In re The 1031 TAX GROUP LLC.

• Decision Date: 01 November 2010
• Docket Number: Bankruptcy No. 07-11448 (MG).,Adversary No. 09-01129 (MG).
• Citation: 439 B.R. 78
• Parties: In re The 1031 TAX GROUP, LLC, et al., Debtors. Gerald A. McHale, Jr., not individually but solely in his capacity as Chapter 11 trustee for The 1031 Tax Group, LLC, et al., Plaintiff, v. Boulder Capital LLC, et al., Defendants.
• Court: U.S. Bankruptcy Court — Southern District of New York

439 B.R. 78

In re The 1031 TAX GROUP, LLC, et al., Debtors.

Gerald A. McHale, Jr., not individually but solely in his capacity as Chapter 11 trustee for The 1031 Tax Group, LLC, et al., Plaintiff, v. Boulder Capital LLC, et al., Defendants.

Bankruptcy No. 07-11448 (MG).

Adversary No. 09-01129 (MG).

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

Nov. 1, 2010.

Golenbock Eiseman Assor Bell & Peskoe LLP, by Jonathan L. Flaxer, Esq., David J. Eiseman, Esq., Jacqueline G. Veit, Esq., New York, NY, for the 1031 Debtors Liquidation Trust.

Klestadt & Winters, LLP, by Ian R. Winters, Esq., New York, NY, for the Defendants.

The Gordon Law Firm LLP, by Stephen F. Gordon, Esq., Todd B. Gordon, Esq., Boston, MA, for the Defendants.

SUPPLEMENTAL MEMORANDUM OPINION GRANTING TRUSTEE'S MOTION FOR PARTIAL SUMMARY JUDGEMENT

MARTIN GLENN, Bankruptcy Judge.

The Court previously ruled that Gerald A. McHale, Jr., the former chapter 11 trustee of the debtors in this case and now the trustee of the 1031 Debtors Liquidation Trust (the “Trustee”), was entitled to partial summary judgment in the amount of $24,302,845.24 on a fraudulent conveyance claim arising from two transfers made by the debtors in these related bankruptcy cases (the “1031 Debtors”) ¹ to the Boulder defendants (collectively, “Boulder”). ² In re 1031 Tax Group, LLC, Case No. 07-11448(MG), Adv. No., 09-01129(MG), 2010 WL 3369944, at *1 (Bankr.S.D.N.Y. Aug. 27, 2010) (“August27 Opinion”). While concluding that the Trustee had established his entitlement to summary judgment on liability with respect to a third transfer of $18,475,200 to Boulder on June 26, 2006 (the “Third Transfer”), the August 27 Opinion reserved judgment with respect to the amount the Trustee is entitled to recover for all or a portion of the Third Transfer because some of the facts were unclear. Id. at 26.

On October 21, 2010, the parties stipulated to certain facts regarding the Third Transfer. (ECF # 76.) The Court now determines that the Trustee is entitled to partial summary judgment in the amount of $3,340,261.22 in connection with the Third Transfer. The Third Transfer came from a commingled escrow account containing a total of $105,008.427.49. Id. The escrow account contained funds derived from two sources: “tainted” funds of $18,985,211.41 transferred into the escrow account from a bank account of the 1031 Debtor, NES; and “clean” funds of $86,023,216.08 transferred into the escrow account from a loan from Greenwich Capital. ³ The Court determines that the Trustee is entitled to recover a pro rata allocation of the Third Transfer based on the percentage of tainted funds in the escrow account. ⁴

BACKGROUND

The Court assumes familiarity with the August 27 Opinion granting partial summary judgment. See In re 1031 Tax Group, LLC, 2010 WL 3369944. Only those facts bearing on the remaining issues raised by the June 26, 2006 Third Transfer are discussed in this opinion.

The facts surrounding the June 26, 2006 Third Transfer are undisputed. The genesis of the Third Transfer was a $77,625,000 loan by Wachovia-related entities (the “Wachovia Loan”), and an $18 million mezzanine loan by Boulder West Oaks (the “Boulder Loan”), that enabled Edward H. Okun (“Okun”) to purchase the West Oaks Mall (the “Mall”) through several Okun-owned entities. See id. at *3. In June 2006, Okun refinanced the Wachovia Loan and the Boulder Loan. On June 26, 2006, the debtor NES wire transferred $18,985,211.41 from an NES commercial checking account at Wachovia to LandAmerica, as escrow agent, in connection with Okun's refinancing of the Mall. See id. at *26. In addition to the NES funds, Greenwich Capital loaned Okun an additional $86 million that was also transferred into the LandAmerica escrow account. Id. The parties have now stipulated that the total sum deposited in the LandAmerica escrow account on June 26, 2006 was$105,008,427.49. (ECF # 76.) On the same day, LandAmerica transferred $18,475,200 from the escrow account to Boulder to repay the Boulder Loan, and transferred $77,625,544.30 to Wachovia to repay the Wachovia Loan. (Mem. in Supp. of Trustee's Mot. For Partial Summ. J. on Claim For Fraudulent Conveyance (the “Trustee Memorandum”) at 15-16 (ECF # 28.).)

