In the
United States Court of Appeals
For the Seventh Circuit
____________________
No. 13‐1377
IN RE:
MISSISSIPPI VALLEY LIVESTOCK, INC.,
Debtor.
____________________
Appeal from the United States District Court for the
Northern District of Illinois, Western Division.
No. 12‐C‐50341 — Frederick J. Kapala, Judge.
____________________
ARGUED SEPTEMBER 30, 2013 — DECIDED MARCH 12, 2014
____________________
Before WOOD, Chief Judge, and BAUER and KANNE, Circuit
Judges.
WOOD, Chief Judge. 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 bank‐
ruptcy, Mississippi Valley paid J&R nearly $900,000 repre‐
senting completed sales. The bankruptcy trustee now seeks
to recover those funds under the preferential‐transfer provi‐
2 No. 13‐1377
sion 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. Important‐
ly, 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 ac‐
cumulated, 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 cat‐
tle for which J&R had not yet been paid. “I still have not re‐
ceived 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 tomor‐
No. 13‐1377 3
row. This is getting old, the lies and waiting for it. You are
just using it.” Lahr’s pleas did not fall on deaf ears. Over the
next month, Mississippi Valley sent seven checks to J&R to‐
taling $862,747.31.
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 pref‐
erential 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 nev‐
er 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 un‐
contested facts in this case show that Mississippi Valley only
held the property as bailee for J&R,” the district court con‐
cluded, “Mississippi Valley had no equitable or legal interest
in the property.” Therefore, the court determined, the pay‐
4 No. 13‐1377
ments were not a transfer of an interest of the debtor in
property. The court did not analyze the propriety of impos‐
ing 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, 638 F.3d 549, 553 (7th Cir. 2011). The deci‐
sion whether to grant summary judgment is a legal conclu‐
sion. In re Midway Airlines, Inc., 383 F.3d 663, 668 (7th Cir.
2004).
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 Val‐
ley held J&R’s cattle. We then address two additional ques‐
tions: 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 “cre‐
ated and defined by state law,” see Butner v. United States,
440 U.S. 48, 55 (1979), we look to the law of Illinois, which
the parties agree governs in this case, to see if bailment is the
proper characterization of the arrangement.
No. 13‐1377 5
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 redeliv‐
ered to the bailor, or otherwise dealt with according to his
directions, or kept till he reclaims them.’” Kirby v. Chi. City
Bank & Trust Co., 403 N.E.2d 720, 723 (Ill. App. Ct. 1980)
(quoting Knapp, Stout & Co. v. McCaffrey, 52 N.E. 898 (Ill.
1899)); see also Berglund v. Roosevelt Univ., 310 N.E.2d 773,
775 (Ill. App. Ct. 1974) (“Bailment is defined as the rightful
possession of goods by one who is not an owner.”). Al‐
though bailment takes many forms, the “characteristics
common to every bailment are the intent to create a bail‐
ment, delivery of possession of the bailed items, and the ac‐
ceptance of the items by the bailee.” Id. at 775–76.
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 op‐
portunities of each to exercise control over the property.”
Wall v. Airport Parking Co. of Chi., 244 N.E.2d 190, 192–93 (Ill.
1969). Historically, Illinois courts have found bailment in
cases in which the alleged bailee took possession of goods to
be sold for the bailor’s benefit. See Wolf & Son v. Shannon, 50
Ill.App. 396, 402 (Ill. App. Ct. 1893) (“[T]hese cattle [were
placed] in the custody of Strahorn & Co., to be sold for the
benefit of Wolf & Son … . Strahorn & Co, by receiving the
cattle with such knowledge and direction, became bailees,
holding the cattle for the use of Wolf & Son.”).
Illinois courts distinguish bailments from conditional
sales, which create only an ordinary debtor‐creditor relation‐
6 No. 13‐1377
ship. See Chickering v. Bastress, 22 N.E. 542, 543 (Ill. 1889)
(“[W]hen the identical thing is to be restored in the same or
an altered form, the contract is one of bailment … but when
there is no obligation to restore the specific article, and the
receiver is at liberty to return another thing of equal value,
or the money value … it is a sale.”); see also People v. Moses,
31 N.E.2d 585, 587 (Ill. 1940) (bailment exists when goods are
“disposed of in some particular manner as directed or
agreed upon for [the owner’s] benefit”).
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, 120 F. 64, 68 (7th Cir. 1903) (applying
Illinois law). Compare Chickering, 22 N.E. at 543 (finding sale
where recipients “were vested with the power and right of
discharging themselves from any further obligations … by
paying” for goods), with Lenz v. Harrison, 36 N.E. 567, 568–69
(Ill. 1893) (finding bailment where contract contained “no
provision under which [sales agent] could at any time be‐
come the owner of the property”).
