In 2013 the U.S. Supreme Court handed down an opinion that shed light on the meaning of the word “defalcation” as it is used in the Bankruptcy Code’s list of nondischargeable debts. The opinion disabuses of their error those who thought the word had something to do with a bathroom bodily function. In this post we will look at the Supremes’ decision in the larger context of nondischargeability under 11 U.S.C. § 523(a)(4).
I. Nondischargeable Debts In A Personal Bankruptcy: Section 523(a)(4)
As readers of this blog know, 11 U.S.C. § 523(a) contains the exceptions to discharge in Chapter 7, 11, 12, and 11 U.S.C. § 1328(b) hardship discharge Chapter 13 bankruptcies. Included in that list is the following:
A discharge under section 727, 1141, 1228 (a), 1228 (b), or 1328 (b) of this title does not discharge an individual debtor from any debt— . . . for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.
11 U.S.C. § 523(a)(4).
The list of debts that are nondischargeable in a completed Chapter 13 plan discharge ― found in 11 U.S.C. § 1328(a) ― is shorter than the list of exceptions to discharge found in 11 U.S.C. § 523(a). However, § 1328(a) includes § 523(a)(4) by reference, so a debt incurred through “fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny” is never dischargeable in any personal bankruptcy.
However, § 523(a)(4) is not self-executing. According to 11 U.S.C. § 523(c)(1):
[T]he debtor shall be discharged from a debt of a kind specified in paragraph (2), (4), or (6) of subsection (a) of this section, unless, on request of the creditor to whom such debt is owed, and after notice and a hearing, the court determines such debt to be excepted from discharge under paragraph (2), (4), or (6), as the case may be, of subsection (a) of this section.
Thus, the creditor can only make the debt survive the bankruptcy discharge by successfully prosecuting a special kind of lawsuit in the Bankruptcy Court. That kind of lawsuit is called an adversary proceeding.