The current U.S. and Michigan economies are being compared to those of the Great Depression. Under these circumstances it is easy to understand that a contractor’s financing can become stretched and stressed. It is important for contractors, their officers and employees in charge of financial matters, to keep in mind their responsibilities under the Michigan Builders Trust Fund Act
in order to avoid both civil and criminal liability. More important, a corporate officer or employee in charge of payments to subcontractors and suppliers may find him or herself facing personal civil and criminal liability for what may otherwise be considered corporate debts.
What makes these types of prohibited transfers equally troubling is that they may also be deemed “nondischargeable” and survive a personal bankruptcy. The Michigan Building Contract Fund Act, commonly referred to as to the Michigan Builders Trust Fund Act (“MBTFA”) has been in existence since 1931.
The MBTFA was enacted as a Depression-era measure to afford protection to subcontractors and material suppliers supplemental to the construction lien laws. The MBTFA is designed to prevent contractors from juggling funds between unrelated projects. While the MBTFA does not proscribe any particular method for doing so, it mandates that funds for a particular project be to be first used for payment to subcontractors, laborers, and supplies on that particular project.
The statute prohibits the “Robbing Peter to pay Paul” concept. In general the recipient to pay for expenses related to another project cannot use terms, funds received by the contractor on one project. Section 2 of the MBTFA provides that violation of the Act is a felony punishable by a fine of not less than $100, or more than $5,000; and not less than six months, or more than three years imprisonment.
In a nutshell, funds that are paid to a general contractor are to be held in trust for payment to subcontractors and material suppliers who provide labor and material for the general contractor on that particular project.
Upon payment by the general contractor to first tier subcontractors, the funds held by the first tier subcontractors are held in trust for the benefit of its subcontractors, suppliers, and material providers, and so on down the line. The MBTFA applies only to private construction projects, although there have been recent legislative proposals to broaden its application to include public projects as well.
In those cases where a general contractor or subcontractor is organized as a corporation, limited liability company, or a limited partnership, the provisions of the MBTFA may be available to impose personal liability upon those persons who participate in misappropriation of building contract funds.
For example, in Au Bon Pain Corp v Artect, Inc, the owner hired a general contractor to construct three bakery shops. Two of the shops were located in Michigan. During the course of construction, the president of the general contractor signed certifications that were required for obtaining progress payments. The certifications stated that all amounts paid pursuant to previous certificates had been distributed to subcontractors, laborers, and material suppliers.
However, the owner soon discovered that a number of the subcontractors, laborers, and material suppliers remained unpaid despite the certifications. The owner filed suit against the president of the general contractor as a co-defendant based on common law fraud and breach of fiduciary duty under the MBTFA.
The Second Circuit Court of Appeals held that the president could be held personally liable under the provisions of the MBTFA for failing to use advances to reimburse subcontractors, laborers, and material suppliers. Generally, a director of the “trustee” contractor must know or approve of the misappropriation to be personally liable.
Although the MBTFA’s provisions may provide a civil remedy to a myriad of other situations, it is perhaps most beneficial to an owner or unpaid subcontractors, laborers and subcontractors where the contractor files for bankruptcy protection after receiving funds from the owner.
The court interpreting the MBTFA in a bankruptcy context has held that the statute renders the debts to owners and unpaid subcontractors, laborers, and suppliers no dischargeable. Section 523(a)(4) of the U.S. Bankruptcy Code exempts from discharge certain debts created when a debtor acts in a fiduciary capacity.
The Sixth Circuit Court of Appeals has long held debts created by a breach of the fiduciary duty imposed by the MBTFA satisfy the requirements for the non-discharge ability of debts created by a bankrupt’s defalcation while acting in a fiduciary capacity. Thus, where a general contractor incurs debts that fall within the purview of the MBTFA, those debts will survive the debtor’s bankruptcy.
It is recommended that contractors and subcontractors handle funds paid to them with due care. It is important to remember that construction funds received on a project must first be used to pay the subcontractors, laborers, and material suppliers on that particular project and be able to prove that they did. In these ever-challenging economic times, corporate officers handling such funds should keep in mind their responsibilities under the MBTFA.