California Bankruptcy Court Finds Employer’s Debt For Unpaid Benefit Fund Contributions To Be Dischargeable

An employer that files for bankruptcy generally has its debts discharged, including debts for unpaid contributions owed to employee benefit funds.  However, Section 523 of the Bankruptcy Code contains a list of debts that, as an exception to the general rule, are not dischargeable.  In particular, Section 523(a)(4) makes debts non-dischargeable if they are for “fraud or defalcation while acting in a fiduciary capacity.”  Under what circumstances can an employee benefit fund use Section 523(a)(4) as grounds for preventing an employer from being discharged of its liability for unpaid contributions?  That was the issue before the bankruptcy court for the Eastern District of California in Bensi v. Eshelman, Case No. 10-31713-A-7, Adv. No. 10-2473 (Bankr. E.D. Cal. March 31, 2015), a decision finding that under the particular facts of that case, the employer’s debt for unpaid contributions was dischargeable and that Section 523(a)(4) did not apply.

Eshelman owned a family-run construction business that had collective bargaining agreements with a local of the International Union of Operating Engineers.  In a 2006 audit, auditors for the pension and welfare funds affiliated with the union determined that the company was liable for unpaid contributions, including contributions that Eshelman had failed to pay for probationary employees.  In 2010, after Eshelman filed Chapter 7 bankruptcy on behalf of himself and his company, the funds brought an adversary proceeding in the bankruptcy court claiming that Eshelman’s debt for the unpaid contributions was non-dischargeable under Section 523(a)(4) because his failure to make the required contributions to the funds constituted fraud or defalcation while acting in a fiduciary capacity.

ERISA defines a fiduciary to include someone who exercises control or discretionary authority over plan assets.  See 29 U.S.C. §1002(21)(A).  In Carpenters Pension Trust Fund for Northern California v. Moxley, 734 F.3d 864 (9th Cir. 2013), the U.S. Court of Appeals for the Ninth Circuit, which includes California, wrote that a “persuasive case” could be made that if documents governing an employee benefit plan define unpaid contributions as plan assets, an employer that controls those assets is a plan fiduciary.  The Ninth Circuit also held, in In re Hemmeter, 242 F.3d 1186 (9th Cir. 2001), that a fiduciary of an ERISA-governed employee benefit plan is a fiduciary for purposes of Section 523(a)(4).

In their adversary proceeding against Eshelman, the funds pointed out that their trust agreement defined unpaid contributions owing as plan assets.  They argued that he was therefore a fiduciary and that he breached his fiduciary duty by not paying contributions due.  In his decision finding Eshelman’s debts to the funds to be dischargeable, bankruptcy judge Michael McNanus pointed out that the amendment to the trust agreement defining unpaid contributions as plan assets came after the period for which the funds’ auditors found that Eshelman owed contributions.

In addition, the bankruptcy court found that even if Eshelman were deemed a fiduciary by virtue of the contributions he owed, his debt would still be dischargeable because the funds failed to establish that his failure to pay the contributions constituted “fraud or defalcation” under Section 523(a)(4).  In Bullock v. BankChampaign, N.A., 133 S. Ct. 1754 (2013), the Supreme Court held that a fiduciary only commits “defalcation” within the meaning of Section 523(a)(4) by violating his or her duty knowingly or with reckless disregard of that duty.  Applying that standard, Judge McNanus concluded that Eshelman did not commit fraud or defalcation within the meaning of Section 523(a)(4).  He found, for example, that Eshelman reasonably and in good faith believed that he owed no contributions for probationary employees, especially since the funds had been aware of his failure to contribute for probationary employees but never challenged his practice prior to the audit.

Despite the disappointing outcome for the benefit funds in Eshelman, the case suggests that under a more favorable set of facts, an employer’s debt for unpaid contributions might be found to be not dischargeable.  In particular, a benefit funds case would be stronger if, at the time the contributions became due, the trust agreement provided that unpaid contributions were plan assets and if the funds could show that the employer knew that its failure to pay the contributions owed constituted a violation of the plan terms.

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