In the
United States Court of Appeals
For the Seventh Circuit
No. 93-3743
ARTHUR MEYER (through his estate),
DOROTHY WATSON, HAROLD NEES,
GEORGE PATTERSON, and ROSS STRAUCH
(through the co-administrator of his Estate,
Arlene Long), as assignees of
Federal Deposit Insurance Corp.,
Plaintiffs-Appellees,
v.
ROBERT ALBERT RIGDON,
Defendant-Appellant.
Appeal from the United States District Court
for the Central District of Illinois.
No. 93 C 2019--Harold A. Baker, Judge.
ARGUED MAY 13, 1994--DECIDED SEPTEMBER 22, 1994
Before CUDAHY, KANNE, and ROVNER, Circuit Judges.
KANNE, Circuit Judge. Robert Rigdon was the presi-
dent of People's State Bank of Clay County, Indiana. He
was also a member of the Bank's board of directors and
owned a controlling interest in the Bank. In August of
1984, the Federal Deposit Insurance Corporation ("FDIC")
and the Indiana Department of Financial Institutions de-
termined that the Bank was insolvent. Thereafter, the
Bank was closed and the FDIC was appointed receiver
of the Bank pursuant to 12 U.S.C. sec. 1821(e). The FDIC
then brought suit against Rigdon and the other members
of the Bank's board of directors--Arthur Meyer, Dorothy
Watson, Harold Nees, George Patterson, and Ross Strauch
and Arlene Long as co-administrators of the estate of
Ross Strauch--in the United States District Court for the
Southern District of Indiana. The FDIC's complaint al-
leged, inter alia, that the defendants breached their fidu-
ciary duty to the Bank in "managing, conducting, super-
vising, and directing the Bank's making, supervising and
collecting of loans." The FDIC's complaint further item-
ized specific instances in which the defendants had alleged-
ly breached their fiduciary responsibilities.
The district court entered a default judgment against
Rigdon in the FDIC case because he failed to respond
to the complaint. Thereafter, the FDIC assigned its de-
fault judgment to Rigdon's co-defendants ("Meyer Defen-
dants") under the terms of a settlement agreement dated
July 24, 1989. The Meyer Defendants subsequently filed
a motion in the Indiana federal court requesting the court
enter a final money judgment against Rigdon based on
the default judgment. The district court granted the mo-
tion and entered a money judgment against Rigdon in the
amount of $1,613,181.43.
In February of 1992, Rigdon filed a bankruptcy peti-
tion under chapter seven of the Bankruptcy Code in the
United States Bankruptcy Court for the Central District
of Illinois. Shortly thereafter, the Meyer Defendants filed
a complaint in the bankruptcy court seeking a determina-
tion as to whether Rigdon could discharge his debt arising
from the Indiana federal court judgment. The Meyer De-
fendants subsequently filed a motion for summary judg-
ment in the Bankruptcy Court, arguing, inter alia, that
Rigdon's debt was not dischargeable under 11 U.S.C.
sec. 523(a)(11). That provision provides in pertinent part:
(a) A discharge under section 727, 1141, 1228(a),
1228(b), or 1328(b) of this title does not discharge an
individual debtor from any debt--
(11) provided in any final judgment, unreviewable
order, or consent order or decree entered in any
court of the United States or of any state, issued by
a Federal depository institutions regulatory agency,
or contained in any settlement agreement entered in-
to by the debtor, arising from any act of fraud or
defalcation while acting in a fiduciary capacity com-
mitted with respect to any depository institution or
insured credit union.
Rigdon argued that section 523(a)(11) was not controlling
because the judgment at issue was a default judgment
and under the prevailing case law, default judgments are
not entitled to preclusive effect in discharge exception pro-
ceedings. The bankruptcy court granted the Meyer Defen-
dant's motion for summary judgment. According to the
bankruptcy court, the default judgment "fits within the
definition of 'any final judgment' under sec. 523(a)(11)." The
court stated that "had Congress intended to exempt de-
fault judgment[s] obtained by Federal depository regu-
latory institutions from the scope of the term 'any final
judgment,' it could easily have done so by wording the
statute differently."
Rigdon appealed to the district court, again claiming
that section 523(a)(11) does not apply to default judgments.
Rigdon further argued that section 523(a)(11) was inap-
plicable because the FDIC's complaint did not allege that
he had committed acts of "defalcation." The district court
rejected Rigdon's arguments. First, the court found that
the "plain, straightforward and unqualified language of
sec. 523(a)(11)" dictates the outcome of the dischargeability
issue and prevents relitigation of the issue in either the
bankruptcy court or the district court. Second, the court
found that the word "defalcation" encompasses "the fail-
ure to carry out fiduciary duties," which is precisely what
the FDIC's complaint charged. Rigdon now appeals to this
court.
