## Facts

- Gary D. Leitner provided legal and accounting services to Leo G. Wetherill and Wetherill’s closely held company, L.G.W. Energy Resources, Inc.
- Between 1986 and 1992, Leitner embezzled substantial funds from L.G.W. and used some of the misappropriated money to buy a residence at 15623 Acuff Lane, Olathe, Kansas, for himself and his wife.
- Wetherill and L.G.W. sued Leitner in Kansas state court seeking, among other relief, imposition of a constructive trust on the residence.
- To prevent disposition of the residence, Wetherill obtained a prejudgment attachment order dated March 5, 1993, and recorded it on March 8, 1993, in the county real estate records; related filings provided public notice of the claim.
- Leitner later filed a Chapter 7 bankruptcy petition.
- The Chapter 7 trustee, Carl R. Clark, filed an adversary proceeding seeking a declaration that no constructive trust existed and that the residence was property of the estate, and seeking to avoid the attachment under the trustee’s avoidance powers.
- While the trustee’s summary judgment motion was pending, the state court (after relief from the automatic stay) entered judgment declaring the residence subject to a constructive trust in favor of Wetherill and L.G.W.

## Issues

1. Whether, under applicable state law, a constructive trust in favor of Wetherill and L.G.W. arose from Leitner’s fraud such that the debtor held only bare legal title and the equitable interest in the residence was excluded from the bankruptcy estate under 11 U.S.C. § 541.
2. Whether the trustee could avoid the constructive trust interest and/or the recorded prejudgment attachment under 11 U.S.C. § 544(a) as a hypothetical judicial lien creditor or bona fide purchaser.
3. Whether the constructive trust interest and/or attachment constituted an avoidable preferential transfer under 11 U.S.C. § 547(b).

## Decision

- The court denied the trustee’s motion for summary judgment.
- The court held that Wetherill and L.G.W. were beneficiaries of a constructive trust in the residence based on Leitner’s embezzlement and the tracing of misappropriated funds into the property.
- The court concluded that, because the constructive trust arose at the time of the wrongful conduct, the equitable interest did not become property of the bankruptcy estate; the estate held only bare legal title.
- The court held the trustee could not avoid the constructive trust or the attachment under § 544(a) because the recorded attachment and related public filings provided notice sufficient to bind a hypothetical lien creditor or bona fide purchaser.
- The court rejected avoidance under § 547(b), reasoning that the constructive trust related back to the fraud and therefore did not involve a transfer of an interest of the debtor in property within the preference period.

## Legal Principles

- State law determines the nature and extent of the debtor’s property interests; the bankruptcy estate under § 541 includes only those interests the debtor held as of the petition date.
- Under the majority approach applied by the court, a constructive trust arises at the time of the conduct giving rise to the trust, and a later judgment is declaratory of an already-existing equitable interest.
- When property is subject to a constructive trust, the debtor holds bare legal title while the beneficiary holds the equitable interest; the trustee generally takes subject to that equitable interest.
- A trustee’s § 544(a) status as a hypothetical lien creditor or bona fide purchaser is limited by state-law notice rules; recorded attachments and other record notice can prevent the trustee from taking free of the equitable claim.
- A constructive trust that relates back to prepetition wrongdoing may defeat a § 547(b) preference theory where the challenged “interest” is treated as not being a debtor-owned interest transferred during the preference period.

## Conclusion

The court held that Leitner’s fraud and the tracing of stolen funds into his residence gave rise to a constructive trust at the time of the wrongdoing, leaving the estate with only bare legal title and preventing the trustee from avoiding the beneficiaries’ interest or the recorded attachment under §§ 544(a) and 547(b).


In re Leitner, 236 B.R. 420 (Bankr. D. Kan. 1999)