OPINION
In this case we must decide whether a state court jury decision holding attorney Theodore Garver (“Garver”) liable to R.E. America, Inc. (“REA”) for $600,000 under breach of contract and fiduciary duty is dis-chargeable under the United States Bankruptcy Code (“Bankruptcy Code”). The bankruptcy court refused to discharge the debt, holding that it was the result of defalcation by Garver. 1 The district court affirmed. For the following reasons, we REVERSE.
I. BACKGROUND 2
Garver is an attorney and former partner in the Cleveland, Ohio office of Jones, Day, Reavis & Pogue. Ás a tax specialist, Garver developed numerous long term clients, including REA. In late 1989, while acting as counsel to REA, Garver proposed a business transaction between REA and himself to acquire a struggling company which needed an infusion of capital and new management. REA agreed to participate in Garver’s proposed venture. Under their agreement, each party would contribute $600,000 for 50% ownership in a company called A.A. Gage (“Gage”). When the transaction was completed, however, REA had invested $600,000 in exchange for an unsecured promissory note in the amount of $600,000 executed by Garver on behalf of the Fostoria Braude Corporation, a holding company which Gar-ver controlled. 3 Fostoria Braude, in turn, owned 100% of the Gage stock. Garver, meanwhile, had contributed only $17,500 toward the purchase of Gage.
During the following year, Gage became insolvent and filed for bankruptcy in late 1991. As a result, REA lost its investment and sued Garver in state court, alleging legal malpractice, breach of contract, and fraud. Specifically, REA alleged that Garver, as a business partner in the transaction, breached his contractual duty to contribute $600,000 to acquire Gage and, as attorney for REA, breached various fiduciary duties owed to REA under the attorney-client relationship. In the state court trial, Garver testified that he never intended to contribute $600,000 to the venture. Rather, according to Garver, the deal only required him to contribute his “sweat equity” to Gage. Thus, under Garver’s version of the agreement REA carried nearly the entire financial risk of the deal. Not surprisingly, the jury believed REA and concluded that Garver: 1) committed legal malpractice by breaching unspecified fiduciary duties owed to REA as his client and 2) breached his contract with REA to contribute $600,000 to the venture. The jury also specifically found that Garver had not committed fraud. The jury then awarded REA $600,000 in damages. 4
Garver subsequently filed a voluntary petition under Chapter 7 of the Bankruptcy Code. REA, as a judgment creditor, responded by filing this adversary proceeding in the bankruptcy court to determine whether Gar-ver could discharge his debt to REA. The dischargeability of Garver’s obligation turned entirely upon whether the state court judgment was the result of “defalcation” within the meaning of 11 U.S.C. § 523(a)(4). The
II. ANALYSIS
In considering an appeal from a district court decision which is on appeal from a bankruptcy court, this court independently reviews the bankruptcy court’s findings of fact for clear error and its conclusions of law de novo.
Longo ¶. McLaren (In re McLaren),
Although many debts are dischargeable under the Bankruptcy Code, § 523(a)(4) provides that “a discharge under [the Bankruptcy Code] does not discharge an individual debtor from any debt ... for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.” 11 U.S.C.A. § 523(a)(4) (West 1993 & Supp.1997). It is undisputed that no embezzlement or larceny occurred in this case and the state court jury specifically found no fraud. Therefore, to avoid discharge of the debt in bankruptcy, REA must show by a preponderance of the evidence that the debt was incurred through defalcation while acting in a fiduciary capacity.
See Grogan v. Garner,
The federal courts are not in perfect agreement as to the requirements necessary to prove defalcation under § 523(a)(4). A review of the eases reveals that the courts generally agree that defalcation requires: 1) a fiduciary relationship; 2) breach of that fiduciary relationship; and 3) a resulting loss. They often differ, however, as to the nature of the fiduciary relationship necessary to trigger the defalcation provision of § 523(a)(4).
Some federal courts construe the term “fiduciary capacity” found in the defalcation provision of § 523(a)(4) narrower than they construe the term “fiduciary relationship” as used in the legal profession generally.
Fowler Bros. v. Young (In re Young),
Other federal courts construe the term fiduciary capacity in § 523(a)(4) more broadly, holding that the attorney-client relationship by itself establishes the necessary fiduciary relationship for purposes of the defalcation provision.
Tudor Oaks Ltd. Partnership v. Cochrane (In re Cochrane),
Although this court has not yet explicitly identified the nature of the fiduciary relationship required under the defalcation provision of § 523(a)(4), we are guided by our previous decision in
Capitol Indem. Corp. v. Interstate Agency, Inc. (In re Interstate Agency),
In this case, despite the absence of an express trust, the parties stipulated to the existence of a fiduciary relationship satisfying the defalcation provision of § 523(a)(4).
In re Garver,
We find that the bankruptcy court erred in relying upon this dictionary definition of defalcation because the dictionary definition improperly expands upon our previous definition of the term contained in
Interstate Agency.
As noted above,
Interstate Agency
defined defalcation as the embezzlement, misappropriation of trust funds held in a fiduciary capacity, and failure to properly account for trust funds.
Interstate Agency,
Accordingly, the decision of the district court is REVERSED with directions to discharge the debt.
Notes
. The bankruptcy court's opinion is published at
. Although Garver disputes a portion of the following facts, both parties agree that given the state court jury decision in favor of REA these facts must be taken as true for purposes of this appeal.
. REA sued on this promissory note and won, but did not recover any money because of Fosto-ria Braude's insolvency. From its inception, Fostoria Braude contained no assets other than the stock of Gage.
. Adding prejudgment interest, the state court ordered Garver to pay $815,178 to REA.
. Although Interstate Agency defined defalcation under § 17(a)(4) of the old Bankruptcy Act, the precursor to § 523(a)(4), neither party argues, and we conclude, that this distinction is irrelevant to our analysis.
. Garver argues that the definition of defalcation contained in the Sixth Edition of
Black’s Law Dictionary
expands the concept of defalcation to an untenable level because any debt resulting from an attorney’s failure to meet a fiduciary obligation would automatically become nondis-chargeable under the Bankruptcy Code. In light of our holding today, Garver's fear is unwarranted. Because the attorney-client relationship by itself is insufficient to create the necessary fiduciary relationship for purposes of the defalcation provision of § 523(a)(4), an attorney’s breach of fiduciary duty, without more, does not constitute defalcation. Absent an express or technical trust, an attorney’s legal malpractice, like all other types of professional malpractice, remains dischargeable under the Code.
See Freeman v. Frick (In re Frick),