04-5638-bk In Re:Charles A

twood Flanagan

UNITED STATES COURT OF APPEALS 1 FOR THE SECOND CIRCUIT 2 3

_______________ 4 5 August Term, 2006 6 7 (Argued September 14, 2006 Decided: October 9, 2007) 8 9 Docket Nos. 04-5638-bk(L), 06-0731-bk(XAP) 10 11

_______________ 12 13 In Re: Charles Atwood Flanagan 14 15 *************************************************** 16 17 Cadle Co., D.A.N. Joint Venture, L.P., 18 19 Appellants-Cross-Appellees , 20 21 v. 22 23 Bonnie C. Mangan, Trustee. Charles Atwood Flanagan, 24 John C. Flanagan, 25 26 Appellees-Cross-Appellants , 27 28 U.S. Trustee, 29 30 Trustee
. 31 32

_______________ 33 34 Before: 35 CARDAMONE, MINER, and STRAUB, 36 Circuit Judges

. 37 38

_______________ 39 40 Appellants the Cadle Company and D.A.N. Joint Venture, L.P. 41 appeal from a September 30, 2004 judgment of the United States 42 District Court for the District of Connecticut (Arterton, J.), 43 affirming the July 3, 2003 decisions of the United States 44 Bankruptcy Court for the District of Connecticut (Dabrowski, 45 B.J.), which denied appellants' request for the imposition of a 46constructive trust over certain securities. Appellee-Cross1 Appellant Bonnie C. Mangan, trustee, cross-appeals from the same 2 judgment insofar as it found that a payment of $99,542.87 made by 3 the debtor Charles Flanagan to appellants was partially protected 4 from avoidance by the earmarking doctrine. 5 6 Affirmed. 7 8

_______________ 9 10 EDWARD C. TAIMAN, Jr., Sabia, Taiman, Moskey, Albano & Shea, LLC, 11 Hartford, Connecticut, for Appellants-Cross-Appellees

. 12 13 JOSEPH L. RINI, New Haven, Connecticut, for Appellee-Cross14 Appellant John C. Flanagan

. 15 16 JAMES C. GRAHAM, Pepe & Hazard, LLP, Hartford, Connecticut, for 17 Appellee-Cross-Appellant Bonnie C. Mangan, Trustee

. 18 19

_______________ 202

CARDAMONE, Circuit Judge : 1 This appeal arises from two separate but related adversary 2 bankruptcy proceedings that we will describe in a moment. 3 Charles A. Flanagan (debtor) filed a petition under Chapter 11 of 4 the U.S. Bankruptcy Code, 11 U.S.C. § 101 et seq ., for bankruptcy 5 relief in the United States Bankruptcy Court for the District of 6 Connecticut (Dabrowski, B.J.) on February 17, 1999. While 7 debtor-in-possession under Chapter 11, Flanagan instituted the 8 first adversary proceeding (Preference Action) in the bankruptcy 9 court against Cadle Company to avoid and recover for the bankrupt 10 estate a $99,542.87 payment he had made to Cadle Company. 11 Following the conversion of Flanagan's Chapter 11 case to one 12 under Chapter 7, Bonnie C. Mangan was appointed trustee of 13 Flanagan's bankrupt estate and substituted as party plaintiff in 14 the Preference Action. 15 Cadle Company and D.A.N. Joint Venture, L.P. (collectively 16 Cadle Creditors or appellants) then brought a second separate 17 adversary proceeding (Constructive Trust Action) seeking a 18 declaratory judgment and the imposition of a constructive trust 19 over certain securities that Flanagan owned prior to the 20 bankruptcy filing. In two memorandum decisions issued on May 22, 21 2003, the bankruptcy court denied the equitable relief requested 22 by the Cadle Creditors and ruled the trustee could avoid the 23 payment from Flanagan to Cadle only to the extent of $14,542.87. 24 The bankruptcy court went on to hold that the payment was 25 partially protected from avoidance by the earmarking doctrine. 263

Following a motion for reconsideration, the bankruptcy court 1 affirmed its original decisions on July 3, 2003. Both parties 2 appealed. The United States District Court for the District of 3 Connecticut (Arterton, J.) affirmed the decisions of the 4 bankruptcy court on September 30, 2004. 5 As Sir Walter Scott observed "Oh, what a tangled web we 6 weave, when first we practise to deceive." Marmion, Canto VI, 7 Stanza 17 (1808). Such well describes the circumstances of the 8 debtor's conduct revealed by the record in the appeal before us. 9 Fortunately, these tangled facts were carefully sorted out in the 10 bankruptcy court in its decisions and in the district court's 11 September 30, 2004 decision affirming the judgment of the 12 bankruptcy court. We now in turn affirm the judgment of the 13 district court. 14
BACKGROUND 15 The facts of this case were laid out in detail by the 16 district court in Cadle Co. v. Mangan, 316 B.R. 11, 14-17 (D. 17 Conn. 2004). Nonetheless, for purposes of clarity and analysis, 18 we include a summary of those facts relevant to the disposition 19 of this appeal. 20 Prior to Flanagan's bankruptcy filing of February 17, 1999, 21 the Cadle Creditors obtained several money judgments against 22 Flanagan in federal and state court. Most significant for our 23 purposes is a judgment obtained by Cadle against Flanagan on 24 March 20, 1997 in the United States District Court for the 25 District of Connecticut (Covello, J.) in the amount of $90,747.87 264

