Neglect Of Fiduciary Duty Can Render Some Debts Nondischargeable In BankruptcyIn the recent Chapter 7 bankruptcy of a Texas debtor, the bankruptcy court ruled that debt owed to a partnership would be nondischargeable because the debtor willfully neglected their fiduciary duty.

Early on in his tenure as president of B & W, Harwood (the debtor) began withdrawing funds from FNFS for his personal use, including a $200,000 loan in 1997 to finance construction of a large steel-frame gymnasium on his property in Arp, Texas (the “Arp property”). In 1998, Harwood memorialized these loans in two promissory notes to FNFS-a $700,000 “Master Note” accompanied by a deed of trust in favor of FNFS on the Arp property, and a $125,000 note (the “Frazier Note”) secured by a second-lien deed of trust in favor of FNFS on a residential rental property on East Frazier Street in Tyler, Texas (the “Frazier property”). Harwood prepared and signed the Notes and security documents, which he kept in a personal “loan file” in a desk drawer in his office. He never filed the deeds of trust with the county clerk.

Although the B & W board of directors routinely approved employee loans, including Harwood’s, the testimony at trial established that the board was only generally aware of Harwood’s growing indebtedness to FNFS and the fact that Harwood did not make any significant effort to pay down the principal amount of the Notes. The board apparently believed the Notes to be sufficiently collateralized, and McKinney orally assured the board that he would personally cover any losses to the limited partners in the event that Harwood failed to repay his debts to the partnership.

The debtor in this case argued that while he had a fiduciary duty to B&W he did not have the same duty to FNFS.  But the bankruptcy court disagreed saying that because he had power to execute FNFS notes and that he had a trust obligation to the company. The failure to record the deeds as noted above, and the failure to make any significant efforts to repay the debts amounted to a violation of his fiduciary duty.

Bankruptcy Section 523(a)(4) states in pertinent part:

(a) A discharge under section 727 . . . does not discharge an individual debtor from any debt-

(4) for fraud or defalcation while acting in a fiduciary capacity….

11 U.S.C. § 523(a)(4). This bar to discharge reaches “debts incurred through abuses of fiduciary positions . . .[and] involving debts arising from the debtor’s acquisition or use of property that is not the debtor’s.” Texas Lottery Comm’n v. Tran (In re Tran), 151 F.3d 339, 342 (5th Cir. 1998) (citation and internal quotation marks omitted). The party promoting the exception to discharge must prove by a preponderance of the evidence that the debt is nondischargeable. Grogan v. Garner, 498 U.S. 279, 286 (1991). Exceptions to discharge are strictly construed against the creditor and liberally construed in favor of the debtor. Hudson v. Raggio (In re Hudson), 107 F.3d 355, 356 (5th Cir. 1997).