Overcash v. Knisley et al

Filing 12

MEMORANDUM OPINION - Under the de novo standard of review, the Court finds a genuine issue of fact regarding the existence of a bailment under Nebraska law that would extended to the proceeds of the sales, and, therefore, whether the proceeds were debtor property. A separate order will be entered in accordance with this memorandum opinion. Ordered by Senior Judge Lyle E. Strom. (AOA)

IN THE UNITED STATES DISTRICT COURT FOR THE
DISTRICT OF NEBRASKA
IN THE MATTER OF

)
)
BIG DRIVE CATTLE, L.L.C., )
)
Debtor.
)
)
CAROL KNISLEY,
)
)
Appellant,
)
)
v.
)
)
JAMES A. OVERCASH, Chapter 11 )
Trustee,
)
)
Appellee.
)
______________________________)

BK. 11-42415

4:14CV3064

MEMORANDUM OPINION

This matter is before the Court on the appeal of Carol
Knisley from the judgment of the United States Bankruptcy Court
for the District of Nebraska.
I. Jurisdiction
District courts have jurisdiction to hear appeals “from
final judgments, orders, and decrees” of the bankruptcy courts.
28 U.S.C. § 158(a)(1).

The United States Bankruptcy Court for

the District of Nebraska issued an order granting appellee’s
motion for summary judgment in this case on February 20, 2014.
This is an appeal from a final order of the bankruptcy court.
This Court has jurisdiction to hear the appeal.
II. Standard of Review
A court hearing an appeal from the judgment of a
bankruptcy court “review[s] [a] grant of summary judgment de
novo, viewing the facts in the light most favorable to the

nonmoving party.”

In re Marlar, 267 F.3d 749, 755 (8th Cir. 2001).

III. Factual Background
The appellant held an equity membership interest in Big
Drive Cattle, L.L.C. (“BDC”) which operates a commercial feedlot.
Appellant made several separate purchases of cattle that he
shipped to BDC for feeding and care until they reached an
appropriate weight, at which time BDC sold them to third parties
on appellant’s behalf.

BDC would deposit the proceeds from the

sale of appellant’s cattle with Farm Credit Services of America,
where it would be applied against BDC’s $1.5 million line of
credit account.

BDC would then pay appellant an amount equal to

the proceeds of the sale less the cost of feed.

Several payments

to appellant under this arrangement occurred in the year before
BDC filed for relief under Chapter 11 of the Bankruptcy Code on
September 9, 2011, during which time BDC was insolvent.
Importantly, at no time did appellant transfer or intend to
transfer legal title or ownership of these cattle to BDC.
The trustee James Overcash filed to recover the
payments made to appellant after September 9, 2010.

The

bankruptcy court found in favor of the trustee, and this appeal
followed.

These facts were not disputed in the bankruptcy court,

nor are they disputed here.
IV. Discussion
As noted by the bankruptcy court, the Eighth Circuit
has given guidance on avoidance of preference payments:

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“Under the Bankruptcy Code’s
preference avoidance section, 11
U.S.C. § 547, the trustee is
permitted to recover, with certain
exceptions, transfers of property
made by the debtor within 90 days
before the date the bankruptcy
petition was filed.” Barnhill v.
Johnson, 503 U.S. 393, 394 (1992).
“This rule ‘is intended to
discourage creditors from racing to
dismember a debtor sliding into
bankruptcy and to promote equality
of distribution to creditors in
bankruptcy.’” Lindquist v. Dorholt
(In re Dorholt, Inc.), 224 F.3d
871, 873 (8th Cir. 2000) (quoting
Jones Truck Lines, Inc. v. Cent.
States, Se. & Sw. Areas Pension
Fund (In re Jones Truck Lines,
Inc.), 130 F.3d 323, 326 (8th Cir.
1997)).
“Title 11 U.S.C. § 547(b) requires
that in order for a transfer to be
subject to avoidance as a
preference, (1) there must be a
transfer of an interest of the
debtor in property, (2) on account
of an antecedent debt, (3) to or
for the benefit of a creditor, (4)
made while the debtor was
insolvent, (5) within 90 days prior
to the commencement of the
bankruptcy case, (6) that left the
creditor better off than it would
have been if the transfer had not
been made and the creditor asserted
its claim in a Chapter 7
liquidation.” Buckley v. Jeld-Wen,
Inc. (In re Interior Wood Prods.
Co.), 986 F.2d 228, 230 (8th
Cir.1993).
Wells Fargo Home Mortgage, Inc. v. Lindquist, 592 F.3d 838, 842
(8th Cir. 2010).
The appellant argues that the first element -“transfer of an interest of the debtor in property” -- was not
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met because the funds were held in trust by BDC as bailee for the
appellant, and were never property of the debtor’s.

Recognizing

that the proceeds were not traceable to the funds transferred to
appellant because of BDC’s use of the proceeds to pay its debts,
appellant argues that Nebraska’s “swollen assets” doctrine allows
for a constructive trust that traces the funds to the debtor’s
estate.
Debtor Property
The bankruptcy court first determined that because the
proceeds from the sale of appellant’s cattle were not segregated,
they could not be traced, and, therefore, appellant’s
relationship with BDC was -- if it was not already -- converted
to a debtor-creditor relationship.