(federal judgment). Among Flanagan's assets at the time of the 1 federal judgment was a 50 percent equity interest in Thompson & 2 Peck, Inc. and Flanagan/Prymus Insurance Group, Inc. 3 (collectively Thompson & Peck), valued in excess of $100,000. 4 Flanagan had possession of the Thompson & Peck stock certificates 5 at the time of the federal judgment in March 1997. In September 6 1997 he transferred the certificates to Socrates Babacas as 7 security for loans made by Babacas to him in the amount of 8 $85,000 (Babacas loan). 9 Cadle's attempts to locate assets with which to satisfy its 10 federal judgment focused principally upon Flanagan's equity 11 interest in Thompson & Peck. In March 1998 Cadle subpoenaed 12 Flanagan to appear before Judge Covello for an examination of the 13 debtor and for Flanagan to produce, inter alia, "[a]ll documents 14 and communications related to or evidencing any interest which 15 [Flanagan] may hold in Thompson & Peck, Inc." Flanagan appeared 16 for the hearing but did not produce any documents that would 17 reveal his interest in Thompson & Peck. On March 12, 1998 Cadle 18 made a motion for a turnover order commanding Flanagan to "turn 19 over all evidence of . . . ownership and/or other interest in 20 Thompson & Peck . . . including any and all stock certificates in 21 [his] possession, under [his] control and/or available to [him]." 22 The turnover order was granted by the district court on April 13, 23 1998 and upheld on reconsideration. 24 Despite this court order, Flanagan persistently failed to 25 comply with its instructions. Consequently, on November 16, 1998 265

a hearing was held at which Flanagan was ordered to show cause 1 why he should not be held in contempt for his failure to comply 2 with the court's turnover order. At the conclusion of the 3 hearing, Judge Covello found Flanagan had willfully and 4 intentionally not complied with the turnover order and ordered 5 him committed to the Bureau of Prisons until he complied. The 6 execution of the contempt order was stayed and a hearing 7 scheduled a week later to allow Flanagan one final opportunity to 8 comply. 9 When Flanagan's father, John Flanagan, learned that his son 10 was facing contempt sanctions, he lent him $100,222.87 for the 11 purpose of satisfying the federal judgment (family loan). John 12 Flanagan had never loaned money to his son before and did so on 13 this occasion only to prevent Charles Flanagan from being 14 imprisoned and to protect the family's reputation. The family 15 loan was secured by the debtor's equity interest in Thompson & 16 Peck and Flanagan arranged for Babacas to deliver the stock 17 certificates to his father's home. Immediately upon receipt of 18 the family loan, Flanagan delivered the funds to his lawyer so 19 that the federal judgment could be satisfied. On November 20, 20 1998 Flanagan's attorney deposited the funds into the registry of 21 the district court and Cadle received payment on December 3, 1998 22 (Payment). 23 Following Flanagan's bankruptcy and the filing of the 24 Preference Action to avoid and recover the Payment as a 25 preferential transfer under 11 U.S.C. § 547, the Cadle Creditors 266

mounted a two-pronged defense. In the Preference Action and in 1 the Constructive Trust Action instituted by appellants, the Cadle 2 Creditors sought the imposition of a constructive trust over the 3 Thompson & Peck stock for their benefit. Appellants argued it 4 was solely because of Flanagan's wrongful concealment of his 5 equity interest in Thompson & Peck that they had been unable to 6 execute upon the stock and secure the federal judgment and other 7 judgments they had obtained prior to the 90-day preference 8 period. Thus, they sought the imposition of a constructive trust 9 over the Thompson & Peck stock to restore them to the secured 10 position they would have occupied absent Flanagan's misconduct. 11 The Cadle Creditors asserted the Payment did not improve their 12 position relative to other creditors (as required by 11 U.S.C. 13 § 547(b)(6)) because, due to their constructive possession of the 14 Thompson & Peck stock, the Cadle Creditors possessed a fully 15 secured lien in the stock prior to the preference period. 16 The second prong of the Cadle Creditors' defense against the 17 Preference Action was their argument that the family loan funds 18 had been earmarked by John Flanagan for the sole and specific 19 purpose of satisfying the federal judgment against his son. 20 Accordingly, they maintained that the family loan funds had never 21 constituted an "interest of the debtor in property" as required 22 by § 547(b). 23 The bankruptcy court resolved the Preference Action and the 24 Constructive Trust Action in two decisions issued on May 22, 25 2003. Both decisions were upheld on reconsideration and a 267

modified opinion was issued in the Preference Action on July 3, 1 2003. In response to Cadle's constructive trust claim, the 2 bankruptcy court found the imposition of a trust inappropriate in 3 the circumstances. It noted the Cadle Creditors possessed "only 4 an expectation of the potential fruits of execution [on the 5 stock]," and concluded that a constructive trust should not be 6 imposed to "protect property rights which may or may not have 7 become vested and indefeasible." 8 The bankruptcy court also ruled the Payment was partially 9 protected from avoidance by the earmarking doctrine because the 10 family loan was made for the sole and specific purpose of 11 enabling Flanagan to satisfy the federal judgment. But the 12 bankruptcy court further held that "even though the transaction 13 fits the earmarking defense insofar as it replaced one creditor 14 (Cadle) with another ([John] Flanagan), the substitution of a 15
securedfor an unsecuredobligation attenuates that defense 16 because, and to the extent, it caused a diminution to Flanagan's 17 personal estate." As a consequence, the bankruptcy court entered 18 judgment in favor of the trustee to avoid the transfer but only 19 to the extent of $14,542.87, an amount equal to the difference 20 between the family loan and the Babacas loan whose security 21 interest had been supplanted. 22 The Preference Action and the Constructive Trust Action were 23 consolidated on appeal to the district court. On September 30, 24 2004 Judge Arterton of the United States District Court for the 25 District of Connecticut affirmed the decisions of the bankruptcy 268

