A claim for money stolen from a bankrupt estate has no higher status in the thief’s bankruptcy, according to a decision by District Judge Laura Taylor Swain of Manhattan.
The July 15 opinion by Judge Swain also stands for the proposition that complying with a court order does not preclude a transfer from being set aside as a preference. Similarly, a court order cannot create a trust when the trust property has already disappeared. Judge Swain was a bankruptcy judge before being elevated to the district court in 2000.
Mark Dreier headed a 250-lawyer firm bearing his name. Seemingly successful, Dreier was able to pay the firm’s attorneys and other expenses only because he was stealing from his clients’ trust accounts. He was also taking a healthy portion of the stolen money to support his own elegant lifestyle.
Dreier’s crimes in part consisted of selling notes to investors purportedly on behalf of a prominent real estate owner in New York. In fact, he was conducting a Ponzi scheme by using money from new note investors to pay high rates of interest and return of principal to prior investors. Money from the Ponzi scheme cycled through the Dreier clients’ trust account.
Dreier pleaded guilty in May 2009 to money laundering, conspiracy, securities fraud, and wire fraud and was sentenced to 20 years in prison. Initially in receivership, his firm quickly went into chapter 11 in December 2008, to be supervised by a chapter 11 trustee. The disclosure statement in connection with the liquidating plan confirmed in May 2014 told creditors there was about $360 million in unsecured claims.
The victims of the fraud included lawyers from a bankruptcy boutique who merged their firm into Dreier’s. They represented a company in chapter 11 named Cosmetics Plus that generated a $350,000 settlement held in the Dreier firm’s trust account. Within a few months of the deposit, the trust account had a negative balance.
Not long before the Dreier firm’s bankruptcy, the bankruptcy court dismissed the Cosmetics Plus chapter 11 case and directed that the settlement funds be paid to a secured creditor. Around that time, the Dreier trust account had $48 million.
After the Dreier fraud surfaced but before the firm’s bankruptcy filing, the lawyers managed to have the Dreier firm transfer $350,000 into another trust account which they controlled. After bankruptcy, at the demand of Dreier’s trustee, the lawyers turned the $350,000 over to the trustee, to abide disposition by the court.
In her July 15 decision, Judge Swain upheld rulings by the bankruptcy court relegating the $350,000 claim to the status of a general unsecured claim. She also upheld the bankruptcy court’s ruling that the funding of the lawyer’s trust account immediately before bankruptcy was a preference.
On the preference issue, the lawyers argued that the $350,000 was not estate property and thus not a preference. Judge Swain held that the money was estate property because the Dreier trust account at one point had been “completely dissipated” and proceeds of the settlement could not be traced into the lawyers’ trust account later.
The lawyers contended that the order directing turnover to the secured creditor of Cosmetics Plus gave priority over Dreier’s other unsecured creditor claims. Judge Swain held that a court’s order directing payment “creates a legal obligation similar to that of a contract.” There is no authority, she said, that “such an obligation constitutes anything more than a general unsecured claim.”
Judge Swain also rejected the lawyers’ constructive trust theory. To carve out $350,000 from the Dreier firm’s assets “would inflict further injury on others whose fiduciary funds were similarly mishandled” and “would undermine the orderly and equitable asset distribution process” required by the Bankruptcy Code.
A claim for money stolen from a bankrupt estate has no higher status in the thief’s bankruptcy, according to a decision by District Judge Laura Taylor Swain of Manhattan.