THE TEXAS CONSTRUCTION TRUST FUND ACT
THE TEXAS CONSTRUCTION TRUST FUND ACT AND BANKRUPTCY PREFERENCES
By Fred D. Wilshusen & Stephen T. Hutcheson
The Texas Construction Trust Fund Act[i] benefits those furnishing labor or materials for the construction or repair of a house, building, or improvement by providing that any funds to a contractor, subcontractor or supplier made in payment of labor and materials are held in trust for all parties in the construction chain.[ii] The Construction Trust Fund Act recognizes that general contractors typically deposit project monies into a few common accounts, and allows subcontractors and suppliers to get paid from these accounts without first pleading entitlement to those funds, under a constructive trust, and then tracing their entitlement to the payments received by the general contractor.[iii] The Act provides for civil and criminal penalties to those who misappropriate trusts funds and fail to pay for labor and materials.[iv]
The language of the Act as well as amendments affecting the Construction Trust Fund Act reemphasize the Texas Legislature’s intent that an identifiable construction fund exists for the sole purpose of protecting payments due downstream subcontractors and suppliers, from being diverted away from them through misappropriation by upstream parties such as general contractors.[v] Nevertheless, the intent of the Legislature is not followed in every instance. In bankruptcy adversary proceedings, bankruptcy courts have been hesitant to give full meaning to the words of the Construction Trust Fund Act, and as a result, payments rightly belonging to downstream subcontractors and suppliers are being treated as if they belonged to the general contractor.
Numerous cases give guidance regarding the interplay of the Construction Trust Fund Act and § 523 of the Bankruptcy Code, that part of the Bankruptcy Code that provides for exceptions to the discharge of a debt in bankruptcy. However, the interplay of the Construction Trust Fund Act and 11 U.S.C. §547, that part of the Bankruptcy Code that deals with preferences, is not clear in the Fifth Circuit. This article will explore the relationship of the Construction Trust Fund Act and 11 U.S.C. §547 by analyzing how federal courts outside of the Fifth Circuit have applied their state trust fund laws to §547 and by exploring how the Fifth Circuit has interpreted the effect of the Act on 11 U.S.C. §523. To understand the relationship between the Construction Trust Fund Act and §547, a review of pertinent portions of both statutes is appropriate.
The Texas Construction Trust Fund Act
The Texas Legislature dictates that a trust fund arises upon payment of funds under a construction contract to a contractor, subcontractor or supplier.[vi] The general contractor or other party receiving such payments, and having control or direction over such payments, is deemed a trustee over the funds he has received.[vii]
Numerous other states have enacted trust fund acts as well.[viii] “Contractors doing business in trust fund states are deemed fiduciaries of the subcontractors and suppliers for whose labor and material they receive payment.[ix] Trust fund statutes take different forms including those that provide expressly for a trust, provide criminal penalties for misapplication of trust monies, create a lien on funds or arise out of the lien laws.[x] The trust fund laws around the country recognize that “the building trades have gradually created a set of commercial expectations as the result of the customs and practices of the industry.[xi] Unlike other industries, construction contractors and suppliers “cannot spread their risks in the same way as a grocer or other merchants with many customers.[xii] If the upstream contractor goes bankrupt, there is a significant chance it could take subcontractors with it, multiplying the loss to the economy and the owner, at worst, or leading to long and wasteful lien disputes at best.[xiii]
Like trust laws around the country, the trust concept created by the Construction Trust Fund Act comports with the reality of the construction billing and payment process. Commercial construction jobs are too complex to wait for full payment at the end of the construction project. Consequently, payments are broken up into monthly progress payments reflecting percentage of completion for each month and a final payment of retainage, usually in the amount of five or ten percent.
When an upstream party such as a general contractor is paid, only a relatively small portion of the monies received actually belong to the general contractor. The general contractor has earned only the portions of the payment that represent work that the general contractor itself performed as well as its markup for overhead and profit. The remainder, which usually represents the bulk of the payment, belongs to downstream subcontractors and suppliers who furnished labor and materials to the construction project. Because the work of the downstream subcontractor and suppliers represents a part of the general contractor’s overall scope of work, it is billed through the general contractor’s pay application. Still the money that the general contractor receives is earned directly through the efforts of downstream parties. For this reason, the Texas Legislature has declared that all payments received by a general contractor are held in trust for the benefit of downstream subcontractors and suppliers.
A healthy body of law, which is not completely consistent, has arisen regarding the interpretation of the Act. Certain matters have been consistently recognized by the courts. As is the case in any remedial statute, courts “must” give the Construction Trust Fund Act “broad construction to effectuate its protective purposes.”[xiv] Unlike a mechanic’s lien, provided for in Chapter 53 of the Texas Property Code and Article 16, Section 37 of the Texas Constitution, there are no procedural requirements made of a subcontractor or materialman before they qualify for protections under the Construction Trust Fund Act.[xv] It has been recognized from the beginning that the protections in the Act are “additional security over and above the security provided in favor of laborers and materialmen under the existing [lien] statutes.[xvi] Although the statute “does not expressly authorize civil suits to enforce its terms” such suits are allowed.[xvii] Throughout its history, in general, Texas courts have presumed that the Act created actual trust rights for the listed beneficiaries, subject only to the listed statutory exceptions or affirmative defenses.[xviii]Counterbalanced against this solidified state property right is the policy of the Bankruptcy Code regarding preferential transfers during the period leading up to a bankruptcy filing.
Bankruptcy Preferences Under 11 U.S.C. 547
During the last few months prior to filing for protection under the Bankruptcy Code a debtor’s relationship with its creditors typically becomes strained. However, there are usually a few key creditors or vendors that the debtor desperately needs to keep happy in order to keep its doors open and its lenders at bay. It is during this time that the debtor may be tempted to agree to special payment arrangements with these key creditors over other less essential creditors. It is to these essential creditors, benefiting from short-lived special status, that the provisions of 11 U.S.C. §547 are focused. No matter how honored a creditor might have felt that its invoices were paid, those good feelings end when the creditor receives a complaint from a bankruptcy trustee[xix]asking the creditor to return all monies that it received in the 90 days before the debtor filed its bankruptcy petition.
Equality of distribution among creditors is a central policy of the Bankruptcy Code. According to that policy, creditors of equal priority should receive pro rata shares of the debtor's property.[xx] The purpose of § 547 is “two-fold.”[xxi] By permitting the trustee to avoid transfers that occur within a short time before bankruptcy, creditors are discouraged from racing to the courthouse to dismember the debtor during his slide into bankruptcy.[xxii] This protection enables the debtor to work his way out of a difficult financial situation through cooperation with all of his creditors.[xxiii] The provisions of § 547 also promote the bankruptcy policy of equality of distribution among a debtor’s creditors.[xxiv] Any creditor, without viable defenses, who was paid at a time when other creditors of the same class went unpaid, will find its payments disgorged so that all of a debtor’s similarly situated creditors may share equally in the distributions made by a debtor in the days before bankruptcy.[xxv] Section 547 not only avoids a debtor’s preferential treatment of key creditors, it also prevents unusual collection actions by a creditor during a debtor's slide into bankruptcy.[xxvi]
Section 547 allows the bankruptcy trustee to recoup a “transfer” of property made in the form of money or other property, to or for the benefit of a creditor in payment of a pre-existing debt, while a debtor was insolvent, if and only if that transfer allowed a creditor to receive more that it would receive under chapter 7 of the Bankruptcy Code.[xxvii] Transfers can be avoided as to any creditor, if the payment was made in the 90 days before the debtor filed for bankruptcy.[xxviii] Transfers can be avoided as to “insiders” if the transfer was made within a year before the debtor filed.[xxix]
In order to successfully prosecute a cause of action to avoid a transfer, as defined above, a bankruptcy trustee must clear five hurdles:
- The property transferred must have been one in which the debtor held an interest;
- The transfer must have been made to the creditor or benefited the creditor;
- The transfer must have been in payment of or on account of pre-existing debt owed by the debtor to the creditor before such transfer was made;
- The transfer must have been made while the debtor was insolvent;[xxxi]
- The transfer must have left the creditor better off than if the transfer had not been made and the creditor had asserted its claim in a chapter 7 liquidation.[xxxii]
Whether property transferred by the debtor is money that it held in trust for another implicates the first element of proving a preference. Consequently, this article will focus on the debtor’s interest in the property transferred.
