Jan. 20, 2023 – A worker's compensation settlement agreement that required $400,000 to be paid to a law firm’s trust account created an express trust for the claimant’s medical creditors, the U.S. Court of Appeals for the Seventh Circuit has ruled.

In Ryan v. Prpa, No. 22-1536 (Dec. 19, 2022), the Seventh Circuit also held that a provision of state law did not exempt the $400,000 from the bankruptcy estate of the worker's compensation claimant.

Worker's Compensation Case Settles

After filing a worker's compensation claim against his employer, Rodney Ryan and the employer executed a compromise agreement. Under the agreement, the employer and the insurer paid Ryan $150,000, minus attorney fees, and $400,000 to the trust account of Fortune & McGillis, the law firm that represented Ryan.

Under the agreement, Fortune & McGillis were to disburse the $400,000 to the medical providers who had provided care to Ryan.

A state administrative law judge (ALJ) approved the agreement. Under an order issued by the ALJ, the employer and the insurer were to pay $120,000 to Ryan, $30,000 to the law firm, and $400,000 to the law firm’s trust account for disbursement to the medical providers within 21 days.

Ryan Files for Bankruptcy

Less than a month later, and before the law firm could disburse any of the $400,000, Ryan and his wife filed for bankruptcy.

In his bankruptcy schedules, Ryan claimed the $400,000 was exempt from the bankruptcy estate, citing Wis. Stat. section 102.27(1). That section specifies that no claim for worker's compensation claim or award or payment “may be taken for the debts of the party entitled thereto.”

Ryan argued that because section 102.27(1) exempted the $400,000 from the reach of non-bankruptcy creditors, it also exempted it from the reach of bankruptcy creditors.

Dueling State Statutes

According to Ryan’s bankruptcy schedules, he owed $800,000 in unpaid medical bills to various creditors, including Dr. Branko Prpa. Prpa, a surgeon, treated Ryan after he suffered the workplace injury that led to the worker's compensation claim.

Prpa filed an objection to Ryan’s attempt to shield the $400,000 from bankruptcy creditors, and cited section 102.26(3)(b)2. That section specifies that medical expenses, witness fees, and other charges related to a claim may be paid out of the amount awarded a party in a state legal proceeding.

Prpa argued that the $400,000 set aside by the ALJ’s order were medical expenses related to a claim for purposes of section 102.26(3)(b)2.

The $400,000 never belonged to Ryan, Prpa argued, because it was held in trust by the law firm. At best, Prpa argued, Ryan had legal but not equitable title to the $400,000.

As a result, Prpa argued, the $400,000 was available to be disbursed to Ryan’s doctors despite the bankruptcy petition.

The bankruptcy court granted Prpa’s motion for summary judgment, reasoning that the ALJ’s order created an express trust in favor of Prpa. The U.S. District Court of the Eastern District of Wisconsin affirmed.

Ryan appealed.

Agreement Created Express Trust

Writing for a three-judge panel, Judge Thomas Kirsch explained that the ALJ’s order created an express trust in favor of Prpa and other medical creditors, which meant Ryan never had equitable title in the $400,000.

Kirsch reasoned that Ryan’s case was analogous to In re Lenk, 44 B.R. 814 (Bankr. W.D. Wis. 1984), a case cited by the bankruptcy court in granting summary judgment for Prpa.

In Lenk, the Wisconsin Department of Transportation (DOT) required a debtor, who was potentially liable for an auto accident for which his uninsured minor son was responsible, to deposit funds with the department in case a judgment was entered against the son.

The court in Lenk held that the homestead exemption provided by state law did not protect the funds because they were not part of the bankruptcy estate.

When the father gave the money to DOT, an express trust was created for the benefit of the accident victim, the court noted.

“In both cases, the clear intent was to deposit funds with a neutral intermediary for the benefit of a third party,” Judge Kirsch wrote. “Since neither Ryan nor Lenk held equitable title to the trust property, it was excluded from both estates.”

No Relief from Section 102.27(1)

Ryan argued that under section 102.27(1), he was the only “party entitled to” the amount of the worker's compensation settlement. Prpa argued that Ryan had waived his rights under section 102.27(1) when he asked the ALJ to approve the settlement agreement, because under section 102.26(3)(b)2, medical expenses must be paid out of a worker’s compensation award when requested by the claimant.

Kirsch concluded that Prpa was correct.

“By asking the ALJ to approve the Settlement, Ryan ‘requested’ that his ‘medical expenses’ ‘be paid out of the amount awarded,’” Judge Kirsch wrote. “Section 102.(27)(1) thus offers Ryan no relief.”

Economic Reality Governs

Ryan also argued that if the $400,000 was held to be reachable by bankruptcy creditors, any creditor could go after a lump sum payment made after a worker is injured, which is prohibited by section 102.27(1).

That argument ignored the economic reality of the situation, Kirsch noted.

“The practical effect of Ryan’s reading would be that Prpa and the other debtors are forever barred from collecting on their debts while Ryan takes the $400,000 free and clear,” Judge Kirsch wrote.

“We think it unlikely – to put it mildly – that the ALJ or the insurer would have ever agreed to the Settlement if they had known that not a penny would flow to the doctors who incurred hundreds of thousands of dollars in expense caring for Ryan.”