Over a century ago, our court (applying Illinois law) de‐
cided 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
No. 13‐1377 7
trustee took control of the wagons in Galt’s possession in or‐
der 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 Company and could not be sold to satisfy Galt’s debts.
Galt, 120 F. at 68–69.
More recently, an Illinois court applied the distinction be‐
tween bailment and sales in Nassar v. Smith, 315 N.E.2d 692
(Ill. App. Ct. 1974). In Nassar, two different parties—Nassar
and Bralock—separately delivered tires to another person,
Walden. A third party then seized all the tires in Walden’s
possession in execution of a judgment debt against Walden.
The court found that Walden had the authority to sell Nas‐
sar’s tires if he paid the cost to Nassar. Therefore, it conclud‐
ed that the transaction between Nassar and Walden was a
sale. In contrast, Walden held Bralock’s tires only for the
purpose of whitewalling them, after which the tires were to
be returned to Bralock. According to the court, this relation‐
ship presented a “classic form[] of bailment.” Based on this
distinction, the court concluded that Nassar’s tires could be
sold to satisfy Walden’s debt, but Bralock’s had to be re‐
turned to Bralock. Id. at 694–96.
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. Al‐
though 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
8 No. 13‐1377
pay J&R immediately after the sales, as in Galt. This made
Mississippi Valley J&R’s undisclosed agent. Mississippi Val‐
ley 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 determin‐
ing 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. Be‐
cause 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 ob‐
tained money to which he is not entitled, under such cir‐
cumstances that in equity and good conscience he ought not
retain it … to avoid unjust enrichment.”Smithberg v. Ill. Mun.
Ret. Fund, 735 N.E.2d 560, 565 (Ill. 2000); see also
RESTATEMENT (FIRST) OF RESTITUTION § 160 (1937) (“Where a
person holding title to property is subject to an equitable du‐
No. 13‐1377 9
ty to convey it to another on the ground that he would be
unjustly enriched if he were permitted to retain it, a con‐
structive trust arises.”).
The remedy of constructive trust applies to a subset of
unjust enrichment: that resulting from the unauthorized or
invalid transfer of property. See Kull at 287–88. In such cas‐
es—for example, transfers effected by conversion, fraud,
mistake, coercion, undue influence, or breach of fiduciary
duty—the law provides that true ownership of the property
never passes from transferor to transferee. Although the
transferee (such as a bailee) may have actual and even legal
possession, ownership remains vested in the transferor, who
has a legal right to demand the return of the property. See In
re Teltronics, Ltd., 649 F.2d 1236, 1239 (7th Cir. 1981) (“The
rule that property obtained by fraud is not part of the bank‐
rupt’s estate represents the policy that property should re‐
main in the hands of its rightful owners, no matter how le‐
gitimate the claims of creditors.”). The term “constructive
trust” describes the legal fiction pursuant to which the trans‐
feree holds the property for the benefit of the true owner. It
is a trust imposed by law, rather than one created through
the voluntary act of the settlor. Just as the assets of a conven‐
tional trust do not enter the bankruptcy estate when the
bankrupt person is the trustee, see 11 U.S.C. § 541(d); Begier
v. IRS, 496 U.S. 53, 62–66 (1990); In re Marrs‐Winn Co., 103
F.3d 584, 589 (7th Cir. 1996); Matter of Wayco, Inc., 947 F.2d
1330, 1332–33 (7th Cir. 1991), the assets of a constructive trust
do not either.
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
10 No. 13‐1377
does the transferee become the rightful owner of such prop‐
erty 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, 877 F.2d 512,
513 (7th Cir. 1989); see also 5 COLLIER ON BANKRUPTCY ¶
541.28[2][a] (Alan N. Resnick & Henry J Somme eds., 16th
ed. 2011). As Justice Black put it, “[t]he Bankruptcy Act
simply does not authorize a trustee to distribute other peo‐
ple’s property among a bankrupt’s creditors.” Pearlman v. Re‐
liance Ins. Co., 371 U.S. 132, 135–36 (1962).
We acknowledge that some courts have rejected this view
of constructive trusts in bankruptcy. See, eg., In re Omegas
Group, Inc., 16 F.3d 1443, 1451 (6th Cir. 1994) (citing Emily L.
Sherwin, Constructive Trusts in Bankruptcy, 1989 U. ILL. L. REV.
297). They view the constructive trust as “fundamentally at
odds with the general goals of the Bankruptcy Code” be‐
cause, as they see it, that device privileges some creditors
over others in a way unconstrained by the Code’s mandates.
