Opinion ID: 173386
Heading Depth: 2
Heading Rank: 2

Heading: Imposition of Constructive Trust Upon Attorneys' Fees

Text: We next address whether the district court committed reversible error by imposing a constructive trust upon $238,300 in fees that Castro paid to defense counsel Jeffrey Benice. For the reasons explained below, we affirm the district court's order.
The FTC Act endows the district court with broad authority to `grant any ancillary relief necessary to accomplish complete justice,' including the power to compel the payment of restitution to injured consumers. FTC v. Stefanchik, 559 F.3d 924, 931 (9th Cir.2009) (quoting FTC v. Pantron I Corp., 33 F.3d 1088, 1102 (9th Cir.1994)). Consistent with the Act's expansive statutory authorization, this court reviews a district court's grant of equitable relief under the FTC Act only for abuse of discretion or the erroneous application of legal principles. See FTC v. Pantron I Corp., 33 F.3d, 1088, 1102 (9th Cir.1994). Similarly, factual findings relating to the payment of attorneys' fees are also reversed only for clear error. See, e.g., Berkla v. Corel Corp., 302 F.3d 909, 917 (9th Cir.2002); FTC v. Assail, Inc., 410 F.3d 256, 262 (5th Cir.2005). Constructive trust is a form of remedy that is flexibly fashioned in equity to provide relief where a balancing of interests in the context of a particular case seems to call for it. In re N. Am. Coin & Currency, Ltd., 767 F.2d 1573, 1575 (9th Cir.1985). It is a creature of the common law, rather than any federal statute. Id. Thus, while the FTC Act's broad authorization of equitable remedies is the immediate source of the district court's power to fashion relief in this case, we also look to common law principles of equity to determine whether the district court's application of constructive trust constitutes legal error. At common law, where property has been obtained by fraud, a court in equity has jurisdiction to reach the property either in the hands of the original wrong-doer, or in the hands of any subsequent holder and to convey that property to the one who is truly and equitably entitled to the same. Harris Trust & Sav. Bank v. Salomon Smith Barney, Inc., 530 U.S. 238, 251, 120 S.Ct. 2180, 147 L.Ed.2d 187 (2000) (quoting Moore v. Crawford, 130 U.S. 122, 128, 9 S.Ct. 447, 32 L.Ed. 878 (1889)). Importantly, that a transferee was not `the original wrongdoer' does not insulate him from liability for restitution. Id. If, however, an innocent third-party transferee purchases ill-gotten assets for value, in good faith, and without actual or constructive notice of the wrongdoing, the third-party transferee cannot be held liable for restitution and the assets are not the proper subject of a constructive trust. Id. Known as the bona fide purchaser rule, this exception grants an innocent transferee a higher right to the obtained assets than the victim of the original fraud. See id.; CRS Recovery, Inc. v. Laxton, 600 F.3d 1138, 1144-45 (9th Cir. 2010) (discussing the bona fide purchaser principle in the context of California's law of conversion). The parties' arguments before this court rely on these common law principles. First, Appellants contend, the monies paid to Benice are not the proper subject of a constructive trust because the evidence before the district court does not establish that the funds were the proceeds of an unlawful scheme. Second, Appellants urge, even assuming the fees were paid with ill-gotten funds, Benice was a bona fide purchaser because he supplied legal services in a good-faith exchange and lacked notice that the funds were derived from unlawful business practices. The FTC disputes these contentions. The district court found that Benice had been paid with tainted funds, that the fee arrangements were not made in good faith, and that Benice had sufficient notice to preclude his status as a bona fide purchaser. We conclude that those findings are supported by the evidence and that Judge George's conclusions are sound.