Discussion
We, like the district court, review the bankruptcy
court's factual findings for clear error and its legal con-
clusions de novo. In re Wiredyne, Inc., 3 F.3d 1125, 1126
(7th Cir. 1993). The proper construction of section 523(a)(11)
is a legal issue which we review de novo. Oviawe v. INS,
853 F.2d 1428, 1431 (7th Cir. 1988).
Applicability of section 523(a)(11)
The Bankruptcy Code delineates several exceptions to
the normal rule that all debts are dischargeable in bank-
ruptcy. For instance, under section 523(a)(4) a debtor may
not discharge any debt resulting from "fraud or defalca-
tion while acting in a fiduciary capacity . . . ." The bank-
ruptcy court normally makes an independent determina-
tion as to whether a debt is excepted from discharge
under section 523(a)(4). See In re Bercier, 934 F.2d 689,
692 (5th Cir. 1991) ("The bankruptcy court has exclusive
jurisdiction to determine dischargeability of these debts.").
However, if a court of competent jurisdiction has previous-
ly entered judgment against the debtor for "fraud or de-
falcation while acting in a fiduciary capacity," the debtor
may not re-litigate the underlying facts in the bankruptcy
court. In other words, the doctrine of collateral estoppel/1
applies in bankruptcy discharge exception proceedings.
Klingman v. Levinson, 831 F.2d 1292, 1294-1295 (7th Cir.
1987); Grogan v. Garner, 498 U.S. 279, 285 n.11, 111 S. Ct.
654, 658 n.11 (1991) ("Our prior cases have suggested, but
have not formally held, that the principles of collateral
estoppel apply in bankruptcy proceedings under the cur-
rent Bankruptcy Code. . . . We now clarify that collateral
estoppel principles do indeed apply in discharge excep-
tion proceedings pursuant to sec. 523(a).").
Collateral estoppel is a judge-made doctrine that serves
the "dual purpose of protecting litigants from the burden
of relitigating an identical issue with the same party or
his privy and of promoting judicial economy by prevent-
ing needless litigation." Parklane Hosiery Co. v. Shore,
439 U.S. 322, 326, 99 S. Ct. 645, 649 (1979) (citation omitted).
For collateral estoppel to apply, four elements must be
met: "(1) the issue sought to be precluded must be the
same as that involved in the prior litigation, (2) the issue
must have been actually litigated, (3) the determination
of the issue must have been essential to the final judg-
ment, and (4) the party against whom estoppel is invoked
must be fully represented in the prior action." La
Preferida, Inc. v. Cerveceria Modelo, S.A. de C.V., 914
F.2d 900, 906 (7th Cir. 1990).
As Rigdon correctly points out, a default judgment is
normally not given preclusive effect under the collateral
estoppel doctrine because no issue has been "actually liti-
gated." In re Cassidy, 892 F.2d 637, 640 n.1 (7th Cir.),
cert. denied, 498 U.S. 812, 111 S. Ct. 48 (1990). However,
because collateral estoppel is a common law creature, it
can, of course, be pre-empted by Congressional action.
Pre-emption is essentially an issue of Congressional in-
tent. Allis-Chalmers Corp. v. Lueck, 471 U.S. 202, 208,
105 S. Ct. 1904, 1910 (1985) ("The purpose of Congress
is the ultimate touchstone.") (citation omitted). In deter-
mining Congress' intent, we initially focus on the state
of the law as it existed prior to the passage of section
523(a)(11). Under section 523(a)(4), a debtor was already
prevented from discharging any debt "for fraud or de-
falcation while acting in a fiduciary capacity." Section
523(a)(11) also prevents a debtor from discharging a debt
arising from his "fraud or defalcation while acting in a
fiduciary capacity." Section 523(a)(11) is narrower than sec-
tion 523(a)(4), in that it applies only to acts of fraud or
"defalcation" "committed with respect to any depository in-
stitution or insured credit union." Nonetheless, as is readily
apparent, any debt dischargeable under section 523(a)(11)
was already dischargeable under section 523(a)(4). Why
then did Congress go to the trouble of enacting section
523(a)(11)?
