A little known statute, the MCL 570.151 et seq. commonly referred to as the Michigan Builders’ Trust Fund Act (“MBTFA”) is a statute that imposes a trust on any monies paid to a contractor; the benefit of the person making the payment and for persons whom the money is to be paid. It was designed to eliminate a common practice at the beginning of the 20th century where a builder would take money to pay for another job’s expenses. Which ultimately if things go wrong, the persons at the end of the ‘passing expenses on’ chain, lose. The Michigan legislature believed this to be such a problem that it created this as a criminal statute as a right of prosecution.
Contractors are automatic trustees. In re Certified Question from U. S. Dist. Court for Eastern Dist. of Michigan, 411 Mich. 727, 311 N.W.2d 731 (1981). The MBTFA imposes a duty upon the trustee, “The appropriation by a contractor, or any subcontractor, of any moneys paid to him for building operations before the payment by him of all moneys due or so to become due [to the trust beneficiaries], shall be evidence of intent to defraud” (see MCL 570.153). Any trustee who, with such intent to defraud, retains or uses the proceeds, or any portion thereof, for any purpose other than first paying trust beneficiaries is guilty of a felony for appropriating such funds (see MCL 570.152). Although this is a criminal statute, Michigan courts have long recognized that the MBTFA creates a private cause of action for civil redress (see Reiter v. Kuhlman, 59 Mich. App. 54, 57, 228 N.W.2d 830 (1975); and, Livonia Bldg. Materials Co. v. Harrison Const. Co. 276 Mich.App. 514 (2007)).
So what does this mean to a contractor, owner, subcontractor?
Money paid to a contractor can only be used for the owner’s project. If for example, an owner pays a contractor $5,000, that money is held in ‘trust’ by the contractor (knowingly or not). If the owner preforms $2,500 worth of work and materials, and then gets fired before the job is completed, the contractor must return the $2,500. Furthermore, this money falls outside of bankruptcy, since it is not part of the contractors estate.
No debt is dischargeable in bankruptcy that was incurred by larceny, embezzlement, fraud, or defalcation whilst acting in a fiduciary capacity (see 11 U.S.C.A. § 523(a)(4)). And a violation of the MBTFFA is an act of defalcation while acting in a fiduciary capacity within the meaning of section 523(a)(4) of the Bankruptcy Code. (see In re Strickfaden, 421 B.R. 802, 62 Collier Bankr. Cas. 2d (MB) 1602 (Bankr. E.D. Mich. 2009), aff’d, 2010 WL 3583427 (E.D. Mich. 2010)). Note, an objective standard exists for determining defalcation, which does not require a debtor to know the laws or possess an intent or motive to violate the laws (see In re Johnson, 691 F.2d 249, 255, 7 Collier Bankr. Cas. 2d (MB) 685, Bankr. L. Rep. (CCH) P 68874 (6th Cir. 1982), citing Citizens Mut. Auto. Ins. Co. v. Gardner, 315 Mich. 689, 696–699, 24 N.W.2d 410 (1946)). The In re Johnson court further noted that this position is consistent with the standard for liability imposed by MCL 570.153.
A sole shareholder, director, or corporate officer who oversees the day-to-day financial affairs of the company is personally liable for the corporation’s breach of its fiduciary duty to the beneficiary under the MBTFA. (see In re Kriegish, 275 B.R. 838, Bankr. L. Rep. (CCH) P 78701 (E.D. Mich. 2002), aff’d, 97 Fed. Appx. 4 (6th Cir. 2004)). Corporate officers who control the distribution of trust funds are personally liable for the corporation’s breach of its fiduciary duty. People v. Brown, 239 Mich. App. 735, 743, 610 N.W.2d 234 (2000) (criminal liability); and, Au Bon Pain Corp. v. Artect, Inc., 653 F.2d 61, 65, 31 Fed. R. Serv. 2d 1615 (2d Cir. 1981) (civil liability)). It has been acknowledged in Whipple, that in most cases it is practically impossible to prove exactly how a contractor spent the construction funds. Rather, a reasonable inference of appropriation arises from the payment of constructions funds to a contractor and the subsequent failure of the contractor to pay those entitled to payment under the statute (see People v. Whipple, 202 Mich. App. 428, 435–436, 509 N.W.2d 837 (1993); and expanded by, H.A. Smith Lumber & Hardware Co. v. Decina, 258 Mich. App. 419, 670 N.W.2d 729 (2003), judgment vacated in part on other grounds, appeal denied in part, 471 Mich. 925, 689 N.W.2d 227 (2004)).
The Sixth Circuit Court of Appeals considered the issue of an ‘estate’ in bankruptcy and held that a Michigan building contractor does not have sufficient beneficial interest in funds impressed with the statutory trust to constitute property of the bankruptcy estate (see Selby v. Ford Motor Co., 590 F.2d 642, 647, 19 C.B.C. 466, 1 Collier Bankr. Cas. 2d (MB) 42, Bankr. L. Rep. (CCH) P 67033 (6th Cir. 1979)). Thus, trust funds held by the debtor contractor at the time of filing the bankruptcy petition will not be available for distribution to creditors in the bankruptcy proceeding (see Huizinga v. U.S., 68 F.3d 139, Unempl. Ins. Rep. (CCH) P 14834B, 95-2 U.S. Tax Cas. (CCH) P 50574, 76 A.F.T.R.2d 95-7025, 1995 FED App. 0315P (6th Cir. 1995)).
In an ideal world, a contractor should hold any money they receive in a segregated account, however if they do not, the owner and subcontractors have a method through criminal and civil prosecution to get paid (or paid back).