court. The Cadle Creditors appealed, and the trustee, Bonnie C. 1 Mangan, together with John and Charles Flanagan (appellees) 2 cross-appealed. 3 Meanwhile, the Cadle Creditors instituted two additional 4 proceedings against Charles Flanagan: (1) a civil RICO action in 5 the United States District Court for the District of Connecticut 6 (Covello, J.) alleging, inter alia, fraud and conspiracy in 7 connection with resisting creditors' collection efforts, and (2) 8 an adversary proceeding in bankruptcy court seeking denial of 9 discharge. In 2004, the discharge action was withdrawn from the 10 bankruptcy court and consolidated with the RICO action in the 11 district court before Judge Covello. 12 On April 8, 2005 while the instant appeal was pending, the 13 Cadle Creditors and Flanagan entered into a proposed settlement 14 agreement in the consolidated RICO/discharge action. As part of 15 the proposed settlement, the Cadle Creditors and Flanagan entered 16 into a "Mutual Release of All Claims" (General Release) which 17
stated 18 Upon execution of this Release, both Cadle 19 and Flanagan hereby release each other of and 20 from any and all claims, whether now known or 21 unknown, whether now in existence or arising 22 hereafter, which each has or may have against 23 each other from the beginning of time until 24 the date of the execution of this Release. 25 26 Judge Covello entered an order approving the proposed settlement 27 on May 5, 2005, and dismissing the RICO/discharge action with 28 prejudice. 299 DISCUSSION 1 I Jurisdiction 2 The first issue we address is whether, in light of the 3 General Release, we retain subject matter jurisdiction over that 4 portion of the appeal relating to the Constructive Trust Action. 5 Appellees assert that by executing the General Release the Cadle 6 Creditors relinquished all claims against Flanagan, including 7 claims against Flanagan's bankrupt estate. The trustee thus 8 reasons the Cadle Creditors have extinguished the basis for the 9 relief sought in the Constructive Trust Action, rendering that 10 portion of the appeal moot. 11 In order for there to be a valid exercise of subject matter 12 jurisdiction, a federal court must have before it an actual 13 controversy at all stages of review, not simply at the time the 14 complaint was filed. Steffel v. Thompson, 415 U.S. 452, 459 n.10 15 (1974). In general, if an event occurs while an appeal is 16 pending that renders it impossible for the court to grant any 17 form of effectual relief to plaintiff, the matter becomes moot 18 and subject matter jurisdiction is lost. Altman v. Bedford Cent. 19 Sch. Dist. , 245 F.3d 49, 69 (2d Cir. 2001); see also Church of 20 Scientology of Cal. v. United States , 506 U.S. 9, 12 (1992). 21 However, when an appellant retains an interest in a case so that 22 a favorable outcome could redound in its favor, the case is not 23
moot. See Firefighters Local Union No. 1784 v. Stotts , 467 U.S. 24 561, 568-72 (1984). 2510 The crux of the trustee's contention is that the Cadle 1 Creditors' claims against Flanagan's bankrupt estate became 2 unenforceable when they entered into the post-petition settlement 3 agreement with the debtor that included a mutual general release 4 of all claims. In making this argument, appellees rely on 5 language in § 502(b)(1) of the Bankruptcy Code. That section 6 states a claim is disallowed in bankruptcy to the extent that it 7 is "unenforceable against the debtor and property of the debtor, 8 under any agreement or applicable law for a reason other than 9 because such claim is contingent or unmatured." 11 U.S.C. 10 § 502(b)(1). The trustee asserts that § 502(b)(1) should be read 11 to disallow not only claims that are unenforceable against the 12 debtor at the time the bankruptcy petition is filed but also 13 those claims that become unenforceable against the debtor over 14 the course of the bankruptcy and prior to discharge. 15 We think the trustee's interpretation of § 502(b)(1) is an 16 untenable reading of the statutory text because it ignores the 17 provision's context within the Bankruptcy Code. Section 502(b) 18 instructs the bankruptcy court to "determine the amount of such 19 claim . . . as of the date of the filingof the petition" except 20 to the extent that "such claim is unenforceable against the 21 debtor." 11 U.S.C. § 502(b), (b)(1) (emphasis added). A plain 22 reading of the statute thus suggests that the bankruptcy court 23 should determine whether a creditor's claim is enforceable 24 against the debtor as of the date the bankruptcy petition was 25 filed. Were this Court to adopt the trustee's interpretation of 2611