The simple answer is that Congress wanted to expand
the preclusive effect given certain prior actions in bank-
ruptcy discharge exception proceedings. In order to in-
voke collateral estoppel, an issue must have been "actually
litigated" in the prior action. Accordingly, default judg-
ments are not given preclusive effect in subsequent court
proceedings. Nor are most consent decrees. Consent decrees,
"while settling the issue definitively between the parties,
normally do not support an invocation of collateral estop-
pel." La Preferida, 914 F.2d at 906 (citations omitted).
"The rationale behind this general rule is that issues
underlying a consent judgment generally are neither ac-
tually litigated nor essential to the judgment." Id. (cita-
tion omitted). Collateral estoppel may only be applied to
consent decrees if " 'the parties could reasonably have
foreseen the conclusive effect of their actions.' " Kling-
man, 831 F.2d at 1296 (quoting 1B J. Moore, J. Lucas
& T. Currier, Moore's Federal Practice para. 0.444[1], at 794
(2d ed. 1984)). See also 18 C. Wright, A. Miller & E.
Cooper, Federal Practice & Procedure sec. 4443, at 382
(1981) ("Issue preclusion does not attach unless it is clearly
shown that the parties intended that the issue be fore-
closed in other litigation."). Similarly, settlement agree-
ments not approved by a court are not given preclusive
effect.
Administrative agency decisions will only be given pre-
clusive effect under the collateral estoppel doctrine if (1)
the original action was properly before the agency, (2) the
same disputed issues of fact are before the court as were
before the agency, (3) the agency acted in a judicial capaci-
ty, and (4) the parties had an adequate opportunity to liti-
gate the issue before the agency. Frye v. United Steel-
workers of Am., 767 F.2d 1216, 1220 (7th Cir.), cert. denied,
474 U.S. 1007, 106 S. Ct. 530 (1985); Lightsey v. Harding,
Dahm & Co., Inc., 623 F.2d 1219, 1221 (7th Cir. 1980),
cert. denied, 449 U.S. 1077, 101 S. Ct. 855 (1981).
The plain language of section 523(a)(11), however, alters
the common law collateral estoppel rules with respect to
default judgments, settlement agreements, and certain ad-
ministrative agency decisions. Section 523(a)(11) provides
that a debt arising from the debtor's breach of fiduciary
duty to a financial institution is not dischargeable if that
debt is provided in "any final judgment, unreviewable
order, or consent decree or order" entered in any federal
or state court; "any settlement agreement entered into
by the debtor;" and any order "issued by a Federal de-
pository institutions regulatory agency." (emphasis added).
The plain language of section 523(a)(11) requires the bank-
ruptcy court give preclusive effect to dispositions, like de-
fault judgments (a default judgment is any judgment) and
non-court approved settlement agreements, that would not
be given preclusive effect under the common law. There-
fore, we must conclude that Congress intended to pre-
empt the common law by enacting section 523(a)(11).
Any other interpretation would render section 523(a)(11)
a redundancy. Section 523(a)(11) prevents the discharge
of debts arising from the same substantive conduct as sec-
tion 523(a)(4), i.e., "fraud or defalcation while acting in
a fiduciary capacity." If section 523(a)(11) also preserves
the common law collateral estoppel doctrine, as Rigdon
contends, it would be virtually identical in effect to sec-
tion 523(a)(4). Congress could not have meant for such a
specific provision to be mere surplusage. See United States
v. Dean, 908 F.2d 215, 217 (7th Cir. 1990), cert. denied,
501 U.S. 1206, 111 S. Ct. 2801 (1991) (citing United States
v. Franz, 886 F.2d 973, 978 (7th Cir. 1989)). We do not
believe that Congress, in enacting section 523(a)(11), en-
gaged in a "meaningless legislative exercise." See Brun-
didge Banking Co. v. Pike County Agric. Stabilization
& Conservation Comm., 899 F.2d 1154, 1163 (11th Cir.
1990).
Our reading of section 523(a)(11) is supported by its
legislative history. Congressman Jack Brooks, Chairman
of the House Judiciary Committee, made the following
statement during the floor debate on section 523(a)(11) and
(12):/2
The second part of the bill I would like to briefly
mention is the savings and loan section. These are
changes to the Bankruptcy Code which close off the
bankruptcy escape hatch for bank and thrift insiders
whose acts of financial fraud and malice will end up
adding perhaps half a trillion dollars to the Federal
debt. . . . Banking regulators will now be able to
prosecute these con artists with the needed confidence
that the victories won in enforcement proceedings will
not be nullified in bankruptcy proceedings.
