Section 3.19 Constructive Trusts

• Library: Bankruptcy Practice (2007 Ed. + 2015 Cum Supp)

6. (§3.19) Constructive Trusts

A constructive trust is an equitable remedy imposed under circumstances when it would be unfair for the owner of the property to enjoy the beneficial interest and thereby receive unjust enrichment. In re N.S. Garrott & Sons, 772 F.2d 462
(8^th Cir. 1985). The remedy is created in law for the benefit of a person injured by a mistake or by some wrongdoing. This equitable remedy may only be invoked when the aggrieved party has no adequate remedy at law. See, e.g., In re BroadviewLumber Co., 168 B.R. 941 (Bankr. W.D. Mo. 1994) (Federman, B.J.), aff’d,118 F.3d 1246 (8^th Cir. 1997) (no constructive trust because money judgment entered was deemed to be an adequate remedy at law); see also In re Jeter, 178 B.R. 787 (W.D. Mo. 1995) (Clark, D.J.), aff’d,73 F.3d 205 (8^th Cir. 1996).

When money is paid to the debtor by mistake, it most likely does become property of the estate, but only for as long as it takes for the aggrieved party to seek an order of the court requiring return of the funds wrongly held. Id. When the constructive trust results from wrongdoing (e.g., conversion), the property is recoverable, but the claimant must be able to specifically trace their property into the hands of the debtor. In re Mid-Am. Lines, Inc., 24 B.R. 52 (Bankr. W.D. Mo. 1982) (Stewart, B.J.). In Mid-American Lines, the claimant could not trace the funds; the court allowed it a general unsecured claim and suggested that it may file a nondischargeability complaint for the conversion. Id. at 54.

Between the high degree of proof required to impose a constructive trust as shown below, the imprecise standards for tracing, and a healthy dose of equitable considerations, it appears that these elements may be construed to fit a desired result. In most cases, the greatest weight appears to be placed on not permitting the wrongdoer a windfall and not prejudicing other creditors.

In In re The Landing, 160 B.R. 820 (Bankr. E.D. Mo. 1993) (Barta, B.J.), the plaintiffs were a group of limited partners in one limited partnership who alleged that their investments in the limited partnership were diverted by the general partner of the debtor and other limited partnerships of the general partner. First, the court found that there was no wrongdoing by the debtor but only by its general partner. The Landing, 160 B.R. at 823. The second, and “central,” issue was commingling. The court found that the plaintiffs’ funds lost their specificity at the outset when they were commingled with other funds invested in the limited partnership. The evidence of concomitant withdrawals from the limited partnership and deposits into the debtor was insufficient because there was no record that the transferred money was used specifically to purchase or construct any particular asset of the debtor. Id. at 823–24. Finally, the court looked at the balance of harm and concluded that a constructive trust would not prevent the alleged wrongdoer, the general partner, from deriving an unjust enrichment but would...