Johnson, In re

• Decision Date: 20 October 1982
• Docket Number: No. 81-1291,81-1291
• Parties: 7 Collier Bankr.Cas.2d 685, Bankr. L. Rep. P 68,874 In re Gerald JOHNSON, Bankrupt, CARLISLE CASHWAY, INC., Plaintiff-Appellant, v. Gerald JOHNSON, Defendant-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 249

691 F.2d 249

7 Collier Bankr.Cas.2d 685, Bankr. L. Rep. P 68,874

In re Gerald JOHNSON, Bankrupt,

CARLISLE CASHWAY, INC., Plaintiff-Appellant, v. Gerald JOHNSON, Defendant-Appellee.

No. 81-1291.

United States Court of Appeals, Sixth Circuit.

Argued May 21, 1982.

Decided Oct. 20, 1982.

David M. Thompson, Law, Weathers & Richardson, Grand Rapids, Mich., for plaintiff-appellant.

Gerald Johnson, pro se.

Before EDWARDS, Chief Circuit Judge, KENNEDY, Circuit Judge, and GORDON, Senior District Judge. ^*

CORNELIA G. KENNEDY, Circuit Judge.

Carlisle Cashway, Inc. (Cashway) appeals from a decision of the District Court, 10 B.R. 322, affirming a decision of the Bankruptcy Court denying Cashway's application to declare debts of Johnson to Cashway nondischargeable in bankruptcy. For the reasons stated below, the decision of the District Court is reversed.

Since 1974 Johnson has been engaged in the business of constructing pole barns and other structures. His business, which grossed $143,081.12 in 1976 and $161,227.20 in 1977, fell off sharply which led to his filing a petition for bankruptcy in October 1978. In the spring of 1978, Johnson agreed to build pole barns for three individuals, Pierce, Elderkin and Noor. Pierce advanced $6,400 on March 29, 1978 and paid the balance, $1,640, in May 1978. Elderkin advanced $3,112 on April 4, and paid the $778 balance April 21. Noor advanced $2,877 in June and paid the remainder, $1,233, in July. Johnson's total payments from the three owners was $16,040. Cashway was the major supplier of materials for the three pole barns and furnished goods for the three jobs totalling $11,579.75; Pierce, $6,249.30; Elderkin, $2,503.17 and Noor, $2,827.28. No materialmen's lien was perfected. Subsequently, Johnson used the $16,040 he received from the owners to pay laborers, other materialmen and other business and personal expenses. He paid Cashway only $2,000, however, leaving a balance due of $9,579.75.

Cashway filed a complaint in the Bankruptcy Court to have the $9,579.95 owed to it declared nondischargeable under the Bankruptcy Act, section 17(a)(4), former 11 U.S.C. § 35(a)(4) (1976) (current version at 11 U.S.C. § 523(a)(4) (Supp. III 1982)). Cashway asserted that the Michigan Building Contract Fund Act, Mich.Comp. Laws Ann. §§ 570.151-153 made Johnson a fiduciary with respect to the $16,040, and that his failure to pay Cashway and use of the money for personal and non-project related business expenses breached his fiduciary duties. Cashway asserted that the breach constituted a defalcation or misappropriation within the meaning of section 17(a)(4) which prevented the debt from being dischargeable.

The Bankruptcy Court found that the Building Contract Fund Act did not satisfy the "fiduciary capacity" requirement of section 17(a)(4) as a matter of law and that there had been no intentional or bad faith misappropriation or defalcation as a matter of fact. The District Court did not address the legal issue but instead affirmed on the ground that Cashway's failure of proof on the issue of bad faith or intent to defraud was dispositive of its argument that a defalcation or misappropriation had occurred. In reaching this conclusion, the District Court adopted the Bankruptcy Court's determination that Cashway conceded that Johnson was not guilty of any intentional fraud.

The record is clear in this case that Johnson breached his duties under the Building Contract Fund Act by using the greater portion of the $16,040 received from the three owners for purposes other than first paying laborers, subcontractors and materialmen on those three pole barns. At issue on appeal is, first, whether the statutory trust imposed by the Building Contract Fund Act creates such a fiduciary relationship that Johnson was acting in a fiduciary capacity under section 17(a)(4) of the Bankruptcy Act and, assuming the first issue is affirmatively resolved, second, whether some element of specific intent or bad faith is necessary before a breach of one acting in such a fiduciary capacity will constitute a defalcation or misappropriation within the meaning of section 17(a)(4).

