In re Richmond Children's Center, Inc., Bankruptcy No. 83 B 20300.

• Decision Date: 14 May 1985
• Docket Number: Bankruptcy No. 83 B 20300.
• Parties: In re RICHMOND CHILDREN'S CENTER, INC., Debtor.
• Court: U.S. District Court — Southern District of New York

49 B.R. 262 (1985)

In re RICHMOND CHILDREN'S CENTER, INC., Debtor.

Bankruptcy No. 83 B 20300.

United States District Court, S.D. New York.

May 14, 1985.

Zane and Rudofsky, New York City, for Debtor; Edward S. Rudofsky and Morris Sutton, New York City, of counsel.

Anderson, Banks, Moore & Hollis, Mount Kisco, for Yonkers Public Schools; Maurice F. Curran, and Lawrence W. Thomas, Mount Kisco, N.Y., of counsel.

Finkel, Goldstein & Berzow, New York City, for Official Creditors' Committee; Kevin J. Nash, New York City, of counsel.

DECISION ON MOTION FOR TURNOVER OF FUNDS

HOWARD SCHWARTZBERG, Bankruptcy Judge.

The City of Yonkers (the "City"), a creditor in this Chapter 11 case, seeks an order directing the debtor-in-possession, Richmond Children's Center, Inc. ("Richmond"), to turn over $141,499.65 to the City for the reason that these funds are subject to a constructive trust and therefore are beyond the pale of the debtor's estate as defined by 11 U.S.C. § 541. Richmond is an intermediate child care facility for the developmentally disabled. One child care service not rendered directly by Richmond is the education of its children which is provided by outside institutions specializing in this type of education. A state law, relied upon by the City in support of its trust claim, authorizes a child care facility, such as Richmond, to contract for educational services with the Board of Education of the school district in which the facility is located. The educational expenses incurred are reimbursed to the child care facility by the Education Department of New York State.

The dispute in this case concerns the sum of $141,499.65 which was paid by the New York State Education Department to Richmond on April 18, 1983, before the filing of the Chapter 11 petition, as reimbursement for costs of education provided by various Yonkers schools. The City contends that under the statutory reimbursement scheme, Richmond is merely a conduit through which the reimbursement funds are to be passed along to the City's schools. Thus, the argument runs, a turnover is warranted because Richmond never held more than bare legal title to the $141,499.65 as a fiduciary for the benefit of the City's schools.

FINDINGS OF FACT

1. Richmond Children's Center, Inc., a Chapter 11 debtor-in-possession, is an intermediate care facility for developmentally disabled children located in Yonkers, New York. Richmond does not educate its children, but contracts with the City of Yonkers Board of Education, as authorized by statute, to educate the children.

2. Pursuant to the New York State Education Law, the State Education Department reimburses Richmond for the costs of procuring educational services. As invoices are submitted to Richmond by the service-providing schools, a program director at Richmond reviews the bills for accuracy and verifies that the bills correspond with actual attendance records of the children.

3. Richmond and the Yonkers Board of Education entered into a contract, dated July 1, 1982, requiring the school board to furnish appropriate educational programs for the developmentally disabled children for the 1982-83 school year. The rate charged for the services was to be established by the City's statement of cost for each child, which required the parties' approval before becoming part of the contract. The agreement further states that "payments are subject to Richmond's reimbursement by the New York State Department of Education pursuant to Chapter 721 of the 1979 Laws of New York (6)(d)(3)."

4. In April, 1983, the New York State Education Department delivered to Richmond a check for $141,499.65 made payable to the order of Richmond Children's Center. A letter from the State to Richmond, dated April 18, 1983, explained the basis for the payment and stated that "this is a `pass-through' payment to the Yonkers P.S."

5. Richmond deposited the reimbursement funds into the Richmond Children's Center general checking account at the Bank of New York on May 2, 1983. This account contained other funds the debtor received from various governmental agencies upon which Richmond relies for financial support.

6. Richmond did not turn over the $141,499.65 to the City's schools to pay the invoices covering the 1982-83 school year. Instead, these funds were used to meet payroll and other expenses incurred in caring for the children.

7. On June 10, 1983, Richmond filed a petition under Chapter 11 of the Bankruptcy Code, 11 U.S.C. §§ 1101-1174. In its schedule of unsecured debts, Richmond listed the City of Yonkers as a creditor holding a general unsecured claim of $170,010.