Omegas Group, 16 F.3d at 1451 (quoting In re Stotler & Co., 144
B.R. 385, 388 (N.D. Ill. 1992)). We, too, recognize that the
constructive trust can subvert bankruptcy’s distribution
scheme if courts lose sight of the fact that it is an extraordi‐
nary equitable remedy, to be used sparingly. See Amendola v.
Bayer, 907 F.2d 760, 763 (7th Cir. 1990) (citing Suttles v. Vogel,
533 N.E.2d 901, 904–05 (Ill. 1988)). But we trust that courts
will not commit this error.
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 impos‐
ing them “[u]nless a court has already impressed a construc‐
tive trust upon certain assets or a legislature has created a
No. 13‐1377 11
specific statutory right to have particular kinds of funds held
as if in trust.” 16 F.3d at 1449. In its view, unjust enrichment
does not exist in bankruptcy because the debtor does not
benefit from the invalid possession of the claimant’s proper‐
ty. Id. at 1452 (citing our opinion in Belisle, 877 F.2d at 516).
Rather, because “the Code recognizes that each creditor has
suffered disappointed expectations at the hands of the debt‐
or … it makes maximization of the estate the primary con‐
cern.” Id. “Imposing a constructive trust on the debtor’s es‐
tate” the court concluded, “impermissibly subordinates this
primary concern to a single claim of entitlement.” Id. at
1452–53.
Omegas Group disagreed with the Fifth Circuit’s decision
in Matter of Quality Holstein Leasing, 752 F.2d 1009 (5th Cir.
1985), and so at most we need to choose sides on the ques‐
tion whether property subject to a constructive trust can be
excluded from a bankruptcy estate. In our opinion, the Sixth
Circuit’s view draws too sharp a line between constructive
trusts and ordinary trusts. We are confident that state law is
up to the task of policing any possible abuses of the con‐
structive trust. As we know, “Congress has generally left the
determination of property rights in the assets of a bankrupt’s
estate to state law.” Butner, 440 U.S. at 54. Moreover, to the
extent that the Sixth Circuit relied on the idea that a con‐
structive trust cannot exist until a court has expressly im‐
posed that remedy, we understand that issue to be controlled
by state law. We see nothing in Illinois law that calls for such
a result. Finally, we note that Omegas Group has been sharply
criticized in a leading treatise. See DOUGLAS LAYCOCK,
MODERN AMERICAN REMEDIES 713 (4th ed. 2010).
12 No. 13‐1377
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 keep‐
ing 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 unau‐
thorized transfer of the claimant’s property to the debtor’s
creditors. See id.; In re Dameron, 206 B.R. 394, 400 (Bankr. E.D.
Va. 1997); In re Kamand Constr., Inc., 298 B.R. 251, 255 (Bankr.
M.D. Pa. 2003); Sherwin, Constructive Trusts in Bankruptcy,
1989 U. ILL. L. REV. 297, at 317 (court should evaluate “equity
of the remedy in the specific context of a contest between a
constructive trust claimant and other creditors”).
One question remains: How could the debtor’s creditors
(that is, the debtor’s bankruptcy estate) gain an equitable in‐
terest 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, 103 F.3d at 589
(“The bankruptcy court’s jurisdiction over Marrs‐Winn’s
property extends only as far as Marrs‐Winn’s particular in‐
terest in the property. … It is a well‐settled principle that
No. 13‐1377 13
debtors do not own an equitable interest in property that
they hold in trust for another[.]”). But here is why the dis‐
tinction matters: If the issue were only the statutory scope of
the debtor’s property, the debtor’s creditors would always
lose in a contest with a claimant who had a valid restitution
claim against the debtor. But if the constructive trust is un‐
derstood as the remedy for a restitution claim against the es‐
tate, the estate may be able to invoke certain defenses that
were not available to the debtor.
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, 22 N.E. 542, 543 (Ill. 1889)
(“[W]here one party, by means of contract, but without no‐
tice to the world, suffers the real ownership of chattels to be
in himself, and the ostensible ownership to be in another, the
law will postpone the rights of the former to those of the ex‐
ecution or attachment creditors of the latter[.]”); see also
Matter of Iowa R.R. Co., 840 F.2d 535, 545 (7th Cir. 1988)
(denying constructive trust where “[n]othing in the way the
Iowa did business would have alerted other creditors that
the funds ostensibly in its control were held in trust”).
