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Trepanier MacGillis Battina P.A. 8000 Flour Exchange Building 310 Fourth Avenue South Minneapolis, MN 55415 612.455.0500

Eighth Circuit Limits Definition of “Fiduciary” in Creditor’s Effort to Declare Debt Nondischargeable

Under the federal bankruptcy code, a creditor may seek to except a debtor’s discharge of a debt for fraud while acting in a fiduciary capacity. See 11 U.S.C. § 523(a)(4). The Eighth Circuit Court of Appeals recently limited the definition of “fiduciary” in connection with § 523(a)(4), a frequent basis upon which a creditor seeking to avoid the discharge of a debtor’s otherwise dischargeable debts relies upon. An understanding of the court’s decision in In re: Thompson, 2012 U.S.APP LEXIS 15709 (8th Cir., July 30, 2012) may help protect a creditor in a position to influence how a debtor accounts for money it receives.

In In re: Thompson, the Eighth Circuit Court of Appeals grappled with a creditor’s contention that Minn. Stat. § 514.02 created a section 523(a)(4) fiduciary relationship between a construction company owner and one of the subcontractors that had performed services for his company.
The facts of the case are fairly straightforward. The debtor was the sole owner and president of a construction company that entered into a contract with Applebee’s International, Inc. to build a Minnesota restaurant. The creditor was a subcontractor retained by the company to provide labor and materials on the construction project. After the creditor performed the work, the construction company failed to pay amounts owed. Eventually, after the debtor-owner had agreed to personal liability on the company’s debt, he filed a petition for relief under Chapter 7 of the bankruptcy code. The creditor then filed a complaint to avoid the discharge of the debt, arguing that the debt was nondischargeable on account of the debtor’s fraud while acting in a fiduciary capacity, as the debtor failed to apply payments made by Applebee’s towards the obligation owed to the creditor.

The Minnesota Bankruptcy Court determined that that neither 11 U.S.C. § 523(a)(4) nor 11 U.S.C. § 523(a)(6) barred the discharge of the debt. The Bankruptcy Appellate Panel for the Eighth Circuit affirmed the Minnesota Bankruptcy Court’s decision. The creditor appealed the decision to the Eighth Circuit Court of Appeals.

Section 523(a)(4) bars discharge of a debt for “fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.” The creditor alleged that the debtor-owner was a fiduciary, as required by § 523(a)(4), under both Minnesota law and his common law duties as an officer of an insolvent corporation. The primary contention of the creditor was that Minn. Stat. § 514.02, commonly referred to as the “theft of proceeds” statute, created a fiduciary relationship recognized under § 523(a)(4) of the bankruptcy code. The debtor argued that he was not a fiduciary, and therefore § 523(a)(4) did not apply to make his debt nondischargeable.

Minn. Stat. § 514.02, subd. 1(a) provides that proceeds of payments received by a person contributing to an improvement in real estate “shall be held in trust by that person for the benefit of those persons who furnished the labor, skill, material, or machinery contributing to the improvement.” The statute adds, however, that nothing contained in that subdivision “shall require money to be placed in a separate account and not co-mingled with other money of the person receiving payment or create a fiduciary liability or tort liability” on the part of a person receiving payment. Id.
The Eighth Circuit Court of Appeals concluded that Minn. Stat. § 514.02 did not create an express trust recognized by § 523(a)(4), because of the Minnesota statute’s express bar against the creation of a fiduciary relationship. Thus, while there may have been a trust-like character to the contractor’s obligations, and a contractor that receives payment has an obligation to protect the interest of a subcontractor, neither the contractor nor its debtor-owner has a fiduciary liability to the subcontractor of the nature required by § 523(a)(4).

The court also noted that the state cannot transform ordinary agents or contractors into fiduciaries by simply referencing the terms “trust” or “fiduciary.” To the contrary, to meet requirements of § 523(a)(4), the trust must (i) include a definable res; and (ii) impose “trust-like duties.” See In re: Thompson, citing In re: Nail, 680 F.3d 1036, 1040 (8th Cir. 2012). Beyond rejecting the creditor’s contention that the theft of proceeds statute made general contractors fiduciaries with trust-like duties to subcontractors, the court noted that under that statute the purported trust would not be created until the subcontractor had performed work and had a contractual right to be paid. In other words, the trust, to the extent it existed, only came into existence following the performance of services by a subcontractor.

The court also rejected the creditor’s alternative theory that the debtor breached a common law fiduciary duty because, following the insolvency of his corporation, he became a fiduciary of the corporate assets for the benefit of creditors. The court found that this fiduciary capacity is not recognized under § 523(a)(4), as it is not a technical trust or other relationship that calls for the imposition of a high standard of accounting. Further, the court found that even if the common law did create a recognized fiduciary relationship, the duty was limited to precluding directors and officers from engaging in self-dealing. Because the creditor failed to prove that the debtor had engaged in self-dealing, there was no violation of § 523(a)(4).

Conclusion and Recommendations
The Eighth Circuit Court of Appeals’ limitation on the definition of “fiduciary” in connection with § 523(a)(4) raises several concerns for creditors. In the rare event that a creditor is able to anticipate and negotiate with a debtor facing financial problems, a creditor can try to get around the court’s holding by entering into a written contract in which the debtor affirms and assumes the role of a fiduciary on behalf of the creditor. This role ought to include an explicit requirement that funds deposited or received by the debtor be held in trust by the debtor. Further, the debtor should then assume traditional fiduciary duties such as providing a regular accounting to the creditor.

Additionally, creditors dealing with debtors located outside Minnesota should be aware that other states’ laws may have lienholder protection statutes that create express trusts and impose trust-like duties that can satisfy the strict requirements of § 523(a)(4). These laws may provide an option for a creditor seeking avoidance of a debtor’s discharge as to certain debts.
If you are a creditor seeking legal representation in a bankruptcy matter, contact any of the Trepanier MacGillis Battina P.A. business law attorneys.

About the Author:
Minnesota bankruptcy litigation attorney James C. MacGillis represents bankruptcy trustees in preference and fraudulent conveyance actions and has tried multiple cases on behalf of creditors seeking to avoid the discharge of a debtor’s debt. Jim is a member of the National Association of Bankruptcy Trustees. Jim may be reached at 612.455.0503 or Trepanier MacGillis Battina P.A. is a Minnesota bankruptcy litigation firm located in Minneapolis, Minnesota.