KIRSCHENBAUM & KIRSCHENBAUM, P.C. ATTORNEYS AT LAW
200 Garden City Plaza
Garden City, New York 11530
516-747-6700
United States Bankruptcy Court,
S.D. New York.
In re Bernard J. ROSENSHEIN d/b/a Rosenshein Associates, et al., Debtors.
Bankruptcy Nos. 90 B 21262, 90 B 21268.
Feb. 3, 1992.
Lender which advanced development money to Chapter 11 debtors for construction
of shopping center, moved for order directing distribution and return of funds
held by bank in escrow, which was established to induce title company to issue
title policy in connection with debtor's mortgage. Debtors, sellers, and
unsecured creditor's committee objected. The Bankruptcy Court, Howard
Schwartzberg, J., held that fund deposited by debtors and held by lender in
escrow to induce title company to issue mortgage title policy with respect to
lender's construction loan to debtors was property of debtor's estate.
Motion denied.
West Headnotes
[1] Bankruptcy 2547
51k2547 Most Cited Cases
Under New York law, fund deposited by Chapter 11 debtors and held by lender in
escrow to induce title company to issue mortgage title policy to lender with
respect to its construction loan to debtors was property of debtors' estate;
unless or until conditions of escrow arrangement were satisfied debtors
continued to have beneficial interest in fund, having assumed acquisition loan
and having deposited proceeds of loan in escrow account. Bankr.Code, 11
U.S.C.A. § 541.
[2] Deposits and Escrows 18.1
122Ak18.1 Most Cited Cases
(Formerly 122Ak18)
Under New York law, debtor who deposits funds in escrow retains right to funds
and incidents of ownership until escrow conditions are satisfied.
[3] Bankruptcy 2547
51k2547 Most Cited Cases
Where state law bars debtor from having interest in escrow fund, and instead,
requires imposition of constructive trust on debtor's reversionary interest
because of debtor's inequitable conduct, such minimal or bare legal interest,
will not support broad application of bankruptcy concept of property of estate
with respect to escrow fund. Bankr.Code, 11 U.S.C.A. § 541(a).
[4] Bankruptcy 2545
51k2545 Most Cited Cases
Where debtor transfers accounts receivable as security for loan, debtor
continues to enjoy interest in any surplus so that assigned receivables
constitute property of debtor's bankruptcy estate. Bankr.Code, 11 U.S.C.A. §
541(a).
*368 Ohrenstein & Brown, New York City, for debtors.
Waters, McPherson, McNeill, Rosen, Secaucas, N.J., for Creditors' Committee.
*369 Duane, Morris & Heckscher, Philadelphia, Pa., for EAB.
Reich & Reich, White Plains, N.Y., for First American Title Ins. Co.
Kirschenbaum & Kirschenbaum, P.C., Garden City, N.Y., for Toys" R" Us.
DECISION ON MOTION FOR AN ORDER DIRECTING DISTRIBUTION AND RETURN OF ESCROW
FUNDS
HOWARD SCHWARTZBERG, Bankruptcy Judge.
European American Bank ("EAB"), which advanced development money to the Chapter
11 debtors for the construction of a shopping center in Yonkers, New York, on
real estate purchased by the debtors from Toys "R" Us ("Toys"), now moves for an
order directing the distribution and return of the funds held by EAB in escrow.
The escrow fund was established to induce the title company, First American
Title Insurance Company of New York ("First American"), to issue a title policy
in connection with the debtors' development of the real estate. First American
joins in EAB's motion.
The debtors, Bernard J. Rosenshein d/b/a Rosenshein Associates, Rosenshein
Development Corp. ("Development") and the seller of the real estate, Toys,
oppose EAB's motion for different reasons. The debtors contend that the escrow
fund is property of the estate within the meaning of 11 U.S.C. § 541 because
EAB furnished development money to the debtors, and Bernard J. Rosenshein issued
his check to EAB for the creation of the escrow fund. The seller, Toys,
opposes EAB's motion because it claims that it is a third party beneficiary of
the escrow fund on the theory that if it is liable to the debtors for selling
real estate with a defect in title, it may look to the title company, First
American, for reimbursement.
EAB and the title company argue that the escrow fund was created by EAB solely
on condition that the title company, First American, would issue a title policy
to EAB to protect EAB's $10,500,000.00 loan to the debtors. The policy was a
condition precedent to EAB's advancing development funds to the debtors.
Accordingly, EAB and First American reason that if they both agree to cancel the
conditions pursuant to which the escrow fund was created and the title policy
was issued, such cancellation should be exclusively a matter between EAB and
First American. Therefore, they argue that neither the debtors nor Toys may
prevent them from cancelling their obligations to one another.