Debtor’s Interest in the Property Transferred
The first hurdle the debtor or trustee must clear requires proof that the debtor had an interest in the property transferred. The debtor is required to look to both federal and state law for guidance in this matter.[xxxiii] Federal law always determines what property belongs to the estate.[xxxiv] However, a debtor must look to both state and federal law to determine the extent of the debtor’s property interest in the property transferred from the estate.[xxxv] The court must follow this vague formula and somehow accommodate state and federal law in determining whether the debtor really has an interest in property transferred.[xxxvi]
Section 541(a) of the Bankruptcy Code, entitled “Property of the Estate,” provides that any legal or equitable interests of the debtor, on the day the debtor files for protection under the Bankruptcy Code, are “property of the estate.” This “admittedly broad definition” of the estate’s property is influenced by both state law and federal bankruptcy law.[xxxvii] This is to say that the filing of the bankruptcy petition does not expand a debtor’s property interests. The estate of the debtor holds property only to the extent of the right and title possessed by the debtor, the instant before the bankruptcy petition was filed.[xxxviii] For this reason an estate may not avoid transfers of property in which the debtor held only a legal but not an equitable title.[xxxix] One example of this is where property held by the estate was part of a trust.
Federal Application of Trust Fund Law to the Bankruptcy Code
The intersection of trust fund acts with preference law begins with §523 where the effect has been most frequently analyzed. Section 523 includes, as an exception to discharge, any debt incurred for “defalcation while acting in a fiduciary capacity.”[xl] Because the various trust fund laws expressly or impliedly make the trustee of the construction funds a fiduciary[xli], unpaid subcontractors and other creditors have frequently attempted to prevent the bankruptcy trustee from discharging their construction debt in a bankruptcy on the basis that it was caused by a defalcation while the general contractor was acting in a fiduciary capacity.
As noted above, the legal standard for determining whether a debtor was acting in a fiduciary capacity involves a vague combination of state and federal law.[xlii] This may explain why the courts have applied the law in so many varied ways. One court attempting to harmonize the multitude of different holdings found the courts to fall in a spectrum ranging from: (1) finding a fiduciary obligor when a statute imposes specific detailed duties regarding “trust” funds to (2) finding none when a statute only sets out criminal penalties.[xliii] Littered between these poles were cases interpreting statutes that expressly designated construction payments to be “trust” funds without imposing detailed duties on the trustee.[xliv]
There is no current Fifth Circuit case law addressing the treatment of the Construction Trust Fund Act under the preferences sections of the Bankruptcy Code. Consequently, to analyze how the federal courts in the Fifth Circuit may treat the Act in relation to §547, we must examine the treatment they have given the Act in relation to §523.
The Fifth Circuit – Boyle And Nicholas
In re Boyle[xlv]is the leading Fifth Circuit case on the issue of dischargeability where a trust fund created by the Construction Trust Fund Act is involved. It is representative of the issues other courts confronting this issue examine.
In that case, the debtor, Christopher Boyle (“Boyle”), appealed a bankruptcy decision excepting from discharge debts for construction supplies used on a construction project. The lower courts had ruled that the Construction Trust Fund Act[xlvi] had created a trust for the construction funds received by Boyle on one project which Boyle had used for another project. The lower courts had ruled that the use of such funds violated the trust, and as such were debts for “fraud or defalcation while acting in a fiduciary capacity” satisfying the exception to discharge in §523(a)(4).[xlvii] The Fifth Circuit reversed the lower court’s ruling and held that there was no evidence of fraud on Boyle’s part, “nor any basis for any theory of fiduciary defalcation other than the Texas statute itself.”[xlviii] The fact that the Act called the funds “trust funds” was not sufficient to create the fiduciary obligations referred to in §523.[xlix] What does constitute a fiduciary obligation for discharge purposes is defined by a federal law. The court, therefore, analyzed whether the statute created fiduciary obligations as contemplated by §523.[l]
The court started its analysis with early Supreme Court rulings holding that “defalcation in a fiduciary capacity” refers to “technical trusts.”[li] Technical trusts are trusts that exist “prior to the act creating the debt and without reference to the act.”[lii] The obligations the statute places on the purported trustee determine whether a technical trust is created by statute.
The court noted that lien law statutes from other states had been held to create a trust sufficient to meet the § 523(a)(4) exception to discharge.[liii] Some of the various factors that cause a statute to create a technical trust are, (1) prohibiting the commingling of funds from one project with funds from another project; (2) requiring the fund holder to maintain separate identity of any trust res; and (3) allowing a personal liability claim if the fund holder uses funds for one project on another project. Trust fund or lien statutes that lacked some of those distinct trust features were found by other courts not to create a technical trust or to create an exception to dischargeability.
After noting how other courts had resolved this issue the Fifth Circuit held that their decision was based upon the duties imposed by the Construction Trust Fund Act upon the fund holder/debtor.[liv] The court focused specifically on four items missing from the Act: 1) no requirement to segregate funds by project; 2) no prohibition against commingling of funds; 3) no prohibition of using funds from one project to pay bills on another project without an intent to defraud; and 4) no prohibition against using surplus funds from one project to pay creditors on another project without an intent to defraud.[lv] The language of the 1984 version of the Act only had one fiduciary obligation – the fund holder may not, “with intent to defraud,” use the funds for other purposes without paying the beneficiaries first.[lvi] The criminal sanctions are not even triggered until that occurs. Hence, the court concluded, there is no true fiduciary responsibility unless the fund holder diverts the funds with the intent to defraud.[lvii] The court noted that without such a showing of intent, “the statute does not create ‘red,’ ‘blue,’ and ‘yellow’ dollars each of which can only be used for the ‘red,’ ‘blue,’ or ‘yellow’ construction project.”[lviii] There was no finding that Boyle had diverted the funds with the intent to defraud; hence, there was no “fraud or defalcation while acting in a fiduciary capacity” sufficient to create an exception to discharge under the Bankruptcy Code.
