LFD Operating, Inc. v. Ames Department Stores, Inc. (In Re Ames Department Stores, Inc.)LFD Operating, Inc. v. Ames Department Stores, Inc. (In Re Ames Department Stores, Inc.)
MEMORANDUM DECISION REGARDING PROCEEDS FROM THE SALE OF PLAINTIFF’S MERCHANDISE IN DEFENDANTS’ STORES
I. Introduction
On September 6, 2001, Plaintiff, LFD Operating Inc. (“LFD”), commenced this adversary proceeding against Defendants, Ames Department Stores, Inc. and Ames Merchandising Corporation (hereinafter, “Ames”), seeking the return of $8.9 million from Ames to LFD. LFD asserts its claim based upon a series of agreements that allegedly prescribe that the $8.9 million is the property of LFD and, hence, should be excluded from Ames’s bankruptcy estates.
LFD is a licensee that sells footwear and other related merchandise in Ames’s stores. Plaintiff seeks declaratory relief based on contract, agency, trust, and constructive trust principles. LFD’s primary argument is premised on paragraph 41 of the relevant agreement between the parties, which provides that all proceeds from the sale of LFD merchandise shall be the property of LFD from the time of such sale, and that Ames shall act as LFD’s agent and trustee until such time as the proceeds are paid over to LFD. In response, Ames contends that LFD is an unsecured creditor and therefore is not entitled to any return of funds. Ames argues that using the words “trust” or “agent” in a contract does not create a valid trust or agency in bankruptcy if a debtor is allowed to commingle monies and is not required to pay over funds immediately or on demand. Ames has cited to, among other things, a number of “store-within-a-store” decisions of various courts to support this proposition. In response to LFD’s constructive trust theory, Ames contends that the equitable remedy of a constructive trust results in only an unse
In lieu of live testimony, the litigants submitted joint stipulated facts and deposition transcripts of all witnesses to this proceeding. 1 The witnesses to this adversary proceeding, organized alphabetically, are as follows:
• Linda M. Cote — Vice President of Planning and Treasury of Ames, deposed on November 9, 2001;
• Rolando de Aguiar — Chief Financial and Administrative Officer of Ames, deposed on November 2, 2001;
• Kathleen Guinnessey — Vice President of Finance for LFD’s parent, Footstar, as well as Treasurer of LFD, deposed on November 2, 2001;
• David H. Lissy — Senior Vice President and General Counsel of Ames, deposed on November 9, 2001;
• Stephen Metivier — Underwriter and Portfolio Manager for General Electric Capital Corporation (“GECC”), deposed on November 8, 2001;
• Maureen Richards — Senior Vice President, Corporate Secretary and General Counsel of LFD’s parent, Footstar, as well as General Counsel and Corporate Secretary to LFD, deposed on November 5, 2001;
• Mark von Mayrhauser — Vice President Controller of Ames, deposed on November 9, 2001; and
• Elizabeth White — Chief Financial Officer of Casual Male, formerly known as JBI Holding, Inc. (“Baker”), deposed on November 7, 2001.
The Court heard oral argument on the parties submissions, including their memo-randa of law 2 and exhibits, on December 4, 2001. The following decision is the Court’s findings of fact and conclusions of law under Rule 52 of the Federal Rules of Civil Procedure, as incorporated into this adversary proceeding under Rule 7052 of the Federal Rules of Bankruptcy Procedure.
II. Jurisdiction
The Court has subject matter jurisdiction of this matter under 28 U.S.C. §§ 1334(b) and 157(a) and the “Standing Order of Referral of Cases to Bankruptcy Judges” of the United States District Court, dated July 10, 1984 (Ward, Acting C.J.). This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(B) and (E).
III. Factual and Procedural Background
Ames and certain affiliated entities filed these voluntary chapter 11 cases on August 20, 2001. Ames is a regional discount retailer that operates, as of the filing of this complaint, approximately 452 stores in 19 states and in the District of Columbia. LFD is a licensee that sells footwear and related merchandise in Ames’s stores. LFD is the assignee of an agreement entered into between Ames and Baker. The present controversy arose when Ames
A. The Relationship Between Ames and Baker
By agreement dated November 17, 1987 (“Agreement”), Ames licensed Baker to operate shoe departments in various Ames stores (“Departments”), (Stipulation of Facts ¶ 1) (hereinafter “SF”). Baker was the owner of all merchandise that Baker sold in Ames’s stores. (SF ¶ 2.) The Agreement required that Baker furnish and operate the Departments by purchasing and supplying fixtures, purchasing and supplying merchandise, and hiring all necessary personnel as Baker employees. (SF ¶ 2.) All sales of Baker merchandise were to be processed through Ames’s cashiers, (SF ¶ 3), and the proceeds therefrom were processed through the regular channels of Ames’s business. 4 (SF ¶ 12.) The Agreement states that “[a]ll proceeds of cash sales of merchandise in said department shall be paid directly to and handled directly by Ames’[s] cashiers and shall in no event ... be handled by any representative or employee of Baker.... ” (Agreement ¶ 4b at Ex. 1.) The Agreement also required that Ames keep a separate and distinct account and a separatе and complete set of books and records of all sales of Baker’s merchandise. (SF ¶¶ 5, 6.)
The Agreement required Ames to provide to Baker a weekly statement of Baker’s sales of merchandise from the second preceding week, not later than Friday. (SF ¶ 7.) Concurrently, with the delivery of the statement of sales, the Agreement also required Ames to pay to Baker the balance due from the same weekly statement after Ames deducted (1) the amount of commissions, fees and monies due and payable to Ames, and (2) the amount of any and all other charges against Baker’s account made by Ames in accordance with the terms of the Agreement. (SF ¶ 7; Agreement ¶ 4b at Ex. 1.) The Agreement provides that:
“Net Sales” as such term is used in this Agreement shall mean the total (gross) amounts charged by Baker for or in connection with (1) any and all sales of goods, wares and merchandise and/or (2) all services rendered in, upon or from said department or from any part of the store in which the licensed premises are located by Baker, and the total (gross) amount of all charges for services performed by Baker in, upon or from any part of the licensed premises, and sales, wherever made, of goods, wares and merchandise of Baker stored or displayed in said department or in said store, whether such sales shall be for cash or credit.... “Net Sales” shall not include any customer returns, allowances, credits or refunds....
(Agreement ¶ 3c at Ex. 1.)
In practice, the course of dealings between Ames and Baker resulted in Ames providing the statement of sales and payment for Baker’s shoe sales on the Monday immediately after the Friday referred to in the Agreement. (SF ¶ 10.) Both the
The Agreement was amended as of April 29, 1989. 5 (SF ¶ 13.) Amendment I, among other things, added paragraph 41 to the Agreement. Paragraph 41 states in relevant part that:
It is further confirmed and agreed that all proceeds from the sale of merchandise of Baker to customers ... shall be the property of Baker from the time of such sale, that Ames shall act as Baker’s agent in the collection and holding of such proceeds, and that Ames shall hold such proceeds in trust for Baker until such time as they are paid over to Baker....
CAmendment I ¶ 13 at Ex. 2.)
Elizabeth White, Chief Financial Officer of Casual Male, formerly known as Baker, testified that it was her understanding that from 1987 to 2001 Baker’s proceeds and Ames’s proceeds were put into the same cash registers and bank accounts. (White Dep. at 5-10, 12, 22.) Ms. White was responsible at Baker for insuring that monies were received from Ames for Baker’s footwear sales in the Ames stores. (White Dep. at 7.)
