Union-affiliated benefit funds have had limited success when asking bankruptcy courts to refuse to discharge debts for unpaid employer contributions. (See, e.g., May 2015 post on this blog, “California Bankruptcy Court Finds Employer’s Debt for Unpaid Benefit Fund Contributions to Be Dischargeable”). But the bankruptcy court for the Eastern District of New York recently refused to discharge such a debt, when the employer improperly deducted money for the fund contributions from employee paychecks and then failed to pay the money to the funds. See Board of Trustees v. Kern, Case No. 13-71700 (Bankr. E.D.N.Y. April 10, 2017) .
In Kern, trustees of funds affiliated with a Sheet Metal Workers local brought suit in the bankruptcy court against the principal owner of a closely-held sheet metal company that went out of business owing contributions to the funds. The local’s collective bargaining agreements with the company required it to pay a defined dollar amount each month to a fund for employees’ vacations. Undisputed evidence established that the company withheld monies from employees’ paychecks to contribute to the vacation fund, but then failed to send the monies to the fund. Under these facts, bankruptcy judge Alan S. Trust ruled that the owner’s bankruptcy would not free him from the debt owed the vacation fund.
Section 523(a)(4) of the Bankruptcy Code, 11 U.S.C. §523(a)(4), provides that an individual’s debt “for fraud or defalcation” will not be discharged in bankruptcy if committed while the debtor was “acting in a fiduciary capacity.” First, the judge found that the monies taken from employee paychecks constituted assets of the vacation fund, citing a Department of Labor regulation defining benefit plan assets to include amounts a plan participant “has withheld from his wages by an employer.” 29 C.F.R. §2510.3-102(a)(1). The judge next found the company’s owner to have been a fiduciary, based on ERISA’s definition of a fiduciary as including someone who exercises “any authority or control” regarding the disposition of plan assets. 29 U.S.C. §1002(21).
Finally, Judge Trust determined that the owner had committed “defalcation,” which the Supreme Court has defined as wrongful conduct by a fiduciary done either knowingly or with recklessness. See Bullock v. Bankchampaign, N.A., 133 S. Ct. 1754, 1759 (2013). The judge wrote that by taking money for the vacation fund from employee paychecks rather than the company’s coffers, the owner acted “recklessly,” shifting the company’s financial obligation onto its employees in disregard of the collective bargaining agreements. “More importantly,” Judge Trust wrote, the owner “misappropriated the deducted money” by failing to have the company pay it to the vacation fund.
The bankruptcy court’s decision in Kern to refuse to discharge the owner’s debt was undoubtedly correct, made easy by the outrageous set of facts set forth in the court’s ruling. The greater challenge for benefit funds is to try to prevent the discharge of debts in more common situations where a bankrupt employer fails to contribute to the fund from its own monies.