Old Republic National Title Insurance v. Tyler

PUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
In Re: THOMAS H. DAMERON, t/a St.
Asaph Lawyers Title Company,
Incorporated, t/a Beneficial
Settlement Services, Incorporated,
t/a Choice Settlement Services,
Incorporated; MID-ATLANTIC TITLE &
ESCROW SERVICES, INCORPORATED;
HILL MANAGEMENT & INVESTMENT,
LIMITED; INWOOD CENTER
ASSOCIATES; SYLVAN GROVE WASTE
TREATMENT, INCORPORATED,
Debtors.
OLD REPUBLIC NATIONAL TITLE
INSURANCE COMPANY; CHEMICAL
No. 97-2402
RESIDENTIAL MORTGAGE COMPANY,
Plaintiffs-Appellees,
and
MORTGAGE ACCESS CORPORATION,
Plaintiff,
v.
ROBERT O. TYLER, Trustee,
Defendant-Appellant,
and
RICHARD S. MENDELSON; MID-
ATLANTIC TITLE & ESCROW SERVICES,
INCORPORATED; BURKE & HERBERT
BANK & TRUST COMPANY,
Defendants.
Appeal from the United States District Court
for the Eastern District of Virginia, at Alexandria.
Claude M. Hilton, Chief District Judge.
(CA-97-976-A, BK-96-10873-DOT, AP-96-1083)
Argued: June 5, 1998
Decided: September 24, 1998
Before MURNAGHAN and MICHAEL, Circuit Judges, and
BUTZNER, Senior Circuit Judge.
_________________________________________________________________
Affirmed by published opinion. Judge Murnaghan wrote the opinion,
in which Judge Michael and Senior Judge Butzner joined.
_________________________________________________________________
COUNSEL
ARGUED: Robert Terrence Ney, MCGUIRE, WOODS, BATTLE &
BOOTHE, L.L.P., McLean, Virginia, for Appellant. Brian F. Kenney,
MILES & STOCKBRIDGE, P.C., McLean, Virginia, for Appellees.
ON BRIEF: James M. Lewis, Robert R. Vieth, MCGUIRE,
WOODS, BATTLE & BOOTHE, L.L.P., McLean, Virginia; Made-
line A. Trainor, TYLER, BARTL, BURKE & ALBERT, Alexandria,
Virginia, for Appellant. David J. Ervin, MILES & STOCKBRIDGE,
P.C., McLean, Virginia, for Appellees.
_________________________________________________________________
OPINION
MURNAGHAN, Circuit Judge:
Appellant, bankruptcy trustee Robert O. Tyler (Trustee), appeals
the district court's grant of summary judgment to the Appellees, Old
Republic National Title Insurance Co. (Old Republic) and Chemical
Residential Mortgage Co. (Chemical), in an adversary proceeding
commenced by those parties to recover from the bankruptcy estate
2
funds they claim were misappropriated by the debtor. Because we
agree that summary judgment was proper, we affirm.
I.
The debtor, Thomas H. Dameron, is a former member of the Vir-
ginia bar who conducted residential real estate settlements through his
company, Mid-Atlantic Title & Escrow Services, Inc. (Mid-Atlantic).
In the course of that business, Dameron received funds from various
lenders to be held for disbursement to designated third parties follow-
ing closings. Dameron held such funds in his general corporate
account at Burke & Herbert Bank & Trust Co. (B&H).
Four transactions conducted by Dameron are relevant to this
appeal. On January 25, 1996, Dameron received $71,475.40 from
Shelter Mortgage Corp. (Shelter) for use in the Browning settlement.1
Four days later, Dameron received $41,619.20 from Mortgage Access
Corp. (Mortgage Access) for use in the Hedayaty settlement and
$180,749.82 from Chemical for use in the Ruffin settlement.2 Finally,
on January 31, 1996, Dameron received another $164,807.10 from
Chemical for use in the Abercrombie settlement. 3
Early in 1996, the Virginia State Bar received information indicat-
ing that Dameron was misappropriating settlement funds. The State
Bar commenced an action against Dameron in the Circuit Court for
the City of Alexandria, Virginia, and the court appointed a receiver
for Dameron and froze his personal and corporate assets, including
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1 Shelter's closing instructions to Dameron stated as follows: "Settle-
ment of this loan is to be completed in FULL ACCORDANCE with
these instructions. . . . If any of the aforementioned conditions cannot be
met, you may NOT settle the loan or disburse our closing funds."
