Mechanics' Lien Trust Fund Debts Not Dischargeable in Bankruptcy – What Were You Thinking?

by Sherman & Howard L.L.C.

In a recent unanimous decision, the United States Supreme Court made it more difficult to avoid a bankruptcy debtor discharging a debt tied to "defalcation while acting in a fiduciary capacity." [1] In Bullock, the Court stated that a defalcation, or misappropriation of funds, requires a culpable state of mind "involving knowledge of, or gross recklessness in respect to, the improper nature of the relevant fiduciary behavior."   Id.  This heightened mental culpability requirement will impact non-dischargeability litigation in the bankruptcy court, including, importantly for the construction industry, claims based on violations of the Colorado Mechanics Lien Trust Fund Statute[2].

Section 523(a)(4) of the Bankruptcy Code excepts from discharge any debt "for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny."[3] Prior to Bullock, courts construing defalcation under Section 523(a)(4) of the Bankruptcy Code had reached conflicting conclusions concerning the mental state necessary to prove a defalcation.  Some courts required recklessness; others required negligence, gross negligence, or objective recklessness; and yet others, including federal courts in Colorado, required no culpable state of mind at all.  This meant that, prior to Bullock, any violation of the Colorado Mechanics Lien Trust Fund Statute would suffice to establish a non-dischargeable debt under Section 523(a)(4) and it was relatively easy to preserve such claims through a bankruptcy. 

In Bullock, a trustee had taken loans from a family trust to purchase property for his own benefit.  The trustee paid the loans back to the trust in full, with interest.  Prior to the bankruptcy filing, the trustee's brother, a beneficiary of the trust, sued the trustee for using the money.  The state court had concluded that the trustee did not have a "malicious motive" but was involved in self-dealing, which was a breach of fiduciary duty.  After he could not satisfy the state court judgment, the trustee filed for bankruptcy and the creditor objected to the discharge of the debt.  The bankruptcy court said the debt was non-dischargeable because the debtor had engaged in a known breach of fiduciary duty and his conduct was "objectively reckless." 

Before the Supreme Court, the debtor argued there could not be a defalcation under Section 523(a)(4) absent a specific finding of ill intent.  The Supreme Court essentially agreed, holding that, absent bad faith, moral turpitude, or other immoral conduct, defalcation requires an intentional wrong.  The Court further held that intentional conduct includes not just conduct that the fiduciary knows is improper, but also reckless conduct that the criminal law treats as the equivalent of intentional conduct. 

The Bullock decision may have a significant impact on the non-dischargeability of debts involving funds held under the Trust Fund Statute.[4] Plaintiffs must focus on the debtor's mental culpability, including the debtor's knowledge that the funds were held in trust.  Defendants will argue that the use of trust funds to pay other legitimate business expenses, albeit a violation of the Colorado Mechanics Lien Trust Fund Statute, is not a defalcation for purposes of Section 523(a)(4) of the Bankruptcy Code because there was no intentional wrongdoing. 

It remains to be seen how the bankruptcy courts will rule under such circumstances, but if they accept this argument, contractors facing trust fund claims may be successful in discharging debts owed to subcontractors and suppliers through bankruptcy, even though they should have been holding the funds to pay those debts in trust.  Subcontractors and suppliers will then likely look to owners to pay those debts, resulting in potential double payments by project owners. 

[1] See Bullock v. Bankchampaign, N.A., 569 U.S. ____, 2013 WL 1942393 (2013).

[2] C.R.S. § 38-22-127.

[3] 11 U.S.C. § 523(a)(4). 

[4] It is important to note that the Bullock decision does not impact state law litigation based on violations of the Colorado Mechanics Lien Trust Fund Statute.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Sherman & Howard L.L.C. | Attorney Advertising

Written by:

Sherman & Howard L.L.C.

Sherman & Howard L.L.C. on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.