Trustee Held Liable for Failure to Remit Sales Taxes

Failure to remit trust fund taxes is a common cause of bankruptcy and personal liability for the owners of a business. Far less common is the case of a bankruptcy trustee held responsible for the same violation. However, that is what happened in the case of Texas Comptroller of Public Accounts v. Liuzza, No. 09-50544 (5th Cir. 7/6/10). The opinion can be found here.

The case arose out of the bankruptcy of Texas Pig Stands, described by the court as a "venerable San Antonio restaurant company." Despite its venerable status, it wound up in chapter 11. The court appointed a chapter 11 trustee after the debtor failed to remit post-petition sales taxes to the Comptroller. Then the chapter 11 trustee failed to remit the taxes. The court confirmed a plan which required the trustee to pay all delinquent post-petition taxes on the effective date of the plan and to remain current on the sales taxes. The trustee did neither. Shortly thereafter, the Comptroller froze the company's bank accounts and revoked its sales tax permit, after which the case was converted to chapter 7.

The Comptroller brought an adversary proceeding seeking to hold the trustee liable for the taxes. The Bankruptcy Court ruled that the trust agreement limited the trustee's liability to gross negligence and ruled against the Comptroller. The District Court reversed. The Fifth Circuit agreed with the District Court that the trustee was liable.

The Court found that the trustee was personally liable for the taxes under state law. However, it also found that if the confirmed plan of reorganization protected the trustee from liability, this would override state law. The Court stated:

The Comptroller is bound to any liability limitations imposed by the Plan, which included the Trust Agreement. The Plan and Trust Agreement are contracts that must be read in their entirety to be given full meaning. (citation omitted). Further, under the governing law of Texas, "exculpatory clauses are strictly construed, and the trustee is relieved of liability only to the extent to which it is clearly provided that he shall be excused."

Opinion, p. 8.

The Trust had inconsistent provisions. On the one hand, it stated that "persons dealing with the Trustee in matters relating to the Trustee have recourse only against the Trust Assets to satisfy any liability incurred by the Trustee to such person in carrying out the terms of this Agreement or the Plan, and the Trustee shall have no personal or individual obligation to satisfy such obligation. . . ." However, the Trust Agreement also provided that "Except in the case of fraud, willful misconduct or gross negligence, the Trustee shall not be liable for any loss or damage by reason of any action taken or omitted by him pursuant to the discretion, power and authority conferred on him by this Agreement or the Plan." Reading the two provisions together, the Court found that the Trustee had no personal liability so long as he followed the plan and did not commit fraud or willful misconduct. The Court concluded:

Luizza exceeded his authority, violated the Plan, and committed willful misconduct. Accordingly the Trust Agreement does not limit his liability.

Opinion, p. 9.

There are two lessons here.

The first is that entrepreneurs and fiduciaries occupy much different realms. Entrepreneurs take big risks in the hope of big gains. Occasionally it might make rational sense for an entrepreneur to gamble on not paying trust fund taxes in the hope of preserving the enterprise(although usually not). However, fiduciaries don't get paid extra to take risks. Therefore, it will never make sense for a fiduciary to incur personal liability in the hope of making the case work.

Second, this was not a case where better drafting could have saved the day. While the fatal language was probably boilerplate carried over from another document, it would be hard to draft around this problem. The exculpatory provision of the trust document contained exceptions for fraud, willful misconduct and gross negligence. It also limited the exculpatory provision to actions taken "pursuant to the discretion, power and authority conferred on him by this Agreement or the Plan." Thus, the Court was able to find liability because failure to pay the taxes was not authorized by the plan and constituted willful misconduct. It would have been a closer case if the trust had simply stated that the Trustee would not be liable absent fraud or gross negligence or even limited it to just fraud. However, the more broadly the exculpatory provision is drafted, the more likely it would be to draw objection. Further, in order to avoid the problem, the trust's drafters would have to have contemplated that the trustee would continue to misappropriate trust funds. If that were the case, they should not have supported him for trustee.

This is a harsh result for a trustee who received no personal benefit and thought he was doing the right thing for the estate. However, it is often said that insanity is doing the same thing over and over and expecting a different result. In this case, both the debtor in possession and the chapter 11 trustee failed to remit taxes. When this happened, the Comptroller became upset and demanded relief from the Bankruptcy Court. Thus, a reasonable person would have been on notice that continued failure to pay the taxes could lead to bad results. Bankruptcy is a court of second, third and fourth chances. However, eventually the chances run out, even for a trustee.