The unsecured creditors' committee opposes EAB's motion and agrees with the
debtors that the escrow fund is property of the estate because the amount of the
escrow fund, $2,232,559.00, is equivalent to the amount of the purchase money
mortgage held by the seller, Toys. Therefore, if the title acquired by the
debtors from Toys is defective, and Toys obtains a foreclosure judgment, the
escrow fund will be used to satisfy the title company's liability to EAB and to
maintain EAB's junior secured position. As a practical matter, this would be
accomplished by the title company's satisfaction of Toys' foreclosure judgment.
The significance of the skirmishing between the parties is magnified by the
fact that an undiscovered easement affecting the real estate in question has
apparently emerged and is now in dispute. Additionally, Toys commenced a
prepetition mortgage foreclosure action against the debtors in state court where
the debtor asserted counterclaims including that Toys conveyed a defective title
to the debtors because of the existence of an undiscovered easement affecting
the real estate in question. The purchase money mortgage held by Toys is now
fully due in accordance with its self-contained duration. Therefore, the debtors
and the creditors' committee argue that if the debtors acquired a defective
title from Toys, the title company would be required to remedy the defect,
including applying the escrow fund in payment of the purchase money mortgage
held by Toys. Therefore, it is argued that the escrow fund benefits the
debtors and is property of the estate.
*370 EAB disputes that the escrow fund is property of the estate and asserts
that it need not pay off the purchase money mortgage held by Toys because the
escrow fund was established to protect the title company and to induce it to
issue a policy with respect to EAB's loans. EAB argues that the title company
need not first satisfy the Toys' mortgage even if Toys successfully forecloses
on its purchase money mortgage and wipes out EAB's junior secured interest with
respect to the development funds advanced to the debtors.
Finally, the opponents to EAB's motion argue that it is premature to order any
distribution now while Toys' mortgage foreclosure proceeding is pending. They
contend that any distribution of the escrow fund should await a resolution of
the debtors' claim that they acquired a defective title to the real estate in
question.
FINDINGS OF FACT
1. On December 6, 1990, the debtor, Bernard J. Rosenshein and various entities
which he controlled, including Development filed separate petitions with this
court for relief under Chapter 11 of the Bankruptcy Code. The debtors
thereafter continued in possession and control of their properties and
businesses as debtors in possession in accordance with 11 U.S.C. § § 1107 and
1108.
2. On December 7, 1990, this court entered an order procedurally consolidating
the various Rosenshein entities for administrative purposes only.
3. On December 17, 1986, the debtor, Development and Toys entered into a
contract whereby Toys agreed to sell to Development real estate in Yonkers, New
York. The contract provided that Development would pay to Toys the sum of
$100,000.00 upon the execution of the contract and the balance of $2,100,000.00
would be paid at the closing in the form of a promissory note executed by
Development, secured by a purchase money mortgage in favor of Toys, with
interest at twelve percent per annum.
4. Pursuant to the contract of sale, Development was required to obtain a title
report from First American certifying to Development the status of title to the
premises. First American issued its title report which did not disclose the
existence of any encumbrances other than certain permitted encumbrances. At
the closing, Development accepted delivery of a deed from Toys and executed and
delivered to Toys a purchase money note and mortgage for $2,100,000.00.
5. After the transfer of title, the debtors claimed that they subsequently
became aware of an easement impairing Development's title which was created by a
predecessor in title running in favor of an adjoining property owner referred to
as the "Loper Easement."
6. Upon learning of the Loper easement, Development refused to make the
required purchase money mortgage payments to Toys. Consequently, Toys
commenced an action in the Supreme Court of the State of New York, County of
Westchester against the debtors seeking to foreclose the purchase money mortgage
and a judgment to enforce Rosenshein's personal guarantee.
7. The debtors answered the complaint and asserted various counterclaims for
fraud, breach of contract, fraud in the inducement, setoff of the purchase price
against the purchase money mortgage and fraudulent misrepresentations by Toys.
8. Thereafter, in February of 1988, the debtors sought to borrow $8,070,000.00
from EAB for the purpose of constructing a commercial building on the real
estate which Development purchased from Toys. EAB agreed to advance a
construction loan to the debtors provided that the loan was secured by a first
mortgage lien against the property. The title company, First American, would
not issue a mortgage policy of title insurance in favor of EAB while First
American remained potentially liable to the debtors for failing to discover the
Loper easement when it issued a title policy in connection with the debtors'
purchase of the real estate from Toys. First American would only issue the
mortgage title policy if it was provided with funds sufficient *371 to reimburse
itself if it was liable to EAB in the event that the Toys mortgageforeclosure
action was successful.
