This case calls on us to enter the world of commercial livestock operations. In happier times, Mississippi Valley Livestock was in the business of buying and selling fatted livestock for slaughter and processing. Mississippi Valley had an arrangement with J & R Farms (J & R) under which the former agreed to sell some of J & R’s cattle to a particular buyer. Shortly before declaring bankruptcy, Mississippi Valley paid J & R nearly $900,000 representing completed sales. The bankruptcy trustee now seeks to recover those funds under the preferential-transfer provision of the Bankruptcy Code, 11 U.S.C. § 547(b). The trustee’s efforts were unsuccessful in both the bankruptcy court and the district court. Although we have no quarrel with much of what those courts did, we conclude that further proceedings are necessary, because it is unclear how much of the money could properly be traced to a constructive trust in favor of J & R.
I
Beginning in early January 2007, Mississippi Valley agreed to sell cattle to Swift Con-Agra (Swift). It planned to fulfill that agreement in part with cattle it had received from J & R and in part with cattle from other suppliers. Importantly, Mississippi Valley was merely the holder of J & R’s cattle, rather than the purchaser or owner. Because the relationship between Swift and J & R had soured, Mississippi Valley chose not to inform Swift that some of the cattle it was delivering to Swift were actually J & R’s. The unwitting Swift paid for these purchases with checks made out to Mississippi Valley. Mississippi Valley deposited the checks in its own general operating account, and then from time to time, it sent J & R checks representing the proceeds of the sales of the latter’s cattle.
This arrangement worked well until Mississippi Valley stopped making timely remittances to J & R. As the debts accumulated, J & R sent Mississippi Valley increasingly frantic demands for payment. In one handwritten letter dated March 6, 2007, J & R proprietor Ron Lahr listed 14 head of cattle for which J & R had not yet been paid. “I still have not received my money,” complained Lahr. “I think it has been long enough. I don’t want to hear excuses.... I know you have all this money, I want it[.] Fed Ex or wire to me tomorrow. This is getting old, the lies and waiting for it. You are just using it.” Lahr’s pleas did not fall on deaf ears.
Less than 90 days later, on May 25, 2007, several creditors filed an involuntary petition for relief against Mississippi Valley under Chapter 7 of the Bankruptcy Code. Acting as Mississippi Valley’s bankruptcy trustee, Stephen Balsley (the Trustee) sought to avoid the seven payments to J & R as preferential transfers. The parties agreed that the transfers met all the requirements of a preference, if the transferred funds constituted “an interest of the debtor in property.” See 11 U.S.C. § 547(b). But J & R insisted that Mississippi Valley never had the requisite property interest in the funds.
J & R argued that Mississippi Valley held the cattle-sale proceeds for J & R’s benefit — in effect, in trust. Because the proceeds were held in trust, J & R said, they were never part of Mississippi Valley’s estate and therefore the payments did not satisfy the definition of an avoidable preference. The Trustee took the position that Mississippi Valley’s estate did have an interest because the funds were commingled with Mississippi Valley’s general operating account, rather than segregated into a separate account. This meant, the Trustee argued, that payments drawn from that account were indeed avoidable as preferences.
The bankruptcy court granted summary judgment in J & R’s favor, and the district court affirmed. “Because the uncontested facts in this case show that Mississippi Valley only held the property as bailee for J & R,” the district court concluded, “Mississippi Valley had no equitable or legal interest in the property.” Therefore, the court determined, the payments were not a transfer of an interest of the debtor in property. The court did not analyze the propriety of imposing a constructive trust on the funds in J & R’s favor, nor did it trace the payments to the proceeds derived from sales of J & R’s cattle. The Trustee timely appealed the judgment to this court.
II
Like the district court, we review a bankruptcy court’s factual findings for clear error and its legal conclusions de novo. In re Davis,
This appeal turns on the question whether Mississippi Valley’s payments to J & R were a “transfer of an interest of the debtor in property.” See 11 U.S.C. § 547(b). We begin with a closer look at the terms under which Mississippi Valley held J & R’s cattle. We then address two additional questions: first, whether it is possible to impose a constructive trust for bankruptcy purposes; and second, whether the payments made here can be traced to the proceeds of the sales of J & R’s cattle.
