John R. Stoebner v. Consumers Energy Company ( 2011 )

United States Bankruptcy Appellate Panel
FOR THE EIGHTH CIRCUIT
________________
Nos. 11-6045/6046/6047/6048/6049/11-6050/6051
________________
In re: LGI Energy Solutions, Inc; *
LGI Data Solutions Company, LLC *
*
Debtors *
*
John R. Stoebner, Trustee * Appeal from the United States
* Bankruptcy Court for the
Plaintiff - Appellant * District of Minnesota
*
v. *
*
Consumers Energy Company; *
Potomac Electric Power Company; *
Alabama Power Company; *
Atlantic City Electric Company; *
East Cedarbrook Plaza, LLC; *
Florida Power & Light Company; *
Gulf Power Company; *
*
Defendants - Appellees *
________________
Submitted: October 31, 2011
Filed: December 8, 2011
________________
Before FEDERMAN, VENTERS, and NAIL, Bankruptcy Judges
FEDERMAN, Bankruptcy Judge
The Plaintiff-Appellant in these related appeals is the Trustee in the Chapter
7 bankruptcy cases of LGI Energy Solutions, Inc., and LGI Data Solutions Company
LLC, which were in the business of providing utility-management and billing services
to restaurants and other customers. As such, they collected from their customers
funds for payment of the customers’ utility bills, and were in turn to pay those funds
on to the utilities. Due to volume, they were also able to obtain discounts from some
utilities, and were paid a percentage of such discounts in addition to a monthly fee.
This consolidated appeal involves seven adversary proceedings by the Trustee to
avoid payments made by Debtor LGI Energy to the Defendant utilities prior to the
bankruptcy. The Trustee contends that such payments were preferential and/or
fraudulent transfers under the Bankruptcy Code and applicable state law. The
Bankruptcy Court granted summary judgment in favor of the Defendants, based on
its conclusion that the payments they received for the utilities were not an asset of
either Debtor. The Trustee appeals, and we reverse and remand.
FACTUAL BACKGROUND
The parties agree that all payments at issue came from an account at U.S. Bank
ending in 3321 (“the 3321 Account”). That account was held in the name of “LGI
Energy Solutions, Inc.,” without reference to its being held for any particular purpose
or for the benefit of any other party. The Defendants contend in effect that the 3321
Account was a funnel through which the customers paid their utility bills, and that
LGI Energy typically paid those bills within hours or at most two days after receipt
of payment from its customers. Indeed, LGI Energy’s agreements with at least some
of its customers provided, in somewhat different variations, that LGI Energy was to
acquire no ownership in the payments from the customers as they passed through LGI
Energy.1 For purposes of this appeal, the Trustee agrees that funds paid by customers
1
For example, Paragraph 3(b) of the Energy Services Agreement between
LGI Energy and Buffets, Inc. provided that “At no time shall LGI have a legal or
2
to LGI Energy were required by agreement with the customers to be held pursuant to
a trust or trust-like relationship, and that such funds were to only be used to pay that
customer’s bills.
However, in the period prior to its bankruptcy, the Trustee contends that Debtor
LGI Energy did not treat its customers’ funds consistent with its contractual
obligations to them. According to the Trustee, the Debtors’ principal was siphoning
money out of the Debtors and then engineered a Ponzi and check kiting scheme to
conceal the thefts and induce customers to keep advancing money. The Trustee
contends that the Debtors also shuffled money around from account to account.
Eventually, there was not enough money to pay the utilities. The Trustee asserts that
LGI Energy was commingling the payments from the utility clients with other income
from their servicing and leasing operations, and perhaps with loan funds from a bank.
More specifically, the Trustee’s Complaints against the seven Defendants
identified a total of 59 transfers made to the Defendants via check from the 3321
Account, which were negotiated between November 10, 2008 and November 26,
2008.2 The last deposit into this account by any of the customers of these Defendants
occurred on November 4, 2008. None of the checks at issue here was negotiated by
the Defendant-payees before November 10, 2008. There appears to be no dispute that
the balance of the 3321 Account was frequently reduced to zero or overdrawn
between the dates of the deposits of the customers’ alleged trust money and the dates
when funds were transferred to the Defendants in payment of utility bills.
equitable interest in the Customers Funds and Customer grants no security interest
to LGI.”
