Menu    6 ABR 288 

UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF ALASKA




________________________________________
In re AARON FELIX SCOTT, and
SABRINA MARIE HAVERFIELD,
Case No. A98-01271-HAR
In Chapter 7
Debtor(s) 
________________________________________
SPENARD BUILDERS SUPPLY, INC.,ADV PROC NO A98-01271-003-HAR
(BANCAP No. 99-3025)
Plaintiff(s) 
v.

AARON FELIX SCOTT, and SABRINA
MARIE HAVERFIELD,
MEMORANDUM DECISION DISMISSING
NONDISCHARGEABILITY CLAIM UNDER
11 USC § 523(a)(4)
Defendant(s) 
________________________________________


ContentsPage
1.INTRODUCTION291
2.FACTS AND PROCEDURE291
3.ISSUES293
4.LEGAL ANALYSIS293
 4.1.AS 34.35.062(f),(g) Can Impose a Trust Relationship for the Purposes of 11 USC § 523(a)(4)293
 4.2.Where the Construction Lender Did Not Make Debtor Identify the Prime Contractors and Amount They Were to be P aid as Required by AS 34.35.062(f), a Trust Relationship is Not Created for the Purposes of § 523(a)(4301
5.CONCLUSION302

  TOP      6 ABR 289    Contents   1. INTRODUCTION -  A company owned by the debtor Scott received construction loan draws, but did not pay a supplier for some of the materials included in the draw estimates.

The Alaska Statutes(1) provide that:

a draw on a construction loan may be made only after the owner has filed a certificate identifying the "prime contractors"(2) whose labor and materials are unpaid, and stating what amount it intends to pay them; and,
  
the owner shall use each draw as indicated in the certificates given to the lender.

      Nonetheless, the lender allowed the draws without requiring that the prime contractors and the amount to be paid them be identified.

      The supplier seeks to avoid discharge of its claim based on 11 USC § 524(a) for Scott's defalcation while acting as a fiduciary. Does the statute create an express or technical trust, necessary to hold Scott liable as a fiduciary?

      Although the state statutes might impose a trust obligation, where the prime contractors were not identified, no trust obligation to them exists.

        Contents   2. FACTS AND PROCEDURE-  Aaron F. Scott, one of the debtors, owned A.F. Scott, Inc. (AFSI), a home builder. AFSI bought materials for some homes it was building on speculation from Spenard Builders Supply, Inc. (SBS).

      The construction financing for the homes was procured by AFSI from Key Bank of Alaska. AFSI requested interim construction draws from Key Bank, which, according to SBS, included funds to cover the material it supplied on the various jobs.   TOP      6 ABR 290  AFSI did not, however, pay SBS the full amount it drew from Key Bank, although those funds were included in AFSI's interim draws. As a result, SBS is owed over $83,000.

      Each draw request was made by AFSI on a Key Bank form entitled Cost Breakdown/Draw Request, which contained a statement:

We hereby certify and guarantee that the requested disbursement will be paid to the subcontractors and/or suppliers as they are listed on reverse side of this draw request, and that the funds shall be used in accordance with this draw request only. . . . (3)

      The draw requests generally appear to have been signed by Scott on behalf of AFSI as both owner and contractor. Notwithstanding the wording of the form, the construction lender did not require or ask AFSI to list the names of the subs and material suppliers on the reverse side of the form, or the amount it intended to pay them. This information was not supplied.

      After Scott filed a chapter 7 bankruptcy, SBS started this adversary proceeding to avoid Scott's discharge. One of the counts is based on defalcation while acting in a fiduciary capacity.(4) SBS alleges that the funds paid to AFSI by Key Bank were held in trust by AFSI, in part for SBS to cover its charges for materials. The claim is based on the statutory framework covering construction financing in Alaska, discussed in more detail in Part 4.

      Scott filed a motion for summary judgment to the various counts of the complaint. This Memorandum only deals with the legal issue of whether the Alaska   TOP      6 ABR 291  statutes upon which SBS relies create the type of trust necessary to prevail under § 523(a)(4).

