Personal Liability under the Michigan Builder’s Trust Fund Act, Michigan Court of Appeals Affirms

Proof that a corporate officer personally misappropriated contract proceeds “is not necessary to find an officer liable” for a violation of the Michigan Builder’s Trust Fund Act (MCL 570.151, et seq).  

“[A] reasonable inference of appropriation arises from the payment of  construction funds to a contractor and the subsequent failure of the contractor to pay laborers, subcontractors, materialmen, or other entitled to payment.”  

So declared the Michigan Court of Appeals recently in BC Tile & Marble Co v Multi-Bldg Co., 2010 Mich App LEXIS ____ (Mich Ct App, April 13, 2010) (slip opinion), another decision affirming the principal (and risk) of personal liability for the owners of construction companies under the Michigan Builder’s Trust Fund Act (MBTFA).

In BC Tile, the defendant general contractor built and sold a condominium to a homeowner.  Although the contractor received funds at the closing for Unit 5 to pay his tile and marble subcontractor, the contractor failed to pay the subcontractor citing defective workmanship and delayed performance.  The subcontractor, who had recorded and served a construction lien four days prior to the closing, then filed suit to foreclose his lien, and included a claim against the contractor’s president, in his individual capacity, for violation of the MBTFA. As indicated in an earlier posting to this blog, this fact pattern is fairly typical. 

The MBTFA provides that upon receipt of payment from the owner, a trust is created for the benefit of contractors, laborers, subcontractors and suppliers, and makes the contractor or subcontractor who receives the payment a trustee of the funds.  The MBTFA is a criminal statute, but the courts have also recognized a civil cause of action under common law. To make out a civil cause of action under the MBTFA, a plaintiff must establish the following elements:  

• The defendant is a contractor or subcontractor engaged in the building construction industry, 
• The defendant was paid for labor or materials provided on a construction project, 
• The defendant retained or used those funds, or any part of those funds, 
• The funds were retained for any purpose other than to first pay laborers, subcontractors, and materialmen, and  
• The laborers, subcontractors and materialmen who were engaged by the defendant to perform labor or furnish material for the specific construction project.

See, Livonia Bldg Materials Co v Harrison Construction Co, 276 Mich App 514, 519 (2007). See also, DiPonio Construction Co v Rosati Masonry Co, 246 Mich App 43, 49; 631 NW2d 59 (2001), lv app denied, 465 Mich 896 (2001).

In BC Tile, plaintiff asserted that the president of Muti-Bldg Co. was personally liable because he had signed the closing documents that allowed payment to other contractors, but not BC Tile & Marble Co. The president denied that he had had any day-to-day involvement with or exercised any decision-making for the particular construction project. He further denied that he had personally received any of the funds at closing.

While the Court of Appeals agreed that “there is no evidence here that [the president] personally used the funds owed to BC Tile,” it found that this was not dispositive of the MBTFA claim.

First, the Court reiterated its decision in the appeal of a criminal prosecution under MBTFA:  “there is no requirement that contract payments be made directly to the officer of the corporate contractor in order to hold the officer individually responsible under the MBTFA.”  People v Brown, 239 Mich App 735, 743-744 (2000).

Second, relying on a 2007 decision involving civil claims, the Court of Appeals noted:

“In Livonia Bldg, the defendant contractor received funds for a project but did not pay the plaintiff in full. The corporate officers gave testimony regarding their decision to put the funds received in various accounts and subsequently, their actions in writing checks to entities other than the plaintiff. This Court found that the individual corporate officers ‘acted in direct contravention of the MBTFA.’ According to this Court, there was sufficient evidence to create a presumption of misappropriation and to find the corporate officers individually liable.”

The Court of Appeals concluded that the president of the construction contractor should not have been granted summary disposition, and reversed the trial court’s ruling. The corporate officer thus faces a trial and possibly a personal judgment.

Not addressed in the Court’s decision, but another significant issue for individual defendants, is the impact a trust fund claim may have on a personal bankruptcy. Since the statute is predicated on the existence of a trust, a violation of the MBTFA is also breach of the (contractor) trustee’s fiduciary duties. Under Section 523(a)(4) bankruptcy code, fraudulent conduct while acting in a fiduciary capacity (defalcation) is one of the specified grounds for excluding a claim from discharge. Said another way, a Builder's Trust Fund Act claim is a debt that can survive a bankruptcy when most other claims are discharged.
 

