Home Constructive Trusts A Response Sections 544(a)(1) and (2) and Interests in Personalty vs. 544(a)(3) and Interests in Real Property

Home Constructive Trusts A Response Sections 544(a)(1) and (2) and Interests in Personalty vs. 544(a)(3) and Interests in Real Property

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his article responds to Professor Cuevas's article entitled "Constructive Trusts, the UCC and the Code §544(a)(1) (Part Two)," which appeared in the May 2000 ABI Journal. Professor Cuevas's article discusses the case of Belisle v. Plunkett,1 which held that the trustee's strong-arm powers under §544(a)(3) won out over a party's claim to a constructive trust under §541(d) of the Code. Prof. Cuevas then extrapolates the holding of Belisle to stand for the proposition that the trustee can, and should, win as well under §§544 (a)(1) and (2) of the Code.

However, there are meaningful distinctions between §§544 (a)(1) and (2) on the one hand, and §544 (a)(3) on the other hand, which may allow the constructive trust claimant to be successful as against the trustee with respect to personalty under §§544(a)(1) and (2), yet be unsuccessful with respect to real property under §544(a)(3).

State Law Controls

The starting point for any claim of constructive trust, and the relative priority of such a claim, of course, is state law.2 Section 544 of the Bankruptcy Code gives the trustee certain strong-arm powers that enable the trustee to defeat claims of constructive trust in certain cases. However, the trustee who lives by state law must also fall by it, and in the case of a constructive trust claimed as to personalty, the trustee's powers under §§544(a)(1) and (2) may not be strong enough to defeat the claim to a constructive trust.

Sections 544(a)(1) and (2) give the trustee the rights of a creditor with a judicial lien under state law, and an unsatisfied execution thereon, respectively. Therefore, one must look to state law to determine whether an unsatisfied judicial lien or execution would win against a claim of constructive trust in personal property. Generally, though, state law does not afford a creditor with a judicial lien "bona-fide purchaser" status, and judgment creditors are usually subject to the equitable interests of constructive trust claimants.

The Restatement of the Law of Restitution illustrates the point as follows:

j. Creditors. Where a person holds property subject to a constructive trust, his creditors are not purchasers for value and are subject to the constructive trust, except as stated in Comment k [purchaser at execution or judicial sale]...So also, a creditor who attaches property or obtains and records a judgment or levies execution upon the property is not a bona fide purchaser, although he had no notice of the constructive trust (see Restatement of Trusts §308). This is true whether the property is land, or a chattel, or a chose in action, whether the chose in action is in the form of a negotiable instrument or not.3

The fundamental distinction between §§544(a)(1) and (2) on the one hand and §544(a)(3) on the other was recognized by Judge Easterbrook in Belisle, where he stated:

Sections 544(a)(1) and (2) follow state law, however, in giving the trustee no greater rights than the judgment creditor would have. If the debtor possesses a stolen diamond ring, the real owner's rights would trump those of a judgment creditor, and under the Code therefore would defeat the claims of all of the debtor's creditors. Whether or not we say that the debtor holds the ring in "constructive trust" for the owner is a detail. Under state law, the owner's claims are paramount; the debtor could not defeat those rights by pledging or selling the ring, and the creditors in bankruptcy receive only what state law allows them...Under most states' laws, however, the buyer in good faith of real property can obtain a position superior to that of the rightful owner, if the owner neglected to record his interest in the filing system. Section 544(a)(3) gives the trustee the same sort of position.4

Limits on Reach of Belisle

In that sense, one can agree that Judge Easterbrook "got it right" in Belisle. It would be a mistake, however, to extrapolate this decision, which relies on §544(a)(3) for its essential holding, to problems of constructive trusts in personalty. Generally, state law protects bona fide purchasers for value of real property with land title recording statutes. At the same time, judgment creditors generally do not enjoy such protection (nor should they—they generally haven't loaned any money against the asset that is the subject of the competing constructive trust claim).

The distinction between §§544(a)(1) and (2) and §544(a)(3) will certainly lead to inconsistent results within the same circuits and between creditors claiming constructive trusts on personalty (who can win against the trustee) and creditors claiming constructive trusts in real property, who generally will lose to the trustee under §544(a)(3). Moreover, the distinction between the rights of bona fide purchasers of real property (§544(a)(3)) and the rights of judgment lien creditors (§§544(a)(1) and (2)) will lead to inconsistent results among circuits with respect to precisely the same kinds of claims. This is the inevitable result of the fundamental premise of both §541, defining property of the estate, and §544, granting the trustee strong-arm powers, in that both sections look to state law for a determination of property rights and priorities. To the extent that the law of one state grants greater protections to judgment lien creditors than the law of another state, so too will the trustees have greater powers in one circuit than another.

The courts are reluctant to allow constructive trusts in bankruptcy cases.5 First, the courts often reject constructive trust claims—where the claimant merely has an unsecured claim and is trying to disguise that claim as an ownership interest—under the rubric of a constructive trust. The courts' reluctance is justified because to allow constructive trusts in bankruptcy cases would permit one party to elevate its claims above that of the other creditors, thereby doing violence to the fundamental element of equality of treatment among similarly situated creditors. However, if the problem is viewed as one of ownership of the asset in question, as opposed to one of priority among competing creditors, then the claimants are not similarly situated as to that property. The constructive-trust claimant equitably may own the asset (subject of course to proof problems, such as strict tracing rules), while unsecured and ultimately disappointed creditors never had any truly legitimate interest in being paid out of that asset in the first place if the debtor had no legitimate ownership interest in the asset.


The reliance on state law to define property interests under §§541 and 544 inevitably leads to distinctions rooted in state law. Generally, holders of judicial liens are subject to equitable claims against property ostensibly held by their debtors, while bona fide purchasers of real property are not. There is, therefore, a meaningful distinction under the Code between §544(a)(1) and (2), relating to personalty, and §544(a)(3), relating to real property.

Journal Date: 
Friday, December 1, 2000