Court Opinion

ID: 3034017
Source: CourtListenerOpinion
Date Created: 2015-10-13 22:50:24.337718+00
Date Added: 2024-06-11T09:33:02.882772
License: Public Domain

United States Bankruptcy Appellate Panel
                            FOR THE EIGHTH CIRCUIT

                                    _______________

                                    No. 03-6081MN
                                   ________________

In re:                                      *
                                            *
Graphics Technology, Inc.,                  *
                                            *
         Debtor.                            *
                                            *
                                            *
James E. Ramette, Trustee                   *
                                            *     Appeal from the United States
         Plaintiff - Appellee,              *     Bankruptcy Court for the
                                            *     District of Minnesota
               v.                           *
                                            *
Digital River, Inc.                         *
                                            *
         Defendant - Appellant.             *

                                          _____

                                 Submitted: March 2, 2004
                                  Filed: March 18, 2004
                                          _____

Before FEDERMAN, MAHONEY, and VENTERS, Bankruptcy Judges.
                            _____

VENTERS, Bankruptcy Judge.
       This is an appeal from an order of the bankruptcy court1 holding that Digital
River, Inc. (“Digital River”) was liable to James E. Ramette, the Chapter 7 trustee
(“Trustee”), for $97,514.44 in preferential transfers made to it by Graphic
Technologies, Inc. (“Debtor”). The fundamental issues on appeal are whether the
funds paid to Digital River in the ninety days preceding the Debtor’s bankruptcy
filing belonged to the Debtor or to Digital River and, if the funds belonged to the
Debtor, whether a constructive trust should be imposed in favor of Digital River. For
the reasons stated below, we affirm the order of the bankruptcy court.

                          I. STANDARD OF REVIEW

       “Findings of fact, whether based on oral or documentary evidence, shall not be
set aside unless clearly erroneous, and due regard shall be given to the opportunity
of the bankruptcy court to judge the credibility of the witnesses.” Fed. R. Bankr. P.
8013. Findings of fact are reviewed for clear error, and legal conclusions are
reviewed de novo. Blackwell v. Lurie (In re Popkin & Stern), 223 F.3d 764, 765 (8th
Cir. 2000); Official Committee of Unsecured Creditors v. Farmland Industries, Inc.,
296 B.R. 188, 192 (B.A.P. 8th Cir. 2003). Matters committed to the bankruptcy
court’s discretion will be reversed only if the court has abused its discretion. C.T.
Development Corp. v. Barnes (In re Oxford Development, Ltd.), 67 F.3d 683, 685 (8th
Cir. 1995); City of Sioux City, Iowa v. Midland Marina, Inc. (In re Midland Marina,
Inc.), 259 B.R. 683, 686 (B.A.P. 8th Cir. 2001).

                               II. BACKGROUND

      Tech Squared, Inc. (“Tech Squared”) entered into a credit card processing
agreement with Paymentech Co. (“Paymentech”) prior to 1999. That agreement

      1
          The Honorable Nancy C. Dreher, United States Bankruptcy Court for the
District of Minnesota.
                                         2
provided that Paymentech would hold a portion (3%-5%) of each credit card sale in
reserve for six months to cover chargebacks. After six months, Paymentech would
disburse the funds to Tech Squared. Eventually, Digital River, a sister company to
Tech Squared, was informally added to the same merchant account.2 Digital River
and Tech Squared – apparently without the involvement or approval of Paymentech
– worked out an arrangement whereby all of their credit card sales would be
processed through the Paymentech account and Tech Squared, upon receipt of the
reserve funds each month, would apportion to Digital River the portion of the reserve
account disbursements related to Digital River’s credit card sales. At all times,
however, the name of the account holder was Tech Squared, and at no time was
Digital River a party to the credit card processing agreement with Paymentech.

