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In re Harris

United States Bankruptcy Appellate Panel for the Eighth Circuit

January 6, 2017

In re: Michael P. Harris, As surety for Faribault Mills Inc., As surety for Faribault Woolen Mill Company Debtor
Michael P. Harris Defendant-Appellant U.S. Department of Labor Plaintiff- Appellee

          Submitted: December 8, 2016

         Appeal from United States Bankruptcy Court for the District of Minnesota - Minneapolis

          Before FEDERMAN, Chief Judge, SALADINO and NAIL, Bankruptcy Judges.

          FEDERMAN, Chief Judge

         Debtor Michael Harris appeals from the Bankruptcy Court's[1] Order granting summary judgment in favor of the United States Department of Labor and declaring the Debtor's debt to it nondischargeable pursuant to 11 U.S.C. § 523(a)(4). For the reasons that follow, we AFFIRM.


         The Department of Labor obtained a pre-bankruptcy judgment against the Debtor in the United States District Court, which found that, under ERISA, the Debtor breached his fiduciary duty when the company of which he was CEO failed to remit funds withheld from its employees' paychecks for their health insurance plan. The DOL sought to have that judgment debt declared nondischargeable as a debt for defalcation while acting in a fiduciary capacity under 11 U.S.C. § 523(a)(4). In granting summary judgment in favor of the DOL on its nondischargeability action, the Bankruptcy Court was required to determine that the Debtor committed defalcation, while acting in a fiduciary capacity, within the meaning of § 523(a)(4) of the Bankruptcy Code. As will be shown, that holding required the Bankruptcy Court to conclude: (1) that the health insurance premiums withheld from employee wages were held in trust by the employer until they were paid into the health plan (in other words, that there was a trust res); (2) that the Debtor himself was a fiduciary of that trust within the meaning of § 523(a)(4); and (3) that the Debtor's decision not to remit withheld wages to the health plan constituted defalcation within the meaning of that statute.


         The BAP reviews de novo the bankruptcy court's grant of summary judgment.[2] Summary judgment is appropriate "only when all the evidence presented demonstrates that 'there is no genuine issue as to any material fact and the moving party is entitled to judgment as a matter of law.'"[3]

         The Bankruptcy Court here gave collateral estoppel effect to certain of the District Court's factual findings in the ERISA case.

The binding effect of a former adjudication, often generically termed res judicata, can take one of two forms. Claim preclusion (traditionally termed res judicata or "merger and bar") bars relitigation of the same claim between parties or their privies where a final judgment has been rendered upon the merits by a court of competent jurisdiction. Issue preclusion (or "collateral estoppel") applies to legal or factual issues actually and necessarily determined, with such a determination becoming conclusive in subsequent suits based on a different cause of action involving a party to the prior litigation.[4]

         Collateral estoppel bars relitigation of a factual issue if the following requirements are met: (1) the issue sought to be precluded must be the same as that involved in the prior action; (2) the issue must have been actually litigated; (3) the issue must have been determined by a valid and final judgment; and (4) the determination must have been essential to the prior judgment.[5] The party seeking to apply collateral estoppel has the burden of proving that all four elements are present.[6]"Collateral estoppel may only be applied if the party against whom the earlier decision is being asserted had a 'full and fair' opportunity to litigate the issue in the prior adjudication."[7]

         With regard to the three above-mentioned conclusions required for summary judgment under § 523(a)(4), we hold that the Bankruptcy Court did not err in giving collateral estoppel effect to the District Court's findings that the funds withheld from the employees' paychecks constituted a trust res and that ERISA imposed fiduciary duties upon the Debtor as to those funds. We further hold that the Bankruptcy Court did not err in concluding that the Debtor's ERISA fiduciary duties satisfied § 523(a)(4)'s definition of a fiduciary. Finally, we hold that the undisputed facts support the conclusion that the Debtor committed defalcation while acting in that fiduciary capacity under § 523(a)(4).


         The parties filed an agreed statement of undisputed facts which were based largely on (were nearly identical to) the District Court's findings in the ERISA case. As relevant here:

         Faribault Woolen Mills Company was a blanket manufacturing company established in 1865. The Debtor became its CEO, President, and Board Chairman in 2001. He owned 0.3% or less of Faribault's outstanding stock and had common stock options.

         Faribault sponsored, and was the Plan Administrator for, a Health Plan to provide health insurance for its employees. The Health Plan contracted with HealthPartners Health Insurance Company to provide the healthcare benefits for the plan participants. The participants (employees) paid 100% of the premiums via payroll deductions. Faribault withheld the premiums from the paychecks and sent monthly payments to HealthPartners on the first of each month to provide coverage for that month. Faribault did not create a separate account to hold the deductions; rather, it held them in its general operating account from which other corporate expenses were paid.