§ 502(b)(1), we would be forced to conclude that all pre-petition 1 unsecured claims are disallowed to the extent they did not 2 represent non-dischargeable debts. For, as the bankruptcy court 3 aptly noted in In re Strangis , 67 B.R. 243 (Bankr. D. Minn. 4 1986), "[a]bsent a finding of nondischargeability, no such 5 unsecured claim is enforceable post-petition against a debtor and 6 property of a debtor." Id. at 246. 7 The General Release could not have impacted any claims held 8 by or against Flanagan's bankrupt estate for an additional and 9 related reason. Flanagan simply did not have the authority to 10 settle any claims against the bankrupt estate. It is well 11 established that once a trustee is appointed, a debtor loses all 12 authority to litigate any claim for or against the estate. As 13 noted in Collier on Bankruptcy 14 The trustee, as representative of the 15 estate, has the exclusive capacity to sue and 16 be sued on behalf of the estate, and is 17 charged by law with representing the interest 18 of the estate against third parties claiming 19 adversely to it. . . . 20 21 . . . After appointment of a trustee, a 22 debtor no longer has standing to pursue a 23 cause of action that existed at the time the 24 order for relief was entered. Only the 25 trustee has the authority and discretion to 26 prosecute, defend and settle, as appropriate 27 in its judgment, such a cause of action. 28 29 3 Collier on Bankruptcy¶ 323.03, .03[1], at 323-7 to -9 (Alan N. 30 Resnick et al. eds., rev. 15th ed. 2007); see also10 Collier on 31 Bankruptcy¶ 6009.03, at 6009-3 to -6.1. 3212 Here, not only was the trustee not a party to the General 1 Release, but there is no indication the bankruptcy court was ever 2 presented with a motion to settle, compromise, disallow, or 3 otherwise dismiss the Cadle Creditors' claims. SeeFed. Bankr. 4 R. 9019 ("On motion by the trustee and after notice and a 5 hearing, the court may approve a compromise or settlement."); 10 6 Collier on Bankruptcy¶ 9019.01, at 9019-2 (noting that any 7 "settlement must be approved by the court"). While Flanagan may 8 have had the authority to settle civil claims that arose against 9 him after his bankruptcy filing, he had no authority to settle 10 claims against the bankrupt estate. 11 Having established that the bases for the relief sought by 12 the Cadle Creditors in the Constructive Trust Action have not 13 been extinguished, and that a favorable result could redound in 14 their favor, we conclude those claims are not moot. Hence, we 15 retain subject matter jurisdiction to review them. 16 II Standard of Review 17 In an appeal from a district court's review of a bankruptcy 18 court's decision, we conduct an independent examination of the 19 bankruptcy court's decision. Supplee v. Bethlehem Steel Corp. 20 (In re Bethlehem Steel Corp.) , 479 F.3d 167, 172 (2d Cir. 2007). 21 The bankruptcy court's factual findings will be upheld unless 22 clearly erroneous, and its legal conclusions are reviewed de 23

novo . Id. The ultimate determination of whether or not to 24 impose an equitable remedy -- such as a constructive trust or an 25 equitable lien -- is reviewed for abuse of discretion. See 2613

Adelphia Bus. Solutions, Inc. v. Abnos , 482 F.3d 602, 607 (2d 1 Cir. 2007) (bankruptcy court's decision whether to exercise its 2 equitable authority is reviewed only for abuse of discretion); 3

see also Burkhart Grob Luft und Raumfahrt GmbH v. E-Systems, 4
Inc. , 257 F.3d 461, 469 (5th Cir. 2001) ("Because a constructive 5 trust is an equitable remedy, the decision whether to impose it 6 is entrusted to the discretion of the district court, and we 7 review the district court's decision only for an abuse of 8 discretion."). However, legal determinations upon which the 9 dispensation of equitable relief may depend are reviewed de novo

. 10
See Superintendent of Ins. v. Ochs (In re First Cent. Fin. 11 Corp.) , 377 F.3d 209, 213 (2d Cir. 2004) (reviewing de novothe 12 legal conclusion as to whether a party has been unjustly 13 enriched). 14 III General Law on Transfer Avoidance 15 Pursuant to § 547(b) of the Bankruptcy Code, a trustee in 16 bankruptcy may avoid certain transfers if the following criteria 17
are met: 18 (1) the transfer is of an interest of the 19 debtor in property; 20 (2) to or for the benefit of a creditor; 21 (3) on account of an antecedent debt; 22 (4) made while the debtor was insolvent; 23 (5) within 90 days of bankruptcy or within a 24 year of bankruptcy if the creditor was an 25 insider; 26 (6) and the transfer enabled the creditor to 27 receive more than it would have received in a 28 chapter 7 liquidation had the transfer not 29 taken place. 3014

11 U.S.C. § 547(b). The burden of proof to establish each of 1 these elements by a preponderance of the evidence rests on the 2 trustee in bankruptcy. Lawson v. Ford Motor Co. (In re Roblin 3 Indus., Inc.) , 78 F.3d 30, 34 (2d Cir. 1996). The Cadle 4 Creditors do not contest that the Payment was made within 90 days 5 of Flanagan's bankruptcy, while he was insolvent, on account of 6 an antecedent debt, and for the benefit of a creditor. It is 7 therefore only the first and sixth of these criteria that are at 8 issue in this appeal. 9 IV Transfer Improves Cadle Creditors' Position in Bankruptcy 10
A. The Constructive Trust Claim 11 Concerning the sixth criterion required by 11 U.S.C. 12 § 547(b), the Cadle Creditors aver that the Payment did not 13 improve their position in bankruptcy. They allege that as a 14 result of their constructive possession of the Thompson & Peck 15 stock, they possessed a fully secured lien in the stock. The 16 imposition of a constructive trust is necessary, they insist, to 17 remedy the harm caused by Flanagan's willful failure to comply 18 with the turnover order, which prevented them from perfecting 19 their judgments more than 90 days prior to the bankruptcy filing. 20 We believe the lower courts' refusal to impose a constructive 21 trust on the Thompson & Peck stock was well founded. 22 The effect of a constructive trust in bankruptcy is 23 profound. While the bankrupt estate is defined very broadly 24 under § 541(a)(1) of the Bankruptcy Code to include all legal or 25 equitable interests of the debtor, any property that the debtor 2615

