Court Opinion

ID: 64097
Source: CourtListenerOpinion
Date Created: 2010-04-26 05:08:30+00
Date Added: 2024-06-11T13:04:59.584502
License: Public Domain

IN THE UNITED STATES COURT OF APPEALS
                     FOR THE FIFTH CIRCUIT  United States Court of Appeals
                                                     Fifth Circuit

                                                                            FILED
                                                                          August 18, 2008

                                             No. 07-50803             Charles R. Fulbruge III
                                                                              Clerk

In The Matter Of: N A FLASH FOUNDATION INC

                                                     Debtor
--------------------------------------------------

TRUSTEE JOHN PATRICK LOWE

                                                     Appellant
v.

PALMETCO INC

                                                     Appellee

                      Appeal from the United States District Court
                           for the Western District of Texas
                                USDC No. 5:05-CV-814

Before PRADO, ELROD, and HAYNES, Circuit Judges.
PRADO, Circuit Judge:*
        In this appeal, we are called upon to decide whether Texas law concerning
construction trust funds and materialman’s liens prevents a bankruptcy trustee
from avoiding three prepetition transfers of funds as preferential transfers under

        *
         Pursuant to 5TH CIR. R. 47.5, the court has determined that this opinion should not
be published and is not precedent except under the limited circumstances set forth in 5TH CIR.
R. 47.5.4.
                                  No. 07-50803

11 U.S.C. § 547(b). Because the creditor in this case would have received the
same amount in a hypothetical Chapter 7 proceeding as a result of Texas
construction trust fund law as it did in the allegedly preferential transfers, we
affirm the district court’s decision to refuse to avoid the transfers. Consequently,
we need not decide whether an alternative analysis based on materialman’s liens
would reach the same result.
            I. FACTUAL AND PROCEDURAL BACKGROUND
      This case arises out of the bankruptcy proceedings of Debtor N.A. Flash
Foundation, Inc. (“NA Flash”). NA Flash is a contractor who works directly with
property owners to make concrete foundations for houses. Appellee Palmetco,
Inc. (“Palmetco”) is a supplier of re-enforcing steel, which is used by builders in
the foundations of buildings. Palmetco was a subcontractor on many of NA
Flash’s projects.
      In October 2003, NA Flash made three transfers of money to Palmetco in
payment of debts that NA Flash owed: $5,710.50 on October 3, 2003; $10,000.00
on October 6, 2003; and $24,100.00 on October 20, 2003. The payments totaled
$39,810.50. The first two transfers were made by cashier’s checks drawn on NA
Flash’s general operating account, and the third transfer was made when NA
Flash endorsed a check from Paradise Homes over to Palmetco. Upon receipt of
these checks, Palmetco released its materialman’s liens on various properties
and refrained from filing materialman’s liens on other properties.
      On December 29, 2003, NA Flash filed for Chapter 7 bankruptcy. NA
Flash’s bankruptcy trustee, Appellant John Patrick Lowe (“the Trustee”), filed
the instant adversary proceeding against Palmetco in an attempt to recover the
three transfers described above. The Trustee alleged that he could avoid the
transfers because they were preferential transfers under 11 U.S.C. § 547(b),
which provides as follows:

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                                   No. 07-50803

      (b) Except as provided in subsections (c) and (i) of this section, the
      trustee may avoid any transfer of an interest of the debtor in
      property--
            (1) to or for the benefit of a creditor;
            (2) for or on account of an antecedent debt owed by the debtor
            before such transfer was made;
            (3) made while the debtor was insolvent;
            (4) made--
                    (A) on or within 90 days before the date of the filing of
                    the petition; or
                    (B) between ninety days and one year before the date of
                    the filing of the petition, if such creditor at the time of
                    such transfer was an insider; and
            (5) that enables such creditor to receive more than such
            creditor would receive if--
                    (A) the case were a case under chapter 7 of this title;
                    (B) the transfer had not been made; and
                    (C) such creditor received payment of such debt to the
                    extent provided by the provisions of this title.
The parties stipulated to subsections (1), (2), (3), and (4)—specifically, that the
transfers were (1) made for the benefit of Palmetco, (2) on account of an
antecedent debt, (3) while NA Flash was insolvent, and (4) within ninety days
of NA Flash’s Chapter 7 petition. The parties could not agree on whether the
transfers were “of an interest of the debtor [NA Flash] in property” and whether
the transfers enabled Palmetco to receive more than it would have received if the
transfers had not been made, the case had been filed under Chapter 7, and
Palmetco had received payment in accordance with the eventual distribution
(subsection (5)).
      The bankruptcy court held a short hearing on May 24, 2005, and heard
testimony from the Trustee, the president of Palmetco, and Palmetco’s attorney.
The testimony indicated that, because of the transfers, Palmetco received 100%

