By: Ron Kramer and Chris Busey

Fiduciaries who breach their duties may pay the consequences far longer than they may think, for they may not even be able to escape liability through personal bankruptcy.  In Raso v. Fahey (In re Fahey), No. 11-1118 (June 11, 2013), the U.S Bankruptcy Court for the District of Massachusetts became the first court to apply the new defalcation guidelines laid down by the Supreme Court in Bullock v. BankChampaign, NA, 133 S. Ct. 1754 (2013), to an ERISA fiduciary, finding that a debtor who breached his fiduciary duties with regard to contributions to his company’s multiemployer funds could not discharge his fiduciary liability in bankruptcy because he had engaged in “defalcation.”

James Fahey served as president, treasurer and sole shareholder of  Zani Tile Co.  Zani, through its union contract, contributed on behalf of employees to various multiemployer funds.  When business faltered, Zani stopped contributing even though it continued making other payments, including payments on a loan personally secured by Fahey and payments to Fahey himself.  The funds obtained a judgment for the unpaid contributions against both Zani and Fahey.

Fahey filed for Chapter 7 bankruptcy in January 2011.  In April 2011, the funds filed a complaint seeking to establish the non-dischargeability of all unpaid funds owed to the plans pursuant to the Bankruptcy Code § 523(a)(4), the defalcation exception.  Under this exception a plaintiff must establish:  (1) an express or technical trust existed; (2) the debtor acted as a fiduciary; and (3) the debt arises from a defalcation.  Initially, the court found that a technical trust existed, but rejected the idea that Fahey could become a fiduciary to a fund for Zani having missed contribution payments. 

The funds appealed and the U.S. Bankruptcy Appellate Panel for the First Circuit reversed in November 2012.  Under the funds’ definition of assets, contributions were “assets” as soon as they were due and owing.  By exercising discretion over those “assets,” Fahey acted as an ERISA fiduciary and breached his fiduciary duties when he chose to have Zani pay obligations owed himself over the funds.  The Panel also held, despite acknowledging a court split, that ERISA fiduciaries were, by definition, §523(a)(4) fiduciaries.  Moreover, even if an ERISA fiduciary did not per se satisfy § 523(a)(4), the Panel nevertheless held Fahey’s functional control and authority over the plan met the fiduciary requirement.  The First Circuit remanded the case back to the bankruptcy court to determine if the final element, defalcation, was satisfied.

After noting that the precise definition of defalcation “has long confounded courts,” the court discussed the new standard stated in Bullock.  There, the Supreme Court found that the term “defalcation” should be treated similarly to “fraud.”  The Supreme Court declared that “where the conduct at issue does not involve bad faith, moral turpitude, or other immoral conduct, the term requires an intentional wrong.”  The Supreme Court included as “intentional” not only conduct that the fiduciary knew was improper, however, but gross recklessness similar to that under the Model Penal Code.  Culpability can be found where a fiduciary “consciously disregards (or is willfully blind to) a substantial and unjustifiable risk” that his conduct will violate a fiduciary duty.  The Supreme Court further acknowledged that the First Circuit already interpreted defalcation similarly, referencing a case that the bankruptcy court expressly noted had held that defalcation may be presumed from a breach of the duty of loyalty.

With this in mind the court found that Fahey’s conduct constituted defalcation.  Fahey knew of the remaining unpaid obligations to the funds, but instead “prioritized the payment of corporate expenses that were beneficial to him.”  Fahey’s liability for his fiduciary breach could not be discharged in bankruptcy.

Bullock has been heralded for providing increased protection to fiduciaries, given that only liability for fiduciary breaches involving actual knowledge of wrongdoing or gross recklessness will not be subject to discharge in bankruptcy.  In re Fahey, however, is a stark warning to ERISA fiduciaries that Bullock is not a silver bullet.  Many fiduciary breaches, such as a breach of the duty of loyalty, still will be considered defalcation such that the fiduciaries will not be able to escape that liability through a bankruptcy filing.  How broadly Bullock will be applied in other ERISA fiduciary breach situations remains to be seen.

In re Fahey also serves as a reminder to anyone, whether the owner of a company or a corporate officer who may exercise discretionary control over whether to pay multiemployer fund contributions, that they may be found to be acting as fiduciaries and thus be personally liable for missed contribution payments.