2
A transfer made by check is deemed to occur when the check is honored,
not when written or when the payee receives it. See, e.g., In re Pyatt, 486 F.3d
423, 427 (8th Cir. 2007) (citing Barnhill v. Johnson, 503 U.S. 393, 112 S. Ct.
1386, 118 L. Ed. 2d 39 (1992)).
3
For example, according to the Trustee, the account balance at the end of
November 4, 2008 – after customer Buffets, Inc. deposited the amount of
$208,567.28 for the payment of its utility bill – was just $1.22. Yet the utility bill for
which Buffets had made its deposit on that day had not yet been paid at that point.
According to the Trustee, Buffets’ money obviously went somewhere else, and
someone else’s money was used to later pay Buffets’ utility bill.
In the three weeks after November 4, 2008, the 3321 Account was almost
perpetually overdrawn, including on the last business day, November 7, before the
first of the checks to Defendants was negotiated. The Trustee asserts that, after
November 4, 2008, every other deposit into the 3321 Account was from a source
other than the customers at issue here. Some deposits were from a different customer
not implicated in these adversary proceedings, and some were from other accounts
belonging to the Debtors, and not from those customers. The Defendants do not
dispute that funds were commingled and that the dollars used to pay their respective
utility bills were not necessarily the same dollars paid by the customer whose bill was
being paid. In other words, the Defendants concede that they cannot trace the money
directly from the customer to the payment of that customer’s utility bills. Rather, as
discussed more fully below, the Defendants assert that, so long as they show that a
customer’s “trust” money went into the account, they need not trace those funds on
to the Defendants.
The Bankruptcy Court essentially agreed. It held that in order for the
Defendants to prevail based on the argument that funds paid to them were never
property of the Debtors, the Defendants were not required to show that the funds they
received were the funds paid by their utility users to LGI Energy. Such tracing might
be required, the Court held, if the Debtor was still holding funds which competing
parties contended were held in trust for them. However, the Court further held, no
such tracing is required where the Debtor has already made payments which it was
obligated to make, regardless whose money was used to make them.
4
As discussed more fully below, we hold that that ruling is inconsistent with
Minnesota law and Eighth Circuit precedent. If a trust or agency relationship was
intended to be created by the agreements between LGI Energy and its customers, then
the Defendants were nevertheless required to prove that LGI Energy honored that
relationship and treated the funds accordingly. In other words, they had to trace the
money. For that reason, we reverse and remand for further findings.
STANDARD OF REVIEW
We review findings of fact for clear error, and legal conclusions de novo.3 The
Bankruptcy Court’s grant of summary judgment is reviewed de novo.4 Summary
judgment is appropriate if, viewing the evidence in the light most favorable to the
nonmoving party, there is no material factual dispute, and the movant is entitled to
judgment as a matter of law.5 “To create a genuine issue of material fact – at trial or
on appeal – a nonmoving party (or appellant) must set forth specific facts and present
affirmative evidence showing there is a genuine issue of material fact precluding
summary judgment.”6
3
See In re Waterman, 248 B.R. 567, 570 (B.A.P. 8th Cir. 2000).
4
See U.S. v. Horras (In re Horras), 443 B.R. 159, 161–62 (B.A.P. 8th Cir.
2011) (citing Taylor v. St. Louis County Bd. of Election Comm’rs, 625 F.3d 1025,
1028 (8th Cir. 2010)).
5
Fed. R. Civ. P. 56(c); Bremer Bank v. John Hancock Life Ins. Co., 601
F.3d 824, 829 (8th Cir. 2010).
6
In re Horras, 443 B.R. at 167 (citing Fed. R. Civ. P. 56(e); Anderson v.
Liberty Lobby, Inc., 477 U.S. 242, 248–49, 106 S. Ct. 2505, 2510, 91 L. Ed. 2d 202
(1986)).
