• Sixth Circuit Court of Appeals Upholds Denial of Discharge of Debt Owed to Subcontractor by Bankrupt Officer of General Contractor Under Bankruptcy Code Section 524(a)(4)
  • August 20, 2009 | Author: James M. Matthews
  • Law Firm: - Office
  • The nationwide decline in real estate values has spawned many failed development projects in its wake. Unpaid subcontractors sometimes are left holding the bag when project developers or general contractors file for bankruptcy relief. However, subcontractors doing business in the State of Michigan may gain some comfort from the recent decision of the U.S. Court of Appeals for the 6th Circuit in the case, Patel v. Shamrock Floorcovering Services, Inc., 565 F.3d 963 (decided May 12, 2009).

    Patel, the debtor in a Chapter 7 bankruptcy case, was an officer and shareholder of a construction company that served as the general contractor on a Michigan real estate development project. The project was abandoned, and Patel's company went out of business, before Shamrock and other subcontractors were paid. Shamrock obtained a state court judgment against both Patel and his company for the sums owed to it on the failed project, which triggered Patel's personal bankruptcy filing. Shamrock sought a determination in Patel's Chapter 7 case that its judgment against Patel was not dischargeable by him under Section 523(a)(4) of the Bankruptcy Code, which bars individuals from discharging in bankruptcy debts that arise from (among other things) "defalcation while acting in a fiduciary capacity."

    Shamrock established that Patel's company had received funds from the developer to pay Shamrock and other subcontractors, but had not used the funds for that purpose. Shamrock argued that, under the Michigan Builders Trust Fund Act ("MBTFA"), both Patel's company and Patel himself had received the funds from the developer in a fiduciary capacity for the benefit of the subcontractors, and that their failure to use the funds to pay the subcontractors was, in and of itself, proof that they had committed "defalcation."

    The bankruptcy court initially ruled against Shamrock, holding that only Patel's company, and not Patel himself, was the "contractor" under the MBTFA on whom fiduciary duties to the subcontractors were imposed. However, in subsequent appeals, both the district court and the Court of Appeals agreed with Shamrock that Patel also qualified as a "contractor" under the MBTFA, and thus personally owed fiduciary duties to Shamrock. The Court of Appeals rejected Shamrock's argument that the "defalcation" of the funds, as required under Section 523(a)(4) of the Bankruptcy Code, was established solely by the fact that the funds provided by the developer to pay subcontractors were not used by Patel for that purpose. However, the Court of Appeals ruled that Shamrock did not have to prove intent by Patel to misappropriate the funds, and need only shown an "objectively reckless failure" by Patel to account for the funds. The Court concluded that this had been established by Shamrock, and that Patel's debt to Shamrock on the judgment therefore was not dischargeable in his bankruptcy case.