Testifying on the course of dealings between Baker and Ames, Ms. White stated that it was her understanding that after payments were made at Ames’s cash registers for Baker merchandise, and prior to the time Ames made payment to Baker approximately two weeks later, Ames took the cash, checks and other means of payment from the cash registers and deposited them into bank accounts. (White Dep. at 8-9, 22.) Whatever bank accounts Ames was using, it was Ms. White’s understanding that customer sales from Baker merchandise and Ames’s other receipts were put into the same bank accounts. (White Dep. at 22.) Ms. White was unaware of any changes in the way Ames processed money from 1987 until Baker assigned its rights under the Agreement to LFD in 2001. (White Dep. at 9-11.)
Ms. White explained that the reason Ames kept an account of what Baker product was sold was to use that information to pay Baker. 6 (White Dep. at 17-18.) For instance, Ms. White testified that there was a point of sale record made by Ames that identified Baker merchandise sold at Ames stores. (White Dep. at 13-14.) This was accomplished through a so-called “stock-keeping unit” or “SKU” number that Ames had assigned to Baker merchandise. (White Dep. at 13-14.) Using this system, it was possible for Ames to track each and every item of sale through each individual Ames store. (White Dep. at 18, 19.) On a daily basis, Ames would report each and every sale to Baker by specific dollar amount. (White Dep. at 14-15, 18.) From the SKU information, Baker would generate a report of all sales of Baker merchandise sold in Ames stores on a daily basis. (White Dep. at 20.)
Ms. White possessed no knowledge of whether Ames could track cash proceeds from the sale of Baker merchandise. (White Dep. at 19.)
On April 25, 1990, Ames commenced a voluntary chapter 11 proceeding in the Southern District of New York (“Ames F). (Lissy Dep. at 3-4; Defs.’ Ex. 28.) Ames I ultimately consummated a plan of reorganization on December 30, 1992. (Lissy Dep. at 34.)
Beginning in June 1990, David Lissy was hired by Ames Department Stores, Inc., as a consultant and thereafter as vice-president and general counsel of Ames. (Lissy Dep. at 4.) During Ames I, Mr. Lissy had the overall responsibility for the legal issues dealing with Ames I, which included every prepetition claim against the bankruptcy estate of any significance. (Lissy Dep. at 5-6.)
Mr. Lissy testified that in connection with Ames I, Baker had a claim. (Lissy Dep. at 5-6.) Baker’s claim totaled $13.7 million, as a consequence of Ames’s failure to pay Baker for their prepetition collection of proceeds from the sale of Baker merchandise. (Lissy Dep. at 8; Defs.’ Ex. 28.) In the Ames I proceeding, Baker’s claim in Ames I was treated as an unsecured claim. (Lissy Dep. at 6-8; Defs.’ Exs. 28, 29.) Mr. Lissy testified that, to the best of his recollection, at no time did anyone from Baker assert that Baker had anything but an unsecured claim. (Lissy Dep. at 6.) Baker’s unsecured claim was for prepetition amounts not paid by Ames to Baker from the sale of merchandise for a period of time comparable to LFD’s predicament in Ames’s current chapter 11 cases. (Lissy Dep. at 30-31.)
In Ames I, pursuant to section 365 of the Bankruptcy Code, Baker’s contract to sell shoes in Ames’s stores was assumed by Ames as of the consummation date of the plan based on a stipulation agreement with Baker (the “Stipulation”). (Lissy Dep. at 6-7; Defs.’ Ex. 28.) Mr. Lissy executed the Stipulation on behalf of Ames in Ames I. (Lissy Dep. at 7-8; Defs.’ Ex. 28.) The terms of the Stipulation entailed a partial cash payment upon the consummation of a plan of reorganization, with the balance due subject to a promissory note secured by a mortgage on the home office of Ames Department Stores. (Lissy Dep. at 8-9; Defs.’ Exs. 28, 29.) As part of the Stipulation, Ames and Baker amended the Agreement (“Amendment II”), but did not change the way Ames prospectively handled funds from Baker’s shoe sales. (Lis-sy Dep. at 11-12; Defs.’ Exs. 28, 29.) Amendment II included, among other things, modifications that enhanced the parties’ ability to terminate the Agreement in the event Baker failed to achieve certain performance standards. (Defs.’ Ex. 29.)
After consummation of the plan, Ames and Baker continued with their prepetition contractual relationship regarding footwear sales by Baker in Ames’s stоres until Baker assigned the contract to LFD. (Lis-sy Dep. at 9-10.) Mr. Lissy testified that Baker never requested that Ames change any of the procedures relating to the handling of the proceeds from Baker’s shoe sales, including placing such funds into a trust account. (Lissy Dep. at 10-11.)
C. Baker’s Assignment of the Agreement to LFD
On February 3, 2001 and with Ames’s consent, (SF ¶ 23), Baker assigned to LFD all of Baker’s rights in and to the
Agreement,
7
and LFD assumed all of Baker’s obligations. (SF ¶ 22.) Pursuant to that assignment, LFD agreed that it would “assume, observe, perform, fulfill, and be
Before the assignment to LFD, Baker had businesses in apparel retail as well as licensed footwear departments. (Guinnes-sey Dep. at 12.) LFD is a wholly owned subsidiary of Footstar Corporation. (Guinnessey Test. Hr’g on T.R.O. at 8, 44-45.) LFD and Footstar share common officers. (Guinnessey Test. Hr’g on T.R.O. at 45; Guinnessey Dep. at 5, 10-11; Richards Dep. at 4.) In February 2001, LFD/Footstar acquired all ongoing footwear businesses of Baker. (Richards Dep. at 8-9; Guinnessey Dep. at 12; Guinnes-sey Test. Hr’g on T.R.O. at 8-9.) The Baker assets sold to LFD/Footstar encompassed approximately 13 license agreements with retailers, including Ames. (Guinnessey Dep. at 12.) Some of the other major accounts LFD/Footstar acquired from Baker included Today’s Man, Spiegel, Stein Mart and Roses. (Guinnes-sey Dep. at 11, 13.) Before the Baker acquisition, Footstar already operated footwear departments in stores like Kmart and Rite-Aid. (Richards Dep. at 22-23; Guinnessey Dep. at 13,14.)
Maureen Richards, Senior Vice President, Corporate Secretary and General Counsel of LFD’s parent, Footstar, as well as General Counsel and Corporate Secretary to LFD, testified that she was in charge of all the legal work concerning Baker’s assignment to LFD, including due diligence. (Richards Dep. at 4, 8, 21; SF ¶ 59; Pl.’s Ex. 10.) Ms. Richards did not have any discussions with Baker or recollect seeing any documents from Baker concerning how Ames handled Baker’s proceeds. (Richards Dep. at 8-10, 20, 21.) Ms. Richards was unaware of any communication with Ames concerning Ames’s handling of the Baker proceeds. (Richards Dep. at 11.) Kathleen Guinnessey, Treasurer of LFD, understood that as a result of Baker’s assignment to LFD, LFD had succeeded to the relationship Ames had with Baker. (Guinnessey Dep. at 4-5, 25-26, 47-48; SF ¶ 54.)
Following the assignment from Baker to LFD, the procedures and relationships between the parties relevant to this proceeding remained the same as they existed between Baker and Ames prior to the assignment, as set forth below:
• LFD was the owner of all merchandise sold in Ames’s stores. (SF ¶ 24.)
• All sales of LFD merchandise were processed through Ames’s cashiers. (SF ¶ 28.)
• LFD knew the proceeds from LFD merchandise sold in Ames’s stores were being received in the same cash registers that received proceeds from Ames’s merchandise. (SF ¶ 65.)
• Sales of LFD’s merchandise were identified at the point of sale at the cash register by SKU numbers which enabled Ames to identify and track the sales of LFD’s merchandise. (SF ¶ 29.)
