Third Circuit Rules on Transfer From Debtor to a Constructive Trust—Whose Property is it Anyway?

Third Circuit Rules on Transfer From Debtor to a Constructive Trust—Whose Property is it Anyway?

On January 9, 2025, the Third Circuit issued a (non-precedential) opinion affirming the Bankruptcy and District Court’s findings that when a Debtor has legal title to property, the transfer of that property to a constructive trust is not a transfer of Debtor’s property. Snyder v. Biros (In re U Lock Inc.) 24-1202 (3d Cir. January 9, 2025).

In this case, numerous individuals formed a corporation to buy real property wherein one of its owners lent it money to buy the property. Resultantly, the corporation was the property owner. The corporation defaulted under the loan and the lender sued the corporation claiming that the lender was the equitable owner. The Pennsylvania state trial court imposed a constructive trust on the property and concluded that the lender was the equitable owner as she had funded the purchase and was not repaid. The state court ordered the corporation to transfer title to the lender. This ruling was appealed and the state appellate court affirmed the ruling. The Pennsylvania Supreme Court then denied a petition for leave to appeal. Lender then recorded title to the property in her name. Thereafter, a creditor (who had purchased claims belonging to the estate) filed an involuntary bankruptcy petition against the corporation. This creditor then filed an adversary proceeding (“Complaint”) in Bankruptcy Court against the lender, claiming that the transfer of the property was a preference, or in the alternative, a fraudulent transfer.

The Bankruptcy Court issued an order granting lender’s motion for summary judgment and dismissed the Complaint. The Bankruptcy Judge opined that the imposition of a constructive trust was not a transfer of the debtor’s property, negating both a fraudulent transfer and a preference claim. The District Court affirmed. On appeal, The Third Circuit also affirmed. Citing to 11 USC Section 547(b), the Third Circuit stated that plaintiff, to prevail, had the burden and had to “demonstrate that there was a transfer of a property interest from [the debtor corporation] to [the lender]”. Herein, Pennsylvania state law determines the interest, if any, that Debtor has in property.

In the case on appeal, the Third Circuit concluded that the beneficiary of a constructive trust is deemed to have held equitable title from the date the original owner conveyed the property, and the trustee is deemed to “have never owned the equitable interest in [the] property in the first place”.

By imposing the constructive trust, the state court held that the lender was the beneficial and equitable title holder and that the debtor, as trustee, held only legal title. The “imposition of a constructive trust”, the Third Circuit said, “is not a transfer of an interest from the debtor in the property”. The Third Circuit held that the debtor “never had any equitable interest in the property to transfer”. Consequently, “any transfer of bare legal title for such property is not a transfer of property of the estate”.

The appeals court upheld dismissal of the preference and fraudulent transfer claims because “neither the state court’s declaration that [the lender] was the property’s equitable owner, nor the subsequent transfer of legal title to her, constituted a transfer of property of the estate”.

Put another way, when a constructive trust is imposed, the Debtor is not deemed to be the true owner of the property and is only the holder in trust for the rightful beneficiary. This principle can be important in bankruptcy proceedings as a trustee who tries to liquidate Debtor’s assets cannot claim property held in a constructive trust as part of the bankruptcy estate.

To discuss the issues raised here or any other issues involving creditors rights and bankruptcy, please contact Leslie Beth Baskin at 215-241-8926 or at lbaskin@sgrvlaw.com.

 

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