At about the same time that the Fifth Circuit was handing down its decision in Boyle, the state legislature was busy amending the language of the Construction Trust Fund Act relied on by the court in Boyle.[lix] Specifically, the legislature added the words “intentionally or knowingly” as additional scienter requirements that could trigger liability for a trustee of funds under the Act.[lx] No longer was it necessary to prove the trustee acted with “intent to defraud” to establish misapplication of trust funds. For example, simply showing that the trustee had “knowingly” retained or used trust funds “without first fully paying all current or past due obligations incurred by the trustee to the beneficiaries of the trust funds” was sufficient to show misapplication of the trust funds even in the absence of an intent to defraud.[lxi]
The Fifth Circuit examined this additional statutory language in In re Nicholas.[lxii] The court noted that “exceptions to discharge are generally to be narrowly construed against . . . the creditor and in favor of the bankrupt. . . .”[lxiii] After examining the amendments, the court agreed that they brought the Texas statute closer in line to the Oklahoma statute construed by the Fifth Circuit in Carey Lumber to create a technical trust.[lxiv]
The court focused its analysis on amendments to an exception to the creation of the trust at §162.031(b). Previously, at the time of Boyle, a trustee of construction trust funds had been allowed to “use trust funds to pay the trustee’s reasonable overhead expenses that [were] directly related to the construction or repair of the improvement.”[lxv] The 1987 amendments changed that to “the trustee’s actual expenses directly related to the construction or repair of the improvement.”[lxvi] This exception allowed a trustee of funds to pay a certain amount of project monies on its overhead expenses to run a project. Before the 1987 amendments, this related project expenses defense was treated as an exception where the burden of proof was on the prosecution in a criminal action.[lxvii] The 1987 amendments modified the Act to make it an affirmative defense where the burden of proof was on the trustee of the trust funds.
Nicholas relied on a Texas Attorney General’s Opinion[lxviii] to the effect that the Act allowed trust funds to be paid to cover expenses of non-beneficiaries, as long as the expenses were actually incurred. This was so even though the expenses were not readily traceable to a particular job.[lxix] The court found this to be a key difference between the Oklahoma and Arizona statutes which were found to create a trust.[lxx] These statutes “brook no payment to non-beneficiaries”.[lxxi] The court held that because of the related project expenses affirmative defense, there was still no obligation to segregate “red,” “blue,” and “yellow” dollars for use only on “red,” “blue,” or “yellow” construction projects.[lxxii]
Remarkably, the court placed the burden of proof for disproving the related project expenses affirmative defense on the creditor for purposes of establishing an exception to discharge under § 523.[lxxiii] The court reasoned that the ultimate burden of proof is on the creditor to prove that the debt falls within the exception to discharge under §523(a)(4).[lxxiv] Therefore, the creditor must show that the monies received by the trustee were not spent on directly related project expenses.
Proving a Technical Trust Under Boyle and Nicholas for §523
Under Boyle, a creditor seeking to establish a technical trust arising out of the Construction Trust Fund Act for purposes of establishing an exception to discharge under §523(a)(4) had to show that the trustee of the fund retained, used, disbursed or diverted funds “with intent to defraud.”[lxxv]
After Nicholas, a creditor seeking to establish a technical trust could also prove that the trustee of the fund intentionally or knowingly retained, used, disbursed, or diverted trust funds without first fully paying all current or past due obligations incurred by the fund trustee to the beneficiaries. Further, under Nicholas, to discharge its burden of proof on the related project expenses affirmative defense, the creditor must show evidence that money spent was not on actual expenses directly related to keeping the project in question going.[lxxvi] The creditor’s evidence of this can be direct or inferential.[lxxvii] Because the related project expenses affirmative defense was in the statute construed by Boyle, it is arguable that proof of “intent to defraud” is sufficient to sustain the creditor’s burden of proof.[lxxviii]
It appears that the four decisive issues to the Boyle court have either been explained away by Nicholas or eliminated by the 1987 amendments. The first two issues were that the Act did not: (1) require segregation of the trust funds or (2) prohibit commingling of the trust funds. However, Nicholas found that with regard to these two issues, the Act is no different from the Oklahoma or Arizona statutes where a technical trust was found to exist.[lxxix] The last two issues focused on the requirement that the creditor prove an “intent to defraud.” The 1987 amendments substantially diluted the requirement of showing the trustee’s intent to defraud by allowing proof of “knowing” or “intentional” conduct.
With the elimination of all four factors influencing the outcome in Boyle, how could the Fifth Circuit in Nicholas still declare that the Act “remains less broad than those in Carey and Baird, and it falls far short of the statutes described in Boyle as creating classic, express trust arrangements”?[lxxx]
First, although a very quotable statement, it is irrelevant that the Act falls far short of creating a classic express trust as long as it meets the standards of Carey Lumber which the Fifth Circuit already held created a technical trust. A comparison of the operative statutory language from the statute construed in Carey and the Construction Trust Fund Act shows them to be quite similar.[lxxxi]
The only remaining difference between the statute in Carey Lumber and the Act is the requirement that the creditor disprove the fund trustee’s affirmative defense regarding related project expenses. The Fifth Circuit in Nicholas notes that this provision is “realistic,” but treats it as if it is a significant “open-ended” obstacle to proving the existence of a technical trust for purposes of §523.[lxxxii] It does place the creditor in the perplexing situation of having to prove a negative – trust funds were not spent on overhead, not readily traceable, but directly related to the project. However, it does not necessarily have to be an overwhelming obstacle as a reference to the Texas Attorney General Opinion relied on by the Nicholas court reflects.[lxxxiii]
The specific question put to the Attorney General was whether the related project expenses exception included “expenses which, though not readily traceable to a particular job, are necessary to obtaining or completing the job (e.g., office rent, employee salaries, workers’ compensation insurance, liability insurance, communications bills, etc.).”[lxxxiv] The legislative history quoted in the Attorney General’s opinion makes clear that the defense only applies to overhead “but for” which the job could not have been performed.[lxxxv] As was stated in Senate Committee hearings on the bill: “It ought not to be that hard to figure out some proportion of your overhead that goes to per day, per hour, per man hour worked.”[lxxxvi] Overhead can sometimes be challenging to calculate for a bankrupt company, or where a project has gone badly wrong. However, calculating overhead is not a great mystery. Every general contractor has to have an idea of what its overhead is in order to calculate its markup on subcontractor and other costs. Once source for deducing a contractor’s markup is to compare the line item valuations that are used on many jobs for monthly pay applications. These typically break the job down into distinct work components to allow the upstream parties to evaluate the accuracy of the amount of each work item claimed to be completed that month as the basis for the amount billed. The amount the general contractor marks up each subcontractor item is a clue to its overhead and profit markup. Further, the change orders that occur on so many jobs reflect how much markup the general contractor is placing on his subcontractor’s cost estimate for that work.
Evidence that the debtor was regularly “robbing Peter to pay Paul” is certainly proof of knowing use of trust funds without first paying a beneficiary. Further, if the creditor can show “intent to defraud” that would seem to qualify at least as the inferential proof Nicholas required that the fund trustee was not using the fund to pay qualifying overhead.
Before evaluating their applicability to preferences, it would be helpful to analyze the Supreme Court authority underlying the Boyle and Nicholas decisions.
