In re Automated Recovery Sys. of N.M.

1

In re: AUTOMATED RECOVERY SYSTEMS OF NEW MEXICO, INC., Debtor.

No. 22-10225-t11

United States Bankruptcy Court, D. New Mexico

April 12, 2023

OPINION

Hon David T. Thuma, United States Bankruptcy Judge

Before the Court is Debtor's motion to authorize the payment of attorney fees to its special counsel for work done prepetition. Debtor argues it is holding the fees in trust so the money is not property of the estate. A creditor objected, disputing that the funds are held in trust and asserting that special counsel is an unsecured creditor and not entitled to payment of its prepetition claim. After an evidentiary hearing, the Court finds and concludes that any collected attorney fees in Debtor's possession are held in trust, are not property of the bankruptcy estate, and should be turned over to special counsel.

A. Facts.^[1]

The Court finds:^[2]

Since August 2003, Patricia L. Simpson, P.C., d/b/a Simpson Law Office ("Simpson") has represented Debtor in state court collection actions. As compensation, Debtor paid Simpson a small monthly fee ($750), plus any amounts Debtor collected from attorneys' fees awarded by the court.^[3] On May 1, 2010, Debtor and Simpson entered into a written agreement memorializing their longstanding arrangement (the "Agreement"), which provides inter alia:

All Attorneys' Fees collected from defendants on judgments awarded to ARSNM, Inc. as plaintiff shall be retained by ARSNM, Inc. All attorney fees collected will be remitted to the Attorney by the tenth (10^th) day of the following month.

In determining whether any attorney fees were collected on a given judgment, the parties agreed that money collected would be applied first to principal, interest, and court costs, and only then to awarded attorney fees. The parties further agreed that Debtor would give Simpson periodic accountings of all amounts collected and how they were applied. Finally, the parties agreed that every month Debtor would remit the collected and retained fees to Simpson.

Other than the monthly $750, the fees Debtor collected were Simpson's only source of payment; Simpson did not have recourse against Debtor if no attorney fees were collected on a particular judgment. Only about half the awarded fees were ever paid to Debtor and remitted to Simpson.

Debtor filed this subchapter V case on March 23, 2022. On its schedules it listed "1500 Collection Judgments against multiple debtors." These were obtained by Simpson's efforts. Debtor stated that the face amount of the judgments was $10,000,000, with an unknown value.

Debtor's representative, Brian Myers, described the collected attorney fees as "her [i.e., Simpson's] funds" and testified at the § 341 meeting and the final hearing on the motion that Debtor would collect "any monies awarded to her [Simpson] by the Court," and remit them to Simpson once a month.

Mr. Myers testified that on the petition date, Debtor was holding attorney fees collected between March 1-23, 2022. He did not know the amount.^[4] Neither Debtor's bankruptcy schedules nor its Statement of Financial Affairs ("SOFA") disclose any money held in trust. Mr. Myers testified that he did not list the attorney fees as "property held for another"^[5] because it did not occur to him that the held attorney fees were "property" as that term is used in the SOFA.

In September 2022, Debtor applied to employ Simpson as special counsel. The Court granted the application in part on October 11, 2022, but reserved the issue of whether Debtor could pay Simpson the attorney fees collected on account of Simpson's prepetition work.

On May 23, 2022, Simpson filed a proof of claim for $24,291.97, which included amounts for fees Debtor collected in March and April 2023. Simpson amended her claim in June to include fees Debtor collected in May 2023.

Pending a Court ruling, Debtor has held all fees collected since the petition date. Postpetition, Debtor has continued to send Simpson monthly accountings of the fees collected.

On October 12, 2022, Debtor filed the motion now before the Court. By then, the attorney fees collected and held had grown to $69,973.14. Debtor asks for permission to pay the funds to Simpson under the theory that they are held in trust for Simpson.

Mitchell and Victoria Hawkes (together, the "Creditor") argues that the funds are not trust funds, that Simpson does not have a charging lien on the funds, and that there is insufficient evidence for the Court to determine the amount owed under the Agreement.

B. Funds Held in Trust are Not Property of the Estate.

Under § 541(a), all legal or equitable interests of a debtor in property on the petition date are property of the bankruptcy estate unless otherwise excepted. Section 541(d) provides the following exception:

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 … 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.