5
DISCUSSION
Property of the Debtor
Count I of the Trustee’s Complaint sought to avoid the transfers as preferences
under 11 U.S.C. § 547. Section 547(b) provides that a trustee “may avoid any
transfer of an interest of the debtor in property” to or for the benefit of a creditor, on
account of an antecedent debt, while the debtor was insolvent, on or within 90 days
before the filing of the petition, and that enables such creditor to receive more than
such creditor would receive if the case were a case under chapter 7 and the transfer
had not been made.7 The theories relied on by the Trustee in the other counts of the
Complaint, for avoidance of fraudulent transfers under 11 U.S.C. § 548 and
Minnesota law, similarly require proof that the Debtor held an interest in the property
transferred.8
Significantly, we note at this point that the Bankruptcy Code provides that
preferences and fraudulent transfers may be recovered either from the recipient of the
payment, or from the creditor (here, the customers) for whose benefit the payment
was made.9 Consequently, the Trustee could have sued either the Defendants or the
customers whose utility bills were paid.
7
11 U.S.C. § 547(b) (emphasis added).
8
11 U.S.C. §§ 548(a)(1) and 544(a). The Trustee’s Complaint also asserted
a Count IV which was an objection to the Defendants’ claims. Because the
Defendants had not filed claims in the case by the time of the hearing on the
Motion for Summary Judgment, the Bankruptcy Court dismissed Court IV as
moot. The Trustee does not appeal from that part of the Judgment.
9
11 U.S.C. § 550(a)(1). While the Bankruptcy Court held that the
Defendant utilities are creditors of the Debtor, the payments to them could in any
event be avoidable as payments for the benefit of the customers, who are creditors.
6
The Bankruptcy Code does not define “interest of the debtor in property”
before a bankruptcy is filed. However, in Begier v. Internal Revenue Service, the
Supreme Court held that that term is “best understood as that property that would
have been part of the estate had it not been transferred before the commencement of
bankruptcy proceedings.”10 Section 541 of the Bankruptcy Code provides, as relevant
here, that the estate is comprised of “all legal or equitable interests of the debtor in
property as of the commencement of the case . . . .”11 While bankruptcy law
determines whether an asset is property of the estate, the existence and extent of
property is defined by state law.12 Under Minnesota law, funds held in a bank
account are presumed to belong to the account holder.13 Courts have, however, held
that in certain circumstances, such presumption can be rebutted, as will be shown.
In Begier, the Supreme Court held that taxes withheld from employee
paychecks, commonly referred to as “trust fund taxes,” which were paid by the debtor
to the IRS could not be the subject of a preference avoidance because they were never
“property of the debtor” under § 547. It held that, because a debtor does not own an
equitable interest in property he holds in trust for another, that interest is not
“property of the estate,” nor is such an equitable interest “property of the debtor” for
purposes of § 547(b).14
10
496 U.S. 53, 58, 110 S.Ct 2258, 2263, 110 L. Ed. 2d 46 (1990).
11
11 U.S.C. § 541(a)(2).
12
See In re N.S. Garrott & Sons, 772 F.2d 462, 466 (8th Cir. 1985).
13
See In re Estate of Whish, 622 N.W.2d 847, 850 (Minn. App. 2001). See
also 5 Collier on Bankruptcy ¶ 541.08 (Alan N. Resnick & Henry J. Sommer, eds.,
16th ed. 2011) (“Deposits in the debtor's bank account become property of the
estate under § 541(a)(1)”).
14
Begier, 496 U.S. at 2263.
7
As distinguished from the contractual trust which may have been created by
LGI’s agreements with its customers here, the Court in Begier emphasized that the
Internal Revenue Code expressly provides that trust fund taxes are, by statute, held
in trust by the employer. The trustee in Begier argued that the trust funds lost their
trust status when they were put into, and transferred out of, the debtor’s general
operating accounts.
In rejecting the trustee’s argument in Begier, the Supreme Court said:
In the absence of specific statutory guidance on how we are to determine
whether the assets transferred to the IRS were trust property, we might
naturally begin with the common-law rules that have been created to
answer such questions about other varieties of trusts. Unfortunately,
such rules are of limited utility in the context of the trust created by §
7501 [of the Internal Revenue Code]. Under common-law principles,
a trust is created in property; a trust therefore does not come into
existence until the settlor identifies an ascertainable interest in property
to be the trust res. A § 7501 trust is radically different from the
common-law paradigm, however. That provision states that “the amount
of [trust-fund] tax ... collected or withheld shall be held to be a special
fund in trust for the United States.” Unlike a common-law trust, in
which the settlor sets aside particular property as the trust res, § 7501
creates a trust in an abstract “amount” – a dollar figure not tied to any
particular assets – rather than in the actual dollars withheld.