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                                 No. 07-50803

of what it was owed, while the unsecured creditors were going to receive five
cents on the dollar. Palmetco defended the transfers under Texas law regarding
materialman’s liens and construction trust funds. Palmetco’s president testified
that it was Palmetco’s usual practice to follow all of the requirements for
perfecting a materialman’s lien under Texas law whenever NA Flash was late
on its payments. Palmetco’s president also testified that Palmetco was typically
able to recover 100% of the money that it was owed whenever it used the lien
procedures. The bankruptcy court then took the matter under advisement. On
June 28, 2005, the bankruptcy court issued its decision orally and made several
findings of fact, ultimately deciding that the Trustee had failed to demonstrate
a preferential transfer because Palmetco would have received the same amount
in a bankruptcy proceeding through either a materialman’s lien or a construction
trust fund.
      The Trustee appealed to the district court for the Western District of
Texas. The district court held that Palmetco would have received the same
amount of money under a construction trust fund theory, but not under a
materialman’s lien theory. Although the district court styled its order as
affirming in part, reversing in part, and remanding, the order was essentially
an affirmance as it left the bankruptcy court’s judgment intact. The Trustee has
appealed to this court.
              II. JURISDICTION AND STANDARD OF REVIEW
      When a district court remands a case to the bankruptcy court for further
proceedings, this court makes a two-prong inquiry to determine whether it may
exercise appellate jurisdiction over the district court’s decision. Andrews &
Kurth, L.L.P. v. Family Snacks, Inc. (In re Pro-Snax Distribs., Inc.), 157 F.3d
414, 420 (5th Cir. 1998). First, we decide whether the order of the bankruptcy
court was final in character, and second, we decide whether the district court’s
remand requires extensive further proceedings. Id. Here, the answers to those

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                                  No. 07-50803

questions clearly demonstrate that appellate jurisdiction exists. The bankruptcy
court’s order was a final order—it resolved all of the issues between the parties,
determined that the Trustee would take nothing, and assigned costs against the
Trustee. The district court’s order, although indicating a remand, left nothing
for the bankruptcy court to do, as the district court did not alter the bankruptcy
court’s judgment. Therefore, in light of the finality of the bankruptcy court’s
order and the lack of a need for any further proceedings, we may exercise
jurisdiction over the Trustee’s appeal.
      We review the decision of the district court by applying the same standard
to the bankruptcy court’s findings of fact and conclusions of law as the district
court applied. Plunk v. Yaquinto (In re Plunk), 481 F.3d 302, 305 (5th Cir. 2007).
A bankruptcy court’s findings of fact are reviewed for clear error, while its
conclusions of law are reviewed de novo. Id. This court may affirm on any
grounds supported by the record, even if those grounds were not relied upon by
the lower courts. Id.
                              III. DISCUSSION
      The question raised by the Trustee on appeal is whether the bankruptcy
court and district court erred in concluding that Palmetco would have received
the same amount in a Chapter 7 proceeding as it did in the allegedly preferential
transfers. Pursuant to 11 U.S.C. § 547(g), the Trustee generally has the burden
of proving the elements of a preferential transfer. See Jenkins v. Chase Home
Mortgage Corp. (In re Maple Mortgage, Inc.), 81 F.3d 592, 596 (5th Cir. 1996).
Thus, the Trustee must establish that, in a hypothetical Chapter 7 proceeding,
Palmetco would not have received as much as it did from the allegedly
preferential transfers.   In this case, the Trustee’s evidence consisted of
demonstrating that NA Flash made the transfers to Palmetco out of NA Flash’s
general operating account, enabling Palmetco to recover 100% of what it was
owed, while NA Flash’s unsecured creditors received approximately five cents