1. Bailment
J & R contends that Mississippi Valley held its cattle in bailment. Because property interests in bankruptcy are “created and defined by state law,” see Butner v. United States,
Under Illinois law, “bailment is ‘the delivery of goods for some purpose, upon a contract, express or implied, that after the purpose has been fulfilled [the goods] shall be redelivered to the bailor, or
Intent to create a bailment may be shown by “either an express agreement ... or an agreement by implication, which may be gathered from the circumstances surrounding the transaction, such as the benefits to be received by the parties, their intentions, the kind of property involved, and the opportunities of each to exercise control over the property.” Wall v. Airport Parking Co. of Chi.,
Illinois courts distinguish bailments from conditional sales, which create only an ordinary debtor-creditor relationship. See Chickering v. Bastress,
In distinguishing bailment from sale, the key question is whether “the sender [has] the right to compel a return of the thing sent, or has the receiver the option to pay for the thing in money?” In re Galt,
Over a century ago, our court (applying Illinois law) decided a case similar to this one: In re Galt. Galt sold wagons on behalf of the Mitchell and Lewis Company. Under the parties’ agreement, Galt neither owned nor had an option to buy the wagons. The agreement required Galt to keep the wagons until they were sold, and then to remit cash received for them by draft payable to the Company. He was allowed to keep any funds obtained in excess of the Company’s price. At any time prior to sale, the Company could compel Galt to return the wagons in his possession, because the Company was the owner until sale. When Galt filed for bankruptcy, the trustee took control of the wagons in Galt’s possession in order to sell them for the benefit of Galt’s creditors. We found that the arrangement between Galt and the Company was a bailment. This meant that the wagons had to be returned to the
More recently, an Illinois court applied the distinction between bailment and sales in Nassar v. Smith,
Applying these principles, we conclude that a bailment existed between J & R and Mississippi Valley. As with Galt’s wagons and Bralock’s tires, Mississippi Valley never had an ownership interest in J & R’s cattle; it did not even have an option to purchase. Rather, Mississippi Valley possessed the cattle solely for the purpose of selling them to Swift. Although Mississippi Valley did not return the cattle to J & R, Mississippi Valley disposed of the cattle as directed by J & R. In addition, the agreement required Mississippi Valley to pay J & R immediately after the sales, as in Galt. This made Mississippi Valley J & R’s undisclosed agent. Mississippi Valley had no ownership or potential ownership stake in the cattle. Bailment is the best legal description that Illinois law furnishes for this arrangement.
2. Constructive Trust in Bankruptcy
Identifying Mississippi Valley as the bailee, however, is not enough. That is simply a stop along the way to determining whether some or all of the payments made to J & R were monies that the Trustee could recapture for the bankruptcy estate. Had Mississippi Valley sent the very same cattle back to J & R (as when a theater-goer retrieves her own car from a parking garage after the show), the case would be easy. The complicating fact is that Mississippi Valley transferred cash to J & R, not cattle, and money is fungible. The bankruptcy court had to create a link between J & R’s cattle and the funds that Mississippi Valley sent to J & R. To accomplish this, the court needed to impose a constructive trust on the funds. Because a constructive trust is a device that should be used with care, this step requires our close scrutiny.
A constructive trust is an equitable remedy for certain claims in restitution. See generally Andrew Kull, Restitution in Bankruptcy: Reclamation and Constructive Trust, 72 Am. Bankr.L.J. 265 (1998) (cited as Kull). In Illinois, as in most states, the remedy is appropriate “[w]hen a person has obtained money to which he is not entitled, under such circumstances that in equity and good conscience he ought not retain it ... to avoid unjust enrichment.” Smithberg v. Ill. Mun. Ret. Fund,
The remedy of constructive trust applies to a subset of unjust enrichment: that resulting from the unauthorized or
The transferee in possession does not own the property any more than a parking garage owns a customer’s car, or a pickpocket owns the wallet he swipes from a purse. Nor does the transferee become the rightful owner of such property by filing a bankruptcy petition. This is the reason assets in a constructive trust are insulated from the claims of the debtor’s general creditors. See Belisle v. Plunkett,
We acknowledge that some courts have rejected this view of constructive trusts in bankruptcy. See, e.g., In re Omegas Group, Inc.,
The Sixth Circuit, in its influential Omegas Group opinion, declared constructive trusts to be “anathema to the equities of bankruptcy,” and it barred bankruptcy courts from imposing them “[ujnless a court has already impressed a constructive trust upon certain assets or a legislature has created a specific statutory right to have particular kinds of funds held as if in trust.”
