BULLOCK v. BANKCHAMPAIGN
In 1978, Randy Curtis Bullock became the trustee of his father’s trust. The trust’s only asset was his father’s life insurance policy, and Bullock and his four siblings were the trust’s only beneficiaries. As trustee, Bullock was only allowed to borrow from the trust to pay the life insurance premiums and to satisfy a withdrawal request from another trustee. Despite these restrictions, Bullock borrowed from the trust three times: to satisfy a debt on his father’s business, to allow him and his mother to purchase certificates of deposit, and to allow him and his mother to purchase real estate. All of the loans were fully repaid.
When Bullock’s two brothers learned of the existence of the trust and their brother’s actions, they sued him in Illinois state court. They claimed that Bullock had breached his fiduciary duty by taking loans that violated the guidelines of the trust. The brothers moved for summary judgment and the court granted it. The court ordered Bullock to pay $250,000 in damages for the benefits he received from his dealings with the trust, $35,000 in attorneys’ fees, and placed the property Bullock purchased—a mill in Ohio—in a constructive trust. The constructive trust was awarded to BankChampaign, which replaced Bullock as the trustee of his father’s trust. Bullock was unable to sell the mill to satisfy the Illinois judgment.
In 2009, Bullock filed for bankruptcy under Chapter 7 to discharge his debt from the Illinois judgment. The bank started an adversary proceeding in bankruptcy court where it argued that debts arising out of fraud in a fiduciary capacity are not dischargeable by bankruptcy. The bank moved for summary judgment and the bankruptcy court granted the motion. Bullock appealed the bankruptcy court’s judgment to district court, and the district court affirmed. The district court did recognize that the only way for Bullock to satisfy the judgment debt was to sell the mill, and the bank could not hold it in perpetuity, so the district court concluded that the bank was abusing its power. The U.S. Court of Appeals for the Seventh Circuit affirmed the judgment of the bankruptcy court.
Are debts arising out of fraud in a fiduciary capacity dischargeable in a Chapter 7 bankruptcy proceeding?
Legal provision: 11 U. S. C. §523(a)(4)
No. Justice Stephen J. Breyer delivered a unanimous opinion holding that a bankruptcy proceeding resulting from “fraud or defalcation” is not dischargeable and that the term “defalcation” encompasses knowledge of or grossly reckless behavior in a fiduciary capacity. The Court held that the term should include a knowledge or intent requirement because such a reading follows statutory and judicial precedent. Additionally, this interpretation differentiates the term from others in the statute and provides a clear definition on which courts may rely.
NOTICE: This opinion is subject to formal revision before publication in the preliminary print of the United States Reports. Readers are requested to notify the Reporter of Decisions, Supreme Court of the United States, Washington, D. C. 20543, of any typographical or other formal errors, in order that corrections may be made before the preliminary print goes to press.
SUPREME COURT OF THE UNITED STATES
RANDY CURTIS BULLOCK, PETITIONER v. BANKCHAMPAIGN, N. A.
on writ of certiorari to the united states court of appeals for the eleventh circuit
[May 13, 2013]
Justice Breyer delivered the opinion of the Court.
Section 523(a)(4) of the Federal Bankruptcy Code provides that an individual cannot obtain a bankruptcy discharge from a debt “for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.” 11 U. S. C. §523(a)(4). We here consider the scope of the term “defalcation.” We hold that it includes a culpable state of mind requirement akin to that which accompanies application of the other terms in the same statutory phrase. We describe that state of mind as one involving knowledge of, or gross recklessness in respect to, the improper nature of the relevant fiduciary behavior.I
In 1978, the father of petitioner Randy Bullock established a trust for the benefit of his five children. He made petitioner the (nonprofessional) trustee; and he transferred to the trust a single asset, an insurance policy on his life. 670 F. 3d 1160, 1162 (CA11 2012); App. to Pet. for Cert. 33a. The trust instrument permitted the trustee to borrow funds from the insurer against the policy’s value (which, in practice, was available at an insurance-company-determined 6% interest rate). Id., at 17a, 34a, 50a.
In 1981, petitioner, at his father’s request, borrowed money from the trust, paying the funds to his mother who used them to repay a debt to the father’s business. In 1984, petitioner again borrowed funds from the trust, this time using the funds to pay for certificates of deposit, which he and his mother used to buy a mill. In 1990, petitioner once again borrowed funds, this time using the money to buy real property for himself and his mother. 670 F. 3d, at 1162. Petitioner saw that all of the borrowed funds were repaid to the trust along with 6% interest. App. to Pet. for Cert. 17a, 45a, 50a; Brief for Petitioner 3; Brief for Respondent 2.
In 1999, petitioner’s brothers sued petitioner in Illinois state court. The state court held that petitioner had committed a breach of fiduciary duty. It explained that petitioner “does not appear to have had a malicious motive in borrowing funds from the trust” but nonetheless “was clearly involved in self-dealing.” App. to Pet. for Cert. 45a, 52a. It ordered petitioner to pay the trust “the benefits he received from his breaches” (along with costs and attorney’s fees). Id., at 47a. The court imposed constructive trusts on petitioner’s interests in the mill and the original trust, in order to secure petitioner’s payment of its judgment, with respondent BankChampaign serving as trustee for all of the trusts. 670 F. 3d, at 1162; App. to Pet. for Cert. 47a–48a. After petitioner tried unsuccessfully to liquidate his interests in the mill and other constructive trust assets to obtain funds to make the court-ordered payment, petitioner filed for bankruptcy in federal court. Id., at 27a, 30a.
BankChampaign opposed petitioner’s efforts to obtain a bankruptcy discharge of his state-court-imposed debts to the trust. And the Bankruptcy Court granted summary judgment in the bank’s favor. It held that the debts fell within §523(a)(4)’s exception “as a debt for defalcation while acting in a fiduciary capacity.” Id., at 40a–41a. Hence, they were not dischargeable.
The Federal District Court reviewed the Bankruptcy Court’s determination. It said that it was “convinced” that BankChampaign was “abusing its position of trust by failing to liquidate the assets,” but it nonetheless affirmed the Bankruptcy Court’s decision. Id., at 27a–28a.
In turn, the Court of Appeals affirmed the District Court. It wrote that “defalcation requires a known breach of a fiduciary duty, such that the conduct can be characterized as objectively reckless.” 670 F. 3d, at 1166. And it found that petitioner’s conduct satisfied this standard. Ibid.
Petitioner sought certiorari. In effect he has asked us to decide whether the bankruptcy term “defalcation” applies “in the absence of any specific finding of ill intent or evidence of an ultimate loss of trust principal.” Brief for United States as Amicus Curiae 1. See also Pet. for Cert. i. The lower courts have long disagreed about whether “defalcation” includes a scienter requirement and, if so, what kind of scienter it requires. Compare In re Sherman, 658 F. 3d 1009, 1017 (CA9 2011) (“defalcation” includes “even innocent acts of failure to fully account for money received in trust” (internal quotation marks and brackets omitted)), with In re Uwimana, 274 F. 3d 806, 811 (CA4 2001) (defalcation occurs when “negligence or even an innocent mistake . . . results in misappropriation”), with 670 F. 3d, at 1166 (“defalcation requires . . . conduct [that] can be characterized as objectively reckless”), and with In re Baylis, 313 F. 3d 9, 20 (CA1 2002) (“defalcation requires something close to a showing of extreme recklessness”). In light of that disagreement, we granted the petition.II A
Congress first included the term “defalcation” as an exception to discharge in a federal bankruptcy statute in 1867. See id., at 17. And legal authorities have disagreed about its meaning almost ever since. Dictionary definitions of “defalcation” are not particularly helpful. On the one hand, a law dictionary in use in 1867 defines the word “defalcation” as “the act of a defaulter,” which, in turn, it defines broadly as one “who is deficient in his accounts, or fails in making his accounts correct.” 1 J. Bouvier, Law Dictionary 387, 388 (4th ed. 1852). See also 4 Oxford English Dictionary 369 (2d ed. 1989) (quoting an 1846 definition that defines the term as “ ‘a breach of trust by one who has charge or management of money’ ”). Modern dictionaries contain similarly broad definitional language. Black’s Law Dictionary, for example, defines “defalcation” first as “Embezzlement,” but, second, as “[l]oosely, the failure to meet an obligation; a nonfraudulent default.” Black’s Law Dictionary 479 (9th ed. 2009) (hereinafter Black’s). See also American Heritage Dictionary 474 (5th ed. 2011) (“To misuse funds; embezzle”); 4 Oxford English Dictionary, supra, at 369 (“monetary deficiency through breach of trust by one who has the management or charge of funds; a fraudulent deficiency in money matters”); Webster’s New International Dictionary 686 (2d ed. 1954) (“An abstraction or misappropriation of money by one, esp. an officer or agent, having it in trust”); Webster’s Third New International Dictionary 590 (1986) (“misappropriation of money in one’s keeping”).
