What Is a Debt Owed for “Fraud in a Fiduciary Capacity”?

You can’t discharge debts “for fraud or defalcation while acting in a fiduciary relationship, embezzlement, or larceny.” What do these include?

This is the last of our series of blogs on types of debts that might not be discharged — legally written off — in bankruptcy, and this one may sound the most confusing.

We need to start by emphasizing that for most people, all of the debts they want to discharge do get discharged when they file for bankruptcy. So we are talking here about exceptions to what is ordinary. But people in all kinds of circumstances have to think about getting relief from bankruptcy, and that may include you.

The Reason for this Exception

Bankruptcy is intended to give a fresh start to the “honest” debtor, honest both in presenting your financial information to the bankruptcy court AND honest in how you acquired your debts. So, debts or claims against you that arose as a result of your allegedly dishonest, fraudulent and wrongful behavior may well not be discharged in bankruptcy. The exception to discharge that we are covering in this blog, referred to in Section 523(a)(4) of the Bankruptcy Code, is one category of dishonest debts.

What Does “Acting in a Fiduciary Capacity” Mean?

Generally, a fiduciary has the right and responsibility to act on behalf of another, in a relationship of trust. Besides formal trustees and similar legal agents, the following are examples of types of people who have fiduciary capacity: corporate officers and directors of an insolvent corporation toward the corporation’s creditors, an attorney with client’s funds in trust account, a partner toward the partnership and the other partners, a real estate broker toward the buyer or seller she is contracted with, and the executor of a decedent’s estate toward the beneficiaries.

How Is This Different From “Fraud” or “Willful and Malicious Injury”?

This subsection of the bankruptcy Code actually does seem largely redundant. In the last few blogs we covered the exceptions for “fraud and misrepresentation” in Section 523(a)(2) and for “willful and malicious injury” in Section 523(a)(6). “Fraud while acting in a fiduciary capacity” is simply just one version of fraud. Embezzlement — the fraudulent taking of something that is not yours but is lawfully under your control or in your possession — and larceny — the taking of something not yours and not lawfully under your control or in your possession — clearly seem to be merely versions of “willful and malicious injury” to another’s property. And that odd word, “defalcation,” means misappropriating or failing to account for assets belonging to someone else that are under your care. Since that CAN include unintentional behavior — situations involving only negligence or recklessness — this addition seems to be the only expansion beyond what is already not dischargeable under the two earlier provisions.

Civil Damages vs. Criminal Penalties

Embezzlement and larceny, as well as serious fraud in a fiduciary capacity, often turn into criminal matters, with the risk of potential prison time, restitution and other criminal penalties. Bankruptcy does NOT discharge any criminal penalties — neither Chapter 7 nor 13. What it does address are the civil damages that can arise even if you are not charged with a crime, or if you are charged but are also facing civil lawsuits for the same behavior.

If you are facing allegations of or have been defending a lawsuit involving any of these kinds of behaviors, we at the Leinart Law Firm are dedicated to helping you clearly understand your pertinent bankruptcy options. Our mission is to assist you in making wise, fully-informed decisions about any of your debt-related matters. We can start to have that happen for you with a free and confidential consultation. Contact our Dallas – Fort Worth bankruptcy attorneys at Bailey & Galyen today.