136 Cong. Rec. H13288, 13289 (daily ed. October 27, 1990)
(statement of Rep. Brooks) (emphasis added). Of course,
the only way a banking regulator's victory could be nulli-
fied is if a debtor is permitted to discharge a debt aris-
ing from his misdeeds. That is a possibility under section
523(a)(4) because the bankruptcy court is only required
to give preclusive effect to a final judgment on the merits.
Before Congress enacted section 523(a)(11), a bank officer
could enter into a private settlement agreement with the
FDIC, for instance, admit that he had committed acts of
fraud, and still have the debt arising from his fraud dis-
charged in bankruptcy. By enacting section 523(a)(11), Con-
gress intended to limit the bankruptcy court's ability to
nullify regulatory victories through its independent power
to determine dischargeability.
Our research has revealed only one case interpreting
section 523(a)(11) and that came from a bankruptcy court
in Florida. In re Harris, 135 B.R. 434 (Bankr. S.D. Fla.
1992). In that case, Bruce N. Harris filed a bankruptcy
petition pursuant to chapter seven of the Bankruptcy
Code. The National Credit Union Administrative Board
("NCUAB")/3 subsequently commenced an adversary pro-
ceeding ("Adversary") in the bankruptcy court seeking
to have Harris' potential debt to it declared non-discharge-
able under section 523(a)(11). NCUAB had previously com-
menced a civil action against Harris in the United States
District Court for the District of Massachusetts alleging
that Harris, while serving in various positions on the
Board of Directors of Barnstable Community Federal Credit
Union, "participated in fraudulent schemes in violation of
state and federal criminal laws, and the Federal Credit
Union Act." Id. at 435. The district court case had not
yet been resolved by the time Harris filed his bankruptcy
petition. Consequently, NCUAB sought a stay of the
bankruptcy proceedings until that case had been decided.
The bankruptcy court noted that section 523(a)(11) had
recently been added to the bankruptcy code. According
to the court, "[i]ts obvious aim, coming as it did in the
midst of a national banking crisis, is to streamline litiga-
tion against the scoundrel bankers, and prevent the use
of the Bankruptcy Court as a shield against such litiga-
tion." Id. at 436. In granting the stay, the court stated
the following:
Arguably, 523(a)(11) adds little to the existing state
of the law regarding nondischargeability. Since fraud
can be determined to be nondischargeable pursuant
to 523(a)(2) and (4), the fraudulent banker would in
most cases be prevented from receiving a discharge
of the resulting debt. The difference is that the issue
would have to be proven in the bankruptcy court.
Further, there is significant case law relative to if
and when pre bankruptcy judgments based on fraud
govern the issue of dischargeability. Brown v. Felsen,
442 U.S. 127, 99 S. Ct. 2205 (1979) [(holding that the
doctrine of res judicata, as opposed to collateral
estoppel, does not apply in discharge exception pro-
ceedings)]; In re Neely, 125 Bankr. 392 ([Bankr.]
S.D.N.Y. 1991).
Statutory construction requires this Court to assume
that Congress knew the state of the law under 523(a)(2)
and (4) when it nevertheless decided to add Section
523(a)(11) to the Code. This Court's duty is to en-
force that section as adopted by Congress.
This court believes that the language of 523(a)(11)
requires that the motion at issue be granted and the
Adversary stayed. To construe it otherwise would be
to render it essentially meaningless and to cause du-
plicative litigation which would be wasteful of the
resources of the Court and the parties. . . .
Conducting a full trial on dischargeability in this
forum will essentially require all the proofs which will
ultimately be introduced in the District Court Case.
This would not only be inconvenient to both parties
and a significant waste of judicial economy, but it
would also raise the specter of inconsistent judg-
ments.
Id. We agree that in order to give meaning to section
523(a)(11) it must be read as altering the common law
rules concerning the preclusive effect given certain actions
in bankruptcy discharge exception proceedings. We also
agree that Congress' intent in passing section 523(a)(11)
was to prevent "inconsistent judgments."
However, we do not agree with the bankruptcy judge's
subsequent statement in Harris that, "[f]ollowing a judg-
ment in the District Court Case, this Court may accept
or request, in its discretion, further evidence from the par-
ties to supplement the record of the District Court Case."
Id. at 437. Under the plain language of section 523(a)(11),
the bankruptcy court is required to give preclusive effect
to, inter alia, certain final judgments entered by federal
courts. If the debt results from a final judgment arising
from the debtor's fraud or "defalcation" while acting in
fiduciary capacity of a depository institution, the debt is
per se nondischargeable in bankruptcy. No additional evi-
dence need or may be submitted to the bankruptcy court--the
debtor is estopped from challenging the nondischarge-
ability of his debt.
