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Embezzlement, Theft or Breach of Fiduciary Duty

Any debt for embezzlement, theft, conversion, fraud or defalcation (misuse of funds) by a fiduciary can not be discharged in a Chapter 7, 11 or 13 case.  11 U.S.C. § 523(a)(4) and § 1328(a)(2).

1. Conversion. Commonly defined as an unauthorized act that deprives an owner of personal property of the use, possession and/or enjoyment of the property without his consent. A conversion of property is purely a civil wrong, as opposed to theft, which is similar, but involves only criminal penalties. The elements of proof necessary to establish an unlawful conversion of property are:

1.1. First, the plaintiff owns or has the right to possess the property at the time of the interference.

1.2. Second, the defendant intentionally interfered with the plaintiff's right to possess and enjoy the property. Stated another way, the debtor exercised "dominion and control" over the property without consent or permission.

1.3. Third, the interference deprived the plaintiff of possession or use of the property.

1.4. Fourth, the interference caused damages to the plaintiff.

2. Fiduciary Duty. A fiduciary duty is an obligation to act in the best interest of another party. For instance, a corporation's board member has a fiduciary duty to its shareholders, a trustee has a fiduciary duty to the trust's beneficiaries, and an attorney has a fiduciary duty to a client. A fiduciary obligation exists whenever the relationship with the client involves a special trust, confidence, and reliance on the fiduciary to exercise his discretion or expertise in acting for the client. The fiduciary must knowingly accept that trust and confidence to exercise his expertise and discretion to act on the client's behalf. When a person agrees to act as a fiduciary for another, the law forbids the fiduciary from acting in any manner adverse or contrary to the interests of the client, or from acting for his own benefit in relation to the subject matter. The client is entitled to the best efforts of the fiduciary and the fiduciary must exercise all of the skill, care and diligence at his disposal when acting on behalf of the client. A person acting in a fiduciary capacity is held to a high standard of honesty and full disclosure in regard to the client and must not obtain a personal benefit at the expense of the client.

"Defalcation" refers to a failure to account for and produce funds entrusted to a fiduciary.   Prior to 2013 the courts were divided concerning the level of a debtor's knowledge of wrongdoing that must be proven in order to apply the discharge exception for "defalcation" while acting in a fiduciary capacity.  In 2013, in Bullock v. BankChampaign, N.A., the Supreme Court decided the issue by holding that defalcation under § 523(a)(4) requires proof of "a culpable state of mind" with a "knowledge of, or gross recklessness in respect to the improper nature of the relevant fiduciary behavior." Where the conduct at issue does not involve bad faith, moral turpitude, or other immoral conduct, the term requires an proof of an intentional wrong. The intentional conduct can  involve "conduct that the fiduciary knows is improper but also reckless conduct of the kind that the criminal law often treats as the equivalent."

3. Embezzlement. Commonly defined as the fraudulent conversion of another's property by a person who is in a position of trust, such as an agent or employee.

Example. P.I. Joe is a personal injury lawyer. He settles a $50,000 personal injury claim for Client. He is in financial difficulty when he settles the case and uses the settlement funds to pay his personal bills. Unfortunately, P.I. Joe’s financial problems get worse. He contemplates filing for bankruptcy. P.I. Joe is guilty of converting (stealing) Client’s settlement funds. He can not discharge the $50,000 debt owed to Client in any bankruptcy case (Chapter 7, 11 or 13).

 

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