The Builders Trust Fund Act A Viable Remedy to Collect an Unsecured Debt

Journal Issue

Nov 1997

Column Name

Journal HTML Content

Your client, the building subcontractor, calls you
frantically with the following tale of woe: "My company had a contract
with General Contractor Corp. We provided masonry work on a new
construction project. We finished the job and expected to be paid on our
final invoice. Rather than receiving a check, we were handed a
bankruptcy notice! I was shocked. We never expected General Contractor
Corp. to file bankruptcy; that's why my company never perfected its lien
rights against the construction project, and now the time has expired to
perfect liens. I just found out that General Contractor Corp. never
posted a bond—I have nothing to proceed against. The only thing I
heard is that the project owner hasn't paid General Contractor Corp.
yet—is there anything I can do to get my hands on my money?"At
first blush, most lawyers might conclude that the client is out of luck
given its failure to protect itself by timely perfecting a construction
lien. Consequently, most lawyers would advise the client to
immediately file an unsecured proof of claim in General Contractor
Corp.'s bankruptcy case, in the hope that a nominal distribution to the
client will eventually be made.Thanks, however, to a Builders' Trust
Fund Act (BTFA), which has been enacted in several states, your client
might be protected after all. In order to properly represent any

client in the building business, you need to determine whether the
applicable state has enacted a Builders' Trust Fund Statute. Michigan
has enacted such a statute. This article will review that statute and
the case law decided thereunder to show how the BTFA may provide a
viable way to collect an unsecured debt. To this writer's knowledge, at
least 12 states have enacted a BTFA similar to that enacted in Michigan.
Those states are Colorado, Maryland, New York, Texas, California,
Tennessee, Oklahoma, Delaware, Ohio, Wisconsin, Washington and Utah.
Please refer to your state's BTFA and the case law construing it to
determine if your client can benefit from the BTFA.In Michigan, the
BTFA<a name="RET1"></a><a href="#FN1">[1]</a>
provides, in pertinent part, as follows:<blockquote>In the building
construction industry, the building contract fund paid by any person to
a contractor, or by such person or contractor to a subcontractor, shall
be considered by this act to be a trust fund, for the benefit of the
person making the payment, contractors, laborers, subcontractors or
material men, and the contractor or subcontractor shall be considered
the trustee of all funds so paid to him for building construction
purposes.</blockquote>The BTFA, therefore, actually creates a trust
fund upon construction proceeds received by a contractor, which runs to
the benefit of all of the contractor's unpaid laborers, subcontractors
and suppliers.The application of the BTFA has particular significance
in the bankruptcy context. In construing the BTFA, it has been
determined that builders' trust funds do not constitute property of the
debtor's bankruptcy estate.<a name="RET2"></a><a href="#FN2">[2]</a> In Selby v. Ford Motor
Co., the 6th Circuit Court of Appeals expressed the following policy
considerations:<blockquote>The Michigan Builders' Trust Fund Act is
designed to remedy problems in the construction industry. Like the law
merchant of an earlier day, the building trades have gradually created a
set of commercial expectations as the result of the customs and
practices of the industry. The nature of the industry is such that the
commercial expectations of the parties are defeated when a building
contractor or subcontractor does not use accounts paid to him on a job
to pay subcontractors or material men. Unless the parties see that
construction funds are properly applied down the line, the liabilities
of the parties up the line are affected. The unpaid workers must
undertake the lengthy and wasteful process of filing, perfecting and
foreclosing on their mechanics liens. The owners' property and the
construction lender's security are encumbered.The statutory builders
trust is not simply special legislation that the building trades have
lobbied through state legislatures. Its justification is that the
contractor, subcontractor and material men cannot spread their risks in
the same way as the grocer or other merchants with many customers. Large
quantities of labor and materials may go into a single construction
project over a long period of time. A large part of a tradesman's
capital may be tied up in a small number of construction projects. There
is a substantial risk that a general contractor who goes bankrupt will
pull down with him some of his subcontractors and material men, as well
as cause serious economic loss to the owner.The construction lender,
owner, disbursing agent, contractor, subcontractor or surety company
which furnishes a payment bond may not have a direct contractual
relationship with a material man down the line. The courts and
legislatures have increasingly found that the parties have an
independent legal duty arising from reasonable commercial expectations
to see to the proper application of construction funds. In the absence
of statute, courts have declared that construction funds in the hands of
a contractor are held subject to a constructive trust or an equitable
assignment or an equitable lien. (citations omitted). Even in the
absence of a state builders' trust statute, federal bankruptcy courts in
a variety of situations have refused to apply the property, preference
and statutory liens sections of the bankruptcy act to favor unsecured
creditors over the equitable claims of subcontractors and material men
to the proceeds of a construction project in the hands of a bankrupt
contractor. (citations omitted).</blockquote>State builders' trust
fund statutes simply recognize in statutory form the principles embodied
in these court decisions. The remedies provided by mechanics lien laws
are unsatisfactory, and state legislatures in a number of states, like
Michigan, have adopted builders trust fund statutes. The property rights
created by these state statutes should be recognized and enforced in the
bankruptcy system. The trustee in bankruptcy should not be permitted to
appropriate the trust of another and distribute it to the bankrupt's
creditors.In light of the persuasive reasoning expressed in