Chapman, Davis and Their Progeny
Boyle, Nicholas and other cases interpreting the concept of “fiduciary” as used in §523(a)(4) ultimately reach back to a series of Supreme Court decisions interpreting predecessor statutes. The first was Chapman v. Forsyth,[lxxxvii] interpreting the Bankruptcy Act of 1841. The specific language in the statute excepted from discharge: “debts . . . created in consequence of a defalcation as a . . . trustee, or while acting in any other fiduciary capacity. . . .“[lxxxviii] The Court held that the defalcation of a “trustee” did not involve “cases of implied but special trusts, and the ‘other fiduciary capacity’ mentioned, must mean the same class of trust.”[lxxxix] From these observations, the Court held that “the act speaks of technical trusts, and not those which the law implies from contract.”[xc]
This language was further interpreted by the Supreme Court in Davis v. Aetna Acceptance Co.[xci] Davis interprets the subsequent Bankruptcy Act of 1898, which had a similar exception to discharge provision.[xcii] The Davis Court expressly relied on the decision in Chapman and expanded on its meaning by stating: “It is not enough that by the very act of wrongdoing out of which the contested debt arose, the bankrupt has become chargeable as a trustee ex maleficio. He must have been a trustee before the wrong and without reference thereto.”[xciii]
The court in In re Turner[xciv] surveyed Chapman, Davis, and related Supreme Court holdings regarding this requirement of a technical trust, and demonstrated that the rationale of the Supreme Court changed through its various decisions without express recognition by the Supreme Court. The Turner court found that reducing the variety of holdings to a “single intelligible rule” was not easy. It ultimately concluded that the key factor was whether the fiduciary capacity arose before any wrongdoing. This was the case whether the trust was voluntary, such as a trust created by agreement, or even an involuntary trust such as a trust imposed by statute.[xcv]
The court in In re Turner was examining whether an Oklahoma trust fund statute created fiduciary obligations in a general contractor for the benefit of an unpaid materialman regarding payments the general contractor received from an owner.[xcvi] Because the Oklahoma statute in the Turner case created a trust as soon as there was payment to the general contractor, the court concluded that fiduciary obligations were created for purposes of §523, because payment predates any diversion of funds by the general contractor. Hence, under the Supreme Court precedents, the obligation arose prior to the wrongdoing.[xcvii] Applying the court’s analysis from In re Turner, it would appear that the Construction Trust Fund Act creates fiduciary obligations under the Bankruptcy Code because the obligations arise prior to the use or diversion, which is prohibited.[xcviii]
The Interaction of Trust Fund Rights and Bankruptcy Preferences
A number of cases outside of the Fifth Circuit have applied construction trust fund rights to §547 to find that no avoidable preference exists regarding construction payments received by subcontractors.[xcix] The cases rejecting the trust defense to a §547 preference complaint involve states where no construction trust rights are recognized.[c] Consequently, there is significant authority to support the use of construction trust fund rights to defeat a preference action under §547.
Applying Boyle and Nicholas in their current form to §547 preference actions is problematic. This is because of the law regarding commingling.
It is not unusual for a general contractor to deposit its project monies into a few common accounts. Consequently, trust fund cases often present the court with the problem of tracing trust monies through the debtor to the beneficiary. The problem of applying Boyle and Nicholas to §547 becomes evident after examining the law regarding commingling.
If trust funds are permitted to be commingled and a trust fund right is asserted by downstream subcontractors or suppliers in defense of an avoidance action, it appears that the majority view in the law gives the trustee or debtor an advantage. When funds have been commingled, the bankruptcy trustee is not required to identify property that is not part of the trust. In one case, the Fifth Circuit found that the Debtor's possession of funds in a bank account in its name, coupled with the unfettered discretion to pay creditors of its own choosing, demonstrates a sufficient "interest of the debtor in property" for purposes of preference law.[ci] This suggests a shift in the burden of proof in the case of trust funds commingled with non-trust funds.[cii]
The court in In re Casco Electric Corp.[ciii] took a different approach to this issue. In Casco, a general contractor made payments to a subcontractor within ninety days of the filing of the bankruptcy petition. The checks written by the debtor/contractor were from its general operating account. The debtor/contractor did not keep funds received on behalf of subcontractors in a segregated account. After reviewing New York lien law and cases that had interpreted it, the Casco Court found that a statutory trust had been created and that it was the trustee’s burden to prove that the money the debtor paid to the general contractor was not part of the trust’s assets.[civ] The Court noted that, “the Second Circuit held that New York's lien law gave a subcontractor the right to have monies due an insolvent debtor contractor from an owner impressed with a trust in its favor.”[cv]
The prevailing view, however, is that in order to assert a trust fund claim, the claimant must be able to trace the payments it received into an identifiable trust fund held by the debtor.[cvi] The seminal case on the treatment of statutory trust funds for construction projects is Selby v. Ford Motor Co.[cvii] It analyzes the use of the lowest intermediate balance test to satisfy the tracing requirement for trust funds held by a debtor in a bankruptcy case.
In Selby, the Sixth Circuit held that “the beneficial interests of subcontractors . . . should not be regarded as property of the bankrupt debtor, at least so long as the beneficial interests are traceable.”[cviii] The resultant reasoning is that a claimant in a bankruptcy case seeking to establish rights as a trust recipient must: (1) demonstrate that the trust relationship and its legal source exist; and (2) identify and trace the trust funds if they are commingled.[cix] To the extent a beneficiary cannot satisfy this tracing requirement, it has a general unsecured claim.[cx]
Courts have generally applied the lowest intermediate balance test to satisfy the tracing requirement for trust funds held by a debtor in a bankruptcy case.[cxi] This test allows trust beneficiaries to assume the trust funds are withdrawn last from a commingled account.[cxii] The bankruptcy court will follow the trust fund and demand restitution to the party who benefits from the trust when the amount in the commingled account has at all times equaled or exceeded the amount of the trust fund.[cxiii]If new money is deposited before the balance is reduced, the reduction should be considered to be from the new money and not from the monies held in trust. For this reason, the lowest intermediate balance in a commingled account represents trust funds that have never been dissipated and which are reasonably identifiable.[cxiv] Trust claimants are therefore accorded the status of general unsecured creditors with regard to the balance of the obligation left unsatisfied by the application of the lowest intermediate balance test.[cxv]
However, when as the result of appropriation and comingling, all of the money, once held in trust, is withdrawn, the equity of the trust is lost, even after monies from other sources are subsequently deposited in the same account.[cxvi]In the intermediate case where the account is reduced to a lower sum than the amount held in trust, the full amount of the trust must be regarded as dissipated, except as to the lower balance, and funds subsequently added from other sources cannot be subjected to the equitable claim of the trust.[cxvii]
The Construction Trust Fund Act and §547
Applying the Boyle/Nicholas rationale along with the Fifth Circuit’s requirement of tracing trust funds from commingled accounts creates a dilemma in the context of §547 where, unlike §523, the creditor has actually received payment. If the creditor proves the debtor dissipated trust funds on unrelated expenses to disprove the related project expense affirmative defense, then, how can it trace its payment back to the trust res? If, on the other hand, it successfully traces, then how can the creditor prove that the debtor used or diverted trust money intentionally or knowingly or with intent to defraud?
Since, the Fifth Circuit has entertained trust arguments under the Act, with regard to §523(a)(4), it is unlikely that the Fifth Circuit will go so far as to declare that a creditor defending against a §547 action cannot argue that it received construction trust funds. Therefore, some modifications to the approach used in §523 cases would seem to be necessary when applying the Act in a §547 preference case.
