Tag Archives: estate

January 20, 2015

Tenth Circuit BAP Adopts Majority Rule That Bankruptcy Estate does not Include Property Placed in Escrow by the Debtor Absent Debtor’s Compliance With Escrow Terms

In its opinion in LTF Real Estate Company, INc. v. Expert South Tulsa, LLC (In re Expert South Tulsa), 2014 WL 6845675 (10th Cir. BAP 2014), the Tenth Circuit Bankruptcy Appellate Panel agreed with the majority rule that funds placed in escrow pre-petition by the debtor, and which the debtor may obtain only through performance as required by the escrow agreement, are not property of the debtor’s bankruptcy estate.  Instead, only the debtor’s right to the escrow funds pursuant to the escrow agreement is property of the estate.

In Expert South Tulsa, the debtor agreed to sell real property to LTF Real Estate Company, with the debtor to construct at its cost improvements to the property.  The debtor escrowed 120% of the estimated cost to construct the improvements, for a total of $1,226,400, as required by the agreement.  The agreement entitled the debtor to receive disbursements from the escrow upon completion of certain milestones in the construction process.   The agreement further provided that LTF could use the funds to complete any of the improvements if the debtor failed to do so.  The debtor failed to complete any of the construction milestones before an involuntary bankruptcy petition was filed against it.  LTF filed an adversary proceeding seeking declaratory judgment that the funds in escrow were not property of the bankruptcy estate and were instead available to LTF to complete the improvements to the property.  The debtor disagreed and contended that, since it supplied the escrow funds and had completed some of the improvements, the funds were property of its bankruptcy estate. 

The BAP granted summary judgment to LTF, finding the escrow funds were not property of the bankruptcy estate.  The court began its analysis with § 541(a)(1), which defines the term “property of the estate” as “all legal or equitable interests of the debtor in property as of the commencement of the case,” “wherever located and by whomever held.”  The court then noted, however, that while § 541(a)(1) is construed broadly, it is not without limits, and the estate succeeds only to the same property interest the debtor possessed at the time the case is commenced.  The court cited the well-known principle that federal law determines the extent to which a debtor’s property interests are property of the estate, while state law defines the debtor’s interest in property.

In this case, governing Oklahoma law provided that an entity’s interest in escrowed funds is limited where the entity places the funds in escrow for a specific purpose and that purpose has not been achieved when the case is filed.  In this instance, the agreement was clear that the debtor was entitled to disbursements from the escrow only on meeting certain construction milestones, none of which it met.  As a result, the court concluded that, while the debtor’s rights under the contract were property of its estate, it did not have an present right to a disbursement of the funds from the escrow when the case was commence, and therefore the funds themselves were not property of the bankruptcy estate.  The court was persuaded by the reasoning of the court in In re Palm Beach Heights Dev. & Sales Corp., 52 B.R. 181 (Bankr. S.D. Fla. 1985), which held, in connection with an escrow funded by a debtor to pay for road and drainage improvements under which disbursements to the debtor were contingent on completion of improvements: “any claim, contingency of chose in action against the trust fund is the property of the estate, but the fund itself is not.  The debtor may not have any part of said fund until such time as the debtor establishes that all prior claims in the fund have been paid and that a residuum remains to which it is entitled.”  Palm Beach, 52 B.R. at 183.  Likewise, the BAP ruled that the debtor’s estate included its rights under the escrow agreement to the funds at such point as the construction milestones were met, but that the funds themselves in the escrow were not property of the estate.

May 23, 2013

Tenth Circuit Holds that Property Transferred by the Debtor Pre-petition and Subject to Avoidance is not Protected by the Automatic Stay

Section 541(a)(1) defines “property of the estate” to include all legal or equitable interests of the debtor in property as of the commencement of the case.  Although this broad definition brings into the estate many assets to which the debtor may claim entitlement, the Tenth Circuit Court of Appeals held in Rajala v. Gardner, 709 F.3d 1031 (10th Cir. 2013) that it is not so broad as to include property transferred by the debtor pre-petition and which is subject to avoidance, but not yet recovered by the trustee. 

The debtor in Rajala owned several wind-generated power projects and entered into a Memorandum of Understanding with Edison Capital to sell three of those projects to Edison.  The debtor’s insiders formed a new entity (“Newco”) which received an alleged fraudulent transfer of the three projects, and which then concluded an agreement with Edison for the sale of the projects.  Eventually Newco brought suit against Edison in federal court in Pennsylvania seeking to recover the last installment due under the contract. 

The debtor was placed into bankruptcy in Kansas after Newco’s Pennsylvania suit was commenced. 
The bankruptcy trustee brought suit in federal district court in Kansas against Newco and the insiders alleging that the transfer of the power projects to Newco was a fraudulent transfer.  The trustee requested the Kansas court to stay Newco and the insiders from pursuing the Pennsylvania litigation, asserting that the proceeds from any judgment would be property of the debtor’s bankruptcy estate and that the automatic stay precluded Newco and the insiders from prosecuting the Pennsylvania action.  The Kansas court denied the motion, and the trustee prosecuted an appeal.

On appeal the Tenth Circuit stated that “the underlying issue we must decide is whether a bankruptcy estate includes fraudulently transferred property that the Trustee has not yet recovered.”  The Tenth Circuit held that such property does not become property of the estate until such time as the trustee recovers it. 

The court arrived at its conclusion by analyzing the plain language of sections 541(a)(1) and 541(a)(3) of the Bankruptcy Code.  The former defined property to include “all legal or equitable interests” the debtor has as of the date the petition is filed, while the latter brings into the estate “interest in property that the trustee recovers under section . . . 550.”  Section 550 empowers a trustee recover transferred property if the transfer is voidable under section 548.  The Tenth Circuit noted a dispute between the Fifth and Second Circuits over whether fraudulently transferred property constitutes property of the estate before it is recovered.  The Fifth Circuit has determined that it is and that the automatic stay protects such property, Am. Nat’l Bank of Austin v. MortgageAmerica Corp. (In re Mortgage America Corp.), 714 F.2d 1266 (5th Circ. 1983), whereas the Second Circuit has determined that it is not and that the automatic stay does not protect such property, Fed. Deposit Ins. Corp. v. Hirsh (In re Colonial Realty Co.), 980 F.2d 125 (2nd Cir. 1992). 

The Tenth Circuit found that the plain language of the statute supported the Second Circuit’s holding in Colonial Realty, and agreed with it.  The court determined that “equitable title” under section 541(a)(1) is such as will give the holder the right to acquire formal legal title. However, interpreting “equitable title” to include an interest in property that has been allegedly fraudulently transferred goes too far and violates concepts of equity.  Further, the court held that interpreting section 541(a)(1) to include property which is recovered by the trustee would render meaningless the provisions of section 541(a)(3).  In addition, because Fed. R. Civ. P. 65 and Fed. R. Bankr. P. 7065 provide a mechanism for a trustee to obtain injunctive relief prohibiting a transfer of property pending the outcome of a fraudulent transfer action, there was no policy reason to justify extending the automatic stay to property which is alleged to have been fraudulently transferred but has not yet been recovered.