Comment: To avoid personal liability issues, contractors must take care in these turbulent economic times to address shortfalls in payment with subcontractors and suppliers by securing waivers and releases that include officers and shareholders, especially when making compromise payment agreements, and documenting the reasons for non-payment to subcontractors and suppliers where facts and circumstances warrant the withholding of payment. 

  
For More Information

Since the facts of each case are unique, this case summary should not be taken as legal advice. For more information about the Michigan Builder's Trust Fund Act, and how it might affect you personally or your business, please contact Peter Cavanaugh or visit our website at www.MichiganConstructionLaw.com. 

Update: The Michigan Court of Appeals decided June 8, 2010 to publish this decision.  A full citation will follow. 

AGC Legal Brief Highlights Recent Builder's Trust Fund Decision, Other Michigan Decisions

The December, 2008 issue of the AGC Legal Brief highlights a number of recent court decisions and legislative changes affecting design professionals, contractors, subcontractors and residential builders in Michigan.

The current issue of the AGC Legal Brief was written by attorneys from Dickinson Wright and its construction practice group, and includes the following articles:

• Joseph W. DeLave, Bankruptcy Court Recognizes Preclusive Effect of State Court Default Judgment Entered Under the Michigan Builder's Trust Fund Act to Bar Subcontractor from Disputing Nondischargeability of Resulting Debt [reporting on In Re Brunett, 394 B.R. 425 (Bkrtcy. E.D. Michigan, October 8, 2008)] (slip opinion here)
  

• Michelle L. Alamo, Contractor Claims Against the Project Engineer Hang in the Balance after the Michigan Court of Appeals' Recent Decision in Keller Construction, Inc. v. U.P. Engineers & Architects, Inc.

• Jeffrey M. Wesselhoff, Licensed Builders Shed Consumer Protection Claims [reporting on the Michigan Supreme Court's decision in Liss v Lewiston-Richards]

• Leslee M. Lewis, Michigan Bolsters Residential Builder Licensing Laws including Licensing Requirements and Consumer Remedies [reporting on Public Acts 155-158 of 2007]
  

AGC Legal Brief is published quarterly by the AGC of Michigan and its Legal Advisory Committee. The full text of the December issue can be found here at the AGC's website.

New Article Discusses Interplay Between Section 523(a)(4) of Bankruptcy Code and Michigan Builder's Trust Fund Act

As discussed in an earlier post, the Michigan Builder's Trust Fund Act (MCL 570.151, et seq) may impose personal liability upon corporate officers, or members of a limited liability company, who misappropriate construction proceeds in violation of the statute. Pending legislation, such as H.B. 6176, would codify the imposition of personal liability, which is now a function of case law.

The Builder's Trust Fund Act also plays a role in bankruptcy, in which certain debts that arise when the debtor is acting in a "fiduciary capacity" may not be dischargeable. I am not a bankruptcy attorney, but Thomas R. Morris, who is an experienced bankruptcy attorney, has written an excellent article on this important topic, which appears in the latest issue of the Michigan Business Law Journal:

Pursuant to 11 USC 523(a)(4), a debt owing by an individual "for fraud or defalcation while acting in a fiduciary capacity" is not dischargeable in bankruptcy. Two United States Supreme Court cases, one from 1844 and one from 1934, establishes a definition of "fiduciary" for purposes of section 523(a)(4). However, the enactment by Congress and the state legislatures of "statutory trust" laws has created a new type of fiduciary duty not specifically addressed by the Supreme Court cases. The lower courts are not in agreement as to whether a statutory trust creates a "fiduciary capacity" for purposes of section 523(a)(4). As a result, there are a number of unanswered questions which arise under section 523(a)(4). Of particular interest to Michigan attorneys are questions relating to the dischargeability of liability under the Michigan Building Contract Fund Act (MBCFA) or "Builders Trust Fund."

Thomas R. Morris, "Trust Fund Statutes and the Discharge of 'Trustee' Debts Under Bankruptcy Code Section 523(a)(4)," 28 MI Bus LJ 11 (Spring, 2008). For the full text of this article, click here. We also reported on a previous article Mr. Morris wrote on this subject in a February, 2007 post.

Mr. Morris is a member of the West Bloomfield firm of Silverman & Morris, PLLC. Mr. Morris is a 1986 graduate of the University of Michigan Law School. Mr. Morris and his firm concentrate their practice in the areas of bankruptcy, commercial law, workouts, bankruptcy litigation and similar matters, and represents both creditors and debtors. For more information on any of these issues, contact Thomas R. Morris directly.

