans he took from the trust and made the loans only to himself and his mother, he asserts that there is neither a shortage of funds in the trust nor a failure to account for funds. Further, Bullock contends that his return of trust property negates any mental state that would be required to find him guilty of a crime that requires willful misconduct. Accordingly, Bullock claims, his actions did not amount to defalcation, and his debt should be discharged.

In response, the Bank argues that defalcation requires either a misappropriation of trust funds or a failure to account for trust funds, but it does not require both elements. The Bank encourages the Court to read the elements as mutually sufficient to amount to defalcation because there is a clear misappropriation of funds that establishes defalcation by Bullock. The Bank notes, however, that Bullock has failed to account for trust funds because he has failed to report to the trust beneficiaries regarding the financial performance of the trust. Under this reading of “failure to account,” the Bank asserts that there are further grounds upon which to find that Bullock committed defalcation sufficient to render his debts non-dischargeable.



After becoming the trustee to his family’s trust, Randy Curtis Bullock made three loans from the trust, to himself and his mother for various business endeavors in which Bullock had a financial interest. In 2001, two of Bullock’s brothers who were also trust beneficiaries, sued him for breach of his fiduciary duty, and the court held Bullock liable to the trust for $285,000. In 2009, when Bullock filed for bankruptcy under Chapter 7 and sought to discharge the debt owed to the trust from the 2001 decision, BankChampaign, as successor trustee, filed an adversary proceeding to prevent Bullock’s discharge of this debt, pursuant to Section 523(a)(4) of the Bankruptcy Code. This provision excepts from discharge debts incurred by defalcation while acting as a fiduciary. Lower courts are divided as to whether a fiduciary such as Bullock must possess wrongful intent in order to commit defalcation under Section 523(a)(4). Bullock argues that the Eleventh Circuit’s interpretation of defalcation is inappropriate because a literal reading of the statute, in keeping with the goal of bankruptcy to provide a debtor with a “fresh start,” indicates that a person must act with intent to deceive, and his action must result in a loss of assets from the trust. BankChampaign, in contrast, argues that because a trustee owes a duty of loyalty to trust beneficiaries, any instance of self-dealing amounts to defalcation, regardless of both the trustee’s mental state and whether there has been a net loss in the trust’s assets. How the Court defines the elements of “defalcation” will determine how easily debtors in bankruptcy may discharge their debts. The Court will address the balance between rights of debtors, who seek a fresh start through bankruptcy, and the protection of creditors, whose claims as trust beneficiaries may survive bankruptcy.


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