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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Dec/Jan 2000

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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,<a href="#1" name="1a">1</a> 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).

<h3>State Law Controls</h3>

The starting point for any claim of constructive trust, and the relative priority of such a claim, of course,
is state law.<a href="#2" name="2a">2</a> 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:
<blockquote>
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 <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… of Trusts §308</a>). 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.<a href="#3" name="3a">3</a>

</blockquote>

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:
<blockquote>
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.<a href="#4" name="4a">4</a>
</blockquote>

<h3>Limits on Reach of Belisle</h3>

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.<a href="#5" name="5a">5</a> 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.

<h3>Conclusion</h3>

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 Authors

Brian Francis Kenney

Journal Date

Friday, December 1, 2000 - 12:00