In re Schick

• Decision Date: 13 March 2000
• Docket Number: 96 B 46282(SMB). Adversary No. 98-8182A.,Bankruptcy No. 96 B 42902(SMB),96 B 43969(SMB)
• Citation: 246 BR 41
• Parties: In re David SCHICK, Venture Mortgage Corp., and A & D Trading Group, L.L.C., Debtors. Aurora Cassirer, Chapter 11 Trustee for the Estate of David Schick, Debtor, Plaintiff, v. Sterling National Bank & Trust Company of New York, Defendant. Sterling National Bank & Trust Company of New York, Third-Party Plaintiff, v. The Merchants Bank of New York and Israel Discount Bank of New York, Third-Party Defendants.
• Court: U.S. Bankruptcy Court — Southern District of New York

246 B.R. 41 (2000)

In re David SCHICK, Venture Mortgage Corp., and A & D Trading Group, L.L.C., Debtors.

Aurora Cassirer, Chapter 11 Trustee for the Estate of David Schick, Debtor, Plaintiff, v. Sterling National Bank & Trust Company of New York, Defendant.

Sterling National Bank & Trust Company of New York, Third-Party Plaintiff, v. The Merchants Bank of New York and Israel Discount Bank of New York, Third-Party Defendants.

Bankruptcy Nos. 96 B 42902(SMB), 96 B 43969(SMB), 96 B 46282(SMB). Adversary No. 98-8182A.

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

March 13, 2000.

COPYRIGHT MATERIAL OMITTED

Parker Chapin Flattau & Klimpl, LLP, New York City, Joel Lewittes, Amos Alter, of counsel, for plaintiff.

Kaye, Scholer, Fierman, Hays & Handler, LLP, New York City, Herbert S. Edelman, Jeffrey T. Kirshner, of counsel, for defendant and third-party plaintiff.

Zeichner Ellman & Krause, New York City, Stuart A. Krause, Peter Janovsky, of counsel, for third-party defendant Merchants Bank of New York.

Blank Rome Tenzer Greenblatt LLP, New York City, James D. Glass, Lawrence M. Rosenstock, Deborah J. Piazza, of counsel, for third-party defendant Israel Discount Bank of New York.

MEMORANDUM DECISION DENYING DEFENDANT STERLING BANK'S MOTION FOR SUMMARY JUDGMENT

STUART M. BERNSTEIN, Chief Judge.

Aurora Cassirer, the chapter 11 trustee of the estate of David Schick, commenced this adversary proceeding to avoid and recover four preferential transfers from Sterling National Bank & Trust Co. ("Sterling" or the "Bank"). Sterling moves for partial summary judgment with respect to two of the transfers. It contends that Schick paid the Bank with money he had converted from third parties, and therefore, had no interest in the transferred property. As a result, the trustee cannot recover the transfers for the benefit of the estate.¹

Sterling's argument is based on an erroneous legal postulate. Schick had legal title to the funds subject, at most, to an equitable duty to reconvey the funds to the victims of his conversion. The Bank, who is not the victim, lacks standing to raise their rights either offensively, or as a defense in this adversary proceeding. Accordingly, its motion is denied.

BACKGROUND

The material facts are straightforward and undisputed. In the first transaction, Schick repaid a $1 million loan to Sterling. At the time of the repayment, Schick was engaged in the business of bidding on mortgage portfolios owned by the Federal Deposit Insurance Corporation and the Resolution Trust Corporation. Schick had to show the availability of substantial funds, and raised the funds through borrowings from investors. See Cassirer v. Herskowitz (In re Schick), 234 B.R. 337, 340 (Bankr.S.D.N.Y.1999) ("Herskowitz").

Gary Fragin was one of his investors. In late February, 1996, Schick, Blackstone Associates, an entity represented by Schick, and Fragin entered into a Deposit Agreement.² Fragin agreed to let Schick pledge his securities as collateral for a $2 million loan. The proceeds were to remain the property of Fragin and to be held by Schick as escrow agent in a trust account at Fleet Bank. At the end of 150 days, Schick was required to return the deposit to Fragin.

After acquiring the right to pledge Fragin's securities, Schick promptly ignored his obligations under the Deposit Agreement. He used Fragin's property to collateralize a $2 million loan from Republic National Bank, and deposited the proceeds into his personal account at Sterling. He then instructed Sterling, on or about March 1, 1996, to debit his personal account in the amount of $1 million, satisfying his outstanding obligation. The trustee's first claim for relief in the adversary complaint seeks to avoid and recover this $1 million payment.

In the second transaction, Schick repaid a $500,000.00 loan to Sterling. This time, he used what were ostensibly trust funds held by his law firm, Schick & Simon LLP.³ On or about March 13, 1996, Schick directed the Republic National Bank to transfer $500,000.00 from the "Schick & Simon LLP IOLA Trust Account,"⁴ to his personal account at Sterling.⁵ Schick then used these proceeds to repay the $500,000.00 loan. The trustee's fourth claim for relief in the adversary complaint seeks to avoid and recover this payment.

DISCUSSION

Sterling contends that the moneys used to repay the two loans belonged to Fragin or Schick & Simon rather than Schick. The funds would not have been "property of the estate," see 11 U.S.C. § 541, and hence, Schick's trustee cannot avoid and recover the transfers through her preference action. The trustee responds, inter alia, that Sterling lacks standing to invoke any rights Schick's victims might have.⁶ The answer to the question lies in the relationship between property rights and remedies that arise from their deprivation.