Overcash v. Knisley, In re

Big Drive Cattle L.L.C., BK11-42415 A13-4040, Filing No. 28.

The

bankruptcy court relied on precedent from the Eighth Circuit
which stated:

“once the funds were commingled and it became

impossible to actually trace the principal's own money, the
relationship had to be treated as a creditor-debtor relationship
under the Bankruptcy Code with respect to those disputed funds.”
In re Rine & Rine Auctioneers, Inc., 74 F.3d 854, 860 (8th Cir.
1996).
The court in Rine did look past the ownership of the
property before the sale and considered the treatment of the sale
proceeds separately to determine whether they were property of
the debtor.

Id. at 860-62.

However, the court did not say that

treatment by the debtor “converts” or “transforms” the
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relationship.

Rather the court used the treatment of the

proceeds as evidence of whether the underlying agreement between
the debtor and the owner of the property contemplated debtor
ownership of the funds following the sale.

Id.

In each of the

cases cited, and Rine itself, the contracts or agreements allowed
the debtor to use the funds before remitting payment to the owner
of the sold property, often depositing the funds in a general
account.

Id. (citing In re Walker Indus. Auctioneers, Inc., 38

B.R. 8 (Bankr. D. Or. 1983); In re Bellanca Aircraft Corp., 96
B.R. 913 (Bankr. D. Minn. 1989); In re Farrell & Howard
Auctioneers, Inc., 172 B.R. 712 (Bankr. D. Mass. 1994)).
However, Rine also involved a novel argument that,
although the creditor could not identify the particular proceeds
from the auction of his property, the funds in one particular
account were not “an interest of the debtor in property” under
§ 547(b) because they consisted only of auction proceeds, which
belonged to auction customers, not the debtor.

Id.

In rejecting

this argument, the Eighth Circuit clearly reflected an aversion
to giving one creditor preference over identical creditors -- all
auction customers whose funds were deposited in the account.

The

creditor in Rine argued for an equitable preference on the sole
basis that he was first to file to recover his property from the
dwindling pool of funds in the auction proceeds account.
A loosening of the tracing requirement in such a case is
inconsistent with the Bankruptcy Code’s attempts to treat
identical creditors similarly.
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See id.

The present case is different.

The appellant is not

making the same novel claim under § 547(b) to recover funds from
an account containing only commingled non-debtor property.
Rather, appellant is, appropriately, looking to state law to
resolve the underlying property rights.

See In re MJK Clearing,

Inc., 371 F.3d 397, 401 (8th Cir. 2004) (“State law governs the
resolution of property rights within a bankruptcy proceeding.”).
Appellant argues that a resolution of those property rights in
his favor would exclude the proceeds from the debtor’s estate
under 11 U.S.C. § 541(d).

Notably, the funds in this case were

not commingled but allegedly misused to pay the debtor’s debts.
Further, because appellant argues he was a bailor attempting to
recover his own property rather than a creditor, the Bankruptcy
Code’s goal of treating similarly situated creditors equally is
maintained.
Finally, unlike Rine, et al., in this case, the
debtor’s treatment of the sale proceeds does not simply confirm
that it was the owner of the funds acting within his rights under
its agreement with the sellers.

It is unclear whether this was a

business transaction like the auction and sale cases in Rine:

in

those cases the agreement to sell on behalf of the property owner
was an arms-length transaction in which it was part of the
debtor’s business to make such sales.

It makes sense that the

funds passed through the debtor’s hands as general operating
funds owned by the debtor -- especially where the terms of the
agreement allowed for such.

Here, it is unclear whether this
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type of transaction was part of the regular business of the
debtor or a bailment undertaken to accommodate a part owner of
the debtor enterprise or whether the agreement between the debtor
and the appellant anticipated the debtor’s use of the sale
proceeds.

If it was the latter, the sale proceeds may also have

been held in trust by the debtor as a bailee.

The debtor’s

misuse of bailment funds does not warrant the same treatment as
funds which debtor was authorized to take ownership of and use
under the debtor-owner agreement.
The bankruptcy court also explicitly refused the
imposition of a constructive trust, citing the following
precedent from the bankruptcy courts of the Eighth Circuit:
“There are at least two requirements before a constructive trust
can be imposed:

the debtor’s misconduct allows principles of

equity to override legal considerations, and the contest is
between the creditor and the debtor, not among creditors.”
Kunkel v. Ries (In re Morken), 199 B.R. 940, 964 (Bankr. D. Minn.
1996).

The bankruptcy court held that the appellant failed the

test because he “is one of a number of creditors seeking payment
from a limited amount of assets and the imposition of a
constructive trust would be unfairly prejudicial to those other
creditors.”

In re Big Drive Cattle L.L.C., BK11-42415 A13-4040,

Filing No. 28.
Morken’s recitation of Eighth Circuit precedent was
sufficient for its purposes but was, ultimately, imprecise.