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                                  No. 07-50803

on the dollar.   As noted above, Palmetco relied on Texas law concerning
materialman’s liens and construction trust funds to argue that it would have
received 100% of what it was owed regardless of any preferential transfer. We
now consider what effect Texas construction law has on the outcome of this case.
A.    Preferential Transfers
      As described in § 547(b)(5), for a transfer to be preferential, the creditor
must receive more from the transfer than it would have received if the case had
proceeded under Chapter 7, the transfer had not been made, and the creditor
had received payment of its debt to the extent provided under the bankruptcy
laws. This analysis requires the court to construct a hypothetical Chapter 7
liquidation and determine what the creditor would have received had the
transfers not taken place. Cunningham v. T & R Demolition, Inc. (In re ML &
Assocs., Inc.), 301 B.R. 195, 202 (Bankr. N.D. Tex. 2003). If the creditor receives
a greater percentage of its debt as a result of the prepetition transfer than it
would have in a bankruptcy distribution, the transfer is preferential. See
Krafsur v. Scurlock Permian Corp. (In re El Paso Refinery, L.P.), 171 F.3d 249,
253-54 (5th Cir. 1999). In constructing a hypothetical Chapter 7 case, we are to
assume that all persons would act in a commercially reasonable and businesslike
manner. In re ML & Assocs., 301 B.R. at 202.
      Further, the alleged preferential transfer must not diminish or deplete the
debtor’s estate. Lovett v. Homrich, Inc. (In re Philip Servs. Corp.), 359 B.R. 616,
630 (Bankr. S.D. Tex. 2006); see also Cage v. Wyo-Ben, Inc. (In re Ramba, Inc.),
437 F.3d 457, 460 (5th Cir. 2006) (“Essentially, a voidable preference must have
depleted the estate.”). This is because the preferential transfer statute was
designed, in part, “to prevent a transfer to one creditor that would diminish the
estate of the debtor that otherwise would be available for distribution to all.”
Triad Int’l Maint. Corp. v. S. Air Transp., Inc. (In re S. Air Transp., Inc.), 511
F.3d 526, 530 (6th Cir. 2007) (internal quotation marks omitted). Thus, as the

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                                  No. 07-50803

Fourth Circuit stated, the relevant inquiry focuses “not on whether a creditor
may have recovered all of the monies owed by the debtor from any source
whatsoever,” but instead on whether the creditor would have recovered 100% of
the debt from the debtor’s estate. Smith v. Creative Fin. Mgmt., Inc. (In re
Virginia-Carolina Fin. Corp.), 954 F.2d 193, 199 (4th Cir. 1992). Here, Palmetco
argues that Texas law concerning materialman’s liens and construction trust
funds would result in Palmetco recovering 100% of what it was owed without
depleting NA Flash’s estate. We turn first to construction trust funds, as that
is the theory relied on by the district court.
B.    Construction Trust Funds
      Texas law concerning construction trust funds is found in Chapter 162 of
the Texas Property Code. Pursuant to § 162.001(a), “Construction payments are
trust funds under this chapter if the payments are made to a contractor . . .
under a construction contract for the improvement of specific real property in
this state.” “A contractor . . . who receives trust funds or who has control or
direction of trust funds, is a trustee of the trust funds.” Id. § 162.002. A
subcontractor who furnishes labor or material for an improvement on a specific
piece of real property is a beneficiary of any trust funds paid or received in
connection with the improvement. Id. § 162.003. Subsequent provisions of
Chapter 162 make it a Class A misdemeanor for a trustee to misapply trust
funds. Id. § 162.032. The construction trust fund is self-executing—in other
words, there are no procedures with which a subcontractor must comply before
the contractor is obligated to hold the funds in trust. See Exchanger Contractors,
Inc. v. Comerica Bank-Tex. (In re Waterpoint Int’l L.L.C.), 330 F.3d 339, 345 (5th
Cir. 2003) (noting that funds are required to be held in trust under Chapter 162
without regard to the subcontractor’s compliance with any lien procedures).
      Both the bankruptcy court and the district court used the construction
trust fund concept to conclude that Palmetco would have received the same