In summary, we conclude that Congress pre-empted the
common law collateral estoppel doctrine when it enacted
section 523(a)(11). Under the plain language of that sec-
tion, any final judgment, including default judgments,
must be given preclusive effect so long as they arise from
the debtor's fraud or "defalcation" while acting in a
fiduciary capacity for a financial institution. Accordingly,
the only issue left for us to consider is whether the default
judgment entered against Rigdon arose from "any act of
fraud or defalcation while acting in a fiduciary capacity."
Fiduciary Capacity and Defalcation
The FDIC's complaint alleged that Rigdon breached his
fiduciary duty to the Bank "[i]n managing, conducting,
supervising, and directing the bank's making, supervis-
ing and collection of loans . . . ." Because of Rigdon's
conduct, the FDIC alleged that it had suffered losses in
its capacity as receiver of the Bank "due to nonpayment
and default by debtors and guarantors on imprudently
made loans."
1. Fiduciary Duty
The existence of a fiduciary relationship is a question
of federal law under section 523(a)(11). See In re Angelle,
610 F.2d 1335, 1341 (5th Cir. 1980). Under 11 U.S.C. sec. 523(e),
"[a]ny institution-affiliated party of a depository institu-
tion or insured credit union shall be considered to be act-
ing in a fiduciary capacity" for the purposes of section
523(a)(11). The Bankruptcy Code adopts the banking law
definition of institution-affiliated party. 11 U.S.C. sec.
101(33)(a). That law, the Federal Deposit Insurance Act, defines
institution-affiliated party as:
(1) any director, officer, employee, or controlling stock-
holder (other than a bank holding company) of, or
agent for, an insured depository institution . . . .
12 U.S.C. sec. 1813(u) (emphasis added). Section 523(e) may
not be applicable to this case, however, because it was
enacted at least six years after Rigdon ceased to be mem-
ber of the Bank's Board of Directors. Yet we need not
decide whether Congress intended for section 523(e) to be
applied retroactively because "state law . . . may create
fiduciary status in an officer which is cognizable in bank-
ruptcy proceedings . . . ." In re Long, 774 F.2d 875, 878
(8th Cir. 1985). In Indiana, a director owes a fiduciary
duty to the corporation and its shareholders. See Yerke
v. Batman, 376 N.E.2d 1211, 1214 (Ind. Ct. App. 1978)
("It is correct . . . that, concerning matters affecting the
general well being of the corporation, the officers and
directors are fiduciaries to the corporation and to the
shareholders of the corporation."); Griffin v. Carmel Bank
& Trust Co., 510 N.E.2d 178, 182 (Ind. Ct. App. 1987)
("It needs no elaborate citation of authority to demon-
strate that directors and officers of a corporation act in
a fiduciary capacity, and their acts must be for the benefit
of the corporation."); see also In re Marchiando, 13 F.3d
1111, 1115-1116 (7th Cir.), cert. denied, 114 S. Ct. 2675
(1994) (recognizing in dicta that a director owes a fiduciary
duty to the corporation and its shareholders for the pur-
poses of section 523(a)(4)). Therefore, Rigdon was acting
in a fiduciary capacity with respect to the Bank and its
shareholders.
2. Defalcation
Rigdon contends that the FDIC's complaint does not
allege that he engaged in acts of "defalcation" within the
meaning of section 523(a)(11). Specifically, Rigdon argues
that mere acts of negligence are not "defalcations." "De-
falcation" is not defined in the Bankruptcy Code. Nor does
the legislative history of section 523(a)(11) shed any light
on congressional intent as to how it should be interpreted.
However, the term "defalcation" has been used in the
Bankruptcy Code since 1841. Central Hanover Bank &
Trust Co. v. Herbst, 93 F.2d 510, 511 (2d Cir. 1937).
Therefore, we can assume that Congress intended to give
the term "defalcation," as it is used in section 523(a)(11),
the same meaning that courts have given it in interpreting
other provisions of the Bankruptcy Code.
The leading case defining "defalcation" is Central Han-
over Bank & Trust Co. v. Herbst. In that case, Judge
Learned Hand noted that "[c]olloquially perhaps the word,
'defalcation,' ordinarily implies some moral dereliction, but
in this context it may have included innocent defaults, so
as to include all fiduciaries who for any reason were short
in their accounts. . . . Whatever was the original mean-
ing of 'defalcation,' it must here have covered other de-
faults than deliberate malversations, else it added nothing
to the words, 'fraud or embezzlement." Id. at 511. The
court went on to state, however, that "[w]e do not hold
that no possible deficiency in a fiduciary's accounts is dis-
chargeable; in [In] re Bernard, 87 F.2d 705, 707 [(2nd. Cir.
