Bankruptcy Court Finds that Claim Based on Maryland Construction Trust Statute Not Grounds to Except Debt from Discharge Under 11 U.s.c. § 523(A)(4)

Recently, the United States Bankruptcy Court for the District of Maryland held that an alleged violation of Maryland’s Construction Statute was not grounds for excepting the debt from discharge pursuant to 11 U.S.C. § 523(a)(4).  In re Vito, 598 B.R. 809 (Bankr. D. Md. 2019).

The individual chapter 7 debtor, Sandra Vito (“Vito”), was employed as the president of Vito Construction, Inc.  (the “Company”).  K&M Electrical Services, Inc. (“K&M”) was a subcontractor and creditor of the Company, and was not paid in connection with work performed on several construction projects.  K&M alleged that the Company was paid in full on each of the projects.

K&M filed a complaint against Vito premised on the Maryland Construction Statute, Md. Code Ann. Real Prop. § 9-201 et seq. (the “Trust Statute”).  K&M sought to except the debt owed to it from discharge pursuant to 11 U.S.C. § 523(a)(4) (fraud or defalcation while acting in a fiduciary capacity, embezzlement or larceny) or § 523(a)(6) (claims resulting from willful and malicious injury).

The basis for K&M’s dischargability claim under § 523(a)(4) was twofold, first based on the Trust Statute and second based on the parties’ intent to create a fiduciary relationship.  The basis for its claim under § 523(a)(6) was that Vito intended to cause it economic harm by using the funds received for purposes other than paying K&M.  Vito filed a motion to dismiss the claims pursuant to Fed.R.Civ.P. 12(b)(6).

In a well-reasoned opinion, Judge Harner found that neither basis to except the debt from discharge was available under § 523(a)(4).  Citing the Supreme Court’s decision in Chapman v. Forsyth, 43 U.S. 202, 208, 11 L. Ed. 236 (1844), Judge Harner noted that the term fiduciary in the context of a bankruptcy discharge refers to fiduciaries in connection with “technical trusts and not those which the law implies from the contract.”  In re Vito, 598 B.R. at 818.

Judge Harner also relied on an opinion from the Maryland Bankruptcy Court, In re Holmes, 117 B.R. 848 (Bankr. D. Md. 1990) in reaching her decision.  She concluded:

the language and structure of the Trust Statute do not rise to the level of an express or technical trust.  The Trust Statute imposes a trust on payments received by a contractor or subcontractor relating to a construction project, regardless of the intentions of the parties.  No trust or fiduciary relationship exists between the parties at the outset of the contract or with respect to the parties’ general working relationship.  The trust-like obligation springs into existence only with respect to, and upon payment of, certain funds… The statute likewise does not impose a duty to segregate or to separately account for funds.

In re Vito, 598 B.R. at  821.

Judge Harner made other observations concerning the Trust Statute. For instance, she observed that the Trust Statute unilaterally alters the terms of the basic debtor-creditor relationship by imposing a trust before funds are misused and providing a remedy for a potential harm as the sole purpose of the trust. Id. Additionally, she noted that statutory trusts are not express or technical trusts but are quasi or constructive trusts and/or resulting trusts created by law regardless of the intentions of the parties. Id. at 822. She concluded, “in the context of trusts, only express or technical trusts create the kind of fiduciary relationship covered by section 523(a)(4) and the Trust Statute does not satisfy that standard.” Id. at 823.

K&M also sought recovery based on facts suggesting that Vito told K&M that she was aware of the amounts owed and would try to make payments when funds became available.  The Court found that such statements also would not meet the standard set forth in § 523(a)(4).

What the Court giveth it taketh away with the other hand.  The Court found that K&M stated a plausible cause of action based on § 523(a)(6) “for willful and malicious injury by the debtor to another entity or to the property of another entity.”  The Court reasoned that K&M’s argument that Vito knowingly used funds for purposes other than paying its claim based on promises to pay, potential statutory liability and the use of funds for other purposes could demonstrate an intent to cause economic injury to K&M.  The Court noted that Vito’s intent, as a subjective matter, would turn on the evidence presented at trial.

Stay tuned.  This part of the case is moving into discovery and the ultimate outcome will be determined in future proceedings.

For further information on the Maryland Construction Statute and dischargeability claims in bankruptcy, please contact James Schraf at [email protected] or 443-569-0755.  In addition, Yumkas, Vidmar, Sweeney & Mulrenin, LLC is a boutique bankruptcy law firm that is well-equipped to represent debtors and creditors in all aspects of bankruptcy proceedings.