One possibility would be for the court to recognize that the key to establishing a fiduciary obligation under the Bankruptcy Code by means of a statutory trust has evolved into a timing issue as set out in In re Turner[cxviii], and hold that the Act creates a trust for purposes of §547, without the additional scienter demonstrations required under Boyle and Nicholas for purposes of establishing an exception to discharge under §523(a)(4). This recognizes the important role of state court law in determining property interests.[cxix] It further recognizes the differences between §523 and §547.
Section 523 exceptions are interpreted narrowly.[cxx] This is to serve the fundamental bankruptcy policy of providing the debtor with a “fresh start.”[cxxi] In line with this narrow interpretation, Boyle and Nicholas and their holdings regarding technical trusts arise out of a line of Supreme Court cases that deal exclusively with the language in §523(a)(4) and its predecessors regarding “defalcation while acting in a fiduciary capacity.” Such language and those holdings should not be determinative of trust rights as applied in §547.
Under §523, §547 is tied to whether payments received were property of the estate under §541. When the Bankruptcy Code was passed, legislative history made clear that the Congress intended to respect the state statutes that created trust rights for the benefit of creditors of the debtor.[cxxii] Congress intended property created under a statutory trust to be outside of the property of the estate.
This is not a case of state law manipulating federal bankruptcy priorities. Construction trust fund rights are recognized throughout many parts of the nation and have existed for decades.[cxxiii] If a trust must arise out of an agreement or statute prior to the bankruptcy and a creditor can trace the payments it receives back to the trust payments paid to the debtor, there is little risk of bankruptcy policy being undermined simply by respecting the property rights declared by the state legislature.
Respecting the Construction Trust Fund Act will further serve one of the prime goals of §547 preference law, which is to reduce the incentive of creditors to “rush in and dismember a financially unstable debtor.”[cxxiv] “Credit is the life blood of the construction industry.”[cxxv]The trust fund statutes reflect the commercial expectations that have arisen in the construction industry that recognize the special rights downstream parties have in payments received by upstream parties.
The only hope a struggling contractor has to pull out of a financial setback is the continued cooperation of subcontractors and suppliers in furnishing credit. If the official policy of the bankruptcy laws is that the large monthly payments received by downstream parties are insecure and subject to the financial whims of the upstream contractor, then at the first hint of financial instability, credit, the “life-blood” of construction, will be cut off. There will be no hope of pulling out of a financial tailspin or of reorganizing in bankruptcy.
The intent of the Texas Legislature to create trust rights for subcontractors and suppliers under the Construction Trust Fund Act is indisputable. Although the Act cannot overwhelm federal bankruptcy priorities, the intent of the Legislature should be respected when it reflects the state’s public policy regarding property rights and furthers important bankruptcy goals. If the goal of §547 is, in part, to encourage continued commercial dealings with financially struggling companies, the federal courts should protect the Construction Trust Fund Act as it furthers this goal.
* Fred D. Wilshusen, Esq. is a member with the Dallas, Texas law firm of Thomas, Feldman & Wilshusen, L.L.P., which specializes in construction law and litigation. Stephen T. Hutcheson, Esq. is a member in the Dallas law firm of Rochelle, Hutcheson, & McCullough L.L.P., which specializes in corporate reorganization and commercial litigation. Special thanks to Anne Myers, Esq. of Rochelle, Hutcheson, & McCullough, L.L.P.; Regan Gayle O’Steen, Esq. of Thomas, Feldman & Wilshusen, L.L.P.; and Kate Patrick, Esq. of Rochelle, Hutcheson, & McCullough, L.L.P. for assistance with the preparation of this article.
[i] Tex. Prop. Code Ann. § 162.001 et seq. (Vernon 2002 Supp). In this article, the Texas Construction Trust Fund Act will be referred to as the “Construction Trust Fund Act” or the “Act”.
[ii] Tex. Prop. Code Ann. § § 162.002 and 162.003; Vulcan Materials Co. v. Jack Raus, Inc. 157 B.R. 592, 597 (Bankr. W.D. Tex. 1993) (finding “that payment gives rise to a trust for all parties in the subcontract chain.”).
[iii] See Holladay v. CW&A, Inc., 60 S.W.3d 243, 246 (Tex. App. – Corpus Christi 2001, pet. denied) (“Construction payments are trust funds if the payments are made to a contractor or subcontractor or to an officer, director, or agent of a contractor or subcontractor, under a construction contract for the improvement of specific real property in this state. A contractor, subcontractor, or owner or an officer, director, or agent of a contractor, subcontractor, or owner, who receives trust funds or who has control or direction of trust funds, is a trustee of the trust funds. A party who misapplies these trust funds is subject to civil liability if (1) it breaches the duty imposed by the Texas Construction Fund Act, and (2) the requisite plaintiffs are within the class of people that the act was designed to protect and have asserted the type of injury the act was intended to prohibit.”) (citations and quotations omitted).
[iv] See Park Environmental Equipment, Ltd. v. Texas Capital Funding, Inc., 102 S.W.3d 243, 244 (Tex. App. –Houston [14th Dist.] 2003, no writ) (“The Act provides civil and criminal penalties for those who misappropriate trust funds by not paying for labor or materials on the project.) (citing Tex. Prop. Code § 162.032).
[v] See Holladay at 245-246. (“Under the Texas Construction Fund Act, a trustee of funds is liable for misapplication of trust funds if he intentionally or knowingly or with intent to defraud, directly or indirectly retains, uses, disburses, or otherwise diverts trust funds without first fully paying all current or past due obligations incurred by the trustee to the beneficiary of the trust funds.”) (citing Tex. Prop. Code Ann. § 162.031(a)). Please note that the trust fund applies to all upstream parties receiving construction payments. For example, a subcontractor receiving a payment from a general contractor is also a trustee of those funds to the extent they have been earned by the supplier who supplied materials to the subcontractor for performing work on the project. Since the most common application of trust fund rights is between the general contractor and subcontractor, that will be the focus of comments in this article.
[vi] Tex. Prop. Code § 162.002 (Vernon 2000 Supp.).
[vii] Tex. Prop. Code § 162.002 (Vernon 2000 Supp.) (dictating that the party “receiving such payments or funds, or having control or direction of same, is hereby constituted a Trustee of such funds so received, or under his control or direction.”).
[viii]3 Philip L. Bruner and Patrick J. O’Connor, Jr., Bruner and O’Connor on Construction Law, §841 at 82. (2002).
[x] Id. at 82-86.
[xi] Selby v. Ford Motor Co., 590 F.2d 642, 647 (6th Cir. 1979).
[xiv] Vulcan Materials Co., 157 B.R. at 597 (emphasis added); North Tex. Operating Eng’rs Health Benefit Fund v. Dixie Masonry, 544 F. Supp. 516, 519 (N.D. Tex. 1982); Owens v. Drywall & Acoustical Supply Corp., 325 F. Supp. 397, 400 (S.D. Tex. 1971).
[xv] See In re Waterpoint International, LLC, 330 F.3d 339, 345 (5th Cir. 2003)
[xvi] Panhandle Bank & Trust Co. v. Graybar Elec. Co., Inc., 492 S.W. 2d 76, 81 (Tex. Civ. App.—Amarillo 1973, writ ref’d n.r.e.) (no mechanic’s and materialmen’s lien necessary to establish priority to funds.); see also McCoy v. Nelson Utilities Srvces., 736 S.W.2d 160, 164 (Tex.App.—Tyler 1987, writ ref’d n.r.e.).
