Here, debtor, a former police officer, applied for and was approved for a loan from Hartford Police Federal Credit Union for $150,000.

The loan was for the purpose of paying off an existing second mortgage on debtor’s residence and for the purchase of a business.

At the closing on the credit union’s new mortgage, debtor executed the closing documents, including a second mortgage lien that the credit union later filed on debtor’s residence.

The closing was conducted at the credit union’s attorney’s office; the credit union attorney neglected to withhold any money from the proceeds to pay off debtor’s existing second mortgage. In fact, only closing costs were withheld from the proceeds and debtor was presented with a check for more than $149,000.

Debtor took the check without comment; he did not pay off the second mortgage, and used some of the funds to purchase a balloon business; the remainder of the funds were used to pay accumulated bills and living expenses.

Debtor filed a chapter 7 bankruptcy less than two years later and scheduled the credit union as a third mortgagee on his residence.

The Court thereafter granted all three mortgagees relief from stay to permit foreclosure in state court.

Following said foreclosure, the credit union received no proceeds from the sale to satisfy its position as a third mortgagee.

The credit union filed an adversary proceeding in bankruptcy seeking to: (1) hold the entire $150,000 loan as nondischargeable; or (2) among other things, hold the amount that should have been advanced to pay off debtor’s then existing second mortgage as nondischargeable. Debtor testified that the balance owing to his second mortgage company at the time of this intended refinance was approximately $84,000.

The Bankruptcy Court found that when debtor received the check of more than $149,000 from the credit union, he knew there had been a mistake and when debtor diverted these monies for other purposes, he knew he was misappropriating the monies, constituting embezzlement.

Embezzlement is:

…the fraudulent appropriation of property by a person to whom such property has been entrusted, or into whose hands it has lawfully come.

The Court concluded that debtor’s actions constituted embezzlement and that the sum of $84,000, which should have been utilized to pay of the then existing second mortgage, would be a nondischargeable debt owing to the credit union.

The Court denied, however, the credit union’s claim that the entire $150,000 debt should be nondischargeable, as the Court found the debtor had not intended to defraud the credit union in his application for the loan or in fraudulently obtaining the loan proceeds.

The misappropriation was effected when debtor utilized the funds knowing they were intended to pay off his existing second mortgage. Matter of DeMaio, 159 B.R. 383 (Bkrtcy. D. Conn.).

Author: Charles R. Harroun, Attorney at Law