Marcus v. Horton (In re Horton)

Decision Date26 June 2020
Docket NumberCase No. 19-11162-t7,Adv. No. 20-1004-t
Citation618 B.R. 22
Parties IN RE: Dean L. HORTON and Frances H. Horton, Debtors. Robert Marcus, liquidating trustee of the Las Uvas Valley Dairies, Plaintiff, v. Dean L. Horton, Frances H. Horton, and Clarke Coll, trustee, Defendants.
CourtU.S. Bankruptcy Court — District of New Mexico

Paul M. Fish, Albuquerque, NM, for Plaintiff.

Clifford C. Gramer, Jr., Chris W. Pierce, Walker & Associates, P.C., Albuquerque, NM, for Defendants.

OPINION

Hon. David T. Thuma, United States Bankruptcy Judge

Plaintiff sued defendants, seeking a declaration that the main assets in this bankruptcy estate, a very expensive house and its furnishings, are held in constructive trust for the estate he represents. Before the Court is defendants Dean and Frances Hortons' motion for judgment on the pleadings, asking that the proceeding be dismissed for failure to state a claim. Plaintiff counters that he has stated a valid claim for recognition of a constructive trust. The Court, having reviewed the parties' pleadings and briefs, concludes that the Hortons' motion is not well taken and should be denied.

I. FACTS

To rule on the motion, the Court assumes that the allegations in Plaintiff Robert Marcus's complaint are true. The factual allegations are summarized as follows:

On September 15, 2017, Las Uvas Valley Dairies, a New Mexico general partnership ("LUVD") filed a chapter 11 case. The Court confirmed a plan of liquidation on June 14, 2018. Marcus is the liquidating trustee under the plan and holds all estate claims.

On May 17, 2019, the Hortons filed this chapter 7 case. Defendant Clarke Coll was appointed trustee.

The Hortons own a house on 584.4 acres (together with furnishings and fixtures, the "House"), valued at $6,900,000. They and Coll assert that the House is property of the Hortons' bankruptcy estate.

For many years the Hortons were the sole owners of LUVD. In 2012 they assigned small partnership interests to their children, but the Hortons have always controlled LUVD.

The dairy industry is cyclical. While a dairy might generate profits for several years, the inevitable downturns require that, for long term success, a dairy husband its resources during the good years.

Despite that, in 2008 the Hortons decided to build the House, paid for by LUVD. In addition, the Hortons lived a lavish lifestyle, supported by large distributions from LUVD.

In 2008 LUVD had a net profit of $2,291,522, but the Hortons took out $2,730,360 that year, so LUVD's net worth decreased by almost $500,000.

In 2009 LUVD lost $10,889,428. Nevertheless, the Hortons caused LUVD to fund House construction costs of $448,152.05 and personal living expenses of $1,572,766.

2012 was a particularly bad year for LUVD, which lost over $9.7 million. On December 31, 2012, LUVD had less cash in the bank than outstanding checks and owed almost $4.3 million to trade and feed creditors. These problems notwithstanding, in 2012 LUVD spent more than $2.3 million on the House and distributed over $2.5 million to the Hortons.

On December 13, 2012, LUVD conveyed the House to the Hortons but continued to pay for its construction and furnishings.

Between 2008 and 2015 LUVD lost $15,064,135 in operations yet paid $11,603,727.73 to build the House and distributed $12,883,874.27 to the Hortons. The Hortons spent some of their distributions on household goods and furnishings for the House.

In 2008, LUVD's total debt was $21,209,650. In 2015, the total debt was $73,655,962. In 2008, amounts owed to trade creditors totaled $1,154,172. By the end of 2015 that amount had grown to $11,347,746.

Cash reserves were similarly depleted. At year-end 2008, "Cash in banks" was an asset on LUVD's balance sheet at $8,625,914. At year-end 2015, "cash" was not shown as an asset. Instead, there was a liability called "Outstanding checks in banks" of $892,288.

As of February 22, 2016, LUVD owed Production Credit Association of Southern New Mexico about $16.8 million. LUVD had to file bankruptcy because it could not resolve that debt. LUVD also owed Metropolitan Life Insurance Company over $30 million.

LUVD could not reorganize in bankruptcy and was forced to liquidate. But for the costs of the House and the Hortons' exorbitant distributions for personal expenses, LUVD could have paid all its unsecured creditors in the normal course of business. The Hortons' conduct destroyed LUVD.

II. DISCUSSION

The Hortons argue that Marcus's complaint does not state a viable claim because (1) Marcus does not allege unfair retention of the House; (2) constructive trusts are disfavored in bankruptcy; (3) no constructive trust was imposed prepetition; and (4) Coll's "strong arm" power under § 544(a)(3)1 can avoid constructive trusts.

A. Rule 12(c) Motions.2

"A motion for judgment on the pleadings under Rule 12(c) is treated as a motion to dismiss under Rule 12(b)(6)." Atl. Richfield Co. v. Farm Credit Bank of Wichita , 226 F.3d 1138, 1160 (10th Cir. 2000). "[T]o withstand a Rule 12(b)(6) motion to dismiss, a complaint must contain enough allegations of fact, taken as true, to state a claim to relief that is plausible on its face." Khalik v. United Air Lines , 671 F.3d 1188, 1190 (10th Cir. 2012) (quoting Bell Atlantic Corp. v. Twombly , 550 U.S. 544, 570, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007) ).