[xvii] Lively v. Carpet Services., Inc., 904 S.W.2d 868, 871-73 (Tex.App.—Houston [1st Dist.] 1993, writ denied).
[xviii] See e.g., Herbert v. Greater Gulf Coast Enterprises, Inc., 915 S.W.2d 866, 870 (Tex.App.—Houston [1st Dist] 1995, no writ); Houston Plumbing Supply Co., Inc. v. Ornelas Plumbing Supply Co., Inc., 636 S.W.3d 608, 610 (Tex.App.—El Paso 1982, no writ).
[xix] In addition to the trustee, others can bring a complaint to avoid a preference. For example, the debtor-in-possession can also bring a preference action in a Chapter 11 reorganization proceeding. For ease of reference, this article will refer to the trustee as the party bringing the adversary complaint to recover the preference from the creditor. Because this article also deals with a trustee under the Construction Trust Fund Act, for clarity, any reference to the trustee in bankruptcy will be as the “bankruptcy trustee.”
[xx]See Begier v. IRS, 496 U.S. 53, 58; 110 S.Ct. 2258, 2262-3; 110 L.Ed.2d 46 (1990)(“According to that policy, creditors of equal priority should receive pro rata shares of the debtor's property. Section 547(b) furthers this policy by permitting a trustee in bankruptcy to avoid certain preferential payments made before the debtor files for bankruptcy. This mechanism prevents the debtor from favoring one creditor over others by transferring property shortly before filing for bankruptcy.”) (citing 11 U.S.C. § 726(b) and H.R.Rep. No. 95-585, supra).
[xxi]H.R.Rep. No. 595, 95th Cong. 1st sess. 177- 78 (1977), U.S.Code Cong. &Admin.News, 1978, pp. 5787, 6138.
[xxv] See generally, In re Furrs Supermarkets, Inc., 296 B.R. 33 (Bankr. D.N.M. 2003).
[xxvi] See Union Bank v. Wolas, 502 U.S. 151, 161, 112 S.Ct. 527; 116 L.Ed.2d 514, (1991).
[xxvii] 11 U.S.C. § 547(b) (A “trustee may avoid any transfer of an interest of the debtor in property (1) to or for the benefit of a creditor, (2) for or on account of an antecedent debt owed by the debtor before such transfer was made; (3) made while the debtor was insolvent; (4) made (A) on or within 90 days before the date of filing of the petition; or (B) between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider; and (5) that enables such creditor to receive more than such creditor would receive if (A) the case were a case under chapter 7 of this title; (B) the transfer had not been made; and (C) such creditor received payment of such debt to the extent provided by the provisions of [Chapter 7]”). See also, In re El Paso Refinery, L P, 171 F.3d 249 (5th Cir. 1999); Union Bank v. Wolas, 502 U.S. 151, 112 S.Ct. 527 112 S.Ct. 527 (1991).
[xxix] See 11 U.S.C. § 101(31) for the Code’s definition of an insider. In re Fabricators, Inc., 926 F.2d 1458 (5th Cir 1991) (finding while a person or entity’s control of a debtor is a sufficient basis to establish insider status; a formal relationship between the parties is persuasive but not the defining characteristic of an insider). This is good news for directors and officers of a debtor corporation who held positions with lofty titles, but absolutely no influence over the direction of the debtor corporation. It is worth noting, however, that lack of influence of the direction of a debtor corporation does not get a potential “insider” off the hook for payments it received during the year before a debtor files for bankruptcy. The daughter of a CEO who is able to finance the purchase of her home with a note held by a debtor corporation may well find her home is owned by the debtor after the resolution of a preference action. When “the debtor is a corporation” included in the definition of “insider” are “relative[s] of a general partner, director, or officer, or person in control of the debtor.” See § 101(31)(B)(vi).
[xxx] See 11 U.S.C. § 101(10) for the Code’s definition of “creditor.”
[xxxi]11 U.S.C. § 547 (4)(A) and (B) provide that a debtor is presumptively insolvent as to any payment made to any creditor in the 90 days before the debtor filed for bankruptcy. This period of presumptive insolvency goes back a year as to insiders. The presumption of insolvency can be overcome if the creditor presents evidence, at the trial of a avoidance action, that the debtor was solvent at the time the transfer was made. Upon the presentation of evidence, by a creditor, that the debtor was solvent when the creditor received the transfer, the burden of proof shifts to the debtor to prove to the court that it was in fact insolvent when the transfers at issue were made. In re Georgia Steel, Inc., 58 B.R. 153, 156 (Bankr. M.D. Ga. 1984) (“The effect of the statutory presumption of insolvency is set forth in Fed.R.Evid. 301, which provides: In all civil actions and proceedings not otherwise provided for by Act of Congress or by these rules, a presumption imposes on the party against whom it is directed the burden of going forward with evidence to rebut or meet the presumption, but does not shift to such party the burden of proof in the sense of the risk of nonpersuasion, which remains throughout the trial upon the party on whom it was originally cast. Because the Trustee has the burden of establishing the elements of a preferential transfer in section 547(b), the effect of the statutory presumption of insolvency is to impose on [a creditor] the burden of going forward with evidence of solvency, but the ultimate burden of persuasion remains with the Trustee.”).
[xxxii] In re Interior Wood Products Company, 986 F.2d 228 (8th Cir.1993); In re Jet Florida Systems, Inc., 861 F.2d 1555, 1558 n. 2 (11th Cir.1988).
[xxxiii] Barnhill v. Johnson, 503 U.S. 393, 397, 112 S.Ct. 1386, 1389, 118 L.Ed.2d 39 (1992) (“What constitutes a transfer and when it is complete is a matter of federal law. This is unsurprising since, as noted above, the statute itself provides a definition of ‘transfer.’ But that definition in turn includes references to parting with ‘property’ and ‘interest in property.’ In the absence of any controlling federal law, ‘property’ and ‘interests in property’ are creatures of state law. Congress has generally left the determination of property rights in the assets of a bankrupt's estate to state law.) (citations omitted); Patterson v. Shumate, 504 U.S. 753, 758, 112 S.Ct. 2242, 2246, 119 L.Ed.2d 519 (1992) (finding for purposes of Bankruptcy Code provision excluding from estate debtor's interest in property subject to restriction on transfer enforceable under applicable nonbankruptcy law, was not limited to state law, and included ERISA and other federal law).
[xxxiv] Barnhill at 397.
[xxxv]Id.; see, Butner v. United States, 440 U.S. 48, __, 99 S.Ct. 914, 918, 59 L.Ed.2d 136, __ (1979) (“Congress has generally left the determination of property rights in the assets of a bankrupt’s estate to state law.”) and In re Southwestern Fabricators, Inc., 40 B.R. 790, 791 (Bankr.W.D.Tex. 1984) (“State law is determinative on the issue of entitlement to property rights . . . .”). Cf., Patterson at 758 (“The natural reading of the provision entitles a debtor to exclude from property of the estate any interest in a plan or trust that contains a transfer restriction enforceable under any relevant nonbankruptcy law. Nothing in § 541 suggests that the phrase ‘applicable nonbankruptcy law’ refers, as petitioner contends, exclusively to state law. The text contains no limitation on ‘applicable nonbankruptcy law’ relating to the source of the law. Reading the term ‘applicable nonbankruptcy law’ in § 541(c)(2) to include federal as well as state law comports with other references in the Bankruptcy Code to sources of law.”)).
