Opinion ID: 200238
Heading Depth: 2
Heading Rank: 2

Heading: Application of Defalcation Standard to Facts

Text: 54 There is no dispute as to the material facts and we are assisted by the probate court findings. 5 55 The bankruptcy court granted Baylis's summary judgment motion because it found mere negligence in Baylis's actions: 56 The Debtor did not stand by and do nothing. And he did more than merely ask Ballard to agree to the sales. He put pressure on her in two ways, first by presenting her with agreements signed by the buyers and later by filing a petition in court to sell the properties. Although he was adjudicated to have been negligent in not going further and requesting a court order against her, he surely was not in reckless disregard of his obligations concerning Ballard's fiduciary defaults. 57 Rutanen, 222 B.R. at 5. Ignoring the probate court's contrary finding, the bankruptcy court found nothing improper in the Trust's payment of the expenses of the suit against Baylis for fraud. 58 The district court overturned the grant of summary judgment to Baylis and entered summary judgment for the creditors. It found that Baylis, by executing purchase and sale agreements even though Ballard refused to agree to a sale, practically assured a lawsuit. Rutanen, 275 B.R. at 152. Baylis also used trust funds in a resulting lawsuit brought against him personally, not only to pay attorneys' fees, but also to settle the lawsuit. Id. at 153. Finally, the district court noted that Baylis is an attorney who specializes in the law of trusts and estates. He was well aware of the duties required of a fiduciary under trust law. Id. 59 Both courts treated the question of the dischargeability of the debt as a unitary one. We think it more helpful to consider the different components of the judgment debt. The judgment debt comprises three elements: $27,322.90 for the trust expenditures for Baylis's benefit on the Youngs' lawsuit against him; over $937,000 for the loss in value of the property due to the failure to sell; and the pre-judgment interest. 60 We start with the $27,322 payment for Baylis's benefit in the lawsuit against him by the Youngs and the associated interest. Of course, not all payments from a trust to trustees are inappropriate. Trustees may receive fees and be reimbursed for expenses. They may be defended and indemnified in lawsuits. Nevertheless, the impropriety of those payments here was resolved by the state courts, and that is a binding ruling. See Rutanen, No. 88E0072-G1, slip op. at 22 (Apr. 15, 1993). The probate court found that although the trust had no obligation to defend Baylis on the fraud charges brought against him personally or to indemnify him, Baylis caused fees for his defense to be paid by the Trust. That wrongdoing was compounded by Baylis having the trust pay the $15,000 it took to settle the Youngs' claims of fraud against him personally. Baylis is bound by the probate court's holding, affirmed by the SJC, that these payments were inappropriate. See Montana v. United States, 440 U.S. 147, 153, 99 S.Ct. 970, 59 L.Ed.2d 210 (1979). 61 Baylis's actions as to this component of the debt do constitute defalcation. Baylis's actions were in violation of his duty of loyalty. He used trust monies to pay the attorney's fees and settle the lawsuit brought by the Youngs. His breach of the duty of loyalty is exacerbated by the fact that Baylis, in breach of various fiduciary duties, brought about the conditions that led to the lawsuit. 62 Even after it was apparent to him that Ballard, his co-trustee, had refused to assent to a sale of property to either the Youngs or to Ramshorn, Baylis forwarded purchase and sale agreements to both prospective buyers, who signed them and put down deposits. He thus virtually guaranteed the ensuing litigation with the Youngs, which led to a wasting of the trust's assets in defending and settling the litigation. 63 Given Baylis's active role in creating the conflict over which the Youngs were suing, he should have requested permission from the probate court before he used trust assets to defend himself against the personal aspects of the Youngs' lawsuit. He did not do so. Instead, he proceeded to use trust assets to defend himself, an extremely reckless thing to do in light of his duty of loyalty. 64 Given this combination of the fiduciary breach which caused the lawsuit and the self-dealing to defend against it, we find that Baylis's actions here constitute defalcation under 11 U.S.C. § 523(a)(4). Thus, the $27,322 of the judgment debt relating to these actions is non-dischargeable. 65 Whether the remaining damages attributed to the loss in value of the trust from the failure to sell the property resulted from defalcation presents a different question. Baylis, as co-trustee, was obliged to participate in the administration of the trust and to use reasonable care to prevent a co-trustee from committing a breach of the trust. Rutanen, 678 N.E.2d at 140 (citing Restatement (Second) of Trusts § 184 (1959)). Co-trustees may not acquiesce in the other trustee's refusal to exercise a power the trustees are obligated to exercise. Id. Should that occur, the co-trustee must apply to the courts for instructions. 66 Baylis argues he acted reasonably in compliance with these obligations when he applied to the probate court in December 1986 to conduct a sale, and so any breach cannot be a defalcation. Reasonableness, as we have said, is not the test for whether a breach is a defalcation, but if the trustee has acted reasonably, there is no defalcation. For the prior 15 years, Baylis had let Ballard manage the trust properties, largely ignoring his obligations, yet during most of those 15 years it was not evident that Ballard was in breach of her fiduciary obligations. Still, Ballard's breach of her own duty of loyalty around the time of the proposed sales was sufficiently egregious as to amount to a defalcation. It is a different matter whether her co-trustee's failure to bring her defalcation to the attention of the probate court was itself a defalcation. 67 We are troubled by the fact that when Baylis went to the probate court for instructions to sell, he failed to disclose material information to the court. He did not describe the co-trustee's conflict of interest, her breach of fiduciary duty, or the facts giving rise to the problem. Nonetheless, it was not unreasonable for Baylis to think that the matter would be resolved if the court gave instructions to sell the property. His various judgments about how best to handle his troublesome co-trustee were flawed and clearly negligent, but not so reckless as to rise to the level of fault needed to constitute a defalcation.