Defalcation Law and Legal Definition

Defalcation is a term used by the United States Bankruptcy Code to describe a category of bad acts that taint a particular debt such that it cannot be discharged in bankruptcy. Debts of a civil nature acquired through entirely legal means may not be dischargeable if discharge would allow a debtor to easily calculate declaration of bankruptcy into a profitable financial plan. The term is used in legal proceedings outside of bankruptcy to refer more generally to embezzlement and in the context of the title insurance business.

A title agent who misuses funds intended to be used to close insured transactions is said to be involved in a defalcation. The reduction of the claim of one of the contracting parties against the other, by deducting a smaller claim from it is also defalcation. The bankrupt act of 1841 (now repealed), declares that a person who owes debts which have been created in consequence of a defalcation as a public officer, or as executor, administrator, guardian or trustee, or while acting in any other fiduciary capacity, shall not have the benefit of that law.

Defalcation implies that funds have been mishandled, particularly where an officer or agent has breached his or her fiduciary duty. It is commonly applied to public officers who fail to account for money received by them in their official capacity, or to officers of corporations who misappropriate company funds for their own private use. The term means any type of bad faith, deceit, misconduct, or dishonesty. Defalcation is defaulting on a debt or other obligation to account for public or trust funds. Defalcation has another legal meaning referring to the setting-off of two debts owed between two people by the agreement to a new amount representing the balance. The term is used for combining two or more debts to create one total debt. Theft or misuse of funds which were not owned by the defalcator, but under the control of them is also defalcation.