1937)], we said that 'the misappropriation must be due
to a known breach of duty, and not to mere negligence or
mistake.' Although that word [misappropriation] probably
carries a larger implication of misconduct than 'defalca-
tion,' 'defalcation' may demand some portion of miscon-
duct; we will assume arguendo that it does." Id. at 512.
In interpreting Herbst, courts have split over the ques-
tion of whether mere negligent acts may be "defalca-
tions." In In re Johnson, 691 F.2d 249 (6th Cir. 1982),
the court adopted an "objective standard for finding a
defalcation." Id. at 255. Under this standard, the bank-
ruptcy petitioner is charged with knowledge of the law
and his intent or motive is irrelevant in determining
whether a debt is dischargeable. According to the court,
"creating a debt by breaching a fiduciary duty is a suffi-
ciently bad act to invoke the section 17(a)(4) exception
even without a subjective mental state evidencing intent
to breach a known fiduciary duty or bad faith in doing
so." Id. at 256. Nonetheless, the court held that "mere
negligence or a mistake of fact" is insufficient to constitute
a "defalcation." Id. at 257.
In Carey Lumber Co. v. Bell, 615 F.2d 370 (5th Cir.
1980), the Fifth Circuit interpreted the term "misappro-
priation" as it was used in section 17(a)(4), the prede-
cessor of section 523(a)(4). In that case, the bankruptcy
petitioner argued that in order for a debt to be excepted
from discharge under section 17(a)(4), it would have to be
shown that he "intentionally diverted, stole, or misappro-
priated funds . . . ." Id. at 375. The petitioner relied on
language in In re Bernard, 87 F.2d 705 (2d Cir. 1937),
"to the effect that misappropriation under section 17(a)(4)
'must be due to a known breach of the duty, and not to
mere negligence or mistake.' " Carey Lumber Co., 615
F.2d at 375-376 (quoting Bernard, 87 F.2d at 707). The court
initially held that, despite the language in In re Bernard
that a misappropriation "must be due to a known breach
of the duty," the petitioner is "charged with knowledge
of his legal duties." Id. at 376. The court also went on
to address the issue of whether a misappropriation may
occur through negligent conduct:
Moreover, there is doubt as to the continued valid-
ity of the dicta in In re Bernard that misappropria-
tion under section 17(a)(4) may not be found on the
basis of "mere negligence or mistake." In In re Ham-
mond, [98 F.2d 703 (2d Cir. 1938), cert. denied, 305
U.S. 646, 59 S. Ct. 149 (1939)] supra, a debt incurred
by a bankrupt corporate director who had unlawfully
taken advantage of a corporate opportunity that the
corporation had been financially unable to take ad-
vantage of was held nondischargeable in bankruptcy
under section 17(a)(4), despite a complete absence of
evidence that the director's wrongdoing had been in-
tentional. More recently, in Matter of Kawczynski,
supra, the court wrote that " '[d]efalcation' has been
interpreted by the Second Circuit to include innocent
defaults." 442 F. Supp. at 418. Thus there is no re-
quirement that a misappropriation must be shown to
have been intentional in order to be covered by sec-
tion 17(a)(4).
Id.
The Fifth Circuit more recently defined the term "de-
falcation" within the meaning of section 523(a)(4) as "a
willful neglect of duty, even if not accompanied by a fraud
or embezzlement." In re Moreno, 892 F.2d 417, 421 (5th
Cir. 1990) (citing L. King, 3 Collier on Bankruptcy para. 523.14
at 523-93 to 523-95 (15th ed. 1988)); see also In re Ben-
nett, 989 F.2d 779 (5th Cir.), cert. denied, 114 S. Ct. 601
(1993); Matter of Davis, 3 F.3d 113, 115 (5th Cir. 1993)
(citing, inter alia, Carey Lumber, 615 F.2d at 375-376)
("Defalcation includes willful neglects of duty unaccom-
panied by fraud or embezzlement.").
By using the word "willful," the Fifth Circuit has put
into question the validity of the Carey Lumber dicta con-
cerning the issue of whether a negligent act may be a
"defalcation." Black's Law Dictionary 1599 (6th ed. 1990)
defines "willful" as "[p]roceeding from a conscious motion
of the will; voluntary; knowingly; deliberate. Intending the
result which actually comes to pass; designed; intentional;
purposeful; not accidental or involuntary." According to
Black's, "[a] willful act differs essentially from a negligent
act. The one is positive and the other negative." Id.
A bankruptcy court in the Fifth Circuit recently tried
to reconcile Matter of Moreno and Carey Lumber. See In
re Gaubert, 149 B.R. 819 (Bankr. E.D. Tex. 1992). The
Gaubert court rejected an argument made by the FDIC,
based on In re Chavez, 140 Bankr. 413 (Bankr. W.D. Tex.
1992), that a mere breach of fiduciary duty meets the requirement
for establishing a "defalcation." The court recon-
ciled Moreno and Carey Lumber in the following manner:
As a mere breach of fiduciary duty is negligent, the
Moreno court's use of the term "willful" takes mere
breaches of duty out of the defalcation category. On
the other side, the Carey Lumber decision demon-
strates that a standard that is less than intent is
appropriate. It is consistent with the term willful
and the purposes of the Bankruptcy Code to impose
a standard of recklessness.
Gaubert, 149 B.R. at 827.
The Eleventh Circuit has also recently addressed the
perplexing "defalcation" question. In Quaif v. Johnson,
4 F.3d 950 (11th Cir. 1993), the court stated the following:
"Defalcation" refers to a failure to produce funds
entrusted to a fiduciary. In re Alvey, 56 B.R. 170
(Bankr. W.D. Ky. 1985). However, the precise mean-
ing of "defalcation" for purposes of sec. 523(a)(4) has
never been entirely clear. Turner, 134 B.R. at 657.
An early, and perhaps the best, analysis of this ques-
tion is that of Judge Learned Hand in Central Han-
over Bank & Trust Co. v. Herbst, 93 F.2d 510 (2nd
Cir. 1937). Judge Hand concluded that while a purely
innocent mistake by the fiduciary may be discharge-
able, a "defalcation" for purposes of this statute does
not have to rise to the level of "fraud," "embezzle-
ment," or even "misappropriation." Id. at 512. Some
cases have read the term even more broadly, stating
that even a purely innocent party can be deemed to
have committed a defalcation for purposes of sec. 523(a)(4).
See McCormick, 70 B.R. at 51; American Ins. Co.
v. Lucas, 41 B.R. 923 (W.D. Pa. 1984).
Id. at 955. The Eleventh Circuit held that the conduct
at issue in Quaif "was far more than an innocent mistake
or even negligence." Id. Numerous district and bankrupt-
cy courts have also addressed the question of whether
negligent acts may be "defalcations." Most have concluded
that they can./4
Nonetheless, we agree with the Sixth Circuit (and pos-
sibly the Fifth) that a mere negligent breach of a fiduciary
duty is not a "defalcation" under section 523(a)(11). "It
is a well recognized principle in bankruptcy law that ex-
ceptions to discharge are strictly construed against the
objecting creditor and in favor of the debtor. This is based
on the strong policy of the Bankruptcy Code of providing
a debtor with a 'fresh start.' " In re Marvin, 139 B.R.
202, 205 (Bankr. W.D. Wis. 1992) (citing Gleason v. Shaw,
236 U.S. 556, 35 S. Ct. 287 (1915)). Given this well-recog-
nized principle, and the split of authority concerning whether
a "defalcation" may result from negligence, we cannot say
that Congress intended for a debt arising from a mere
negligent breach of fiduciary duty to be excepted from
discharge under section 523(a)(11).
The FDIC's complaint does not use the magic words
"willful" or "reckless." Nonetheless, we believe that it
does allege more than a mere negligent breach of fiduciary
duty. For instance, the complaint alleges that:
Despite receiving repeated admonitions and warnings
against such practices from federal and state banking
authorities and other persons who reviewed the Bank's
procedures, and in contravention of the Bank's own
policies, defendants approved and disbursed loans
without adequate underlying information, or super-
vised and thereby permitted the approval and disbur-
sal of loans without adequate information about the
borrower, guarantor and/or the potential collateral.
In this manner, loans were approved and disbursed
without the following:
(i) completion of applications;
(ii) receipt of financial statements or other re-
quired credit information;
(iii) attempts to verify the accuracy of information
submitted;
(iv) undertaking or receiving the results of indepen-
dent credit checks;
(v) performance of independent appraisals or other
means of confirming the alleged value of
proffered collateral;
(vi) ordering or receiving the results of title searches
of assets to be pledged as collateral;
(vii) maintaining current financial information; and
(viii) making loans without adequate margin of se-
curity.
