Defalcation occurs when an employee of a company mishandles or misappropriates funds with which they have been entrusted. This can occur in many ways, and the act of defalcation is illegal and punishable in a court of law. Similar to embezzlement defalcation is most commonly perpetrated by employees who have full access to the company’s finances or accounting records. Defalcation can also occur when a person combines two debts to create one debt without the consent of the other party. To explore this concept, consider the following defalcation definition.

Definition of Defalcation


  1. Misappropriation of funds held by a fiduciary
  2. The act of embezzling funds
  3. Failure to hold a promise or expectation


15th century   Late Middle English

Types of Defalcation

There are many types of defalcation, with some being more common than others. These most often include:


Embezzlement occurs when an employee that has access to company funds steals those funds for personal use, taking steps to prevent the theft from being discovered, such as altering account records or expense reports. For example, John works as an accountant at a plumbing supply company. He writes checks to supply houses and keeps records so that the company knows what is being paid out. John writes a check to himself, cashes it, and buys personal items, then records the check in the ledger under supplies to cover his tracks.

Fiduciary Negligence

This type of defalcation consists of officers or employers entrusted with the company’s resources using the funds for purposes other than for what they were intended. For example, an accountant may be given a specific amount of money to purchase office supplies, but instead this employee uses it for company lunches. In this instance, the employee is negligent because he failed to use the funds for their original purpose. In fiduciary negligence cases, the employee is often terminated from the company, but criminal charges are usually filed.

Debt Consolidation

Combining two or more debts into a single debt for the purpose of repayment is legal, and sometimes a good strategy, if all parties consent to the debt consolidation. For example, John owes Sally $100, and Sally owes Amanda $20. If all three parties agree, these debts could be combined into a single debt, with John paying off Sally’s $20 debt to Amanda, then owing only $80 to Sally. When debt consolidation occurs without the consent of all parties, however, it is illegal. For example, if John and Amanda made a deal for Amanda to forgive Sally’s $20 debt, with a plan for John to then repay only $80 to Sally without her consent, the agreement would be illegal and invalid.

Real Estate Defalcation

Real estate defalcation occurs when a title agency misappropriates a person’s funds held in a trust. Often times, the funds are intended to be disbursed through a real estate transaction that involves title insurance at the closing of the real estate transaction.

When a title agent is authorized by the state to act as an escrow agent, they receive funds from others with an agreement and specific instructions for distribution of the funds at closing of the real estate transaction. This involves issuing insurance binders, commitments, and guarantees of titles. If the title agent misappropriates the funds, the resulting loss can be significant for the intended buyer.

For example, John, a real estate agent accepts an offer from Sam on a house that was on the market. The house passed inspection and John referred Sam to a title agency that he has used in the past. At the closing, John receives his commission check, but his celebration is short-lived because the check bounces when he deposits it. Upon investigation, it is discovered that the buyer’s money was being held up because the title agency mishandled the funds.

Protection Against Real Estate Defalcation

Real estate agents and buyers should protect themselves against the potential threat of real estate defalcation by asking for protection letters that include defalcation insurance. This ensures that the buyer is protected in the event funds are mishandled or misappropriated. It is also important to be sure the title agent is in good standing with the insurer, and that the title agency has a valid license.

Penalties for Defalcation

Defalcation is punishable in a court of law, and though penalties for defalcation vary greatly from state to state, they may include fines, restitution, and jail time. The exact punishment often depends on such factors as:

  • Amount of funds mishandled or misappropriated
  • Use of the funds
  • Previous criminal history of the defendant

Hiring an Attorney

When a person has been charged with defalcation or another crime revolving around theft, he should seek the help of an experienced attorney. Not only can an attorney help him through the judicial process, the attorney can ensure his rights are fully protected. If a person suspects that his funds have been mishandled or misappropriated, or that he is a victim of defalcation, he should report the incident to law enforcement authorities, and seek the help of an attorney, who can help with the investigation process, which is required in order to recoup losses.

Related Legal Terms and Issues

  • Embezzlement – the theft or misappropriation of funds that has been placed in one’s trust by an employer.
  • Fiduciary Negligence – failure of a fiduciary to honor their obligations or responsibilities.
  • Misappropriate – the dishonest or unfair use of funds or physical property for personal use.
  • Mishandle – to wrongly or ineffectively manage or deal with funds or other assets.
  • Title Agency – an independent agency that issues documents for outside parties, most commonly used in real estate transactions.