• LFD received daily transmissions from Ames’s point of sale system that showed LFD’s footwear sales. (Guinnessey Dep. at 57-60.)
In turn Ames:
• Maintained separate and distinct account records of all sales from LFD merchandise. (SF ¶ 27.)
• Did not maintain separate bank accounts for proceeds from the sale of LFD merchandise. (SF ¶ 67.)
• Used information from Ames’s point of sale system to create a daily sub-account of the sales of LFD’s mеrchandise. (SF ¶30; von Mayrhau-ser Dep. at 9-11.) On a weekly ba-
sis, the information from the sub-account was fed into Ames’s general ledger system, which created an account that identified the amount of the sales of all LFD merchandise. (SF ¶ 30.)
• Used information from the point of sale system to accumulate the amounts that were applicable to LFD sales, and determined from those totals, using the contractual rate, how much had to be remitted to LFD on a periodic basis, (von May-rhauser Dep. at 4, 9-12.) After calculating the amount of the Net Sales of LFD’s merchandise, the only further deductions Ames would make in calculating the Net Sales Proceeds to be remitted to LFD are Ames’s licensing fee, and an amount equal to 5% of the credit card fees that Ames is charged by credit card companies. 8 (SF ¶ 71.)
• Wired to LFD every Monday the amount of Net Sales Proceeds Ames calculated it owed to LFD for sales of LFD merchandise during the second preceding calendar week ending the second preceding Saturday. (SF ¶11.)
Of Ames’s approximately $4 billion dollars in revenue for the fiscal year ending February 2001, approximately 4% was generated from the proceeds of LFD footwear sales, (de Aguiar Dep. at 31.) As of the filing of Ames I, Baker’s sales through Ames were even greater than LFD’s sales in Ames stores. (Lissy Dep. at 31.) Footstar’s sales generated from the Kmart footwear departments are greater than LFD’s sales from Ames’s footwear departments. (Richards Dep. at 25.)
D. Ames’s Deposit Accounts
Under Ames’s cash management system, funds collected by Ames’s stores are deposited into local and depository bank accounts (the “Store Accounts”) and, thereafter, transferred upon Ames’s request, on a daily basis, to certain blocked accounts established by Ames (the “Blocked Accounts”), with Chase Manhattan Bank N.A. (“Chase”). (SF ¶ 42 n. 1; ¶¶ 42-44.) Additional operating income and corporate account remittances are periodically deposited into lock box accounts (the “Lock Box Accounts”), which are maintained by Fleet Bank N.A. (SF ¶ 42 n. 1; ¶¶ 42, 45.)
Sales proceeds from Ames’s stores that are deposited in the Store Accounts include monies from the sales of both LFD’s merchandise and Ames’s merchandise. (SF ¶ 43.) Usually, the business day after monies are deposited in the Store Accounts, those monies are transferred to the Blocked Accounts. (SF ¶ 44.) Ames transfers the amounts contained in the Lock Box Accounts to the Blocked Accounts at least once a week. (SF ¶46.) Credit card processors wire funds representing credit card payments into the Blocked Accounts. (SF ¶ 47.) The monies in Ames’s Blocked Accounts are transferred to a GEC.C concentration account on the day Ames’s funds are deposited in the Blocked Accounts. (SF ¶ 48.)
E. Ames’s Credit Facility & Disbursement Account
As of March 2, 2001, Ames, and various affiliated entities, entered into a credit
Upon Ames’s request, the Secured Lenders would advance money to Ames up to the limits of credit availability under Ames’s Revolver. (SF ¶ 49.) Ames’s Secured Lenders advance money to Ames by depositing money into a blocked Disbursement Account (“Disbursement Account”) consisting of funds provided exclusively from GECC. (SF ¶ 50; Metivier Dep. at 48.) The Disbursement Account is used to fund the continuing operations of Ames, including payroll, and operating expenses. (SF ¶ 50 n. 2.) All payments made by Ames are made from this Disbursement Account. (Metivier Dep. at 49.) Ames is advanced funds in a lump sum that Ames can use to meet Ames’s obligations. 9 (Me-tivier Dep. at 43-44.) GECC does not receive any documentation from Ames to trigger a payment from Ames to LFD. (Metivier Dep. at 43.)
Ames’s credit advances under the Revolver are subject to reserve amounts. (Metivier Dep. at 27-30; Pl.’s Exs. 14-18.) A reserve amount reduces credit availability in the amount of the reserve. (Metivier Dep. at 27-42; Cote Dep. at 36; Pl.’s Exs. 14-18.) One of the reserve amounts under the Revolver was referred to as an ineligible shoe sales reserve (the “Reserve”). (Metivier Dep. at 27-30; PL’s Exs. 14-18.) The amount of the Reserve is based on a strict average of monthly historical payments that correspond to Ames’s prior payments to Baker/LFD. (Metivier Dep. at 33-36.) Mr. Metivier’s testimony indicates that the Reserve involved no actual segregation of proceeds from LFD shoe sales. (Metivier Dep. at 30.)
F. Events Leading to Ames Current Chapter 11 Petition
Between February 3, 2001 and August 13, 2001, Ames’s financial condition deteriorated significantly. (SF ¶ 51.) On August 12, 2001, the Board of Directors of Ames met and authorized the filing of a chapter 11 petition. (SF ¶ 52.) On August 13, 2001, Ames failed to turn over to LFD $2,036,000.00 in Net Sales Proceeds. (SF ¶ 53.) The amount that was due to LFD on August 13 reflects LFD sales from the week beginning Sunday, July 22, 2001 and ending Saturday, July 28, 2001. (Compl. ¶ 14.) On August 20, 2001 Ames filed a chapter 11 petition under the Bankruptcy Code. (SF ¶ 61.)
During the week before filing bankruptcy, Ames decided to preserve cash, (de Aguiar Dep. at 9.) Except for normal payroll, very few payments were made that week, (de Aguiar Dep. at 9-10.) The Chief Financial Officer of Ames, Rolando de Aguiar, testified that there was no specific discussion of the LFD payment before filing bankruptcy. (Defs.’ Ex. 30; de Aguiar Dep. at 9, 13.) Based on a general discus
On August 15, 2001 Ames paid approximately $3.2 million in retention bonuses to 124 employees. (SF ¶ 58; de Aguiar Dep. at 10.) All of the 124 employees entered into written retention bonus agreements before receiving their payments, (de Agu-iar Dep. at 15.) By way of example, Mr. von Mayrhauser received a retention bonus but committed to return the incentive if he did not remain employed for a certain period of time, (von Mayrhauser Dep. at 56-58.) Ms. Cote received a retention bonus for her agreement to remain employed by Ames Department Stores until March 1, 2002. (Cote Dep. at 11-12.) There was no discussion about the payment to LFD as compared to the retention bonuses, (de Aguiar Dep. at 12-13.) It was Mr. de Aguiar’s belief that the retention bonuses paid to employees had nothing to do with Ames’s nonpayment to LFD. (de Aguiar Dep. at 12-13.)
On August 13, 2001, Mr. de Aguiar instructed that no wire transfers be made, (de Aguiar Deр. at 62.) Ames does not pay all of its bills by bankwire or electronic transfer, (von Mayrhauser Dep. at 54.) Ames sometimes uses written checks from the Disbursement Account, (von Mayrhau-ser Dep. at 55.) On August 14, 2001, Kathleen Guinessey, the Treasurer of LFD, telephoned Mr. de Aguiar, and inquired why Ames had not wired to LFD the $2,036,000.00 in Net Sales Proceeds that was due on August 13, 2001 and when LFD could expect to receive payment. (SF ¶ 54; Guinnessey Dep. at 25-26.) Ms. Guinnessey testified that Mr. de Aguiar said that he would check on the status of the payment and get back to her that same day. (Guinnessey Dep. at 25-26.) During the conversation, Mr. de Aguiar did not disclose to Ms. Guinnessey that Ames had decided to file for bankruptcy relief under chapter 11. (SF ¶ 57.)