We must accept as true the FDIC's allegation that Rig-
don was told before he undertook these actions that they
were impermissible. Therefore, the FDIC's complaint does
allege that Rigdon "knowingly" breached his fiduciary
duty to the Bank. Since a knowing breach of fiduciary
duty is more culpable than a mere negligent breach of
duty, we conclude that the FDIC's complaint does allege
a "defalcation" as that term is used in section 523(a)(11).
Conclusion
The decision of the district court, affirming the bank-
ruptcy court's disposition, is AFFIRMED.
FOOTNOTES
/1
As used in this opinion, "collateral estoppel" is
synonymous with the term "issue preclusion," " 'which
refers to the effect of a judgment in foreclosing litigation
in a subsequent action of an issue of law or fact that has
been actually litigated and decided in the initial action.' "
La Salle Nat'l Bank v. County of DuPage, 856 F.2d 925,
930 n.2 (7th Cir. 1988), cert. denied, 489 U.S. 1081, 109
S. Ct. 1356 (1989) (quoting Kirk v. Board of Educ., 811
F.2d 347, 351 n.7 (7th Cir. 1987)). The term "collateral
estoppel" must be distinguished from the terms "res
judicata" or "claim preclusion," which refer to " 'the
preclusive effect of a judgment in foreclosing litigation of
matters that were or could have been raised in an earlier
suit.' " Id. The Supreme Court has held that res judicata
does not apply in bankruptcy discharge exception pro-
ceedings. Brown v. Felsen, 442 U.S. 127, 99 S. Ct. 2205
(1979).
/2
New section 523(a)(12) provides: "(a) A discharge under
sections 727, 1141, 1228(a), 1228(b), or 1328(b) of this ti-
tle does not discharge an individual debtor from any
debt--(12) for malicious or reckless failure to fulfill any
commitment by the debtor to a Federal depository institu-
tions regulatory agency to maintain the capital of an in-
sured depository institution, except that this paragraph
shall not extend any such commitment which would other-
wise be terminated due to any act of such agency."
/3
The National Credit Union Administration is an in-
dependent agency of the executive branch managed by
the NCUAB. See 12 U.S.C. sec. 1752a.
/4
See, e.g., Laughter v. Speight, 92-5123, 1993 U.S. Dist.
LEXIS 19856, at *14 (W.D. Ark. 1993) (quoting In re Oot,
112 B.R. 497 (Bankr. N.D.N.Y. 1989)) ("Defalcation may
be established even though debtor's failure to account for
money he received while acting in a fiduciary capacity was
through ignorance or negligence"); In re Hatfield,
C0477 MHP, 1991 U.S. Dist. LEXIS 7382, at *8,9
(N.D. Cal. 1991), aff'd 976 F.2d 736 (9th Cir. 1992) (quoting
In re Wolfington, 47 B.R. 762, 764 (Bankr. E.D. Pa. 1985))
(" 'Defalcation' is broadly defined to include 'the failure
of a fiduciary to account for money he received in his
fiduciary capacity' regardless of the fact that such failure
may have resulted from ignorance or negligence."); In re
Failing, 124 B.R. 340, 344 (W.D. Okla. 1989) (citing In
re Cowley, 35 B.R. 526, 529 (Bankr. D. Kan. 1983))
("Defalcation may also result from the debtor's negligence
or ignorance."); Kwiat v. Doucette, 81 B.R. 184, 190 (D.
Mass. 1987) (quoting In re Gans, 75 B.R. 474, 490 (Bankr.
S.D.N.Y. 1987)) ("Whereas fraud under the Bankruptcy
Code 'refers to positive fraud, involving moral turpitude,'
defalcation is broadly defined to include 'the failure of a
fiduciary to account for money he received in his fiduciary
capacity' regardless of the fact that such failure may have
resulted from ignorance or negligence."); In re Smith, 72
B.R. 61, 63 (N.D. Iowa 1987) (citing In re Cowley, 35 B.R.
526, 529 (Bankr. D. Kan. 1983)) ("Defalcation includes a
broad range of misfeasance: . . . It is the slightest miscon-
duct, and it may not involve misconduct at all. Negligence
or ignorance may be defalcation . . . ."). But see, e.g.,
In re Martin, 161 B.R. 672 (9th Cir. BAP 1993) ("Because
a defalcation requires more than a mere failure to use
ordinary care . . . ."); In re Reed, 155 B.R. 169, 172 n.5
(Bankr. S.D. Ohio 1993); In re Stewart, 123 B.R. 817, 819
(Bankr. W.D. Tenn. 1991).