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Eighth Circuit Holds Recipients of Avoidable Transfers Asserting Trust Defense Must be Able to Trace the Funds

Wednesday, January 4, 2012
Adrienne Woods | Bloomberg Law Stoebner v. Consumers Energy Co. (In re LGI Energy Solutions, Inc.), Nos. 11-6045/6046/6047/6048/6049/11-6050/6051., 2011 BL 309428 (8th Cir. Dec. 08, 2011)
  • Holding that, under Minnesota law and Eighth Circuit precedent, tracing is required when trust funds are commingled.
  • Concluding that a party asserting that funds were held pursuant to a trust relationship must demonstrate that the counterparty has honored that relationship.
The United States Court of Appeals for the Eighth Circuit rejected the bankruptcy court's conclusion that funds transferred to defendants were not property of the debtors, finding that an agreement intending to create a trust relationship must be honored in order for the funds to be treated as though held in trust. To that end, the Eighth Circuit reversed and remanded the bankruptcy court's order granting summary judgment finding it inconsistent with Minnesota law and Eighth Circuit precedent requiring the tracing of non-statutorily created trust funds.

The Avoidance Actions

LGI Energy Solutions, Inc. and LGI Data Solutions Company LLC (together, "Debtors") were in the business of providing utility management and billing services prior to their bankruptcy. Debtors collected funds from their customers and placed them into an account held in the name of LGI Energy Solutions, Inc. The account referenced no specific purpose for, or beneficiary of, the funds. Debtors' agreements with customers generally provided that Debtors were to acquire no ownership interest in the funds they received. Debtors did not, however, honor this contractual arrangement, and, ultimately, there were insufficient funds to pay the utilities. Debtors had commingled funds from multiple clients and the account was often overdrawn in the weeks leading up to the bankruptcy. The chapter 7 trustee ("Trustee") in the bankruptcy cases sued seven utility companies (collectively, "Defendants") in separate adversary proceedings asserting causes of action under 11 U.S.C. §§ 547 and 548 for the avoidance of preferential and/or fraudulent transfers Defendants received from Debtors prior to the bankruptcy. Defendants did not dispute the facts as alleged but contended that Debtors held the customers' funds in trust to pay Defendants and, as a result, Defendants were not required to trace the actual funds to each client. The bankruptcy court granted summary judgment for Defendants, holding that the payments they had received were never the property of Debtors as the funds were held in trust for payment to the utilities on behalf of Debtors' customers. Trustee appealed.

Absent a Statutory Exception, Trust Funds Must be Traceable

The Eighth Circuit began its analysis with a discussion of what constitutes an "interest of the debtor in property" in the context of an avoidance action, noting that, according to the Supreme Court, it is "best understood as that property that would have been part of the estate had it not been transferred before the commencement of bankruptcy proceedings." Begier v. Internal Revenue Service, 496 U.S. 53, 58 (1990). Next, the Eighth Circuit explained that, while bankruptcy law determines what property constitutes property of the estate, property ownership itself is defined by state law. The Eight Circuit further instructed that, under Minnesota law, there is a rebuttable presumption that funds held in a bank account are owned by the account holder. The Eighth Circuit reasoned that, while the Supreme Court found that tracing was not required in Begier, the facts in Begier were distinguishable as Begier dealt with a tax trust fund imposed by statute and was not required to be tied to any specific res. The Eight Circuit found that, absent a statutory mandate, common law principles provide that a trust is created in the property itself and, thus, the specific property must be ascertainable and identifiable. For tracing purposes, the Eight Circuit noted that both Minnesota and the Eighth Circuit employ the "lowest intermediate balance" test, under which "a court follows the trust fund to and decrees restitution from an account where the amount on deposit has at all times since the commingling of the funds equaled or exceeded the amount of the trust fund." The Eight Circuit explained further that, if the account is fully depleted after the res of the trust is deposited, the trust fund is deemed to be lost. Further, the Eight Circuit pointed out that the party asserting that commingled funds were held in trust must demonstrate, in addition to proving the existence of an agreement between the parties establishing a trust, that such agreement to hold funds in trust was in fact honored by the holder of the funds. The Eight Circuit observed that, regardless of what a contract says, if the parties do not honor the agreement and treat the funds as a trust, the court may find that there is no trust.

The Eighth Circuit Reversed and Remanded the Matter to the Bankruptcy Court

Determining that the bankruptcy court erroneously ruled that tracing was not required due to the alleged trust relationship, the Eighth Circuit reversed and remanded the matter to the bankruptcy court for consideration of whether the agreements created a trust relationship, whether such trust relationship was honored and any other remaining factual issues between the parties. DisclaimerThis document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.  

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