CEO Who Failed to Remit Employees’ Contributions to Health Plan Cannot Use Bankruptcy to Escape Liability, Court of Appeals for the Eighth Circuit Holds

By Peter D. DeChiara

pdechiara@cwsny.com

Posted August 2018

Another court has now ruled that it will not discharge in bankruptcy an employer’s liability for intentionally failing to contribute to an employee benefit fund if the unpaid contributions were money taken from employees’ paychecks.  That was the holding of a New York bankruptcy court reported on this blog in May 2017.  And it was the holding of a decision last week by the U.S. Court of Appeals for the Eighth Circuit.  See re Michael P. Harris, Case No. 17-1261 (8th Cir. Aug. 3, 2018).

In Harris, a blanket manufacturer named Faribault Woolen Mills Company maintained an employee health plan funded entirely by the company’s employees. Faribault would withhold money from the employees’ paychecks, deposit the money into the company’s bank account — where it was comingled with other monies — and then write a check for the premium to the health insurance company. Over three months in 2009, Faribault, which later liquidated, failed to remit to the insurer approximately $55,000 that it had withheld from the employees’ paychecks and deposited in its bank account. During the same three-month period, Faribault wrote checks on the account to pay other creditors and corporate expenses. Among these payments were payments made for Michael Harris, the company’s CEO, including a payment of over $21,000 towards an equity line of credit on Harris’ home. Harris asked the company’s CFO to make that payment even though the CFO had told him that the company’s contributions to the health plan were past due.

The United States Department of Labor sued Harris for breach of fiduciary duty and obtained a judgment against him for the amount of employee contributions not paid to the health plan. In 2015, Harris filed for Chapter 7 bankruptcy. The DOL brought an adversary proceeding in the bankruptcy court asking the court not to discharge Harris’ liability for the judgment. The bankruptcy court ruled for the DOL, holding Harris’ liability for the unpaid health plan contributions to be nondischargeable under Section 523(a)(4) of the Bankruptcy Court, 11 U.S.C. §523(a)(4), which makes liability nondischargeable if it is for “fraud or defalcation while acting in a fiduciary capacity.” The Eight Circuit Bankruptcy Appellate Panel affirmed.

The Eight Circuit Court of Appeals did too, refusing to discharge Harris’ liability. In an opinion by Chief Judge Lavenski Smith, the court found that Harris was a fiduciary within the meaning of Section 523. It distinguished cases in which employers failed to pay employer contributions to a health plan. (For a discussion of one such case, see the May 2015 post on this blog). The court noted that when the unpaid contributions have consisted of money withdrawn from employees’ paychecks, employers have been found to be Section 523 fiduciaries.

The appeals court also found that Harris had a sufficiently culpable state of mind to warrant a finding that he had engaged in defalcation under Section 523. To support this conclusion, Judge Smith wrote that “Harris knew he had an obligation to remit the withheld employee contributions to [the health insurance company] but instead chose to prioritize payments of corporate expenses and creditors, including payments on his own personal line of credit.” Harris argued that he borrowed on his line of credit to keep the company afloat. The court was not swayed. It pointed out that Harris had not been in contact with the employees about the unpaid health insurance premiums, leaving them in the dark about the company’s failure to pay them.