A Transfer from the Debtor to a Constructive Trust Isn’t a Transfer of Debtor’s Property

One of several related Circuit appeals that result from a contentious and litigious business separation. The bankruptcy, district, and circuit appeals are winding down (all favorably - so far - to the creditor/beneficiary. The RICO action against the debtor-side parties is still pending.

It isn't clear whether the constructive trust remedy depended on the corporation not yet been formed when it purported to obtain the secured loan. If that's the rationale, then I have no quarrel with the Third Circuit decision other than that this should have been made clear. But if under the law of Pennsylvania (or any state) a default in repaying a secured purchase money loan means that the collateral was held in constructive trust for the lender ab initio, then it's the same situation as when the lender gets a mortgage in a "title state" where the mortgage transfers legal title, subject to the condition that the lender reconvey the property when the secured debt is paid. Sure, the lender has title (either legal or equitable) from day one, but when foreclosure or other change in the lender's status from secured creditor to owner occurs, this constitutes a second transfer for purposes of bankruptcy avoidance powers. The Third Circuit erred in holding otherwise (or seeming to).

Under California Civil Code sections 2223 and 2224 one who wrongfully or fraudulently obtains property holds it in trust for the rightful beneficial owner. If a debtor is wrongfully holding such property on the petition date the rightful owner needs to file an adversary proceeding to impose an involuntary trust and get the property back.