  Contents   3. ISSUES - Does AS 34.35.062(f),(g) allow creation of an express or technical trust for which the debtor is liable for fraud or defalcation while acting in a fiduciary capacity under 11 USC § 523(a)(4)? If so, does the fact that SBS was not listed as one of the intended recipients of the construction draws negate such a trust?

  Contents   4. LEGAL ANALYSIS - ;

  Contents   4.1. AS 34.35.062(f),(g) Can Impose a Trust Relationship for the Purposes of 11 USC § 523(a)(4)-  The discharge of an individual debtor's debt may be denied under 11 USC § 523(a)(4) "for fraud or defalcation while acting in a fiduciary capacity, . . ." The basis of SBS's claim is that Scott, as principal owner of AFSI, allowed AFSI to receive construction draws from Key Bank without paying for the cost of the SBS materials used as a basis for those draws. SBS argues that the "fiduciary capacity" element is supplied by Alaska statutes, AS 34.35.062(f), (g), (h):

(f) A draw against construction financing may be made only after certification of job progress is delivered to the lender by the owner. The form of the certification may be prescribed by the lender and must include

(1) a statement of the progress of the project, including the percentage of completion of the project;

(2) the name, address, and telephone number of each prime contractor who has furnished labor, material, service, or equipment for the project;

(3) the amount owed by the owner to each listed prime contractor; and

(4) the portion of the draw that the owner will pay to each listed prime contractor.

  TOP      6 ABR 292  (g) The owner shall use each draw as indicated in the certificates given by the owner to the lender under (f) of this section. The lender may not be required to verify the information in a certificate and is not liable for an error in a certificate.

(h) An owner who intentionally fails to apply construction financing proceeds as indicated by the certificate required under (f) of this section is guilty of a class A misdemeanor. The penalty provided under this subsection does not replace any other penalty that may be provided for by law for the same conduct.

      There are a number of decisions discussing the application of § 523(a)(4) in relation to state statutes enacted to protect contractors and material suppliers from loss for failure of an owner or prime contractor to pay funds received and passing them through to the contractors or material suppliers whose labor or materials provided the basis for the owner or prime contractor receiving payment.(5)

      In re Baird(6) is one of those cases from the 9th Circuit BAP. Baird(7) laid out the black letter law governing the interpretation of the words "fiduciary capacity" in § 523(a)(4):

  TOP      6 ABR 294  While a trust created by statute is not an "express" or "technical" trust according to some authorities,(14) the 9th Circuit, as well as other circuits, skip over this nicety and hold that a fiduciary capacity sufficient for § 523(a)(4) purposes can be created by statute.(15)

      Although it seems to fly in the face of the fresh start policy of the bankruptcy code for honest debtors when construing nondischargeability sections relating to "bad actors," 11 USC §§ 523(a)(2),(4),(6), the 9th Circuit holds that an innocent (i.e., one where there is no fraud or only ordinary negligence) failure to account for or turn over entrusted funds may be a defalcation.(16)

      In re Baird involved a § 523(a)(4) action with facts analogous to the case at bar. It arose in Arizona which has a statute which provided that money paid by an owner to a contractor as payment for labor or materials "shall be deemed for all purposes to be paid in trust and shall be held by the contractor for the benefit of the person or persons" furnishing the labor or materials and not "diverted nor used for any purpose other than to satisfy the claims of those for whom the trust is created . . ."(17)

  TOP      6 ABR 295  The BAP held that the Arizona statute was sufficient to create an express or technical trust. It noted three schools of opinion in cases involving similar construction contractor statutes promulgated to protect subcontractors' rights as to whether they created express trust obligations under § 523(a)(4):

      The BAP observed that, in the last category (cases imposing a trust, even though the state statute gave little detail as to the trustee's duties), there was a split of authority. Some cases, such as the Carey case from the 5th Circuit(21) (interpreting   TOP      6 ABR 296  an Oklahoma law) and the Johnson case from the 6th Circuit(22) (interpreting Michigan law), with statutes similar to Arizona's, found a technical trust existed. Other courts have not.(23)

      The Michigan statutes(24) in Johnson(25) bear some similarity to the ones in Alaska, and some differences. They specifically make the contractor a trustee of funds paid to it for the benefit of subcontractors and materialmen. The Alaska statutes do not specifically identify an owner who receives funds from a construction lender as a "trustee" or provide that the funds are to be "held in trust," but do say the owner shall use the draws "as indicated" in the owner's certification(26) (which requires the owner to identify prime contractors, the amount owed to each, and the amount to be paid to each from the draw).(27)

      The Michigan statutes in Johnson, like the Alaska statutes, mix the fiduciary obligation with a penal statute for failure to comply.(28) Yet the BAP in Baird found Johnson strong authority for its holding in finding that the Arizona statute established a fiduciary relationship.

