Ferguson Trenching Co. Inc. v. Kiehne

CHASANOW, Judge. In this case, we construe for the first time Maryland’s construction trust statute, Maryland Code (1974, 1988 Repl. Vol., 1992 Cum.Supp.), Real Property Article, §§ 9-201 to 9-204. 1 At issue is the personal liability of a corporate general contractor’s president for funds that the corporation held in trust for a subcontractor, but used for other purposes. The construction trust statute provides that a corporate officer of a contractor may be held personally liable when, with intent to defraud, the officer retains or uses the funds for a purpose other than the payment of those subcontractors for whom the funds were being held in trust.

I. This case arises from a contract between appellant, Ferguson Trenching Co., Inc. (Ferguson), and Advanced Excavation Company, Inc. (Advanced), of which appellee, C. ¹⁷² Stuart Kiehne (Kiehne), is the president. On August 16, 1989, Advanced entered into a $279,380 contract with Triple Brook Partnership to perform excavation work for Mount Oak Estates, a Triple Brook real estate development in Anne Arundel County. On September 15, 1989, Advanced executed a $44,549 contract with Ferguson which called for Ferguson to install a water line on the Mount Oak job. Ferguson completed its work and billed Advanced on February 5, 1990 for the contract price.

Advanced received only $251,000 in payments from Triple Brook towards its $279,380 Mount Oak contract. It paid out approximately $78,000 to subcontractors other than Ferguson and $82,000 in equipment costs for the project, and incurred approximately $46,000 in labor costs for its hourly employees on the project. 2 According to Advanced, the balance of about $45,000 was devoted to “the payment of debts incurred in connection with other construction projects and to Advanced’s operating expenses.” Three subcontractors or suppliers, including Ferguson, did not receive payment from Advanced for their work on the Mount Oak project. Ferguson sought and obtained a judgment against Advanced for the amount due under the contract. In addition, Ferguson filed a complaint in the Circuit Court for Anne Arundel County alleging that Kiehne, Advanced’s president, had violated Maryland’s construction trust statute.

Section 9-201(a) of the statute provides: “(a) Moneys to be held in trust.—Any moneys paid under a contract by an owner to a contractor, or by the owner or contractor to a subcontractor for work done or materials furnished, or both, for or about a building by any subcontractor, shall be held in trust by the contractor or subcontractor, as trustee, for those subcontractors who did work or furnished materials, or both, for or ¹⁷³ about the building, for purposes of paying those subcontractors.” Section 9-202 of the statute provides: “Any officer, director, or employee of any contractor or subcontractor, who, with intent to defraud, retains or uses the moneys held in trust under § 9-201 of this subtitle, or any part thereof, for any purpose other than to pay those subcontractors for whom the moneys are held in trust, shall be personally liable to any person damaged by the action.” With respect to establishing the requisite “intent to defraud” for purposes of imposing personal liability under § 9-202, § 9-203 provides that “[t]he use by a contractor or subcontractor or any officer, director, or employee of a contractor or subcontractor of any moneys held in trust under § 9-201 of this subtitle, for any other purpose than to pay those subcontractors who did work or furnished materials, or both, for or about the building, shall be prima facie evidence of intent to defraud in a civil action.” In its complaint, Ferguson claimed that when Kiehne paid other debts of Advanced with money received for Ferguson’s work, Kiehne became personally liable to Ferguson under §§ 9-202 and 9-203. The case was tried before Judge Lawrence H. Rushworth, sitting without a jury. At trial, Kiehne testified that Advanced lost over $200,000 in 1989 and that he had gone so far as to consult with an attorney about a Chapter 11 bankruptcy filing. At the time Ferguson billed Advanced for its work on the Mount Oak job, Advanced was 90 to 150 days behind in payments to its creditors.

In his Memorandum of Opinion and Order, the judge found that at the time Kiehne purchased Advanced in 1988, the business “was undergoing financial difficulties” which the court attributed to “earlier poor management and unseasonably wet weather.” He also found that Advanced’s problems “were made even more severe by the decline in the development industry from 1989 to the present period.” He observed that ¹⁷⁴ Kiehne had “placed large amounts, up to Sixty-Five Thousand Dollars ($65,000.00), of his own funds into the company in an attempt to keep the corporation solvent.” Noting that these facts are important “only as they go to the intent to defraud” which triggers personal liability under the statute, Judge Rushworth concluded that Ferguson had failed to make “a showing by a preponderance of the evidence of a clear intent to defraud” and entered judgment in Kiehne’s favor. 3 Ferguson appealed to the Court of Special Appeals, and we granted certiorari before the intermediate appellate court could consider the case. Md.Code (1974, 1989 Repl.Vol., 1992 Cum.Supp.), Courts & Judicial Proceedings Art., §§ 12-201 & 12-203. On appeal, Ferguson contends that the trial judge erred in two principal ways. First, Ferguson argues that the judge failed to recognize Kiehne’s fiduciary duty to subcontractors such as itself, and therefore did not impose upon Kiehne the obligations that attend fiduciary status.