The district court found that the FTC had presented clear and convincing evidence that the funds Castro paid to Benice were derived from the unlawful kiosk scheme. Using several methods of analysis, FTC financial expert Kenneth Kelley determined that all of the funds withdrawn from the custodial accounts and used to pay Benice could be traced to NSD and the other Castro companies. According to Kelley's analysis, 90 percent of the funds were traceable to NSD's accounts and revenue from the kiosk scheme. The remaining funds were all attributable to at least one of the Castro companies, but because those entities regularly transferred money to one another and paid each others' expenses, Kelley could not state conclusively which company initially generated the funds. Based on the FTC's evidence, the district court concluded that all of Castro's businesses formed a common enterprise and were co-participants in the unlawful practices. Appellants call this finding meritless and insist that, because the FTC failed to demonstrate with exact precision which funds initially came from which companies, the district court erred in imposing a valid constructive trust. Far from being meritless, however, the district court's conclusion appears eminently reasonable. Our cases hold that entities constitute a common enterprise when they exhibit either vertical or horizontal commonalityqualities that may be demonstrated by a showing of strongly interdependent economic interests or the pooling of assets and revenues. See SEC v. R.G. Reynolds Enters., Inc., 952 F.2d 1125, 1130(9th Cir.1991); Brodt v. Bache & Co., Inc., 595 F.2d 459, 460 (9th Cir.1978). In this case, the FTC presented evidence of both. The undisputed evidence is that Castro's companies pooled resources, staff, and funds; they were all owned and managed by Castro and his wife; and they all participated to some extent in a common venture to sell internet kiosks. [13] Thus, all of the companies were beneficiaries of and participants in a shared business scheme, and the common revenue generated in the course of that scheme was the proper subject of the court's equitable powers under the FTC Act. The remedy of constructive trust was appropriate here despite the fact that the res of that trust encompassed funds that had been commingled among several participants in the same unlawful enterprise. The FTC presented substantial evidence that traced the custodial account funds to Appellants' statutory violations, and the district court did not err when it fashioned equitable relief based on this evidence.
Appellants also invoke the bona fide purchaser rule and contend that Benice is entitled to his full fee because he accepted the ill-gotten money in good faith and after a diligent review of the circumstances. (Appellant's Br. at 35.) The district court properly concluded, however, that Appellants had failed to establish that Benice acted with good faith and without notice, that is, he did not discharge his duty of inquiry. An attorney is an officer of the court who, by virtue of his or her professional position, undertakes certain special duties ... to avoid conduct that undermines the integrity of the adjudicative process. ABA MODEL RULES, Rule 3.3, Cmt. 2. These special duties apply with full force to the manner by which an attorney may collect his or her fee. See Commodity Futures Trading Comm'n v. Co Petro Marketing Group, 700 F.2d 1279, 1285 (9th Cir.1983) (As an officer of the court, [attorney] was under a duty to inquire as to the exact terms of the district court's decision before depositing[his fee] check [in violation of a contemporaneous injunction].) For example, it is well established that funds derived from criminal activity and used to pay attorneys' fees may be subject to forfeiture, even in the attorney's hands. In re Moffitt, Zwerling & Kemler, P.C., 846 F.Supp. 463, 474 (E.D.Va.1994), aff'd United States v. Moffitt, Zwerling & Kemler, P.C., 83 F.3d 660, 665 (4th Cir.1996); see also In re Bell & Beckwith, 838 F.2d 844 (6th Cir.1988) (attorney not entitled to bona fide purchaser status where the circumstances surrounding the payment of his fees were sufficient to place him on notice that client's funds were obtained by fraud). Extending this rationale to fees paid with the proceeds of unlawful business practices under the FTC Act, the Fifth Circuit stated: [T]here is a clear principle that an attorney is not permitted to be willfully ignorant of how his representation is funded.... [W]hen taken together, [the legal authorities] teach that when an attorney is objectively on notice that his fees may derive from a pool of frozen assets, he has a duty to make a good faith inquiry into the source of those fees. Failure to make such an inquiry in the face of this duty will result in disgorgement of the funds. Assail, 410 F.3d at 265. The clear principle recognized in Assail and Bell & Beckwith is applicable here: an attorney is not permitted to be willfully ignorant of how his fees are paid. Though the funds in this case were not yet subject to an asset freeze at the time of the fee arrangement, the record clearly demonstrates sufficient facts to trigger Benice's duty of inquiry as to the source of the funds. See Assail, 410 F.3d at 266; Bell & Beckwith, 838 F.2d at 849-50. At the time that Castro and Benice entered into the flat fee arrangement, Appellants and their previous counsel had been engaged for months in protracted negotiations with the FTC. The FTC had provided Castro with a draft complaint alleging violations of the FTC Act and the Franchise Rule, and Castro had provided the FTC with sworn financial statements, revealing that almost all of his liquid assets were housed in the custodial accounts