The Seventh Circuit expounded on the definition of “defalcation,” which the appeals court said is “a word that only lawyers and judges could love.”
The case allowed Circuit Judge David F. Hamilton to apply Bullock v. BankChampaign NA, the 2013 Supreme Court decision on Section 523(a)(4) holding there is no “defalcation” while acting in a “fiduciary capacity” unless the bankrupt had knowledge that the conduct was improper or there was gross recklessness about the improper nature of the action.
A lawyer filed bankruptcy after being socked in state court with a malpractice judgment for what Judge Hamilton called “egregious breaches of fiduciary duty.” The lawyer claimed it was error to except the debt from discharge, contending that the bankruptcy judge applied an objective test.
Judge Hamilton’s March 18 opinion is a scholarly exploration of “defalcation.” In applying its definition to the facts of a case, he said it is permissible for the bankruptcy court to base its findings on circumstantial evidence. Although the judge could draw inferences about the lawyer’s state of mind from objective circumstances, “the court applied the correct subjective standard,” the opinion states.
“The bankruptcy court’s finding of subjective recklessness,” Judge Hamilton said, “was a reasonable finding from the circumstantial evidence.”
The case is a reminder that lawyers must pay attention to ethical precepts even in small matters. As a consequence of receiving $400 for preparing documents for a real estate closing, the lawyer ended up with a $26,000 nondischargeable judgment for malpractice.