Second, Ferguson argues that the trial judge improperly interpreted § 9-203 of the statute, which provides that use of trust moneys by a contractor’s officer for a purpose other than payment of the subcontractors who worked on the job constitutes prima facie evidence of intent to defraud. We address each of these contentions.

II

The construction trust statute, titled “Trust Relationships in the Construction Industry,” was enacted by Chapter 345 of the Acts of 1987 to protect subcontractors ¹⁷⁵ from dishonest practices by general contractors and other subcontractors for whom they might work. To this end, it provides two distinct bases of liability. Section 9-201 creates a trust relationship between the contractor or subcontractor that has been paid by the owner and the subcontractor for whose work the owner has paid. Under § 9-201, upon receiving payment from the owner, the contractor or subcontractor holds the funds in trust for the benefit of the subcontractor that has performed work or provided materials for the project.

Section 9-202 establishes the personal liability of officers, directors, or employees of contractors or subcontractors who fraudulently retain or use such trust moneys. The statute applies to both private and public construction projects, but not to contracts for the construction and sale of a single family residential dwelling, or to home improvement contracts by licensed home improvement contractors. § 9-204. The personal liability provisions of the statute must be viewed in the context of basic corporate law. Officers and directors of a corporation generally are insulated from personal liability for the debts of the corporation.

As we said in Ace Dev. Co. v. Harrison, 196 Md. 357, 366 , 76 A.2d 566, 570 (1950), “when an official or agent signs a contract for his corporation it is simply a corporate act. It is not the personal act of the individual, and he is not personally liable for the corporate contract unless the matter is tainted by fraud....” See also Bart Arconti & Sons, Inc. v. Ames-Ennis, Inc., 275 Md. 295, 312 , 340 A.2d 225, 235 (1975) (“the corporate entity will be disregarded only when necessary to prevent fraud or to enforce a paramount equity”). As one author has observed, under common law rules litigants faced great difficulties in proving that corporate officers or directors committed fraud and noted that, prior to the statute’s enactment “an unscrupulous individual could establish a thinly capitalized construction company, use funds from a project to pay handsome salaries to the company’s officers, and be fairly confident that the officers would not be personally ¹⁷⁶ responsible for the debts of lower-tiered subcontractors and suppliers.” David F. Albright, The Maryland Construction Trust Statute: New Personal Liability—Its Scope and Federal Bankruptcy Implications, 17 U.Balt.L.Rev. 482, 484 (1988).

In a letter to the chairman of the Senate committee considering the legislation, the president of the Maryland Society of the American Institute of Architects described the effect of a subcontractor’s failure: “[a] major subcontractor’s financial failure precipitates a chain reaction due to the accumulation of. unpaid monies to their subcontractors and suppliers that must be repaid by the Owners or General Contractor to free the project from mechanic liens. “Virtually every major construction project sees a subcontractor fail financially. To the extent that retainage is inadequate to cover the unpaid subcontractors and suppliers of the failed subcontractor for work performed, the General Contractor or Owner must make up that difference. Usually the failed subcontractor simply reopens business under a new name and continues to plague our industry.” Letter from Phillip W. Worrall to the Hon. Walter M. Baker (Mar. 10, 1987) (in Legislative Bill file for S.B. 374, 1987 Term).

By specifically providing for personal liability of officers, directors, and employees who intend to defraud subcontractors, and by providing that proof of a diversion of trust funds is prima facie evidence of intent to defraud, the statute makes recovery easier for subcontractors who fall victim to unscrupulous practices. As originally drafted, Senate Bill 374 sought to impose both criminal and civil liability. It originally provided that any officer, director, or employee of the contractor or subcontractor who, with intent to defraud, retained or used the trust moneys for any purpose other than to pay the subcontractors would have been guilty of larceny and subject to a fine not to exceed $5,000 and imprisonment of not more than one year. S.B. 374, 1987 General Assembly of ¹⁷⁷ Maryland, proposed § 9-116.

The bill was subsequently amended to delete the criminal sanctions. In the five years since its enactment, the statute has been reviewed only five times in reported opinions, each time by the federal bankruptcy court. See In re Piercy, 140 B.R. 108 (Bankr.D.Md.1992); In re Marino, 139 B.R. 380 (Bankr.D.Md.1992); In re Parks, 141 B.R. 92 (Bankr.D.Md.1991); In re Holmes, 117 B.R. 848 (Bankr.D.Md.1990); In re Marino, 115 B.R. 863 (Bankr.D.Md. 1990). The instant case presents the first opportunity for a Maryland court to interpret the statute, and we now turn to that task.