[xxxvi] Cf. In re Turner, 134 B.R. 646, 649 (Bankr. N.D. Ok. 1991) (addressing the vague confluence of state and federal in determining who is a fiduciary for purposes of §523(a)(4)).
[xxxviii]United States v. Whiting Pools, 462 U.S. 198, 204, n. 8, 103 S.Ct. 2309, 2313 n. 8, 76 L.Ed.2d 515 (1983) (“Section 541(a)(1) speaks in terms of the debtor’s ‘interests . . . in property,’ rather than property in which the debtor has an interest, but this choice of language was not meant to limit the expansive scope of the section. The legislative history indicates that Congress intended to exclude from the estate property of others in which the debtor had some minor interest such as a lien or bare legal title.”) (citing and 124 Cong.Rec. 32399, 32417 (1978) (remarks of Rep. Edwards); id., at 33999, 34016-34017 (remarks of Sen. DeConcini); cf. § 541(d) (property in which debtor holds legal but not equitable title, such as a mortgage in which debtor retained legal title to service or to supervise servicing of mortgage, becomes part of estate only to extent of legal title); 124 Cong.Rec. 33999 (1978) (remarks of Sen. DeConcini) (§ 541(d) ‘reiterates the general principle that where the debtor holds bare legal title without any equitable interest, . . . the estate acquires bare legal title without any equitable interest in the property’)).
[xl] 11 U.S.C. §523(a)(4).
[xli]3 Philip L. Bruner and Patrick J. O’Connor, Jr., Bruner and O’Connor on Construction Law, §841 at 82 (2002).
[xlii] In re Turner, 134 B.R. at 649.
[xliii] In re Baird, 114 B.R. 198, 202-03 (9th Cir. BAP 1990).
[xliv] Id. at 203.
[xlv] In re Boyle, 819 F.2d 583 (5th Cir. 1987).
[xlvi] The Boyle Court interprets the Construction Trust Fund Act as codified in 1984. It does not interpret the amendments to the Act of 1987.
[xlvii] In re Boyle, 819 F.2d at 585 (debts for fraud or defalcation while acting in a fiduciary capacity are not dischargeable).
[xlviii] In re Boyle, 819 F.2d at 592.
[li] Davis v. Aetna Acceptance Co., 293 U.S. 328, 55 S.Ct. 151; 79 L.Ed. 393 (1934); Chapman v. Forsyth, 43 U.S. 202 (1844).
[lii] In re Boyle, 819 F.2d at 588.
[liii] See e.g. Carey Lumber Co. v. Bell, 615 F.2d 370 (5th Cir. 1980); Besroi Construction Corp. v. Kawczynski, 442 F. Supp. 413 (W.D.N.Y. 1977).
[liv] In re Boyle, 819 F.2d at 592. (The Act when examined in Boyle required a finding of fraudulent intent as the sole scienter requirement in the criminal penalties section. As discussed below, this has been subsequently amended.).
[lv] Id. at 586.
[lvi] The Boyle Court interprets the Construction Trust Fund Act prior to the amendments of 1987.
[lvii]Unlike the Construction Trust Fund Act, the Oklahoma lien statute which was found to create a technical trust in Carey did not require that the diversion of funds occur with any fraudulent intent.[lvii]
[lviii] In re Boyle, 819 F.2d at 586.
[lix] Act of June 18, 1987, 70th Leg., Ch. 578. Sec. 4, 1987 Tex. Gen. Laws 2283 (1987).
[lx] Id.; Tex. Prop. Code Ann. §162.031 (Vernon 2002 Supp.); In re Nicholas, 956 F.2d at 112.
[lxii] In re Nicholas, 956 F.2d 110 (5th Cir. 1992).
[lxiii] Id. at 113.
[lxiv] See Carey Lumber Co. v. Bell, 615 F.2d 370 (5th Cir. 1980). A comparison of the amended Act language with the Oklahoma statute shows them to be remarkably similar: (Texas) “A trustee who . . . knowingly . . . uses trust funds without first fully paying all current or past due obligations . . . to the beneficiaries of the trust . . . has misapplied the trust funds.” (Oklahoma) “. . . no portion thereof shall be used for any other purpose until all lienable claims due and owing shall have been paid.”
[lxv] In re Boyle, 819 F.2d at 586.
[lxvi] In re Nicholas, 956 F.2d at 113. This is no longer the case regarding residential construction amendments to the Construction Trust Fund Act in 1999 placed detailed segregation and bookkeeping obligations on residential construction contractors. Tex. Prop. Code Ann. §16.007.
[lxvii] McElroy v. State, 667 S.W.2d 856, 865 (Tex. App.—Dallas, 1984), aff’d, 720 S.W.2d 490 (Tex. Crim. App. 1986).
[lxviii] Texas Attorney General Opinion 1988 JM-945.
[lxix] In re Nicholas, 956 F.2d at 113.
[lxxii] In re Nicholas, 956 F.2d at 113.
[lxxiii] Id. at 114.
[lxxv] In re Nicholas, 956 F.2d 110, 113 (5th Cir. 1992) (interpreting Boyle and citing to 819 F.2d at 592, although that conclusion is more clearly stated on page 593.).
[lxxvi] Id. at 113.
[lxxvii] Id. at 114.
[lxxviii] Since proof of “intent to defraud” would probably constitute inferential proof that the debtor was not spending monies on actual legitimate expenses directly related to the project, this may not be that significant.
[lxxix] Id. at 112-13. (“The Arizona statute at issue in Baird, like that in Carey Lumber, did not expressly oblige the fund holder to maintain the separate identity of any trust res, nor did it require the segregation of funds or impose bookkeeping obligations on the trustee.”) (The Fifth Circuit held that Carey Lumber satisfied technical trust requirements despite the absence of those requirements.)
[lxxx] Id. at 113.
[lxxxi] Carey Lumber Co. v. Bell, 615 F.2d at 373. Compare O.S. §152 (1971) (“Such trust funds shall be applied to the payment of said valid lienable claims and no portion thereof shall be used for any other purpose until all lienable claims due and owing shall have been paid.”) with Tex. Prop. Code Ann. §162.031 (“A trustee who, intentionally or knowingly or with intent to defraud, directly or indirectly retains, uses, disburses, or otherwise diverts trust funds without first fully paying all current or past due obligations incurred by the trustee to the beneficiaries of the trust funds, has misapplied the trust funds.”) (emphasis added). In re Baird, 114 B.R. 198, 203 (9th Cir. BAP 1990). (“The Texas statute at issue in Boyle prohibits only the fraudulent misapplication of trust funds. In other relevant respects, the Texas statute is similar to [that] considered in Carey Lumber Co. . . . .”)
[lxxxii] In re Nicholas, 956 F.2d at 113.
[lxxxiii] Texas Attorney General Opinion 1988, No. JM-945.
[lxxxiv] Id. at page 4761.
[lxxxv] Id. at page 4764.
[lxxxvi] Id. at page 4765 quoting Senator Parker, Senate Committee Hearing, Tapes 2 and 3, 5-19-87.
[lxxxvii] Chapman v. Forsyth, 43 U.S. 202 (1844).
[lxxxviii] Id. at 207.
[lxxxix] Id. at 208.
