                                 In the

     United States Court of Appeals
                   For the Seventh Circuit
                       ____________________
No. 14-3339
STOUGHTON LUMBER COMPANY, INC.,
                                                     Plaintiff-Appellee,

                                   v.


PETER A. SVEUM,
                                                 Defendant-Appellant.
                       ____________________

         Appeal from the United States District Court for the
                     Western District of Wisconsin.
       No. 3:13-cv-00789-wmc — William M. Conley, Chief Judge.
                       ____________________

        ARGUED APRIL 17, 2015 — DECIDED JUNE 4, 2015
                 ____________________

   Before POSNER and WILLIAMS, Circuit Judges, and WOOD,
District Judge. *
   POSNER, Circuit Judge. Peter Sveum and his wife declared
bankruptcy under Chapter 7 of the Bankruptcy Code. Sveum
had since 1989 owned with his brother a home-building


*Hon. Andrea R. Wood of the Northern District of Illinois, sitting by des-
ignation.
2                                                  No. 14-3339


company in Wisconsin named Kegonsa Builders, Inc. One of
Kegonsa’s creditors, Stoughton Lumber Company, had sued
Sveum along with his brother and their company under
Wisconsin law, alleging breach of contract and theft by con-
tractors. The suit had been settled for approximately
$650,000 (plus some other consideration, which however we
can ignore). Sveum violated the settlement agreement and
Stoughton sued again and this time obtained a default
judgment for $589,638.10. Unable (we assume) to pay the
judgment, Sveum filed for bankruptcy, and asked the bank-
ruptcy judge to discharge his debts, including the debt to
Stoughton, on the ground that he lacked the wherewithal to
pay them. Stoughton responded by filing an adversary pro-
ceeding in the Sveums’ Chapter 7 bankruptcy, claiming that
Sveum’s debt to Staughton was not dischargeable. The bank-
ruptcy judge agreed and denied discharge, and was affirmed
by the district court, from which Sveum appeals to us.
    The Bankruptcy Code forbids discharge of a debt “for
fraud or defalcation while [the person or firm committing it
is] acting in a fiduciary capacity [in relation to the victim of
the fraud or defalcation].” 11 U.S.C. § 523(a)(4). “Defalca-
tion” refers to the misappropriation of funds entrusted to
one—a form of embezzlement. It differs from fraud in not
requiring a false statement. “‘Defalcation,’ as commonly
used … can encompass a breach of fiduciary obligation that
involves neither conversion, nor taking and carrying away
another’s property, nor falsity.” Bullock v. Bankchampaign,
N.A., 133 S. Ct. 1754, 1760 (2013). Fraud and defalcation are
interchangeable in the present case, because Sveum, as we’ll
see, made many false statements, though they were not
made directly to Stoughton but rather seem to have been in-
tended to enable Sveum to pay other creditors ahead of
No. 14-3339                                                   3


Stoughton from money, held by Sveum’s company in trust
for Stoughton, to which Stoughton alone was entitled.
     The specific wrong, which is both fraud and defalcation,
alleged by Stoughton is what Wisconsin law calls “theft by
contractors.” Wis. Stat. § 779.02(5). As explained in the stat-
ute, “all moneys paid to any prime contractor or subcontrac-
tor by any owner for improvements, constitute a trust fund
only in the hands of the prime contractor or subcontractor to
the amount of all claims due or to become due or owing
from the prime contractor or subcontractor for labor, ser-
vices, materials, plans, and specifications used for the im-
provements, until all the claims have been paid … . The use
of any such moneys by any prime contractor or subcontrac-
tor for any other purpose until all claims, except those which
are the subject of a bona fide dispute and then only to the
extent of the amount actually in dispute, have been paid in
full or proportionally in cases of a deficiency, is theft by the
prime contractor or subcontractor of moneys so misappro-
priated.” See also Mark Hinkston, “Wisconsin’s Construc-
tion Trust Fund Statute: Protecting Against Theft by Con-
tractor,” www.wisbar.org/newspublications/wisconsinlawye
r/pages/article.aspx?Volume=78&Issue=5&ArticleID=1000
(visited May 10, 2015).
   Between 2008 and 2011 Kegonsa bought hundreds of
thousands of dollars’ worth of building materials from
Stoughton, on credit, for 34 homes that Kegonsa built and
sold. A portion of the money received for those sales became
by operation of the Wisconsin statute that we just quoted a
trust fund that though administered by Kegonsa could be
used only to pay for materials used in the construction of the
homes, such as the building materials bought from Stough-
4                                                  No. 14-3339