III

With respect to Ferguson’s first argument, that Kiehne himself had a fiduciary duty to Ferguson, we need look only as far as the statute’s plain language to see that Kiehne in fact had no such duty. “In construing a legislative enactment the fundamental judicial task is to determine and effectuate the legislature’s intent, and indeed the very language of the statute serves as the primary source of the legislature’s intent.” Scheve v. Shudder, 328 Md. 363, 371-72 , 614 A.2d 582, 586-87 (1992). Thus, when the language of a statute is clear and unambiguous, we need look no further to determine the legislature’s intent. Management Personnel Servs. v. Sandefur, 300 Md. 332, 341 , 478 A.2d 310, 341 (1984). In § 9-201, the statute creates a trust relationship between the contractor or subcontractor that has received payment from an owner and the subcontractor for whose performance the owner has paid.

Nothing in the statute makes a corporate officer, director, or employee a fiduciary with respect to a party that has entered into a contract with the corporation. Section 9-201, in fact, clearly states that moneys “shall be held in trust by the contractor or subcontractor, as trustee” for the subcontractors. (Emphasis added). Section 9-204(c), which supplies definitions for the statute, provides that “[i]n this subtitle, ... ‘contractor,’ and ‘sub ¹⁷⁸ contractor’ have the same meanings as in § 9-101 of this title.” Section 9-101, in turn, provides that a “contractor” is “a person who has a contract with an owner,” § 9-101(d), while a “subcontractor” is “a person who has a contract with anyone except the owner or his agent.” § 9-101(g).

Finally, § l-101(j) of the Real Property Article, which provides definitions for use throughout the Article, defines “person” as including “any partnership, firm, association, public or private corporation, or any other entity.” Thus, whatever the duties of a trustee or fiduciary may be, a question that is not before us today, these duties are imposed only on the party to the contract. In the case of a corporate party, these duties flow to the corporation, but not to its individual officers or directors. Several of the federal bankruptcy cases referenced above have addressed this very question and reached the same conclusion. In In re Marino, 115 B.R. at 870, 872 , for example, the court, Derby J., said: “The instant Contractor was a corporation, of which Debtor was an officer.

It was the Contractor that was the contracting party with the owner plaintiffs, and it was the Contractor on which the trust obligations were imposed literally. $ * H* * * [Section 9-202] does not explicitly make corporate officers liable generally for application of trust funds. While § 9-202 places personal liability on an officer, it does so only when the officer diverts trust funds ‘... with intent to defraud,----’ It is not a general fiduciary liability for all purposes.” The liability of corporate officers under the Maryland statute can be contrasted with the liability of corporate officers under statutes from other states. Oklahoma’s trust statute provides that “[i]f the party receiving any money under [the section imposing the trust] shall be a corporation, such corporation and its managing officers shall be liable for the proper application of such trust ¹⁷⁹ funds....” Okla.Stat.Ann. tit. 42, § 153(3) (West 1990) (emphasis added); see Carey Lumber Co. v. Bell, 615 F.2d 370, 374-75 (5th Cir.1980) (finding that Oklahoma statute creates an express trust between materialmen and both the corporate contractor and its officers, imposing a fiduciary duty on corporate officers); In re Marino, 115 B.R. at 870-72 (contrasting two Maryland trust statutes with the Oklahoma law and finding that the Maryland statutes, unlike the Oklahoma law, did not directly impose liability on a corporate contractor’s directors and officers). Similarly, the Texas construction trust fund statute provides that “[a] contractor, subcontractor, or owner or an officer, director, or agent of a contractor, subcontractor, or owner, who receives trust funds or who has control or direction of trust funds, is a trustee of the trust funds.” Tex.Prop.Code Ann. § 162.002 (West 1984) (emphasis added); cf. Nuclear Corp. of America v. Hale, 355 F.Supp. 193, 197 (N.D.Tex.) (stating that under prior, but essentially similar, Texas construction trust fund statute, officers and directors of a corporate subcontractor were trustees of funds and were personally liable for funds spent in violation of that trust), aff'd, 479 F.2d 1045 (5th Cir.1973).

Had the contract been executed between Ferguson and Kiehne as an individual, then as a party to the contract Kiehne would indeed have become a trustee under § 9-201 and acquired fiduciary duties towards Ferguson. The instant contract, however, was between Ferguson and Advanced, and thus the trial judge was correct in imposing no fiduciary duty on Kiehne personally.

IV

Ferguson’s second argument is that the trial judge misconstrued or misunderstood the personal liability provisions of the statute. The judge found that Ferguson had failed to prove Kiehne acted with “intent to defraud,” and therefore decided Kiehne was not susceptible to personal liability under § 9-202. Ferguson contends that, under § 9-203, proof that the trust funds were diverted to a ¹⁸⁰ purpose other than paying the subcontractors on the job is equivalent to conclusive proof of intent to defraud. Ferguson, however, misreads the statute.

Section 9-203 provides that diversion of trust funds shall be only “prima facie evidence of intent to defraud____” (Emphasis added). This Court considered the meaning of “prima facie evidence” in a number of cases addressing now-superseded §§ 140 and 142 of Article 27. Former § 140 of Article 27 defined and provided penalties for the crime of false pretenses. It provided: “Any person who shall by any false pretense obtain from any other person any chattel, money or valuable security, with intent to defraud any person of the