Mark Houle, United States Bankruptcy Judge.
In October 2012, Innovation Ventures, LLC, and International IP Holdings, LLC
On November 30, 2012, the district court entered an order stating, among other things, that:
On December 28, 2012, the district court entered a substantively similar order with respect to Donna Roman.
Pursuant to these asset restraining orders (the "Freeze Orders"), several Bank of America accounts held by the Debtors ("Frozen Accounts") were frozen. The amount of funds frozen in the Frozen Accounts pursuant to the Freeze Orders was no less than $426,030.53 (the "Funds").
On January 15, 2013, Debtors and Defendants entered into a stipulation, and the district court entered an order approving the stipulation that day (the "First Agreement Order"). The First Agreement states, in pertinent part:
On February 12, 2013, the Funds were removed from the Frozen Accounts and deposited into an account held by the Debtors' attorney, Barry Rothman ("Rothman"), which the Plaintiff describes as a "client trust account" and the Defendants describe as an "attorney escrow account" (the "Account").
On July 16, 2013, the Debtors and Defendants entered into a second written agreement that resolved the District Court Action (the "Second Agreement"). On July 19, 2013, pursuant to the Second Agreement, the Funds were transferred out of the Account into an account maintained by the Defendants' counsel, Geoffrey Potter ("Potter").
On July 22, 2013, the Debtors commenced the instant bankruptcy by filing a Chapter 7 voluntary petition.
On July 14, 2014, the Trustee filed an adversary complaint ("Adversary Complaint") against Defendants to avoid and recover preferential transfers pursuant to 11 U.S.C. §§ 547 and 550. Specifically, Trustee seeks to avoid and recover the transfer of the Funds from the Account to the Defendants' counsel on July 19, 2013.
On June 18, 2015, Trustee filed a motion for summary judgment. On June 19, 2015, Defendants filed a motion for summary
On April 17, 2017, Trustee appealed the Court's ruling to the Bankruptcy Appellate Panel for the Ninth Circuit. On November 20, 2017, the BAP entered judgment affirming in part, vacating, and remanding.
Trustee asserts that when Debtors transferred the Funds out of the Account to Defendants' counsel on July 19, 2013, pursuant to the Second Agreement, a transfer of the Debtors' interest in the Funds occurred. Trustee alleges that he may avoid the transfer pursuant to 11 U.S.C. § 547(b).
Conversely, Defendants assert that no transfer of the Debtors' interest in the Funds occurred within ninety days of the Petition Date because when the Debtors transferred the Funds into the Account on February 12, 2013, the transfer was into an "escrow account" created pursuant to the terms of the First Agreement. Defendants assert that under applicable law, for purposes of determining when a transfer of a debtor's interest in escrowed funds occurs, the applicable date is the date that the funds are deposited into escrow. Here, the Funds were deposited into the account in question on February 12, 2013.
In the alternative, Defendants assert that when the Funds were deposited into the Account, they were held in custodia legis.
For the reasons set forth below, the Court finds that no genuine issue of material fact exists, and that Plaintiff is not entitled to avoid the transfer of Debtors' interest in the Funds that occurred pursuant to the Second Agreement.
As a preliminary matter, the Court does not address the choice of law arguments briefed by the parties. As is further explained in section (III)(B)(2)(b), the Court finds that the applicable nonbankruptcy
When seeking summary judgment, the moving party has the burden of establishing (1) the absence of a genuine issue of material fact and (2) they are entitled to judgment as a matter of law. Celotex Corp. v. Catrett, 477 U.S. 317, 323, 106 S.Ct. 2548, 91 L.Ed.2d 265 (1986). A fact is material if it "might affect the outcome of the suit under the governing law." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986).
Here, the dispute regarding whether the Account was an "escrow account" or a "trust account" (or neither) is immaterial, as discussed below, since the plain language of the First Agreement Order dictates Debtors' property rights in the Account, and, therefore, resort to these labels is unnecessary. The focus on how to characterize the Accounts seems to be a red herring; the label is less important than the substance of the rights. Instead, the operative legal question is whether the Funds would have been property of the estate if Debtors had filed bankruptcy ninety days earlier, at which time the Funds were held in the Account. If the Funds would not have become property of the estate if Debtors filed bankruptcy while the Funds were held in the First Account, then it necessarily follows that no transfer of property of the estate occurred.
Defendants assert that the transfers of the Funds to the Account placed the funds in custodia legis. Pursuant to 11 U.S.C. § 547(e)(1)(B), a transfer of personal property "is perfected when a creditor on a simple contract cannot acquire a judicial lien that is superior to the interest of the transferee." Under California and New York law, a creditor on a simple contract cannot acquire a lien on personal property held in custodia legis superior to the interest of a particular transferee who is the beneficiary of the property held in custodia legis. Credit Bureau of San Diego v. Getty, 61 Cal.App.2d Supp. 823, 832, 142 P.2d 105 (1943)(holding that funds held in custodia legis were incapable of being reached by garnishment or levy on the part of the depositor's creditors); Clarkson Co. Ltd. v. Shaheen, 716 F.2d 126, 129 (2nd Cir. 1983)(applying New York law and holding that in the absence of express statutory authority, in general, property or funds in custodia legis are not subject to either attachment or garnishment).