Michigan Builder's Trust Fund: Update Regarding Personal Liability

The February 2007 Newsletter of the Debtor/Creditor Rights Committee of the Business Law Section of the State Bar of Michigan contains an interesting article concerning personal liability under the Michigan Builder's Trust Fund Act. Thomas R. Morris reports on a preliminary ruling in a case pending before Judge Shefferly in the U.S. Bankruptcy Court in Detroit:


The Building Contract Fund Act and 523(a)(4): An Issue Long Glossed Over
By: Thomas R. Morris of Silverman Morris, PLLC

"Bankruptcy Judge Thomas Tucker, in Franzone v. Ernst, (In re Ernst), 06‑4803‑TJT (Bankr. E.D. Mich., September 25, 2006) (unreported bench opinion), held that a violation by a corporate contractor of the Michigan Building Contract Fund Act, M.C.L. 570.151 et seq (the "Act") (also known as the "Builders' Trust Fund Act"), does not give rise to a debt on the part of an officer or employee of the contractor that is non‑dischargeable under 11 U.S.C. § 523(a)(4). Judge Shefferly, in Conquest Construction, Inc. v. Cicero, 06-4852-PJS (Bankr. E.D. Mich., November 30, 2006)(opinion denying motion for reconsideration), disagreed.

"Applying the Sixth Circuit's holding in In re Blaszak, 397 F.3d 386, 391‑392 (6th Cir. 2005) and the Supreme Court’s holding in Davis v Aetna Acceptance Co., 293 U.S. 328 (1934), Judge Tucker found that in order to find a "defalcation while acting in a fiduciary capacity" on the part of the debtor, there must be an express trust in existence prior to the alleged defalcation. The elements of an express trust were found by the court of appeals in Blaszak to include: intent to create a trust; a trustee; a trust and a definite beneficiary. Although the Sixth Circuit in In re Johnson, 691 F.2d 249, 252‑253 (6th Cir. 1982), found the Act to fulfill the express‑trust requirements of the Bankruptcy-Act predecessor to § 523(a)(4), in Johnson, the debtor was a sole proprietor, not an officer or other agent of a corporation or other limited-liability business organization."


For the full text of this article, see: http://www.michbar.org/business/newsmag/feb07/Articles.htm#1

For More Information

Since the facts of each case are unique, this update cannot be taken as legal advice. For more information about the Michigan Builder's Trust Fund Act and how it might affect you or your business, please contact Peter Cavanaugh or visit www.MichiganConstructionLaw.com.

Michigan Builder's Trust Fund Act: H.B. 5196

On September 21, 2005, a new bill was introduced in the Michigan Legislature, which would expand the scope of the Michigan Builder’s Trust Fund Act (MBTFA) to include public projects. H.B. 5196 would modify Section 1 of the Act (MCL 570.151), which has been construed by Michigan courts for almost 25 years to apply only to private construction projects, not public ones. H.B. 5196 was introduced by Rep. Joe Hune (R-Howell) and it has been referred to the Committee on Government Operations.

Before deciding whether H.B. 5196 would be good or bad for the construction industry in Michigan, you should consider the current statute and how it is applied by the courts.

The MBTFA is a criminal statute.

On its face, the statute makes it a crime for contractors and subcontractors engaged in the building construction business, to use (appropriate) contract proceeds, with intent to defraud, for their own use before paying their laborers, subcontractors and materialmen (suppliers). The statute creates a trust fund; it provides that upon receipt of payment from the owner, a trust is created for the benefit of contractors, laborers, subcontractors and suppliers, and makes the contractor or subcontractor who receives the funds a trustee.

Among the reported legal decisions, the most common set of circumstances leading to criminal prosecution is the misappropriation of funds by a residential builder, which leaves subcontractors and suppliers unpaid, and homeowner's property subject to construction liens.

The MBTFA also provides a civil remedy.

The more common application of the MBTFA, however, is on the civil side of the law. Michigan courts have long construed the statute to provide a cause of action for unpaid subcontractors and suppliers. See, B F Farnell Co v Monahan, 377 Mich 552, 555; 141 NW2d 58 (1966), and National Bank of Detroit v Eames & Brown, 396 Mich 611; 242 NW2d 412 (1976).