holds in constructive trust for another is excluded from the 1 estate pursuant to § 541(d), which states 2 Property in which the debtor holds, as of the 3 commencement of the case, only legal title 4 and not an equitable interest . . . becomes 5 property of the estate . . . only to the 6 extent of the debtor's legal title to such 7 property, but not to the extent of any 8 equitable interest in such property that the 9 debtor does not hold. 10 11 11 U.S.C. § 541(a)(1), (d); see also Sanyo Elec., Inc. v. 12 Howard's Appliance Corp. (In re Howard's Appliance Corp.) , 874 13 F.2d 88, 93 (2d Cir. 1989). A constructive trust thus places its 14 beneficiary ahead of other creditors with respect to the trust 15

res . 16 The question of whether the imposition of a constructive 17 trust is appropriate in a particular set of circumstances is 18 governed, in the first instance, by state law. See id.; see also 19 Butner v. United States , 440 U.S. 48, 54-55 (1979). The Supreme 20 Court of Connecticut has stated: 21 [A] constructive trust arises contrary to 22 intention and in invitum, against one who, by 23 fraud, actual or constructive, by duress or 24 abuse of confidence, by commission of wrong, 25 or by any form of unconscionable conduct, 26 artifice, concealment, or questionable means, 27 or who in any way against equity and good 28 conscience, either has obtained or holds the 29 legal right to property which he ought not, 30 in equity and good conscience, hold and 31 enjoy. 32 33 Wendell Corp. Tr. v. Thurston, 680 A.2d 1314, 1317 (Conn. 1996). 34 It is uncontested that Flanagan wrongfully concealed evidence of 35 his equity interest in Thompson & Peck. While such conduct could 3616

potentially give rise to a constructive trust in other 1 circumstances, it did not do so here because the Cadle Creditors 2 would not be the proper beneficiaries of such a trust. 3 A constructive trust has been imposed most often by 4 Connecticut courts "to restore to the plaintiff property of which 5 he has been unjustly deprived." Cadle Co. v. Gabel, 794 A.2d 6 1029, 1037 (Conn. App. Ct. 2002) (quoting Restatement (First) of 7 Restitution § 160 cmt. d (1937)); see also Starzec v. Kida, 438 8 A.2d 1157 (Conn. 1981) (affirming imposition of constructive 9 trust for benefit of testator's children where testator gave 10 property to second wife on condition she devise property to his 11 children); Cohen v. Cohen, 438 A.2d 55 (Conn. 1980) (affirming 12 imposition of constructive trust over condominium property where 13 plaintiff conveyed property to son under oral agreement pursuant 14 to which son was to reconvey property back to plaintiff at her 15 request). 16 Here, the Cadle Creditors were never entitled to an 17 ownership interest in the Thompson & Peck stock. Rather, under 18 Connecticut's post-judgment remedy statute, the turnover order 19 only entitled appellants to gain possession of the stock as the 20 first of several steps in executing a levy upon it. See Mangan, 21 316 B.R. at 20-21 (describing and applying to the facts of this 22 case Connecticut's post-judgment remedy statute). As the 23 district court aptly noted: 24 [Appellants'] interests in the stock were 25 subject to a series of contingencies, in 26 which other creditors with secured interests 2717 in the stock were entitled to prevent 1 execution or gain priority status over 2 Appellants. The distinction here -- that the 3 turnover order did not entitle Appellants to 4 own Flanagan's stock, just to gain possession 5 as an aid to execution of a levy upon it -- 6 is one that Appellants appear to have 7 blurred. 8 9 Id. at 21. Indeed, once the federal judgment had been satisfied 10 by Flanagan with the family loan funds, Cadle lost any 11 expectation interest in the Thompson & Peck stock it might have 12 once had as a result of the district court's turnover order. 13 The Cadle Creditors point out Connecticut courts have in 14 some situations imposed a constructive trust when the plaintiff 15 was not entitled to an ownership interest in the trust property 16 and had not suffered a loss commensurate to the benefit received 17 by the defendant. See, e.g. , Gabel, 794 A.2d at 1039 (allowing 18 for constructive trust over property in favor of plaintiff 19 unsecured creditor because defendant had been unjustly enriched 20 by sham transactions used to shield property from creditors). In 21 these situations, "the defendant is compelled to surrender the 22 benefit on the ground that he would be unjustly enriched if he 23 were permitted to retain it." Id. at 1037. 24 However, the argument that Flanagan would be unjustly 25 enriched absent the imposition of a constructive trust is 26 unconvincing when made in the context of a bankruptcy proceeding. 27
See First Cent. , 377 F.3d at 218 ("[W]e believe it important to 28 carefully note the difference between constructive trust claims 29 arising in bankruptcy as opposed to those that do not . . . ."). 3018

