## Facts

- Bryan K. Foster operated Ponzi schemes in which purported investment returns were paid from new investor funds rather than any real business activity.
- Dale Kinzler was one of several investors fraudulently induced to invest in Foster’s scheme.
- Foster commingled investor funds in general bank accounts.
- On August 15, 1996, creditors filed an involuntary Chapter 7 petition against Foster; on September 18, 1996, Foster consented to an order for relief.
- During the period between petition and order for relief, Foster transferred funds from commingled accounts to Kinzler.
- The Chapter 7 trustee sued under 11 U.S.C. § 549 to avoid the postpetition, unauthorized transfers as transfers of estate property.
- Kinzler asserted the transferred funds were held in constructive trust for him and therefore were not property of the estate.
- The bankruptcy court imposed a constructive trust and used the lowest intermediate balance rule to trace Kinzler’s interest in the commingled accounts; the district court affirmed.

## Issues

1. Whether the gap-period transfers to Kinzler involved “property of the estate” or were excluded because the funds were subject to a constructive trust under applicable state law.
2. Whether the bankruptcy court properly used the lowest intermediate balance rule and related tracing presumptions to identify a constructive trust res in commingled Ponzi-scheme accounts.
3. Whether a bankruptcy court may apply constructive trust and tracing doctrines without weighing their effect on other creditors and the Bankruptcy Code’s distribution scheme.

## Decision

- The Tenth Circuit reversed the district court’s judgment affirming the constructive trust and remanded.
- The court held the bankruptcy court erred by imposing a constructive trust on commingled funds based on tracing fictions without adequate equitable consideration of other creditors’ interests.
- The court directed that any constructive trust or tracing determination must account for bankruptcy’s collective distribution framework and similarly situated victims.

## Legal Principles

- Property subject to a valid trust is not property of the bankruptcy estate; however, the claimant bears the burden to establish a constructive trust under applicable state law.
- Constructive trust is an equitable remedy that can conflict with bankruptcy’s policy of ratable distribution; courts must apply it cautiously because it can prefer one creditor over others.
- Tracing rules such as the lowest intermediate balance rule are evidentiary tools and “tracing fictions,” not automatic entitlements; their use must be equitable under the circumstances.
- In cases involving commingled Ponzi-scheme funds, awarding one victim priority based solely on traceability may be inequitable to other similarly defrauded creditors and requires careful judicial analysis.

## Conclusion

The court rejected a mechanical constructive-trust-and-tracing approach to commingled Ponzi funds in bankruptcy, holding that a bankruptcy court must evaluate the equitable consequences for other creditors before using tracing fictions to exclude assets from the estate and defeat a § 549 avoidance action.


In re Foster, 275 F.3d 924 (10th Cir. 2001)