2 Mortgage Access's closing instructions to Dameron stated as follows:
"NO FUNDS MAY BE DISBURSED UNTIL ALL CLOSING CONDI-
TIONS HAVE BEEN COMPLIED WITH." Chemical's instructions
stated similarly: "You may not cash, deposit or disburse our funds until
you have fully complied with all instructions."
3 Chemical's closing instructions stated as follows: "You may not cash,
deposit or disburse our funds until you have fully complied with all
instructions."
3
his account at B&H. On February 23, 1996, various individual
claimants4 (collectively, Lenders) filed an involuntary Chapter 11
petition against Dameron and Mid-Atlantic, claiming to be creditors
in the amount of $458,652, and commenced an adversary proceeding
to recover their share of Dameron's frozen account. As of the petition
date, the account contained $453,338.47.
In the consolidated adversary proceeding, the Lenders moved for
summary judgment and the Trustee filed a cross-motion for summary
judgment. The bankruptcy court, Judge Tice, denied the Trustee's
motion but granted the Lenders' motion on the grounds that they are
entitled to an express or constructive trust over their share of
Dameron's bank account. The Trustee appealed that decision to the
district court, which affirmed the grant of summary judgment to the
Lenders. This appeal followed.
II.
The Trustee contends that the district court erred in granting sum-
mary judgment to the Lenders on the ground that they were entitled
to an express or constructive trust over a portion of Dameron's bank
account. We review de novo the district court's decision to grant sum-
mary judgment to the Lenders. See M&M Med. Supplies & Servs. v.
Pleasant Valley Hosp., Inc., 981 F.2d 160, 163 (4th Cir. 1992) (en
banc). Summary judgment is appropriate only if there is no genuine
issue of material fact and the moving party is entitled to judgment as
a matter of law. See Fed. R. Civ. P. 56(c); M&M, 981 F.2d at 162-63.
Under the Bankruptcy Code, a trustee is entitled to distribute all
property within the scope of the bankruptcy estate. The Code defines
the scope of such property broadly, including within the estate "all
legal or equitable interests of the debtor in property as of the com-
mencement of the case." 11 U.S.C. § 541(a)(1). Expressly excluded
from the estate is any "[p]roperty in which the debtor holds, as of the
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4 Old Republic issued insured closing letters to Chemical, Shelter, and
Mortgage Access in connection with the four settlements at issue. When
called upon to do so, Old Republic paid Shelter and Mortgage Access --
but not Chemical -- for their losses and thereby became subrogated to
their rights in the funds.
4
commencement of the case, only legal title and not an equitable inter-
est . . . ." 11 U.S.C. § 541(d). We have previously explained that the
purpose of § 541(d)'s exclusion is to ensure that the trustee "take no
greater rights [in the property] than the debtor himself had." Mid-
Atlantic Supply, Inc. v. Three Rivers Aluminum Co. , 790 F.2d 1121,
1124 (4th Cir. 1986) (quoting S. Rep. No. 989, 95th Cong., 2d Sess.
82, reprinted in 1978 U.S.C.C.A.N. 5787, 5868). Therefore, when a
"debtor does not own an equitable interest in property he holds in
trust for another, that interest is not ``property of the estate'" for pur-
poses of the Bankruptcy Code. Begier v. IRS, 496 U.S. 53, 59 (1990).
Our consideration of what constitutes an "equitable interest" sub-
ject to exclusion from the bankruptcy estate under§ 541(d) is a ques-
tion of state law. See Butner v. United States , 440 U.S. 48, 55 (1979)
("Property interests are created and defined by state law . . . [u]nless
some federal interest requires a different result . . . ."); Barnhill v.
