DEBTOR CASE NO. 94-70509









VS. ADV. NO. 95-7005










VS. ADV. NO. 95-7004







This matter is before the Court on the issue of the effect of the underlying bankruptcy on the return of assets remaining in the possession of the debtor, and funds held in escrow by defendant McBrayer, McGinnis, Leslie & Kirkland ("MMLK"). By Order of this Court entered on December 11, 1995, the plaintiffs' Motions to enforce the September 24, 1994, Order of the Magoffin Circuit Court was sustained to the extent that defendants Bruce Leslie and MMLK were directed to return all funds paid to them as a result of the underlying litigation in the Magoffin Circuit Court.

The funds at issue are part of a $1.2 million settlement paid by the plaintiffs in August 1994, after the debtor received a jury verdict of approximately $1.9 million in a personal injury case against Eugene Howard and Johnston Coca-Cola Bottling Group, Inc., in Magoffin Circuit Court. Shortly after payment was made, information was brought forward which strongly suggested that the original verdict was the product of jury tampering and fraud. As a result, the Magoffin Circuit Court entered its September 30, 1994, Order requiring restitution of all sums paid pursuant to the verdict and settlement. An appeal was taken as to the jurisdiction of the Magoffin Circuit Court over Leslie and MMLK and the ruling was upheld by both the Kentucky Court of Appeals and the Kentucky Supreme Court.

The debtor filed his Chapter 11 petition in this Court on October 14, 1994. This Court must determine what the debtor's interest was, if any, in the funds in question on the date he filed his petition. 11 U.S.C. '541 provides that a bankruptcy estate is comprised of all legal and equitable interests of the debtor in property as of the commencement of the case. It is axiomatic that the determination of property rights in the assets of the bankruptcy estate is left to state law. Butner v. United States, 99 S.Ct. 914, 917-918 (1979).

The debtor contends that on the petition date he had both legal and equitable title to the funds in question, that they "belonged" to him by virtue of the voluntary settlement, duly executed and "binding upon" the parties. The plaintiffs argue that the debtor has neither a legal nor an equitable interest in the funds because they were obtained by fraud and perjury. Plaintiff Kemper National Insurance Companies ("Kemper") contends that the funds should be impressed with a constructive trust to prevent the property from being wrongly included in the bankruptcy estate. The debtor asserts that a constructive trust theory is all the plaintiffs may offer, but that it fails, in view of the Sixth Circuit Court of Appeals' decision in In re Omegas Group, Inc., 16 F.3d 1443 (1994).

The court in Omegas Group had before it a situation in which an unsecured creditor alleged that the debtor had committed fraud prepetition and that the alleged fraud caused a constructive trust to arise in regard to disputed property which excluded it from the bankruptcy estate pursuant to 11 U.S.C. '541(d). The court said:

We think that '541(d) simply does not permit a claimant .... to persuade the bankruptcy court to impose the remedy of constructive trust for alleged fraud committed against it by the debtor in the course of their business dealings, and thus to take ahead of all creditors, and indeed, ahead of the trustee. Because a constructive trust, unlike an express trust, is a remedy, it does not exist until a plaintiff obtains a judicial decision finding him to be entitled to a judgment '"impressing"' defendant's property or assets with a constructive trust. Therefore, a creditor's claim of entitlement to a constructive trust is not an '"equitable interest"' in the debtor's estate existing prepetition, excluded from the estate under '541(d).

At page 1451. The Kentucky Court of Appeals has similarly held that "....the constructive trust being a creature of equity [does] not come into existence until it [is] created by court order." Cabinet for Human Res. v. Security of Am., Ky. App., 834 S.W.2d 176, at 180-181 (1992), the court noting its decision in Borg-Warner Acceptance v. First National Bank, Ky. App., 577 S.W.2d 29 (1979).

