What Is Defalcation?

The term defalcation primarily refers to an act committed by professionals who are in charge of handling money or other resources. This typically entails the theft, misuse, or misappropriation of money or funds held by an official trustee, or other senior-level fiduciary. As such, it's considered a form of embezzlement, either through the misallocation of funds, or the failure to account for received funds.

There are also other uses of the term, including the sum of misappropriated funds, the use improper use of escrow funds in title insurance, and the consolidation of two debts (carried by two related parties) without the consent of one of the parties.

Key Takeaways

  • Defalcation predominantly refers to the theft, misuse, or misappropriation of money or funds held by an official trustee, or other fiduciary.
  • Defalcation doesn't always involve intent, which is why it isn't always deemed fraud.
  • Common forms of defalcation include embezzlement, debt consolidation, real estate defalcation, and negligence.
  • Embezzlement involves the misallocation of or the failure to account for received funds.
  • Debt consolidation occurs with two opposing debts carried by two related parties to produce a total amount, unbeknownst to one of the parties.

Understanding Defalcation

As mentioned above, defalcation is an illegal act that can have different applications depending on the context. It commonly occurs when public officials misuse and misappropriate funds they are charged with handling.

Trustees and other fiduciaries may channel money that is intended for one purpose into another direction altogether. Or they may knowingly fail to account for monies received that are intended for a client.

Defalcation also has a place in the insurance industry—notably in title insurance. In this case, defalcation is the sum of monies that are misappropriated when a title agent misuses funds deposited into the escrow account that are intended to cover and close real estate transactions.

The U.S. Bankruptcy Code indicates that defalcation takes place when an illegal maneuver is used to taint a specific debt. This connection damages the liability so that it cannot be discharged. When this happens, it may also relieve debtors from their obligations once the Chapter 7 or Chapter 13 bankruptcy is finalized, albeit fraudulently.

Defalcation also occurs when two opposing debts held by two related parties are consolidated to create a single, new debt (and, therefore, a new amount owing) without one party's knowledge and consent. This practice is illegal.

Special Considerations

The act of misappropriating funds must have evident intention. But common law specifies defalcation conduct as involving a degree of culpability greater than negligence. It just doesn't necessarily rise to the level of fraud.

Some cases make it more challenging to pinpoint acts of defalcation. Actions that may be deemed defalcation when committed by executives or high officials entrusted with funds are often, more bluntly, characterized as strict embezzlement when committed by lower-level employees or functionaries. 

Don't confuse defalcation with management fraud. Defalcation doesn't necessarily rise to the level of fraud while management fraud often does.

Types of Defalcation

As noted above, there are types of defalcation. They generally involve different circumstances, but the overall meaning usually transcends across various sectors of the financial services sector. Here are some of the most common types of defalcation.

Debt Consolidation

Debt consolidation, in and of itself, isn't illegal. Many people use it to manage their debt loads and to save money, especially if they can pool their money together into one debt vehicle with a lower interest rate. But it is illegal when two parties owe each other money and one decides to consolidate them together for their own benefit without getting permission from the other.

For instance, let's say Person A has a $100 obligation to Company XYZ, but the company also owes Person A $14. The defalcation of these two debts becomes $86 due by person A to company XYZ. This form of bookkeeping is usually discouraged because it can muddy the accounting waters. At best, it may only be legally executed with the expressed consent of both parties involved.


This is a form of theft. It's a white-collar crime that occurs when a professional cooks the books and uses a company, organization, or individual's money (that they are responsible for) for their own personal use or for something other than the intended purpose. The embezzler may even transfer the money to a third party. The act may continue for some time before it gets noticed, usually when the fraudster takes a little money here and there—amounts that are too small to notice right away.

Defalcation in Real Estate

As noted above, this type of defalcation involves title insurance agents who misuse or misappropriate funds that are held in an escrow or trust account. Rather than using the money to complete the intended real estate transaction, the agent uses the money for their own use. Ultimately, it's the prospective buyer who ends up suffering the loss when the fraud is discovered.


Senior-level executives commit this type of fraud when they knowingly use their companies' money for other, unintended purposes.

Real-World Example

In the infamous defalcation case of Bullock v. BankChampaign filed in the United States Court of Appeals for the Eleventh Circuit, Randy Bullock filed for bankruptcy in 2009 to discharge a judgment debt from a 1999 lawsuit brought forth by his brothers. The brothers sued him for breach of fiduciary duty as trustee of their father's trust.

Bullock, who became the trustee in 1978, took three loans from the trust without the beneficiaries' knowledge, Two of his brothers sued Bullock for breach of trust. They cited that, as the trustee, he went behind their backs to take out these loans and violated the trust.

The state court ordered Bullock to pay damages to his brothers. After that, the trust was transferred to BankChampaign. A court sided with the institution, saying Bullock didn't live up to his role as a fiduciary and that individuals who are accused of defalcation aren't able to discharge their debts through bankruptcy. He ultimately paid back in full.

The U.S. Supreme Court asserted in 2013 that defalcation, as it pertains to the U.S. Bankruptcy Code demands proof of "a culpable state of mind, involving knowledge of, or gross recklessness in respect to, the improper nature of the relevant fiduciary behavior."

Defalcation FAQs

How Is the Defalcation of Cash Done?

The defalcation of cash (or cash fraud) can occur in several ways. An individual may steal money by making payments to satisfy fake accounts payable receipts (and may inflate the dollar amount in the process). The fiduciary may also conceal or delay accounting for credits to certain accounts.

What Is the Difference Between Management Fraud and Defalcation?

Defalcation and management fraud differ when it comes to intention. Defalcation happens when a financial professional, such as a trustee or fiduciary, misappropriated funds through embezzlement or negligence. Individuals may be guilty of something more than negligence. But the act may not necessarily be deemed fraud. Management fraud, on the other hand, is a crime that occurs when someone intentionally misleads the public, including investors, by fudging up financial statements.

What Do Forgery, Defalcation, Pretexting, and Check Kiting Have in Common?

Forgery, defalcation, pretexting, and check kiting are all forms of financial fraud. Forgery is the creation or alteration of documents. Defalcation occurs when funds are misused or misappropriated. Pretexting takes place when someone steals money or information from others by leading them to believe they're someone who can be trusted. Check kiting happens when an individual or business writes a check knowing they don't have enough funds in their account.

Is a Ponzi Scheme a Defalcation?

In a way, a Ponzi scheme is a defalcation. That's because the manager uses money from new investors to pay the returns of people who invested earlier on. This is a scam that promises to pay investors huge returns.

Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
  1. Wall Street Mojo. "Defalcation." Accessed May 12, 2021.

  2. Scott Harris. "Defalcation." Accessed May 12, 2021.

  3. Chegg Study. "Defalcation." Accessed May 12, 2021.

  4. Cornell Law School. "Embezzlement." Accessed May 12, 2021.

  5. Cornell Law School. "Bullock v. BankChampaign, N.A." Accessed May 12, 2021.

Take the Next Step to Invest
The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace.