CEO's Failure to Remit Withheld Employee Wages to Employee Benefit Plan Renders Debt Nondischargeable Under § 523(a)(4)

By Karl Johnson posted 10-10-2018 09:46

Karl Johnson, Hellmuth & Johnson, PLLC
Jeffrey Klobucar, Bassford Remele, P.A.

 Contributing Editor: Phillip J. Ashfield, Stinson Leonard Street, LLP

In U.S. Department of Labor v. Harris (In re Harris), 898 F.3d 834 (8th Cir. 2018), Harris, the former CEO of Fairbault Woolen Mills (“Fairbault”), diverted withheld employee wages to be used for payment of health plan premiums toward corporate and personal expenses, thereby rendering his debt to the Department of Labor (“DOL”) nondischargeable under 11 U.S.C. § 523(a)(4).

While Harris served as its CEO, Fairbault sponsored an employee health plan funded exclusively by employee contributions withheld from employee paychecks. The healthcare company cancelled the plan after Fairbault failed to remit $55,040 in withheld wages toward monthly premiums.

The DOL filed a federal lawsuit alleging Harris breached a duty of loyalty to plan participants in violation of ERISA when he failed to remit withheld wages. The district court held that Harris, as a fiduciary of the withheld funds, breached his duty of loyalty when he diverted the $55,040 in employee contributions toward Fairbault’s corporate expenses and Harris’ own home-equity loan.

After entry of this judgment in favor of the DOL, Harris filed for Chapter 7 relief. During the bankruptcy case, the DOL filed an adversary proceeding to determine Harris’ debt nondischargeable under 11 U.S.C. § 523(a)(4), alleging that the debt owed by Harris was the result of defalcation while acting in a fiduciary capacity. The bankruptcy court granted summary judgment in favor of the DOL, accepting the district court’s legal conclusions and factual findings under collateral estoppel. The BAP and Eighth Circuit each affirmed.

In affirming the bankruptcy court’s decision, the appellate courts had to determine that the DOL satisfied its burden of proof in establishing that Harris (i) acted in a fiduciary capacity, and                (ii) committed fraud or defalcation in the course of acting in such fiduciary capacity.

As to fiduciary capacity, the Eighth Circuit has previously held that it is not enough that an individual acted as an ERISA fiduciary. See Hunter v. Philpott, 373 F.3d 873, 875 (8th Cir. 2004). In Hunter, the Eighth Circuit directed courts to determine whether the debtor was legally obligated to hold property for the benefit of the employee benefit fund. This required the Eight Circuit to determine whether the debtor's fiduciary relationship – i.e., Harris’ control over plan assets withheld from employee wages – preexisted the debt owed to the benefit plan. Harris never challenged the district court’s findings that (i) upon withholding funds from employee wages, a plan asset was created, and (ii) he had control over the plan assets before using them to pay other corporate debts as well as his own personal expenses. Despite these admissions, Harris continued to argue that he was not a fiduciary under the facts of Hunter.  

The Eight Circuit distinguished Hunter because while the company in that case was required to contribute to an employee benefit fund once per month pursuant to a CBA, no funds were actually withheld from employee wages for such purpose. Unlike Harris, the debtor in Hunter was not legally obligated to hold assets (e.g., withheld wages) for the benefit of the employee benefit fund.

Harris further argued that even if he acted as a fiduciary when he failed to remit withheld wages, his conduct was not intentional so as to constitute "defalcation" under § 523(a)(4). Harris argued that he was acting out of desperation to save his company. Relying on In re Fahey, 494 B.R. 16 (Bankr. D. Mass. 2013), the BAP found that Harris committed defalcation when he violated his duty of loyalty by knowingly failing to remit employee withholdings to the benefit plan, and instead using such assets to pay other corporate and personal expenses. Harris urged the Eighth Circuit to disregard Fahey, arguing that the debtor in that case made no attempt to keep the company afloat and that Harris' actions were more akin to the debtor's actions in In re Pottebaum, Adv. 11-9050, 2013 WL 5592368 (Bankr. N.D. Iowa 2013). Pottebaum is distinguishable from Harris according to the Eighth Circuit, however, because the debtor in Pottebaum worked in concert with the employee union to prioritize creditor payments in an effort to keep the company afloat. Harris, on the other hand, was not in contact with Fairbault employees about the defaulted plan premiums and prioritized his own personal expenses above the benefit payments.

The Eighth Circuit accordingly affirmed the judgment of the BAP, concluding that Harris committed defalcation while acting in a fiduciary capacity when he failed to remit withheld employee wages toward the health benefit plan.