Such property is held "in trust" for the equitable benefit of another^[6] and is excluded from the bankruptcy estate. See, e.g., United States v. Whiting Pools, Inc., 462 U.S. 198, 205 n.10 (1983) (discussing § 541(d), the court held that "Congress plainly excluded property of others held by the debtor in trust at the time of the filing of the petition"); and Begier v. Internal Revenue Service, 496 U.S. 53, 59 (1990) ("Because the debtor does not own an equitable interest in property he holds in trust for another, that interest is not 'property of the estate.'").

C. New Mexico Law on Trusts.

State law determines whether property is held in trust. See, e.g., In re Akbari-Shahmirzadi, 2013 WL 3300056, at *4 (Bankr. D.N.M.), citing In re Kalinowski, 449 B.R. 797, 806 (Bankr. D.N.M. 2011), affirmed 482 B.R. 334 (10th Cir. BAP 2012) (state law dictates whether a trust relationship exists); In re White, 271 B.R. 213, *4 (10th Cir. BAP 2001) (unpublished) ("state law is important when determining whether a trust relationship exists").

Like other states, the principal types of trust recognized in New Mexico are express trusts, resulting trusts, constructive trusts, see, e.g., Aragon v. Rio Costilla Co-op. Livestock Ass'n, 112 N.M. 152, 154-56 (S.Ct. 1991), and statutory trusts, see N.M.S.A. § 46A-1-102 (New Mexico's Uniform Trust Code applies to, inter alia, "trusts created pursuant to a statute, judgment or decree that requires the trust to be administered in the manner of an express trust"). Debtor does not say what type of trust governs this dispute.

1. Express trust. In New Mexico, an express trust is created by "the direct and positive acts of the parties, by some writing or deed, or will, or by words either expressly or impliedly evincing a desire to create a trust." Ward v. Buchanan, 22 N.M. 267, 268 ( S.Ct. 1916); see also Tartaglia v. Hodges, 129 N.M. 497, 509 (Ct. App. 2000) ("An express trust is one that is created by the manifest intention of the settlor to create it."); In re Slade, 471 B.R. 626, 648 n.23 (Bankr. D. N.M. 2012) (citing Ward and Tartaglia). The trust arises as a "manifestation of the intention to create it," and "either written or spoken words, or conduct, will suffice, and no particular form of words or conduct is necessary." Rio Costilla Co-op, 112 N.M. at 154 (adopting Restatement (Second) of Trusts § 2 (1957)).

Tenth Circuit law is to the same effect. See, e.g., In re Sawaged, 2011 WL 880464, at *3 n.18 (10^th Cir. BAP) (citing Hore's v. Steele (In re Steele), 292 B.R. 422, 427 (Bankr. D. Colo. 2003)) ("Express trusts are those trust relationships which are intentionally entered into by the parties. An express trust may involve a formal declaration of trust or a situation where the intention of the parties to form a trust relationship may be inferred by the surrounding facts and circumstances."); Akbari-Shahmirzadi, 2013 WL 3300056, at *5 (citing Sawaged).

2. Resulting trust. A resulting trust is like an express trust in that both further the settlor's intention to create a trust:

A resulting trust arises when a person makes a disposition of property under circumstances which raise an inference that such person does not intend that the party taking or holding the property should also have the beneficial interest therein, and where the inference is not rebutted and the beneficial interest is not otherwise disposed of.

Rio Costilla Co-op, 112 N.M. at 155 (adopting Restatement (Second) of Trusts § 404 (1957)). A resulting trust arises when the settlor did not intend that the person taking the legal title to the property should also have its beneficial interest. Id. (citing the Restatement (Second) of Trusts § 1 and 5 A. Scott & W. Fratcher, The Law of Trusts § 404.1 (4^th ed. 1989). Resulting trusts typically arise in situations where property is not fully transferred to a beneficial interest holder or a person gives purchase money to another with the instruction to buy property for a third party. Id. In any case, a resulting trust imposes a duty on the trustee to effectuate the intent of the settlor.

3. Constructive trust. A constructive trust does not effect the intent of a settlor but rather is imposed to prevent the unjust enrichment that would result if the legal title holder to property were allowed to retain the beneficial enjoyment of it. See, e.g., Acheff v Lazare, 2014 WL 894491 at *11 (D.N.M.), affirmed, 595 Fed.Appx. 741 (10th Cir. 2014); In re Horton, 618 B.R. 22, 25 (Bankr. D.N.M.) (citing Tartaglia v. Hodges, 129 N.M. 497, 510, (Ct. App. 2000), the Court held that "[a] constructive trust is an equitable remedy used 'to prevent the unjust enrichment that would result if...