      On December 10, 1999, the Debtor formed T2Acquisition Corporation and
acquired all the assets of Tech Squared. As part of the asset sale and purchase
agreement, the Debtor assumed Tech Squared’s credit card processing agreement with
Paymentech; thus, the Debtor acquired and maintained sole control over the right to
receive disbursements from the reserve account.3 Not wanting to share a credit card
processing account with the Debtor, Digital River subsequently entered into a
separate agreement with Paymentech in January 2000. In the six months preceding
January 2000, several hundred thousand dollars was held by Paymentech in the
reserve account with respect to Digital River’s credit card sales. This money was
duly disbursed by Paymentech to the Debtor under the prior agreement – not to
Digital River. The disbursed funds actually were placed in the Debtor’s deposit

      2
        Digital River provides web-hosting services to vendors that sell products
over the internet. Both Tech Squared and Digital River were operated by the same
chief executive officer, and Tech Squared had an ownership interest in Digital
River.
      3
       At the time of the acquisition, the Debtor knew from an examination of its
books that $25,000.00 of the reserve account belonged to Digital River. This
amount was duly paid to Digital River.
                                         3
account, and the Debtor’s secured lender swept – daily – all the money deposited
therein and applied that money to the Debtor’s loan balance. The Debtor then
borrowed money from the lender to pay for its business operations.

       In June 2000, Digital River notified the Debtor that approximately $660,000.00
that had been withheld by Paymentech in the reserve account and subsequently
disbursed to the Debtor rightfully belonged to Digital River. The Debtor
acknowledged that some of the funds belonged to Digital River, and also
acknowledged that it had used the funds for its own operations. Because the Debtor
lacked the money to make immediate payment, the parties entered into an agreement
on or about June 30, 2000, for repayment of the amount owed. (Appellant’s App. A-
62). The agreement provided for numerous methods of reimbursement, including,
inter alia, an immediate payment of $25,000.00; transmittal by Paymentech to
Digital River of the Debtor’s reserve rebates for July, August, and September of
2000; and weekly payments of $25,000.00. After the Debtor filed bankruptcy on
December 20, 2000, the Trustee sought to avoid $97,514.44 in payments that had
been made to Digital River from the Debtor’s reserve rebates pursuant to this
agreement within the ninety days preceding the filing of the Debtor’s bankruptcy
petition.

                                   III. DISCUSSION

      The parties stipulated that payments made during the preference period totaling
$97,514.44 met all but one of the statutory requirements to make them avoidable
preferential transfers under 11 U.S.C. § 547.4 The dispute in this case concerns

      4
          That section provides:

      [T]he trustee may avoid any transfer of an interest of the debtor in
      property--
            (1) to or for the benefit of a creditor;
                                          4
whether the funds in the reserve account were the property of the Debtor, and if so,
then whether a constructive trust should be imposed on the funds for the benefit of
Digital River.

A. Legal Title to Digital River’s Funds in the Reserve Account

        As an initial matter, we agree with Digital River that the Debtor never obtained
legal title to the funds deposited in Paymentech’s reserve account that were generated
by Digital River’s credit card sales.

       As defined by statute, property of the estate includes “all legal or equitable
interests of the debtor in property as of the commencement of the case.” 11 U.S.C.
§ 541(a)(1). Thus, before the Trustee may recover preference payments made by the
Debtor to Digital River, the property transferred must have belonged to the Debtor
in the first instance, because to the extent an interest in property is limited in the

             (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.

11 U.S.C. § 547(b).
                                           5
Debtor, it is equally limited in the hands of the estate. In fact, this well-settled maxim
is codified in Section 541 of the Bankruptcy Code:

      (d) Property in which the debtor holds, as of the commencement of the
      case, only legal title and not an equitable interest ... becomes property
      of the estate under subsection (a)(1) or (2) of this section only to the
      extent of the debtor's legal title to such property, but not to the extent of
      any equitable interest in such property that the debtor does not hold.

11 U.S.C. § 541(d).

       Logically, property in which the Debtor has no interest would never become
property of the bankruptcy estate. In this case no evidence exists showing that Digital
River ever intended to transfer ownership to the Debtor of the money held in reserve
from its credit card transactions. The mere fact that the Debtor had exclusive control
of the reserve account disbursements does not equate to ownership of all items in that
account. It is axiomatic that a mere possessor of the property of another, without
more, cannot obtain legal title. In the absence of any title in the Debtor, Digital
River’s money – to the extent that it might have existed on the Debtor’s petition date
– never became part of the bankruptcy estate.

B. Tracing

      Despite the fact that the Debtor never had legal title to Digital River’s funds
disbursed from the credit card processing reserve account, the evidence plainly
supports the bankruptcy court’s conclusion that the $97,514.44 in preference period
payments belonged to the Debtor before those payments were made to Digital River.