To make out a civil cause of action under the MBTFA, a plaintiff must establish the following elements:

• The defendant is a contractor or subcontractor engaged in the building construction industry;
  

• A person paid the contractor or subcontractor for labor or materials provided on a construction project;

• The defendant retained or used those funds, or any part of those funds,

• for any purpose other than to first pay laborers, subcontractors, and materialmen, who were engaged by the defendant to perform labor or material for the specific project.
  

See, DiPonio Construction Co v Rosati Masonry Co, 246 Mich App 43, 49; 631 NW2d 59 (2001), lv app denied, 465 Mich 896 (2001).

"Intent to defraud" is not an element required to make out a civil cause of action under the MBTFA.

Common Claims.

The most common fact pattern in a Builder’s Trust Fund claim is one where owner or contractor has paid for the work performed, but the subcontractor or supplier has not been paid, even though a portion of the payment was earmarked for the subcontractor or supplier.[5] Earmarking can be shown through the contractor’s schedule of values, or a sworn statement. Builder’s Trust claims also tend to appear when a contractor is experiencing a severe cash flow restriction, or when a business fails, either with or without a bankruptcy.

In People v Whipple, the Michigan Court of Appeals found that "a reasonable inference of appropriation arises from the payment of construction funds to a contractor and the subsequent failure of the contractor to pay laborers, subcontractors, materialmen, or others entitled to payment." 202 Mich App 428, 435; 509 NW2d 837 (1993).

Personal Liability under the MBTFA.

Another important aspect of the MBTFA is the potential exposure of corporate officers. Personal liability may be imposed upon corporate officers, or members of a limited liability company, who participate in the receipt and disbursement of construction proceeds, which are then (mis) appropriated in violation of the statute. In this regard, the MBTFA is a legal vehicle to "pierce the corporate veil." But unlike traditional "piercing" claims, which must overcome the strong presumption of limited liability to reach individual shareholders, the MBTFA makes it easier to reach responsible corporate officers. This is largely because the MBTFA involves the creation of a trust, which increases the level of responsibility for those with fiduciary duties.

Persons at risk for being named in a Builder's Trust suit include sole shareholders, persons who handle the money, and the person who makes the payment (no payment) decision after reviewing the accounts payable report.

Burden of Proof; Statute of Limitations.

While most plaintiffs bear the burden of proof in a civil action, once the existence of a trust fund is established, the burden of proof under the MBTFA may shift to the contractor to account for the handling and disposition of funds he has received from the owner. There is a split of authority on this issue.

In federal bankruptcy courts, the defendant-trustee has the burden of proof. See, In re Little, 163 BR 497 (ED Mich 1994). In state court, however, the burden remains with the plaintiff. See, James Lumber Co Inc v J&S Const, Inc, 107 Mich App 793; 309 NW2d 925 (1981).

The statute of limitations under the MBTFA is six years. DiPonio Construction Co, supra at 56.

The Bankruptcy Code.

Another aspect of the MBTFA is the role it can play in a bankruptcy proceeding. There are two circumstances under which the MBTFA comes into play.

First, if a bankruptcy occurs before the monies are paid over to subcontractors and suppliers, the MBTFA provides the basis for arguing that money possessed by the contractor as trustee is not property of the contractor and not subject to appropriation by the bankruptcy trustee. The "beneficiaries" of the MBTFA can petition the bankruptcy court for an order releasing these funds from the bankruptcy estate.

The other circumstance under which the MBTFA and bankruptcy code converge is a petition objecting to the debtor's discharge. Ordinarily, unless a claim is excluded from the discharge order, it will be lost upon entry of the order. Under the bankruptcy code, certain claims are excluded from the debtor's discharge, but they must be affirmatively asserted as objections to discharge in the bankruptcy court proceeding. There are deadlines for raising such objections.

In the case of the MBTFA, a violation of the statute is deemed to be the breach of a fiduciary duty. Under the bankruptcy code, this is known as a "defalcation," and is one of the enumerated grounds for excluding a claim from discharge in bankruptcy. Said another way, a Builder's Trust Fund claim is not easily avoided through bankruptcy, but it does require that a creditor take affirmative steps to exclude a claim from discharge.

For More Information

Since the facts of each case are unique, this update cannot be taken as legal advice. For more information about H.B. 5196, and how it might affect you or your business, please contact Peter Cavanaugh or visit www.MichiganConstructionLaw.com.