Mr. de Aguiar testified that he did not know whether LFD’s weekly payment from Ames was made by bankwire, (de Aguiar Dep. at 5-6.) Subsequent to the telephone conversation with Ms. Guinnes-sey, Mr. de Aguiar ascertained that, in fact, no wire transfer had been made to LFD. (de Aguiar Dep. at 63.) Under instructions from counsel not to discuss wire transfers, Mr. de Aguiar did not telephone Ms. Guinnessey concerning the August 13 payment. (SF ¶ 56; de Aguiar Dep. at 63.)
On August 16, 2001 LFD’s General Counsel, Maureen Richards, telephoned Ames’s General Counsel, David Lissy, to discuss the August 13 payment. (SF ¶ 59; Richards Dep. at 12; Pl.’s Ex. 10.) During the conversation, Mr. Lissy informed LFD that Ames was not making any payments to creditors. (Richards Dep. at 13.) When Ms. Richards inquired whether Ames was holding monies in trust or as agent for LFD, Mr. Lissy questioned whether Ames was obligated to do so. (Richards Dep. at 13-14.) Mr. Lissy agreed to check on whether LFD might still be paid, and whether the monies were held in trust or as an agent for LFD. (Richards Dep. at 14.) The following day, Ms. Richards e-mailed Mr. Lissy. (SF ¶ 59; Pl.’s Ex. 10.) The e-mail, among other things, requested that Ames confirm that the Net Sales Proceeds were segregated and held in trust for the benefit of LFD. (Pl.’s Ex. 10.) On August 20, 2001, Ames failed to pay over to LFD $2,306,000.00 in Net Sales Proceeds. (SF ¶ 60.) That same day, Ames and certain affiliated debtors filed these chapter 11 cases. (SF ¶ 61.)
IV. Discussion
The principle issue in this proceeding is whether the proceeds from the sale of LFD’s merchandise in Ames’s stores are LFD’s property and, hence, excluded from Ames’s bankruptcy estates. Section 541 of the Bankruptcy Code provides that a bankruptcy case creates an estate of property comprised of all legal or equitable interests of the debtor as of the commencement of the case. See 11 U.S.C. § 541(a)(1). Subsection 541(d) limits from the estate interests in which the' debtor holds only a legal and not an equitable interest in property. See 11 U.S.C. § 541(d). According to CollieR on Baotc-RUPTCY:
Subsection (d) re-emphasizes the provision of section 541(a)(1) that the estate is to be comprised of all legal or equitable interests of the debtor in property as of [the] commencement of the case. It also reiterates the general principle that an interest that is limited in the hands of the debtor is equally limited in the hands of the estate, and therefore, where the debtor holds bare legal title without any equitable interest, the estate acquires bare legal title without any equitable interest in the property.
L. King et al., 5 Collier on BaNkruptcy ¶ 541.27 (15th ed. rеv.2001).
Section 541(d) describes a typical trust situation: a trustee holds bare legal title to property for the benefit of one or more beneficiaries who hold the equitable title or interest in the trust property.
See Official Comm, of Unsecured Creditors v. Columbia Gas Systems Inc. (In re Columbia Gas Systems Inc.),
Therefore, the question the Court must address is whether Ames holds bare legal title without any equitable interest in the Net Sales Proceeds. If it were established that Ames holds bare legal title without any equitable interest, LFD would be entitled to the immediate payment of the Net Sales Proceeds of not less than $8.9 million. LFD argues that Ames holds only bare legal title, without any equitable interest, to the Net Sales Proceeds based on contract, agency, trust, and constructive trust theories. 10
LFD maintains that the unambiguous terms of the Agreement between Ames and LFD require that this Court find that the Net Sales Proceeds of at least $8.9 million is Plaintiffs property. (Pl.’s Br. at 11; Pl.’s Reply Br. at 1.) The contract between Ames and LFD contains the express term that the proceeds from the sale of LFD’s merchandise “shall be the property” of LFD. (Pl.’s Br. at 11; Pl.’s Reply Br. at 2.) LFD’s contract theory is premised upon the fundamental rule of law that court’s may not rewrite unambiguous provisions of an arms-length contract. (PL’s Reply Br. at 2, 8.)
Plaintiff acknowledges that the relationship between contracting parties must be dеtermined by its real character rather than by the form the parties have given it where the public interest or the rights of third-parties are involved. (PL’s Br. at 11; PL’s Reply Br. at 8-4.)
See Pan Am. World Airways, Inc. v. Shulman Transport Enters., Inc. (In re Shulman Transport Enters., Inc.),
The two cases forming the premise for the Circuit’s finding in
Shulman
are instructive here. First, in
Pepper v. Litton,
Second, the Court of Appeals for the First Circuit in
In re Morales Travel Agency,
Taken together, the authorities relied on by the court in
Shulman
suggest that principles of fairness and equity can override the express terms of an agreement in a bankruptcy case where there are indicia
Here, Plaintiff contends that there are no rights of third-parties to be protected in this bankruptcy case because Ames’s creditors could not have justifiably relied on the Net Sales Proceeds being Ames’s property. (Pl.’s Br. at 12.) Plaintiff hinges this argument on, among other things, certain public disclosures filed by Ames with the Securities and Exchange Commission (“SEC”). LFD argues that Ames’s unsecured “creditors were on either actual notice or constructive notice that the Net Sales Proceeds were not Ames’[s] property or, at a minimum, could not have justifiably relied to the contrary.” (Pl.’s Br. at 13.) Thus, because Ames’s creditors, as a result of the SEC disclosures, either knew, or had reason to know, that LFD had an interest in the Net Sales Proceeds, Plaintiff argues that there is no justification for the Court to rely on the authorities that find that the relationship between contracting parties must be determined by its real character, rather than by the form the parties have given it.
Plaintiff cites to no legal authority for the proposition that SEC disclosures are sufficient, without more, to provide actual or constructive notice оf a right to proceeds. The commercially acceptable procedure for claiming an interest in proceeds is through Articles 2 and 9 of the Uniform Commercial Code (“UCC”). LFD’s SEC disclosure argument vitiates and undermines the policies and provisions of the UCC.
See generally, United States v. Speers,
The inquiry begins with the interpretation of the use of the word “property” in paragraph 41 of the
Agreement.
Here, Ames has collected the Net Sales Proceeds and commingled the funds in its depository accounts and used the funds in an unrestricted manner.
13
Baker was aware of
This finding is supported by the testimony of Ms. White and Mr. Lissy in connection with bank accounts and the parties course of dealings, the timing of Amendment I and the available record from Ames’s prior bankruptcy. Certainly, when the debtors in Ames I sought to assume the Agreement Baker could have raised these issues in the context of adequate assurance of future performance. See 11 U.S.C. § 365(b)(1)(C). Although the record here does not specifically indicate whether any concern over the treatment of the Net Sales Proceeds was raised in Ames I, it is clear that the Stipulation and Amendment II do not reflect any change in Ames’s collection and handling of funds. In addition, the Court’s findings, infra, that Ames and LFD had a debtor-creditor relationship further supports the Court’s conclusion that the Net Sales Proceeds were the property of Ames and not LFD. Therefore, the Court denies LFD’s request for a declaration that the proceeds from the sale of LFD’s merchandise is not property of Ames. The Court reaches this conclusion by applying the rationale provided by Shulman for interpreting contractual relationships and by applying the law relevant to funds placed in Ames’s depository accounts.
