Theft By Contractor Claims In The Bankruptcy Courts

Shady contractors are about as clichéd as dishonest used car salesmen. Nearly every homeowner has some sort of crazy contractor story to tell, and nearly every contractor does too. Unforeseen circumstances and downright odd stories should not be surprising in an industry that ebbs and flows with the economy, and boasts and eclectic mix of highly skilled and relatively unskilled laborers, but every outrageous contractor story we hear seems to outdo the last. This is one of the reasons why there are unique rules that apply when a contractor files for bankruptcy in Wisconsin, and why bankruptcy cases involving contractors can be so contentious.

Though bankruptcy law is federal law, Wisconsin has a theft by contractor law that applies in cases where a contractor has filed for bankruptcy without finishing their work, or without paying for supplies or labor.

Wis. Stat. section 779.02(5), safeguards against the misappropriation of funds by a contractor working on a private construction project by creating a trust fund for the benefit of the project’s owners, laborers, and suppliers. A contractor’s use of the trust funds for any reason other than to pay for labor and materials on the particular project constitutes theft by contractor.

When a contractor files for bankruptcy, laborers and suppliers who are owed money, and/or property owners who claim the work they have paid for is unfinished or unsatisfactory can use the theft by contractor statute to fight for their share of the insolvent contractor’s bankruptcy estate.

In order to keep such claims from being discharged by the bankruptcy court, the laborer/supplier/property owner must establish:

(1) that a trust existed;
(2) that the debtors were fiduciaries of that trust; and
(3) that the debtors committed fraud or defalcation while acting as fiduciaries of the trust.

Wisconsin’s construction trust fund statute typically satisfies the first and second elements since the law says funds paid to a contractor are to be held in a trust, so the challenging part is proving fraud or defalcation.

Fraud requires a false statement, but defalcation is just the misappropriation of funds entrusted to someone. In the construction trust fund context, the Seventh Circuit Court of Appeals has stated that defalcation is more than mere negligence, but less than fraud. This has been interpreted to mean that the contractor must have acted in bad faith or committed some other act of affirmative misconduct.

In these cases, the courts often try to determine if the contractor actually knew they had a fiduciary duty under Wisconsin law because that is an indication that the contractor knew what he or she was doing was wrong, which could satisfy the third element.

Whether any one claim will be preserved or discharged by the bankruptcy court is difficult to predict without knowing a lot of details about the project, the contractor’s actions, and the actions of other parties. If you think you might have a claim for theft by contractor, or a contractor you are working with has filed for bankruptcy in the middle of a project, we encourage you to call our office to schedule a free consultation with one of our experienced bankruptcy attorneys.