Defalcation

This article is about the financial crime. For the bodily process, see Defecation.

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]

In Accounting terminology, especially with respect to the area of Audit, Defalcation means a misappropriation of assets or theft of assets by employees or officers of a corporation.

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 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, for example, 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."

Etymology

Look up defalcation in Wiktionary, the free dictionary.
Defalcation literally means "cutting off (with a falx "sickle").

The term is from Latin, and is analyzed as de- "off" + falx "sickle" + -tion "act of", hence literally "cutting off with a sickle". There is also a verb form, "defalcate" – see Wiktionary for further details.

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)