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Proceeds From Sale of Livestock Held In Bailment; Not Part of Debtor's Estate

Friday, February 1, 2013
By Stephanie M. Acree

A transfer of proceeds from an involuntary Chapter 7 debtor's sale of livestock on another company's behalf could not be avoided because the debtor had no equitable interest in the property, the U.S. District Court for the Northern District of Illinois concluded Jan. 18 (Mississippi Valley Livestock Inc. v. J&R Farms, N.D. Ill., No. 3:12-cv-50341, 1/18/13).

Judge Frederick J. Kapala agreed with the bankruptcy court's ruling that the debtor was merely holding the cattle and the resulting proceeds from the sale of the cattle in bailment and therefore never acquired any legal or equitable interest in the property.


Agreement to Sell Livestock
Mississippi Valley Livestock Inc. (MVL) and J&R Farms were both in the business of buying and selling livestock. In 2006, J&R had a disagreement with a processing facility in Nebraska and was prohibited from selling livestock to the processing facility directly. MVL and J&R entered into an oral agreement under which MVL would sell its own livestock and J&R's livestock to the processing facility under MVL's name and would then remit the proceeds of the sale back to J&R.

Pursuant to the arrangement, MVL would receive checks from the processing facility for all the livestock, with no differentiation between MVL's cattle and J&R's cattle, which it would then deposit in a general business fund. MVL would then write checks to J&R for J&R's share of the proceeds. MVL was sometimes slow in remitting the proceeds to J&R, but according to the bankruptcy court's factual findings, MVL never used the proceeds for any other purpose than returning them to J&R.


Seven Checks
An involuntary Chapter 7 petition was filed against MVL on May 25, 2007. In the 90 days prior to the bankruptcy filing, MVL had remitted seven checks to J&R totaling $862,747. The Chapter 7 trustee initiated an adversary proceeding against J&R to avoid those transfers pursuant to Sections 547, 548, and 550 of the Bankruptcy Code.

J&R moved for summary judgment and argued that the debtor never had equitable title to the proceeds and therefore they could not be included in the debtor's estate pursuant to Bankruptcy Code Section 541(d). The trustee argued that because the debtor had deposited the proceeds into its general business fund, the debtor had “complete control over what was done with the money” and therefore it should be included in the estate. The bankruptcy court granted J&R's motion for summary judgment, concluding that the debtor never had equitable title to the proceeds. The trustee appealed to the district court.


No Equitable Interest
Section 541(a)(1) states that the property of a debtor's estate includes “all legal and equitable interests of the debtor.” However, Section 541(d) excludes from the estate “[p]roperty in which the debtor holds … only legal title and not an equitable interest.” The district court agreed with the bankruptcy court's finding that MVL never possessed an equitable interest in the proceeds from the sale of J&R's cattle.

The district court noted that legal and equitable title are not defined in the Bankruptcy Code and thus those definitions must be derived from state law. In this case, the bankruptcy court found that based on the uncontested facts of the case, MVL was holding J&R's property in bailment. A bailment, the court said, is the “delivery of property for some purpose upon a contract, express or implied, that after the purpose has been fulfilled, the property shall be redelivered to the bailor, or otherwise dealt with according to his directions, or kept until he reclaims it.”


Bailment Not Defeated
In this case, both parties agreed that MVL had no ownership rights to the cattle and was required to remit the proceeds to J&R. However, the trustee argued that depositing the proceeds into the debtor's general business funds was sufficient to defeat the bailment. The district court disagreed and said that “where the parties express an intent to create a bailment, commingling of funds is insufficient to defeat the existence of a bailment.”

Pursuant to state law on bailments, the bailee, in this case MVL, acquires a possessory interest in the property but not a legal or equitable interest. Therefore, the court found that because MVL never had a legal or equitable interest in the property, the transfers could not be avoided. The court noted that even if MVL could prove some legal interest in the proceeds, Section 541(d) would still prevent the proceeds from being included in the estate because MVL lacked an equitable interest in the property. The court said that the purpose of Section 541(d) was to ensure the trustee would not be given greater rights to the property than a judgment creditor would have under state law.

Accordingly, the bankruptcy court's decision was affirmed.

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