It has been observed that the "equities of bankruptcy are not the 1 equities of the common law." XL/Datacomp, Inc. v. Wilson (In re 2 Omegas Group, Inc.) , 16 F.3d 1443, 1452 (6th Cir. 1994). This is 3 particularly true in the context of constructive trust law. As 4 discussed above, the effect of a constructive trust in bankruptcy 5 is to take the property out of the debtor's estate and to place 6 the constructive trust claimant ahead of other creditors with 7 respect to the trust res . 11 U.S.C. § 541(a)(1), (d); Howard's 8 Appliance, 874 F.2d at 93. It is therefore not the debtor who 9 generally bears the burden of a constructive trust in bankruptcy, 10 but the debtor's general creditors. This type of privileging of 11 one unsecured claim over another clearly thwarts the principle of 12 ratable distribution underlying the Bankruptcy Code. As a 13 consequence bankruptcy courts have been reluctant, absent a 14 compelling reason, to impose a constructive trust on the property 15 in the estate. See First Cent. , 377 F.3d at 217-18 (collecting 16 cases); Haber Oil Co. v. Swinehart (In re Haber Oil Co.) , 12 F.3d 17 426, 436 (5th Cir. 1994); Omegas Group, 16 F.3d at 1452 18 ("Constructive trusts are anathema to the equities of bankruptcy 19 since they take from the estate, and thus directly from competing 20 creditors, not from the offending debtor."). 21 The Cadle Creditors make no argument as to why Flanagan's 22 bankrupt estate or, more to the point, Flanagan's general 23 creditors, would be unjustly enriched by the estate's continued 24 ownership interest in the Thompson & Peck stock. Accordingly, we 2519

affirm the bankruptcy court's refusal to impose a constructive 1
trust on the stock. 2
B. Availability of an Equitable Lien 3 In the alternative, the Cadle Creditors declare that an 4 equitable lien should be imposed on the Thompson & Peck stock to 5 the extent of their claims. This point was not raised before the 6 bankruptcy court, but appears to have been prompted by language 7 in the district court's opinion. In noting that the appellants 8 were not claiming they rightfully owned the stock, but only that 9 they were entitled to reach the stock as security for their 10 claims, the district court observed that an "equitable remedy 11 that would give Cadle a perfected lienholder status might be best 12 described as an 'equitable lien.'" Mangan, 316 B.R. at 22. The 13 district court then went on to dismiss the possibility of 14 imposing an equitable lien because it concluded that "an 15 equitable lien, even if enforceable, would not relate back" to 16 before the preference period. Id. at 23. 17 We generally will not consider arguments raised for the 18 first time on appeal. Universal Church v. Geltzer, 463 F.3d 218, 19 228 (2d Cir. 2006). We do, however, retain discretion to 20 consider an argument not presented to the trial court in order to 21 prevent a manifest injustice or where the argument presents a 22 question of law and additional factfinding is unnecessary. Id

. 23 Because the district court considered the equitable lien issue 24 and because the imposition of an equitable lien on the facts of 2520

this case raises only a question of law, we briefly consider the 1
matter. 2 Connecticut law recognizes the equitable lien remedy. See, 3
e.g. , Hansel v. Hartford-Conn. Trust Co. , 49 A.2d 666, 673 (Conn. 4 1946); Bassett v. City Bank & Trust Co. (In re Judd) , 165 A. 557, 5 561-62 (Conn. 1933). The equitable remedy was aptly described by 6 the Connecticut Supreme Court in Hansel 7 An equitable lien creates merely a charge 8 upon the property and when the person 9 entitled to it is not in possession of that 10 property, he has no right to obtain 11 possession from another unless by virtue of 12 some authority to do so expressly granted to 13 him; his remedy to enforce the lien is by a 14 proceeding in equity to bring about its sale 15 and the application of the proceeds to the 16 satisfaction of the obligation secured, or, 17 in some other manner, by order of the court, 18 to make the property available for the 19 discharge of that debt. 20 21 Hansel, 49 A.2d at 673. 22 Equitable liens arise in a variety of circumstances. For 23 example, an equitable lien may arise by express or implied-in24 fact agreement of the parties. See, e.g. , Bassett, 165 A. at 25 561; see alsoDan B. Dobbs, 1 Law of Remedies§ 4.3(3), at 601 26 (2d ed. 1993). Most often, however, equitable liens are imposed 27 to prevent unjust enrichment. See Dep't of the Army v. Blue Fox, 28
Inc. , 525 U.S. 255, 262-63 (1999). In this sense, equitable 29 liens and constructive trusts share the same substantive basis; 30 both are remedies in equity to redress unjust enrichment. See 31 Dobbs, supra, § 4.3(3), at 601 ("The [equitable] lien is imposed 3221

