In re Foos

• Decision Date: 16 June 1995
• Docket Number: Bankruptcy No. 93 B 25069. Adv. No. 94 A 1168.
• Citation: 183 BR 149
• Court: U.S. Bankruptcy Court — Northern District of Illinois
• Parties: In re Saul FOOS, Debtor. BERGER, SHAPIRO & DAVIS, P.A., a Florida professional services corporation, Plaintiff, v. William HAELING; Saul Foos; Marc Michaels Interior Design, Inc., a Florida corporation; Addison Development Group, Inc., a Florida corporation; New Venture, a Florida joint venture; NGN, Inc., a Florida corporation; and EWI, Inc., a Florida corporation, Defendants.

183 B.R. 149 (1995)

In re Saul FOOS, Debtor BERGER, SHAPIRO & DAVIS, P.A., a Florida professional services corporation, Plaintiff, v. William HAELING; Saul Foos; Marc Michaels Interior Design, Inc., a Florida corporation; Addison Development Group, Inc., a Florida corporation; New Venture, a Florida joint venture; NGN, Inc., a Florida corporation; and EWI, Inc., a Florida corporation, Defendants.

Bankruptcy No. 93 B 25069. Adv. No. 94 A 1168.

United States Bankruptcy Court, N.D. Illinois, Eastern Division.

June 16, 1995.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

Daniel A. Zazove, Barbara L. Yong, Micah R. Krohn, Barbakoff, Zazove & Glick, Chtd., Chicago, IL, for trustee William Brandt, Jr.

Dean C. Harvalis, Asst. U.S. Trustee, Dept. of Justice, Chicago, IL, for U.S. Trustee.

Larry M. Wolfson, Jenner & Block, Chicago, IL, for Saul Foos, debtor-co-defendant.

George Collins, Collins & Bargione, Chicago, IL, for William Haeling, defendant.

Thomas L. Abrams, Kenneth W. Shapiro, Berger, Shapiro & Davis, Ft. Lauderdale, FL, Janie Locke Anderson, Miami, FL, Barry A. Chatz, Kamensky & Rubinstein, Lincolnwood, IL, David E. Springer, Steven E. Boyce, Skadden, Arps, Slate, Meagher & Flom, Chicago, IL, for plaintiff.

MEMORANDUM OPINION

RONALD BARLIANT, Bankruptcy Judge.

I. INTRODUCTION

The Debtor, Saul Foos, ran a "Ponzi scheme" with considerable success until its inevitable collapse resulted in this involuntary chapter 7 bankruptcy case. This adversary proceeding is an interpleader action to determine the entitlement to funds that are proceeds of one of the Debtor's deceits. The present motion is by Skadden, Arps, Slate, Meagher & Flom to intervene on the grounds that Skadden was the beneficiary of a constructive trust of which those funds constituted the res. Based on its constructive trust theory, Skadden claims an equitable interest in, and therefore a superior right to, the funds. But in this Court's view, a constructive trust (under both federal and Illinois law) is a remedy, not a real trust, that does not confer any property interest on the alleged "beneficiary" until a court has decreed that relief. A bankruptcy court may not grant that relief, at least on the facts here, even assuming that Skadden has alleged grounds for the imposition of a constructive trust. Because no pre-bankruptcy judgment imposed a constructive trust, Skadden has alleged no interest in the funds. Skadden's motion will therefore be denied.

II. JURISDICTION

This Court has jurisdiction pursuant to 28 U.S.C. § 1334(b) and General Rule 2.33(A) of the United States District Court for the Northern District of Illinois. This matter is a core proceeding under 28 U.S.C. § 157(b)(2)(A), (E), and (O).

III. SKADDEN'S ALLEGATIONS

"In evaluating a motion to intervene, the bankruptcy or district court must accept as true the non-conclusory allegations of the motion and the counterclaim." Lake Investors Dev. Group, Inc. v. Egidi Dev. Group, 715 F.2d 1256, 1258 (7th Cir.1983). Accordingly, Skadden's allegations (except its conclusions) are, for purposes of this motion, taken as the facts of the case.

Saul Foos has admitted defrauding dozens of people after earning their trust as a lawyer, agent, and advisor. This motion involves one of the Debtor's frauds. For legal services rendered, Janet McGrath executed a $270,000 promissory note in favor of Skadden. The note was secured by a mortgage on real property in New Jersey and Connecticut. By October 27, 1993, McGrath owed Skadden at least $351,417.52, including interest.

In order to reduce her obligation to Skadden, McGrath promised that she would turn over the proceeds from the first sale of her real property holdings. The Debtor, Mr. Foos, was McGrath's lawyer and agent in connection with her real estate holdings. In February 1993, McGrath sold property in New York and instructed the Debtor to pay the proceeds to Skadden. The Debtor did not do so. Instead, he deposited the sale proceeds in an account at an Illinois bank, where they were commingled with other funds.¹ To hide his diversion of the funds, the Debtor falsely told Skadden that the sale had not occurred. Skadden did not learn of the closing until after the commencement of this bankruptcy case in November 1993.

