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Defalcation: How to Get Paid Even if the General Contractor Goes Bankrupt

It is not news to residents of Michigan that the economy has been limping along. Now the nation knows what most Michiganders have been going through these last few years. The building industry had held up rather well despite the economic blues, but this year the economy seemed to have a significant impact on contractors. I write this article with the thought that while we all need to maintain a positive attitude, we also need “tools” in our toolbox to deal with the realities of these economic times.

One of those realities is that some contractors are declaring bankruptcy. This becomes an even harsher reality if that contractor owes you money from a project. Bankruptcy is designed to give debtors a “fresh start,” wiping away all debts of the bankrupt party. Ordinarily, whatever a debtor’s assets are allocated amongst his creditors. Certain assets are protected from distribution, and it is an extremely rare case where the creditors get more than pennies on the dollar for their debts.

However, some debts are not dischargeable in bankruptcy, and among these are debts arising from “defalcation while acting in a fiduciary capacity.” Defalcation is the act of embezzling money or recklessly failing to properly account for funds. In Michigan, a contractor who receives money for a project is required to pay “all monies due or so to become due laborers, subcontractors, materialmen, or others entitled to payment” before he pays himself or his crew. Failure to make those payments is “evidence of intent to defraud.” See MCL 750.153.

So what does this mean to the average subcontractor whose general contractor unfortunately goes bankrupt? What it means is you can likely enforce your construction lien and possibly collect from the general contractor despite the bankruptcy. The Builder’s Trust Fund Act makes the general contractor a trustee of the project and imposes a duty to pay the beneficiaries – the subcontractors and others as outlined above – before paying themselves and their employees and before paying any other expenses.

If you have a general contractor that has been paid money for a project, they are considered a fiduciary to all others who have contributed labor and/or materials to the project. If they have not properly accounted for the funds, your claim can survive through the bankruptcy process.

If any of you have questions about this topic or anything related to it, please do not hesitate to contact me. The call is free and the business life you save may be your own.

Besides being a past President of the Home Builders Association of the Grand Traverse Area and a licensed contractor, Robert Whims is an attorney at Whims Legal Group, PLC, located at 12935 S. West Bay Shore Drive, Traverse City, MI 49684. Telephone: 231-938-6099; Facsimile: 231-421-6686; E-mail:

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