9. At the debtors' request, EAB agreed to make available to the debtors a
second loan in the sum of $2,430,000.00, which was to provide the title company
with an escrow fund as protection against the Toys' foreclosure action and to
pay the costs of closing the loans.
10. At the closing of the loans on February 25, 1988, the debtors executed a
mortgage note in the amount of $2,430,000.00 in favor of EAB and a building loan
mortgage note in the amount of $8,070,000.00 in favor of EAB and executed
supporting security documents. EAB then advanced to the debtors the sum of
$2,232,559.00 for the purpose of being transferred by the debtors to an escrow
fund to be held by EAB for the title company's protection (referred to as the
"Acquisition loan"). EAB also advanced $8,070,000.00 to the debtors as a
construction loan (referred to as the "Construction loan").
11. After the closing, the debtor, Bernard J. Rosenshein, delivered to EAB his
check dated February 25, 1988 in the sum of $2,232,559.00, which was derived
from the funds advanced by EAB to the debtors for the escrow fund. EAB then
agreed to hold the escrow fund to reimburse the title company, First American,
in the event of its liability to EAB should the Toys' mortgage foreclosure
succeed against the debtors' property.
12. No formal escrow agreement was ever executed reflecting the agreement of
the parties, although various drafts were prepared but not signed.
13. As a result of the two loans, the debtors were liable to EAB in the total
sum of $10,500,000.00; $8,070,000.00 under the construction loan and
$2,430,000.00 under the escrow loan. That a $10,500,000.00 loan from EAB to
the debtors was contemplated by the parties can be seen from a memorandum
contained in EAB's files, which states:
As noted in prior memoranda, Mr. Rosenshein had previously been approved for a
$10,500 M Construction loan with the borrower to be Rosenshein Development Corp.
Since Bernie and the title companies were still at odds over damages and delay
caused by title issue, it was agreed that funds advanced by EAB to satisfy the
PMM would be held in escrow pending resolution of these matters. The title
company for EAB, First American, authorized EAB to deposit these funds in an EAB
account subject to an escrow agreement to be drafted.
Trial Ex. # 1.
14. First American is also potentially liable to the debtors under the separate
title policy which it issued to them in connection with the debtors' purchase of
the real estate from Toys. However, the escrow fund was created in connection
with the title policy issued by First American with respect to EAB's subsequent
$10,500,000.00 loan to the debtors.
15. EAB and First American state that if EAB's motion for distribution is
granted, and if the funds are distributed to EAB, EAB agrees to release First
American from any liability under its title policy. EAB will then apply the
escrow funds to reduce the debtors' outstanding obligations to EAB under the
debtors' mortgage note.
DISCUSSION
[1] This case illustrates the old saying that it all depends on how you slice
it. The debtors and the unsecured creditors' committee claim that the escrow
fund held by EAB is property of the estate. They reason that the debtors
received two loans totalling $10,500,000.00 from EAB, from which the debtors
delivered a check to EAB for $2,232,559.00 to be held in escrow in connection
with the Toys' mortgage litigation and the balance to be applied by the debtors
towards the construction of a commercial building on the real estate in
question.
EAB and First American argue that the escrow fund is not property of the estate
and may be distributed in accordance with the agreement between EAB and First
American. This position is bottomed on the view that EAB made two advances,
and *372 that only the Construction loan, the second advance, was made to the
debtor. The first advance, the Acquisition loan in the sum of $2,430,000.00,
was advanced to protect First American, to induce it to issue a title policy to
EAB in support of EAB's first mortgage lien against the real estate in question,
and as protection against Toys' mortgage foreclosure action and the easement
dispute. The second advance to the debtors was the Construction loan in the
sum of $8,070,000.00. Thus, EAB and First American conclude that the fund from
the Acquisition loan did not belong to the debtors and is not property of the
debtors' estate, whereas the fund from the Construction loan admittedly belongs
to the debtors and is property of the debtors' estate.
Toys joins EAB and First American in their argument that the escrow fund under
the Acquisition loan is not property of the debtors' estate. However, Toys
parts company with EAB and First American and opposes EAB's motion for
distribution of the escrow fund because Toys argues that it is a third party
beneficiary of the fund, which may not be distributed until Toys' purchase money
mortgage is satisfied.
