In re Nicholas

• Court: Court of Appeals for the Fifth Circuit
• Decided: May 20, 1992
• Docket: 91-4597
• Status: Published

Opinion

UNITED STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT

____________________

No. 91-4597 ____________________

IN RE:

WILSON J. NICHOLAS, JR.,

Debtor.

COBURN COMPANY OF BEAUMONT,

Appellant,

versus

Appellee.

_________________________________________________________________

Appeal from the United States District Court for the Eastern District of Texas _________________________________________________________________

(March 23, 1992)

Before WISDOM, JONES, and SMITH, Circuit Judges.

EDITH H. JONES, Circuit Judge:

Appellant Coburn Company of Beaumont, a plumbing sub-

contractor to Nicholas and his company S&N on four construction

projects, contests the bankruptcy and district courts' conclusions

that the debt owed to Coburn from these projects was not non-

dischargeable in Nicholas's Chapter 7 bankruptcy. 11 U.S.C.

§ 523(a)(4). This court must decide whether the Texas Construction

Trust Fund Statute, Tex. Property Code § 162.001 et. seq. (Vernon

Supp. 1991) created a fiduciary duty between Nicholas and Coburn as sub-contractor and, if so, whether Nicholas acted in fraud or

defalcation of that duty.1 We conclude that because no fiduciary

duty existed even under the 1987 amendments to the statute,

§ 523(a)(4) does not bar the dischargeability of Coburn's debt.

Accordingly, we affirm.

BACKGROUND

Coburn supplied plumbing materials to Nicholas's company

as a sub-contractor on four construction projects. S&N was paid in

full on three of those projects, but Coburn was never paid for any

of the materials supplied. As of the date of Nicholas's

bankruptcy, Coburn was owed over $27,000.

Nicholas is the president and sole shareholder of S&N.

Nicholas represented to each general contractor that he had paid

all of his sub-contractors and suppliers when in fact Coburn had

not been paid.

Ruling on the applicability of 11 U.S.C. § 523(a)(4), the

bankruptcy court held that Texas law made Nicholas a trustee for

Coburn of funds received by S&N on the construction project to

which Coburn supplied materials. The court held, however, that

Nicholas did not intend to defraud Coburn of these funds and that

while the evidence was "rather sketchy on exactly what happened to

1 11 U.S.C. § 523(a)(4) provides: "(a) a discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt . . . (4) for fraud or defalcation while acting in a fiduciary capacity. . . ." In the courts below, Coburn also contended that Nicholas's actions violated § 523(a)(2), dealing with the receipt of money by false pretenses. The courts' rejection of that theory is not appealed here.

2 the money that was received," all of the money from the projects

went into the operation of Nicholas's business.2 The court also

found that there was no evidence that the funds received from the

owners of the project were used for any purpose other than to pay

bills of the corporation. As a result, the bankruptcy court found

neither fraud nor defalcation by Nicholas while acting in a

fiduciary capacity. The district court affirmed.

DISCUSSION

We review the bankruptcy court's application of the law

de novo and its findings of fact under the clearly erroneous

standard. Richmond Leasing Co. v. Capital Bank, N.A., 762 F.2d

1303, 1307-08 (5th Cir. 1985). On appeal, Coburn contends that the

bankruptcy court did not properly apply the Texas Construction

Trust Fund Statute and that it clearly erred in its finding that

the debtor established his affirmative defense under that statute.

Nicholas relies on a previous decision of our court holding that an

earlier version of the Texas Construction Trust Fund Statute

created a fiduciary relationship under § 523(a)(4) only if

construction trust funds were diverted "with intent to defraud."

Boyle v. Abilene Lumber, Inc., 819 F.2d 583 (5th Cir. 1987). It is

therefore incumbent on us to determine whether post-Boyle

amendments to the Texas statute created a fiduciary duty.

2 Neither of the parties notes that the district court applied the clear and convincing evidence standard of fraud to this non-dischargeability case, a standard that was shortly afterward rejected by the Supreme Court. Grogan v. Garner, ___ U.S. ___, 111 S. Ct. 654 (1991). That error does not change our analysis, but it is noted for the parties' and the courts' edification.

3 Like its predecessor, the amended version of the statute

imposes criminal penalties on trustees who misapply construction

trust funds. Payments received on construction contracts for the

improvement of real property are designated as "trust funds," and

the recipient of those funds -- in this case, the general

contractor -- is deemed "trustee" of those funds. See Texas

Property Code §§ 162.001-002. The beneficiaries of this "trust"

are subcontractors who, like Coburn, provide the labor and

materials on construction projects. Section 162.003. Other than

revise the applicable criminal penalties, the only significant

change made by the 1987 amendments was to explain in more detail

what constitutes a trustee's "misapplication" of trust funds. The

statute relied on by the court in Boyle provided that a trustee

misapplied trust funds only if he acted "with intent to defraud"

the beneficiary of those funds. See § 162.031(a). The amended

statute broadens the scienter requirement:

A trustee who, intentionally or knowingly or with intent to defraud, directly or indirectly retains, uses, disburses, or otherwise diverts trust funds without first fully paying all current or past due obligations incurred by the trustee to the beneficiaries of the trust funds has misapplied the trust funds.