      To reclaim money or property from a bankruptcy estate on the basis that the
property belongs to the reclaiming party and not to the debtor, the reclaiming party

                                            6
must be able to definitively trace its property. Fore Way Express, Inc. v. Mid-
American Airlines, Inc. (In re Mid-American Lines, Inc.), 24 B.R. 52, 53 (Bankr.
W.D. Mo. 1982). Even when property is commingled, that property must be
positively identified, or else the reclaiming party is relegated to the status of a general
unsecured creditor, regardless of the equities. Id. The manner in which the debtor
or the estate came into possession of the property is irrelevant.5 See 5 Collier on
Bankruptcy ¶ 541.11[3], p. 541-66 (Lawrence P. King et al. eds., 15th rev. ed.
Matthew Bender 2003) (stating that even for property acquired by wrongdoing, the
creditor must be able to trace its property into the estate). Under Minnesota
jurisprudence, tracing of commingled funds is accomplished as follows:

      The trust fund may be recovered back even if it does not so appear that
      the identical money of the trust fund is in the mixture, if it appears that,
      since the confusion of the funds there has always remained on hand a
      balance of the mixture equal to the amount of the trust fund which
      originally entered into the mixture. But, if at any time the balance has
      been reduced to a less amount, then the cestui que trust may recover out
      of the mixture an amount equal to the smallest balance which has
      remained on hand since the moneys were confused. This rule is based on
      the presumption that the trustee drew first his own money out of the
      indistinguishable mass, leaving the trust funds in the balance on hand.

Bishop v. Mahoney, 73 N.W. 6, 6 (Minn. 1897). See also Empire States Surety Co.
v. Carroll County, 194 F. 593, 604-05 (8th Cir. 1912) (stating that the legal
presumption is that the holder of commingled funds regarded the law and did not pay
out the property belonging to the other, but kept it sacred); Nash v. Nash, 388 N.W.2d
777, 781 (Minn. App. 1986) (stating that a party is not required to produce the serial
numbers on a bill).

      5
       Counsel for Digital River stated in oral argument that the Debtor had
converted or even stolen the money belonging to Digital River in the reserve
account. However, counsel was unable to point to any evidence in the record of
criminal or other unlawful activity.
                                            7
       Under the rule in Bishop, Digital River can trace into the reserve fund monies
disbursed by Paymentech up to the lowest intermediate balance of the reserve
account. Unfortunately for Digital River, however, John Harvatine, the Debtor’s
Chief Financial Officer, testified that after Paymentech disbursed six-month-old
money from the reserve account to the Debtor’s bank account, the Debtor’s secured
lender swept out that cash on a daily basis.6 Because the last credit card transaction
that Digital River processed through Tech Squared’s agreement with Paymentech
occurred no later than the end of January 2000, the last disbursement by Paymentech
from the reserve account that included Digital River’s funds would have occurred no
later than August 2000. Accordingly, by September 2000 – the beginning of the
preference period – the Debtor had spent all of Digital River’s money and none of the
funds disbursed by Paymentech would have been related to Digital River’s credit card
transactions. All the money held in the reserve account during the preference period
rightfully belonged to the Debtor. Therefore, we must affirm the finding by the
bankruptcy court that $97,514.44 in preference period payments constituted the
property of the Debtor.

      6
         At oral argument, Digital River attempted to introduce an exhibit showing
that in April 2000 Paymentech’s credit card reserve account held $381,988.00 in
Digital River’s funds. Apart from having very little probative value concerning
ownership of the money paid from the Debtor to Digital River in the ninety days
before the Debtor’s bankruptcy in December 2000, the exhibit was not shared with
opposing counsel. We will not consider exhibits or evidence introduced for the
first time on appeal – especially when that exhibit has not been shared with
opposing counsel. See Huelsman v. Civic Ctr. Corp., 873 F.2d 1171, 1175 (8th
Cir. 1989) ("An appellate court can properly consider only the record and facts
before the [trial court] and thus only those papers and exhibits filed in the [trial
court] can constitute the record on appeal.").
                                          8
C. Constructive Trust

      Finally, there is no basis in this case to impose a constructive trust on the
preference period payments in favor of Digital River.