DISCUSSION

JURISDICTION

Although not raised as an issue by the parties, the court notes preliminarily that this action to impose a constructive trust is not a "related to" proceeding within the meaning of 28 U.S.C. § 157(c)(1) so as to require entry of an order by the district court. This result obtained under the former Emergency Rule adopted in this district following the Supreme Court's decision in Northern Pipeline Construction Co. v. Marathon Pipe Line Co., 458 U.S. 50, 102 S.Ct. 2858, 73 L.Ed.2d 598 (1982), see Salomon v. Kaiser (In re Kaiser), 722 F.2d 1574, 1582 (2d Cir.1983), and continues in cases governed by the jurisdictional provisions of the Bankruptcy Amendments and Federal Judgeship Act of 1984. See Varon v. Salomon (In re Martin Fein & Co., Inc.), 43 B.R. 623, 629 n. 5 (Bkrtcy.S. D.N.Y.1984). That a constructive trust action may be asserted in a state court where such trusts are commonly imposed does not necessarily make the proceeding a "related to" case under the provisions relating to bankruptcy jurisdiction. Salomon v. Kaiser (In re Kaiser), 722 F.2d at 1582; see also 28 U.S.C. § 157(b)(3) ("A determination that a proceeding is not a core proceeding shall not be made solely on the basis that its resolution may be affected by State law.") The instant action for a constructive trust is akin to those "matters concerning the administration of the estate" and "proceedings affecting . . . the adjustment of the debtor-creditor . . . relationship" which are set forth as examples of core proceedings in which bankruptcy judges may enter dispositive orders and judgments.

CONSTRUCTIVE TRUST CLAIM

Section 541(a)(1) of the Bankruptcy Code defines the bankruptcy estate as "comprised of . . . all legal or equitable interests of the debtor in property as of the commencement of the case." 11 U.S.C. § 541(a)(1). Property in which the debtor holds "only legal title and not an equitable interest," 11 U.S.C. § 541(d), however, is beyond the scope of the estate. Thus, where the debtor's interest in property consists only of bare legal title to a constructive trust, lacking any equitable interest in the trust res, the estate acquires nothing more than bare legal title. See, e.g., In re Wyatt, 6 B.R. 947, 953 (Bkrtcy.E.D.N.Y. 1980). The relationship of the trustee and beneficiary of a constructive trust vis-a-vis the bankruptcy estate has been described succinctly by the Eighth Circuit Court of Appeals.

Where, under state law, the debtor\'s fraud or other wrongful conduct gives rise to a constructive trust, so that the debtor holds only bare legal title to the property, subject to a duty to reconvey it to the rightful owner, the estate will generally hold the property subject to the same restrictions. E.g., In re Shepard, 29 B.R. 928, 931-32 (Bkrtcy.M.D. Fla.1983); 4 Collier on Bankruptcy ¶ 541.13 (15th ed. 1983).

In re Flight Transportation Corporation Securities Litigation, 730 F.2d 1128, 1136 (8th Cir.1984).

The concept of a "constructive trust" for purposes of administering a bankruptcy case is not defined in the Code. Georgia Pacific Corp. v. Sigma Service Corp., 712 F.2d 962, 967 n. 4 (5th Cir.1983). The legislative history to section 541, however, reveals the following policy in regard to a constructive trust:

Situations occasionally arise where property ostensibly belonging to the debtor will actually not be property of the debtor, but will be held in trust for another. For example, if the debtor has incurred medical bills that were covered by insurance, and the insurance company had sent the payment of the bills to the debtor before the debtor had paid the bill for which the payment was reimbursement, the payment would actually be held in a constructive trust for the person to whom the bill was owed.

H.R.Rep. No. 595, 95th Cong., 1st Sess. 368 (1977); S.Rep. No. 989, 95th Cong., 2d Sess. 82 (1978), reprinted in, 1978 U.S.Code Cong. & Ad.News 5787, 5868, 6324. This legislative reference does not implicate federal law in the determination of the existence of a constructive trust, but simply indicates that distribution of the bankruptcy estate may hinge on the application of state law trust principles. It is the claimant's burden to establish the existence of the trust relationship which will remove the trust res from the pool of assets available to be administered pursuant to the distribution scheme of the Bankruptcy Code. Georgia Pacific Corp. v. Sigma Service Corp., 712 F.2d at 969.

Under the New York State Education Law, children who reside in a non-state operated intermediate care facility for the mentally retarded shall be admitted to the public schools, and the school district in which such facility is located is obliged to provide educational services to these children. Section 3202(5)(d)(2) of the Education Law authorizes intermediate care facilities to contract with the Board of Education of the local school district for the provision of such services. The state education department reimburses the facility for all educational costs incurred that are not federally reimbursable. The relevant subsections of the statute read as follows:

(1) Children who reside in an intermediate care facility for the mentally retarded, other than a state operated school for the mentally retarded, as defined in regulations of the office of mental retardation

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