In a case decided after Omegas Group became the law in the Sixth Circuit, Matter of McGraw, 176 B.R. 149 (Bkrtcy.S.D.Ohio 1994), the court dealt with a situation in which the debtor had failed to turn over property divided under a domestic relations court order prepetition. The court stated, in discussing the impact of the Omegas Group decision on this situation:

It would appear then, that when a court of competent jurisdiction orders property divided between spouses prepetition, the debtor at best could only hold legal title to that property awarded to the non-debtor spouse. The Debtor would hold no equitable interest, and the property would not become property of the estate.

In Omegas the Sixth Circuit followed the reasoning of In re Stotler, 144 B.R. 385,388 (N.D.Ill. 1992) in generally disfavoring the imposition of constructive trusts .... The Court, however, went on to say that '"[b]ecause a constructive trust, .... does not exist until a plaintiff obtains a judicial decision finding him to be entitled to a judgment ''impressing'' defendant's property or assets with a constructive trust."' Id. at 1451. It could be argued that here, and in other cases where there is a valid Domestic Relations Court order predating the bankruptcy, there has in fact been a judicial determination by a court in a separate proceeding that the Debtor's property is held for the benefit of another.

At pages 151-152.

It does not appear that the within matter fits within the confines of a constructive trust theory, or that it must be resolved on that basis. In the Omegas Group case fraud was only alleged. There was no order from another court predating the filing of the bankruptcy petition which established the interest of the claimant in the disputed property.

In this matter, before the debtor filed his Chapter 11 petition, an order was entered by a court of competent jurisdiction which ruled in part:

It is hereby ORDERED and ADJUDGED by the Court that the verdict of the jury rendered on April 21, 1994, and the Judgment of this Court dated April 27, 1994, thereon are hereby set aside, under CR 60.02, for perjury or falsified evidence and/or fraud affecting the proceedings and the defendants are granted a new trial in this action.

The Court finds that the plaintiff and his attorneys have received the funds of $1,200,000. from Kemper National Insurance Companies and General Star National Company .... based upon the aforesaid perjury and/or fraud affecting these proceedings and it is therefore ORDERED by the Court that said sums of $1,200,000. shall immediately be returned by the plaintiff and his attorneys to the defendants' insurance carriers, Kemper National Insurance Companies and General Star National Company, in said amounts paid by them.

The court could not have been clearer in stating that these funds were not the debtor's property. The debtor's receipt of the funds from the settlement was "based upon the aforesaid perjury and/or fraud," and he and his attorneys were ordered to return them "immediately."

In addition, while it was the question of jurisdiction and not interest in property which was before the Kentucky Court of Appeals and the Kentucky Supreme Court on appeal from the order of the Magoffin Circuit Court, the Supreme Court gratuitously opined that neither the debtor nor his attorneys had an ownership interest in funds which they had been ordered to return. The Supreme Court stated in its Memorandum Opinion:

Money paid in response to a judgment which is later set aside must be repaid. Alexander Hamilton Life Insurance Co. v. Lewis, Ky., 550 S.W.2d 558 (1977). Restatement of Restitution '74. This situation can be compared to a jury verdict which is reversed on appeal. Under such circumstances, the law acts as if the judgment never existed and the prevailing party is entitled to complete restitution of all funds improperly paid thereunder. See Clay v. Clay, Ky.App., 707 S.W.2d 352 (1986). When a judgment is set aside pursuant to CR 60.02, the party receiving the benefit of that judgment and those in privity with him are obligated to make full restitution of all funds received by them. Peoples Building & Loan Assn. v. Wagner, 297 Ky. 558, 180 S.W.2d 295 (1944).

It is clear that Kentucky courts at every level have determined that the funds at issue were not the property of the debtor.

In consideration of all of the foregoing, it is therefore the opinion of this Court that the plaintiffs should have restitution of the remaining funds held by the debtor. An order in conformity with this opinion will be entered separately.


By the Court -





Copies to:


Gillard B. Johnson III, Esq.

Daniel A. Simons, Esq.

Ronald G. Polly, Esq.

Michael J. Schmitt, Esq.

U.S. Trustee