First Federal of Michigan v. Barrow

• Decision Date: 16 June 1989
• Docket Number: 87-1402 and 87-1414,Nos. 86-1855,s. 86-1855
• Citation: 878 F.2d 912
• Parties: , Bankr. L. Rep. P 72,985 FIRST FEDERAL OF MICHIGAN, City of Detroit, et al., Defendants, City of Detroit (86-1855/87-1402), Manufacturers National Bank of Detroit (87-1414), Defendants-Appellants, v. Thomas J. BARROW, Trustee, Plaintiff-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 912

878 F.2d 912

14 Fed.R.Serv.3d 899, Bankr. L. Rep. P 72,985

FIRST FEDERAL OF MICHIGAN, City of Detroit, et al., Defendants City of Detroit (86-1855/87-1402), Manufacturers National Bank of Detroit (87-1414), Defendants-Appellants, v. Thomas J. BARROW, Trustee, Plaintiff-Appellee.

Nos. 86-1855, 87-1402 and 87-1414.

United States Court of Appeals Sixth Circuit.

Argued March 1, 1988.

Decided June 16, 1989.

Peter W. Macuga, Mary Richman (argued), City of Detroit Law Dept., Michael D. Boutell, Michael R. Main, Detroit Mich., for defendants-appellants.

Thomas J. Barrow, Detroit, Mich., pro se.

Wright W. Blake, Detroit, Mich., John B. Kemp (argued), Francis C. Flood, James C. Steffl, Kemp, Klein, Endelman & Beer, Birmingham, Mich., for plaintiff-appellee.

Before ENGEL, Chief Judge ^*; and MERRITT and KRUPANSKY, Circuit Judges.

KRUPANSKY, Circuit Judge.

Defendants-appellants, ¹ two certified classes of creditors, appealed from the district court's decision affirming the bankruptcy court's determination which mandated the repayment of certain avoidable preferential transfers to the bankrupt estate in this proceeding commenced by Thomas J. Barrow (Trustee), the trustee of the bankruptcy estate, to recover such payments. The record disclosed the following facts.

Salem Mortgage Company, Fidelity Fund, Inc., Fidelity Securities Corp., Nationwide Mortgage Co., Inc., and Mutual Mortgage Company (collectively referred to as debtors), were individual corporations engaged in the business of mortgage investments. Joseph Steingold (Steingold) was the principal shareholder and chief operating officer of each corporation. For purposes of this appeal, the businesses of the debtor corporations are considered collectively as a single enterprise with Steingold, its motivating force, acting through his principal alter ego Salem Mortgage Company (Salem) at the hub of the operation.

The underlying concept of the enterprise was simply to match interested property owners and available lenders for the purpose of arranging or coordinating a loan between the parties evidenced by a personal note secured by a real estate mortgage which was, pursuant to a collateral agreement with the investor, to be serviced by Salem for a fee based upon the amount of the monthly mortgage payment.

Ostensibly, interested property owners, upon being matched with interested lenders/investors by a debtor corporation, would execute a personal note secured by a real estate mortgage to the debtor corporation which would assign the note and mortgage to the appropriate investor who funded the loan. Pursuant to a loan servicing agreement contemporaneously executed by the investor, Salem would collect the monthly installment mortgage payments including the principal and interest payable on the note, 1/12 of the annual hazard insurance premium, 1/12 of the annual property taxes, 1/12 of any accrued annual property assessment, together with accrued "wrap around" payments against a first mortgage if one existed. The monthly mortgage receipts were purportedly segregated and deposited into individual escrow accounts from which disbursements were to be allocated and paid to the appropriate principal, i.e., taxing authority, insurance carrier, first mortgagee, if any, and the appropriate investor at designated regular intervals after deduction of the service charge.

In reality, however, at least from early 1982, when debtors' cash flow became critical, to the date of the bankruptcy proceedings, the debtors' modus operandi experienced calculated radical changes. The concept of depositing mortgage receipts into segregated bank accounts, from which disbursements were made to appropriate principals, was abandoned. Thereafter, all monies received by the debtors, including investor loan advances, mortgage payments, rental payments, and debtor cash receipts from a variety of miscellaneous sources were deposited and commingled in a Salem zero balance Depository Account. ² The commingled funds in the Depository Account were, on a daily basis, automatically transferred into the Salem Mortgage Company Central Account (Central Account) where the newly deposited funds were again commingled with existing cash balances in that central account. The Central Account was the reservoir from which funds were automatically transferred into various other Salem zero balance checking accounts, including but not limited to the Servicing Account, Mortgage Account, and Payroll Account, to honor payment of any checks that had been written on any of those accounts. Accordingly, at the end of each business day, Salem's Depository Account, its Servicing Account, its Mortgage Account, its Payroll Account, and all similar accounts were zero balanced.