  TOP      6 ABR 297  The Oklahoma statutes in Carey,(29) a case followed by the BAP in Baird, were straight forward. They said the funds received under a mortgage for construction or remodeling shall be held in trust for the payment of any lienable claims and applied to the payment of those lienable claims until they were satisfied. They are analogous in many respects to the Alaska statutes.

      Two questions should be addressed: (a) does the failure of the Alaska statutes to use the specific words "trust" and "trustee" matter; and, (b) does the imposition of a criminal penalty make a difference?

      Failure to use specific words to create the trust does not defeat the creation of a trust relationship.(30) The important points in establishing a statutory trust are that the state statutes must: (a) define a trust res; (b) spell out the trustee's fiduciary duties; and (c) impose a trust prior to and without reference to the wrong which created the debt.(31) AS 34.35.062(f),(g) identifies the res (the construction draw), and AS 34.35.062(g) spells out the fiduciary duties (the obligation to pay the draw over to the listed "prime contractors"(32) [i.e., those providing labor, material, and services to the "owner"(33)] in the amount stated in the certificate).

  TOP      6 ABR 298  The 9th Circuit BAP, in In re Schneider,(34) held that a debtor operated in a fiduciary capacity despite the apparent lack of any explicit reference to a "trust" or "trustee." The court found the debtor, a minister, who agreed to assist a widow in his congregation (who became his lover), to preserve her inheritance, and then used it in a risk venture with his brother, operated in a fiduciary capacity.

      Scott argues that this case is closer to the 9th Circuit case of In re Pedrazzini(35) than to the Johnson or Carey cases. But, the trust in the case at bar is imposed without regard to the possible sanctions imposed for noncompliance spelled out in AS 34.35.062(h). That section could be left out altogether without impairing the trust duties created by AS 34.35.062(f),(g).

      In Pedrazzini, decided under § 17(a)(4) of the Bankruptcy Act, the bankrupt was a swimming pool contractor. The California statutes which the creditor sought to use as a basis for establishing fiduciary responsibility were: (a) one which subject a general contractor to disciplinary action by a licensing agency for diverting funds meant to pay subcontractors;(36) and, (b) a penal statute which made it a crime to receive money intended to pay for services, labor, material or equipment incident to construction and to willfully fail to apply it in that manner.(37)

      The court stated:

With one exception, all of the courts that have dealt with statutes imposing criminal or other penalties for this kind of diversion of   TOP      6 ABR 299  funds have refused to find a trust relationship. The rationale is that even if a trust is created by such a statute, the trust arises only upon the act of misappropriation and cannot be said to exist prior to the wrong and without reference to it.(38)

      Unlike the statutes in Pedrazzini, the Alaska AS 34.35.062(f),(g) establish a fiduciary responsibility without reference to the criminal sanction in AS 34.35.062(h). In this respect the Alaska statutory framework is similar to the Michigan statutes involved in the Johnson case.

      But, even if the Alaska statutory framework can create a fiduciary responsibility which will make a debt subject to nondischargeability under § 523(a)(4), did it in this case where Scott never identified the prime contractors as required by AS 34.35.062(f) because the construction lender did not require it?

  Contents   4.2. Where the Construction Lender Did Not Make Debtor Identify the Prime Contractors and Amount They Were to be Paid as Required by AS 34.35.062(f), a Trust Relationship is Not Created for the Purposes of § 523(a)(4)-  AS 34.35.062(f) is addressed to the construction lender, as well as the owner. It provides that a construction financing draw may be made only after a certificate is delivered to the lender containing certain information, including: (a) the name, address and phone number of each prime contractor; (b) the amount owed to each listed prime contractor; and, (c) the amount of the draw to be paid to each listed contractor.