Id. (emphasis added).

The amendment also created affirmative defenses to a

trustee's liability for misapplication if (a) the proceeds of the

trust fund are "used to pay the trustee's actual expenses directly

related to the construction . . .," or (b) the trustee has a

reasonable, good faith belief that the beneficiary is not entitled

4 to such proceeds, or (c) the trustee pays the beneficiaries "all

trust funds they are entitled to receive" within 30 days of being

notified of a criminal investigation. § 162.031(b) and (c). While

the statute thus broadens the scienter requirement to include acts

done knowingly or intentionally by a "trustee," its affirmative

defenses carefully refine the potential scope of coverage. For

present purposes, only the first defense, which allows a trustee to

pay "actual expenses directly related to the construction," must be

considered.

Without mentioning the newly codified affirmative

defenses, Coburn contends that Texas's broadening of the scienter

requirement brings the statute more in line with the Oklahoma Lien

Trust Statute, held by a pre-Boyle decision of this court to create

a fiduciary relationship. See Carey Lumber Co. v. Bell, 615 F.2d

370 (5th Cir. 1980). In arguing for this result, Coburn also cites

a Ninth Circuit decision, In re Baird, 114 B.R. 198 (B.A.P. 9th

Cir. 1990), which concluded that Arizona's Construction Trust Fund

Statute created a fiduciary relationship for purposes of

§ 523(a)(4). In Baird, the Bankruptcy Appellate Panel surveyed the

decisions evaluating similar dischargeability claims construed

under the construction trust statutes of various states.

Concluding that they could generally be divided into three groups,

Baird noted,

courts hold that states which only impose criminal or other penalties for failure of a contractor to make a certain disposition of construction funds do not create fiduciary capacity for dischargeability purposes. These courts reason that any trust relationship that

5 is created by such statutes does not arise prior to and independently of the wrong.

At the other end of the spectrum, courts hold that states which expressly designate the funds received by the contractor as trust funds and which explicitly impose specific and detailed duties on the contractor regarding the funds create a fiduciary relationship for dischargeability purposes. . . .

Between the two ends of the spectrum are cases, such as this one, dealing with statutes which refer to the funds as trust funds but which do not specifically impose specific and detailed duties upon the contractor with respect to those funds. Carey Lumber Co. . . . found the requisite trust relationship under statutes, similar to the statute at issue in this case. . . . On the other hand, In re Boyle . . . determined that the requisite trust relationship did not exist under similar, but not identical statutes.

Id. at 202-03 (citations omitted). Distinguishing Carey Lumber

from Boyle, Baird stressed that the Texas statute at issue in Boyle

prohibited only the fraudulent misapplication of trust funds, but

was in other relevant aspects similar to the Oklahoma statute found

to create a fiduciary duty in Carey Lumber Co. Id. at 203.

The Arizona statute at issue in Baird, like that in Carey

Lumber, did not expressly oblige the fund holder to maintain the

separate identity of any trust res, nor did it require the

segregation of funds or impose bookkeeping obligations on the

trustee. See Baird, id. It did, however, expressly prohibit the

diversion or use of trust funds for any purpose other than to

satisfy the claims of beneficiaries. A.R.S. § 33-1005. For this

reason, the Ninth Circuit panel concluded that the Arizona statute

created an express or technical trust sufficient to find a

6 fiduciary relationship for purposes of § 523(a)(4), holding that

"[t]o the extent Boyle is indistinguishable from Carey Lumber and

supports a contrary result, we find it unpersuasive." Id. at

203-04.

