Under Washington Law, Marriage Establishes No Express or Technical Trust With Respect to the Exception from Discharge Provided in Bankruptcy Code Section 523(a)(4)

On behalf of Macdonald Fernandez LLP on Wednesday, November 27, 2013.

In In re Mele, 13 C.D.O.S. 12737, No. WW-13-1173-DTaKu (November 25, 2013), the Bankruptcy Appellate Panel of the United States Court of Appeals for the Ninth Circuit held that a property allocation judgment arising from marital dissolution proceedings in Washington is dischargeable in a chapter 13 case notwithstanding Bankruptcy Code Section 523(a)(4), which excepts from discharge debts "for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny...."

In Mele, the separated husband spent the spouses' $274,000 retirement savings, including spending hundreds of dollars on comic books and related expenses, and stopped paying child support, all apparently in violation of a court order. Accordingly, the family court awarded the wife a judgment for return of her interest in the funds. The husband commenced a chapter 13 bankruptcy case, and the bankruptcy judge ruled in favor of the wife in her nondischargeability action.
The BAP reversed. First, there was a subsequent change in the law when the Supreme Court of the United States decided Bullock v. BankChampaign, N.A., 133 S.Ct. 1754 (2013), in which the Court rule that "defalcation" includes "a culpable state of mind requirement akin to that which accompanies application of the other terms in the same statutory phrase. We describe that state of mind as one involving knowledge of, or gross recklessness in respect to, the improper nature of the relevant fiduciary behavior." The former standard was very low and was triggered by even the most minor failure to observe fiduciary duties. The bankruptcy court did not apply the new, higher standard.
More fundamentally, the BAP determined that a marital relationship under Washington law does not constitute an express or technical trust, which is a requirement that courts have long ascribed to the words "while acting in a fiduciary capacity." An express trust is one created by expressly by the parties by words or agreement. A technical trust arises from statute or at law. In re Lewis, 97 F.3d 1182 (9th Cir. 1996).
Crucial to the BAP's ruling is that Washington has a statute governing when and how a trust is created, which was not applicable to marriages in general. Revised Code of Washington Section 11.98.008. Although there is Washington case law describing the fiduciary duties of spouses as arising from a confidential relation of trust, the court found no authority actually holding that a marriage constitutes an express or technical trust. It will be interesting to see how this ruling is used in the context of other states' marital property regimes.