B. Agency & Trust Theories
LFD argues that Plaintiff should prevail under both an agency and a trust theory. In support of its agency theory, LFD argues that paragraph 41 of Amendment I unambiguously identifies Ames as LFD’s agent for the collection and holding of the Net Sales Proceeds. That same paragraph identifies Ames as trustee and LFD as beneficiary of the Net Sales Proceeds held in trust.
The distinction between a trustee and agent lies in the element of control and the extent of disposition of the proрerty. A party who merely has possession of property of another and, although authorized to deal with that property, is subject to control by its owner, is an agent of the owner. A trustee, however, holds legal or equitable title to the property placed in his possession and may or may not be subject to the beneficiary’s control. An agent-trustee is one who holds a title but is also subject to control by the beneficiary.
S.E.C. v. Am. Bd. of Trade, Inc.,
Where there is an agent-trustee, it is the agency relation that predominates, and the principles of agency, rather than the principles of trust, are applicable. See I Austin WaxemaN Soott & William Franklin FRAtcher, The Law of Trusts § 8, at 95 (4th ed.1987) (“Soott on Trusts”). Nevertheless, the Court finds it appropriate for a more complete analysis of the issues to discuss each theory.
(i) Agency
An “[a]gency is the fiduciary relation which results from the manifesta
When the existence of an agency relationship is uncertain, courts often look to the alleged principal’s right to control as a critical indicator.
See Maritime Ventures Int’l, Inc. v. Caribbean Trading & Fid., Ltd.,
LFD cites to
Shulman
as the authority in this Circuit on the agency issue before the court. (Pl.’s Reply Br. at 7.)
Shulman
recognized that if an alleged agent’s acts concerning a certain subject matter cannot be controlled and directed by the principal, there is no agency relationship with regard to that subject matter.
See, e.g., Drexel Burnham,
In
Shulman,
the Second Circuit upheld the district court’s affirmance of a bankruptcy court order rejecting Pan Am’s claim of an interest superior to that of a secured creditor in Shulman’s bankruptcy case.
Shulman,
Notwithstanding the express terms оf the agreement, the Second Circuit approved of the district court’s examination into the substance of the relationship between Shulman and the air carriers.
Id.
at 295. The district court observed that by relying on the authority of
Morales,
the bankruptcy judge properly found that the “agency” and “property” language employed in the agreement was a draftsman’s device designed to insure that the carriers would be paid regardless of the debtor’s solvency.
Pan American World Airways, Inc. v. Continental Bank,
In finding that the district court did not err in holding that the money in Shulman’s possession was not held in the fiduciary capacity of an agent, the Second Circuit ruled that “[ajbsent the critical element of control by Pan Am over Shulman’s collection and handling of funds, Shulman cannot be said to have acted as Pan Am’s agent for receipt of transportation charges.”
Shulman,
Another factor relevant to the court’s conclusion that Shulman was not a fiduciary to Pan Am, was the fact that Shulman had no contractual duty to remit the proceeds of sale, but monthly payment out of debtor’s general funds was sufficient.
Shulman,
Here, Plaintiff argues that LFD was in control of the prineipal/agent relationship because LFD owns and controls the merchandise up to the point of sale. (Pl.’s Br. at 20.) In addition, LFD asserts that it was in control of the relationship at all times because Ames was required, among other things, to collect and submit information relating to LFD’s sales.
14
(Pl.’s Br.
Even assuming that LFD exercised some control over aspects of the Ames/ LFD relationship, the issue before the court is not simply whether LFD exercised any measure of direction and control over Ames. The issue here, similar to Shulman, is whether LFD had the right to direct and control Ames’s collection and handling of the Net Sales Proceeds and, therefore, whether Ames was LFD’s agent in this specific capacity. Shulman recognized that if an alleged agent’s acts concerning a certain subject matter cannot be controlled and directed by the principal, there is no agency relationship with regard to that subject matter. As applied here, the Court finds that Ames was not the agent of LFD for the remittance of the Net Sales Proceeds because LFD was not in control of the collection and handling of such funds. This conclusion is based on the findings that (i) Ames commingled the Net Sales Proceeds, (ii) Ames used the Net Sales Proceeds by placing funds in the Blocked Accounts to be swept by GECC, and (iii) Ames paid LFD from its general accounts with funds made available by GECC in Ames’s Disbursement Account. These findings are also consistent with Baker’s conduct in Ames I and the available evidence concerning which party bore the risk of loss on bounced check and credit transactions.
First, it is undisputed that the
Agreement
contained no provision that required that Ames place the Net Sales Proceeds in a segregated bank account. To the contrary, the
Agreement
requires that the proceeds be processed through the regular channels of Ames’s business and, as discussed below, Ames has no restriction on the use of those proceeds. The discretionаry element of determining the regular channels of Ames’s business has, in practice, resulted in Ames commingling the Net Sales Proceeds in Ames’s depository accounts with proceeds from non-Baker/LFD merchandise. LFD, therefore, has no control or right to control how the proceeds are processed by Ames and where the Net Sales Proceeds are ultimately deposited. Courts have found that the absence of a segregation of funds is inconsistent with an agency relationship.
Welding Metals,
This finding is also supported by the record from
Ames I.
There is nothing to indicate to the Court that the original parties to the
Agreement
ever contemplated that
Amendment I
required that Ames place Baker’s proceeds into a segregated bank account. On the contrary, the
Agreement,
according to its terms and a course of dealings thereto, only required that Ames keep a separate and distinct account of all sales of Baker merchandise. (SF ¶¶ 5, 6, 22.) It is undisputed that Ames
Second, once the Net Sales Proceeds were placed in Ames’s depository accounts, LFD had no control where and how Ames directed and used those funds. It is undisputed that Ames used the proceeds from the sale of LFD merchandise to pay Ames’s Secured Lenders by placing those funds in the Blocked Accounts that were swept by GECC. It is self-evident that Ames could just have easily used those funds for any other corporate purpose— such as purchasing inventory, paying salaries, etc. Because LFD had no right to alter or direct any aspect of this process under the Agreement, LFD had no control over the use of the Net Sales Proceeds once the funds were placed in Ames’s cash management system. The Court finds that this element is inconsistent with the control necessary for an agency relationship.
Finally, the amounts Ames actually paid to LFD every week, cannot be traced back to the precise funds Ames received from the sales of LFD’s merchandise. Through Ames’s cash management system, Ames used the proceeds from the sale of LFD merchandise to pay Ames’s Secured Lenders by placing those funds in the Blocked Accounts that were swept by GECC. All payments made by Ames are made from a Disbursement Account. The funds made available in Ames’s Disbursement Account are not the same monies from the sale of LFD merchandise. Ames’s Disbursement Account is a blocked account funded exclusively through advances provided by GECC. Ames wires LFD weekly for payment of LFD mеrchandise sold in Ames’s stores from general funds made available by GECC in Ames’s Disbursement Account. Thus, Ames’s obligation to LFD was satisfied by a payment from its Disbursement Account and there was no expectation or requirement that the actual proceeds from the sale of LFD merchandise be paid to LFD, less Ames’s commission. This Court finds that this element is inconsistent with the fiduciary relationship necessary between principal and agent.
This finding is also supported by the record from Ames I. The parties’ conduct in relation to Ames I indicates that so long as Baker was paid the Net Sales Proceeds due every week in accordance with the Agreement, the source of the payment was irrelevant. This finding is supported by the failure of Amendment II to address the issue of Ames’s prospective handling of the proceeds from Baker’s sales. Despite an opportunity to raise the issue regarding the manner that Ames prospectively handled sales proceeds in the wake of a $13.7 million unsecured claim in Ames’s prior chapter 11 case, Amendment II did not address this issue. Mr. Lissy’s testimony concerning the nature of Baker’s claim went unrebutted.