Common-law tracing rules, designed for a system in which particular
property is identified as the trust res, are thus unhelpful in this special
context.15
Thus, because of the express language of the Internal Revenue Code, the Supreme
Court held that it did not matter that the trust fund taxes had been commingled, since
that statutory trust is not created in a res. But where, as here, a debtor’s obligations
as to the use of funds are not imposed by statute, a trust is only created as to those
15
Id. at 2265 (citations omitted; emphasis added by Begier Court).
8
assets which constitute its res.16 In that situation, the Supreme Court directed courts
making this analysis to apply “reasonable assumptions” to govern the tracing of
funds.17
Similarly, under Minnesota law, tracing would be required for the Defendants
to establish that the funds were held pursuant to an express trust. Indeed, the
Defendants concede that under Minnesota law, an express trust cannot exist unless
there is “a definite trust res wherein the trustee’s title and estate is separated from the
vested beneficial interest of the beneficiary . . . .”18 Similarly, applying Minnesota
law, the Eighth Circuit has held that a constructive trust may not be imposed unless
the claimant can identify specify property to which such trust would attach.19
In MJK Clearing, Inc., the plaintiff had deposited cash with the debtor to be
used as collateral for the purchase of stock. In seeking to latch onto funds held by the
debtor in a commingled account at the time of its bankruptcy, the plaintiff asked for
imposition of a constructive trust. The Eighth Circuit held that, in order to impose
such a trust, tracing was required.20 Significantly, the plaintiff in MJK Clearing asked
16
Id.
17
Id. at 2267.
18
Principal Brief of Respondents [Defendants-Appellees] at 26 (citing In re
Bush's Trust, 249 Minn. 36, 81 N.W.2d 615 (1957)).
19
In re MJK Clearing, Inc., 371 F.3d 397, 401 (8th Cir. 2004).
20
Id. (“A constructive trust may be imposed only when there is some
specific property identified as belonging, in equity and conscience, to the plaintiff.
. . . A constructive trust does not arise unless there is property on which the trust
can be fastened, and the property is held by the person to be charged as
constructive trustee.”) (quoting Rock v. Hennepin Broad. Assocs., 359 N.W.2d
735, 739 (Minn. Ct. App. 1984) (requiring “clear and convincing evidence” before
imposing constructive trust)).
9
the Eighth Circuit to apply the Supreme Court’s decision in Begier to determine that
the trust was created at the inception, and that tracing rules did not apply. The Eighth
Circuit rejected that argument, holding that tracing is required in the absence of a
statutory trust. Thus, it held, “like a common-law trust, a constructive trust creates
a trust in specific property, not an amorphous ‘amount.’”21
The Eighth Circuit further held that the “lowest intermediate balance” test
should be applied to trace assets in an account.22 The lowest intermediate balance test
has also long been used to apply tracing rules in Minnesota,23 and we have previously
said that that test applies to trace money when a preference defendant asserts a
constructive trust as a defense.24 Under that test, “a court follows the trust fund to and
decrees restitution from an account where the amount on deposit has at all times since
the commingling of the funds equaled or exceeded the amount of the trust fund.”25
“However, if the account is depleted after the trust fund has been deposited, the trust
21
Id. at 402.
22
Id. at 401.
23
See Bishop v. Mahoney (In re Irish-American Bank), 70 Minn. 238, 240-
41 (1897) (holding that a trust fund may be recovered even if it does not appear
that the identical money of the trust fund is in a commingled account if there has
always remained on hand a balance of the mixture equal to the amount of the trust
fund which originally entered into the mixture; but, if at any time the balance has
been reduced to a less amount, then the trust may recover out of the mixture an
amount equal to the smallest balance which has remained on hand since the
moneys were commingled).
24
See Ramette v. Digital River, Inc. (In re Graphics Technology, Inc.), 306
B.R. 630 (B.A.P. 8th Cir. 2004).
25
In re MJK Clearing, 371 F.3d at 402 (citation and internal quotation
marks omitted).