      AS 34.35.062(g) says that the owner shall apply the draw proceeds as indicated in the certificate given under AS 34.35.062(f). The lender is not liable for any error in the certificate and does not have to verify the information given by the   TOP      6 ABR 300  owner. The teeth are apparently in the criminal sanctions to which an owner is subjected under AS 34.35.062(h) for intentionally not applying the proceeds as certified.

      AS 34.35.062 is a 1986 rewrite of construction financing laws from an earlier version in 1979, which apparently was not working.(39) AS 34.35.062(f),(g),(h) were added as new sections. The drafting is not user friendly; the three subsections are plunked down amidst complicated, detailed sections on the new "stop lending" procedure. AS 34.35.062(f),(g),(h) are not completely divorced from the rest of the statute, but, they possibly should have been separated and suitably subtitled for clarity.

      The statute says what it says. The owner is to pay the prime contracts listed in the amounts stated. Where the construction lender does not require the information to be listed, what is the effect on the "fiduciary capacity" status of a debtor under § 523(a)(4)? I will resolve this question by interpreting the dischargeability exception strictly and narrowly in favor of the debtor.(40) Where the state statute creates the loophole that exists in this case, a debtor may slip through it.

  Contents   5. CONCLUSION-  The court has issued its oral ruling dismissing other counts of the complaint. As to the § 523(a)(4) count against debtor Scott, it shall be dismissed also. The court will enter a separate order of dismissal.

  TOP      6 ABR 301  The decision outlined in Part 4 of this Memorandum alleviates the need to address other issues, such as the fact that the "owner" under AS 34.35.062(f),(g) is not debtor Scott, but AFSI.(41)



DATED: January 4, 2000 
 HERBERT A. ROSS
 U.S. Bankruptcy Judge



N O T E S:

TOP    6 ABR 289  1. AS 34.35.062(f),(g).

TOP    6 ABR 289  2. AS 34.35.120(15).

TOP    6 ABR 290  3. See, Exhibit C to Defendant's Motion for Summary Judgment to Establish Dischargeability Under Sections 523(a)(2)(A) and 523(a)(4) and to Establish Non-Liability of Barbara Haverfield. Docket Entry 12, filed October 27, 1999.

TOP    6 ABR 290  4. 11 USC § 523(a)(4).

TOP    6 ABR 292  5. See, 3 Norton Bankruptcy Law & Practice 2nd, § 47:25 at fn 4-7(1999).

TOP    6 ABR 292  6. Woodworking Enterprises, Inc. v Baird (In re Baird), 114 BR 198 (9th Cir BAP 1990).

TOP    6 ABR 292  7. In re Baird at 201-02.

TOP    6 ABR 292  8. In re Baird, citing Ragsdale v Haller, 780 F2d 794, 796 (9th Cir 1986).

TOP    6 ABR 292  9. In re Baird, citing Ragsdale at 796.

TOP    6 ABR 293  10. In re Baird, citing Carlisle Cashway, Inc. v Johnson (In re Johnson), 691 F2d 249, 251 (6th Cir 1982), decided under § 17(a)(4) of the Bankruptcy Act, the predecessor of 11 USC § 523(a)(4).

TOP    6 ABR 293  11. In re Baird, citing Ragsdale at 796; see, also, Carey Lumber Co. v Bell, 615 F2d 370, 374 (5th Cir 1980), a § 17(a)(4) case.

TOP    6 ABR 293  12. In re Baird, citing Ragsdale at 796-97.

TOP    6 ABR 293  13. In re Baird, citing Butler v Weedman (In re Weedman), 65 BR 288, 291 (Bankr WD Ky 1986).

TOP    6 ABR 294  14. 76 AmJur2d § 159; CRL of Maryland, Inc. v Holmes (In re Holmes), 117 BR 848, 853-55 (Bankr D Md 1990).

TOP    6 ABR 294  15. Lewis v Short (In re Short), 818 F2d 693, 695 (9th Cir 1987) (applying Washington partnership statute), citing Hartford Acc. & Indemn. Co. v McCraney (Matter of McCraney), 63 BR 64, 65 fn 3 (Bankr ND Ala 1986) as listing cases from seven other circuits; Ragsdale v Haller, 780 F2d 794, 795-96 (9th Cir 1986); Runnion v Pedrazzini (In re Pedrazzini), 644 F2d 756, 758 (9th Cir 1981).

