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The Trouble with Constructive Trusts

By Harold D. Jones and Adam P. Wofse

The equitable remedy of constructive trust is employed when “property has been acquired in such circumstances that the holder of the legal title may not in good conscience retain the beneficial interest,” and therefore equity converts him into a trustee. In re Koreag, Controle et Revision S.A., 961 F.2d 341, 353 (2d Cir. 1992). This legal theory arises in bankruptcy cases when a non-debtor party with a pre-petition contract, which ostensibly grants such party an ownership interest in funds or which establishes an agency relationship with a debtor, seeks, in the bankruptcy case, to assert its ownership rights to the funds held by the debtor.

As case law in the U.S. Court of Appeals for the Second Circuit holds, such contractual language, without other factors, will likely result in a determination that the imposition of a constructive trust is not warranted and consequently, the funds are property of the debtor's estate. Such a result affords the non-debtor party to the contract merely the rights of a general unsecured creditor.

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