§ 159.3     Fraud and Defalcation: § 523(a)(4)
Cite as:    Keith M. Lundin, Lundin On Chapter 13, § 159.3, at ¶ ____, LundinOnChapter13.com (last visited __________).
[1]

The second “fraud” exception to the dischargeability of debt added to § 1328(a) by BAPCPA is § 523(a)(4): “for fraud or defalcation while acting in a fiduciary capacity, embezzlement or larceny.”1

[2]

Much of what is said above with respect to § 523(a)(2) applies as well to § 523(a)(4).2 Prior to BAPCPA, § 523(a)(4) was an exception to the dischargeability of debt in Chapter 7 cases and at hardship discharge before completion of payments in a Chapter 13 case but did not apply at the completion of payments under a plan under § 1328(a). BAPCPA expanded the debts that are nondischargeable at the completion of payments to include fraud, defalcation in a fiduciary capacity, embezzlement and larceny under § 523(a)(4).

[3]

Section 523(a)(4) is one of the “fraud” exceptions to the dischargeability of debt that is treated specially by the Bankruptcy Code in § 523(c). A determination of dischargeability under § 523(a)(4) in a Chapter 13 case must be made by the bankruptcy court. The strict time limitation in Interim Rule 4007(c) on the filing of a complaint to determine dischargeability under § 523(a)(4) applies in Chapter 13 cases after BAPCPA: “A complaint to determine the dischargeability of a debt under § 523(c) shall be filed no later than 60 days after the first date set for the meeting of creditors under § 341(a).”3 A debt described in § 523(a)(4) that would otherwise be nondischargeable becomes dischargeable in a Chapter 13 case at the completion of payments under the plan if a complaint is not filed within 60 days of the first date set for the meeting of creditors.

[4]

The 60 days after the first date set for the meeting of creditors within which a timely complaint to determine dischargeability under § 523(a)(4) can be filed in a Chapter 13 case will often extend beyond the 45 days after the meeting of creditors within which the bankruptcy court must hold a hearing on confirmation.4 Many Chapter 13 cases will reach confirmation before the deadline for the filing of a complaint to determine dischargeability under § 523(a)(4). For the reasons discussed above with respect to § 523(a)(2),5 the possibility that a complaint will be filed to determine dischargeability under § 523(a)(4) after confirmation should not routinely delay the hearing on confirmation. A determination of nondischargeability under § 523(a)(4) is not likely to be accepted as a basis for separate classification for more favorable treatment of an unsecured claim through a confirmed Chapter 13 plan.6

[5]

The debts that are nondischargeable under § 523(a)(4) include debts for common law fraud and defalcation while acting in a fiduciary capacity. There are many reported pre-BAPCPA cases arising under other chapters of the Code which define “defalcation” and “fiduciary capacity” for purposes of § 523(a)(4). At risk of oversimplification, most courts require an actual contractual or statutory trust that preexists the alleged misconduct as a predicate for “fiduciary capacity” in § 523(a)(4). Fiduciary capacity is sometimes found among partners in a general partnership under state law but rarely extends to the relationship of officers and directors to a corporation—at least prior to the insolvency of the corporation. Embezzlement and larceny for § 523(a)(4) purposes have common law elements, including the wrongful appropriation of property that has come into the debtor’s possession either lawfully (embezzlement) or unlawfully (larceny).

[6]

It is reasonable to speculate that the new exception to discharge for debts described in § 523(a)(4) will not have quite the impact on Chapter 13 practice as § 523(a)(2).7 The pre-BAPCPA § 523(a)(4) reported decisions often dealt with the liability of partners, corporate officers and directors and others who have acted to the disadvantage of creditors in business situations. Chapter 13 debtors are somewhat less likely to have those facts. Section 523(a)(4) is sometimes used to resolve the civil aspects of criminal misconduct when a debtor has been charged or convicted of crimes involving the theft of money or property. Those situations are also relatively rare in Chapter 13 practice.

[7]

Debtors in Chapter 13 cases may be able to use the Chapter 13 plan to manage dischargeability litigation under § 523(a)(4). Attorney’s fees for defense of a § 523(a)(4) complaint are allowable under § 330(a)(4)(B) and would be expenses of administration entitled to priority and full payment through the Chapter 13 plan.8 Although nondischargeability under § 523(a)(4) is not an attractive basis for favorable classification of an unsecured debt,9 the nondischargeable debt can be paid in whole or in part through the Chapter 13 plan with any unpaid portion surviving discharge as a personal liability of the debtor after the completion of payments to other creditors.

[8]

This is not to understate the leverage that an unsecured creditor gains in a Chapter 13 case by commencing dischargeability litigation under § 523(a)(4). Dischargeability litigation is expensive, and few Chapter 13 debtors can afford to finance that litigation even through a Chapter 13 plan without significant impact on other confirmation issues. Ironically, if debtors’ attorneys’ fees for defense of a § 523(a)(4) complaint are allowed as expenses of administration in a Chapter 13 case, those attorneys’ fees would be paid from funds that would otherwise be available for distribution to general unsecured creditors under a confirmed plan.


 

1  11 U.S.C. § 523(a)(4) (incorporated into 11 U.S.C. § 1328(a)(2)).

 

2  See 11 U.S.C. § 523(a)(2), discussed in § 549.1 [ False Representations and Fraud: § 523(a)(2) ] § 159.2  False Representations and Fraud: § 523(a)(2).

 

3  Interim Bankr. R. 4007(c), discussed further in § 544.1 [ Time for Determining Dischargeability of Debt ] § 156.3  Time for Determining Dischargeability of Debt.

 

4  See 11 U.S.C. § 1324(b), discussed in § 502.1 [ Timing of Hearing on Confirmation ] § 115.2  Timing of Hearing on Confirmation after BAPCPA.

 

5  See § 549.1 [ False Representations and Fraud: § 523(a)(2) ] § 159.2  False Representations and Fraud: § 523(a)(2).

 

6  See § 87.1  Power to Classify Unsecured Claims: Tests for Unfair Discrimination, § 88.1  In General, § 88.2  Nondischargeable Claims after BAPCPA and § 88.10  Claims That Are or Might Be Nondischargeable Only in a Chapter 7 (Chapter 12, or Individual Chapter 11) Case.

 

7  See 11 U.S.C. § 523(a)(2), discussed in § 549.1 [ False Representations and Fraud: § 523(a)(2) ] § 159.2  False Representations and Fraud: § 523(a)(2).

 

8  See §§ 294.1 [ Debtors’ Attorneys’ Fees ] § 136.6  Debtors’ Attorneys’ Fees before BAPCPA and 515.1 [ Debtors’ Attorneys’ Fees ] § 136.7  Debtors’ Attorneys’ Fees after BAPCPA.

 

9  See § 463.1 [ Nondischargeable Claims ] § 88.2  Nondischargeable Claims after BAPCPA.