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By: Andrew J. Olejnik and Abraham M. Salander
In In re Mississippi Valley Livestock, Inc., No. 13-1377 (7th Cir. Mar. 12, 2014), the Seventh Circuit held that payments made by a bailee to a bailor shortly before the bailee’s bankruptcy case could be subject to a constructive trust in favor of the bailor and thus not recoverable by the bankruptcy trustee as a preferential payment. The debtor (the bailee) ran a commercial livestock operation which included an agreement with a company (the bailor) where the debtor would sell the company’s livestock to a buyer and return the proceeds to the company. Shortly before the debtor’s bankruptcy, the debtor paid the company substantial amounts of proceeds that the debtor had been improperly withholding.
After determining that a bailment arrangement had been established under Illinois law, the Seventh Circuit decided that property subject to a constructive trust can be excluded from a bankruptcy estate where state law permits a constructive trust. The court clarified, however, that a constructive trust is a remedy for a restitution claim and that a debtor’s estate may have equitable defenses that would bar the restitution claim. In addition, a claimant’s restitution claim requires tracing – there can be no constructive trust without tracing a claimant’s interest to specific property. In this case, the payments at issue had come from a commingled account, which required application of the lowest-intermediate-balance rule to determine the extent of the claimant’s interest in the account. Because the record had not been fully developed on all these issues, the Seventh Circuit remanded the case for further proceedings.