TOP    6 ABR 294  16. Lewis v Scott (In re Lewis), 97 F3d 1182, 1186-87 (9th Cir 1996); contra, Schwager v Fallas (Matter of Schwager), 121 F3d 177, 185 (5th Cir 1997); Moreno v Ashworth (Matter of Moreno), 892 F2d 417, 421 (5th Cir 1990); Carlisle Cashway, Inc. v Johnson (In re Johnson), 691 F2d 249, 254-57 (6th Cir 1982); Meyer v Rigdon, 36 F3d 1375, 1384-85 (7th Cir 1994).

TOP    6 ABR 294  17. ARS § 33-1005.

TOP    6 ABR 295  18. In re Baird at 202, citing Runnion v Pedrazzini (In re Pedrazzini), 644 F2d 756 (9th Cir 1981) (a case decided under § 17(a)(4), and analyzing California law governing construction contractors); other citations omitted.

TOP    6 ABR 295  19. In re Baird at 202-03, citing Besroi Construction Corp. v Kawczynski (In re Kawczynski), 442 FSupp 413 (WDNY1977) (cited with approval in Pedrazzini, supra).

TOP    6 ABR 295  20. In re Baird at 203.

TOP    6 ABR 295  21. Carey Lumber Co. v Bell, 615 F2d 370, 374 (5th Cir 1980).

TOP    6 ABR 296  22. Carlisle Cashway, Inc. v Johnson (In re Johnson), 691 F2d 249 (6th Cir 1982).

TOP    6 ABR 296  23. Boyle v Abilene Lumber, Inc. (In re Boyle), 819 F2d 583 (5th Cir 1997), interpreting Texas law.

TOP    6 ABR 296  24. Mich Comp Laws Ann §§ 570.151-.153.

TOP    6 ABR 296  25. In re Johnson, 691 F2d at 252 fn 3-5.

TOP    6 ABR 296  26. AS 34.35.062(g).

TOP    6 ABR 296  27. AS 34.35.062(f).

TOP    6 ABR 296  28. Mich Comp Laws Ann §§ 152-153 and AS 34.35.062(h).

TOP    6 ABR 297  29. Carey Lumber Co. v Bell, 615 F2d at 373 fn2 (42 OS §§ 152, 153 (1971)).

TOP    6 ABR 297  30. 76 AmJur2d, Trusts, § 77, Use of Express or Particular Words or Phrases; In re Elrod, 42 BR 468, 473 (Bankr ED Tenn 1984).

TOP    6 ABR 297  31. In re Baird, 114 BR at 202.

TOP    6 ABR 297  32. As defined in AS 34.35.120(15).

TOP    6 ABR 297  33. As defined in AS 34.35.120(13).

TOP    6 ABR 298  34. Schneider v Davis (In re Schneider), 99 BR 974 (9th Cir BAP 1989).

TOP    6 ABR 298  35. Runnion v Pedrazzini (In re Pedrazzini), 644 F2d 756 (9th Cir 1981).

TOP    6 ABR 298  36. Cal Bus & Prof Code, § 7108, 7108.5 (West 1975 & West Supp 1979).

TOP    6 ABR 298  37. Cal Penal Code, § 484b (West Supp 1979).

TOP    6 ABR 299  38. In re Pedrazzini, 644 F2d at 759 (citations omitted).

TOP    6 ABR 300  39. See, Notice of Filing Legislative History Information, Docket Entry 26, filed December 9, 1999, by defendants at the request of the court.

TOP    6 ABR 300  40. Houtman v Mann (In re Houtman), 568 F2d 651, 656 (9th Cir 1978); Household Finance Corp. v Danns (In re Danns), 558 F2d 114, 116 (2nd Cir 1977); Cornwell Quality Tools v Rodgers (In re Rodgers), 115 BR 678, 681 (Bankr CD Cal 1990).

TOP    6 ABR 301  41. Cf, In re Baird, 114 BR at 204-05.