As Salem's cash flow became progressively more precarious in late 1982 and early 1983, immediately preliminary to its bankruptcy proceedings, the reservoir Salem Central Account consistently reflected five figure negative balances as a result of cascading cash demands and overdrafts. As a result, sums deposited into that account from whatever source continued to be commingled and suffered an irretrievable loss of identity since the available cash balances in the consistently overdrawn Central Account at any given time were used to honor outstanding checks issued to satisfy obligations incurred during previous days, weeks, or months. The record further disclosed that for at least ninety days immediately preceding the March 30, 1983 filing date of the petition for bankruptcy, and probably for some time prior thereto, Salem, motivated by its self interest, was disbursing its commingled funds from the Central Account to certain favored creditors and appellants herein on behalf of selective investors.

The debtors filed a petition for Chapter 11 reorganization in the Bankruptcy Court for the Eastern District of Michigan on March 30, 1983. On August 4, 1984, the trustee commenced the present action to recover funds paid to investors, first mortgage holders, taxing authorities, insurance carriers and insurance agencies within ninety days prior to the filing of the petition, pursuant to Bankruptcy Rule 7023. ³

On September 16, 1985, subsequent to oral arguments on the cross motions of the parties for summary judgment, the Bankruptcy Court concluded that the payments here at issue were avoidable preferential transfers within the dictates of 11 U.S.C. Sec. 547(a) and therefore subject to recovery by the trustee pursuant to 11 U.S.C. Sec. 550(a).

Thereafter, the insurance companies and insurance agencies negotiated a settlement of the trustee's claims and the taxing authorities and first mortgage holders pursued a timely appeal to the United States District Court for the Eastern District of Michigan. The appellants collectively charged that the district court erred in concluding that the payment of accrued taxes and mortgage payments were avoidable preferences because the payments were made from funds collected by virtue of Salem's servicing contracts with its investors that were held in constructive trust for disbursement to appropriate beneficiaries, i.e. first mortgagees and taxing authorities; that the transfers were not made for or on account of an antecedent debt owed by Salem; that the transfers did not enable the appellants to receive more than similarly situated creditors would have received had the case proceeded pursuant to Chapter 7 of this title; and that the payments were not exempted preferences authorized within the ordinary course of business exception of 11 U.S.C. Sec. 547(c)(2).

Initially, it is noted that the predicate for the trust doctrine as applied in bankruptcy is a perpetuated integrity of the trust properties so as to avoid conflict with and between creditor classes; consequently, this court's attention is directed to 4 L. King Collier on Bankruptcy, p 541.13, at 541-78--541-79 (15th ed. 1988) wherein the doctrine, as applied within the majority of the circuits, is discussed:

Once the trust relationship has been established, one claiming as a cestui que trust thereunder must identify the trust fund or property in the estate, and, if such fund or property has been mingled with the general property of the debtor, sufficiently trace the trust property. If the trust fund or property cannot be identified in its original or substituted form, the cestui becomes merely a general creditor of the estate.

Id. (footnotes omitted).

Accordingly, having asserted a constructive trust of which they were beneficiaries, the appellants assumed the burden of identifying the sums of their entitlements by tracing the trust funds through Salem's commingled accounts. It is equally clear that the Bankruptcy Act of 1978 explicitly defined the order of creditor priority and declared the congressional intent of federal supremacy over declared but conflicting state law orders of priority. See, e.g., Danning v. Bozek (In re Bullion Reserve of North America), 836 F.2d 1214 (9th Cir.), cert. denied, --- U.S. ----, 108 S.Ct. 2824, 100 L.Ed.2d 925 (1988); In re Kennedy & Cohen, Inc., 612 F.2d 963 (5th Cir.), cert. denied, 449 U.S. 833, 66 L.Ed.2d 38 (1980); Gulf Petroleum v. Collazo, 316 F.2d 257 (1st Cir.1963); Elliott v. Bumb, 356 F.2d 749 (9th Cir.), cert. denied, 385 U.S. 829, 87 S.Ct. 67, 17 L.Ed.2d 66 (1966).

To support their constructive trust theory of recovery and to avoid their burden of tracing the controversial payments received from the commingled Salem Central Account immediately prior to commencement of the bankruptcy proceedings, the appellants have relied primarily upon this circuit's pronouncements in Selby v. Ford Motor Company, 590 F.2d 642 (6th Cir.1979). Appellants' argument is misplaced and Selby is easily distinguished from the instant case in that "tracing" within the context of "commingled funds" was not an issue that was joined, addressed, considered, or discussed in that disposition. It is beyond peradventure that, as a...