for reasons that, in principle, are the same as those that 1 warrant the constructive trust . . . ."). 2 The traditional distinction between a constructive trust and 3 an equitable lien is that the beneficiary of a constructive trust 4 receives complete title to the asset whereas the holder of an 5 equitable lien receives only a lien on the asset through which it 6 may satisfy a money claim. See Airwork Corp. v. Markair Express, 7 Inc. (In re Markair, Inc. ), 172 B.R. 638, 643 (B.A.P. 9th Cir. 8 1994); Dobbs, supra, § 4.3(3), at 601. Yet, in some states -- 9 including Connecticut -- there is little practical difference 10 between the two remedies because courts have held that a 11 constructive trust beneficiary does not necessarily obtain a 12 right to possess the trust property, but may only receive a lien 13 on the property equal to the amount of the plaintiff's claim. 14
See Wendell680 A.2d at 1320 ("To say that the . . . property is 15 subject to a constructive trust in Wendell's favor is not to say 16 that Wendell owns the property. On the contrary, it is to say 17 only that Wendell may seek satisfaction of its debt, and no more, 18 out of that property . . . ."). Thus, in Connecticut, the right 19 to recover under a constructive trust is limited in a similar way 20 as it would be under an equitable lien theory. 21 The Cadle Creditor's contention that they should receive an 22 equitable lien on the stock fails for the same reason as their 23 constructive trust argument. Both the equitable lien and 24 constructive trust remedies are equitable devices to prevent 25 unjust enrichment. But, as discussed above, appellants have 2622

failed to demonstrate how Flanagan's bankrupt estate would be 1 unjustly enriched by its continued ownership interest in the 2 Thompson & Peck stock. Because no equitable lien arises in these 3 circumstances, we need not review the district court's conclusion 4 that, even if an equitable lien did arise, it would not relate 5 back to a time before the preference period. 6 V Earmarking Doctrine 7 In order for a transfer to be avoidable by a trustee in 8 bankruptcy, it must be of "an interest of the debtor in 9 property." 11 U.S.C. § 547(b). The requirement that the 10 transfer be of an interest of the debtor in property is not 11 defined in the Bankruptcy Code and has therefore been left to the 12 courts to interpret. In so doing, courts have crafted a doctrine 13 that has come to be known as the earmarking doctrine. 14 The earmarking doctrine applies "where a third party lends 15 money to the debtor for the specific purpose of paying a selected 16 creditor." Glinka v. Bank of Vt. (In re Kelton Motors, Inc.) , 97 17 F.3d 22, 28 (2d Cir. 1996). In such situations, the loan funds 18 are said to be "earmarked" and the payment is held not to 19 constitute a voidable preference. McCuskey v. Nat'l Bank of 20 Waterloo (In re Bohlen Enters.) , 859 F.2d 561, 565 (8th Cir. 21 1988). 22 Early applications of the earmarking doctrine concerned 23 situations in which the debtor's obligation was secured by a 24 guarantor. See id. Where the guarantor paid the creditor on 25 behalf of a debtor, the courts rejected the proposition that the 2623

payment could be avoided by the trustee. Id. The rationale for 1 such an outcome was that the property transferred belonged to the 2 guarantor and thus the transfer of that property in no way 3 diminished the debtor's estate. See Nat'l Bank of Newport, N.Y. 4 v. Nat'l Herkimer County Bank, 225 U.S. 178, 185 (1912) ("Neither 5 directly nor indirectly was this payment to the bank made by the 6 [debtor], and the property of [the debtor] was not thereby 7 depleted."). It is likely that courts were also mindful that the 8 opposite result would have the inequitable effect of forcing the 9 guarantor to pay the same obligation twice. See McCuskey, 859 10 F.2d at 565. 11 Today, the earmarking doctrine has been extended beyond the 12 guarantor context and several courts have held that it applies 13 whenever a third party provides funds to the debtor for the 14 express purpose of enabling the debtor to pay a specified 15 creditor, that is substituting a new creditor for an old 16 creditor. See Glinka, 97 F.3d at 28; Adams v. Anderson (In re 17 Superior Stamp & Coin Co.) , 223 F.3d 1004, 1008 (9th Cir. 2000); 18 Buckley v. Jeld-Wen, Inc. (In re Interior Wood Prods. Co.) , 986 19 F.2d 228, 231 (8th Cir. 1993); In re Smith, 966 F.2d 1527, 1533 20 (7th Cir. 1992); Mandross v. Peoples Banking Co. (In re Hartley) , 21 825 F.2d 1067, 1070 (6th Cir. 1987); Coral Petrol., Inc. v. 22 Banque Paribas-London, 797 F.2d 1351, 1356 (5th Cir. 1986). But 23

see Manchester v. First Bank & Trust Co. (In re Moses) , 256 B.R. 24 641, 646-49 (B.A.P. 10th Cir. 2000) (stating that the earmarking 25 doctrine should not be extended beyond guarantor situations); 2624

McCuskey, 859 F.2d at 566 (expressing doubt as to whether 1 earmarking doctrine should be extended beyond guarantor 2 situations but ultimately adopting test that allows for 3 application of earmarking doctrine outside that limited context). 4 Several formulations have been developed to determine 5 whether the earmarking doctrine applies in a particular case. 6
See Manchester, 256 B.R. at 649-50 (discussing various approaches 7 to application of earmarking doctrine). An oft cited approach is 8 that adopted by the Eighth Circuit in McCuskey

