The provisions of the United States Bankruptcy Code are intended to provide fair and orderly relief for the “honest but unfortunate debtor” who can obtain a “fresh start” by distributing available assets, if any, to creditors and discharging debts “unhampered by the pressure and discouragement of preexisting debt.”  Grogan  v.  Garner, 498 U.S. 279, 286–87 (1991).   There are, however, debts which cannot be discharged and are set forth in 11 U.S.C. § 523 – “Exceptions to discharge”.  Lawyers can take comfort in knowing that what is included in or excluded from these exceptions to discharge will keep lawyers and courts busy until definitions can be digitized – which effectively means never.

In Estate of Cora v. Jahrling (In re Jahrling), 2016 U.S. App. LEXIS 5013 (7th Cir. Ill. Mar. 18, 2016),  the Court addressed whether an attorney who was sued for malpractice could discharge a judgment entered against him as a result of his malpractice.  The attorney, Jahrling, represented Cora, a 90-year old man, in a real estate sale in which Cora sold his home for approximately one-quarter of its value.

Section 523(a)(4) of the United States Bankruptcy Code does not allow a debtor to discharge a debt if the debt is “for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.”  11 U.S.C. § 523(a)(4).  To satisfy § 523(a)(4), a creditor must prove that (1) “the debtor acted as a fiduciary to the creditor at the time the  debt was created,” and (2) “the debt was caused by fraud or defalcation.”  the debtor acted as a fiduciary to the creditor at the time the debt was created,” and (2) “the debt was caused by fraud or defalcation.  Estate of Cora at *6.

The undisputed facts upon which the malpractice judgment against Jahrling was based were that Jahrling was selected by the attorney representing the parties who purchased Cora’s home; that Cora only spoke Polish; that Jahrling spoke only English; and that, therefore, Jahrling had never spoken to Cora.

Reduced to its essentials, Jahrling’s ‘interesting’ argument was that, although he was grossly incompetent, he had not intended that Cora be deceived and defrauded, and therefore should be permitted to discharge the malpractice judgment entered against him because he had not intended to defraud Cora.

The dictionary definition of legal fraud is “the intentional use of deceit, a trick or some dishonest means to deprive another of his/her/its money, property or a legal right.”  The Court did not address Jahrling’s argument that the malpractice judgment against him was a result of his incompetence  which, given the facts of the case, would have been hard to disprove.  Instead, the Court focused on the meaning of defalcation.

“The claim here is not for actual fraud but for ‘defalcation'” – a word that only lawyers and judges could love.  As Justice Breyer explained for the Supreme Court, “Congress first used the term in a federal bankruptcy statute in 1867.  And legal authorities have disagreed about its meaning almost ever since.”  Bullock v. BankChampaign, N.A., 133 S. Ct. 1754, 1758 (2013).

The 7th Circuit Court of Appeals agreed with the Bankruptcy Court’s finding that “the risks to client Cora were so obvious that Jahrling must have recognized them yet forged ahead recklessly, acting in a way that amounted to a ‘gross deviation’ from the standards expected of an attorney in a fiduciary role.”  Therefore, the Court concluded that the malpractice claim against Jahrling could not be discharged under § 523(a)(4).

Now, it is reasonable to ask how Jahrling could have been held to have acted recklessly if he was so clueless that he did not know what he was doing was reckless.  The Seventh Circuit Court of Appeals answered this question by using an objective standard against which Jahrling’s conduct was measured rather than a subjective one which would have required it to figure out what he was thinking, if he was thinking at all.  A “state-of-mind finding satisfies the Bullock standard under § 523(a)(4)”.  See also In re Sheridan, 57 F.3d at 634  (circumstantial evidence may be used to determine intent to deceive under § 523(a)(2)(B)).  The Court found that the bankruptcy court did not erroneously apply a purely objective standard by finding that Jahling’s reckless representation was a “gross deviation” from accepted standards to warrant the finding that the debt was incurred by defalcation.

This case provides an important lesson for those seeking legal representation.  Hire a lawyer who is completely independent of anyone who is connected to the transaction.

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