In determining the amount of the Third Transfer that should be avoided, the Trustee submits that a pro rata allocation of the commingled funds (between the tainted and clean funds) is warranted as a matter of law. Since a portion of the funds repaid to Boulder and Wachovia were tainted, to the extent the payments included funds derived from NES, the Trustee argues that the Court should award the Trustee the percentage of the Third Transfer that was derived from NES funds. ⁵ Id. at 16. In responding to the motion for partial summary judgment, Boulder did not respond to the Trustee's assertion that a pro rata allocation is appropriate in these circumstances.

The Court concludes that a pro rata allocation is appropriate. An analysis of case law and other legal authority weighs in favor of adopting such an approach. Accordingly, for the reasons discussed below, the Court concludes that, as a matter of law, the Trustee is entitled to summary judgment avoiding the pro rata portion of the Third Transfer derived from the NES funds contained in the commingled escrow account.

DISCUSSION

A. Law Favors Pro Rata Allocation of Commingled Funds

Courts have discretion when determining how to allocate commingled funds where a party has acted improperly in obtaining the funds. See S.E.C. v. Infinity Grp. Co., 226 Fed.Appx. 217, 218 (3d Cir.2007) (“[T]he Courts of Appeals repeatedly have recognized that pro rata distribution of a defrauder's assets to multiple victims of the fraud is appropriate and that District Courts act within their discretion in approving such distributions.”). Further, the Restatement of Restitution and Unjust Enrichment recognizes that courts must “make a rough, practical compromise between the competing interests of the restitution claimant and of the other persons with an interest in the fund.” RESTATEMENT (THIRD) OF RESTITUTION AND UNJUST ENRICHMENT § 59 cmt. b (Tentative Draft No. 6, 2008). Particularly where there is evidence of fraudulent behavior, such as the kind Okun engaged in here, courts have discretion to determine the proper way to allocate the resulting harm. Cf. S.E.C. v. Credit Bancorp, Ltd., 290 F.3d 80, 88-89 (2d Cir.2002) (concluding that the courts retain the “equitable authority ... to treat all the fraud victims alike (in proportion to their investments) and order a pro rata distribution.”). Since Boulder received repayment of the Boulder Loan from a combination of “clean” and “tainted” funds, and no finding has been made that Boulder itself engaged in fraud, Boulder should only be requiredto repay a portion of the Third Transfer. ⁶ Accordingly, this Court retains discretion to determine what portion of the Third Transfer should be avoided as a fraudulent conveyance.

Courts in the Second Circuit and elsewhere, in addition to treatises relating to restitution and trusts, have recognized the viability of a pro rata allocation of funds where such funds have been commingled and multiple parties have claims to the funds. The Trustee properly refers the Court to Restatement (Third) of Restitution and Unjust Enrichment which provides, in relevant part:

When a commingled fund contains the property of multiple claimants, their interests in the fund and any product thereof are determined in the proportion that each claimant's traceable contribution bears to the balance of the fund at the relevant time.

Id. § 59(5) (Tentative Draft. No. 6, 2008). Further, Restatement (First) of Restitution § 213 lends support that the pro rata approach is equitable, especially in the context of wrongful mingling of funds. RESTATEMENT (FIRST) OF RESTITUTION AND UNJUST ENRICHMENT § 213 (1937). Section 213, titled “Mingling Money of Several Persons” provides:

[W]here a person wrongfully mingles money of two or more persons, each of them is entitled to share in the mingled fund or in property acquired with the fund, in such proportion as his money bore to the whole amount of the fund.

Id. at § 213(1). Comment (a), titled, “Where no further disposition is made of the mingled fund,” states:

Where the money of two or more persons is wrongfully mingled in a fund, each of them is entitled in equity to claim a proportionate share of the mingled fund. Although the identity of the money of each can no longer be shown, each acquires an interest in the mingled fund. If no further disposition is made of it, it is immaterial whether they claim a share of or lien upon the fund.

Id. § 213 cmt. a.

In addition, the Restatement (Second) of Trusts supports a pro rata allocation of commingled funds. Section 202(1), comment (i), titled “Effect of withdrawals from the mingled mass,” provides:

Where the trustee wrongfully mingles trust funds with his individual funds in one indistinguishable mass, and subsequently makes withdrawals from the mingled fund, the beneficiary is entitled to a proportionate share both in the part which remains and in the part which is withdrawn, or at his option he is entitled to an equitable lien upon both parts to secure his claim for reimbursement.

RESTATEMENT (SECOND) OF TRUSTS § 202(1) at cmt. i (emphasis added).

While sitting as a district judge, Judge Learned Hand embraced the concept of pro rata allocation as an equitable manner of allocation of commingled assets. See In re Walter J. Schmidt & Co., 298 F. 314, 316 (S.D.N.Y.1923). In Walter J. Schmidt, Judge Hand rejected the so-called “rule in Clayton's Case” which adopted a “first-in,first out” concept in favor of a pro rata allocation of funds. In so holding, Judge Hand explained:

The rule in Clayton's Case is to allocate the payments upon an account. Some rule had to be adopted, and though any presumption of intent was a fiction, priority in time was the most...