On the other hand, an 1842 bankruptcy treatise warns that fiduciaries “are not supposed to commit defalcation in the matter of their trust, without . . . at least such criminal negligence as admits of no excuse.” G. Bicknell, Commentary on the Bankrupt Law of 1841, Showing Its Operation and Effect 12 (2d ed. 1842). Modern dictionaries often accompany their broad definitions with illustrative terms such as “embezzle,” American Heritage Dictionary, supra, at 474, or “fraudulent deficiency,” 4 Oxford English Dictionary, supra, at 369. And the editor of Black’s Law Dictionary has written that the term should be read as limited to deficiencies that are “fraudulent” and which are “the fault of someone put in trust of the money.” B. Garner, Modern American Usage 232 (3d ed. 2009) (emphasis added).
Similarly, courts of appeals have long disagreed about the mental state that must accompany the bankruptcy-related definition of “defalcation.” Many years ago Judge Augustus Hand wrote that “the misappropriation must be due to a known breach of the duty, and not to mere negligence or mistake.” In re Bernard, 87 F. 2d 705, 707 (CA2 1937). But Judge Learned Hand suggested that the term “may have included innocent defaults.” Central Hanover Bank & Trust Co. v. Herbst, 93 F. 2d 510, 511 (CA2 1937) (emphasis added). A more modern treatise on trusts ends its discussion of the subject with a question mark. 4 A. Scott, W. Fratcher, & M. Ascher, Scott and Ascher on Trusts §24.26 p. 1797 (5th ed. 2007).
In resolving these differences, we note that this longstanding disagreement concerns state of mind, not whether “defalcation” can cover a trustee’s failure (as here) to make a trust more than whole. We consequently shall assume without deciding that the statutory term is broad enough to cover the latter type of conduct and answer only the “state of mind” question.B 1
We base our approach and our answer upon one of this Court’s precedents. In 1878, this Court interpreted the related statutory term “fraud” in the portion of the Bankruptcy Code laying out exceptions to discharge. Justice Harlan wrote for the Court:
“[D]ebts created by ‘fraud’ are associated directly with debts created by ‘embezzlement.’ Such association justifies, if it does not imperatively require, the conclusion that the ‘fraud’ referred to in that section means positive fraud, or fraud in fact, involving moral turpitude or intentional wrong, as does embezzlement; and not implied fraud, or fraud in law, which may exist without the imputation of bad faith or immorality.” Neal v. Clark, 95 U. S. 704, 709 (1878) .
We believe that the statutory term “defalcation” should be treated similarly.
Thus, where the conduct at issue does not involve bad faith, moral turpitude, or other immoral conduct, the term requires an intentional wrong. We include as intentional not only conduct that the fiduciary knows is improper but also reckless conduct of the kind that the criminal law often treats as the equivalent. Thus, we include reckless conduct of the kind set forth in the Model Penal Code. Where actual knowledge of wrongdoing is lacking, we consider conduct as equivalent if the fiduciary “consciously disregards” (or is willfully blind to) “a substantial and unjustifiable risk” that his conduct will turn out to violate a fiduciary duty. ALI, Model Penal Code §2.02(2)(c), p. 226 (1985). See id., §2.02 Comment 9, at 248 (explaining that the Model Penal Code’s definition of “knowledge” was designed to include “ ‘wilful blindness’ ”). That risk “must be of such a nature and degree that, considering the nature and purpose of the actor’s conduct and the circumstances known to him, its disregard involves a gross deviation from the standard of conduct that a law-abiding person would observe in the actor’s situation.” Id., §2.02(2)(c), at 226 (emphasis added). Cf. Ernst & Ernst v. Hochfelder, 425 U. S. 185 , n. 12 (1976) (defining scienter for securities law purposes as “a mental state embracing intent to deceive, manipulate, or defraud”).2
Several considerations lead us to interpret the statutory term “defalcation” in this way. First, as Justice Harlan pointed out in Neal, statutory context strongly favors this interpretation. Applying the canon of interpretation noscitur a sociis, the Court there looked to fraud’s linguistic neighbor, “embezzlement.” It found that both terms refer to different forms of generally similar conduct. It wrote that both are “ ‘ejusdem generis,’ ” of the same kind, and that both are “ ‘referable to the same subject-matter.’ ” 95 U. S., at 709. Moreover, embezzlement requires a showing of wrongful intent. Ibid. (noting that embezzlement “involv[es] moral turpitude or intentional wrong”). See Moore v. United States, 160 U. S. 268 –270 (1895) (describing embezzlement and larceny as requiring “felonious intent”). See also, e.g., W. LaFave, Criminal Law §19.6(a), p. 995 (5th ed. 2010) (“intent to deprive” is part of embezzlement). Hence, the Court concluded, “fraud” must require an equivalent showing. Neal, supra, at 709. Neal has been the law for more than a century. And here, the additional neighbors (“larceny” and, as defined in Neal, “fraud”) mean that the canon noscitur a sociis argues even more strongly for similarly interpreting the similar statutory term “defalcation.”
Second, this interpretation does not make the word identical to its statutory neighbors. See Babbitt v. Sweet Home Chapter, Communities for Great Ore., 515 U. S. 687, 698 (1995) (noting “[a] reluctance to treat statutory terms as surplusage”). As commonly used, “embezzlement” requires conversion, and “larceny” requires taking and carrying away another’s property. See LaFave, Criminal Law §§19.2, 19.5 (larceny); id., §19.6 (embezzlement). “Fraud” typically requires a false statement or omission. See id., §19.7 (discussing fraud in the context of false pretenses). “Defalcation,” as commonly used (hence as Congress might have understood it), can encompass a breach of fiduciary obligation that involves neither conversion, nor taking and carrying away another’s property, nor falsity. Black’s 479. See, e.g., In re Frankel, 77 B. R. 401 (Bkrtcy. Ct. WDNY 1987) (finding a breach of fiduciary duty and defalcation based on an unreasonable sale of assets).
Nor are embezzlement, larceny, and fiduciary fraud simply special cases of defalcation as so defined. The statutory provision makes clear that the first two terms apply outside of the fiduciary context; and “defalcation,” unlike “fraud,” may be used to refer to nonfraudulent breaches of fiduciary duty. Black’s 479.
Third, the interpretation is consistent with the long-standing principle that “exceptions to discharge ‘should be confined to those plainly expressed.’ ” Kawaauhau v. Geiger, 523 U. S. 57, 62 (1998) (quoting Gleason v. Thaw, 236 U. S. 558, 562 (1915) ). See Local Loan Co. v. Hunt, 292 U. S. 234, 244 (1934) ; Neal, supra, at 709. It is also consistent with a set of statutory exceptions that Congress normally confines to circumstances where strong, special policy considerations, such as the presence of fault, argue for preserving the debt, thereby benefiting, for example, a typically more honest creditor. See, e.g., 11 U. S. C. §§523(a)(2)(A), (a)(2)(B), (a)(6), (a)(9) (fault). See also, e.g., §§523(a)(1), (a)(7), (a)(14), (a)(14A) (taxes); §523(a)(8) (educational loans); §523(a)(15) (spousal and child support). In the absence of fault, it is difficult to find strong policy reasons favoring a broader exception here, at least in respect to those whom a scienter requirement will most likely help, namely nonprofessional trustees, perhaps administering small family trusts potentially immersed in intrafamily arguments that are difficult to evaluate in terms of comparative fault.
Fourth, as far as the briefs before us reveal, at least some Circuits have interpreted the statute similarly for many years without administrative, or other practical, difficulties. Baylis, 313 F. 3d 9. See also In re Hyman, 502 F. 3d 61, 69 (CA2 2007) (“This [scienter] standard . . . also has the virtue of ease of application since the courts and litigants have reference to a robust body of securities law examining what these terms mean”).
Finally, it is important to have a uniform interpretation of federal law, the choices are limited, and neither the parties nor the Government has presented us with strong considerations favoring a different interpretation. In addition to those we have already discussed, the Government has pointed to the fact that in 1970 Congress rewrote the statute, eliminating the word “misappropriation” and placing the term “defalcation” (previously in a different exemption provision) alongside its present three neighbors. See Brief for United States as Amicus Curiae 16–17. The Government believes that these changes support reading “defalcation” without a scienter requirement. But one might argue, with equal plausibility, that the changes reflect a decision to make certain that courts would read in similar ways “defalcation,” “fraud,” “embezzlement,” and “larceny.” In fact, we believe the 1970 changes are inconclusive.III
In this case the Court of Appeals applied a standard of “objectiv[e] reckless[ness]” to facts presented at summary judgment. 670 F. 3d, at 1166. We consequently remand the case to permit the court to determine whether further proceedings are needed and, if so, to apply the heightened standard that we have set forth. For these reasons we vacate the judgment of the Court of Appeals and remand the case for further proceedings consistent with this opinion.
