Court Opinion

ID: 9651338
Source: CourtListenerOpinion
Date Created: 2023-08-23 16:15:08.910227+00
Date Added: 2024-06-11T13:27:13.491720
License: Public Domain

PERRIS, Bankruptcy Judge,
concurring in part and dissenting in part:
I agree with the majority’s resolution of the subrogation issue and its determination that a fiduciary relationship exists for purposes of section 523(a)(4). I disagree, however, with the majority’s determination that a defalcation requires bad faith or reprehensible conduct. Por this reason, I dissent from the majority’s reversal of the bankruptcy court’s decision.
The term “defalcation” is not clearly defined in the Bankruptcy Code or its legislative history. Similarly, courts have provided inconsistent indications of whether the term requires some level of culpability greater than negligence or whether any breach of a trust obligation which leads to the loss of trust property is sufficient. In the seminal case, Central Hanover Bank & Trust Co. v. Herbst, 93 F.2d 510 (2d Cir.1937), the court indicated that thé term “defalcation” may include innocent defaults so as to reach- all fiduciaries who for any reasons are short in their accounts and that the term did not require as much misconduct as the term “misappropriation,” which had been held to require an actually or constructively known breach of duty and not mere negligence or mistake. The court then assumed, arguendo, that defalcation does require some misconduct and determined that the debtor’s conduct in taking money on a conditional authority which he knew could be revoked amounted to a defalcation.6
Many cases, both before and after the enactment of the Bankruptcy Code have relied upon Herbst to determine that the term “defalcation” does not require intentional misconduct and includes failures to account arising from negligence or mistake. See, e.g., Carey Lumber Co. v. Bell, 615 F.2d 370, 375 (5th Cir.1980); In re Kawczynski, 442 F.Supp. 413 (W.D.N.Y.1977). Other cases, however, have indicated that a defalcation clearly requires acts amounting to misconduct or reflecting bad faith or a known breach of duty and not merely inadvertence, mistake or negligence. See, e.g., Kadish v. Phx.-Scotts Sports Co., 11 Ariz.App. 575, 579, 466 P.2d 794, 798 (1970).
In this circuit, at least two Bankruptcy Appellate Panel decisions have stated and applied the rule that a defalcation includes innocent as well as negligent or intentional defaults so as to reach all fiduciaries who are short in their accounts. In re Baird, 114 B.R. 198, 204 (9th Cir.1990); In re Gonzales, 22 B.R. 58 (9th Cir. BAP 1982). This rule was also stated, arguably in dicta, in In re Short, 818 F.2d 693, 695-96 (9th Cir.1987).7 In Baird and Gonzales, the conduct at issue involved the failure of the debtors to pay over trust funds to the subcontractors entitled to those funds. The key factor leading to a finding of defalcation in those cases was that the debtors breached their trust obligations by failing to pay over the pertinent sums. Although there are indications in those cases that the debtors paid the funds to other subcontractors, there is no indication that the debtors acted in bad faith or engaged in intentional misconduct. In fact in Gonzales, the Panel rejected the debtor’s contention that there was no defalcation because the failure to account for the funds was unintentional. In Baird, the fact that the debtor may have acted in accordance with common industry practice did not prevent a finding of defalcation.
Although, as the majority suggests, there are arguable policy reasons supporting a restricted definition of the term defalcation, there are also policy reasons supporting a *680determination that defalcation should include innocent defaults by a fiduciary. Even if nondischargeable debts must arise from some culpable conduct, the requisite culpability or “badness” to conform to the spirit of the bankruptcy laws is supplied by the special legal status of a fiduciary and the breach of the attendant duties and higher standard of dealing. See In re Johnson, 691 F.2d 249, 256 (6th Cir.1982); In re Twitchell, 72 B.R. 431, 436 (Bankr.D.Utah 1987), rev’d 91 B.R. 961 (D.Utah 1988), rev’d without op. 892 F.2d 86 (10th Cir.1989); see also Restatement (Second) of Torts § 874, comment b (one who commits a breach of fiduciary duty is guilty of tortious conduct). In addition, in other provisions of the Bankruptcy Code, Congress has provided special protection for those in a trust relationship with the debtor. See § 541(d). A recognition that debts arising from any breach of such trust relationships are nondischargeable is consistent with this special protection.
The majority’s standard of some element of bad faith or reprehensible conduct is, I believe, flawed. The majority does not explain what level of culpability is required. Is reckless conduct sufficient or must the conduct be intentional tortious conduct? If intentional tortious conduct is required, the majority’s standard renders section 523(a)(4) unnecessary in light of the broad definition of willful and malicious conduct applied under 11 U.S.C. § 523(a)(6). See, e.g., In re Cecchiwi, 780 F.2d 1440, 1443 (9th Cir.1986). Finally, what would be the result when a trustee does not adequately supervise his or her employees and funds are misdirected through the intentional misconduct of the employee? Arguably, the fact that the trustee’s conduct does not rise above the level of negligence would allow the debt to be discharged.
I believe that we are compelled to follow Baird and Gonzales,8 Those cases reject a requirement of some degree of culpability beyond a mere breach of fiduciary duty that results in a shortage in the trust fund or trust property.
Applying that rule in this case, the state court found that the debtor breached the fiduciary duties placed upon him under Cal. Prob.Code § 2401 by faffing to use ordinary care in managing and controlling the property. This breach resulted in a loss to the property. There has, therefore, been a defalcation under section 523(a)(4).

. In Herbst, the debtor, a receiver of a parcel of real property, took and spent money awarded to him under a court order approving his intermediate account without waiting for the expiration of the time to appeal the order. The order was appealed and reversed. The court determined that the debtor knew or was charged with notice that the order might be appealed and would not protect him if it was reversed. The court found that the debtor committed a defalcation.

. In Short, the debtor used partnership funds to pay for his personal expenses. The conduct at issue, therefore, involved intentional conduct and the court's suggestion that defalcation includes innocent defaults of a fiduciary who fails to account for money received was not necessary to its decision.

. California Dept. of Health Services v. United States Dept. of Health & Human Services, 853 F.2d 634, 638 (9th Cir.1988) (a circuit court panel must follow a previous decision of another panel, absent a subsequent change in substantive law).