Brown v. Coleman

Decision Date20 December 1989
Citation318 Md. 56,566 A.2d 1091
PartiesEllyn L. BROWN et al. v. David COLEMAN et al. 70 Sept. Term 1988.
CourtMaryland Court of Appeals

T. Webster Brenner, Asst. Atty. Gen. (J. Joseph Curran, Jr., Atty. Gen., both on brief), Baltimore, for appellants.

Janet A. Bradley (William S. Rose, Jr., Asst. Atty. Gen., Gary R. Allen, William S. Estabrook, all on brief), Washington, D.C., for appellees.

Argued before MURPHY, C.J., and ELDRIDGE, COLE, RODOWSKY, McAULIFF, ADKINS and BLACKWELL, JJ.

ELDRIDGE, Judge.

This case involves competing claims of the United States and the victims of a fraudulent investment scheme for the proceeds from a liquidation sale of the defrauder's assets. The United States asserts that a federal statute entitles its claim to priority. The investors assert that the proceeds are their property because they have sufficiently traced their investments into those proceeds.

I.

David Coleman was the owner of Data Video Concepts, Inc., a Delaware corporation qualified to do business in Maryland, trading under the name of Computer Concepts. Computer Concepts operated several retail outlets for home video equipment, home rental movies, personal computers, and other equipment.

David Coleman was also the president and chief executive officer of Coleman and Associates, an unincorporated business entity which purported to offer financial planning services to the public. From at least January 1, 1983, until July 25, 1983, Coleman and a co-conspirator operated a scheme that resulted in defrauding unknowing investors of more than 1.6 million dollars. Coleman issued "Promissory Notes" and "Certificates of Investment" in non-existent investment opportunities and guaranteed returns as high as 40% over a three month period. The companies in which the investments were to be made often did not exist, and, when they existed, they had not authorized Coleman to act on their behalf. Coleman took money from early investors and paid some of these investors with funds acquired from later investors. These early payments were made to give the appearance of legitimacy to the investment opportunity and fuel Coleman's scheme, commonly known as a "pyramid" or "Ponzi" scheme.

The certificates and notes issued by Coleman were investment contracts, which are required to be registered with the Securities Commissioner of Maryland. See Maryland Code (1975, 1985 Repl.Vol., 1989 Cum.Supp.), §§ 11-101(p)(xi) and 11-501(1) of the Corporations and Associations Article. Coleman did not register them. Learning of Coleman's activity, the Securities Commissioner issued letters to him and to his co-conspirator regarding possible violations of the Maryland Securities Act. On June 30, 1983, the Commissioner issued a subpoena duces tecum and a show cause order.

On July 5, 1983, Coleman fled the state. Using what were described as "large sums of money," Coleman "gambled heavily," placing "large bets" at racetracks in Pennsylvania, New Jersey, and New York. On July 12, 1983, as many of the investments were maturing and coming due, management of Coleman's Computer Concepts stores closed operations because it could not meet the payroll demand. Coleman subsequently returned to the state.

The Commissioner filed a complaint in the Circuit Court for Baltimore County on July 25, 1983, pursuant to Code (1975, 1985 Repl.Vol., 1989 Cum.Supp.), § 11-702 of the Corporations and Associations Article, on behalf of all defrauded investors, seeking, inter alia, to enjoin Coleman from engaging in any further fraudulent securities violations and to establish a receivership for Coleman and Associates.

On August 16, 1983, the court issued an order enjoining Coleman from engaging in fraudulent acts and appointing a permanent receiver for all of the "funds, securities, bank accounts and other assets and property of, belonging to, or in the possession of" Coleman and affiliated entities and persons. The receiver was appointed to preserve those assets "for the benefit of the injured Maryland residents who shall hereafter establish claims against" Coleman.

The court-appointed receiver, on August 16, 1983, proceeded to seize Coleman's assets, which included inventory and fixtures from the Computer Concepts stores and corporate headquarters, along with a Mercury Cougar automobile. The receiver sold the automobile to a used car dealer for $9,250.00. A liquidation sale of the inventory and fixtures grossed $235,512.76. Debited by costs of administration and credited by interest and a few further sales, the funds held by the receiver, as of September 1988, approximated $220,000.00.

The State filed a criminal information against Coleman in the Circuit Court for Baltimore County on April 18, 1984. On June 7, 1984, pursuant to a plea agreement, Coleman entered guilty pleas to one count charging securities fraud and one count charging the sale of an unregistered security. According to the statement of facts in support of the pleas, Coleman and his associate received approximately $2,368,762 in funds from approximately 243 investors, of which $670,444 was returned to some early investors. Another $70,890 was paid out in commissions to those who innocently solicited investments on Coleman's behalf. Thus, the profits from the scheme approximated $1,627,428.