State law determines the extent of an interest in property, absent an overriding federal policy, Butner v. United States, 440 U.S. 48, 55, 99 S.Ct. 914, 59 L.Ed.2d 136 (1979); Morton v. National Bank of New York City (In re Morton), 866 F.2d 561, 563 (2d Cir.1989); Sanyo Elec., Inc. v. Howard's Appliance Corp. (In re Howard's Appliance Corp.), 874 F.2d 88, 93 (2d Cir.1989), but bankruptcy law determines whether that interest is "property of the estate." Official Committee of Unsecured Creditors v. PSSS Steamship Co., Inc. (In re Prudential Lines, Inc.), 928 F.2d 565, 569 (2d Cir.), cert. denied, 502 U.S. 821, 112 S.Ct. 82, 116 L.Ed.2d 55 (1991); Herskowitz, 234 B.R. at 342. A preference action is designed to recover property that would have been available for distribution to creditors but for the transfer. Begier v. IRS, 496 U.S. 53, 58, 110 S.Ct. 2258, 110 L.Ed.2d 46 (1990); Glinka v. Bank of Vermont (In re Kelton Motors, Inc.), 97 F.3d 22, 25 (2d Cir.1996); Herskowitz, 234 B.R. at 342; In re Regency Holdings (Cayman), Inc. v. The Microcap Fund, Inc. (In re Regency Holdings (Cayman), Inc.), 216 B.R. 371, 375 (Bankr.S.D.N.Y.1998). Accordingly, the scope of "property of the estate" in 11 U.S.C. § 541 determines the scope of property interests recoverable under section 547. Begier v. IRS, 496 U.S. at 58-59, 110 S.Ct. 2258; Herskowitz, 234 B.R. at 342; In re Regency Holdings (Cayman), Inc., 216 B.R. at 375.

"Property of the estate" includes "all legal or equitable interests of the debtor in property as of the commencement of the case." 11 U.S.C. § 541(a)(1). If the debtor holds only legal title to the property, that is all that vests in the estate. 11 U.S.C. § 541(d). The equitable title or interest is neither "property of the estate" under section 541 nor "property of the debtor" under section 547(b). Begier v. IRS, 496 U.S. at 59, 110 S.Ct. 2258; Herskowitz, 234 B.R. at 342.

The central premise of Sterling's defense is that Schick did not own the funds he used to pay the Bank, i.e., a thief acquires no title. Like many generalizations, this is not always true. The victim of a conversion may bring a damage action, Dan B. Dobbs, Law of Remedies: Damages-Equity-Restitution § 5.13(1), at 545 (2d ed. 1993) ("Dobbs"), or under appropriate circumstances, seek equitable relief, such as the imposition of a constructive trust.⁷ Id. § 5.18, at 592; see Fur & Wool Trading Co. v. George I. Fox, Inc., 245 N.Y. 215, 156 N.E. 670, 671 (1927) (a thief may be treated as a trustee of the proceeds of the stolen property); Provisional Government of French Republic v. Cabot, 53 N.Y.S.2d 293, 294 (N.Y.Sup.Ct.) ("even a thief may be treated as a constructive trustee of the proceeds of his theft"), aff'd, 269 A.D. 745, 55 N.Y.S.2d 121 (1945). In this regard,

A constructive trust is the formula through which the conscience of equity finds expression. When property has been acquired in such circumstances that the holder of the legal title may not in good conscience retain the beneficial interest equity converts him into a trustee.

Beatty v. Guggenheim Exploration Co., 225 N.Y. 380, 122 N.E. 378, 380 (1919) (Cardozo, J.); accord Counihan v. Allstate Ins. Co., 194 F.3d 357, 360 (2d Cir.1999); Simonds v. Simonds, 45 N.Y.2d 233, 408 N.Y.S.2d 359, 380 N.E.2d 189, 193 (1978); Sharp v. Kosmalski, 40 N.Y.2d 119, 386 N.Y.S.2d 72, 351 N.E.2d 721, 723 (1976). The right to impose a constructive trust is determined by state law. In re Howard's Appliance Corp., 874 F.2d at 93-94. Under New York law, this generally requires proof of (1) a confidential or fiduciary relationship, (2) a promise, (3) a transfer in reliance on the promise, and (4) unjust enrichment. Koreag Controle et Revision, S.A. v. Refco F/X Assocs., Inc. (In re Koreag, Controle et Revision S.A.), 961 F.2d 341, 352 (2d Cir.1992), cert. denied, 506 U.S. 865, 113 S.Ct. 188, 121 L.Ed.2d 132 (1992); Sharp v. Kosmalski, 386 N.Y.S.2d 72, 351 N.E.2d at 723. Nevertheless, it is a flexible remedy. Hence, New York courts do not insist that the facts fit within the framework of these four elements, Counihan v. Allstate Ins. Co., 194 F.3d at 362; Palazzo v. Palazzo, 121 A.D.2d 261, 503 N.Y.S.2d 381, 383-84 (N.Y.App.Div.1986); see In re Koreag, Controle et Revision S.A., 961 F.2d at 352 (the four factors provide important guideposts, but the constructive trust doctrine is equitable in nature and should not be rigidly limited), provided the "trustee" acquired and holds property under unconscionable and inequitable circumstances, and is unjustly enriched. Counihan v. Allstate Ins. Co., 194 F.3d at 362.

Though analogized to a trust, a constructive trust is not a trust at all, but an equitable remedy designed to prevent unjust enrichment. Strom v. Goldman, Sachs & Co., 202 F.3d 138, 144 (2d Cir. 1999) (quoting I Austin Wakeman Scott & William Franklin Fratcher, The Law of Trusts § 17, at 243 (4th ed. 1989) ("Scott on Trusts")); Dobbs § 4.3(2), at 401; see Counihan v. Allstate Ins. Co., 194 F.3d at 361. In other words, a constructive trustee is "not compelled to convey the property to the beneficiary because he is a constructive trustee; it is...