Selby, the courts have been clear in holding that builders' trust
funds are not subject to the claims of secured creditors, lienors or a
bankruptcy trustee.<a name="RET3"></a><a href="#FN3">[3]</a> Thus, a BTFA can provide a
subcontractor with super-priority status over all claimants, including a
bankruptcy trustee or secured creditor.<a name="RET4"></a><a href="#FN4">[4]</a>Interestingly enough, it
should follow that builders' trust funds are not subject to a bankruptcy
trustee's surcharge powers asserted under 11 USC §506(c). Section
506(c), which was enacted as part of the extensive 1978 revisions of the
bankruptcy laws, governs the definition and treatment of secured claims,
as well as a trustee's ability to surcharge for the costs and expenses
he or she incurs in preserving or disposing of such property. In
analyzing this bankruptcy statute, the Supreme Court, in United
States v. Ron Pair Enterprises,<a name="RET5"></a><a href="#FN5">[5]</a> determined that
§506(c) applies only to claims by creditors that are secured by a
lien on property in which the estate has an interest. Because the courts
have held that builders trust funds are not part of a debtor's
bankruptcy estate, it would logically follow that a bankruptcy trustee
could not obtain a §506(c) surcharge against any of such proceeds
he may collect for the debtor, since the proceeds are not part of the
bankruptcy estate.Accordingly, when confronted with a factual
situation similar to the one presented in this article, you should
determine whether your state law includes a BTFA. If so, you and your
client may be pleasantly surprised with the results that you can
achieve.<hr><h3>Footnotes</h3><a name="FN1">[1]MCLA 570.151.</a><a href="#RET1">[RETURN TO TEXT]</a><a name="FN2">[2]Selby v. Ford Motor Co.,
590 F. 2d 642 (6th Cir. 1979).</a><a href="#RET2">[RETURN TO
TEXT]</a><a name="FN3">[3]See,
e.g., Parker v. Klochko Equipment Rental Co. Inc., 590 F. 2d 649
(6th Cir. 1979); In re Imperial Title and Contracting Co., 940
B.R. 97 (Bankr. W.D. Mich 1988); Blair v. Trafco Product Inc.,
142 Mich. App. 349 (1985); and B.F. Farnel Co. v. Monahan, 377
Mich. 552 (1996).</a><a href="#RET3">[RETURN TO
TEXT]</a><a name="FN4">[4]See
Weather Vane Window Inc. v. White Lake Construction Co., 192 Mich.
App. 316 (1991), which held that builders' trust funds never become
property of the debtor regardless of when received and are, therefore,
not subject to intervening or subsequently perfected claims of secured
creditors, lienors or a bankruptcy trustee.</a><a href="#RET4">[RETURN TO TEXT]</a><a name="FN5">[5]United States v. Ron Pair
Enterprises, 49 U.S. 235, 109 S. Ct. 1026, 103 L. Ed. 2d 290,
(1989).</a><a href="#RET5">[RETURN TO TEXT]

Journal Authors

Robert A. Peurach

Journal Date

Saturday, November 1, 1997 - 12:00