As support for the proposition that Ames assumed credit risk with respect to bounced checks, Ames cites to the unre-butted testimony of Ms. Cote to evidence that all bounced check transactions, including bounced checks from the purchase of LFD merchandise, are pursued by Ames through collection services. (Cote Dep. at 72-89, 93-94.) Because Ames’s collection efforts do not result in any deduction from monies due LFD, (Cote Test. Hr’g on T.R.O. at 93-94), Ames contends that, at least in this respect, Ames bears the risk of not being paid. In response, LFD argues that Ames has voluntarily assumed this risk because the Agreement does not forbid Ames from charging back LFD. In so arguing, LFD does not expressly refute that LFD is not charged by Ames for bounced checks from the purchase of LFD merchandise. Here, Ames’s practice of sending weekly payment to LFD in the absence of any adjustment for the bounced check transactions supports the conclusion that their relationship was more akin to a debtor-creditor relationship than that of agent-trustee. In practice then, Ames bore the risk of not collecting on bounced check transactions that included LFD merchandise.
In further support of the proposition that Ames bore the risk of credit sales, Ames argues that it may advance credit to customers by any method Ames elects,
(Agreement
f4c at Ex. 1), and that Net Sales include the total amount charged by Baker/LFD for its sales in Ames stores whether such sales are for cash or credit, less deductions for “customer returns, allowances, credits or refunds.”
(Agreement
¶ 3c at Ex. 1.) Based on the wording that authorizes deductions from Net Sales, Ames concludes that this provision does not contemplate deductions for failed credit transactions, but only for problems with footwear merchandise resulting in “customer returns, allowances, credits or refunds.” In response, LFD contends,
inter alia,
that Ames has never actually extended credit with respect to thе purchase of LFD merchandise.
15
In addition, LFD argues that paragraph 4c of the
Agreement
demonstrates that because LFD granted permission for Ames to advance credit, this fact supports the inference that Ames was LFD’s agent. However, a more logical inference to be drawn from this provision and the entire
Agreement
is that the risk of loss on the purchase of LFD’s merchandise was to be borne by Ames. This conclusion is consistent with the terms of the
Agreement
as to credit exten
In sum, the Court finds that Ames was not the agent of LFD for the collection and remittance of Net Sales Proceeds because LFD has no right to control Ames’s collection and remittance of the Net Sales Proceeds. Hence, the record supports the conclusion that Ames was not acting as a fiduciary for this purpose at any time under the Agreement. In addition, LFD has not proven that it bore the risk of loss on either the bounced check transactions or the credit sales provision under the Agreement As a consequence, the Court denies LFD’s request for a declaration that the proceeds from the sale of LFD’s merchandise were held by Ames as an agent for LFD.
(ii) Express Trust
An express trust is “a fiduciary relationship with respеct to property, subjecting the person by whom the title to property is held to equitable duties to deal with the property for the benefit of another person, which arises as a result of a manifestation of an intention to create it.” Restatement (Seoond) of TRUSTS § 2 (1959) (“Restatement of TRusts”). Generally, four elements comprise an express trust: (i) a designated beneficiary; (ii) a designated trustee who is not the beneficiary; (iii) a fund or other property sufficiently designated or identified to enable title thereto to pass to the trustee; and (iv) the actual delivery of the fund or other property, or the legal assignment thereof to the trustee, with the intention of passing legal title thereto to him or her as trustee.
E.g., Brown v. Spohr,
It is firmly established that if a recipient of funds is not prohibited from using the funds as his own and the recipient is not prohibited from commingling the funds with his own monies, a debtor-creditor relationship, not a trust relationship, exists.
Dampskibsselskabet Af 1912 Aktieselskab v. Black & Geddes, Inc. (In re Black & Geddes),
In New York, if there is no distinct trust fund but merely a general obligation to ultimately pay a sum of money, then there is no trust, but only a debt.
See Petition of Travers,
Here, Ames has commingled the Net Sales Proceeds with all other proceeds from its stores since 1987. It is undisputed that the Agreement contained no provision that required that Ames place the Net Sales Proceeds in a segregated bank account. LFD has stipulated that it had no indication that Ames placed the proceeds from the sale of LFD merchandise in a separate bank account. (SF ¶ 66.) Through Ames’s cash management system, Ames used the proceeds from the sale of LFD merchandise to pay its Secured Lenders by placing those funds in the Blocked Accounts that were swept by GECC. Ames paid LFD out of general funds made available by GECC in Ames’s Disbursement Account. The funds made available in Ames’s Disbursement Account are not the same monies from the sale of LFD merchandise. Ames’s Disbursement Account is a blocked account funded exclusively through advances provided by GECC. Therefore, the Court finds that Ames did not hold the Net Sales Proceeds in trust for LFD because Ames, at all relevant times, has commingled the Net Sales Proceeds and used the funds between settlement dates for purposes other than paying LFD, before making payment to LFD out of general funds provided by GECC. These facts are dispositive of LFD’s trust claim. Hence, the Court finds that the parties never manifested an intent to create a true trust mechanism and therefore Ames was not a fiduciary to LFD.
At oral argument on December 4, 2001, counsel for LFD argued that Ames’s actual commingling of proceeds should not factor in the Court’s determination. LFD contends that cash is fungible and, therefore, proceeds are sufficiently segregated where funds are identifiable on a separate basis, such as through a separate book entry in a business’s accounting records. As support for this proposition, LFD’s counsel argued that banks generally commingle monies from trust accounts. Because banks purportedly commingle monies from trust accounts and the integrity of the trust accounts are not questioned, LFD concludes that the physical isolation of cash is irrelevant. LFD justifies this result by reasoning that if there was a rigid requirement to segregate trust funds, then all trust accounts would operate like safe deposit boxes.
LFD directs the Court to no legal authority or evidence in the record for the proposition just articulated. In any event, LFD’s argument improperly merges a trustee’s duties to segregate trust funds with a bank’s administration of deposits. Whereas trustees cannot properly deposit trust money in their personal bank account as an application of the rule that trustees have a duty to keep trust property separate from their own property,
see
Restatement of Trusts § 180 cmt. c, LFD’s argument presupposes that banks would assume a derivative duty to the
If a general deposit is properly made by a trustee ... the bank does not become a trustee of the money but a debtor to the trustee. The trustee becomes a creditor of the bank and holds [the] claim against the bank in trust for the beneficiaries of the trust.... If the bank fails, the trustee or the beneficiaries are not entitled to priority over other creditors of the bank even though the money deposited is traceable.
V Soott on Trusts § 527 (footnote omitted). See also Restatement op TRusts § 180 cmt. a (“A trustee may deposit trust funds in a bank for the purpose of making the funds available from time to time for the payment of expenses or pending investment or distribution. This is a reasonable method for safekeeping of the funds, more reasonable than keeping the funds in a safe deposit box. This was true even before bank deposits were partially insured by the Federal Deposit Insurance Corporation; although the deposit was an unsecured loan, it was proper as a method of safekeeping.”). Accordingly, because there is no basis for LFD’s legal theory, the Court denies LFD’s request for a declaration that the proceeds from the sale of LFD’s merchandise are held in an express trust for the benefit of LFD.
C. Constructive Trust Theory
LFD argues that it is entitled to a constructive trust on the Net Sales Proceeds because (i) Ames was a fiduciary to LFD, (ii) Ames made promises to turn over to LFD the Net Sales Proceeds, (iii) LFD relied on those promises in allowing Ames to collect and hold the Net Sales Proceeds, and (iv) Ames would be unjustly enriched if it is permitted to retain the Net Salеs Proceeds. (Pl.’s Br. at 21-22.)
