While attempting to salvage a failing business, a company’s owner didn’t commit a nondischargeable “defalcation” by failing to make employer’s contributions to a union welfare fund, according to bankruptcy and district judges in the Eastern District of New York.
The union contended that the company’s owner was saddled with a nondischargeable debt for a “defalcation while acting in a fiduciary capacity” under Section 523(a)(4) because he did not cause the business to pay its obligations to the union welfare fund.
The allegation was not fanciful because ERISA turns an owner into a “fiduciary.” 29 U.S.C. § 1002(21)(A). Furthermore, ERISA made the owner personally liable when the company did not make required contributions to the welfare fund. 29 U.S.C. § 1109(a). The union therefore contended that the owner committed a defalcation while serving in a fiduciary capacity.
Halpin and Its Loophole
The leading authority in the Second Circuit is In re Halpin, 566 F.3d 286 (2d Cir. 2009), where the appeals court held that employer contributions to a union fund become assets of the fund only after being paid. Because the payments had not been made and the company officer therefore did not improperly dispose of the fund’s assets, the Second Circuit held that the officer’s liability was dischargeable.
However, the Second Circuit went on to say in dicta that the parties may agree by contract that contributions are plan assets even if they are not paid.
That’s what happened in the appeal before District Judge Frederic Block of Brooklyn, N.Y. The collective bargaining agreement said that contributions became plan assets when they were due and owing, with the employer retaining no right, title, or interest to any sums due from the employer.
Because the owner had the company spend plan assets elsewhere, the union argued that the owner’s personal liability was nondischargeable, citing the dicta in Halpin.
The Issue is ‘Defalcation’
The owner ended up in a personal bankruptcy. Bankruptcy Judge Alan S. Trust of Central Islip, N.Y., ruled that the owner’s debt for the unpaid contributions was dischargeable, even though he spent plan assets elsewhere.
Among other things, Judge Trust decided there was no defalcation. In his June 24 opinion, District Judge Block said he “entirely agrees with the bankruptcy court’s analysis.”
Judge Block did not decide whether the dicta in Halpin was right or wrong. He said the Second Circuit might “reconsider or refine its pronouncement if squarely confronted with the issue.” However, the question was “irrelevant,” he said, “because the dispositive issue is not whether unpaid employer contributions are trust assets, but whether [the owner’s] failure to pay them amounted to ‘defalcation.’”
The governing definition of defalcation is contained in Bullock v. Bankchampaign N.A., 569 U.S. 267 (2013), where the Supreme Court said there can be no “defalcation” while acting in a “fiduciary capacity” unless the debtor had knowledge that the conduct was improper or there was gross recklessness about the improper nature of the action.
Judge Block agreed with Judge Trust’s analysis under Bullock. The owner had not taken any company assets for his personal use. To the contrary, the owner was trying to keep the company afloat and spent $750,000 of their own money in the process.
Judge Trust found no bad faith or immoral conduct. He said the evidence fell “far short” of demonstrating intentional misconduct that the owner knew to be improper.
Judge Block said that making “the difficult decision to pay some creditors and not others (perhaps even, as in this case, contributing personal funds) hardly means that he or she is engaged in intentional wrongdoing or reckless conduct.”
Judge Block upheld the decision by Judge Trust because the union failed to show a “defalcation.”
Question
Would the debt have been nondischargeable if the owner had not spent any of his own money trying to salvage the business?
While attempting to salvage a failing business, a company’s owner didn’t commit a nondischargeable “defalcation” by failing to make employer’s contributions to a union welfare fund, according to bankruptcy and district judges in the Eastern District of New York.
The union contended that the company’s owner was saddled with a nondischargeable debt for a “defalcation while acting in a fiduciary capacity” under Section 523(a)(4) because he did not cause the business to pay its obligations to the union welfare fund.
The allegation was not fanciful because ERISA turns an owner into a “fiduciary.” 29 U.S.C. § 1002(21)(A). Furthermore, ERISA made the owner personally liable when the company did not make required contributions to the welfare fund. 29 U.S.C. § 1109(a). The union therefore contended that the owner committed a defalcation while serving in a fiduciary capacity.
Halpin and Its Loophole
The leading authority in the Second Circuit is In re Halpin, 566 F.3d 286 (2d Cir. 2009), where the appeals court held that employer contributions to a union fund become assets of the fund only after being paid. Because the payments had not been made and the company officer therefore did not improperly dispose of the fund’s assets, the Second Circuit held that the officer’s liability was dischargeable.
However, the Second Circuit went on to say in dicta that the parties may agree by contract that contributions are plan assets even if they are not paid.