         Gary Glienke, Faribault's Vice President of Human Resources, was responsible for receiving and rectifying the bills from HealthPartners for the health insurance premiums. He would then send the bills to Carla Craig, the Accounts Payable Administrator at Faribault. From January 2008 through April 1, 2009, the Debtor; Gleinke; and Faribault's CFO, Carmen Dorr, all had signatory authority on the general operating account, payroll account, and other Faribault accounts.

         Faribault's payments to HealthPartners were untimely ten times in 2008, including two bounced checks, but the company was able to obtain extensions of time for payment, so coverage was not terminated. However, on January 27, 2009, Faribault issued a check, signed by the Debtor, to HealthPartners for $22, 593.02 to pay the premiums owed for January 2009. That check also bounced.

         In a letter dated February 28, 2009, HealthPartners informed Glienke that the January check had bounced and that it intended to cancel the Health Plan if Faribault did not pay in full. HealthPartners also sent letters to the Plan participants, informing them that Faribault had failed to remit the January premium payment. Since the Debtor was a Plan participant, he received that letter.

         Meanwhile, on February 27 (the day before the bounced-check letters were sent), Faribault issued another check signed by the Debtor to HealthPartners for $19, 466.91 to pay the February premium. HealthPartners returned that check to Faribault, along with a notice that HealthPartners would now only accept wire payments due to the prior bounced checks.

         On March 26, the Debtor personally asked HealthPartners for an extension to pay the January and February premiums. HealthPartners denied that request and demanded full payment of the January and February premiums by March 31. It is undisputed that the total available to Faribault for payment to HealthPartners between March 26 and 31 was in excess of $70, 000, [8] but Faribault paid other expenses instead. It is also undisputed that, from that $70, 000, the Debtor directed that Faribault make a March 30 payment of $4, 000 to his American Express account, and a March 31 payment of $21, 531.48 on his home equity line of credit.[9]

         While this was happening, the Faribault Board, on March 27, 2009, voted to retain a turnaround consultant. Harris lost control of the company's finances sometime after March 2009, and resigned as CEO in May 2009. The company was later liquidated.[10]

         HealthPartners canceled the policy on April 1, 2009, retroactive to January 31, 2009, due to non-payment of the premiums. Faribault never remitted $55, 040.61 it had withheld from the employees' paychecks for insurance premiums from January 9 to March 20, 2009. Forty-two employees (and some of their families) were affected by the Plan's cancelation.

         On December 19, 2012, the Secretary of the Department of Labor filed a lawsuit against the Debtor, alleging he violated ERISA by failing to remit the $55, 040.61 in withheld healthcare premiums to HealthPartners. Specifically, the Secretary alleged that, by failing to remit the withheld premiums, the Debtor breached his fiduciary duty of loyalty to Faribault's employees and their Health Plan in violation of ERISA § 404(a)(1)(A), 29 U.S.C. § 1104(a)(1)(A). Following a three-day bench trial, on November 9, 2015, the District Court for the District of Minnesota entered judgment in favor of the DOL in the total amount of $67, 839.60 (which included pre-judgment interest), concluding that the Debtor violated his fiduciary duty of loyalty under ERISA by diverting the employee contributions to pay for corporate expenses and his own home equity loan.

         The Debtor filed a Chapter 7 bankruptcy case on November 23, 2015. The DOL filed an unsecured claim for $67, 839.60 based on the judgment. It also filed this nondischargeability action under § 523(a)(4). After both parties filed motions for summary judgment, the Bankruptcy Court granted the DOL's motion for summary judgment at a hearing held on July 19, 2016.

         NONDISCHARGEABILITY UNDER 11 U.S.C. § 523(a)(4)

         Section 523(a)(4) excepts from an individual debtor's discharge any debt "for fraud or defalcation while acting in a fiduciary capacity."[11] The exception to discharge under §523(a)(4) is construed narrowly against the creditor opposing discharge.[12]

         "The fiduciary relationship must be one arising from an express or technical trust, and, thus, the fiduciary relationship required under section 523(a)(4) is more narrowly defined than that under the general common law."[13] Although often created by contract, a trust relationship satisfying § 523(a)(4) can be created by statute, [14] such as ERISA. However:

It is not enough [ ] that a statute purports to create a trust: A [statute] cannot magically transform ordinary agents, contractors, or sellers into fiduciaries by the simple incantation of the terms "trust" or "fiduciary." Rather, to meet the requirements of § 523(a)(4) a statutory trust must (1) include a definable res and (2) impose "trust-like" duties.[15]

         In addition, the debtor must be a trustee "before the wrong and without ...

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