Omegas Group disagreed with the Fifth Circuit’s decision in Matter of Quality Holstein Leasing,
When a restitution claim is made against a bankruptcy estate, the key question to ask is whether the estate — not the now-defunct debtor — would be unjustly enriched by keeping the claimant’s property. See Kull at 279-80 (“Restitution in bankruptcy involves a kind of ‘second-order’ restitution, meaning that the transfer at issue is once removed from the transfer in which the restitution claim originates.”). The court should focus its attention on the equities of the unauthorized transfer of the claimant’s property to the debtor’s creditors. See id.; In re Dameron,
One question remains: How could the debtor’s creditors (that is, the debtor’s bankruptcy estate) gain an equitable interest when the debtor itself had none? To answer it, we must remember what, in substance, the constructive trust is designed to do. The question is not whether the debtor had a legitimate ownership interest in the disputed property. The question is whether the law should presume that the debtor was holding the property for the benefit of another. If so, then the rightful owner has a claim in restitution against the bankruptcy estate. The remedy for that claim, if proven, is return of the property, unless a good defense exists.
Even we have not always described this distinction as clearly as we might. See, e.g., Marrs-Winn,
For example, in this case, J & R allowed Mississippi Valley to sell J & R’s cattle alongside Mississippi Valley’s own cattle without notice to Mississippi Valley’s other creditors about the true ownership of the cattle. This failure to notify third parties would have no bearing on J & R’s restitution claim against Mississippi Valley itself. In some cases, however, such an arrangement may prevent the restitution claimant from asserting priority against the claims of the bailee’s other creditors. See Chickering v. Bastress,
It is also possible, though we do not resolve this, that J & R’s anonymous use of Mississippi Valley in order to deceive Swift into buying its cattle might support the equitable defense of unclean hands for the Trustee. See Baal v. McDonald’s Corp.,
We need not explore every nook and cranny in the complex area of constructive trust in bankruptcy. It is enough to say that, in bankruptcy, a restitution claimant must at a minimum prove its interest in specific property in the estate’s possession to warrant the remedy of constructive trust. The estate, acting on behalf of the debtor’s general creditors, may have state-law defenses against the restitution claim that the debtor did not have. On remand, the court should look to Illinois law to determine whether J & R has a good claim in restitution against the estate (and ultimately Mississippi Valley’s creditors). The court should also consider whether equitable defenses bar J & R from recovering on that claim.
3. Tracing Proceeds
Finally, we turn to tracing. Although tracing is an element of J & R’s restitution claim, we discuss it separately to emphasize its importance. There can be no constructive trust without tracing a claimant’s interest to specific property. See Travelers Cas. & Sur. Co. of Amer., Inc. v. Northwestern Mut. Life Ins. Co.,
The bankruptcy and district courts were right to recognize that commingled funds require special treatment. But they failed to identify what that special treatment entails. When tracing funds in a commingled account, the lowest-intermediate-balance rule determines the extent of the claimant’s interest in the account. C.O. Funk & Sons, Inc. v. Sullivan Equip., Inc.,
The lowest-intermediate-balance rule caps the restitution claimant’s interest because later deposits are made with assets to which all the debtor’s creditors have an equivalent claim. If multiple restitution claimants successfully trace their property back to the same commingled account, these claimants share the traced funds pro rata. The same equitable principle may rebut the assumption that the debtor spends its own money first. In a Ponzi scheme, for example, the fraud operates by paying “investors” with other victims’ deposits. In such a case, all victims of the fraud may have equivalent claims, thus destroying any particular victim’s entitlement to a constructive trust over the entire pool. “Between claimants similarly situated, the equities of restitution (like the equities of bankruptcy) favor ratable distribution.” See Kull at 285. Cf. In re Foos,
But even fraud victims must trace. In Cunningham v. Brown,
[The recipient of the alleged preference] could have followed the money wherever they could trace it and have asserted possession of it on the ground that there was a resulting trust in their favor.... [This] they could do without violating any statutory rule against preference in bankruptcy, because they then would have been endeavoring to get their own money, and not money in the estate of the bankrupt. But to succeed they must trace the money, and therein they have failed.... In such a case, the defrauded lender becomes merely a creditor to the extent of his loss and a payment to him by the bankrupt within the prescribed period ... is a preference.
Id. at 12-13,
IV
Based on the facts found by the bankruptcy court, it appears likely that a con
Reversed and Remanded.