It is so ordered.
ORAL ARGUMENT OF THOMAS M. BYRNE ON BEHALF OF THE PETITIONER
Chief Justice John G. Roberts: We'll hear argument next in case 11-1518, Bullock versus Bank Champaign.
Thomas M. Byrne: Mr. Chief Justice, and may it please the Court:
This case presents one of the most confounding questions of bankruptcy law, and that is the meaning of defalcation which is found currently in Section 523(a)(4) of the Code.
It is an undefined term in a Bankruptcy Code with more than 100 defined terms and it has been in the Bankruptcy Code or Bankruptcy Act, excuse me, since 1841 and in every version of it since then.
There is no plain contemporary, ordinary meaning that we can resort to with respect to interpretation of the word because it is not in common use.
This case presents both the question of the action required to establish defalcation and the mental state that most -- that must accompany it.
And on the mental state issue, the circuits have split in probably three ways at least.
The Eleventh Circuit here held that Petitioner committed defalcation by acting recklessly and affirmed on summary judgment, a summary judgment order that was granted for the petitioning creditor.
Justice Samuel Alito: Well, before we get to the various candidates for applicable mental state, if there is one, could you tell me what this mental state applies to?
Does it apply to facts or does it apply to law?
Thomas M. Byrne: Your Honor, it should apply to both, but it applies -- the act must be accompanied by a culpable mental state.
We will argue that -- and have argued that mistake of law can be relevant to the knowledge that the actor has when he commits the act, and we have argued that in this particular circumstance particularly involving dischargeability, that a mistake of law ought to be permissible in responding to the claim of defalcation.
Justice Ruth Bader Ginsburg: Well, what we have here is, I think everybody agrees, that these transactions were not authorized and they were self-dealing to the extent that there was a benefit to Mr. Bullock from the investments that were made.
So what, in addition to being unauthorized and self-dealing, which the government tells us should be enough to make defalcation, what else other than that it was not authorized and it was self-dealing?
Thomas M. Byrne: Your Honor, we believe that a showing of extreme recklessness at least is required as to the self-dealing, and so we have advocated for the First and Second Circuit standard, which requires either extreme recklessness or conscious misbehavior by the actor.
Justice Ruth Bader Ginsburg: But is a trustee who is taking -- borrowing against the cash value of the life insurance making an investment for the benefit of himself and his mother getting profit from that investment and not sharing it with the other siblings who are also.
So what more than -- I mean, he did that all advertently.
Thomas M. Byrne: Well, Your Honor, let me go back to the question, first were -- were the loans authorized.
Now, this case -- the finding of defalcation here is based entirely on the two Illinois court orders in collateral estoppel.
And the Illinois courts specifically reserved the question of whether the loans were authorized.
But let me put that aside, please, and answer your second question.
And what -- what sets this case apart and what -- what at least creates a factual question on whether Mr. Bullock committed defalcation was what was his -- was the overall transaction.
This is a family trust, it was created by his father, involving his father's life insurance policy.
There is uncontradicted evidence that he did not know that making a loan to his mother at his father's request would somehow run afoul of the law more than a decade later when this all came -- when this all came to court.
So we say, Your Honor, that there is at least a factual question that would have entitled him, should have entitled him to a trial on the question of the mental state that accompanied his actions.
Justice Ruth Bader Ginsburg: But what about the two other transactions which were not done at the bidding of the father?
Thomas M. Byrne: Well, Your Honor, they were done at the bidding of the mother and also they were -- they went into the family business.
These are two loans that went into the business created by the father and the mother, the garage building business.
That's where the proceeds went.
And so it would have been a surprise, we say, to the average person to learn that there was a legal problem with those loans.
Chief Justice John G. Roberts: Well, I mean, it's often the case that -- that children don't want to go into the family business and it's often the case that some of them do and some of them don't and the idea that one of the children who wants to put the money back in the family business is -- you know, you wouldn't think that was wrong when the other children want to take the money out or put it somewhere else.
That's not at all unusual.
Thomas M. Byrne: Well, it's not unusual to have some sort of conflict about that, Your Honor.
But the record is very limited in this case as to what the preferences of the others were.
It is -- it seems clear that--
Justice Sonia Sotomayor: Their preference is that they wanted a piece of the action.
They still do.
They want the profits from that investment.
Whether they're entitled to it is a different issue, but--
Thomas M. Byrne: --That -- that position seems clear now, Your Honor, that -- that background, these loans were made, please, recall, in the '80s.
Justice Anthony Kennedy: I -- I assume the other children did not have an interest in the business, but just the trustee and the mother did.
Or is that clear from the record.
Thomas M. Byrne: That is not clear from the record, Your Honor.
I think I know the answer to that question, but it is not in the record in the case, so--
Justice Stephen G. Breyer: Could -- could you go back, please, to Justice Alito's question?
I -- I don't understand the answer to that.
That is, I don't understand, and it's just something I don't understand.
I'm not saying it facetiously.
I don't understand the relationship of mental state to the issue.
I mean, I didn't think there is any doubt here that the individual, your client, knew what he was doing.
He knew for a fact that he was taking money from the trust.
He knew he was giving it to his mother.
And he knows where it's going.
And he knows it was later paid back with 6 percent interest.
So you don't have to assume extreme recklessness.
He knew it.
Now, what he didn't know was that that was unlawful.
And therefore, if I look at the accompanying things -- embezzlement, larceny, fraud in the trust -- I don't think any of them require a knowledge that what you're doing is unlawful.
So if I -- or do they?
I don't think -- you can be convicted of embezzlement while misunderstanding the law of embezzlement.
You can be convicted of larceny, it's saying.
And as far as I know, a person to commit fraud lies, knows it's material, knows, et cetera, but he doesn't have to know there's a law against it.
And -- and so -- if I do what Justice Harlan was doing and comparing it to the other three, it looks as if you don't need to know that what you're doing is against the law, where you commit defalcation.
Now, that I think is what Justice Alito was driving at.
And I'd like to hear an absolutely clear answer on that.
Thomas M. Byrne: --Your Honor, let me -- let me try.
Let me try to give such an answer.
The first, with respect to larceny, embezzlement and fraud, a mistake of law is admissible where it negates the scienter or the mental state.
Justice Stephen G. Breyer: But I didn't think there's any respect here in which missing, mistake of law, would negate the mental state as to having taken money from the trust, used it in the family business and then paid it back, which I take it are -- we assume, which is a different question I have -- but for present purposes, we are assuming that that's sufficient for defalcation.
Is that right?
Where is it -- and where does it negative the intent in respect to what happened?
Thomas M. Byrne: Well, Your Honor, the knowledge of the law, knowledge of wrongdoing I think is what -- what you're asking, where does that come into this?
And it comes into the question A, if you didn't have it; and B, the question becomes was it extremely reckless under the scienter standard that the First and Second Circuits -- the First and Second Circuits follow--
Justice Stephen G. Breyer: No, it had nothing to do with recklessness.
He did these three things knowingly.
That is a stronger mental state than recklessness, not a weaker one.
Thomas M. Byrne: --Well, Your Honor, but he did it without knowing that they--
Justice Stephen G. Breyer: Were unlawful.
So we're back at the same question, and I'm now assuming you have no answer to the question because there is none.
Thomas M. Byrne: --Well, Your Honor, in many instances -- not many -- but in some instances, the Court has held that not knowing that a practice is unlawful is a defense to a charge of the crime.
Justice Sonia Sotomayor: --My problem is the following, which is let's assume he had taken the money and lost it and he never repaid it.
What does it matter whether he thought he could take the money or not?
I thought the very basic definition of defalcation in every dictionary at the time and forever, one of the three definitions has always been that you cause a loss to the -- to the trust.
Why does mental state matter at all, is my bottom line?
I think that your stronger argument is that loss to the estate, or the one that you have to -- can direct your attention to, is what is the loss to the trust?
But what does it matter whether I intended to lose it or not if I wasn't entitled to lose it?
Thomas M. Byrne: Well, Your Honor, the question would be whether or not on the mental state -- and then I'll get to the actus reus element of this quickly -- but as to the mental state, if the mental state is not culpable then it seems entirely inconsistent--
Justice Sonia Sotomayor: Well, that's Justice Breyer's point, which is if you took the money and lost it, what does it matter?