Distilled further, LFD maintains a constructive trust is warranted because Ames was a fiduciary to LFD based on the. Agreement and Ames’s behavior in relation to the filing of its current and previous chapter 11 cases. Alternatively, and in the absence of a fiduciary relationship, LFD also claims that a constructive trust is justified because Ames converted the Net Sales Proceeds and, therefore, Ames was unjustly enriched. (Pl.’s Br. at 21-24.)
“A constructive trust is an equitable remedy designed to prevent unjust enrichment, and restore legal title to one who, in equity, owns the
res.” Tekinsight.com, Inc. v. Stylesite Mktg., Inc. (In re Stylesite Mktg., Inc.),
In New York, a party seeking to impose a constructive trust must ordinarily establish four elements: (i) a confidential or fiduciary relationship; (ii) a promise, express or implied; (iii) a transfer made in reliance on that promise; and (iv) unjust enrichment.
16
Koreag,
Notwithstanding the stated requirements, the remedy is a flexible one, and the facts need not satisfy every element in all cases. For example, a court may impose a constructive trust in the absence of a fiduciary relationship, or wrongful conduct by the defendant. Even innocent parties may be unjustly enriched, and what is required is that the dеfendant hold property “under such circumstances that in equity and good conscience he ought not to retain it.”
Stylesite,
Despite the elasticity of the doctrine, the prevention of unjust enrichment remains the key requirement for a constructive trust.
See Securities Inv. Prot. Corp. v. Stratton Oakmont, Inc.,
(i) Ames as Fiduciary to LFD
LFD contends that Ames undertook a fiduciary duty, under paragraph 41 of the Agreement, to act as agent and trustee to LFD. (Pl.’s Br. at 7, 22.) In addition to LFD’s contract, LFD posits that Ames’s knowledge that it would be filing a bankruptcy petition also gave rise to a fiduciary duty to LFD. (Pl.’s Br. at 22.)
LFD’s first argument, that the Agreement imbued Ames with fiduciary duties, is unpersuasive because LFD is not able to establish that Ames acted as an agent or trustee for the Net Sales Proceeds under paragraph 41. As demonstrated in section IV.B., supra, of this discussion, the presence of language purporting to create an agency or trust is insufficient, without more, to conclude an effective agency or trust in a bankruptcy case where there are indicia of a contrary understanding. The Court has already found sufficient facts to contra-indicate the existence of an agency or a trust. Thus, LFD has failed to establish that its relationship with Anes was anything other than an arms-length contractual arrangement to make weekly payments based on LFD’s sales.
In New York, no fiduciary relationship exists where parties were acting and contracting at arms-length to a business transaction.
See Beneficial Commercial Corp. v. Murray Glide Datsun, Inc.,
LFD’s second argument is that Ames’s knowledge that it would be filing for bankruptcy gave rise to a fiduciary duty to LFD. As support for its claim, LFD alleges that Ames engaged in “predatory acts and omissions by which it improperly induced LFD to continue to sell merchandise in order to maximize the Net Sales Proceeds Ames was holding at a time when [Ames] knew it would not be turning those proceeds over to LFD.” (Pl.’s Br. at 22.) The basis for this assertion is that from February 3, 2001 to August 13, 2001, Ames’s financial condition deteriorated to the point where bankruptcy was inevitable. (Pl.’s Br. at 22.)
As further support for its second argument, LFD concedes that although “[a] failure by a company headed toward bankruptcy to disclose the imminency of its bankruptcy may not, by itself, be a breach of fiduciary duty,” Ames’s conduct in Ames I coupled with Ames’s behavior before the filing of the current chapter 11 case, reveals that Ames fraudulently induced LFD to continue selling merchandise. (PL’s Br. at 23.) LFD’s argument is premised upon a telephone conversation that occurred on August 14, 2001 and retention bonuses Ames paid to some employees on August 15, 2001. (PL’s Br. at 23.)
Under New York law, a fiduciary relationship exists when a person is under a duty to act or render advice for another’s benefit.
See Trumpet Vine Invs., N.V. v. Union Capital Partners I, Inc.,
LFD argues that Mr. de Aguiar misled Ms. Guinnessey on August 14, 2001, by not disclosing, among other things, his decision to halt wire payments out of Ames. Mr. de Aguiar testified that there was no specific conversation (within Ames) concerning payment to LFD subsequent to Ames’s decision to conserve cash for the bankruptcy. (Defs.’ Ex. 30; de Aguiar Dep. at 9, 13.) In Mr. de Aguiar’s August
As for the retention bonuses, Mr. de. Aguiar testified that there was no connection between the retention bonuses paid and the amounts due to LFD. Based on Mr. Mayrhauser’s testimony and Ms. Cote’s testimony, the retention bonuses were apparently paid prepetition as a reasonable attempt by Ames to insure that key individuals remained with the company through its reorganization process. Based upon the available record, the Court finds nothing untoward occurred as a result of Ames’s prepetition retention bonuses in relation to any specific obligation Ames had toward LFD. 17
In this case, LFD has failed to set forth dealings between Ames and LFD that suggest that such were not arms-length, or were so extraordinary in nature that they would normally give rise to a fiduciary relationship between the parties. There is nothing in the record to suggest a relationship of trust or confidence between Ames and LFD, nor the breach of any noncon-tractual duty imposed as a matter of social
(ii) Ames’s Alleged Conversion and Unjust Enrichment as the Basis for a Constructive Trust
In the alternative, and in the absence of a fiduciary relationship, LFD also claims that a constructive trust is justified because Ames converted the Net Sales Proceeds and, therefore, Ames was unjustly enriched. As support for this proposition, LFD argues that conversion is a well recognized basis for the imposition of a constructive trust. (Pl.’s Br. at 23-24.) LFD’s claim is based on the theory that, rather than hold the proceeds as required, Ames wrongfully subjected the proceeds to the hen of GECC and then turned those proceeds over to GECC. (Pl.’s Reply Br. at 20.)
Under New York law, conversion is any unauthorized exercise of control by one who is not the owner which interferes with a superior possessory right of another in property.
W.S.A, Inc., v. ACA Corp.,
No. 94 Civ. 1493(CSH),
The Plaintiff has failed to establish the elements of conversion as the basis for the imposition of a constructive trust for the following reаsons.
First, LFD’s conversion theory must fail because, as discussed more fully in section IV.A., supra, the Net Sales Proceeds are the property of Ames.
Second, the Agreement between Ames and LFD gives LFD no right of immediate possession to the Net Sales Proceeds. Instead, as discussed more fully in section IV.B., supra, LFD is paid at regular intervals from general funds made available in Ames’s Disbursement Account. The funds in Ames’s Disbursement Account are not the identical funds from the sale of LFD merchandise.
Third, as discussed more fully in section IV.B., supra, because the Agreement expressly contemplated that the Net Sales Proceeds were to be processed through the regular channels of Ames’s business, its possession of such funds is not wrongful. Therefore, LFD cannot maintain that Ames was in the unauthorized possession of the Net Sales Proceeds.