10
fund is treated as lost.”26 In MJK Clearing, because the particular account into which
the plaintiff’s money went dipped to zero, the Eighth Circuit held that the plaintiff
could not trace its money, and the trustee prevailed.27
The Defendants rely on a Sixth Circuit decision, In re Computrex, Inc., for the
proposition that no tracing is required here.28 They argue on appeal that the
Bankruptcy Court itself relied on Computrex in holding that the funds paid to it were
not property of the estate. While the Court’s ruling contains no such reference, we
nevertheless consider Computrex because it is the leading case adopting the
Defendants’ position here.
In that case, Contech Construction Products, Inc., a manufacturer of metal and
plastic pipe, engaged the debtor, Computrex, to assist it with the processing and
payment of Contech’s freight charges. As set forth in the agreement between the two
parties, Computrex, after receiving bills from the carriers, would process the bills and
send a compiled invoice to Contech at the end of each week. Contech wired the funds
to Computrex, who was then supposed to pay the freight carriers the following day.
Computrex started having cash flow problems, so it developed a “float” system
whereby, in violation of the agreement with Contech (and its other clients), it would
hold onto the wired funds for increasing periods of time so that it could earn interest
off the money, rather than paying the carriers immediately. Eventually, when it did
not have enough money in the account to pay all of the clients’ carriers, it started
paying the carriers of the clients who complained ahead of carriers of other clients in
the queue. Contech complained, so its carriers were paid significant amounts of
26
Id. (citing First Fed. of Mich. v. Barrow, 878 F.2d 912, 915 (6th Cir.
1989); In re United States Cigar Stores Co. of Am., 70 F.2d 313, 316 (2d Cir.
1934)).
27
Id. at 403.
28
403 F.3d 807 (6th Cir. 2005), reh’g en banc denied Sept. 9, 2005.
11
money, whereas other clients’ carriers were not paid before an involuntary bankruptcy
was filed against Computrex. Clearly, as is the case here, because Computrex paid
all the carriers from one account containing commingled funds, it had used money
from other clients to pay Contech’s carriers.
The Sixth Circuit determined that the agreement between the parties required
Computrex to hold such funds, in effect, as a “disbursing agent,” and that the
relationship was essentially the same as a bailment.29 Under that theory, the Sixth
Circuit held that the money never became property of the debtor, even though it had
been commingled. We do not consider that to be a correct interpretation of bailment
law under Eighth Circuit and Minnesota law.
The general concept of a bailment is fairly universal:
A “bailment” in its ordinary legal sense imports the delivery of personal
property by the bailor to the bailee who keeps the property in trust for
a specific purpose, with a contract, express or implied, that the trust
shall be faithfully executed, and the property returned or duly accounted
for when the special purpose is accomplished or that the property shall
be kept until the bailor reclaims it.30
29
Id. at 812.
30
Lackawanna Chapter of Ry. & Locomotive Historical Soc’y, Inc. v. St.
Louis County, Missouri, 497 F.3d 832, 837 (8th Cir. 2007) (referring to Missouri’s
definition of bailment as the “traditional concept.”) (citations omitted). See also 8
C.J.S. Bailments § 18 (“Although variously stated from jurisdiction to jurisdiction,
the basic elements of a bailment are the delivery of personal property from one
person to another for a specific purpose, the acceptance by the transferee of such
delivery, an agreement that the purpose will be fulfilled, and an understanding that
the property will be returned to the transferor or dealt with as the transferor
directs.”).
12
Similarly, in Minnesota, “[a] bailment occurs when property is delivered to a party,
without ownership being transferred, under an agreement that the property will be
returned.”31
Although bailment is most typically thought of in the context of personal
property or chattels – such as a car, for example – the concept has been held to
include other types of property, including money, as the Court in Computrex stated.
By its nature, the analysis of bailment of money is more complicated than that
involving a car, for example. Either way, however, one of the core principles of a
bailment is that the bailee holds specific and identifiable property for the bailor. “[I]f
either by contract or otherwise, there is no obligation to restore the specific property,
and the bailee is at liberty to return another thing of equal value or the money value
the transaction is not a bailment.”32 One treatise has described the bailment of money
as follows:
While the parties to a bailment of money have the right and authority to
change their relation, by a later contract, to that of debtor and creditor
as parties to a loan, a bailment of money is not converted into a loan by
reason of the mere fact that the bailee is not able to return the identical
currency or specie deposited with him or her. Whether one who
transfers money to another should be considered a bailor or a creditor
turns on the intent of the parties to the transaction, as manifested by their
conduct and statements and any other relevant evidence. A bailment of
money is created when a special or specific bank account is created,
title to the funds remains with the account holder, and the funds are
separated from other deposits.33
31
Leighton v. Rossow, 2010 WL 772341 at *4 (Minn. App. 2010) (not
reported) (citing Wallinga v. Johnson, 269 Minn. 436, 438, 131 N.W.2d 216, 218
(1964)).