ton on credit. Rather than segregating the revenues held in
trust, Kegonsa deposited all its revenues in a single bank ac-
count from which it paid all its bills. Segregation of the trust
funds was not required either by the statute or, as far as
we’re aware, the case law; but while Kegonsa was therefore
free to commingle the funds with other moneys, it had to
preserve intact the assets of the trust fund for Stoughton. It
didn’t.
    Sveum argues that he committed an innocent mistake by
failing to pay Stoughton what Kegonsa owed it—that alt-
hough he was aware of the statute he didn’t know about its
provision for a trust fund, and acting as he did out of igno-
rance did not commit fraud or defalcation and therefore
should not have been denied his discharge. The bankruptcy
judge who presided at Stoughton’s adversary proceeding
didn’t believe Sveum’s protestations of innocence. An edu-
cated person with a college degree in business administra-
tion, Sveum had been in the building business for forty years
and had supervised the construction and sale of hundreds of
homes. Evidence presented in the adversary proceeding in-
dicated that the statute’s trust-fund requirement was gener-
ally known in the industry. In addition, it was inconceivable
that Sveum didn’t know that proceeds of the sale of a home
or other building have to be held in trust for subcontractors
of the builder. It is vital knowledge for a builder, because a
subcontractor who isn’t paid can sue the buyer of the build-
ing, who can in turn sue the builder. Apart from such litiga-
tion risk, a builder who gains a reputation for exposing his
customers to suit by subcontractors will have trouble getting
hired to build homes. That’s why prime contractors routine-
ly insist on lien waivers from their subcontractors (that is,
commitments by the subcontractors not to impose any liens
No. 14-3339                                                      5


on the buildings they’re working on, which would make the
owner liable), and why the Wisconsin legislature provides
subcontractors with the substitute protection of a trust. See
Hinkston, supra.
    It’s not just that Sveum should have known that Kegonsa
as a prime contractor in the construction and sale of homes
was required to hold its revenues from sales of the homes in
trust until the firm’s subcontractors, such as Stoughton, were
paid; it was a permissible inference that he did know, or at
the least that he was playing ostrich—that is, that he sus-
pected that he was violating the law but avoided confirming
his suspicion in order to preserve a patina of innocence. That
is what is sometimes called—besides “playing ostrich”—
“conscious disregard” of risk, “willful blindness,” or “gross
recklessness,” Bullock v. Bankchampaign, N.A., supra, 133 S. Ct.
at 1759, but is more perspicuously understood as knowing
that there is a risk of serious harm and that it can be averted
at reasonable cost, yet failing to act on that knowledge. Reck-
lessness as we have just defined it is a mental state on which
a finding of fraud can be based. Id. at 1759–60; SEC v. Lyttle,
538 F.3d 601, 603 (7th Cir. 2008); Kaloti Enterprises, Inc. v. Kel-
logg Sales Co., 699 N.W.2d 205, 211 (Wis. 2005).
    Evidence of Sveum’s recklessness abounds. Stoughton
had first sued him for theft by contractor in January 2011.
Sveum admitted making no effort to apprise himself of the
obligations imposed by the statute until July or August of
the following year even though he was represented by coun-
sel in the litigation. And he represented on owner affidavits
that all his subcontractors had been paid in full. An owner’s
affidavit is a sworn statement by a seller of real estate
(Sveum) concerning the property being sold. Sveum swore
6                                                 No. 14-3339


in these statements that all subcontractors who had supplied
materials to construct a building on the property had been
paid in full. (Title companies generally require owners’ affi-
davits because they’re ensuring the home buyer against the
risk that someone else owns the property, and subcontrac-
tors who aren’t paid in full may have liens on the property,
which impair its value to its buyer.) Sveum knew he was
swearing falsely.
    He also submitted draw requests (requests for partial
prepayment from home buyers or the buyers’ mortgagees)
in which he said that the subcontractors who had supplied
materials for a building project would be paid a specified
amount from each draw. That was another false representa-
tion.
                                                    AFFIRMED
