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Fiduciary Duty in Bankruptcy Discharges

What obligations does a debtor in bankruptcy have to his fiduciaries? In a case handed down by Judge Bailey last month, the Bankruptcy Court held that the debtor fiduciary was in violation of the bankruptcy code and as such, the debt to that creditor was not dischargeable in bankruptcy.

What is a Fiduciary?

First, what is a fiduciary? A fiduciary is a person, or an entity such as a bank, which is entrusted to hold assets, such as money, for another person or entity. A trust fund, such as in this case, is managed and controlled by a fiduciary.

Fiduciaries are held to a very high standard, because of the entrustment of monies for others. In this case, the fiduciary was an individual who had a company doing business with the creditor, Western Union.

Adversary Proceeding in Bankruptcy Court

The Bankruptcy Code clearly states that a debtor cannot get a discharge for debt when he or she commits “defalcation while acting in a fiduciary capacity”. This is under Section 524(a)(4). In this case, the plaintiff creditor claimed that the debtor had taken his trust fund money, $24,621.20, plus interest and attorney fees, and misappropriated it to himself.

In this case, the debtor, Felix Lugo, filed for Chapter 7 personal bankruptcy.  The creditor, filed an Adversary Proceeding. That is, the creditor filed a lawsuit in Bankruptcy Court claiming that the debt to the creditor was not dischargeable. While most debts are dischargeable, many are not. Those include student loans, some taxes, and anything relating to fraud.

In the Adversary Hearing trial, the debtor failed to testify as to what he did with the monies. It is not clear why, however, the debtor did not speak English, neglected to retain an attorney, and failed to testify as to his counterclaims against the creditor. The Court found that “lacking an explanation from the only person who can explain” Mr. Lugo must have “appropriated the funds to his own use” in violation of his fiduciary duties to the creditor.

Willful and Malicious Injuries are Exempt from Discharge

The Court also found that the debtor was in violation of the Bankruptcy Code for willful and malicious injury, under Section 523(a)(6) deciding that the injury, or financial loss, was both willful and malicious. The Court found that the conversion was a “theft” in that the debtor took the monies for his own use and that he did so knowingly.

What to do in an Adversary Proceeding in Bankruptcy Court?

First and foremost, try to avoid them. Prior to filing for bankruptcy, go over each and every debt with your attorney. If there is any fraud, or possible allegation of fraud, work with your attorney to have the documents and witnesses ready to counter any claims by the debtors. Second, if the creditor has a colorable claim, negotiate.

Furthermore, retain the services of an experienced bankruptcy attorney. In this case, the debtor had multiple counterclaims under Fair Credit Reporting Act and the Massachusetts Consumer Protection Act. We don’t know, but there may have been facts that would have helped the debtor here.

The lesson from this case should be to retain an experienced bankruptcy lawyer. In this case, Mr. Lugo lost the opportunity to discharge the debt, plus interest and attorney fees, which were about equal to the entire debt. With that amount of money on the line, utilizing the services of a bankruptcy attorney only makes sense.

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