Carlson Orchards, Inc. v. Linsey (In Re Linsey)
2003 Bankr. LEXIS 937, 2003 WL 21946740, 296 B.R. 582 (2003)
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Rule of Law:
A creditor may impose a constructive trust or equitable lien on property acquired or improved with embezzled funds, even when the debtor is in bankruptcy, provided the creditor can prove wrongdoing and trace the funds to the specific assets.
Facts:
- Nina Linsey was employed as a bookkeeper for Carlson Orchards, Inc. from January to November 2001.
- During her employment, Linsey embezzled over $120,000 from Carlson by diverting checks and writing unauthorized paychecks to herself.
- Linsey deposited the embezzled funds into personal bank accounts she controlled, which were kept separate from her husband's funds.
- Using the embezzled funds, Linsey purchased a 1999 Plymouth Grand Caravan and a 1995 Ford F150.
- Both vehicles were titled in the name of her husband, David Linsey.
- Linsey also used embezzled funds to pay for approximately $25,000 in improvements to the home she owned with her husband, including new windows, siding, landscaping, and electrical work.
- David Linsey had filed a Declaration of Homestead on their property in 1994, years prior to the embezzlement.
Procedural Posture:
- David and Nina Linsey filed for Chapter 13 bankruptcy.
- Carlson Orchards, Inc. filed an adversary proceeding (a lawsuit within the bankruptcy case) against the Linseys in the U.S. Bankruptcy Court.
- Count I of the complaint sought to have Nina Linsey's debt declared non-dischargeable.
- Count II of the complaint requested a declaratory judgment vesting title to two vehicles and an interest in the Linseys' real property in Carlson.
- The parties filed an Agreement for Judgment where Nina Linsey conceded that her debt to Carlson was non-dischargeable.
- The Bankruptcy Court entered judgment against Nina Linsey on Count I, leaving only Count II to be decided.
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Issue:
May a creditor impose a constructive trust or equitable lien on vehicles and home improvements purchased with embezzled funds, despite the debtors' bankruptcy filing and homestead exemption claim?
Opinions:
Majority - Rosenthal, J.
Yes, a creditor may impose a constructive trust or equitable lien on property purchased or improved with embezzled funds, even in bankruptcy. To obtain a constructive trust, a party must show (1) wrongdoing by the debtor in acquiring the property and (2) the ability to trace the wrongfully held property. Nina Linsey's admitted embezzlement satisfies the wrongdoing requirement. The tracing requirement is met because the Linseys conceded the vehicles were purchased with embezzled funds, and Carlson successfully traced specific checks from Linsey's accounts containing stolen funds to payments for home improvements. The court applied the 'lowest intermediate balance test' to trace funds through commingled accounts, presuming that the debtor spends her own funds first, leaving the trust funds intact. The Linseys' homestead exemption does not defeat Carlson's claim, as a homestead cannot be used as a shield to protect property improved with fraudulently acquired funds. The appropriate remedy is a constructive trust over the vehicles, as they were purchased entirely with stolen funds, and an equitable lien on the real property for the specific amount of stolen funds ($25,413) used for improvements.
Analysis:
This decision illustrates the power of equitable remedies to prevent unjust enrichment in bankruptcy. It affirms that a creditor victimized by fraud can recover specific assets bought with stolen funds, thereby 'jumping the line' ahead of general unsecured creditors who must share in a pro-rata distribution. The case reinforces the principle that bankruptcy protections and state law exemptions, such as a homestead, cannot be used to shield assets acquired through wrongdoing. By meticulously applying the 'lowest intermediate balance test,' the court provides a clear roadmap for how creditors can meet the stringent tracing requirements necessary to impose a constructive trust or equitable lien.
