defalcation

Definition of defalcation

Noun

defalcation (plural defalcations)

1. (law) The act of cancelling part of a claim by deducting a smaller claim which the claimant owes to the defendant.
2. embezzlement

Related terms

• defalcate

Further reading

A defalcation is an amount of funds misappropriated by a person trusted with its charge; also, the act of misappropriation, or an instance thereof. The term is more specifically used by the United States Bankruptcy Code to describe a category of bad acts that taint a particular debt such that it cannot be discharged in bankruptcy.[1]

Defalcation occurs when a debtor commits a bad act while acting in a fiduciary capacity.[2] The classic example of defalcation is when a trustee recklessly invests trust funds and loses the money. If the beneficiary successfully wins a judgment against the trustee, and the trustee files for bankruptcy, the debt (the judgment) cannot be discharged in bankruptcy because the debt was the result of a defalcation.

Defalcation only applies when a debtor is acting in a fiduciary capacity. To constitute a defalcation, the conduct involves a degree of culpability that is greater than negligence, but the act does not need to rise to the level of a "fraud" under common law. Defalcation requires a showing of conscious behavior or extreme recklessness.[3]

The term is used in legal proceedings other than bankruptcy to refer more generally to embezzlement; it is often used in the context of the title insurance business. A title agent who misuses funds intended to be used to close insured transactions is said to be involved in a defalcation. Many title insurers have their own "defalcation units."

References

1. US Bankruptcy Code, section 523(a)(4)
2. Collier on Bankruptcy, 523.10 (15th ed. rev. 2007)
3. In re Hyman, 502 F.3d 61 (2d. Cir. 2007)