You took it.
Unless -- unless you were drugged and didn't know that you were taking the money and somebody else forced you to in some -- under some sort of duress defense, some outrageous question -- isn't the issue the one that Justice Breyer came to?
If you're a fiduciary, why should an excuse of ignorance of the law ever save you when you are required to exercise the highest protection of the trust?
Thomas M. Byrne: --Well, Your Honor, of course, it does not save you from liability.
Our issue here is dischargeability, which is a--
Justice Sonia Sotomayor: Why should you be discharged if you took -- if you knowingly did an act, the actus reus, with its concomitant mental state.
You intended to take the money.
Thomas M. Byrne: --Well, Your Honor, because for dischargeability purposes, because of Gleason v. Thaw, and the rule that -- that bankruptcy discharge exceptions are confined to those plainly expressed doubts, are resolved in favor of the debtor.
And if you look at the other requirements for exceptions to discharge in Section 523(a) you see a high level of culpable conduct.
For example, in Geiger, the Court held that reckless torts do not amount--
Justice Stephen G. Breyer: Yes, but you see -- should I have to write the opinion in this case, I would have to deal with this issue, and I'd have to say something about it.
And as soon as I look at the other words, those are words like “ embezzlement ”, “ larceny ” and “ fraud ”.
Now, elsewhere in the U.S. Code where those are crimes ignorance of the law is not an excuse.
It often is an excuse where in fact it's a tax violation or some other technical violation.
So I would have to explain why the word “ defalcation ” when linked to those three is being treated differently.
Or I'd have to say Congress used words which never have ignorance of the law as an excuse and meant them differently.
Each of those is pretty hard to say.
Thomas M. Byrne: --Well, Your Honor, you're alluding to Cheek v. United States and Rasco v. United States, cases in which ignorance of the law as an exception to the general rule was found to be a defense in those cases.
And what you had in those cases was a complex legal regime.
You had the tax laws and then you had the -- anti-structuring statute.
And here, we say that trust law in and of itself is a complex enough legal regime that a mistake of law at least ought to be admissible, not for liability but for establishing bankruptcy--
Justice Stephen G. Breyer: I have one other question on a different subject that may be more helpful to you or not.
I think of defalcation as the individual who has defalcated shows up in Rio with two suitcases full of money, and it seems to me if you look at the root of the word, it consists of deminishing, taking a sickle and cutting something down, and therefore it did seem to refer to an instance where you take the corpus or money belonging to the trust -- now it becomes ambiguous -- and you run off with it.
Is there anything you would like to say about that?
Thomas M. Byrne: --Yes, Your Honor.
I would like to say that defalcation requires a shortage in accounts at the end of the day.
And so there must be -- in the trust, there must be some res missing when the trustee is called to account.
Chief Justice John G. Roberts: But there is a shortage of accounts at the end of the day.
It's just a question of what day it is.
When he takes -- takes the stuff and it's a lost -- it's either viewed as a lost opportunity or an increase in the risk to the beneficiary, and that's a loss to them at that point.
The fact -- it's like a bank robber giving back the money.
There is no loss to the bank, but it's still crime.
Thomas M. Byrne: Well, Your Honor, the deletion of the word “ misappropriation ” in 1978 from the Bankruptcy Code by Congress suggests that misappropriations that -- that are on an interim basis that cause -- that do not cause a loss to the trust and are -- are never accounted for is not the kind of action or act that should result in an exception to discharge.
But if you look with respect to defalcation at the definitions at the time, the definitions that were available in 1841 as I believe Justice Breyer has done, the -- the definitions you get are, for example, in Webster's 1828 dictionary, the act of cutting off or deducting a part.
And the origin of the defalcation exception, and I believe the amici for Respondent are correct in this respect, was the Swartwout scandal in 1838, when one Samuel Swartwout, who was the -- in charge of collections for the New York Customs House, which was a substantial part of the Federal budget at that time, was found after he departed the country to have $1.2 million missing from his accounts.
And that was referred to as a defalcation at the time and it's quite reasonable to assume that's how it ended up in the statute.
So the loss of res there for loss of funds to which the -- the fiduciary is responsible for collecting at the time of -- that -- that he turns over his office, because this really originated with public officials, is the relevant time.
Justice Elena Kagan: But I guess the question is how do you measure this loss?
I mean, if you take money away and then you give it back, or even if you give it back with 2 percent interest or something, I mean, maybe if that money had remained in the trust -- and I realize that this is a strange trust, but -- but we have to think about other kinds of trusts -- if that money had remained in the trust, there would have been a profit to be made from that money.
And, you know, it's not -- if you say, well, I gave it back, well, yes, but if you had just left it there, you would have had that money plus all the money that that money earned.
Thomas M. Byrne: Correct, Justice Kagan.
But here, there was never any money taken from the trust that didn't wind up with the trust at the end of the day.
The evidence is that the net policy value on the day Mr. Bullock unwittingly became a trustee in 1978 was the same as when he, at the end of his tenure--
Justice Ruth Bader Ginsburg: But what -- what about the profit from the transactions, the profit that he made?
Yes, he paid back everything with interest, but in addition to that, according to the Illinois court judgment, there was a profit that he made that he didn't put back in the trust, he didn't put in the trust.
Thomas M. Byrne: --He was -- he was charged with having profited with respect to one or more of the loans, Your Honor.
Justice Antonin Scalia: A quarter of a million dollars in loans.
Thomas M. Byrne: That's correct, Your Honor.
Justice Antonin Scalia: And that did not go back into the trust.
Thomas M. Byrne: It did not.
Justice Antonin Scalia: As it should.
Doesn't the trustee have to disgorge whatever he makes by improper use of the trust funds?
Thomas M. Byrne: He -- he does for liability purposes, of course, Justice Scalia.
But here the question is whether there is a bankruptcy defalcation.
And that's a question of Federal law.
Justice Ruth Bader Ginsburg: May I ask you question that is not a technical bankruptcy question, but he -- the objective of filing for bankruptcy was to get rid of this judgment debt, this Illinois judgment debt, right?
Thomas M. Byrne: Yes, Your Honor.
Justice Ruth Bader Ginsburg: And the Eleventh Circuit said, you know, we're really sympathetic to that, but the problem is that the bank would not let you sell the collateral.
If you could sell the collateral, then you could pay off the loan and you wouldn't need to declare bankruptcy.
Did you bring such a suit, the suit that suggests that the bank was the culpable party here by not letting you sell the property which would have enabled you to pay the debt?
Thomas M. Byrne: That -- that action has not been brought, Your Honor.
And in that action, let's say it were brought today, it could do nothing to relieve Petitioner of the judgment of the Eleventh Circuit and the lower courts here that he has a debt that is -- a substantial debt that is excepted from discharge.
He could continue litigating perhaps if he has the resources in -- in Illinois for many more years perhaps, but--
Justice Sonia Sotomayor: Counsel, give me your best answer to the rule that we should write, okay?
Forgetting that I don't accept that you need a mental state, okay?
Let's go to just the loss issue.
If I agree with you that you need to prove the loss, this is a very unusual trust, because the measure of what the trust's res should be is fixed.
It was the amount of the trust plus the fixed interest, essentially.
This is a very unusual trust.
In the norm, the trust just says to the trustee, invest prudently.
And the trustee self-deals by taking the res out, puts the investment in his or her own name and takes the profit.
In that situation, how would you measure the loss?
In the normal self-dealing where the trustee just has to invest prudently and is depriving the trust of that investment value, would you say in that situation that the loss is measured by the lost opportunity?
Thomas M. Byrne: --Your Honor--
Justice Sonia Sotomayor: Because there is a difference between what the trust loses and the gain that the trustee makes, which under normal trust principles the gain has to be disgorged.
Are you separating out those two things and how are you separating them out and how would I -- how would we write, the Court write this opinion to give loss meaning?
What's the -- what's the meaning you want to give it?
Thomas M. Byrne: --Your Honor, the -- the loss to the trust should be measured by the economic loss to the trust between points A and point B.
And -- and it's -- it's as simple as that, and of course here there wasn't loss to the trust.
As you point out, it's an unusual situation perhaps, but of course life insurance trusts and other kinds of trusts that present this situation are--
Justice Sonia Sotomayor: So under your theory, the profit to the trustee is never a measurement.
Thomas M. Byrne: --The profit to the trustee would not come into play.
It could come into play for fraud.
It could come into play for embezzlement.
It could come into play if the mental state that we argue for is -- is otherwise met.
