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Bankrupt CEO owes $67K for failing to send paycheck-deducted premiums to health insurer

By Lorene D. Park, J.D.

A company CEO could not avoid a $67,839 judgment through bankruptcy where it was undisputed that he directed the company to pay his personal expenses even though he knew that insurance premiums withheld from employee paychecks had not been remitted to the insurer, which had demanded payment by month’s end or the plan would be canceled. Affirming summary judgment for the U.S. Department of Labor, a bankruptcy appellate panel for the Eighth Circuit explained that the funds withheld from paychecks constituted a trust, that the CEO was a fiduciary with respect to the trust, and that he committed defalcation in directing the payment of his expenses rather than past due premiums (In re Harris, January 6, 2017, Federman, A.).

CEO pays personal debts, but not insurance premiums. The debtor in this bankruptcy appeal was the CEO of Faribault, a blanket manufacturer. Faribault sponsored and administered a health insurance plan under which participating employees paid 100 percent of the premiums via payroll deductions. Premiums were withheld from paychecks and sent each month to HealthPartners, the insurer. The VP of human resources received the bills, which were sent to accounts payable. The VP, accounts payable administrator, CFO, and CEO all had signatory authority on the account.

In 2008, Faribault was late in paying HealthPartners on ten occasions, including two bounced checks. After a $22,593 check bounced in January 2009, HealthPartners notified Faribault that it would cancel the plan if payment was not received. While Faribault had over $70,000 in its accounts, it did not use that to pay HealthPartners. The CEO, however, had $4,000 paid to his American Express account and $21,531 to his home equity line of credit. HealthPartners canceled the policy on April 1, retroactive to January 31, affecting 42 employees. The CEO resigned in May and the company was later liquidated.

DOL’s ERISA suit. Faribault never remitted the $55,040 it had withheld from the employees’ paychecks for insurance premiums from January 9 to March 20. In December 2012, the DOL filed suit against the CEO alleging that he violated ERISA by failing to remit to HealthPartners the withheld in premiums. The DOL claimed he breached his fiduciary duty to employees and the health plan. After a three-day bench trial in November 2015, the district court in Minnesota awarded the DOL $67,839. Two weeks later, the CEO filed a Chapter 7 bankruptcy case.

Was debt dischargeable? In the bankruptcy court, the DOL filed a nondischargeability action under 11 U.S.C. Sec. 523(a)(4), which excepts from an individual debtor’s discharge any debt “for fraud or defalcation while acting in a fiduciary capacity.” Though often created by contract, a trust relationship satisfying Sec. 523(a)(4) can be created by statute, such as ERISA, if the statutory trust includes a “definable res” and imposes “trust-like” duties.

Here, the conclusions required for the bankruptcy court to grant summary judgment for the DOL under Sec. 523(a)(4) included: (1) there was a trust res; (2) the CEO had fiduciary duties to the trust; and (3) he committed defalcation in directing Faribault to pay expenses other than past due premiums. On these elements, the bankruptcy court gave collateral estoppel effect to the district court’s findings in the ERISA case that premiums withheld from paychecks constituted a trust res and the CEO was a fiduciary under ERISA. The bankruptcy court further held that the CEO’s ERISA fiduciary duties satisfied Sec. 523(a)(4)’s definition of a fiduciary and that he committed defalcation.

Withheld premiums as trust res. Affirming, the bankruptcy appellate panel explained that the premiums withheld from employee paychecks were “plan assets” as of the dates the paychecks were cut and Faribault was then holding funds that actually belonged to someone else—a trust res—and it had a duty to use the employees’ money to make the premium payments.

CEO was fiduciary. The appeals court also agreed with the bankruptcy court that the CEO was a fiduciary. In contrast to Sec. 523(a)(4)’s “strict and narrow” construction, the term “fiduciary” is broadly construed under ERISA and it was sufficient that the CEO exercised authority and control regarding the management and disposition of the premiums withheld from employees’ paychecks. Indeed, he exercised his authority over plan assets by paying personal expenses in March 2009.

CEO committed defalcation. While the district court in the ERISA suit found that the CEO breached his fiduciary duty under ERISA, it did not address the Bankruptcy Code, Sec. 523(a)(4), which requires a showing of intentional wrong. The appeals court therefore reviewed the undisputed facts. By at least March 26, 2009, the CEO knew that the January and February premium payments had not been made and that HealthPartners demanded full payment by March 31 or the plan would be canceled. It was also undisputed that between March 26 and March 31, over $70,000 was either transferred to other Faribault accounts or was used to pay expenses or creditors other than HealthPartners. Moreover, during that time the CEO directed the CFO to pay the CEO’s personal expenses and home equity line of credit.

Based on this, the appeals court found that the bankruptcy court properly held, as a matter of law, that the CEO acted with “conscious disregard to a substantial and unjustifiable risk that his conduct” in not using the $70,000 to pay the premiums or to repay the employees, would violate a fiduciary duty. He therefore acted with the requisite intent and the DOL was entitled to summary judgment.