Johnson, 503 U.S. 393, 398 (1992) ("In the absence of any controlling
federal law, ``property' and ``interests in property' are creatures of state
law."); American Bankers Ins. Co. v. Maness , 101 F.3d 358, 363 (4th
Cir. 1996) ("[W]hile federal law creates the bankruptcy estate, Butner
and the cases following it establish that state law, absent a counter-
vailing federal interest, determines whether a given property falls
within this federal framework."). Therefore, in the present case, we
must first decide whether, in light of Virginia law, the Lenders are
entitled to a trust over some portion of Dameron's account.
Virginia law recognizes three basic forms of trust. See Leonard v.
Counts, 272 S.E.2d 190, 194-95 (Va. 1980) (discussing express, con-
structive, and resulting trusts). Of these, the two that are potentially
relevant to the instant case are the express (or actual) trust and the
constructive trust. An express trust is created when the parties affir-
matively manifest an intention that certain property be held in trust
for the benefit of a third party. See Peal v. Luther, 97 S.E.2d 668, 669
(Va. 1957); Broaddus v. Gresham, 26 S.E.2d 33, 35 (Va. 1943). An
express trust may be created "without the use of technical words."
Broaddus, 26 S.E.2d at 35. All that is necessary are words, see id. at
35 (citation omitted), or circumstances, see Woods v. Stull, 30 S.E.2d
675, 682 (Va. 1944) (citation omitted), "which unequivocally show an
intention that the legal estate was vested in one person, to be held in
some manner or for some purpose on behalf of another. . .,"
5
Broaddus, 26 S.E.2d at 35; see also Schloss v. Powell, 93 F.2d 518,
519 (4th Cir. 1938). In contrast to an express trust, a constructive trust
"arise[s] by operation of law, independently of the intention of the
parties . . . ." Crestar Bank v. Williams, 462 S.E.2d 333, 335 (Va.
1995) (citation omitted). Such trusts "occur not only where the prop-
erty has been acquired by a fraud or improper means, but also where
it has been fairly and properly acquired, but it is contrary to the prin-
ciples of equity that it should be retained . . . ." Leonard, 272 S.E.2d
at 194-95 (citation omitted). With either form of trust, Virginia law
recognizes the beneficiary as "equitable owner of the trust property."
Broaddus, 26 S.E.2d at 36 (quoting Austin W. Scott, Scott on Trusts
§ 12.1, at 86).
In the case at bar, the Lenders maintain that the parties created an
express trust in Dameron to hold the Lenders' funds for the benefit
of specified third parties. They point out that, pursuant to the plain
language of their closing instructions, Dameron was to hold the funds,
essentially as an escrow, for disbursement after closing. That arrange-
ment, they contend, is the very definition of an express trust.
We agree. The language of the parties' agreements and the circum-
stances under which the Lenders advanced their funds to Dameron
leave no doubt that the parties intended Dameron to act merely as an
intermediary. There was plainly no expectation that Dameron would
keep the Lenders' funds after closing or that he would develop any
equitable interest in the funds. In fact, under Virginia law, a trust fidu-
ciary is prohibited from acquiring an equitable interest in trust prop-
erty adverse to his principal. See Greenspan v. Osheroff, 351 S.E.2d
28, 37 (Va. 1986) ("It is well settled that where one person sustains
a fiduciary relation to another he can not acquire an interest in the
subject matter of the relationship adverse to such other party.") (quot-
ing Horne v. Holley, 188 S.E.2d 169, 172 (Va. 1936)). Therefore,
under Virginia law and the law of trusts generally, we have no doubt
that an express trust was created. See Restatement (Second) of Trusts
§ 32 cmt. d. ("Where the owner of property delivers in escrow the
subject matter or instrument of transfer, manifesting an intention that
upon the happening of a certain event the depositee should deliver the
subject matter or the instrument to a third person as trustee, and the
owner does not reserve a power of revocation, a trust is created at the
time of the delivery in escrow."). In light of that conclusion and the
6
plain language of § 541(d), the district court was correct to hold that
the Lenders' funds are beyond the reach of the bankruptcy estate. See
United States v. Whiting Pools, Inc., 462 U.S. 198, 205 n.10 (1983)
("We note . . . that Congress plainly excluded[from the bankruptcy
estate] property of others held by the debtor in trust at the time of the
filing of the petition."); In re Omegas Group, Inc., 16 F.3d 1443,
1449 (6th Cir. 1994) ("A debtor that served prior to bankruptcy as
trustee of an express trust generally has no right to the assets kept in
trust . . . ."); Gulf Petroleum v. Collazo , 316 F.2d 257, 261 (1st Cir.