. McCuskeyheld 9 that in order for a transaction to qualify under the earmarking 10 doctrine, three requirements must be satisfied: "(1) the 11 existence of an agreement between the new lender and the debtor 12 that the new funds will be used to pay a specified antecedent 13 debt, (2) performance of that agreement according to its terms, 14 and (3) the transaction viewed as a whole (including the transfer 15 in of the new funds and the transfer out to the old creditor) 16 does not result in any diminution of the estate." 859 F.2d at 17 566; see also Kaler v. Cmty. First Nat'l Bank (In re Heitkamp) , 18 137 F.3d 1087, 1088-89 (8th Cir. 1998) (applying McCuskey 19 formulation). Other courts have focused primarily on whether the 20 debtor lacked control over the funds supplied by the new 21 creditor. See, e.g. , Hansen v. MacDonald Meat Co. (In re Kemp 22 Pac. Fisheries, Inc.) , 16 F.3d 313, 316 (9th Cir. 1994); Coral, 23 797 F.2d at 1358. 24 We have long recognized the earmarking doctrine, though our 25 early cases did not refer to it by that name. See, e.g. , Smyth 2625

v. Kaufman (In re J.B. Koplik & Co.) , 114 F.2d 40, 42-43 (2d Cir. 1 1940); Grubb v. Gen. Contract Purchase Corp. , 94 F.2d 70, 72-73 2 (2d Cir. 1938) (L. Hand, J.). We have held that where a debtor 3 receives funds subject to a clear obligation to use that money to 4 pay off a preexisting debt, and the funds are in fact used for 5 that purpose, those funds do not become part of the estate and 6 the transfer cannot be avoided in bankruptcy. See Grubb, 94 F.2d 7 at 73. However, we have been equally clear that where a new 8 creditor provides funds to the debtor with no specific 9 requirement as to their use, the funds do become part of the 10 estate and any transfer of the funds out of the estate is 11 potentially subject to trustee's avoidance powers. See Smyth, 12 114 F.2d at 42 (finding that transfer could be avoided where 13 "nothing indicat[ed] that [the new creditor] loaned this $500 on 14 condition that it should be applied to this particular 15 creditor."). This result does not change even where the new 16 creditor knows, but does not require, that the new loan funds 17 will be used to pay off a preexisting debt. See id

. 18 In this case, the bankruptcy court found that Flanagan's 19 father provided the family loan for the specific purpose of 20 paying the federal judgment. There was no doubt that the 21 debtor's father made such funds available "for the sole purpose 22 of purging Flanagan's contempt before Judge Covello through 23 satisfaction of the underlying Judgment." This factual finding 24 is not clearly erroneous and we accept it on this appeal. 2526 The trustee does not seriously dispute that the family loan 1 was made for the purpose of allowing Flanagan to pay the federal 2 judgment. She insists, however, that the earmarking defense does 3 not apply because Flanagan obtained possession of the funds 4 temporarily. The fact that Flanagan temporarily had possession 5 of the family loan funds does not necessarily demonstrate that 6 Flanagan had control of them. The proper application of the 7 earmarking doctrine depends not on whether the debtor temporarily 8 obtains possession of new loan funds, but instead on whether the 9 debtor is obligated to use those funds to pay an antecedent debt. 10
See5 Collier on Bankruptcy¶ 547.03[2], at 547-24 ("The 11 [earmarking] rule is the same regardless of whether the proceeds 12 of the loan are transferred directly by the lender to the 13 creditor or are paid to the debtor with the understanding that 14 they will be paid to the creditor in satisfaction of his claim 15 . . . ."); see also Superior Stamp, 223 F.3d at 1009. Compare 16
Grubb, 94 F.2d at 73 with Smyth, 114 F.2d at 42. Flanagan's 17 receipt of the family loan funds was specifically conditioned 18 upon his use of those funds to pay the federal judgment, and he 19 never obtained control of the funds in the sense of being able to 20 control how they were ultimately distributed. The earmarking 21 doctrine therefore potentially applies to protect the Payment 22 from avoidance. 23 There is, nonetheless, an important limitation on the 24 earmarking doctrine. The doctrine will only protect a transfer 25 from avoidance to the extent it did not diminish the debtor's 2627

estate. Glinka, 97 F.3d at 28. Where a debtor replaces an 1 unsecured obligation with a secured obligation, the payment is 2 voidable to the extent of the collateral transferred by the 3
debtor. Id. ("[T]o the extent that the debtor offered its own 4 property as collateral for the [loan], the debtor transferred an 5 interest in its property and therefore the earmarking defense is 6 not available."); see also Mandross , 825 F.2d at 1071. In the 7 case at hand, Flanagan satisfied the unsecured obligation of the 8 federal judgment by taking on the secured obligation of the 9 family loan. However, the bankruptcy court also found that the 10 lien obtained by the debtor's father in the Thompson & Peck stock 11 supplanted Babacas's lien in the stock. As a consequence, the 12 bankruptcy court concluded the net diminution of the estate was 13 equal to the difference between the Babacas loan ($85,000) and 14 the Payment ($99,542.87), or the extent to which John Flanagan 15 encumbered previously unencumbered property of the debtor estate 16 to enable the Payment. 17 The trustee disputes the bankruptcy court's finding that the 18 family loan lien supplanted, rather than merely subordinated, 19 Babacas's lien. We believe the bankruptcy court's finding that 20 the Babacas lien was supplanted by the family loan lien finds 21 support in the record and is not clearly erroneous. 22 Consequently, we conclude that the Payment can be avoided by the 23 trustee, but only in the amount of $14,542.87. 2428 CONCLUSION 1 Accordingly, for the foregoing reasons, the judgment of the 2 district court is affirmed and appellees' motion to dismiss for 3 lack of subject matter jurisdiction is denied. 4