Supreme Court Rules that Defalcation by a Fiduciary Requires an Express Trust - in 1844

Chapman v. Forsyth & Limerick, 43 U.S. 202 (1844)

Issue:  When a person sells goods for the account of the owner and thereafter does not pay the owner, is the debt discharged under the bankruptcy laws at the time?       

Holding:  Yes, the concept of defalcation by a fiduciary requires an express trust.       
 
Justice John McLean
The debtor filed a voluntary bankruptcy petition under the 1844 bankruptcy law and received a discharge.  The law at the time provided,
“’all persons whatsoever . . . , owing debts which shall not have been created in consequence of a defalcation as a public officer, or as executor, administrator, guardian, or trustee, or while acting in any other fiduciary capacity,' shall, on a compliance with the requisites of the bankrupt law, be entitled to a discharge under it.”

Later the debtor was sued by a creditor who alleged he should not have received a discharge at all because “he was indebted in a fiduciary capacity.”  The debtor had sold “150 bales of cotton” owned by the creditor on behalf of and for the account of the creditor.  The issue was whether or not this section applied to this debtor at all; whether, if it did, he was entitled to a discharge at all; and whether the creditor could attack the discharge after it was entered.

The Supreme Court ruled that if this section applied to the debtor, he would still receive a discharge of his other debts.  “The debts here specified are excepted from the operation of the act.  This exception applies to the debts and not to the person, if he owe other debts.”  The Supreme Court reached that conclusion by reading “the fourth section” of the act which provided “’that no person who after the passage of the act shall apply trust-funds to his own use,’ shall be discharged.”  The court said that “from this provision the strongest implication arises, that if the fiduciary debts were contracted before the passing of the act, the petitioner would, for other obligations, be entitled to a discharge.”

As to whether the debt was non-dischargeable, the court said, “The second point is, whether a factor, who retains the money of his principal, is a fiduciary debtor within the act.”  The court said, “’the defalcation of a public officer,' 'executor,' 'administrator,' 'guardian,' or 'trustee,' are not cases of implied but special trusts, and the 'other fiduciary capacity' mentioned, must mean the same class of trusts.  The act speaks of technical trusts, and not those which the law implies from the contract.  A factor is not, therefore, within the act.”

“This view is strengthened and, indeed, made conclusive by the provision of the fourth section, which declares that no 'merchant, banker, factor, broker, underwriter, or marine insurer,' shall be entitled to a discharge, 'who has not kept proper books of accounts.'  [Therefore] a factor who owes his principal money received on the sale of his goods, is not a fiduciary debtor within the meaning of the act.”

As to the last issue, the Supreme Court said that a creditor who was given notice of the bankruptcy and received a dividend and did not object to the discharge is estopped from arguing later that the debt was not discharged.  “As a creditor, he has a right to come into the bankrupt court and claim his dividend.  He does not establish his claim as a fiduciary one, but as a debt 'provable within the statute.'  And having done this, he can never controvert the discharge.”  If the creditor did not “come into the bankrupt court, prove his debt, &c., he is not bound by the discharge, but may sue for and recover his debt from the discharged bankrupt, by showing that it was within one of the exceptions of the first section.”

Notes:
1. Justice John McLean was appointed to the Supreme Court by President Andrew Jackson in 1830.  He wrote a fierce and lengthy dissent in the Dred Scott case in 1857, four years before his death in 1861.
2. This case arises under the Bankruptcy Act of 1841 which was repealed about a year after it was enacted.  Justice McLean acknowledged this saying, “These questions are far less important than they would have been had the bankrupt law not been repealed.  But they are still important as affecting a large class of citizens and to a large amount.”