Pursuant to 5TH CIR. R. 47.5, the court has determined that this opinion should not *

be published and is not precedent except under the limited circumstances set forth in 5TH CIR.

R. 47.5.4.

IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

No. 09-20061

Summary Calendar

In the Matter of: DONALD L SWOR, deceased; MYRA L SWOR,

Debtors

MYRA L SWOR

Appellant

v.

BARTLEY TEXAS BUILDERS HARDWARE INC,

Appellee

Appeal from the United States District Court

for the Southern District of Texas

USDC No. 4:08-CV-644

Before JONES, Chief Judge, and DENNIS and HAYNES, Circuit Judges.

EDITH H. JONES, Chief Judge:*

Bartley Texas Builders Hardware, Inc. (“Bartley”) objected to the

discharge of a debt in Donald and Myra Swor’s (“the Swors”) Chapter 7

United States Court of Appeals

Fifth Circuit

F I L E D

October 2, 2009

Charles R. Fulbruge III

Clerk
No. 09-20061

2

bankruptcy case because the Swors impermissibly diverted their business’s trust

funds to themselves. The bankruptcy court ruled that the debt was

dischargeable, finding that the Swors were allowed to repay loans they made to

the business. The district court reversed, concluding that this repayment was

not a valid use of trust funds.

We agree with the district court that the diversion of trust funds in this

manner would render the debt nondischargeable. But because the account from

which the payments were made included both trust and non-trust funds (as

allowed under Texas law), it is unclear whether Bartley met its burden to trace

the payments to trust funds. We therefore reverse the decision of the district

court and remand for this determination and further appropriate proceedings.

I. BACKGROUND

Swor’s Glass & Mirror, Inc. (“Swor’s Glass”), the debtors’ small business,

filed for chapter 11 bankruptcy (later converted to chapter 7) in October 2005.

The Swors later filed a voluntary chapter 7 petition to discharge their personal

debts, which included Donald Swor’s guarantee of the business’s debts.

It is undisputed that the Swors made exemplary efforts involving personal

sacrifice to maintain the business. The bankruptcy court described these:

Mrs. Swor testified that once Swor’s Glass began having financial

difficulty, in order to continue operating the business, she and her

husband infused over $106,000 of their personal funds into the

business. They refinanced their home, cashed in life insurance

policies, and Mr. Swor sold a small plane he owned. The funds from

all of these sources were put into the business in order to maintain

operations and attempt to avoid having to file bankruptcy.

. . .

The Swors honorably ran their business for over thirty years,

devoted all of their energy into maintaining their business and

trying to provide for their employees. Although [the Swors] invested

their life savings into the business, took meager salaries, and lived
No. 09-20061

3

modestly, late in their lives they were unable to continue operating

Swor’s Glass successfully.

During this period of the business’s financial difficulty, however, the Swors

wrote checks to themselves from corporate accounts.

When Swor’s Glass entered bankruptcy, it owed $8,883.08 to Bartley for

commercial construction hardware. Although Swor’s Glass received payment for

construction projects on which the hardware was used, no funds remained to pay

Bartley. Bartley argues that this debt is non-dischargeable in bankruptcy

because of the payments the Swors made to themselves.

The bankruptcy court found the debt dischargeable. It apparently

determined that the infusions of money by the Swors to Swor’s Glass were loans

and that the checks to the Swors constituted repayment. Based on this factual

determination, the bankruptcy court reached the legal conclusion that the funds

received on the projects upon which Bartley supplied materials were not

misapplied by the Swors.

On appeal, the district court reversed the bankruptcy court, finding that

the Swors did not loan money to the business but instead made capital

contributions. It then held that the Swors improperly paid themselves with

money they held in trust for Bartley, and these actions rendered the debt nondischargeable.

Before this court, Mrs. Swor argues: (1) The repayment of the loans they

made to the company was an ordinary business expense of the company and thus

a legitimate use of trust funds, and (2) even if impermissible, Bartley failed to

meet its burden to show that the payments were made using trust funds.

II. ANALYSIS

This court reviews a bankruptcy court’s application of the law de novo and

its findings of fact for clear error. Richmond Leasing Co. v. Capital Branch,

N.A., 762 F.2d 1303, 1307–08 (5th Cir. 1985).
No. 09-20061

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Section 523(a)(4) of the Bankruptcy Code exempts certain debts from

discharge: “A discharge . . . does not discharge an individual debtor from any

debt—for fraud or defalcation while acting in a fiduciary capacity,

embezzlement, or larceny.” 11 U.S.C. § 523(a)(4). Defalcation includes the

failure to produce funds entrusted to a fiduciary, even where such conduct does

not reach the level of fraud. See In re Faulkner, 213 B.R. 660, 664

(Bankr. W.D. Tex. 1997).

The Texas Property Code requires, “Construction payments are trust

funds . . . if the payments are made to a contractor . . . under a construction

contract for the improvement of specific real property in this state.” TEX. PROP.