Section 17(a)(4) of the Bankruptcy Act provides that debts created by ¹ the bankrupt's "fraud, embezzlement, misappropriation, or defalcation while acting as an officer or in any fiduciary capacity," are not dischargeable in bankruptcy proceedings. A debt created while acting in a fiduciary capacity is a special debt, created by a breach of trust obligations defined by law, and is separate and distinct from any underlying contractual debt which arises from a bankrupt's agreement with respect to goods or services. 11 U.S.C. § 35(a)(4) (1976); Carey Lumber Co. v. Bell, 615 F.2d 370 (5th Cir. 1980); Clarke & Rapuano, Inc. v. Morris Ketchum, Jr. and Associates (In re Morris Ketchum, Jr.), 409 F.Supp. 743, 745 (S.D.N.Y.1975). The question of who is a fiduciary for purposes of section 17(a)(4) is one of federal law, although state law is important in determining when a trust relationship exists. ² Pedrazzini v. Runnion, (In re Pedrazzini), 644 F.2d 756, 758 (9th Cir. 1981); Angelle v. Reed (Matter of Angelle), 610 F.2d 1335, 1341 (5th Cir. 1980). The term "fiduciary" applies only to express or technical trusts and does not extend to implied trusts, which are imposed on transactions by operation of law as a matter of equity. Davis v. Aetna Acceptance Co., 293 U.S. 328, 333, 55 S.Ct. 151, 153, 79 L.Ed. 393 (1934); Chapman v. Forsyth, 43 U.S. (2 How. 202, 207, 11 L.Ed. 236 (1844)). Moreover, the requisite trust relationship must exist prior to the act creating the debt and without reference to it Davis, supra, at 333-34, 55 S.Ct., at 153-54. State statutes which impose a trust ex-maleficio are not within the scope of section 17(a)(4) since such trusts only arise upon an act of misappropriation. Id.; Pedrazzini, supra, at 759. Angelle, supra, at 1340; Schlecht v. Thornton (In re Thornton), 544 F.2d 1005, 1007 (9th Cir. 1976). See also Devaney v. Dloogoff (In re Dloogoff), 600 F.2d 166 (8th Cir. 1979). Contra, Allen v. Romero (In re Romero), 535 F.2d 618 (10th Cir. 1976).

The Michigan Building Contract Fund Act imposes a "trust" upon the building contract fund paid by any person to a contractor or subcontractor for the benefit of the person making the payment, contractors, laborers, subcontractors and materialmen. Mich.Comp. Laws Ann. § 570.151. ³ The contractor or subcontractor receiving the payments is the "trustee". Id. The statute imposes a duty upon the trustee to use the money in the building contract fund to first pay laborers, subcontractors and materialmen on the particular project for which the funds were deposited before he uses the fund for any other purpose. Id., § 570.152. ⁴ People v. Miller, 78 Mich.App. 336, 345, 259 N.W.2d 877 (1977). Any contractor or subcontractor, who, with intent to defraud, retains or uses any portion of the building contract fund for any purpose other than to first pay the trust beneficiaries, is guilty of a felony in appropriating trust funds to his own use. Id. The appropriation by a contractor or subcontractor of any monies in the building contract fund before the payment of monies due or to become due trust beneficiaries, is evidence of intent to defraud. Id., § 570.153. ⁵ That the statute does not mandate any particular form or procedures in handling trust funds neither undercuts the validity of the trust nor renders the statute unconstitutionally vague. Miller, supra. The Building Contract Fund Act may give rise to a civil cause of action as well as criminal penalties. National Bank of Detroit v. Eames & Brown, Inc., 396 Mich. 611, 242 N.W.2d 412 (1976); B. F. Farnell Company v. Monahan, 377 Mich. 552, 141 N.W.2d 58 (1966).

The Building Contract Fund Act satisfies the express or technical trust requirements of section 17(a)(4). The trust relationship is unambiguously imposed on a contractor or subcontractor by the language of the statute. The trust res is clearly defined as the monies paid by any person into the building contract fund. The trustee is charged with specific affirmative duties, including paying out trust funds in accordance with the statutorily imposed priority scheme, not using funds for its own purposes so long as trust beneficiaries, laborers, subcontractors and materialmen remain unpaid and using funds obtained for a specific project to first pay for labor and materials furnished for that specific project. The fact that the trustee is afforded some measure of discretion in handling trust funds does not defeat the trust under section 17(a)(4).

The Michigan statute satisfies the requirement that the trust exist separate from the act of wrongdoing and not arise ex-maleficio. The fiduciary relationship established by the Building Contract Fund Act arises at the time any monies are paid to the contractor or subcontractor whether or not there are any beneficiaries of the trust at that time and continues until all of the trust beneficiaries have been paid. Mich.Comp. Laws Ann. § 570.152; Miller, supra.

In this case a requisite trust was created when Pierce, Elderkin and Noor each paid Johnson for the pole barns. The fact that less than all of the total building contract fund had been advanced for each project prior to Johnson's purchase of lumber and other materials from Cashway does not contravene the requirement that the trust be created prior to the act of wrongdoing out of which the contested debt arose. The relevant relationship within the meaning of section 17(a)(4) is the fiduciary relationship imposed by statute, not the debtor/creditor relationship created by Johnson's purchase of the materials from Cashway. The relevant "debt" is the obligation caused by the breach of Johnson's fiduciary duties to Cashway, not that unpaid balance on the contract. The relevant "act creating the debt" or "act of wrongdoing out of which the contested debt arose" is that created by...