In Belisle v. Plunkett,¹ the U.S. Court of Appeals for the Seventh Circuit held that the assertion of a constructive trust is insufficient to defeat the employment of the trustee's strong-arm powers. There, the debtor signed a contract, in his own name, to purchase a lease for $1.2 million. The debtor organized five partnerships to obtain the funds to purchase the lease, then utilized the partnerships' funds to purchase the lease. But the debtor closed the transaction in his own name, and he recorded the lease assignment in his own name. Subsequently, the debtor and his wife filed for chapter 7, and the trustee asserted that the lease was property of the estate. The partners filed an adversary proceeding seeking a declaratory judgment that the lease was not property of the estate. The bankruptcy court granted the trustee summary judgment, and the district court affirmed the granting of summary judgment.

In an opinion written by Circuit Judge Easterbrook, the Seventh Circuit held that under Bankruptcy Code §544(a)(3), the trustee was able to avoid the partners' interest in the lease. The debtor defrauded the partners, and the lease was subject to a constructive trust for the benefit of the partners. The imposition of a constructive trust usually survives the commencement of a bankruptcy case. However, §544(a)(3) grants a trustee the status of a bona fide purchaser. A bona fide purchaser, without knowledge of the earlier claim, would take priority over an entity that had not recorded its interest, or otherwise taken steps to preclude bona fide purchasers, such as recording a lis pendens against the property.

The partners contended that Bankruptcy Code §541(d) precluded the use of the strong-arm powers. According to the partners, §§541(d) and 544(a)(3) allow a trustee to recover property transferred out of the estate before the commencement of a bankruptcy case, but these provisions preclude a trustee from recovering property that is subject to a constructive trust.

The Seventh Circuit rejected the partners' argument. One of the purposes of §544(a)(3) was intended to deal with the problem of ostensible ownership. In addition, §544(a)(3) recognizes that a good-faith purchaser is able obtain greater rights to property than the rightful owner if the rightful owner neglected to record its interest. Section 544(a)(3) grants a trustee the status of a bona fide purchaser. Under applicable non-bankruptcy law, a bona fide purchaser would have priority over the partners because the partners failed to record their interests. Consequently, the trustee, as a bona fide purchaser, has priority over the partners.

The court also ruled that there was no conflict between §§541(d) and 544(a)(3). The Seventh Circuit stated:

Section 541(d) does not have anything to say about the effects of §544(a)(3). It forbids including property in the debtor's estate "under subsection (a) of this section" and does not address whether property may be included under some other part of the Code.²

The legislative history of §541(d) reflected that it was intended to deal with transactions in the secondary mortgage market. Section 541(d) ensures that creditors of the service corporation stand behind the owners of the income stream. Therefore, there was no indication that Congress intended that §541(d) was intended to limit the application of §544(a).

Plunkett is a significant decision. Circuit Judge Easterbrook is one of the leading law and economics scholars, and has an excellent understanding of commercial and corporate law. Plunkett is a correct interpretation of bankruptcy law and policy. Ostensible ownership is an important policy permeating secured lending. The recording statutes are designed to facilitate commercial lending. The purpose of obtaining a security interest is to enable a lender to be repaid in the event of an insolvency proceeding. An unrecorded or secret lien vitiates the reliability of the recording statutes because recognition of an unrecorded or secret lien destroys the reliability of the recording system.

In a world without bankruptcy, a judgment creditor would have priority over a creditor with an unperfected security interest.³ Section 544(a)(1) recognizes the priority provision contained in Article 9. Section 544(a)(1) enables the trustee or debtor-in-possession to enforce this priority for the benefit of the unsecured creditors. The trustee or debtor-in-possession is acting to collect assets for the benefit of all the unsecured creditors. Under these circumstances, the trustee enforces the entitlements that the unsecured creditors possessed against the debtor's property prior to the bankruptcy case because of §544(a)(1). Therefore, a constructive trust should not be permitted to defeat the utilization of the trustee's strong-arm powers.

This is also the correct result under Butner v. United States.⁴ There, the Supreme Court held that non-bankruptcy law determines property interests in a bankruptcy case. The court stated:

Property interests are created and defined by state law. Unless some federal interest requires a different result, there is no reason why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding. Uniform treatment of property interests by both state and federal courts within a state serves to reduce uncertainty, to discourage forum shopping, and to prevent a party from receiving "a windfall merely by reason of the happenstance of bankruptcy."⁵

The enforcement of the strong-arm provisions ensures that a creditor with an unperfected security interest will not receive a windfall because of the happenstance of bankruptcy. If a creditor was unperfected prior to the bankruptcy case, then the creditor's lack of perfection should be subject to attack under the strong-arm clause.

The Seventh Circuit correctly interpreted the relationship between §§541(d) and 544(a). There is nothing in the text or in the legislative history of §541(d) that §541(d) was intended to supercede §544(a). In addition, the language and history of §544(a) reflects that this provision was intended to sanitize the estate of any malfeasance committed by the debtor. Therefore, interpreting §541(d) as restricting the utilization of §544(a) is an erroneous interpretation of the Bankruptcy Code.

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Footnotes

¹ 877 F.2d 512 (7th Cir. 1989). Return to article

² Id. at 516. Return to article

³ U.C.C. §9-301(1)(b). Return to article

⁴ 440 U.S. 48 (1979). Return to article

⁵ Id. at 55. Return to article