Justice Sonia Sotomayor: Assume that that is distasteful, because for all the reasons the Government argues in its amicus brief, the idea that a trustee could self-deal is the height of a breach of fiduciary duty.
So give me something that -- that would win your case without upsetting the fact that defalcation somehow should, in the norm, include something as egregious as self-dealing.
You don't think your guy did, because he didn't know, but let's assume the worst case.
The guy knew.
Thomas M. Byrne: Well, for the -- for that worst case, Your Honor, there is embezzlement in the statute.
So if a -- if someone comes into possession of property and misuses it and does so with fraudulent intent, it sounds like here, then there is a -- then embezzlement can be established under the statute.
Justice Ruth Bader Ginsburg: Mr. Byrne, I -- I wasn't finished asking you about the background of this.
It -- it seems the simplest thing, if the bank is the culprit, then why not go after the bank and then get the money which would make the Chapter 7 unnecessary?
Thomas M. Byrne: Your Honor, there is a good bit not in the record on that, and I presume you want me to stick to the record in responding and there is no real explanation for that.
There is in the record a consistent track of Petitioner trying to get the bank to sell the collateral in order to pay the debt off over time and with an urgency to it because the collateral was deteriorating in value.
But beyond that, there's not anything else in the record about the practicality or availability of the remedies in the Illinois court.
Justice Ruth Bader Ginsburg: But it was what the Eleventh Circuit thought was a solution to this problem.
Thomas M. Byrne: It was, Your Honor.
Justice Ruth Bader Ginsburg: And were they wrong in--
Thomas M. Byrne: As a practical matter, Your Honor, yes, and also as a legal matter, because the Illinois courts cannot set aside the order here excepting the debt from discharge.
The only -- the only agenda potentially left for Petitioner would be litigation in the -- in the Illinois courts against the trustee to create some sort of a judgment that might be used in some way to ameliorate the effect of the bankruptcy court's judgment, but he still has -- basically, he's been consigned to permanent insolvency the way that this judgment now sits.
Justice Anthony Kennedy: The briefs -- the briefs on your side of the case say, well, you know, there is a series of words here: Fraud, defalcation, embezzlement, larceny.
But really, fraud and defalcation are defined in a further way where embezzlement and larceny are not.
Fraud and defalcation, while acting in a fiduciary capacity, then embezzlement and larceny.
So I'm not quite sure it's there to say that all four words must be consulted for the use of generous -- because fraud and defalcation are qualified by “ in a fiduciary capacity ” and then a comma.
Thomas M. Byrne: Well, that is correct, Your Honor, that -- that that's the way that this particular version of the Bankruptcy Act is set up.
In the past however, in Neal v. Clark, in an important decision by this Court in 1878, the Court held that fraud should be construed to require fraud with moral turpitude because of the presence of embezzlement in the 18--
Justice Anthony Kennedy: Yes.
In that respect, I think the word “ fraud ” gives you some assistance in arguing your case.
Thomas M. Byrne: --Thank you, Your Honor.
Unless there are further questions, I'll reserve the remainder of my time for rebuttal.
Chief Justice John G. Roberts: Thank you, counsel.
ORAL ARGUMENT OF BILL D. BENSINGER ON BEHALF OF THE RESPONDENT
Bill D. Bensinger: Mr. Chief Justice, and may it please the Court:
The Petitioner's act of self-dealing was a reckless breach of his fiduciary duty of loyalty and was therefore a defalcation.
Justice Anthony Kennedy: Was there a finding of recklessness in the State court?
Bill D. Bensinger: No, Your Honor.
There was not a finding of recklessness.
The State court simply found that the debtor engaged in self-dealing, that he used trust assets for his own purposes and, thereby, created a split, a conflict of interest between his interest and the interest of the trust.
The moment that he made those loans, there is an absolute certainty that there would be a conflict of interest and a reasonable person, a reasonable trustee in the Petitioner's position would not have made those loans, because the risk was so high, nigh on an absolute certainly that there would be this conflict of interest, and that has been the harm incurred at the moment he made the loans, Your Honor.
Justice Anthony Kennedy: Is the crime of embezzlement proven if you show recklessness or do you need a further criminal intent?
Bill D. Bensinger: Generally speaking, Your Honor, embezzlement does require some sort of specific mental intent, an intent to deceive or to defraud.
But defalcation does not require that same mental intent and that's borne out by the history.
Justice Anthony Kennedy: Well, of course, that's one of the things we are arguing about here.
I don't think that's conceded.
Bill D. Bensinger: No, Your Honor, it's certainly not conceded, but it's borne out in the history of the Bankruptcy Act.
Defalcation was first added to the Bankruptcy Act in 1841 and it was simply an exception to discharge for defalcation.
There was no mention of fraud, there was no mention of embezzlement, there was no mention of larceny.
It wasn't until 1867 that Congress in the Bankruptcy Act of 1867 that Congress added an exception to discharge for embezzlement and for fraud.
Justice Samuel Alito: You think recklessness is required?
Bill D. Bensinger: I'm sorry, Your Honor?
Justice Samuel Alito: You think recklessness is required?
Bill D. Bensinger: Yes, Your Honor.
Recklessness is required as to the objective act.
Justice Samuel Alito: Recklessness as to the law, as to what the law requires of the trustee.
Bill D. Bensinger: Recklessness as to the law, correct, Your Honor, but also as to the act.
This was a reckless act.
Justice Stephen G. Breyer: Wait, wait.
You say -- you mean either, both?
I mean, there is no doubt here, I agree with you, as far as the act is concerned.
It wasn't just reckless, it was intentional.
So you don't have to worry about that one.
Thus Justice Kennedy's basic question I'd like to hear your answer to.
I thought it might have come from the other side, but you concede, I take it, that there has to be an element in which the person not only knows what he has done, but that he does it with an element of moral turpitude; i.e., he knows that the law forbids it or -- or are you conceding this and then fill in the blanks, or.
Bill D. Bensinger: No, Your Honor, and I apologize if I misspoke.
All that is required is an intent to do the act and that's what--
Justice Stephen G. Breyer: All right.
Then if that's your position, what do you say to what Justice Kennedy said, add in Justice Harlan's comment that embezzlement and larceny are set off.
These two concern fraud and defalcation in respect to the trust.
There is a case of this Court that says fraud in respect to the trust requires an element of moral turpitude.
That suggests a knowledge that what you are doing violates the law.
And if we read in pari materia, we get the same kind of requirement for this, indeed more so.
Indeed, you just conceded it existed even in respect to embezzlement, which is outside the parenthesis.
Bill D. Bensinger: --Your Honor, fraud, like embezzlement, does require a specific mental intent, but defalcation does not.
Justice Stephen G. Breyer: Why?
Defalcation on your definition would seem to be more likely to be thought innocent by someone who commits it in some circumstances than would fraud.
Bill D. Bensinger: Your Honor, defalcation must mean something other than fraud.
The statute says that--
Justice Stephen G. Breyer: No.
It may mean, for example here, fine, okay, no fraud, but what you did was you took some money that belonged to the trust given by your father to help your mother.
And your mother says, help me, and the brothers and sisters will benefit well too.
And so you go to your insurance guy and he says, sure, no problem.
And then, lo and behold, they did it.
I mean, innocence just radiates from what the conduct was as described.
Bill D. Bensinger: --When it's described like that, maybe, Your Honor.
However, it was still a reckless act, Your Honor, in that a reasonable trustee--
Justice Antonin Scalia: I don't understand.
Where does this reckless act come from?
Where do you get reckless act out of either fraud or defalcation?
Bill D. Bensinger: --Your Honor, the courts have traditionally ascribed -- most courts have said that defalcation does require some form of reckless--
Justice Antonin Scalia: Perhaps so.
Where did they get it from?
Bill D. Bensinger: --Your Honor, that's the genesis of this case.
Justice Sonia Sotomayor: What does it matter -- if the money is missing, what does it matter the reason why in terms of recklessness or intent?
You took the money.
Justice Breyer and I both agree you intended to take the money.
So why are you adopting the need for recklessness, unless you're trying to avoid the second component that the other side's talking about, which is that you caused a loss to the trust?
Because that's where you have a problem here, where you have a problem, because there really is no loss to the trust in a traditional sense.
Bill D. Bensinger: Possibly in the traditional sense there might not have been a loss, but there was a loss in the context of trust law, Your Honor.
The Petitioner in this case used trust funds for his own benefit.
Justice Sonia Sotomayor: Well, the problem is that, yes, there was a breach of the trust.
But in terms of the terms of the trust, the trust got every penny that it would have earned if the money had not been taken.
It got the trust plus the fixed 6 percent that the trust was entitled to.