        A constructive trust requires, at a minimum, a finding that one party holds legal
title to property that was obtained in the commission of some wrong such that the
person with legal title must, in equity, return the property to its rightful owner.
Black’s Law Dictionary 314-15 (6th ed. rev. 1990). Although there is no “unyielding
formula” under Minnesota law necessary to create a constructive trust, and a court of
equity may do so wherever unjust enrichment would otherwise result, Iverson v.
Fjoslien, 213 N.W.2d 617, 628-29 (Minn. 1973), no constructive trust may be
imposed in this case because, as noted supra, the Debtor never held legal title to the
disputed property, and no trust res is clearly identified in the Debtor’s bankruptcy
estate.7

        Furthermore, even in the absence of legal title in the constructive trustee and
a trust res, the Debtor did not engage in any inequitable conduct sufficient to support
the imposition of a constructive trust.

       Under Minnesota law, a court may impose a constructive trust only when there
is clear and convincing evidence that a constructive trust is necessary to prevent

      7
        We note that a constructive bailment might be more apropos to the facts of
this case. See Dow-Arneson, Co. v. St. Paul, 253 N.W. 6, 8 (Minn. 1934) (citing
Wentworth v. Riggs, 143 N.Y.S. 955, 956 (N.Y. App. Div. 1913)). A debtor never
obtains legal title to property subject to a bailment. See, e.g., Norris v. Boston
Music Co., 151 N.W. 971, 973 (Minn. 1915) (“It has always been the law that a
bailor may pursue his property and reclaim it, even in the hands of a good faith
purchaser from or under the bailee, unless estopped by his own conduct from
causing loss to such purchaser.”). Even a constructive bailment, however, would
suffer from the lack of a clearly identified res in this case.
                                           9
unjust enrichment and whenever legal title to property is obtained through fraud,
oppression, duress, undue influence, force, crime, or similar means, or by taking
improper advantage of a confidential or fiduciary relationship. In re Estate of Eriksen,
337 N.W.2d 671, 674 (Minn. 1983) (citing Knox v. Knox, 25 N.W.2d 225, 228 (Minn.
1946)); Bly v. Gensmer, 386 N.W.2d 767, 769 (Minn. App. 1986). Unjust enrichment
occurs when a claim is based on the failure of consideration, fraud, mistake, and in
other situations where it would be morally wrong for one party to enrich himself at
the expense of another. Cady v. Bush, 166 N.W.2d 358, 361-362 (Minn. 1969). To
show unjust enrichment, however, more is required than a mere benefit to one party
– "it must be shown that a party was unjustly enriched in the sense that the term
unjustly could mean illegally or unlawfully." Schumacher v. Schumacher, 627
N.W.2d 725, 729 (Minn. App. 2001) (quoting First Nat'l Bank of St. Paul v. Ramier,
311 N.W.2d 502, 504 (Minn. 1981)).

       In this case, the Debtor never took affirmative action to wrongfully acquire
Digital River’s property; rather, the Debtor’s alleged misconduct was the failure to
affirmatively act under the circumstances. The Debtor knew when it acquired the
Paymentech credit card reserve account from Tech Squared that $25,000.00 in the
account belonged to Digital River and it duly tendered that amount. John Harvatine,
the Debtor’s Chief Financial Officer, testified that the Debtor did not know Digital
River was “hooked” onto its assumed agreement with Paymentech. In fact, when
confronted by Digital River, the Debtor agreed that it owed Digital River money and
the parties agreed on a method for repayment. These facts simply do not demonstrate
clear and convincing evidence that the Debtor obtained Digital River’s property
through fraud, oppression, duress, undue influence, force, crime, or similar means,
or by taking improper advantage of a confidential or fiduciary relationship. The
Debtor was not unjustly enriched in the sense that it acted unlawfully or illegally.
Furthermore, Digital River bears some responsibility in this case inasmuch as it
knowingly consented to having its funds distributed to an account over which it had
no control. Additionally, Digital River apparently failed to effectively communicate

                                          10
with the Debtor regarding its ownership of the commingled funds in the reserve
account from January to June 2000. Had Digital River contacted the Debtor before
June 2000, perhaps much, if not all, of the current litigation could have been avoided.

      Accordingly, we affirm the decision of the bankruptcy court.

                                          11