B. Marcus States a Constructive Trust Claim.

State law is the starting point for determining whether a constructive trust may and should be recognized by a bankruptcy court. In re Foster , 275 F.3d 924, 926 (10th Cir. 2001) (courts must "look to state law to determine whether a party has met th[e] burden" of establishing constructive trust requirements); See, e.g., In re C.W. Mining Co. , 740 F.3d 548, 561 (10th Cir. 2014) (applying Utah constructive trust law) ; In re Taylor , 133 F.3d 1336, 1342-43 (10th Cir. 1998) (same).

New Mexico recognizes the use of constructive trusts. See, e.g., New Mexico Military Institute v. NMMI Alumni Association, Inc. , 458 P.3d 434, 443 (N.M. App. 2018). A constructive trust is an equitable remedy used "to prevent the unjust enrichment that would result if the person having the property were permitted to retain it." Tartaglia v. Hodges , 129 N.M. 497, 510, 10 P.3d 176 (Ct. App. 2000), quoting Aragon v. Rio Costilla Cooperative Livestock Ass'n , 112 N.M. 152, 156, 812 P.2d 1300 (S. Ct. 1991) ; see also Bassett v. Bassett , 110 N.M. 559, 566, 798 P.2d 160 (S. Ct. 1990) ("A constructive trust arises where a person who holds title to property is subject to an equitable duty to convey it to another on the ground that he would be unjustly enriched if he were permitted to retain it.") (citation omitted).

There is no precise test in New Mexico for determining when a constructive trust should be recognized. Aragon , 112 N.M. at 156, 812 P.2d 1300 ("The circumstances where a court might impose such a trust are varied."). Constructive trust claimants must generally show wrongdoing such as fraud, duress, undue influence, breach of a fiduciary duty, or abuse of confidence. Id. ; see also Gushwa v. Hunt , 145 N.M. 286, 292, 197 P.3d 1 (S. Ct. 2008) ; Tartaglia , 129 N.M. at 510, 10 P.3d 176 ; City of Rio Rancho v. Amrep Southwest, Inc. , 150 N.M. 428, 260 P.3d 414, 428 (2011). Entitlement to a constructive trust must be proved by clear and convincing evidence. Matter of Estate of McKim , 111 N.M. 517, 519, 807 P.2d 215 (S. Ct. 1991).

Assuming the truth of Marcus' allegations, he has stated a claim under New Mexico constructive trust law. Marcus alleges that the Hortons breached their fiduciary duties to LUVD by looting the partnership of its much-needed cash over the years to build and furnish the House, causing LUVD to fail. The alleged facts are sufficient to underpin findings of breach of fiduciary and unjust enrichment. The Hortons are not entitled to dismissal because of a defect in pleading.3

C. Constructive Trusts in Bankruptcy.

The Hortons also question the viability of constructive trust claims in bankruptcy. While the argument has some merit, dismissal on this ground is not appropriate.

Courts often cast a jaundiced eye on constructive trust claims in bankruptcy, because constructive trusts appear to be a form of "secret lien"4 that prefers trust beneficiaries over other creditors. For example, in XL/Datacomp, Inc. v. Wilson (In re Omegas Group, Inc. ), 16 F.3d 1443 (6th Cir. 1994), the Sixth Circuit held:

We think that § 541(d) simply does not permit a claimant in the position of Datacomp to persuade the bankruptcy court to impose the remedy of constructive trust for alleged fraud committed against it by the debtor in the course of their business dealings, and thus to take ahead of all creditors, and indeed, ahead of the trustee.

Id. at 1451. Elsewhere the Omegas court stated that "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." Id. at 1452 ; see also Oxford Organisation, Ltd. v. Peterson (In re Stotler and Co. ), 144 B.R. 385, 388 (N.D. Ill. 1992) ("[A] constructive trust is fundamentally at odds with the general goals of the Bankruptcy Code."). In WAS, LLC v. Coll (In re DC Energy, LLC ), 555 B.R. 786 (Bankr. D.N.M. 2016), this Court stated that "the modern trend in the case law strongly disfavors bankruptcy courts imposing constructive trusts on assets that otherwise would be estate property." Id. at 791.

There is another view, however. As Justice Black held in Pearlman v. Reliance Insurance Co. , 371 U.S. 132, 135-36, 83 S.Ct. 232, 9 L.Ed.2d 190 (1962), "the Bankruptcy Act simply does not authorize a trustee to distribute other people's property among a bankrupt's creditors."5 If a constructive trust is recognized in appropriate circumstances, then the trust res really is "other people's property"6 and should not be used to pay the debtor's creditors.

This view is argued persuasively by Professor Andrew Kull in Restitution in Bankruptcy: Reclamation and...

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    ...61.22 Miller v. J.D. Abrams, Inc. (In re Miller) , 156 F.3d 598, 605 (5th Cir. 1998).23 Complaint, ECF No. 22, page 8.24 In re Horton , 618 B.R. 22 (Bankr. D. N.M. 2020) citing XL/Datacomp, Inc. v. Wilson (In re Omegas Group, Inc.), 16 F.3d 1443 (6th Cir. 1994).25 In re DC Energy, LLC, 555 ......
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