Here, Defendants assert that when the Funds were transferred into the Account pursuant to the First Agreement Order, they were maintained in custodia legis because Rothman was acting as an officer of the court. In custodia legis is defined as "in the custody of the law." BLACK'S LAW DICTIONARY 10
The Court will take this opportunity to clarify the approach and rationale contained within its previous opinion and to respond to certain concerns raised by the BAP in its opinion. There is a clearly established two-step process for determining whether funds are property of the estate. First, the Court looks to non-bankruptcy law
It is important to note, however, that the two steps are related; the characterization of the respective property interests only needs to be detailed enough for the Court to determine whether the Funds were property of the estate. In other words, in this situation, the Court needs to reference non-bankruptcy law to the extent necessary to ascertain whether the Funds are property of the estate; if the Court reaches a determination that the property is not property of the estate, any further reference to non-bankruptcy law is unnecessary.
The Court further notes that the latter step, determining the estate's interest in property, can overwhelm the former step, delineating the respective property interests under non-bankruptcy law, and produce some confusion. For example, the following excerpt is from pages 19-20 of the BAP opinion, and represents a continuation of the excerpt contained in footnote 4 of this opinion:
While the quotation identified above makes it appear that Scanlon is on the verge of applying state law, the quotation, in its complete form, takes a quick left turn. To wit:
In re Scanlon, 239 F.3d 1195, 1197-98 (11th Cir. 2001) (emphasis added) (citations and footnote omitted). A review of Scanlon makes it clear that the Court considered the terms and nature of the
In order to determine to what extent this Court must ascertain the contours of the respective property interests by reference to non-bankruptcy law, this Court must first ascertain the relevant standard for determining whether property is property of the estate. Therefore, the Court will proceed in the following order. First, the Court will determine the applicable standard for property of the estate, using cases with relatively similar factual situations. Then the Court will look to non-bankruptcy law to determine the Debtors' interest in the Funds while the Funds were subject to the First Agreement Order. Then the Court will apply the applicable standard for determining property of the estate to Debtors' interest in the funds.
11 U.S.C. § 541(a)(1) states:
Plaintiffs and Defendants dispute whether the First Account should be characterized as a trust account or an escrow account. As noted above, the Court considers this dispute to be a red herring; the label is less important than the substance of the rights.
While the parties have cited to cases which suggest that funds held in trust accounts are typically classified as property of the estate, while funds held in escrow are typically excluded from a bankruptcy estate, this tendency is simply a reflection of the fact that the latter is typically used to characterize arrangements in which a debtor has been divested of control of the funds, while the former is predominantly used to characterize arrangements in which a debtor retains some form of oversight or control. See, e.g., Dzikowski v. NASD Regulation, Inc., 247 B.R. 867, 869-70 (S.D. Fla. 2000) (control of escrow determinative regarding question whether funds become property of estate); In re Royal Bus. School, Inc., 157 B.R. 932, 942 (Bankr. E.D.N.Y. 1993) ("Trustee has no immediate possessory interest in the Key Account within the meaning of the concept of property of the estate so as to entitle him to an order directing the turnover of
In reviewing the case law, the Court found two cases to be particularly relevant to the property of the estate standard. In re B & B Plastics, Inc., 2005 WL 3198656 (Bankr. S.D. Fla. 2005) involved a debtor that was sued for patent infringement in federal district court. Prior to the filing of the district court case, the debtor deposited a sum into its "attorney trust account," which was to be used to cover future payments or liability to the plaintiff. Id. at *1. The debtor made some attempt to deposit the funds in the court registry, but it appears that debtor did not follow through. Id. The district court instructed debtor's attorney to transfer the funds from his "escrow" account (the attorney trust account) to an interest bearing "escrow" account, but the attorney did not do so. Id. at *2. Shortly before debtor filed bankruptcy, the federal district court entered judgment against the debtor. Id. The federal court plaintiff was unable, however, to recover against its judgment before the debtor filed bankruptcy. Id. After debtor filed bankruptcy, its attorney turned the funds over to the trustee. Id. at *3. The bankruptcy court was tasked with determining whether the property held in the attorney trust account constituted property of the estate.