The critical issue in this case concerns whether or not the debtors have any
interest in the escrow fund as property of the estate which would bar EAB and
First American from cancelling their obligations to each other and distributing
the escrow fund as they might agree. The concept of property of the estate is
defined in 11 U.S.C. § 541(a)(1) to include "all legal or equitable interests
of the debtor in property as of the commencement of the case." In United
States v. Whiting Pools, Inc., 462 U.S. 198, 103 S.Ct. 2309, 76 L.Ed.2d 515
(1983), the Supreme Court instructed that the scope of this statutory provision
should be interpreted broadly, whereas property interests of others in which the
debtor has some minor interest, such as a lien or bare legal title, should be
excluded from this broad concept. In determining what interest the debtors in
the instant case had in the escrow fund, reference must be made to state law.
Butner v. United States, 440 U.S. 48, 99 S.Ct. 914, 59 L.Ed.2d 136 (1979).
After the debtor's property interest is determined under state law, federal
bankruptcy law will dictate to what extent that interest is property of the
estate. In re N.S. Garrott & Sons, 772 F.2d 462, 466 (8th Cir.1985), rehearing
den. (Oct. 14, 1985) (en banc).
[2][3] According to New York law, a debtor who deposits funds in escrow retains
a right to the funds and the incidents of ownership until the escrow conditions
are satisfied. Alexander v. Quality Leather Goods Corp., 150 Misc. 577, 269
N.Y.S. 499 (1934); Press v. Marvalan Industries, Inc., 422 F.Supp. 346, 349
(S.D.N.Y.1976); In re Pan Trading Corp. S.A., 125 B.R. 869, 878
(Bankr.S.D.N.Y.1991) (depositor of funds in escrow retained interest until the
happening of prescribed contingencies). Where state law bars a debtor from
having an interest in an escrow fund, and instead, requires the imposition of a
constructive trust on the debtor's reversionary interest because of the debtor's
inequitable conduct, such minimal or bare legal interest, will not support a
broad application of the bankruptcy concept of property of the estate with
respect to the escrow fund. Garrott, 772 F.2d at 467. In the Garrott case the
debtor wished to obtain a loan from a bank on certain real estate encumbered by
a first mortgage. The bank was precluded by law from making a loan on real
estate unless it received a first mortgage on the property. To circumvent this
obstacle, the debtor obtained a written commitment from a title company for
title insurance on the real property. The debtor and others executed an escrow
agreement with the title company whereby the title company controlled a fund in
escrow deposited by the debtor and others for the purpose of making payments to
the first mortgagee in accordance with its mortgage. The title company then
issued a title policy to the bank that did not reflect the first mortgage on the
debtor's property. Thereafter, the debtor filed a Chapter 11 petition for
reorganization and the Bankruptcy Code and requested that the escrow agent turn
over the funds to the debtor. The bankruptcy court held that *373 the entire
escrow fund was property of the estate. The district court affirmed the
bankruptcy court's ruling. On appeal, the Court of Appeals reversed both lower
courts and held that it would be unfair for the debtor to enjoy a beneficial
interest in the escrow fund and that such result would be unjust enrichment.
Hence, a constructive trust was imposed on the escrow fund subject to the
equitable interests of the first mortgagee. After the payment of the first
mortgagee, any remaining amounts would be regarded as property of the debtor's
estate within the meaning of 11 U.S.C. § 541(a). Had the debtor not been
guilty of inequitable conduct, the entire fund would have been regarded as
property of the estate.
So, while we agree with the district court that the entire fund is technically
property of the estate, we cannot agree that the debtors' interests in the main
fund are unlimited. Since the estate cannot acquire greater interests than
those which the debtors had, we conclude that the estate holds the main fund,
apart from the excess interest, in trust, subject to the equitable interests of
others. As such the bankruptcy court is bound to recognize those equitable
interests.
Garrott, 772 F.2d at 467 (citation omitted).
In Wilson v. United Savings of Texas (In re Missionary Baptist Foundation of
America, Inc. ), 792 F.2d 502 (5th Cir.1986), the debtor's predecessor in
interest with respect to a nursing home established an escrow fund for the
purpose of covering expenditures for capital improvements, taxes and insurance
throughout the life of a bank loan obtained by the debtor's predecessor for
those purposes. The debtor sold the nursing home before it filed a Chapter 11
petition and was relieved of any further liability for expenditures for the
property. The Chapter 11 trustee sought a turnover of the escrow funds as
property of the estate, even though the debtor's predecessor in interest, and
not the debtor, had deposited the funds in escrow. The lending bank opposed
the trustee's turnover application. Judge Edith H. Jones, writing for the
Eighth Circuit Court of Appeals, affirmed the lower courts' rulings that the
funds were property of the debtor's estate even though the debtor's obligation
to make capital expenditures for the property was extinguished when it sold the
nursing home. The amounts on deposit in the escrow fund exceeded the debtor's
total annual liabilities so that the excess funds reverted to the debtor and not
to the lending bank. Id.
