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Construction Law

: The South Carolina Construction Law Blog

Trust Fund Statutes

By Ryan McCabe

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            Officers of a closely-held construction company usually first pay debts for which shareholders may be found personally liable such as employment taxes or personally guaranteed debts. Many states have trust fund statutes that require contract income to be held in an express statutory trust for the benefit of subcontractors. Companies who pay other debts out of this trust may face the following consequences: (1) personal liability to unpaid subcontractors; 2) nondischargeable debt in bankruptcy; (3) possible charge of criminal theft.

            In his article Nondischargeability of Personal Debts for Violations of Construction Trust Fund Statutes, Stephen A. Hess discusses nondischargeable personal debt. Contractors are trustees of a trust fund, while the owner, the subcontractors, and materialmen are the beneficiaries of the trust. Contractors cannot pay themselves over trust beneficiaries.

            Violations of a trust fund can result in personal liability. In addition, in bankruptcy, a debtor will not be relieved of nondischargeable debt: ?any debt ? for fraud or defalcation while acting in a fiduciary capacity?.? 11 U.S.C. § 523(a)(4). The contractor, as trustee, has a fiduciary duty not to defalcate or misappropriate the money. If the contractor does so, the resulting personal liability will be nondischargeable.

            In a bankruptcy proceeding, the creditor must show by a preponderance of evidence that the debt is nondischargeable. The contractor has several defenses. The contractor may first challenge the validity of the debt. The contractor may also argue that the trust is an implied trust, because nondischargeability applies to express trusts only. Many times creditors bring actions against debtors in state courts first. Once a state court imposes liability on a debtor for a breach of trust, the creditor can easily obtain a nondischargeability judgment. But if a creditor sues in state court for debt due to a personal guarantee, but chooses to leave out the nondischargeability claim arising out of the same facts, the creditor might later be precluded from claiming nondischargeability. Lastly, most courts require that the debtor be at least negligent to be personally liable.

            Attorneys should be aware of these trust fund rules to advise debtors about possible personal liability, and creditors of possible rights, concerning nondischargeability.

Full post as published by The South Carolina Construction Law Blog on February 09, 2009 (boomark / email).