[xci] Davis v. Aetna Acceptance Co., 293 U.S. 328 (1934).
[xcii] “Subdivision 4 excludes the liabilities of a bankrupt ‘created by his . . . misappropriation or defalcation while acting as an officer of in any fiduciary capacity.’” Davis, 293 U.S. at 331.
[xciii] Id. at 333.
[xciv] 134 B.R. 646, 656 (Bankr. N.D. Ok. 1991) ( an excellent discussion of the development of the law).
[xcv] Id. (The court concluded that the use of the terms “technical,” “voluntary,” and “express” were misleading and that the only unifying principle regarding the timing of the creation of the trust obligation.).
[xcviii] In re Turner, 134 B.R. 646.
[xcix] Selby v. Ford Motor Co., 590 F.2d 642 (6th Cir. 1979) (Michigan law); In re Valerino Const., Inc., 250 B.R. 39 (Banker W.D. N.Y. 2000) (New York law – not avoidable even though payees were not beneficiaries of the trust); In re Trans-End Technology, Inc., 228 B.R. 181 (Bankr. N.D. Ohio 1998) (Ohio law); Gold v. Alban Tractor Co., Inc., 202 B.R. 424 (E.D. Mich. 1996) (Michigan law – no preference for payment directly from general contractor directly to debtor’s supplier); In re Casco Elec. Corp., 35 B.R. 731 (E.D. N.Y. 1983) (New York law).
[c] In re Sierra Steel, Inc., 96 B.R. 271 (9th Cir. BAP 1989) (Nevada law – no trust fund statute or basis for equitable trust); In re H. & A. Const. Co., Inc., 65 B.R. 213 (Bankr.D.Mass. 1986) Massachusetts law – no trust fund statute); Matter of Nami Bros., Inc., 63 B.R. 160 (Bankr.D.N.J. 1986).
[ci] See In re Southmark, 49 F.3d 1111, 1116 (5th Cir.1995).
[cii] In re Carrozzella & Richardson, 247 B.R. 595, 600 (2nd Cir. 2000) (shifting the burden of proof by finding that “an alleged beneficiary of a trust must trace his property to a particular trust res.”); In re Sierra Steel, Inc., 96 B.R. 271, (9th Cir. 1989) (finding that “a laborer/materialman is only entitled to funds under a trust if it can prove that the money it received or claims can be traced to funds paid to the subcontractor by the contractor”).
[ciii] 28 B.R. 191, 195 (E.D.N.Y.1983), aff'd 35 B.R. 731, 732 (D.C.1983) aff’d, 35 B.R. 731 (E.D. N.Y. 1983).
[civ] Id. (“If the money represented assets of the statutory trust created by New York's Lien Law in Wesco's favor, its receipt by Wesco was not a preference. Since it is undeniable that Casco received monies constituting trust assets, the burden lay on the trustee to prove that the money paid Wesco was not part of such trust assets. Indeed, it is arguable that by the very act of payment, Casco identified the funds as trust assets.”).
[cv] Id., citing Wickes Boiler Co. v. Godfrey-Keeler Co., 116 F.2d 842 (2d Cir.1940), mod. on reh. 121 F.2d 415, cert. denied 314 U.S. 686, 62 S.Ct. 297, 86 L.Ed. 549 (1941).
[cvi] See In re Carrozzella & Richardson, 247 B.R. 595, 600 (2nd Cir. 2000) (shifting the burden of proof by finding that “an alleged beneficiary of a trust must trace his property to a particular trust res.”); In re Sierra Steel, Inc., 96 B.R. 271, (9th Cir. 1989) (finding that “a laborer/materialman is only entitled to funds under a trust if it can prove that the money it received or claims can be traced to funds paid to the subcontractor by the contractor”); Georgia Pacific Corp. v. Sigma Service Corp., 712 F.2d 962, 969 (5th Cir.1983) (“When property of the estate is alleged to be held in trust, the burden rests upon the claimant to establish the original trust relationship. This burden is based in part upon the statutory intent reflected by the sweeping marshalling and avoidance powers accorded a trustee in order to secure all the debtor's property for an equal distribution according to the terms of the Code.”) (quotations and citations omitted); In re H. & A. Const. Co., Inc. 65 B.R. 213 (Bankr. D. Mass. 1986) (“When property of the estate is alleged to be held in trust, the burden rests upon the claimant to establish the original trust relationship. In short, the defendants in this case must (1) establish title; (2) identify the trust fund or property; and (3) trace the property in the event the trust fund or property has been mingled with the general property of the debtor.”).
[cvii] 590 F.2d 642 (6th Cir. 1979).
[cviii] Selby at 649.
[cix] Goldberg v. New Jersey Lawyers’ Fund for Client Protection, 932 F.2d 273, 281 (3rd Cir. 1991).
[cx] 4 Collier on Bankruptcy § 541.13 at 541-78 (Lawrence P. King, ed., 1996 ed.).
[cxi] See, e.g., Official Committee of Unsecured Creditors v. Columbia Gas Systems, Inc., 997 F.2d 1039, 1063 ( 3rd Cir. 1993); see also In re The Globe Store Acquisition Co., 178 B.R. 400, 403 (Bankr. M.D. Penn. 1995).
[cxii] Columbia Gas, 997 F.2d at 1063 (“The lowest intermediate balance rule, a legal construct, allows trust beneficiaries to assume the trust funds are withdrawn last from a commingled account. Once trust money is removed, however, it is not replenished by subsequent deposits. Therefore, the lowest intermediate balance in a commingled account represents trust funds that have never been dissipated and which are reasonably identifiable.”).
[cxiii] In re Felton’s Foodway, Inc., 49 B.R. 106, 108 (Bankr. M.D. Fla. 1985).
[cxiv] Columbia Gas, 997 F.2d at 1063.
[cxv] In re Felton’s Foodway, Inc., 49 B.R. 106 (Bankr. M.D. Fla. 1985).
[cxvi] Id. at 108.
[cxvii] Columbia Gas, 997 F.2d at 1063; Felton’s Foodway, 49 B.R. at 108.
[cxviii] 134 B.R. at 656.
[cxix] Butner, 440 U.S. 48, __, 99 S.Ct. 914, 918, 59 L.Ed.2d 136, __.
[cxx] Boyle, 819 F.2d at 588.
[cxxi] Id. at 587.
[cxxii] Selby v. Ford Motor Co., 590 F.2d at 648 citing S.Rep. 989 at 82, 95th Cong., 2d Sess. (1978), U.S.Code Cong. & Admin.News 1978, pp. 5787 at 5868; 124 Cong.Rec..S17.413 (daily ed. Oct. 6, 1978) (remarks of Sen. DeConcini); 129 Cong.Rec. H11,096 (daily ed. Sept. 28, 1978) (remarks of Rep. Edwards).
[cxxiii] 3 Philip L. Bruner and Patrick J. O’Connor, Jr., Bruner and O’Connor on Construction Law at §8.41; see Selby 590 F.2d at 644 (Michigan law at issue enacted in 1967).
[cxxiv] In re El Paso refinery, L.P., 178 B.R. 426, 432 (Bankr. W.D. Tex. 1995), reversed on other grounds, 171 F.3d 249 (5th Cir. 1999).
[cxxv] House Bill Analysis, Tex.H.B. 740, 75th Leg. R.S. (1997).