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Employer Can Discharge Debt Owed to Employee Benefits Trust

Discharge Debt to Employee Benefits Trust Fund The Bankruptcy Code says that a debtor cannot discharge (legally write off) debts arising from the debtor's "fraud or defalcation while acting in a fiduciary capacity." See 11 U.S.C. § 523(a)(4). In other words if a person owes a debt, in the amount of, say $504,282.59, because of doing something wrong "while acting in a fiduciary capacity" that person could NOT be absolved of that debt in bankruptcy. If that same bad behavior occurred while NOT "acting in a fiduciary capacity," that person could be absolved of that half-million+ dollar debt.

WHAT'S A FIDUCIARY FOR PURPOSES OF THIS PHRASE?

Generally speaking, a fiduciary is a person who has a legal obligation to act for another's benefit. Some common examples of fiduciaries are an executor of a will administering a decedent's estate, an attorney acting on behalf of his or her client, and a trustee of a trust administering assets on behalf of the trust beneficiaries.

But what's crucial here is not the general meaning of a fiduciary but rather its very specific meaning in this bankruptcy statute. That is the topic of this blog post, and that was the topic of a recent decision of the U.S. Ninth Circuit Court of Appeals, Bos v. Board of Trustees.

WHAT KIND OF POTENTIAL FIDUCIARY WAS INVOLVED IN THE BOS DECISION?

Gregory Bos was owner and president of Bos Enterprises, Inc. ("BEI"). Bos contractually agreed that his company would make monthly payments to certain employee benefit trust funds for his employees' benefits. These funded the employees' health insurance, vacation pay, and their pensions. Bos acknowledged having "full control over BEI's finances, as well authority to make payments on behalf of BEI, whether to the Funds or to other creditors."

Bos didn't make the required payments on behalf of BEI, and an arbitrator determined that he and his company both owed $504,282.59 to the employee benefit trust funds.

IS FAILING TO PAY MONEY INTO A TRUST FUND MISUSING THE TRUST FUND?

In straightforward terms, that was the crux of the issue here. Arguably a person can only abuse his or her "fiduciary capacity" as to the assets being held in trust on behalf of another, not as to assets that should have been paid into the trust fund but weren't. But wouldn't the failure of the employer, Gregory Bos, to put money into the employee benefit funds, when he was obligated to do so, itself be a violation of his fiduciary duty to his employees? Wasn't he a "fiduciary" for bankruptcy purposes as to those misusing trust fund assets, and so he should not be able to discharge the $504,282.59 arbitration award against him?

HOW DID THE COURT DECIDE THIS?

Actually three courts were involved. First, the bankruptcy court in Sacramento decided that Bos could NOT discharge this debt under the statute cited above because he committed wrongdoing while acting as a fiduciary of the employee benefit funds. Gregory Bos "controlled money which was contractually required to be paid to the [employee benefit] Funds . . . and therefore was a fiduciary."

Second, on appeal, the federal District Court agreed. So Bos could not discharge this debt.

But then on further appeal, the third court, a Ninth Circuit three-judge panel based in San Francisco, overturned these two lower decisions in determining that an employer cannot be a fiduciary (for purposes of this bankruptcy statute) with respect to unpaid contributions to employee benefit funds because those yet-unpaid contributions are not assets of those funds.

WHAT WAS THE BASIS OF THE NINTH CIRCUIT DECISION?

The Ninth Circuit panel looked to other Circuit courts all over the country. It cited two Circuits –the Second (consisting of the states of Connecticut, New York, and Vermont), and Eleventh (Florida, Alabama, and Georgia) Circuits—which were consistent with the two lower courts here in making this kind of employer debt not dischargeable, and then two other federal Circuits—the Sixth (Ohio, Michigan, Tennessee, and Kentucky) and Tenth (Colorado, Kansas, New Mexico, Oklahoma, Utah, and Wyoming)—which make this kind of debt dischargeable in bankruptcy. With the Circuits so balanced in their disagreement this was clearly not an easy decision.

The different Circuit courts disagreed on whether there should be an exception to the general rule that "unpaid contributions by employers to employee benefit funds are not plan assets," and therefore the employers are not fiduciaries as to those unpaid contributions. The exception used by the Second and Eleventh Circuits, and by several district courts within the Ninth Circuit, is when the benefit "plan document expressly defines the fund to include future payments." (One of the federal district courts cited as upholding this exception is the local Central District of California based out of Los Angeles, in the case Trustees of the Southern California Pipe Trades Health and Welfare Trust Fund v. Temecula Mechanical, Inc.)

These courts have held where the pertinent documents clearly state that the fund includes payments not yet made, the entity failing to make the payments is a "fiduciary," and a debt arising from his or her failure to pay is not dischargeable in bankruptcy.

The document at issue in the Bos case—the Carpenters' Master Agreement—(as well as other related trust funds)—described the fund as including "all contributions required by the [Agreement] . . . to be made for the establishment and maintenance of the [respective plan], and all interest, income and other returns of any kind." So the exception would apply to Gregory Bos, making his debt not dischargeable.

But the Ninth Circuit panel determined that the exception is not a valid one.

HOW DID THE NINTH CIRCUIT DECIDE THAT THE EXCEPTION WAS NOT LEGALLY SOUND?

The Ninth Circuit panel simply found the rationale of the Sixth and Tenth Circuit opinions more persuasive that that of the Second and Eleventh Circuit ones.

Its own rationale is as follows.

First, its settled law that

[f]or a debt to be held nondischargeable under § 523(a)(4) . . . the debtor must have been a fiduciary prior to his commission of the fraud or defalcation. [Citation omitted.] In other words, the act of wrongdoing that created the debt cannot be the same act that gives rise to the fiduciary relationship.

Second, the Ninth Circuit has "adopted a narrow definition of 'fiduciary' for purposes of § 523(a)(4)."

Third, BEI's unpaid benefit contributions "could be classified as the contractual right to collect payments once they become due." But

an employer with no authority over the management of the plan—such as BEI here—has no control over enforcing such a right; rather, as demonstrated by the existence of the present lawsuit brought by the Board against Bos, the designated fund administrator has the authority to enforce the contractual right. Thus, because an employer would lack the requisite control over such plan asset, it could not qualify as a fiduciary for purposes of . . . § 523(a)(4).

And finally, an unpaid benefit contribution

could be classified as amounts which the employer must eventually contribute to the plan, but which are not yet due, thus avoiding the problem of the act of wrongdoing creating the fiduciary status. The classification logically fails, however, as, until the time payment is due, the plan does not actually possess the money, and in fact has no present right to it. . . .. Thus, such asset is in fact more appropriately classified as the contractual right to bring a claim against the employer for delinquent payments if the payments are in fact never made. Because, as discussed above, the typical employer—like BEI—would have no control over such a right, the employer would lack the requisite authority to be considered a fiduciary under § 523(a)(4).

The Ninth Circuit panel concluded that under the general rule that unpaid contributions to employee benefit funds are not plan assets, Gregory Bos was not a fiduciary as to those unpaid contributions. And so his debt was dischargeable under § 523(a)(4). Because there was no other basis to the contrary, the panel ordered the district court to instruct the bankruptcy court to discharge the $504,282.59 debt.

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