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After decades, Supreme Court finally defines bankruptcy concept

Although the basic premise behind personal bankruptcy is relatively easy to comprehend, the legal framework supporting this method of debt relief is anything but simple. Michigan residents who have successfully completed bankruptcy probably know this to be true.

For nearly 150 years, one concept in bankruptcy has remained unclear. The bankruptcy code provides that debts can be discharged unless the filing party demonstrates "fraud or defalcation." The former legal issue is pretty well understood, but "defalcation" has long been a nebulous concept.

Recently, the U.S. Supreme Court clarified what exactly this legal concept means. According to the justices, defalcation is a situation in which a person trusted with financial assets demonstrates "gross negligence" and "knowledge that what he or she is doing is improper." If that definition cannot be met in a court of law, then it's likely that debt discharge can proceed.

The top court's ruling came as the result of a man that was designated trustee for his late father's trust, which only included a life insurance policy. Even though all of his siblings were also designated as beneficiaries of the trust, the man issued loans from the policy and personally benefited, but paid all the money back with interest. His siblings claimed that he breached fiduciary duty and demonstrated defalcation. Now, however, his bankruptcy case could move forward, because the justices handed his case back to an inferior court for judgment.

When a person is considering bankruptcy, it is important for them to understand exactly what their legal rights and options are. Claims of malfeasance could derail a filing for months or even years, which would also delay much needed financial relief. Being fully informed and prepared can help bankruptcy proceedings move along smoothly and efficiently.

Source: Thomson Reuters News & Insight, “Justices finally say what 'defalcation' means,” Lawrence Hurley, May 14, 2013

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