[4] Similarly, where a debtor transfers accounts receivable as security for a
loan, the debtor continues to enjoy an interest in any surplus so that the
assigned receivables constitute property of the debtor's estate as expressed in
11 U.S.C. § 541(a). Dewhirst v. Citibank (Arizona), (In re Contractors
Equipment Supply Co., 861 F.2d 241 (9th Cir.1988).
The cases the movants cite in support of their position that the escrow fund
held by EAB does not constitute property of the estate simply do not stand for
this principle. All but one of the cases stand for the proposition that funds
placed in escrow by a debtor cannot be recovered by a trustee in bankruptcy as a
voidable preferential transfer if the deposit occurred beyond the 90-day
preference period despite the fact that the release date was within the 90-day
period. Cate v. Nicely (In re Knox Kreations, Inc.), 656 F.2d 230, 231 (6th
Cir.1981); Aspen Data Graphics v. Boulton (In re Aspen Data Graphics, Inc.),
109 B.R. 677, 682 (Bankr.E.D.Pa.1990); In re Coco, 67 B.R. 365, 369
(Bankr.S.D.N.Y.1986); Hassett v. Blue Cross and Blue Shield of Greater New York
(In re O.P.M. Leasing Services, Inc.), 46 B.R. 661 (Bankr.S.D.N.Y.1985). The one
case cited by EAB which did not involve a preferential transfer issue was also
inapplicable because the debtor was the escrow agent and not the depositor of
the funds, so that the debtor had no beneficial interest in the funds. In re
Summit Airlines, Inc., 102 B.R. 32 (E.D.Pa.1989).
In the instant case, it is not claimed that the debtors were guilty of any
misconduct or fraud. They received the $10,500,000.00 loan from EAB and
immediately thereafter issued a check to EAB in the sum of *374 $2,232,559.00
for the purpose of having the proceeds held by EAB in escrow as an inducement
for First American's issuance of a mortgage insurance policy to EAB with respect
to EAB's $10,500,000.00 loan to the debtors. As stated in the Garrott case,
"the entire fund is technically property of the estate...." Garrott, 772 F.2d
at 467. Although the movants argue that the debtors were merely acting as a
conduit for the funds, they overlook the significant fact that the debtors did
more than simply deposit the check with EAB to be held in escrow; the debtors
signed mortgage notes for both the Acquisition loan and the Construction loan,
totalling $10,500,000.00. Having assumed the $2,430,000.00 Acquisition loan,
and having deposited the proceeds of the Acquisition loan in an escrow account
held by EAB, it cannot now be said that the debtors have no beneficial interest
in the escrow fund. Unless or until the conditions of the escrow arrangement
are satisfied, the debtors continue to have a beneficial interest in the
Acquisition fund, which interest constitutes property of the estate within the
meaning of 11 U.S.C. § 541. Garrott, 772 F.2d 467. Accordingly, EAB and First
American may not distribute or dispose of property of the estate as they see
fit.
Having determined that the escrow fund is property of the estate under 11
U.S.C. § 541, the court need not address the argument that Toys is a third
party beneficiary of the fund other than to note that the escrow fund was
created with respect to the Construction loan rather than the earlier purchase
money mortgage loan. The collateral for the purchase money loan whichToys
advanced to the debtors is the real estate in question and not the escrow fund.
Toys may look to the real estate and its pending mortgage foreclosure action,
which this court allowed Toys to pursue when it previously modified the
automatic stay for this purpose.
CONCLUSIONS OF LAW
1. This court has jurisdiction of the subject matter and the parties pursuant
to 28 U.S.C. § 1334 and 28 U.S.C. § 157(a). This is a core proceeding within
the meaning of 28 U.S.C. § 157(b)(2)(A) and (D).
2. The $2,232,559.00 fund deposited by the debtors and held by EAB in escrow to
induce First American to issue a mortgage title policy to EAB with respect to
EAB's Construction loan to the debtors is property of the estate within the
meaning of 11 U.S.C. § 541(a).
3. The joint motion filed by EAB and First American for an order authorizing
EAB to distribute the escrow fund as they might agree is denied because they may
not distribute or dissipate property of the estate.
SETTLE ORDER on notice.
136 B.R. 368, 22 Bankr.Ct.Dec. 938
END OF DOCUMENT
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