So it suffered no loss in its traditional sense.
Bill D. Bensinger: Maybe not in the traditional sense, but in the context of a fiduciary obligation a trustee is not allowed to benefit from his position as trustee.
Justice Antonin Scalia: Well, the -- why are you giving away that it's not in the traditional sense?
I think it's a loss in the traditional sense.
The trust was entitled to whatever profit was made from the use of its funds, right?
Bill D. Bensinger: Correct, Your Honor.
Justice Antonin Scalia: And he made a quarter million dollars that should have belonged to the trust.
It's not enough to say, well, you know, I'll pay you 2 percent interest or whatever the going rate of interest was.
He made $250,000 which should have been given to the trust.
Bill D. Bensinger: That's correct, Your Honor.
And that is what the Illinois State court found, and that is borne out also by the other exceptions to discharge in Section 523(a)(4).
If a fraudster commits fraud, he doesn't just remedy that by paying back what he took.
He has to return all of the profits that he has obtained.
Justice Samuel Alito: But the question here -- the question here is not whether the trustee is liable.
Yes, the trustee is liable.
The question is whether it's dischargeable.
Bill D. Bensinger: Correct, Your Honor.
Justice Samuel Alito: And if you look at the other, the other words in this list, fraud, embezzlement, larceny, those are bad acts.
There is a degree of moral culpability involved and maybe there are people who commit fraud, embezzlement and larceny and don't realize that it's illegal, but there are not many.
It's commonly understood that those are bad.
So in a very impressionistic sense, there is a difference between that and the kind of conduct that's presented to us here.
But you think that's irrelevant.
Bill D. Bensinger: It is irrelevant, Your Honor, because a reasonable trustee would not act this way.
A reasonable trustee would know that the moment he makes loans to himself he has created a conflict of interest between himself and his trust.
Justice Samuel Alito: Well, what about a reasonable trustee who just invests very imprudently, an unreasonable trustee who invests very imprudently?
Any reasonable trustee would realize that investing in, you know, the widget factory totally unrelated to him is a really bad idea and money is lost there.
What about that trustee?
Is that a defalcation?
Bill D. Bensinger: If it's unreasonable, it would be, Your Honor.
Justice Stephen G. Breyer: Is it -- before we leave this conduct, I mean, I understand I was painting you a picture of they're being innocent.
But we are in a court that this Court has described as a court of equity or akin thereto.
Bill D. Bensinger: Yes, sir.
Justice Stephen G. Breyer: One principle I used to learn was he who has clean hands can come into equity, but nobody else.
Now, we have two lower courts that are saying your client has pretty dirty hands or at least they don't understand it; that this, the other client tried to get him to sell the property, but they write the properties are abandoned and uninsurable.
Even though Mr. Bullock produced a buyer, they won't sell it.
And so do you have clean hands?
Not you yourself.
You didn't take the money and you do not have dirty hands, all right?
But did your client here -- does he lack clean hands because two courts have said he should have just sold his collateral and he would have gotten the money and saved everybody a lot of trouble?
Bill D. Bensinger: No, Your Honor.
Justice Stephen G. Breyer: Because?
Bill D. Bensinger: Because, first of all, the bankruptcy court never made any specific finding of facts.
Those were allegations that were included in -- in the record of the district court--
Justice Stephen G. Breyer: Did we remand it so they could?
Bill D. Bensinger: --No, Your Honor, because the Petitioner had every opportunity to bring those facts into -- into evidence at the bankruptcy court and he did not.
There are facts outside the record as there are on both sides with regard to this issue, why the trust would not allow subsequent sales.
But it does go back to an important point, and that's that the Petitioner did have, and retains today, an opportunity to go back to State court and seek a reduction in this judgment should he so desire.
A reduction in the judgment would reduce the debt, and if there is no debt, then there is nothing for the trust to collect subsequent to this discharge or subsequent to the lack of discharge, as Respondent is requesting.
Justice Ruth Bader Ginsburg: So there's nothing in the record that shows why the bank refused to release any of the collateral.
Bill D. Bensinger: No, Your Honor, there is not.
That was not an issue that ultimately came before the bankruptcy court.
The bankruptcy court made no finding of facts.
There were only allegations on appeal to the district court and to the Eleventh Circuit, Your Honor.
However, to return back to the point concerning that the required mental intent or the mens rea, both in the petition and here this morning, the Petitioner has not been able to articulate exactly what mens rea is required, that is, what mental intent is required.
But the mental intent that he asked is that it be something greater than extreme recklessness, in effect.
However, that cannot work in the code, because it would make other code sections superfluous.
Specifically, if the mental intent required were an intent to cause an injury, Section 523(a)(6) of the Bankruptcy Code already accepts from discharge debts for willful and malicious injury.
Justice Anthony Kennedy: Well, a number of embezzlers -- not all of them -- many embezzlers fully intend to pay everything back once things turn out all right.
But there's still an embezzlement.
But there is also a criminal intent at the time, or a wrongful intent, even if -- even if you plan to pay it back.
And it -- it seems to me that you're standing very firm on the fact that defalcation means something different than fraud in the first clause, or embezzlement and larceny in -- in the following clause.
Bill D. Bensinger: It does, Your Honor.
Defalcation when it was first introduced into the Bankruptcy Act of 1941 had a known meaning, and that known meaning, at least according to the Oxford English Dictionary, is a monetary deficiency through breach of trust.
That was when--
Justice Anthony Kennedy: And the problem is, as the -- your friend on the other side points out, that there's two problems with this.
Number one, it's not consistent with these -- with the meaning of the other three terms in the -- in the statute; and two, it's not consistent with the idea that discharges should be freely given so that debtors can begin again.
Bill D. Bensinger: --But, Your Honor, the subsequent inclusion of the terms fraud, embezzlement and larceny cannot retroactively modify or change the known definition of the word defalcation.
This Court in Schwager v. Northern Burlington considered two sections of -- or two statutes in the Securities and Exchange Act, Section 14(e) and Section 10(b).
Section 10(b) was the first enacted statute.
Section 14(e) was subsequently enacted.
Both statutes prohibited a manipulative type of transaction with regard to securities.
Section 14(e) also prohibited a fraudulent act with regard to securities.
This Court stated in that case -- while it wasn't central to its holding -- the Court did state that the inclusion of the term “ fraudulent ” in Section 14(e) could not modify the understanding of the term “ manipulative ”.
And the same logic applies here.
The subsequent inclusion of the terms “ fraudulent ” and “ embezzlement ” and “ larceny ” cannot modify the known meaning, even if that known meaning has been lost, the meaning of the word “ defalcation ”.
Justice Elena Kagan: Mr. Bensinger, if I heard you correctly, you said that the definition was a monetary deficiency arising from a breach of trust.
Is that -- does that mean that you're conceding that there has to be a loss of monetary deficiency?
Bill D. Bensinger: Your Honor, there was a monetary deficiency in this case when the--
Justice Elena Kagan: Whether there was or was not in this case, but you're conceding that there has to be a monetary deficiency according to the traditional definitions.
Bill D. Bensinger: --Yes, Your Honor.
For there to be even a debt, which is what the Bankruptcy Code discharges, there must be a monetary deficiency in this case, or in the case of a defalcation.
And that is what this Court--
Justice Sonia Sotomayor: So are we fighting about the meaning of loss?
That's really the question.
Bill D. Bensinger: --I'm sorry, Your Honor?
Justice Sonia Sotomayor: Are we fighting about what loss means?
Bill D. Bensinger: Your Honor, that is certainly an issue that the parties have contested in the briefs before this Court and in the courts below, whether there was a loss.
And there was a loss.
The State court recognized that there was a loss in the amount of $250,000.
That judgment of $250,000 creates a claim.
The Bankruptcy Code at Section 101-5 defines a claim as a right to payment.
Chief Justice John G. Roberts: So if he made nothing on the deal, and it just turns out he got whatever the -- the trust was getting under its interest rate and gave it back, there'd be no defalcation, because there'd be no loss in the sense of a lost opportunity?
Bill D. Bensinger: There would be a defalcation, Your Honor, but there would be no debt in that case.
And that -- there would be nothing--
Chief Justice John G. Roberts: I'm sorry.
I understood your answer to Justice Kagan to be that you -- there must be a loss, right?
Bill D. Bensinger: --Your Honor, there -- there needs to be a loss for there to be a debt.
Chief Justice John G. Roberts: Right.
Does there have to be a loss for there to be a defalcation?
Bill D. Bensinger: No, Your Honor.
Inconsistent in that answer, I apologize.
I did not intend to be.
There must be a loss for there to be a debt.
