Under Wisconsin's theft by contractor statutes (Wis. Stat. §§ 779.02(5) and 779.16), any money paid to a prime contractor or subcontractor for the construction of improvements on land are a "trust fund" for the amounts owed by the prime contractor or subcontractor, supplier, or service provider for labor, services, materials, plans, and specifications performed, furnished, or procured for the improvements.  A prime contractor or subcontractor cannot use any of the money paid to it on a project for any purpose other than to pay for labor, services, materials, plans, and specifications used on the project until all claims related to the project have been paid.  Use of the money for other purposes is considered theft by contractor and is punishable as criminal theft.  

Federal and state case law in Wisconsin were inconsistent regarding whether funds held by a bankruptcy trustee were held in trust under Wisconsin's trust fund statutes, and therefore afforded priority secured status in bankruptcy proceedings.  In 1986, the bankruptcy court in Matter of Don's Electric held that a trust is only created with respect to funds actually held in the hands of the prime contractor, citing Visser v. Koenders, a 1959 Wisconsin Supreme Court case.  However, the Wisconsin Supreme Court in Wisconsin Dairies Cooperative v. Citizens Bank & Trust subsequently overruled Visser, stating that there is no reason for treating payments to a bankruptcy trustee differently from direct payments to the contractor for purposes of the theft by contractor statutes.  The Wisconsin Dairies court stated that the purpose of the statute is to assist subcontractors in getting paid; therefore, regardless of who receives payments, the subcontractor should receive the funds.  Id. at 768.

On March 13, 2008, in In re Straight Arrow Construction Company, Inc., Case No. 04-17056-7, the Bankruptcy Court for the Western District of Wisconsin ruled that Don’s Electric is no longer controlling law.  In this case, Straight Arrow was a subcontractor on certain public improvements projects, including a public project under CJ Moyna & Sons, Inc.  Straight Arrow filed bankruptcy on October 1, 2004.  Construction Fabric & Materials Corporation (CFM) furnished Straight Arrow with materials on these projects.  CFM filed a proof of claim on January 21, 2005 and stated that a portion of its claim was secured based on Wisconsin's theft by contractor statute (Wis. Stat. § 779.16).  In particular, the proof of claim stated that CFM was owed $31,421.79 for materials it supplied for the CJ Moyna project.  Subsequent to CFM filing its proof of claim, the trustee received a $40,000 payment from CJ Moyna relating to the CJ Moyna project.  The bankruptcy court, following Wisconsin Dairies, held that CFM had a secured claim in the amount of $31,421.79.  The court said for a subcontractor to have a secured claim, it is necessary for the creditor to trace their claim to materials supplied on a particular project and the trustee must have been paid on that project.

In light of the decision in In re Straight Arrow, creditors in a bankruptcy proceeding that are owed money for labor, services, materials, plans, and specifications provided on a private or public improvement project should be careful when preparing their proof of claim.  The proof of claim should indicate the creditor has a secured claim based on the applicable Wisconsin theft by contractor statute.  The proof of claim should also include an attachment, identifying the construction projects in which the creditor is owed money and specifying the amount that is owed with respect to each project.  Based on In re Straight Arrow, if the trustee receives any payments with respect to such projects, the creditor will then have a secured claim and priority to those funds.  Note that if more than one creditor has a secured claim to funds received on a particular project and the funds received are not sufficient to pay all the secured creditors claims, the trustee would likely pay the claims on a pro-rata basis.

Philip Bradbury and Charity McCarthy represented CFM in In re Straight Arrow.  Please feel free to contact either of them if you have any questions regarding the above information.