1963) ("Courts of bankruptcy recognize that money held in escrow is
not property which vests in the trustee . . . since the bankrupt in such
a case, and subsequently his trustee, is to be regarded as holding the
so-called escrowed funds in trust under the terms of the agreement
and not for the general creditors . . . ."); American Service Co. v.
Henderson, 120 F.2d 525, 530 (4th Cir. 1941) ("The rule is elemen-
tary that a trustee . . . succeeds to only the title and rights in property
that the particular debtor had . . . .).5
The Trustee argues that the intended beneficiaries, rather than the
trustors, are the proper plaintiffs to sue for disgorgement of the trust
property. We disagree. An escrow arrangement, like all express trusts,
is a contractual relationship, in which disbursement by the trustee is
conditioned upon the happening of a specified occurrence. See
Winslow, Inc. v. Scaife, 254 S.E.2d 58, 60 (Va. 1979) ("The deposi-
tory of an escrow is, in fact, the agent of both parties. As the agent
of the grantor it is his business to withhold the[trust property] until
the condition is performed; as the agent of the grantee it is his busi-
ness to hold it for him and to deliver it to him after the condition is
performed.") (citation omitted). It is, therefore, elementary that when
trust conditions are not satisfied the trustee has a duty to return the
property to the trustor. See Gulf Petroleum, 316 F.2d at 261 ("[The
trustee] must be held to have received the [funds] in trust and to have
assumed the fiduciary duty of holding them intact and returning them
to [the trustor] if, as happened, the closing under the contract was pre-
vented from taking place . . . .") (citations omitted). In the present
_________________________________________________________________
5 Because we conclude that the parties intended to create an express
trust, we have no occasion to address the district court's alternative hold-
ing that the Lenders are entitled to recover under a theory of constructive
trust.
7
case, the parties' agreements expressly provided that disbursement of
the Lenders' funds was authorized only if all conditions of settlement
were satisfied. Because those conditions were not met, Dameron had
a fiduciary duty to return the trust property to the Lenders.6
In light of the discussion thus far, the sole remaining issue is
whether the Lenders can adequately trace their assets into Dameron's
frozen bank account. Ordinarily, a party claiming entitlement to a
trust must be able to trace its assets into the fund or property that is
the subject of the trust. See In re United Cigar Stores Co., 70 F.2d
313, 316 (2d Cir. 1934) (citations omitted) ("There can be no recov-
ery . . . where all that can be shown is enrichment of the trustee. [The
trust property] must be clearly traced and identified in specific prop-
erty."). Although this Court has not previously addressed the issue,
other courts have held, and we agree, that tracing is an issue of federal
rather than state law. See Conn. Gen. Life Ins. v. Universal Ins. Co.,
838 F.2d 612, 618-19 (1st Cir. 1988) ("[B]ecause it pertains to distri-
bution of assets from an entity in federal bankruptcy proceedings,
[tracing] is exclusively a question of federal law."); Matter of Ken-
nedy & Cohen, Inc., 612 963, 966 (5th Cir. 1980) (same).