For there to be a defalcation, that merely goes to the bad act.
The act of in this case self-dealing.
Chief Justice John G. Roberts: So taking the money out is sufficient for defalcation even if it's brought back in full and even if there is no lost opportunity.
Bill D. Bensinger: Correct, Your Honor.
Justice Antonin Scalia: That's not consistent with the original meaning of defalcation to which you were appealing.
It's pretty clear to me that the original meaning of -- is a cutting off, a failure to turn over money that was due.
So you -- are you appealing the original meaning or not?
Bill D. Bensinger: Your Honor--
Justice Antonin Scalia: You're saying defalcation just means breach of trust.
Bill D. Bensinger: --No, Your Honor.
We're saying that in this case, the breach of trust, the self-dealing, was that cutting off of the--
Justice Antonin Scalia: And that's what made it a defalcation, no?
Bill D. Bensinger: --Correct, Your Honor.
Justice Antonin Scalia: Well, so then you say there has to be a cutting off.
There has to be a loss, for defalcation.
Not just for -- for a debt, but also for the defalcation.
Bill D. Bensinger: Your Honor, at that point, there was a--
Justice Antonin Scalia: Why are you fighting that?
You're going to have to prove the loss anyway.
You say there is a loss.
Bill D. Bensinger: --Your Honor, the loss in that case occurs -- Your Honor is absolutely right -- at the time that there is that cutting off, at the time in this case the Petitioner used the trust assets for his own benefit.
Justice Stephen G. Breyer: And then what's the loss?
I mean, let's assume the trust was worth $1 million plus 6 percent, and every year, they have in their coffer $1 million plus 6 percent.
Bill D. Bensinger: Your Honor--
Justice Stephen G. Breyer: The only part they don't have is the extra money that the trustee made, that there is no cutting down of the size of the trust.
At least that's an argument.
Now, what's the answer?
Bill D. Bensinger: --Because, Your Honor, the loss occurred.
There was a loss in the amount of the loans that he took out.
And that loss was compounded, if you will, Your Honor, by the Petitioner's failure to return those -- the proceeds of those loans--
Justice Sonia Sotomayor: But he did.
This is the unusual part of this trust, which is that by the terms of this trust, it was only going to grow at principal plus a fixed interest.
Most trusts are not written this way.
This is the highly unusual trust, where it never -- should have made more money, because, taking the Chief Justice's hypothetical, which is he had invested it and just gotten the interest due, why would there be a defalcation?
What's the loss opportunity or the loss that you would have suffered.
Bill D. Bensinger: --Your Honor, the loss that the trust suffered was that its principal was taken away, was it invested by the trustee for his own benefit--
Justice Sonia Sotomayor: Yes.
But let's assume a different fact scenario, that he didn't make $250,000, that he happened to make just the amount of the interest required, and he paid all of that back just as he did here, what would have been the defalcation under the Chief Justice's hypothetical?
Bill D. Bensinger: --The defalcation there, Your Honor, would be that the trustee has split his interest, has created a conflict of interest, and that causes a loss.
There might not be a monetary -- a straight monetary loss at that time.
Justice Sonia Sotomayor: I've never heard of a defalcation that didn't result in some monetary loss.
What would have been the monetary loss in the Chief's hypothetical?
Bill D. Bensinger: In that case, Your Honor, there would not have been a strict monetary loss in that hypothetical had the -- all the proceeds -- had there not been any benefit that the trustee obtained from the investment and use of those funds.
Chief Justice John G. Roberts: But there is still a loss.
I mean, when you're investing obviously the return is part of it, but also the question is what risk you assume.
And the trust would have suffered because during that period they were incurring a greater risk.
That's one reason you set up a trust, so you don't -- you protect people from that risk.
Bill D. Bensinger: That's correct, Your Honor.
Chief Justice John G. Roberts: Mr. Gannon?
ORAL ARGUMENT OF CURTIS E. GANNON ON BEHALF OF THE UNITED STATES, AS AMICUS CURIAE, SUPPORTING RESPONDENT
Curtis E Gannon: Mr. Chief Justice, and may it please the Court:
No particular mens rea is inherent in the term “ defalcation ” or the structure of Section 523(a)(4).
Justice Anthony Kennedy: Unlike fraud -- fraud, larceny and embezzlement?
Curtis E Gannon: Each of those terms does have some mens rea associated with it.
It is not, however, the willfulness requirement that my friend was invoking on the other side.
There is no obligation under any of those that there be an intentional violation of a known legal duty.
There are specific intents to defraud, but I think we know that this can't be -- it can't have that mens rea because that would make it superfluous.
That's what Judge Hand said in the Herbst decision, and that's what even the Second Circuit and the First Circuit recognized here, that they could not adopt the same mens rea that belongs with the other terms here and I--
Justice Stephen G. Breyer: Because?
Curtis E Gannon: --Pardon?
Justice Stephen G. Breyer: Because?
I mean, I thought defalcation is -- supposes that the person does pack his suitcases with the money and he goes and shows up in Rio.
I take it that would be defalcation.
That isn't fraud.
Curtis E Gannon: That would probably be embezzlement and it would be superfluous in that sense.
I think that the dictionary definitions, if you look at the dictionary definitions of defalcation that we quote on pages 10 and 11 of our brief, both the English dictionary definitions and the legal dictionary definitions, they basically--
Justice Stephen G. Breyer: But you didn't cite to the Latin, did you?
Curtis E Gannon: --Pardon?
Justice Stephen G. Breyer: But you didn't have the Latin definition, which I take it from my colleague and it was confirmed by my law clerk, it comes from medieval Latin, starting with a sickle and meant to cut down, to cut down, and that suggested reduction.
Curtis E Gannon: We did quote the Samuel Johnson dictionary and the Webster's 1828 dictionary that have that meaning.
If you look at the Oxford English Dictionary definition, that was an obsolete meaning.
And I think that it's quite clear that the meaning that Congress was invoking here is what is dealt with under heading five in the Oxford English Dictionary.
And my friend quoted it earlier: There is either a monetary deficiency through a breach of trust by one who has the management or charge of funds--
Justice Elena Kagan: Well, monetary deficiency, again, isn't that a loss?
But I thought that your position was that there didn't need to be a loss.
Curtis E Gannon: --Well, there are two questions there and I think that one of the illustrative quotations that the OED uses for that very definition doesn't actually refer to a monetary deficiency, and neither do most of the other dictionary definitions.
So I do think that there's probably an open question about what the purest meaning of the term defalcation, whether it requires a loss.
Here, we do think that there is a loss.
There is a loss in a very real and traditional sense.
There is no doubt about it that because the Petitioner took, engaged in self-dealing and made a profit with that, with the money that he had taken out of the trust corpus and refused to return those profits to the trust, that is a loss to the trust, just as it would be had he taken the money and invested it in some great investment scheme and -- or he decided to bet it at the track--
Justice Elena Kagan: Well, that's certainly true--
Curtis E Gannon: --and he decided--
Justice Elena Kagan: --in an ordinary trust, but isn't there a real question as to this trust, because if this trust would -- the trustee shouldn't have been investing this in the first place.
All that this trust was going to get was the principal plus a fixed income.
Curtis E Gannon: --I don't think that's a fair statement of the way this trust operates.
It's not consistent with Petitioner's own arguments.
Petitioner's argument in the State court and in the Bankruptcy Court, the argument that he says is the reason why there is no determination about whether this was an authorized use of the money under the trust instrument is that -- that he was allowed to invest the assets of the trust.
And so the way the courts -- and the parties have offered to lodge the trust instrument with the Court.
As I understand it it's not otherwise in the record.
But the point here is that he did--
Justice Sonia Sotomayor: Would you just repeat what you said?
Your voice turned.
Curtis E Gannon: --The last part I said, that the parties have offered to lodge the trust instrument with the Court, but my understanding is that it's not in the record.
But I don't think anybody has taken the position that the only thing that could ever be in the trust was the life insurance policy plus 6 percent.
Justice Sonia Sotomayor: That's what I understood.
So you're saying that that is not the case?
Curtis E Gannon: I believe that that is not the case and that is not even consistent with Petitioner's own position in the State court, where he said he was taking this money and investing it in some alternative thing because he thought that would be safer than leaving the money with the life insurance company.
And I think if I can go back to explaining why I think that this is a loss and so I think that this trust is not as unusual or unique as you think it is, in part because we don't have the language of it in front of us.