The Trustee provided Skadden with a schedule of payments the Debtor made from the bank account. These payments were made prior to the filing of the petition and prior to the time the Debtor's account had a zero balance. Among the payments were two, on November 8 and 12, 1993, totaling $157,000 to the Florida law firm of Berger, Shapiro & Davis, P.A., for the benefit of one of its clients, William Haeling. Skadden alleges that it can trace the sale proceeds that its client had instructed the Debtor to pay to Skadden to the payments to the Florida law firm.

IV. PROCEDURAL BACKGROUND

On November 24, 1993, the Florida law firm filed this interpleader action in a Florida state court to resolve competing claims to those funds by Mr. Haeling and others. Mr. Foos was one of the named defendants. On November 30, 1993, creditors of Mr. Foos filed an involuntary petition against him for relief under chapter 7 of the bankruptcy code. Shortly thereafter, with the Debtor's consent, this Court entered an order for relief under chapter 7. This Court approved the election of William A. Brandt as Trustee of the chapter 7 estate on March 2, 1994. Mr. Foos, therefore, has no further interest in this litigation. The ultimate question now is which of his innocent creditors will get the benefit of the disputed funds, Skadden alone or all the unsecured creditors.

On March 4, 1994, the Trustee filed a notice of removal with the United States Bankruptcy Court for the Southern District of Florida pursuant to 28 U.S.C. §§ 1334(b) and 1452(a) and Federal Rule of Bankruptcy Procedure 9027 to remove the interpleader action from the Florida state court to the Bankruptcy Court for the Southern District of Florida, and the interpleader action was removed. The Trustee then moved for a change of venue to this Court, which was granted on June 13, 1994. On February 6, 1995, Skadden filed the motion currently before the Court, seeking to intervene as a defendant in the interpleader adversary proceeding, to assert an answer to the complaint, and to file a counterclaim. It is in those pleadings that Skadden lays out its claim to sole entitlement to the funds. The Trustee opposes the motion, claiming the funds belong to the estate, to be distributed among all creditors.

V. ISSUES AND SUMMARY OF COURT'S CONCLUSIONS

It is Skadden's position that it, not the estate, owns the funds. Skadden maintains that the funds are the subject of a constructive trust. It claims that, as the "beneficiary" (i.e., the defrauded entity) of the constructive trust, it has a property interest in the "res" (i.e., the proceeds of the fraud), and that the "constructive trustee" (i.e., the perpetrator of the fraud or his successor in interest to the "res") has no more than a bare legal interest in that property. On this analysis, Skadden contends, this fund is excluded from the estate by virtue of § 541(d) of the bankruptcy code, which excludes from bankruptcy estates equitable interests in trust property in which the debtor has only a legal interest.

The Trustee, on the other hand, denies that this fund is the subject of a constructive trust. He argues that the imposition of a constructive trust would be contrary to the bankruptcy code's provisions for distribution of assets to unsecured creditors on an equitable basis. Awarding the funds to Skadden would obviously give it a greater proportionate return on its claim than other creditors would receive. Of course, Skadden says that it would only be getting its own property back, but the Trustee cites authorities that hold that constructive trusts have no place in bankruptcy and the property at issue is property of the estate. See, e.g., XL/Datacomp, Inc. v. Wilson (In re Omegas Group, Inc.), 16 F.3d 1443, 1452 (6th Cir.1994) ("Constructive trusts are anathema to the equities of bankruptcy since they take from the estate, and thus directly from competing creditors, not from the offending debtor").

This Court is persuaded by the insightful reasoning of the Sixth Circuit in In re Omegas Group and Professor Emily L. Sherwin in Constructive Trusts in Bankruptcy, 1989 U.ILL.L.REV. 297 (hereinafter "Sherwin"). These authorities (and others cited below) demonstrate that a "constructive trust" is a remedy for unjust enrichment, not a real trust. Therefore, the existence of grounds for imposition of a constructive trust does not lead to the conclusion that the "beneficiary" has an equitable, or any other, interest in the property; rather, the "beneficiary" has a particular remedy for a legal wrong. If that remedy is granted, then the "beneficiary" has a right to immediate possession and ownership of the "res." See Suttles v. Vogel, 126 Ill.2d 186, 193, 127 Ill. Dec. 819, 822, 533 N.E.2d 901, 904 (1988) ("The sole duty of the constructive trustee is to transfer title and possession of the wrongfully acquired property to the beneficiary"). But in a bankruptcy case filed before another court has imposed a constructive trust, the "beneficiary" is merely an unsecured creditor, with no interest in the disputed property.

Moreover, Denial of Skadden's motion is compelled by Illinois law, which is applicable here.² The Illinois Supreme Court has treated constructive trust as a remedy, not a trust. See Suttles, 126 Ill.2d at 193, 127 Ill.Dec. at 821, 533 N.E.2d at 904 ("A constructive trust is created when a court declares the party in possession of wrongfully acquired property as the constructive trustee of that property"); Washburn v. Dyson (In re Security Casualty Co.), 127 Ill.2d 434, 447, 130 Ill.Dec. 446, 452-53, 537 N.E.2d 775, 781-82 (1989) ("A constructive trust is an equitable remedy imposed by a court to prevent the unjust...