32
8 C.J.S. Bailments § 7
33
Id. (citations omitted; emphasis added).
13
Similarly, Minnesota courts have held that “[w]here money paid to another is not
required to be segregated by the payee and held as a separate fund for the benefit of
the payor, there is no trust.”34 And, in the context of bank accounts, “[w]here the
depositor of cash consents to commingling it with other funds of the depositee, the
relationship resulting from the transaction is not that of trustee and beneficiary, even
though the deposit is for the latter’s benefit, but that of debtor and creditor.”35
“[W]here the money is kept intact the transaction is a bailment.”36 Money deposited
in a bank to be commingled with its other funds loses its identity and the depositor
ceases to be the owner of the deposit, even if the deposit is to be used for the benefit
of the depositor.37
Even the case cited by Computrex for the proposition that money may be the
subject of a bailment emphasized that such bailment requires that the money not be
commingled. That case, Hargis v. Spencer,38 involved a bag of gold coins. The
alleged bailor argued that the alleged bailee had commingled the coins by placing the
bag in the same trunk with her own money, and, therefore, she was ipso facto liable
for conversion of the coins. The Court in that case expressly disagreed, finding no
evidence that the bailee had mixed the coins, noting that she could have returned the
very same bag of coins to the bailor.39 In other words, the bailment had not been
violated because there had been no commingling. This is consistent with the general
34
Farmers State Bank of Fosston v. Sig Ellingson & Co., 16 N.W.2d 319,
323 (Minn. 1944).
35
Id. at 324.
36
Id. (citing Furber v. Barnes, 32 Minn. 105, 19 N.W. 728 (1884)).
37
Id.
38
71 S.W.2d 666 (Ky. App. 1934).
39
Id. at 669.
14
concept that bailment involve specific and identifiable property which can be returned
to the bailor.
Nevertheless, Computrex further stated that “[t]he fact that a bailee, which has
a possessory interest in the property entrusted to him, but no legal or equitable
interest, may commingle the funds his clients entrust to him does not give the bailee
any property interest in the funds.”40 However, the case it cites for that proposition,
In re Crouthamel Potato Chip Co.,41 involved the bailment of equipment, and
commingling was not an issue.
As the Trustee further points out, Computrex’s viability even in the Sixth
Circuit is in some question. First, the Sixth Circuit reached the opposite result in
another case, First Federal of Michigan v. Barrow.42 In that case, the debtors were
engaged in the business of mortgage investments. Pursuant to loan servicing
agreements with their clients, the debtors collected mortgage payments, deposited
them into segregated escrow accounts, and made disbursements to the client’s lender,
taxing authority, and insurance carrier. At one point, however, the debtors stopped
segregating the money, and instead commingled the clients’ funds in one account.
When cash flow became a problem, the debtor began favoring some creditors by
paying them first out of the commingled funds. When the bankruptcy trustee sued
those creditors for recovery of the payments, they asserted that the payments were not
property of the debtor because they were held in a constructive trust. They
specifically argued that tracing was not necessary. The Sixth Circuit expressly
rejected that argument, holding that “[i]t is beyond peradventure that, as a general
rule, any party seeking to impress a trust upon funds for purposes of exemption from
40
403 F.3d at 812.
41
6 B.R. 501, 507 (Bankr. E.D. Pa. 1980).
42
878 F.2d 912 (6th Cir. 1989).
15
a bankrupt estate must identify the trust fund in its original or substituted form.”43
The Sixth Circuit further held that, because the defendants had not traced their funds
beyond the deposits into the commingled account, they could not prevail:
In the instant case, [defendants] have not attempted to trace their funds
beyond the deposits into the commingled Salem Central Account, which
evidence, standing alone, is insufficient to support their constructive
trust theory of recovery. Since the purported constructive trust consisted
of money, which had no extrinsic identifiable characteristics of its own,
that was initially deposited and commingled into the Salem Depository
Account with unidentifiable funds received from innumerable and
diverse other sources and daily redeposited and again commingled in the
negative balance Salem Central Account, [defendants’] funds
irretrievably lost their identity and “tracing” became a futile pursuit as
a result of which the controversial payments here in issue became
avoidable transfers within the meaning of 11 U.S.C. § 547(b) and
550(a).44
Although the Sixth Circuit later came to a different result in Computrex, the
Computrex Court did not mention First Federal v. Barrow at all.