In the course of its analysis, the bankruptcy court stated that "funds that are deposited into an escrow account by a debtor, for the benefit of others, cannot be characterized as property of the estate." Id. at *4 (quoting In re Scanlon, 239 F.3d 1195, 1198 (11th Cir. 2001)). B & B Plastics, however, distinguished its situation from the situation in Scanlon by stating: "The Court holds that the disputed funds were not held in an escrow account because there was no written escrow agreement or court order which specified the terms of such agreement or the conditions under which the funds in the account would be released." Id. Scanlon, on the other hand, involved a case where a securities dealer, accused of defrauding investors, entered into a settlement agreement that provided for a temporary escrow account from which the funds would eventually be transferred to the defrauded investors. Id. at *9. While still in the temporary escrow account, the securities dealer filed bankruptcy, and the bankruptcy court held that the funds were not property of the estate. Id. In explaining the holding of Scanlon, B & B Plastics stated:
Id. at *8 (citations and quotations omitted). In distinguishing Scanlon from its situation, the bankruptcy court in B & B Plastics noted two important differences: (1) the account in Scanlon was set up after litigation began, pursuant to agency order, while in its own case, the account was unilaterally created prior to litigation; and (2) the account in Scanlon was specifically created to compensate victims of wrongdoing, while the disbursement directives in B & B Plastics were less clear. The Court in Scanlon rested its conclusion on the following:
In re Scanlon, 239 F.3d 1195, 1198-99. The critical observation in the above excerpt is the restriction on the Scanlon debtor's control and use of the funds, and thus his, and the bankruptcy estate's, interest in the funds. See In re B & B Plastics, Inc., at *8 ("The Eleventh Circuit also noted that the debtor did not have control over the funds in the temporary escrow account, and he could not control who would receive the funds. Similarly, the debtor's counsel could not release the funds in the escrow account without the approval of the bankruptcy court or by the consent of all the parties involved.").
Now the Court must look to non-bankruptcy law to ascertain the Debtors' interest in the Funds while the Funds were held pursuant to the First Agreement Order. As is noted in the Court's original opinion, while the First Agreement Order divested Debtors of some interest in the Funds, the establishment of the Account did not divest Debtors of all interest in the Funds. See generally In re Schwarzkopf, 626 F.3d 1032, 1039 (9th Cir. 2010). For example, Debtors certainly held a contingent interest in the Funds which would mature upon entry of a court order in their favor in the underlying District Court Action. See generally In re Pless, 202 B.R. 664, 667 (Bankr. N.D.N.Y. 1996).
While it is clear, however, that Debtors retained some interest in the Funds ninety days prior to the filing of the bankruptcy petition, it is equally clear that that interest was limited. While in Scanlon, the Eleventh Circuit was tasked with considering the terms and nature of the escrow agreement in determining the respective property interests, here the Court is
The interest Debtors had in the Funds when the Funds were held in the Account can generally be described as a contingent, disputed, unliquidated interest. More specifically, upon the occurrence of one of two conditions (either final resolution of the District Court Action or agreement of the parties), Debtors may have had some right to some part of the Funds. The First Agreement Order is clear, however, that, while the Funds were in the Accounts, Debtors had no right to use, control, direct, or otherwise dispose of the Funds. Compare with In re B & B Plastics, Inc., 2005 WL 3198656 at *8 (Bankr. S.D. Fla. 2005) ("The Eleventh Circuit also noted that the debtor did not have control over the funds in the temporary escrow account, and he could not control who would receive the funds. Similarly, the debtor's counsel could not release the funds in the escrow account without the approval of the bankruptcy court or by the consent of all parties involved."). That limitation on Debtors' ability to use the Funds was indefinite — and would continue until the federal district court ordered otherwise.
Finally, after ascertaining Debtors' property interests in the funds with reference to applicable non-bankruptcy law, the Court applies the control test identified by the Eleventh Circuit in Scanlon and the courts identified in section (III)(B)(2)(b), supra. Ultimately, Debtors had no meaningful ability to exert control over the Funds while the Funds were in the Account. If Debtors had filed bankruptcy while the Funds were being held in the Account, the trustee would not have had the right to obtain turnover of those funds. This is because 11 U.S.C. § 541(a) restricts the bankruptcy estate's interests to the interests that are held by the debtor. 124 CONG. REC. H. 11096 (daily ed. Sept. 28, 1978) ("To the extent that such an [equitable or legal] interest is limited in the hands of the debtor, it is equally limited in the hands of the estate except to the extent that defenses which are personal against the debtor are not effective against the estate."). To allow Trustee the right to use, direct, control, or otherwise dispose of the Funds in such a situation, would be to allow the bankruptcy estate a greater interest in the Funds that Debtors possessed, in contravention of the Code.
The BAP substantially incorporated the above quotation into its opinion, although it favored a different citation. The BAP opined: "Here, the bankruptcy court's analysis assumes that because Debtors were divested of exclusive control over the Funds, they were divested of all leverage over the Funds."
The Trustee's motion for summary judgment is DENIED, and the Defendants' motion for summary judgment is GRANTED.
The Court will interpret the BAP's opinion as vacating and remanding with respect to the determination whether the Funds were property of the estate, rather than reversing, which would require the BAP to have made an affirmative finding that the Funds were property of the estate, which did not occur.
