Earlier this year, Judge Kevin J Carey, Chief Judge of the Delaware Bankruptcy Court, issued a decision in the Interlake Material Handling bankruptcy, whereby the Court dismissed a complaint that sought to impose a constructive trust. The dispute in Interlake concerned the terms of a distributorship agreement (the "Agreement"). Pursuant to the terms of the Agreement, the Court in Interstate addressed the issue of constructive trust under Illinois law. Although state law governed, the Court's analysis in Interstate provides a useful look at how issues of constructive trust are decided in a bankruptcy context.
National Store Fixtures ("National Store") is an operating division of United Fixtures Company, which in turn is one of the debtors that filed bankruptcy petitions in the Interlake bankruptcy. National Store sold shelving to Tiare International, Inc. ("Tiare"). Two months after National Store and United Fixtures filed for bankruptcy, Tiare filed an adversary complaint alleging that certain funds received by National Store and its lender, NCBC, were not property of the bankruptcy estate and were instead subject to a constructive trust. Opinion at *1-2.
Under the Agreement, Tiare purchased shelving from National Store and then re-sold the shelving to Tiare's customers. For larger orders, National Store agreed to invoice Tiare's customers directly. After Tiare's customers paid National Store's invoice, National Store would pay Tiare the difference between its agreed to price with National Store and the price paid by Tiare's customers (the "Mark-up"). Opinion at *4.
A few months prior to National Store filing for bankruptcy, Tiare submitted orders to National Store for two of Tiare's customers. After the petition date, these customers paid National Store's invoices. Payment of the invoices generated a Mark-up worth $207,711.13. NCBC, acting under a credit agreement, swept National Store's account, which included the funds constituting the Mark-up. Opinion at *4-5.
National Store and NCBC both filed motions to dismiss Tiare's complaint, alleging Tiare failed to state a claim upon which relief can be granted as to the constructive trust claim. In granting the motions, the Court began by noting that section 541 of the Bankruptcy Code creates a bankruptcy estate that consists of "all legal and equitable interests of the debtor in property." Opinion at *5. Next, the Court cited a decision by the Second Circuit that holds that "[w]here the debtor's conduct gives rise to the imposition of a constructive trust, so that the debtor holds only bare legal title to the property, subject to a duty to reconvey it to the rightful owner, the estate will generally hold the property subject to the same restrictions." In re Howard's Appliance Corp., 874 F.2d 88, 93 (2d Cir. 1989), quoting In re Flight Transp. Corp. Securities Litigation, 730 F.2d 1128, 1136 (8th Cir. 1984).
Turning to Illinois law, a constructive trust is created "when a court declares the party in possession of wrongfully acquired property as the constructive trustee of that property, because it would be inequitable for that party to retain possession of the property." Opinion at *6, citing Suttles v. Vogel, 533 N.E.2d 901, 904 (Ill. 1988). A court will not impose a constructive trust unless the complaint alleges "wrongdoing, such as fraud, breach of fiduciary duty, duress, coercion or mistake." Id. at 905. The nonpayment of money does not constitute "wrongdoing" sufficient to support a constructive trust, nor does a claim for breach of contract. Opinion at *6 (citations omitted).
In Interlake, Tiare argued that the wrongdoing committed by the Defendants arose from their improper claim to the Mark-up. In support of its argument, Tiare cited In re Bake-Line Group, LLC, 359 B.R. 566 (D. Del. 2007), where the court imposed a constructive trust on a check which the debtor deposited into its bank account. The Court, however, found In re Bake-Line Group distinguishable from the facts presented in Interlake. In Bake-Line, the debtor deposited the check in to its own account and then, realizing its mistake, returned the funds to the defendant. The Interlake debtor, on the other hand, received checks that were made payable to the debtor. Further, Tiare and the debtor in Interlake had a "long-standing, arms-length relationship." Opinion at *7.
Having considered the facts alleged in the light most favorable to Tiare, the Court found that Tiare had not provided a "plausible basis for determining that there was any mistake or wrongdoing" by the Defendants. Id.