In addition to LFD’s failure to satisfy the elements of conversion as the basis for the imposition of a constructive trust, the Court finds that Ames has not been unjustly enriched. Unjust enrichment results when a person retains a benefit which, under the circumstances of the
The relationship between Ames and LFD is arms-length and contractual in nature. Both LFD and Ames are sophisticated corporate entities with millions of dollars in revenues. Ames has operated under the Agreement in a consistent manner since 1987. Baker, the assignor of the Agreement to LFD, operated under the Agreement in a consistent manner up and until the Assignment to LFD in February 2001. LFD performed due diligence in relation to the purchase of the Baker assets. LFD did not ascertain whether Ames held the Net Sales Proceeds from the sale of Bаker merchandise in trust or as agent for Baker despite the availability of the information from both Baker and Ames. Footstar/LFD operates similar shoe departments in other retail stores. LFD’s Treasurer understands that LFD succeeded to the relationship between Baker and Ames. Since Baker’s assignment to LFD, the commercial relationship between Ames and LFD is indistinguishable from the Ames/Baker relationship-that of debtor-creditor. Under the circumstances of this case and considering the sophistication of both Ames and LFD, the Court finds that it would be equitable for Ames to retain the benefits of the Net Sales Proceeds. A constructive trust will be erected whenever justice so requires, but a constructive trust in the instant ease is not justified considering all the facts before the Court. As a consequence, the Court denies LFD’s request for a declaration that the proceeds from the sale of LFD’s merchandise are held by Ames in a constructive trust.
(in) The Availability of a Constructive Trust as a Remedy Under the Bankruptcy Code
Ames argues that even if the elements of a constructive trust were established, a constructive trust is nothing more than an equitable remedy that can be satisfied by a money judgment and hence a general unsecured claim entitled to ratable distribution from the bankruptcy estate. The leading case on the issue of equitable remedies and the definition of “claim” under § 101(5) the Bankruptcy Code is
CRS Steam, Inc. v. Engineering Resources, Inc. (In re CRS Steam, Inc.),
V. Subrogation
LFD argues that it is entitled to stand in the shoes of Ames’s secured creditors with respect to the $8.9 million of trust funds transferred to Ames’s Secured Lenders in reduction of Ames’s indebtedness. (Pl.’s Br. at 26.) LFD maintains that where a trustee wrongfully uses trust funds to discharge an obligation owed individually by the trustee to a third-person, the beneficiary is entitled to be subrogated to the rights that the third-party had before the obligation was discharged. (Pl.’s Br. at 26-27.) Under New York law,
[s]ubrogation, [is] an equitable doctrine ... broad enough to include every instance in which one party pays a debt for which another is primarily answerable, and which in equity and good conscience should have been discharged by the latter, so long as the payment wasmade either under compulsion or for the protection of some interest of the party making the payment, and in discharge of an existing liability.
Gerseta Corp. v. Equitable Trust Co.,
Here, LFD’s subrogation argument fails because the Court has already determined that there was no true trust mechanism between Ames and LFD. Therefore, the Net Sales Proceeds were not LFD’s trust property and the funds used to pay Ames’s Secured Lenders were Ames’s property and not subject to any trust theory argued by LFD. As a consequence, the Court denies LFD’s request for a declaration that LFD is subrogated to the rights of Ames’s secured lenders to the extent of all prepetition proceeds from the sale of LFD merchandise.
VI. Conclusion
For the reasons just stated, the Court finds: (1) that the proceeds from the sale of LFD merchandise are (a) not LFD’s property, (b) not held by Ames as agent for LFD, and (c) are not held by Ames as express trustee for LFD; (2) that a constructive trust is not warranted under the facts and circumstances of this ease; (3) that the elements of conversion have not been established to form the basis for the imposition of a constructive trust; and (4) that having failed to establish that the proceeds at issue were property of LFD under any of its theories, the claim for subrogation is denied. Therefore, all the claims contained in LFD’s complaint for declaratory relief are hereby dismissed.
Defendants SETTLE ORDER and JUDGMENT.
Notes
. In addition, the parties offered into evidence a transcript from a hearing before this Court on September 24, 2001 where the Court received testimony in connection with Plaintiff’s earlier request for a temporary restraining order. The request for a temporary restraining order was denied on September 25, 2001.
. In particular, LFD submitted ''Plaintiff's Initial Written Submission in Lieu of Trial” dated November 19, 2001 and ''Plaintiffs Written Reply Submission in Lieu of Trial” dated November 30, 2001 (hereinafter, ‘‘Plaintiff’s Brief” and "Plaintiff's Reply Brief” respectively). Defendants submitted a "Memorandum of Ames Department Stores, Inc. and Ames Merchandising Corporation in Opposition to Plaintiff's Initial Written Submission in Lieu of Trial,” dated November 28, 2001 (hereinafter, "Defendants’ Brief”).
. Ames submits that LFD's prepetition claim is actually $9,292,577.05. (Defs.' Br. at 25.)
. The actual wording of the Agreement that formulates SF ¶ 12, provides, in part, that "Ames agrees that all . .. cash proceeds (including checks accepted by Ames) from the operation of said department to be conducted by Baker, shall go through the regular channels of the business of Ames, according to its usual and ordinary methods of doing business.” (Agreement ¶ 4b at Ex. 1.)
. For the remainder of the discussion, when the Court refers to the April 29, 1989 Amendment to the Agreement, the reference will be to "Amendment I". Subsequent amendments shаll be numbered sequentially. All references to the Agreement, as amended, shall be to the "Agreement”.
. The amounts required to be paid every week by Ames to Baker shall hereinafter be referred to as the “Net Sales Proceeds.” (SF ¶ 9.)
. The Agreement was amended as of August 1, 2000 to add Ames Merchandising Corporation as a party to the Agreement. (SF ¶ 21.)
. The litigants do not dispute that the Agreement is silent on the origins of the 5% fee. They did not provide any explanation, other than pure speculation on the part of LFD, as to its origins. Mr. von Mayrhauser testified that the 5% fee for credit card charges predates Baker’s assignment of the Agreement to LFD. (von Mayrhauser Dep. at 4-5, 17-19, 106-107.)
. The debtor in possession financing in this case operates in a substantially similar manner. (Metivier Dep. at 44.)
. Whereas the Code defines property of the bankruptcy estate, interests in property are created and defined under state law.
See Butner v. United States,
. The Court notes that the discussion in
Shulman
has been applied to situations outside of the bankruptcy context.
See, e.g., Delta Air Lines, Inc. v. Tie Cargo Corp.,
No. 96-CV-3792 (JG),
. The Court notes that Plaintiff renews a similar contract argument with respect to the use of the terms "trust” and "agent" in the
Agreement.
Specifically, LFD argues that notwithstanding the nature of the parties’ contract, use of the words "trust” or "agent” should end this Court's inquiry. For the same rationale that the use of the word "property” is not dispositive of the ultimate issue before the Court, courts have found that the talismanic use of the word "trust,”
see Morales,
.The Court notes that the practical interpretation of a contract by the contracting parties, manifested by their conduct subsequent to its formation for a considerable length of time before it became the subject of controversy, is entitled to great, if not controlling, weight in the construction of a contract.
In re Dayton Seaside Assocs. # 2, L.P.,
. LFD cites to
Greenfield Direct Response, Inc. v. ADCO List Management (In re Greenfield Direct Response, Inc.),
. Ames's extension of credit should be distinguished from third party credit cards which the parties stipulated Ames accepts for the purchase of LFD merchandise. (SF ¶¶ 42 n. 1, 64.) The risk of loss regarding the default on payments due to the credit card processors from Ames's customers presumably lies with the credit card issuer.
Ames's counsel argued that the risk of loss from the default on payments due to Ames from credit card processors is shouldered by Ames. See, for example,
World Travel Vacation Brokers Inc. v. Bowery Savings Bank (In re Chargit, Inc.),
. Courts have additionally required that the claimant establish proof of a
res
to which the constructive trust could attach and have required the claimant to trace the property.
. This finding is limited to the relationship these bonuses have to the issues raised by LFD in this proceeding. The Court's finding should not be interpreted to endorse the advisability or appropriateness of the prepetition bonuses in relation to the captioned Debtors' chapter 11 cases.