CODE § 162.001(a). The contractor holds these construction payments in trust

for the benefit of the materialmen that furnished construction material. TEX.

PROP. CODE §§ 162.002–003. The Fifth Circuit has determined that violation of

this trust can result in non-dischargeability under § 523(a)(4). In re Nicholas,

956 F.2d 110, 112–14 (5th Cir. 1992).

Texas law does not require trust funds to be kept in separate accounts.

In re Boyle, 819 F.2d 583, 592 (5th Cir. 1987). Nor must these funds be spent

only on the project for which they were received—they may be spent on other

projects or on expenses related to general business overhead. Id. Mrs. Swor

does not dispute that they held the payment in trust for Bartley or that if

impermissible payments were made using trust funds, § 523(a)(4) would render

the debt to Bartley non-dischargeable.

Permissibility of Payments to the Swors

Although Mrs. Swor characterizes the funds they infused into the business

as loans and the checks as repayment, the district court correctly treated money

provided to the business as capital contributions:

A loan is a capital contribution when payments correlate with

the debtor’s sense of his own financial situation and the debtor
No. 09-20061

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repays the money at his own discretion. The Swors had to show the

court—an objective outsider—that they were debtors of their

company, not just unwise investors.

The Swors cannot prove debt. The absence of either

documentation of the loan or interest payments indicates capital

rather than debt. The Swors never had its company issue a

promissory note for the loan nor did they enable the company to pay

interest regularly to them.

We agree with the district court that the bankruptcy court clearly erred in its

conclusion that the Swors had loaned money to Swor’s Glass.

Withdrawing capital from a business is not a permissible use of trust

funds. See TEX. PROP. CODE § 162.031(a) (“A trustee who, intentionally or

knowingly or with intent to defraud, . . . diverts trust funds without first fully

paying all current or past due obligations incurred by the trustee to the

beneficiaries of the trust funds, has misapplied the trust funds.”); In re Faulkner,

213 B.R. at 665(“[I]f the funds in question were retained, used, or diverted to any

use other than ‘actual expenses directly related to the construction or repair of

[an] improvement,’ then they will be held to have been ‘misapplied’ in a fashion

that is actionable under section 523(a)(4).” (alteration in original) (quoting TEX.

PROP. CODE § 162.031(b)).

Use of Trust Funds

The only remaining question is whether the funds with which the Swors

paid themselves were trust funds. Neither the bankruptcy court nor the district

court made any factual findings on this point.

Bartley quotes Moody v. Pitts, 708 S.W.2d 930 (Tex. App.—Corpus Christi,

1986, no writ), for the proposition that tracing is unnecessary: “If a trustee

commingles trust funds with the trustee’s own, the entire commingled fund is

subject to the trust.” Id. at 937. While this appears correct where trust funds

have been improperly mingled with non-trust funds, Texas law permits
No. 09-20061

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contractors the mingling that occurred here. In re Boyle, 819 F.2d 583, 592 (5th

Cir. 1987) (“[T]he Texas statute . . . does not require any segregation of funds;

it does not obligate the fund holder to maintain the separate identity of any trust

res; it imposes no bookkeeping obligations on the fund holder.”); cf. TEX. PROP.

CODE § 162.006(a) (“A contractor who enters into a written contract with a

property owner to construct improvements to a residential homestead for an

amount exceeding $5,000 shall deposit the trust funds in a construction account

in a financial institution.”).

Where the law unambiguously permits trust and non-trust funds to

mingle, the trustee will not be punished by merging the full amount into the

trust. Bartley, therefore, bore the burden to show that trust funds were

misused, causing the debt to fall within the § 523(a)(4) exception. See In re

Nicholas, 956 F.2d 110 (5th Cir. 1992).

Tracing payments from a blended account back to trust or non-trust

deposits is greatly aided by the presumption that “[w]hen a trustee has

commingled funds and has expended funds, the money expended is presumed to

be the trustee’s own.” Moody, 708 S.W.2d at 937. Applying this presumption,

one possible method of tracing is the “lowest intermediate balance” test. See

5 Collier on Bankruptcy, ¶ 541.11 (15th ed. rev. 2008). Under this approach, the

amount of trust funds in a commingled account increases whenever trust funds

are deposited but decreases only when the account balance drops below the trust

amount.

The district court correctly reversed the bankruptcy court’s finding that

the Swors’ payments to themselves constituted permissible use of trust funds.

But the payments came from an account mingling trust funds with non-trust
No. 09-20061

 To the extent Mrs. Swor is arguing that there was no evidence on the use of trust 1

funds, we conclude that Bartley did provide some evidence on this subject. Mrs. Swor testified

about her accounts, and the court admitted exhibits, such as Defendant’s Exhibit 6, regarding

the accounts.

7

funds, and neither court analyzed whether the payments were made with trust

funds.1

III. CONCLUSION

For the foregoing reasons, we reverse the district court’s judgment that the

debt is non-dischargeable and remand for determination whether the Swors paid

themselves out of trust funds, and for further appropriate proceedings.

REVERSED AND REMANDED.