More recently, in In re R.W. Leet Electric,45 a Sixth Circuit BAP decision, the
Chapter 7 trustee sought to avoid preferences that the electrical-contractor debtor
made to its supplier on various construction projects. In that case, a statute provided
for the creation of a trust in money received by a contractor that is owed to its
subcontractors. The Sixth Circuit BAP held that, even though the debtor had been
holding funds in trust for the subcontractor, “it must be established that the payments
43
Id. at 915.
44
Id. at 915-16.
45
Meoli v. Kendall Electric, Inc. (In re R.W. Leet Electric, Inc.), 372 B.R.
846 (B.A.P. 6th Cir. 2007).
16
actually paid to [the subcontractor] are traceable to the trust funds received by the
Debtor.”46 The BAP distinguished Begier’s ultimate holding because that case
involved a specific statute that created the trust in an amount of money withheld from
employee paychecks, rather than a res. Instead, it held, under Sixth Circuit law,
including Barrow, courts universally agree that the trust beneficiary must be able to
trace the funds.47 Further, “if an interest of the debtor in property means property that
would become property of the estate had the transfer not occurred, . . . then it is
irrelevant whether the transfer was pre or postpetition.”48 The BAP in R.W. Leet
Electric did not discuss Computrex.
The Defendants also rely on Daly v. Deptula (In re Carrozzella &
Richardson),49 which held that, in contrast to the typical situation where the plaintiff
is the trust beneficiary suing the defendant-trustee to recover funds in trust, in the
unique posture of bankruptcy preference litigation, only the deposited trust funds
must be traced – a preference defendant need not trace their funds because, when the
debtor (as trustee of the trust) transferred funds back to the defendants on request, the
debtor has essentially “traced” the funds for the defendants. However, in order to
reach that conclusion, the bankruptcy court expressly declined to follow the Second
Circuit BAP’s direction in a prior decision in a related case that tracing was
required.50
46
Id. at 853 (citing Begier).
47
Id. at 853-54.
48
Id. at 854 (citations and internal brackets omitted).
49
255 B.R. 267 (Bankr. D. Conn. 2000).
50
Daly v. Radulesco (In re Carrozzella & Richardson), 247 B.R. 595
(B.A.P. 2d Cir. 2000).
17
In sum, we do not view Computrex’s or the bankruptcy court’s holding in
Carrozzella – that tracing is not required when trust funds are commingled – as being
consistent with Eighth Circuit precedent or Minnesota law. Indeed, in MJK Clearing,
the Eighth Circuit relied on the Sixth Circuit’s contrary decision in Barrow in its
holding that, if the commingled account is depleted after the trust fund has been
deposited, “the trust fund is treated as lost.”51
The Eighth Circuit has further held that, in addition to the agreement between
the parties, a party asserting that commingled funds were held pursuant to an agency
relationship must also demonstrate that the holder of such funds in fact honored that
relationship. In In re Rine & Rine Auctioneers,52 the debtor was an auction company.
It auctioned off certain property owned by an entity named Huddle. The auctioned
property was collateral for a loan by Huddle to a Bank. The debtor sold the property
and deposited the proceeds into its general bank account, commingled with other
funds. It then paid some of the proceeds to Huddle, and some to the Bank in
satisfaction of its security interest. When the auction company filed bankruptcy, the
trustee sought to recover the payments to Huddle and the Bank as preferences. The
bankruptcy court had held that the Debtor and Huddle were in an agent-principal
relationship, and not a debtor-creditor relationship, and that the money was therefore,
at all times, Huddle’s. In reversing, the Eighth Circuit agreed that, as a general rule,
if property is in the debtor’s hands as agent, the property or proceeds therefrom are
not treated as property of the debtor’s estate. However, the Court stated that “[t]he
wording of the contract, as well as the Debtor’s actions, are conclusive on ownership
of the sales proceeds.”53
51
371 F.3d at 402.
52
Rine & Rine Auctioneers, Inc. v. Douglas County Bank & Trust Co. (In re
Rine & Rine Auctioneers, Inc.), 74 F.3d 854 (8th Cir. 1996).