But secondly, I was trying to say that had he taken this money for an authorized purpose or not and decided he was going to go invest it, he had some boffo scheme, he had some friend who had a great stock tip, or he had a tip at the races and he was going to go down to the track and bet this money, he made 1,000 percent, and he decided, well, you know what, had I not taken the money out of the trust all I would have to do is return, all I have to do is make it whole in the sense of having the 6 percent that it otherwise would have had, that everybody would understand, that's a breach of his duty of loyalty.
That's a defalcation.
It is an injury to the trust.
It is a loss in every relevant sense.
And in addition here, the $35,000 that the State court awarded for attorney's fees and costs is also another concrete loss to the estate.
And this Court's decision in Cohen v. De la Cruz, which was about nondischargeability of a fraud judgment, of a debt for fraud, said that that debt for fraud included all of the legal liability associated with the underlying fraud--
Justice Sonia Sotomayor: But there is two components of the award, the attorney's fees plus the $250,000 profit.
And you're representing to me right now that as a trustee he was entitled to invest that fund for the trust?
And so there was a lost opportunity here as well?
Curtis E Gannon: --It's not that there -- it's not the opportunity loss.
It's not the fact that the trust wasn't already earning the interest in the -- vis -- vis the insurance company as it otherwise would.
Petitioner's position is if he already gave back the money that it would have earned in interest vis -- vis the insurance company, my position, the Government's position, is that the loss here is that he failed to disgorge the profits that he made by self-dealing in the assets of the trust corpus.
That is a--
Justice Stephen G. Breyer: What about the other argument?
I just don't want you to leave without addressing the other argument.
Curtis E Gannon: --The other argument--
Justice Stephen G. Breyer: In your brief you talk about and quote Learned Hand and say it means --
"If it doesn't mean a deliberate malversation. "
said Learned Hand--
Justice Antonin Scalia: “ Malversation ”.
Justice Stephen G. Breyer: --then it must be the same as fraud or embezzlement.
So I will go look up “ malversation ” as soon as I return to my office, and I will get that.
Now, the other argument was, yes, fine, a loss; two, done deliberately; but with an innocent state of mind because he didn't understand the law.
Justice Kennedy quoted, fraud -- from this Court, that fraud in bankruptcy for purposes of this provision requires some degree of moral turpitude.
Well, that suggests that you aren't innocent in respect to knowledge that it's against the law.
What about that?
Curtis E Gannon: --My response to that is that the Neal v. Clark decision that's being discussed here is -- and we discuss this in our brief -- is distinguishable in part because its current descendent is not this provision.
It is not this reference to fraud.
It is the exception from discharge in paragraph (a)(2)(A).
And what makes this different is that this is fraud in a fiduciary capacity which was not true in the context of Neal v. Clark, and that's something that the Court said at the time, that because it did not actually have the limitations of the fiduciary context, they needed to infer some type of limitation.
They inferred it, the Court inferred it, from embezzlement.
And so, going back to Justice Kennedy's question, the way Congress has dealt with that is that it has put actual fraud in (a)(2)(A), and here it has grouped fraud with defalcation in a fiduciary capacity and therefore it includes the type of limitation that the Court was trying to impose in Neal v. Clark.
We don't think that there is any inherent mens rea in defalcation and--
Justice Samuel Alito: Could you explain what you mean, before your time expires, in footnote 18?
I understood your argument until I got there, but then you said that there was no particular mental state required.
And then in footnote 18 you said: Well, there may be cases where a particular mental state is required.
Curtis E Gannon: --Well, I think when it gets further away from the heartland definition of defalcation, which does -- which, as was discussed in this Court's 1844 decision in Chapman and in the 1841 bankruptcy law, the defalcation was equated with self-dealing in trust assets.
And so we think that's the heart of defalcation.
As you move away from that particular type of fiduciary breach, and if you move away from there it may become more relevant whether there is--
Justice Samuel Alito: Where are courts supposed to look to find out what is the border between the heartland of defalcation and the badlands of defalcation and whatever else?
Curtis E Gannon: --Well, to be fair, the dictionary definitions are broad enough to include other types of fiduciary breaches, but it's not clear that that means that defalcation needs to be doing all the work here of potentially putting limits on the scope of the exception.
And so if you look at the Ninth Circuit, for instance, the way it has handled this is it has recognized, as we do, that defalcation can be innocent and -- but it has, it has concluded that the essence of defalcation is the failure to account for or to produce funds, and therefore it wouldn't be something that would just be garden variety mismanagement of the assets.
Justice Antonin Scalia: Well, why not?
I mean, it's a -- it's a violation of the trustee's responsibility when he makes a negligent investment of the funds, right?
And so he doesn't turn over as much money as should be turned over.
It's a defalcation.
Curtis E Gannon: Well, we certainly do think that that may well be the ultimate answer.
We think that would be further away from the core of defalcation, but it's not this case, so we would urge the Court to affirm.
Chief Justice John G. Roberts: Thank you, counsel.
Mr. Byrne, you have five minutes left.
REBUTTAL ARGUMENT OF THOMAS M. BYRNE ON BEHALF OF THE PETITIONER
Thomas M. Byrne: Thank you, Your Honor.
Justice Sonia Sotomayor: Is it your position that he couldn't have invested this?
Let's assume that he knew -- that he knew.
Thomas M. Byrne: Assuming he knew, Your Honor, he could -- his position is and it was -- it was true his position in the State court was that he could have invested it, but--
Justice Sonia Sotomayor: As a trustee for the trust.
Thomas M. Byrne: --As a trustee for the trust.
Justice Sonia Sotomayor: Okay.
Then you may be losing this case.
Thomas M. Byrne: Well, Your Honor, that is--
Justice Sonia Sotomayor: Because if he could invest it for the trust, why isn't the loss -- isn't it a loss for the trust that he took this opportunity away from the trust?
Thomas M. Byrne: --Well, Your Honor, the -- of course, the Illinois court never decided whether he was right about whether he could actually invest the money other than as -- as specified.
Justice Sonia Sotomayor: Let's assume he could have.
Thomas M. Byrne: If you assume he could have--
Justice Sonia Sotomayor: Then why isn't the loss of opportunity?
Thomas M. Byrne: --Well, Your Honor, the -- the -- the trust instrument, I think you'll see does not expressly authorize him to do that.
He's making -- he was making an argument--
Justice Sonia Sotomayor: Let's assume his argument that he could.
Thomas M. Byrne: --If the argument is or if the trust provided that he could invest in other things and it made him prudent investments, then there could be a loss to the trust.
Then his mental state would -- would be poor.
Justice Sonia Sotomayor: Then we have to go back to -- to the first issue, whether a mental state is required or not.
Thomas M. Byrne: That's correct, Your Honor.
Now, to respond to a few things said by Respondent and by the solicitor, the Petitioner actually did put into the record when he opposed summary judgment pro se in the bankruptcy court all of his evidence about what he -- what should have been done with the money that was in the constructive trust, what should have been done with the property that was in the constructive trust during that period.
He put that in -- in evidence, it's in the record and his repeated pleas that the assets be sold to pay the judgment are reflected by that.
The Respondent relied entirely on the two Illinois court orders and put in no evidence other than the original pleadings, if they are evidence, in the -- in the Illinois case.
So there is that question about the record, and Petitioner did track what -- what his efforts were to try to persuade the trustee to consent to the sale of the property.
And it's interesting, the constructive trust, of course, was imposed on the properties that were acquired with loans two and three.
So if there are any profit from the loans, they would have been caught in those properties.
And eventually, of course, they were not sold.
But to determine the amount of the loss here, a trial would be needed.
And that's really why we were hoping the Court will give us -- give Mr. Bullock a day in court here to establish under the proper legal standard what any loss really was, if there was one.
And it was said earlier that a conflict of interest itself is a defalcation, but not if there's no loss.
That's just -- that's entirely inconsistent with the other exceptions to discharge in the Code.
Mr. Gannon read the -- noted that the dictionary definitions evolved over time, but the 1856 definition of defalcation from Bouvier's Law Dictionary that's quoted in the Government's brief actually still reflects the -- the idea that -- or the definition that defalcation is the act of a defaulter.
And a defaulter is defined as,
"one who fails in making his accounts correct. "
So by 1856, years after the first enactment of defalcation, that was still the definition that was prevailing in the day, at least according to that dictionary, and according to the others that -- that we cite earlier.
Petitioner here made a mistake in judgment.
There was never any finding of dishonesty on his part.
There was never any finding that he acted with a malicious intent.
In fact, there was a finding that he acted with no apparent malicious intent in the Illinois courts.
This question is one of dischargeability, and his debt is really what bankruptcy is for.
It's for a fresh start for an honest, but unfortunate debtor.
Unless the Court has any further questions, that concludes my remarks.
Chief Justice John G. Roberts: Thank you, counsel.
The case is submitted.