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                                        No. 07-50803

amount in a hypothetical Chapter 7 proceeding as it did from the allegedly
preferential transfers. In a hypothetical case, NA Flash would be required to
hold the amounts received from property owners in trust for its subcontractors
on those projects, including Palmetco, or face criminal liability for misuse of
trust funds. TEX. PROP. CODE ANN. §§ 162.001(a), 162.032. Therefore, in the
hypothetical bankruptcy proceeding, where the court is to presume everyone will
act reasonably, NA Flash would have held any payments it received on Palmetco
projects between October 2003 (when the transfers hypothetically never took
place) and December 29, 2003 (the date of the bankruptcy), in trust for Palmetco;
otherwise, NA Flash would have faced criminal liability. The trust funds would
have given Palmetco a priority claim to the funds in the subsequent bankruptcy
proceeding. See Southmark Corp. v. Grosz (In re Southmark Corp.), 49 F.3d
1111, 1118 (5th Cir. 1995) (noting that money in a constructive trust gives the
claimant priority over the debtor’s unsecured creditors); see also Begier v. I.R.S.,
496 U.S. 53, 59 (1990) (stating that money held in trust for another is not
property of the debtor for purposes of § 547(b)). Consequently, in a hypothetical
proceeding, Palmetco would have received 100% of the money it was owed, and
NA Flash’s estate would not be depleted of any money that would have otherwise
been available to the unsecured creditors.1
       The Trustee’s only argument in response is that Palmetco conceded that
it could not prove a construction trust fund theory and that the district court
refused to make a finding on whether a construction trust fund theory would
apply in this case. The Trustee errs, though, by conflating two areas in which
construction trust funds and preferential transfers intersect. As described

       1
         The Trustee did not set forth any evidence to dispute Palmetco’s claim that NA Flash
would have received at least $39,810.50 in payments subject to a constructive trust fund
during the relevant time period. It was the Trustee’s burden to demonstrate that a 100%
recovery was not possible; thus, his failure to present any evidence on this issue is fatal to his
claim.

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                                         No. 07-50803

above, construction trust funds can be used in a hypothetical Chapter 7
proceeding to demonstrate that Palmetco would have received the same amount
in a bankruptcy case as it did from the allegedly preferential transfers. This is
the theory argued by Palmetco and relied upon by the district court.
      A separate argument concerning construction trust funds is whether the
funds that were actually transferred in October 2003 were “of an interest of the
debtor in property.” See 11 U.S.C. § 547(b). The idea behind this second theory
is that, to the extent NA Flash transferred trust funds in October 2003, it did not
transfer any interest it had in property, as NA Flash would have no interest in
funds held in trust for another. See Begier, 496 U.S. at 58 (“The reach of
§ 547(b)’s avoidance power is therefore limited to transfers of ‘property of the
debtor.’”); Vulcan Materials Co. v. Jack Raus, Inc. (In re HLW Enters. of Tex.,
Inc.), 157 B.R. 592, 596-98 (Bankr. W.D. Tex. 1993) (holding that transferred
funds were trust funds under Chapter 162 and therefore not the property of the
debtor). It is this second theory—that the funds actually transferred to Palmetco
were construction trust funds—that Palmetco conceded and the district court
declined to consider, primarily because Palmetco could not prove that the specific
funds transferred were funds that NA Flash had been holding in trust for
Palmetco.2
      Consequently, Palmetco’s concession that it could not refute the Trustee’s
evidence that the $39,810.50 transferred to Palmetco was NA Flash’s property

      2
          Specifically, the exchange before the district court was as follows:
      Mr. Lowe [Trustee]: Your Honor, is the Court finding that, in each of the three
      transfers, there was a transfer of the interest of the Debtor in property?
      The Court: I’m avoiding that issue. You can take that up on appeal. If it goes
      up on appeal, you can argue the trust fund theory. So, I’m not making a finding
      on the trust fund theory.
Similarly, when Palmetco conceded that it could not make out the requirements of the trust
fund theory, it was referring to its inability to trace the transferred funds to a specific
project—a requirement of the second type of trust fund theory.

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                                 No. 07-50803

has no effect on Palmetco’s other construction trust fund argument regarding the
hypothetical Chapter 7 proceeding. As described above, because the law of
construction trust funds would provide Palmetco with a full recovery in a
hypothetical Chapter 7 proceeding, the Trustee has failed to demonstrate that
the transfers at issue were preferential under § 547(b). As a result, we affirm
the judgment of the district court and need not consider whether an analysis of
the law regarding materialman’s liens would lead to the same conclusion.
                             IV. CONCLUSION
      For the foregoing reasons, we AFFIRM the judgment of the district court
and decline to avoid the transfers to Palmetco.
      AFFIRMED.

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