In the present case, the Trustee argues that tracing is impossible,
since it is undisputed that Dameron commingled the Lenders' funds
in his general corporate account. We find that argument to be without
merit, since courts have consistently rejected the notion that commin-
gling of trust property, without more, is sufficient to defeat tracing.
See, e.g., Chiu v. Wong, 16 F.3d 306, 310 (8th Cir. 1994); Conn. Gen.
Life, 838 F.2d at 619. In cases where the trust property has been com-
mingled, courts resolve the issue with reference to the so-called "low-
est intermediate balance" rule, see Schuyler v. Littlefield, 232 U.S.
707 (1914); Cunningham v. Brown, 265 U.S. 1 (1924); Conn. Gen.
Life, 838 F.2d at 619 (citing 4 Collier on Bankruptcy 541-77 (L. King
15th ed. 1987)); 5 A. Scott & W. Fratcher, The Law of Trusts 634-36
(4th ed. 1989); Restatement (Second) of Trusts § 202 cmt. j (1959),
which is grounded in the fiction that, when faced with the need to
withdraw funds from a commingled account, the trustee withdraws
_________________________________________________________________
6 Of course, to prevent double recovery, the Lenders must now relin-
quish any deeds of trust they received over the subject properties in
return for their loans.
8
non-trust funds first, thus maintaining as much of the trust's funds as
possible. Hence, pursuant to the lowest intermediate balance rule, if
the amount on deposit in the commingled fund has at all times
equaled or exceeded the amount of the trust, the trust's funds will be
returned in their full amount. See Conn. Gen. Life, 838 F.2d at 619.
Conversely, if the commingled fund has been depleted entirely, the
trust is considered lost. See id. Finally, if the commingled fund has
been reduced "below the level of the trust fund but not depleted, the
claimant is entitled to the lowest intermediate balance in the account."
Id.; Cunningham, 265 U.S. at 12. In no case is the trust permitted to
be replenished by deposits made subsequent to the lowest intermedi-
ate balance. See Conn. Gen. Life, 838 F.2d at 619.
In the present case, at the time of the bankruptcy filing, the balance
of Dameron's account was $453,338.47. The Lenders claim entitle-
ment to a trust in the amount of $458,651.52. Because the account has
been reduced below that amount but not depleted entirely, the Lend-
ers are entitled to the lowest intermediate balance, without the benefit
of any deposits made after such balance was reached.
Based on the uncontroverted affidavit of Charles P. Cocke, a Certi-
fied Public Account, the district court accepted the following facts
with regards to Dameron's account:
1. On January 25, 1996, Shelter7 deposited $71,475.40 into
the account for the Browning settlement. By January
29, 1996, various unrelated withdrawals created a defi-
cit in the account in the amount of $5,313.05. Because
Shelter was the only lender with funds then in the
account, the court presumed, based on the lowest inter-
mediate balance rule, that the withdrawals depleted
Dameron's own funds first and that Shelter's funds
were withdrawn only to the extent necessary to cover
any remaining deficit. Therefore, Shelter's funds were
reduced by $5,313.05, leaving Shelter with a lowest
intermediate balance of $66,162.35.
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7 Recall that Old Republic has been substituted in these proceedings for
Shelter and Mortgage Access.
9
2. On January 29, 1996, Mortgage Access transferred into
the account $41,619.20 for the Hedayaty Settlement.
Because those funds were subjected to no subsequent
withdrawals, Mortgage Access has a lowest intermedi-
ate balance of $41,619.20.
3. On January 29, 1996, Chemical transferred into the
account $180,749.82 for the Ruffin Settlement. Chemi-
cal later transferred another $164,807.10 in connection
with the Abercrombie Settlement. Because the account
was subjected to no subsequent withdrawals, Chemi-
cal's lowest intermediate balance is $345,556.92.
In the lower courts, the Trustee presented no affidavits to contradict
Cocke's analysis. Therefore, because no genuine issue of material fact
remains, summary judgment was appropriately granted to the Lend-
ers.
The judgment of the district court is, therefore,
AFFIRMED.
10