A number of claims against the funds held by the receiver were made by, inter alia, business creditors and individuals claiming to have invested in Coleman's scheme. The record indicates that the court approved a total of 118 claims from defrauded investors, amounting to $1,167,429.31. The court also concluded that "as much as $200,000" in claims from business creditors was "properly chargeable" against funds held by the receiver.

From August 2, 1985, through October 10, 1985, the United States of America, Internal Revenue Service (IRS), filed in court four Proofs of Claim for taxes, the last of which asserted that Coleman owed the United States $911,556.03, including penalties and interest. This claim was based on income that should have been reported by Coleman, primarily on the basis that the monies he garnered through fraud constituted federal gross income under section 61 of the Internal Revenue Code, 26 U.S.C. § 61 (1982, Supp. V 1987). See James v. United States, 366 U.S. 213, 81 S.Ct. 1052, 6 L.Ed.2d 246 (1961) (embezzled funds constitute federal gross income, taxable to the embezzler in the year in which the funds are misappropriated); Cohen v. United States, 297 F.2d 760, 768-769 (9th Cir.), cert. denied, 369 U.S. 865, 82 S.Ct. 1029, 8 L.Ed.2d 84 (1962) (money secured by false representation that "lenders" would become part owners of various enterprises, where taxpayer never intended to repay "loans," constitutes taxable income).

The IRS asserted priority over any "distribution to creditors to the extent provided by law," basing its priority on the so-called "federal insolvency statute," 31 U.S.C. § 3713. This claim, far in excess of the funds held by the receiver, would, if granted priority, entirely deplete those funds. 1

On July 24, 1986, in an attempt to avoid what the State has characterized as an "unjust result," the Securities Commissioner, acting on behalf of the defrauded investors, filed in the action a "Motion for Declaration of Constructive Trust." The Commissioner argued that because David Coleman breached a fiduciary responsibility to the investors by committing a fraud upon them, the funds in the receivership were held in constructive trust for the benefit of the defrauded investors, and thus were not available to satisfy the IRS claim. 2

The IRS did not dispute that the investors were defrauded of their money. Rather, the IRS argued that, as a matter of Maryland law, the Commissioner had failed to satisfy the prerequisites for establishing a constructive trust.

The circuit court (Fader, J.), in a written order issued on January 22, 1988, denied the Commissioner's motion, holding that the Commissioner had failed to trace the interest of any investor to the purchase of inventory and fixtures later sold by the receiver. Thus, the IRS was entitled to a priority claim under 31 U.S.C. § 3713. 3

The Commissioner filed a timely notice of appeal from the circuit court's order. 4 Thereafter, this Court issued a writ of certiorari prior to argument in the Court of Special Appeals. The sole issue on appeal concerns the correctness of the circuit court's holding that the Commissioner failed to trace the interest of any investor to the purchase of assets later sold by the receiver and that, therefore, the United States claim was entitled to priority. None of the circuit court's other rulings are contested by any party.

II.

The assertion by the IRS that its claim has priority over other claims to the funds held by the receiver is grounded on the federal insolvency statute, 31 U.S.C. § 3713, which reads in relevant part as follows:

"s 3713. Priority of Government claims

(a)(1) A claim of the United States Government shall be paid first when--

(A) a person indebted to the Government is insolvent and--

(i) the debtor without enough property to pay all debts makes a voluntary assignment of property;

(ii) property of the debtor, if absent, is attached; or

(iii) an act of bankruptcy is committed...."

This statute, previously codified as 31 U.S.C. § 191, and often referred to as Revised Statutes § 3466 (1875), is derived without significant modification from Section 5 of the Act of March 3, 1797, c. 20, 1 Stat. 515 (1797). 5 See United States v. Moore, 423 U.S. 77, 81, 96 S.Ct. 310, 313, 46 L.Ed.2d 219 (1975); Weiprecht v. Ripple, 217 Md. 337, 347-348, 143 A.2d 62, 68 (1958); Mickelson v. Barnet, 390 Mass. 786, 793, 460 N.E.2d 566, 570 (1984); Back v. Internal Revenue Service, 51 Md.App. 681, 692, 445 A.2d 1057, 1064 (1982).

The federal insolvency statute "on its face permits of no exceptions whatsoever" and it "applies to all the insolvent's debts to the Government, whether or...

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