The Challenges of the New Defalcation Standard

Abstract

The crux of bankruptcy law is giving debtors a fresh start by discharging their debts. Yet society has recognized that some debts should not be discharged because they either have a high level of societal importance or derive from a debtor’s culpable conduct. One of these exceptions from discharge is for defalcation while acting in a fiduciary capacity. The legal meaning of defalcation has been unclear for 172 years, ranging from a breach of trust by one who has charge of money to the misappropriation of money in one’s keeping. A three-way federal circuit split developed on whether a state of mind was required for defalcation and if so, how culpable. In May 2013, the U.S. Supreme Court resolved the circuit split in Bullock v. BankChampaign by establishing a new, heightened mental standard based on the Model Penal Code’s definition of “recklessly.” Bullock’s holding is significant because it did not adopt any of the tests from the circuit split. Bullock’s new test is challenging for three reasons. First, applying a Model Penal Code culpability to civil fiduciary law is awkward because the various sources of fiduciary duties rarely contain a mental state requirement. Second, the Model Penal Code’s recklessly definition is abstract and difficult to apply. For example, instead of focusing on the breach of a fiduciary duty, it concentrates on the risk that a fiduciary duty will be breached. Further, some elements of recklessly must be evaluated from a subjective standard while others require an objective one. Finally, in delineating the new recklessly test, Bullock parenthetically grafted in the separate criminal law doctrine of willful blindness. This synthesis of recklessness and willful blindness, which are two completely different tests, results in a seemingly unworkable standard that does not make sense. This Article explores each element of the new recklessly standard and identifies pitfalls to avoid. It also suggests an approach to reconcile the troubling analytical problems resulting from combining recklessness and willful blindness. This Article concludes by establishing an analytical framework to apply Bullock’s new test.

Keywords: bankruptcy, discharge, exception to discharge, defalcation, 523(a), Bullock, Bankchampaign, reckless, recklessly, model penal code, willful blindness, subjective, objective