Defalcation

What is Defalcation?

Defalcation, a term used in Chapter 7 of the United States Bankruptcy Code, is an act of misappropriation of funds or resources, by a person who is entrusted with the office of those assets.

A person charged with defalcation implies that he/she has mishandled the funds or resources of the office or trust that he was in charge of. It is common law in the United States of America and applies more often to officials who serve in a public capacity.

Chapter 7 of the U.S. Bankruptcy Code establishes law on the discharge orders on a debt or other forms of debt. The primary purpose of the Bankruptcy Code is to discharge certain debts to give the debtor a “fresh start” in cases where he is honest, and the court finds him to be reasonably incapable of satisfying debt conditions.

Defalcation

Examples

Bullock vs BankChampaign case, courts had a tough time speaking out on what constitutes defalcation by a fiduciary. Let us understand the case first.

#1 – The Case

The case goes back to 1978 when Mr. Bullock was made the trustee of his father’s trust. Mr. Bullock had four siblings. Thus, his father’s trust had five beneficiaries. Bullock was allowed only to pay the premiums of his life insurance and to satisfy a withdrawal request from another trustee. This was distinctly mentioned in the trust operations guidelines.

#2 – The Breach

Despite these restrictions, Bullock violated the terms of the trust guidelines and borrowed from the trust on three different occasions. Firstly, to settle debt payments of his father’s business. Secondly, to purchase certificates of deposit. And thirdly, to purchase the real asset. All the loans were repaid although.

#3 – The Accusation

Bullock’s two brothers learned of the borrowings of Bullock from the trust. They sued their brother in state court claiming that Bullock had breached his fiduciary duty by borrowing money from the trust violating the guidelines of the trust.

#4 – The Summary Judgement

The court ordered Bullock to pay the damages upon a summary judgment appealed by the brothers. The state court required Bullock to satisfy payments against the mill that Bullock had purchased from the trust’s money. However, he could not sell his mill and make payments, and hence filed for bankruptcy.

#5 – The Court Verdict

  • In later developments, the trusteeship changed hands and went to BankChampaign. The bank argued in the court that while acting in a fiduciary capacity and defalcating, a person cannot discharge owed debts by way of bankruptcy filing. The court granted the motion held Bullock guilty for knowingly breaching his fiduciary duty.
  • Summarily, in all cases where the involved individuals argue their incapability to pay debts, those cases that have the slightest element(s) of defalcation will not be granted discharge motion outrightly. Such cases have been tried in courts and exceptional rulings have been ordered.

Source: United States Bankruptcy Code

Types

Types of Defalcation

#1 – Embezzlement

Fraudulent activities that are supported by manipulation and acts to conceal the discovery of fraud, constitute embezzlement.

#2 – Defalcation on Debt

It involves the absence of consent of all the involved parties in cases of debt consolidation. If debt consolidation and payments are made without the consent of all the involved parties, the agreement would be termed invalid and void.

#3 – Fiduciary Defalcation

It is a type, where a person entrusted with a duty to look after a firm’s resources or funds, utilizes the same for purpose or purposes other than those defined in the agreement.

Defalcation vs Embezzlement

  • Speaking, defalcation is when someone deducts or takes away a part of (or whole) income or funds. On the other hand, embezzlement is when someone steals or fraudulently misappropriates the money along with manipulation to cover-up his act.
  • Embezzlement is also a type of defalcation. If a person who has access to company funds misuses his/her position and steals funds, it will come under the category of defalcation. However, if the person tries to manipulate and create records or reports in a way that prevents his theft or fraud from being discovered, he/she will be said to have involved in embezzlement.

Penalties of Defalcation

This is a punishable offence and there are several penalties. However, penalties differ a lot from one jurisdiction to another. But the guidelines on which the penalties are based have similarities. Following are some common bases for punishment:

  1. Intention or degree of intent that was involved
  2. Amount of money or resources that were involved or defalcated
  3. Involvement of the accused in prior cases

Remedy – A defalcation-accused person should seek the help of an attorney who has experience pleading in these cases. On the other hand, the victim should report defalcation or breach of agreement (in fiduciary negligence case) to enforcement authorities. This should help him recover as much loss as possible.

Conclusion

  • It was mostly confined to the law books of the United States from where it transgressed borders and today, it is a law, in some form or the other, in many countries. This is closely associated with the misappropriation of funds by an individual in an official capacity. Nevertheless, it is more common to see cases of debt and liability misappropriations that are adjudicated on the law of defalcation.
  • The law finds substance because of the crux of the Bankruptcy code that establishes that such a debtor who has filed for bankruptcy and has been granted discharge debts motion, is not liable to be held for not satisfying discharge debts. However, such a privilege is not accessible to partnerships or corporations.

Recommended Articles

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