Express Trusts and Bankruptcy Discharge: some Quick Hits

Adas v. Rutkowski, 2013 WL 6865417 (N.D.Ill. 2013), illustrates the confluence of Federal bankruptcy law and state law fiduciary duty and express trust principles in a case involving a failed construction partnership.

The plaintiff and bankrupt debtor (defendant) formed a partnership to buy real estate, build a house  on it and split the profits once the house was sold.

The venture failed and the plaintiff got stuck with a sizeable deficiency judgment in a lender’s foreclosure suit.  After the defendant filed for bankruptcy, the plaintiff objected to defendant’s discharge based on defendant’s lengthy pattern of keeping plaintiff in the dark about the failed venture’s finances.  The bankruptcy court agreed and the defendant appealed.

Held: Affirmed.  Defendant’s obligation to plaintiff is nondischargeable.


Normally, a bankruptcy filing gives a debtor a reprieve from creditor collection efforts and forgives (or “discharges”) most of his debts. 

An exception is where the bankrupt debtor engages in fraud, defalcation, embezzlement or larceny.  11 U.S.C. §. 523.

The creditor must show (1) an express trust or fiduciary relationship between the debtor and creditor, and (2) that the debt was caused by fraud or defalcation.  Defalcation equals (roughly) intentional conduct that’s more than negligence but less than fraud.  * 4, 8.

Express Trust – State and Federal Law

The court held that the parties’ business relationship constituted an express trust. 

In Illinois, an express trust exists where (1) there is an intent to create a trust, (2) definite subject matter or trust property, (3) trust beneficiaries, (4) a trustee, (5) a specific trust purpose, and (6) delivery of trust property to the trustee. 

While trusts are normally manifested in a writing (such as a will or property deed), it doesn’t have to be and a trust can be shown through circumstantial evidence. 

The Federal courts view the trust hallmarks as (1) segregation of funds (no commingling, e.g.), (2) management of the funds by an intermediary, and (3) the entity that controls the trust funds or property has only bare legal title to the funds.  *6.

The court found the evidence established a trust arrangement between the parties.  There was an intent to create a trust, trust property (loan funds), subject matter (the house), a trustee (defendant), a beneficiary (plaintiff) and delivery of the trust property.  *5.

Fiduciary Duty

The Court also blocked defendant’s discharge because defendant breached his fiduciary duties to the plaintiff.  Federal law defines a fiduciary relationship as one where there is an imbalance of power between parties and a stronger party takes advantage of weaker one.

Here, the defendant occupied a position of power and influence over the plaintiff and abused the position by excluding the plaintiff from all aspects of the parties business. *7.


Finally, the Court refused to discharge defendant’s debt to plaintiff because of the defendant’s “defalcation.”  

Defalcation applies where a debtor’s conduct is intentional or criminally reckless.  The conduct must go beyond negligence, doesn’t rise to the level of fraud, but still requires subjective intent. 

Defendant’s conduct easily met the defalcation standard.  He engaged in a pattern of secretive and ethically challenged business activity by submitting inflated sworn statements and phantom receipts, commingling funds, and hiding project data from the plaintiff.   *8-9.  


(1)  An express trust will exist where someone gives money or property to another with explicit directions as to how to apply those funds; and no writing is required;

(3) a creditor can defeat a bankrupt debtor’s discharge if it can show the debtor intentionally or recklessly violates an obligation to the creditor – even if the debtor’s conduct doesn’t rise to the level of fraud.


Fraud In the Inducement and Fraudulent Concealment – Illinois Primer

hoodwinkIn Thorne v. Riggs, 2013 IL App (3d) 120244-U (September 3, 2013), the trial court rescinded a real estate contract and the Third District affirmed.  In doing so, the Court examined Illinois fraud in the inducement and fraudulent concealment law and discussed the “special relationship” fiduciary duty rule.

Facts: Plaintiffs sued two LLC members alleging they fraudulently induced them into investing in a realty development.  Plaintiffs claimed the defendants misstated the deal’s status, timing, and whether an easement existed on the property. After trial, the trial court rescinded the contract and ordered defendants to return plaintiffs’ $1.2M investment.

Holding: Appellate Court affirmed trial court.

Reasoning/rules:  Plaintiffs’ fraud claims were premised on defendants’ misrepresentations and concealing material information about the project.

To show fraud in the inducement,  a plaintiff  must show (1) a defendant’s false statement of material fact, (2) known or believed to be false by the defendant; (3) intended to induce the plaintiff to act; (4) plaintiff acted in reliance on the truth of the representation; and (5) resulting damage ¶ 45.

Fraudulent concealment requires a showing that: (1) defendant concealed a material fact under circumstances creating a duty to speak; (2) defendant intended to induce a false belief; (3) plaintiff couldn’t have discovered truth through reasonable inquiry or inspection (or was prevented from doing so); (4) justifiable reliance by the plaintiff; (5) plaintiff would have acted differently if he was aware of the hidden information; and (6) damages. ¶ 62.

A fraudulent concealment plaintiff must also show a fiduciary relationship between him and the defendant.  Fiduciary relationships can exist (a) as a matter of law; or (b) where there is a special or confidential relationship.  The former (as a matter of law) category includes attorneys and clients, principals and agents and partners in a partnership and joint venturers in a joint venture.  Thorne, ¶ 63.

The “special relationship” fiduciary duty rule applies where one party puts trust and confidence in another who stands in a dominant position in terms of age, education, mental status or business acumen. (¶ 64).

Applying these elements, the Court held that the plaintiffs proved fraud in the inducement and fraudulent concealment at trial.

(1) Misrepresentation/concealment: defendants misrepresented status of the project and failed to alert plaintiffs that part of the property was subject to an easement and repurchase agreement (¶¶ 47-63);

(2) Knowledge of falsity – multiple witnesses testified that defendants knew of storm water issues affecting the parcels for several years but never told plaintiffs (¶¶ 52, 57);

(3) Justifiable reliance: defendants controlled the flow of information from the municipality concerning the project’s status.  Defendants divulged only selective information to plaintiffs concerning governmental requirements necessary to complete the project.  The defendants control of information made it reasonable for plaintiffs to rely on defendants.  (¶ 69, 82-83).

The court rejected defendants argument that the information was public record and therefore prevented a finding of justifiable reliance.  The court stressed that plaintiffs were neophyte investors who relied on defendants’ real estate experience.

Another factor relied on by the Court was the absence of record evidence that the easement or the storm water issues were recorded public documents.  (¶ 82).

(4) Fiduciary Duty: while plaintiffs were highly educated, they were real estate novices compared to defendants and completely relied on defendants’ expertise.  This led the Court to sustain the trial court’s “special relationship” fiduciary duty finding.  The Court also found that since defendants controlled the project information they received from the Municipality, they owed plaintiffs a precontractual fiduciary duty.  (¶ 69);

(5) Inducement – there was no other reason for defendants to represent that there were no impediments to plat approval other than to entice plaintiffs to sign the purchase agreement (¶¶ 73-75);

(6) Injury/Damages – plaintiff paid $1.2M for an investment that was promised not to exceed $550,000.  (¶¶ 85-86).

Take-aways: Both plaintiffs had multiple post-graduate degrees.  Still, the court found that they relied on and were in a vulnerable position compared to the defendants, experienced real estate developers.

Thorne also illustrates that where a defendant monopolizes the flow of a deal’s information from outside sources (i.e. a governmental agency), the plaintiff can establish the justifiable reliance prong of his fraud claim.