The

Morken court’s categorical conclusion that “constructive trusts
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cannot be used to alter the priority scheme explicitly prescribed
by Congress” is at odds with the Eighth Circuit precedent which
Morken itself admits would allow the imposition of a constructive
trust under some circumstances.

In re Morken, 199 B.R. 940.

Morken involved a typical bank-creditor that was attempting to
jump priority over other bank-creditors on the basis of equity.
Id.

Like Morken, the primary Eighth Circuit precedent involved

an unsecured creditor who had loaned the debtor money.

In re

Jeter, 171 B.R. 1015, 1017 (Bankr. W.D. Mo. 1994) aff'd, 178 B.R.
787 (W.D. Mo. 1995) aff'd, 73 F.3d 205 (8th Cir. 1996) (relying
on the “excellent analysis” of the bankruptcy judge).
The Jeter analysis on which Morken relied distinguished
the successful Eighth Circuit constructive-trust plaintiffs in
Chiu v. Wong, 16 F.3d 306 (8th Cir. 1994) and United States v.
Whiting Pools, Inc., 462 U.S. 198 (1983), as “cases where the
party seeking a constructive trust possessed an ownership
interest in the property held by the debtor.”
B.R. at 1020-21.

In re Jeter, 171

The court also noted the policy implicit in the

Bankruptcy Code against imposing a constructive trust in favor of
the creditor who is “speediest or most able to afford the expense
of litigation.”

Id.

Finally, the court considered the general

equities of the case including whether the plaintiff was able to
protect himself from the fraud of the debtor.

Id.

Here, appellant is a purported bailor whose bailment
property was misused by the debtor-bailee -- said misuse leading
to the inability of the appellant to recover under the bailment
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agreement alone.

In other words, unlike the unsuccessful

plaintiffs in Morken and Jeter, the appellant faces the loss of
property in which he did have an ownership interest.

The

appellant is also distinct from the Morken and Jeter plaintiffs
in that he was not a similarly situated creditor who was arguing
equity on the basis of his diligence in racing to the courthouse.
The debtor’s misuse of the alleged bailment funds uniquely
prejudiced the appellant’s claim to the property, whereas no
other creditors were harmed by that act.

The appellee raises the

specter of unclean hands or waiver by suggesting that appellant’s
insider status gave him knowledge of the misuse, the power to
stop it, or both.

Ultimately, neither party has submitted

evidence dispositive of this issue or the existence of a bailment
in regard to the sales proceeds.
State Law
Appellant’s claims of error are harmless if Nebraska
law would not allow for the imposition of a constructive trust.
As outlined below, the Court finds that the claim is colorable.
Under Nebraska law, trust assets that cannot be traced
because of some action by the trustee may be excused from strict
identification via the “swollen assets” doctrine.

“The swollen

assets doctrine . . . allows a beneficiary to trace into the
estate of an insolvent trustee on the theory that the use of
trust funds to pay the personal debts of the trustee relieved him
from using his individual property for that purpose and
consequently increased the amount of it on hand at insolvency.”
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In re Estate of Chaney, 232 Neb. 121, 138, 439 N.W.2d 764, 775
(1989).
While it is true that the “swollen assets” doctrine
appears to have emerged from a string of cases involving the
insolvency of banks and also true that the Nebraska Supreme Court
in Chaney declined to extend the doctrine to the realm of probate
disputes, the Nebraska Supreme Court did not dismiss the
application of the doctrine outside of bank insolvencies out of
hand.

Id.

Rather, the Court relayed the general principles of

the doctrine in the generic terms of trust assets, trustees, and
creditors of the trustee.

Id.

The Court rejected the

application of the “swollen assets” doctrine in that particular
case because it was not compatible with the beneficiaries theory
of recover under the probate code.1

Id.

The appellee has not

presented, nor does the Court find, such incompatibility exists
in the bankruptcy context.

1

In Chaney, the beneficiaries sought to recover specific
trust property from a decedent’s estate. Chaney, 232 Neb. at
132, 439 N.W.2d at 772. The Nebraska Supreme Court found that
this did not constitute a “claim” under the Nebraska probate
statutes because the statute explicitly excluded “dispute[s]
regarding title of a decedent to specific assets.” Id. at 138,
439 N.W.2d at 775. Because of this distinction, the
beneficiaries were not barred by their failure to meet the
specific statutory requirements for the bringing of “claims”
against the estate. Id. For the same reason that the
beneficiaries’ dispute was not a “claim,” -- it sought specific
assets alleged to be owned by the decedent -- it also could not
invoke the “swollen assets” doctrine which “by its very nature,
does not implicate ‘specific assets.’” Id. at 138, 439 N.W.2d at
775.
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V.

Conclusion
Under the de novo standard of review, the Court finds a

genuine issue of fact regarding the existence of a bailment under
Nebraska law that would extended to the proceeds of the sales,
and, therefore, whether the proceeds were debtor property.

A

separate order will be entered in accordance with this memorandum
opinion.
DATED this 13th day of June, 2014.
BY THE COURT:
/s/ Lyle E. Strom
____________________________
LYLE E. STROM, Senior Judge
United States District Court

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