It is also possible, though we do not resolve this, that
J&R’s anonymous use of Mississippi Valley in order to de‐
ceive Swift into buying its cattle might support the equitable
defense of unclean hands for the Trustee. See Baal v. McDon‐
14 No. 13‐1377
ald’s Corp., 422 N.E.2d 1166, 1171 (Ill. 1981) (“Under Illinois
law, misconduct on the part of a plaintiff which will defeat a
recovery in a court of equity under the doctrine of ‘unclean
hands’ must have been conduct in connection with the very
transaction being considered or complained of, and must
have been misconduct, fraud or bad faith toward the de‐
fendant making the contention.”); see also Kull at 273 (sug‐
gesting that the constructive trust in Omegas Group could
have been denied on the basis of unclean hands). Viewing
constructive trust in bankruptcy for what it is—the remedy
for a claim in restitution where the estate possesses property
belonging to another—allows these defenses to be available
to the estate.
We need not explore every nook and cranny in the com‐
plex area of constructive trust in bankruptcy. It is enough to
say that, in bankruptcy, a restitution claimant must at a min‐
imum 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 Val‐
ley’s creditors). The court should also consider whether equi‐
table defenses bar J&R from recovering on that claim.
3. Tracing Proceeds
Finally, we turn to tracing. Although tracing is an ele‐
ment 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
No. 13‐1377 15
Ins. Co., 480 F.3d 499, 502 (7th Cir. 2007) (“The imposition of
a constructive trust … requires the plaintiff to trace property
that is rightfully his to the defendant.”); see also 5 COLLIER
ON BANKRUPTCY ¶ 541.28. Without tracing, the basic ra‐
tionale of restitution falls away: the claimant can no longer
point to its specific property in another’s possession. Accord‐
ingly, to establish its right to a constructive trust over the
funds that Mississippi Valley received from the sale of its
cattle, J&R needed to trace the money it received to those
proceeds. See In re Comm’r of Banks & Real Estate, 764 N.E.2d
66, 109–10 (Ill. App. Ct. 2001) (claimant has the burden to
trace property in restitution claim).
The bankruptcy and district courts were right to recog‐
nize 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., 431 N.E.2d 370, 372 (Ill. 1982); In re
Comm’r of Banks & Real Estate, 764 N.E.2d at 101. This doc‐
trine assumes that the debtor withdraws its own funds first
and leaves the trust funds intact. If the balance of the ac‐
count dips below the amount of deposited proceeds, the
claimant’s interest abates accordingly. The claimant’s interest
does not increase if the debtor later deposits additional
funds into the account. Rather, “the claimant has no priority
over other creditors to any amount in excess of the lowest
intermediate balance.” C.O. Funk & Sons, 431 N.E.2d at 372–
73.
The lowest‐intermediate‐balance rule caps the restitution
claimant’s interest because later deposits are made with as‐
16 No. 13‐1377
sets 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’ de‐
posits. 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. “Be‐
tween claimants similarly situated, the equities of restitution
(like the equities of bankruptcy) favor ratable distribution.”
See Kull at 285. Cf. In re Foos, 183 B.R. 149, 152–54 (Bankr.
N.D. Ill. 1995) (erroneously applying Omegas Group to deny
constructive trust over debtor’s Ponzi scheme proceeds).
But even fraud victims must trace. In Cunningham v.
Brown, 265 U.S. 1 (1924), the Supreme Court considered a
bankruptcy trustee’s avoidance action against an alleged
preferential payment to a victim of the debtor Charles
Ponzi’s scheme. The Court assumed that the payment re‐
dressed a fraud, but it nevertheless granted the trustee’s
preference action. The Court explained:
[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 vi‐
olating 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
No. 13‐1377 17
succeed they must trace the money, and therein
they have failed. … In such a case, the de‐
frauded 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. The same tracing logic applies in this case.
IV
Based on the facts found by the bankruptcy court, it ap‐
pears likely that a constructive trust over the funds in Mis‐
sissippi Valley’s account was in some amount proper. Missis‐
sippi Valley took J&R’s property (the cattle), sold it, and held
the proceeds for J&R’s benefit. But we cannot find anything
in the record to tell us such critical things as how much
money was in Mississippi Valley’s account, what the lowest
intermediate balance of the account was after the proceeds
were deposited, and thus whether all of the money was
properly impressed with the trust. In other words, J&R has
not yet shown that all of the funds paid were its property.
Nor can we be certain that the courts below have given ade‐
quate consideration to potential defenses available to the es‐
tate. Because we cannot determine whether the transferred
funds were “an interest of the debtor in property” as re‐
quired to support the trustee’s preference action under 11
U.S.C. § 547, we remand for further proceedings consistent
with this opinion.
REVERSED AND REMANDED.