from which Benice was ultimately paid. Benice himself admits that he understood[Appellants] were in a dispute with the FTC and that the FTC could eventually take action against them. In oral argument before this court, Benice went even further, acknowledging that he was aware of the draft complaint and stating that his co-counsel Marc Forsythe had discussed the status of the FTC negotiations with Peter Spivack. I knew exactly the status [of Appellants' negotiations with the FTC], Benice told this court. Benice, however, never spoke personally with Spivack. Nevertheless, Benice claims that he independently concluded that the money used to pay his fee came not from the alleged violations of the FTC Act but from Castro's legitimate business activities. Benice admits that his independent conclusions were based primarily on information provided by Castro himself. Thus, on the one hand, Benice claims to have satisfied his professional obligations by undertaking an inquiry as to the source of the funds. On the other, however, he asserts that he learned of no circumstances in the course of his inquiry that were sufficient to place him on notice that his fees were potentially derived from the alleged unlawful practices. The evidence satisfies us that an objectively reasonable and diligent inquiry would have revealed that Appellants' assets were potentially tainted by their participation in the kiosk scheme. See Assail, 410 F.3d at 266; Moffitt, 846 F.Supp. at 474-75. Benice claims to have relied on Castro's representations, but the draft complaint and other materials that Benice was aware of should have cast doubt on the reliability of Castro's statements. All of Castro's businesses were named in the draft complaint as participants in the unlawful scheme, and the millions of dollars generated in the course of that scheme were Appellants' primary alleged source of income. Benice also claims to have reviewed Appellants' financial documents, which would have confirmed not only that the kiosk scheme was the primary source of revenue for Castro's companies but also that the custodial accounts from which Benice was paid contained almost all of Castro's liquid assets. Castro had provided sworn statements to the FTC regarding the custodial account funds, and Benice knew or should have known that these funds were the subject of Castro's ongoing settlement negotiations with the FTC. A diligent review of the circumstances such as the one Benice claims to have undertakenwould also have revealed what claims were asserted against Appellants and which of Appellants' assets were likely subject to disgorgement if the FTC prevailed on those claims. In light of the FTC's allegations that the custodial funds were derived from a fraudulent scheme, Benice could not sufficiently discharge his duty of inquiry merely by relying on the contrary representations of his client. See Assail, 410 F.3d at 266(Once on notice, [attorney] needed to do far more than simply take his client at his word that the fees were not tainted.... Trusting [his client's] truthfulness unconditionally was especially unreasonable considering that he was accused of fraud, an allegation going directly to his honesty.). Benice's acceptance of a nonrefundable $375,000 flat fee under such circumstances unwittingly provided Castro with a vehicle to transfer a substantial portion of his assets seemingly out of the FTC's reach. Just eight days after secretly emptying the custodial accounts, Castro made a $375,000 cash payment to Benice. That Castro failed to disclose the withdrawal of the custodial account funds to the FTC supports the inference that Castro was deliberately attempting to insulate or conceal his assets in advance of an asset freeze. Even if Benice notified the district court and the FTC of the terms of his retainer agreement, and did not knowingly act to facilitate Castro's attempted obfuscation, we cannot conclude that Benice's acceptance of such a payment was in good faith and without notice. In sum, we conclude that although Appellants' assets were not yet frozen when Benice accepted his fee, Benice received sufficient notice to trigger a duty to make a good faith inquiry into the source of th[e] fee[]. Assail, 410 F.3d at 265. Benice failed to discharge this duty because he relied primarily on Castro's representations and did not discuss the source of his fees with Appellants' former counsel. Considering the totality of the circumstances, Benice's inquiry was not objectively reasonable. The district court's conclusions that Benice was not a bona fide purchaser and did not discharge his duty of inquiry were well supported, and its order imposing a constructive trust was neither an abuse of discretion nor legally erroneous.
The district court did not entirely divest Benice of his fees in this case. Instead, the court permitted Benice to retain, in equity, his reasonable fees for work done before Appellants' assets were frozen. In a three-sentence paragraph at the close of their brief, Appellants assert that the district court erred when calculating the fees granted to Benice. The court based its calculation on a $300 hourly rate, rather than the $450 hourly rate that Benice had initially requested. Without elaborating, Appellants claim that the district court's refusal to accept the $450 hourly rate was unsupported. (Appellant's Br. at 50.) Appellants' unsupported assertion does not satisfy us that the district court erred. See Camacho v. Bridgeport Financial, Inc., 523 F.3d 973, 980 (9th Cir.2008) (fee applicant bears the burden of producing evidence to support requested rates). On this record, we hold the court did not abuse its discretion in granting Benice a limited fee recovery of $136,700.