53
Id. at 861 (quoting Salem v. Lawrence Lynch Corp. (In re Farrell &
Howard Auctioneers, Inc., 172 B.R. 712, 716 (Bankr. D. Mass. 1994)).
18
In Rine, despite the wording of the contract, the Eighth Circuit considered the
following factors to show that the money was the debtor’s property, and was not held
by it as Huddle’s agent: (1) the sale proceeds were deposited into the debtor’s
general bank account, which lacked any idicia of Huddle’s ownership, (2) the
proceeds were commingled with other funds in the debtor’s possession and control;
(3) the general bank account had a negative balance on several occasions; (4) the
money paid to Huddle could not have been the actual proceeds from the sale of
Huddle’s property – in other words, the funds could not be traced; (5) the debtor bore
the risk of loss if the successful bidders failed to pay for assets they purchased; (6)
the debtor “was engaging in a distinct occupation, unsupervised by Huddle and
entirely independent of Huddle’s business”; (7) the account was subject to any claims
by the debtor’s creditors; and (8) Huddle exercised no control over Debtor’s conduct
with respect to the auction proceeds.54
Although some of the factors applied in Rine came from Nebraska agency law,
these factors may be helpful in determining whether, the language of the agreements
notwithstanding, the actions of the parties in this case resulted in LGI Energy
acquiring an ownership interest over the customers’ payments.
The Eighth Circuit commented in Rine that “a major goal of the Bankruptcy
Code is to treat equal classes of creditors equally” and that one of the tools for doing
that is the preference statute.55 In other words, the preference and fraudulent transfer
provisions of the Bankruptcy Code are intended to equalize the playing field when
a debtor is in trouble by preventing the strongest and fastest creditors from getting all
54
Id. at 858-59.
55
Id. at 860 (citation omitted).
19
the money. 56 The Computrex case is an example of why this principle should likewise
apply to require tracing when a preference defendant asserts a trust or bailment exists:
Contech’s purported trust money was commingled with similarly-situated bailors’
money, yet Contech’s creditors got paid from the commingled funds because it
complained the loudest, to the detriment of the other purported bailors. Indeed, as the
Sixth Circuit BAP recognized in In re R.W. Leet Electric: “Without a tracing
requirement, insolvent trustees who have converted trust assets for their own use
would be able to choose, on the eve of bankruptcy, who is to be repaid and who is
not. Thus, similarly situated creditors would receive disparate treatment.”57
Fraudulent Transfers
Although the Bankruptcy Court’s grant of summary judgment in favor of the
Defendants on all of the preference and fraudulent transfer counts was based on the
threshold determination that the payments were not the Debtors’ property, the
Bankruptcy Court also appears to have held, as to the fraudulent transfer counts, that
the Debtors received reasonably equivalent value for the payments and that the
transfers to the Defendants were not made with any intent to hinder, delay, or defraud
creditors. Because the Bankruptcy Court did not make sufficient factual findings
upon which we could address these issues, we leave them to the Bankruptcy Court
to consider as appropriate on remand.58
56
At oral argument, the Defendants’ counsel argued social policy,
contending in effect that such Defendants should not be made to repay a
preference since they did not choose to extend credit to the Debtors. We note,
however, that the same was true for the bank defendant in Rine, which had
received auction proceeds from an auctioneer hired not by the bank, but by its
customer.
57
372 B.R. at 855 (citation omitted).
58
See Rine, 74 F.3d at 863 n. 7.
20
CONCLUSION
For the foregoing reasons, the Orders Granting Summary Judgment in favor of
the Defendants are REVERSED and REMANDED. On remand, the Bankruptcy
Court should determine whether the contracts between LGI Energy and its customers
created a trust relationship or bailment, and whether LGI Energy honored that
relationship in its treatment of the customers’ funds, as well as any remaining factual
disputes between the parties.
21