Appellant argues that because the Texas statute was

amended post-Boyle to prohibit all intentional diversions of

funds -- and not just fraudulent diversions -- it is now in line

with the Oklahoma and Arizona statutes and therefore triggers the

same fiduciary responsibilities cognizable under the Bankruptcy

Code. We agree that the Texas statute's amendments have expanded

the realm of debts that are nondischargeable under the Bankruptcy

Code. But the statute remains less broad than those in Carey and

Baird, and it falls far short of the statutes described in Boyle as

creating classic, express trust arrangements. See, e.g., In re

Kawczynski, 442 F. Supp. 413 (N.D. N.Y. 1977). Construing the

Texas statute in light of Boyle's admonition that exceptions to

discharge are generally to be "narrowly construed against . . . the

creditor and in favor of the bankrupt," Boyle, 819 F.2d at 588,

quoting Murphy & Robinson Investment Co. v. Cross (In re Cross),

666 F.2d 873, 879-80 (5th Cir. 1982), Coburn's claim must fail.

The essential element of our inquiry continues to be

"determining what fiduciary duties are imposed on the fund holder

and the manner in which the state's statutory construction funds

`trust' interacts with the Bankruptcy Code debt discharge exception

for these debts arising from fiduciary activities." Boyle, 819

F.2d at 586-87 (emphasis in original). Boyle interpreted the

7 former Texas statute to create a fiduciary duty only to the extent

that a trustee should not divert trust funds with intent to

defraud. 819 F.2d at 592. The amended statute criminalizes

knowing or intentional as well as fraudulent misapplications of

trust funds, subject to the three above-mentioned affirmative

defenses. Relevant to this discussion, no criminal penalty

attaches to the retention, use or disbursement of funds to pay the

trustee's actual expenses directly related to the construction or

repair of the improvement -- whether or not such expenses were owed

to "beneficiaries" of the trust fund. § 162.031. If, however,

trust funds were knowingly or intentionally paid for more than the

actual expenses, or for expenses not "directly related" to the

construction or repair project, criminal sanctions could be

imposed, and Boyle renders such actions subject to

nondischargeability. § 523(a)(4).

The statute's affirmative defense for payment of "actual

expenses directly related" to a construction or repair project

differentiates it from the Oklahoma and Arizona statutes, which

brook no payments to non-"beneficiaries." Texas Attorney General

Opinion 1988, No. JM-945. The Oklahoma statute provided that once

the trustee had received payments from construction projects, "no

portion thereof shall be used for any other purpose until all

lienable claims due and owing shall have been paid." 42 O.S. § 153

(1971) (cited in Carey Lumber, 615 F.2d at 373 n.2). Under the

affirmative defense to the Texas Construction Trust Fund Statute,

there is no such express prohibition; general contractors may use

8 the payments they receive from construction projects to keep those

projects going even if, in some instances, the beneficiaries are

not paid first. What Boyle said still almost precisely describes

the Texas statute: ". . . the statute does not create `red,'

`blue,' and `yellow' dollars each of which can only be used for the

`red,' `blue,' or `yellow' construction project." 819 F.2d at 586.

While perhaps realistic, the Texas statute's affirmative

defense for payment of actual expenses directly related to the

construction or improvement of the project is also open-ended, as

the bankruptcy court's opinion reflects. The bankruptcy court

found no violation of § 523(a)(4) because

all of the money [from the construction project] went into the operation of this business. We're not dealing with an individual who took money from the contractor . . . which he diverted for his own use or . . . for some frivolous use not connected with the operation of this business . . . there is absolutely no testimony that anything happened with this money other than that it was used to pay bills in the corporation.

Coburn objects to these findings because they do not apply to

Nicholas the burden of proof of the affirmative defense under Texas

law. This observation ignores that federal law, although initially

requiring the debtor to make a prima facie showing that he is

entitled to a discharge, ultimately places the burden on the

creditor to prove that the debt falls within the § 523(a)(4)

exception. 3 Collier on Bankruptcy ¶ 523.13[6] (15th ed. 1988);

Garrie v. James L. Gray, Inc., 912 F.2d 808, 811 (5th Cir. 1990).

Demonstrating the gap between receipts by Nicholas's company on the

9 construction projects and his payments to contractors such as

Coburn might establish a § 523(a)(4) violation under a broader

trust fund statute such as that in Baird, see 114 B.R. at 204.

Because the Texas statute permits application of trust fund

receipts for "actual expenses directly related" to the project,

however, a beneficiary seeking to avail itself of § 523(a)(4) must

adduce some evidence that funds were misapplied under this test.

Coburn offered neither direct nor inferential evidence of such

misapplication.

CONCLUSION

We are bound by Boyle's conclusion that the Texas

Construction Trust Fund Statute creates fiduciary duties

encompassed by 11 U.S.C. § 523(a)(4) only to the extent that it

defines wrongful conduct under the statute. Because the scope of

such wrongful conduct has been broadened by the legislature's

amendments to the statute, § 162.031, the potential grounds for

nondischargeability have also broadened. Nevertheless, Coburn did

not demonstrate that it could take advantage of this expansion,

inasmuch as it was unable to persuade the bankruptcy court that

Nicholas's plumbing company paid trust fund receipts to non-

beneficiaries for items other than "actual expenses directly

related" to the construction projects on which Coburn worked.

The judgments of the bankruptcy and district courts are

AFFIRMED.