July 16 (Westlaw Journals) - The former trustee of a family life insurance trust is asking the U.S. Supreme Court to upset a federal appellate panel’s finding that he cannot discharge a state court judgment entered in connection with his purported misuse of trust property.

Bullock v. BankChampaign NA, No. 11-1518, petition for cert. filed (U.S. June 14, 2012)

Randy C. Bullock says in a petition for certiorari that the 11th U.S. Circuit Court of Appeals erred when it found he had recklessly disregarded his fiduciary duty by making loans from the trust to himself and his mother that later were repaid in full with interest.

He argues that in the absence of the Supreme Court’s imposing a higher threshold for fraud by a trustee, also known as defalcation, innocent acts by a trustee may result in liability.

“This was a squabble about family trust administration that escalated perversely and culminated in financial tragedy for petitioner,” Bullock’s petition says.

THE LIFE INSURANCE TRUST

Bullock became the trustee of a trust established by his father in 1978.

The trust’s sole asset was an insurance policy on the father’s life.  The policy had a $1 million death benefit and accumulated cash value.  Bullock and his four siblings were the beneficiaries.

The trust authorized Bullock to use money from the trust only to pay life insurance premiums and to satisfy a beneficiary’s request for withdrawal, court records say.

Bullock borrowed money from the trust to loan to his mother and to purchase real property on three occasions from 1981 to 1990.  The loans totaled $263,000.

All of the loans, which eventually were repaid in full with interest, were evidenced by notes to the trust and were secured by first mortgages on property, Bullock says.

STATE COURT LITIGATION

Bullock’s two brothers filed suit in Illinois state court in 1999, claiming he had breached his fiduciary duty as trustee.

The court granted the brothers’ motion for summary judgment in 2002, finding the loans made by Bullock while acting as trustee were self-dealing transactions.

The trial court entered judgment against Bullock in the amount of $285,000 and placed the property obtained by the loaned funds under constructive trusts.

BankChampaign, which had replaced Bullock as the trustee after he resigned in 1998, was awarded the constructive trusts.

BANKRUPTCY PROCEEDINGS

Unable to sell the property to satisfy the judgment, Bullock filed a Chapter 7 petition in the U.S. Bankruptcy Court for the Northern District of Alabama.  The 2009 filing sought to discharge the Illinois state court judgment.

BankChampaign responded early the following year with an adversary complaint, claiming the state court judgment was not a dischargeable debt under 11 U.S.C. § 523(a)(4) because Bullock had incurred it through misappropriation of funds, or defalcation, while acting in a fiduciary capacity.

The Bankruptcy Court granted the bank’s motion for summary judgment in May 2010, holding Bullock was collaterally estopped from challenging the state court judgment.

On appeal, the U.S. District Court for the Northern District of Alabama upheld the Bankruptcy Court and the ruling was affirmed by the 11th Circuit.  In re Bullock, 670 F.3d 1160 (11th Cir. 2012).

The appellate panel noted a wide split among the circuit courts as to the meaning of defalcation under Section 523(a)(4).

The 4th, 8th and 9th circuits hold that even an innocent act by a fiduciary can be a defalcation.

By contrast, the 5th, 6th and 7th circuits require a showing of recklessness by the fiduciary, and the 1st and 2nd circuits require extreme recklessness.

The 11th Circuit ultimately sided with the courts that require a showing of recklessness to prove defalcation.

The appellate court then agreed with the Bankruptcy Court’s determination that Bullock had committed a defalcation by making the three loans while he was the trustee of his father's trust.

Bullock turns to the Supreme Court

Bullock says the case gives the Supreme Court “a compelling opportunity to resolve a deep and long-standing conflict among the federal circuits concerning the meaning and application of the phrase ‘defalcation while acting in a fiduciary capacity’” in Section 523(a)(4).

He argues that no court has found he actually knew the loans were improper, and he asks the Supreme Court to uphold the “extreme recklessness” standard adopted by the 1st and 2nd Circuits.

The Supreme Court docket indicates the bank’s response is due July 18.

Attorneys:

Petitioner: Thomas M. Byrne, Sutherland Asbill & Brennan, Atlanta

(Reporting by Chip Giambrone, Westlaw Journal Bankruptcy)