What Is Fiduciary Liability Under 31 U.S.C. 3713?

The Federal Priority Statute, 31 U.S.C. 3713, establishes the U.S. government’s right to be paid first when a person or estate indebted to the government is insolvent. This law ensures that federal claims, such as taxes, are satisfied before most other creditors receive payment. Enacted in its earliest form in 1797, the statute’s purpose is to secure public revenue. It applies outside of formal bankruptcy proceedings and has significant implications for individuals responsible for managing an insolvent party’s assets.

Conditions for Government Priority

For the government’s priority to take effect, a specific set of conditions must be met. The law requires the simultaneous existence of a government claim, the debtor’s insolvency, and a distinct action that demonstrates this financial state. All of these elements must be present for the government’s claim to supersede those of other creditors.

The first condition is a debt owed to the United States. While federal taxes are the most frequent type of debt, the statute’s reach is broad. A “claim” can include any right to payment, whether it is unliquidated, contingent, or disputed. The government’s claim can arise from various sources, including loans or contractual obligations, and does not need to be a fixed amount when the other conditions are met.

Next, the debtor must be insolvent. Insolvency under the statute is determined using a balance sheet test, meaning the person’s or estate’s liabilities exceed the fair market value of their assets. This is different from an equity test, where insolvency means being unable to pay debts as they come due.

The final requirement is a triggering act that makes the insolvency manifest, as insolvency alone does not activate the government’s priority. The debtor must either voluntarily assign their property for the benefit of creditors, have their property attached by a creditor, or commit an “act of bankruptcy.” This historical term includes actions like making a preferential payment to another creditor while insolvent.

Fiduciary Personal Liability

The Federal Priority Statute imposes personal liability on the representative of a person or estate who pays other debts before satisfying a known government claim. This enforcement provision is not punitive but is designed to recover funds that were improperly paid to a lower-priority creditor.

A fiduciary is any individual or entity in control of the debtor’s assets. This includes executors of a decedent’s estate, court-appointed receivers, or corporate officers liquidating a company. These individuals have a duty to manage and distribute the property under their control. The statute exempts trustees in a formal bankruptcy case, as those proceedings have their own priority rules.

Liability is incurred when the fiduciary pays any part of a debt of the person or estate before paying the government’s claim. The fiduciary becomes personally responsible to the government for the amount of the improper payment. The government’s cause of action against the fiduciary accrues at the moment the wrongful payment is made.

An element for imposing personal liability is the fiduciary’s knowledge of the government’s debt, which includes both actual and constructive knowledge. Constructive knowledge means the fiduciary was aware of facts that would lead a reasonably prudent person to inquire about a government claim. A fiduciary cannot avoid liability by ignoring signs of a potential federal debt, such as missing tax returns.

A fiduciary’s personal liability is the lesser of the amount paid to the junior creditor or the total amount of the unpaid U.S. government claim. For example, if an estate owes the IRS $50,000, has only $30,000 in assets, and the executor uses $10,000 to pay a credit card bill, the executor becomes personally liable for $10,000. This payment diminished the assets available to pay the government’s priority claim.

Limitations and Exceptions to Government Priority

The Federal Priority Statute is not absolute and is subject to several limitations and exceptions established through statutory provisions and judicial interpretations.

A primary limitation is that the statute does not apply in formal bankruptcy proceedings filed under Title 11 of the U.S. Code. The Bankruptcy Code has its own distinct system for prioritizing and paying creditor claims. Once a bankruptcy petition is filed, the Federal Priority Statute’s rules are superseded, and trustees in bankruptcy cases are exempt from personal liability.

Another exception is for certain perfected security interests, known as “choate” liens. For a non-federal lien to have priority over a government claim, it must be choate, meaning it is fully perfected and specific. Courts have established a three-part test for a lien to be considered choate:

• The identity of the lienholder must be established.
• The property subject to the lien must be specific.
• The amount of the lien must be fixed and certain.

A prior mortgage on a specific piece of real estate is a common example of a choate lien that would have priority over a later-arising federal claim.

In addition to perfected liens, courts have carved out exceptions for expenses necessary to administer the assets for the benefit of all creditors. For a decedent’s estate, these often include reasonable funeral expenses and the costs of administering the estate, such as court costs and reasonable compensation for the fiduciary. These administrative expenses are allowed to be paid before the government’s claim because they are incurred to preserve the assets from which all creditors will be paid.