Opinion ID: 801585
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Heading: Defalcation While Acting in a Fiduciary Capacity

Text: Section 523(a)(4) bars discharge of an obligation a debtor incurs through fraud or defalcation while acting in a fiduciary capacity. The meaning of these words has been fixed by judicial construction since before the Civil War; the statute `speaks of technical trusts, and not those which the law implies from the contract.' Davis v. Aetna Acceptance Co., 293 U.S. 328, 333, 55 S.Ct. 151, 79 L.Ed. 393 (1934), quoting Chapman v. Forsyth, 43 U.S. 202, 208, 2 How. 202, 11 L.Ed. 236 (1844). It is not enough that, by the very act of wrongdoing out of which the contested debt arose, the bankrupt has become chargeable as a trustee ex maleficio. He must have been a trustee before the wrong and without reference thereto. Id. Whether a relationship is a `fiduciary' one within the meaning of § 523(a)(4) is a question of federal law. In re Cochrane, 124 F.3d 978, 984 (8th Cir.1997) (quotation omitted). The fiduciary relationship reflected in an express or technical trust is typically created by contract. Numerous cases have addressed whether a bankrupt debtor's alleged defalcations of contractual obligations to a secured lender such as Arvest were committed while acting in a fiduciary capacity. It is the substance of a transaction, rather than the labels assigned by the parties, which determines whether there is a fiduciary relationship for bankruptcy purposes. In re Long, 774 F.2d 875, 878-79 (8th Cir.1985). Most secured lending agreements impose duties on the borrower in dealing with the creditor's collateral, but those duties seldom create a § 523(a)(4) fiduciary capacity. In Davis, for example, the Supreme Court affirmed the discharge of an automobile dealer from its secured debt to a bank even though the debtor had breached duties reflected in a document called a trust receipt. The trust receipt and bill of sale were a mortgage in another form, the Court explained. A mortgagor in possession before condition broken is not a trustee for the mortgagee within the meaning of this statute, though he has charged himself with a duty to keep the security intact. 293 U.S. at 334, 55 S.Ct. 151. In In re Long, 774 F.2d at 878-79, we cited Davis in affirming a decision that § 523(a)(4) did not render a secured debt nondischargeable; we concluded that the contract between a secured inventory lender and the bankrupt merchant in which the borrower agreed to become trustee of an express trust was nonetheless intrinsically more contractual than fiduciary. Applying these authorities, the bankruptcy court and the BAP properly rejected Arvest's contention that the mortgage document itself created an express trust. That document did nothing more than provide for a contractual assignment of certain proceeds. Indeed, Arvest has more or less abandoned that contention on appeal, [2] instead urging, as the bankruptcy court concluded, that Ark.Code § 4-58-105(b)(2) created the requisite fiduciary relationship by declaring that Ms. Nail became the trustee of the funds upon receipt of the Settlement Proceeds, and then committed a defalcation by spending the proceeds instead of remitting them to Arvest. It is now well settled that a state statute may create the fiduciary relationship required by § 523(a)(4). See In re Long, 774 F.2d at 878. Determining whether a particular statute has done so can be difficult. It is not enough [ ] that a statute purports to create a trust: A state cannot magically transform ordinary agents, contractors, or sellers into fiduciaries by the simple incantation of the terms `trust' or `fiduciary.' Rather, to meet the requirements of § 523(a)(4), a statutory trust must (1) include a definable res and (2) impose `trust-like' duties. Matter of Tran, 151 F.3d 339, 342-43 (5th Cir.1998). In Matter of Dloogoff, 600 F.2d 166, 169-70 (8th Cir.1979), we held that a statute making it unlawful for a construction contractor to fail to apply payments owed to labor and material lienholders did not create a § 523(a)(4) fiduciary relationship because the Supreme Court of Nebraska had held that the statute did not create an express trust. Similarly careful analyses of other state lienholder protection statutes have produced differing § 523(a)(4) outcomes. Compare In re Nicholas, 956 F.2d 110 (5th Cir.1992) (Tex. Construction Trust Fund Statute), and Matter of Angelle, 610 F.2d 1335 (5th Cir.1980) (La. law), with Carey Lumber Co. v. Bell, 615 F.2d 370, 374-76 (5th Cir.1980) (Okla. Lien Trust Statutes), In re Baird, 114 B.R. 198 (9th Cir.BAP 1990) (Ariz. Construction Trust Fund Statute), and Matter of Kawczynski, 442 F.Supp. 413 (W.D.N.Y.1977) (N.Y. Lien Law). In Matter of Marchiando, 13 F.3d 1111, 1113 (7th Cir.1994), the Seventh Circuit concluded that the Illinois Lottery Law proviso that the proceeds of sales of lottery tickets `shall constitute a trust fund until paid to the [State]' did not create a § 523(a)(4) fiduciary relationship: The key to knitting the cases into a harmonious whole is the distinction stressed in Davis ... between a trust... that has an existence independent of the debtor's wrong and a trust ... that has no existence before the wrong is committed. A lawyer's fiduciary duty to his client ... pre-exists any breach of that duty, while in the case of a constructive... trust there is no fiduciary duty until a wrong is committed. [In this case, the trust] has a purely nominal existence until the wrong is committed. Technically, Marchiando became a trustee as soon as she received her license to sell lottery tickets. Realistically, the trust did not begin until she failed to remit ticket receipts. Id. at 1115-16; accord In re Tran, 151 F.3d at 345 (Tex. lottery sales proceeds statute). In In re McGee, 353 F.3d 537, 540-41 (7th Cir.2003), the court, applying Marchiando, held that a municipal ordinance requiring landlords to hold tenant security deposits as trust funds did create a § 523(a)(4) fiduciary relationship because the ordinance imposed trust-like duties, such as requiring segregation of funds in an interest-bearing financial institution account to ensure that the money would be available for return to the tenants if they kept their own promises. Viewed in light of these cases, we agree with the BAP that Ark.Code § 4-58-105(b)(2) does not create a fiduciary relationship in the strict and narrow sense required by § 523(a)(4). Hunter, 373 F.3d at 876. As the BAP observed, the statute simply prescribes the legal effect when a party to an assigned account in good faith pays the assignor rather than the unknown assigneepayment is an acquittance to the payor (here, the builders), and the assignor (Ms. Nail) is accountable and liable to the prior assignee (Arvest). The statute imposes no trust-like duties such as segregation of the Miscellaneous Proceeds. And while the statutory trust was created when the settlement proceeds were paid (assuming without deciding those proceeds were Miscellaneous Proceeds), as in Marchiando the trust had a purely nominal existence until Ms. Nail failed to remit those proceeds to Arvest. In other words, Ms. Nail was not a trustee before the wrong and without reference thereto. Davis, 293 U.S. at 333, 55 S.Ct. 151. In these circumstances, we agree with the BAP that the mere use of the word trustee, when viewed in the context of the statute as a whole, does not reflect a legislative intent to create the kind of express or technical trust required in the strict and narrow sense under § 523(a)(4). Therefore, the $65,000 debt was not nondischargeable under the fiduciary capacity subpart of § 523(a)(4). [3]